Sustainability of Fiscal and Monetary Policies under Fixed Exchange Rate Regime in Jordan

Abstract

This study aims to analyze the sustainability of fiscal and monetary policies and the relationship between them under a fixed exchange regime that is characterized by high budget deficit and public debt in the past four decades. This study is critical for countries adopting a fixed exchange regime to achieve national priorities. Annual data from 1980 to 2020 were employed using Markov Switching Modelling to assess the sustainability of fiscal and monetary policies by identifying the main dimensions of fiscal and monetary policy that affect their sustainability. The findings show that fiscal policy is dominated by unsustainability, as the number of years of unsustainability was estimated to be more than four times the number of years in which it witnessed sustainability. Regarding monetary policy, sustainability was dominant, as it was found that the number of years of sustainability is about 1.3 times the number of years of unsustainability. Under a fixed exchange rate, there is no evidence confirming that there is sufficient coordination between fiscal and monetary policies. The study suggests that policymakers should follow complementary and balanced fiscal and monetary policies to achieve sustained economic growth.

1. Introduction

Monetary and fiscal policy sustainability has great importance in both developed and developing countries. Both policies play an important role in achieving economic growth and sustainable development. The sustainability of both policies, in addition to the coordination between them, enables the design and implementation of efficient and effective policies. This enables investors to predict the future and implement their plans as well. The sustainability of policies leads to the stability of markets for goods and services and reduces levels of risk in predicting the future. The main policies that can be used to achieve stability in the economy with fewer vulnerabilities are fiscal and monetary, and this can happen in full coordination between them [1]. However, the exchange rate regime that a country follows can determine the nature of sustainability between both policies. For example, under a fixed exchange regime, fiscal policy dominates monetary policy in a way that benefits countries by achieving equilibrium income and an increase in trade [2]. The switch of most countries towards flexible exchange regimes led to an unsustainable relationship between the two policies. Therefore, monetary and fiscal policies need to operate independently and should cooperate in achieving mutual interests and objectives. One of the most important strengths in which fiscal and monetary policies have to be prudent and predictable is the characteristic of sustainability. Despite the different objectives of fiscal policy and monetary policy, the main and final objective of all economic policies adopted by the government is to maximize the wealth of society and improve the level of its welfare. Both fiscal and monetary policies aim to achieve this goal by attaining sustainable growth and reducing unemployment rates, in addition to achieving stability in price welfare levels and controlling inflation rates to acceptable levels [3]. The focus on achieving their goals individually and in isolation from other economic goals may lead to unsustainability and economic imbalances that prevent the implementation of the economic strategies adopted by the government. According to [4], fiscal policy is considered sustainable if the current value of the budget deficit is in line with the trend of public debt; that is, the public budget deficit in a year is determined based on the outstanding public debt in the previous year. Regarding monetary policy, it is considered to be sustainable if real interest rates respond to changes in inflation rates [5,6]. In reality, the sustainability of both policies is different and depends on the adopted exchange rate regime and the nature of coordination between the two policies [7]. According to [8], a fixed-rate regime is not sustainable, especially if it is associated with large ongoing deficits and rising debt levels. Accordingly, under a fixed exchange rate regime and limited scope to use monetary policy, the stability of the economy relies on fiscal policy. On the contrary, with a floating exchange rate, monetary policy is more effective and sustainable than fiscal policy. Since 1996, fiscal policy has been the main policy that has had an effect on the Jordanian economy, with continuous government budget deficits and increasing public debt [1]. During the study period, budget deficit and public debt evolved rapidly due to regional and international crises accompanied by an influx of refugees and population growth [9,10]. Understanding the relationship between fiscal and monetary policy in a developing country like Jordan is vital for policymakers to achieve inclusive economic growth under various exchange rate regimes. Therefore, as a response to the increasing budget deficit and public debt, this study attempts to identify the main dimensions of fiscal and monetary policy that affect their sustainability and examine the relationship between them, along with analyzing the essence of sustainability under a fixed exchange regime. Moreover, it aims to investigate the status of coordination between the fiscal and monetary policies and the extent of sustainability in their performance from 1980 to 2020. This study provides an evidence-based analysis of the level of coordination between monetary and fiscal policies in achieving inclusive and sustained economic growth under a fixed exchange regime. In this context, this study aims to identify the interaction between fiscal and monetary policies by estimating policy responses using the Markov Switching Model. This model has been used in the literature to identify periods of unsustainable and sustainable monetary and fiscal policies under floating exchange regimes [11,12,13]. Further, this study adds to the literature by providing new insight into how sustainable monetary and fiscal policies coordinate and interact with each other under a fixed exchange regime.

The layout of the paper corresponds to the organization of the work as attempted during the period of the study. Following the introduction, Section 2 demonstrates an understanding of the study through a relevant literature review. Section 3 aims to describe the evolution of fiscal policy and monetary policy from 1980 to 2020. Section 4 employs Markov Switching Modelling. Section 5, Section 6 and Section 7 describe the methodology, data analysis used, and empirical results. Section 8 concludes the paper through the presentation of the results, conclusions, policy implications, and limitations.

2. Literature Review

A sustainable fiscal policy is defined as a policy that considers the ratio of debt to GDP to converge back to its initial level [14]. Similarly, ref. [4] illustrates that sustainability is about the way fiscal policy reduces high debt values. To clarify, it is the state of ensuring that the budget deficit and public debt are at a sustainable level. Accordingly, a sustainable monetary policy refers to anchoring inflation expectations for low and stable inflation [15]. However, after the high increase in the budget deficit, public debt, inflation, and unemployment in most developing countries, it became an important issue for policymakers to look for more sustainability in fiscal and monetary policies to find solutions to the increase in these indicators and their impact on the economy. Yet, the increase in crises and shocks that face both developing and developed countries gives both fiscal and monetary policies more importance to stabilizing the economy and achieving economic and social developments through increased economic growth and reducing unemployment and poverty rates. Both policies’ objectives contribute to achieving these goals if more coordination exists between them. However, the increased budget deficit, public debt, poverty, and inflation rate call for more accommodating fiscal and monetary policies to stabilize developing countries’ economies [16,17]. This is true for countries that are more vulnerable to external shocks and suffer from imbalances in their budget and balance of payments. Ref. [18] concluded that in all cases, it is necessary to carry out major reforms to support inclusive growth with a more sustainable fiscal space. Therefore, the strength of both fiscal and monetary sustainability was at the core of achieving economic development in developing countries. Several studies found weak coordination between the monetary and fiscal policies [19,20,21]. While fiscal policy focuses on reducing unemployment rates, even if this leads to an increase in inflation rates in the economy, the monetary policy aims at controlling inflation rates without paying attention to the budget deficit. In some cases, fiscal policy is found to be the dominant monetary policy, and price instability is a result of fiscal policy measures [22,23]. The channels through which both fiscal policy and monetary policy affect economic growth are important in the context of developing countries. According to [24], the effect of monetary policy on growth moves from money supply and prices to real GDP. The economy is considered under the control of fiscal policy if the dimensions of the current and future budget and the sources of funding are controlled by the Ministry of Finance. While the economy is entitled to be under the control of monetary policy, the primary budget deficit aims to reduce borrowing, and the Central Bank does not inject more liquidity into the market [25]. Under different exchange rate regimes, achieving monetary and financial sustainability depends on the exchange rate regime adopted by the country. In some cases, countries have fixed exchange regimes with capital control. In other cases, countries have fixed exchange regimes without capital control, and finally, countries have floating exchange regimes without capital control [26].

3. Evolution of Fiscal and Monetary Policies 1980–2020

The Jordanian economy has gone through challenges and several shocks during the past four decades. The most prominent of which was the economic crisis at the end of the eighties, which led to a sharp rise in public debt, high unemployment and inflation rates, and losses of foreign reserves at the Central Bank, which preceded a sharp decline in the exchange rate of Jordanian dinar against foreign currencies [27]. After Jordan implemented structural reform programs with the International Monetary Fund and the World Bank during the years 1990–2004, it was able to restore its balance of the economy, improving the growth rate and rebuilding foreign reserves at the Central Bank [7]. In 2008, Jordan was affected by the global financial crisis that shocked all countries in the world and led to a rise in oil prices. This had a large negative impact on the trade balance deficit and the rise in costs of subsidizing oil derivatives in the general budget [28]. In 2011, the political instability in the region had a significant impact on the economy too. Jordan, with its limited resources, received more than 1.3 million Syrian refugees, who contributed to putting pressure on government services, increasing spending in the budget, and increasing the deficit and debt [29]. The economy has gone through a severe state of slowdown during the past two decades, and growth rates have ranged around 2.5% annually, which is less than the rate of normal and abnormal increase in the population, which led to a reduction in the real per capita income during this period. Jordan’s economy began to be affected by COVID-19 at the end of the first quarter of 2020, which led to a contraction in the economy for the first time since 1989, at a rate of −1.6% [30,31]. The public budget deficit rose dramatically, and the current account deficit and public debt increased sharply. Figure 1 illustrates the downward trend of the public debt-to-GDP ratio from 1991 until 2009, which recorded the lowest debt ratio to GDP during the past four decades, but after the start of the global financial crisis, the public debt began to rise continuously to finance the steady rise in the public budget deficit. During the period following 2009, the trend of the budget deficit was not in line with the trend of public debt, and there was a clear weakness in the response of the public budget deficit in a specific year to the level of public debt in a previous year.

The development of credit interest rates and inflation has been analyzed to measure the extent of monetary policy’s success in achieving its objectives during the same period. Figure 2 illustrates a clear relationship between the monetary policy tool (interest rates, left axis) and its main objective (the inflation rate, right axis), despite the fact that its degrees have varied over the past forty years. The rise in the inflation rate within a year pushes the Central Bank to increase interest rates in the banking sector. Figure 2 indicates that the relationship was weak during the period 1991–2003, but it was very strong during the period 2004–2020, which indicates that the Central Bank was able to successfully confront the monetary challenges of crises that the economy was facing after 2004, which were the global financial crisis and the Arab Spring that began in 2011.

The direction of fiscal policy and monetary policy as indicated in Figure 3 illustrates that, except for the period between 1991 and 2004, the general direction of both fiscal and monetary policies is not homogeneous or opposite to some extent. This indicates that in cases where the Central Bank tightened its monetary policy to cut inflation and maintain price levels, especially exchange rates, there was an expansion in public spending that led to an increase in the public budget deficit.

During the years 1980–2020, different exchange rate regimes have been adopted. Since 1995, the Central Bank’s policy in managing foreign reserves has been based on fixing the exchange rate of the dinar against the US dollar and adopting a monetary policy aimed at setting a reasonable margin between the interest rate on the dinar and the interest rate on the US dollar in favor of the Jordanian dinar to make it more acceptable to depositors and investors. Further, during the years 1991–2004, Jordan implemented strong and comprehensive adjustment programs through the International Monetary Fund and the World Bank, especially in the areas of rebuilding foreign reserves at the Central Bank and controlling the public budget deficit and public debts [32].

4. Methodology

The changes in monetary and fiscal policies and the uncertainty faced by the economy from 1980 to 2020, as well as the structural break, show that both policies had different impacts on economic outcomes. The response of both policies indicates that the variables vary over time, producing nonlinearities. To overcome this problem in the variables, several studies used different techniques employing the Markov Switching Model [33,34,35,36]. Therefore, this study uses the vector autoregressive (VAR) model with the Markov Switching Technique to measure the impact of such changes on the evolution of Jordan’s economy. The Markov Switching technique uses dynamic patterns [37], and thus this model can measure the sustainability of fiscal or monetary policies during different periods. For instance, ref. [38], shows that the channels of transmission of fiscal policy in the Brazilian economy are the public debt to GDP ratio on money demand, the primary surplus, the nominal interest rate, investment, and the output gap.

This exploratory study adopted an analytical approach that is based on a quantitative analysis that uses the vector autoregressive (VAR) model with the Markov Switching Technique. The Markov Switching technique is popular for nonlinear time series models and is suitable for describing correlated data that exhibit distinct dynamic patterns during different periods [37]. It assumes that change in economic behavior from one state to another occurs internally, which means that the behavior of any economic policy is determined accordingly to capture more complex dynamic patterns, and thus the number of these patterns can be reduced to two states: sustainability and unsustainability [39]. Further, this model can measure the sustainability of fiscal or monetary policies during the period 1980–2020, by assuming two main regimes in which fiscal policy and monetary policy can occur based on a continuum variable named (Z_t). Accordingly, Regime 1 with a value of 1 assumes that the policy is sustainable and Regime 2 with a value of 0 is unsustainable. Hence, the Markov Switching Model for the variable Z_t involves two AR specifications as Continuum Variable (Z_t) with Regime 1 and Regime 2. Equations (1) and (2) for the variable Z_t can be written as:

Z_t = α₀ + βz_t−1 + €_t

(1)

Z_t = α₀ + α₁ + βz_t−1 + €_t

(2)

When α₁ ≠ 0, the model has two dynamic structure levels: the state variable (S_t) = 0, if the regime is unsustainable, and S_t = 1, if the regime is considered sustainable. This is a stationary AR(1) process with a mean equal to α₀/(1 − β) when St = 0, and it switches to another stationary AR(1) process with a mean equal to α₀ + α₁/(1 − β) when S_t changes from 0 to 1. In the Markov Switching Model, the properties of Z_t are jointly determined by the random characteristics of the driving innovations €t and the state variable St.

To capture the general dynamic structures of the model, Equations (1) and (2) can be extended to a vector autoregressive (VAR) model with switching intercepts. The Markov Switching model is characterized by using multiple equations for the time series behaviors in different regimes [37]. The link between fiscal policy and monetary policy using the Markov Switching Model can be evaluated by measuring the probability that the system will change from one state to another (sustainable or unsustainable). The advantage of using this model is that it allows the characteristics of time series data to change across regimes and assumes that at any given time there is a probability that the series may be in any of the regimes and may transition to a different regime [40]. Therefore, the probability that the fiscal policy or monetary policy is sustainable (or unsustainable) in a certain year and the probability of moving from one state in a specific year to another next year can be expressed by developing fiscal and monetary switching models that capture changes in time series behavior. Accordingly, the following models can be written as:

• Fiscal Policy Switching Model

$$B{D}_t={\alpha }_0\left(Z_t\right)+{\alpha }_1\left(Z_t\right)D{G}_t+{\alpha }_2\left(Z_t\right)G{E}_t+{\alpha }_3\left(Z_t\right)R{R}_t+\left(Z_t\right){\mathsf{\mu }}_t$$

(3)

2.

Monetary Policy Switching Model

$$R_t={\beta }_0\left(Z_t\right)+{\beta }_1\left(Z_t\right)P_t+{\beta }_2\left(Z_t\right)G{E}_t+{\beta }_3\left(Z_t\right)B{D}_t+{\beta }_4\left(Z_t\right)E_t+\left(Z_t\right){€}_t$$

(4)

where:

• BD_t: the budget deficit as a ratio to GDP.
• R_t: the Central bank of Jordan re-discount rate (main rate).
• DG_t: public debt as a ratio of GDP.
• GE_t: two control variables of expenditures and GDP represent the gap between the values of these variables and their trends. In this study, GH is defined to represent the GDP gap, and EH is the gap in expenditures.
• RR_t: real interest rate, is equal to nominal discount rate minus inflation.
• P_t: the inflation rate.
• E_t: exchange rate of Jordanian Dinar against US Dollar.
• €_t and µ_t: error factors in the models of fiscal and monetary respectively.

5. Data Analysis

This study employed annual data obtained from the Ministry of Finance [41], the Central Bank [42], and the Department of Statistics for the period 1980–2020 [43]. The data were collected for all variables from these sources except for two variables, namely the output gap (GH) and the expenditure gap (EH), that were calculated through the Hodrick-Prescott filter to create long-term trends by removing short-term fluctuations associated with the business cycle. Stability tests have been conducted to detect stationarity in time series data to ensure that the data are reliable and can be used in the above models.

6. Stability Tests

To measure the stability of variables described in the previous models and to ensure if the variables have a unit root (stationary) or not (nonstationary). Different stability tests like the Augmented Dickey-Fuller (ADF), Phillips-Perron (PP), and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) were employed to determine the stability of variables that will be used in the Markov Switching Model, namely: public budget deficit as a percentage of GDP (BD), public debt as a percentage of GDP (DG), GDP Gap (GH), Public Expenditure Gap (EH), Real Interest Rate which equals to credit Interest Rate (RR) minus Inflation Rate (P), and the exchange rate of the dinar against the US dollar (E).

Table 1. Unit Root Tests.

Variable	ADF	PP	KPSS
BD	Level **	Level *	Level *
r	1st Difference *	1st Difference *	Level *
P	Level *	Level *	Level ***
DG	Level *	1st Difference *	1st Difference *
E	Level *	Level *	2nd Difference *
RR	Level *	Level *	2nd Difference *
GH	Non-stationary	Level *	2nd Difference *
EH	2nd Difference *	Level *	2nd Difference *

*: Stable at 99% level of significance. **: Stable at 95% level of significance. ***: Stable at 90% level of significant.

shows the results of the ADF, PP, and KPSS tests.

According to the results in Table 1, the ADF test indicates that the variables public budget deficit as a percentage of GDP (BD) and inflation rate (P) are all stationary at level. The test shows that the discount rate (r) is stationary at the first difference. The PP test confirms that the public budget deficit as a percentage of GDP (BD) and the inflation rate (P) are all stationary at this level. The test shows that the discount rate (r) is stationary at the first difference. The KPSS test indicates that the public budget deficit as a percentage of GDP (BD) is stationary at a confidence level of 5%, the inflation rate (P) is stationary at a level of 10%, and the discount rate (r) is stationary at a level of 5%. Despite the fact that the levels of stability differed from one test to another, the results of the tests indicate that all variables are considered stable and can be employed by the Markov Switching Model, and the model is considered to be reliable and statistically acceptable [44]. According to ref. [4], fiscal series that are not scaled by GDP are misleading in the context of unit root testing. Another condition for using the Markov Switching Model is to check the strength of the constructed model using the Jarque-Bera test. Figure 4 illustrates that the Jarque-Bera test and the error coefficient used in the fiscal policy switching model (µ and €) are distributed normally, which confirms the strength of the model.

Similarly, the Jarque-Bera test for the monetary policy switching model in Figure 5 shows that the error coefficients of the Markov Switching Model (µ and €) are distributed normally.

7. Empirical Results

Table 2. Markov Switching Model For the Fiscal Policy.

Variable	Coefficient	Std. Error	z-Statistic	Prob.
Regime 1 (Sustainability)
Public debt (DG)	−0.025	0.007	−3.554	0.000
Real interest rate (RR)	0.662	0.289	2.295	0.022
Expenditure gap (EH))	0.003	0.005	0.534	0.593
GDP gap (GH)	0.982	2.437	0.403	0.687
Regime 2 (Unsustainability)
Public debt (DG)	0.043	0.004	12.919	0.000
Real interest rate (RR)	0.167	0.054	3.098	0.002
Expenditure gap (EH))	−0.002	0.000	−6.604	0.000
GDP gap (GH)	0.382	0.076	5.034	0.000
Common
LOG (SIGMA)	−4.308	0.127	−33.941	0.000
Transition Matrix Parameters
P11-C	1.802	0.950	1.898	0.058
P21-C	−3.294	1.056	−3.126	0.002
Mean dependent var	0.031	S.D. dependent var		0.027
S.E. of regression	0.028	Sum squared resid		0.018
Durbin-Watson stat	2.069	Log likelihood		86.043
Akaike info criterion	−4.690	Schwarz criterion		−4.186
Hannan-Quinn criter.	−4.523

Source: Author’s calculations.

shows the fiscal policy response function that was built using the Markov Switching Model in the years 1980–2020 as described in Equation (3). Based on the SIGMA test, the hypothesis of fluctuations or errors in the model can be rejected with a confidence level close to 100%. The results of the Durbin-Watson test equal 2.068, confirming that there is no sequential or autocorrelation between the variables used. The table also shows that during periods of sustainable fiscal policy (Regime 1), the public budget deficit is adversely affected when the public debt rises in the previous year. During periods of sustainability of fiscal policy, the Ministry of Finance reduces public expenditures to control the public budget deficit whenever there is a rise in the public debt balance. However, fiscal policy adopts a tight policy in a year when there is a rise in public debt from the previous year. During these periods of sustainability, the public budget deficit is directly related to the real interest rate, so the deficit rises whenever real interest rates rise. The budget deficit is also directly related to the public expenditure gap and the GDP gap. The analysis of Regime 2 indicates that during periods of unsustainability, the budget deficit is correlated with all variables included in the model with a high level of confidence. It can also be noted that the association between the budget deficit and public debt during these periods is positive. This means that when the public debt balance rises in a year, the Ministry of Finance adopts an expansionary fiscal policy and raises the deficit in the following year. This leads to the entry of fiscal policy into a vicious circle: as the ministry borrows to finance the deficit, the public debt rises and its service burdens rise within public expenditures, which in turn increases the budget deficit.

The results in

Table 3. Probabilities and Periods of Sustainability for Fiscal Policy.

Constant Transition Probabilities:
P(i, k) = P(s(t) = k|s(t − 1) = i)
(row = i/column = j)
1	2
0.858308	0.141692
0.035772	0.964228
Constant expected durations:
1	2
7.057561	27.95478

Source: Author’s calculations.

indicate that during any year in which the fiscal policy is sustainable, the probability that this sustainability will remain is 0.858, and the probability that it will turn from sustainable in one year to unsustainable in the following year is 0.141. During any year in which the fiscal policy is unsustainable, the probability that the state of unsustainability will remain in the following year is 0.964, and the probability that it will change from unsustainable to sustainable from year to year is 0.0357. Because the probability of unsustainability of fiscal policy is higher than the probability of sustainability, the state of unsustainability is the dominant feature of fiscal policy during the years 1980–2020. As for the period of sustainability, the results in the table indicate that the number of years of the unsustainability of fiscal policy is about four times the number of years of its sustainability, as the period of sustainability is on average seven years, while the period of unsustainability is 27 years.

Figure 6 shows the periods of sustainability of fiscal policy S(t) = 1 and unsustainability S(t) = 2, where unsustainability was the dominant feature of the fiscal policy during the years 2000–2020, while the fiscal policy was stable during the years 1991–1996.

Figure 7 indicates the strength of the fiscal model and the high degree of confidence in its results. The deviation of the data estimated from their actual values is limited and confined to a category with specific dimensions, except for 1990 and 1999.

The results of the Markov Switching model for monetary policy in

Table 4. Markov Switching Model for the Monetary Policy.

Variable	Coefficient	Std. Error	z-Statistic	Prob.
Regime 1
P(−1)	0.084794	0.160931	0.526897	0.5983
S	−0.006155	0.168751	−0.036471	0.9709
E	0.048909	0.005668	8.629144	0.0000
D (D((GH)))	0.148040	0.094119	1.572901	0.1157
LOG (SIGMA)	−3.882587	0.158936	−24.42868	0.0000
Regime 2
P(−1)	−0.375375	0.179962	−2.085857	0.0370
BD	−0.550348	0.535266	−1.028177	0.3039
E	0.033592	0.017046	1.970732	0.0488
D (D((GH)))	0.064524	0.167402	0.385441	0.6999
LOG (SIGMA)	−3.025999	0.181039	−16.71460	0.0000
Transition Matrix Parameters
P11-C	2.498037	0.802786	3.111710	0.0019
P21-C	−2.229199	0.835330	−2.668645	0.0076
Mean dependent var	0.050692	S.D. dependent var		0.049218
S.E. of regression	0.051577	Sum squared resid		0.077145
Durbin-Watson stat	1.978781	Log likelihood		73.78102
Akaike info criterion	−3.168257	Schwarz criterion		−2.656392
Hannan-Quinn criter.	−2.984605

Source: Author’s calculations.

show that the hypothesis of fluctuations or errors in the monetary policy cycle in the years 1980–2020 can be rejected with a confidence level close to 100% based on the SIGMA test. The results also indicate that the Durbin-Watson correlation coefficient is equal to 1.9789, which is very close to 2, and that confirms no sequential or autocorrelation between the variables used. Further, Table 4 shows that during periods of monetary policy sustainability (Regime 1), interest rates are directly affected by the rise in the rate of inflation in the previous year, so the Central Bank, during periods of sustainability, raises interest rates in the banking market to control prices whenever there is a rise in the rate of inflation. This means that monetary policy adopts a tightening approach in a year when there is a rise in the inflation rate from the previous year. During these periods of sustainability, real interest rates are directly correlated with the exchange rate of the Jordanian dinar against the US dollar, and since the exchange rate of the dinar has been fixed against the US dollar since 1995, this result is valid for the period preceding the year of fixing the exchange rate. Monetary policy during periods of sustainability responds to the GDP gap, while results show that real interest rates during periods of sustainability are affected by the deficit of the general budget. The reason for this is that the increase in the deficit leads to an increase in the government’s demand for borrowing and leads to the government crowding out the private sector in obtaining internal financing. In addition to that, the increase in the budget deficit is caused by the increase in expenditures, which raises liquidity in the market and pushes the Central Bank to raise interest rates to absorb excess liquidity and reduce its negative impact on inflation.

As for periods of unsustainability (Regime 2), monetary policy does not respond as required to the rise in inflation. The results indicate that real interest rates during these periods declined in a year if there was a rise in the inflation rate in the previous year. As for the relationship between real interest rates and other variables in the model, it is the same relationship between them during periods of sustainability, where there is a positive relationship between real interest rates and both the exchange rate and the economic growth gap, while there is a negative relationship with the public budget deficit.

The results in

Table 5. Periods of Sustainability in Markov Switching Model for Monetary Policy.

Constant Transition Probabilities:
P(i, k) = P(s(t) = k|s(t − 1) = i)
(row = i/column = j)
	1	2
1	0.924004	0.075996
2	0.097159	0.902841
Constant Expected Durations:
	1	2
	13.15860	10.29242

Source: Author’s calculations.

indicate that during any year in which monetary policy is sustainable, the probability that it will remain sustainable for the next year is 0.924, and the probability that it will turn from sustainable in one year to unsustainable in the following year is 0.0759. In any year during which monetary policy is unsustainable, the probability that the state of unsustainability will remain in the following year is 0.902, and the probability that it will change to sustainable is 0.0971. Because the probability of sustainability in monetary policy is higher than the probability of unsustainability, the state of sustainability was dominant in monetary policy during the years 1980–2020. As for the period of sustainability, the results show that the number of years of sustainability of the monetary policy is about 1.3 times the number of years of unsustainability; the period of sustainability is on average 13.2 years, while the period of unsustainability is 10.3 years.

Figure 8 shows the periods of monetary policy sustainability S(t) = 1, and unsustainability S(t) = 2 during the years 1980–2020, where sustainability was dominant during the years 1994–2005, and 2010–2020.

What also indicates the strength of the model and the degree of confidence in Figure 9 is the limited deviation of the data estimated according to the model from the actual values (excluding the year of Jordan’s economic crises, 1989, and the year of the global financial crisis, 2009).

8. Conclusions, Policy Implication and Limitations

Traditional methods and mechanisms that have been used in the past by fiscal and monetary policies are not sufficient anymore to achieve sustainable policies that lead to equilibrium [45]. It was found that there is a clear relationship between interest rates and inflation rates. What draws attention to this relationship is the response of monetary policy and its ability to face the challenges and crises that affect the monetary and banking sectors during the global financial crisis and the outbreak of political conflict in the region, which is opposite to the performance of fiscal policy. The existence of a direct relationship between the inflation rate and the budget deficit indicates that an increase in the inflation rate in one year leads to a rise in the deficit in the following year. This means that the government expands public spending during periods when inflation is high, which is inconsistent with the objectives of monetary policy to control inflation rates. In addition, fiscal policy adopts a tight approach in cases where the unemployment rate is increasing. This indicates that the fiscal policy is not adopting an expansionary policy through which it increases the level of public spending or decreases taxes to help the economy grow and reduce the unemployment rate [46]. When the efficiency of fiscal policy is examined through the response of the public budget deficit to the developments of public debt, the study showed that the general trend of the budget deficit was inconsistent with the general trend of public debt. Concerning the sustainability of both fiscal and monetary policies, the results showed that the nature of fiscal policy in Jordan is dominated by unsustainability, as the number of years of unsustainability was estimated to be more than 4 times the number of years in which it was sustainable. However, the sustainability of monetary policy is dominant, as the number of years of sustainability in monetary policy is about 1.3 times the number of years of unsustainability. These results are consistent with the studies of [11,12,13]. The results have implications for scholars and policymakers. Under a fixed exchange rate regime, the monetary policy role is limited, and fiscal policy directly affects monetary indicators. It is evident that the focus of the Ministry of Finance and the Central Bank on achieving their goals individually and in isolation from other economic goals may lead to economic imbalances and prevent the implementation of national priorities. Therefore, coordination must be at the core of public policies to ensure the achievement of economic objectives following government plans and strategies [47]. Thus, policymakers can benefit from measuring the coordination between fiscal and monetary policies to improve the decision-making process and achieve national priorities.

However, the conflict between fiscal and monetary policies to achieve the objectives of each of them and the tightening or expansion of performance emphasize the importance of coordination between the Ministry of Finance and the Central Bank. Furthermore, there is a need to achieve a balanced budget by restructuring the public budget to reduce the budget deficit. Finally, the Central Bank should have more interest in responding to developments in the economy, including changes in fiscal policy in its various main aspects (deficit, revenues, expenditures, and debt), considering that these changes have a significant impact on the main objective of the Central Bank. The current study has some limitations related to the availability of public debt data before 1988, which are considered to be missing values. Moreover, when aligning public debt data with the budget deficit and other factors that impact it, we assumed that using budget deficit data could not change results because trends in variables are considered when running the models.