Monetary Policy trumps Fiscal Policy

The Economic Policy Institute (EPI) twitted a version of the chart below which purports to show that if only fiscal policy had not been so austere, the economy would be much further on the way to recovery.


Seems we are reliving the 1960s debates over the relative effectiveness of fiscal and monetary policy!

We know that the recovery from the 2007-09 recession has been the weakest ever. But is that really due to “austerity”? Note that during the 2007-09 recession the growth of real public spending was just as strong as during the other recessions, but that didn´t stop this recession from being the most virulent.

But the chart provides us with a chance to test the “fiscal rules” proposition. Observe that real government spending was much stronger following the 2001 recession than following the 1990 recession. In fact, following the 1990 recession government spending basically stayed ‘put’. Ceteris Paribus, one could surmise that the recovery from the 2001 recession was more pungent than that following the 1990 one.

The chart below provides a visual of the ‘recovery landscape’ through the prism of real output after the more recent recessions.


The 1990 and 2001 recovery show the same behavior of real output despite the large difference in real government spending. It appears the ‘ordering’ of recoveries is not defined by the ‘ordering’ of government spending.

The next chart shows the behavior of nominal spending (NGDP) across recessions. It appears that that´s what determines the ‘ordering’ of recoveries. The similarity in the expansion following the recessions of 1990 and 2001 appears to be due to the similar increase in NGDP on both occasions (despite very different fiscal actions). I think the more robust expansion following the 1981 recession and the weak recovery following the 2007 recession are related to the very different behavior of NGDP. And the behavior of NGDP is directly determined by monetary policy!


6 thoughts on “Monetary Policy trumps Fiscal Policy

  1. Excellent blogging…the Fed is still jibber-jabbering about inflation and Krugman about deficits…maybe 2014 will be the year of Market Monetarism.

  2. Pingback: Monetary Policy trumps Fiscal Policy - The Corner The Corner

    • Greg. The “beginning” for each cycle is the date the recession started. The present cycle had the longest “peak to through” (6 quarters). I aligned all the cycles to the trough (0).

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