Posted by: Dirk | April 23, 2010

Countercyclical fiscal policy, Irish edition

I have recently read some working papers by Philip Lane, which you can find via his website. IIS Discussion Papers 272, 274, 314 and 315 slowly build up to conclude that fiscal policy should be used to counter recessions. In #315, Lane concludes on p.22:

While I welcome fresh thinking on economic policy-making, this reminds me of the old idea of countercyclical fiscal policy. Here is the entry on Encyclopedia Britannica:

  • government influence on economy (in government economic policy (finance): Fiscal policy) Overall fiscal policy involves the government in deciding whether it should spend more than it receives or less. The development of countercyclical fiscal policies in the post-World War II period reflected the explicit attempt by some governments to protect their population from world recessions by deliberately spending additional money at appropriate times. Experience with …

So, talking about fiscal rules and an independent fiscal policy council is what was once understood as the core of Keynesian fiscal policy-making. I find it hard to understand how you can write four papers about it and either a) be not aware of the fact or b) ignore it. With all this talk about not repeating the mistakes from the past, should we really start this discussion of fiscal policy (rules) at zero?

If that’s how it is, I would have a question for Philip Lane. Given that the government saves more during good times, would it not have to hand over its additional savings to the private sector, where it is transformed into additional investments, thereby creating/increasing the bubble that it is supposed to fight? (Think of Rubinomics and how all this abundant capital had helped fuel the internet bubble.)

P.S.: Alternatively, the savings could be handed to either foreign lenders or households, creating more liquidity there. When the government reigns in its lending it will remove liquidity from markets in times of trouble, which as we have seen in the last years, is bad. Credit crunch comes to mind.


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