Monetarist vs Fiscalist

Giles Wilkes (ex special advisor to Vince Cable, Business Secretary in the current UK government and LibDem) has a post that compares those he calls ‘fiscalists’ like myself and Jonathan Portes to market monetarists (MM). His post follows some comments and a post by Mark Sadowski responding to an earlier post of mine where Mark took exception to my saying “the major factor behind the second Eurozone recession is not[controversial] : contractionary fiscal policy”. You find much the same debate in this post by Scott Sumner, attacking (mainly) Paul Krugman.

I think Giles Wilkes gets a lot of things right, but I thought it might be useful to set out as clearly as I can how I see the nature of the disagreement. The first, and probably the most important, thing to say is that the disagreement is not about whether fiscal contraction is contractionary, if the monetary authority does nothing. (See, for example, Lars Christensen here.)That is actually what I meant with my statement about the Eurozone recession, which linked to a study that calculated the impact of austerity holding monetary policy ‘constant’. This is so important because, in their enthusiasm to denounce countercyclical fiscal policy, MM often give the impression of thinking otherwise.

The disagreement is over what monetary policy is capable of doing. The second thing to say is that this is all about the particular circumstances of the Zero Lower Bound (ZLB). I do not like the label fiscalist for this reason - it implies a belief that fiscal policy is always better than monetary policy as a means of stabilising the economy. (Giles Wilkes is not the first to use this term - see for example Cardiff Garcia, who includes more protagonists.) Now there may be some economists who think this, but I certainly do not, and nor I believe does Paul Krugman or Jonathan Portes. I described in this article what I called the consensus assignment: that monetary policy should look after stabilising aggregate demand and fiscal policy should be all about debt stabilisation, and there I described recent research (e.g.) which I think strongly supports this assignment. However there has always been a key caveat to that assignment - it does not apply at the ZLB.

Before talking about that, let me illustrate why language can confuse matters. Suppose we had fiscal austerity well away from the ZLB. Suppose further that for some reason the monetary authority did not take measures to offset the impact this had on aggregate demand, and there was a recession as a result. I suspect a MM would tend to say that this recession was caused by monetary policy, even though monetary policy had not ‘done anything’. (In this they follow in the tradition of that great monetarist, Milton Friedman, who liked to say that monetary policy caused the Great Depression.) The reason they would say that is not because fiscal policy has no effect, but because it is the duty of monetary policy to offset shocks like fiscal austerity. That is why fiscal policy multipliers should always be zero, because monetary policy should make them so. So Mark Sadowski got upset with my statement because in his view ECB policy failed to counteract the impact of Eurozone austerity, and could have done so, which meant the  recession in 2012/3 was down to monetary policy, not fiscal policy.

So we come to the heart of the disagreement - the ability of monetary policy to offset fiscal actions at the ZLB. This is all about the effectiveness of unconventional monetary policy (UMP), which is both Quantitative Easing and what I call forward commitment (promising positive output gaps in the future: see David Beckworth here). I do not want to go over these arguments again, partly because I have already written about them elsewhere (e.g. here, here and here). Instead I just want to make an observation about asymmetry.

Economists like Paul Krugman, Jonathan Portes and myself (and there are many others) do not argue against using UMP. Indeed PK pioneered the idea of forward commitment for Japan, and I have been as critical as anyone about ECB policy. We do not argue that fiscal policy will be so effective as to make unconventional monetary policy unnecessary, and so write countless posts criticising those promoting UCM. To take a specific example, I happen to think that the recent ECB moves will have less impact on the Eurozone than continuing fiscal austerity, but I do not say the ECB is wasting its time as a result. They should do more.   

I’m interested in this asymmetry, and where it comes from. Why do MM hate fiscal expansion at the ZLB so much? It could be ideological (see Noah Smith here), but I suspect something else matters. I think it has something to do with monetarism, by which I mean a belief that money is at the heart of issues to do with stabilisation and inflation. MM is not about controlling the money supply as monetarism originally was, but I think many other aspects of monetarism survive. My own view is more Wicksellian(or perhaps Woodfordian), whence the failure to be able to lower interest rates below zero naturally appears central. To those not trained as macroeconomists (and perhaps some that are) these sentences will appear mysterious, so if this idea survives comments I may come back to it later.