A Suggested Framework for Monetary-Fiscal Analysis

Abstract

T HE now orthodox treatment of monetary and fiscal policy is to present the two techniques separately as dissimilar devices for achieving the same general goals. Monetary policy, it is said, influences aggregate expenditures in the private sector indirectly by affecting the cost and availability of credit. Fiscal policy, on the other hand, affects aggregate demand directly by varying government expenditures and/or the tax load on the private sector. From the beginning it has been recognized that the two instruments are not independent: they are necessarily connected by the problem of debt management, and a budget deficit or surplus may carry with it implications for the stock of money. Nevertheless, in terms of their impact monetary and fiscal policy are as a rule compared only in a general way, the point of contact being effective demand. Yet, fundamentally monetary and fiscal policy resemble each other not merely in the goals that they are designed to achieve, but in the methods used to achieve them. Both techniques affect the use of economic resources by influencing the same general variables -i.e., the availability of income and capital funds. At one time the two techniques could be set in sharp contrast on the basis of their origins in separate historical epochs. In itself, monetary policy partakes of the classical tradition, which held the government's impact on the economy to be at best neutral and at worst parasitical. For the classicals the only reasonable course of action was to restrain the ever-expansive lusts of the government and to minimize government influence on the economy by adherence to the balanced budget rule. Monetary policy was a dependent phenomenon. It was not intended to determine the allocation of productive effort between investment and consumption -a prerogative rightfully belonging to the individual citizens taken in sum but instead to enable the voluntary savings of the public to be embodied in useful capital goods. The banking mechanism properly should neither force savings nor permit public willingness to save to be wasted through the failure to extend additional loans to business. The sole variable influencing the decision to save was the interest rate, in the setting of which the banking system was not to act independently, but instead to seek fairly to represent the balance between productivity and thrift. Thus neoclassical monetary policy was limited to making effective the public's savings decisions by transferring to industry the available capital funds.' Fiscal policy, in its initial orientation, diverged sharply from monetary policy. Of fundamental importance for its early development was the conviction that the long-run, as well as the immediate, economic problem was that of coping with depressed conditions. During the I930's when expansion could be regarded as the sole desideratum of economic policy, fiscal policy came to be viewed as a powerful stimulant while monetary policy came to be regarded as ineffective. In this atmosphere of abortive expansion, it is not strange that the two instruments were viewed in sharply contrasting terms. Fiscal policy, it was argued, added directly to aggregate demand, whereas monetary policy could only affect aggregate demand indirectly -by (weakly) influencing the desire to invest out of borrowed funds. Even under conditions of depression, so sharp a dichotomy is only partially valid. It applies to the expansion of government expenditures, considered in isolation. Tax reduction, however, achieves its purpose not by adding directly to demand but by persuading consumers or inves-