Inverting monetary and fiscal policies

We illustrate our remarks with the cases of the euro zone and Japan. The usual recommendation to combat a situation of excess savings over investment is to conduct a highly expansionary monetary policy, whereby the real interest rate is lowered to the point where savings and investment rebalance . But this policy is not proving to be very effective, either because the nominal interest rate has hit the zero lower bound, or because savings and investment do not depend much on the real interest rate. In the euro zone and Japan, the highly expansionary monetary policy has not succeeded in rebalancing savings and investment. This has led to a proposal to invert monetary and fiscal policies: an expansionary fiscal policy would then become the main instrument for rebalancing savings and investment, with monetary policy remaining expansionary to stop interest rates from rising and hampering the work of fiscal policy. The key weapon for combating deflation would then no longer be an ultra-expansionary monetary policy, but an ultra-expansionary fiscal policy, as suggested by modern monetary theory. This is already the case in Japan, and will probably become so in the euro zone.