Skip to content

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

A risk manager is assessing why high public debt can weaken the effectiveness of monetary policy. Which channel best reflects the concern of 'fiscal dominance'?

Fiscal dominance means large public debt pressures the central bank to keep interest rates low to hold down government borrowing costs, which constrains its ability to tighten policy and fight inflation, thereby eroding confidence in price stability and monetary independence.

  1. ACentral bank independence is strengthened because the government relies on its balance sheet
  2. BInflation expectations fall as investors expect heavy debt repayment
  3. CFiscal deficits become irrelevant because monetary policy sets the interest rate
  4. DPressure to keep borrowing costs low for government debt constrains the central bank's ability to raise rates to control inflationCorrect

Explanation

Fiscal dominance describes a situation in which debt-servicing concerns limit the central bank's freedom to tighten policy, undermining the inflation objective and trust. The other options describe effects opposite to or unrelated to that concern.

Did you get it right without looking?

One question tells you little. A timed set on Monetary and Fiscal Policy: Safeguarding Stability and Trust shows your real accuracy, how long you take and where you lose marks.

Practise Monetary and Fiscal Policy: Safeguarding Stability and TrustFree diagnostic mock

More Monetary and Fiscal Policy: Safeguarding Stability and Trust questions