High public debt levels worldwide have reignited concerns about their potential impact on central banks' ability to control inflation. While central banks can still manage inflation with high debt, they must recognize that elevated debt raises the interest rates needed to maintain price stability. Since the global financial crisis, public debt has surged in both the United States and the euro area, fueled by factors like the green transition and increased defense spending. This has revived debates about whether high debt could fuel inflation, a concern originally addressed by the Maastricht Treaty's limits on fiscal deficits and debt-to-GDP ratios.
The economic community remains divided on whether monetary policy can always control inflation or if fiscal policy could undermine this ability. Most monetary models align with Milton Friedman's view that central banks can maintain inflation control as long as they remain independent. However, the fiscal theory of the price level argues that without future fiscal surpluses to back current debt, fiscal policy could drive inflation. Recent research has expanded this debate, with some economists suggesting that low interest rates on government bonds could allow debt to be rolled over without future tax hikes, while others highlight how fiscal stimulus can increase prices when supply is limited.
A key factor in this debate is whether households are 'Ricardian,' meaning they save debt-financed transfers in anticipation of future taxes. Empirical evidence suggests households often spend a portion of such transfers, indicating non-Ricardian behavior. Research by Dupraz and Rogantini Picco (2025) found that public debt can become inflationary when households are not Ricardian, but central banks can typically counteract this by raising interest rates. However, there is a limit to how high debt can go before even very high interest rates fail to curb spending. The study estimates this limit at about 5.4 times annual GDP, well above current debt levels in advanced economies.
To prevent high debt from causing inflation, central banks could proactively raise interest rates in response to increases in public debt, rather than waiting for inflation to rise. This approach acknowledges that public debt influences the natural rate of interest, which balances demand with economic output. By monitoring public debt levels, central banks can better implement monetary policy to maintain price stability, even if this requires navigating institutional sensitivities about appearing to react to fiscal decisions.