Fiscal, Monetary and Macroprudential Regimes: Incentives-Values Compatibility in Constitutional Democracies

Abstract

I have been asked to write something about the appropriate institutional structure for monetary, macroprudential and fiscal policies in an environment of persistently low interest rates. That is one important plausible scenario the macroeconomic regime needs to be capable of coping with, but not the only one as we are being reminded by recent inflationary cost shocks and excess demand. There are others too, such as banking crises.

At a high level of abstraction, we can say two things about institutions in general, and so about policy regimes. First, they must be incentive compatible for the key actors; incentive-compatible things happen, incentive-incompatible things do not. Second, they must be values compatible, by which I mean that they must be compatible with the deep political values that animate a state's highest-level institutions. Otherwise, economic institutions will not be resilient in the face of disappointments, setbacks and unreasonable demands.

Adding a legitimacy test to economists' more familiar mechanism-design demands means addressing the division of labour between elected and unelected power. It cannot simply be a case of allocating the various parts of a benign social planner’s optimal plan to whichever organs of the state are most capable of executing each of them. That banal thought matters because central banks’ latent capabilities are extraordinary.