How refreshing to hear a center-right politician talk good sense about monetary policy. Here is George Osborne, the UK’s chancellor of the exchequer, who spoke at AEI last week:
Proponents of the “secular stagnation” argument say that over recent decades monetary policy has had to work harder and harder to sustain growth, and has now reached its limits. Demand, they say, can only be sustained with further fiscal stimulus and higher government debt.
This argument is difficult to defend in light of recent developments. The evidence increasingly shows that monetary policy, broadly defined and effectively deployed, can work, but with two caveats. Banks need to be well capitalized so that the monetary-transmission system is working. And fiscal policy must be credible.
Quibbles with Osborne about how exactly monetary policy works are more than offset by general agreement about the potential effectiveness of monetary policy. While Republicans have been quick to point to Europe as cautionary tale of fiscal excess, the real lesson is one of the dangers of monetary restraint. As economist Michael Darda recently put it:
Both the U.S. and euro area have had sharp fiscal consolidations; however, the U.S. has enjoyed steady, albeit unspectacular, growth, whereas the euro are fell into a two-year double-dip recession. Given similar fiscal adjustments in both regions, the difference in economic performance over the last few years is largely explained by relative monetary policies. In other words, the Fed has done a better job sustaining NGDP growth with QE and forward guidance, whereas the ECB made the fateful error of tightening monetary policy twice in 2011, precipitating a double-dip recession that has just recently begun to abate.
Three charts from Darda: The first showing fiscal austerity in the form of declining deficits between the US and Eurozone; the second showing unemployment; the final showing industrial production