Jean-Louis Combes, Xavier Debrun, Alexandru Minea and
René Tapsoba

INTRODUCTION

Since the 1990s, many countries have enacted extensive reforms of their macroeconomic policy frameworks. On the monetary side, central bank independence, often along with some form of inflation targeting (IT), is thought to have contributed to lower and more stable inflation both in advanced and in developing economies (see Batini and Laxton, 2007, Gonçalves and Salles, 2008; Lin and Ye, 2009; or de Mendonça and de Guimarães e Souza, 2011, for recent studies).

On the fiscal side, governments have tried to tackle chronic excessive deficits and procyclical policies through fiscal policy rules (FR). A growing literature has suggested that well-designed FRs are generally associated with greater fiscal discipline (Alesina and Perotti, 1995; Alesina and others, 1999; Debrun and others, 2008; Hallerberg and others, 2009; Dabla-Norris and others, 2010; Gollwitzer, 2011; or Tapsoba, 2012).

To the best of our knowledge, however, empirical analyses assessing the impact of macroeconomic institutions on policy outcomes have tended to consider monetary and fiscal policy in isolation. This dichotomy is unfounded. First, from a purely empirical perspective, the assumption that the monetary regime has no influence on the conduct of fiscal policy is a restriction that can, and therefore, should be rigorously tested. The same argument applies to the restriction that the framework guiding fiscal choices has no bearing on monetary policy.

Either way, existing empirical results may suffer from an omitted-variable bias. Second, those two restrictions are at odds with predictions from standard theories of optimal monetary and fiscal institutions. Clearly, improving the incentives of monetary and fiscal policymakers—the precise objective of these institutional reforms—is bound to affect the outcome of their strategic interaction (Beetsma and Bovenberg, 1997a, b; 1998; Debrun, 2000; Beetsma, Debrun, and Klaassen, 2001 Dixit and Lambertini, 2003; and Castellani and Debrun, 2005).

This literature points not only to cross-effects between fiscal (monetary) outcomes and monetary (fiscal) frameworks, but also to interactions between the two types of reforms.

The present paper aims at filling this important gap in the literature on the effects of inflation targeting and fiscal rules on policy performance. Specifically, we look into the interactions between IT and FR in two different ways with potentially first-order policy implications.

First, we test the theoretical propositions that IT and FR complement each other by comparing their joint effects on inflation and fiscal behavior to isolate their effects. Second, we explore the potential role of the sequencing of IT and FR adoption.