This is a comment on Cardiff Garcia’s post on fiscalists and market monetarists, and
also some related criticism of Bernanke’s recent remarks on
fiscal policy, criticism which I think is totally wrong. I want to argue that a
‘monetarist’ position which is indifferent to what fiscal policy is doing in
current circumstances is untenable. As a result, central bankers have to speak
out on the dangers of austerity. [1]
There are two lines that monetarists might take. The first is
that unconventional monetary policy, Quantitative Easing (QE), is a perfect
substitute for conventional monetary policy. The second is that an appropriate
monetary policy regime can, through expectations, undo the restriction imposed
by the zero lower bound (ZLB). Let me take each in turn.
The first argument is wrong mainly because of uncertainty.
Macroeconomists know little enough, but we do know something about how
conventional monetary and fiscal policy works, and we have a lot of data that
can help us. We know so much less about unconventional monetary policy. What
kind of model we should use is unclear, and we have very little data.
The second argument would be right if we could fix inflation
expectations in exactly the same way as we could, absent the ZLB, fix nominal
interest rates. Would a nominal GDP target do that? Of course not. I think it
would help, particularly compared to an inflation target regime, because the
latter actually inhibits inflation expectations rising above that target. That
is why I have recently argued that a path for nominal GDP should be
adopted by central banks as an intermediate target. Would adopting such a target raise inflation
expectations and speed a recovery? - I think it would. Would it raise inflation
expectations by enough to negate the need for any fiscal stimulus (or, more
realistically, to counteract the impact of fiscal tightening)? There is no
logical reason why it should. But let us just suppose it did. Does that mean we
can ignore fiscal policy?
Absolutely not. What we are getting in this case is a recovery
achieved by raising expected inflation above (in the UK, US and Eurozone) 2%.
That is costly, because it means actual inflation must be allowed to go above
2%. The more we deflate demand through fiscal austerity, the higher inflation
has to go (or the longer it has to be above 2%). So monetarists who believe in
the expectations channel cannot be indifferent to fiscal policy, unless they
also believe it has no effect, or that inflation above 2% is costless. (I make
a similar point a little more carefully here.) If, as Paul Krugman says, fiscal policy makers are doing the wrong thing, that is a cost worth paying, but it is a cost nonetheless.
This is why it is really important that central banks, like the
Fed, make it publicly clear the difficulties that fiscal tightening is causing
them in meeting their mandate. Either this is because they are, quite rightly,
uncertain about the impact of QE, or they are aware that the more fiscal
tightening there is, the more inflation will have to go above 2% to counteract
its impact.
The idea that to speak this truth is wrong because it might
frighten the horses is silly. I have used the following analogy before. No one wants to hear a pilot tell
passengers that they are no longer in control of the plane. However a better
analogy in this case would be the pilot not telling the co-pilot, which would be highly
dangerous. The horses that matter here are those in charge of fiscal policy,
and they need frightening.
[1] Sorry Nick. I have a lot of sympathy for the point
that we should not routinely exaggerate with language. The (I think just
British) phrase I hate is ‘black hole’ when used to describe a
worsening in the government’s accounts. The use of austerity to describe what
is happening in parts of Europe and the UK right now is less obviously loaded
or misleading, but I’m open to persuasion.
