If the monetary authority increases rates in response to high inflation, the economy enters a recession, which increases the debt-to-GDP ratio. If the monetary tightening is not supported by the expectation of appropriate fiscal adjustments, the deterioration of fiscal imbalances leads to even higher inflationary pressure.
As a result, a vicious circle of rising nominal interest rates, rising inflation, economic stagnation, and increasing debt would arise.23 A central bank can do a great deal for price stability. It can nurture a reputation for controlling inflation. It can also accumulate foreign exchange reserves, to help protect the solvency of the country.24  But central banks are not immune to fiscal outcomes.