The establishment switches from monetary to fiscal policy

It was only yesterday that I was analysing the way that the Bank of England Governor was playing a game with the media. Today I wish to look at another issue where so many of those who told us that we needed ever more extraordinary monetary policy measures have changed their tune. For example a couple of years or so ago Governor Carney was assuring us that monetary policy was not “maxxed-out” but now he seems to be shuffling in that direction. Recently the Bank of England produced a working paper on itself which concluded it had been doing a good job.

It finds reasonably strong evidence of QE having had a material impact on financial markets, generating a significant loosening in credit conditions. There is also evidence of QE having served to boost temporarily output and prices, in a way not associated with other central bank balance sheet expansions.

Yet there is little sign of balance as the bad bits are simply ignored and put at the back of the darkest cupboard they could find.

This leaves to future research important issues such as the impact of a reversal in QE policies and the distributional consequences of QE.

Actually the Bank of England has suggested that the distributional consequences of QE are the responsibility of government as it sings along to Shaggy.

It wasn’t me……It wasn’t me

However there are a litany of issues here. Firstly the very concept of QE had fiscal elements to it. These were that it required treasury permission and that it made it cheaper for governments to borrow and loosened fiscal policy for them via lower bond yields.

Indeed you could argue that elements of what has been called monetary policy is simply a transfer to companies or another type of fiscal policy. For example this from the ECB (European Central Bank).

Corporate bonds cumulatively purchased and settled as at 28/10/2016 €37,815 (21/10/2016: €35,886) mln

Or this from this morning’s statement from the Bank of Japan.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

It is fast becoming the Tokyo Whale.

A Further Shift

Now rather than elements of fiscal policy being tucked away in monetary policy it is now emerging blinking into wider media exposure. Sadly there is virtually no challenge made about the fact that all the extraordinary monetary measures were supposed to rescue us. Below are the words of the former IMF Chief Economist Olivier Blanchard on the subject/

I think there is fiscal space in nearly every country.

Sadly they do not ask why as part of the IMF he applied fiscal austerity to places like Greece and Portugal and then did a complete U-turn on the subject. But there is something almost as extraordinary.

Take a country like Spain. They have a 100% debt-to-GDP ratio, a bit more. Investors don’t seem to be very worried. They think that is sustainable. Now suppose Spain decides to do a really big public investment program. So they decide to spend 2% more of GDP for two years. This is big. This is major fiscal expansion. With the multipliers, GDP goes up, so in fact spending 2% more, they get 1% in revenues so this increases the debt-to-GDP ratio from a 100% to 103%. Do you run for cover? No, I am quite sure they do not.

There are a whole litany of issues here. Firstly the economic news from Spain is very good right now with annual GDP growth at 3.2% so why does it need public investment as well? Spain had lots of investment pre credit crunch which led it to trouble and an economic cul-de-sac which our latter-day Dr.Pangloss ignores.

So the whole issue is whether governments spend the money right.

A bit like Portugal’s roads to nowhere. Also it is extraordinary that “Investors don’t seem to be very worried.” was unchallenged as the main new investor now is of course the ECB which has bought some 126.4 billion Euros and rising of Spanish government bonds.

Oh and on the subject of another crossover between monetary and fiscal policy I think he was right first time.

Yes. Initially I thought the proposal by [Harvard Professor] Ken Rogoff, among others, to basically eliminate cash was insane. But maybe it is less crazy than I thought.

World Economic Forum

This has entered the fray today with this from Chatham House ( originally written in September).

It is time for fiscal stimulus to gradually assume more of the burden of propping up a global economy that still looks worryingly fragile.

Really why? That seems to be missing. All we get are some political statements including an implication rather rare in these times that Donald Trump may be on one right track. What is missing is any analysis of why we are here?

The Bank of Japan (BoJ), which in 1999 became the first central bank to cut rates to zero, looks set to be the first to signal that monetary policy is approaching its frontier.

In the “lost decade” period Japan has had a lot of fiscal policy and is adding to existing stimulus as it has run fiscal deficits so we are back to “More, more, more” with no explanation of why it will work this time when it has not done so before.

Stanley Fischer

For a man who is apparently just about to raise interest-rates the Vice Chair of the US Federal Reserve spends a lot of time discussing stimulus measures! I have written before about how frequently he denies that he has any plans to introduce negative interest-rates. Well now he seems to be advocating expansionary fiscal policy.

Over the years, many economists–some of them textbook authors–have noted that expansionary fiscal policy could raise equilibrium interest rates. To illustrate this possibility, the next two bars on the slide show the estimated effect on interest rates of two possible expansionary fiscal policies, one that boosts government spending by 1 percent of GDP and another that cuts taxes by a similar amount. According to the FRB/US model, both policies, if sustained, would lead to a substantial increase in the equilibrium federal funds rate. Higher spending of this amount would raise equilibrium interest rates by about 50 basis points; lower taxes would raise equilibrium rates by 40 basis points.


So we see a shift towards fiscal policy here too. Will this Stan be like the one described by Eminem?

Well, gotta go, I’m almost at the bridge now
Oh sh*t, I forgot, how’m I supposed to send this sh*t out?
[car tires squeal][CRASH]
.. [brief silence] .. [LOUD splash]


The fundamental point is that we were led into a trap by those who argued for extraordinary monetary polices. Nearly eight years down the road there has been so little progress that we are seeing much more additional easing than any reversal or tightening. The US Federal Reserve opened 2016 hinting at “3-5” interest-rate rises this year and now we maybe will get one.  Yet the same establishment moves like the “Slippery People” sung about by Talking Heads onto fiscal policy and claims that will work.

The problem here is that quite a few countries have been seeing expansionary fiscal policy. Japan for example had an attempt at reining it back with the 2014 consumption tax rise but now adds ever more and the UK is a lower scale example but similar in principle. Germany has taken the other path and managed to apply it to some of the weaker Euro area economies but deficits have continued. So we are told stimulus is a good idea but we get no explanation of why it has not worked so far.

Meanwhile we get the occasional flicker from the bond vigilantes as bond yields rise but lets face it even 1.27% for a ten-year UK Gilt is historically very cheap and compared to inflation prospects may well be not far off insane.



18 thoughts on “The establishment switches from monetary to fiscal policy

  1. Hello Shaun,

    Its going to be painful , and painful to watch . Having stopped a 1930’s style depression by pumping up assets and bailing out TBTF Banks without a plan to deflate them or separate high street banking from the stock exchange ( Glass / Steagall) .

    We are set up now for a 30 year depression .

    Frankly is it too late to let ’em go ?

    Now the governments are buying stocks of companies , to help the Banks again ??

    Nothing I’ve seen or heard addresses the issues .

    So grab a bag of popcorn and pull up a chair – this is a good show , lots of clowns so far 😉


    • Forbin, aren’t clowns scary nowadays?

      Shaun, how much of a fiscal stimulus do they want? Japan’s deficit was 6% of GDP in 2015 and ours is over 5% – could they have not noticed or are they wilfully blind?

      • I don’t think they know . What ever they propose , if it doesn’t work , they will claim if they had done nothing it would have been worse ….

        and now as the first attempt didn’t work they will need more , much much more…….


  2. Great blog, Shaun. It inspired me to add a few new definitions for your dictionary of modern financial speak:
    1.”This leaves to future research important issues such as the impact of a reversal in QE policies” : means “we haven’t a clue as to how to get out of this”
    2. “We need more fiscal stimulus” : means QE isn’t working and we haven’t a clue why not
    3. “Sadly they do not ask why as part of the IMF he applied fiscal austerity to places like Greece and Portugal” means “who on earth cares about Greece and Portugal?
    4. “Investors don’t seem to be very worried”. Translation : we have rigged the market.
    What a bunch of jokers we have in control of our economies…

    • James I’d posit that

      “Investors don’t seem to be very worried”.

      means they know heads they win , tails the tax payer bails them out

      Morals ?

      for mere mortals I’m afraid


      • I have looked up the word “morals” in my banking dictionary and I think that you must have misspelt it, as it is missing. Did you mean “masters of the universe”?, as that is there in black and white. The problem with the dictionary is that the whole thing is dominated by the 74,000 pages devoted to the word “bonus”.

  3. Great blog, Shaun, as always.
    Nowhere has the pendulum towards more use of fiscal policy swung more dramatically than here in Canada. A balanced budgeter at the beginning of the 2015 federal election campaign, Justin Trudeau became a born-again deficit-lover at the end of August, about a month after the Parliamentary Budget Officer (PBO) published a report suggesting that the $1.4B surplus the April 2015 budget had forecast for 2015-16 would actually be a $1.0B deficit, based not on his own best judgement, but on parameters supplied to him by the Liberal Finance Critic, Scott Brison, the same politician who Carney and his family vacationed with in the summer of 2012. In an interview with CTV (formerly Canadian Television, now Clinton Television) reporter Steve Murphy, Trudeau confessed that the PBO report was responsible for his road-to-Damascus conversion to the need for major fiscal stimulus.
    Now it appears that it was all based on a misapprehension. Earlier this month, the Department of Finance announced that the final estimate for 2015-16 showed a deficit of $1.0B, suspiciously identical to that PBO forecast, rather than the $5.4B deficit that Finance Minister Bill Morneau had forecast in his March 2016 budget. The PBO’s Economic and Fiscal Outlook, published October 24, indicated that absent Liberal fiscal measures, there would have been a $2.9B surplus in 2015-16. (A lot of the difference between the April 2015 budget forecast and the higher PBO estimate is due to higher corporate tax revenues, the fruit of initiatives launched years earlier against corporate tax evasion.) This aspect of the PBO report received surprisingly little attention from the Canadian media, especially given that Trudeau went through the 2015 election campaign telling voters that we were in deficit, and Stephen Harper had put us there. We now know that we weren’t in deficit at that stage of the 2015-16 fiscal year and if we ended up in deficit it was only because the new government put us there.

    • Hello Andrew,

      Can you clarify that for me?

      you mean they spent more and it didnt work ?

      perhaps they didn’t spend enough …..


      • Hello, Forbin. I will quote you the relevant parts of the PBO report (the PBO was created by PM Harper in 2006 and is quite similar to the Office for Budget Responsibility in the UK): “In April, the Government estimated that its new tax and spending measures would cost $3.9 billion in 2015-16. This was primarily attributable to the Government’s decisions to enrich Veteran’s Benefits ($3.7 billion) and roll-back public sector sick leave reforms ($0.9 billion). Absent these new initiatives, the Government would have reported a $2.9 billion surplus in 2015-16.” So the extra spending related mostly to increased transfer payments but also to increased public employee compensation. It wasn’t really spending that would help grow the economy much although if you listened to the government’s rhetoric you would think that all their new spending was going to growth-enhancing infrastructure spending.

  4. Shaun, on a different topic, do you have any idea why Carney would want to stay on until 2019 but not until 2021? Is there some big international economic position that would open up about that time?

    • Hi Andrew

      I know expat has already replied but just to add that the story doing the rounds over here is that it will be in time for the regional elections in Canada. Personally I think that he was put on a relatively short string ( i.e one extra year) and will get the others I still think he wants if the government approves of what he does in the meantime. That is the opposite view to the Financial Times which if history is any guide is a very good place to be.

  5. 1.27% yield is barking mad. Using 1990s textbooks it computes to negative real return without any allowance for risk. It only makes sense if you purchase the bonds using counterfeit money or dirty money which needs laundering. Those responsible should be rocking to Elvis, jailhouse rock.

    • “it only makes sense if you purchase the bonds using counterfeit money or dirty money which needs laundering.”

      isn’t that the definition of QE and QEE ?


    • ” It only makes sense if you purchase the bonds using counterfeit money or dirty money which needs laundering.”

      Or, if spending someone else’s money to perpetuate a system from which they benefit.

      Fiduciary duty joins moral hazard as historical precepts.

  6. We have a large PSBR at a time of reasonable growth.

    We already have slowing growth and may well go into recession in the next two years.

    There are secular trends pushing spending higher (pensions, health spending).

    The debt interest burden is already significant even at current record low interest rates.

    There is talk of spending even more on infrastructure.

    You do not have to be a raging pessimist to see the national debt being substantially higher in ten years time than now.

    If interest rates increase only marginally the effect on spending will be substantial.

    And this is the answer to the nasty side effects of monetary policy?!

    This is not the answer; it is just one more indication that there is no answer.

    • Hi Bob J

      Or to put in another way the monetary tin can may finally catch a break but only because the establishment has switched to kicking a can with fiscal policy on it. Actually let me do that Hitch-hikers Guide to the Galaxy style FISCAL POLICY on it…

  7. Hi Shaun, remember me questioning you about this shift a few months ago? It is emanating from the IMF and the global authorities appear to be listening and doing the IMF’s bidding.

    On the Fed you are unfair, they said the expected rises would be “data dependent”. I would venture that by September there was enough data to justify a rise except they have a joker in the pack called the Presidential election which I guess has them spooked.

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