A decade ago, the prevalent view about fiscal policy among academic economists could be summarised in four admittedly stylised principles:
- Discretionary fiscal policy is dominated by monetary policy as a stabilisation tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.
- Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).
- Moreover, fiscal stabilisation needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.
- Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimising harmful side effects and long-run fiscal harm.
Today, the prolonged aftermath of the Global Crisis, the increased realisation that equilibrium interest rates have been declining for decades and a better understanding of economic policy from the last eight years of experience have led the shift away from this ‘Old View’ of fiscal policy.1
Theory and evidence for the New View of fiscal policy
The New View of fiscal policy largely reverses the four principles of the Old View – and adds a bonus one.
- First, fiscal policy is often beneficial for effective countercyclical policy as a complement to monetary policy.
With low interest rates limiting the effectiveness of conventional monetary policy, central bankers and international organisations increasingly endorse the idea that monetary policy cannot, by itself, be fully effective and would benefit from supportive fiscal policy
