Thursday, 22 March 2018
Pure monetary policy does not make sense, and nor does pure fiscal policy.
By “pure monetary” policy, I mean adjusting interest rates. The problem there is (strange to relate) that interest rates have to be kept artificially high for that to work, which results in mortgagors paying an artificially high rate of interest year after year. Reasons are thus.
There is no good reason for government (i.e. taxpayers) to pay interest to anyone simply for hoarding the state’s liabilities (i.e. hoarding base money). That is, as Milton Friedman and Warren Mosler explained, interest on the national debt should ideally be zero.
National debt and base money are virtually the same thing as Martin Wolf, chief economics correspondent at the Financial Times explained. Thus anyone holding national debt essentially has a term account with a bank called “the state” (i.e. government and central bank) which pays interest.
Thus for the state to be able to cut interest rates come a recession, interest on the debt has to be kept at an artificially high level (assuming negative interest rates are not an option, and certainly negative rates do pose problems).
In addition to mortgagors paying an artificially high rate of interest, it is widely accepted in economics that GDP is maximised when prices are at their free market level, unless there are very specific reasons for thinking market forces have got it wrong in some way. And in this case (i.e. in the case of interest rates) I see no reason for thinking that the free market rate of interest isn't the optimum or “GDP maximising” rate.
Conclusion so far: pure monetary policy does not make sense, though (like Milton Friedman) I wouldn’t rule out interest rate adjustments in an emergency.
As to pure fiscal policy, I define that as: “government borrows $X, spends $X (and/or cuts taxes) and gives $X worth of bonds to those it has borrowed from.
Now the problem with that is that while spending the latter money is stimulatory, borrowing money has the opposite effect: it is “anti-stimulatory” or “deflationary” to use another term. But what’s the point of doing something anti-stimulatory when the object of the exercise is stimulus? It’s pointless.
Indeed, when governments do implement “borrow and spend”, the central bank has to make sure that additional borrowing does not raise interest rates: indeed the central bank is quite likely to actually cut interest rates, assuming government is right to think the economy is not at capacity, and hence that some “borrow and spend” is justified. But how do central banks implement that interest rate reducing effect? Well they print money and buy back government debt! But that’s monetary policy!
So why not cut all the complexity there and simply print money and spend it (and/or cut taxes) when stimulus is needed. As just explained, that’s more or less what happens anyway, but in a roundabout and unnecessarily complicated way. Or put another way, monetary policy in the form of interest rate adjustments do not make sense, and fiscal policy doesn’t work propertly without the assistance of monetary policy.
The only problem with the latter novel “print and spend” way of imparting stimulus, is that many people would object to politicians getting too near the money printing press. Well actually they can quite easily be kept away: it wouldn’t be difficult to set up a system where politicians keep control of strictly political decisions, like what proportion of GDP goes to public spending, while some committee of economists (perhaps at the central bank) decides on the size of the deficit or surplus.
Bernanke actually gave his approval to such an arrangement. See para starting “A possible arrangement…” halfway down here. The title of the article is "Here's How Ben Bernanke's "Helicopter Money" Plan Might Work."