The times are a’changing, as recent macroeconomic fashions are being abandoned and old verities are being restated. 

Alan Blinder, an American economist, described as ‘one of the great economic minds of his generation,’ was an economic adviser to President Clinton and was a Vice Chair of the American Federal Reserve (central bank). He is known to many as the co-author of an extremely successful textbook.

He recent monograph Fiscal Policy Reconsidered is an important statement by a saltwater economist contrasting with the failure of the freshwater Austerians (those who advocate fiscal austerity). It argues that it is possible to have an effective fiscal policy (that varying government taxation spending and borrowing can be beneficial for the economy) and that monetary policy (what central banks do) may not be effective.

 His position is summarised in a rejection of two standard neoliberal propositions.

            - that sensible fiscal policy is impossible because Congress is too slow and too political;

            - that fiscal policy is superfluous because monetary policy can always do the job.

I explain what this means by the New Zealand experience. Even so, some readers may find the column all a bit technical. Sorry. If anyone can simplify without losing the rational economics, please have a go.

Once Were Macroeconomics

In the 1960s and 1970s both propositions that Blinder rejects would have been thought odd. It was quite usual to change fiscal settings in order to change the direction of the economy – to protect the balance of payments, to change employment levels and to restrain inflation.

The prime minister commanded parliament so he did not have the difficulties that the US president has, but there were implementation lags; it took about six months to set up a change in income tax. Formulating the right policy response is not easy either.

One of the tricks in the fiscal system was that the tax system was progressive so that a rise in incomes from economic growth or inflation meant that tax revenues rose proportionally faster than the economy – a phenomenon called ‘fiscal drag’. That meant the main tax changes usually involved cutting rates, which are easier to get through parliament. The flattening of our income tax scale has reduced this progression with the consequence of less fiscal drag and a loss of the ‘automatic stabilisers’ which we thought important at the time, as does Blinder does today.

Spending changes were harder. I recall once in the late 1970s when Treasury officials had been instructed to increase infrastructural spending and were scrambling around to find projects which could be implemented immediately. Was that the time when the government gave a one-off increase in the family benefit because it could be done very quickly? An additional worry is how to wind spending down when there was too much expenditure pressure.

The difference between spending and current revenue has to be borrowed. Looking back all those years, I think we were a bit sloppy in our thinking. Debt is a burden on future generations. Today we might say that current spending and revenue should be equal over the business cycle but that the government may borrow for long term for investment. Nowadays, infrastructural investment is the big thing, but once a lot of government borrowing was for investment by state owned enterprises. In either case, assuming the investment is effective – it was not always – future generations had its benefit to offset the burden of debt.

The role of monetary policy in this macroeconomic framework was to support fiscal policy, not an alternative to it. Generally monetary policy was thought to take a long time to be effective; I recall about ten years. Moreover it worked through interest rates impacting on investment and consumer borrowing, not through the quantity of money, which Monetarists like Friedman thought. (One trouble was there were so many definitions of money and if you targeted one all the others moved differently.)

I’ve set down as briefly, and as non-technically, as I dare the standard macroeconomic framework of the times. There is no question that Muldoon misused it. The conventional macroeconomists of the day criticised him; so did the Monetarists.

Then Came Monetarism

In the mid-1980s, the Rogernomes abandoned the standard macroeconomics framework and imposed a monetarist one based on principles not unlike the two which Blinder criticised. It substantially reduced the significance of fiscal policy and put the weight of macroeconomic control onto monetary policy.

I recall that at the time it was suddenly assumed that monetary policy worked quickly – in months rather than years. I do not recall any empirical evidence to support that conclusion. We seem to have simply adopted the American monetarist framework including the idea that parliament could not manage fiscal policy. It was colonial cringe, taking over the imperial ideology with little thought of its local relevance.

One of the strange results was that the Treasury in charge of fiscal policy and the Reserve Bank in charge of monetary policy did not talk to one another, a matter not addressed until the late 1990s.

That said, a close reading of RBNZ statements indicates that their economists thought fiscal policy important – certainly more important than the public rhetoric. I think what was happening was that there were still conventional macroeconomists in the institutions who, while not dominant, continued to use the standard framework.

The Monetarists claim the great success of their framework was the squeezing out of inflation from double digits (above 10 percent a year) to very low levels. But the story is more complicated.

First, much of the inflation of the mid-1980s was from government policies (such as introducing GST, raising State Owned Enterprise prices and hiking the exchange rate). Once the new initiatives stopped you would expect inflation to fall.

Second, world inflation was falling so there were not the same external pressures on domestic inflation.

Third, Rogernomics and (later) Ruthanasia (deliberately) broke the linkages and protective mechanisms which enabled a price rise in one part of the economy was transmitted through the rest.

Fourth, inflationary expectations were reduced. This reduction could be attributed to the new monetary policy but equally Muldoon could say that his price freeze reduced expectations too. It was not so much the policy itself but that the public believed the policy.

Thence was the GFC

If you look at the economists who predicted something like the GFC would happen – they got neither the exact timing nor the magnitude correct, of course – they were using the conventional rather than the monetarist framework. The conventional framework has proved more helpful since the GFC. Indeed Monetarists have repeatedly said policies which involve enormous increases in the stock of money will generate inflation. They have not in the short run (although they may in the long run, as the conventional framework allows).

However, stimulation from monetary policy by itself has not led to a strong economic recovery. Again holders of the conventional framework are not surprised and there have been increasing calls for a fiscal stimulus, typically by government borrowing to spend on (infrastructural) investment.

This is the context of Blinder’s paper. Let me finish by saying that there is nothing in the conventional framework which says that fiscal and monetary initiatives should be ill-disciplined. They have to be applied with care and thoughtfulness and with a pragmatism rather than ideological fervour.

Comments (13)

by Antoine on November 16, 2016

> However, stimulation from monetary policy by itself has not led to a strong economic recovery. Again holders of the conventional framework are not surprised and there have been increasing calls for a fiscal stimulus, typically by government borrowing to spend on (infrastructural) investment.

In NZ, has the National Govt not spent on infrastructure (roads, fibre), and has this not contributed to a better recovery from the GFC than in other countries?


by Murray Grimwood on November 16, 2016
Murray Grimwood

Actually no, it hasn't, 'Antoine'.

We are further in debt - jointly and severally - than we were. And even closer to the point where growth cannot even be pretended (which is what is happening now). Parliament were given the head-up a long time ago:

Our biggest failure is the fact that we listen to any kind of 'economist' - because this is a real world we are depleting, and no economist ever addresses permanent depletion of a linchpin resource. I don't remember - but stand to be corrected - even Steve Keen getting to that one.

Actually, one economist worked it out, a long time ago. Doesn't seem to get quoted much - name's Herman Daly:

And, Brian, the people who predicted the GFC best were energy-studiers. You are right about the debt being foisted on future generations - what you seem to avoid is that they are being handed a real debt (a compound one - depletion, overpopulation, pollution, too much unmaintainable and inappropriate infrastructure) which is physically unrepayable. The monetary debt is just numbers, and the system will probably fold - the GFC suggested how. The problem then - the real problem - is the amount of damage (and the lack of resources to deal with it) we are handing on.

In my humble opinion, it closely resembles fraud. Maybe we should ask Professor Geddis whether taking from future generations without full renumeration and without advocacy on their behalf, is defrauding them? And is ignorance - particurlarly chosen ignorance - a valid defence?




by Brian Easton on November 17, 2016
Brian Easton

Antoine, yes. But add also the Canterbury earthquake recovery. B. 

by Antoine on November 17, 2016

Well that's good then.


by Murray Grimwood on November 17, 2016
Murray Grimwood

"Combined, these processes render the usual indicators of economic health and prosperity at least useless and even more likely misleading"

I couldn't have put it better, Brian.


by Andrew Hart on November 17, 2016
Andrew Hart

A derail here.

I am amused to think what will happen to monetary policy in the USA now we have President Trump. The republican party has been very ambivalent about the Federal Reserve. The Governor of Texas said Ben Bernake would get a very dark welcome if he went to Texas.

That doesn't mean they wouldn't direct it to lower interest rates when it suited them such as the 2001 Twin towers attack. (why did that need a monetary stimulus ?).

We saw Key and Bill English directing Allen Bollard to reduce rates during the global Financial crisis.

Monetary policy seems like Social Credit policy, low interest rates for the most deserving.

by Brian Easton on November 18, 2016
Brian Easton

It is a bit hard, Andrew, to know how Republicans could direct the US Fed to lower interest rates, other than by replacing Janet Yellen, the chair but that cannot happen immediately.

Neither John Key or Bill English can direct the Governor of the Reserve Bank, except by a written direction tabled in parliament. (This contrasts with the earlier arrangements in which Muldoon would secretly phone the Governor.) I know on no such direction tabled in parliament.  

by Dennis Frank on November 19, 2016
Dennis Frank

"Nowadays, infrastructural investment is the big thing" wrote Brian, and it looks like that may be the primary strategic focus for the incoming US administration - if you believe one of Trump's key advisers.  Which, given the horror stories of neglected US infrastructure that have appeared in recent years, seems appropriate.

When John Banks was mayor of Auckland he spent a lot of time whining about the need to build more roads in the city.  As a minister of the Bolger govt in the nineties, he participated in its policy decisions to starve Auckland of infrastructure spending necessary to keep up with population growth & the consequent increase in traffic. I never saw anyone in the media, nor any leftist politicians, point out that he had created the problem he was complaining about.  It's as if mainstreamers lack the cerebral process that correlates cause & effect.

by Dennis Frank on November 19, 2016
Dennis Frank

Philosophically, I favour Murray's position, though I'd make the point more strongly: growth addiction is a pathology, and the advocacy of economic growth is sociopathic behaviour.  Daly was quite correct in advocating a steady-state economy.  Modelling the economy on nature always seemed sensible:  new plants emerge, grow, flourish, wane & die (after spreading their seeds to reproduce their design) just like businesses.

Economic policy that presumes perpetual growth in a finite world is mass insanity.  I suspect folks other than the greens are finally waking up to the fact, forty years too late.  The collapse of growth resulting from the gfc is just what the world needs.  The irony that this result was achieved by the collective endeavour of the top capitalists has been a source of satisfaction for me for eight years so far.  We should give the Wall Streeters a medal.  Made of plastic.

by Murray Grimwood on November 19, 2016
Murray Grimwood


I suspect the economists on Easter Island advocated 'growth in statue-building' as a remedy for there being ever-less jobs involving trees. Presumably the right wing ones thought that only a chosen few should own statues, while the left wingers thought everyone should. Maybe they even wrote short pieces explaining that this or that monetary policy would somehow fix things.



by Dennis Frank on November 19, 2016
Dennis Frank

When economist Gareth Morgan went public, a year or two back, with his opinion that God invented economists to make astrologers look good, he didn't cite his apparent source (economist JK Galbraith).  I suspect the reason predicting the future is so unsuccessful lies in the inherently indeterminacy of complex systems.

If Blinder is pointing to a way through the failure of neoliberalism, Brian may be right to suspect that fiscal policy developed with pragmatism will prove more helpful than monetarism.  I gather the failure of quantitative easing to produce the predicted inflation is due to the corporate beneficiaries being too reluctant to inject the imaginary dollars into the global economy (thereby making them real).  The exasperation with which the Fed governors regard the recalcitrant CEOs can be readily imagined.  Not much fun pulling the strings when the puppets fail to perform.

And one's reputation as a financial wizard really does depend on the alchemy actually generating real-world results.  Ok, they've staved off another crash thus far, so qe obviously works on a practical basis (regardless the lack of growth), but mainstreamers' belief in capitalism as a boundless cornucopia is what props up the system.  Trump happens only when blind faith evaporates.

Just like the inhabitants of Rapanui believed in their perpetual economy based on deforestation, eh Murray?  The good news for economists is that there's a legal precedent which, if you examine it carefully, shows how economics can actually be credibly described as a science.  It was established in the early twentieth century by the legal counsel employed by the super-successful astrologer, Evangeline Adams, one of whose clients bailed out the US govt from bankruptcy (twice, JP Morgan):

Readers ought only to delve down this particular rabbit hole if they possess an open mind, a multi-disciplinary perspective, and a natural tendency to learn from history.

by Murray Grimwood on November 20, 2016
Murray Grimwood

so qe obviously works on a practical basis (regardless the lack of growth),

Not quite, I think. I suspect it's part of the rampant upping of 'housing values' worldwide, the other reason being a lack of other valid-seeming options.

At the end of the day - and probably soon - the fiscal system will do 2008 x2, and fail. That's just numbers, albeit they will cause grief to many. But in the real world, the resources underpinning wealth will only have been depleted by one day's worth, on the day of the crash. Just how we go about further extraction, post-crash,  is an interesting quesion.

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