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The policy mix

In truth, though, the issue is not so much fiscal policy as the mix of fiscal and monetary policy.

I say this for a simple reason. A looser fiscal policy implies stronger aggregate demand and hence higher incipient inflation. But for a given inflation target, this should mean higher interest rates. A 'reset' of fiscal policy thus means a reset of monetary policy, too. To give a rough idea of the magnitudes here, the Bank of England has estimated that a one percentage point rise in Bank rate reduces output by around 0.6 per cent. This implies that if we assume a fiscal multiplier of around 1.2 then a fiscal easing of 1 per cent of GDP should lead to Bank rate being two percentage points higher than it otherwise would be.

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