Explainer-Jackson Hole’s big question: who pays the government’s bill?

In the coming days, central bankers and economists at the Federal Reserve's annual meeting in Jackson Hole, Wyoming will grapple with a contentious issue: the possibility of central banks stepping in to help governments pay their soaring debts. This concept, known as fiscal dominance, has long been considered taboo due to the risks of inflation and currency devaluation.

However, mounting government debt burdens and high borrowing costs are causing investors to question whether central banks should intervene. While governments often turn to shortcuts like raising taxes or restricting money flows to manage their deficits, these solutions are politically difficult. In some cases, central banks have provided financial assistance, an act previously deemed illegal in advanced economies.

The United States, for instance, has run annual deficits exceeding 4% of its GDP since 2019, a figure typically associated with recessionary periods. This has put a strain on investor confidence, with long-term Treasury yields climbing and auction demand waning. The Treasury has attempted to alleviate the pressure through bond buybacks, but the Fed's limited resources prevent it from directly purchasing debt.

While the Fed's chair, Kevin Warsh, has dismissed rumors of political interference, the line between central bank autonomy and government influence has blurred in the past. Past examples, such as the Fed's Operation Twist in 2011 and Japan's long-term bond yield capping, illustrate how central banks have accommodated fiscal demands.

Some radical proposals, like debt cancellation or bond write-offs, have resurfaced in discussions, but mainstream economists caution that such steps could undermine confidence and violate EU rules. As government debt accumulates, the question looms: can the separation between fiscal and monetary policy endure?