Cardiff Garcia´s take on “Fiscalists versus Market Monetarists”:
To recap, this debate is about the best way to accelerate the recovery and return to pre-crisis trend growth while interest rates are at the zero lower bound. (When rates are above the ZLB, many fiscalists — in particular the neo-Keynesians — are monetarists again.)
In this post I will show, through a string of examples from several Eurozone countries plus Denmark, although not in the euro is linked to it through a fixed exchange rate between the Danish Krona and the euro, and the US.
The examples show the Fiscal stance – measured by government consumption expenditures in each country which is indexed to 1 in the first quarter of 2007 – the rate of RGDP growth and the Monetary Stance (MP Stance), measured by the NGDP gap.
The NGDP gap is the percent difference between the level of spending (NGDP) and the trend level. For example, if monetary policy is being strongly tightened, the gap is rising at an increasing rate. If monetary policy is ‘less tight’, the gap stops increasing and if monetary policy is expansionary, the gap decreases (or, if positive, increases more).
I´ll use the US as a practical example. Note that beginning in early 2008 monetary policy was strongly tightened. Note also that at that time the fiscal stance was expansionary (Government Consumption was rising), but that did not stop real growth from tanking. When QE1 was implemented in March 2009, monetary policy became much less tight and real growth picked up. In 2010 the fiscal stance became ‘neutral’ (Government Consumption stopped rising) but real growth remained positive and stable. But in any case, monetary policy is still tight and we could say that if the Fed adopted an NGDP level target, monetary policy would quickly become expansionary, increasing real growth and employment , even in the absence of fiscal ‘stimulus’.
But we are going in the ‘wrong direction’. As Evan Soltas puts it in recent post:
If the Fed can’t clarify without tightening, that’s a big problem for monetary policy. The next few stages of the exit are necessarily complex. If it wants to avoid snuffing out the recovery, the Fed will need to clarify its clarifications. Next week won’t be a moment too soon.
The fiscal and monetary stance in the countries surveyed differs ‘far and wide’. For example, in France fiscal stimulus increases monotonically throughout but initially monetary policy tightens strongly and real growth falls precipitously. When monetary policy ‘eases up’, real growth resumes, only to drop again when monetary policy tightens up (when the ECB raises rates in April and June 2011).
In Finland fiscal stimulus has been in place for most of the time but it is monetary policy that clearly determines the outcome.
Much the same, although with different intensity, can be said of the Netherlands. Note here, comparing the Netherlands with Finland, that the ‘one shoe’ monetary policy doesn´t ‘fit all’. The centralized ECB monetary policy has clearly been tighter for the Netherlands than for Finland, implying that real growth in the Netherlands has been worse than in Finland.
Denmark is an example of a country that for a time had an expansionary monetary policy, with the NGDP gap being reduced. But when monetary policy becomes tight again, real growth falters, despite a temporary pick-up in fiscal stimulus.
Countries like Italy and Spain suffer from both ‘afflictions’: Tight fiscal and monetary policy. But from what we observed in the other cases, the fall in real growth is mostly due to contractionary monetary policy.
Finally, Germany is a point ‘off the curve’. Germany has experienced continuous fiscal stimulus and a monetary policy that completely reversed direction and now maintains Germany´s NGDP close to trend. So why, even in such ‘favorable circumstances’ real growth has disappeared?
The chart below may help explain. With real growth in Germany being very export dependent, the growth crash in major customers has stopped export growth in Germany. One more evidence of the inefficient ‘one size (tries) to fit all’ monetary policy!