From Monetary Science, Fiscal Alchemy to monetary alchemy, fiscal science

A nice article by Jeff Frankel. He says earlier we thought monetary policy was a science and fiscal was alchemy. Time to think otherwise..

2013 is a 100 year anniversary for 2 institutional innovations- income tax and Federal reserve..

2013 marks the 100th anniversary of US federal income tax and the establishment of the Federal Reserve. What lessons have we learnt about macroeconomic policy since then? This column assesses the postwar lessons and argues that fiscal expansion is much more likely to be effective in the short term than any monetary expansion stimulus. Indeed, compared with fiscal policy, monetary policy seems more alchemy than science.

The main idea is that fiscal multipliers are much higher than what people thought earlier. It has led to better economic outcomes. Mon Pol on the other hand

Nevertheless, if the question is whether it is monetary policy or fiscal policy that can more reliably deliver demand expansion under current conditions, the answer is the latter. One might even dramatise the contrast by speaking of ‘monetary alchemy and fiscal science’.

A much-admired paper by Eric Leeper (2010) had it the other way around: he characterised monetary policy as science and fiscal policy as alchemy. It is true that the state of knowledge and practice at central banks, which actually set the instruments of monetary policy, is close to the best that modern society has to offer. It is likewise true that the instruments of fiscal policy are set in a very political process that is poorly informed by the state of economic knowledge and largely motivated by politicians’ desire to be re-elected. These political realities may be what Leeper had in mind.

Alchemists were not stupid or selfish. Nor were they not listened to. Rather, alchemy fell far short of modern chemistry. The term alchemy could be applied to pre-Keynesians like US Treasury Secretary Andrew Mellon, whose Depression prescription was that President Herbert Hoover should “liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system”. It could also be applied to the UK ‘Treasury view’ circa 1929, defined by Churchill as the Treasury believing that “when Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process raises the rent of money to all who have need of it”. But in light of all that was learned in the 1930s, it would be misleading to characterise the current state of fiscal policy knowledge as ‘alchemy’.

Interesting..The crisis has been a home coming of sorts for fiscal policy..

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