The Pivot To Fiscal?

The final Mario Draghi press conference had him underlining the importance of fiscal policy. Since I am supposed to be working on my slides for my presentation in the panel "MMT: Who is Listening?", one might argue that it looks like a lot of people. However, it is unclear how significant the shift in opinion is from a practical perspective.


My long-held argument is that the only way we will get a secular bond bear market is a switch towards fiscal activism. (Note the word "secular", we certainly can have cyclical bond bear markets.) The usual conventional policy prescription, which would be to use non-targeted aggregate demand management (across-the-board tax cuts, mailing everyone a cheque, whether it is a universal basic income or "helicopter money") is going to generate the most nominal demand for the least amount of job creation. One might imagine that such policies would be inflationary, as was argued in the 1960-1970s. (Disclaimer: I am not interested in debating what the "true" cause of the 1970s inflation was, I am just noting the arguments made by Minsky, and presumably others.)

As a result, for anyone interested in bond market economics, a shift towards fiscal activism needs to be on the analytical radar. If I had any commercial sense whatsoever, I would be pounding the table that bonds are doomed, and telling people to buy premium-priced books on how to survive the coming bond apocalypse. Unfortunately, I do not see any particular need to be excited about these developments.

In the absence of a recession, at most we will see some countries launch relatively tiny fiscal stimulus packages. It is a good bet that any fiscal packages will have a low multiplier, as was the case for the Trump tax cuts. However, these will be at least partly offset by the drag of negative interest rates. The drag comes from two channels: the loss of interest income from government bond holdings, and the disastrous effects that low discount rates have on pension funds and savers.

In the absence of a recession, it is hard to see how fiscal stimulus is a political winner in the Euro area. Governments still face treaty restrictions on debt and deficits, and they have seen how European institutions crucified Greece. Meanwhile, macroeconomic objectives have been redefined to only look at the inflation outcome. Telling people that the inflation rate ought to be 2% instead of 1.5% is not going to drive a lot of support for a political programme.

The difference might show up in a recession; there might be a greater willingness to increase spending in a downturn. However, it is a near certainty that once the dust settles, fiscal conservatives would use the increase in government debt levels that is an inevitable consequence of the automatic stabilisers as a reason to cut welfare state spending. They are not going to care what some liberal-left academics or central bank economists say.

In summary, I would argue that the sclerotic growth of the developed economies is the result of a wide range of policy decisions, as well as structural forces like the drag from the baby boom generation and the rich hoarding financial assets. A greater willingness to mail cheques to people during a once-per-decade recession is not going to move the needle versus those forces.

MMT Navel-Gazing

From a Modern Monetary Theory (MMT) perspective, this creates a bit of a marketing problem among the broad public. Since the prominent neoclassical talking heads are no longer arguing that monetary policy can solve all macroeconomic ills, an easy point of differentiation is gone. Instead, one is stuck with a less attention-getting narrative: "Sure, we agree that fiscal policy ought to be emphasised more, but the proposed policy programmes are structured badly." Since nobody has a good model that can accurately predict the outcomes of the programmes, that is a harder story to sell. The neoclassicals will "win" purely by relying on society's deference to credentials. Furthermore, a good portion of the political spectrum will ignore this debate as being yet another left-wing internecine squabble.

The alternative is to push a policy programme that is associated with MMT, such as a Job Guarantee. However, my argument is that politics is about coalition building, and the reality is that it would need to drag along a wider group of supporters. As a result, I expect that a Job Guarantee would need to be "discovered" to be implied as a "optimal policy" by neoclassical economic theory in order for it to be an easy sell.

Conversely, the theoretical squabbles between MMTers and neoclassicals will remain of interest to the tiny portion of the population that has an interest in economic theory. For a lot of that audience (such as fixed income analysts), there is a professional bias to stay away from political economy debates. However, the way in which MMT needs to be marketed to such people is quite different than it would for political activists. (To what extent my presentation will have a theme, that is probably it.)

(c) Brian Romanchuk 2019