Authors Carlos Carvalho, Stefano Eusepi and Christian Grisse use cross-country data to study various monetary and fiscal policies and their influence on inflation and GDP expectations. The economists focus on expectations because they convey more information about the potential effectiveness of policies than economic outcomes do. There is also a time lag between when a policy is implemented and when its effects are known.
To illustrate their point, the authors go back to the Lehman Brothers’ bankruptcy in 2008. Around that time, the prospects for growth and inflation plunged and policymakers began to consider ways to kick-start the economy. Central banks around the world, the authors note, considered monetary policy options while legislators examined fiscal stimulus.
The authors found that overall, these expansionary monetary and fiscal policies succeeded in shaping expectations of a recovery. Both monetary and fiscal stimulus had an effect on expectations, and the efforts complemented each other. In particular, monetary policies affected inflation forecasts while fiscal policies influenced expectations of economic growth. “From this perspective, the policies were effective at stimulating economic activity and preventing deflationary pressures during the global recession,” the study says.
However, the consequences of fiscal and monetary policies depend on specific circumstances. For example, the study found that countries in which interest rates were near or at the zero lower bound had higher “fiscal multipliers,” suggesting that monetary and fiscal policies can have substantially different effects on expectations, depending on each country’s unique economic conditions.
Carlos Carvalho is an associate professor of economics at Pontifícia Universidade Católica do Rio de Janeiro; Stefano Eusepi is a senior economist at the Federal Reserve Bank of New York; Christian Grisse is an economist at the Swiss National Bank.