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.

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