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

Which policy configuration is most consistent with monetary dominance as discussed in the context of safeguarding stability and trust?

Monetary dominance exists when fiscal authorities adjust budgets to keep debt sustainable, which lets an independent central bank pursue its inflation target credibly. The alternatives, such as financing deficits or minimising government borrowing costs, subordinate monetary policy to fiscal needs.

  1. AFiscal authorities adjust budgets to keep debt sustainable, allowing an independent central bank to target inflation crediblyCorrect
  2. BThe central bank sets interest rates to minimise government borrowing costs
  3. CThe central bank commits to buy unlimited government debt irrespective of inflation
  4. DFiscal authorities set the inflation target and the central bank finances deficits

Explanation

Monetary dominance means fiscal policy adapts to ensure sustainability, so the central bank can pursue price stability. The other options describe central banks subordinated to fiscal needs, which is fiscal dominance.

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