The rule based fiscal regimes unravelled during the crisis as both governments and central banks implemented expansionary policies in close coordination. While such coordination during the crisis was not questioned except by extreme purists, now in the recovery period, several fundamental concerns are resurfacing. At the heart of these concerns is whether monetary policy is once again becoming hostage to fiscal compulsions?
This overlaps with the signaling effect associated with the “quantity” that I just mentioned.6 One possible problem is that the theoretical foundations seem not to be well established. Standard theories simply assume that rational expectations automatically hold, while they tend to be silent on exactly what it would take to change the way firms and households formulate their expectations.