The weekly post on Monday was on the new Japanese LDP Prime Minister Abe’s threat to strip the Bank of Japan of its independence as a central bank. The thrust of his threat goes to the integration of monetary and fiscal policy to create a consolidated government balance sheet so that government can better serve its policy aims.
Tim Duy has a good post on this issue that I highly recommend. And the big idea that Tim has here is that it is fiscal policy that is king here. As I have been saying for some time now, tight fiscal and loose monetary leads to recession. Fiscal will always win in a debt deflationary or deleveraging environment. The problem for policy makers is that fiscal and monetary policy are not necessarily completely aligned. And so those who are looking to push the envelop on government stimulus and economic support will always favour a consolidated balance sheet approach.
As Tim points out, Bernanke is also onboard here as judged by his famous helicopter speech:
Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
Notice the pointed reference to working ‘in cooperation with other agencies’, resulting in what I call the ‘consolidated balance sheet’ effect. Bernanke is saying that monetary policy will become the handmaiden of fiscal policy; they will work in concert to achieve the same aim – much as they did in the early post World War II era.
I don’t have a whole lot more to add here. But on the whole, I think this is a big deal. We have been sort of creeping in this direction for a while now since the financial crisis began but now the consolidated balance sheet approach is being made explicit. And I think it demonstrates the relative impotence of so-called bond vigilantes in the face of a government determined to suppress nominal rates. In that vein, Wolfgang Munchau, writing for the German news site Spiegel, named Shinzo Abe Man of the Year for just this reason. I’m sorry I don’t have a translation of this article but here’s the link in German. The gist here is that Munchau believes that the move away from price stability as the predominant interest of central banks has now been signalled loudly by Abe. We are entering a new era.
I agree this is a new era of central banking, one of less independence and less concern about inflation targets. But, let’s remember that monetary policy is still king. No one in Europe is talking about fiscal as a saviour. And in the US, monetary policy is still driving the stimulus train while fiscal policy is being reined in – to the point of creating recession. So I see this as a massive shift in central banking and monetary policy toward a model of integration and coordination with fiscal policy. But, as yet, this shift is incomplete. Expansive fiscal policy is still seen as a problem in contrast to expansive monetary problem, which is seen as a solution. And so we are now in a period of loose monetary and tight fiscal. Fiscal will win this battle and that will create more economic weakness, making the move to a coordinated loose monetary and fiscal policy the only move left. Japan is leading the way.