How does fiscal policy affect the transmission of monetary policy into cross-border bank lending? Cross-country evidence

Summary

Focus

Governments have recently implemented large-scale fiscal operations. These fiscal policies interact with monetary policy in affecting credit supply and thereby the economy. Yet studying this interaction is difficult because monetary and fiscal policies work through similar channels and often address similar objectives.

Contribution

We use a rarely accessed BIS data set to identify the interaction of monetary and fiscal policies in international bank lending. We focus on cross-border lending in five reserve currencies: the US dollar, the euro, the Japanese yen, the British pound and the Swiss franc. Our identification is based on the premise that monetary policies associated with these five currencies are independent of fiscal policies used in the home countries of bank lending systems. As an example, we examine how US monetary policy interacts with German fiscal policy in affecting US-dollar-denominated cross-border bank lending from German banks to borrowers in foreign countries, such as Malaysia. To ensure our focus is on independent policies, we exclude banking systems' lending in their home currencies as well as their lending to home country borrowers. For instance, in the above example, we exclude US banks' lending in US dollars and their lending to borrowers in the United States.

Findings

We find significant policy interactions. A tightening fiscal stance in the source country amplifies the negative effect of tightening monetary policy on cross-border bank lending. The interaction is significantly stronger for US monetary policy and US-dollar-denominated bank lending. The results imply that the interaction of monetary and fiscal policies has an economically significant impact on cross-border lending.

Abstract

We use a rarely accessed BIS database on bilateral cross-border bank claims by bank nationality to examine the interaction of monetary and fiscal policies. We find significant interactions: the transmission of the monetary policies of major currency issuers is significantly influenced by the fiscal stance of source (home) lending banking systems. Fiscal consolidation in a source country amplifies the effect of currency issuers' monetary policy on lending. For instance, a reduction in the German debt-to-GDP ratio amplifies the negative impact of US monetary policy tightening on USD-denominated cross-border bank lending. 

JEL classification: E63, F34, F42, G21, G38

Keywords: monetary policy, government debt, cross-border claims, difference-in-differences