Fiscal and Monetary Interplay


Duncan Black on monetary policy: “if there’s the possibility of any help the Fed should be doing more, and the fact that they haven’t tried is scary, but I still don’t think that all we need to do as have Bernanke flip the switch and everything will be great.”

A couple of responses to this. One is that in this point, we’ve developed a sufficient quantity of compounding problems that no one thing in particular is going to fix them all. The other is that I think there’s too much focus on making everything “great” when “better” would be good enough. Narayana Kocherlakota is a monetary policy skeptic who’s also a fiscal policy skeptic but as I’ve pointed out before even according to his own analysis monetary measures should be able to reduce unemployment by one or two percentage points.

The larger issue is that there’s an interplay between monetary and fiscal issues. Anything we do in terms of fiscal policy or exchange rates that works will end up raising the price level. Which means it will only work if monetary authorities accommodate it. If the FOMC’s attitude toward the recession is to view it as a welcome opportunity for opportunistic disinflation then fiscal policy can’t accomplish much. More generally, I think there’s evidence that some FOMC members are just feeling generally antsy about the “unconventional” measures undertaken in 2008 and are eager to respond to any sign of improving conditions with monetary tightening. Paul Krugman did a funny post on this circularity problem and Scott Sumner has a longer take, but it underscores the fact that monetary cooperation is essential to making anything work.