Fiscal and Monetary Policy: interaction and the sustainability of public debt

Problems of the utmost concern that are often faced by both developing and developed countries are those of inflation, the budget deficit and the accumulated public debt. It is believed that the main reason for high inflation in most developing countries and countries with transition economies is the financing of the budget deficit by seigniorage. This means that in most such cases it is the budget deficit that is responsible for high inflation. From time to time tensions that had accumulated in the fiscal sphere and mistakes that had been made in monetary policy have serious consequences, such as hyperinflation or a debt crisis. The government and the central bank are interconnected by a consolidated public sector budget constraint: the operational deficit of the budget is financed by new borrowings and by seigniorage. On one hand, the central bank, which controls money emission, has an important goal to achieve, namely a low and stable level of inflation. On the other hand, the central bank must also be concerned about the stability of the financial system, and in particular about the sustainability of the public debt. This means that, even given the central bank’s formal independence of the government, the former must nevertheless take into account problems in the fiscal sphere and cover a certain part of the budget deficit by seigniorage. In other words, the policies of the government and of the central bank interact with each other. This work covers a series of questions which are of principle concern in the analysis of the interaction between fiscal and monetary policies.

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