How do you solve a problem like inflation?

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One might imagine that a government and its central bank work together to ensure that their actions complement rather than contradict each other and that the most appropriate monetary and fiscal tools are used to tackle any given problem. This was often the case historically, with many European countries between the second world war and the inflation crisis in the 1970s using monetary-fiscal coordination to achieve strong growth, develop industrial sectors, bring down government debt, and invest in the future. 

While not entirely absent, monetary-fiscal coordination has felt more sporadic and coincidental in Europe since the 1970s. There have been times when it has been notably lacking. In other parts of the world, however, monetary-fiscal coordination has more recently been deliberately deployed. 

There are urgent challenges that monetary-fiscal coordination could help to address. For example, in many countries, two factors jeopardise unlocking the public and private green investments nations need to combat climate change. First, the higher interest rate environment makes borrowing and investment more expensive. Second, fiscal rules encourage fiscal consolidation for many countries. NEF analysis, for example, showed only three EU countries could meet EU climate and social targets from borrowing while staying within fiscal rules. Good monetary-fiscal coordination could help overcome these challenges.

In addition, keeping monetary policy and fiscal policy in strict silos with set responses (eg interest rate hikes are always the best tool to tackle inflation) has hampered countries’ abilities to address crises. For example, in the previous decade, even unorthodox monetary policy responses failed to sufficiently raise consistently deficient demand in the absence of fiscal policy support. Meanwhile, recent supply-side inflation has illustrated that traditional responses to inflation have limited effect in certain circumstances. A country should use the most appropriate tools at its disposal to address crises. This is particularly crucial given that because of climate change and geopolitical tensions, economic disruption may occur more frequently in the future. We therefore argue that more intentional monetary-fiscal coordination would help central banks meet their primary price stability mandates, while also allowing governments to increase public investments towards agreed objectives, including climate action. 

Monetary-fiscal coordination is becoming harder to ignore. Central banks have been operating since the 2008 financial crisis using a broader definition of their price stability mandates than had previously been the case. For example, buying government debt has raised concerns about central bank independence and the role of a central bank in supporting government finances, while buying select corporate debt has exposed the myth of central bank ​‘market neutrality’. Meanwhile, there has been extensive debate around many central banks now addressing climate change as part of their price and financial stability mandates. 

As another example, central banks are recording losses on their balance sheets and moving into negative capital positions due to large interest payments on their reserves created during quantitative easing (QE) programmes. They are also making losses from unwinding QE. In cases, such as the UK, this results in large transfers from the government to the central bank, with this money being passed on to commercial banks. How central banks share profits and losses with treasuries is thus finding newfound importance.

Inflation has also become a decisive issue for elections and political stability. Rising prices, particularly in essentials such as food, energy, and housing, have a direct and visible impact on voters’ everyday lives. Public dissatisfaction with inflation often erodes trust in the government, making it a key battleground in electoral contests. Ensuring price stability through monetary-fiscal coordination is therefore not only an economic imperative but also a political necessity to maintain democratic legitimacy and counter the rise of extremist force.

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