In recent debates: The concept of « fiscal dominance » is back in the spotlight for central bankers. Last week, the BIS (the « central bank of central banks ») organized a working seminar bringing together several central bankers devoted entirely to this topic.
To address these concepts, we need to consider the current economic context, in which governments have very high levels of debt, making the risk of default a major issue. In this context, there are two possible scenarios:
– either the government is forced to cut spending and increase revenue (austerity and tax increases) and the central bank continues its « usual » monetary policy (to simplify: it sticks to its inflation target)
– or the central bank must abandon its inflation target in order to monetize the government’s debt and thus avoid a budgetary adjustment.
The first outcome describes a situation of » monetary dominance , » where the monetary target takes precedence over the fiscal target.
The second describes a situation of » fiscal dominance , » where the fiscal objective takes precedence over the monetary objective.
NB: another option not discussed here is coordination between the two entities.
Julien P.
