Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.
Tuesday, 11 August 2015
Flawed ideas on peoples’ QE.
There has been an upsurge in interest in the UK in the last week or two in the idea that the state should simply print money and spend it, and/or cut taxes when stimulus is needed, rather than BORROW money and spend it. E.g. see this article by Simon Wren-Lewis (Oxford economics prof). As Thomas Hirst put it in the opening sentence of his article published on 9th August, “Over the past few weeks there has been a lot of discussion on the topic of a People's Quantitative Easing …”
That increased interest is partly down to the fact that Jeremy Corbyn who is running for leadership of the Labour Party has endorsed the idea. Of course Corbyn being on the political left wants “print and spend” rather than “print and cut taxes” which is what a right wing politician might go for. But the basic principles behind the two versions of the idea are much the same.
I have a few quibbles with some of these recent articles, and the purpose of the paragraphs below is to deal with these.
The History.
The “print and spend” idea goes back a long way. Keynes advocated it in the 1930s – see 5th paragraph here. That’s the sentence starting “Individuals must be induced…” (2nd half of the 5th para). And Milton Friedman in a paper published in 1948 argued that (at least in peacetime) the only liability that the state should issue should be base money: i.e. he argued that governments should not issue interest yielding debt. See para starting “Under the proposal..”
In short, Friedman’s proposal was more extreme than Corbyn’s: Friedman advocated a total ban on “borrow and spend” and replacing it with “print and spend”, whereas Corby advocates just supplementing “borrow” with “print”.
Slippery slopes.
Thomas Hirst and Tony Yates (economics prof in Birmingham, UK) seem to be worried about the fact that once printing starts, that’s the beginning of what Yates refers to as a “slippery slope” – leading at worst to full blown Mugabe type hyperinflation.
Well the solution to that problem was set by the three authors of this submission to the Vickers commission.
Their solution is to have the TOTAL AMOUNT of printing (i.e. total amount of stimulus) determined by some sort of central bank committee or some other committee of economists independent of government. Meanwhile, strictly POLITICAL matters, like what proportion of GDP is allocated to public spending remain (quite rightly) with politicians and the electorate.
And that’s actually very similar to the EXISTING system in that many central banks already have the final say in the size of any stimulus package: that is, they have to power to counteract any fiscal stimulus which the CB believes to be deficient or excessive. CBs do that by adjusting interest rates, QE, etc.
Of course it’s always possible that politicians would put pressure on CBs (especially just prior to elections) to allow too much printing. But by the same token, politicians can put pressure on CBs under the existing system to keep interest rates too low for too long.
Thus THERE IS NO REASON WHATSOEVER to think that the dangers of excess inflation are any more under “print and spend” than under the existing regime.
Moreover, we’ve actually implemented print and spend over the last few years in that we’ve implemented fiscal stimulus followed by QE. (Fiscal stimulus equals “government borrows £X, spends it back into the private sector and gives £X of bonds to creditors”. And QE equals “the state prints £X and buys the bonds back”. That nets out to “the state prints £X and spends it”.)
Another alleged problem to which Hirst refers is “highly uncertain estimates of the amount of available slack in the economy..”. Well that again is just as much a problem under the existing regime.
Full reserve / 100% reserve banking.
Incidentally, the above Friedman paper had something else in common with the above Vickers submission, namely that both works advocated full reserve banking: a system under which the only form of money is state issued money. That is, private banks are not allowed to create or “print” money.
As Friedman put it, “The particular proposal outlined below involves four main elements . . . . . 1, A reform of the monetary and banking system to eliminate both the private creation or destruction of money and discretionary control of the quantity of money by central bank authority. The private creation of money can perhaps best be eliminated by adopting the 100 per cent reserve proposal, thereby separating the depositary from the lending function of the banking system.”
Friedman repeated his advocacy of 100% reserve banking a decade later in his book “A Program for Monetary Stability” (Ch3, under the heading “How 100% Reserves Would Work”).
Moreover, it’s no coincidence that two works advocate a combination of “print and spend” and 100% reserve banking. Reason is that the two mesh nicely. That is, if (as under print and spend) the main or only form of stimulus is new money created by the state, that type of control of demand is more precise if private money creation is banned or curtailed as is the case with 100% reserve banking. Put another way, if private money creators cannot give us housing bubbles out of the blue, then gyrations in demand should be ameliorated.
Simon Wren-Lewis.
The main difference between SW-L’s ideas on print and spend and the above submission’s is that SW-L claims that print and spend should only be used when interest rates are at or near zero (i.e. when interest rates can’t be cut any further). That is, SW-L is saying that interest rate adjustments are fine when rates are above zero.
In contrast, the above submission specifically criticises interest rate adjustments, and I agree with the authors there, i.e. I disagree with SW –L. Strikes me there are two weaknesses with interest rate adjustments. First there is decent empirical evidence that they are not very effective. In the words of Jamie Galbraith, “Firms invest when they can make money, not when interest rates are low”.
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How do you propose to measure how much money has been "printed and spent"?
ReplyDeleteIt seems to me that the accumulated government debt is a good measure of how much money has been created and spent.
Because banks are also allowed to create money, the total amount of bank debt would be added to the amount of government debt (to measure the total amount of fiat money created and spent). (Of course we would eliminate government debt held by banks to prevent double counting.)
Remembering that money, once created, will exist until the debt is paid, we see that government bonds (and bank debt instruments) must be money in a condition of suspended animation.
Bank reserves must be a measure of money not yet placed into suspended animation.
There is no sharp dividing line between money and non-money. But basically under full reserve the creation of money by private banks is banned. So the only money is central bank created money, i.e. bank reserves and physical cash.
DeleteRe your claim that government debt equals money, that’s not correct. It’s true, as Martin Wolf pointed out in the FT recently, that there’s sharp dividing line between base money and national debt. But one can at least draw arbitrary lines. And anyway, the real problems (asset price bubbles etc) derive from privately created money, not publically created money.
It seems to me that the decision makers who decide how much money the government should print need to know how much to print , how much remains to be spent, and who/which people will get the new money.
ReplyDeleteSo which economic axiom is correct:
1. New money is created when money is traded for government debt, thereby increasing the amount of government debt and the money supply.
2. Money is only destroyed when government collects taxes and pays down debt, or banks retire loans.
Roger,
DeleteQE for the people has nothing to do with and is totally different from creating money by having the central bank buy government debt (i.e. traditional QE). Arguably the latter does not constitute money creation at all since government debt (as pointed out by Marin Wolf) is a sort of money – in the broadest sense of the word money. Moreover, that operation has no effect whatever on what MMTers call “private sector net financial assets” (PSNFA). Reason is that if I someone sells £X of debt to the CB, they lose that, and gain £X in cash.
PQE in contrast DOES INVOLVE an increase in PSNFA: when the CB / government machine creates £Y and spends it, the private sector is up to the tune of £Y.
Re your claim that “that the decision makers … need to know how much to print”, yes: quite right. The decision as to how much to print under PM’s system is taken by some sort of committee of economists.
Re your phrase “remains to be spent” that is essentially meaningless. Reason is that money in the hands of a money issuer is meaningless: the BoE can create a trillion, trillion, trillion pounds in the next few seconds by a simple book keeping entry. That’s irrelevant. It’s the SPENDING of money that has the effect (as David Hume pointed out in his essay “Of Money” 200 or so years ago).
You assert, yet again, that:
ReplyDelete"central banks already have the final say in the size of any stimulus package: that is, they have to power to counteract any fiscal stimulus which the CB believes to be deficient or excessive. CBs do that by adjusting interest rates, QE, etc."
This is wildly incorrect (and inconsistent with Ralphanomics) because:
1. In May 1997 the Government granted the Bank of England operational independence allowing it to set domestic interest rates.
However, the Government still determines fiscal policy (expenditure and taxation) and the Government sets the inflation target within which the Bank must operate when implementing monetary policy .
The Bank of England Act 1998 formally sets out the role and constitution of the BoE Monetary Policy Committee.
"In relation to monetary policy, the objectives of the Bank of England shall be –
(a) to maintain price stability (ie continued low inflation), and
(b) subject to that, to support the economic policy of the Government, including its objectives for growth and employment."
Thus the BoE does not decide the budget deficit or target inflation rate. These are set by the Government.
The main role of the MPC is merely to set the base rate of interest in support of Government economic policy.
2. Ralphanomics correctly argues that "adjusting interest rates, QE, etc." has little effect on aggregate demand.
In this post (last para) and in previous posts you say "there are two weaknesses with interest rate adjustments. First there is decent empirical evidence that they are not very effective...“Firms invest when they can make money, not when interest rates are low”.
And in earlier posts you have agreed with the general view that QE has had little effect on demand.
If interest rates and QE are largely ineffective, it follows that a CB does NOT have the "power to counteract any fiscal stimulus", contrary to your repeated assertions that it does.
Positive Money's proposes that the magnitude of the budget deficit should be decided by a new unelected committee of "experts" at the BoE.
Plainly, as pointed out by critics of PM, this would be a MAJOR INCREASE in the powers of the BoE, with a corresponding reduction in the powers of government ministers who are democratically accountable to Parliament.
Hi KK,
DeleteRe your point No.1, basically you’re saying that the BoE does what government tells it to do. Quite right: ultimate power is always in the hands of politicians. But government has given the BoE the job of “maintaining price stability” (to quote you) and the tools to do that, i.e. BoE has been given control of interest rates. Put another way, government / politicians have given the BoE the right to overrule the effect of a budget deficit if the BoE thinks the effect of a budget deficit is too inflationary.
Re your point No.2, I agree that the powers given to BoE are not desperately effective, but they seem to have been just sufficiently effective to date: witness the fact that inflation has been well under control over the last fifteen years or so. Inflation was a bit above the 2% target between roughly three and six years ago, but the BoE thought that was mainly cost push rather than demand pull, and so they didn’t do much about it (quite rightly).
Put another way, you are right in that the Chancellor could go wild with the budget deficit, and the BoE might not be able to contain the resulting inflation. But that would make a nonsense of government’s instruction to the BoE to contain inflation.
Re your claim that giving the BoE the right to determine the size of a stimulus package as per PM’s system would constitute a big increase in the BoE’s powers, that’s clearly not the case IN THAT or TO THE EXTENT THAT the BoE already has those powers. And it already does have those powers IN THAT it is able to control inflation.
In contrast, if we had a Chancellor who was in the habit of implementing ludicrously large deficits and didn’t give a hoot about the inflationary consequences, and the BoE were then given the job of controlling inflation, then that WOULD CONSTITUTE an extension of BoE powers.