The Relationship between Fiscal and Monetary Policies in Colombia: An Empirical Exploration of the Credit Risk Channel
The series Working Papers on Economics is published by the Office for Economic Studies at the Banco de la República (Central Bank of Colombia). The works published are provisional, and their authors are fully responsible for the opinions expressed in them, as well as for possible mistakes. The opinions expressed herein are those of the authors and do not necessarily reflect the views of Banco de la República or its Board of Directors.
The series Borradores de Economía (Working Papers on Economics) contributes to the dissemination and promotion of the work by researchers from the institution. On multiple occasions, these works have been the result of collaborative work with individuals from other national or international institutions. This series is indexed at Research Papers in Economics (RePEc). The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.
Abstract
This paper aims to provide evidence on the relationship between fiscal and monetarypolicy in Colombia through an empirical exploration of the credit risk channel. Underthis approach, fiscal policy plays an important explanatory role in the sovereign riskpremium, which, in turn, could affect the exchange rate and inflation expectations.The Central Bank reacts to inflation expectations using the policy interest rate; conse-quently, such reaction could be indirectly influenced by fiscal behavior. Using monthlydata from January 2003 to December 2019, we estimate both jointly and independentlythe reduced-form core equations of a system that describes the credit risk channel in asmall open economy. Our findings are in line with the model predictions. Fiscal policyaffected the country’s sovereign risk during this period, but only slightly. Hence, thereis insufficient evidence to sustain the idea that monetary policy has been significantlyinfluenced by government fiscal management.
