I n certain circles, it has become fashionable to argue that monetary policy is a superior instrument to fiscal policy – more predictable, faster, without the adverse long-term consequences brought on by greater indebtedness. Indeed, some advocates wax so enthusiastic that they support recent drives for austerity in many European countries, arguing that if there are untoward effects they can be undone by monetary policy. Whatever the merits of this position in general, it is nonsense in current economic circumstances.

Traditionally, monetary authorities focus policy around setting the short-term government interest rate. But, leaving aside the fact that with interest rates near zero there is little room for manoeuvre, the impact on the real economy of changes in the interest rate remains highly uncertain. The fundamental reason should be obvious: what matters for most companies (or consumers) is not the nominal interest rate but the availability of funds and the terms that borrowers have to pay. Those variables are not determined by the central bank. The US Federal Reserve may make funds available to banks at close to zero interest rates, but if the banks make those funds available to small and medium-sized enterprises at all, it is at a much higher rate.

Indeed, in the last US recession, the Fed’s lowering interest rates did stimulate the economy, but in a way that was disastrous in the long term. Companies did not respond to low rates by increasing investment. Monetary policy (accompanied by inadequate regulation) stimulated the economy largely by inflating a housing bubble, which fuelled a consumption boom.