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The Links between Fiscal and Monetary Policy

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Presentation YSI Amsterdam 2014 Ehnts

Veröffentlicht in: Wirtschaft & Finanzen
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The Links between Fiscal and Monetary Policy

  1. 1. breakout  presenta-on:     The  Links  between  Fiscal  and   Monetary  Policy   Dirk  Ehnts   Berlin  School  of  Economics  and  Law  
  2. 2. IS/LM:  a  false  dichotomy?   LM  curve   IS  curve   A   interest  rate   income  
  3. 3. IS/LM:  a  false  dichotomy?   LM  curve   IS  curve   A   Moving  the  IS  curve  inde-­‐ pendently  of  the  LM  curve   =  fiscal  policy     B   interest  rate   income  
  4. 4. IS/LM:  a  false  dichotomy?   LM  curve   IS  curve   A   C   Moving  the  IS  curve  inde-­‐ pendently  of  the  LM  curve   =  fiscal  policy     Moving  the  LM  curve  inde-­‐ pendently  of  the  IS  curve       =  monetary  policy   B   interest  rate   income  
  5. 5. IS/LM:  a  false  dichotomy?   LM  curve   IS  curve   A   D   fiscal  policy     plus     monetary  policy     equals       policy  mix   B   C   interest  rate   income  
  6. 6. IS/LM:  a  false  dichotomy.   „We  now  know  that  it  is  not  enough  to  think  of  the   rate  of  interest  as  the  single  link  between  the  financial   and  industrial  sectors  of  the  economy;  for  that  really   implies  that  a  borrower  can  borrow  as  much  as  he   likes  at  the  rate  of  interest  charged,  no  aQen-on  being   paid  to  the  security  offered.  As  soon  as  one  aQends  to   ques-ons  of  security,  and  to  the  financial  intermedi-­‐ a-on  that  arises  out  of  them,  it  becomes  apparent  that   the  dichotomy  between  the  two  curves  of  the  IS-­‐LM   diagram  must  not  be  pressed  too  hard.“     John  Hicks  (1980)  
  7. 7. IS/LM  2.0:  the  Hicksian  cure   LM  curve   IS  curve   A   D   Expansionary  fiscal  policy   expands  the  range  of   collateral  in  the  private   sector  through  issuance  of   addi-onal  government   bonds  which  allows  it  to   borrow  more  from  banks.   B   C   interest  rate   income  
  8. 8. IS/LM  v.  2.014/€   LM  curve   IS  curve   interest  rate   income  
  9. 9. Lending  to  households  falls  ...  
  10. 10. ...  and  lending  to  NFCs  falls  as  well  ...  
  11. 11. ...  while  sovereign  debt  has  increased!   hQp://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=121.GST.A.I7.N.B0X13.MAL.B1300.SA.G   Euro  area  government  debt  to  GDP   Euro  area  18  (fixed  composi-on)  -­‐  Maastricht  assets/liabili-es  -­‐  General  government   (ESA95)-­‐NCBs  -­‐  All  sectors  without  general  government  (consolida-on)  (ESA95)  -­‐  NCBs  -­‐   Financial  stocks  at  nominal  value  -­‐  Percentage  points,  series(t)/GDP(t)  -­‐  Neither  seasonally   nor  working  day  adjusted  
  12. 12. Dichotomy  of  monetary  and  fiscal  policy   Summary:     IS/LM  model:          complete  dichotomy   IS/LM  model  2.0:        posi1ve  correla1on   IS/LM  model  v2.014/€:    no  posi1ve  correla1on     à    What  are  the  links  then  between        monetary  and  fiscal  policy?  
  13. 13. The  Links  between  Fiscal  and  Monetary  Policy   What  the  evidence  tells  us  about  the  eurozone:     -­‐  weak  loan  demand   -­‐  weak  economic  growth   -­‐  (too)  low  infla-on  rate   -­‐  rising  sovereign  debt  
  14. 14. The  Links  between  Fiscal  and  Monetary  Policy   What  the  evidence  tells  us  about  the  eurozone:     -­‐  weak  loan  demand   -­‐  weak  economic  growth   -­‐  (too)  low  infla-on  rate   -­‐  rising  sovereign  debt  
  15. 15. Bank Loans to entrepreneurs 100 deposits 100 Entrepreneurs Loans from bank 100 deposits 100 Consumers Based loosely on Wicksell (1898), Geldzins und Güterpreise, page 170 ff. Step 1: Entrepreneurs demand loans from banks given the interest rate. Banks create deposits which are used as money.Creation of I.O.U.s Creation of I.O.U.s
  16. 16. Bank Loans to entrepreneurs 100 deposits 100 Entrepreneurs Loans from bank 100 deposits 100 Consumers Step 1: Entrepreneurs demand loans from banks given the interest rate. Banks create deposits which are used as money. Step 2: Entrepreneurs pay households to buy their labour and produce. [production] 100 Based loosely on Wicksell (1898), Geldzins und Güterpreise, page 170 ff. exchange money vs labor
  17. 17. Bank Loans to entrepreneurs 100 deposits 100 Entrepreneurs Loans from bank 100 deposits 100 Consumers Step 1: Entrepreneurs demand loans from banks given the interest rate. Banks create deposits which are used as money. Step 2: Entrepreneurs pay households to buy their labour and produce. Step 3: Households buy goods. [production] 100 Based loosely on Wicksell (1898), Geldzins und Güterpreise, page 170 ff. exchange money vs goods
  18. 18. Bank Loans to entrepreneurs 100 deposits 100 Entrepreneurs [production] 100 Consumers Step 1: Entrepreneurs demand loans from banks given the interest rate. Banks create deposits which are used as money. Step 2: Entrepreneurs pay households to buy their labour and produce. Step 3: Households buy goods. Step 4: Entrepreneurs repay bank loans. deposits 100 Loans from bank 100 Destruction of I.O.U.s Destruction of I.O.U.s Based loosely on Wicksell (1898), Geldzins und Güterpreise, page 170 ff.
  19. 19. The  ying  of  aggregate  demand...   "If  income  is  to  grow,  financial  markets  must  generate  an   aggregate  demand  that,  aside  from  brief  intervals,  is  ever  rising.   (..)  For  real  aggregate  demand  to  be  increasing,  it  is  necessary   that  current  spending  plans  be  greater  than  current  received   income  and  that  some  market  technique  exist  by  which   aggregate  spending  in  excess  of  aggregate  an-cipated  income   can  be  financed.“                              Minsky  (1982)  
  20. 20. „The  saving  of  any  sector  is,  by  defini-on,  the  excess  of  its  cur-­‐   rent  receipts  over  its  current  expenditures.  But  an  excess  of   current  receipts  over  current  expenditures  (flows)  must   necessarily  imply  either  a  buildup  of  (stocks  of)  total  assets  or  a   reduc-on  of  liabili-es  (or  some  combina-on  of  the  two)  equal  in   amount  to  the  excess  of  current  receipts  over  current   expenditures.  Thus  the  saving  of  any  sector  must  be  equal  to  the   change  in  its  total  assets  minus  the  change  in  its  liabili-es,  which   in  turn  equals  the  change  in  its  net  worth.“                            RiQer  (1963)   ...  and  the  yang  of  aggregate  demand  
  21. 21. The  sectoral  balances  approach   •  Some  sectors  spend  more  than  they  receive,   whereas  other  sectors  receive  more  than  they   spend.  While  the  formers  sectors  are  dissaving,   the  laQer  sectors  are  saving.     It  might  make  sense  to  focus  on  three  sectors  and   their  balance  of  payments  iden-ty:     (  Sp  –  I  )  +  (  T  –  G  )  =  (  EX  –  IM  )  
  22. 22. The  Links  between  Fiscal  and  Monetary  Policy   (  Sp  –  I  )  +  (  T  –  G  )  =  (  EX  –  IM  )     An  increase  in  aggregate  demand  can  come   from  more  private  debt,  more  public  debt  or   more  exports  (debt  of  the  ROTW).     Y  =  C  +  I  +  G  +  (EX  –  IM)  
  23. 23. The  Links  between  Fiscal  and  Monetary  Policy   (  Sp  –  I  )  +  (  T  –  G  )  =  (  EX  –  IM  )     An  increase  in  aggregate  demand  can  come   from  more  private  debt,  more  public  debt  or   more  exports  (debt  of  the  ROTW).     Y  =  C  +  I  +  G  +  (EX  –  IM)  
  24. 24. The  Links  between  Fiscal  and  Monetary  Policy   (  Sp  –  I  )  +  (  T  –  G  )  =  (  EX  –  IM  )     An  increase  in  aggregate  demand  can  come   from  more  private  debt,  more  public  debt  or   more  exports  (debt  of  the  ROTW).*     Y  =  C  +  I  +  G  +  (EX  –  IM)     *  Less  imports  is  also  possible,  but  clearly  defla1onary  as  they  equal  less   exports  elsewhere,  which  shi<s  the  problem  from  one  to  the  other.  
  25. 25. The  Links  between  Fiscal  and  Monetary  Policy   LM  curve   IS  curve   A   interest  rate   income   new  IS  curve   Moving  the  IS  curve     =  fiscal  policy   =  increase  in  government   debt  
  26. 26. The  Links  between  Fiscal  and  Monetary  Policy   LM  curve   IS  curve   A   interest  rate   income   new  LM  curve   Moving  the  LM  curve     =  monetary  policy   =  increase  in  private  sector   debt  
  27. 27. The  Links  between  Fiscal  and  Monetary  Policy   The  elephant  in  the  room:     Why  is  loan  demand  so  weak?     (Hint:  aggregate  demand  shortall)  
  28. 28. „The  saving  of  any  sector  is,  by  defini-on,  the  excess  of  its  cur-­‐   rent  receipts  over  its  current  expenditures.  But  an  excess  of   current  receipts  over  current  expenditures  (flows)  must   necessarily  imply  either  a  buildup  of  (stocks  of)  total  assets  or  a   reduc-on  of  liabili-es  (or  some  combina-on  of  the  two)  equal  in   amount  to  the  excess  of  current  receipts  over  current   expenditures.  Thus  the  saving  of  any  sector  must  be  equal  to  the   change  in  its  total  assets  minus  the  change  in  its  liabili-es,  which   in  turn  equals  the  change  in  its  net  worth.“                            RiQer  (1963)   ...  and  the  yang  of  aggregate  demand  
  29. 29. The  Links  between  Fiscal  and  Monetary  Policy   A  shortall  in  aggregate  demand  is  caused  by  a  combina-on  of   these  factors:     1)  some  sectors  have  piled  up  savings  and  other  sectors  have   been  driven  into  debt  but  have  now  stopped  to  spend   (àmacroeconomic  imbalances)   2)  inside  some  sector  some  have  piled  up  savings  and  others   have  been  driven  into  debt  but  have  now  stopped  to  spend   (àinequality)  
  30. 30. Central  bankers  on  inequality  (1)     Mersch/ECB  (2014):  „S1ll,  a  central  bank  with  a  clear  mandate   to  safeguard  price  stability  needs  to  act  forcefully  when  push   comes  to  shove.  These  distribu1onal  side-­‐effects  the  need  to  be   tolerated.  They  are  one  more  reason  to  recognise  that  the  non-­‐ standard  measures  we  have  introduced  have  to  be  temporary.“       Inequality  and  Economic  Policy   hQp://www.ecb.europa.eu/press/key/date/2014/html/sp141017_1.en.html  
  31. 31. Central  bankers  on  inequality  (1)     •  To  maintain  price  stability  is  the  primary  objec1ve  of  the   Eurosystem  and  of  the  single  monetary  policy  for  which  it  is   responsible.  This  is  laid  down  in  the  Treaty  on  the  Func1oning   of  the  European  Union,  Ar1cle  127  (1).   •  "Without  prejudice  to  the  objec1ve  of  price  stability",  the   Eurosystem  shall  also  "support  the  general  economic  policies   in  the  Union  with  a  view  to  contribu1ng  to  the  achievement  of   the  objec1ves  of  the  Union".  These  include  inter  alia  "full   employment"  and  "balanced  economic  growth".   hQps://www.ecb.europa.eu/mopo/intro/objec-ve/html/index.en.html     Inequality  and  Economic  Policy  
  32. 32. Central  bankers  on  inequality  (2)     Yellen/Fed  (2014):  „The  extent  of  and  con1nuing  increase  in   inequality  in  the  United  States  greatly  concern  me.  The  past   several  decades  have  seen  the  most  sustained  rise  in  inequality   since  the  19th  century  a<er  more  than  40  years  of  narrowing   inequality  following  the  Great  Depression.  [...]  It  is  no  secret  that   the  past  few  decades  of  widening  inequality  can  be  summed  up   as  significant  income  and  wealth  gains  for  those  at  the  very  top   and  stagnant  living  standards  for  the  majority.  I  think  it  is   appropriate  to  ask  whether  this  trend  is  compa1ble  with  values   rooted  in  our  na1on‘s  history,  among  them  the  high  value   Americans  have  tradi1onally  placed  on  equality  of  opportunity.“   Inequality  and  Economic  Policy   hQp://www.federalreserve.gov/newsevents/speech/yellen20141017a.htm  
  33. 33. Inequality  and  Economic  Policy  
  34. 34. Inequality  and  Economic  Policy  
  35. 35. Correla-on  is  not  causa-on,  but  as  stressed  by   Hicks,  loan  demand  is  backed  up  by  collateral,   and  given  rising  prices  of  financial  assets  there  is   a  danger  that  monetary  policy  might  cause  shius   in  the  income  distribu-on.     How  would  fiscal  policy  lead  to  an  increase  in   the  amount  of  deposits?   Inequality  and  Economic  Policy  
  36. 36. bank private sector bonds   reserves   central bank treasury reserves   bonds   Government  exchanges  bonds  for  reserves  at  central  bank  ...   The  Links  between  Fiscal  and  Monetary  Policy  
  37. 37. reserves   deposits   deposits   net  worth   ...  and  pays  private  sector  through  bank  transfer  ...   The  Links  between  Fiscal  and  Monetary  Policy   bank private sector central bank treasury bonds   reserves   reserves   bonds   widgets   widgets  
  38. 38. ...  with  banks  preferring  to  hold  interest-­‐bearing  bonds  and  the   private  sector  ready  to  spend  the  addi-onal  deposits  created.   The  Links  between  Fiscal  and  Monetary  Policy   bank private sector central bank treasury bonds   reserves   widgets   bonds   reserves   deposits   deposits   net  worth   widgets  bonds  
  39. 39. Alterna-ve:  tax  cuts  leave  more  deposits  with  private  sector   The  Links  between  Fiscal  and  Monetary  Policy   bank private sector central bank treasury bonds   deposits   deposits   taxes  bonds   net  worth   taxes   net  worth  
  40. 40. Conclusion:     •  Euro  zone  has  an  aggregate  demand  problem,  so  ...   •  more  exis-ng  deposits  need  to  be  spend  (not  QE)  or  ...   •  addi-onal  deposits  need  to  be  created  (fiscal  vs  monetary   policy)  ...   •  which  would  lead  to  a  welcome  rise  in  infla-on  via  labour   market  pressures  (and  less  inequality  as  a  side  result)  and  ...   •  more  aggregate  demand  would  make  monetary  policy  whole   again  (and  allow  interest  rates  to  rise)  ...   •  ...  if  the  monetary  union  can  be  completed.   Government  as  the  deposit  creator  of  last  resort   (DCoLR)  
  41. 41. •  Scope  for  coopera-on  (policy  mix)   The  Links  between  Fiscal  and  Monetary  Policy  

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