Does Policy Matter?

Continuing on from my previous post, I started 2013 with a prediction that it would be a better year than 2012, but that if the Fiscal Cliff occurred it would not. A sizable portion of the Fiscal Cliff did happen, but 2013 was not much different from 2012. In September 2012, I spoke positively about the Fed starting its third round of Quantitative Easing (QE), and, at least by job growth and available GDP figures, things haven’t exactly taken off. One conclusion is that fiscal spending levels and the stance of monetary policy don’t matter. That would mean that the basic models of classical economics were 100% correct, Laissez Faire is always the optimal policy, and why have we been wasting paper on new textbooks? That’s basically the consensus that made the Great Depression worse.

The other (correct) explanation, is that fiscal and monetary policy have been canceling each other out. In the beginning of the recession we had more expansionary fiscal policy. Monetary policy, on the other hand, is looser today than it was at the start, when stimulus measures were in even greater need. Short term interest rates didn’t drop to around 0% until the end of 2008, nearly a year after the recession began. The first two rounds of QE were for fixed amounts that were too small to get their intended results (the current round is supposed to go on until policy goals are reached).

The point is that fiscal and monetary policy have essentially pulled in opposite directions, making it look somewhat like neither have mattered. But don’t you believe it.