Must-Read: Jason Furman: The New View of Fiscal Policy and Its Application

Must-Read: Jason Furman: The New View of Fiscal Policy and Its Application: “A decade ago, the prevalent view about fiscal policy among academic economists could be summarized in four admittedly stylized principles…

1. Discretionary fiscal policy is dominated by monetary policy as a stabilization tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.
2. Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).
3. Moreover, fiscal stabilization needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.
4. Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimizing harmful side effects and long-run fiscal harm.

Today, the tide of expert opinion is shifting the other way from this “Old View,” to almost the opposite view on all four points…. Although the New View is increasingly found in research by academics, policy-oriented economists, and international institutions…. many policymakers still shy away from implementing it in practice…. One reason for the disconnect is that some policymakers still have not accepted the substantive theory and evidence behind the New View. But the disconnect is partly institutional in origin. In the United States… weak automatic stabilizers. In the case of the Europe, the institutional issues run deeper. Most notable among them is the fact that macroeconomic institutions have been built in accord with the Old View….

In stylized form, the five principles of this [New] View [of fiscal policy] are:

1. Fiscal policy is often beneficial for effective countercyclical policy as a complement to monetary policy.
2. Discretionary fiscal stimulus can be very effective and in some circumstances can even crowd in private investment. To the degree that it leads to higher interest rates, that may be a plus, not a minus.
3. Fiscal space is larger than generally appreciated because stimulus may pay for itself or may have a lower cost than headline estimates would suggest; countries have more space today than in the past; and stimulus can be combined with longer-term consolidation.
4. More sustained stimulus, especially if it is in the form of effectively targeted investments that expand aggregate supply, may be desirable in many contexts.
5. There may be larger benefits to undertaking coordinated fiscal action across countries.
   I will discuss each of these five in turn.