Afternoon Must-Read: Simon Wren-Lewis: Post-Recession Lessons

A generation or two ago, the push for central-bank independence was all about harnessing central banks’ credibility as inflation fighters in a context in which it was feared that elected legislators would lean overboard on the excessive spending side.

Today, Simon Wren-Lewis calls for transferring not just monetary policy but fiscal policy stabilization authority over to central banks, on the grounds that their technocratic chops are much better for fiscal policy then relying on elected legislators who are the prisoners of ordoliberal ideologies, the belief the governments like households need to balance their budgets, and of the austerity-loving 0.1%.

What could possibly go wrong?

…the year that the US, UK and Eurozone switched from fiscal stimulus to fiscal contraction… this policy switch is directly responsible for the weak recovery in all three countries/zones. A huge amount of resources have been needlessly wasted as a result, and much misery prolonged. This post is… about… taking that as given and asking what should we conclude…. To answer that question, what happened in Greece (in 2010, not two days ago) may be critical…. Let me paint a relatively optimistic picture of the recent past. Greece had to default because previous governments had been profligate and had hidden that fact from everyone…. Recessions… tend to be when things like that get exposed. If Greece had been a country with its own exchange rate, then it would have been a footnote… fiscal stimulus that had begun in all three countries/zones in 2009 would have continued (or at least not been reversed), and the recovery would have been robust. Instead Greece was part of the Eurozone…. Policy makers in other union countries prevaricated…. So the Greek crisis became a Eurozone periphery crisis…. This led to panic not just in the Eurozone but in all the advanced economies. Stimulus turned to austerity. By the time some in organisations like the IMF began to realise that this shift to austerity had been a mistake, it was too late. The recovery had been anemic.

Why is that an optimistic account? Because it is basically a story of bad luck…. Now for the pessimistic version. The political right in all three countries/zones was always set against fiscal stimulus…. Without Greece, we still would have had a Conservative led government taking power in the UK in 2010, and we still would have had Republicans blocking stimulus moves and then forcing fiscal austerity. The right’s strength in the media, together with the ‘commonsense’ idea that governments like individuals need to tighten their belts in bad times… [meant] austerity was bound to prevail…. Greece may have just voted against austerity, but there is every chance that in the UK the Conservatives will retain power this year on an austerity platform and the Republicans are just the presidency away from complete control in the US. If the pessimistic account is right, then it has important implications for macroeconomics. Although it may be true that fiscal stimulus is capable of assisting monetary policy when interest rates are at the ZLB, the political economy of the situation will mean it may well not happen….

When some economists over the last few years began to push the idea of helicopter money, I was initially rather sceptical… helicopter money when you have inflation targets is identical to tax cuts plus Quantitative Easing (QE), so why not just argue for an expansionary fiscal policy?… However, if the pessimistic account is correct, then arguing with politicians for better fiscal policy is quite likely to be a waste of time…. A more robust response is to argue for institutional changes so that politicians find it much more difficult to embark on austerity at the ZLB…. Central banks have QE, but helicopter money would be a much more effective instrument. To put it another way, central bank independence was all about taking macroeconomic stabilisation away from politicians, because politicians were not very good at it. The last five years have demonstrated how bad at it they can be…