Even many central bankers admit that monetary policy is exhausted, and that fiscal policy should increasingly be the focus of efforts to stimulate the economy. When monetary policy has reached the limits of its effectiveness, economists sometimes refer to continued monetary easing as “pushing on a string.” Fiscal and monetary policies have both been employed globally to ameliorate the impact of the Great Recession. Most countries engaged in some form of fiscal stimulus in 2009–10. In the U.S., a combination of state budgetary restrictions and the federal budget sequestration led to fiscal contraction, which partially negated the impact of loose monetary policy. Both presidential candidates have made increased infrastructure spending and other forms of fiscal stimulus part of their economic plan.

TO PUSH OR TO PULL? THAT IS THE QUESTION
The debate over which government policies should be implemented to boost economic growth is often phrased in terms of a “string.” When monetary policy seems to have reached the limits of its effectiveness, which certainly seems to be the current case globally, monetary policy is said to be “pushing on a string”—a metaphor for ineffective action. Increasingly, policymakers are looking to fiscal policy to fix what ails the global economy.

But what do these terms mean? Monetary policy refers to the management of the money supply and interest rates within a country, or in the case of the European Union, across a number of countries. Monetary policy is set by central banks, for example the Federal Reserve (Fed) in the U.S., the European Central Bank (ECB) in Europe, or the Bank of England in the United Kingdom. These central banks are generally considered independent of the government, though some countries, most notably China, do not have this separation. Monetary policy also includes setting some of the rules regarding the availability of credit, typically through banks. The Chinese authorities often use changes in lending rules, such as the amount required as a down payment on property purchases, as a policy tool.

Fiscal policy refers to a nation’s taxation and spending policy, and is a function of its government, not a central bank or other agency. In this regard, fiscal policy is more directly impacted by politics and elections, whereas monetary policy is generally considered above the fray. Because fiscal policy is a function of politics, discussions quickly get heated. It’s important to remember that fiscal policy refers to both tax and spending policy, and tax cuts can be just as impactful as spending increases.

FISCAL POLICY TIED IN A KNOT

The initial response to the global financial crisis of 2008 consisted of coordinated monetary and fiscal policies. Interest rates globally were slashed, and in some countries, bank lending rules were eased. At the same time, most countries engaged in fiscal policy expansion. Figure 1 details some of these responses and the mixture of policy between tax cuts and spending. These policies were typically enacted over a period of years, with most of the impact felt in 2009–10, depending upon the country.

A few things stand out. Not all countries expanded fiscal policy; a few countries, like Ireland, engaged in austerity policies by raising taxes and cutting spending. China is also an outlier, as most of its policy response was done through the expansion of bank lending, which is technically part of monetary policy. In a country without an independent central bank and where the government is so entwined with the private sector, these sorts of distinctions become blurry at best.

Economists will debate for decades the effectiveness of these policies. But regardless of whether these policies were the most effective ways of preventing the kind of downward spiral seen in the 1930s, the global economy avoided the worst possible outcome from the financial crisis.

SIDEBAR – Accounting for Government Spending

When doing national income accounting (calculating things like GDP), government spending includes anything purchased by the government, from aircraft carriers to paper clips. It also includes salaries for government employees. But GDP does not include government spending in the form of transfer payments, that is, payments directly to individuals. This includes Social Security, Medicare, unemployment insurance, welfare programs, and similar types of spending.

Fiscal and monetary policies did not stay aligned for long. Interest rates remained low, with most major central banks engaging in some form of quantitative easing (QE). Yet, fiscal policy tightened globally. This is especially true in the U.S. [Figure 2]. The U.S. is rare, globally, in that fiscal spending is done at both the state and federal level. Already by 2010, state and local spending were contracting. Most states have some legal provisions, either constitutionally or by statute, requiring a balanced budget. So whether there was a deliberate effort to cut spending, or there simply was a decline in revenue that necessitated a reduction in spending, fiscal policy on the state level began to counteract federal spending. If the intention of fiscal policy is to be “counter-cyclical”—to go against the trend in the economy—rigid rules like balanced budget laws defeat this purpose.

First « 1 2 » Next