Wednesday, 8 March 2017

Should the Bank of England control fiscal stimulus?

Simon Wren-Lewis says yes – see the 3rd para of his article entitled “Budget Day Nonsense”. However he only seems to advocate that for when interest rates are low.

Now why not implement that policy even when interest rates are high? Positive Money, the New Economics Foundation and Richard Werner advocated the latter policy in their joint submission to Vickers. The answer SW-L would give, I’m pretty sure, is that when interest rates are high, the state can control aggregate demand by adjusting interest rates. I prefer the phrase “interfere with interest rates”.

Reason I say “interfere” is that the traditional way of raising rates is to have the central bank sell government debt with a view to rendering commercial banks short of reserves. But that is an ENTIRELY ARTIFICIAL interference with the free market: reason is that money the state borrows or appears to borrow as part of that exercise is not actually used for anything: it isn't invested in infrastructure for example. I.e. the sole purpose is to raise interest rates.

And presumably GDP is maximised where interest rates are at their free market level: i.e. where the state DOES NOT interfere with interest rates.

You could of course argue that fiscal stimulus is also an artificial interference. My answer is that it is not because money financed fiscal stimulus simply amounts to implementing the mechanism that the free market, if it was allowed to operate, would implement in a recession.

That is, in a totally free market and given a recession, prices and wages would fall, which would increase the real value of base money (and indeed the real value of government debt, which as Martin Wolf and Warren Mosler pointed out is pretty much the same thing as base money). And that increase in the real value of private sector paper assets would stimulate spending, which would cure the recession. 

But of course employees (understandably) put up extreme resistance to having their wages cut (even where as a result of falling prices they suffer no loss of real income). So the free market’s cure for recessions does not work.

However, an equally good cure is for the state to artificially boost the supply of the above paper assets, as I seem to remember Keynes pointed out, though I can’t remember where.


P.S. (9th March, 2016). Re the final paragraph just above, Keynes points out in Ch 19 of his General Theory that a decline in money wages comes to the same thing in various respects as a rise in the money supply. However, he does not seem to understand the crucial importance of what Pigou called "real balances". To quote from Wikipedia's article entitled "Pigou effect" (for what that's worth), "Real wealth was defined by Arthur Cecil Pigou as the sum of the money supply and government bonds divided by the price level. He argued that Keynes' General Theory was deficient in not specifying a link from "real balances" to current consumption and that the inclusion of such a "wealth effect" would make the economy more 'self correcting' to drops in aggregate demand than Keynes predicted."

The term "real wealth" there is not a good one, since obviously there are forms of real wealth other than bank balances etc (e.g. cars, houses, etc). I.e. that sentence from Wiki could be better phrased, e.g. as: "What the private sector perceives as its sock of real wealth includes the sum of the money supply and government bonds." But even that is not quite right because base money is a NET ASSET as seen by the private sector, whereas private bank created money is not. I'll leave it to the reader to formulate EXACTLY the right phraseology to replace Wiki phraseology, if the reader wants to do that.

Note that MMTers get all the above stuff SPOT ON. That is, MMTers for example get the distinction between base money (i.e. central bank created money) and private bank created money.  

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