Klaas Knot: The case for fiscal stabilization in a low interest rate environment

Text of the Witteveen lecture by Mr Klaas Knot, President of the Netherlands Bank, at the Erasmus School of Economics, Rotterdam, 11 June 2021.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thank you.

It is a great honor to give this lecture. A lecture that bears the name of a man who has greatly influenced economic policymaking. Both in theory and in practice, both at home and abroad.

I saw Johan Witteveen a few times in the late 1990s, when I worked at the IMF. As a former managing director he still had his office at the Fund, and he regularly visited to discuss economics and share his views with IMF staff. Although I never intensely spoke to him one-on-one, it was clear to me that after all those years he was still a very respected economist, and that he was held in the highest esteem by those around him. In fact, watching him from a distance, it was easy to imagine John Maynard Keynes himself walking there, in the corridors of the institution of which he was the spiritual father.

The association with Keynes is not so strange because, of course, Witteveen was a Keynesian economist. He held the view that fluctuations in aggregate demand can create business cycle fluctuations. And because markets do not always adjust smoothly, he believed that both monetary and fiscal policy have a role to play in dampening these fluctuations. And that their effectiveness in stabilizing the economy depends on how they interact with one another.

Witteveen's views on the importance of monetary and fiscal stabilization policies are highly relevant today. In his spirit, today I will present a case for a more active role of fiscal policy in stabilizing the economy, in a world with persistently low interest rates. I will start by briefly reviewing some of the conventional channels along which monetary and fiscal policy interact in normal times, when interest rates are much higher than they are now. We will then see how this interaction is modified when interest rates are persistently low, and what this implies for the role of fiscal policy. Next, we will move away from the theory and have a look at how fiscal and monetary policy in the euro area interacted in practice. Here we will look in particular at the European debt crisis ten years ago, and compare that episode to the more recent Covid crisis. I will end with some remarks about possible implications for the fiscal framework in the euro area.

The channels of monetary-fiscal policy interaction in normal times

Let us start by briefly reviewing how monetary and fiscal policy interact in normal times.