Revisiting the Standard Macroeconomic Policy Framework: Should Monetary and Fiscal Policy Be More Closely Coordinated?

The standard macroeconomic policy framework rests on a strict separation of monetary and fiscal policy, and assigns the primary role for managing aggregate demand (“stabilization policy”) to an independent, technocratic central bank. This “flexible inflation targeting” framework developed in response to the challenges of high inflation in the 1960s and 1970s, and was informed by economic debates and developments in economic theory. 

The experience of the Global Financial Crisis and Great Recession that it triggered, coming on top of that of Japan’s secular deflation since the mid-1990s, have raised questions about the effectiveness of this framework when the threat to full employment and price stability is “from below” (too little aggregate demand and employment and too little inflation) rather than “from above” (too much demand and too high inflation). 

In this study group, we will revisit the thinking behind the standard macroeconomic policy framework and explore whether the framework needs to be modified in light of the Great Recession and Japan’s experience and, if so, how. What is the difference between “fiscal policy” and “monetary policy,” and why is one the preserve of “politicians” and the other that of “technocrats”? Has the imperative to keep the government’s hands off the printing press over-constrained the use of fiscal policy? Is the reliance on monetary policy feeding excessive “financialization” of the economy? Can the euro area survive without the monetary union becoming a fiscal (and political) union too? Will policymakers have enough “policy ammunition” in the next economic downturn and what sort of unconventional policy responses might be in store? What does an optimal macroeconomic policy framework look like in a world of “secular stagnation”? We will touch on these and related questions.

Suggested reading Paul Sheard, 2018 “Rethinking Macroeconomic Policy Frameworks,” in Reinventing Bretton Woods Committee and Astana International Financial Center, The 10 Years After The End of the Familiar…Reflections on the Great Financial Economic Crisis, pp.177-185.