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.




Published by freethinkingeconomist

I'm a mid 40s, former special adviser (Downing Street 2017-19, BIS from 2010-14), former FT leader writer and Lex Columnist, former financial dealer (?) at IG, student of economic history, PPE like the rest of them, etc. This blog has large gaps for obvious reasons. The name is dumb - the CentreForum think tank blog was called Freethink, I adapted that, we are stuck now.

10 thoughts on “The fiscalists vs the monetarists: lacking a common language

  1. Giles
    Why is this debate still going on? It seems to me that the monetarists have won hands down. They are only ones with a coherent explanation of why, say, the US is growing, while reducing government expenditure, while, Europe, even Greece for heavens sake, is still increasing state expenditures but still seeing contraction or slow growth. Then we have the excellent example of Japan, finally they are following the advice of the monetarists and surprise they are are growing after years of trying fiscalism with no results except a massive increase in Government debt. What is it going to take to convince these people?

    1. I didn’t even mention the example of Japan! Thanks for doing that. I agree that the data points of the last two years have shifted it to the market monetarists. I do think however that the fiscalists have an element of pragmatism on their side. I think the theory “with ideal monetary policy pursued with utter credibility, there is no need for fiscal demand management” may hold true. I think in 2003 it was well believed. But we do not have that ideal monetary policy, and people like Simon Wren Lewis recognise this too I think it is even possible to find Scott Sumner posts conceding that fiscal policy can boost demand given the wrong monetary policy.

      The question is what monetary policy you should assume when designing your fiscal policy. For the Greeks, you have to assume it is going to be pretty Germanic.

    2. Given that the USA didn’t change the inflation target, didn’t implement any of the MM proposals put forward, perhaps there is more to this story than meet the eye?

      Worth noting that proponents of fiscal boosting in the Eurozone are usually in favour of monetary boosting too – it’s mainly the MMers who try to reduce the number of levers available for the system. And anyone who has studied system dynamics knows that that isn’t a good idea…

      1. Metatone

        Fair comment on some people being just too purist, as if the point of all this is to prove a macro point and not just get things working again.

        But I would say that the Evans rule and Bernanke in Sep 2012 was surely some sort of test of the MM view?

      2. The Fed did change the inflation target. It used to be implicit, but on January 25, 2012, the Fed set an explicit 2% inflation target.

    1. Great reply, and thanks for posting it here – have already tweeted it.

      What all this tells me is that economic history is becoming ever more important as a discipline for proving issues to do with normative macro. Am not sure modelling as a method of settling arguments is as valuable nowadays

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