Understanding monetary-fiscal interactions: Cyclical behaviour and distributional effects

Guide(s)

Subramanian, Chetan

Department

Economics

Area

Economics

University

Indian Institute of Management Bangalore

Place

Bangalore

Publication Date

3-31-2026

Year Awarded

March 2026

Year Completed

March 2026

Year Registered

June 2021

Abstract

Understanding the interactions between monetary and fiscal policies is critical for ascertaining the effectiveness of unexpected policy decisions in terms of aggregate economic welfare and their distributional consequences. Policymakers emphasise publicly communicating their views and self-evaluations to anchor agent behaviour and expectations in desired macroeconomic outcomes. In my thesis, I analyse such monetary-fiscal policy and public interactions to examine their effect on the cyclical behaviour and their distributional impact on an economy. In my first essay, I provide new evidence on the effects of conventional monetary policy, total factor productivity and fiscal spending shocks on consumption inequality. I utilise novel high-frequency identification and structural vector autoregression methods to extract the three shocks from Indian macroeconomic data. Applying the shocks as instrumental variables to a rich monthly dataset on Indian household consumption from April 2014 to April 2021, using the local projections framework, I find that a one percentage point unexpected increase in all three aggregate policies leads to a rise in consumption inequality. The banking channel significantly influences the distributional consequences of aggregate policy and real shocks. In my second essay, I develop an augmented version of the Two-Agent New Keynesian (TANK) model that incorporates both constrained and unconstrained agents within an incomplete markets framework featuring financial frictions. Constrained agents are at their borrowing limit but have access to illiquid assets. In my framework, the financial sector operates under an endogenous leverage constraint due to agency costs. Monetary, fiscal and productivity shocks affect income distribution through three primary channels: (a) the interest rate exposure channel, wherein changes in policy rates asymmetrically impact savers (unconstrained) and borrowers (constrained); (b) the income distribution channel, reflecting how fluctuations in returns from illiquid assets redistribute income across households; and (c) the financial friction channel, capturing how variations in the financial sector’s leverage constraint influence income distribution via movements in the term premium. Calibrated to Indian data, my model indicates that expansionary monetary shocks tend to reduce consumption inequality, whereas positive productivity and fiscal spending shocks increase it. Furthermore, although unconventional monetary policy (term premium targeting) can enhance welfare in the face of monetary and productivity shocks, it may worsen in the presence of a fiscal expenditure shock. Term premium targeting intensifies cross-sectional disparities in income and consumption in response to monetary and productivity shocks, but dampens them in response to fiscal expenditure shocks. In my third essay, I use speeches from central banks and fiscal authorities to develop two novel text-based indices, namely monetary-led and fiscal-led measures, to quantify the degree of fiscal-monetary interaction. My analysis yields four important results. First, there is a substantial thematic commonality between the public information received from governing management of each policymaker, even though central banks discuss their stated objectives of monetary policy and financial markets, and fiscal authorities review fiscal policy and macroeconomic conditions. Second, fiscal-monetary interaction, measured using either of my measures, increases during recessions, consistent with a greater need for coordinated policy action during downturns. Third, using a panel vector autoregression framework, I find that fiscal-monetary interaction intensifies in response to shocks to inflation expectations and government debt, and this effect is amplified during recessions. Fourth, the optimal measure of fiscal-monetary interaction depends on the discount factor. When agents are forward-looking, monetary-led interaction yields higher welfare, whereas fiscal-led interaction is more beneficial when agents are relatively myopic.

Pagination

xii, 167p.

Copyright

Indian Institute of Management Bangalore

Document Type

Dissertation

DAC Chairperson

Subramanian, Chetan

DAC Members

Dasgupta, Kunal; Murali, Srinivasan

Type of Degree

Ph.D.

Relation

DIS-IIMB-FPM-P26-03

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