Another day, another fiscal policy framework

It’s an exciting time in fiscal policy. A new paper out features three unlikely bedfellows. Financiers cum public servants Peter Orszag and Robert Rubin, advocates of fiscal discipline and balanced budgets in the Clinton and Obama administrations, have published with Nobel Laureate Joseph Stiglitz, of “resigning from the World Bank in protest” fame.

Their core message is simple but profound: the world is uncertain, and policy makers have a poor track record predicting the future. The defining macroeconomic events of the last fifteen years, the GFC, Trump, Brexit, and Covid-19, surprised specialists and laypeople alike. Economists did not predict the years of stagnation across the developed world, or today’s era of low interest rates.

What does that mean for fiscal policy though?

It is as inadvisable to assume we are in a “new normal” of perpetually low interest rates as it was to assume in 2009 that we were on the verge of returning to an “old normal.”

Policy makers should eliminate normal from their vocabularies, or in their words: a cogent fiscal policy framework should account for this deep uncertainty and provide fiscal policymakers tools to manage it and its fiscal consequences

What does it mean in practice, what are the ‘tools’?

The familiar: expand automatic stabilisers, make infrastructure spending more automatic and less pro-cyclical, increase debt maturities, and index long-term entitlement spending.

The novelty is their call for fiscal discretion. Hard fiscal anchors like the 3% deficit limit, or the 60% debt/GDP ratio need to go. Alongside automatic stabilisers, governments need discretion to respond to the unique challenges thrown up by an uncertain world.

This is a big shift. As I’ve written about before, the goal for many decades was to limit government discretion as much as possible, whether by legislating spending limits, or policing from independent central banks. The closer government was to an algorithm, the better.

In practice, their proposals do not differ much from Summers and Furman’s recent policy paper, however, their caution against taking today’s low-interest rate environment as given is a good one.

Most importantly, placing true uncertainty – Knightian uncertainty – at the centre of their framework is a positive step forward.

As you might expect from such unlikely bedfellows, there were some interesting tensions on display which I’ll get into tomorrow.