Patrick Nolan: How to stop spending too much in the good times
Patrick Nolan is Chief Economist at Reform.
At a time when the IMF is talking of ‘rewriting the macroeconomists’ playbook’ there is value in looking to see how different countries are redesigning their fiscal and monetary policy institutions. In the latest of its series of Reformer lunches yesterday Reform held a lunch with Anne-Marie Brook of the New Zealand Treasury to discuss whether and how to make fiscal policy a more stabilising influence. The idea is that the government would change its spending or tax plans to help cool or heat up the economy and help make the job of the monetary authority easier. This event was held under the Chatham House rule.
Different countries are coming into the debates on the interaction of monetary and fiscal policy from different starting points. New Zealand is a small open economy with its own currency and relatively low levels of public debt. Eurozone countries are looking at fiscal policy to compensate for their lack of independent macro-policy tools. Countries like the UK, the USA and Japan are looking at fiscal policy as they are approaching the limits of what monetary policy can do (as they are facing the zero interest rate bound).
However, the discussion highlighted real concerns with the idea of a more ‘stabilising fiscal policy.’ Can we really trust politicians not to spend surpluses in good times and, in the bad times, how can we know when the economy needs extra support (and how much) and respond with fiscal policy changes in a timely way? Even if the political economy and measurement problems could be solved, wouldn’t a more stabilising fiscal policy damage other fiscal policy objectives? Tax rates that vary by economic conditions would, for example, be less certain and stable and create an environment that is damaging to investment. The risk with rewriting the playbook in this way is that we may be creating a cure that is worse than the disease.