Kenneth Rogoff says with policy interest rates near zero in most advanced economies, there is little room for monetary policy to maneuver in a recession without considerable creativity. But those who think fiscal policy alone will save the day are stupefy

By Kenneth Rogoff*

If you ask most central bankers around the world what their plan is for dealing with the next normal-size recession, you would be surprised how many (at least in advanced economies) say “fiscal policy.” Given the high odds of a recession over the next two years – around 40% in the United States, for example – monetary policymakers who think fiscal policy alone will save the day are setting themselves up for a rude awakening.

Yes, it is true that with policy interest rates near zero in most advanced economies (and just above 2% even in the fast-growing US), there is little room for monetary policy to maneuver in a recession without considerable creativity. The best idea is to create an environment in which negative interest-rate policies can be used more fully and effectively. This will eventually happen, but in the meantime, today’s overdependence on countercyclical fiscal policy is dangerously naïve.

There are vast institutional differences between technocratic central banks and the politically volatile legislatures that control spending and tax policy. Let’s bear in mind that a typical advanced-economy recession lasts only a year or so, whereas fiscal policy, even in the best of circumstances, invariably takes at least a few months just to be enacted.

In some small economies – for example, Denmark (with 5.8 million people) – there is a broad social consensus to raise fiscal spending as a share of GDP. Some of this spending could easily be brought forward in a recession. In many other countries, however, notably the US and Germany, there is no such agreement. Even if progressives and conservatives both wanted to expand the government, their priorities would be vastly different. In the US, Democrats might favor new social programs to reduce inequality, while Republicans might prefer increased spending on defense or border protection. Anyone who watched the US Senate confirmation hearings last September for Supreme Court Justice Brett Kavanaugh cannot seriously believe this group is capable of fine-tuned technocratic fiscal policy.

This does not mean that fiscal stimulus should be off the table in the next recession. But it does mean that it cannot be the first line of defense, as altogether too many central bankers are hoping. Most advanced countries have a considerable backlog of high-return education and infrastructure projects, albeit most would take a long time to plan and implement. If left-leaning economists believe that fiscal policy is the main way out of a recession in 2019 or 2020, they should be lobbying for the government to prepare a pile of recession-ready projects. Former US President Barack Obama wanted to create an infrastructure bank in part for this purpose; tellingly, the idea never got off the ground.

Likewise, many observers advocate bolstering “automatic stabilizers” such as unemployment benefits. Europe, with much higher levels of social insurance and taxation, has correspondingly stronger automatic stabilizers than does the United States or Japan. When incomes fall, tax revenues decline and insurance payments rise, providing a built-in countercyclical fiscal stimulus. But proponents of higher automatic stabilizers pay too little attention to the negative incentive effects that come with higher government spending and the taxes needed to pay for it.

To be clear, like many academic economists, I favour significantly raising taxes and transfers in the US as a response to growing inequality. But if there were a broad political consensus in favor of moving in this direction, it would have happened already.

A more exotic concept is to create an independent fiscal council that issues economic forecasts and recommendations on the overall size of budgets and budget deficits. The idea is to create an institution for fiscal policy parallel to the central bank for monetary policy. Several countries, including Sweden and the United Kingdom, have adopted much watered-down versions of this idea. The problem is that elected legislatures don’t want to cede power, especially over taxes and spending.

One can appreciate why central bankers don’t want to get gamed into some of the nuttier monetary policies that have been proposed, for example “” (or more targeted “drone money”) whereby the central bank prints currency and hands it out to people. Such a policy is, of course, fiscal policy in disguise, and the day any central bank starts doing it heavily is the day it loses any semblance of independence. Others have argued for raising inflation targets, but this raises a raft of problems, not least that it undermines decades of efforts by central banks to establish the credibility of roughly 2% inflation.

If fiscal policy is not the main answer to the next recession, what is? Central bankers who are serious about preparing for future recessions should be looking hard at proposals for how to pay interest on money, both positive and negative, which is by far the most elegant solution. It is high time to sharpen the instruments in central banks’ toolkit. Over-reliance on countercyclical fiscal policy will not work any better in this century than in it did in the last.

Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Folly, his book, The Curse of Cash, was released in August 2016. Copyright: Project Syndicate, 2019, and published here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.


"The best idea is to create an environment in which negative interest-rate policies can be used more fully and effectively."
It's not an idea, it's The Plan....and it's not over the economic horizon; it's right here, in front of us, right now.

I think the next GFC/recession will bring on full blown global deflation. If NZ experiences a negative cash rate its hard to fathom the mess our biggest trading partners will be found. Lets say deflation is running at -2%, and short dated term deposits are say -0.5, you're still ahead as cash is certainly king. Those who lose least will win most. It will just be a new normal with debt value soaring against shrinking security.

Unfortunately for those besotted with property, fiscal policy as we've known it for decades is certainly at a dead end. Much pain awaits you.

RP - I think having a healthy % of one's wealth in cash is obviously a good idea but I would limit that to 10-20 % as has happened in the likes of Cyprus and Iceland cash held in bank accounts of every type get a massive haircut and you are left with very little. Sitting of freehold or near freehold property whilst it would drop in value too no one is going to take it off you. Hope your term deposits work out ok but there is no gaurentee that they are a safe place ! Cash maybe under your bed in $US dollars would work ! Much pain awaits term deposit holders when banks fail as is the regulations I believe in our banking system.

Shoreman, no debt is good debt when the asset is sinking in value. Those freehold property owners with significant cash would be wise to spread it amongst all major banks to reduce "one off" over exposures such as you describe. Not even in the prolonged 1930s slump did all banks fail. In such an event, it could easily take decades for property prices to return to their pre-slump high point. Many would be rendered under water. Why risk one's lifestyle being starved of cash and overweight with illiquid assets no one else wants? Sounds awfully depressing, unnecessary and right now totally avoidable. Sticking cash under the mattress is for doomsday preppers - not me. I prefer to continue living.

Interesting RP you do come across as a person with a glass half empty and a dislike of those who have made a fortune in property. Dare I say what happened with the banks in the 1930's doesn't translate to how many could fold in the future. In a crash I would not trust the banks with my nest egg and watch helplessly while they raid accounts to save themselves which they legally can. Go read up about Cyprus it will give you sleepless nights.

Shoreman, you've just been reading the wrong books. You're more a conspiracist than a healthy minded realist. I've no issues with others who generate wealth on property, as long as they largely own it. I've got issues with over leveraged wannabes who destabilize the entire system driven by dreams, seminars and rumours. I suspect you're very much the latter, acting as temporary caretaker for your banks security.

Maybe the old adage for gold “if you don’t hold it you don’t own it” now applies for cash lol.

You are living in fantasy land if you believe in -2% deflation for any period of time, every example of fiat currency in existence has experienced the exact opposite. Cash is the very worst place to hold your wealth and the longer your time horizon, the worse it is. Buying income producing assets with maximum leverage is the proven way to wealth.

With maximum leverage.. the quickest way to bankruptcy when the economy hits a speedbump

Not if you invested in income producing assets.

Assuming they keep producing income.. When that income drops significantly because of lack of spending power from consumers who don't have jobs/limited hours... then what?

the next crash is the collapse of DEBT (and with it the value of money/currencies)
which makes income producing assets as you are envisaging them useless
you cant unwind a ponzi

Just keep making the debt cheaper it’ll be fine.

Isn't this the Prof who had his Econ 101 students at Harvard walk out in protest of his teaching only the neoclassic economics worldview?

Harvard University’s Kenneth Rogoff, who co-wrote what is widely considered the definitive book on financial crisis recovery, This Time Is Different, said the very factors that made the 2008 crash so devastating and enduring in impact are now helping to extend the recovery. “You’re going to see that the next 10 years will be better than the last 10 years.”

Yeah right.

Maybe, but he's definitely the professor who made bold claims about austerity that were highly influential and based on pretty amazing data errors.

Well apart from an outright global depression and if you believe in growth for ever its not a un-realistic proposition, I mean he has a greater than 50% chance of being right I suppose.

Personally my view is we are staring at a second Great Depression......OBR events etc.

best of luck!

Such a policy is, of course, fiscal policy in disguise, and the day any central bank starts doing it heavily is the day it loses any semblance of independence.

Substitute "independence" with "control" - and he might earn himself a bit of credibility :-).

“If fiscal policy is not the main answer to the next recession, what is?”

I’d hope it’s not the answer, it’s one of the major reasons we’ve got problems in the first place.

Withay, if it all seized up, debt forgiveness on an unprecedented scale would be the one solution. It releases those wild west spenders of their moral obligations to continue spending while leaving institutions and Governments straddled with the bill. I doubt institutions (banks) or the remaining (hopefully employed) tax paying voters would welcome the idea. It could certainly wind up being one long winter of discontent!

I’m so interested to see what happens! Debt forgiveness has been used historically many times but not recently and I can’t see the powers that be using it.
My best guess is we are in for “stimulus” in the form of inflationary measures - loosening lending standards and lower interest rates amongst others. As well as infrastructure spending, especially with our current gov.
Will it work? Again my best guess is no and we will see something rather large come to pass. if it does work however, it must be the very last time those measures will be effective as they will be completely tapped out.
Time for a real change of systems, our current one is just flat out broke.

Agreed, while mass debt forgiveness is one way forward, it's highly unlikely to be used. It's just so unpalatable to most. Especially to the more prudent debt averse amongst us. That's why it will likely be a longer than usual winter of discontent.

Debt forgiveness is why Greece is in such a mess. The people over there were borrowing money like there was no tomorrow with no intentions of ever paying it back. I would suggest that those who have worked hard and cleared their debts in New Zealand would not stand idle if this suddenly started to impact them.

Uh, no they didnt get their debt "forgiven" still a pretty much crippled economy 30% down? and still owe a lof of that debt.

This will impact them ie the prudent will be expected to pay out the property gamblers en mass for one. For myself the only way I can see not to get screwed royally is not have any money in the banks(s) and that's rather hard to achieve.

debt forgiveness is wealth forgiveness - there are no debt averse ... EVERYONE is in the debt system (unless you only trade in barter / hunt gather?). Money is Debt.
commodity production isnt viable without the consumers ability to raise more debt
and the consumer debt only works if they can promise increased output into the future....

There is no answer really. Its going to be default at some stage the only Q is how many years is it away.

„Negative“ Interest Rates and the War on Cash

The talking heads featured on the corporate mainstream media have started to disseminate the idea that cash is a barbarous relic and needs to be abolished. Central bankers have been particularly articulate, such as former IMF staffers Kenneth Rogoff and Peter Bofinger, or current Bank of England spokesman Andrew Haldane.

Ex-Credit Suisse bankers arrested in $2bn fraud investigation
Trio arrested in London on US charges as calls grow for debt claim against Mozambique to be dropped

The Kiwi among them also features in the Panama Papers;

How China Colonized An Entire Continent Without Firing A Single Shot

"In 1972, Ferdinand Marcos, President of the Philippines, declared martial law. Out of economic necessity, he claimed, the government began to impose an economic modernization program which he believed would pull his nation out of what was then called third world status. To achieve this goal, along with political repression Marcos’ government would, as is usual in these cases, borrow heavily. According to estimates published by the NBER, the investment share of GNP which had been 21.6% in 1972 climbed to 31% by 1979. The part of overall “investment” contributed by the government surged from 2.1% of GNP to 7.3% at the close of the decade.

While outwardly the program appeared to have worked by 1980, it had only masked the great costs to achieve whatever gains were made. The Philippines had a small current account surplus to start the 1970’s, rising to 5% in 1973 with the commodity price jump, but would fall to serious deficit for the remainder of the period. By 1982, its size was figured to be 8.1%, but even at that level there was considerable doubt at the time as to whether that was a true figure."

"To be clear, like many academic economists, I favour significantly raising taxes and transfers in the US as a response to growing inequality".

Raising taxes on who I wonder?

Is he saying that economists are clueless? (Gosh, who knew?)

Or, is he saying that democracy doesn't work and that economists should be in charge?

Or, is he saying both?

Many certainly are

‘Interest rates near zero’ is not a thing in NZ.
Homeowners with a mortgage are still paying relatively high interest rates - eg 5.95% interest on floating mortgages which is not much lower than 2007 pre-GFC despite an OCR of 1.75%. In 2007/8 the OCR was 8.xx & floating 9/10%.

The automatic stabilser par excellence could be a government job guarantee. Anyone unemployed can get a job at the minimum wage doing community work for up to full-time hours. No need to squabble over projects and funding, It just kicks in automatically. The wage paid becomes the inflation anchor for the macroeconomy and a floor under wages and conditions in the private sector. The value of the $ becomes how much job guarantee labour it buys. Centrally funded but administered by local communities. People get dignity and don't fall into bad habits, social costs of recessions are reduced and the economy gets its helicopter drop. Consumption and demand is sustained much better allowing for quicker recovery of private sector.

After the embarrassing data errors and omissions that Reinhart and Rogoff made in their research supposedly supporting austerity earlier this decade (in which NZ data featured quite prominently funnily enough - Waterfront Strike years used as emblematic) that were called out by some PhD students trying to replicate their work, I would have thought Rogoff would have been quietly put out to pasture.
However in economics it seems that people who are spectacularly wrong in the past get trotted out as experts. Which makes one tend to conclude that macro is really ideology not science. Remember Blanchard in 2008 just before all hell broke loose "the state of macro is good". Nevertheless, he's still one of the gurus. I would have been fired from my job long ago if I'd been so wrong.

That automatic stabiliser is awesome. You'd get people from the left and right voting for that. When are you running for PM?

There is infinite room to move monetary policy even with rates at 2%, every time you halve interest rates, you double the interest cover ratio. Interest rates can go to 1% or 0.5% or 0.001% and keep getting lower infinitely. I could service a billion dollar loan at 0.1% for the same as I could service a million dollar loan at 10%. I could also do a lot more stimulating with that much money, and if banks create the money from thin air then it actually doesn't matter what the interest rate is, because the intrinsic value is near zero.

skudiv, banks create money from thin air? Here's me thinking they borrowed money themselves and on-lent at a profit.


How quaint.

This is wishful thinking only. You need to continually outpace the rising energy cost of energy and diminishing returns on resource extraction in general (these dont magically decrease to insignificant % increments)
simply put, monetary policy cant conjure up new easy resources.

This is a good read

"money isn’t output or wealth (both are provided by energy ) Money is a claim on output. Creating more of these claims doesn’t make us wealthier – it just adds financial risk."

As in many areas, I feel that the author of this article takes a too narrow a focus, ignoring a bigger picture. I find much of the article ironic. " If you ask most central bankers around the world what their plan is for dealing with the next normal-size recession" Ask a banker how to deal with a problem largely caused by banks? Isn't that like asking speeders and drunks how to fix the road death toll?

With the detail will need to be scrutinised, I suggest the answer to deal with any recession, and to avoid the next one is robust regulation, especially of the banks. Governments need to understand the fundamental reason for their existence; that is to protect the ordinary people they are elected to represent. Recessions are largely caused by people manipulating markets, and them getting out of control. And in this day and age the only "people" with this ability are the mega wealthy and the banks, thus regulation needs to be in place to limit or stop their abiity to do this?

But then of course the banks and wealthy have bought off our politicians who are either too stupid to see what is going on round them, or they are too busy feeding at the trough to care.