Monetary vs. Fiscal Policy: Could we see a greater shift out of monetary policy focus?

Could we see a greater shift out of monetary policy focus?

Over the last few weeks, there are 2 independent events that may be indicative of a larger paradigm shift that may be happening. Japan decided to focus on fiscal policy rather than monetary policy. Trump has already started talking about massive tax cuts and infrastructure spending. Is this shift towards fiscal policy for real?

2008 – Global macro sync…

The story of monetary policy actually began in the midst of the financial crisis in 2008 after the fall of Lehman. The contagion effect was so strong that nations across the world followed the US strategy of infusing substantial liquidity and cutting rates sharply. The result was that rates came near to zero and liquidity taps were kept open. However, after 8 years nations are increasingly questioning the wisdom of synchronized monetary policy across the world. Increasingly, there is a demand to tailor-made monetary policies.

Effectiveness stands reduced…

Monetary policy works when there is room for further maneuver. With rates near zero and government piling on debt, there was little room left. Central banks like the BOJ and ECB have failed to spur growth even after pushing interest rates to negative zone. Countries like UK have pushed their current account deficit to 7% of GDP. Japan is already one of the most indebted nations in the world. Obviously, monetary policy may not have too many answers.

Trump shows the way…

In the midst of the hype and rancor over the Trump election, most people forgot that Trump had already made a silent transition away from monetary policy. Trump announced that corporate taxes rates would be cut from 35% to 15%. He also proposes to cut personal tax rates drastically to put more money in the hands of people. Additionally, Trump also proposes to invest $1 trillion in infrastructure to bring the US infrastructure at par with developed Asia. This is likely to trigger a virtuous cycle of growth, jobs and consumption demand in the economy. Japan is planning something on similar lines.

High time the shift happens…

The problem with too much focus on monetary policy is that it only creates asset price inflation. When too much money chases too few assets, the result is that assets get inflated. That is exactly what we are seeing across the world today. Equities have been buoyant despite no growth and the only reason is liquidity. The shift to fiscal policy will actually be a reality check. Trump and Japan may just be the beginning. We may see a lot more nations focusing on good old taxes and public spending to spur growth!

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