The ECB is running out of policy space: Can fiscal policy help? CEPS Policy Insights No 2019-17/December 2019

Given persistently low inflation, sluggish growth and global uncertainties, the ECB needs to provide even more monetary stimulus. However, with interest rates already negative and strong opposition to further asset purchases (Financial Times, 13 September 2019), it seems to have run out of ammunition. This is why former ECB President Draghi, in his last press conference, called for fiscal policy ‘to do its part’ (Draghi, 2019). A further argument in favour of fiscal stimulus concerns the strident complaints of German savers about negative rates (Bindseil et al., 2015). An expansionary fiscal policy would presumably drive interest rates higher. According to this line of argument ‘the Germans’ should thus favour a fiscal stimulus in their own interest. Evaluating the Impact of Fiscal Expansion on inflation and interest rates To understand whether an expansionary fiscal policy can provide significant support to the ECB (and relief for German savers) a quantitative model is needed. There exist many different macroeconomic models making it possible to study the effect of fiscal policies. We use the mainstream models used by central banks and international institutions. This allows us to test the proposition, made by ECB representatives, that a fiscal expansion would materially help in achieving the inflation target within the type of models used by the ECB itself