What are the circumstances in which fiscal expansion (see below) might be appropriate? And those in which it would be inappropriate? These questions are extremely important in Britain. There has been a stream of pronouncements warning against a no-deal exit, and lurid warnings of fiscal disaster should a government pursue such a course. That has led to plans from No.11 and the Treasury to support the economy if necessary with expansionary fiscal policy.
Any sensible discussion of this question must start by recognising the causes of our present economic situation, in which negative real (ie, after-inflation) interest rates and asset-price and credit bubbles are necessary to keep on deferring recession across the globe. The cause of the problem is too little saving: too much spending has been brought forward from the future. As that future now looms into our present, there is a need to repair (or attempt to repair) balance sheets by reducing spending relative to income. That means the economy will slow below its trend growth rate unless the private sector is given greater and greater incentives – such as negative real rates, the illusion of stockmarket and housing wealth, and insouciance about debt levels – to bring even more spending forward from the future. In such circumstances, fiscal expansion simply means that instead of giving the private sector more incentives (via monetary policy) to bring spending forward, the public sector does the deed itself. Thus fiscal expansion, of the sort routinely recommended by economists such as David Blanchard and Larry Summers, just builds up more trouble for the future.
A genuinely Keynesian approach would look different.
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