Thursday, July 9, 2015

What is in the control of central banks?

Former Bank of England Governor Mervyn King once quipped that central bankers aren’t really obsessed with inflation. What keeps them up at night is fiscal policy.
-WSJ

Fiscal policy should keep us all up at night. The movement from austerity to profligate spending has been one of the biggest issues in macroeconomics since before the Great Recession. Raising rates by the Fed may have a small impact by comparison with what can be the effect of poor fiscal policy. At the spending extreme, we see the problems of Greece and Puerto Rico as just two examples of too much spending that comes back to haunt a government. To little spending in the US may have placed more of the burden on the Fed to serve as the only solution to the output gap. 

Fiscal policy is outside the control of the central bank, so it is an issue or worry that cannot be solved. Inflation can be a large concern, but it can be under the control of the central bank or at least it is their view that it is controllable. Poor spending decisions may require the central bark to follow policies it may not prefer in order to bail-out an economy from the fiscal issues. Japan is one perfect example where the burden has been on the BOJ to act because the government has been unwilling or unable to make reforms and actions necessary to improve the economy.

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