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by Robert Skidelsky - Project Syndicate

That should have ended the argument. But it did not. Some economists claim that governments faced a balance of risk in 2010: Cutting the deficit might have slowed growth; but not committing to cut it might have made things even worse.

The Keynesian remedy, the argument went, ignored the effect of fiscal policy on expectations. If public opinion believed that cutting the deficit was the right thing to do, then allowing the deficit to grow would annul any of its hoped-for stimulatory effect. Expecting that taxes would have to rise to "pay for" the extra spending, households and companies would increase their saving. Fearing sovereign defaults, bond markets would charge governments punitive interest rates on their borrowing.

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This is part of the mess into which macroeconomics has gotten itself. Once beliefs and expectations are introduced into economics, as is surely reasonable, the results of fiscal policy become indeterminate. Too much depends on what people think the results of the policy will be. In the economists' lingo, policy results are "model-dependent."

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If fiscal policy is in a muddle, so is monetary policy. Central banks have tried to avoid the confidence fairy by printing money - technically, by buying government bonds on the secondary market. The extra money is expected to percolate through the economy, quickening activity. The European Central Bank has just started a €1.1 trillion ($1.17 trillion) bond-purchase program to bypass the German veto on fiscal expansion.

But the effects of so-called quantitative easing also depend on expectations. If giving businesses extra cash makes them more confident, they will spend more. If they mistrust the policy, they will hoard the cash.

Nice little corner we've painted ourselves into. We cant even discuss fiscal policy, because TINA. And we can't discuss monetary policy because we're stuck at ZIRP and the second-guessers and the algos go all aquiver over how the central banks even try to phrase the suggestion that they might be considering how or when or whether to maybe someday raise interest rates.

Now where are we going and what's with the handbasket?

by budr on Wed Mar 25th, 2015 at 01:47:31 PM EST

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