Fiscal Dominance and Monetary Policy Effectiveness in a Resource Dependent Economy: An Econometric Analysis of Algeria (2020 - 2025)

Abstract

This article examines whether fiscal dominance attenuates monetary policy transmission in Algeria, a hydrocarbon dependent economy, during the period 2020-2025. The study combines a macro-structural overview for 2020-2025 with a monthly reduced form investigation for January 2022 to December 2024. Fiscal dominance is proxied by the ratio of net claims on government to broad money (M2), while monetary policy effectiveness is assessed through the response of monthly inflation to interbank conditions, monetary aggregates, and credit growth. Because the available monthly window yields only 25 usable observations, the econometric analysis is necessarily exploratory: standard unit root and cointegration tests lack sufficient power, and ordinary least squares (OLS) estimates must be interpreted as conditional correlations rather than as causal structural parameters. The baseline results reveal a weak and statistically insignificant interest rate channel, whereas credit growth exhibits a positive and significant association with inflation. In the interaction specification, the fiscal dominance coefficient is positive and marginally significant, but the interaction between fiscal dominance and the interbank rate does not attain conventional significance levels. Consequently, the hypothesized attenuation of the interest rate channel by fiscal dominance cannot be confirmed with the available data. A major omitted variable the parallel foreign exchange market premium, which is a well documented determinant of Algerian inflation likely biases the estimated coefficients. The article distinguishes between classical fiscal dominance (direct monetisation of deficits à la Sargent and Wallace) and fiscal procyclicality (hydrocarbon revenue volatility that generates automatic liquidity swings), noting that the net claims proxy captures the former while Algeria simultaneously exhibits the latter. The findings are consistent with the view that, in resource-dependent economies, large fiscal financing requirements are associated with constrained conventional monetary transmission, but the evidence should be treated as preliminary pending longer samples and the inclusion of exchange rate variables.