The pandemic response saw a tight interaction of monetary and fiscal policy. As monetary policy has sought to control a larger segment of the yield curve, the overlap with public debt management has grown, noted RBI’s Financial Stability Report for July.
It noted that with monetary policy committed to an easy stance for some time in many countries, the fiscal stance becomes important.
Too loose a fiscal stance could cause inflation surprises and financial conditions could tighten, it said, adding that a more constrained fiscal policy would add pressure on monetary policy.
“It would test the efficacy of further monetary expansion and could heighten intertemporal tradeoffs,” it said.
The extraordinary combination of high debt-to-GDP ratios and ultra-low interest rates raises three challenges, said the central bank’s report, with the first being the risk of fiscal dominance.
Further, it may also lead to a situation where fiscal positions may ultimately prove unsustainable and the complications of the possible joint “normalisation” of fiscal and monetary policies would also crop.
Growth-friendly fiscal policy, the RBI suggested, can help by effectively targeting public infrastructure and productivity.
(Only the headline and picture of this report may have been reworked by the Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)
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