Luis I. Jacome and his coauthors show how populist governments in the past have financed public deficits via central bank lending to the central government (“deficit monetization”), and what were the effects on inflation. Then they explore if past exposure to this kind of monetization and to populist regimes changes how today’s central banks set policy, especially in countries with explicit inflation-targeting frameworks. As many countries face higher public deficits, rising inflation, and renewed political pressure on central banks, these questions are highly relevant: If populist governments are more likely to use central banks to finance the budget, and this fuels inflation, central banks must both resist short-term political demands and rely on strong institutional safeguards. The paper therefore contributes to current debates on central bank independence, the dangers of fiscal dominance, and the way historical experience shapes today’s monetary-policy rules and credibility.

How populism, central-bank financing and inflation are connected

Using historical cross-country evidence, the authors document a robust association between the arrival of populist governments, especially left-leaning populists, and subsequent increases in central bank claims on the central government. They find that, on average, a new populist regime is followed by substantial cumulative growth in central bank lending over a multi-year horizon. When they split regimes by ideological orientation, the effect is economically large and statistically significant for left-of-center populists: ten years after taking office, central bank credit to government can be several times larger than in comparable non-populist episodes. Right-wing populists do not show the same pattern and sometimes show weaker or opposite dynamics. The paper then links these financing episodes to prices: increases in central bank credit are associated with higher inflation paths, with larger and quicker inflation responses when central bank financing is unusually large.

Long-run legacy on monetary-policy rules

The paper also shows that the historical experience of populism and past episodes of deficit monetization have persistent consequences for how modern central banks set policy. Focusing on a panel of countries that currently follow explicit inflation-targeting regimes, the authors estimate augmented Taylor-type reaction functions in which the interest-rate response to deviations of inflation expectations from the target is allowed to depend on historical exposures. They find that countries with a past history of left-wing populist rule that rely on large central bank financing respond more aggressively to an inflation-expectations gap today: in other words, central banks that lived through populist-driven monetization behave more “hawkishly” (raising rates more when expectations drift above target) to re-establish and signal credibility. This stronger reaction persists after controlling for the country’s past average inflation, financial development, trade openness and other structural variables, suggesting that the effect is about institutional memory and reputational rebuilding rather than simply past inflation statistics.

What policymakers should take away

Legal and institutional limits on central bank lending to the government matter: places with weak safeguards are more vulnerable to politically induced monetization that can fuel inflation. Moreover, as episodes of fiscal monetization leave a long memory that alters central-bank behavior, policymakers should not view present credibility as costless; countries with populist histories may need stronger communication, transparency, and explicit rules to anchor expectations. Fiscal discipline remains central: preventing repeated recourse to monetary financing is the cheapest way to avoid costly inflation episodes and to minimize the need for harsher monetary tightening later. Finally, the evidence suggests a two-track response for international institutions and advisors: support for stronger central-bank legal frameworks and for fiscal rules that make reliance on central-bank financing less likely, combined with pragmatic short-term assistance when political pressures and funding gaps threaten stabilization. Together, these measures reduce the chance that temporary political demands become persistent macroeconomic legacies.

Fiscal Populism and Monetary Policy Rules

Authors:

Luis I. Jácome (Georgetown University)

Nicolás E. Magud (International Monetary Fund)

Samuel Pienknagura (International Monetary Fund)

Martín Uribe (Columbia University)

(paper presented at the 2nd Economic Policy: Papers on European and Global Issues Conference)