The problem with rating agency and IMF calls for governments to tighten fiscal policy is that monetary policy cannot offset it under current circumstances. We have reached the zero lower bound for interest rates in Japan, the US and UK while quantitative easing in its current form has disappointed.
I would feel relaxed about fiscal tightening if interest rates were 10 per cent or more and central banks could cut them as inflation dropped. But I am not convinced monetary policy can take up the strain if we are seeing fiscal retrenchment at the same time. An expansion of both fiscal and monetary policy offers the best hope for the future.
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