Fiscal Shocks and the Effectiveness of Monetary Policy

Abstract

The effectiveness of monetary policy via the two tools has always been subject to debate in different economies, considering the conquest of cashless transactions resulting in loss of control over money supply in the advanced economies opposed to the effectiveness of money supply in combating inflationary pressures in emerging economies. In this regard, this study focused on examining the effectiveness of conventional and unconventional approaches to monetary policy via the three transmission mechanism channels in response to fiscal shock along with considering the relevancy of monetary autonomy of countries. By estimating the Panel Structural VAR (PSVAR) on the data of 50 countries, the results showed that the conventional approach to monetary policy is more effective in advanced economies while the unconventional approach via quantitative easing is more effective in developing economies. Considering the response in presence of fiscal shocks, the results present the effectiveness of conventional approach in developing economies while unconventional in advanced economies. Furthermore, the autonomy of central banks reveal that in developing economies, the monetary independence ensures the effectiveness of unconventional approach, while the autonomy does not give a clear picture regarding the effectiveness of two approaches in the selected advanced economies.