Thursday, 24 March 2011
Why separate monetary and fiscal policy?
The phrases “monetary policy” and “fiscal policy” are a boon for economics commentators who want to sound important. These commentators, or at least 99% of them simply accept the status quo, namely that the two policies should be separate. They rarely consider the possibility that the two should be merged.
Blind acceptance of the status quo is of course a common human weakness. No doubt 99% of those living in ancient Egypt accepted that spending a large portion of GDP on building million ton pyramids was a good idea.
The current bizarre set up.
The separation of monetary policy (MP) and fiscal policy (FP) arises to a significant extent from the bizarre way in which governments get extra monetary base into private sector hands, which is thus. 1, Treasury borrows from the markets to fund extra spending and issues government bonds to those it has borrowed from (which is so called “fiscal”). 2. Then the central bank creates new money, and buys up the bonds (which is so called “monetary”).
It would of course be much simpler for the “government / central bank machine” to simply create money and spend it, where stimulus is needed. And where inflation looms, i.e. dose of deflation is needed, it would be simpler for the “machine” to do the opposite, i.e. raise taxes, rein in money and “unprint” or extinguish money.
Indeed Keynes approved of the latter sort of policy, while Abba Lerner advocated it more openly than did Keynes.
Would merging be too much of an upheaval?
As mentioned above, an important reason for keeping MP and FP separate is the they happen to be naturally separated under our current (and illogical) institutional arrangements. That is, central banks are responsible for MP, and elected representatives are responsible for FP.
But there is a big flaw in this arrangement. This is that both MP and FP influence aggregate demand, thus the current set up involves two bodies being responsible for influencing demand: you might as well have a car with two steering wheels, each of the controlled by different people.
The printing press.
Conventional folk (i.e. the above mentioned 99%) will doubtless answer the latter point by claiming that the current set up at least keeps politicians’ hands off the printing press. Well it doesn’t! At least, to all intents and purposes it doesn’t, and for the following reasons.
The problem with irresponsible use of the printing press is that it leads to excessive demand, which in turn leads to excessive inflation. But as just pointed out, and as is generally accepted, FP influences demand! Thus even though politicians cannot print actual currency units (US dollars in the US), they can get as near as makes no difference: that is, they can issue debt, and debt equals the promise to pay currency units to holders of such debt at some point in the future. Indeed, government debt, particularly debt which is near maturity is accepted as money in the world’s financial centres.
Moreover, the temptation to go mad with the latter form of “almost money printing” is currently a major problem: that is, numerous countries have been piling up debt at an alarming rate recently.
Re-arranging government and central banks’ responsibilities.
And not only that, but if MP and FP WERE merged, that would or could involve a much more effective way of keeping politicians’ hands off the printing press (the money printing press AND the debt printing press). That is, central banks could be responsible for strictly technical matters, in particular whether demand was too high or too low, and thus whether government net spending needed reducing or increasing. While elected politicians could be responsible for the strictly political stuff, that is for example the proportion of GDP grabbed by government and the MAKE UP of government spending.
The advantages of a merger.
One major advantage of merging the two policies is that there is a huge amount of argument amongst economists as to which policy is better AND which elements of each policy work and which don’t. For example the crowding out argument looks like going on till the end of time.
In contrast, under a “merged” policy, it doesn’t make much difference which element of the policy does the real work. For example if government reduces employees’ contribution to a payroll tax, does the effect come from the employees’ increased take home pay, or from the fact that their net financial assets are boosted? Well it doesn’t matter too much: as long as at least ONE of the latter effects works, the policy as a whole will work.
The big problem: politicians' and economists' egos.
In practice, there are two major obstacles to merging MP and FP, both of them psychological or political.
The first has to do with the fact that the merged policy involves increasing the monetary base from time to time. As Lerner righly pointed out, this produces a knee jerk reaction: inflation.
That is that about 99% of the population, including economists who should know better, think that the mere fact of increasing the money supply is inflationary. That is they think that if someone prints a billion tons of $100 bills and hides them down a disused mineshaft, that somehow inflation will go thru the roof.
Put another way, only a very small portion of the population (economists included) can work out that additional money only has an effect WHEN IT IS SPENT. Given that most economists cannot work this simple point out, one has to wonder whether economists know anything about economics.
The second problem: tinkering with the controls.
The second problem is that both economists and politicians love tinkering with the buttons and levers that control the economy. That is, as soon as politicians are elected, they cannot resist the temptation to tinker, even though their qualifications for operating the controls are non-existent. (To some extent, politicians cannot be blamed for this because electors vote for politicians who appear to be "doing something", even when what they are doing is totally fatuous.)
As to economists, five thousand economists worldwide would be out of a job if it became generally accepted that tinkering can be drastically reduced.
Abba Lerner’s “Functional Finance” (aka Modern Monetary Theory) involves merging MP and FP, and as he pointed out, what puts most people off Functional Finance is its sheer simplicity. Or in his own words, functional finance is “too logical”. The ego’s of self styled technical experts are severely dented if someone demonstrates that most of the technicalities are a waste of time. That is, technicians would rather bamboozle the public with irrelevant technicalities than solve any of the world’s major problems, like unemployment.
Or as Lerner put it (p.39), functional finance “like every important discovery, is extremely simple”. And on the above point about the need to massage the egos of professional economists, Lerner points out (p.39) that “what progress the theory has made so far has been achieved . . . by dressing it up to make it more complicated, and accompanying the presentation with impressive but irrelevant statistics.”
Afterthought, same day 24th March 2011.
For more on the subject of national debt being little different to currency units (e.g. dollars) see Mike Norman.