Fiscal dominance
Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT
Meaning
Fiscal dominance is a situation where large government deficits and debt limit what the central bank can do. The central bank feels pushed to keep interest rates low, so that government borrowing stays cheap, or even to finance the deficit by creating money. When this happens, controlling inflation takes second place to the government's funding needs.
Example
Before 1997, the Indian government's deficits were funded through ad hoc Treasury bills. This meant the RBI automatically created money for the government, which is called automatic monetisation. The 1994 and 1997 agreements ended this and brought in ways and means advances, which are short-term overdrafts from the RBI. Under the FRBM framework, from 2006 the RBI is barred from buying government securities at the time of issue (primary issues), except under an escape clause.
Don't confuse with
- Monetary accommodation for growth: the central bank may choose to cut rates because inflation is low and growth is weak. Under fiscal dominance, rates stay low because of the government's borrowing needs, not because of economic conditions.
Related concepts
- Inflation targeting
- Flexible inflation targeting
- Monetary Policy Committee
- Monetary policy stance
- Central bank independence
- Taylor rule
- Neutral rate of interest