Fed Watch: Three Parts to Macro Policy

Tim Duy:

Three Parts to Macro Policy, by Tim Duy: The G20 has accepted Japan's policy approach. From the Financial Times:

The yen fell sharply against other major currencies on Friday after the Japanese finance minister said Japan’s monetary policies had not met with resistance at the G20 group of nations in Washington.

This interpretation of the meeting helped sink the Yen to almost 100. More specifically, from the statement:

In particular, Japan’s recent policy actions are intended to stop deflation and support domestic demand.

Still, there remains a pro-austerity contingent:

Japan should define a credible medium-term fiscal plan.

I think the only credible medium-term plan for fiscal consolidation first involves higher near-term growth. More broadly than just Japan, but including Japan:

We will continue to implement ambitious structural reforms to increase our growth potential and create jobs.

How do these pieces fit together? I tend to see room for all three policy tools - monetary, fiscal, and structural - in fighting weak growth and outright recessions, although the weighting will vary according to circumstances. For instance, I don't deny the need for structural changes in the European periphery or Japan. Those changes, however, need to be cushioned with expansionary monetary and fiscal policy to yield a positive growth trajectory.

With this in mind, consider this recent post by Ed Harrison. He expands the Reinhart/Rogoff debate to current events in Japan:

This is the takeaway in Japan: stimulus without reform leads to a policy cul-de-sac. Monetary and fiscal stimulus is not a cure-all for economies or Japan would be the model and it most assuredly is not the model. If you want to use stimulus, then you need to have reform policies as well. It’s a three-pronged approach. The supply side matters. And that is the promise of Abenomics, isn’t it: fiscal and monetary stimulus as bridges to sustainable growth due to economic reform. Supposedly, this is what Abenomics is all about. And the Wall Street Journal told us yesterday that this reform, the third leg of this stool is now being put into place. Be sceptical, of course. Let’s just see what happens.

Mixing the RR debate and the Japanese and European experiences leads him to these conclusions:

Take a cue from Japan. The lesson is not to stimulate and deficit spend like mad and hope this succeeds in reflating the economy. That’s just a risk shift onto the public balance sheet. And the Japanese experience shows that people are uncomfortable with these kinds of deficits and will always work to reduce them irrespective of the consequences. You need supply side fixes too.

Take a cue from the euro zone. The lesson is also certainly not to undergo painful – and front-loaded – austerity like the euro zone. The Europeans have tied their hands with the euro. There is no currency sovereignty there and the ECB is legally forbidden to be politically aligned with any national government. The threat of insolvency is real. But Britain doesn’t have to go down this path. They have a lot more policy space. The bond vigilantes are a myth.

Read the post for more good insights.