Atlas Macro

Central banks

Fiscal Dominance

A situation in which a government's debts become so large that its central bank feels unable to raise interest rates as much as inflation requires, because doing so would make the debt unaffordable.

Key points

  • The opposite of an independent central bank setting rates purely to control inflation.
  • The risk grows as government debt and interest costs rise.
  • Investors who fear it may demand higher long-term yields as protection against inflation.

Example

If higher rates would push a government's interest bill to unsustainable levels, markets may doubt the central bank will raise them, and inflation expectations can rise.

In history

During and after the Second World War the Fed capped US Treasury yields to help finance the war debt, until the 1951 Treasury-Fed Accord restored its independence.

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