Fiscal dominance is an economic condition that occurs when a country has a large government debt and deficit such that monetary policy targets keeping the government from bankruptcy as opposed to economic targets such as inflation, growth and employment.
Healthy Monetary PolicyA healthy monetary policy is focused on controlling inflation in order to achieve sustainable growth and employment for an economy. Generally speaking, this means raising interest rates when an economy is growing and near full employment in order to reduce the threat of high inflation.When high inflation does occur, a health monetary policy may reduce money supply and increase interest rates in order to prevent inflation from damaging the economy.
Fiscal DominanceFiscal dominance occurs when a national debt has reached levels such that a nation is unable to pay it down with taxes and requires monetary policy support in order to stay solvent. In such a situation, it is difficult to control inflation because raising interest rates can make it impossible for the government to pay its debt. Raising interest rates in the presence of an extremely high government debt can cause markets to doubt the stability of the government resulting in a collapsing currency and increased inflation due to factors such as higher import costs.Fiscal dominance puts an economy at risk of severe problems such as hyperinflation and complete collapse of normal economic activity.
|Definition (1)||A high government debt that renders monetary policy ineffective.|
|Definition (2)||When monetary policy is focused on keeping a government solvent as opposed to economic targets such as inflation, employment and growth.|
|Related Concepts||Economic ProblemsHyperinflation|
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