Blog Post

The fiscal stance puzzle

What’s at stake: In a low r-star environment, fiscal policy should be accommodative at the global level. Instead, even in countries with current account surplus and fiscal space the IMF appears to have trouble advocating fiscal expansion. This also raises a political economy puzzle regarding the persistence of the current policy mix of tight fiscal and easy money.

By: Date: August 29, 2016 Topic: Global Economics & Governance

The IMF in theory and practice

Brad Setser writes that in theory, the IMF now wants current account surplus countries to rely more heavily on fiscal stimulus and less on monetary stimulus. This makes sense in a world marked by low interest rates, the risk that surplus countries will export liquidity traps to deficit economies, and concerns about contagious secular stagnation. Fiscal expansion tends to lower the surplus of surplus countries and regions, while monetary expansion tends to increase external surpluses.

Brad Setser read through individual IMF country recommendations and found that, in practice, the Fund seems to be having trouble actually advocating fiscal expansion in any major economy with a current account surplus. Best I can tell, the Fund is encouraging fiscal consolidation in China, Japan, and the eurozone. To be fair, the Fund isn’t calling for on-balance sheet fiscal consolidation, and even seems open to breaching the 3 percent of GDP limit for the headline deficit if that is needed to support more aggressive reforms. Directionally, though, the Fund still wants consolidation.

Brad Setser writes that if the Fund wants fiscal expansion in surplus countries to drive external rebalancing and reduce current account surpluses, it actually has to be willing to encourage major countries with large external surpluses to do fiscal expansion. Finding limited fiscal space in Sweden and perhaps Korea won’t do the trick. 20 or 30 basis points of fiscal expansion in small economies won’t move the global needle. Not if China, Japan, and the eurozone all lack fiscal space and all need to consolidate over time.

Alexander Kentikelenis, Thomas Stubbs, and Lawrence King write that while the IMF rhetoric has radically changed its ways to offer financial assistance has not. The authors find little evidence of a fundamental transformation of IMF conditionality for a sample of 131 countries over the years 1985-2014. The organization’s post-2008 programmes reincorporated many of the mandated reforms that the organization claims to no longer advocate. They also find that policies introduced to ameliorate the social consequences of IMF macroeconomic advice have been inadequately incorporated into programme design.

The fiscal tight and easy money policy mix

Duncan Weldon writes that years of tight fiscal policy and monetary loosening have taken us to where we are: negative or at best negligible government yields. Approximately mid 2010 (I’d date it to the Toronto G-20) an incomplete economic recovery in the developed economies has been increasingly reliant on monetary policy to accelerate it with fiscal policy acting as brake (or at best staying neutral). This (and most of this post) applies especially in the Europe and to a lesser extent in the US.

Duncan Weldon writes that we have seen in the past few years is a scarcity of supposedly safe assets as government issuance of decent credit has been less than private demand whilst central banks have bought up much of the stock. This has pushed the price of those assets up and the rate of interest on them down. The death of the rentier was supposed to be a side effect of an economy operating at full employment. Instead, across much of Europe the rentier is being gradually euthanized whilst workers continue to suffer from weak real income growth and high unemployment.

Martin Sandbu writes that fiscal retrenchment across virtually the entire developed world has no doubt meant more monetary stimulus is required than would otherwise be the case to keep existing labor and capital employed. But it is, however, problematic to pin ultra-low interest rates largely on an inappropriate fiscal-monetary policy mix. First, because regardless of the fiscal-monetary mix, the overall demand stimulus is too weak. Second, because the reason historically low interest rates are driven as much by the supply side as by the demand side of the economy. A different fiscal-monetary mix will not address supply-side challenges.

The Political Economy of tight fiscal and easy money

Duncan Weldon doesn’t understand the political economy that has brought us tight fiscal and easy money — it simply isn’t creating enough winners to be sustainable. Aggressive deficit-financed state spending may (unusually) create two sets of winners — the workforce who benefit from faster growth, tighter labor markets and stronger real income growth and the mass of (relatively) small scale rentiers who would benefit from higher rates.

Paul Krugman writes that is is presuming that older voters understand something about macroeconomic policies and what they do. No doubt there are some such people; but we know from polling that the general public is always and everywhere afraid of budget deficits and addicted to the household analogy. There’s also the role of Very Serious People, for whom deficit posturing is a signifier of identity; a posture that works in part because the public always thinks of deficits as a Bad Thing.

Duncan Weldon wonders whatever happened to the deficit bias – the idea that governments have a tendency to allow deficit and public debt levels to increase. Certainly when I learned my macroeconomics, the textbooks believed this was a thing. And it makes obvious sense that the public should prefer to be taxed less or enjoy higher spending than would otherwise be the case. And yet the public no longer seem to agree. Rather than a democratically driven deficit bias we seem to be infected with a democratically driven surplus bias.

Paul Krugman writes that it’s surely relevant that the two big advanced economies — the US and the eurozone — both have fiscal policy paralyzed by political gridlock, leaving the central banks as the only game in town. The problem now is that while advocates of more fiscal push seem to be winning the intellectual battle, the institutional arrangements that produce macro gridlock are likely to persist.

Duncan Weldon writes that there is a real and perplexing possibility that independent central banks have been able to do more to support growth through easing than directly controlled central banks, subject to more political pressure, would have been able to achieve. I say “perplexing” as this almost entirely reverses the academic arguments for independent central banks.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Silvia Merler

President Trump’s budget: the 3% growth quandary

What’s at stake: the Trump administration released its full budget proposal. Economists have been arguing about the feasibility of the underlying growth assumptions, and on whether there is a double-counting implied. We review the most recent contributions to this debate.

By: Silvia Merler Topic: Global Economics & Governance Date: May 29, 2017
Read about event More on this topic

Upcoming Event

Jun
1-2
08:30

Fiscal frameworks in Europe: background and perspectives

On 1-2 June Bruegel together with Danmarks Nationalbank and the Copenhagen Business School will organise a conference about fiscal frameworks in Europe. The conference will re-evaluate fiscal frameworks in Europe in light of experience gathered since the formation of the Economic and Monetary Union (EMU). The implications for the design of fiscal policy stemming from […]

Topic: European Macroeconomics & Governance Location: Danmarks Nationalbank
Read about event More on this topic

Upcoming Event

Jun
14
12:30

Lessons for the future governance of financial assistance in the EU

On 14th June, Randall Henning will present his latest book on the Euro crisis and we will discuss how financial assistance should be governed in the euro area in the future.

Speakers: Servaas Deroose, C. Randall Henning, André Sapir, Rolf Strauch and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Zsolt Darvas

Debt relief or a fourth financial assistance programme for Greece?

The Eurogroup faces a difficult choice on Greece — implementing a debt reduction plan drastic enough to make a return to market borrowing possible, or agreeing to a fourth financial assistance programme and continuing to fund Greece at the preferential lending rate.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: May 22, 2017
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Dial N for NAIRU, or not?

What’s at stake: The concept of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) has recently divided the minds in the economic blogosphere. We review the most important contributions on its usefulness, its shortcomings, alternatives and we discuss why it is such a contested concept.

By: Pia Hüttl Topic: Global Economics & Governance Date: May 22, 2017
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
DSC_0794

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The US and the productivity puzzle

What’s at stake: Productivity growth fell sharply following the global financial crisis and has remained sluggish since, inducing many to talk of a “productivity puzzle”. In the US, we may be seeing what look like early signs of a reversal. We review recent contributions on this theme.

By: Silvia Merler Topic: Global Economics & Governance Date: May 8, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The Trump tax cut

What’s at stake: on Wednesday, the Trump administration - now 100 days old - unveiled a draft tax plan including the intention to enact a radical cut to the corporate income tax, lowering it to 15 percent. While we are still missing details on how this and other measures would be implemented, we review some of the early reactions.

By: Silvia Merler Topic: Global Economics & Governance Date: May 2, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The decline of the labour share of income

What’s at stake: at odds with the conventional wisdom of constant factor shares, the portion of national income accruing to labour has been trending downward in the last three decades. This phenomenon has been linked to globalisation as well as to the change in the technological landscape - particularly “robotisation”. We review the recent literature on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: April 24, 2017
Read article Download PDF More by this author

Working Paper

Cover WP 2017_06

Regional and global financial safety nets: the recent European experience and its implications for regional cooperation in Asia

Comparing and evaluating financial assistance programmes of four euro-area countries (Greece, Ireland, Portugal, and Cyprus) and three non-euro-area countries (Hungary, Latvia, and Romania) of the European Union in the aftermath of the 2007/08 global financial and economic crisis. Asian countries can draw several lessons from European experiences.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance Date: April 20, 2017
Read about event More on this topic

Past Event

Past Event

Global outlook and policy priorities

At this event the Managing Director of the International Monetary Fund, Christine Lagarde, will speak about the global outlook and policy priorities, ahead of the 2017 IMF Spring Meetings

Speakers: Christine Lagarde, Jean-Claude Trichet and Guntram B. Wolff Topic: Global Economics & Governance Location: Brussels Date: April 12, 2017
Read article More on this topic More by this author

Blog Post

Lagarde picture

Building a more resilient and inclusive global economy

Curtain raiser speech ahead of the 2017 IMF Spring Meetings delivered at Bruegel by the Managing Director of the International Monetary Fund.

By: Christine Lagarde Topic: Global Economics & Governance Date: April 12, 2017
Load more posts