Monetary vs. Fiscal Policy: What's at Stake?

      I think it's important to understand that the stakes in this debate are not just academic-if they were it wouldn't be worth the amount of time we spend on this question. No in  a recent post I made what I think of as a significant breakthrough on the question of what area fiscal and monetary policy respectively and how important are each relatively in dealing with a bad downturn.

      As far as this "breakthrough" is concerned, to be sure it is first and foremost very helpful for me at least in better answering this question. However a commentator-Greg, if I understand rightly he is an MMTer-indicates that he finds my breakthrough as being fruitful. In any case it is a new way of thinking about monetary vs. fiscal policy for me and I think it advances the discussion significantly.

      http://diaryofarepublicanhater.blogspot.com/2012/04/regarding-krugman.html

      http://diaryofarepublicanhater.blogspot.com/2012/04/regarding-krugman.html

       This question has been a vexing one in the econo blogs. Lars Christensen in a quite ingenuous argument tried to claim that "there is no fiscal policy" it doesn't exist at all. It's all about monetary poliyc and there are better and worse kinds. 

       While ultimately I believe his argument must be roundly rejected it shows you how skillful the Monetarists are at sophistical arguments against fiscal policy's role.

        Dan Kervick recently argued that an important difference is that monetary policy is executed by unelected bureaucrats, fiscal policy by elected officials. Somone else on Kervkic's blog over at New Economic Perspectives has suggested that the difference between them is one of shape-monetary policy can only impact the size of stimulus not it's "shape." I think that's a good way to look at it, and one commentator and Sumner's Money Illusion suggested that the real argument is political. I agree with that. Partly what you call fiscal or monetary policy is a deeply political question.

      I thik all these are good ways to better understand the difference. My idea that fiscal policy pertains to the real economy and monetary policy is about the financial economy for me really helps better understand why Sumner's gambit to try to say "Whatever you need to do, you should do via monetary policy as it doesn't add to our debt" is profoundly wrong.

      With the recent debate about Krugman-in the above link "Krugman Considered" I suggested that MMT's real complaint with Krugman is theoretical. On the level of policy we all-we on Team Keynes-agree. The argument against Krugman could be that while he opposes the policies we opposes he doesn't have enough going on in his theoretical toolkit to do the heavy lifting needed to defeat these policies. After all don't the New Keynesians accept an awful lot in common with the Monetarists? The accept the NeoClassical paradigm with just few wrinkles.

     For example, even Delong and Eggertsson agree with Sumner that you normally should favor monetary policy in most downturns, this is only special because of the "liquidity trap."

     A post Sumner published yesterday shows what's at stake. The name of it was "Fiscal policy worth getting excited about."

      http://www.themoneyillusion.com/?p=13925

      "Over the past three years I’ve become very depressed seeing economists trying to substitute demand-side fiscal stimulus for monetary stabilization policy. The central bank must do something, so why not set policy at a level expected to produce on-target demand growth? Even supporters of fiscal stimulus must be frustrated by how illogical it is to ask Congress to make up for the lack if stabilization finesse at the Fed. Surely there’s a better way. Now Alberto Alesina and Francesco Giavazzi point the way forward

    
     "Economists have engaged in some lively debates about how to measure and evaluate the effects of large fiscal adjustments episodes in OECD countries (Europe in particular). But a careful and fair reading of the evidence makes clear a few relatively uncontroversial points, despite the differences in approaches. The accumulated evidence from over 40 years of fiscal adjustments across the OECD speaks loud and clear:

• First, adjustments achieved through spending cuts are less recessionary than those achieved through tax increases.
• Second, spending-based consolidations accompanied by the right polices tend to be less recessionary or even have a positive impact on growth.

     "These accompanying policies include easy money policy, liberalisation of goods and labour markets, and other structural reforms"

      Yes just what we want-more structural reforms. Sumner  declares:

       "That’s right, use monetary policy to boost NGDP and supply-side fiscal reforms to produce a better P/Y split. A&G continue:

     "Tax-based stabilisations not only eventually fail, in the sense that they are unable to stop the growth of the debt-to-GDP ratio. When these fiscal packages are announced entrepreneurs’ confidence falls sharply, and this is reflected in a fall in output. On the other hand, spending-based stabilisations (especially if accompanied by appropriate contemporaneous polices) do not negatively affect economic confidence contemporaneously. Moreover they are often accompanied by an increase in output within a year."

     "It stands to reasons that European countries where tax revenues are close to 50% of GDP do not have the room to increase revenues even more."

     "A paper by Harald Uhlig and Mathias Trabandt (2012) nicely shows how close many European countries are to the top of realistically measured Laffer curves. Thus any additional tax hikes would lead to relative low increases in tax revenues and could be very recessionary, through the usual supply- and demand-side channels."


. . .
      "One should go even further in disentangling the effects of composition."

• Which spending cuts are more likely to be effective?
• Which kind of tax reforms could achieve the same amount of tax revenue with fewer distortions?
• From where should market liberalisations start, and how fast should they proceed?

     "Some answers may be the same for all countries, others may differ."

• For instance, in general moving taxation towards the VAT and away from income taxes is preferable.
• In some countries there is no way out without a substantial raise in retirement age and cuts in government employment.

     "Incidentally this provides a clear link with labour-market reforms. Public-sector employment can only be reduced after firing constraints are moved and appropriate safety nets are put in place. Similarly the emphasis on the need and productivity of physical infrastructures is often misleading, at least in many countries."
. . .
     "We are in for a big disappointment on the centrepiece of Eurozone austerity – the fiscal compact. The fiscal compact bears the seeds of its failure:

• The new fiscal compact that Europe has decided to impose upon itself through a treaty change makes no mention of the composition of fiscal packages.
• European economies will remain stagnant – if not further fall into recession – if adjustments will be made mostly on the tax side and debt ratios will not come down.

     "And in the end, as was the case with the Growth and Stability Pact, the rules will be abandoned."

       If you don't like the sound of this kind of fiscal policy that pleases Sumner  and Alesina then you see why it is necessary to understand the difference between fiscal and monetary policy. For this is Sumner's endgame as Morgan Warstler always urges. NGDP targeting or in any case the monetary authorities alone deal with stimulus or stabilization policy and for the fiscal side? Supply side trickle down economics and structural reforms-ie, hyper austerity.

       What Morgan disagrees with is Sumner should position himself as a far right conservative Republican and explain to the Right what his real agenda is. I think Morgan is quite wrong. Sumner has become such a phenomenon with such a large following preciously because his style doesn't alienate liberals or even those more in the political mainstream. Many of the liberals who read him probably think they are even on the same side as Sumner seems to be so critical of austerity. As we saw above, nothing if further from the truth. He is all about austerity.

      That this must be case is only clear when you understand that monetary policy is about the financial sector and stabilizing the banks while fiscal policy is about the real economy. You can't demand just monetary stimulus-or even just fiscal stimulus-as the two are completely different types of medicine. Again, what led me to realize this is Minsky's analysis of how the US avoided a depressions in 1975-Minsky believes a worldwide depression would have happened without the US government's intervention both on the fiscal and monetary side.

     One more note about Sumner. I pick on him a lot as his name is most synonymous with the school "Market Monetarism" and he gets a very large readership at his Money Illusion. There is more than one reason his blog is so popular.

    Part of it is that he is a very good host. He answers all questions-even when as sometimes happens he has over 100 comments. In many ways his site is a very pleasant location to visit. There is minimal of the deeply visceral polemics and snark at most of the political blogs whether Right or Left wing. There is a sense that his blog is more about finding light then raising heat.

    Compare that to Krugman or Delong for example. Krugman has never given me the time of day as he doesn't answer his comments. There has been question as to whether or not Delong censors comments sometimes-I have no idea, but I do know that I've tried more than once to leave a comment and even when I think I have, I later discover it wasn't published.

     If anything Krugman plays a very poor political game. He may well think that a real marcoeconoist shouldn't engage in such things but this is naive. He is simply unaware of the political realm.

     If Sumner didn't target a more mainstream audience than he's have if he positioned himself as being just another Limbaugh or Breitbart et. al he wouldn't have such a large platform. When you look at his proposals here they are everything that a liberal hates. When he quotes Alesian approvingly about how tax cuts are a much worse drag on growth than spending cuts and that if you must have taxes better make them "value-added" this is tax regressvitiy on steroids. What's clear is that Herman Cain's 9-9-9 plan would totally fit the bill of the kind of fiscal policy that would excite Sumner-Alesina.

    After all Cain did raise taxes but on the nonrich alone-by coming up with a very high national sales tax-to go along with what consumers already pay at the state level it imposes a 30% sales tax.

    Normally in the political sphere Sumner would be quite unpopular for his policy preferences which are fully in line with Walker or Ryan Michigan's Rick Snyder who has being having a field day imposing the emergency manager law across the state.

     If Team Keynes is to win it has to answer a major challenge like Sumner's pure theory.