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.
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.
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