Is it acceptable for an independent central bank to exert a strong influence over a country’s fiscal policy? The case of the euro zone

Since the crisis, central banks in OECD countries have conducted policies that have had a strong influence on fiscal policies : persistently very low interest rates; government bond purchases. The problem is that central bank independence (the absence of coordination between fiscal policy and monetary policy) was introduced based on the premise that monetary policy did not interact with fiscal policy. If fiscal and monetary policy do interact (monetary policy has an externality on fiscal policy), then they ought to be coordinated. In the absence of coordination, the most likely scenario is one in which monetary policy is captured by fiscal policy, i.e. fiscal policy is too expansionary, which forces the central bank to conduct an expansionary monetary policy to restore fiscal solvency (this is known as “fiscal dominance”). When we look at actual developments in the euro zone since the crisis , we see that: In a first period (2010-2014), the ECB refused to run the risk of enabling an overly expansionary fiscal policy, and both monetary policy and fiscal policy were too restrictive; In a second period (2015-2019), the ECB yielded to fiscal dominance and both fiscal policy and monetary policy were too expansionary.