Bostjan Jazbec: Rethinking monetary-fiscal policy coordination
Opening remarks by Mr Bostjan Jazbec, Governor of Bank of Slovenia, at the BoS-IMF High
Level Seminar on Rethinking Monetary-Fiscal Policy Coordination, Portorož, 19 May 2016.
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It is a great pleasure to welcome you all to the high-level seminar on "Rethinking
Monetary-Fiscal Policy Coordination" organized jointly by the Bank of Slovenia and
International Monetary Fund. It is a great honour to have a very distinguished gathering of
central bank governors, senior officials of governments and international institutions, leading
academics and practitioners to discuss a very critical issue that occupies the minds of policy
makers in the euro area and elsewhere.
The objective of the seminar is to explore current thinking on the roles and coordination of
monetary and fiscal policies. The presentations and discussion will focus on three main
themes: (1) the principles and practical experience in the coordination of monetary and fiscal
policies; (2) fiscal policy implementation in the EU institutional framework and implications for
monetary policy; and (3) conducting monetary policy when fiscal space is limited. I will now
briefly touch on these themes in general terms.
Policy makers in the euro area face considerable challenges in fostering sustained strong
growth, price stability and financial stability. Following the onset of the global financial crisis,
economic recovery has been slow and growth remains lackluster. Inflation is much below the
medium-term objective of lower than, but close to 2 percent. For some time now, inflation
continually has been weaker than expected and market-based measures of inflation
expectations stand at their historical lows. Therefore, monetary policy has become increasingly
accommodative relying on several non-standard measures and negative interest rate policy.
There is broad agreement that in the current setting there are limits to the scope of monetary
policy actions and their effectiveness for lifting the Eurozone's economy. Concerns are
mounting that the outlook may be one of a prolonged period of low inflation and low interest
rates, which can adversely affect both the real and financial sectors. Therefore, many of us
have emphasized on numerous occasions that "monetary policy cannot be the only game in
town". Strong sustainable growth, price stability and financial stability will require a coherent,
integrated policy strategy that also includes fiscal and structural policies.
The message on the importance of fiscal policy supporting monetary policy is founded on
historical precedence. In 1936, prescribing the way out of the Great Depression, Keynes wrote:
"It seems unlikely that the influence of [monetary] policy on the rate of interest will
be sufficient by itself. I conceive, therefore, that a somewhat comprehensive
socialization of investment will prove the only means of securing an approximation
to full employment."
These words are very relevant at the current juncture as well.
The ECB has emphasized that fiscal policies should support the economic recovery while
remaining in full compliance with the EU's fiscal rules. Otherwise, credibility in the fiscal
framework cannot be maintained. A critical question, therefore, is whether the prevailing rules
could be barriers to achieving the desired coordination of monetary and fiscal policies.
There are two key prerequisites for obtaining effective fiscal support to monetary policy within
the Stability and Growth Pact rules. Governments must have adequate fiscal space and fiscal
policy must ensure the sustainability of public finances. In both respects, there appears to be
little room for a meaningful fiscal expansion within the existing rules. There is broad agreement
that the fiscal framework has failed to ensure long-term sustainability while avoiding
procyclical fiscal behavior. Countries did not build up sufficient fiscal space during the pre-crisis
expansionary period and fiscal space narrowed following the onset of the financial crisis. Public
debt increased sharply during the crisis years and the policy focus turned to an austerity mode
when market pressures heightened. Most of the Eurozone countries still face long-term fiscal
sustainability issues and are expected to keep their fiscal consolidation effort, in terms of the
cyclically-adjusted deficit, ongoing. In 2016, only four countries - namely, Germany,
Luxembourg, Cyprus, and Estonia - have fiscal space for additional discretionary measures
according to the Stability and Growth Pact rules.
What then is the way forward? It has been emphasized on many occasions that for countries
without fiscal space, fiscal policy can still support demand by altering the composition of the
budget. In particular, they point out that consideration should be given to cutting distortionary
taxes and unproductive expenditure and increasing investments that improve total factor
productivity over the medium term. Investment and structural reforms that increase the growth
potential of the economy create fiscal space by raising future government revenues. It should
be noted that some of these measures will require political resolve and social support as they
are likely to affect social entitlements. Some analysts have remarked that these measures will
not have much impact in the short term.
Should there be a re-thinking of the monetary policy framework? In a recent blog in April 2016,
Bernanke has argued that:
under certain extreme circumstances - [such as] sharply deficient aggregate
demand, exhausted monetary policy, and unwillingness of [fiscal authorities] to use
debt-financed fiscal policies - [money-financed fiscal programs, colloquially known
as helicopter drops] may be the best available alternative" and that "it would be
premature to rule them out".
Earlier in this vein, in 2003, Bernanke had recommended that Japan fight deflation through an
expansionary fiscal policy financed by permanent purchases of government debt by the central
bank. The permanency of central bank purchases of public debt rules out that the new debt
will ever be placed on the market, thereby eliminating Ricardian equivalence effects and
preventing new public debt accumulation.
However, an essential aspect of money-financed fiscal programs is that it involves revocation
or suspension of central bank independence. Precisely for this reason and because
governance of money-financed fiscal programs is inherently difficult (since it creates perverse
incentives for legislators to facilitate tax cuts or spending when such actions no longer make
macroeconomic sense), this option is not something that central banks in general are
discussing or even considering.
In the euro area, the principle of central bank independence is one of the cornerstones of the
economic policy constitution enshrined in the Maastricht Treaty. A fundamental expectation is
that monetary-fiscal policy coordination will be achieved with different institutions acting
independently within their mandates. To preserve this framework, the focus should be on
improving the governance structure so as to ensure that the euro area does not gradually slide
into a regime of fiscal dominance. Within the constraint of its given mandate, the ECB has
moved towards improving the policy mix through the expansion of its balance sheet aimed at
stimulating economic activity.
It is my sincere hope that the seminar will provide a useful springboard for moving forward with
bolder policy actions and reforms that will help put the Eurozone on a path of strong sustained
growth and price stability.