For our part, one important gauge of that credibility is expected inflation in financial  Chart 14: Financial-market measures of inflation expectations have been stable  markets. Were there a serious concern that inflation would drift away from target, whether because of higher levels of debt or for any other reason, you’d expect to see it reflected in higher “breakeven rates” in gilts markets (i.e. the difference in the yields on conventional and indexed debt). Thus far that has not happened (Chart 14). Come what may, the MPC will respond to  Sources: Bloomberg Finance L.P, TradeWeb and Bank calculations. economic events as they unfold to ensure, in line with our remit, that the stability of inflation is maintained. Thank you. 21  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  21  References Bailey, A. 2020. “Bank of England is not doing ‘monetary financing’”. Financial Times, 5 April 2020. Barro, R. J. 1987. “Government spending, interest rates, prices, and budget deficits in the United Kingdom, 1701-1918”. Journal of Monetary Economics, Vol. 20, pp. 221-247. Blanchard, O. 2019. “Public debt and low interest rates”. The American Economic Review, Vol. 109, No. 4, pp. 1197-1229. Boivin, J., Kiley, M. T. and Mishkin, F. S. 2010. “How has the monetary transmission mechanism evolved over time?” Handbook of Monetary Economics, Vol. 3, Chapter 8, pp 369–422, Elsevier. Bordo, M. D. and Kydland, F. 1995. “The gold standard as a rule; an essay in exploration”. Explorations in Economic History, Vol. 32, No. 4, pp. 423-464.
Or is there “fiscal dominance” over the central bank, which is then forced to subordinate its own objectives to those of the fiscal authority? Because they naturally respond to the economic cycle, looking at the instruments of policy on their own (fiscal and monetary measures) doesn’t really help you that much in distinguishing one situation from the other. A better method might simply be to look directly at the institutional arrangements themselves (are monetary and fiscal policies determined by independent agencies? how is that independence safeguarded?). As this is ultimately a question of ends rather than means, a better measure still is the behaviour of objectives of policy. If inflation rises materially above its target, and if it tends to do so in particular when the public finances are under strain, that may be evidence of “fiscal dominance”. If, on the  1  See https://www.bankofengland.co.uk/research/bank-of-england-agenda-for-research. 2  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  2  other hand, easier monetary policy is necessary simply to stabilise inflation, and succeeds in doing so, it’s hard to see how it can qualify as “monetary finance”, no matter how the fiscal balance is behaving2. That’s not to say the fiscal position is wholly irrelevant because higher inflation may help – if only to a degree, and at a wider economic cost – in easing fiscal constraints. Very high levels of debt could therefore test those institutional arrangements.