David Camilo López-Valenzuelaa, 
Jesús Antonio Bejarano-Rojasa Fiscal policy and monetary policy are intricately connected, as government policies influence various macroeconomic variables, affecting prices and, consequently, Central Bank decisions. To elucidate this relationship, this document outlines the model employed by Banco de la República’s technical staff to analyze and quantify the impact of fiscal policy on key macroeconomic variables, featuring a detailed fiscal structure that distinguishes it from other models. Furthermore, as an illustration of the analyses conducted with this model, the document presents a simulation that assumes an increase in the risk premium, examining two potential responses the government might consider under tighter financial conditions: adjusting public investment to comply with the fiscal rule, or not adjusting public expenses and incurring in additional debt, leading to non-compliance with the fiscal rule. When the adjustment involves reducing public investment, domestic demand, inflation, and the monetary policy rate decrease. Conversely, financing the revenue shortfall with public debt, thereby failing to comply with the fiscal rule, exacerbates negative effects on private demand.
The most recent
COFFEE (Colombian Framework for Fiscal Policy Economic Evaluation) is a newly developed dynamic macroeconomic model designed to enhance policy analysis in Colombia’s small open economy. The model is the result of a collaborative effort between Banco de la Rep´ublica (Colombia’s central bank), the Ministry of Finance and Public Credit, and the International Monetary Fund (IMF), with technical support from the IMF’s Institute for Capacity Development. COFFEE provides a unified and internally consistent framework for evaluating fiscal policy, debt dynamics, and external shocks in conjunction with monetary policy. In response to recent macroeconomic challenges—including commodity price volatility, the COVID-19 pandemic, and heightened global financial uncertainty—Colombian policymakers identified the need for an integrated tool capable of simulating complex policy interactions. COFFEE meets this need by combining detailed fiscal architecture with robust macroeconomic foundations, making it a valuable platform for scenario analysis and medium-term policy assessment...
In a scenario of tighter financial conditions, when the government decides to adjust investment to comply with the fiscal rule, there is a short-term decline in domestic demand and inflation, which allows the central bank to lower the interest rate, leading to a faster recovery in private consumption and investment.