Wednesday, 25 April 2018

Having the central bank decide the size of the deficit is “undemocratic”?

Richard Murphy claims it would be "undemocratic" for the central bank to control the size of the budget deficit. See the two paras starting "In other words..." in Murphy’s article entitled “IPPR’s new macroeconomic report: in need of revision.” (Incidentally Ann Pettifor makes the same “undemocratic” claim.) That "undemocratic" claim by Murphy does not actually stand inspection and for the following reasons.

It would be perfectly feasible, and arguably desirable, to have an arrangement under which the central bank (CB) controls not just interest rates, but also the size of the budget deficit. That arrangement is actually advocated in a recent IPPR work which Murphy considers in his article. It is also advocated by Positive Money.

An ever popular argument against that arrangement is that since under existing arrangements, it’s the finance minister / treasury / politicians (FTP) that control the size of the deficit, and since politicians are democratically elected, ergo the above “CB controls the deficit” must be less democratic. That’s actually false logic, and for the following reasons.

Politicians have two motives for expanding the deficit, one of which is totally unacceptable: that’s the desire to ingratiate themselves with voters by funding public spending via borrowing so as to get future generations to foot some of the bill for today’s spending. Trump is doing that right now.

Another motive (an entirely acceptable one) is to bring about stimulus. But there’s a problem there, namely that independent CBs (or at least NOMINALLY independent CBs) have the power to override the latter stimulatory effect via interest rate rises. Thus the alleged “democratic” right that politicians have to boost stimulus is one big illusion!!!

To summarize, the whole idea that FTP has any sort of useful “democratic” right deriving from the right to determine the size of the deficit lies in ruins: i.e. when that right is exercised, either its motivated by a desire to rob the next generation, or it’s a futile attempt to boost stimulus, given that the CB has the final say on stimulus.

Ergo, having the CB decide the size of the deficit, rather than FTP doing so, has no effect on “democratic” rights. In particular, note that having the CB decide the size of the deficit most certainly does not take away from politicians the right to decide what proportion of GDP is allocated to public spending, or how that is allocated as between education, defence and so on. It is only the DIFFERENCE between total government income (from tax) and government spending that the CB controls.

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