How Fiscal Policy Affects the Transmission of Monetary Policy into Cross-border Bank Lending: Cross-country Evidence
Introduction
Fiscal policy, which involves government spending and taxation, can play a significant role in influencing the transmission of monetary policy into cross-border bank lending. This paper examines the relationship between fiscal policy and cross-border bank lending in a sample of 23 advanced economies from 1998 to 2017. The findings suggest that fiscal expansionary policies tend to increase cross-border bank lending, while fiscal contractionary policies tend to decrease it.
Cross-border Bank Lending and Monetary Policy
Monetary policy, which involves the setting of interest rates and other measures by central banks, is the primary tool used to manage the economy. Monetary policy can influence cross-border bank lending by affecting the relative attractiveness of lending in different countries. For example, lower interest rates in a particular country can make it more attractive for banks to lend in that country, while higher interest rates can have the opposite effect.
Fiscal Policy and Cross-border Bank Lending
Fiscal policy can also influence cross-border bank lending through several channels. First, fiscal expansionary policies, which involve increasing government spending or reducing taxes, can lead to increased economic activity. This, in turn, can increase demand for bank loans, including cross-border loans. Second, fiscal contractionary policies, which involve decreasing government spending or increasing taxes, can lead to decreased economic activity and, consequently, reduced demand for bank loans.
Empirical Analysis
To assess the relationship between fiscal policy and cross-border bank lending, the authors use a panel regression model with country and year fixed effects. The dependent variable is the annual change in cross-border bank lending as a percentage of GDP. The independent variables include fiscal policy variables, such as the government budget balance and the level of government debt, as well as monetary policy variables, such as the short-term interest rate and the inflation rate.
Results
The results show that fiscal expansionary policies have a positive and statistically significant effect on cross-border bank lending. A one percentage point increase in the government budget deficit is associated with a 0.25 percentage point increase in cross-border bank lending. In contrast, fiscal contractionary policies have a negative and statistically significant effect on cross-border bank lending. A one percentage point decrease in the government budget deficit is associated with a 0.15 percentage point decrease in cross-border bank lending.
Conclusion
The findings of this paper suggest that fiscal policy plays a significant role in influencing the transmission of monetary policy into cross-border bank lending. Fiscal expansionary policies tend to increase cross-border bank lending, while fiscal contractionary policies tend to decrease it. This relationship is likely due to the effects of fiscal policy on economic activity and the relative attractiveness of lending in different countries.
Implications
These findings have important implications for policymakers. When monetary policy is used to manage the economy, policymakers need to consider the potential impact of fiscal policy on cross-border bank lending. For example, if monetary policy is used to stimulate economic activity, it may be necessary to implement fiscal policies that support this goal. Conversely, if monetary policy is used to cool down the economy, it may be necessary to implement fiscal policies that restrain economic activity and reduce the demand for bank loans.
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