In this article, We learn about “Fiscal dominance “.Let’s Go!
Fiscal dominance refers to a macroeconomic situation in which the central bank’s monetary policy decisions are seriously affected or restricted by the government’s fiscal policies and budget requirements.
This limits the central bank’s ability to achieve its own inflation and economic goals.
What is fiscal leadership?
Fiscal dominance occurs when a fiscal authority (such as a government’s treasury or treasury) faces a large current deficit and debt burden, leaving little room for additional borrowing.
To fund spending, the government then turns to the central bank to help cover the deficit by printing money.
Under normal circumstances, central banks are independent and pursue monetary policy objectives such as inflation targeting, employment stabilization or exchange rate management.
But the government’s financing pressure and budget constraints force the central bank to set its policy goal at helping meet the government’s financing needs through loose monetary policy.
How does fiscal dominance happen?
Some of the ways fiscal dominance emerges are:
- Huge Budget Deficits – Persistent high fiscal deficits require increased government borrowing and debt issuance, which depends on central bank support.
- High Debt Levels – Existing high levels of public debt undermine the government’s fiscal space and ability to fund further deficits, once again relying on central banks.
- Financial Crisis Bailouts – In times of crisis, governments may run large deficits and take on large public debt due to banking bailouts or economic stimulus packages. This expands financing needs.
- Implicit Government Controls – Even in the absence of large deficits or debt, government influence on appointments and operations can influence central bank decisions.
What are the consequences of fiscal dominance?
Fiscal dominance can have multiple effects:
- Higher Inflation – Printing money to finance deficits could bring the risk of higher inflation, which central banks would otherwise try to prevent.
- Interest Rate Distortion – Easy government borrowing can keep interest rates too low for an extended period of time, not based on economic conditions.
- Currency Depreciation –Expanding the money supply in this way will exacerbate currency depreciation pressures.
- Limited policy space – Fiscal needs limit the central bank’s ability to flexibly use monetary policy to achieve macroeconomic goals.
- Debt Monetization – Excessive monetization of debt undermines confidence in a government’s prudent fiscal commitment.
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