Ams posted a comment on the article about the difference between monetary and fiscal policy, and asked how are these kept in synch since one is formed by the government and the other by the central bank.
This is an interesting question, and within the same country being in synch is not such a big problem but it has been a problem for the Eurozone, where 17 countries share a common currency and their monetary policy is controlled by ECB while their fiscal policies are controlled by each member country.
Ashok brought up this great point in the previous post. Here is his comment.
Ashok February 2, 2013 at 7:26 am
Simple and good article. Very easy to understand.
Is it the case in EU countries that the monetary policy is administered centrally by the ECB and the fiscal policy is administered individually by each country and that is why the views may not converge and leads to a crisis in EU? For e.g. Greece may want the interest rates to go down, but the central bank may not want it because it may lead to inflation in other countries (just an example….).
Interest rates and money supply are controlled by the ECB (European Central Bank) and they target inflation at 2% which is how the monetary policy is transmitted across all Eurozone countries.
But the fiscal policy is a bit harder to control because each country has its own budget and are free to tax and spend as they like. The Eurozone countries have an overall deficit target of bringing down their fiscal deficit to 3% of GDP, but because each country’s current fiscal situation varies so widely it is hard for all of them to bring down their deficit to 3% immediately, and so they have intermediate targets, but largely, they get missed too.
For example, in March last year Spain said that it wouldn’t be able to meet its target of a deficit of 4.4% of GDP and would be at somewhere around 5.8%. Spain had overshot its target in 2011 also, and I’m unable to find the final number for 2012.
The Eurozone countries all have quite varied fiscal positions, and this link shows the latest numbers for all countries that are part of the EU. You can see that this ranges from Sweden’s 0.2% surplus to Ireland’s 31.3% deficit!
Last year the EU countries also came up with a ‘golden rule’ which had certain conditions that each EU country that agrees to it will abide by like retaining the deficit under 0.5% if your debt is more than 60% of GDP, and under 1% if the your debt is less than 60% of your GDP.
There are a lot of other rules as well, and framing these rules and having these intergovernmental treaties is a way to synch up fiscal policies with monetary policy.
The last few years have shown that this has not been really successful and there is little reason to believe that things will change in the future. They do however are a good example of what needs to be done, and in a perfect world how it could be done.