Monday, 7 November 2016

Pure fiscal stimulus is flawed, as is pure monetary stimulus. Cooperation between them is best.

By pure fiscal stimulus I mean “government borrows money and spends it, and/or cuts taxes”. But borrowing as such is DEFLATIONARY! Why do something deflationary when the intended effect is the opposite?

By pure monetary stimulus I mean “the state prints money and buys back government bonds so as to cut interest rates or do QE”. But that’s flawed as well. First it assumes that a recession is caused by inadequate lending, borrowing and investment spending when in fact the cause may well be a lack of some other form of spending.

Second, deliberately interfering with the rate of interest means setting interest rates at something other than their free market level, which on the face of it reduces GDP. So in what scenario is there no government interference in interest rates?

Well government borrowing will artificially raise interest rates if such borrowing is not justified. So what forms of government borrowing are justified?

First, as is generally agreed, government should not borrow so as to fund CURRENT spending. As to CAPITAL spending, the arguments for borrowing there are much weaker than is commonly supposed: Milton Friedman and Warren Mosler oppose/d all forms of government borrowing. But if the justification for government borrowing is that it funds capital spending, the state cannot then print money and buy back government bonds with a view to cutting interest rates because that amounts to an “after the event” funding of capital spending via printed money. That’s a self contradiction!

Another nonsense in having the two options “fiscal” and “monetary” is this.  Why have two different organisations charged with the same task, namely adjusting demand? That makes as much sense as a car with two steering wheels each controlled by a different person.

A possible objection to the above argument is that given excess unemployment, the state has to “interfere” in SOME WAY to rectify the situation. Well the answer to that is that having the state print extra money and spend it and/or cut taxes comes to much the same thing as the free market’s cure for excess unemployment. That is, given excess unemployment in a perfectly functioning free market, wages and prices would fall, which would raise the real value of money (base money in particular). And that would induce “money holders” (which is a very large cross section of the population and economy, public and private sectors) to spend more. That effect is known as the “Pigou effect”.

However, the Pigou effect doesn’t work too well in the real world because of the “wages are sticky downwards” effect. But boosting the real value of the total stock of money by having the state print and distribute it in some way comes to the same thing. Ergo, in a sense, the latter policy is not an artificial interference in the economy.


P.S. (A few hours after putting the above online). Another problem with monetary stimulus is that the stimulus, at least initially, is concentrated in the "borrowing and lending" sector of the economy: i.e. the capital goods sector. All else equal, it is better to spread stimulus as widely as possible. Reason is that while the unemployed are not the most skilled section of the workforce, there is nevertheless a wide variety of skills there, thus ideally the unemployed need as wide a variety of jobs to choose from as possible.


  1. Quote:

    First, as is generally agreed, government should not borrow so as to fund CURRENT spending.

    I'm not sure an MMT purist would quite agree there....from that perspective, the government just spends, whether it is for current or capital expenditure; the deficit takes care of itself, and under present arrangements, by law, regulation or convention, treasury securities have to be sold, to correspond to the amount spent.

    Mosler, B.Mitchell, and Wray would prefer for present arrangements to be changed, and for no treasury securities to be sold, but the MMT approach can "work" with or without them (as I understand it).

    Ideally (and obviously, it seems to me) fiscal and monetary policy should work hand in hand. The only time I can see it really clashing is in the (unlikely, any time soon) event of a government being allowed by its Treasury to "spend like a drunken sailor", and its more conservative (or neo-liberal) central bank taking it into its own hands to "put an end to this madness", and crank up interest rates, or perhaps some other fiendish monetary tool (there may be some others, after all, QE was new when it first came on the scene).

    I think this may actually happen one day if Corbyn, or someone like him came to power (and had got wise to MMT in the meantime).

    1. Don't really disagree with any of that. Though I don't think a seriously spendthrift government would let its central bank stand in its way: it would just tell the CB it no longer had independence. Ultimate power always rests with politicians.


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