Unit 3 · Level 2 · Government debt & fiscal policy
The two levers
Economies are steered with two levers. FISCAL policy is the government's wallet: taxing and spending, voted by politicians. MONETARY policy is the central bank's dial: interest rates and money conditions, set by unelected technocrats. They're meant to work in concert, but they answer to different masters, and sometimes they pull in opposite directions.
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What you get asked
Match each term to the right lever
Wallet versus dial. Both can heat or cool the economy: fiscal by moving money directly, monetary by changing the price of borrowing it.
In 2021-22, governments kept spending big while inflation surged. Central banks had to:
One foot on the accelerator, one on the brake: pandemic-era spending stoked demand while central banks slammed rates up to cool it. The tension made the inflation fight slower and rougher.
When a central bank keeps rates low mainly to ease its government's debt costs, economists call it fiscal ___.
Fiscal dominance means the wallet has captured the dial: rates serve the treasury, not price stability. History's hyperinflations usually feature exactly this arrangement.
Why are central banks kept independent from governments?
A politician facing voters always wants cheap money NOW; the inflation bill arrives after the election. Independence exists to keep that temptation away from the dial.
When fiscal and monetary policy pull in opposite directions, markets tend to get:
The UK's 2022 gilt storm was exactly this: a spending government colliding with an inflation-fighting central bank. When wallet and dial disagree, bond markets referee, loudly. 🐜
The rest of this unit
Deficits, bond markets, and the day investors say no.