And in this corner, we have fiscal versus monetary policy!

December 16th, 2015 at 9:34 am

For years, since about 2010, fiscal policy has been working against monetary policy. The central bank has pushed the pedal to the metal while, at least from late 2010-2013, fiscal policy has been contractionary. Not quite European levels of austerity, but enough in 2013 to zap 1.5 percentage points off of GDP growth. In fact, one reason the US economy has done better since 2014 is because fiscal policy shifted from reverse to neutral.

As of today, it looks like that relationship will flip.

Last night, the Congress apparently reached a deal on both the budget and a tax package. The budget deal appropriates about $1.1 trillion in discretionary spending next year ($548 bn for defense, $518 bn for non-defense) and the tax cuts come with a $650 bn, 10-year price tag. I’m pretty sure that amounts to “positive fiscal impulse” meaning a bit more spending this year than last. Since government spending feeds directly into GDP, that boosts growth a bit.

Meanwhile, down the road from the Capital, the Federal Reserve interest-rate-setting committee is concluding their two day meeting wherein they’re widely expected to announce (at 2:30pm) a small rate increase of one-quarter of a percent (25 basis points).

That’s designed to slow the economy a tad based on their concerns that while inflation is sleepy for now, it’s poised to speed up and they aim to get ahead of it. I’ve offered many arguments as to why that concern does not seem to fit the data, but so be it.

What’s interesting today is that Congress appears to moving slightly from neutral to positive fiscal mode while the Fed, after seven years at zero, is moving the other way.

In my latest book, The Reconnection Agenda, I spend a number of pages explaining how important it is for fiscal and monetary policy to work together (see the discussion around Table 2, pg. 71). The downsides of not doing so have been glaringly obvious here and more so in Europe.

So it’s weird to see this flip, if that’s what’s happening. Both the positive impulse from fiscal policy and the negative one from monetary policy are small (with fiscal plus probably > than monetary negative), but, while the political independence of the Fed is absolutely crucial, I wish these two institutions were more in sync on behalf of the real economy and the people in it.

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2 comments in reply to "And in this corner, we have fiscal versus monetary policy!"

  1. Jill SH says:

    I totally agree with you on just about everything, but do you think it’s maybe possible MAYBE, that by doing this rate increase the Fed is saying, well the economy is doing pretty good now and life is humming along, and that will say to the markets and business people that yeah things are pretty good so let’s start humming more and louder, and it works because it’s all a weird kind of confidence boost? Ya know, like here after all come the Confidence Fairy, in the back door?
    Just maybe…. Well, time will tell.


    • Jared Bernstein says:

      Fair point, for sure. If you made two columns–reasons to raise and reasons not to–your thought would go in column 1. And there’d be other stuff in that column too, like the certainty benefits for just taking the damn question of “when” off the table. But based on slack, asymmetric risks, lack of inflation, the other column (don’t raise) would probably have more compelling arguments in it.

      At the end of the day, 25 bps probably won’t be a big deal. It’s all about what happens next. Follow the money inflation.


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