Fiscal Dominance Taboo Rattled as Fed Grapples with Government Debt

The Fed's symposium in Jackson Hole is set to tackle a sensitive topic known as 'fiscal dominance,' where governments rely on central banks to finance their debt. This concept has been shunned for decades due to concerns about runaway inflation and currency devaluation.

The US public debt has steadily increased since the 2008 financial crisis, with deficits above 4% of GDP every year since 2019. Investors have absorbed new issuance so far, but long-term Treasury yields have risen sharply, making it more expensive for the government to borrow.

Treasury Secretary Scott Bessent has suggested that the Fed consider increasing its lending facility for foreign central banks to shield the US bond market from volatility. However, this proposal blurs the line between fiscal and monetary policy, which officials aim to maintain.

The new Fed Chair Kevin Warsh has rejected speculation about being more accommodating towards President Donald Trump than his predecessor Jerome Powell. Yet, the Fed itself launched 'Operation Twist' in 2011, effectively lowering Washington's financing costs by selling short-term securities and buying longer-dated ones.