Independent fiscal policy: I told you so . . .

The case for more independent fiscal policy has always struck me as bleedingly obvious. I still think it is kind of inevitable but we’re certainly taking our time.  The adventures of the last decade both here and in most other developed countries are a nice illustration of why it’s necessary. It was touch and go in many countries whether a fiscal stimulus would be pursued while the financial sector melted down and monetary policy sat in a liquidity trap.  But a fiscal stimulus helped make things less disastrous than they would otherwise have been.  But now the architects of those policies, each in their way being quite politically bold in implementing those policies, are now gone (Gordon Brown) or mired in populist rhetoric about how spendthrift they are and how urgent it is to rein in spending (Barack Obama).

Meanwhile in their countries, Krugman and others with a bit of Keynesian sense point out that the market doesn’t look like driving bond yields up any time soon.  And since growth is still dangerously weak, now is no time to pull back on the stimulus. (I’m not addressing these comments to the Australian situation where we’re obviously much further from any bond market concern about the government’s debt position and we look like we’re returning to economic health, though I’m a great believer in my own and everyone else’s ignorance on that score). Krugman has bemoaned the way in which this madness is taking over his own country.  But, as Clive Crook points out, that’s not really good enough. There is an issue for the US particularly, which is that if your political system seems inured to irresponsible deficit budgeting, that ultimately removes a lot of your discretion to engage in fiscal stimulus. We hear plenty of complaining from Krugman about the fact of the US’s irresponsibility on this (it’s related to the revolutionary irresponsibility of its Republican Party).  But if that’s the case why should we be so sanguine about continuing to push up US debt.

It’s a weak part of his argument.  Here’s Clive Crook quoting Bill Galston.

I think Krugman is correct to argue against “fiscal austerity now now now”, especially for the US. But Galston’s view, as I say, is consistent with this. It’s the long-term outlook they disagree about. I don’t understand why Krugman won’t more fully acknowledge the long-term problem. Why not give equal emphasis to the need for further short-term stimulus combined with tax increases and/or spending cuts later? Difficult to do, of course, but what is the objection in principle?

Perhaps Krugman believes that yielding ground on the long-term problem would weaken the case for stimulus now now now. If so, as a matter of political judgment, he is wrong. His blunt refusal to engage with the other side undermines his case. Or does he think there really is no long-term problem? Again and again he says that financial markets are not (yet) pushing US long-term rates higher, as though that is all you need to know. This would be an even weirder thing for him, of all people, to think. Markets know best? Sounds like those looney-tunes in Chicago.

Crook doesn’t finish this piece of analysis. It’s quite simple, unless you have credibility you can’t get far with stimulatory fiscal policy. And, given the difficulty with which the electorate are able to understand the arguments about the appropriate fiscal stance, not to mention the crudity of its options (vote for one of two major paries once every four or so years), institution building seems the only way out.

So why don’t we talk more about it. On the bright side the British Conservatives have made the right move with their Office of Budget Responsibility, though it’s unclear how much it will be able to take a position on the appropriateness of fiscal policy – as opposed to scrutinising forecasts. Anyway, the case to move fiscal policy further towards the model we have now arrived at for monetary policy seems overwhelming.

So far lots of countries have toyed with fiscal transparency bodies, but, as I’ve argued previously, it’s not an absence of basic fiscal transparency that allowed Reagan or Bush II to be as irresponsible as they were. So at a minimum if we’re to get anywhere, we need some independent but official source of public advice to the government – and some similarly official, public and independent comment on how well it’s going. Ideally we’d develop out of this some backstop way in which taxes could be changed across the board to deliver appropriate fiscal policy, with the government always free to deliver the requisite policy in some other way. Then again it took many decades to deliver some semblance of independence to monetary policy, so I guess we’re not making such bad progress . . .

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Martin
Martin
11 years ago

I don’t understand why Krugman won’t more fully acknowledge the long-term problem. Why not give equal emphasis to the need for further short-term stimulus combined with tax increases and/or spending cuts later? Difficult to do, of course, but what is the objection in principle?

Sorry, this must be some other Paul Krugman than the one who posts on the New York Times. The NYT Krugman consistently talks about the long-term problems, about how tax increases are necessary and how health-care costs need to brought under control and has been doing this for years. What he’s saying at the moment is that given that there is over 9% unemployment at the moment, now is not the right time to start and in any case, any stimulus package would be negligible in the scheme of things, Brad deLong has addressed this as well.

Now they may be wrong, but to accuse Krugman of not addressing the long-term problems is just hackery.

Martin C. Jones
Martin C. Jones
11 years ago

Nicholas, are you thinking of something along the lines of the German Council of Economic Advisors? They have no binding influence on the Government, but they command a lot of respect, and, given a few more powers, would seem to be moving in the direction you propose.

Don Arthur
Don Arthur(@don-arthur)
11 years ago

It seems to me that the case for independent fiscal policy hinges on the idea that the problems it addresses are technical rather than political.

When a problem is purely technical everyone agrees what a good outcome looks like and what a bad outcome looks like. I suspect that economists overestimate the degree of consensus in the broader population.

I don’t think there’s a consensus in the US that fiscal policy addresses problems that are purely technical. Many Americans treat things like tax rates as moral issues (ie they can be judged good or bad independent of their economic outcome).

Because people suspect that the ‘experts’ may have different moral views to their own, they are not willing to delegate decisions outside of the political process.

Technical problems are delegated when lay people accept that:

1. they lack the expertise to solve them; and
2. they can identify a group of people who do have the expertise.

I doubt that there is there any consensus about who has economic expertise. Economists are often seen as divided into ideological camps. Many lay people feel entitled to decide which group they think has expertise and which group does not.

Taxing and spending lie at the heart of ideological divisions in the US. Interest rates do not.

derrida derider
derrida derider
11 years ago

Many Americans treat things like tax rates as moral issues

– Don

Yes, and those “many Americans” are perfectly correct to do so.

How much to tax (let alone who to tax) and how much to spend (let alone what to spend it on) are not mere technical questions – they go to the core of what you think goverment is FOR. You’re managing a lot more than money when you’re managing a government budget.

Instead you’d have a bunch of unaccountable and unrepresentative bureaucrats, with a background in financial markets or in mainstream academic economics and driven by their desire for approval from these. How are they placed to judge the relative merits of short-term demand management, intergenerational equity, restricting or enlarging the scope of government and keeping bond markets happy?

You or I might have views on the relative importance or relevance of each of these at a given time, but the point is that we can and should properly express those views at the ballot box. They are precisely questions that we elect the government of the day to resolve, not some shadowy unaccountable elite.

I’d never adopt German macroeconomic institutions. Look how consistently dreadful (usually in the direction of massive overcaution) German macoreconomic policy has been over the last thirty years!

derrida derider
derrida derider
11 years ago

There’s bipartisan agreement in Australia that it’s good to balance the budget through the cycle

True, though such a consensus doesn’t have much support in economic theory. Theory says in a growing population you should be running a structural deficit because the component of your spending that represents long-lived investment should be paid for by those who will benefit from it – ie future taxpayers; there will after all be more of them and they’ll be richer than you too.

But on the other hand I suppose at a practical level you need a disciplining rule of thumb for the pollies, even if that rule means we’re paying too much tax and our children too little.

Ken Parish
Admin
Ken Parish(@ken-parish)
11 years ago

However, there doesn’t seem to be even general/broad agreement among economists about the optimal “fiscal stance” (rough net size of deficit/surplus). James Farrell’s recent post about whether and to what extent the fiscal stiumulus can be proven to have worked is a good example. It apppears that these are very much questions about which reasonable minds may differ (i.e. they are political rather than technical questions, as Don suggests).

In similar vein, what about issues of inter-generational equity? Again there appear to be widely differing views about how much provision the current generation should make for future impacts of an aging population etc. Should we run a larger surplus and plough the accumulated money into a Future Fund (whether to fund social services for a future aged population or to fund measures to deal with the effects of climate change etc)? Or should we leave future generations to fund such needs when they arise, even though the current generation is contributng to the creation of the problem, on the theory that they will be much wealthier than us anyway and therefore better able to cope with the cost?

That’s why I tend to think that enhanced transparency measures are really as far as we can properly take it. Having an unquestionably independent, neutral and expert body (like the RBA) issue an annual report specifying the range of net fiscal stances that would be consistent with economic responsibility (defined as the optimal mix of long and short term prosperity) would at least make it harder for someone like Tony Abbott to get away with convincing the ignorant that Labor’s current fiscal settings are somehow grossly irresponsible, when in fact we have by far the lowest net debt of any western country.

Martin
Martin
11 years ago

Nicholas,

I went on about it, because the main quote in your article from Clive Crook contains amongst other jabs at Krugman

I don’t understand why Krugman won’t more fully acknowledge the long-term problem. Why not give equal emphasis to the need for further short-term stimulus combined with tax increases and/or spending cuts later? Difficult to do, of course, but what is the objection in principle?

So by quoting that article with that specific lengthy quote from Clive Crook, you seemingly endorse the position that Krugman is unconcerned about the long-term position. If your main point as you clarify is that Krugman is not sufficiently sanguine about deficit financing due to the institutional problems inherent in the USA political system (though from my reading of him, he’s well aware of this problem), then I don’t really see the relevance of the large quote from Clive Crook to that issue, which is clearly misrepresenting Krugman.

As well, you make Krugman a major part of your criticism, yet I see very little in the article as to why Krugman’s current position is particularly relevant to your proposed solution.

As to the actual proposal, I’m not convinced that the performance of central bankers around the world in recent times lends any confidence to the notion that replicating that structure in fiscal policy will result in a better economy

Grant Musgrove
Grant Musgrove
11 years ago

A very attractive idea in principal. If only the economics profession had sufficient consensus, demonstrably more so than elected governments.

For example, in Australia monetary policy in the early 1990’s was appalling, leading to a terrible recession. The economics profession was utterly divided against itself, and as some recent political history has revealed, Treasurer Keating did successfully lean on the “independent” RBA to moderate at least one interest rate increase. While both the treasury and the RBA got it very badly wrong, some courageous academic economists (eg John Pitchford) led the argument against the Treasury /RBA line.

Purely technical problems do not automatically lead to a consensus within the profession. Indeed, the profession is now very much going through a period of flux, a period where many debates on the efficacy of fiscal policy, seemingly resolved in the last century, are being retested.

I’m afraid we must rely on the imperfect sytem of elected governments, if only as as a risk management strategy for a profession sometimes deeply divided against itself.

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[…] Here is an Australian perspective (Club Troppo is a well respected economics and politics blog): http://clubtroppo.lateraleconomics.com.au/2010/06/12/independent-fiscal-policy-i-told-you-so/ […]

Grant Musgrove
Grant Musgrove
11 years ago

Question time could certainly do with reform, but that’s another issue. To return to the example I used. I recall then Opposition leader Hewson challenging Treasurer Keating in Question Time to raise interest rates further, prosecuting the RBA/Treasury Line.

Treasurer Keating was less wrong than the RBA/Treasury, so on further misguided rise was avoided. So a forum for debate is very healthy. Our current system also has budget estimates committees and a senate, all of which have their own issues.

The transmission vectors for alternative view points seem to be critical here, and the institutionalization and codification of relatively independent processes. Quality blogs like this are a start. Consensus on fiscal policy seems inextricably liked with both political ideology and personal life journeys through economic literature, so independent consensus on fiscal policy may never be achievable. Still an attractive idea worthy of further development Nicholas.

FYI a recent discussion with a very senior RBA official juts pre the last federal budget revealed that the RBA had no idea of some of the initiatives that were announced days later. I mention this because it raises the question of the co-ordination of fiscal and monetary policy. I perceive a much more distant relationship between these two institutions than was once the case. Another worthy discussion.