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

Which policy mix would most credibly support fiscal sustainability and market trust in a highly indebted sovereign, according to the logic of the monetary and fiscal policy reading?

A credible medium-term fiscal framework combined with an independent central bank targeting price stability best preserves trust. It limits fiscal dominance and anchors expectations, whereas monetary financing, heavy short-term issuance or unfunded spending raise inflation, rollover and credibility risks.

  1. ARelying on the central bank to buy debt permanently to hold yields down
  2. BA credible medium-term fiscal framework with institutional safeguards, alongside an independent central bank focused on price stabilityCorrect
  3. CShort-term debt issuance to exploit lower yields and avoid commitments
  4. DRapid unfunded spending to raise growth above the interest rate

Explanation

Trust depends on credible, rule-based medium-term fiscal plans and central bank independence, which anchor inflation expectations and limit fiscal dominance. Permanent monetary financing risks inflation and loss of credibility, short-term issuance raises rollover risk, and unfunded spending is not a reliable path.

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