Consequently the value of real debt is now higher than the present value of future tax payments. Households feel richer and thus consume more, causing output and inflation to increase. Monetary policy has to stabilise real debt to avoid an inflation spiral, with the result that it responds at a rate of less than 1 to 1 to inflation, thereby violating the Taylor principle.
Thus, higher inflation reduces debt in real terms and lower real interest rates reduce the real debt service burden of existing government debt. In each of the two cases, a regime of fiscal dominance is characterised by higher inflation and probably also more volatile inflation. Monetary policy is no longer able to control the inflation rate, and therefore welfare losses will occur.