When debt gets too high, fighting inflation makes the debt problem worse — Egypt has lived through this loop before

🏦 What happens when a country’s unchecked debt piles up to the point that it starts constraining monetary policy? That’s the question behind the growing focus on fiscal dominance — a situation in which fiscal pressures can limit a central bank’s ability to prioritize price stability. With public debt and deficits running high, central banks can face a high-stakes trade-off between keeping inflation in check and keeping government borrowing costs manageable.

The Central Bank of Egypt’s (CBE) Monetary Policy Committee meets on Thursday to decide whether to hold rates steady or resume cutting — and whichever way it goes, the decision will be shaped as much by the state’s own borrowing needs as by inflation. So, what’s the case for Om El Donia? And what can be done to prevent fiscal pressures from taking the reins of monetary policy?

Flipping the switch from monetary to fiscal policy

Let’s get theoretical. In ideal, textbook policymaking, monetary policy and central bank decisions operate independently of fiscal governance. Central banks are meant to prioritize price and economic stability, which can mean adjusting interest rates to keep inflation in check and the economy on a sustainable path. Fiscal authorities, on the other hand, have things covered through tax and spending policies designed to keep public finances and debt sustainable.

While the two policies shouldn’t infringe on each other’s core objective, they still co-exist. Naturally, monetary policy has some fiscal consequences. But an important distinction is that inflation isn’t determined by monetary policy alone — it is also shaped by a range of other factors, including the interaction between monetary and fiscal policy. So, while price stability falls under the central bank’s purview, under normal circumstances, a responsible fiscal agent facilitates sound economic policy and doesn’t risk public finances through persistent deficits.

Functionally, what does that dynamic look like? The appropriate arrangement is one where the central bank is active, and the fiscal authority is passive. An active central bank adjusts its policy rate targets to pursue price stability and broader macroeconomic goals — in Egypt, this would be the CBE’s interest rate corridor system, which it uses to steer the overnight interbank rate. Central banks essentially direct inflation outcomes. Conversely, a central bank becomes passive when monetary policy starts accommodating fiscal needs, for example, by keeping interest rates lower than necessary to help manage outstanding government debt.

For fiscal authorities, being passive means increasing taxes and primary surpluses and cutting spending as needed to keep public debt sustainable. When fiscal policy becomes active instead, persistent or unsustainable spending can undermine the balance between monetary and fiscal policy, potentially putting pressure on the central bank to accommodate the government’s financing needs — aka fiscal dominance.

Fiscal dominance at work

In fiscally dominant regimes, monetary policy effectively works around mounting government debt, with interest-rate decisions focused on preventing debt-servicing costs from pushing the debt burden even higher. Beyond keeping interest rates low, the central bank may also face pressure to support the government bond market and ensure continued access to affordable financing. This setup shows a clear shift in policy dynamics: fiscal policy becomes a primary driver of inflation, while the central bank becomes increasingly reactive to fiscal decisions.

Where the loop starts — and doesn’t end. A standoff between the two authorities can emerge as both attempt to force the other to adjust: the central bank by resisting deficit monetization and large-scale money creation, and the treasury by refusing to cut spending or raise taxes. Ultimately, neither wants an economic crash or sovereign default.

But as public debt and debt-servicing costs pass a certain threshold, fighting inflation with higher interest rates then becomes counterproductive. Why? Because higher benchmark rates raise the government’s interest bill and, in turn, widen the overall fiscal deficit. If monetary policy yields to those fiscal pressures through deficit monetization, the resulting inflationary pressure can feed back into the cycle, creating the very conditions that make the debt harder to stabilize.

The case for Egypt

Egypt’s case looks more complicated. Historically, the country has run persistently high budget deficits relative to GDP, according to a July 2026 study published in the Journal of Legal and Economic Research, with the government at times relying on central bank financing to help meet its funding needs — raising concerns around periods of fiscal dominance. Inflation was often closely linked to fiscal pressures over the past decades, but the picture has been looking brighter in recent years.

It’s worth noting that Egypt’s current legislative framework does not fully prohibit the CBE from financing government deficits. Under Article 47 of Law No. 194 of 2020, which governs the CBE and the banking system, the central bank may provide financing to the government to cover seasonal budget deficits. However, this financing is subject to strict limits: it cannot exceed 10% of the state budget’s average revenues over the previous three fiscal years, and the full amount must be repaid within a 12-month timeframe from the date it was granted.

Egypt’s experience during periods of economic stress since 2017, including the Covid-19 pandemic, suggests that monetary and fiscal policy have worked in tandem rather than encroaching on each other’s mandates. That coordination was supported by reforms such as limits on direct CBE financing and market-based debt management.

“Fiscal and monetary authorities in Egypt exhibit a moderately strong level of coordination,” the study notes, compared to empirical evidence of fiscal dominance from 1980-2017. It adds that “fiscal dominance in Egypt today can be described as moderate: no longer the overriding constraint it once was, but still a significant factor shaping monetary policy outcomes.”

In recent years, the CBE has maintained a firm anti-inflationary stance, using higher interest rates when needed, while fiscal policy has focused on targeted support. This policy coordination highlights the importance of an independent central bank in maintaining macroeconomic stability.