Conversely, when the outlook is exuberant, businesses may borrow and invest even more, despite the central bank’s desire to slow an expansion by raising interest rates (think savings and loan crisis). The downward-sloping IS curve does not allow for either of these possibilities. Yet both outcomes can, and do, occur.
One final point. Krugman says there is an inherent tradeoff between fiscal and monetary policy. I agree, but not with the tradeoff he describes. Deficits don’t automatically drive interest rates higher, and higher interest rates don’t automatically translate into lower private spending.
That tradeoff is disputed, and not just by MMTers. The tradeoff that matters is the one that Hyman Minsky and James K. Galbraith have highlighted. Monetary policy “works” by driving people into debt. Fiscal policy works by driving income into people’s pockets. As Galbraith put it:
There are two ways to get the increase in total spending that we call ‘economic growth.’ One way is for government to [deficit] spend. The other is for banks to lend. For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets…This is called an increase in ‘net financial wealth’… In contrast, when a bank makes a loan, the cash is not owned free and clear.
That’s the tradeoff that interests me. Should we lean more heavily on (monetary) policy that works by leveraging the private sector’s balance sheet or on (fiscal) policy that works by strengthening it?
So, there you have it. Two no’s, a not really and a yes in response to Krugman’s questions. (Un)fortunately, this will be the last response from me, since my editors have asked me to continue any further discussion offline. I thank Paul for engaging me and am more than happy to do this.
This article was provided by Bloomberg News.