Improving Economic Policy

The consensus model (CM) holds that there is only one equilibrium that needs to be maintained for economic stability. This follows, as a matter of logical necessity, from the model’s fundamental assumptions. The evidence is, however, clear that, independently of each other, asset prices, money supply and demand all need to be kept in balance. The widespread scepticism among economists and central bankers over the single equilibrium assumption is thus abundantly justified. Two important conclusions follow: CM must therefore be discarded if economic policy is to achieve growth with low and stable levels of unemployment and inflation. The existence of three possible disequilibria requires at least three independent policy instruments to allow the economy to be managed successfully. In addition to monetary and fiscal policy, another instrument is thus needed, which tax policy can and should provide. If used appropriately, these three tools can preserve stability. Importantly, the correct use of tax policy should not only prevent the policy errors which have led to rapid inflation and financial crises but restore the trend growth of developed economies to the rates achieved before 2000.