How Much Does Monetary Policy Affect the Fiscal Multipliers in a Small and Open Economy? Evidence from Peru

This paper examines the influence of monetary policy and the zero lower bound (ZLB) on government consumption and investment multipliers in Peru from 1996Q1 to 2023Q3. Using a hybrid Time-Varying Parameter Vector Autoregression with Stochastic Volatility (TVP-VAR-SV), the study estimates impulse response functions, fiscal multipliers, forecast error variance decompositions, and historical decompositions for each quarter of the sample. The results indicate that a tighter monetary policy stance is associated with lower estimated government consumption and investment multipliers, consistent with standard monetary-fiscal interaction mechanisms documented in the literature. Moreover, following the adoption of an explicit policy rate framework, estimated fiscal multipliers exhibit greater sensitivity to interest rate conditions. In this context, the COVID-19 period provides a natural episode of historically low policy rates, approximating a ZLB-type environment from an analytical perspective, under which estimated government investment multipliers increase significantly, in line with the international literature. These findings contribute to the literature on monetary–fiscal policy interactions in emerging market economies operating under inflation targeting and a managed floating exchange rate regime.