A return to the convertibility principle? Monetary and fiscal regimes in historical perspective. The internal evidence.

With the establishment of the EMU and the ECB, the interaction between monetary and fiscal polices is now a major policy issue in the Euro-area, dealt with in detail in the Maastricht and Amsterdam treaties and in the Stability and Growth Pact. This paper provides a background to this issue by exploring the long-run relationship between monetary and fiscal policies. We examine a large set of data covering major economies, including eleven out of the fifteen present members of EU, during the past 115 years. The evidence suggests the existence of a close interaction between the monetary regime, that is the behaviour of the central bank, and the fiscal regime, that is the tax and spending behaviour of governments as reflected in the evolution of budget deficits and public debt. The creation of the EMU and of the euro should properly be regarded as a return to the convertibility principle. The European central bank (ECB) declared in 1998 price stability as the primary goal of its policy. The present twelve members of the euro area are committed to support this goal by a policy of fiscal prudence. In short, the new European monetary regime is designed to dominate the fiscal regime in order to guarantee the credibility and sustainability of the goal of price stability.