{"id":507112,"date":"2022-01-05T15:11:31","date_gmt":"2022-01-05T20:11:31","guid":{"rendered":"https:\/\/www.rochester.edu\/newscenter\/?p=507112"},"modified":"2024-07-31T07:52:10","modified_gmt":"2024-07-31T11:52:10","slug":"monetary-policy-vs-fiscal-policy-which-is-more-effective-at-stimulating-the-economy-507112","status":"publish","type":"post","link":"https:\/\/www.rochester.edu\/newscenter\/monetary-policy-vs-fiscal-policy-which-is-more-effective-at-stimulating-the-economy-507112\/","title":{"rendered":"Monetary policy vs. fiscal policy: Which is more effective at stimulating the economy?"},"content":{"rendered":"

Rochester economist Narayana Kocherlakota explains the difference between the two\u2014and why fiscal policy comes out ahead.<\/h2>\n

When the country experiences an economic shock that leads to an increase in the unemployment rate and a decline in living standards, the debate begins anew. Politicians, pundits, and the general public grapple with how best to promote economic recovery. Is it, for example, by lowering interest rates or by issuing stimulus checks?<\/p>\n

The debate ultimately boils down to a single question: Which is more effective at stimulating a sluggish economy\u2014monetary policy or fiscal policy?<\/p>\n

According to Narayana Kocherlakota<\/a>, there\u2019s a textbook answer, and it\u2019s the wrong one.<\/p>\n

Kocherlakota is the Lionel W. McKenzie Professor of Economics at the Ä¢¹½´«Ã½<\/a> and a former president of the Federal Reserve Bank of Minneapolis. During a recession, he explains, the longstanding consensus has been to rely on monetary policy by lowering interest rates. Once that approach stops working, there\u2019s typically a switch to fiscal policy, such as issuing stimulus checks. As he points out, once rates get too low, they can\u2019t be cut any further.<\/p>\n

In a National Bureau of Economic Research working paper called \u201cStabilization with Fiscal Policy<\/a>,\u201d Kocherlakota argues that, contrary to the long-standing consensus view, monetary policy is ineffective at stabilizing the economy during periods of shock. Instead, he presents a model showing that fiscal policy\u2014in the form of stimulus checks for all adults\u2014is actually a more reliable tool.<\/p>\n

\"Narayana
Narayana Kocherlakota, the Lionel W. McKenzie Professor of Economics. (Ä¢¹½´«Ã½ photo \/ J. Adam Fenster)<\/figcaption><\/figure>\n

Why is that the case? His reasoning goes like this: During bad economic times, the demand for goods drops because consumers are worried about their financial futures. The goal, then, is to restore that demand. Lower interest rates do stimulate current<\/em> demand\u2014people find borrowing to be more attractive than saving\u2014but, according to Kocherlakota, lower interest rates create a drag on future <\/em>demand.<\/p>\n

As he explains, \u201cWhen interest rates are cut, savers earn less income from their financial assets. That means that, in the future, they have less money to spend, which creates a drag on overall future demand. This future drag means that monetary policy is relatively ineffective at fostering fast economic recoveries.\u201d<\/p>\n

In contrast, Kocherlakota\u2019s model shows that a fiscal policy approach\u2014such as issuing lump-sum transfers to all consumers\u2014is likely to increase current demand and future demand. The key, according to Kocherlakota, is that the higher transfers won\u2019t increase the country\u2019s tax burden from debt.<\/p>\n

\u201cSome economists worry a lot about the government\u2019s going deeper into debt because they believe that the government will have to collect taxes later to pay for it,\u201d says Kocherlakota, the Lionel W. McKenzie Professor of Economics. \u201cBut this concern seems out of date, because it ignores how low interest rates have been over the past three decades. The government can readily afford to pay off the costs of additional borrowing simply by issuing more debt.\u201d\u00a0<\/strong><\/p>\n

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Q&A: A closer look at monetary and fiscal policy<\/strong><\/h2>\n

Kocherlakota\u2019s findings are best appreciated with a little context. He offers that context by answering some basic questions about monetary and fiscal policy and how they work to support the US economy.<\/p>\n

What is monetary policy?<\/strong><\/h3>\n