High public debt levels worldwide have reignited debates about whether they could undermine central banks' ability to control inflation. While central banks can still manage inflation with high debt, they must recognize that greater 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 raised concerns about whether fiscal policy could weaken the central bank's grip on inflation, a question that divides economists.
The debate hinges on whether monetary policy or fiscal policy primarily drives inflation. Traditional monetary models, influenced by Milton Friedman, argue that central banks can control inflation if they remain independent. However, the fiscal theory of the price level suggests that if public debt isn't backed by future fiscal surpluses, fiscal policy could determine inflation. Recent research, such as Blanchard (2019), adds complexity by noting that when interest rates on government bonds are below economic growth rates, debt doesn't necessarily need future surpluses to be sustainable.
Household behavior also plays a crucial role. Non-Ricardian households, who spend rather than save debt-financed transfers, contribute to inflationary pressures. Research by Borusyak, Jaravel, and Spiess (2024) found that US households spent 8-11% of their 2008 tax rebates on non-durable goods immediately, indicating non-Ricardian behavior. Dupraz and Rogantini Picco (2025) estimate that public debt could reach about 5.4 times annual GDP before causing uncontrollable inflation, a threshold far above current levels in advanced economies.
To maintain control over inflation, central banks should monitor public debt levels and adjust interest rates preemptively rather than waiting for inflation to rise. This approach acknowledges that higher debt influences the natural rate of interest, which balances economic demand and supply. While reacting to fiscal decisions may be institutionally sensitive, it is essential for effective monetary policy in economies with significant public debt.