The Crisis As a Pivot: The Limits to Fiscal and Monetary Policy and the Need to Devise New Policy Tools

The recent financial crisis not only has led to a recession deeper and more severe than any since the Great Depression of the 1930s but also has shown the limits deriving from the previous policy.

New limits have also arisen. First, they refer to the use of some tools. In fact, soaring public debt has constrained expan­sionary fiscal policy, whereas zero interest rates have limited conventional expansionary monetary policy. The crisis has overburdened public finances in most countries. The limits to increases in public debt derive from the implied excessive burden thrown on future generations; the risks deriving for the stability of the system, possibly emphasised by the operation of financial markets; and the constraint deriving from high levels of public debt on the potential for fiscal policy to deal with the next negative shocks and secular stagnation. The attitude of governments has changed, and they have set or confirmed limits to public debt or both to it and the public deficit. The United States has confirmed existing constraints to rising debt in absolute terms by only slightly adjusting the ceiling. In the European Monetary Union (EMU), the ‘fiscal compact' has set more stringent limits to both deficit and debt as a ratio to gross domestic product (GDP; see Section 3.8).5 The length of the crisis and the unavailability of fiscal policy have put stress on conventional monetary policy as the ZLB has been reached.

Thus, insurgence of constraints practically implies drop­ping (at least) one policy tool (fiscal policy) or confining its use within strict boundaries, which is tantamount to the impossibility of respecting the golden rule of economic policy for reaching fixed policy targets and the need to resort to a second-best prospect. The implications for managing public policy thus have been negative, as the set of tools available for a lasting exit from the crisis has been impover­ished, thus overburdening monetary action, which, on the other hand, remained stuck at the ZLB.

Hence, the need to (re-)invent a series of unconventional policy measures has arisen, with emphasis being put on monetary action in the long-term section of financial assets, as well as announcements on the future path of policy and possibly recourse to ‘helicopter money' (see Section 5.3). Due to the mixed nature of some unconventional policies, response to the crisis has also blurred the distinction between monetary and fiscal policy to the point that the distinction between them may appear to have vanished. Microeconomic prudential rules have been adapted to face systemic risks, giving rise to macro-prudential policies. These new policies

Bycontrast, in 2013, Australia repealed the debt ceilinginstitutedin 2007. as well as the double nature of some monetary policies make the case for coordinating all macroeconomic policies, balan­cing their extent and timing, also in order to ensure proper functioning of democratic institutions. In addition, the need arises to reflect on the adequacy of the low inflation targets inherited from previous decades, which are set at too low a level for the monetary policy to relieve the economy at a sustained pace and reduce soaring public debt.

The issues we will inquire about in dealing with these instruments are as follows. Under what circumstances and through which channel can these new policies be expected to work? What lessons should be learned for the conduct of monetary and fiscal policies, and what roles should be ascribed to the central bank and to government in the future?

5.3