John Hooley, Mika Saito, 06 December 2021

During the COVID-19 pandemic, the debate on monetary financing has been reignited and several economists have called for governments to borrow from their central banks to finance larger deficits. This column looks to sub-Saharan Africa, a region where ‘fiscal dominance’ has long been widespread, for useful insights into this debate. It finds that central bank financing of government does have an inflationary impact through the exchange rate channel. Numerical legal limits on central bank financing can be an effective way to mitigate the risks, even if they are not always binding.  

Jean Barthélemy, Eric Mengus, Guillaume Plantin, 13 November 2021

High levels of public debt may prevent central banks from fighting inflation. This column examines the conditions under which fiscal dominance – that is, the determination of the price level by the solvency of the government – may emerge. It argues that fiscal dominance prevails when the government has, wittingly or not, exhausted its fiscal capacity. The government may wittingly and optimally choose such a path if interest rates do not respond to fiscal expansions. In response, the central bank may find it desirable to engage into pre-emptive inflation.

Enrique Alberola, Carlos Cantú, Paolo Cavallino, Nikola Mirkov, 12 July 2021

Textbook models predict that a monetary policy tightening should lift the exchange rate. Yet the empirical evidence for emerging market economies fails to support this prediction. This column uses data from Brazil to show that the exchange rate’s response to monetary policy shocks changes with the fiscal regime. A contractionary monetary surprise leads to an appreciation in normal times. By contrast, a depreciation results when fiscal fundamentals are deteriorating and markets worry about debt sustainability. 

Luis Garicano, Jesus Saa-Requejo, Tano Santos, 06 October 2020

One lasting effect of the Global Crisis and the Covid-19 crisis will be a large increase in general government debt worldwide. This may lead to a scenario of ‘fiscal dominance’, in which expansionary fiscal policies are combined with accommodating monetary policies to alleviate the debt burden. This column argues that such a situation would put central banks in a precarious position of having to contain inflationary pressures and maintain financial stability. Expanding the independence of central banks and reaffirming the commitment to fighting inflation may be necessary in case of an unexpected inflation shock. 

Rashad Ahmed, Joshua Aizenman, Yothin Jinjarak, 28 June 2019

Countries have significantly increased their public-sector borrowing since the Global Crisis. This column documents several potential fiscal dominance effects during 2000-17 under inflation targeting and non-inflation-targeting regimes. A higher ratio of public debt to GDP is associated with lower policy interest rates in advanced economies. In emerging economies under non-inflation-targeting regimes, composed mostly of exchange-rate targeters, the interest rate effect of higher public debt is non-linear and depends both on the ratio of foreign currency to local currency debt, and on the ratio of hard currency debt to GDP.


CEPR Policy Research