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JOURNAL OF INTERDISCIPLINARY RESEARCH

THE IMPACT OF POLICY MIX INSTRUMENTS ON THE EURO AREA ECONOMY IN LOW
INTEREST RATES ENVIRONMENT

JOANNA STAWSKA

University of Lodz, 39 Rewolucji 1905 Street, Lodz, 90-214,
Poland
email:

joanna.stawska@uni.lodz.pl

Acknowledgement: This work was supported by the Polish Ministry of Science and
Higher Education through research project for Young Researchers under the contract
no. B1711200001674.02.

Abstract: The aim of the article is to examine the relationship between instruments of
policy mix and selected economic variables in the euro area economy with regard to
low interest rates. Moreover, the article verifies the hypothesis that policy mix
instruments exerted a statistically significant impact on the euro area economy
between 1999-2016. The research methods include a review of the relevant scientific
literature and statistical analysis methods. The analysis is original as it emphasizes the
importance of proper monetary and fiscal policies and reveals their growing
significance for economic processes.

Keywords: policy mix, euro area, interest rate, monetary policy, fiscal policy.

1 Introduction

Monetary and fiscal policy to a great extent affect the economy
of a given country. Decisions made by economic authorities
influence each other, which is also reflected in the values of
macroeconomic ratios, Economic literature defines a notion of
policy mix as a combination of fiscal and monetary policy. A
significant impact of policy mix on the economy was described,
among others, by M. Buti and A. Sapir

as well as by R.

Clarida, J. Gali, M. Gertler

or D.K. Foley, K. Shell, M.

Sidrauski.

Furthermore, the issue of policy-mix was discussed

by R. Beetsma and X. Debrun

, L. Onorante

, A. Hughes Hallet,

P. Mooslechner, M. Schuerz

and others.

For central banks, interest rates are an instrument with which
they shape the behavior of economic agents and consumers and
regulate money supply, the supply and demand for loans, and the
general economic situation. The extent to which interest rates
can influence the economy depends on many factors, mainly on
the lag with which the economy reacts to interest rate
adjustments, economic slowdowns and financial crises. The
recent financial crisis has had a particularly strong effect on
economic variables, reflected in the levels of variables
determined by monetary policy. In turn, an instrument of
government fiscal policy that is the most frequently mentioned is
budget deficit that to some extent affects, among others, GDP
growth and inflation. Hence, while talking about the economic
policy. coordination of central bank and government activities is
connected with consistent application of instruments of
monetary and fiscal policy so that assumed objectives could be
met. According to that approach a notion of coordination was
formulated by W. Nordhaus

who claimed that coordinated

macroeconomic policy is observed when central banks interest
rates adjust appropriately so that effects of fiscal policy can be
neutralized. Therefore, the aim of the paper is to examine the
relationship between policy mix instruments and selected
economic variables in the euro area economy with regard to low
interest rates. Moreover, the article verifies the hypothesis that
policy mix instruments exerted a statistically significant impact
on the euro area economy between 1999-2016.

BUTI M., SAPIR A.: Economic Policy in EMU, Clarendon Press-Oxford, 1998.

CLARIDA R., GALÍ J., GERTLER M.: Monetary Policy Rules and Macroeconomic

Stability: Evidence and Some Theory, “Quarterly Journal of Economics”, 2000.

FOLEY D.K., SHELL K., SIDRAUSKI M.: Optimal Fiscal and Monetary Policy and

Economic Growth, “Journal of Political Economy” vol. 77/4, 1969.

BEETSMA R., DEBRUN X.: The Interaction between Monetary and Fiscal Policies

in Monetary Union: A Review of Recent Literature, [in:] R. BEETSMA et. al.,
Monetary Policy, Cambridge, 2004.

ONORANTE L.: Interaction of Fiscal Policies in the Euro Area: How Much Pressure

on the EBC? [in:] R. BEETSMA et. al., Monetary Policy, Cambridge, 2004.

HUGHES HALLET A., MOOSLECHNER P., SCHUERZ M.: eds. Challenges of

Economic Policy Coordination within European Monetary Union, Dordrecht, 2001.

NORDHAUS W.: Policy Games: Coordination and Independence in Monetary and

Fiscal Policies, “Brooking Paper on Economic Activity”, 1994, No.2, 194 p.

2 Monetary and fiscal policy in low interest rates
environment and the Eurozone economy

According to J. Skrzypczynska, the core of the coordination of
monetary and fiscal policy (policy mix) is based on the
combination of the both policies to enable to achieve goals
related to price stability and economic growth and employment.

P. Jacquet, J. Pisani-Ferry emphasize the importance of
coordination of monetary and fiscal policies exemplifying the
Eurozone. They claim that in reality a national fiscal policy and
structural policy influence an average level of inflation in a
given country and thus the decisions of fiscal authorities of the
member states may affect the decision of a central bank related
to common monetary policy in the euro area.

It should be

stressed that the liberty of national authorities at conducting
fiscal policy was limited by the rules of the Maastricht Treaty.
Hence it seems that desirable coordination of fiscal and
monetary policy is not easy achievable in the process of pursuing
financial stability.

I. Woroniecka – Leciejewicz conducted an analysis of balance in
the monetary-fiscal game emphasizing priorities of the central
bank and government in conducting macroeconomic policy. It
has been assumed that central bank strives to minimize inflation,
whereas government wants to maximize a real economic growth
while taking into consideration an impact of budget deficit on
GDP growth. These studies indicated that economic authorities
try to implement their dominant strategies i.e. to choose a
restrictive monetary policy and expansive fiscal policy or both
restrictive policies.

Woroniecka –Leciejewicz expanded the research by studying the
interactions between the decisions of the monetary and fiscal
authorities and their mutual conditioning using a simulation
study based on a fiscal-monetary game, in which fiscal and
monetary policy strategies varied regarding restrictiveness and
expansionism. The game was carried out assuming that an
increasing interest rate slows down, ceteris paribus, the rate of
economic growth and reduces inflation, and that an expanding
budget deficit pushes, ceteris paribus, inflation upwards. It was
also assumed that an expanding budget deficit improves, ceteris
paribus, the rate of GDP growth. Two cases were considered, in
one of which the monetary authorities sought to minimize
inflation and the fiscal authorities maximize GDP growth, and in
the other the monetary and fiscal authorities pursued their own
goals defined, respectively, by the inflation target and the GDP
growth rate. A logistic function used to determine how economic
growth and inflation were related to the fiscal and monetary
policy instruments showed an increasingly restrictive monetary
policy to have a limited potential for reducing inflation, likewise
increasingly expansionary fiscal policy for stimulating economic
growth. The study showed that the contribution of a fiscal
instrument (budget deficit) to a higher rate of GDP growth
represented by an increasing logarithmic function grows until the
instrument reaches a certain level. Like an increasingly
expansionary fiscal policy has a dampening effect on the
simulation of economic growth, an increasingly restrictive fiscal
policy has limited potential for improving the production growth
rate. A similar situation is observed regarding the impact of the
budget deficit on inflation. Moreover, as the interest rate
increases the rate of GDP growth decreases from maximal when
the monetary policy is extremely expansionary to minimal when

SKRZYPCZYŃSKA J.: Koordynacja polityki fiskalnej I pieniężnej strefy euro w

obliczu kryzysu finansowego, „Rocznik Integracji Europejskiej” 6/2012, 289 p.

JACQUET P., PISANI-FERRY J.: Economic policy co-ordination in the euro-zone.

What has been achieved?, What should be done?, :Sussex European Institute Working
Paper” 40/2001, 7 p.

SKRZYPCZYŃSKA J.: Koordynacja …, op. cit.

WORONIECKA – LECIEJEWICZ I.: Analiza policy-

mix z uwzględnieniem

interakcji decyzyjnych między bankiem centralnym a rządem i ich priorytetów,

Zeszyty Naukowe Wydziału Informatycznych Technik Zarządzania Wyższej Szkoły

Informatyki Stosowanej i Zarządzania „Współczesne Problemy Zarządzania” No. 1,
2011, 39 – 60 pp.

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