Blog Post

The fiscal stance puzzle

What’s at stake: In a low r-star environment, fiscal policy should be accommodative at the global level. Instead, even in countries with current account surplus and fiscal space the IMF appears to have trouble advocating fiscal expansion. This also raises a political economy puzzle regarding the persistence of the current policy mix of tight fiscal and easy money.

By: and Date: August 29, 2016 Topic: Global economy and trade

The IMF in theory and practice

Brad Setser writes that in theory, the IMF now wants current account surplus countries to rely more heavily on fiscal stimulus and less on monetary stimulus. This makes sense in a world marked by low interest rates, the risk that surplus countries will export liquidity traps to deficit economies, and concerns about contagious secular stagnation. Fiscal expansion tends to lower the surplus of surplus countries and regions, while monetary expansion tends to increase external surpluses.

Brad Setser read through individual IMF country recommendations and found that, in practice, the Fund seems to be having trouble actually advocating fiscal expansion in any major economy with a current account surplus. Best I can tell, the Fund is encouraging fiscal consolidation in China, Japan, and the eurozone. To be fair, the Fund isn’t calling for on-balance sheet fiscal consolidation, and even seems open to breaching the 3 percent of GDP limit for the headline deficit if that is needed to support more aggressive reforms. Directionally, though, the Fund still wants consolidation.

Brad Setser writes that if the Fund wants fiscal expansion in surplus countries to drive external rebalancing and reduce current account surpluses, it actually has to be willing to encourage major countries with large external surpluses to do fiscal expansion. Finding limited fiscal space in Sweden and perhaps Korea won’t do the trick. 20 or 30 basis points of fiscal expansion in small economies won’t move the global needle. Not if China, Japan, and the eurozone all lack fiscal space and all need to consolidate over time.

Alexander Kentikelenis, Thomas Stubbs, and Lawrence King write that while the IMF rhetoric has radically changed its ways to offer financial assistance has not. The authors find little evidence of a fundamental transformation of IMF conditionality for a sample of 131 countries over the years 1985-2014. The organization’s post-2008 programmes reincorporated many of the mandated reforms that the organization claims to no longer advocate. They also find that policies introduced to ameliorate the social consequences of IMF macroeconomic advice have been inadequately incorporated into programme design.

The fiscal tight and easy money policy mix

Duncan Weldon writes that years of tight fiscal policy and monetary loosening have taken us to where we are: negative or at best negligible government yields. Approximately mid 2010 (I’d date it to the Toronto G-20) an incomplete economic recovery in the developed economies has been increasingly reliant on monetary policy to accelerate it with fiscal policy acting as brake (or at best staying neutral). This (and most of this post) applies especially in the Europe and to a lesser extent in the US.

Duncan Weldon writes that we have seen in the past few years is a scarcity of supposedly safe assets as government issuance of decent credit has been less than private demand whilst central banks have bought up much of the stock. This has pushed the price of those assets up and the rate of interest on them down. The death of the rentier was supposed to be a side effect of an economy operating at full employment. Instead, across much of Europe the rentier is being gradually euthanized whilst workers continue to suffer from weak real income growth and high unemployment.

Martin Sandbu writes that fiscal retrenchment across virtually the entire developed world has no doubt meant more monetary stimulus is required than would otherwise be the case to keep existing labor and capital employed. But it is, however, problematic to pin ultra-low interest rates largely on an inappropriate fiscal-monetary policy mix. First, because regardless of the fiscal-monetary mix, the overall demand stimulus is too weak. Second, because the reason historically low interest rates are driven as much by the supply side as by the demand side of the economy. A different fiscal-monetary mix will not address supply-side challenges.

The Political Economy of tight fiscal and easy money

Duncan Weldon doesn’t understand the political economy that has brought us tight fiscal and easy money — it simply isn’t creating enough winners to be sustainable. Aggressive deficit-financed state spending may (unusually) create two sets of winners — the workforce who benefit from faster growth, tighter labor markets and stronger real income growth and the mass of (relatively) small scale rentiers who would benefit from higher rates.

Paul Krugman writes that is is presuming that older voters understand something about macroeconomic policies and what they do. No doubt there are some such people; but we know from polling that the general public is always and everywhere afraid of budget deficits and addicted to the household analogy. There’s also the role of Very Serious People, for whom deficit posturing is a signifier of identity; a posture that works in part because the public always thinks of deficits as a Bad Thing.

Duncan Weldon wonders whatever happened to the deficit bias – the idea that governments have a tendency to allow deficit and public debt levels to increase. Certainly when I learned my macroeconomics, the textbooks believed this was a thing. And it makes obvious sense that the public should prefer to be taxed less or enjoy higher spending than would otherwise be the case. And yet the public no longer seem to agree. Rather than a democratically driven deficit bias we seem to be infected with a democratically driven surplus bias.

Paul Krugman writes that it’s surely relevant that the two big advanced economies — the US and the eurozone — both have fiscal policy paralyzed by political gridlock, leaving the central banks as the only game in town. The problem now is that while advocates of more fiscal push seem to be winning the intellectual battle, the institutional arrangements that produce macro gridlock are likely to persist.

Duncan Weldon writes that there is a real and perplexing possibility that independent central banks have been able to do more to support growth through easing than directly controlled central banks, subject to more political pressure, would have been able to achieve. I say “perplexing” as this almost entirely reverses the academic arguments for independent central banks.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read about event More on this topic
 

Past Event

Past Event

A debate on fiscal rules and the new monetary strategy

Presentation of the Yearbook of the Euro 2022.

Speakers: Maria Demertzis, Fernando Fernández, Gonzalo García Andrés, José Carlos García de Quevedo, Pablo Hernández de Cos and Jorge Yzaguirre Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 17, 2022
Read article More on this topic More by this author
 

Opinion

A role for the Recovery and Resilience Facility in a new fiscal framework

Discussions on reforming European Union fiscal rules must consider a more permanent but targeted role for the Recovery and Resilience fund to meet climate ambitions.

By: Maria Demertzis Topic: Macroeconomic policy Date: January 10, 2022
Read about event More on this topic
 

Past Event

Past Event

Fiscal policy and rules after the pandemic

What are the possibilities for shaping the new fiscal policy?

Speakers: Zsolt Darvas, Maria Demertzis, Michel Heijdra and Katja Lautar Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 24, 2021
Read article More by this author
 

Blog Post

Fiscal arithmetic and risk of sovereign insolvency

The record-high debt levels in advanced economies increase the risk of sovereign insolvency. Governments should start fiscal consolidation soon in an environment of low nominal and real interest rates and post-COVID growth.

By: Marek Dabrowski Topic: Global economy and trade, Macroeconomic policy Date: November 18, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

What should public spending look like?

What should we do about the increase in public spending due to COVID-19? Bruegel Director Guntram Wolff and Former Deputy Secretary-General of OECD Ludger Schuknecht discuss.

By: The Sound of Economics Topic: Global economy and trade Date: July 14, 2021
Read article More on this topic More by this author
 

Opinion

Is Bidenomics more than catch-up?

The Biden administration's promises to 'think big' and rebuild the country seem like a major historical departure from decades of policy orthodoxy.

By: Jean Pisani-Ferry Topic: Global economy and trade Date: June 3, 2021
Read article More on this topic More by this author
 

Blog Post

International tax debate moves from digital focus to global minimum

International corporate tax reform is coming closer if countries can set aside their differences and work for progress rather than the perfect deal.

By: Rebecca Christie Topic: Global economy and trade Date: May 27, 2021
Read article More by this author
 

Opinion

European governance

Europe must fix its fiscal rules

The pandemic has shown that the EU’s spending framework reflects an outdated economic orthodoxy.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: May 27, 2021
Read about event More on this topic
 

Past Event

Past Event

After COVID-19: a most wanted recovery

This event, jointly organised with ISPI, as the National Coordinator and Chair of the T20 Italy, is part of the T20 Spring Roundtables and it will focus on strategies for a swift and sustainable economic recovery for Europe.

Speakers: Franco Bruni, Maria Demertzis, Elena Flores, Paul De Grauwe, Christian Odendahl, Miguel Otero-Iglesias and André Sapir Topic: Macroeconomic policy Date: May 19, 2021
Load more posts