Monetary policy and fiscal policy: the need for their unification[1]

[1] The need to use a bottom-up approach, that is to say from specific to an all-encompassing general, seems immanent in human history. Also the so-called exact sciences, with all due reserve on this definition, especially in the field of physics, have long (for all the twentieth century up to this day) been trying to design overall and unifying approaches to interpret the functioning of microcosms and macrocosms, trying, to the maximum possible extent, to find sense in the whole.

It would be easy to prove, with empirical and logical-deductive considerations, as well as through formal demonstrations, the loss in efficiency and, thus, in effectiveness, inherent in such an economic governance design (however, still very common), in which the two economic policy levers are separated and opposing: the monetary one and the fiscal one.

With the present institutional structure, the only possibility for the two economic policy sections to communicate lies in the fact that the State, to cover its current and investment expenses, in addition to using the resources from taxation[1], can get into debt with private lenders or the central bank and the latter will supply money against the transfer to it of government securities.

This leads to the focal point: where in need for money, the State must get into debt[2] with the central bank and, essentially, with the banking system in its entirety[3].

Therefore, at present, setting aside the lever based on taxation, which seems to have reached considerable levels of relative saturation[4], the financing of government expenditure, both in terms of current and non-current expenses, generates debt.

It is worth noting that the overall economic circuits (that is to say, including both private and public players) operate based on the “debt paradigm”. This needs not come as a shock: based on the contents of this paper so far, it can be seen that debt is necessary in order to transfer financial resources from “units” having surplus to those having a deficit (this is how economists put it). In short, the economy that functions through the creation of debt and credit (with the relevant utilities) is something “natural”. It is natural to wonder whether the State (as the exponential product of individuals) must always be subject to the “debt criterion”. It certainly must when it acts as a normal economic player (signing private-law contracts – for example, to purchase stationery – as lovers of law would say), but it is not so certain when the State acts in its fundamental role, which is essential in today's complex societies, of economic governance and steering. In the latter case the “debt criterion or paradigm” in itself seems, especially in times of economic stagnation, recession and depression, utterly inadequate or, at least, insufficient, and even having the opposite effect.

Moreover, it is quite obvious that the creation of debt against money supply can be conceived only and exclusively in a scenario where there are two parties; on the one hand, the party supplying money – the central bank – and, on the other, the party receiving the money, i.e. the State, that undertakes the obligation to repay it.

This leads to the observation that a unified action is a "must have" in economic policies, also irrespective of the parties that are vested with the responsibility and power for it. Probably, if this takes place, it would be at first a structurally unified action and later, perhaps, unified agents[5]. Unified agents may never be established to preserve a physiological counterbalance ensuring cross control based on powers assigned to different parties (the power for fiscal policy to the government – parliament and the power for monetary policy to the central bank). However, a system so designed, based on more than one party vested with powers and responsibilities (we may say institutional parties, given their role) entails a large gap in terms of representation and democracy, with regard to the people that is subject to the effects of the decisions made. It is well known that the meetings of the Boards of the various financial institutions, including the ECB and the Bank for International Settlements (BIS) for instance, are held behind closed doors and information to the public is provided later and to the minimum possible extent. 

Were the State the entity directly creating money (or directly imposing its creation[6]), based on its own authority – prerogative[7], no debt would be generated by money issuance, except for the possibility to drive inflation, that is to say, progressively destroying money's purchasing power, which, as pointed out at the beginning of this paper, is its ultimate and only reason for existing.

The preconditions and logical effects of a possible form of economic governance in line with the proposed model are examined in the next paragraph.

[1] At present, the margins for tax manoeuvre aiming at tax increases are next to non-existent (see also the consideration in Note 43 below), except for the much-talked of fight to tax evasion. Conversely, the detected trend is to reduce taxation, with specific reference to companies (flat tax). The economic analysts that have dealt with this have observed that, in the last thirty years, corporate taxes have decreased, whereas taxes on income from work have increased.

[2] This pattern is irrespective of the introduction of the Euro; indeed, also before 2002, if the Government needed to be provided with resources by the Bank of Italy, it had to transfer Government securities. Of course, in a domestic scenario, the central bank would inform the markets of its willingness to purchase Government securities that had not been purchased at a given rate and this would immunize them from speculative attacks, as occurred in 2010 with the sovereign debt crisis.

[3] The trade-off that presently seems to be immanent in the monetary governance system has already been reported above, with the monetary governance system that is torn between private-law and public-law criteria that concomitantly exists in its institutional bodies.

[4] Relative saturation meaning that taxation in itself could have, in theory, very high percentage limits. If the system of taxation and provision of public services, whose extent can vary over time, were well-functioning, efficient and effective, tax revenue higher than the present one would also be tolerable.

[5] An example is the very recent action implemented by the People's Bank of China to handle the financial crisis on the Chinese market. In this regard, one may wonder whether such quick action has been decided by the governing bodies of the PBOC (in accordance with tradition) or, as certainly happened, by the Chinese Government: in this case, the Central Bank has implemented a decision made by the Country's political Government.

[6] The practical opportunity of having duality of roles (even though within a unified economic policy action) in the governance of monetary and fiscal policies has already been pointed out.

[7] Whose existence can hardly been denied, other than for opportunity reasons only. An example is the very recent Chinese QE: it is natural to imagine that the Central Bank has promptly implemented the directives imposed by the Chinese Government and that the usual transfer of government debt securities - as a guarantee for the new and substantial creation of money - was the last concern of the Chinese Government (and maybe never made). It is easy to note the decision-making swiftness resulting from a unified action compared with the long time required by the QE programme to be implemented by the ECB, which started only after a time-consuming arm wrestling between the Countries of Northern-central Europe on one side, and the Mediterranean Countries on the other.