High Debt & Monetization
When a heavily indebted government finances its deficits by printing money (fiscal dominance), inflation accelerates in a way that monetary tightening alone cannot stop, because the inflation is rooted in the budget, not just the money supply.
| Mechanism | Fiscal dominance |
|---|---|
| Theory | Sargent–Wallace (1981) |
| Fix | Credible fiscal correction |
Hyperinflation is the extreme; this is the everyday version of the same force. When public debt is high and deficits persist, governments can be tempted to lean on the central bank to finance spending, a regime economists call fiscal dominance.
Sargent and Wallace's "Some Unpleasant Monetarist Arithmetic" (1981) made the surprising point that under fiscal dominance, tighter money today can mean higher inflation later: holding inflation down now raises the debt that must eventually be inflated away. In that world, long-run inflation is ultimately a fiscal phenomenon, and the central bank cannot independently control it.
The implication is uncomfortable: where inflation is driven by the deficit, raising interest rates is not enough. It takes a credible fiscal correction, restoring the budget and the central bank's independence, to durably bring inflation down. The Argentina scenario shows where the unchecked version leads.
Sources: Sargent & Wallace (1981); Sargent (1982). See the methodology.