Must-Read: Gavyn Davies: Sims Highlights Fiscal Dominance at Jackson Hole

Must-Read: Gavyn Davies: Sims Highlights Fiscal Dominance at Jackson Hole:

The most far reaching speech at the Federal Reserve’s Jackson Hole meeting last week was…

…the contribution on the fiscal theory of the price level (FTPL) by Professor Christopher Sims of Princeton University…. The subject is now moving centre stage…. It has important implications for the conduct of macro-economic policy, especially in Japan and the eurozone member states…. Government debt is an asset to the private sector. Prof Sims says that a reduction in future government deficits will make this debt a more attractive investment and this will induce the private sector to hold more of the debt, thus reducing demand for goods and services. This exerts a deflationary effect on the economy….

We are all familiar with… inflation if an irresponsible government (eg Brazil in the 1980s) persists in running excessive deficits…. Prof Sims reminds us that this can work in reverse, with all the signs changed. It is clear that this is directly relevant to the effectiveness of QE by the central bank…. Viewed in this light, the ineffectiveness of QE in offsetting a chronic shortage of private demand is not that surprising…. Prof Sims suggests that Japan can escape from its deflationary trap only by explicitly joining up fiscal and monetary policy, and making both subordinate to the inflation target…