Not All Fiscal Policy is Equal

Cardiff Garcia says we all need to get along. At least the fiscalists and market monetarists who believe there is still a aggregate demand shortfall. He makes the case that both sides should tolerate and even embrace each other. Here is Garcia on market monetarists:

But there is one sense in which even the monetarist position is amenable to fiscal stimulus, and it is this. A belief of the market monetarists is that if NGDP level targeting were properly embraced, then the awful outcomes characteristic of a Great Recession — a slowdown of NGDP growth, calamitous falls in asset prices, the disintegration of usable collateral — would be avoided in the first place…

As such, the very impetus for using fiscal policy to stabilise the economy and accelerate the recovery would be unnecessary…The monetarists therefore wouldn’t be inconsistent if they were to say: Sure, keep fiscal stabilisation policy at the ready in case we fail. We just don’t think it will be necessary. If it does turn out to be necessary, well, go for it.

Okay, but not all fiscal policy is equal. Fiscal policy geared toward large government spending programs is likely to be rife with corruption, inefficient government planning, future distortionary taxes, and a ratcheting up of government intervention in the economy. So I will pass on this type of fiscal policy. Fiscal policy, however, that largely avoids these problems and directly addresses the real issue behind the aggregated demand shortfall–an excess demand for safe, money-like assets–I will endorse. And that form of fiscal policy is a helicopter drop, a government program that gives money directly to households. The Fed would finance it and the Treasury Department would deliver it to each household. This idea is not new. It was originally suggested by Milton Friedman and recently discussed by the conservative AEI. So it should have appeal across both parties.

Here is how I would operationalize this policy. First, the Fed adopts a NGDP level target. Doing so would better anchor nominal spending and income expectations and therefore minimize the chance of ever entering a liquidity-trap. In other words, if the public believes the Fed will do whatever it takes to maintain a stable growth path for NGDP, then they would have no need to panic and hoard liquid assets in the first place when an adverse economic shock hits.

Second, the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed.

This two-tier approach to NGDP level targeting should create a foolproof way to avoid liquidity traps. It should also reduce asset boom-bust cycles since NGDP targets avoid destablizing responses to supply shocks that often fuel swings in asset prices. This approach is consistent with Milton Friedman’s vision of monetary policy, would impose a monetary policy rule, and provide a solid long-run nominal anchor. Finally, per Cardiff Garcia’s request it would satisfy both fiscalists and monetarists. What is there not to like about it?

P.S. I would be glad to submit this proposal to Representative Kevin Brady for consideration in his centennial commission on monetary policy. It would be great to see Congress discuss reforming the Fed along these lines.

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