Sorting Out Monetary and Fiscal Policies
Both monetary and fiscal policies have gone off-course, and need to be reset. Sustained unprecedented monetary ease has failed to stimulate an acceleration in economic growth. Fiscal policies have resulted in increases in debt but they have not addressed some of key structural factors that are undercutting economic performance. Both involve substantial risks.
I mention regulatory policies in the same breath as monetary and fiscal policies because each has unique economic effects. In order to improve performance and standards of living, we need to address the sources of the underperformance with the proper policy tools, rather than rely on standard monetary and fiscal stimulus that are unlikely to have desired outcomes.
While alarming government debt projections focus attention on the future, in fact, future concerns are become today’s realities. The allocative effects of the government’s spending programs and our inefficient tax system are harming current economic performance.
The economy is characterized by sizeable pockets of persistently high unemployment and low wages. The weak trends in productivity have contributed to lower potential growth. We all want better performance. But the issue is how to achieve it. As a wealthy nation, we are misdirecting resources through fiscal policy and relying on monetary policy for the wrong objectives.
The reality is monetary policy cannot create permanent jobs, improve educational skills, permanently reduce unemployment of the semi-skilled, or raise productivity or boost wages. Yet all too frequently, observers urge the Fed to ease monetary policy—or recently, to delay taking away the excessive ease that has stimulated financial markets but not the economy.
The Fed’s $4.5 trillion portfolios and low rates reduce budget deficits but this is temporary, and encourages undesirable fiscal maneuvers and contributes to Congress’s delay in addressing fiscal challenges. It involves high risks that jeopardize the Fed’s independence and credibility.
The Fed’s sustained monetary ease temporarily suppresses the government’s budget deficits, but involves sizeable risks that the Fed conveniently fails to mention. The Congressional Budget Office estimates that a one percentage point rise in interest rates would increase budget deficits by $1.6 trillion over its 10-year budget projection. The Fed’s own forecasts of sustained economic growth, 2% inflation and a rising Fed funds rate point to higher bond yields.
The Fed must continue to normalize monetary policy and proceed with its plan to begin unwinding its massive portfolio. It must step back from its policy over-reach, including fully unwinding its mortgage-backed securities (MBS) holdings, which serve no purpose.
The need for fiscal policy reform is much more pressing. The entitlement programs—Social Security, Medicare and Medicaid--are well-intended and important programs for American citizens, but their persistent spending increases have clearly impinged on spending for other programs, including infrastructure, job retraining and research and development. This adversely affects current economic performance – it harms productivity, constrains wages and reduces job opportunities for many working age people– and lowers sustainable potential growth. These entitlements are the primary source of rising debt projections.
Aside from monetary and fiscal policies, labor market performance and business decisions are affected by a growing web of economic and labor regulations imposed by the Federal, state and local governments. Private industries add to the list of regulatory requirements, including the expanding imposition of occupational certification requirements and other practices like “non-compete” job contracts. Certainly, while some of these government regulations and industry rules serve important roles, many constrain the mobility of a sizeable portion of the labor force, limit job opportunities and are very costly to the economy. Obviously, these are beyond the scope of monetary and fiscal policy.
Congress faces several alternative fiscal policy paths. It may continue to avoid initiatives to reform current spending programs and the widely-acknowledged inefficient tax system. This would reinforce disappointing economic growth and allow large pockets of underperformance in labor markets and slow wage growth to persist. This would generate mounting reliance on income support and place mounting strains on government programs. Government debt would continue to rise rapidly.
Alternatively, Congress may pursue meaningful and fair fiscal reforms. This would focus on entitlements, improving their structures in a fair way that maintains their intent. This would allow more spending for infrastructure, skills training, and other programs. Corporate tax reform and simplification, as opposed to more fiscal stimulus involving higher deficits, would be a high priority. These efforts would raise sustainable economic growth, improve the productivity, and lift wages and economic well-being of workers, and ease burdens on income support systems and improve government finances.
Mickey Levy is the chief economist for the Americas and Asia of Berenberg Capital Markets, LLC, and member, Shadow Open Market Committee. The views expressed in this column are the author’s own and do not reflect those of Berenberg Capital Markets, LLC.
This is based on testimony delivered to the Subcommittee on Monetary Policy and Trade of the House Committee on Financial Services on July 20. The full testimony can be found here.
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