Non-linear monetary policy modelling with government debt as a threshold: The case of the Czech Republic

Abstract

In this paper, we examine the extent to which monetary policy might be constrained by the evolution of government indebtedness. We employ a threshold vector autoregression (TVAR) model to capture the possible asymmetries in the relationship between monetary policy and the real economy, corresponding to a switch between low and high growth rates of the government debt-to-GDP ratio. The analysis is performed on Czech data over the 2001-2016 period. Results show that the reaction of a central bank to macroeconomic shocks can be regime-dependent. We find that a rising government debt could constrain monetary policy, which manifests through an altered monetary policy transmission to the real economy. Overall, our study demonstrates the advantages of using a non-linear approach to study the fiscal and monetary policy interactions.