The interaction between fiscal policy and monetary policy to achieve price stability in emerging economies

The failure of inflation targeting regimes in several emerging economies has received renewed interest among academics and policymakers alike. This ineffectiveness can be attributed to worsening fiscal positions in the aftermath of the Global Financial Crisis, which sheds light on the importance of coordinating fiscal policy and monetary policy to achieve price stability. This thesis, therefore, aims to investigate the effects of fiscal policy on the different transmission channels of monetary policy, which ultimately results in high inflation. We build on the theory of sovereign risk premium, which is a point of difference from previous studies. Another empirical contribution of the thesis is the use of the linear and non-linear autoregressive distributed lag (ARDL) approach to test the relationship between fiscal policy and the transmission channels of monetary policy in several emerging economies, including Brazil, the Philippines, and Turkey. The study finds that a deterioration of fiscal position significantly leads to higher inflation expectations in Brazil and Turkey. An expansion of fiscal deficits results in higher interest rates and domestic currency depreciation for Brazil. Interestingly, fiscal policy affects monetary variables in an asymmetric way, such that the impact of fiscal deterioration is more powerful than that of fiscal improvement. However, there is no relationship found between fiscal policy and the transmission channels of monetary policy for the Philippines. The findings are in favour of the view that fiscal consolidation is an important requirement for the success of an inflation targeting regime in emerging economies. The divergence in empirical results among countries sheds light on the importance of a strong policy commitment towards a sustainable path to diminish the negative effects of fiscal imbalances on monetary policy.