The major effect of globalization of financial markets is to give these markets considerable influence on macroeconomic policy. In an influential book, Thomas Friedman (2000)5 coins the term “golden straitjacket”. He argued (pp.101-111) that to have access to international financial markets a country has to follow a set of rules which make up this straitjacket and if a country breaks these rules it is ‘disciplined’ (his word p. 110) by financial markets either avoiding or withdrawing its money from that country.
The golden straitjacket has in all 16 rules. The three that directly affect fiscal policy are maintaining a low rate of inflation, shrinking the size of the government sector and maintaining as close to a balanced budget as possible. Giving complete priority to price stability over full employment as a goal of macroeconomic policy clearly limits the use of fiscal policy to reduce unemployment.
A rule that requires a continual reduction of the size of the government sector is presumablyhyperbole, but a small government sector reduces the size of the effects of automatic stabilisers.payments. The bigger these the larger the automatic stabilising effects. While the size of these parameters need not depend on the size of the general government sector, they almost always do.
The aim of always achieving a budget balance obviously limits the use of fiscal policy though it does not neuter it altogether. The balanced budget multiplier can still operate and government expenditure can be biased towards labour-intensive areas. Such a bias will both maximise the increase in employment and usually increase the size of the balanced budget multiplier with respect to GDP.
Overall, if all three rules are followed, the use of fiscal policy to stimulate economic
activity is severely limited. Therefore, the validity of Friedman’s assertion, that the golden straitjacket must be observed to pacify financial markets, is crucial in evaluating the effects of globalization on fiscal policy.
