Thread by @jnordvig

Why is it important to coordinate fiscal and monetary policy (FisQEl policy, if you will):

some initial observations/thread, maybe we will have to reply in more detail on our new policy blog:

moneyinsideout.exantedata.com

https://twitter.com/jnordvig/status/1336022328925433856

First, If one macro policy operates in isolation, it can be contradicted by ‘the other’ policy. This is especially relevant with monetary policy. In the past, expansive fiscal policy was often associated with monetary tightening (=not good, if you have spare capacity, low inf.)

Policy coordination, which ensures that monetary policy, and market rates, are not ‘fighting’ the fiscal policy can help solve this problem. =>coordination is good.

There has in the past been a debate around ‘fiscal multipliers’ and the notion that counter-cyclical monetary policy may work to reduce fiscal multipliers. This is a specific angle on this issue, as discussed by the CBO for example.

cbo.gov/sites/default/…

Another way to think about it, is that there may be declining marginal returns to certain policies. For example, if fiscal policy is focused on infrastructure there will be an initial set of ‘high return’ initial projects, and returns will decline from there.

Similarly, monetary easing has declining returns, the more maxed out the central bank is (and the easier financial conditions already are). This is an argument to combine the two policies, to maximize impact, achieve highest overall marginal returns.

Third, there is an argument that policy should have a shock effect, to impact expectations (which is crucial to inflation) the most. This was the argument behind Abenomics & while Abenomics has not been fully successful (perhaps in part due to VAT), the argument is a valid one

The argument is that the shock effect, and ability to move expectations, if you max / go aggressive on all policies at the same time

Fourth, coordinated monetary and fiscal easing will matter not just in terms of the contemporary impact, but also in relation to expectations for future coordination.

In the US, the Fed is currently committing to not raise rates preemptively in response to rising inflation expectations (under the AIT banner).

Coordination between fiscal and monetary policy can serve a similar purpose and anchor an easy monetary policy in the future even in the face of aggressive fiscal expansion, to ensure that monetary policy will not ‘work against’ fiscal policy at any point on the horizon.

Obviously, there are political constraints on all this, especially in democracies, where government changes. But that is a different debate. I will leave it at that. Expanding via fiscal and monetary together is good. END