Anchoring fiscal expectations is as important


I came across this paper from Eric Leeper, an econ professor at Indiana University. The paper addresses an issue which has bothered me quite a bit. I keep asking myself- why is research on fiscal policy usually about the various fiscal multipliers (whether higher with taxes or expenditures), impact in recessions etc etc. Why isn’t there adequate research on fiscal policy instiutions? On their functioning? On their relationship with central banks (we usually get this research from a central bank perspective).

However, when you look at monetary policy, the research and its scope just gets larger and larger. Not that mon pol is not important but fiscal policy is as important. Just like most economies have central banks, they also have finance minsitries/treasuries. If we know much more about central banks, we should know about  finance minsitries/treasuries as well.

If you are looking for such research on fiscal policy, Eric Leeper is the economist. The abstract of the paper says:

In this lecture, I argue that there are remarkable parallels between how monetary and fiscal policies operate on the macro economy and that these parallels are sufficient to lead us to think about transforming fiscal policy and fiscal institutions as many countries have transformed monetary policy and monetary institutions.

Making fiscal transparency comparable to monetary transparency requires fiscal authorities to discuss future possible fiscal policies explicitly. Enhanced fiscal transparency can help anchor expectations of fiscal policy and make fiscal actions more predictable and effective. As advanced economies move into a prolonged period of heightened fiscal activity, anchoring fiscal expectations will become an increasingly urgent need.

He says there has been a revolution in both monetary policy and monetary policy research in last 15 years. But nothing much in fiscal policy:

It is now widely accepted that for monetary policy to effectively stabilize the real economy and inflation: monetary policy should be independent of fiscal policy, insulated from political pressures, and avoid fooling people in order to offset the dynamic effects of distortions in the economy; in addition, central bankers should communicate  transparently about their objectives and their strategies for achieving those objectives  they should be held accountable for their decisions.

Still more remarkable is that this transformation occurred in the absence of any real evidence that transparency of monetary policy and improved communication by central banks actually matter for the performance of the economy. Two conditions  drove the move toward greater transparency. First, a professional consensus emerged that inflation is a monetary phenomenon and that inflation control is the appropriate purview of the central bank. Second, and perhaps more important, a political consensus developed that low and stable inflation is desirable because inflation fluctuations redistribute wealth in capricious ways [Faust and Henderson (2004)]. It took several decades of poor macroeconomic performance for these consensuses to develop. 

Why have we seen no corresponding enlightenment in governments’ tax and spending policies? Despite a range of changes in fiscal frameworks across advanced countries since the 1990s, in general, fiscal policy remains as opaque as ever. Is it desirable to transform fiscal policy in a manner that is analogous to what has occurred with monetary policy? Is it feasible? Can professional and political consensuses on the effects and role of fiscal policies be reached?

He says transparency means different hings to both but should actually be similar.

Monetary authorities and fiscal authorities appear to mean different things by “transparency.” For central banks it is a means to an end: the better the public understands and anticipates monetary policy choices, the more firmly expectations will be anchored on actual monetary policy goals, and the more effective monetary policy will be in achieving its objectives. This is the sense in which I shall use the term. But this is not how fiscal authorities apply the term. In fiscal realms, “transparency” means the adoption of generally accepted accounting principles, the conduct of policy in an open and public way, and so forth. Fiscal transparency is more about establishing the integrity of the fiscal process than it is about helping the public to form expectations of future tax and spending policies. Although fiscal authorities compute and publish fiscal projections, the projections typically condition on current policies; they are silent on possible future  policies and, therefore, contribute little to transparency and the anchoring of fiscal expectations.

Excellent stuff. The paper then goes on to explain how most fiscal reforms are artificially done and non-transparent. Whereas monetary policy reforms are not just better executed but transparent and well researched.

Read the entire thing. Leeper provides fresh insights into the fiscal policy research.

3 Responses to “Anchoring fiscal expectations is as important”

  1. The logic of the day Says:

    […] Anchoring fiscal expectations is as important […]

  2. How Important Does The Business Plan To Lenders? | Narrotin News Says:

    […] Anchoring fiscal expectations is as important « Mostly Economics […]

  3. Lack of Fiscal expectations could undermine Taylor rule « Mostly Economics Says:

    […] of Fiscal expectations could undermine Taylor rule By Amol Agrawal I had said earlier we should read Eric Leeper. He brings really interesting interactions between fiscal and monetary […]

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