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It's All in the Mix: How Monetary and Fiscal Policies Can Work Or Fail

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It's All in the Mix: How Monetary and Fiscal Policies Can Work Or Fail GENEVA REPORTS ON THE WORLD ECONOMY 23 Elga Bartsch, Agnès Bénassy-Quéré, Giancarlo Corsetti and Xavier Debrun IT’S ALL IN THE MIX HOW MONETARY AND FISCAL POLICIES CAN WORK OR FAIL TOGETHER ICMB INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES CIMB CENTRE INTERNATIONAL D’ETUDES MONETAIRES ET BANCAIRES IT’S ALL IN THE MIX HOW MONETARY AND FISCAL POLICIES CAN WORK OR FAIL TOGETHER Geneva Reports on the World Economy 23 INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB) International Center for Monetary and Banking Studies 2, Chemin Eugène-Rigot 1202 Geneva Switzerland Tel: (41 22) 734 9548 Fax: (41 22) 733 3853 Web: www.icmb.ch © 2020 International Center for Monetary and Banking Studies CENTRE FOR ECONOMIC POLICY RESEARCH Centre for Economic Policy Research 33 Great Sutton Street London EC1V 0DX UK Tel: +44 (20) 7183 8801 Fax: +44 (20) 7183 8820 Email: [email protected] Web: www.cepr.org ISBN: 978-1-912179-39-8 IT’S ALL IN THE MIX HOW MONETARY AND FISCAL POLICIES CAN WORK OR FAIL TOGETHER Geneva Reports on the World Economy 23 Elga Bartsch BlackRock Investment Institute Agnès Bénassy-Quéré University Paris 1 Panthéon-Sorbonne, Paris School of Economics and CEPR Giancarlo Corsetti University of Cambridge and CEPR Xavier Debrun National Bank of Belgium and European Fiscal Board ICMB INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES CIMB CENTRE INTERNATIONAL D’ETUDES MONETAIRES ET BANCAIRES THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB) The International Center for Monetary and Banking Studies (ICMB) was created in 1973 as an independent, non-profit foundation. It is associated with Geneva’s Graduate Institute of International and Development Studies. Its aim is to foster exchanges of views between the financial sector, central banks and academics on issues of common interest. It is financed through grants from banks, financial institutions and central banks. The Center sponsors international conferences, public lectures, original research and publications. In association with CEPR, the Center has published the Geneva Reports on the World Economy since 1999. These reports attract considerable interest among practitioners, policymakers and scholars. ICMB is non-partisan and does not take any view on policy. Its publications, including the present report, reflect the opinions of the authors, not of ICMB or any of its sponsoring institutions. The President of the Foundation Board is Jaime Caruana and the Director is Ugo Panizza. CENTRE FOR ECONOMIC POLICY RESEARCH (CEPR) The Centre for Economic Policy Research (CEPR) is a network of over 1,300 research economists based mostly in European universities. The Centre’s goal is twofold: to promote world-class research, and to get the policy-relevant results into the hands of key decision-makers. CEPR’s guiding principle is ‘Research excellence with policy relevance’. A registered charity since it was founded in 1983, CEPR is independent of all public and private interest groups. It takes no institutional stand on economic policy matters and its core funding comes from its Institutional Members and sales of publications. Because it draws on such a large network of researchers, its output reflects a broad spectrum of individual viewpoints as well as perspectives drawn from civil society. CEPR research may include views on policy, but the Trustees of the Centre do not give prior review to its publications. The opinions expressed in this report are those of the authors and not those of CEPR. Chair of the Board Sir Charlie Bean Founder and Honorary President Richard Portes President Beatrice Weder di Mauro Vice Presidents Maristella Botticini Ugo Panizza Hélène Rey Philippe Martin Chief Executive Officer Tessa Ogden About the authors Elga Bartsch, Managing Director, is Head of Macro Research of the BlackRock Investment Institute. Prior to joining BlackRock, she was Global Co-Head of Economics and Chief European Economist at Morgan Stanley in London. She started her career as a research associate at the Kiel Institute for the World Economy, a large German economic think-tank where she worked at the President’s office and managed the Advanced Studies in International Economic Policy Research programme. She has more than 20 years of macro research experience and is a member of the ECB Shadow Council and a trustee of the IFO Institute for economic research. She also served on and chaired the Economic and Monetary Policy Committee of the German Banking Association. She graduated with a Master’s degree from Kiel University, where she subsequently also completed a PhD. Agnès Bénassy-Quéré is a Professor of Economics (on leave) at University Paris 1 Panthéon-Sorbonne and at the Paris School of Economics. She worked for the French Ministry of Finance, before moving to academic positions at the universities of Cergy- Pontoise, Lille II, Paris-Ouest and Ecole Polytechnique. She also served as a Deputy- Director and Director of CEPII, and later chaired the French Council of Economic Analysis (advising the Prime Minister). She was a member of the Commission Economique de la Nation (an advisory board to the Finance Minister), the French macro-prudential authority, tax advisory council, national productivity council, the Franco-German council of economic experts and the general board of the Banque de France. She is a member of the Bruegel board and a CEPR Associate Fellow. Giancarlo Corsetti is Professor of Macroeconomics and fellow of Clare College at the University of Cambridge. After graduating from Yale, he taught at the universities of Rome, Yale, and Bologna, before moving to the European University Institute, where he was Pierre Werner Chair until 2010. He is a leading scholar in international economics and open macro, with theoretical and empirical contributions on currency, financial and sovereign crises; monetary and fiscal policy; and the international business cycle. His work is published in international journals including American Economic Review, American Economic Journal: Macro, Quarterly Journal of Economics, Review of Economic Studies, and the Journal of International Economics (where he has long served as co-editor). Corsetti is a Research Fellow of CEPR, a research consultant to the ECB and the Bank of England and theme coordinator at Cambridge-INET. Xavier Debrun is an advisor in the Research Department of the National Bank of Belgium. He studied economics at the University of Namur and the Graduate Institute in Geneva where he obtained a PhD in International Economics. Xavier spent most of his 20-year professional career in the Fiscal Affairs and Research Departments of the International Monetary Fund (IMF). In 2006-07, he was a visiting Fellow at Bruegel and a visiting Professor of International Economics at the Graduate Institute in Geneva. He has regularly taught in academic institutions, including the University of Geneva, the University of Clermont-Auvergne and the Catholic University of Louvain (UCL). His research interests include international policy coordination, the economics of currency unions, and macro-fiscal issues, including debt sustainability assessments and the stabilizing role of fiscal policy. His work has been disseminated in peer-reviewed journals, VI IMF flagship reports, and conference volumes. He led many technical assistance missions for the IMF in relation to the design and operation of fiscal policy rules, macro-fiscal forecasting, and the introduction of independent fiscal institutions. HOW MONETARY AND FISCAL POLICIES CAN WORK TOGETHER OR FAIL IT’S ALL IN THE MIX Contents About the authors v Acknowledgements viii List of conference participants ix Foreword xvii Executive summary 1 Introduction 5 1. The mix of monetary and fiscal policies: Why does it matter? 9 1.1 The nuts and bolts of monetary and fiscal policies 10 1.2 The policy mix: Lessons from the classical literature 17 1.3 The making of a good policy mix 21 1.4 The evolution of the policy mix 26 1.5 The policy mix across borders and in a monetary union 29 1.6. The policy mix at the zero lower bound: The standard view on its head? 30 1.7 Conclusions 31 2. The policy mix at work: Congruent, divergent or destabilising? 33 2.1. Macroeconomic policies and the business cycle 33 2.2. Congruence is rare 35 2.3 Understanding procyclicality 46 2.4 Conclusion 51 3. ‘Tail risk’ challenges to the policy mix 53 3.1 What is tail risk? 54 3.2 Complementarity of policies and interdependence of monetary and fiscal authorities 55 3.3 Getting the policy mix wrong: The euro area experience after the GFC 61 3.4 Policy mix unravelling: Mismanaging the monetary-fiscal interdependence 63 3.5 Exiting unbalanced policy regimes: A case study of yield curve control 66 3.6 Conclusions 80 4. Objectives and instruments for a Great Normalisation 83 4.1 Determinants and consequences of a low and falling R* 84 4.2 Raising R*: A shared policy objective 88 4.3 Enhancing the policy mix: A review of proposals 91 4.4 Conclusions 99 Conclusion 101 Discussions 105 References 127 Appendices 135 Appendix A: Variables and data sources 135 Appendix B: Additional figures 136 Appendix C: Logit estimation results 138 Acknowledgements We are grateful to Ugo Panizza for suggesting that we team up to work on a topic that we found increasingly fascinating and challenging as we moved forward in our analysis. We VIII thank Rodrigo Hernán Pazos for superb research assistance, especially on Chapters 2 and 3. Special thanks are due to William Brainard, who managed to convey to us the spirit and the depth of the debate on the policy mix led by Okun and Tobin. Without implication in the remaining errors and omissions, extensive comments from our discussants, Katrin Assenmacher, Marco Buti, Benoît Coeuré, Bill English, and Ricardo Reis, as well as from Stefan Gerlach, Ugo Panizza, Angel Ubide, and conference participants, led to considerable improvements in the report.
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