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Fiscal (budgetary) policies and monetary policies are macroeconomic and conjunctural in nature. They are developed and applied by different authorities, independent of each other, namely the government and the central bank. This does not mean that the two types of economic policies are not interdependent. Both act on the economy and influence its overall performance, and the interdependence between them is manifested by the reciprocal effects and constraints that they impose on each other. As a result, the coordination of fiscal and monetary policy is necessary for the stability of the economy, the promotion of sustainable economic growth and the efficient approach to various challenges.

Interdependence between fiscal and monetary policy

The macroeconomic nature of the policies discussed here stems from the fact that they act on aggregate economic variables: consumption, investment, GDP, unemployment, etc. They are conjunctural, because they act in the short term, having, among other things, a function of regulating (stabilizing) the economy.

The instruments of the two types of policies are different (taxation, public spending, interest rate, etc.), and their effects are transmitted through the channels constituted by the components of total (aggregate) demand: consumption, investment, exports, etc.

Fiscal policy is developed and applied by the government and consists of the set of decisions through which it seeks to influence the macroeconomic situation by using the state budget. These decisions concern state revenues, formed mainly by mandatory levies (taxes, fees and contributions) and public expenditures (operating, social and investment expenditures). Ordinary revenues and public loans allow the financing of state expenditures. The budget balance (surplus or deficit) has two types of effects on the economy: stabilizing and discretionary.

Stabilizing effects are automatic in nature and consist of the spontaneous and rebalancing reaction of the state budget to the growth or contraction of the economy. Thus, if economic growth is weak or negative, public spending increases automatically (mainly as a result of unemployment benefits), and state revenues automatically decrease. These changes in state income and spending exert regulating effects on consumption and investment, as they restore the purchasing power of the population and businesses. If economic growth accelerates, the stabilizing effect occurs in the opposite direction. Public spending decreases (because unemployment benefits are reduced), and state revenues increase. These automatic adjustments have regulating effects on consumption and investment, as they reduce the purchasing power of economic agents.

Discretionary effects come from the deliberate modification by the government of mandatory levies or public expenditures (modifying tax rates on income of the population and turnover of enterprises, increasing or decreasing administrative expenses, public investments, etc.) in order to adjust total demand and, therefore, to influence economic activity, exports, imports, unemployment, etc.

Monetary policy is developed and applied by the central bank and consists of controlling the quantity of currency in circulation and its cost. The main objective of monetary policy is to maintain price stability (defined by the National Bank of Romania through an annual inflation rate of around 2.5%). Without prejudice to the achievement of the price stability objective, the central banks of the European System of Central Banks (of which the NBR is also a part) support the general economic policy of the state. The main instrument of monetary policy is the key interest rate (the interest rate at which commercial banks refinance themselves with the central bank). The change in the key interest rate (monetary policy rate) has repercussions on the interest rates on the money market (interbank) and on the interest rates that commercial banks apply in lending operations to the population and enterprises, respectively in deposit-taking operations. Other channels of transmission of monetary policy are the prices (rates) of financial assets, the exchange rate of the currency and the expectations of economic agents regarding inflation.

In the euro area, monetary policy is single, and fiscal policies are national and subject to European budgetary rules. Monetary policy is independent, in the sense that neither the European Central Bank nor the national central banks can seek or accept instructions from the institutions, bodies, offices or agencies of the Union, from the governments of the Member States or from any other body. Also, in the EU member countries, monetary financing (monetization of debts) of the Member States through overdrafts or other types of loans granted to governments, public institutions, Community bodies, etc. is prohibited.

Fiscal policy and monetary policy influence economic agents’ decisions (consumption, investment, borrowing) through a plurality of channels (taxation, public spending, interest rates, prices of goods and services, credit volume, exchange rate, expectations, etc.). They influence each other: monetary policy directly influences the cost of public borrowing and indirectly the total demand in the economy, prices and tariffs, government revenues and expenditures. Fiscal policy indirectly influences the price level through its effects on aggregate demand and supply (impact on production capacities).

Both policies can be oriented in two directions – expansionary or restrictive – and their combination can be convergent or divergent. They are convergent if they are oriented in the same direction (expansionary or restrictive) and divergent if not. The term used in the literature to designate a particular combination is policy mix. Its content materializes the interdependence between the effects that the respective policies have on economic activity, which can be cumulative (convergent combinations) or neutralized (divergent combinations). The policy mix also materializes the interdependence between the two types of policies resulting from the constraints that one imposes on the room for maneuver of the other. The design of the policy mix depends on economic conditions. Thus, during a period of recession, the combination of an expansionary fiscal policy with an accommodative monetary policy stimulates aggregate demand and promotes economic recovery. In a period of high inflation or overheating of the economy, the combination of restrictive fiscal policy with a relatively tight monetary policy allows inflationary pressures to be controlled.

Coordination of fiscal and monetary policy

Coordination of fiscal and monetary policy can sometimes be difficult, due to differences in their objectives, underlying decision-making processes and political considerations. Fiscal policy is influenced by political events, electoral cycles and political priorities, while monetary policy is defined by the central bank’s mandate to ensure price stability and financial stability. These differences can create conflicts and obstacles in coordinating the two types of policies. Achieving effective coordination requires clear communication, political dialogue and institutional mechanisms that encourage cooperation between the fiscal and monetary authorities.

One of the factors on which both the effectiveness of fiscal and monetary policy depends is their credibility, which conditions both the success of each taken separately and the combined effects they exert on the economy. The credibility of each policy also contributes to increasing the effectiveness of the other. Thus, a fiscal policy that ensures the “sustainable” evolution of public debt avoids the risk of fiscal dominance, i.e. the imposition by the government of an excessively expansionary monetary policy, a potential source of inflation. On the other hand, an adequate and balanced monetary policy helps to limit the increase in interest rates and, therefore, to keep the cost of public debt under control.

An essential condition for the efficiency of monetary policy is the independence of the central bank. An independent and credible central bank in terms of its commitment to price stability contributes, among other things, to increasing the effectiveness of fiscal policy. It can make monetary policy decisions based on an analysis of the economic situation, not on short-term political considerations, which creates stable and predictable conditions for the implementation of an adequate fiscal policy. The independence of the central bank also contributes to anchoring inflation expectations and increasing the credibility of both monetary and fiscal policy.

In the context of economic globalization and global integration of the financial system, fiscal policy and monetary policy carried out by a state can have an impact on the economies of other countries (spill-over effects). Thus, expansionary fiscal policy, respectively accommodative monetary policy, carried out by a great power, but also by smaller states, important from an economic and financial point of view, determine international capital flows and movements in the exchange rate of the main world currencies, which affects economic conditions in other countries. In a globalized world, it is therefore necessary to coordinate the economic policy mixes of various states in order to manage the propagation effects and potential conflicts, which arise as a result of divergent political measures.

Other areas in which fiscal policy and monetary policy interact strongly are financial stability and the management of systemic risks. Fiscal policy has an impact on financial stability through the action it exerts on the level of public debt and the volume and yields of public debt securities, causing variations that can affect the financial and banking system. For example, the high level of public debt puts pressure on the state’s finances and creates the risk of its inability to pay, a risk that can spread throughout the financial and banking system, causing payment blockages and bankruptcies in a chain. In turn, monetary policy influences financial stability through its impact on interest rates, lending conditions and the prices (exchange rates) of financial assets. Changes in interest rates cause the cost of credit to increase or decrease, the size of the public debt service (due rates plus interest) and the market value of financial assets. All these phenomena have implications for financial institutions and financial market stability. It follows that another reason why it is necessary to coordinate fiscal policy and monetary policy is to manage systemic risks and ensure financial stability.

Fiscal and monetary policy have different sectoral effects and have a strong impact on income distribution. Expansionary fiscal policy, such as increased government spending, can stimulate certain sectors of the economy. For example, infrastructure spending boosts construction and related industries, while social assistance programs support sectors that target low-income people. Monetary policy decisions, such as the aforementioned change in the policy rate, influence the borrowing costs of various industries and sectors. Areas that are relatively sensitive to interest rates, such as housing construction and industries that need investment, are more affected. Policymakers’ knowledge of the sectoral effects and distributional implications of fiscal and monetary policy is therefore important for assessing their impact on economic growth, employment, and income inequality.

An important factor influencing the transmission mechanism of monetary policy is the way in which public debt is managed. Issuing government bonds to finance the budget deficit increases the supply of securities on the financial market. As a result, the quantity and prices of government bonds influence interest rates, the yields on bonds issued by companies and the overall effectiveness of the monetary policy transmission mechanism. For example, increasing the supply of government bonds puts pressure on the yields of these securities, worsens financial conditions and increases the cost of loans contracted by enterprises and the population. It follows that another circumstance, which requires coordination between the government and the central bank, is the need to ensure compatibility between public debt management, on the one hand, and the objectives of monetary policy and supporting the proper functioning of the financial market, on the other.

A monetary policy instrument used by modern central banks is guiding the expectations of economic agents. The orientation of expectations is achieved by the central bank communicating its future intentions, which influences, among other things, fiscal policy. The clear and consistent orientation of the central bank shapes the expectations of economic agents regarding future monetary policy decisions and provides important information for fiscal policy planning. The alignment of fiscal and monetary policy increases the effectiveness of the process of anchoring expectations and facilitates the coordination of the two policies. For example, the commitment of the central bank to maintain a low interest rate increases the government’s confidence that it will be able to conduct an expansionary fiscal policy.

In the current conditions, the coordination of fiscal and monetary policy is also imposed by economic shocks, such as financial crises or external imbalances. In a period of economic recession, the government tries to conduct an expansionary fiscal policy in order to increase aggregate demand. Thus, increasing government spending or reducing taxes and fees are used to support the economic recovery. In turn, the central bank can adopt an accommodative monetary policy to increase bank credit and the volume of liquidity in the economy. For example, in the case of recent crises (the 2008-2009 financial crisis, the Covid-19 crisis and the war in Ukraine), reducing interest rates and applying unconventional measures, such as quantitative easing, have contributed to improving financial conditions, encouraging lending and overcoming the impasse. The combination of fiscal and monetary measures therefore leads to the attenuation of the negative effects of shocks and the stabilization of the economy.

The current case of Romania

An eloquent proof of the interdependence between fiscal policy and monetary policy is the financial and monetary crisis in which the Romanian state has been for a long time (in 2024, the budget deficit was 9.3% of GDP, public debt 53% of GDP and the annual inflation rate 5.1%).

In this context, at its last monetary policy meeting on October 8, 2025, the Board of Directors of the National Bank of Romania decided to maintain the monetary policy interest rate at 6.5%. This, given that Romania and Hungary have the highest key rate in Central and Eastern Europe, even higher than Serbia (5.75%). The interest rate on the lending facility (Lombard) (7.5%) and the interest rate on the deposit facility (5.5%), as well as the current levels of the minimum reserve requirements for lei and foreign currency liabilities of credit institutions, were also kept unchanged.

The NBR’s expectation is that while the annual inflation rate was higher than expected, it will plateau in the third quarter, and then begin to decline “very slowly.” It remains concerned about the “large jump” in inflation in the third quarter of 2025, due to electricity and VAT prices, as well as the increase in excise prices. The NBR is also concerned about the monetary effects of future fiscal measures, which could lead to a rise in inflation again, as well as about the probable “modest” growth of the economy in the second half of 2025.

Overcoming these difficulties and increasing the effectiveness of the fiscal and monetary policy carried out by the Romanian state through its two institutions - the government and the central bank - requires once again, if necessary, their internal coherence and mutual compatibility.

Photo source: PxHere.com.