The fiscalists vs the monetarists: lacking a common language

My feedstream is perpetually full of people I admire fighting with one another.

On Marcus Nunes’ blog, Mark Sadowski has a bit of a go at Simon Wren Lewis for saying it is obvious that the Euro recession is the consequence of contractionary fiscal policy. To people like Mark, and market monetarists like Lars, David Beckworth and others, it is equally obvious that without a decisive change in monetary policy, the Euro area cannot prosper.

The most decisive argument from recent history in favour of the market monetarists is the relative performance of the US versus the EU economy.  Taken as a whole, each have been fairly tough on the fiscal side.  But the US economy has grown well, while the EU … well, you know the story of the EU.  The best explanation from the market monetarist side is that US monetary policy has been far more loose.

Professor Wren-Lewis doesn’t duck this counterexample, and indeed puts the figures on his latest blog post.  The factors he pulls out to explain the EU underperformance are: the EU having its crisis in 2012; the way the US has finished deleveraging; and finally a fall in the US savings ratio.

The problem I have here is that the two sides speak entirely different language (I know, having wandered like a struggling pupil between their virtual lecture halls for a few years now).  SWR breaks GDP growth down into its subcomponents and tries to account for each part: so investment did X because Y, Governments did this, households did that, finally exports. I did this with “Slash and Grow?” to argue that history suggests Osborne’s fiscal approach would not produce an investment and export boom as he promised.

The market monetarists instead describe total spending in the economy.  They don’t much care for each component.  That NGDP can be broken into categories doesn’t change the overriding fact that it is effectively set by the central banks.  Looser policy boosts NGDP.  How it is then categorised is a residual.

I don’t think the market monetarists would be discomfited by Simon’s response. If monetary policy boosted US NGDP, in response to the decisive loosening stemming from Bernanke’s actions of September 13, 2012, then it was going to break down into some set of subcomponents or other.  If the EU is to have too tight monetary policy, it will break into some components or other, be that worse net exports (because the Euro is way too strong), weaker investment, or whatever. That doesn’t constitute an alternative explanation, just a breakdown.

The key difference in the approaches, for me as an eager pupil, is that the approach of fiscalists like SWR, and Portes and possibly others, is that they see monetary policy as a demand lever alongside the others.  SO: demand might come from consumers starting to borrow again; or from the currency weakening; or from the government/businesses investing/or it might come from rates being lowered.  The market monetarists instead see monetary policy as setting the entire envelope of income and spending in the economy. It is not an alternative to these other categories, but encompasses them.

In 2012 Bernanke signalled a decisive change in US monetary policy.  In late 2012, Mark Carney instituted a debate about UK policy, flirting with NGDP targeting, introducing “forward guidance” that has annoyed Chris Giles into accusing it of “institutional doveishness”. A bias against tightening policy is what many of us might have wanted (I still think it would be far more efficient just to announce a high NGDP target than have all these contortions).

From early 2013, despite the predictions of everyone the UK economy finally started growing strongly. It will never be possible entirely to disentangle all the cause and effect in macroeconomics, but I think market monetarists are amongst the least surprised. The more ungainly have been the contortions of Carney et al in defending what they are doing, the clearer it has been that they want to keep monetary policy loose come hell or high water.  That is just what we need.