FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust
A risk manager is assessing a scenario in which markets begin to doubt that fiscal authorities will stabilize rising public debt, and long-term yields climb even though the central bank has not changed its policy rate. According to the reasoning in the reading on monetary and fiscal policy and trust, which interpretation is most consistent?
Rising long-term yields without a policy rate change point to higher term premia from fiscal sustainability doubts. This can impair monetary policy transmission and strain financial stability, making inflation control harder because the central bank must contend with fiscal-driven market stress.
- AHigher term premia reflect fiscal concerns, which can undermine monetary policy transmission and complicate the central bank's inflation controlCorrect
- BThe yield rise is purely a signal of lower expected inflation and implies easier financial conditions
- CThe yield rise has no implications for financial stability because bond markets are independent of fiscal policy
- DThe central bank's independence is strengthened because yields now set policy automatically
Explanation
Fiscal sustainability doubts raise risk or term premia on government debt. This can tighten financial conditions disorderly, impair transmission, and put pressure on the central bank, blurring the fiscal-monetary boundary. Lower inflation expectations would not push yields up in this context.
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