The Soulless Minions of Fiscal Orthodoxy

by George Hatjoullis

Fiscal orthodoxy has now overwhelmed the Keynesian revolution. The precise definition of fiscal orthodoxy is not important. It refers broadly to governments keeping balanced budgets over some specified time horizon. The corollary is that debt to GDP levels will also need to be harmonised and kept below specified levels. Fiscal policy will thus converge across all states irrespective of their domestic economic conditions. If the each state is restricted as to its fiscal policy then aggregate domestic demand conditions are determined by corporate and household decisions operating through markets. This was the orthodoxy that Keynes challenged in the General Theory. He has finally been defeated.

The victory of fiscal orthodoxy is a victory for Germany. It is in this state that the idea has been powerful. Moreover, because it is a powerful and successful state it has been able to promote its political economy. Eurozone states have been forced to sign up to fiscal orthodoxy. Receiving assistance from the ESM requires signing up to the Treaty governing the ESM and this states:

It is acknowledged and agreed that the granting of financial assistance in the framework of new programmes under the ESM will be conditional, as of 1 March 2013, on the ratification of the TSCG by the ESM Member concerned

The TSCG is none other than the Treaty on stability, coordination and governance in the economic and monetary union. This treaty has a section entitled Fiscal Compact which states quite unambiguously in paragraph 1:

The budgetary position of the general government shall be balanced or in surplus.


The rules mentioned under paragraph 1 shall take effect in the national law of the Contracting Parties at the latest one year after the entry into force of this Treaty through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national budgetary processes.

The situation is actually worse than the one confronting Keynes. In his context central banks were not independent and some states were able to get around fiscal orthodoxy through monetary financing. However, owing to abuse of this facility and other developments in political economy, central banks cannot engage in monetary financing. Moreover, their independence typically comes with a very specific inflation target. Of the major central banks, only the Federal Reserve of the US has a ‘dual mandate’ which includes employment and even this body cannot engage in monetary financing.

The spread of fiscal orthodoxy, in the absence of monetary financing, and in the context of independent central banks having specific, and quite similar, inflation targets, is creating the type of policy coordination last seen under the gold standard. Aggregate demand is becoming wholly endogenously determined by corporations and households. If it falls short, and it will, nothing can be done to offset it because we have legislated away this freedom. The application of the Keynesian insights has been imperfect and caused other problems. No one disputes this. However, one should never blame the tool for the work. More important one should never lock it up and throw away the key. The world is sleep walking itself into potential catastrophe for ideological reasons.