Redistributive policy

Is fiscal policy fairer? – Econlib

Jesse Horwitz recently asked me if there would be better distributional effects by using fiscal policy rather than monetary policy as a stabilization tool. The intuition is that monetary policy involves the purchase of financial assets while fiscal policy can directly provide money to the public.

I don’t see any significant distributional differences, and I think my view is fairly common among economists. But I notice that many non-economists see things differently, and it’s worth asking why.

The first thing to note about fiscal policy is that it does not involve the creation of new funds, but rather that it takes existing money and moves it around. When the government sends you a check, the money comes from taxes or a loan. The public as a whole does not have more money, rather the money is transferred from Peter to Paul.

The perception that fiscal policy is fairer may stem from the fact that fiscal spending can redistribute money from the richer half of society to the poorer half of society. But this type of redistribution is essentially unrelated to the use of fiscal policy as stabilization tool. Even governments that don’t use fiscal policy as a tool for stabilization often have a welfare state, but they don’t change the size of the welfare state as a tool for reducing the business cycle. Instead, they often rely on monetary policy.

I suspect that some people mistakenly consider fiscal policy to be fairer because they confuse the existence of a fiscal stabilization regime with expansionist tax policy. But the stabilization policy necessarily uses both policy of expansion and contraction. An expansionary policy occurs when the policy is more expansionary than the average and a restrictive policy occurs when the policy is less expansionary than the average.

It is true that the national debt tends to increase over time, which may give the impression that expansionary policy is more common than restrictive policy. But the national debt will tend to increase over time whether or not fiscal policy is actively used to stabilize the economy. In the late 2010s, the federal government increased the national debt to take advantage of the downward trend in interest rates, not because we were in a recession. If the average (cyclically-adjusted) fiscal deficit is $X, then an active fiscal stabilization policy widens the deficit above $X when stimulus is needed and results in a deficit below $X when the policy stabilization calls for cuts in spending. In this framework, there is no lastingly expansionary stabilization policy.

Economists tend to think of equity issues in terms of the long-term distribution of income. It is not clear why a fiscal or monetary stabilization policy would have a long-term impact on income distribution. Even if the government does not use fiscal or monetary policy to stabilize the economy, there will be a government budget and there will be money supply. In most cases, both will tend to increase over time. It is certainly possible that the mere existence of a public budget has distributional effects, and perhaps even that the existence of a money supply has distributional effects. But it’s not obvious (at least to me) how changing money supply or government spending in a counter-cyclical fashion would have large distributional effects.

The Fed’s balance sheet has widened significantly over the past few decades, even as a percentage of GDP. (I wish we had stayed with the much smaller pre-2008 balance sheet.) But this balance sheet expansion was not due to expansionary monetary policy, rather it reflects the Fed’s move to a floor system. with the payment of interest on bank reserves, and also the downward trend in the growth of the NGDP (which reduces interest rates and increases the demand for base money). Before 2008, the Fed conducted a very active stabilization policy without buying a lot of financial assets. The two questions are essentially unrelated.

PS. I have no objection to so-called “automatic stabilizers”, which cause the budget deficit to develop somewhat counter-cyclically, even without an active fiscal stabilization policy. But the active stabilization policy is best conducted by the monetary authority.