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

Brexit: Now for something completely different?

The life of Brexit. After a week of ECJ rulings, delayed votes, Theresa May’s errands across Europe and the vote of no confidence, we review the latest economists’ opinions to try to make sense of what has changed and what hasn’t.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: December 17, 2018
Read article More by this author

Blog Post

Economic policy challenges in Southern and Eastern Mediterranean

For a long time, southern and eastern Mediterranean countries struggled with serious socio-economic challenges and dysfunctional economic systems and policies. Marek Dabrowski reviews the challenges the region has to face to get out of a low growth trap.

By: Marek Dabrowski Topic: Global Economics & Governance Date: December 11, 2018
Read article More by this author

Blog Post

Les gilets jaunes

For weeks, protesters wearing yellow motorist vests have taken to the streets of Paris to protest against the rising price of fuel. They have since taken on a wider role, and are seen as symbols of the growing popular discontent with President Macron. Silvia Merler reviews scholars’ opinions about this movement.

By: Silvia Merler Topic: Energy & Climate, European Macroeconomics & Governance Date: December 10, 2018
Read article More by this author

Blog Post

Green central banking

A few weeks ago, Silvia Merler discussed the rise of “ethical investing”. A related question emerging from the discussion is whether central banks should also “go green”. Silvia reviews the latest developments and opinions on this topic.

By: Silvia Merler Topic: Energy & Climate, Finance & Financial Regulation Date: December 3, 2018
Read article More on this topic More by this author

Blog Post

Machine learning and economics

Machine learning (ML), together with artificial intelligence (AI), is a hot topic. Economists have been looking into machine learning applications not only to obtain better prediction, but also for policy targeting. We review some of the contributions.

By: Silvia Merler Topic: Innovation & Competition Policy Date: November 29, 2018
Read about event More on this topic

Past Event

Past Event

Reviewing the EU fiscal framework

What are the positive and negative developments and is there scope for improvement?

Speakers: Niels Thygesen and Anne-Laure Delatte Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 22, 2018
Read article More on this topic More by this author

Blog Post

The Brexit withdrawal agreement

On November 14th the UK government cabinet approved the draft text of the withdrawal agreement, the deal reached between EU and UK negotiators. The decision was followed the next day by the resignations of several members of Parliament. We review the first reactions in the blogosphere.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: November 19, 2018
Read article More on this topic More by this author

Blog Post

US mid-term elections and the global economy

Democrats won control of the House and Republicans held onto the Senate in the most consequential US mid-term elections in decades. Bowen Call reviews economists’ and scholars’ analyses of the impact this might have on the world economy.

By: Bowen Call Topic: Global Economics & Governance Date: November 12, 2018
Read article More on this topic More by this author

Blog Post

Jair Bolsonaro’s Brazil

Far-right candidate Jair Bolsonaro won the Brazilian presidential elections after a highly polarising campaign. We review economists’ and scholars’ views of what this means for Brazil going forward.

By: Silvia Merler Topic: Global Economics & Governance Date: November 5, 2018
Read article More on this topic More by this author

Opinion

Plädoyer gegen eine Politik der Scheinlösungen

Der Daueraufschwung verdeckt, dass Deutschland für die nächste Krise schlecht gerüstet ist. Und das Zeitfenster für Reformen schließt sich.

By: Jochen Andritzky Topic: European Macroeconomics & Governance Date: October 31, 2018
Read article More on this topic More by this author

Blog Post

The rise of 'ethical' investing

We are used to think about the value of investment as measured by financial return. But investing with an eye to environmental or social issues and, more generally, ethical considerations, has become more prominent. We review contributions to this debate.

By: Silvia Merler Topic: Finance & Financial Regulation Date: October 29, 2018
Read article Download PDF More on this topic

Policy Contribution

European fiscal rules require a major overhaul

In this Policy Contribution prepared for the French Conseil d’Analyse Économique, the authors assess current European fiscal rules and propose a major simplification. They recommend substituting the numerous rules with a new simple one, which would help reconcile fiscal prudence and macroeconomic stabilisation of the economy.

By: Zsolt Darvas, Philippe Martin and Xavier Ragot Topic: European Macroeconomics & Governance Date: October 24, 2018
Load more posts