Fiscal "alchemy" must mimic monetary science

August 28, 2010 5:24 PM EDT

Tax and budget policies need the same regularity and independence as monetary policy if countries around the world are to cope with looming stresses from pension programs, world central bankers were told at a Federal Reserve conference on Saturday.

"Modern monetary research and practical policy-making are united in aiming to make monetary policy scientific," said Indiana University Economics Professor Eric Leeper in a paper. "No analogous transformation has occurred with macro fiscal policy."

Leeper presented his paper at an annual conference held by the U.S. Federal Reserve in Jackson Hole, Wyoming.

His view will have resonance for policy-makers who in many countries have already cut interest rates to historically low levels and launched extensive asset purchase programs to stimulate growth. With prospects for new fiscal stimulus programs politically unpopular, central bankers are considering additional measures to ease financial conditions to support flagging recoveries in many countries represented at the conference.

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In addition, U.S. politicians have for many years debated without resolution whether to raise taxes or cut benefits to the Social Security and Medicare retiree pension and health care programs, which face stiff financial challenges as the baby boom generation retires.

Fiscal policy can have as strong an effect on economic activity and inflation as monetary policy decisions, Leeper said.

Central bankers are likely to have to pay more attention to taxation and budgeting in the future as the stresses from the financial obligations of retirement programs increase, he said.

Since there is general agreement that central bank decisions should be made without political meddling, financial markets can be reasonably confident of policy makers' responses to a slowdown in economic growth or a rise in inflation, Leeper said.

However, no such predictability exists for fiscal policy, which can shift with political winds.

"There is a fairly clear consensus on the objectives of monetary policy, but none for fiscal policy," Leeper wrote.

"Governments devote shockingly few resources into understanding fiscal policy's impacts," he wrote.

He urged central bankers to be more outspoken on fiscal issues, reversing their preference for wading into politically sensitive areas.

"Central bankers have a role to play ... They can break away from the taboo against saying anything substantive on fiscal policy," he wrote.

(Reporting by Mark Felsenthal; Editing by Leslie Adler)