For decades, politicians focused on the size of the state, while central banks tamed business cycles. This neat arrangement is breaking down
. For a while the Fed managed to shrink its balance-sheet, but since September its assets have started to grow again as it has injected liquidity into wobbly money-markets. On October 8th Jerome Powell, the Fed’s chairman, confirmed that this growth would continue.
One implication of this new world is obvious. As central banks run out of ways to stimulate the economy when it flags, more of the heavy lifting will fall to tax cuts and public spending. Because interest rates are so low, or negative, high public debt is more sustainable, particularly if borrowing is used to finance long-term investments that boost growth, such as infrastructure. Yet recent fiscal policy has been confused and sometimes damaging.
While incumbent politicians struggle to deploy fiscal policy appropriately, those who have yet to win office are eyeing central banks as a convenient source of cash. “Modern monetary theory”, a wacky notion that is gaining popularity on America’s left, says there are no costs to expanding government spending while inflation is low—so long as the central bank is supine.
In a mirror image, central banks are starting to encroach on fiscal policy, the territory of governments. The Bank of Japan’s massive bondholdings prop up a public debt of nearly 240% ofand low rates provide budgetary relief to indebted southern countries—which this month provoked a stinging attack on the central bank by some prominent northern economists and former officials . Mario Draghi, the’s outgoing president, has made public appeals for fiscal stimulus in the euro zone.
Here lies the danger in the fusion of monetary and fiscal policy. Just as politicians are tempted to meddle with central banks, so the technocrats will take decisions that are the rightful domain of politicians. If they control fiscal levers, how much money should they give to the poor? What investments should they make? What share of the economy should belong to the state?In downturns either governments or central banks will need to administer a prompt, powerful but limited fiscal stimulus.
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