Friday, 23 July 2010

The phrases “fiscal policy” and “monetary policy” should be abolished.

The opening sentence of this economics tutorial site reads: “Fiscal policy should not be seen in isolation from monetary policy.” Too right. I’d go further: the two are so intertwined that making a distinction between them is near meaningless. Or as Robert Skidelsky puts it, “In Keynesian theory, monetary and fiscal policy are parts of a single process”.

Certainly those who refer to FS or MS alone normally fall flat on their faces.

For example this Wikipedia site suggests in its opening few paragraphs that FS can influence aggregate demand (AD). Well that is debatable.

Fiscal policy is normally seen as consisting of government raising or reducing taxes or spending and altering borrowing by an equivalent amount. But there’s a problem: the deflationary effect of the borrowing (assuming the objective is stimulus) to some extent negates the stimulatory effect of the spending (a problem called “crowding out”). So what do governments do about this? Exactly what they’ve done over the last two years: reduce interest rates to make sure that there is a stimulatory effect. But to force down interest rates they have to print money and buy some of the government debt they have issued. I.e. the money supply goes up (monetary policy again).

The two are well and truly intertwined! Moreover, since money printing has a definite effect, while the effect of borrowing is debatable, why bother with borrowing? Abba Lerner was right: borrowing is a farce. I give more reasons as to why borrowing is a farce here.

Instead of the phrases MS and FS it would be better if those advocating any economic policy just said what the policy consisted of: e.g. “have government borrow $Xbn and channel it to Wall Street” or “abolish the Federal Reserve” or “shoot the governor of the Bank of England.”

But spelling out a proposal in detail involves THINKING (shock, horror). It involves commitment – it involves the risk of someone pointing to errors in your proposal.

It’s far easier to make vague and near meaningless generalisations about MS and FS. So just jumble up the words “fiscal”, “monetary” and “policy” with a thousand other words from the English dictionary at random, and you have an article you might get paid for.

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