Explain fiscal dominance.

What will be an ideal response?


Most of the time, fiscal and monetary policies proceed independently. The government finances its deficit through borrowing. The central bank chooses the supply of money so as to achieve its objective (for example, low inflation). But, when the fiscal situation is bad, either because deficits are large or debt is high, and the interest rate faced by the government is high, it becomes increasingly tempting for the government to want to finance itself through money finance. Fiscal policy then determines the behavior of the money supply, a case known as fiscal dominance.