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Monetary policy under fiscal stress: A forward-looking analysis of fiscal dominance

Author

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  • Bajaro, Donna Faye E.
  • Galimberti, Jaqueson K.
  • Qureshi, Irfan A.

Abstract

Subdued economic activity and low tax revenues, especially during crises, drive borrowing and increase public debt. Central banks may face pressure to deviate from policy targets during these periods to ease the debt burden. Under fiscal dominance, debt sustainability relies on low interest rates and high inflation rather than consolidation. This paper empirically tests the presence of fiscal dominance using forward-looking Taylor rules and data from 52 countries over three decades. The results detect fiscal dominance, with stronger effects in “de jure” inflation-targeting emerging economies with low central bank independence, especially those without debt rules and with high debt-to-GDP ratios. Emerging economies with high foreign currency-denominated debt are further affected by exchange rate debt valuation effects, and fiscal dominance leads their central banks to follow exchange rate stabilization policies. Since 2022–23, interest rate responses to fiscal imbalances have strengthened, posing challenges for future policy.

Suggested Citation

  • Bajaro, Donna Faye E. & Galimberti, Jaqueson K. & Qureshi, Irfan A., 2025. "Monetary policy under fiscal stress: A forward-looking analysis of fiscal dominance," Journal of Macroeconomics, Elsevier, vol. 86(C).
    • Handle: RePEc:eee:jmacro:v:86:y:2025:i:c:s0164070425000370
    DOI: 10.1016/j.jmacro.2025.103701
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    2. Gazi Salah Uddin & Anh H. Le & Naoki Yago & John Beirne & Donghyun PARK, 2026. "Global Fragmentation, Fiscal Policy, and Economic Growth: A Cross-country Analysis," Working Papers wp62, South East Asian Central Banks (SEACEN) Research and Training Centre, revised Feb 2026.

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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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