Friday, 15 March 2013

Mervyn King opposes merging fiscal and monetary policy – he’s wrong.

Advocates of Modern Monetary Theory (and other groups, e.g. Positive Money and the New Economics Foundation) tend to favour merging fiscal and monetary policy. That is, they advocate that in a recession, the government / central bank machine (gcbm) should simply create new money and spend it (and/or cut taxes). And if inflation looms, “the machine” should do the opposite: cut spending / raise taxes and “unprint” the money collected or saved. Certainly Abba Lerner suggested the idea on p.40 here. And Milton Friedman suggested the idea (p.250) here.
Mervyn King opposed the idea in this speech and for four reasons, none of which stand inspection. His reasons were as follows.
1. A merge would give a central bank (CB) a say over strictly political decisions, like what proportion of GDP is allocated to public spending.
2. It would give politicians access to the printing press.
3. Stimulus done in a “merge style” would be more difficult to reverse than fiscal or monetary stimulus done separately.
4. CBs must have a stock of government debt in order to influence what King calls “monetary conditions”.

King’s speech.
The relevant part of King’s speech is the three paragraphs starting “Over the past three years…”, and I’ve put the three paragraphs in full at the end of this article because they consist of 370 words: a rather long passage which would interrupt the flow the argument.
Let’s take King’s four claims in turn.
1. Central banks would have a say over political decisions?
If the decision as to how much money to “create and spend” is given to some sort of independent committee of economists (as advocated by for example Positive Money), it’s hard to see why that gives the committee any say over what proportion of GDP is allocated to public spending. Indeed, we ALREADY HAVE a committee that takes decisions on stimulus in the UK: the Bank of England Monetary Policy Committee (MPC). And no one has ever suggested the MPC can force government to change the proportion of GDP allocated to public spending, or that the MPC can induce government to spend more on defence and less on education or vice versa.
To illustrate, if an MPC type committee decided an extra £Xbn of spending was warranted, it would say as much to government, plus supply government with the relevant funds. Government, assuming it wanted to behave in a democratic manner would then boost public spending and private spending in accordance with the way the electorate thought GDP should be split as between public and private spending.
Of course a government would have the power to ignore the electorate’s wishes. But then political parties, once in power, frequently ignore manifesto promises. So nothing new there.

2. Politicians would get access the printing press?
As to King’s second claim, namely that a merge would give politicians access to the printing press, that is equally mysterious. In as far as a central bank is genuinely independent (and the degree of independence varies from country to country) politicians do not influence MPC type committees. Thus there is equally little reason to suppose they would influence and “MPC type” committee.

3. Reversing stimulus.
King then claims, “It is peculiar, to say the least, that some of the same people who believe that the Governor of the Bank is too powerful also believe that he should stand on the steps of Threadneedle Street distributing £50 notes – a policy which you will appreciate is rather hard to reverse. For the same reason, the Bank could not countenance any suggestion that we cancel our holdings of gilts. The Bank must have the ability  to reverse its policy – to sell gilts and withdraw money from the economy – when that becomes  necessary. Otherwise, we run the risk of losing control over monetary conditions.”   
Now there is a big problem with that point, which is that as King himself rightly says, a helicopter drop or “distributing £50 notes” is the same as merging monetary and fiscal stimulus combined. (See final paragraph in passage quoted below). So if £50 note distributions are difficult to reverse, then monetary and/or fiscal stimulus must be equally difficult to reverse.

4. Monetary conditions.
As just mentioned, King claims that CBs need a stock of government debt in order to influence what he calls “monetary conditions”  - presumably he means interest rates.
Well the problem with that point is that it is irrelevant to the main argument. That is, the question or “main argument” is: should the government / central bank machine have a separate fiscal and monetary policy, or should the two latter be merged?
If we implement a merge, then stimulus (or its opposite) does have a monetary element. To that extent, King’s complaints about an MPC type committee not being able to influence “monetary conditions” are invalid.
However, King does have some sort of point here. That is, if the ONLY form of stimulus effected is “merge stimulus”, then that by definition rules out having monetary policy act independently of fiscal policy. And contrary to King’s suggestions, there are some very good arguments for abandoning interest rate adjustments. See this submission to the Vickers commission.
However, one COULD HAVE a system in which the BASIC regulatory tool was having gcbm creating (destroying) money and spending (withdrawing) it as required, with interest rate adjustments playing only a backup role.
But a CB  does not need a stock of government debt in order to adjust interest rates.
If a CB has no stock of government debt at all, and for example wants to raise interest rates, it can simply announce that it is willing to borrow at above the going rate of interest. Of course a CB may not  be able to do the latter under the rules that currently govern CBs in  some countries. But that is irrelevant: those rules or laws can easily be changed. That is just a legal or technical point.
As to where a CB gets the money from to pay interest on the debt it has incurred, it wouldn’t need to find the money for a year (assuming interest is paid annually). And that ought to give enough time for the MPC type committee and government to raise taxes so as to fund the interest.

Contrary to Mervyn King’s suggestions, merging monetary and fiscal policy needn’t reduce politicians’ or the electorate’s freedom to take strictly political decisions. Second, it needn’t involve politicians getting near the printing press. Third, merging monetary and fiscal stimulus would not be any more difficult to reverse than monetary or fiscal measures alone. Fourth, an absence of government debt in the hands of a central bank does not stop a central bank withdrawing money from an overheating economy.

The three paragraphs from King’s speech.

“Over the past three years, the Bank of England has bought £375 billion of government bonds – gilts – from the private sector to create a lot of new money. Many – perhaps some of you – are understandably concerned about the use of such an unusual and unfamiliar policy. Some people talk about the dangers of money creation. I want to explain why it is important to distinguish between “good” and “bad” money creation. In essence, the argument is very simple. “Good” money creation is where an independent central bank creates enough money in the economy to achieve price stability. “Bad” money creation is where the government chooses the amount of money that is created in order to finance its expenditure. Insufficient money creation can lead to a contraction of the money supply and a depression. We saw that in the United States during the Great Depression and we see it today in Greece. Excessive money creation leads to accelerating inflation and ultimately the collapse of the currency.
The role of the Bank of England is to create the right amount of money, neither too much, nor too little, to    support sustainable growth at the target rate of inflation. We are not doing it at the behest of the    Government to help finance its spending. It is the independence of the Bank that allows us to create money    without raising doubts about our motives. But just as it is crucial that governments do not control the printing    of money, so too the unelected central bank must not determine the levels of taxes and public spending.    Fiscal policy is a matter for elected governments.   
There has been some talk about the possibility that money created by the Bank could be used directly to finance additional government spending, or even that money could be given away. Abstracting from the colourful metaphor of “helicopter money”, such operations would combine monetary and fiscal policies.”


  1. Quote: "As to where a CB gets the money from to pay interest on the debt it has incurred, it wouldn’t need to find the money for a year (assuming interest is paid annually). And that ought to give enough time for the MPC type committee and government to raise taxes so as to fund the interest."

    - Surely, in a brave new (PM) world of debt-free money, it just prints the money to repay the interest?

    - As I understand it, in PM's proposals, a new committee, the Money Creation Committee, will both create and destroy money, based on the then current inflation rate, independent of the government (supposedly). This will replace the MPC, and neither the government or the BoE will have any say over interest rates (which are "left to the market"). Apart from being slightly uncomfortable about their faith in the markets, this does seem very reasonable, since in the past, interest rates were one (clumsy) tool to control the money supply, and now this would be done directly, so there would seem to be no need to control interest rates.

    Personally, I think interest rates should always be as low as possible (in a new, debt-free currency world) (although there should be strict lending and borrowing controls to control both inflation and personal debt levels, and maybe business debt levels as well - I don't believe the money supply level on its own is enough to control inflation - where I disagree with PM). Although interest rates have been used to control inflation (debatable whether they do this very well), Michael Rowbotham argues that it is interest that leads to inflation, and I agree (although I am no economist).

    One final point: I was rather shocked, reading an old-ish posting (from 2012) on the PM forum, apparently from a PM representative, it seemed that he was saying that public spending in the brave new world would be funded by a combination of:-

    1. Taxation
    2. New debt-free money "printed" by the BoE
    3. "Sale of securities to the financial sector."

    er, pardon?

    You mean (they mean), the government will STILL be borrowing money to finance its spending?

    I don't get it. Unless I am seriously misunderstanding, this is contrary to what PM's campaign has been saying all along, or seems to be. I didn't think we were campaigning for partial debt-free money but ALL debt-free money. In fact, they can't co-exist, can they?

    1. “Surely, in a brave new (PM) world of debt-free money, it just prints the money to repay the interest?”

      No – PM advocates printing money when stimulus is order, not specifically to pay interest. Moreover PM opposes interest rate adjustments as a means of regulating the economy.

      But if those who think along PM lines (like me) made a slight concession to the conventional wisdom, i.e. accepted that sometimes an interest rate hike might be in order, then there is the problem I alluded to above, namely that the initial effect of dishing out more by way of interest payments has a stimulatory effect: the opposite of the desired effect.

      Re “Sale of securities to the financial sector”, that isn’t BLATENTLY inconsistent with PM’s advocacy of debt free money. Reason is that those securities, while they are a form of debt, are not a form of money.

      But that’s not to say I favour government debt. That is, I agree with Warren Mosler, Milton Friedman when they argued that governments just shouldn’t have debts: that is, the only liability they should issued is monetary base.

  2. Quote: "But that’s not to say I favour government debt. That is, I agree with Warren Mosler, Milton Friedman when they argued that governments just shouldn’t have debts: that is, the only liability they should issued is monetary base."

    Interesting. I must try to study them.

    Going back to Mervyn King's statement, unless I missed it, he made no mention of the commercial bank's current role in creation of money, while being rather preachy about keeping politicians away from the printing presses. At least the politicians are accountable (to some extent) to the public, whereas the bankers aren't, and they can print pretty much as much as they want to.

    I think it is OK for politicians to have at least some say in the amount of money created, although they shouldn't be sole arbiter, and need some restraint. But then perhaps the BoE shouldn't be sole arbiter either. There are those who say that central banks are the creatures of the banking sector as a whole. I don't know how fair that is. According to Richard Werner, the BoJ does pretty much its own thing, to the point of being obstructive to its government. I think it's only been officially independent for about as long as ours has, but in practice, it's acted independently for years.

    Well, while the BoE and the MPC (and its successors or analogues like the FPC) may be technically independent, they are given a remit by government, such as keeping inflation at a target level.

    However, these remits and targets could be changed - George Osborne was even making noises about reviewing the role of the MPC in the 2013 budget - for instance they could also target specific employment and growth levels.

  3. Ralph,

    I looked at the paper you link to from the top page ("Consolidation causes little austerity") and the other one it references ("Government borrowing is near pointless"). Both very interesting. I'll have to read them again to make sure I understand them, and also try to read some of the "further reading".

    They got me thinking, or wondering whether Mervyn King did have some justification in insisting on the BoE (or "The Bank", as he likes to call it) having the right to sell and buy gilts, in order to control the money supply.

    I can't really think of any other way the BoE could influence the money supply.

    The other ways of doing it seem only open to the government, i.e. by raising taxation or adjusting public spending. The problem with taxation is that, done traditionally, it tends to be slow to change and implement. (A dynamic financial transaction tax would be another matter). Whereas the gilt market is very liquid and I guess the effects of buying and selling can be quite rapid.

    I was wondering what would happen if the Werner plan that we discussed was put into effect, if it was needed to quickly reduce the money supply. I suppose the government could quickly replay sufficient of the loans as was necessary to reduce the money supply by the necessary amount.

    Again though: that's government doing it, not the BoE. That's OK by me, but I can see the BoE not being very happy.

    Then again, as I said before: should the BoE be the sole arbiter of financial rectitude? Who elected them to be Monetary Popes? I didn't see any white smoke.

    I suppose the answer is that they did it themselves, back in 1694, when they had the king over a barrel, and wrote the rules to suit themselves and their banker friends (not to be to conspiracy-theoretical about this... :-) ).

    1. Re having Merv buy or sell guilts, that does not achieve a HUGE amount because money (or monetary base to be exact) and gilts are almost the same thing. Certainly a gilt due to mature in one week is indistinguishable from cash / monetary base.

      Re tax or public spending adjustments (i.e. fiscal policy) being slower to work than buying/selling gilts (i.e. monetary policy) that is debatable. It’s generally accepted that monetary policy takes a good year to work. So I suggest the lags in both cases are similar. I actually attacked monetary policy here:

      Plus changes in tax can be done quickly: VAT was changed twice during the crisis by the UK government. As to changes to public spending being slow to implement, my answer to that is that they NEED’T be slow for some types of spending. E.g. local authorities could have it drilled into their heads that come a recession, central government will give them additional funds to hire assistant teachers, pot-hole repairers, etc.

      Re the question as to whether the BoE should be the “sole arbiter of financial rectitude”, I favour the system advocated by Richard Werner, Positive Money and the NEF (link below). This involves an independent committee of economists (something like the BoE MPC committee) deciding on stimulus, which the electorate and politicians decide the strictly POLITICAL decisions like what proportion of GDP is allocated to public spending.


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