Fiscal policy and financial stability: revisiting the nexus

Claudio Borio, Marc Farag and Fabrizio Zampolli

Chapter 9 in Fiscal Policy in a Turbulent Era, 2024, pp 139-153 from Edward Elgar Publishing

Abstract: Fiscal policy is key to preserving macro-financial stability. This chapter explains why. It first describes the channels through which sovereign and financial risks can become mutually reinforcing, giving rise to so-called “doom loops”. The chapter then discusses how to lessen or break these loops. Action on two fronts is required. First, financial stability considerations should be incorporated into the design of fiscal policy so as to prevent financial instability from undermining fiscal sustainability and to protect the room for manoeuvre to address any eventual financial crises. Second, prudent regulation of financial institutions should acknowledge that public debt is not entirely risk free and should therefore include measures to discourage or limit banks’ sovereign exposures, although with due regard to the special role of government debt in the financial system and country-specific characteristics.

Keywords: Economics and Finance; Politics and Public Policy (search for similar items in EconPapers)
Date: 2024
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