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FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A central bank faces high public debt and a government that pressures it to keep rates low so debt service stays affordable, even though inflation is above target. Which term best describes a regime in which fiscal needs constrain the central bank's ability to pursue price stability?

Fiscal dominance is the term for a regime in which the government's financing needs and debt burden constrain the central bank from tightening policy to meet its inflation goal. Under monetary dominance, by contrast, fiscal policy adjusts to ensure debt sustainability and the central bank acts freely.

  1. AFiscal dominanceCorrect
  2. BMonetary dominance
  3. CRicardian equivalence
  4. DCentral bank independence

Explanation

Fiscal dominance describes a situation where government financing needs limit the central bank's ability to raise rates or tighten policy to control inflation. Monetary dominance is the opposite: the central bank sets policy freely and fiscal policy adjusts to keep debt sustainable.

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