Mervyn King, Governor of the Bank of England, once summed up these concerns in slightly exaggerated terms by saying: “Central banks are often accused of being obsessed with inflation. This is untrue. If they are obsessed with anything, it is with fiscal policy.” But where does this “obsession” come from? Why does escalating government debt pose problems for monetary policy?
The reasons for this are not immediately apparent. After all, monetary policy – in the industrial countries, at least – is usually independent and equipped with a clear mandate to safeguard price stability. One could, therefore, incorrectly conclude that unsound public finances are not relevant to monetary policy.