The cool kids in economics are getting excited about what I call fiscatary policy. After decades of assuming that fiscal and monetary policy could not effectively complement each other — they were frenemies at best and counterproductive at worst — there is an evolving view that they can be most effective when they work together.
A few definitions: Fiscal policy is taxing and spending by governments. In this context, think of extending unemployment insurance in a recession, for example, or borrowing to fund a one-time infrastructure program. Monetary policy is the actions of central banks, like our Federal Reserve, whose main tool is the interest rate they control.
The context for this discussion of their intersection — fiscatary policy — is how these two policies should be thought of not just in recessions, but in weak or incomplete recoveries. (I’d characterize our current recovery as the latter. Yes, GDP growth has slowed, but not as much as in other advanced economies, and our job market has been robust. Still, we’re not at full employment, and many households haven’t yet been adequately lifted by the current expansion.)
The idea for fiscatary policy dates back to John Maynard Keynes, who presciently worried about times when monetary policy — lowering interest rates to make credit cheaper — would be as effective as “pushing on a string.” But I started thinking about it back in the Great Recession, when both the Fed and the Obama administration (of which I was a member) were working together to push back on gale force economic headwinds.
The one-two punch of monetary and fiscal policy was highly effective in reversing the slide in GDP growth and slowing the loss of job growth, but while the Fed kept up the pressure, the fiscal side dropped the ball. What struck me back then was the fact that Ben Bernanke, the chair of the Fed, kept going up to Congress begging them to complement the Fed’s interest rate policies with more fiscal stimulus. Bernanke’s call for fiscatary policy seemed absolutely correct to me but inconsistent with conventional economic thinking, which maintained that fiscal policy was too slow, too ineffective, and too dependent on raising the deficit to help much (economist Jason Furman explains this conventional view at the beginning as this recent paper).
The insights of that period led to Chapter 4 in my book, “The Reconnection Agenda,” which argued that at times like now, the combination of fiscatary policy will be much more effective than either monetary or fiscal policy alone. The argument begins with U.S.-Europe comparisons, a bit of a natural experiment as we, at least initially, liberally [sic] applied fiscatary policy, whereas they pivoted to fiscal austerity much sooner. To this day, the results can be seen as our unemployment rate, at 5 percent, is about half of theirs. Yet we, too, pivoted too soon away from fiscal stimulus, and in 2013, for example, the pivot cost us between 1 and 2 percentage points of GDP and over a million jobs.
Why, then, does fiscatary policy work, at least under certain conditions? (And what are those conditions?) As I put it in the book, “the Fed can set the table, but it takes fiscal policy — a temporary boost in stimulative government spending — to get people in the restaurant.” No question, the cost of credit (the interest rate) is a critical price in our economy, but credit has been very cheap for very long, and yet most advanced economies continue to slog along.
The missing ingredient is “demand,” that very simple dynamic of consumers/investors having spending money in their pockets and enough confidence in the future to take advantage of low rates and make longer-term investments. That’s essentially what Bernanke was saying back then, with a crucial added twist (paraphrasing): “be assured, Congress, that if you do ramp up spending to help close the remaining output gap, we at the Fed will not offset the demand you’ll induce by hitting the interest rate brakes.”
The Furman paper, referenced above, runs deep with all these ideas. The new view, Furman argues, is that rather than fiscal policy being a wasteful laggard, when it is accommodated by monetary policy, private investment can be crowded in, not out, as the old view asserted. Moreover, even amid debt and deficit concerns, with borrowing rates low and the Fed along for the ride, stimulus may cost less than “headline estimates would suggest” because by boosting growth, the debt/GDP ratio may well be unaffected or even diminished.
If that sounds far-fetched, then consider these new findings from The International Monetary Fund, not exactly a bastion of revolutionary thought. IMF researchers recently asked what impact an ongoing investment of 1 percent of GDP would have under conditions like today’s: underutilized resources, low rates, and a generally accommodating Fed. Their conclusion is that a “… productivity-enhancing case for a permanent increase in government investment is strong.” The investment’s got to go to places that need it — bridges to nowhere won’t cut it. But in their simulations, public investment pulls in private investment, boosts consumer spending and GDP growth, and in so doing, raises tax revenue such that the debt ratio ends up about a point of GDP lower than it would otherwise be (see their Figure 3; caveat: an ongoing 1 percent of GDP government investment would be highly unusual for us, but the finding still points the way forward).
Is there any hope for the application of fiscatary policy — the one-two punch of fiscal and monetary policy working together to achieve full employment — in our current economy?
I think so. As I argued the other day on this page, Hillary Clinton has made a first-100-day commitment to infrastructure investment that fits right into this framework. The challenge is that two institutions need to go along, the first of which — the Congress — is … um … problematic.
The second is the Fed, which is thinking about slightly raising rates to slow growth, with the intention of heading off future inflation. I really don’t see that in the data, but even if I’m wrong, the fact that they’ve undershot their inflation target for about four years running implies that overshooting it would be warranted.
That said, a tiny uptick in rates followed by a data-driven pause would not be inconsistent with the needed fiscatary policy agenda, and I’m quite confident that the thinking of Fed chair Janet L. Yellen is consistent with much of the above (see her comments here, for example, about the potential benefits of running a “high-pressure” economy).
Fiscal and monetary policy, working together, is precisely what’s needed to ensure that the benefits of this expansion finally reach those who’ve yet to see them.