Why is DNB concerned with public finances?

Ensuring financial stability is one of DNB's core tasks. Stable prices and healthy financial institutions are key to make this happen. To monitor financial stability, we focus on risks that could affect the financial system and provide advice to reduce these risks.

Public finances are linked to financial stability in two ways. Firstly, in order to support the economy in a crisis, the government needs to build up buffers in good times. During an economic downturn, the government can use these buffers to prevent it from having to make cutbacks or raise taxes immediately, since making cutbacks in difficult economic times would reinforce the downturn and thus increase the risks to financial stability. Government interventions during the financial crisis and the coronavirus crisis have shown how important such buffers are.

Secondly, doubts about the sustainability of public finances could also be a risk to financial stability. When financial markets doubt the repayment capacity of the Dutch government, interest rates on government loans (government bonds) can rise sharply. The value of such bonds then falls, which can lead to problems for banks and other investors holding them. This in turn may also affect the availability of bank loans and hence the investment opportunities of businesses and households.

Monetary policy

Besides monitoring financial stability, DNB also has the core task of monitoring price stability. The European Central Bank (ECB) influences the money circulating in the euro area by conducting monetary policy. The ECB’s Governing Council is responsible for taking monetary policy decisions. DNB President Klaas Knot has a seat on the Governing Council, and this allows DNB to influence these decisions. The ultimate goal of monetary policy is to bring inflation in the euro area to 2%.

With a budget of almost 50% of gross domestic product (GDP), the government can influence the Dutch economy and thus inflation. Higher government spending or a lower tax burden increases domestic demand and usually cause prices to rise. Conversely, reducing government spending or increasing the tax burden tends to press down prices because there is less demand for certain products and services. In addition, cost-increasing taxes such as VAT and excise duties have a direct impact on the prices of goods and services, such as food and fuel.

Given the impact of fiscal policy on inflation, it is important for our task of monitoring price stability that fiscal policy and monetary policy move in the same direction. If inflation is too high and the central bank tries to curb inflation by raising interest rates, while the government pushes the accelerator with additional spending or lower taxes, this would have a negative effect on price stability. The same applies vice versa when inflation is too low. For monetary policy to be effective, matching fiscal policy is important.

In short, the financial system needs sound public finances to ensure price and financial stability as much as possible. And that's how fiscal policy touches directly on DNB's mission.

How does DNB support prudent fiscal policy and sound public finances?

We are part of the Working Group on Fiscal Space, which advises on the budget target and fiscal policy to be pursued for each government term. We also publish studies, analyses and position papers on public finances, and provide economic advice. For instance, our President has regular meetings with the Minister of Finance and we advise the regular meetings of the Prime Minister and the Minister of Economic Affairs, the Minister of Finance, the Minister of Social Affairs, and the Minister of Interior and Kingdom Relations of the Netherlands on the cabinet's general financial, macroeconomic and socio-economic decision-making. In doing so, we provide independent advice based on our price and financial stability mandate. Ultimately, it is up to politicians to make decisions on public finances.