In recent debates: The term has been used repeatedly in certain monetary debates since Hellebrandt, Posen, and Tolle used it in a research article entitled « Does monetary cooperation or confrontation lead to successful fiscal consolidation? » (2012).
The « tough love » policy describes a policy whereby a central bank tightens its monetary policy to improve the government’s fiscal situation. What is the logic behind this? Two factors can be cited.
First, according to its proponents, an expansionary monetary policy reduces the government’s incentive to implement structural fiscal consolidation reforms (since things are not so bad, why make politically and socially difficult efforts?). By avoiding this moral hazard, the central bank is doing the government a favor.
Second, concerns about the government deficit could push up inflation expectations and thus make fiscal consolidation more difficult through higher long-term interest rates. By communicating a restrictive monetary policy, the central bank would therefore act to anchor inflation expectations, which would help stabilize the interest rates paid by the government.
Julien P.
