Coherence of Monetary and Fiscal Policy in the Function of Reducing Inflation in the European Union

Abstract

This study aims to analyze the interactions between various fiscal and monetary determinants affecting inflation across 27 European Union (EU) member states from 2010 to 2023. Using the System Generalized Method of Moments (GMM) model, we investigate the impact of government deficits, unemployment, wages, central bank interest rates, and exchange rates on inflation dynamics. The results reveal a significant positive relationship between government deficits and inflation, highlighting the inflationary risks associated with persistent fiscal imbalances. Additionally, a negative correlation between unemployment and inflation aligns with the traditional Phillips Curve, indicating that rising unemployment tends to reduce inflationary pressures. The study also finds that wage growth positively influences inflation, necessitating careful management of fiscal policies to balance wage increases with productivity enhancements. Based on these findings, we recommend that EU policymakers adopt coherent fiscal and monetary strategies to stabilize inflation. This includes maintaining fiscal discipline, supporting employment through targeted programs, and aligning fiscal measures with monetary objectives. A synchronized approach will be crucial to achieving sustained price stability and fostering long-term economic growth in the EU.