In recent debates: We are following up on last week’s discussion of this topic. The concept of « fiscal dominance » is back in the spotlight for central bankers. Two weeks ago, the BIS (the « central bank of central banks ») organized a workingseminar bringing together several central bankers to discuss this topic exclusively.
« Strong fiscal dominance » describes a situation where the central bank, faced with the government’s budgetary problems, is directly forced to monetize the government’s debt to the point where it can reasonably be expected that the resulting inflation will exceed the inflation target (this is the definition commonly used for the concept of « fiscal dominance »).
What could be described as « weak fiscal dominance « ( using the definition given by Willem Buiter, chief economist at Citigroup) describes a slightly more vague situation, where the central bank would be forced to provide assistance to the government, or would intervene in the market, thereby indirectly helping the government, without this conflicting with its inflation target.
Some observers, for example, spoke of « weak fiscal dominance » during the ECB’s SMP (Security Market Program): by purchasing Greek, Portuguese, and Spanish bonds in particular, the ECB directly provided aid to governments, claiming to be acting to « repair the transmission channels of its monetary policy « (an argument that cannot be refuted, given that the very high risk premium in these countries prevented a fall in key interest rates from being passed on to borrowing rates).
The same suspicion of « weak fiscal dominance » could apply to the ECB’s LTROs: through this program, the ECB provided significant liquidity to banks (two programs worth around €500 billion), which in turn lent it to governments through their purchases of Treasury bills. In doing so, it indirectly helped governments. Was this one of the objectives in response to insufficient fiscal adjustment by certain countries? Officially, no, hence only possible « suspicions. »
J.P.
