Friday, 14 October 2016

Merge monetary and fiscal policy?

Positive Money says the two should be merged.

Here’s why that’s a good idea (which is not to suggest Pos Money would agree with all the points below).

1. Fiscal stimulus on its own has flaws.

Fiscal stimulus on its own equals “government borrows $X and spends $X (and/or cuts taxes)”. Problem with that is that borrowing AS SUCH is deflationary. Now what’s the point of doing something deflationary when the object of the exercise is the opposite, i.e. stimulus?

Put another way, what’s the point of the state borrowing money when it can print the stuff?

And for the benefit of the Pavlov dogs who chant “inflation” whenever the words “print” and “money” appear in the same sentence, as long as the AMOUNT of money printed and spent is not excessive, i.e. as long as it’s enough to raise numbers employed, but not so much as to cause inflation, then (roll of drums) there won’t be any excess inflation.

Of course if (and it’s a big if) it makes sense to borrow so as to fund infrastructure and in that stimulus consists of more infrastructure spending, then it would make sense to borrow to fund that infrastructure via borrowing. However, rapid changes to infrastructure spending are just not feasible: first, most infrastructure projects are not shovel ready. And second, it doesn’t make sense to abandon a bridge building project when its half complete just because a recession comes to an end. Ergo infrastructure spending is not particularly suited to dealing with recessions.

As to whether it makes sense for governments to borrow to fund infrastructure, Milton Friedman and Warren Mosler thought not.

2. Some merging of monetary and fiscal stimulus is needed ANYWAY.

The extra borrowing involved in traditional fiscal stimulus probably raises interest rates which is the last thing needed when stimulus is required. Thus the central bank has to print money and buy back some of the newly issued government debt so as to keep interest rates down: i.e. at least a FINITE amount of monetary stimulus has to accompany fiscal stimulus.

3. The flaws in monetary policy on its own.

There’s a glaring flaw in implementing monetary stimulus (at least in the form of interest rate cuts) on its own: it’s that there is no reason whatever to assume a recession is caused by inadequate borrowing, lending and investment any more than there’s reason to assume it’s caused by inadequate spending on education or ice-cream.

It’s certainly true that given a recession, interest rates will probably fall, but what’s the reason for thinking interest rates will not fall of their own accord, given a recession? There’s nothing much to stop them: to illustrate, there’s been a substantial fall in interest rates over the last twenty years or so which has quite clearly NOT BEEN caused by central banks.

As for the other possible element in monetary policy, QE, much  the same goes. QE is designed to increase investment spending in riskier assets. But there are zero reasons to assume a recession is caused by inadequate investment spending.

Moreover, not even the fact that investment spending has fallen prior to a recession is proof that inadequate investment spending is the problem: that fall may have taken place for perfectly good reasons.

4. Merging monetary and fiscal is compatible with the basic purpose of the economy.

The basic purpose of the economy is to produce what people want: both what they normally buy out of their disposable income and what they want by way of publically provided goods and services which people vote for at election time. That being the case, the logical solution to a recession is to give people more of the stuff that enables them to buy stuff out of disposable income, i.e. money.

Thus one element in curing a recession should be boosting household bank balances: perhaps via tax cuts or via increased social security payments. As to publically produced goods, more should be spent on those as well, though the exact ratio of increased PRIVATE vis a vis PUBLIC spending is clearly a political choice.

Increasing those two forms of spending by simply printing new money and spending it amounts to a combination of fiscal and monetary policy.

5. Lags.

There might be an argument for concentrating on monetary policy if the lags there were shorter than in the case of fiscal policy, but that doesn’t seem to be the case.

6. Investment spending rises ANYWAY.

Those with a fetish about investment might like to know there’s nothing a bank manager likes more than a business with plenty of customers coming thru the door. I.e. raise demand generally, and increased investment will probably follow. But if businesses decide more investment is not needed on a big scale to meet the extra demand, there is no reason to think that’s any sort of problem.

7. A “merge” is close to the free market’s cure for recessions.

The above GENERAL rise in demand is what would happen in a perfectly functioning free market given a recession. That is, given a recession, wages and prices would fall, which in turn would increase the REAL value of money (base money particular). That effect is known as the Pigou effect. It would also increase the real value of the national debt, which as Martin Wolf pointed out more or less amounts to money.

In short, in a free market spending by those in possession of base money and national debt would rise which is a FAIRLY widespread rise in demand as distinct from the relatively NARROW rise in demand that takes place when interest rates are cut with a view to raising investment spending.

8. Reversibility.

Some thought must be given to whether any form of stimulus is reversible, and it might seem that reversing helicopter drops is politically difficult as it means tax increases. However, interest rate rises hit most of those with mortgages, so that’s not politically popular either. Also the UK raised the VAT sales tax a few years ago and there wasn’t even a whiff of riots.

Also, in that raising interest rates is politically easier than raising taxes, then after some helicoptering, it would always possible to assist the reversal by a temporary rise in interest rates.

9. Deciding the size of a stimulus package is a decision for experts.

Re the charge against fiscal stimulus that it depends on a collection of squabbling children sometimes known as “politicians”, Positive Money and co-authors thought of that one long ago. See here. The solution is to have ECONOMISTS, not politicians decide on the TOTAL SIZE of a stimulus package, while strictly POLITICAL decisions like what % of GDP is allocated to the public sector and how that is allocated as between education, infrastructure etc are left in the hands of politicians: easily done.

In other words converting to a system where monetary and fiscal policy are merged requires a significant re-arrangement and the responsibilities of governments and central banks, but that’s not a big problem in principle. The problem is explaining the new system to all and sundry.

Incidentally, that re-arrangement largely disposes of another criticism of fiscal policy namely that fiscal changes take a long time where they are dependent on the whim of politicians.

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