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Threat of fiscal dominance?

  • Bank for International Settlements
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    The massive expansion of central bank balance sheets to contain the worst financial crisis in living memory raises questions about the theory and practice of monetary policy. The persistence in many advanced countries of large fiscal deficits and the prospect of high public debt/GDP ratios for many years is likely, at some point, to create policy dilemmas not only for central banks but also for public debt managers. Some countries have already had to cope with higher sovereign risk. Worries about both "fiscal dominance" and "financial repression" have certainly gained ground. Whatever view is taken of this, the boundary between monetary policy and government debt management has become increasingly blurred. Policy interactions have changed in ways that are difficult to understand. The current delineation of policy mandates may need to be reassessed. The aim of this BIS-OECD workshop was to better understand these issues. Theoretical perspectives draw on a long and rich body of monetary theory, but the theory is far from settled. Analysis of the history of fiscal/debt/monetary policy interconnections shows how such linkages have varied across countries and over time - there is no "one size fits all". And careful review of empirical studies shows that precise estimates of the impact of large-scale central bank purchases of government bonds need to be treated with caution. There is great uncertainty about the impact of increased government debt on inflation, on interest rates and on future growth. Much will depend on future policies. Do monetary policies need to be better coordinated with other macroeconomic or financial policies? Could government financing decisions and financial sector regulation drive the long-term interest rate too low, at least in the short-term? What medium-term risks could this create? What could be the implications for the efficiency and stability of the financial system? The papers and discussions in this volume do not, of course, converge on simple answers to any of these questions. Indeed, opposite views are expressed. The aim rather is to stimulate discussion about the complex interactions between fiscal deficits, government debt management and monetary policy in unusual macroeconomic circumstances. Some of these interactions are new, but many would be very familiar to an earlier generation of central bankers faced with heavy government debts and thin financial markets.

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    This book is provided by Bank for International Settlements in its series BIS Papers with number 65 and published in 2012.
    ISBN: 92-9131-135-9
    Handle: RePEc:bis:bisbps:65
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    1. Eric T. Swanson, 2011. "Let's Twist Again: A High-Frequency Event-study Analysis of Operation Twist and Its Implications for QE2," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(1 (Spring), pages 151-207.
    2. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "Large-scale asset purchases by the Federal Reserve: did they work?," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 41-59.
    3. António Afonso & Manuel M. F. Martins, 2010. "Level, Slope, Curvature of Sovereign Yield Curve and Fiscal Behaviour," Working Papers Department of Economics 2010/23, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
    4. Farooq Ahmad & James Steeley, 2008. "Secondary market pricing behaviour around UK bond auctions," Applied Financial Economics, Taylor & Francis Journals, vol. 18(9), pages 691-699.
    5. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 309-338.
    6. Harald Hau & Massimo Massa & Joel Peress, 2010. "Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change," Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1681-1717, April.
    7. Christopher J. Neely, 2010. "The large scale asset purchases had large international effects," Working Papers 2010-018, Federal Reserve Bank of St. Louis.
    8. Jonathan H. Wright, 2011. "What does Monetary Policy do to Long-Term Interest Rates at the Zero Lower Bound?," NBER Working Papers 17154, National Bureau of Economic Research, Inc.
    9. Joyce, Michael & Lasaosa, Ana & Stevens , Ibrahim & Tong, Matthew, 2010. "The financial market impact of quantitative easing," Bank of England working papers 393, Bank of England.
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