Friday, 27 March 2020

Lessons for later

There will be lots of economic policy lessons from covid-19. One of them, I hope, will be about the coordination of fiscal and monetary policy.

Before the virus, there were many people saying that monetary policy had already been loosened so much that it left central banks too little room for further support if the proverbial encountered the wind redistribution device. And they were right.

Have a look at this simple and I'd say uncontroversial macroeconomic policy schema. There are four states of the world, too high/low inflation crossed with too high/low unemployment. Some folks might prefer an 'output gap' to 'unemployment' but same diff.

What's 'too high' or 'too low' inflation? Judgement call, but there's enough of a consensus these days around 'materially above/below 2%' as a good enough rule of thumb. And 'too high' or 'too low' unemployment? Unemployment is unwelcome at any substantial level, but for these purposes let's call it 'materially above/below the level that would get inflation accelerating' (the 'NAIRU' in the trade). Nobody has a very tight grasp on that level, but (according to Figure 5.3 down the back of the RBNZ's most recent Monetary Policy Statement in February), it's somewhere in the 4% to 4.75% area. So let's say 'clearly above 4.75%/clearly below 4.0%'.

In principle, in two states of the world (the green boxes) fiscal and monetary policy ought to have been pulling together. In the top right quadrant, anything the RBNZ did to boost inflation would likely do the real economy some good, and ditto for fiscal policy helping to increase inflationary pressures.

Did any of that happen? No. In practice the official cash rate got all the way down to 1.0% before fiscal policy belatedly came to the party by way of the $12 billion infrastructure spending plan in the December 11 Half-Year Economic and Fiscal Update. Here's the stance of fiscal policy, from that HYEFU.

During the whole of the 2012 through to 2017 period fiscal policy was actually contractionary - not expansionary, as it should have been, since unemployment was too high through all that period as this chart from the RBNZ shows (again from February's Statement).

I've painted things rather black and white, and there are some nuances being left out. One is that I can see some of what contractionary policy was trying to achieve which, in part, was to restock the ammo after the splurge on anti-GFC and post-earthquake support. And another is that whether the OCR was 5% or 3% or 1% at the onset of the covid-19 out breakout has become somewhat moot, since monetary policy would have seen the OCR cut to its present 0.25% and unconventional monetary tactics deployed either way. And I'm conscious that we're far from the worst in the world at this: the eurozone, for example, pushed monetary policy even further than we did (into negative interest rate territory and into tactics like quantitative easing) and were even more feeble on the fiscal front.

All that said, there has to be a better way. Pushing one setting of policy to Full Steam Ahead and leaving the other on Mild Astern makes no sense in periods when they should be coordinated (like most of the past decade). When we get out of this, we need No 1 The Terrace and No 2 The Terrace to get their act together.

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