Philip Arestis and Malcolm Sawyer
Fiscal policy has not been taken seriously by policymakers since the Great Financial Crisis (GFC) of 2007-2008, with some exceptions over the period 2009-2010, notably after the G20 meeting in London (April 2009). The GFC prompted significant government and central bank interventions, both to restore confidence in the financial system and to contain the impact of the crisis on the real economy. Monetary and fiscal policy responses became very accommodative in many countries. Central banks responded by flooding the financial markets with liquidity, while fiscal authorities attempted to deal with the decline in the solvency of the banking sector. Those policies before 2010 had helped to avoid a complete collapse of the financial system and the real economy after the emergence of the GFC. Subsequently “unorthodox” monetary policies have been implemented, which have not been successful in terms of producing and maintaining healthy growth in the economy. Fiscal policy has increasingly been concerned with “balancing the budget” and “expansionary austerity” rather than being genuinely expansionary.
There are several reasons for such a change in terms of fiscal austerity going out of fashion. An important one being the failure of the austerity policies to bring about significant recovery despite the claims made for “expansionary fiscal consolidation.”
The UK government provides an example of a government adopting a “fiscal surplus” rule, which in their case was to be achieved by 2020. With the result of the referendum of UK’s membership in the EU (June 23, 2016) and the perception that this would add to the slow-down of the UK economy, and the replacement of the former Chancellor of the Exchequer has resulted in the declared abandonment of the fiscal surplus rule. The new UK Chancellor has been given the opportunity to be “radical” with fiscal policy and he seems to be promising to help investment in the UK, which is weak in this country; indeed, the government needs to sort out this problem, and urgently.
The new UK Chancellor and the Governor of the Bank of England seem to have agreed on a coordinated action to account for UK’s economic problems, including fiscal stimulus (in terms of the importance of fiscal and monetary policy coordination along with financial stability, see Arestis 2015). Andrew Haldane, chief economist and member of the Monetary Policy Committee of the Bank of England, argued in a Sunday Times article (August 14, 2016) that “monetary policy can offer no more than a short-term balm for economic uncertainty.” Under such circumstances, “other arms of policy are needed” to ensure healthy growth. These comments are very much in line with the view that Britain’s government needs to unveil a new fiscal plan in order to produce healthy growth in the economy.
The fiscal policies of the new Canadian government marks the move away from austerity (New York Times, October 23, 2015). The President of the ECB (Draghi, 2014) also argued that “it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints.” Draghi (2016) argues that “it matters for monetary policy whether fiscal policy is steering aggregate demand in the same direction, and how strongly.” This, however, did not happen in the EMU case; Draghi (op. cit.) went further to suggest that “in a context of disrupted transmission that has led to a slower return of output to potential than if fiscal policy had been more supportive.” The decision by the European Council (August 8, 2016) to accept the European Commission’s proposal not to penalise Portugal and Spain for having failed to meet the European Union deficit rules may well mark the beginning of the effective abandonment of the “fiscal compact” in EMU.
The result of the recent meeting of the G20 finance ministers and central bank governors of the leading countries around the world in China may also be seen as a further marker of shifts from fiscal austerity. They have echoed this important trend in favour of fiscal policy along with monetary policy and structural reforms. However, given that structural reforms cannot deliver quickly and that monetary policy has nearly exhausted its weapons, which in any case have not been successful, fiscal policy measures have emerged as the winner. Even the IMF, which supported austerity in the past, seems to be now one of the strong supporters of fiscal policy along with monetary and structural reforms. The IMF (2016) calls for policymakers in large economies to identify and implement policies that would boost growth and contain risks. Such policies, in this view, should include: structural reforms, fiscal support—most valuable at this juncture it is suggested—and monetary policy to lift inflationary expectations. Above all, of course, stimulating aggregate demand is most important, whereby expansionary fiscal policy is paramount and prominent.
It is also the case that the recent “unorthodox” Quantitative Easing (QE) and negative interest rate types of monetary policies, implemented in many countries around the world, have not really been successful; let alone the fact that central banks are reaching the limits of their monetary policies. A good example in this context is Japan where the “Quantitative and Qualitative Easing” (QQE) monetary policy with negative interest rates (-0.1) aspect of “Abenomics” has not worked. However, the fiscal part of “Abenomics” has introduced, early August 2016, a new large fiscal stimulus, which amounts to 6% of GDP. Interestingly enough, this fiscal stimulus is in synergy with monetary policy, as stated by the Japanese central bank governor. Other countries, especially European, should introduce similar fiscal policies; the Japanese initiative is a lesson for the world.
An interesting question is the extent to which this change in attitude towards fiscal policy would produce the “proper” fiscal stance. This is a relevant question but at the end of the day it is important that the rising disenchantment is promising. In any case, with monetary policy having failed to produce healthy levels of employment and GDP growth, fiscal policy has now to shift from pursuit of budget surplus to promoting expansion.
References
Arestis, P. (2015), “Coordination of Fiscal with Monetary and Financial Stability Policies Can Better Cure Unemployment”, Review of Keynesian Economics, Vol. 3, No. 2, pp. 233-247).
Draghi, M. (2014), “Unemployment in the Euro Area”, Speech at the Annual Central Bank Symposium in Jackson Hole, 22 August. Available at: http://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html
Draghi, M. (2016), “On the Importance of Policy Alignment to Fulfil Our Economic Potential”, 5th Annual Tommaso Padoa-Schioppa Lecture at the Brussels Economic Forum 2016, Brussels, 9 June. Available at: https://www.ecb.europa.eu/press/key/date/2016/html/sp160609.en.html
International Monetary Fund (IMF) (2016), “Too Slow for Too Long”, World Economic Outlook (WEO), April, International Monetary Fund: Washington, D.C., US.
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