Following on from my previous post….
Phillip Hammond has suggested a ‘reset’ of fiscal policy might be in order, which could be read as him recognising that monetary policy might not be able to offer an adequate response to the potentially recessionary shock that the Brexit vote imparted.
But in the absence of a proper fiscal framework, it’s he who gets to decide how much stimulus, if any, is imparted. And there is nothing binding him to explain what the objectives are. Moreover, while everyone else stays in the dark about what is meant by a reset, there can be no confidence over what future monetary policy will be, since that will depend in large part on the fiscal response.
Ideally, Hammond would be obliged to make up for monetary inadequacy if it was agreed that monetary policy was inadequate. Though he could undertake more than was necessary, he could not, without suspending the fiscal framework, do less. Something on which the BoE, and all those who depend on her to figure out their long term financing costs, could depend.
And if Hammond were to do more, perhaps by engaging in deficit financing of public investment, there would be an open and independent assessment of how the costs of this would be met by the forecast returns from that future investment.
Whatever happens, the reset has to be done with care. It would be nice to think that the reset gets us closer to an ideal fiscal framework, one that is robust to the zero bound to monetary policy, which we are likely to live near for quite some time to come. And it would be nice to think that after a good reset, there would fewer such resets in the future.
Monetary policy has not had any resets, really, since the enlightened one of 1997. The Bank of England Act can be modified by a straight majority of Parliament. The inflation target, and instructions to weigh deviations from it against fluctuations in real activity, can be modified simply by the Chancellor writing a letter. The real obstacles to messing with monetary policy were the existence of a cross-party consensus that the Bank of England was mandated to do the right thing, and the slowly growing reputational cost that messing after a period of no messing imposes.
Given the scale of disagreements between political factions about what fiscal policy should do, these hopes might seem utopian. But before the inflation target was first thought of in 1992 in the UK, there were similarly disagreeing and vague conceptions of the role of monetary policy.