First,
I do like this chart which shows the – er – amazing benefits of the 2009 cut in
base rates in the UK. More specifically, the base rate plunged, and the result?
Rates charged by commercial banks, etc to borrowers went up.
Next,
Brad DeLong and Laura Tyson give five reasons why it used to be thought that
monetary policy alone could deal with recessions.
All
five reasons are thoroughly defective. The reasons copied straight from their paper
are as follows (in brown), followed by my comments in black.
1. The problem of
legislative confusion: Legislatures that were told that expansionary policies which led to cyclical
deficits in downturns were good might
have difficulty retaining the other important lesson that structural deficits which led to perpetually
rising debt-to-GDP ratios were bad.
Better, it was thought, to keep the legislative process focused on “classical” considerations of the benefits
and costs of spending programs and taxation levels.
No
doubt most of us agree that the legislature should concentrate on the strictly
political matters, like what proportion of GDP should be allocated to public
spending and how that should be split between education, defence and so on. But
that doesn’t preclude fiscal stimulus: the degree of fiscal stimulus can be
decided by a fiscal council or some other independent committee of economists,
while the above mentioned “political matters” remain untouched. E.g. if a
fiscal council cuts taxes and raises public spending by the same proportion and
with a view to imparting stimulus, then the proportion of GDP allocated to
public spending remains untouched.
Moreover,
it is easy to build in an element of variability into sales taxes for example:
indeed, VAT has been altered three times in the last five years in the UK
without a full vote in the House of Commons. Likewise an element of variability
could easily be built into social security benefits, payroll taxes, etc.
2. The problem of
legislative process: Legislatures are, by design, institutions that find it very difficult to
make decisions quickly. Central banks,
by contrast, can move asset prices in an hour. Fiscal policies that take effect this year as a result of
decisions made by a legislature last year based on information from two or
three years ago would seem to guarantee
sub-optimal economic outcomes.
Total
confusion here.
First,
even assuming that central banks can take decisions quicker by a few weeks or
months AND ASSUMING that fast acting fiscal councils are not possible, the “in
an hour” point is irrelevant. The IMPORTANT question is the TOTAL LAG as
between the decision to act and the eventual effect. And in that lag for both
fiscal and monetary policies seems to be around a year. So if it takes a fiscal
council a month longer to act than a central bank, that is near irrelevant.
Next,
whence the assumption that decisions on fiscal stimulus are based on “information
from two or three years ago” but decisions on monetary stimulus are based on
more recent information? The “information” will be EXACTLY THE SAME in each case:
the most important pieces of information being whether unemployment is rising
or falling and ditto for inflation.
3. The problem of
implementation: Public bureaucracies have limited capacities to ramp-up or ramp-down their
spending levels quickly without incurring
substantial waste. The larger the fiscal-policy intervention to balance aggregate demand, the less likely the
intervention would be well timed, well designed and well executed.
Obviously
there are areas where “ramping up or down” involves waste. A classic example is
one of the most popular proposed forms of anti-recessionary spending, that is
infrastructure. It’s normally impossible to get infrastructure projects going
quickly, plus if anti recessionary spending is concentrated on just one area
(infrastructure or whatever), the requisite skilled labour probably won’t be
available.
However,
there shouldn’t be any of the above waste if stimulus is spread over the entire
economy or a large portion of it, as occurs when taxes or benefits are
adjusted.
Moreover,
adjusting interest rates suffers from exactly the problem mentioned above:
namely concentrating stimulus on one or two narrow areas of the economy. That
is, cutting interest rates concentrates stimulus on capital expenditure
(assuming interest rate cuts work as they are supposed to, which looks doubtful
if the above chart is any guide). As mentioned above, big increases in demand
for PARTICULAR PRODUCTS care likely t o run into the above mentioned shortage
of skilled labour problem.
4. The problem of
rent-seeking: In a world where we fear that the
structure of government already leads to policies favoring too-many politically-powerful winners at the expense
of politically-weak losers, an additional
excuse to undertake fiscal projects and programs that would not meet conventional societal benefit-cost
tests is not welcome.
Rent
seeking is a problem that occurs where corporations can bribe politicians into
allocating government spending to PARTICULAR projects or forms of spending. In
contrast, fiscal committees or similar are NOT CONCERNED with specific projects
or similar. Fiscal committees are concerned with changes to tax or spending
which do not impinge to any great extent on one project or area of the economy.
5. The problem of
superfluity: Monetary policy was strong enough to do the job. Fiscal policy was simply not
necessary.
The
fact that something is “strong enough to do a job” is not a good reason for
supposing it’s the BEST TOOL for the job. In particular, monetary policy is
DISTORTIONARY (as mentioned above) in that it concentrates stimulus on capital
spending.
An
Abrams tank is “strong enough” to plough a field. But it’s not the best tool
for the job, is it?
And
to cap it all, monetary policy, as DeLong and Tyson correctly point out becomes
a feeble implement at the zero bound.
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