The other extreme is “monetary dominance”. Central banks raise interest rates to avoid the inflationary effects of excessive budget deficits. Real interest rates rise across the maturity spectrum and the prospect of higher-and-higher debt service costs then forces governments to reduce their primary deficits. This seems to fit the UK story in the late 1980s and early 1990s when tighter macroeconomic policies (monetary and fiscal) brought down inflation. But it took many years for this policy stance to earn credibility and reduce long-term interest rates (see panel C of Graph 3). The adoption of a tighter monetary policy regime was.
