Central banks are maintaining fiscal solvency

Central banks in OECD countries have chosen to add the preservation of fiscal solvency to their usual objectives (price stability, full employment). Could this third objective come into conflict with their first two objectives? In the event of a surge in inflation, the central bank’s reaction would have to entail a smaller increase in nominal interest rates than the increase in inflation so as to not drive up real interest rates, which would erode fiscal solvency; so real interest rates can no longer be allowed to rise in response to inflation. This is a significant constraint; In the event of a fall in inflation, the central bank must respond strongly to prevent real interest rates from rising; In the event of a rise in unemployment, the state of public finances will deteriorate, making a strong reaction by the central bank welcome; But in the event of a fall in unemployment, the central bank cannot react by driving up real interest rates. So there is an asymmetric conflict of objectives: the introduction of a fiscal solvency objective compromises the central bank’s response to increases in inflation and upturns in growth, but not at all to disinflation or recessions, in which cases it must respond strongly. This asymmetry in the central bank ’s response is quite consistent with the facts.