Tuesday, July 5, 2016

Fiscal Rock and Hard Place

The rock and the hard place has finally arrived. For those of you not familiar with this terminology, when you are between a rock and a hard place there are no easy or good options to solve your problem. Basically you have let things fester so long that all the reasonable solutions no longer exist. You have procrastinated so long that every solution left is painful.

We see this all the time. It is easy to put off a diet or an exercise program. A diet or exercise program is easy but also so easy to put off until later. But then when you get too heavy or too out of shape, even a small movement in the right direction is much tougher. Geez, do I really have to lose 100 pounds? Yikes. No way. If this seems silly then just read the most current news coming out of Brazil, Argentina, and Venezuela. The past governments spent all the money. Now they have only horrible options.

I wrote two weeks ago about monetary policy and how the Fed still continues to procrastinate about returning to a normal policy. Today’s post turns to fiscal policy. It focuses on how we deal with the fiscal rock and hard place. Basically it is to make believe – make believe that the rock and hard place does not exist.

How can I say that? Easy. I read the latest policy advice coming out of the OECD (Organization for Economic Cooperation and Development). The OECD is a world organization with 34 country members. The OECD studies and writes about the world economy and routinely makes forecasts and gives policy advice.

The latest words from the OECD are titled “Policymakers: Act now to keep promises” can be found at http://www.oecd.org/eco/economicoutlook.htp

I summarize but the main advice given by the OECD is (1) since interest rates are so low countries should enlarge fiscal deficits so as to increase aggregate demand, (2) structural policies should be used to increase productivity growth. Such policies include shifting fiscal policies to increase investment, encourage firm market entry, reform labor and product markets, and improve functioning of financial markets. (3) Avoid further monetary policies since they risk less effectiveness and more harmful side effects.

This advice is totally useless. The OECD must be doing this work on another planet. It flies in the face of what we know and basically proves that we are between a rock and a hard place.

     First, while we all know that monetary policy is now doing nothing but causing imbalances, most countries are fully engaged in almost exclusively relying on monetary policy. The OECD's monetary advice is correct but will fall on deaf ears. They know that so why give it?
     Second, as for using low and negative interest rates to finance further fiscal expansions this advice totally ignores the increased national debt loads in most countries. Sure it is nice to take advantage of low interest rates to borrow. But there are limits to prudent borrowing. Most countries have no room to borrow. This is horrible advice. 
     Finally, the most disingenuous of the policy advice given above has to do with structural reform. Most countries have totally rejected structural reforms because they are too political in nature. Take Paris right now. What self-respecting union is not on strike right now? The current government of France wanted a tiny little bit of labor market reform. Non merci. The best most of us can do is to argue that infrastructure spending is good structural reform. But please – this is just a flimsy excuse to increase debt. As we learned recently from shovel-ready projects  -- infrastructure spending might impact our national economic policies when your grandson becomes eligible for Social Security.

The OECD and others are correct to worry about but short- and medium term productivity and economic growth. But what they don’t want to tell us is that we have procrastinated so long that even sensible policy suggestions seem ludicrous. It won’t take anything creative or fancy to solve problems in most countries. But the politics are too ripe for any of that boring stuff to be supported. Now seems to be the time for impassioned speeches and exaggerated emotion. Make mashed potatoes illegal but never preach the virtues of simple everyday vegetables and modest portions! Get monetary policy back to normal. Get debt back to normal. Don’t throw  business under the bus. But alas, those policies will cause major and painful adjustments. On to snake oil.  


  1. Sounds s if the OECD's advice was written by Paul Krugman. Your "Take Paris right now" comment sounds like a line from a Henny Youngman monologue...."Take my wife....Please!"

    1. The sad thing is that we expect that nonsense from Paul Krugman. But the OECD and just about everyone else are so afraid to admit the rock/hard place reality that they are all making up fantasies. The global economy needs some tough love and it is not going to get it from our current crop of so-called leaders. Nice point about Henny Y. But I am best remaining silent in response. :-)