Appropriate Roles of Monetary and Fiscal Policies

The financial crisis and recession are over. Global economies are rebounding at a healthy albeit uneven pace. The US is recovering slowly. Inflation is low in the US and Europe, and the probability of deflation is low, while Japan continues to struggle with mild but persistent deflation. Inflation pressures are mounting in fast-growing emerging nations.

Global macroeconomic policies vary widely. Most notably, US monetary and fiscal policies maintain a short-run focus, driven primarily by high unemployment, and seemingly brace for the worst possible conditions, while Europe has moved decidedly toward fiscal austerity and the European Central Bank has discussed its exit policy. China, India, Brazil and other emerging nations’ central banks have begun to hike rates. Japanese monetary and fiscal policies remain in a muddle-through mode, and Japan has intervened in an attempt to prevent further yen appreciation.

Both US monetary and fiscal policies have deviated significantly from their long-run sustainable trends and objectives. With the economy growing slowly and unemployment high, macroeconomic policymakers debate whether they should pursue further stimulus, and when policy should be put back on track toward long-run sustainability.

US fiscal policy is in complete disarray. The fiscal stimulus failed to stimulate the economy or create many jobs. Government debt is surging, with unknown costs, and the uncertainty about tax and spending policies is undermining credibility and private sector confidence. US fiscal policy requires change—the kind of change that is already taking place globally—and it desperately needs a roadmap toward longrun fiscal responsibility. The thrust of US fiscal policy must be shifted away from short-term, temporary programs, and deficit spending targets must be established that require legislated reductions in future deficit spending and entitlements reform that will be implemented over a reasonable period of time.

The monetary policy debate about more quantitative easing brings up a host of issues regarding the efficacy of monetary policy, and whether current slow growth stems from insufficient demand that potentially can be remedied by monetary stimulus, or from structural problems related to necessary elongated adjustments to household balance sheets and distressed housing sector and mortgage market, that are likely to be resistant to more monetary stimulus. With the financial system already awash in liquidity, and the economy and job creation constrained by a host of nonmonetary policy factors, more quantitative easing at this point is a low-benefit policy course with potentially high long-run costs, and should be avoided. Instead, addressing barriers to growth directly through nonmonetary means (i.e., dealing with the millions of distressed homeowners facing foreclosure) would be a surer route to healthy expansion than excessive reliance on monetary stimulus.

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