Wanted: Goal-Oriented Non-Ideological Fiscal Policymaker
Once upon a time, households and businesses had confidence in the long-run track of aggregate demand. That confidence was grounded in central banks. If there was an adverse demand shock that was expected to push down on prices and employment, everyone knew that the central bank would cut rates by a lot. That move might come a little late and be a little weak, and so it might not eliminate the recession completely. But it would allow aggregate demand to recover reasonably rapidly. As a result, over the long haul, whoever was President or in Congress, the course of the economy was thought to be defined largely by its technological capabilities.
That confidence is gone. Central banks are widely perceived to be operating near the limits of their ability or willingness to help their economies. (That’s not my own perception, but it is a commonly held one.) They are expected to stay near those limits for many years. Who does the public expect to buffer the economy against adverse demand shocks? It should be no wonder that there are great uncertainties about the medium-run behavior of our own economy and the world’s. Of course, that uncertainty is, in and of itself, a large drag on the current performance of the economy.
We need a government that is committed to removing that uncertainty. This means that we need a government that is firmly committed to using the power of fiscal policy to fill the void that is being left by monetary policy. That government should be willing to using fiscal policy tools to achieving an appropriate growth outcome in the absence of shocks. But, even more importantly, it should communicate its willingness to use the tools of fiscal policy to offset adverse shocks to the economy. In that way, it can reduce or eliminate the uncertainty about the long run that is such a drag on current outcomes.
How can it best manifest the needed commitment? The government should be quantitatively clear about its goals for employment and/or growth. It should be willing to say that its goal is for real GDP to be x% (where x% could be a number like 6% or 12% or maybe even 20%) higher by the end of 2020. More importantly, it should be clear that it is willing to use its tools as necessary to offset adverse shocks in order to achieve its objective for real GDP.
There is a risk that any stated growth objective, no matter how low, could come into conflict with keeping inflation close to the Federal Reserve’s 2% target. But as I discussed here, there are a number of pro-growth policy choices that are actually anti-inflationary. The government should be expected to avail itself of those supply-side tools in order to achieve its growth objective. (This switch from demand-side stimulus to supply-side stimulus is why I use the term “non-ideological” in the title.)
What I’m proposing has its risks. The US attempted to do aggregate demand management using fiscal policy in the 1960s, and the result - but only after some very bad monetary policy choices - was the Great Inflation.
But our situation is a lot closer to 1937 than it is to 1965. At the zero lower bound - or whatever we want to call the current situation - the traditional central bank safety net is full of holes. Without that safety net, it is easy for pessimism about future growth and income prospects to become self-confirmed in actual outcomes. We need a government that can and will use its communication and tools to break any such cycle of self-defeatism.
N. Kocherlakota
Rochester, NY, February 25, 2016
P. S. This paper of mine provides a mathematical formulation of the self-confirming pessimism described in the last paragraph.
Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).