Assessing the relative influence of monetary and fiscal policies in Malta : a St. Louis equation

Abstract

The Monetary – Fiscal debate has been going on for quite some time now and various studies have been developed throughout the years to try and find out which policy is the most influential. To try and also this debate, studies adopted the St. Louis equation, with the aim of looking at which policy is significant to influence output growth. Most of these studies point out that monetary policy is more influential on economic growth whilst fiscal policy is not, thus support the classical economist theory. Other studies supported the keynesian economist theory, meaning that fiscal policy is influential whilst monetary policy is not. There is a third theory however, which is the real business cycle theory, stating that none of these policies are influential on economic growth. This study assesses the relative influence of monetary policy and fiscal policy by making use of a modified version of the St. Louis equation on Malta in natural log form (ln) and utilizing the error correction model (ECM). Thus, this paper’s goal is to the find out which of these 3 theories apply mostly to Malta. Assuming ordinary least squares (OLS) throughout, the study finds that real general government consumption representing the fiscal policy variable, broad money representing the monetary policy variable and real exports of goods and services representing the international trade variable, all have a positive effect on real GDP. More importantly this study also finds that the effect of the fiscal policy variable and the monetary policy variable is statistically significant whilst the real exports of goods and services variable is statistically insignificant. Such finding is evident when looking at the long-run relationship of the variables, as well as when looking at the short-run relationship of the variables when computing the ECM. Therefore, results show that Malta does not fall in any of these 3 theories since both policies are influential on economic growth. The research also discusses any breaks which might have occurred in the series due to Malta’s accession in the EU in 2004, Malta’s adoption of the euro and the emergence of the global financial crisis of 2008. These might have affected the stability of the model.