Friday, 20 March 2020

Simon Wren-Lewis agrees with MMT to some extent.

Summary.   In the opening paragraph of a recent article, SW-L (pictured above) says “…fiscal rules should never involve targets for the debt/GDP ratio..”. MMTers will all agree with that. He also says “…public investment should not be part of a fiscal rule…”. That’s not a point that MMTers have made much of, but it’s a good point all the same. He also says “…fiscal rules should never involve targets for . . . . debt interest . . . “. That rather clashes with the MMT “permanent zero rate of interest” idea. I’m sticking to my “MMT guns” there, and argue below that MMT is right there and SW-L is wrong.

Simon Wren-Lewis (former economics prof at Oxford) makes the above points in an article entitled “Fiscal rules: a primer for the budget.”

The reason for thinking the debt/GDP ratio should never be a target is simply that attaining full employment (while keeping to the inflation target) is a vastly more important target. That’s first because minimising unemployment means maximising GDP, or maximising output per hour for the workforce as a whole. Second, there are undesirable social effects of excess unemployment.

As for the popular idea that interest on the debt will rise too much if a much larger than usual debt/GDP ratio is needed to minimise unemployment, why on Earth would government pay an elevated rate of interest on the debt? If creditors want a higher rate of interest on the debt, government should just tell them to shove off. That leaves creditors with what they regard as an excess stock of low interest yielding debt, and if that’s their view, then they’ll tend to try to spend away that excess (either on other investments or on current consumption) both of which tend to raise demand, which is precisely the object of the exercise!!

As for SW-L’s point that investment spending should not be part of the deficit, that’s correct and for the simple reason that it just isn't practical to switch on billions of dollars worth of investment projects, like infrastructure projects, come a recession, and then bring them to a grinding halt come the recovery. Indeed, that’s just an example of a more general point, namely that deficit spending should never be concentrated too much on any one area, else we get bad value for money from such spending.

A permanent zero rate of interest?

The basic argument behind the MMT permanent zero rate of interest idea is that government debt is simply base money which sundry private sector actors have loaned to government at interest. But why should people who want to hoard an excess stock of money be paid any interest for doing so, particularly as that interest is funded by taxes raised on the population in general, which includes the less well off?

Milton Friedman advocated a more or less permanent zero rate regime (i.e. a “no government borrowing” regime), though he thought government borrowing COULD BE justified in an emergency, like war time. (See under his heading “The Proposal”.)

That seems reasonable. I’d just add that another possible “emergency” is a serious outbreak of irrational exuberance, leading to excess demand. In those circumstances, having government withdraw base money from the private sector by offering attractive rates of interest on the money borrowed is clearly a useful tool to have in reserve. So a “more or less permanent zero rate” is better than a “permanent zero rate”.

So what are SW-L’s reasons for letting interest on the debt rise significantly above zero? Well they strike me as vague and complicated. In contrast the basic logic behind the MMT “more or less permanent zero rate” idea is beautifully simple and clear: to repeat, it is simply that there is no good reason to reward money hoarders with interest funded by taxes on the less well off.

A possible reason for having interest on the debt relatively high (i.e. permanently having the less well-off fund interest paid to money hoarders) is that adjusting the rate of interest may be a quicker way of adjusting demand than fiscal adjustments. Unfortunately the evidence does not support that: there is a Bank of England study which claims interest rate adjustments take a year to have their full effect.

Plus Jason Furman argues in a recent Wall Street Journal article that fiscal stimulus works relatively quickly.

The only reservation there, is that politicians can spend months quarrelling over the size of tax cuts/increases or the size of public spending cuts/increases. Well the solution to that problem is simple, and has been advocated by Positive Money for years: it’s to have some committee of economists decide the size of the deficit, while politicians retain the right to take strictly political decisions, like what proportion of GDP is allocated to public spending. That committee could perfectly well be the central bank committees which currently decide on interest rate changes at central banks. Moreover, Ben Bernanke gave a thumbs up to that sort of system recently.

E.g. the latter committee might decide that more stimulus in the form of an extra $Xbn with of deficit was needed in the next year. The committee would inform government of that decision, and hopefully government would then raise public spending by $Xbn, or cut taxes by $Xbn or some combination of the two.

Maybe government should have the right to ignore that advice from the above committee, on the grounds that in a democracy power should ultimately rest with democratically elected politicians. But any government failing to implement the advice of those experts would probably pay a penalty at the next election, especially if excess unemployment was the result of ignoring the advice. Any government which ignored the advice of medical experts in the current Corona Virus outbreak would pay a very heavy price at the next election. Plus possibly they’d have to deal with widespread riots.

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