Brad Delong writes
The principal argument for monetary policy is that, by modifying asset supplies and thus asset prices, it induces households and businesses to boost their spending on things that they almost bought anyway. Thus–for marginal policy shifts, starting out at a first-best optimum, and if the relative distribution of wealth corresponds to social welfare (or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)–monetary policy will not push you far away from the free-market optimum.
Fiscal policy, by contrast, works through expanded government purchases ΔG. These must be financed by distortionary taxes to amortize the debt in the future. These taxes do drive a wedge between the social and the private values of output in the future. And what the government buys is determined by a political rather than by an optimizing economic logic. [2]
Before we get into the relative merits I want to stop and ask whether or not this makes sense.
How can these two instruments have this fundamental difference?
I understand how to walk through the steps in our standard model, but when we get to the end my intuition says, something has gone wrong here.
Two paths from point A to point B must wind-up having equivalent offsets. For each time the northern path zigs while the southern path zags the northern path must have some offset zag when the southern path zigs.
Otherwise one cannot end up at the same place.
Right now I am not certain how it works out by my intuition says that when fiscal policy fades, monetary policy must expand or else the price level in the future will be lower than what it otherwise would be.
This expansionary monetary policy causes nominal GDP to exceed the interest rate and amortizes the debt.
That may not be the right answer but I do feel like something is missing.
PS
To be clear I am not saying that Brad or the standard reasoning is wrong. I am just saying that I am not intuitively squaring it.
It seems either that somehow the paths balance or the difference in the paths is equivalent to the difference in end points. So that you don’t actually get to the same B.
But, then that tends to suggest that sometime we amortorize debt through taxes and sometimes not.
You see I just don’t have it squared.
4 comments
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Monday ~ March 12th, 2012 at 10:12 am
Eli
Brad is basically right, but I think of it in terms of real resource consumption rather than in terms of future distortion through taxation. After all, future debt repayment can be financed by printing money.
When the central bank buys Treasurys, no real resources are immediately consumed. Sellers of Treasurys have more money and either use it to consume real resources of their chosing or lend it out to the private sector, which uses it to consume real resources. These private actors tend to make decent resource consumption decisions.
When Congress borrows money and spends it on real resources, those resources are often (partially) wasted. Congressional spending does not approximate the highest-valued use of resources.
So the equivalence of monetary and fiscal stimulus depends on whether Congress is undertaking new spending. If Congress is cutting taxes and keeping spending constant, that is roughly equivalent to additional monetary expansion, because the private sector is making decisions about which additional real resources to consume (again, future debts can be paid for with printed money). But if ΔG is positive, then fiscal policy is like monetary policy + real resource waste.
Monday ~ March 12th, 2012 at 12:42 pm
Nick Rowe
I think Brad is basically right. I would say it this way: fiscal policy has got lots of jobs to do, while monetary policy has only got one job it can do. If we use fiscal policy to do what monetary policy could do, then fiscal policy will be performing suboptimally in its other jobs. There’s an opportunity cost to using fiscal policy to control AD. There is no opportunity cost to using monetary policy to control AD, because monetary policy is a one-trick pony.
Monday ~ March 12th, 2012 at 4:11 pm
KH
“When Congress borrows money and spends it on real resources, those resources are often (partially) wasted. Congressional spending does not approximate the highest-valued use of resources.”
Similarly, when businesses borrow money and spend it on real resources, those resources are often (partially) wasted. Business spending does not approximate the highest-valued use of resources.
When households spend money, all but the part spent on basic food, shelter, and medical care are wasted.”
Fixed it.
Stunning to see that an author’s conclusions follow ineluctably from his or her assumptions.
Monday ~ March 12th, 2012 at 7:08 pm
anonymous
http://fairlysafedelusions.blogspot.com/2012/03/at-zlb-central-bank-should-monetize.html