Is Powell relying on help from fiscal policy?
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