Tuesday, 19 February 2013

Mervyn King thinks helicopter drops blur the distinction between political and economic decisions. He’s wrong.

I’m a fan of Mervyn King. But in this speech in October 2012 he made a few mistakes. He pointed out (correctly) that helicopter drops come the same thing as merging monetary and fiscal stimulus. See paragraph starting “There has been some talk….”.
However, he claimed that if fiscal decisions (traditionally the responsibility of politicians) are combined with monetary stimulus decisions (traditionally the responsibility of central banks), it follows that political considerations will then influence money printing, and second, that central banks will be able to influence political decisions, like what proportion of GDP is allocated to public spending. As he put it (I’ve put “King quotes” in green):
“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…. Excessive money creation leads to accelerating inflation and ultimately the collapse of the currency…… 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.”
Well that does not need to happen, as pointed out by Positive Money and co-authors. That is, under a “helicopter drop” regime (i.e. a regime where government and central bank simply create new money and spend it as required (and/or cut taxes)), the electorate and politicians can remain in TOTAL CONTROL of strictly political decisions, like what proportion of GDP is allocated to public spending and what the make up of that spending should be.
AT THE SAME TIME, some sort of committee of economists (something like the existing Bank of England Monetary Policy Committee would do) can decide to what stimulus is needed: that is, said committee can decide to what extent government spending should exceed government income.
Having decided that government spending should exceed government income by £X, government (if it was going to behave in a democratic manner) would allocate the £X to public spending and tax cuts according to the ratio decided by the electorate at the most recent election. But there’d be nothing to stop politicians ignoring the electorate’s wishes: those anti-democracy, lying scum bags we call “politicians” often ignore election manifestos. And they’d be free to behave in a similarly dishonest manner under the regime advocated by Positive Money and friends.

King’s third claim: stimulus reversal.
A third claim made by King was that in a merged monetary and fiscal stimulus regime it  would be more difficult to REVERSE stimulus. As he put it:
“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 the problem with King’s “reverse” point is that he admits that “print and spend” or a “helicopter drop” equals combining monetary and fiscal stimulus. Thus it is hard to see why reversing helicopter drops should be more difficult than reversing monetary and/or fiscal stimulus.

King’s fourth claim: central banks must have a stock of government debt.
As regards his claim that without a “holding of gilts”, the Bank of England would be unable to influence what he calls “monetary decisions”, that is not true. That is, even if there were no government debt, there’d be nothing to stop a central bank that wanted to cool down an overheating economy announcing that it was prepared to borrow at above the going rate of interest.
That ploy might not he legal under the prevailing legislation in some countries, but that’s a minor technical or legal point that can be changed.
As to where a central bank would get the money from to pay interest  for the latter “cooling off” ploy, that is no problem. First, central banks can print money. Second, interest is not normally paid till twelve months after governments or central banks initially borrow. And third, the latter twelve month period probably gives time for the above mentioned MPC type committee to tell government it’s got to raise taxes and/or cut spending so as to raise the funds with which to pay the above mentioned interest.

Is monetary policy compatible with helicopter drops?
The latter points might seem illogical in that if the purpose of this post is advocate combining monetary and fiscal policy, why is monetary policy ALONE being considered? Well, the first purpose is to rebut King’s claim that central banks must have a stock of government debt.
Second, if a country adopts helicopter drops as its main weapon, that does not necessarily rule out monetary policy or interest rate changes as a secondary weapon to be used in emergencies.

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