Is Fiscal Policy for Prosperity Back in Place of Austerity?

Yves here. While as this post indicates, policy makers are finally starting to move away from austerity policies, any embrace of more aggressive fiscal spending is likely to be “too little, too late.”

By Philip Arestis, Professor of Economics at the University of the Basque Country, Spain and Malcolm Sawyer, Professor of Economics, University of Leeds. Originally published at Triple Crisis

Fiscal policy has not been taken seriously by policymakers since the Great Financial Crisis (GFC) of 2007-2008, with some exceptions over the period 2009-2010, notably after the G20 meeting in London (April 2009). The GFC prompted significant government and central bank interventions, both to restore confidence in the financial system and to contain the impact of the crisis on the real economy. Monetary and fiscal policy responses became very accommodative in many countries. Central banks responded by flooding the financial markets with liquidity, while fiscal authorities attempted to deal with the decline in the solvency of the banking sector. Those policies before 2010 had helped to avoid a complete collapse of the financial system and the real economy after the emergence of the GFC. Subsequently “unorthodox” monetary policies have been implemented, which have not been successful in terms of producing and maintaining healthy growth in the economy. Fiscal policy has increasingly been concerned with “balancing the budget” and “expansionary austerity” rather than being genuinely expansionary.

There are several reasons for such a change in terms of fiscal austerity going out of fashion. An important one being the failure of the austerity policies to bring about significant recovery despite the claims made for “expansionary fiscal consolidation.”

The UK government provides an example of a government adopting a “fiscal surplus” rule, which in their case was to be achieved by 2020. With the result of the referendum of UK’s membership in the EU (June 23, 2016) and the perception that this would add to the slow-down of the UK economy, and the replacement of the former Chancellor of the Exchequer has resulted in the declared abandonment of the fiscal surplus rule. The new UK Chancellor has been given the opportunity to be “radical” with fiscal policy and he seems to be promising to help investment in the UK, which is weak in this country; indeed, the government needs to sort out this problem, and urgently.

The new UK Chancellor and the Governor of the Bank of England seem to have agreed on a coordinated action to account for UK’s economic problems, including fiscal stimulus (in terms of the importance of fiscal and monetary policy coordination along with financial stability, see Arestis 2015). Andrew Haldane, chief economist and member of the Monetary Policy Committee of the Bank of England, argued in a Sunday Times article (August 14, 2016) that “monetary policy can offer no more than a short-term balm for economic uncertainty.” Under such circumstances, “other arms of policy are needed” to ensure healthy growth. These comments are very much in line with the view that Britain’s government needs to unveil a new fiscal plan in order to produce healthy growth in the economy.

The fiscal policies of the new Canadian government marks the move away from austerity (New York Times, October 23, 2015). The President of the ECB (Draghi, 2014) also argued that “it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints.”  Draghi (2016) argues that “it matters for monetary policy whether fiscal policy is steering aggregate demand in the same direction, and how strongly.” This, however, did not happen in the EMU case; Draghi (op. cit.) went further to suggest that “in a context of disrupted transmission that has led to a slower return of output to potential than if fiscal policy had been more supportive.” The decision by the European Council (August 8, 2016) to accept the European Commission’s proposal not to penalise Portugal and Spain for having failed to meet the European Union deficit rules may well mark the beginning of the effective abandonment of the “fiscal compact” in EMU.

The result of the recent meeting of the G20 finance ministers and central bank governors of the leading countries around the world in China may also be seen as a further marker of shifts from fiscal austerity. They have echoed this important trend in favour of fiscal policy along with monetary policy and structural reforms. However, given that structural reforms cannot deliver quickly and that monetary policy has nearly exhausted its weapons, which in any case have not been successful, fiscal policy measures have emerged as the winner. Even the IMF, which supported austerity in the past, seems to be now one of the strong supporters of fiscal policy along with monetary and structural reforms. The IMF (2016) calls for policymakers in large economies to identify and implement policies that would boost growth and contain risks. Such policies, in this view, should include: structural reforms, fiscal support—most valuable at this juncture it is suggested—and monetary policy to lift inflationary expectations. Above all, of course, stimulating aggregate demand is most important, whereby expansionary fiscal policy is paramount and prominent.

It is also the case that the recent “unorthodox” Quantitative Easing (QE) and negative interest rate types of monetary policies, implemented in many countries around the world, have not really been successful; let alone the fact that central banks are reaching the limits of their monetary policies. A good example in this context is Japan where the “Quantitative and Qualitative Easing” (QQE) monetary policy with negative interest rates (-0.1) aspect of “Abenomics” has not worked. However, the fiscal part of “Abenomics” has introduced, early August 2016, a new large fiscal stimulus, which amounts to 6% of GDP. Interestingly enough, this fiscal stimulus is in synergy with monetary policy, as stated by the Japanese central bank governor. Other countries, especially European, should introduce similar fiscal policies; the Japanese initiative is a lesson for the world.

An interesting question is the extent to which this change in attitude towards fiscal policy would produce the “proper” fiscal stance. This is a relevant question but at the end of the day it is important that the rising disenchantment is promising. In any case, with monetary policy having failed to produce healthy levels of employment and GDP growth, fiscal policy has now to shift from pursuit of budget surplus to promoting expansion.

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  1. NotTimothyGeithner

    I believe “RabbiGhandi” made a point the other day that Western leaders (Obama specifically?) know “austerity” is an unpopular phrase but have made little if any movement on the matter otherwise.

    1. James Kroeger

      …Western leaders (Obama specifically?) know “austerity” is an unpopular phrase but have made little if any movement on the matter otherwise

      I would suggest that the reason leaders have made little movement is because they lack a shared understanding of how and why tax cuts are essentially contractionary in their primary effects, contrary to everything they were taught in their economics classes.

      In the US, anyway, economics students are taught that tax cuts are on the list of fiscal measures that governments can take to provide a stimulus to the economy.

      This gives them the impression that tax cuts are, by their essential nature, a ‘naturally stimulative’ way to increase aggregate demand, presumably because they increase C = Consumption in a direct manner.

      But what this presumption ignores is the ‘full effect’ of cutting taxes, which happens also to immediately cut government spending G by an equal amount, since governments are not able to spend money they don’t have (all else equal).

      Even if/when the entire amount of a tax cut is spent on C, the drop in G will automatically negate any net stimulative effect of the increase in C. If ANY of the money distributed via a tax cut is saved (a certainty), then the immediate effect of a tax is contractionary, for the increase in C is less than the decrease in G.

      The only way it has been possible to sell the idea that tax cuts are stimulative is if something else is done, i.e., if they are ‘paid for’ by some means that is truly stimulative*. The preferred way to do this is by borrowing: a separate fiscal initiative which is truly stimulative by its very nature, for it takes money that would otherwise be removed from the economy by savers and spends it, instead.

      Even when tax cuts are paid for with a separate fiscal option that is truly stimulative, the tax cut portion of the combo-fiscal-policy is a fundamentally contractionary element that works against the stimulative impact of the truly stimulative element.

      Which is to say, if instead of borrowing money to pay for a tax cut, the borrowed money were used instead by the government to increase its spending on infrastructure, the net stimulative effect would be greater.

      Not every dollar/pound/euro given to taxpayers would be spent, but every one of them borrowed by G would be spent. Why reduce government revenues at all when stimulus is needed and there are concerns about balancing budgets?

      The only fiscal policy options that are truly stimulative are those which directly increase aggregate spending. Contrary to what is taught in economics textbooks, raising taxes on rich people is one of those FP options that is truly stimulative in its direct, immediate effects.

      This, cuz it takes money that would have been removed from the economy by savers and spends it instead. The increase in G is greater than the decrease in C. So once again, contrary to what is widely taught, it is tax increases (especially on rich people) that are a truly stimulative FP option (when they target the biggest savers) and not tax cuts, which actually do the opposite.

      I would suggest that if Western leaders understood these essential truths regarding the challenges of fiscal policy, they would not have hesitated to stimulate their economies out of recession in a way that attacks the problem of government debt directly.

      (*Yes, MMT spending of printed money would also provide a net stimulus, but IMO this solution is a lot harder to sell than simply correcting the errors in economics textbooks re: the false depiction of tax cuts as being ‘inherently stimulative.’)

      1. OpenThePodBayDoorsHAL

        The CBs have completely shot their wad, of course the inverted hyper-communists (who do not believe in free market capitalism) want another way to artificially fool the supply/demand forces that have (eventually) governed commerce since the dawn of time.
        And here’s a head-scratcher for you: is NIRP (negative interest rate policy) even *legal*?
        I thought in order to be legally valid, a contract had to involve “material consideration” for both parties involved.
        So I buy a German 2-year bond for 100 and in two years I receive 98. What “material consideration” did I receive?

        1. animalogic

          Consideration needs to be real, not material. A “pepper corn” as consideration is material in only a technical sense. The consideration you obtain on a (government)NIRP bond:
          Security of investment.
          The possibility of future capital gains.

    2. Synoia

      Austerity is the US’ policy to contain China.

      Any demand stimulus anywhere in the world benefits Chains, the new “Great Enemy” created by the US in a trade effort , which resulted oin manufacturing and its jobs moving to China.

      Now the US “leadership(ir leadershit)” have discovered their mistake, which they cannot reverse. Their solution to containing China is to suppress demand – thus Austerity.

      When considering policies which appear endlessly stupid, please cogitate on “Qui bono.”

  2. Jim Haygood

    In USA, USA! the only fiscal stimulus on offer is the hoary old military Keynesianism lauded by the Depublicrat candidate, Trumplary Clump.

    This takes one to three years to ramp up through defense procurement channels. Moreover, the benefit is transitory, as much of the spending ends up subsidizing value-subtractive overseas activities that do nothing for the domestic economy.

    Most likely, our next surge of fiscal stimulus will be recession-induced, as automatic stabilizers kick in and banksters line up to demand humbly request help.

    Timing? 2017-2018 is a reasonable window, though like J-Yel & Co, we’re data dependent.

    1. reslez

      How much remains of the automatic stabilizers? With the rise of “gigs” and the Uberification of employment, how many people work in jobs that actually qualify for UE? It seems more likely they’ll silently slip from the employment rolls and end up in System D. Spending on SNAP benefits might expand, perhaps a bit less in states that require single people to work in order to qualify (apparently, people with neither dependents nor jobs don’t need to eat). Tax receipts will fall — I guess the resulting deficits might look like an increase in fiscal spending. Oh, bankster bailouts. Yeah, I guess our Neronian elites would count that as “stimulus”.

  3. flora

    I’m glad to see the West is remembering the importance of fiscal policy.

    ” The new UK Chancellor has been given the opportunity to be “radical” with fiscal policy and he seems to be promising to help investment in the UK, which is weak in this country; ….”

    China is using fiscal policy, investment in its own industries, to its benefit.

    ”A key driver of China’s export share gains is its move toward more sophisticated assembly, especially in electronics, which eliminates the need to source components from a vast supply chain across Asia, said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. That’s hurting companies and economies from Singapore to Thailand, Malaysia, Taiwan and South Korea, said Neumann.
    “The government is subsidizing higher technology industries including new advanced information technology, robotics, and new energy vehicles under its “Made in China 2025” plan. More is to come as President Xi Jinping’s blueprint envisions global competitiveness within a decade in 10 industries from machine tools and robots to advanced railway equipment and medical devices”.

    Thanks for this post.

  4. DarkMatters

    Bbbbut, that’s COMMUNISM! It’s a failed economic policy! Just leave everything alone and let the market work it’s magic. More leeches.

    1. Synoia


      Those who fail to plan, plan to fail.

      Leaving it to Mr Market is no plan, it is a random walk which encourages piratical behavior.

      Behold The Brilliant Buccaneers of the Beloved Beltway, in league with the Pestilential Pirates of Pecuniary Passions (Wall St).

  5. Ronald Pires

    Yeah, 8 years, and they are finally starting to whisper deficits as a possible policy choice. Oddly though, it must never be mentioned also as the prescription of MMT over this entire time. Somehow it must be rolled back in (as inflation targeting) under monetarism, as f monetarism had always been making such a recommendation, if only they had listened to the Great Friedman more closely during this period. Anything to no admit they are wrong, have been wrong, and that monetarism itself is wrong.

    1. Skippy

      Good to see you Ronald, yeah its like Hoover all over again albeit the groundhog day version.

      Disheveled Marsupial…. miss the gang…

  6. Bambino

    It seems that the world is changing in two ways.

    The Establishment of the financial markets in the Anglo-Saxon world is demanding fiscal stimulus because they lack of debt to play and charge. Bankers, speculators and financial fund managers need more public debt to extract yields and fees from the people.

    Think for a while. Without public debt guaranteed by the tax payers, where they will have the opportunity to rent and extract money almost risk-free? Without debt how the bankers can extract from the rent seeking activities on the people and Governments?

    The second way is the German way:

    Schäuble teases massive tax cuts for late 2017

    After you got a fiscal surplus you can lower the public debt, you can spend more and you can tax less and stimulate the economy.

    Who are the main losers? Bankers, speculators and fund managers with the German Way. They lack the public debt to extract from the people and the Governments, they have less assets “to manage” with a sure fee but with the lack of effort and skills. They also lack the debt if people have higher purchasing power and repay what they already owe.

    Bear in mind that the austerity is not a goal but it is a tool to provide the safe means to the survival of the State. Bear in mind that the known modern Welfarestate was a creation of the German Conservatives.

    So today we have two ways to stimulate the economy. The wrong way that is the Anglo-Saxon way. And the German way, the good way. Which one will benefit the bankers and the speculators? Which one will benefit the people, the workers and the poor?

    It is all about smoke and mirrors. The bankers, the speculators and the fund managers need the fiscal stimulus because they can extract money from the economy instead to invest in the normal economic activities, like creating new companies, businesses and so on. Because the returns of the financial activities are much higher with less risk instead investing in new businesses and jobs.

    It is all about smoke and mirrors and the so called New Keynesian Thought is the best Trojan Horse of the rent seeking agents.


  7. Jim

    A simple policy of increased Federal spending, by itself, in the absence of first instituting dramatic structural changes that help to contain,weaken or dismantle neo-liberal institutions(such as stopping, in a new financial crisis, the Federal Reserve from ever exceeding its legal mandate or allowing the American State to arbitrarily decide which automobile firms or insurance companies will survive)–is likely to only culminate, once again, as Philip Mirowski recently observed in regards to the 2007/2008 financial crisis, in another moment where a status-quo, largely unchallenged neoliberal political power is exercised to partially suspend the market(in the short-run) in order to save that same market for the long-run.

    Neo-Liberalism requires a strong state to re-regulate and define the market –as ultimately the key institution in modern society–perpetually involved in the search for truth.

  8. ChrisPacific

    Macroeconomics today seems to be about where medicine was in the Middle Ages, with austerity analogous to leeches or bleeding.

    I am skeptical whether TPTB really believe that austerity has failed or if they are just adopting that view as a political cover. We’ve seen in Europe that there is a widely held belief that the only way austerity can fail is if you don’t have enough of it, and the answer to austerity-related problems is always more austerity. If we are seeing evidence-based decision making now, my bet is that it’s reluctant and against the instincts of those concerned, and is therefore likely to fold at any setback.

    1. two beers

      I disagree. Applying leeches actually has some beneficial uses in modern medicine, I kid you not. OTOH, there is no apparent beneficial use for neo-classical macroeconomics.

      I think phrenology is a more apt analogy.

    2. animalogic

      Politics is ALWAYS prior to economics. The politics of the last 30-40 years has been “how can we most directly transfer the largest possible share of GDP into the 1% withoutout completely destroying our economies”. (Note: the concept of economic destruction is never allowed to trump systemic risk taking by the FIRE sector) The 1% define political goals within that overarching Goal, THEN find economic theories they hope they can sell to the world. As this article suggests, they have been quite successful….

  9. Ignacio

    Please don’t forget to mention this stuff in Schauble AG and Rajoy SL. Of course none of them will ever recognize the fallacies of the fiscal compact.

    At least I am happy to see that the EU did not apply the penalty to Portugal and Spain. Nevertheless, the Bank of Spain web site still publishes public debt data under the “Protocol of Excessive Deficit”. Yet much to be done.

    Another positive development is that negotiations to form the government in Spain include measures to remove burdens imposed by the former government to renewables. Furthermore, the Spanish Secretary of Industry (linked with Panama Papers) has been forced by the public to give up on the possibility of beign assigned to World Bank directorship.


  10. salvo

    in the West possibly, yes, though in germany the mainstream is now celebrating the new record trade surplus, once again, we are exportweltmeister after all, and everone else our debtor

  11. Sound of the Suburbs

    The IMF and World Bank have been destroying economies for 50 years with same reforms they have imposed on Greece.

    They have left a trail of wreckage through South America, Africa, Asia, Eastern Europe and have now arrived in Western Europe.

    Unelected technocrats make the same mistakes over and over again because you can’t get them out once they have got their feet under the table.

    As these people just do the same thing over and over again without thinking, let’s do some thinking for them.

    I noticed something major had gone wrong in 2008 and didn’t dismiss it as a one off “black swan” event which has allowed our experts to ignore it and learn nothing.

    Let’s find the real experts that did see 2008 coming.

    Twelve people were officially recognised by Bezemer in 2009 as having seen 2008 coming, announcing it publicly beforehand and having good reasoning behind their predictions.

    Steve Keen is one of those experts who is on record as having seen the private debt bubble inflating in 2005.

    In 2007 Ben Bernake could see no problems ahead.

    What does Steve Keen have in his models that the Central Banks don’t?
    He uses realistic assumptions about money and debt in his models.

    The Central Banks use the childishly simplistic assumptions from Neoclassical Economics.

    Does Steve Keen have anything else to add?

    Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

    Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

    Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

    When bankers lend too much money into an asset bubble it eventually pops leading to debt deflation.

    We have the Central Banker’s “black swan”, we can help their thinking progress from its current stasis.

    Being neoclassical economists they thought the US housing market was heading to a nice high stable equilibrium, now they know better.

    The US housing market was climbing to fall off a cliff in a “Minsky Moment”.

    Have there been any other “Minsky Moments”?

    1929 – US (margin lending into US stocks)
    1989 – Japan (real estate)
    2008 – US (real estate bubble leveraged up with derivatives for global contagion)
    2010 – Ireland (real estate)
    2012 – Spain (real estate)
    2015 – China (margin lending into Chinese stocks)

    How embarrassing, Wall Street did exactly the same thing as it did in 1929, in less than ten years from being freed from 1930s legislation.

    It lent into an asset bubble to inflate prices until it blew up.

    1929 – US stocks
    2008 – US housing

    This time Wall Street had derivatives for global contagion.

    What was learnt from other “Minsky Moments”?

    Japan has been in a balance sheet recession since 1989 and has learnt one hell of a lot.

    Richard Koo has analysed this in detail:

    Fiscal policy is what you need with all this unproductive lending weighing everything down.

    In another of Richard Koo’s videos he tells how Western experts came along and told Japan to cut Government spending and every time things got worse until they increased Government spending again.

    It was long, hard, painful experience.

    Japan was recovering when 2008 hit.
    Japan was getting better again and the Tsunami hit.

    Richard Koo was more of an observer and could not over-ride the Western experts and their bad advice.

    The train of thinking that follows from finding one real expert.

    An expert that thinks, a miracle.

    Austerity doesn’t work and will just make Greece’s problems worse.

    Richard Koo has provided us with a graph of how it was austerity that killed the Greek economy at about 54 mins. You can look at the IMF projection as well for a laugh.

    “We don’t learn anything, because we never take responsibility for anything” the IMF.

    1. Sound of the Suburbs

      Unelected technocrats in action:

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      What shall we do now?
      More QE and lower interest rates.

      Any chance of stopping to think?

  12. Sound of the Suburbs

    Why are Club-Med banks in trouble?

    I suppose we should start by looking at the bleedin’ obvious.

    The EU technocrat’s intellectual superiority means they tend to over-look things that are bleedin’ obvious to lesser beings.

    When you impose austerity it leaves people lower down the scale with less money and because they have less money they are no longer able to make their loan repayments leading to NPLs.

    Those lower down the scale have less money to purchase goods and services, leading to problems with the companies they used to buy goods and services from. These companies then have less money and are no longer able to make their loan repayments.

    These companies in turn bought their goods from other companies, leading to problems with these companies they used to buy goods from. These companies then have less money and are no longer able to make their loan repayments.

    The banking systems of all Club-med nations are in trouble.

    EU technocrats can you work out what you have done to cause the problem?

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