Don't Mix Monetary and Fiscal Policy: Why Return an Old, Flawed Framework?.
In recent years, significant strides have been made in the conduct of monetary policy, as Federal Reserve had successfully pursued the objective of stable, low inflation as a foundation for sustained economic expansion. During the same period, the objectives of fiscal policy have evolved toward deficit reduction, while activists, short-run stabilization proposals have been suppressed. The Fed's credible, low-inflation monetary policy and the reduction of the government's purchases as a share of national output and the freeing of those recourses for private uses have contributed significantly to robust economic and financial performance. But the resulting budget surpluses not bring forth new spending ideas. As politicians debate how to "spend the surpluses," renewed calls that monetary policy will need to be adjusted to fiscal policy changes represent a replay of monetary/fiscal policy mix framework that has led to macroeconomics policy mistakes in the pas and, if pursued, could again unhinge the foundations for sustained healthy economic expansion.
A Flawed Framework- the monetary policy should be adjusted to fiscal policy to achieve desired economic performance; presently suggesting the Federal Reserve will need to "tighten monetary policy" is based on certain assumptions about the roles and effects of fiscal and monetary policy that are simply wrong. This framework is misguided, whether the economy is characterized as "old" or "new," or whether the government budget is in defect or surplus. It assumed that fiscal policy and monetary policy have the same economic effects, and the timing of their lagged impacts is predictable. Further, it assumes that the fiscal policy can be adequately characterized by the size of the budget deficit. Nothing in macroeconomics could be further from the truth, confirmed repeatedly through history.