“Suppose we had fiscal austerity well away from the ZLB. Suppose further that for some reason the monetary authority did not take measures to offset the impact this had on aggregate demand, and there was a recession as a result. I suspect a MM would tend to say that this recession was caused by monetary policy, even though monetary policy had not ‘done anything’. (In this they follow in the tradition of that great monetarist, Milton Friedman, who liked to say that monetary policy caused the Great Depression.)
The reason they would say that is not because fiscal policy has no effect, but because it is the duty of monetary policy to offset shocks like fiscal austerity. That is why fiscal policy multipliers should always be zero, because monetary policy should make themso. So Mark Sadowski got upset with my statement because in his view ECB policy failed to counteract the impact of Eurozone austerity, and could have done so, which meant the recession in 2012/3 was down to monetary policy, not fiscal policy.
So we come to the heart of the disagreement – the ability of monetary policy to offset fiscal actions at the ZLB.”
Sigh. This is *part* of the heart of the disagreement, but an even bigger problem seems to be what constitutes doing “nothing”, and where we seem to think the “ZLB” is located. Let’s review the history of policy interest rates in the big four advanced currency areas since the Great Recession started.
Note that since at least the middle of 2009 policy rates in the U.S., Japan and the U.K. have indeed been more or less constant, and provided one views this strictly in a Neo-Wicksellian sense, it can be argued that the central banks of these currency areas have done “nothing”.
However, notice the big red pimple that bursts forth in 2011. That is the ECB raising the Main Refinancing Operations Rate (MRO) just prior to the start of the second Euro Area recession and the round of the Euro Area sovereign debt crisis. This is most certainly not doing “nothing”, even in an extreme Neo-Wicksellian sense.
Read the whole article here.