Volume : 2, Issue : 7, JUL 2016

FISCAL DOMINANCE: GOVERNMENT BORROWING, MONETARY POLICY CONSTRAINTS AND MACROECONOMIC STABILITY

DR. ANIL KUMAR PARIHAR

Abstract

Fiscal dominance refers to a situation in which persistent fiscal deficits, rising public debt and government financing requirements influence or constrain the conduct of monetary policy. This research paper examines the meaning, causes, monetary-policy implications, economic effects and possible measures for reducing fiscal dominance, with particular attention to developing economies and the Indian context up to 2016. The study explains that fiscal dominance generally emerges when government expenditure remains persistently higher than revenue, resulting in continuous borrowing and increasing debt-servicing obligations. Rising public debt creates pressure on government finances because a substantial part of expenditure may be required for interest payments and debt repayment. Dependence on domestic banks, financial institutions and government securities markets for financing can further increase competition for available savings and credit. The paper also highlights the role of weak fiscal institutions, political pressures and limited fiscal adjustment capacity in sustaining fiscal imbalances. A major concern associated with fiscal dominance is its interaction with monetary policy. When government borrowing requirements are high, monetary authorities may face constraints in raising interest rates because higher rates can increase the government's debt-servicing burden. Similarly, excessive fiscal pressures may encourage monetization of deficits or create expectations of monetary support for government financing, thereby weakening monetary-policy independence and credibility. Fiscal dominance can also influence inflation through increased demand, monetary expansion and weakened confidence in price stability. Persistent government borrowing may crowd out private-sector credit, increase borrowing costs and discourage productive investment. These effects can reduce capital formation and adversely influence employment, productivity and long-term economic growth. The paper further examines the relationship between fiscal dominance and savings and financial markets, particularly the allocation of domestic financial resources toward government securities rather than productive private investment. In developing economies, these concerns can become more significant because financial markets may be less developed and governments may depend heavily on domestic banks and financial institutions for deficit financing. In India, the relationship between government borrowing and monetary policy has been important because of the size of public financing requirements and the role of the Reserve Bank of India in maintaining monetary and financial stability. Fiscal consolidation efforts and the evolving monetary-policy framework up to 2016 were important steps toward reducing fiscal pressures and strengthening policy credibility. The study concludes that reducing fiscal dominance requires sustained fiscal discipline, effective public-debt management, greater transparency in government finances and stronger fiscal institutions. At the same time, central-bank independence and credible monetary policy are essential for maintaining price stability and anchoring inflation expectations. Development of efficient government securities and financial markets can improve the allocation of domestic savings and reduce excessive dependence on banks for government financing. Overall, fiscal and monetary policies must remain appropriately coordinated, but such coordination should not undermine the autonomy of monetary authorities. Sustainable public finances, responsible borrowing, credible monetary policy and effective institutional reforms are therefore essential for reducing fiscal dominance and promoting long-term macroeconomic stability, investment and economic growth.

Keywords

Fiscal Dominance, Fiscal Policy, Monetary Policy, Fiscal Deficit, Budget Deficit, Public Debt, Government Borrowing, Debt Servicing, Debt Management, Monetary Policy Independence, Central Bank Independence, Inflation, Inflation Expectations, Interest Rates, Money Supply, Monetization of Deficit, Government Securities, Domestic Savings, Crowding Out, Private Investment, Financial Markets, Macroeconomic Stability, Economic Growth, Fiscal Consolidation, Fiscal Discipline, Public Finance, Monetary Credibility, Fiscal-Monetary Coordination, Financial Institutions, Developing Economies.

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References

8.1 Books and Academic Literature

8.1.1 Research Papers on Fiscal and Monetary Policy

  1. Sargent, T. J., & Wallace, N. (1981). Some unpleasant monetarist arithmetic. Federal Reserve Bank of Minneapolis Quarterly Review, 5(3), 1–17.
  2. Leeper, E. M. (1991). Equilibria under active and passive monetary and fiscal policies. Journal of Monetary Economics, 27(1), 129–147.
  3. Woodford, M. (1995). Price-level determinacy without control of a monetary aggregate. Carnegie-Rochester Conference Series on Public Policy, 43, 1–46.
  4. Sims, C. A. (1994). A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy. Economic Theory, 4(3), 381–399.

8.1.1.1 Studies on Public Debt and Fiscal Dominance

  1. Reinhart, C. M., & Rogoff, K. S. (2010). Growth in a time of debt. American Economic Review: Papers & Proceedings, 100(2), 573–578.
  2. Alesina, A., & Perotti, R. (1995). Fiscal expansions and fiscal adjustments in OECD countries. Economic Policy, 10(21), 205–248.
  3. Blanchard, O. (2010). Macroeconomics (5th ed.). Pearson.

8.2 RBI Publications and Monetary Policy Documents

8.2.1 Government of India Reports and Budget Documents

  1. Reserve Bank of India. Annual Report. Various issues up to 2016. Mumbai: Reserve Bank of India.
  2. Reserve Bank of India. Report on Trend and Progress of Banking in India. Various issues up to 2016. Mumbai: Reserve Bank of India.
  3. Reserve Bank of India. Handbook of Statistics on the Indian Economy. Various editions up to 2016. Mumbai: Reserve Bank of India.
  4. Government of India. Economic Survey. Various editions up to 2016. New Delhi: Ministry of Finance.
  5. Government of India. Union Budget: Budget at a Glance. Various editions up to 2016. New Delhi: Ministry of Finance.

8.2.1.1 Reports on Fiscal Deficit, Public Debt and Macroeconomic Policy

  1. Government of India. (2016). Economic Survey 2015–16. New Delhi: Ministry of Finance.
  2. Government of India. (2016). Union Budget 2016–17: Budget at a Glance. New Delhi: Ministry of Finance.
  3. Reserve Bank of India. (2016). Annual Report 2015–16. Mumbai: Reserve Bank of India.
  4. Reserve Bank of India. (2016). Report on Trend and Progress of Banking in India 2015–16. Mumbai: Reserve Bank of India.