I met Nick
Macpherson, the most senior
civil servant at the UK Treasury from 2005-16, for the first time (I
think) a few weeks ago. It was at a conference about, among other
things, getting economic ideas across to the public. He is also on
twitter, and I saw the following exchange between him and Tony Yates.
To be fair to Nick,
I get many people saying the same thing: we are at full employment,
so we should not be running deficits. Let’s not on this occasion
discuss how we can be at full employment when nominal wage growth is
so weak, or into the distinction between current and total deficits.
The main point that Tony makes above is that you cannot discuss what an appropriate fiscal
policy setting should be without thinking about monetary policy.
There was one
reason, and one reason alone, that we had fiscal stimulus in 2009. It
was because nominal interest rates had hit their lower bound. A
recession in itself is not a sufficient condition for a fiscal
stimulus if monetary policy can do all the work of getting us out of
the recession. [1] But when interest rates are stuck at their lower
bound, monetary policy has lost its ability to regulate the economy,
which means we are either stuck in a recession or are vulnerable to
any negative demand shock. Unconventional monetary policy, although
better than nothing, is far, far less reliable than conventional
monetary or fiscal policy.
It is therefore a
prime duty of government to ensure that, if interest rates have
hit their lower bound, fiscal policy is solely directed at allowing
monetary policy to raise rates. This idea is not new. It was always
implicit in New Keynesian theory and what I call
the Consensus Assignment. Paul Krugman, Brad DeLong and others have
been going on about it at least since the financial crisis. The idea
should be part of any fiscal rule, as Jonathan Portes and I suggest
here,
and this is still part of Labour’s fiscal credibility
rule.
In the UK, at this
very moment, we are once again at the lower bound for interest rates.
That means fiscal policy is currently too tight. Whether we are at
full employment is neither here nor there. Interest rates are at
their lower bound because the negative influences on aggregate demand
are more than monetary policy can handle. One of those negative
influences is fiscal consolidation. That fiscal consolidation should wait [2] until
interest rates are safely clear of their lower bound.
This is not one
particular theory of monetary and fiscal policy interaction. It is
the consensus theory. That it is not understood by the public is
understandable given mediamacro. But not being understood by senior
civil servants (and I doubt Nick is alone here) when they are free to
speak their minds is much more surprising.
[1] I’m using
consensus theory here, and abstracting from uncertainty.
[2] It can wait
because there is no problem in financing the deficit, and because we
print our own currency there has never been any such problem.
