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Fantasy Fiscal Policy

Many leading central bankers now argue that, instead of just playing its traditional role of deciding the allocation of government spending, investment, taxes, and transfers, fiscal policy must substitute for monetary policy in economic fine-tuning and fighting recession. That would be a big mistake.

LONDON – Will the next recession be worse than you think? With the major central banks having little space for further interest-rate cuts, might the next cyclical downturn become a crash? In theory, fiscal policy can go far in filling the void. The past decade has seen a rise in fiscal evangelism among many economists and policymakers, and it is indeed likely that fiscal fine-tuning will be widely tested in the next downturn. Are they right?

I am skeptical. Fiscal policy is far too politicized to substitute consistently for modern independent technocratic central banks, which until now have largely taken the lead in short-term stabilization. Fiscal policy takes the lead in fundamental but hugely contentious issues – concerning growth, long-term stability, and allocation – that need to be decided in a democratic fashion, at least in advanced economies. And yet academic depictions of fiscal policy as an objective technocratic tool often make one feel like we are living in an episode of the American television series The West Wing.

In that critically acclaimed series, the fictional Democratic US president, Jed Bartlet, is an economist by training. A good and moral person, supported by similarly well-intentioned and brilliant staff, Bartlet exhibits a gift for weighing sophisticated advice from experts to reach nuanced economic-policy decisions that strike a balance between efficiency, fairness, and political realities. Of course, he often faces opposition in getting his legislation passed, but Bartlet and his staff generally prevail. It does not hurt that the ideologues on the right who oppose Bartlet are not only bad people, but also intellectual lightweights.

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