By a complete accident I found a online debate about fiscal policy versus monetary policy in Australia. One of the commentators – “Grim23” – surely is a convinced Market Monetarist. I thought what he is writing is so good that I want to reproduce it here on my blog – I hope he won’t mind…

Here is Grim23 going back and forth with somebody – I don’t care who the other guy is and this is only Grim23’s (unedited) comments:

…How can fiscal stimulus boost demand when the central bank is targeting inflation? If interest rates are above zero, the central bank should have no problem hitting its inflation target. if they fall to zero, there is a case for fiscal stimulus, but monetary policy would still be effective.

Monetary policy in the US, UK and Europe has been extremely tight since mid 2008. Australia had much more effective monetary policy than Britain during the crisis. Fiscal policy has nothing to do with it. Every serious new keyensian macroeconomist will tell you that if interest rates are above zero the fiscal multiplier is zero.

…If you admit that monetary policy was effective, then by definition fiscal policy is ineffective and wasteful. If monetary policy can hit its target of 2-3% trend inflation, what’s the point of fiscal stimulus?

While we are quoting people, how about prominent Keyensian economist Brad Delong:

“Here is the point: an optimizing central bank that cares only about inflation and unemployment because it does not find itself at the zero nominal lower bound and does not fear engaging in nonstandard monetary policy will engage in full fiscal offset: it will take care to make sure that if fiscal policy becomes more stimulative then it will make monetary policy less stimulative by the same amount.”

Tim Harcourt did not take the monetary offset into account. In fact few studies take it into account when they really should.

…Ultimately the point is that because fiscal stimulus boosts aggregate demand, inflation must also rise as well as GDP. If the RBA is targeting inflation (or preferably nominal GDP) then any fiscal stimulus is cancelled out by monetary policy, leaving a “fiscal multiplier” of zero.

…1. You agree with Brad Delong’s quote which means you admit that an inflation targeting central bank will engage in full monetary offset. That means that the fiscal multiplier is zero.

2. In terms of “saving Australia from recession”, inflation and unemployment are the only outcomes that matter. If you agree with the Brad Delong quote, I can’t see how you can still claim that fiscal stimulus boosted aggregate demand and saved the economy.

I would say that most of the countries hit are in the Eurozone, so big fiscal stimulus in one country would work, because each country doesn’t have its own monetary policy. Also, most central banks weren’t brave enough to do unconventional stimulus when interest rates hit zero, so fiscal stimulus would have had some effect, as central banks were no longer really “aiming” to hit a target. Thats why there was some correlation

If you want some links, then the best blog for this is The Money Illusion.

Here’s a post on monetary offset. Read point 6 in particular. Fiscal austerity is deeper in the US than the Eurozone, but monetary policy is easier. US is growing faster. Money wins. http://www.themoneyillusion.com/?p=21008

Here’s a couple of posts about Australia, talking about the stable growth rate of NGDP. Australia has a much higher trend growth rate than other countries, which put us in a better position to start with.

http://www.themoneyillusion.com/?p=12985
http://www.themoneyillusion.com/?p=20684

Ultimately tight monetary policy causes slow NGDP growth, not financial crises or fiscal austerity, and only easy money can support faster NGDP growth, not fiscal stimulus.

Yes, fiscal stimulus can “work”, but only because the central bank allowd it to. Do you really think the RBA would let Australia fall into recession? Particularly when they started off from a much better position than other central banks, with interest rates not even close to zero here. Monetary stimulus would have done the job anyway, without any waste or extra debt. That’s why fiscal policy never “saved” us.

Here’s some more posts discussing fiscal stimulus and monetary policy in general:

http://www.themoneyillusion.com/?p=874
http://www.themoneyillusion.com/?p=2512
http://www.themoneyillusion.com/?p=5776

Fiscal stimulus in unnecessary. Money always wins

…Your argument simply isn’t consistant with standard macro theory; the fiscal multiplier is zero under inflation targeting. Even keynesians like paul krugman, brad delong, michael woodford, ben bernanke, greg mankiw, frederik mischkin and christie romer will attest to that if interest rates are positive.

In Australia interest rates never got close to zero.

You argument does not support recent events, with no correlation between “austerity” and economic growth. Nor have you refuted any of the arguments made in the links.

While Australia recovered quite quickly, other nations have done better since. Germany is one example, where the fiscal stimulus was average but growth has been faster than Australia’s since 2010.

There is still not sufficient evidence that Australia would not be in the same position were it not for the fiscal stimulus. I find it hard to believe that the RBA would have let Australia fall into recession without fiscal stimulus, nor do i doubt that it had the means to stabilise nominal GDP growth, especially with the fortunate position of positive interest rates.

I think the fact that we were the only country with interest rates which never went below zero is just as persuasive as your argument about the relative size of the stimulus. I think it is more persuasive given the wider context and evidence. I think your mistake is assuming that correlation implies causation.

…As you should know, there is no meaningful difference between 0.5% and zero percent benchmark rate.

If famous nobel prize winning economists can talk about the federal reserve having a “zero rate policy”, then that technical detail should not be important. that just shows how out of touch you are with the sophisticated macro debates going on at the moment.

The point is rates can go no further in countries other than poland and australia. I have provided you with plenty of reasons why your figures don’t support your clsim of the effects of fiscal stimulus. In your reply you dont even mention the links, or reply to all of my criticism. Either you didn’t read them, or you can’t refute them. But they explain Australia’s and Poland superior performance without reference to fiscal stimulus. I suggest if you want to learn a little macro, you should read them. What i am saying is not controversial, every single new keyensian economist and every market monetarist will tell you the same thing!

As for Germany, the world bank data said it grew faster in 2010 and 11. My links are sound.

I have no clue who Grim23 is, but he is good good and he can write a guest post on this topic for my blog any time he wants.

PS Grim23 unfortunately didn’t quote this post on Australian monetary policy why it was the “Export Price Norm” that really has kept Australia out of recession.

PPS I believe that RBA recently has allowed monetary conditions to become too tight and the sharp slowdown in NGDP growth over the past year is somewhat worrying.