Bank of International Settlements

Threat of fiscal dominance?

BIS Papers No 65
May 2012

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.

JEL classification: E43, E44, E63, E61

Overview

	Title	Languages
	Threat of fiscal dominance? - workshop summary by Richhild Moessner and Philip Turner	EN

Financial crises and monetary policy

	Title	Languages
	Government debt management and monetary policy in Britain since 1919 by William A Allen	EN
	Keynes's monetary theory of interest by Geoff Tily	EN
	Thoughts on policies and the policy framework after a financial crisis by Lex Hoogduin and Peter Wierts	EN
	Comment by Christophe Chamley	EN

Macroeconomic theory

	Title	Languages
	Sovereign debt management as an instrument of monetary policy: an overview by Fabrizio Zampolli	EN
	Monetary policy and the natural rate of interest by Matthew Canzoneri, Robert Cumby and Behzad Diba	EN
	Comment by Stephen G Cecchetti	EN

Sovereign debt management and economic theory

	Title	Languages
	Is the standard micro portfolio approach to sovereign debt management still appropriate? by Hans J Blommestein and Anja Hubig	EN
	Sovereign debt management and fiscal vulnerabilities by Alessandro Missale	EN
	Debt management and optimal fiscal policy with long bonds by Elisa Faraglia, Albert Marcet and Andrew Scott	EN
	Interactions between sovereign debt management and monetary policy under fiscal dominance and financial instability by Hans J Blommestein and Philip Turner	EN
	Comment by Richhild Moessner	EN

Recent balance sheet policies

	Title	Languages
	The effectiveness of the Federal Reserve's Maturity Extension Program - Operation Twist 2: the portfolio rebalancing channel and public debt management by Torsten Ehlers	EN
	The financial crisis and the changing dynamics of the yield curve by Morten Bech and Yvan Lengwiler	EN
	The financial market impact of UK quantitative easing by Francis Breedon, Jagjit S Chadha and Alex Waters	EN