Properly managed and analysed, taking financial imbalances into account in monetary policy decisions – under certain conditions – means that target fulfilment should be better in the long run. Interaction between monetary and fiscal policy As mentioned above, monetary policy and financial stability are interdependent, but so are monetary policy and fiscal policy. The interaction between these two policy areas plays a central role in the Riksbank's ability to attain low and stable inflation. Some simple reasoning can illustrate the interaction.34 For example, if the central bank cuts the policy rate, the government's interest payments decrease and there is greater scope for a more expansionary fiscal policy. Another example is when the central bank buys government bonds. Among other things, this can mean that the government has lower costs for new borrowing at longer maturities. Conversely, fiscal policy also affects monetary policy. A more expansionary fiscal policy increases demand and ultimately also inflation and thus affects monetary policy. There are also many historical examples where fiscal policy has led to disruptions in the financial system with consequences for monetary policy. Episodes of hyperinflation are extreme examples, but there are also examples of milder crises from, for example, the euro area. Stable public finances are a prerequisite for price stability. If the government's future capacity to obtain tax revenue were to be less than future expenditure, the credibility of the inflation target would be undermined.35 This implies fiscal dominance and can lead to rapid price increases.
And, over a five year period, since each member of the MPC is trying to hit the same inflation target, I predict that it will be impossible to distinguish between “doves” and “hawks”. What will the commentators call us then? If Britain either has or is about to join Monetary Union, then the birds may have flown the nest. But if the MPC is still setting interest rates in Britain, then I hope that we shall be seen as a group that is tediously predictable, sometimes raising interest rates, sometimes cutting them, but always moving in response to the economic data in order to hit the inflation target. BIS Review 53/1998