On September 16 and 17, the Earth Institute at Columbia University (well, at least it’s not called the Universe Institute) and the Asian Development Bank organised a conference at Columbia University on The Future of the Global Reserve System. Papers were presented by the members of the Asian Development Bank’s International Monetary Advisory Group (IMAG), of which I am one (the other members are Prof. Jeffrey Sachs, Dr. Nirupam Bajpai, Dr. Maria Socorro G. Bautista, Prof. Barry Eichengreen, Dr. Masahiro Kawai, Prof. Felipe Larrain, Prof. Joseph Stiglitz, Prof. Charles Wyplosz, Dr. Yu Yongding).
The paper “Is there a case for a further co-ordinated global fiscal stimulus” is my take on the subject assigned to me for the New York conference: “Are the coordinated stimulus plans working and are they effective? Should we continue with fiscal stimulus? Are there other approaches to aggregate demand management?”
I will publish the paper in this blog in two or three installments, as I revise the initial draft. Installment one follows below.
For further internationally co-ordinated expansionary fiscal policy measures to be desirable today, a number of conditions must be satisfied.
First, there must be idle resources – involuntary unemployment of labour and unwanted excess capacity. Output and employment must be demand-constrained.
Second, there must be no more effective way of stimulating demand, say through expansionary monetary policy.
Third, expansionary fiscal policy must not drive up interest rates, either by raising the risk-free real interest rate or by raising the sovereign default risk premium, to such an extent that the fiscal stimulus is emasculated through financial crowding out.
Fourth, at given interest rates, the expansionary fiscal policy measures are not neutralised by direct crowding out (the displacement of private spending by public spending or of public dissaving by private saving at given present and future interest rates, prices and activity levels). Such direct crowding out can occur in the case of tax cuts (strictly speaking, cuts in lump-sum taxes matched by future increases in lump-sum taxes of equal present discounted value) because of Ricardian equivalence/debt neutrality. In economies with very highly indebted households, debt neutrality can occur when taxes on households are cut, because of what I shall call “Minsky equivalence” (see Minsky (2008)). Increases in public spending on real goods and services (“exhaustive” public spending) can fail to boost aggregate demand because of a high degree of substitutability (in the utility functions or the production technology) between private consumption and investment on the one hand and public consumption and investment on the other.
Fifth, there must be cross-border externalities from expansionary fiscal policies that cause decentralised, uncoordinated national fiscal expansions to be suboptimal.
This paper will consider these issues in turn. After reaching some fairly discouraging conclusions on the scope for further conventional expansionary fiscal policy now, unless there are significant political realignments in fiscally challenged nations that support coalitions in favour of significant future fiscal tightening through tax increases or public spending cuts, I briefly outline some unconventional fiscal/financial policies that may be effective in their own right and may help to enhance the effectiveness of conventional expansionary fiscal policy. Collectively, they can be characterised as the equitization of debt – household mortgage debt, bank debt and public debt.