In the 1970s and 1980s, European governments were a wrong macroeconomic policy in the face of oil shocks
They let inflation slip, deficits widen, government debt grew. It took a good part of the 80s and 90s to repair the damage, and not always at best. They learned the lesson that we should no longer use either monetary policy or fiscal policy for stabilization purposes.
Things are better in Europe today. But, one day or another, other shocks will occur
That day, it will be important to know how to respond. It is now time to give up the language of wood and reflect on the future role of macroeconomic policy. First, monetary policy. One of its key roles is to maintain low inflation in the medium term (although keeping inflation below 2% is flirting with the risk of deflation). But its other role must be, in the shorter term, to stabilize demand and activity. If Wall Street collapses, if the war resumes in Eastern Europe, if consumers fell back into depression, lower interest rates, quickly and strongly, would be essential. It is important for the ECB to prepare for it.
Then, fiscal policy. In fact, governments are quietly using what economists call automatic stabilizers. When growth increases, the budget deficit decreases, slowing demand. When growth declines, the budget deficit increases, boosting demand. This automatic and discreet stabilization is useful. But we can surely do better. A more aggressive cyclical fiscal policy with larger deficits in recession and larger surpluses in the expansion is likely to be more effective. At present, it is neither discussed nor even studied. It is also time to get started and think about the best tax instruments to accomplish it.
Finally, the coordination of monetary policy and fiscal policy. If we accept the idea that they can in principle stabilize growth, it follows that it is essential to coordinate their use. It is the combination of a fiscal consolidation policy and a policy of monetary expansion that is the source of US performance in the 1990s. None of this in Europe. Wim Duisenberg hardly meets the eleven Finance Ministers of Euroland. It is essential, if not to create a budgetary decision-making structure that corresponds to the ECB, at least to appoint a representative of all these ministers who can discuss with Wim Duisenberg. Not recognizing the role of macroeconomic policy on production and employment, ignoring the importance of coordinating monetary and fiscal policies, is paving the way for a future disaster.