Mankiw: We Need Fiscal Hawks, Monetary Doves

Arnold Kling

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He writes,

If I understand the news coming out of Europe correctly, the new head of the European Central Bank is offering a simple deal: If fiscal policy becomes hawkish, monetary policy will be dovish. In other words, as government spending is cut to put European governments on a sounder financial footing, monetary policy will do its best to ensure that any adverse impact on aggregate demand is kept to a minimum.

He wonders why we cannot get this sort of deal in the U.S. He makes the point that I made at dinner with Tim Congdon. The would-be monetary doves on the left believe we are in a liquidity trap, and the would-be monetary doves on the right are frightened of inflation.

I think what this is getting us is the worst possible combination--expansionary fiscal policy and non-stimulative monetary policy. The hawkish monetary policy may limit inflation in the near term (when lower inflation is not necessarily a good thing), but meanwhile the long-term inflationary pressures are building due to the fiscal deficits.

On the prospects for Europe actually implementing tighter fiscal policy, color me skeptical. Show me some significant cuts in European agriculture subsidies and I'll change my mind.

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CATEGORIES: Fiscal Policy , Macroeconomics , Monetary Policy

COMMENTS (5 to date)

Latest Comment

John Thacker writes:

This post (and Mankiw's) have thrilled Scott Sumner, understandably.

Posted December 2, 2011 12:40 PM

Gaspard writes:

Agricultural subsidies as % of GDP have been declining for years in the EU - eliminating them entirely would only get you 0.5% of EU GDP these days.

www.oecd.org/dataoecd/37/16/43239979.pdf

Posted December 2, 2011 2:06 PM

Publius The Lesser writes:

The net effect of a monetary expansion combined with a fiscal contraction would be to shrink the relative size of the government sector, which is why this policy will never be adopted until all other alternatives have been exhausted.

Posted December 2, 2011 4:34 PM

NL_ writes:

It's hard not to re-read this as "economists think that politician-led solutions should be abandoned in favor of economist-led solutions."

Democratic principles put fiscal policy mostly in the hands of elected politicians. The principle of central bank independence mostly places monetary policy in the hands of economist technocrats. Is anybody surprised economists think politician solutions are of limited effectiveness but economist solutions are appropriate? Politicians similarly focus their energy on stimulus appropriations and temporary tax rebates, not monetary solutions that (in the US, at least) they can't really control.

Posted December 2, 2011 4:49 PM

NL_ writes:

To rephrase myself: when all you have is a hammer, every problem looks like a nail.

Posted December 2, 2011 4:51 PM

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