The Fiscal Theory of the Price Level and the Interaction of Monetary and Fiscal Policies: The Brazilian Case

Abstract

This paper aims to derive an optimal monetary policy rule in a context of fiscal disequilibrium and to empirically test whether Brazil presents active or passive fiscal and monetary policies. We analyze the transmission channels of the fiscal and monetary policies through estimation of a Philips curve and the fiscal IS curve. The results indicate that the fiscal deficit is statistically significant and affects the inflation rate indirectly via output gap. The empirical findings using the Leeper model indicate that the monetary policy is passive whereas the fiscal policy is active. In this context, we found empirical evidence that the Brazilian economy shows a fiscal dominance regime for the period 1995: I to 2006: II.