9 - Broken shards of fiscal policy

Summary

What follows represents the broken shards of a shattered consensus, and an ultimate answer should not be expected because there actually is none at the moment and one is unlikely to emerge in the near future. It is therefore just as well to follow a chronological order. The lack of a consensus has developed ever since the days of the financial crisis and has become all the more significant because of the Coronavirus pandemic. There are different sides here that have made different arguments and to understand what these mean, it is preferable to put together a sort of timeline of this shattered consensus. In the immediate aftermath of the financial crisis (2007– 08), fiscal policy was called upon to act as a countercyclical tool and has been used extensively to that effect. With the turn of the decade (2010) things changed substantially and there was a shift of opinion in policy circles, whereby the concern about the size of the deficit and all the debt accumulated, as the result of a response to the financial crisis, started coming to the fore to the extent that then there were theories put forward as to how fiscal contraction might be expansionary. Following on the years 2010, 2011 and 2012 saw the unfolding of what has come to be known as the Reinhart-Rogoff controversy. With the latter part of the decade, the insurgence – so to speak – of a seemingly heretical point of view that goes under the name of modern monetary theory (MMT) became relevant.

Immediate aftermath 2007– 08

Calls for using fiscal policy as a countercyclical option followed immediately the realization of how little conventional monetary policy tools could achieve and in the full knowledge that the effectiveness of unconventional ones was very much an unknown quantity. The logic for it was that as much as unconventional policies were trying to release the lending constraint and lead banks to lend again, direct supportive action was needed on the level of demand and spending of the private non-banking sector, because the lack of demand creates the problem and also constraints the expansion of credit on the part of banks. After all, banks could easily find themselves with nobody to lend to, because nobody would be asking for a loan, as there is no demand.