There’s been a lot of buzz regarding some recent statements by Jay Powell on the possible role of fiscal policy during the next recession:
The current low level of interest rates “means that it would be important for fiscal policy to support the economy if it weakens,” he told the House Financial Services Committee on Tuesday.
Less emphasis is being placed on some of his other statements, which suggest that fiscal policy is unlikely to be effective during the next recession. To see why, recall that fiscal policy is not something that can just be pulled out of a bag when you “need it”. For fiscal policy to be helpful it must be systematically countercyclical, expansionary during periods of high unemployment and contractionary during periods of low unemployment.
Fiscal policy is currently very procyclical. At the beginning of 2013, Congress adopted fiscal austerity, cutting the deficit from $1050 billion to $550 billion in just one year. This was done despite 8% unemployment. In recent years Congress has ballooned the deficit back up to a trillion dollars, despite the lowest unemployment in 50 years. Congress is extraordinarily inept at fiscal policy, and cannot be relied upon to engage in effective “fine tuning” of the economy during an emergency, especially given the current partisan gridlock in Washington.
Powell knows all this:
To make room for future fiscal actions to aid the economy, Powell urged lawmakers on Tuesday to rein in budget deficits now.
“Putting the federal budget on a sustainable path when the economy is strong would help ensure that policy makers have the space to use fiscal policy to assist in stabilizing the economy during a downturn,” he said.
Powell is pointing out that to be effectively countercyclical, we need a contractionary fiscal policy right now. He’s also smart enough to know this isn’t going to happen, but he can’t come right out tell Congress that they are inept. I can.
I am reasonably confident that Powell is not expecting much from fiscal policy during the next recession. This is why he is working so hard to delay the next recession for as long as possible. So far he’s doing a pretty good job.
PS. I recommend a new piece by Kenneth Rogoff. Here is the abstract:
Many leading central bankers now argue that, instead of just playing its traditional role of deciding the allocation of government spending, investment, taxes, and transfers, fiscal policy must substitute for monetary policy in economic fine-tuning and fighting recession. That would be a big mistake.
HT: John Hall, Marcus Nunes
READER COMMENTS
Brian Donohue
Feb 12 2020 at 2:25pm
The Fed increased IOER from 1.55% to 1.60% on January 30th. Why? There doesn’t have to be a good reason, I don’t think there is a good reason, but there has to be a reason why they thought this was the right move. What could it be? Not a rhetorical question.
Scott Sumner
Feb 12 2020 at 2:32pm
I don’t know.
Christophe Biocca
Feb 12 2020 at 3:29pm
Powell is advocating contractionary fiscal policy now.
That probably means he’s looking at having (more) contractionary monetary policy now as well (it would be a bit weird to advocate fiscal policy to move in the opposite direction that he’s planning to take monetary policy).
Increasing IOER is contractionary.
It’s certainly more reasonable to do that now than it was in October 2008.
Scott Sumner
Feb 12 2020 at 4:06pm
I favor a more contractionary fiscal policy and a more expansionary monetary policy right now; I wouldn’t be surprised if Powell does as well.
Alan Goldhammer
Feb 12 2020 at 5:00pm
What will be interesting are the Senate hearings on the two Fed appointees that are scheduled for tomorrow. Maybe Judy Shelton has all the answers.
Thaomas
Feb 12 2020 at 6:28pm
The Fed should not count on Congress to act countercyclically although it would mean that its use of monetary policy instruments could be less aggressive in holding to its targets for prices and employment if Congress did follow an NPV rule for investment with the level of transfers defined by the state of the economy rather than by amounts or date.
Shyam Vasudevan
Feb 12 2020 at 7:33pm
Why do we need countercyclical fiscal policy if inflation is currently below target and the 10-year treasury is at 1.6%?
Scott Sumner
Feb 12 2020 at 8:47pm
Shyam, I don’t think we need countercyclical fiscal policy. But if we plan to do so, we don’t slash the deficit in half when unemployment is 8.0% and then double it when it’s 3.6%. (Inflation was low in both cases.)
Thaomas
Feb 13 2020 at 7:24am
I do not think we need “counter-cyclical” fiscal policy right now in the sense that we need surpluses to restrain aggregated demand to control inflation. We need much lower deficits right now to increase savings and free resources for investment. I think a fiscal deficit of about zero when we are near full employment is about right unless we are investing large amounts. This would not prevent the Fed from being a bit more stimulative in order to get the price level back onto a 2% pa track (although aiming for a 5% NGDP track would be even better.)
Shane L
Feb 13 2020 at 9:31am
Here in Ireland we just had a general election.
The outgoing government, for all its flaws, inherited a country reeling from the economic crisis and has governed over a period of rapid economic and fiscal recovery. The year before they came into office, 2010, Ireland had a deficit of €53 billion – by 2018 they had remarkably turned this around to a small surplus of €168 million.
Unemployment is low and falling, the economy is growing swiftly, but there concerns about economic downturns due to international events such as Brexit. Economist Prof Stephen Kinsella remarked that Ireland looked on course for another surplus in 2020, and observed that the government was actually tightening government finances in an election year: “To call that rare is an understatement.” In other words, the government has attempted a prudent, countercyclical fiscal policy, tightening the belt now in a time of economic growth in order to give future governments fiscal room to avoid another round of procyclical austerity in a future recession.
How have the Irish electorate responded to such prudent policy? They’ve abandoned the main governing party Fine Gael, whose seats in parliament have fallen from 36.1% in 2011, to 25.5% in 2016 and 20.9% in 2020. The left-nationalist Sinn Féin have increased their share from 9.9% to 24.5% in the same period.
Thus I think it’s incredibly difficult for governments to pursue competent, countercyclical fiscal policy. When the economy improves, demands for simultaneous spending and tax cuts become a cacophony. Though I suppose some countries might have a more positive culture around this.
Scott Sumner
Feb 13 2020 at 11:53am
Good example.
Phil H
Feb 13 2020 at 12:43pm
I can’t remember who it was that explained this to me, but I am convinced of its correctness: It’s basically politically impossible for a government to run a surplus. Because it’s not their money, it’s money that belongs to the taxpayer. If the government says they’re keeping it, the taxpayer has a good right to be offended; if the government decides they want to save it for the long term, really they’re just handing the next administration a war chest. The combination of democratic accountability and the two party slow tennis of government means there is just no politically stable way to keep surpluses.
You’d need a cross-party consensus on a long-term countercyclical policy, and before we even got into the political difficulty of obtaining that agreement, in order to construct such a policy, first we’d have to know what a cycle is…
Scott Sumner
Feb 13 2020 at 8:14pm
The US ran surpluses in 1999, 2000 and 2001, and also many years earlier in American history.
Thaomas
Feb 14 2020 at 5:43am
I’ve no inside knowledge of Irish politics. The buzz is that people were discontented with housing prices, suggesting inadequate investment in housing. Failure to deal with NIMBYism? Insufficient public housing? Something else? I have not heard complaints with lack of spending/too high taxes per se?
Brendan
Feb 20 2020 at 3:43pm
Even if a lack of spending on public housing was what lost public support for the dominant party, is that not just a symptom of them running a surplus?
I don’t think citizens are against a surplus, but they are against the decrease in benefits created by government expenditure.
Thomas Sewell
Feb 13 2020 at 8:07pm
I think I understand why you’re calling it that, because it’s a move in that direction from the previous year, but is it accurate to call a $550 billion deficit “fiscal austerity” when it’s still a larger deficit than any in history up until the previous decade?
Scott Sumner
Feb 13 2020 at 8:13pm
In the Keynesian model the answer is yes. I don’t buy model, but it’s the one advocates of fiscal policy rely on. If the model is wrong, their arguments fall apart.
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