Fiscal expansion is the dog that hasn’t barked, said Governor of the Bank of Israel Prof. Stanley Fischer in his speech on "Fiscal Policy and the Great Recession," at the 2012 Spring Meeting of the IMF and World Bank yesterday.
Fischer began his lecture by saying, "In the 1990s, critics - some of them friendly - often said that "IMF" stood for "It's Mostly Fiscal". That was not true then, and it is not true now, but the IMF's focus on fiscal policy, both in research and in its programs, has intensified in the last few years.
Fischer continued "There has also been a great deal of thought and action on the monetary and financial side. We, the central bankers, have revisited the liquidity trap, and now understand that reaching an interest rate of zero is not the end of expansionary monetary policy, for beyond that lies quantitative and credit easing, the modern Operation Twist, and more. Facing massive recessions, many central bankers have had to rethink inflation targeting - though that has been less of a problem for those who are flexible inflation targeters. Watching the Fed in action, we understand that the central bank is not only the Lender of Last Resort, it is also the Market Maker of Last Resort."
Fischer responded to critics of fiscal expansion in the face of recession and high deficits. "When the global crisis began, and expansionary fiscal policies were implemented in most countries, there was a general fear or belief among many economists - I among them - that maintaining an expansionary fiscal policy without being able credibly to commit to an exit strategy, would at some point raise long-term real interest rates and cut off the recovery. However that has not happened to any significant extent in the US, where the debate has been most vigorous."
Fischer noted, "During the decades leading up to the Great Recession, the emphasis on fiscal policy as a stabilization tool declined - at least in the advanced economies - relative to the emphasis on monetary policy. This was in part due to the Great Moderation - the decline in and greater stability of the inflation rate during the 1990s and the first half of the last decade; in part due to the fact that fiscal policy decisions are unwieldy and typically slow. However, the pendulum has swung back following the experience of the last few years, not to the view that fiscal policy should be the dominant stabilization tool, but rather to the view that both monetary and fiscal policy should be used actively in stabilizing the economy."
He concluded on this point, "With regard to inflation: serious inflation is not likely to return until aggregate demand strengthens and unemployment rates come down," but cautioned, "But before we take too much comfort from the current situation, we should not forget that market opinions about the credibility of policy frameworks can change rapidly, and hence so can the growth prospects of an economy."
Fischer warned, however, "Sustained large fiscal deficits, leading to large public debt ratios, are bad, likely to have a negative effect on growth, and also on the capacity to use active short-run fiscal stabilization."
As for the crisis in the eurozone, Fischer also rebuts critics who claim that neither governments nor the IMF have growth strategies for troubled countries. "The real problem is not that the IMF does not have a growth solution, but that for countries deep in a fiscal hole, neither the IMF nor anyone else has a sustainable and fast growth solution. To say this is not to underestimate the pain and human and social tensions caused by the extremely difficult economic situations in the European countries in distress. Nor is it to say all solutions are equally painful. Rather it is to say that we have to find the best solutions we can, and keep searching for better ones," he said.
Fischer concluded, "Coming from a central bank in the city in which it was announced 2500 years ago that there is nothing new under the sun, I should conclude by saying that we long ago understood everything I have said today about fiscal policy, said Fischer, adding, "But that is not true. In the last few years we have learned a great deal about the way fiscal policy works, and about how to use it to better advantage. In the future in its country programs and in its country surveillance, the IMF will pay more attention to the use of fiscal policy as a stabilizer in normal times. It will pursue coordination between monetary and fiscal policy - for it is clear that the low interest rate policies across the term structure of major central banks continue to play a central role in the stabilization process."
"When better times return, the IMF will have to continue to warn us that complacency must be avoided, and it will have to preserve its ability to innovate to deal with new problems, some of which are developing as we speak, and of whose identity we are not yet aware."
Published by Globes [online], Israel business news - www.globes-online.com - on April 19, 2012
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