What is the interaction between fiscal and monetary policy?

Answer 1

Fiscal policy chooses government expenditure and taxes. Monetary policy chooses interest rates to reach a set inflation target and minimise the output gap. The interaction in where fiscal authorities chooses a level of government expenditure that is not consistent with its steady state. This effects the output gap/inflation and thus interest rates, hence the interaction.

Answer 2

In some countries, the scope for fiscal policy action has recently come up against its limits. This has raised expectations on monetary policy to do something to stabilise the economy and the financial markets. And indeed, central banks across the world have introduced unconventional measures, in order to fulfil their mandates even under these unusual circumstances. In some countries, this has given rise to tension between fiscal and economic policy.

To achieve as tension-free an economic policy as possible, fiscal and monetary policy implementation has to focus on stability. But how can this be guaranteed? In order to ensure that fiscal and monetary policy authorities do not exploit their discretionary freedom, but instead use their instruments in a targeted way with the aim of achieving sustainable economic policy, there need to be clear and binding rules.

In Switzerland, despite the difficult economic environment, there is currently no tension between monetary and fiscal policy. There are two reasons for this. First, public finances are very healthy. Second, monetary policy has always been focused on stability. Swiss economic policy stands out for having good rules and a stability culture that work through the political structures in a mutually reinforcing way. Thanks to this culture of stability, Switzerland was able to combat the financial and economic crisis with sound finances and a credible and effective monetary policy.