The IMF’s Economic Counsellor and Director of Research Department, Olivier Blanchard, held a press briefing two days ago in Beijing. He left another hint at a return of fiscal policy for 2015:
Let me end with risks to the forecast; there are always risks. The most obvious one involves stagnation in either the eurozone, or in Japan, or in both. In both, using the “three arrows”, to borrow from Abenomics, is clearly the way to go, to use monetary policy, fiscal policy and structural reforms. What is true for Japan is just as true for the eurozone as well.
Let me briefly comment on that. “The way to go [is] to use monetary policy, fiscal policy and structural reforms”, he said. Let me repeat that with an imaginary clipboard in my head, wearing my euro hat, and it comes out like this: “The way to go [is] to use monetary policy – CHECK, fiscal policy and structural reforms – CHECK”. With interest rates basically at zero the ECB has done what it could do, safe for calling for help. Actually, it already did that – here is Mario Draghi’s text at Project Syndicate from January 2nd:
To allow national fiscal stabilizers to work, governments must be able to borrow at an affordable cost in times of economic stress. A strong fiscal framework is indispensable to achieve this, and protects countries from contagion. But the crisis experience suggests that, in times of extreme market tensions, even a sound initial fiscal position may not offer absolute protection from spillovers.
That second part with the ‘may’ depends on the institutional setting, which is fixed in the short run but open to change over the years. So, given that we tried structural reforms (less government spending, wage cuts) in 2010-14 and I did not help much, fiscal policy is the only way out, it seems. If there are institutional roadblocks that need to be cleared, well, … then let’s start talking about it.
In a modern economy with a sovereign currency, both banks and the government can create additional deposits for the private sector. Banks achieve that through lending, and the government through bond issuance. A third way, which doesn’t work for everybody, is to have exports higher than imports, which must result in a net inflow of net financial assets, among them deposits (ex-post). In the euro zone, the private sector does not want to borrow even though interest rates are at zero. If you want a cause, then name it confidence: the firms and households are pretty confident that in this situation of weak demand, high unemployment and falling prices they do not want to more borrow.
It seems like the only way to get the monetary circuit going in Europe is through the creation of private sector deposits by a) cutting taxes (for those who can reasonable expected to use the additional deposits for spending) or b) increasing government spending (which directly creates deposits for the private sector). What this does not mean is a) government has to be bigger (let them hire private companies to do public jobs if you think that it is welfare-improving) or b) that this will become a permanent feature of the economy. As long as the private sector does not spend, government jumps in. When aggregate demand runs hot, taxes can be increased and the central bank’s interest rate hiked up. This would constitute a return to normal. No mass unemployment, the usual bickering about higher taxes, and savers getting money for nothing. Oh, good ol’ times!