Central Banks May Be Called On To Help Pay Government Bills

Rising borrowing costs for heavily indebted governments and growing strains in sovereign bond markets are forcing investors to confront a question once considered unthinkable: will central banks ultimately be called on to help pay the bill?

Fiscal dominance, a situation where a government leans on its central bank to buy its bonds or support it in other ways because it can no longer manage on its own, is being debated at the Federal Reserve's annual gathering in Jackson Hole. This topic has been treated as taboo in wealthy countries for decades.

The concern is that if a central bank prints money to plug budget deficits, it risks stoking inflation, devaluing the currency, and sending foreign creditors running for the exit. By contrast, an institution free from political pressure can focus on controlling inflation, preserving confidence in a country's money and its bonds.

The United States has run deficits exceeding 4% of economic output every year since 2019, a level normally associated with recessions despite sustained growth. Investors have largely absorbed the extra issuance, but demand is showing signs of strain. Long-dated Treasury yields have risen sharply, pushing up costs at bond auctions.