Coordinating Macroeconomic Policies: Down in the Trenches or Clearing Clouds for the Future?
In devising different policies, in particular, those of a macroeconomic type, the interactions between their effects must be recognised, even apart from the notation that some policies, such as helicopter money creation, have a double nature, both of a monetary and a fiscal policy type, and that QE also can have fiscal effects, in particular, due to the fact that at the ZLB there is no clear distinction between the two policies (King 2014).
In addition, there can be either substitutability or complementarity between the effects of the various policies that only a general model of the economy can account for. Policies are substitutes if each has a similar type of effect on some objective. This is the case e.g. of monetary, macroprudential and fiscal policies directed at raising employment and income. Policies are instead complementary if they operate better together. In this case, possibly each of them can be preferentially directed at one objective, which implies a kind of assignment of each instrument to some preferential target. A recent example of this kind of ‘appropriate’ assignment of instruments to targets has been derived by Menna (2016); in a dynamic stochastic general equilibrium (DSGE) model with non-Ricardian consumers, monetary policy can stabilise inflation, while fiscal policy can cope with the effects of productivity shocks on income distribution. In any case, the use of each instrument must be calibrated, as certainly all of them have an influence on all the targets.24
In the rest of this section we deal with two specific interactions between policies, on the one hand, between monetary and fiscal policy and, on the other, between monetary and macro-prudential policy. The need to fight time inconsistency and inflation led some authors (not only, as mentioned earlier, Sargent and Wallace 1981 and Rogoff 1985a but also Walsh 1995) to require separation between monetary and fiscal policy and, in addition, monetary leadership and commitment.
A consensus also gradually emerged on a similar position. This has lasted for three decades. Starting from the Great Recession, a rather unexpected event, it has somewhat lost its appeal, depending on the need to counteract the crisis, and a new orientation seems to have emerged afterwards. However, the policy and the prescriptions that can be derived from it have been or are still almost generally accepted.With the emergence of the crisis, the primary objective of economic policy changed from one of non-inflationary expansion to higher employment and income growth. This was pursued for a time by both expansionary monetary and fiscal policies, the latter being also to some extent coordinated at an international level, especially at the onset of the crisis. The crisis also required bailout interventions, in the immediate term, and the design of macro-prudential policies afterwards. The resilience of the crisis to policy measures (in most cases monetary action, after 2009), sometimes badly designed for a while, as in the Euro-area, has produced a rise in private and public debt not only in absolute terms but also with respect to GDP (Alcidi and Thirion 2016). This again required some kind of strict coordination between macroeconomic policies and, especially in the European Union, discarding the very strict target of non-inflationary monetary policy complemented by tight fiscal policy. Coordination, however, has not materialised, even if monetary policy is now stuck to the ZLB.
The ‘old view' of the 1980s and the 1990s about the role of monetary and fiscal policies has changed from a number of perspectives. Innovative results also have emerged for coordination of the various policies. From the point of view of the results of the leaderships of different instruments, Hughes Hallett (2008) had challenged the old view by pointing out that - in a world of independent authorities in charge of different instruments - fiscal leadership leads to better outcomes not only for output but also for inflation and fiscal balances.[83]
In addition, almost as a preparation for the change induced by the crisis, it was shown that a changing degree of monetary conservatism and independence based on the contingencies can be desirable and produce sensible gains, in particular, if the economy is hit by a big shock such as a natural disaster or a banking crisis (Niemann and von Hagen 2008).
As to the risk of time inconsistency, this can be avoided by well-designed and well-coordinated economic policies if governments have a long enough time horizon and sufficient instruments to control the economic system. Time inconsistency and the need for a commitment technology thus may appear only in certain cases (Acocella, Di Bartolomeo and Hughes Hallett 2013).The new orientation is not generally agreed upon. A recent paper, in fact, shows that in a situation with multiple equilibria, by letting players move with a certain fixed frequency - which allows policies to be committed or, alternatively, rigid for different periods of time - monetary commitment can ensure a Pareto-efficient outcome (Hughes Hallett, Libich and Stehlik 2014). Contrary to this result, other analyses show that a fiscal leadership strategy can lead to a Pareto improvement from the perspective of both economic authorities (Cabral and Diaz 2015).
Apart from the issue of leadership, the extent to which monetary policy can relieve fiscal pain is worth discussing. Usefulness of a rise in the optimal inflation rate (Section 3.5) has already been underlined as a way to reduce not only present but also future public obligations. Moreover, monetary policy can be useful because unconventional monetary policies can rule out self-fulfilling sovereign default (Corsetti and Dedola 2016).
Cooperation also has an international dimension. This topic has come again to the forefront recently, as conventional
conservative central banker, whereas it leads to worse outcomes with a populist one. monetary policy seems to be trapped at the ZLB and fiscal policy is impaired by rising debt. In this situation, the initial shock in a country can be exacerbated by the appreciation of the terms of trade of that country, and the shock propagates internationally. It cannot be countered unless common policies of low interest rates are carried out and complemented by fiscal policy (Cook and Devereux 2013).
The need then arises for a coordinated action both internally - by making joint use of monetary and fiscal policies[84] - and internationally. While the former seems to be feasible prima facie (except in the European Union), the latter appears less implementable. And this can even impair the feasibility of the former. In fact, at least during crises, the feasibility of coordinating monetary and fiscal policies at home depends on the prospect of the fiscal multiplier being high enough to lead to fewer deficits and debts. However, in an open economy, the multiplier is certainly lower, unless other countries also implement the same kind of expansionary policy.
Coordinating monetary and macro-prudential policies brings about a problem similar to coordination of monetary and fiscal policies, as both policies affect real economic variables. They are not mere substitutes and in some cases can be complements.
Economic outcomes are superior if monetary and macroprudential policies are closely coordinated, especially when economic fluctuations are driven by financial or housing market shocks, as both macro-prudential and monetary policies have an influence on financial imbalances and inflation and output (Angelini, Neri and Panetta 2011; Guibourg et al. 2015). Galati and Moessner (2013), however, note that even if superiority of coordination should be recognised, practical problems, such as the lower frequency of macro-prudential decisions, imply that authorities governing these should be the Stackelberg leader, similarly to what happens when dealing with monetary and fiscal policy coordination. A problem arises if macro-prudential regulation targets not only financial imbalances but also real stability. In this case, gains from coordination with monetary policy can be high. However, if the instruments are kept separated, each policy can be assigned to the target for which it is more effective: monetary policy targeting inflation and the output gap and macro-prudential regulation addressing financial stability (Svensson 2012).
As to institutional arrangements, most authors agree that both policies can be implemented by central banks, which have superior monitoring abilities.The source of financial imbalance is particularly relevant for small open countries such as emerging-market economies. If these economies have a large amount of foreign borrowing, this can typically cause financial imbalances that could explode after a financial shock. Coping with them by monetary policy - rather than using macro-prudential tools - is likely to aggravate financial instability (Ozkan and Unsal 2014).
In a monetary union, macro-prudential policies could be useful at the union level, unless the probability is low that financial imbalances arise at that level. This can be the case when integration of national banking sectors is incomplete, and there are heterogeneous financial cycles across countries. In these conditions, financial imbalances tend to arise mainly locally. This makes national macro-prudential policies necessary as a way to avoid financial imbalances and systemic crises at that level, without forcing the union-wide monetary policy to implement contractionary action or implying a union-level macro-prudential action (Kok, Darracq Paries and Rancoita 2015). Otherwise, i.e., if financial cycles are common to the union area, application of the Tinbergen principle states that in order to ensure two targets - price and financial stability - monetary policy should be complemented by macro-prudential policy at the same level, and their coordination is equally desirable, given synergies or trade-offs between the targets (Boeckx et al. 2015). Macro-prudential policy at a union-wide level is particularly necessary in a situation where a prolonged expansionary monetary policy could feed common financial imbalances. Macro-prudential policies at the country level in a monetary union can help monetary policy and reduce changes in the nominal interest, partially substituting for the lack of national monetary policies (Brzoza-Brzezina, Kolasa and Makarski 2013; Quint and Rabanal 2014). In addition, macro-prudential policies can deal with local risks, avoiding the formation of asset bubbles, without the need to alter the expansionary stance of monetary policy (Visco 2015; Burlon et al. 2016b).
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