## POLICY COORDINATION FOR FRACTURED TIMES ## Source details **Canonical URL:** [POLICY COORDINATION FOR FRACTURED TIMES](https://www.imf.org/-/media/files/publications/fandd/article/2026/03/corsetti.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fandd/article/2026/03/corsetti.pdf.md) - [Structured JSON version](/-/media/files/publications/fandd/article/2026/03/corsetti.pdf.json) --- ### Unstable geopolitics and policy coordination - Advanced economies face a mix of high and rising public debt and persistent inflation. - Traditional remedy: central bank commitment to lower inflation backed by credible fiscal adjustment to stabilize debt. - Geopolitical fragmentation increases the risk of supply disturbances that: - Threaten stagflation pressures. - Create demands on fiscal policy that exacerbate outstanding imbalances. - Resulting implication: policymakers across advanced and emerging market economies may need to accept moderate—if temporary—higher-than-desired inflation to preserve fiscal sustainability and macroeconomic stability during a rocky transition. - When geopolitical tensions escalate without backstops, supply disruptions and adverse supply shocks put fiscal and monetary policy into conflict. ### Fiscal sustainability: mechanism and risks - Mechanism linking inflation to fiscal sustainability: - Tightening by central banks raises real interest rates and slows growth. - Slower growth widens the primary deficit and raises the real burden of debt. - Without fiscal consolidation (spending cuts or tax increases), rising interest on government bonds injects money into households, feeding aggregate demand and increasing inflation until the real value of nominal debt aligns with expected future taxation or spending reductions. - Risk: If central banks enforce price stability without credible fiscal frameworks, aggressive tightening can raise debt-service costs, intensify inflationary pressure, and trigger a spiral of further tightening and worsening fiscal imbalances. - Success of monetary contraction in reducing inflation depends on government commitment to adjusting primary surpluses—referred to as fiscal backing. - Effectiveness of monetary-fiscal coordination historically rests on a relatively stable geopolitical environment and a widely accepted international order. ### Historical patterns and supply shocks - Fiscal imbalances are typically resolved through a combination of fiscal adjustment and inflation surprises. - Monetary-fiscal coordination was more successful in periods of demand-driven expansions with favorable supply conditions (example: the 2010s). - Supply disruptions (e.g., oil-market disruptions in the 1970s; post-pandemic supply-chain disruptions and Russia’s invasion of Ukraine) complicate coordination and can contribute to persistent high inflation. - Asymmetry: fiscal backing weakens more in response to supply shocks than to demand shocks, making coordination less effective when adverse supply shocks coincide with large fiscal imbalances. - Central banks face a dilemma under adverse supply shocks: - Tighten to defend price stability at the cost of deeper recession and worse fiscal position, or - Accommodate inflationary consequences to mitigate downturn and ease fiscal burden, at the cost of abandoning price stability. ### Controlled inflation as a pragmatic option - Current drivers weakening fiscal positions across advanced economies: geopolitical tensions, rising defense spending, trade fragmentation, weaker growth prospects, population aging, low productivity growth, and heightened exposure to climate and geopolitical risks. - With high debt, fiscal adjustment must be gradual; sustainable adjustment will likely require pragmatic tolerance for some controlled inflation—termed “fiscal inflation.” - Conditions for fiscal inflation to work: - Temporary and moderate inflation. - No disruptive loss of inflation-fighting credibility. - Effective communication by authorities to assure public of ability to stabilize public debt via reforms and policies to contain supply-side disturbances and deliver plausible productivity gains. - Central bank smoothing or delaying price adjustment is feasible when government bonds are not indexed to inflation and markets expect future fiscal corrections or productivity-driven growth that reduces debt burdens. ### Broader approach and global interactions - Institutional capacities to stabilize debt via inflation vary: - Some countries (examples cited in the text) have mechanisms—explicit rules and unwritten guidelines—that help stabilize debt, partly through inflation; the euro area’s lack of a meaningful federal budget and debt complicates such an institutional equilibrium. - Policy trade-offs in a fragmented geopolitical environment: - Risks include raising revenue via taxes on trade or embracing financial repression (tighter regulation, capital controls) to lower borrowing costs—measures that can increase vulnerability to stagflationary shocks and provoke disruptive two-way feedback between domestic and uncoordinated international policies. - Extended unconventional collaboration integrating internal and cross-border policies could help keep the world economy on a path to sustainable fiscal adjustment. - Emerging markets face special challenges: - Geopolitical shocks can reconfigure global imbalances and alter costs and benefits of export-led policies, capital account liberalization, and inflexible exchange rate arrangements. - Many governments must defend credibility of policy regimes that built local-currency-denominated debt markets; this raises both the potential role of controlled inflation and the temptation to engineer large inflation surprises that could undermine prior progress. ### Policy implications and recommendations - Closer coordination between monetary and fiscal authorities is required to address large fiscal imbalances, adverse demographics, and geopolitical developments. - Enhanced coordination can boost credibility of fiscal stabilization but requires a careful balancing act to avoid: - Overestimating scope for reasonable fiscal inflation. - Downplaying benefits of a credible inflation-targeting regime. - Exaggerating advantages of noncooperation in international economic relations. - Restoring or maintaining geopolitical stability, adherence to accepted legal norms, and effective international institutions are essential backstops for successful monetary-fiscal coordination. - An integrated policy framework that contains economic fragmentation and rising geopolitical tension is necessary to lay the foundation for fiscal sustainability alongside stable control of inflation fluctuations. *Giancarlo Corsetti and Leonardo Melosi (European University Institute; Centre for Economic Policy Research).* --- _Source: https://www.imf.org/-/media/files/publications/fandd/article/2026/03/corsetti.pdf_