Remember When Governments Used to Run Their Economies?

(Bloomberg Opinion) -- With negative interest rates increasingly common even in growing economies, central banks might not have much room to cut in a severe economic downturn. On Monday, both Germany and the U.S. showed that fiscal policy could be used to pick up the slack. After relying primarily on money supply and interest rates for economic stimulus this decade, developed economies may finally be shifting the responsibility back toward fiscal policy – how the government sets spending and taxes.

It's really time the world tried a stimulus plan that wasn't centered on monetary policy. A well-run monetary policy is important to economic growth – in the U.S., for instance, we've seen housing and refinance activity pick up in response to lower interest rates this year – but there are limits to its effectiveness.

What we've seen in the U.S. this decade is that even when interest rates were at the zero lower bound, credit demand was weak. Household mortgage debt as a percentage of gross domestic product continues to fall, and is at its lowest level since 2001. Silicon Valley's innovation and growth, being speculative and largely unprofitable, has mostly been funded via venture capital and equity rather than debt. The biggest increase in private sector debt this decade has come from the corporate sector, not to fund investments, but to buy back stock.

And as we've seen in Japan and Europe, interest rates staying at low or negative levels has hurts the banking system. As lower interest rates make banks less profitable, they may extend fewer loans – meaning that monetary policy ceases to be stimulative.

So it's encouraging that policymakers may be becoming more open to using fiscal policy too. While it may take a deep recession to get Germany to act, reports have emerged that Germany is beginning to discuss what sorts of fiscal stimulus they'd consider. At the same time, the Washington Post reported that the Trump administration has begun discussing a payroll tax cut as a form of fiscal stimulus to stave off any economic weakness that might emerge. While the White House later shot down the specifics of the story, it's the first time since the corporate tax cuts that the Trump administration has floated doing something to support economic growth other than complaining that the Federal Reserve needs to cut interest rates.

Ever since the high inflation of the late 1970s, we've seen the shortcomings of trying to manage the economic cycle primarily through monetary policy. In strong economies, the Federal Reserve has increased interest rates, usually ending the economic cycle just when workers are starting to get larger wage increases. And then in downturns, interest rate cuts and asset purchases from central banks first enrich investors and the financial sector before indirectly benefiting workers and households. 

Interest rate cuts and asset purchases from the Federal Reserve in the wake of the great recession didn't prevent millions of workers from losing their jobs and homes, but they did allow investors to raise funds and borrow money cheaply to buy up a large portion of the foreclosed housing inventory that hit the market at low prices in the early part of the 2010s. It took years for workers to regain lost jobs and wages, at which point the houses they lost and might try to repurchase had increased in value significantly, contributing to the increase in inequality.

Unlike the blunt instruments of central banks, well-targeted fiscal stimulus can go to workers and households directly without flowing through Wall Street and the financial system. In a political environment that has turned more populist, it's also easier for voters to understand and tangibly observe – like a fiscal policy program to build infrastructure, resulting in large-scale hiring.

With the limits of monetary policy increasingly apparent, populism on the rise, and the public looking for policymakers to tackle inequality, fiscal policy could be returning to the spotlight.

To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.

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