Tag Archives: Fiscal policy

“Geldpolitik soll eigenständig bleiben (Monetary Policy Independence),” FuW, 2016

Finanz und Wirtschaft, July 20, 2016. PDF. Ökonomenstimme, July 29, 2016. HTML.

In a perfect world, monetary and fiscal policy are coordinated. In the real world with its political frictions they are not. So much on helicopter money.

Fiscal-Monetary Policy Interaction

In the Richmond Fed’s Econ Focus, Eric Leeper explains his views.

  • Disparate confounding dynamics and simple policy rules:

    My view is that central banks have put far too many resources into understanding tiny fluctuations and too few resources into the things that actually matter. …

    Something like the basic Taylor rule doesn’t really serve as a useful litmus test for what policy is doing in the face of these DCDs, so it’s a little bizarre to me that a lot of central banks routinely calculate what the path of the interest rate would be with a simple Taylor rule as if that’s a useful benchmark. It’s not obvious to me what that’s a benchmark for.

  • Active/passive policy regimes, the fiscal theory of the price level and whether current or previous policy mixes are or were characterized by active fiscal policy:

    Now, how all of [current policy] ties into the active/passive framework is really an open question. A lot of it depends on what you think is going to happen to the Fed’s balance sheet.

    … the recovery from the Great Depression in 1933 when Roosevelt took the United States off the gold standard. Going off the gold standard converted government debt from effectively real debt to nominal debt because the price level under the gold standard was beyond the control of the government. At the same time, the fiscal actions Roosevelt undertook were what nowadays we would call an unbacked fiscal expansion. … This is like a fiscal rule that says the government will run deficits until the price level recovers to some pre-depression level. And the Fed was just keeping the interest rate flat. So it looked a lot like passive monetary/ active fiscal.

  • Walls between monetary and fiscal policy:

    The thing is, there’s not a lot of theoretical justification for creating these walls. What we’re finding more and more is that there’s always some role in optimal policy for using surprise inflation to revalue debt and bond prices, so long as there is some maturity to government debt. … maybe it is a slippery slope once you’re in the political realm. But from an academic perspective, if your objective is to arrive at a rule that would be mechanically followed by a central bank, then there’s no harm in having fiscal variables enter that rule.

Views on the Fiscal Theory of the Price Level

A conference at the University of Chicago’s Becker Friedman Institute addressed the status of the Fiscal Theory of the Price Level and the theory’s implications for current policy. Slides and papers are available on the conference website. Given that the conference was meant to resuscitate research on the FTPL and that the participants were selected accordingly, many contributions appear rather mainstream.

Chris Sims worries about indeterminacy of the price level if monetary policy is constrained by the ZLB and fiscal policy is passive.

Stephen Williamson argues that it is possible, in a simple model, to separate central bank determination of inflation and the price level from fiscal policy. As he writes on his blog:

The key thing here is that the central bank determines prices and inflation without any fiscal support. If the idea you got from the FTPL is that fiscal policy is necessary to determine the price level and inflation, that’s not correct. …

So, the conclusions are:

  1. FTPL forces us to think seriously about fiscal/monetary interaction, and that’s very important. But fiscal support is not necessary for monetary policy to work, nor is it useful to think of fiscal policy determining inflation on its own – the central bank can indeed be independent.
  2. Fiscal/monetary interaction becomes really important when we start thinking about the liquidity properties of government debt.
  3. Helicopter drops? Forget it. This is not some cure-all for a low-inflation problem.
  4. QE can be harmful, as it soaks up useful collateral and replaces it with inferior assets.
  5. Neo-Fisherian denial is not good for you. Central banks that want to increase inflation need to increase nominal interest rates.

John Cochrane argues that to get the cyclical properties of inflation “right” one should focus on the discount factor in the core FTPL equation, not the primary government surplus. The discount factor might also be affected by monetary policy. See also his blog post.

Harald Uhlig remains very skeptical and points to the lack of evidence favoring the FTPL. On his first slide, he asks:

  1. What does FTPL want to be?
    – A theory that can be consistent with the data? OK
    – An equation needed to complete a system? OK
    – A theoretical or extreme possibility? OK
    – A set of predictions, which occasionally work in exotic circumstances (“Brazil”)? PERHAPS
    – A set of predictions, which help often (“Taylor coeff < 1”)? ?
    – A useful framework for practitioners? ?
    – The miracle cure for the failures of other inflation theories? ?
    – A framework for the key interplay of fiscal and monetary policy? ?
  2. Where is the “smoking gun”? What set of facts “scream” FTPL? Specific predictions?
  3. Why is sovereign default off the table? Sure, a central bank can accommodate by inflating away debt … is that all?
  4. The US, Japan, the Eurozone have a near-deflation problem (is it?). Do you advocate “irresponsible” fiscal policies to solve this?
  5. What advice would you give the sunspot-branch of macro?

Helicopter Drops of Money

In his blog, Ben Bernanke discusses the merits of “helicopter drops” as a monetary policy tool.

[A] “helicopter drop” of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.

… the Fed credits the Treasury … in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.

… it should influence the economy through a number of channels, making it extremely likely to be effective—even if existing government debt is already high and/or interest rates are zero or negative. … the channels would include:

  1. the direct effects of the public works spending on GDP, jobs, and income;
  2. the increase in household income from the rebate, which should induce greater consumer spending;
  3. a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and
  4. the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens.

[Debt financed spending programs lack channels 3 and 4.]

[Helicopter drops are subject to various] practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank.

Government Debt Management

In his FT blog, Larry Summers argues for a “quite radical” change in government debt-management. He proposes several lessons:

  • “Debt management is too important to leave to Federal debt managers and certainly to leave to the dealer community. … when interest rates are near zero, it has direct implications for monetary and fiscal policy and economic performance … and … financial stability.”
  • “… it is fairly crazy for the Fed and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years, with the Fed seeking to shorten outstanding maturities and the Treasury seeking to term them out.”
  • “Standard discussions of quantitative easing … are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact on financial markets.”
  • In the US, “the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values it was because of signalling effects … not because of the direct effect of Fed purchases.”
  • “The standard mantra that federal debt-management policies should seek to minimise government borrowing costs is … wrong and incomplete. … it is risk-adjusted expected costs that should be considered. … it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.”
  • “The tax-smoothing aspect, which is central to academic theories of debt policy, is of trivial significance.”
  • Rather than providing opportunities for carry trade, “[t]reasury should reverse the trend towards terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short-term instruments without encouraging risky structures such as banks engaged in maturity transformation.”
  • “Institutional mechanisms should be found to insure that in the future the Fed and Treasury are not pushing debt durations in opposite directions.”

Lack of Trust in the European Commission

In the FT, Henry Foy reports about critical comments by Jeroen Dijsselbloem. The chair of the Eurogroup has argued that the Euro area needs an independent fiscal oversight body to disperse fears of “politicised” European Commission decisions when it comes to evaluating national budgets.

Naturally, lack of trust in the Commission is widespread. But now it seems to have reached the higher echelons of EU institutions themselves.

In the meantime, Tony Barber writes (also in the FT) that “The eurozone’s fiscally lax nations are at it again”.

Effects of Fiscal Tightening on Growth

In a Peterson Institute policy brief, Paolo Mauro and Jan Zilinsky argue that

the evidence is mixed: Those who hold a prior that fiscal adjustment is harmful for growth may find their beliefs confirmed, whereas those who believe a prior that the link is weak may find the evidence unconvincing (even aside from valid concerns about causality). To the extent that the case of Greece involves unique features beyond large fiscal adjustment, the data reveal that drawing conclusions from empirical associations that include this specific case requires caution.

Debt Supercycle rather than Secular Stagnation

In a Vox column, Ken Rogoff argues that the world economy experiences a “debt supercycle” rather than the onset of secular stagnation in the West.

Rogoff argues that macroeconomic developments since the financial crisis are in line with historical experience, as documented in his book “This Time is Different” (with Carmen Reinhart): A large fall in output followed by a sluggish recovery; deleveraging; protracted higher unemployment; and a strong rise of the government debt quota are typical after a boom and bust of house prices and credit.

According to Rogoff, policy makers should have implemented more heterodox policies including debt write-downs; bank restructurings coupled with recapitalisations; and temporarily higher inflation targets. Rogoff supports the (in his view, orthodox) fiscal policy responses that were adopted but criticizes that many countries tightened prematurely.

Rogoff acknowledges that secular forces shape the macroeconomy, in particular population ageing; the stabilization of the female labor force participation rate; the growth slowdown in Asia; and the slowdown or acceleration (?) of technological progress. But

[t]he debt supercycle model matches up with a couple of hundred years of experience of similar financial crises. The secular stagnation view does not capture the heart attack the global economy experienced; slow-moving demographics do not explain sharp housing price bubbles and collapses.

Rogoff doesn’t accept low interest rates as an argument in favor of the secular stagnation view. Rather than reflecting demand deficiencies, low interest rates (if measured correctly—Rogoff expects a utility based interest rate measure to be higher) could reflect regulation (favoring low-risk borrowers and “knocking out other potential borrowers who might have competed up rates”) and to some extent central bank policies.

Rogoff argues that the global stock market boom poses a problem for the secular stagnation view. He proposes changed perceptions about the likelihood and cost of extreme events (Barro, Weitzman) as factors to explain both low real interest rates and the stock market boom (after an initial asset price collapse during the crisis).

Regarding policy prescriptions to expand public investment in light of the low interest rates, Rogoff notes that

it is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. [Moreover] one has to worry whether higher government debt will perpetuate the political economy of policies that are helping the government finance debt, but making it more difficult for small businesses and the middle class to obtain credit.

Rogoff considers rising inequality to be problematic (and a possible factor for higher savings rates):

Tax policy should be used to address these secular trends, perhaps starting with higher taxes on urban land, which seems to lie at the root of inequality in wealth trends

He concludes that the case for a debt supercycle is stronger than for secular stagnation:

[T]he US appears to be near the tail end of its leverage cycle, Europe is still deleveraging, while China may be nearing the downside of a leverage cycle.

“The Fiscal Myth of the Price Level,” QJE, 2004

Quarterly Journal of Economics 119(1), February 2004. PDF.

I examine the “fiscal theory of the price level” according to which “non-Ricardian” policy and predetermined nominal government debt fiscally determine prices. I argue that the non-Ricardian policy assumption and, by implication, fiscal price level determination are inconsistent with an equilibrium in which all asset holdings reflect optimal household choices. In such an equilibrium, policy must be Ricardian even if, in some states of nature, the government defaults or commits to an arbitrary real primary surplus sequence. I propose an alternative to the fiscal theory of the price level, based on nominal flows instead of nominal stocks. While this alternative framework establishes a consistent link between fiscal policy and the price level, it does not introduce inflationary fiscal effects beyond those suggested by Sargent and Wallace.