Monetary-Fiscal Policy Interactions in Africa: Fiscal Dominance or Monetary Dominance?

Mogaji, Peter Kehinde (2023): Monetary-Fiscal Policy Interactions in Africa: Fiscal Dominance or Monetary Dominance?

Abstract

This paper evaluates the interactions of monetary policy and fiscal policy in countries within regional economic communities and monetary blocs of Africa (AMU, EAC, ECCA, ECOWAS and SADC) as well as establish the extent of monetary dominance and/or fiscal dominance in the 48 African countries assessed by this study. The modelling of monetary policy in this study followed the standard Taylor rule which makes the nominal interest rate a function of inflation and output gap. On the fiscal policy side, this study applied the fiscal rule suggested by Davig and Leeper (2006) and Leeper (2013, 2016) in which government revenue/GDP ratio reacts to government expenditure ratio, public debt ratio and output gap in modelling fiscal policy. This study applied annual data of monetary policy and fiscal policy rules of the 48 African countries spanning over the period of 33 years between 1990 and 2021. The econometric estimation method employed is the regime switching regressions of Markov regime switching models of the Taylor monetary rule (augmented by interest rate smoothing) and of the fiscal rule augmented with lagged values of government revenue scaled by output. Although, many of the determining coefficient of inflation (for monetary policy) and the coefficient of public debt/GDP ratio (for fiscal policy) yielded in this empirical study are not statistically significant at choice level of significance, results generated reflect combinations of passive monetary policy and passive fiscal policy in the two Markov switching regimes, for all the economies evaluated, with the exception of Cape Verde that demonstrated monetary dominance with the interaction ‘active’ monetary policy and ‘passive’ fiscal policy, only in the switching regime 1. Although, there are apparent similarities in monetary policy and fiscal policy direction in all the five economic and monetary areas of Africa as revealed in this work, the failure to record ‘monetary dominance’ by majority of the African countries does not portend positive implications for the adoption and implementation of a single monetary policy and the supra-national level of Africa if the African Monetary Union project and the dream monetary integration of Africa would come into fruition.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary-Fiscal Policy Interaction, Monetary Dominance, Fiscal Dominance, AMU, EAC, ECCA, ECOWAS, SADC
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; F - International Economics > F0 - General > F02 - International Economic Order and Integration; F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F45 - Macroeconomic Issues of Monetary Unions

References

Cochrane, J. H. (1999): “A Frictionless View of U.S. Inflation,” in NBER Macroeconomics Annual 1998, ed. by B. S. Bernanke, and J. J. Rotemberg, vol. 13, pp. 323–384. MIT Press, Cambridge, MA.

Davig, T., and E. M. Leeper (2006): “Fluctuating Macro Policies and the Fiscal Theory,” in NBER Macroeconomics Annual 2006, ed. by D. Acemoglu, K. Rogoff, and M. Woodford, vol. 21, pp. 247–298. MIT Press, Cambridge.

Davig, T., and E. M. Leeper (2006): “Monetary Policy-Fiscal Policy and Fiscal Stimulus. NBER Paper No. 15133.

Davig, T., and E. M. Leeper (2011): “Inflation and the Fiscal Limit,” European Economic Review, 55(1), 31–47.

Leeper, E. M. (1991): “Equilibria Under ‘Active’ and ‘Passive’ Monetary and Fiscal Policies,” Journal of Monetary Economics, 27(1), 129–147.

Leeper, E. M. (2005): “A Simple Model of the Fiscal Theory of Price Level” Bloomington: Indiana University.

Leeper, E. M. (2013): “Fiscal Limits and Monetary Policy” NBER Working Paper No 18877.

Leeper, E. M. (2016): “Understanding Inflation as a joint Monetary-Fiscal Phenomenon. Handbook of Macroeconomics Vol. 2 ed. J. B. Taylor and H. Uhlig. Elsevier Press.

Sims, C. A. (1994): “A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy,” Economic Theory, 4(3), 381–399.

Taylor, J. B. (1993): “Discretion versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy, 39, 195–214.

Woodford, M. (1995): “Price-Level Determinacy Without Control of a Monetary Aggregate,” Carnegie-Rochester Conference Series on Public Policy, 43, 1–46.

Woodford, M. (2001): “Fiscal Requirements for Price Stability,” Journal of Money, Credit, and Banking, 33(3), 669–728.

Woodford, Michael. (1994). “Monetary policy and price level determinacy in a cash-in-advance economy”. Economic Theory 4(3), 345–380.

Interview with Eric Leeper (2016): https://www.richmondfed.org/-/media/richmondfedorg/publications/research/econ_focus/2015/q4/pdf/interview.pdf. Accessed 15 November, 2019.