The author is CEO of Lateral Economics and visiting professor at King’s College London
Is President Joe Biden’s $1.9tn fiscal package too big? Some have argued it makes more sense to have a smaller support package now and a huge medium-term investment programme later; we should see how the recovery goes before offering further support.
Such improvisation to meet macroeconomic challenges is now standard in monetary policy. After a generation of reform, central banks set the stance of monetary policy by manipulating short-term interest rates without government interference. By contrast, politicians set the stance of fiscal policy — the size of a budget deficit or surplus.
Biden’s Democrats have erred on the side of too big a stimulus, not just in reaction to their timidity a decade ago but because they will be deprived of their ability to improvise if they lose their Congressional majorities in the 2022 midterm elections. A decade or so ago, the UK saw an equal and opposite politicisation of fiscal policy.
The UK’s plunge into austerity in 2010 was an accident waiting to happen. The David Cameron government wanted to shrink government outlays, but doing so during a recession was always going to do more economic harm than good. Alas, the political narrative it could be made to serve was just too tempting.
Debate on fiscal policy occupies its own special place in the culture wars into which political debate has descended. Here, the right is Dad and the left is Mum. Seriously! Baked into our political psyches, largely immune from evidence, the electorate instinctively feels that the Conservatives manage money better, while Labour’s strength is “caring”. And so the economic pain Cameron inflicted could be depicted as the inevitable result of Labour’s prior fiscal profligacy (real or imagined).
So, in recovering from the deepest recession in three centuries, how could fiscal policy be reformed as monetary policy has been? We must first distinguish its two aspects. The microeconomic composition of taxation and spending — who gets taxed how much and how governments spend the money raised — should continue to be determined by politicians.
However, the macroeconomic question — the extent to which taxes exceed spending or vice versa — should be determined more independently. In the UK, the Office for Budget Responsibility already delivers independent fiscal transparency. But, unlike the Bank of England’s role in monetary policy, it leaves politicians free to set policy. This should change.
Small across-the-board cuts or increases to legislated tax rates would be a fiscal policy instrument analogous to the official bank rate in monetary policy. Just as the Bank of England’s Monetary Policy Committee sets the official bank rate, so the power to make such across-the-board adjustments could be given to an independent fiscal board, or even to the BoE, reconstituted as a consolidated Macroeconomic Stability Board.
This power need not be absolute. For instance, the Reserve Bank of Australia’s monetary policy decisions can be overruled by governments, provided they do so publicly. In practice, no government ever has. The arrangement encourages productive collaboration between the two parties. One might also “nudge” the system towards greater independence in setting the fiscal stance by charging governments with the across-the-board tax changing powers, subject to independent public advice.
I floated these ideas in 1997 and others have made similar suggestions. They were supported by Australia’s main big business lobby. But the case for action today is stronger still. The 2008 financial crisis illustrated the dangers of over-reliance on monetary policy to stimulate the economy over a sustained period. Since then, interest rates have plunged to zero or lower. Reaching for more ammunition, central banks have since turned to “quantitative easing” — with its inherent economic risks and its perceived unfairness in supporting the price of assets owned by the wealthy.
There have also been calls for “people’s quantitative easing”, or the financing of tax cuts or government spending by printing money. But if we are to do this, shouldn’t we do it the way you would expect your pension savings to be invested — by trusted people, charged to serve the public interest? Wouldn’t you also want the policy unwound precisely when they thought it wise, rather than according to the polarised, manipulative narratives politicians thought they could sell to the electorate?
That can only happen if we are ready to make bold but pragmatic reforms to our economic institutions.
Source: Economy - ft.com
