Fiscal policy was on the march at Jackson Hole

Over the weekend many of the world’s central bankers were guests of the Kansas Federal Reserve in Jackson Hole Wyoming. In terms of location I believe it was chosen because a previous chair of the US Federal Reserve Paul Volcker was a keen fisherman. However this late August symposium has become one which influences the economic winds of change as central bankers discussed easing policy in response to the credit crunch and in more recent times a speech was given on what were perceived to be the wonders of Forward Guidance. Michael Woodford was very clever in suggesting to a group who wanted to believe that they could influence events via mere speaking or what has become called Open Mouth Operations.

I shall argue that the most effective form of forward guidance involves advance commitment to definite criteria for future policy decisions.

They are still at that today to some extent although the definite criteria theme has mostly been ignored especially in the UK where it went wrong for the Bank of England almost immediately.

What about now?

The problem for the central bankers is that to coin a phrase that monetary policy may be “maxxed out” or as it is put more formally below.

despite attempts to set economies on normalization paths after the Great Recession and the Global Financial Crisis, the scope for countercyclical monetary policy remains limited: benchmark interest rates have continued to hover near or even below zero.

This is from a paper presented on Saturday by Alan Auerbach and Yuriy Gorodnichenko of the University of California Berkeley. In their conclusion they go further.

Although economists do not believe that expansions die from old age, the prolonged U.S. expansion will end sooner or later and there is serious concern about the ability of policymakers in the United States and other developed countries to fight the next economic downturn. Indeed the ammunition of central banks is much more limited now than before the Great Recession and it is unlikely that expansionary monetary policy can be as aggressive and effective as it was during the crisis.

Actually if monetary policy had been effective the paper would not be necessary as the various economies would have responded and we would be on a road where interest-rates were say 2/3% and central bank balance sheets were shrinking, In reality such interest-rates to quote Star Wars are “far, far away”.

Fiscal policy

If monetary policy has less scope for action then our central planners face being irrelevant so they will be grasping for an alternative and fortunately according to our two valiant professors it is at hand.

With tight constraints on central banks, one may expect—or maybe hope for—a more active response of fiscal policy when the next recession arrives.

The problem with this the familiar theme of the “bond vigilantes” turning up.

It is certainly conceivable (see e.g. Aguiar et al. 2017) that a significant fiscal stimulus can raise doubts about the ability of a government to repay its debts and, as a result, increase borrowing costs so much that the government may find its debt unsustainable and default.

This of course was last seen on a major scale in the Euro area crisis particularly in Greece, Ireland, Portugal and Spain. Of course the European Central Bank intervened by buying bonds and later followed another part of Michael Woodford’s advice by introducing a larger and more widespread QE or bond buying program. So we have seen central banks intervening in fiscal policy via a reduction in bond yields something which government’s try to keep quiet. We have individual instances of bond yield soaring such as Venezuela but the last few years have seen central banking victories and defeats for the vigilantes. In another form that continued this morning as I note that a North Korean ballistic missile passed over Japan but the Nikkei 225 equity index only fell 87 points presumably influenced by the way that the Bank of Japan buys on down days.

What about more overt fiscal policy?

Apparently this can work.

We find that in our sample expansionary government spending shocks have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs (interest rates, CDS spreads). This result obtains especially when the economy is weak. In fact, a fiscal stimulus in a weak economy may help improve fiscal sustainability along the metrics we study.

Indeed this for them is essentially a continuation of past work.

This constraint on monetary policy coincides with a resurgence in activist fiscal policy (Auerbach and Gale, 2009), which has moved from a focus on automatic stabilizers to a stronger reliance on discretionary measures, reflecting not only necessity but also growing evidence of the effectiveness of such policy to fight recessions (e.g., Auerbach and Gorodnichenko, 2012, 2013).

Also I am reminded that we should never believe something until it is officially denied.

Given the nature of the sample analyzed, our results should not be interpreted as an unconditional call for an aggressive government spending in response to a deteriorating economy.

The UK

Jonathan Portes who is an advocate for fiscal policy has written this in Prospect Magazine.

The answer is very technical—£100 billion or so of the extra debt relates to the Bank of England’s Asset Purchase Facility. Briefly, the BoE makes loans to banks and buys corporate bonds, in return for cash (“central bank reserves”).

He suggests that as this has been mostly ignored( not on here) we could borrow for other purposes.


There is a fair bit to consider here as I note that North Korea has done its bit as bond markets have risen today and yields fallen. For example the UK ten-year Gilt yield has dropped to 1% giving us food for thought with inflation at either 2.6% ( CPI) or 3.6% ( RPI). A clear factor in the expected push for fiscal policy is that bond yields are so low as conventional UK Gilt yields do not go above 1.7% and other countries such as Germany Switzerland and Japan can borrow for much less. Against such bond yields theoretical analysis is always likely to look good so the first issue is whether they would be maintained in a fiscal expansion. Or to put it another way are central banks being asked here for a type of QE to infinity?

Next is the issue of how a fiscal stimulus is defined as for example countries which have stopped borrowing and run a surplus like Germany and Sweden are relatively rare. Most have continued to borrow and run annual fiscal deficits albeit usually declining ones. Thus the ballpark seems to have shifted to increasing deficits rather than having one at all which is the sort of “junkie culture” road that monetary policy went down. If we look back to a past advocate of fiscal stimulus John Maynard Keynes he was also someone who suggested that when the growth came there would be a period of payback.

What we also find ourselves mulling is the difference between the specific and the general. I am sure that everyone can think of a project that would provide plenty of benefits and gains but as we move to a more generalist position we find ourselves facing a reality of Hinkley Point and HS2. To be fair our two professors do acknowledge this.

Bridges to nowhere, “pet” projects and other wasteful spending can outweigh any benefits of countercyclical fiscal policy.

As a conclusion the Ivory Tower theory is that fiscal policy will work. There are two catches the first is that if they were even regularly right we would not be where we are. The next is that on some measures we have been trying it for quite some time.

In reality the establishment seems likely to latch onto this as we have discussed before.




14 thoughts on “Fiscal policy was on the march at Jackson Hole

  1. You can be certain of one thing, Shaun. If there is academic support for fiscal policy to be used when QE is maxxed out, then governments will use it to kick the can just that last yard down the road

    • Hi James

      Yes this is a very cute play in some ways by the Professors as I am sure that Michael Woodford’s career headed strongly upwards after his policies were adopted. As for the rest of us these things tend to survive longer than one might ordinarily think but will that be the end of the can kicking when both fiscal and monetary policy have empty ammunition lockers?

  2. There are two points I would make about your piece.

    The first is that, in the Anglo-Saxon World at least the neo liberal philosophy still holds sway and there is a muted drive at the back of much policy to shrink the state. Using fiscal policy goes against this and many will be very reluctant use it for this reason, despite the fact that many are now doubting the beneficence of neo liberalism.

    The second is that there are strong reasons for using fiscal policy where we are at the ZLB – where we have been for nearly ten years – and there are many upsides to doing so. However, as Herr Schauble has said, the use of fiscal policy has to be tempered by the argument that the Schwabian housewife would raise in that without prudence in spending the household budget quickly comes under strain and fiscal policy can be, and frequently is, a cop out, an easy way out of difficulties. It wouldn’t be so bad if we did indeed fix the roof while the sun is shining (run surpluses to counteract the deficits run during recessions) but we seem very reluctant to do this and what we end up with is a gradually expanding stock of public debt, the servicing of which, even at low rates, will, sooner or later impact on the delivery of public services.

    The central bankers may well be now seeing the virtues of fiscal policy but many politicians will not. That we appear to have to make a choice between dishonest politicians and dishonest central bankers perhaps explains why we are in so much difficulty.

    • Hi Bob J

      I take your point but I think that it is only certain sectors of the state that they want to shrink and others seem to tend to grow. Depending what happens with North Korea ( and longer-term China and Russia) we could see defence budgets climbing again. This is happening in Japan for example and I suspect the Ballistic Missile Defence Programme there will be getting a boost.

      The sad part of your final paragraph is that conclusion was essentially reached in the Yes Prime Minister episode on the Bank of England some 30 or so years ago.

  3. Marc Faber summed up this predicament when the Fed started on the road to QE, and predicted it would lead to QE99 and QE to infinity. He wasn’t joking as once this path is taken, there is no way back. And that is where we now find ourselves, a form of perverted Keynsian economics whereby stimulus isn’t provided as a temporary kickstart to the economy as intended by Keynes, but merely to keep alive an economy saturated with debt and to support bubbles previously created to prevent the system from correcting to where it should be.

    Von Mises sumed up the alternatives perfectly, and this is what central bankers are pointlessly fighting to prevent:

    “The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

    Looks like “later” has been chosen, after all the alternative would be for aset prices and more importantly, house prices(ie the UK economy) to collapse.

    The USA has the perfect president for such a scenario, the king of defaults, he has gone bust 5 or six times and thinks he can negotiate away any obligations by re-financing, this time it will be with the dollar and the bond market, massive devaluations on the card for the dollar? Higher rates anyone?, and to keep the debt monkeys in their overpriced shoeboxes regualr helicopter drops of money to pay for it all, what do you think your savings and pension will buy after all that lot???

    And we have Mark Carney, so nothing to worry about there then, the housing market will be saved at any cost. The cost being an entire generations savings and pensions.

    • “Marc Faber summed up this predicament when the Fed started on the road to QE, and predicted it would lead to QE99 and QE to infinity. He wasn’t joking as once this path is taken, there is no way back. And that is where we now find ourselves,”

      And yet we have the Fed that stopped any further QE months ago and are now on the cusp of starting the unwinding of QE, if not in September ten definitely in December.

      “merely to keep alive an economy saturated with debt and to support bubbles previously created to prevent the system from correcting to where it should be.”

      Thee is no place where the system should be, only where it is. Your idea and another person’s idea of where the system should be can differ wildly, so what is the right place where it should be? Authorities would argue that as long as the economy grows sufficiently to service it’s debts then it is where it should be. This argument is a strong one.

      You would presumably argue there should no or very little debt as in times of a downswing with mass unemployment/falling real wages a heavily indebted system will collapse under the strain of trying to service it’s debt load. This is an equally strong argument.

      “The USA has the perfect president for such a scenario, the king of defaults, he has gone bust 5 or six times and thinks he can negotiate away any obligations by re-financing, this time it will be with the dollar and the bond market, massive devaluations on the card for the dollar? Higher rates anyone?”

      I wouldn’t be so sure, the debt ceiling is fast approaching being breached and he has shown no interest in opening negotiations for it to be increased. If it isn’t increased then we can all find out about a collapsed dollar and sky high rates globally.

  4. do you think the CB have finally woken up to the fact that in saving the TBTF banks they have in fact strangled the real economy that the said TBTF banks needed ?


    • Hi Forbin

      I think that they are so focused on “the precious” that they have not. After all many numbers have improved such as unemployment so they have some backing but of course when we move to real wages a different story emerges. Yet each year we get told this time (on real wages) will be different…

  5. The Donald’s great infrastructure plan & much else do not seem to be working out all that well & in any case it appears to me at least that the building part, would be given over to the usual suspects who just have to dip their beaks & Silicone valley appears to be not quite the wunderkind it was supposed to be with Uber in particular struggling.
    Perhaps some are hoping for a new Steve Jobs type genius to save us all, although as Mark Blythe & more lately Yannis Varoufakis pointed out, the different elements of the i-phone were all developed in the public sector, which Steve had the talent to see the potential for.
    Public & Private complimenting each other – it strikes me that when it tilts too far to the advantage of either side it doesn’t work to the benefit of all, but perhaps I am just old fashioned.

    • Hi Stevie

      You are right that we seem to have heard little about the Donald’s infrastructure plan. Maybe if there was a populist wave to help Houston then the Donald would expect positive publicity and pump money into the area. The other possibility is defence spending for a fiscal boost.

      Let me add to your point these days are the banks in the private or public sectors?

  6. Shaun,

    I’ve read your insight but I still have no idea what they are going to do…? I guess the CB’s have only got more QE to use if theings get tough. Maybe they willl have a go at pressuring Govt to do fiscal. Donald can build a wall to keep the Mexicans out and we could build a wall to keep Europe out, encircling Hinkey Point and HS1.5 (to watford).

    So that is my prescription, a limp wristed fiscal expansion, with bonds protected witht he threat of more QE, where they will have ot literally buy their own QE since all the corporate assets are already purchased.


    • “I’ve read your insight but I still have no idea what they are going to do…? ”

      No. they don’t either, the point of Jackson Hole isn’t so much to make agreed policy decisions as to float different ideas for discussion amongst the global CBers and elites.

  7. You know that we are truly stuffed when machine code is worth over $4000 and rising when a taxi app is worth billions of dollars…..when a car company that loses thousands on each car it manufactures has a market cap much bigger than long established world leading manufacturers the clues are there that the game is nearly up.
    The economies of the western world are running on the fumes of arrogance…when only 3% of a currency exists in physical form and almost all of the expanding money supply is created as debt out of thin air….why does anybody pay any attention to these leaders of organised crime

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