Overly Tight Macroeconomic Policy


The level of public debt is high by historical standards in many countries.  Central banks have set their nominal interest rate targets to extraordinarily low - sometimes negative - levels.  Despite these historical comparisons, though, macroeconomic outcomes tell a clear story: Macroeconomic policy remains much too tight in the US and around the world.  

In terms of monetary policy, inflation remains low, and is expected to remain low for years.  Indeed, financial market participants are betting that most major central banks will fall short of their inflation targets over the next decade or two.  Nonetheless, those same central banks (including the Federal Reserve) continue to communicate a strong desire to "normalize" - that is, tighten - monetary policy over the medium term.   

In terms of fiscal policy, many governments are able to borrow long-term at unusually low real interest rates.  They could invest those funds in needed physical and human infrastructure. Or they could return the funds to their citizens through tax cuts - tax cuts that could be tailored to incentivize physical investment or R&D.   But the relevant governments instead continue to emphasize the need to further restrict the level of public debt.  

Economic policymakers can do better.   The key is to focus a lot more on the question of how to use available policy tools to achieve desirable macroeconomic outcomes, and a lot less on historical empirical regularities.   Just because debt is high by historical standards doesn't mean that governments cannot make their citizens better off by issuing more debt   Just because nominal interest rates are low by historical standards doesn't mean that central banks can't achieve their objectives more rapidly by lowering them still further.  

We are only beginning to see the impact of tight policy choices on our economies.  We all know what has been happening in Spanish and Greek labor markets.  But even in the US - which supposedly has a near-normal labor market - the fraction of men aged 25-34 who do not have a job is over 50%(!) higher than it was in 2007.   Given these kinds of macroeconomic outcomes, it should not be surprising that we see increasing signs of social fracturing and disengagement in many developed countries.

I've said that economic policymakers can do better.  Indeed, I increasingly believe that they must do better. 

N. Kocherlakota
Rochester, NY, January 2, 2016

Follow me on Twitter @kocherlakota009.  Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).