Monday, 2 March 2020

George Selgin’s book: “The Menace of Fiscal QE”.


Summary.   This book (or “essay” as Selgin calls it, since it’s shorter than the average book) basically argues against fiscal – monetary coordination (FMC), i.e. having the central bank create money with government spending it (and/or cutting taxes). Selgin’s reason is the inflationary danger.

Unfortunately, as is widely recognised nowadays with interest rates being at record lows, central banks may be right out of ammunition come another recession, in which case some sort of unconventional measure like FMC will just have to be used. But Selgin says very little on how that might work. So to that extent his work is not a useful contribution to the debate.

He does however refer briefly to a “coordinating method” advocated here, which is not set out in much detail but which seems to be roughly similar to the method Positive Money has advocated for about ten years, and which Ben Bernanke advocated a couple of years ago. But Selgin dismisses that method: he claims it still poses inflationary dangers.


There have been increased calls in recent years, as Selgin explains in detail, for direct central bank funding of various government programmes: i.e. calls for central banks to simply create money and to have government spend it.  For example there’s “People’s QE”, “Green QE” and advocates of Modern Monetary Theory tend to argue for that type of “print and spend” system, though in the case of MMT, the forms of spending envisaged are normally not limited to matters “green” or limited to anything else.

Selgin’s recently published book / essay, argues against this development because of the apparent inflationary risks: that is, he argues basically that once everyone, especially politicians, get the idea that the central bank can simply create / print money to fund popular vote winning types of public spending, there’s a danger that the printing presses will then go into over-drive with disastrous inflationary consequences.

The first problem with that argument is that in some countries, politicians have had effective control over central banks (what might be called “non independent” central banks) without disastrous inflationary consequences. The Bank of England was an example up to 1997 when it was given nominal independence. I.e. since WWII and up to 1997 UK politicians controlled the printing press. But for most of that time, inflation in the UK was not excessive. (Although having said that, I do favour independent rather than non-independent central banks.)

Second, given that central banks may be right out of ammunition come another recession, it’s pretty obvious that some sort of unconventional measure will be needed, e.g. FMC. But Selgin has little to say on how that might work. 

Indeed, the concluding chapter is so short (just over a hundred words) that I’ve reproduced it in full below just to demonstrate Selgin’s lack of concern as to how FMC might work.

But first some points on his terminology. His phrase “fiscal quantitative easing” is synonymous with FMC. Second, what he calls the “corridor system” is that system that existed before the very large increase in bank reserves that came about as a result of the 2007/8 crisis: that is, central banks influenced interest rates by keeping commercial banks short of reserves, and varying the extent to which they were short. That’s in contrast to what he calls the “floor system” which is the system in existence at the time of writing, i.e. a system that involves banks have a very large stock of reserves.

The concluding chapter runs thus.

The Fed’s post-crisis operating framework exposes it to pressure to resort to “fiscal” quantitative easing, aimed not at combating recession but at financing government programs. Should the Fed be unable to resist such pressure, or should Congress pass legislation compelling it to undertake fiscal QE, the consequences are likely to prove harmful to both the general public and the Fed itself. And although Congress might take steps to guard against such future abuse of the Fed’s quantitative easing powers, that solution is both less likely and less appealing than the alternative: which is for the Fed itself to rule out the possibility of fiscal QE by switching from its present “floor” operating framework to a symmetric corridor system.

And that’s it!

A possible coordination system.

Having said that Selgin has little to say on how coordination might work, he does refer to a system set out in a very brief and vague fashion in this article (which I dealt with yesterday on this blog).

The passage in that article which according to Selgin sets out a coordination system (which is called a “standing emergency fiscal facility” (SEFF)) runs as follows.

 “Our proposal is for an unusual coordination of fiscal and monetary policy that is limited to an unusual situation—a liquidity trap—with a predefined exit point and an explicit inflation objective. Quasi-fiscal credit easing, such as central bank purchases of private assets, could be operated by the SEFF rather than the central bank alone to separate monetary and fiscal decisions.”

But in the next paragraph, Selgin says “…what is to keep it (i.e. government) from abusing the SEFF? What guarantee is there, in other words, that the SEFF will itself remain entirely under the Fed’s control?”

Well perhaps I can answer that question with another question: what is to stop any government putting pressure, even extreme pressure on a central bank? The answer is “basically nothing”!

After all, government controls the Army, Navy, Airforce and the Police, and when push comes to shove you can’t argue with that lot. And in fact in various counties ever since central banks were first set up, politicians have tried to put pressure on central banks. Donald Trump is certainly not innocent on that count.

All we can do is agree on a set of rules on exactly how the monetary system, interest rates, the deficit and so on are to be organised and try to keep to those rules. Politicians may well trample on those rules, but in a country where there is respect for the rule of law, separation of powers and so on, any politician doing that runs the risk of unpopularity and losing the next election.

Positive Money.

Anyway, having criticised Selgin for his silence on how FMC might work, it is perhaps incumbent on me to be more positive and say how I think it should work. Well the answer is simple: I can’t improve on the system advocated by Ben Dyson (founder of Positive Money) and Andrew Jackson in their book “Modernising Money”, a system which Ben Bernanke recently said he approved of (though Bernanke didn’t specifically mention Dyson & Jackson or Positive Money).

Under the D&J system, the central bank controls not just interest rates, but also the size of the budget deficit. To be accurate, D&J say that it does not absolutely have to be the central bank which wields that control: they say it could by any independent committee of economists, but to keep things simple, let’s assume the central bank does that job.

So under that system, where interest rates had declined to near zero, and more stimulus was needed, the central bank would automatically start to think about expanding the deficit (funded by new money if the central bank thought that appropriate).

Note that the D&J system is entirely consistent with Simon Wren-Lewis’s claim, namely that when interest rates are significantly above zero, interest rate cuts should be used to impart stimulus, whereas when rates are at or near zero, fiscal stimulus should kick in.

D&J’s ideas are also consistent with the claim made by many MMTers (e.g. me) that we should have a permanent zero interest rate, i.e. that there should be no government borrowing.

A couple of obvious, but actually flawed objections can be raised to the D&J system, as follows.

1. It could be argued that D&J were arguing for full reserve banking and that their system is therefore not suitable for a conventional banking set up (fractional reserve). Well the answer to that is that the full versus fractional reserve argument is actually entirely separate from the “FMC versus no FMC” argument. I.e. the DJ system (minus full reserve) would be perfectly feasible.

2. It might be said in criticism of D&J that politicians have a right to have a say in how much stimulus we have in any given year and that the D&J system is therefore undemocratic. Well the simple answer to that is that politicians lost their say in how much stimulus there is long ago where central banks became independent!

That is, politicians can implement as much fiscal stimulus as they like, but if an independent central bank doesn’t like that, it will negate that fiscal stimulus with an interest rate hike!

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