By MATHEUS SILVA*
How monetary policy exercises dominance over fiscal policy or how the Central Bank controls the government
In this article, I aim to present the economic theory behind the independence of the central bank with the aim of demonstrating to the reader how it uses monetary policy instruments to control the government like a hostage.
The return to orthodoxy in the 1970s and 1980s
Fiscal policy as an instrument of economic policy has always been part of the capitalist State's tools for managing public resources, and for much of the 20th century it was the subject of debate between economists of the neoclassical Keynesian synthesis and monetarists or new-classics, discussing topics such as , the effects of the public deficit on inflation and the balance of payments or the impacts of public spending on aggregate demand and private investments.
However, during the 1970-80s, debates on fiscal policy followed other directions, focusing on the issue of public debt sustainability, the credibility of economic policy and the definitions of fiscal rules to control spending.
With the changes that occurred in world capitalist economies in the 1980s, due to the phenomenon of globalization, and the accelerated development of monetarist and new-classic economic theories, the vision for conducting fiscal policy points towards the loss of degrees of freedom on the part of governments regarding product and employment issues. Thus, macroeconomic models began to question the validity of fiscal policy as an adequate instrument to affect the level of product through aggregate demand, employment and income.
And with the strengthening of orthodoxy in mainstream academically, the ideas of credibility of economic policy, sustainability of public debt and rules for controlling public accounts began to gain increasingly greater notability, reflecting a change in the view on the role of fiscal policy and helped to define what Philip Arestis and Malcolm Sawyer called in his article “Reinventing Fiscal Policy” published in Journal of Post Keynesian Economics in 2003 of “new macroeconomic consensus”.
Therefore, discipline in fiscal policy for the new-classical orthodoxy is related to unrestricted and timeless austerity, in which the fiscal authority (central government) is committed to preparing its budgets taking into account financing restrictions, inflation stability and debt commitments to be honored.
In this way, some economists from the orthodox new-classical camp are completely against any type of flexibility in fiscal policy, defending the view that fiscal policy should have as its central objective the generation of surpluses, demanding greater responsibility from governments with greater spending cuts. .
In summary, orthodoxy reached the consensus that the problems of economic variables that are related to fiscal fundamentals can only be resolved by maintaining the reliability of the sustainable trajectory of public accounts.
In this view, the main role of fiscal policy is to be “responsible”, ensuring the good credibility of the government from the perspective of its creditors, as only then will agents who act in accordance with rational expectations, that is, who react by taking positions based on the assessment of the current macroeconomic scenario and the credibility of the adopted economic policy, they would agree to reduce the risk premium (interest rate) and resume investing, maintaining external balance, that is, financing the balance of payments and exchange rate stability.
Thus, economic policy must be seen as a continuous process, independent of the current government, in order to create an environment where private agents (capitalists) believe in the future maintenance of current policies, as the presence of discontinuities could affect the maintenance of their interests and increase market risks. In this theoretical perspective, it is the role of the State, again, independently of the government, to maintain the intertemporal consistency of this unrestricted austerity policy.
The dominance of monetary policy over fiscal policy
During the 1970s, monetarist propositions, led mainly by Milton Friedman, claimed that the problem of inflation was strictly monetary, so the power to control inflation depended exclusively on containing the Central Bank's money supply rate. However, during the 1980s, the new classicists, led mainly by Thomas Sargent and Neil Wallace, proposed that the power of the monetary authority alone would not be enough to control inflation, it would be necessary to establish a type of coordination between monetary policy and Supervisor.
However, this coordination between the two policies cannot be equal, that is, with the determinations of one policy being met in collaboration with the other and vice versa, in the scheme, “one hand washes the other”, no, because the new-classical theorists, came to the conclusion that cases may occur in which, when defining the budget, through public (internal) debt, the government forced the monetary authority to follow its objectives.
And if the State uses public debt securities with real interest rates higher than the economy's growth rate to finance its deficits, the result would be an increase in the debt/GDP ratio, causing the base to expand at some point. inflation and the rise in inflation due to the monetary expansion used to finance the deficit. Thus, for the authors, the problem of fiscal dominance would be a problem of temporality, that is, in exchange for reducing inflation in the present through monetary austerity, we would have higher inflation in the future, making agents seeking to anticipate inflation caused by the expected increase in inflation, would increase prices in the present.
In this way, there would only be success in controlling inflation in the opposite case, that is, if monetary policy, controlled by an independent Central Bank, imposed economic discipline, in the words of Thomas Sargent and Neil Wallace in their article “Some Unpleasant Monetarist Arithmetic” published in 1981 and available on Federal Reserve Bank of Minneapolis: “[…] By doing this obligatory, the monetary authority forces the fiscal authority to choose a sequence D(t) (rule) consistent with the announced monetary policy. This form of permanent monetary containment is a mechanism that effectively imposes fiscal discipline. Alternative monetary mechanisms that impose fiscal discipline have been suggested, for example fixed exchange rates or a commodity monetary standard such as the gold standard. Nothing in our analysis denies the possibility that monetary policy could permanently affect the rate of inflation under a monetary regime that effectively disciplines the fiscal authority.” (SARGENT & WALLACE, 1981, p. 07).
As the idea above may sound very complex to those who are not so familiar with macroeconomic theory, I will summarize the hypotheses worked on.
To defend this change of perspective, new-classical theorists start from the following hypothesis. When the government increases its spending through fiscal policy (building new airports, public hospitals, universities, etc.), private agents (capitalists) incorporate into their rational expectations that it, the State, should increase its level of financing in the future. In the future, it will be able to do this in different ways, taxation, debt issuance, or even monetary issuance.
Rational agents, that is, “rational capitalists”, if they really exist outside the theoretical plane, looking to the future, will tend to increase their level of savings in the present time, and will stop investing, with the absence of investments and increase of spending levels by the State, two simultaneous processes occur: (i) workers start to consume more, as the economy is fueled by government spending.
(ii) Due to the absence of an increase in the level of supply of goods and services by capitalists in the same amount as the aggregate level of demand, a macroeconomic imbalance occurs in the short term that raises the price level, and to dampen the increase in inflation, the Central Bank initiates a restrictive monetary policy, selling securities and taking currency out of circulation, however, capitalists who had increased their savings level, mainly by purchasing securities, now require a higher risk premium to sell these securities, causing that the public deficit rises again.
Therefore, to avoid this cycle of increasing deficits, it is necessary for the Central Bank to use effective budgetary restrictions to nullify the growth of debt. This is, therefore, a scenario where monetary policy exercises dominance over fiscal policy, forcing it to define objectives that are aligned with the determinations of the monetary authority, which is to prevent the increase in public debt at all costs (even in economic circumstances where this increase is necessary).
Fiscal policy, exercised by the government, whatever it may be, in this theoretical position occupies a subordinate position to monetary policy, coordinated by the “independent” Central Bank (whose?) and consequently loses its function as an active macroeconomic policy instrument, leaving the policy responsible for economic stability.
Conclusion
As demonstrated in the text above, the entity that benefits most from the new spending ceiling is the recently co-opted Central Bank by the market, based on the theoretical scheme seen, we now have an idea of why the BC does not propose to start a journey of reduction of short interest on debt, even with the government's warnings about the harmful phenomena caused to the economy, before this (government) presented a scheme of rules, which that (BC) considered appropriate.
What is happening in Brazil is a political situation where, no matter which government is in power, the market (in our case, the financial market) always takes the upper hand and has its interests met, as it can, now from its private bank, force the government elected by popular vote to meet its interests at any time.
The Central Bank is the main owner of the new spending ceiling, and through this rigid rule on State expenses, it will force and impose its own market discipline on the Brazilian people, regardless of the government that the people elect through voting. .
*Matthew Silva is an economist and activist for Popular Unity.
References
ARESTIS, PHILIP; SAWYER, MALCOLM. On The Effectiveness Of Monetary Policy And Of Fiscal Policy. Review of Social Economy, v. 62, no. 4, p. 441-463, 2004.
ARESTIS, PHILIP; SAWYER, MALCOLM. Reinventing Fiscal Policy. Journal of Post Keynesian Economics, v. 26, no. 1, p. 3-25, 2003.
BLANCHARD, OLIVIER J. Current And Anticipated Deficits, Interest Rates And Economic Activity. European Economic Review, v. 25, no. 1, p. 7-27, 1984.
GOBETTI, SÉRGIO WULFF. Topics on fiscal policy and fiscal adjustment in Brazil 2008.
KYDLAND, FINN E.; PRESCOTT, EDWARD C. Rules Rather Than Discretion: The Inconsistency of Optimal Plans. Journal of political economy, v. 85, no. 3, p. 473-491, 1977.
LOPREATO, FRANCISCO LUIZ C. The role of fiscal policy: an examination of the conventional view. Campinas: Unicamp. IE, 2006.
MONTES, GABRIEL CALDAS; ALVES, ROMULO DO COUTO. The debate about the objectives and conduct of fiscal policy: a critical approach to the conventional view.Economy and Society, v. 21, p. 363-386, 2012.
SARGENT, THOMAS J; WALLACE, N. Some Unpleasant Monetarist Arithmetic. Federal reserve bank of minneapolis quarterly review, v. 5, no. 3, p. 1-17, 1981.
WOODFORD, MICHAEL. Monetary Policy And Price Level Determinacy In A Cash-In-Advance Economy. economic theory, v. 4, p. 345-380, 1994.
WOODFORD, MICHAEL. Price-Level Determinacy Without Control Of A Monetary Aggregate. In: Carnegie-Rochester conference series on public policy. North-Holland, 1995. p. 1-46.
the earth is round there is thanks to our readers and supporters.
Help us keep this idea going.
CONTRIBUTE
