If governments continue to incur large fiscal deficits, it will be that much more difficult for central banks to maintain price stability. While the current crisis has shown that price stability is not sufficient to ensure financial stability, price stability is decidedly a necessary condition for financial stability. Higher inflation could also push the yield curve upwards.
This could result in significant mark to market losses for fixed income instruments with potentially adverse implications for banks’ profitability. This again could impair financial stability. In India too, we are confronting the dilemma of managing the tension between fiscal and monetary policies. The government has asked the Finance Commission to indicate a road map for returning to a path of fiscal consolidation.