Friday, 19 August 2016

Why not merge monetary and fiscal policy?

John Williams of the San Francisco Fed published an article recently advocating a bigger role for fiscal policy.

One relevant passage reads:

"Turning to policies that can help stabilize the economy during a downturn, countercyclical fiscal policy should be our equivalent of a first responder to recessions, working hand-in-hand with monetary policy. Instead, it has too often been stuck in a stop-and-go cycle, at times complementing monetary policy, at times working against it. This is not unique to the United States; Japan, and Europe have also fallen victim to fiscal consolidation in the midst of an economic downturn or incomplete recovery.

One solution to this problem is to design stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries (Williams 2009, Elmendorf 2011, 2016). These already exist in the form of programs such as unemployment insurance but are limited in size and scope. Some possible ideas for the United States include Social Security and income tax rates that move up or down in relation to the national unemployment rate, or federal grants to states that operate in the same way. Such approaches could be designed to be revenue-neutral over the business cycle; they also could avoid past debates over fiscal stimulus by separating decisions on countercyclical policy from longer-run decisions about the appropriate role of the government and tax system. Indeed, economists across the political spectrum have championed these ideas."

Well quite. In fact why not take it a stage further and simply fund fiscal deficits via new money? I.e. for each dollar of fiscal stimulus, there’d be an extra dollar of base money in the hands of the private sector (which is monetary stimulus of a sort). And that’s what’s advocated by Positive Money, the New Economics Foundation and Richard Werner.

But instead of the latter monetary policy in the form of adjusting the private sector’s stock of base money, Williams seems wedded to adjusting interest rates. Well the problem with that is that is first that there’s a wealth of evidence that interest rate adjustments don’t actually have much effect. Second, the lag between interest rate changes and actual changes in investment spending are long. Third, the GDP maximising rate of interest is presumably the free market rate. That is, ARTIFICIAL adjustments to interest rates are not on the face of it a GDP maximising way of attaining full employment.


Reference. 'Monetary policy in a low R-Star world'. John Williams.

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