Though it has been episodic in both Europe and (especially) Japan, monetary policy has often been in growth mode, meaning policy measures intended to lower the cost of borrowing with the potentially positive side effects of a more competitive currency (e.g., a weaker yen, which helps to boost Japan’s exports — though “more competitive” sounds a lot better than “weaker”) and higher inflation (which further lowers real interest rates). That puts us in the first column.
But that’s also where the trouble starts. Far too often, here, in Europe and in Japan, fiscal policy has been in neutral mode at best and contraction mode at worst. And without complementary, growth-oriented fiscal policy, monetary policy is “pushing on a string.” The central banks can set the table, as it were, by lowering the cost of borrowing. But if the potential customers have empty pockets — or are deleveraging, have lost a bunch of their housing wealth, and are not seeing any real wage — then no one’s going to come in and order off the menu. (The countries in the Eurozone have the added problem of a common currency, so the more-competitive-currency route is blocked for them.)
In cases like Europe and Japan today — they raised their national sales tax from 5 to 8 percent in May and plan to take it higher next year, though they’re doing a rethink on the latter — and the U.S. as recently as last year, fiscal policy has consistently failed to complement monetary policy. There’s been no consistent one-two, fiscal-monetary punch, where monetary policy lowers the cost of borrowing and fiscal policy incentivizes people to take advantage of it.
Thus, as per the above table, Japan and parts of Europe are in box 7, though at various points before their central banks got the memo, they were in 5 and 8; the U.S. was in box 7 last year, as fiscal drag cost us about 1.5 percentage points of GDP. Now, fiscal policy is neutral — neither helping nor hurting growth — so we’re in box 4.
But since at least 2010, everyone has avoided box 1, though that’s arguably where we need to have been and they need to be. Far too often, our policymakers are acting like fiscal and monetary policies are substitutes, not complements: If one is turned on, so the thinking goes, the other should be turned off. But as I’ve stressed, for monetary policy to really gain some traction in economies where many consumers are still weak when it comes to income, wages and net worth, it needs the tailwinds of fiscal policy behind it.
And thus advanced economies keep getting knocked out. Punch drunk, they crawl off the mat, repeat the same mistake, and get knocked down again. Eventually, the economic mind gets so battered it can no longer think straight.