Jesse Horwitz recently asked me whether there would be better distributional effects from using fiscal policy rather than monetary policy as a stabilization tool. The intuition is that monetary policy involves the purchase of financial assets whereas fiscal policy can directly deliver money to the public.
I don’t see any important distributional differences, and I believe my view is pretty widespread among economists. But I notice that lots of non-economists see things differently, and it’s worth asking why.
The first thing to note about fiscal policy is that it does not involve the creation of new money, rather it takes existing money and moves it around. When the government sends you a check, the money comes from taxes or borrowing. The public as a whole doesn’t have more money, rather the money is moved from Peter to Paul.
The perception that fiscal policy is fairer may come from the fact that fiscal spending can redistribute money from the richer half of society to the poorer half of society. But that sort of redistribution is essentially unrelated to the use of fiscal policy as a stabilization tool. Even governments that do not use fiscal policy as a stabilization tool often have a welfare state—but they don’t vary the size of the welfare state as a tool for reducing the business cycle. Instead, they often rely on monetary policy.
I suspect that some people mistakenly view fiscal policy as being fairer because they conflate the existence of a fiscal stabilization regime with expansionary fiscal policy. But stabilization policy necessarily uses both expansionary and contractionary policy. An expansionary policy occurs when policy is more expansionary than average and a contractionary policy occurs when policy is less expansionary than average.
It’s true that the national debt trends upward over time, which may lead to the impression that expansionary policy is more common than contractionary policy. But the national debt will trend upward over time regardless of whether fiscal policy is actively being used to stabilize the economy. In the late 2010s, the federal government expanded the national debt to take advantage of the trend toward lower interest rates, not because we were in a recession. If the average (cyclically adjusted) budget deficit is $X, then an active fiscal stabilization policy expands the deficit above $X when stimulus is needed and runs a deficit below $X when stabilization policy calls for reduced spending. In this framework, there is no such thing as permanently expansionary stabilization policy.
Economists tend to think of fairness issues in terms of the long run distribution of income. It’s not obvious why either fiscal or monetary stabilization policy would have any long run impact on income distribution. Even if the government does not use fiscal or monetary policy to stabilize the economy, there will be a government budget and there will be a money supply. In most cases, both will trend upward over time. It is certainly possible that the mere existence of a government budget has distributional effects, and perhaps even the existence of a money supply has distributional effects. But it’s not obvious (at least to me) how varying the money supply or government spending in a countercyclical fashion would have any important distributional effects.
The Fed’s balance sheet has greatly expanded in recent decades, even as a share of GDP. (I wish we had stayed with the much smaller pre-2008 balance sheet.) But this balance sheet expansion was not due to expansionary monetary policy, rather it reflects the Fed’s shift to a floor system with the payment of interest on bank reserves, and also the declining trend in NGDP growth (which reduces interest rates and raises the demand for base money.). Prior to 2008, the Fed ran a very active stabilization policy without buying lots of financial assets. The two issues are essentially unrelated.
PS. I’m not arguing against so-called “automatic stabilizers”, which cause the budget deficit to move somewhat countercyclically even without an active fiscal stabilization policy. But active stabilization policy is best done by the monetary authority.
READER COMMENTS
mkg
Jun 1 2022 at 9:57am
More precisely targeting flows of new money, could create temporary wealth transfers.
For instance, if the fed decided to expand the money supply via a bernanke style helicopter money scheme, but congress could direct who was the recipient of the money. This could result in a significantly different short run distribution of money than lowering interest rates, or treasury QE would.
That’s not really fiscal policy, but it’s also quite different mechanically than what people think is monetary policy, which might be how it answers your question why people see it differently.
Whereas for many individuals, the short run is the more impactful horizon to debate exactly because all money is neutral long run.
I do think that the mechanism of money creation we use today advantages those with high credit scores at the start of expansion over those without. But that’s just my intuition.
Spencer Bradley Hall
Jun 1 2022 at 11:12am
LSAPs, in conjunction with remunerating IBDDs, causes income inequality. Bernanke, pg. 287, “Lower long-term rates also tend to raise asset prices, including house and stock prices, which, by making people feel wealthier, tends to stimulate consumer spending-the “wealth effect”
“Since stocks and equity, i.e., claims for profits, are mainly held by the top of the wealth distribution, QE might disproportionately benefit that part of the distribution.”
“Home prices rose 20.6% in March from the year before, an even higher rate than the 20% growth seen in February, according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index.”
Housing Affordability Index (Fixed) (FIXHAI)
https://fred.stlouisfed.org/series/FIXHAI
Iskander
Jun 1 2022 at 2:01pm
I have always thought that the importance of “automatic stabilisers” was their role in supporting peoples’ incomes rather than any stabilization role. Then again, I’ve drank the monetarist nectar for long enough that I don’t see why anyone thinks of fiscal policy as a useful stabilization tool.
David Wright
Jun 1 2022 at 7:13pm
Scott, reminds me of our discussion of fiscal on my podcast
https://youtu.be/DzTCRHtO77o?t=622s
There you called the idea of a digital currency pushing money into people’s accounts a fiscal policy even if it is enacted by the monetary authority. In such a world one could specify distributional starting points very directly in a stabilization policy. Central Bank handing out debit cards to certain folks perhaps.
Thomas Lee Hutcheson
Jun 2 2022 at 6:34am
This is not a very sensible question. A recession (and I assume some monetary policy changes to get NGDP back to the target level) changes the NPV’s of many government activities. Many transfers and investments make sense with borrowing costs lower than during a non-recession and some marginal costs of labor and other input to activities less than market prices. This would lead an income-maximizing government to make spending and taxation changes that would look like Keynesian stabilization.
Matthias
Jun 2 2022 at 12:04pm
Am I right that the kind of monetary policy you favour could be described as automatic stabilisers for monetary policy?
Eg your idea for the Fed to buy and sell ngdp futures at a fixed price?
Scott Sumner
Jun 4 2022 at 9:32pm
Yes, I suppose you could call that an automatic stabilizer.
Everett
Jun 3 2022 at 3:23pm
I’m not qualified to really think about this issue.
Financial assets that directly benefit non-business owners would be mortgages. I assume the purchase of mortgages is part of the reason mortgage rates are just slightly higher than the Fed rate. As addressed above by mkg and Spencer Bradley Hall this disproportionately benefits the higher end of the wealth and credit score distribution.
Some things the Fed absolutely does not purchase are signature loans such as credit card loans, student loans, and worst of all payday loans. Student loans have a rate decrease by reason of being non-dischargeable, but the other two, especially in the case of payday loans, are likely to be just as usurious as in the past.
So in this respect “monetary policy” as practiced is not as fair as a fiscal policy could be. I could tax-deduct my student loan interest payments, not so for credit card debt or payday loans. Imagine how helpful that would be for the working poor, especially if it the tax deductions were refundable.
Everett
Jun 3 2022 at 3:27pm
Trying again:
I’m not qualified to really think about this issue.
“The intuition is that monetary policy involves the purchase of financial assets”
Financial assets that directly benefit non-business owners would be mortgages. I assume the purchase of mortgages is part of the reason mortgage rates are just slightly higher than the Fed rate. As addressed above by mkg and Spencer Bradley Hall this disproportionately benefits the higher end of the wealth and credit score distribution.
Some things the Fed absolutely does not purchase are signature loans such as credit card loans, student loans, and worst of all pay day loans. Student loans have a rate decrease by reason of being non-dischargeable, but the other two, especially in the case of pay day loans, are likely to be just as usurious as in the past.
So in this respect “monetary policy” as practiced is not as fair as a fiscal policy could be. I could tax-deduct my student loan interest payments, not so for credit card debt or pay day loans. Imagine how helpful that would be for the working poor, especially if it the tax deductions were refundable.
Scott Sumner
Jun 4 2022 at 9:35pm
As I suggested in the post, this confuses monetary policy with expansionary monetary policy.
Everett
Jun 7 2022 at 12:59pm
Thanks for responding.
As I said I’m not qualified to really think about this.
So is there a way for monetary policy to address these specific points in a way equivalent to fiscal policy?
Aside: Any chance of a notification option for replies to comments? Otherwise we have to keep tabs open and periodically refresh them.
Jose Pablo
Jun 3 2022 at 9:23pm
“The perception that fiscal policy is fairer may come from the fact that fiscal spending can redistribute money from the richer half of society to the poorer half of society”
This sentence only make sense if the definition of “fairer” is “redistributing money from the richer (much less than “half of society” by the way) to the poorer”. But then it is just a tautology.
Saying that is “fair” “to take money by force from the people that work hard (or skillfully, or both) to earn that money and giving it to people that did nothing to earn it, but voting”, reminds me of The Road to Serfdom’s Chapter 11: The End of Truth
Everett
Jun 3 2022 at 10:06pm
I too believe that we should end all personal tax deductions.
Scott Sumner
Jun 4 2022 at 9:38pm
“But then it is just a tautology.”
Don’t confuse fiscal spending with fiscal policy (which can be both expansionary and contractionary.) See my earlier reply to Everett.
Even if fiscal spending is fairer, that doesn’t make fiscal policy fairer.
Don Geddis
Jun 12 2022 at 1:16pm
Surely the intuition that fiscal policy is “fairer” than monetary policy is based on standard intuitive (but false) theories of monetary policy.
Thinking just about “stimulus”, most people seem to have a belief in Cantillon effects, that government “gives” new money to certain lucky segments of the economy “first”. Those people then have a lucky temporary ability to use extra money to buy additional goods and services at “old” prices, before the economic “pressure” from the new money is able to work its way through the economy (“like ripples in a pond”) so that all prices rise.
In this theory, fiscal policy can give the new stimulus to “more deserving” poor, who then receive the benefits of “new money first”. Whereas monetary policy appears to “give new money” to wealthy financial classes first, hence (apparently) increasing economic inequality. (This is reinforced by even the Fed describing monetary stimulus as “lowering interest rates, thus encouraging borrowing for business investment”.)
The fundamental error is that monetary stimulus doesn’t actually work through Cantillon effects, and Fed OMOs are purchases at market rates — not “gifts” of new money (to anyone). But once you make that error (as almost all non-economists do), the intuitive preference for fiscal stimulus over monetary stimulus seems pretty obvious.
Comments are closed.