Fiscal Policy under Low Interest Rates

Rethinking fiscal and monetary policy in an economic environment of high debt and low interest rates.

Policy makers in advanced economies find themselves in an unusual fiscal environment: debt ratios are historically high, and—once the fight against inflation is won—real interest rates will likely be very low again.  This combination calls for a rethinking of the role of fiscal and monetary policy—and this is just what Olivier Blanchard proposes in Fiscal Policy under Low Interest Rates.

There is a wide set of opinions about the direction that fiscal policy should take. Some, pointing to the high debt levels, make debt reduction an absolute priority. Others, pointing to the low interest rates, are less worried; they suggest that there is still fiscal space, and, if justified, further increases in debt should not be ruled out. Blanchard argues that low interest rates decrease not only the fiscal costs of debt but also the welfare costs of debt. At the same time, he shows how low rates decrease the room to maneuver in monetary policy—and thus increase the benefits of using fiscal policy, including deficits and debt, for macroeconomic stabilization. In short, low rates imply lower costs and higher benefits of debt.

Having sketched what optimal policy looks like, Blanchard considers three examples of fiscal policy in action: fiscal consolidation in the wake of the Global Financial Crisis, the large increase in debt in Japan, and the current US fiscal and monetary policy mix. His conclusions hold practical implications for economic and fiscal policy makers, bankers, and politicians around the world.List of Figures ix
Preface xi
1 Introduction 1
2 Preliminaries 13
3 The Evolution of Interest Rates, Past and Future 27
4 Debt Sustainability 49
5 Welfare Costs and Benefits of Debt and Deficits 89
6 Fiscal Policy in Action 117
7 Summary and Open Issues 139
Bibliography 145
Index 153“This book is Olivier Blanchard at his best. Sound policy must rest on sound analysis, and Blanchard takes the analysis of fiscal policy and its sustainability to new heights. Everyone who wants to worry about deficits or about austerity needs to consider his balanced and judicious evaluation of the issues.”
—Lawrence H. Summers, Charles W. Eliot University Professor and President Emeritus, Harvard University
 
“No one has affected the thinking on macroeconomic policy over the past two decades more than Olivier Blanchard. He has challenged policymakers, not only by developing new ideas but by pushing them to escape from old ones. This masterful book’s analytical framework and concrete case studies provide a road map for designing robust fiscal policies ensuring cyclical stabilization, allocative efficiency, and intertemporal fairness.”
—Marco Buti, Director-General for Economic and Financial Affairs, European CommissionOlivier Blanchard is C. Fred Bergsten Senior Fellow at the Peterson Institute for International Economics and Robert Solow Professor of Economics Emeritus at MIT. He was Chief Economist at the International Monetary Fund from 2008 to 2015.