The state-dependent effects of monetary policy on fiscal balances: an analysis of debt burdens and deficits

This paper investigates the dynamic effects of monetary policy shocks on fiscal conditions, specifically evaluating government debt burdens and fiscal balances. The study employs a Bayesian panel structural vector autoregression model covering 20 economies over the 1990–2023 period. To ensure the accuracy of the empirical framework, the annual structural shocks are validated against high-frequency monetary surprises. Baseline linear estimations indicate that monetary tightening generally leads to a statistical improvement in fiscal balances, a mechanism supported by an active fiscal reaction function and alternative debt adjustment channels such as interest growth differentials. Formal testing of posterior differences reveals that this relationship is fundamentally state dependent. The fiscal adjustments are driven entirely by monetary shocks occurring during easing cycles. During active tightening cycles, the mechanical burden of higher borrowing costs neutralizes potential consolidation efforts, yielding no statistically distinguishable improvements. Subsample analyses confirm that this transmission mechanism has remained consistent over time, showing no structural break after 2007. The results reconcile diverging views on the monetary and fiscal nexus by demonstrating that the budgetary spillovers of central bank actions depend directly on the prevailing macroeconomic environment.