Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 17 September 2015

Central Bank Independence and MMT

This is a follow up to my last post on Corbyn and central bank independence (CBI). No apologies for returning to this topic: not often do you get to talk about policies that are in the process of being formulated. One of the influences that is said to be important for John McDonnell (the new shadow Chancellor) and his advisors is Modern Monetary Theory (MMT).

A comment I sometimes get on my posts is that my arguments are similar to those put forward by followers of MMT. I have not read much MMT literature, but in what I have read I have normally not found anything I take great exception to. On some issues, like the way monetary policy continues to be presented in textbooks, they definitely have good reason to complain about the mainstream. However their account of the way monetary and fiscal policy work seems quite a close match to what many mainstream economists think, which I guess is why my arguments can be similar to theirs.

One area of apparent difference, however, is CBI. You will sometimes hear MMT people talk about CBI being a ‘sham’, whereas mainstream macro attaches great importance to CBI. So which is right? Part of the problem here is that CBI in the UK (where the government decides the goal the Bank has to achieve) is rather different from that in the US (where the Fed has much more discretion over the choice of targets) and the Eurozone (where the ECB is largely unaccountable and has huge power). I’m just going to talk about the UK set up. (For a MMT perspective on the US, see here.)

CBI in the UK, established by Gordon Brown and Ed Balls in 1997, is no sham. The Monetary Policy Committee (MPC) decides when and by how much to change interest rates, and government has no influence on the MPC. How do I know this? From observation and from a huge number of conversations with MPC members. Since 2009 the MPC has decided when and by how much to do QE. Any Treasury authorisation to do QE was a formalisation that essentially followed Bank wishes, but it never specified when and how much QE should happen. So a fair description of the UK set up is that the government defines the goals and instruments of policy, and the MPC decides how to use those instruments to best meet those goals.

I would agree with the comment that this set up leaves the government taking big strategic decisions, like what the target should be. But CBI as defined in the UK still has two major advantages over the pre-1997 alternative

  1. party political motives for changing interest rates are ruled out. I know such motives influenced at least the timing of rate changes before 1997. (How do I know - same answer as before.)

  2. it forces governments to be explicit about their goals, and the relative priorities among these. I personally believe this has an important role in conditioning (but not determining) expectations, which is very useful. (Yes you can call me a New Keynesian for this reason.)

You could add time inconsistency and credibility issues in there as well if you like. (Giving this to secondary importance perhaps makes me less of a New Keynesian.)

Are there any negatives to set against this? One argument you often hear is that CBI is anti-democratic, but I really think this is just nonsense in the UK context. Government delegates technical decisions all the time, and as long as there is strong accountability (which in the UK there is), the right people are on the MPC and they are truly independent (from government or the financial sector) this works well. When governments only face elections every 5 years and elections are won or lost over a whole range of issues, quite why a Chancellor deciding when to change rates following secret advice is more democratic is unclear. It also improves democracy because, as Chris points out, the Chancellor is not held to account for the technical mistakes of his advisors.

A more important argument against CBI is that it makes money financed fiscal expansion much more difficult. A government that is obsessed by the size of its deficit might not undertake a bond financed fiscal expansion when a fiscal expansion is needed. It might have undertaken a money financed fiscal expansion, but CBI prevents it doing this because the central bank controls money creation. However this problem can be easily avoided by (a) taking a more sensible view of government deficits and debt, as MMT would also advocate, or (b) allowing helicopter money.

It is (a) that makes the debate over Corbyn’s QE particularly ironic. A National Investment Bank can be set up perfectly well based on borrowing from the market, and you can ensure it gets the funds it needs by a government guarantee. The only reason you would avoid trying to do that is because the NIB debt would count as part of the government’s deficit, and you were worried about the size of the deficit. The last people who should be worried in this way are followers of MMT.

Scott Fullwiler has an elaborate discussion of why Corbyn’s QE does not interfere with CBI, but concludes: “As such, government guaranteed debt of the NIB would be effectively the same thing as plain vanilla deficits, which as shown above is not different in a macroeconomically significant way from Overt Monetary Financing of Government via People's QE.” Which begs the question, why not go with plain vanilla deficits to fund the NIB. If it is because you are worried about the political costs of higher deficits, that will be as nothing compared to the political costs of instructing the Bank to finance a NIB.

So where does this apparent antagonism for CBI come from? Perhaps it comes from a tendency of some from the mainstream to make too much of CBI. To imply that the more independent a central bank is the better, regardless of who determines goals, whether there is accountability and who makes the decisions. Proof that independence is not all that matters is provided by the ECB. But we should not let the bad drive out the good. If Labour abandons the innovations made by Brown and Balls, I think it will be a classic example of the triumph of ideology over both good economics and self interest. 

116 comments:

  1. I realise I am a bit out of the mainstream of how economics is studied and taught these days but I am really at a loss to understand just why an administrative function/procedure has taken on such incredible importance in economic policy and theory.

    Surely, as has been pointed out many times in comments on earlier posts, the formal institutional structure is of far less importance than the socio-political environment of the people making the decisions. Whether the people deciding on interest rate rises or falls are advising the Chancellor or advising the MPC makes very little difference in the long run.

    Yes, in the past interest rate changes might have been linked to political exigencies. Does anyone really think that they aren't now? Just look at the change when Draghi took over the ECB and announced he would do "Whatever it takes" to save the euro, or the interventions Mervyn King made before the 2010 election (which may well have been drafted by Osborne's advisers).

    The whole concept of CBI is based on the idea that governments - specifically democratic governments - will tend to debauch currencies. This derives, I suppose, from Hayek but I think you would have to go a very long way back to find any (negative) correlation between the level of democracy in a government and the strength of the currency.

    So I would prefer to see the debate return to the more positive grounds of which policies are likely to benefit the economy and the people who make up the economy, rather than the normative grounds of what particular administrative structure might lead to what outcomes. But each to his own.

    ReplyDelete
    Replies
    1. I don’t think anyone suggests that UK Chancellors would “debauch” the currency, given the chance. But I just don’t believe chancellors can resist the temptation to implement A BIT OF stimulus before elections. Plus the foreign exchange market puts a higher value on currencies where the CB controls interest rates than where it doesn’t all else equal, and that benefits living standards in the relevant country. So all in all, I favour CBI. But I take your point, that it wouldn’t be a disaster if CBI was scrubbed.

      Delete
  2. Hi Simon. When a Govt reflects the neo-liberal economic consensus (which covers the whole era of BoE independence) it's pretty impossible to tell if the independence is real - the aims of the BoE are in tune with the aims of the financial sector of the economy which are in tune with the aims of the govt - they're really only gonna disagree at the margin anyhow. It might look independent, but as David's already stated, it's the same folk.
    The BoE has certainly not yet pursued any policies that favoured 'main street' over 'Wall St', so there's clearly some shared belief systems.

    However, imagine a govt which deviated from that consensus - how much the BoE would pursue goals opposed to that govt, or in step with that govt would allow us to make a better judgement.
    As ever - a longer timescale is needed.

    ReplyDelete
    Replies
    1. Also - are we talking MPC independence only? the BoE & HMT already collaborated on Funding for Lending, so it's not unusual already for Govt policy to dictate monetary policy.

      Delete
    2. Forgive me for being blunt, but this kind of woolly thinking gives your perspective a bad name. The MPC moves instruments to hit a target set by government. What is neoliberal about that!?

      Delete
  3. The best argument I have heard for an independent Bank of England is John McDonnell.

    Hardly surprising then that he and his friends oppose it.

    ReplyDelete
  4. "A National Investment Bank can be set up perfectly well based on borrowing from the market, and you can ensure it gets the funds it needs by a government guarantee. The only reason you would avoid trying to do that is because the NIB debt would count as part of the government’s deficit, and you were worried about the size of the deficit."

    Richard Murphy has claimed several times that QE funding of infrastructure investment would cost less than funding it via bonds; e.g., his sixth claim about QE here. He also says in the same post that "the idea that the BoE had operational control of this policy [i.e., their QE] cannot be supported by any evidence" and links to a 2009 letter from the Treasury to the BoE. The difference between you seems to be party terminological (what counts as setting out a framework versus what counts as operation control -- when and how much to buy), but only partly.

    ReplyDelete
    Replies
    1. In thinking about funding an NIB, it is best to think about the government and central bank as a consolidated sector. (All profits by the Bank go to the government.) If you do that, making funding for the NIB cheaper just makes something else the government spends its money on more expensive. On CBI, the facts are clear.

      Delete
  5. Here is Carney criticising People's QE at yesterday's Treasury select committee

    http://www.telegraph.co.uk/news/politics/Jeremy_Corbyn/11870215/Jeremy-Corbyns-policies-will-hurt-economy-Mark-Carney-suggests.html

    Supporters of CBI need to face up to the democratic trade off (always denied y S W-L).

    People like McDonnell and Murphy are right that independent central banks are in conflict with democratic accountability (although they always undermine this by then saying they aren't really independent anyway).

    the question is whether we think that the economic upsides of handing over monetary policy to technocrats with credibility outweighs this loss of democratic accountability.

    Unsurprising that the Bennite left now in position as leader and shadow chancellor of the Labour party think that it is not. More democracy (which they think will further the leftist populist agenda they espouse) has always been their mantra.

    ReplyDelete
  6. Simon,

    I think you undersell CBI quite significantly.

    Specifically you might add competency as another reason for delegation.

    Understanding transmission mechanisms - how QE and indeed interest rate changes affect growth, inflation and unemployment, in different contexts - is difficult. Why is it better to have someone elected but innumerate making these decisions rather than people who have spent their lives endeavoring to understand these processes? (Indeed, people who are still held to account in terms of whether they achieve the government's stated objectives.)

    Moreover politicians will indeed inevitably be partisan - not least because of redistribution between (rich) lenders to (poor) borrowers. For doves and hawks read left and right. Why should we pay a price in terms of adverse macroeconomic outcomes to indulge these preferences?

    As you say delegation is a fact of life all over the public sector. The minister for transport does not decide where to put traffic lights. The minister for health does not perform heart surgery. The Home Secretary does not sentence criminals.

    What is the common denominator? Comparative Advantage. I do not see that John McDonnell or George Osborne have this either.

    ReplyDelete
    Replies
    1. "Understanding transmission mechanisms - how QE and indeed interest rate changes affect growth, inflation and unemployment, in different contexts - is difficult. "

      Arguably, the BoE did not understand the transmission mechanism either. And still does not. Just because they are the "experts" does not mean they are right.

      Delete
    2. Mark Carney, George Osborne or John McDonnell. Who would you prefer?

      Delete
    3. «Moreover politicians will indeed inevitably be partisan - not least because of redistribution between (rich) lenders to (poor) borrowers. For doves and hawks read left and right. Why should we pay a price in terms of adverse macroeconomic outcomes to indulge these preferences?»

      That's stunningly old-fashioned thinking. The biggest borrowers are rich (not necessarily *net* rich), like the City and the South East property owners. They are rich thanks to speculative trading on margin, where the government, of any party, makes them whole again if the collateral used for margin goes down.

      As someone above was noting, when there is a an "establishment" consensus, based in large part on what voters in South East marginals want, nominally independent entities like parties, government, bank of England, the City interests, all move together in much the same way.

      There has been for decades an "establishment" consensus (for example as described by SR Waldan: www.interfluidity.com/v2/213.html a bit euphemistically) that wage increases are "inflation", and boosted profits and capital gains are not "inflation". Indeed the "independent" bank is given a target that in practice is for keeping down wage increases, while the government of either party inflates asset prices and financial profits with great determination while the bank looks on "independently". Because the bank cannot be the opposition.

      In effect the central bank's "independence" boils down to this: the "establishment" has given them the option to sound the alarm and trigger the wrath of the bond market vigilantes if the government of the day steps out of the establishment consensus that wages are inflationary and profits and capital gains are not inflationary.

      As to the difference in technical competence between ministers and central bankers I would think it does not matter a lot because:

      * Ministers can always seek the advice and/or delegate to central bankers. But it is the treasury civil servants are not so eager to do that because they always know best. To some extent "independence" means that the bank of England is independent of the treasury civil servants rather than of the government.

      * Central bankers understand "mechanisms" well when they are trivial, and not at all when they are not trivial. The state of the art in understand the effect of economic policy is not that good, and when there are reasons to believe it to be good it is usually obsolete.

      * Anyhow a lot of the non-understanding of the "mechanisms" is due to the Upton Sinclair principle that "It is difficult to get a man to understand something, when his salary depends on his not understanding it" in the sense that the understanding that goes against the "establishment" consensus leads to career termination. Thus all the central bankers who presumably understood well the inevitable effects of the debt-collateral spiral, and kept really quiet about it.

      Delete
  7. Any economist, please look at this statement from Mr Carney yesterday from the Daily Telegraph.. Is this in any way an INDPENDENT assessment of the implications of inflation?

    "Mr Carney said: “The issue would be imperilling potentially the achievement of price stability. The consequence of that of course would be inflationary.
    “The people who tend to get hurt the most by inflation are the poor, the elderly, those that can’t hedge themselves – that’s been the experience throughout history and I’m sure that will be the experience in the future if the Bank of England were not to conduct policy not consistent with achieving its mandate from parliament.”"

    This is a completely political point, as the only sector of the economy which really loses out with inflation are the holders of fixed interest investments. Other sectors (especially the poor elderly) are completely protected under inflation linked increases by the government to welfare payments or index-linked pensions.

    But the main holders of fixed income securities are the rich, so they are the ones who will lose out. But Carney spins it the other way.

    Further, there is absolutely no automatic conclusion that PQE leads to inflation. Carney should say under which condition PQE will lead to inflation, and compare it to other government actions, such as deficit financing through increasing government borrowing. As Scott Fullwiler did, and it looks like Simon Wren-Lewis agrees with him. Both deficit financing and PQE are equally inflationary. Under the assumptions which Scott Fullwiler made.

    So the governor of the BoE is talking nonsense about inflation, and gives the impression that PQE is dangerous.

    The Bank of England Governor Carney also does not mention that the previous QE was not inflationary (CPI inflatin) and it mainly helped the rich. The outcome of QE was the same as a fiscal policy to help the rich.

    Why is that not addressed by anybody defending BoE independence, the role that QE had in making the rich richer?

    Just imagine we had BoE independence, when the next financial crisis hits. And a Labour government was in power.

    Then, let us say that the independent MPC would again recommend QE as a way of avoiding deflationary impact of crisis. What do you think a Labour led government should do? Just sit back and let QE happen again, an increase of bond and share prices which will make the rich richer? Again?

    Or should there be some political oversight to say. hang on a minute, we have a better way, and that is called PQE??

    So the role of the BoE should be subject to an independent review, at the very least, if it is not automatically abolished. To pretend that the BoE is not political, given the statements by Carney, is not reflecting reality.







    "Mr Carney said: “The issue would be imperilling potentially the achievement of price stability. The consequence of that of course would be inflationary.
    “The people who tend to get hurt the most by inflation are the poor, the elderly, those that can’t hedge themselves – that’s been the experience throughout history and I’m sure that will be the experience in the future if the Bank of England were not to conduct policy not consistent with achieving its mandate from parliament.”"

    ReplyDelete
    Replies
    1. I agree Carney went further than he should (maybe he felt this was the only way he could talk directly to Corbyn/McDonnell before commitments were made, but in political terms it looks bad), just as King did in 2010. But this is about getting the right person to be governor, unless you want to argue that anyone in that position will somehow become corrupted.

      Delete
    2. If governors speak, they always have some political message. Because we are all political in one way or another. It is natural that Carney will defend the importance of his organisation. If there is even a perceived threat to the power, through PQE, he will do all he can to avoid that threat. For all I know Carney might even believe what he said about inflation, because that makes his organisation look like it protects the elderly and the poor. That is good and important spin. When it could be argued that exactly the opposite is the case.

      At the end, the Bank of England governor will always be some ultra-conservative guy with some banking/economics background, so that is the world-view they represent. The things Carney said will be the things every BoE governor will say, 90% of the time.

      It is up to the Treasury Committee where he gives evidence, to question his assumptions, if they feel he is talking nonsense. Maybe they done that and it is just not reported in the Telegraph.

      Delete
    3. So you think John McDonnell if he became Chancellor would appoint some ultra-conservative guy? I suspect in the UK and US central bank governors when they are appointed are more reflections of the current economic and political climate.

      Delete
    4. You said in the article above that CBI was to prevent the BoE (really you talked exclusively of the MPC) from being subject to prevailing political winds. You seem to be chasing your tail on this issue and that leads me to conclude that you are wrong on CBI. I suspected it when you said that your arguments relied on private conversations you had with MPC members and the difficulty there appears to be in maintaining a clear argument appears to confirm this.

      Delete
    5. Doesn't the point about supposed comparative advantage entail that eligible candidates will have been successful bankers for 30 years or so? Throughout that time ongoing and complementary processes of acculturation and selection are at work which means it's predictable that anyone with such a career behind them will have exactly such attitudes. That's the problem - banking is not just a technical field like any other; it's thoroughly politicised (and I'd say inherently or anyway inevitably so).

      Delete
    6. Or you might say 'ideological'.

      Delete
  8. I've also heard that CBI is thought by some to be an obstacle to "functional finance" (ie the government being relaxed about deficit spending). I think that that comes from the mistaken idea that with big deficits and government debts, the bond market would go on a lending strike and refuse to buy treasury debt at anything other than an exhobitant yield. Supposedly only a non-independent CB would step in and do QE to keep a check on treasury bond yields. I think that that is a somewhat bogus argument because with just one government treasury for the currency, the market has a choice of either holding cash or holding treasury debt. Why would they refuse to hold treasury debt if the alternative also is in the same currency and doesn't pay much interest -especially if there was convincing forward guidance that cash rates would stay low for a good while?
    Basically the problem with the euro boils down to there being say German treasury bonds competing with say Greek treasury bonds rather than there just being one treasury for the Euro. It's bogus to say that CBI in the UK gives any similarity to Greece but as you say both those wanting and not wanting deficits mistakenly think it does.

    ReplyDelete
  9. 'A more important argument against CBI is that it makes money financed fiscal expansion much more difficult.'

    Why? However many bonds HM Treasury issues, doesn't the BoE need to buy enough of them to keep the rate on Treasury debt in line with its own target Bank Rate? Fullwiler argues this in the US context here (Section 5: 'Interest rates on government debt are monetary phenomena'): http://www.cfeps.org/pubs/wp-pdf/WP53-Fullwiler.pdf

    Isn't it the same in the UK? And isn't having HM Treasury issue bonds onto the open market that then get immediately bought by the BoE operationally the same as monetary financed fiscal expansion?

    ReplyDelete
    Replies
    1. Not if the Bank says their purchases are temporary, and the government obsesses about their current debt (which includes debt held by the Bank)

      Delete
    2. Thanks for replying.

      The Bank can *say* the purchases are temporary, but since it's locked into making purchases necessary to sustain its rate, wouldn't it effectively just be saying its interest rate policy is temporary? We already knew that, and it's just as true with overt monetary financing.

      Also the government could just as easily obsess about a deficit funded by overt monetary financing (the bogeyman might be inflation rather than default, but the panic could be the same).

      Delete
    3. Agreed. If it take a rational long term view, and stick to inflation targets, it makes no difference. So to make sense of what is going on, it is best to recognise that those future inflation targets are not secure, and look at how different institutional arrangements influence that security.

      Delete
  10. Good article by SW-L as usual. My only quibble is his suggestion that MMTers tend to complain about the undemocratic nature of CBI. Obviously Bill Mitchell (linked to by SW-L above) complains. Another vociferous MMTer who constantly complains on that score is Neil Wilson.

    However, I’ve exchanged hundreds of messages with MMTers over the last three or four years and don’t know of any others who are bothered about CBI.

    ReplyDelete
    Replies
    1. That's useful to know, and reassuring.

      Delete
    2. It's also wrong.

      Richard Murphy dislikes CBI for example. The majority of the MMT people I talk to consider the central bank to be a department of government - as it should be. A subsidiary.

      Ralph has a history of misinterpreting things to fit a priori beliefs. We get the same thing with the Job Guarantee.

      Delete
    3. Is MMT suddenly a dogma? You cannot just choose to categorise the CB as u please, or conflate normative and positive statements. If the ECB is a 'department' or 'subsidiary' of government you are inhabiting another planet.

      Delete
  11. Isn't it true that the UK inflated away much of the WWII debt during a period with treasury borrowing rates pegged at below inflation at a time when there wasn't CBI and perhaps if there had been, then we wouldn't have had those low interest rates and perhaps wouldn't have had such a favourable economic result?
    Although even with CBI, we would never face a Greece style crisis, with a depression and high treasury borrowing rates, perhaps CBI would preclude keeping interest rates low enough for the government to conduct lots of deficit spending with an increasing share going to wages and a profound shift in currency exchange rates. If Corbyn gets democratically elected to do that and the monetary policy commitee thinks we need 5% interest rates for price stability but the government considers that price stability isn't a priority and so we need 1% interest rates, then perhaps that conflict means we can't have CBI?

    ReplyDelete
    Replies
    1. No. The government decides the target. That lack of 'goal independence' is what makes the UK set up in my view much better than elsewhere.

      Delete
    2. Thanks for the clarification. In practice would the MPC go along with having their mandate changed to providing ample fiscal space for public purpose despite any implications for price stability? I suppose some MPC members might resign and then be replaced. Would they be ousted if they refused to switch mandate away from an inflation target?

      Delete
  12. What would be nice is a clear explanation about how central banks do accounting.

    When central banks did QE was that added to their governments' budget deficit? Why would a People's QE have to be different? What about a helicopter drop?

    Instead of threatening the central bank's independence, couldn't Labour just install a governor who agrees with them about monetary policy? Then replace him if he causes trouble as Nixon did with Burns.

    Like I would replace Carney on day one if I were Corbyn.

    ReplyDelete
  13. Krugman blogs with his reply to MMT, in reverse order.

    1. April 28, 2013 'Monetarism Falls Short (Somewhat Wonkish)'

    2. March 19, 2013, 'Misunderstanding IS-LM (Wonkish and Unimportant)'

    3. March 27, 2012 'Minsky and Methodology (Wonkish)'

    4. August 26, 2011 'Academic Debate, Real Consequences (Wonkish)'

    5. April 21, 2011 'What Are Taxes For?'

    6. March 26, 2011 'A Further Note On Deficits and the Printing Press'

    7. March 25, 2011 'Deficits and the Printing Press (Somewhat Wonkish)'




    ReplyDelete
  14. I still don't follow why CBI is a good thing. The plane would be better controlled by one pilot. We don't want those in charge of monetary policy to be fighting what a different group in charge of fiscal policy are trying to achieve.

    In the 00s we saw fiscal policy largely kept too tight, so the CBs (on both sides of the Atlantic) compensated by running a too relaxed monetary policy. Or, I suppose, we could argue that it was the other way around. It doesn't really matter -the control over the economy was not optimal as the crash of 2008 showed.

    ReplyDelete
    Replies
    1. In the UK, the government sets the target, and can change it at any time. So there was no fighting going on in the UK. A better analogy is that you do not want the air steward to also fly the plane.

      Delete
    2. It is an interesting thought-experiment to consider the reaction of the MPC if a government were to raise the inflation target to a much higher level. Say 8%. I suspect that Carney and half the MPC would lobby furiously against the change, and resign if it went hrough.
      (Note that in the Carney quote above, he equated meeting an inflation target and price stability. Most peoples' understanding of price stability is zero inflation.) Almar.

      Delete
  15. Thanks for engaging on this matter with this very fine post!

    The point of my post wasn't to take a position on CBI as much as to investigate whether the arguments of critics of PQE regarding CBI were correct. As you note, I concluded they were not. I will just say on the MMT view that I think it's quite a bit more eclectic and nuanced than a simple "for" or "against," and as Ralph noted above we might not all agree with each other on where we stand on the spectrum between those two, within some limits.

    Regarding plain vanilla deficits (PVD) and PQE--yes, my point was they are not different operationally. The original title of the post at NEP (subsequently changed by Yves at NC) was "Corbynomics 101--It's the Deficit Stupid!" ("stupid" here was a play on the 1992 US election, btw; I wasn't suggesting anyone was stupid). The point there being that the deficit is the point operationally, not whether you do it via PQE or PVD.

    I then suggested--which Richard Murphy agreed with on his blog--that the point of PQE was to reframe the discussion about fiscal policy and alternative approaches to stimulus. One can certainly debate whether or not this particular strategy will be successful, but given the politics of deficits at the moment alternative memes are definitely needed.

    Best,
    Scott Fullwiler

    ReplyDelete
    Replies
    1. The main reason for not doing PVD covered by Gilts is the simple one - why pay interest to third parties when you don't have to?

      It is just corporate welfare paid out for no benefit. It's not as if the Sterling can go anywhere else. The only other options available are spend it (which increases taxation), or leave it on deposit transitively at the Bank of England.

      Taxation does the withdrawal via the auto-stabilisers.

      Delete
    2. Funding with zero interest t-bills (or even negative interest t-bills as some countries have had) also wouldn't entail the government paying interest. Financing with t-bills rather than with base money might have the advantage that if, in the future, for whatever reason, interest rates were wished to be raised above zero, then it would be a very simple matter to do so. A vast excess of base money might make it less straightforward to raise base rates in the future.

      Delete
    3. It's always straightforward to raise rates even with vast excess base money---raise IOR to the desired target rate, do RRPs, issue CB time deposits. Yes, debt service is higher, but it will be also for deficits run at that time. And you can't sell Tbills more than a few bps below the CBs target rate, so your scenario only works for as long as the CBs target rate is at the same level or near where you are trying to sell the Tbills.

      Delete
    4. I totally agree that t-bill financing would only be at zero interest if the target rate was also at zero.
      I'm interested that it is so easy to raise rates even when there is a vast excess of base money. Wouldn't there need to be some novel funding arrangement? Wouldn't that create some political complication?
      It just seems to me that it is perfectly possible to have just enough but no more base money to keep interest rates at zero and then use t-bill financing at zero interest. That would then mean that raising rates would require no novel accounting or funding mechanisms for the central bank. By contrast money financed deficit spending would mean that future interest rate rises could require novel funding and accounting mechanisms from the central bank.

      Delete
    5. Neil, I agree if we can avoid paying interest on gilts we should do so. But the potential interest on commercial bank reserves held at the BoE also worries me. With Bank Rate at 0.5% this is far lower today than would be paid on the assets bought by the BoE if these were held on the market. But it still amounts to £1.6bn pa and will rise rapidly as rates do.

      So I'd like to see some thought given to alternative means of managing interest rates and aggregate demand.

      Delete
    6. STF: thanks for contributing. I fear PQE has done the complete opposite of reframe the debate about deficits. It appears to be accepting the deficit constraint, and saying we can print money instead. That just plays into the hands of those opposed to additional investment spending because they can say it will be inflationary, even if its not.

      Delete
    7. "It appears to be accepting the deficit constraint, and saying we can print money instead."
      I think the idea is to show "money printing" is no different from "borrowing."
      There is irrational fear of "money printing" in econ.
      I do think Corbyn is helping reframe the debate about deficits though, although they are going about it wrongly.
      In the US for example if President Sanders mints a 100 trillion dollar coin and pays off the entire nat debt and there is no inflation? People will stop worrying about it and question how things work.

      Delete
  16. "Which begs the question, why not go with plain vanilla deficits to fund the NIB. If it is because you are worried about the political costs of higher deficits, that will be as nothing compared to the political costs of instructing the Bank to finance a NIB."
    IMV (I am MMTer and don't support PQE)
    1.There is no reason to pay gilt interest, it is corporate welfare, about half of which goes to foreigners.
    2. It shows the govt is not dependent at all on bond markets. The govt just borrows back money it previously spent.

    ReplyDelete
    Replies
    1. 1. If all government debt was converted to money when we are not at the ZLB, interest rates would fall and inflation would rise.
      2. Mainstream macro shows that the government is not dependent on the bond markets unless it becomes optimal for the government to default.

      Delete
    2. 1. Interest rates would fall but it would not necessarily result in inflation. The effects of monetary policy are mixed.
      2. When is "optimal"? Is Japan optimal? I think this is the main sticking point between MMT and Mainstream macro. Nat debt is savings, so you will ban financial savings if it gets too large?

      Delete
    3. I would say 1. is actually the key difference. Is a belief that higher interest rates are as likely to increase rather than decrease aggregate demand universal among MMT followers?

      Delete
    4. I wouldn't describe it as "universal" but most MMTers suggests the effects of monetary policy are uncertain. In addition it seen as better to control bank lending directly - what they are lending for.
      So they just recommend fiscal policy.
      For example-
      Neil Wilson:
      "When the central bank puts interest rates up there is a short term boost to the economy - increasing demand.

      This is caused by savers getting more money from borrowers and increasing spending, whereas fixed rate borrowers don't change anything and variable rate borrowers fail to cut back as quickly (often taking eighteen months or so to scale back).

      And all this appears to be linked to the 'saving/borrowing' ratio. Where there is a lot of domestic saving the perverse effect can last for a lot longer."
      See also:
      http://bilbo.economicoutlook.net/blog/?p=20011

      Delete
    5. "1. If all government debt was converted to money when we are not at the ZLB, interest rates would fall and inflation would rise.'

      This is not true in a system that can pay interest on excess reserves, is it? Surely you could just convert the entire debt stock to interest-paying reserves, and use term-deposits at the Fed to construct a yield curve out to whatever level of maturity one desires?

      Delete
  17. "I have not read much MMT literature, but in what I have read I have normally not found anything I take great exception to. "
    There is a full and detailed MMT primer here.
    http://neweconomicperspectives.org/modern-monetary-theory-primer.html

    ReplyDelete
  18. The most appropriate action at this juncture would be to merge the Bank of England into the DMO.

    That clarifies the situation enormously

    - It gets rid of the stupid arguments about who owns the BoE. If it is a department of HM Treasury there is no argument.

    - Having one department that handles the entire yield curve would be far more sensible than the stock lending farce we see under Funding for Lending. That just showed you had two areas doing the same thing.

    - It makes it crystal clear that the Bank is part of government and does report to the Chancellor. Which is as it should be.

    - The Bank will still have operational day to day independence to do what it needs to do based upon directions set by parliament and HM Treasury. That fits in with the way the Bank of England Acts are worded.

    - It also makes it clear that the job of the Bank is to adapt the economy around the financial decisions of parliament, and that it has no authority to force parliament to fit its financial decisions around the decisions of the Bank. Where there is a disagreement over output gaps, etc. the view of HM Treasury and the government prevails.

    That final point is the key issue. The Bank is an adaptive operation that works to ensure that the parliamentary financial decisions are implemented. That may involve it trying to influence aggregate demand under one set of party philosophies and it may involve it leaving aggregate demand management to the fiscal tax and spending auto-stabiliser under another set of party philosophies.

    The structure has to be able to adapt and handle both so that it can deal with changes in political control. And it also accepts that there is more than one philosophy about how the economy is to be handled and that will be settled politically and will change politically.

    ReplyDelete
    Replies
    1. Do you really think politicians have any competence in deciding what the output gap is? All you would do under your proposal is replace one set advisors by another - civil servants - and that advice could be ignored if it conflicted with the political situation at the time. How that would better achieve a goal which is set by the Chancellor anyway I fail to see.

      Delete
    2. You need the final decisions taken by democratically elected politicians. Civil servants can help.
      IMO monetary policy is poorly targeted and it is better to use fiscal policy for everything.

      Delete
    3. "The view of HM Treasury and government prevails"
      Entrusting George Osborne to make sound macroeconomic judgements and giving him the reins of monetary policy is a good idea?
      How well did his austerity policies work for the UK economy- until he massively eased up on them in 2012/13? It's bad enough he's allowed within a million miles of fiscal policy decisions!

      Delete
    4. None of that addresses the proposal. The proposal brings the bank clearly within the political sphere - as it should be - so that the philosophy of the bank can be altered via the political process, and the people directing the bank changed under the political cycle as they should be.

      Ignoring advice is the penchant of anybody in charge. Mervyn King ignored a bunch of advice and a load of banks blew up. The difference is that when he screwed up it took ages before he was thrown out of a job.

      "Do you really think politicians have any competence in deciding what the output gap is? "

      Do you really think the current set of bankers do? They don't. That's why there is 23 million people unemployed across the EU. The total failure of central bankers to assess things correctly - because they are working with estimations and theories that just don't work. The political philosophy, and it is a *political* philosophy, to which they subscribe is a busted flush and needs discarding.

      The bank is part of the state apparatus, and the individuals that run the bank should operate according to the political cycle - precisely so that we the people can *change* the political philosophy that is directing the bank via democracy.

      And that requires the people running the bank to consist of a minister of government, or report directly to a minister of government to receive their instructions.

      Putting bankers and economists on pedestals as though they actually understand anything fundamental is wrong. They don't. They just have a political idea and a bunch of beliefs. There is lots of evidence and writing that shows how wrong they area. Just like Labour has lots of evidence and writing to show the Tories are wrong, and vice versa.

      Democracy is how we resolve which set of beliefs to go to.

      Carney, the other day, said that the Corbynomics proposals could cause inflation. Well they would only cause inflation if Carney & Co failed to do their job properly. The intentions have been 'signalled' pretty well ahead of any possible implementation date after all!

      So it is either a statement of incompetence from the current Governor, and he should be sacked now, or a statement of political philosophy because he doesn't believe it is his job to make space for the government investment programme by trimming back bank lending sufficiently.

      That's the ultimate problem. Bankers and economist are just as corrupt, just as subject to groupthink, just as subject to political viewpoints as any of the politicians. The difference is that we the people can get rid of the politicians.

      We can't, currently, get rid of the bankers and economists. They wander around as though they have the One Truth and they don't.

      Delete
  19. Mark Carney:
    "The issue would be imperilling potentially the achievement of price stability. The consequence of that of course would be inflationary. The people who tend to get hurt the most by inflation are the poor, the elderly, those that can’t hedge themselves – that’s been the experience throughout history and I’m sure that will be the experience in the future if the Bank of England were not to conduct policy not consistent with achieving its mandate from parliament."
    Inflation hurts the rich. That's is why they hate it.
    Also, Carney your job is to achieve 2% inflation. That's the mandate!

    ReplyDelete
  20. The MPC forecasting record is abysmal and forward guidance is a classic "foot in mouth" operation - these advisors should have been sacked for incompetence long ago!

    ReplyDelete
  21. Any of us technocrats know that we can run our areas far better than the politicians. My career as a Civil Servant proved that to my own satisfaction! But I really cannot understand why CBI is so important if the government can change its mandate at any time. It may be true that the Minister for Transport does not choose where to put traffic lights but he answers to Parliarment for where they are put. He controls the department that puts them there. Why on earth can't the Chancellor do the same with the MPC? Yes, he can appoint members but any attempt to 'pack' the Committee would have the same effect as dictating a rise in interest rate targets. It basically can't be done.

    It has been pointed out more than once that the 'experts' have not got a stellar record either in actions or in pronouncements (not for nothing is the BoE seen as the protector of the City). But the key point, which I tried and failed to post earlier is that the set up is a guarantor of the neo-liberal approach where the function of government is to protect the financial system against the people (I exaggerate but only slightly).

    Sorry, this is something of a rant but I really think that after the last 15 years, and especially the last six, the case for Central Bank Independence has to be better founded than it is at the moment - founded in both theory and practice.

    ReplyDelete
    Replies
    1. They are not technocrats though. They are ideologues. They are as technocratic as Mario Monti.

      Delete
    2. David,

      Yes the government can change the mandate (e.g. move from a 2% target to a 4% inflation target) at any time. (Personally I think that would be a good development. Or some nominal GDP target growth rate.)

      But if government is able to set the interest rate as well as the objective, then even if it is competent (and I think we all agree it is not) it could use its instrumental power to pursue other objectives. I listed one above: interest rates have redistributive effects. Partisan politicians would set the interest rate for reasons over and above macroeconomic stability. As different parties come and go the net effect is unnecessary macroeconomic instability.

      It is not clear to me that the re-election constraint (dumb voters, malign media, etc) is sufficiently strong to rule out partisan or opportunistic policy by politicians.

      So the case for CBI includes competence, but also (independently) includes elimination of unnecessary politically-induced economic volatility. The latter occurs even if politicians were maximally competent. Here is some theory and evidence:

      http://onlinelibrary.wiley.com/doi/10.1111/1468-0297.00115/abstract

      Delete
    3. «I listed one above: interest rates have redistributive effects. Partisan politicians would set the interest rate for reasons over and above macroeconomic stability. As different parties come and go the net effect is unnecessary macroeconomic instability. It is not clear to me that the re-election constraint (dumb voters, malign media, etc) is sufficiently strong to rule out partisan or opportunistic policy by politicians»

      But course CBI is partisan, of course it was not designed to take out monetary policy out of the hands of the corrupt voters and the opportunistic politicians they elect and put it in the hands of of the wise and fair philosopher-kings at the bank of England: it was designed by G Brown as an element in a very partisan, very redistributive, very politically opportunistic approach.

      The political goal was to fund private (plus some public) spending via, directly or mostly indirectly via remortgages on ever rising property prices, cheap (low interest) debt, what C Crouch calls "private keynesianism". With booming cheap debt, not with rising private incomes for private spending; or increasing public tax receipts for public spending.

      The way to achieve this was to engineer low interests rates by pushing down wages, and to guarantee the "bond market vigilantes" that they would be alerted by "one of theirs", the bank of England, if the government of the day intended to step outside the establishment consensus and cause a collapse in bond prices.

      The "bond market vigilantes" were pacified by knowing that the bank of England, one of theirs, would do whatever it took to ensure that wage-inflation stayed below 2% no matter the cost to employment or would telegraph well in advance (triggering a bond sell-off) any increase in wage-inflation by getting the government to announce it publicly in a target setting letter.

      CBI is thus one of the building blocks of a bipartisan consensus policy to redistribute from wage-earners to property-owners by keeping nominal interest rates low by repressing wage-inflation, in order to push property prices higher.

      The usual telling quotes from G Osborne and D Cameron:

      «A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.»

      «It is hard to overstate the fundamental importance of low interest rates for an economy as indebted as ours… …and the unthinkable damage that a sharp rise in interest rates would do.
      When you’ve got a mountain of private sector debt, built up during the boom… …low interest rates mean indebted businesses and families don’t have to spend every spare pound just paying their interest bills. In this way, low interest rates mean more money to spare to invest for the future.
      A sharp rise in interest rates – as has happened in other countries which lost the world’s confidence – would put all this at risk… …with more businesses going bust and more families losing their homes.»

      Delete
  22. "So where does this apparent antagonism for CBI come from?"

    I assume that the main reason is that many people in a modern democratic society are instinctively repulsed by the existence of a major branch of government, with such a large role in the making of national policy, that operates independently of the political process and whose leaders are not subject in any direct way to the electoral process and electoral review. Those policies are not debated in the public sphere and are mostly absent from political campaigns, because politicians have little influence over them.

    British subjects fought for 1000 years to achieve the parliamentary and democratic control over the various aspects of fiscal policy that they enjoy today. Why wouldn't they want to do the same for monetary policy? It's really no different in kind or importance.

    ReplyDelete
    Replies
    1. In the UK the Chancellor periodically appoints the Governor. External MPC members are appointed every 3 years. And I repeat, their job is to try and achieve a goal set by the Chancellor. Given that the MPC has far greater competence at how best to achieve this goal than any politician, I just do not see what would be gained by having the Chancellor sign off or not on every proposed interest rate change.

      Delete
  23. TBH, I'm not quite sure what the debate about CBI is achieving. There seems to be, on one hand, a view that government sets the policy criteria, and the CB executes the monetary side within those criteria, as a purely technocratic exercise "independently". As the government appoints the MPC, that independence is pretty nominal. And yet this is CBI and it's decreed to be important. I don't think many on the left would object to this kind of woolly feel-good arrangement, apart from the implicit dishonesty.

    If the CB was truly independent - and the autocratic view is that it should act as a restraint on politically-driven expenditure - read lefty fiscal spending - then that is transparently unacceptable from a democratic perspective.

    The problem is with those who would seek to employ the former description, while implementing the latter - dressing up autocracy with democratic frills.

    ReplyDelete
  24. This comment has been removed by the author.

    ReplyDelete
  25. It's not really about the structure of the central bank, but about the policies it pursues. Directly financing lots of new government spending will be inflationary if the market believes it to be permanent. If the market believes the spending to be useless you will get inflation and a weak or negative RGDP growth.

    If we need more inflation (or at least more nominal growth) as we probably do, will the spending be useless is thus the key question.

    And on this: Can you trust the record of a Chancellor who helped run the finances of GLC under Ken Livingstone? And can you trust a man like Corbyn who only seems to have ideas about how to spend the UK's wealth rather than creating any?

    ReplyDelete
    Replies
    1. You "create wealth" by spending. This produces jobs and output. Real resources are being wasted due to austerity.
      "Directly financing lots of new government spending will be inflationary if the market believes it to be permanent. If the market believes the spending to be useless you will get inflation and a weak or negative RGDP growth."
      No it doesn't. The "market"? Who is he and why does he decide are future?

      Delete
    2. "Directly financing lots of new government spending will be inflationary if the market believes it to be permanent."

      Really? Do you really think that is how the real world works? Just goes to show the ridiculous lengths to which New Keynesians believe their own ideology.

      Delete
    3. John McDonnell balanced the books of the GLC. Austerity has immobilised the resources that create wealth but a National Investment Bank would stimulate growth.

      Delete
    4. Am not NK,or at least don't think I am.
      Anyway, are you saying money printing doesn't lead to inflation?

      Delete
    5. James, not any more than if you spend a £10 note from a piggy bank.
      Gilts are "money printing" really, just interest bearing IOUs not non interest bearing.
      Govt spending is limited by real resources. If resources are being wasted you can use them.
      The "High powered money" stuff is rubbish the UK has *no* reserve requirements and even if it did, when banks loan they just create deposits.
      If you transfer to someone in the same bank it just works like that.
      If you withdraw as cash or transfer to another bank THEN the banks needs reserves.
      "Reserves" is a misnomer and do not represent actual reserves, just settlement balances, they are on the wrong side of the balance sheet.

      Delete
  26. The market is you and me. If we think the government is uselessly devaluing our currency we will not want to hold it. Causing more inflation and no RGDP growth.

    ReplyDelete
    Replies
    1. "The market is you and me."
      No it isn't.
      "If we think the government is uselessly devaluing our currency we will not want to hold it."
      Really? What will you pay your taxes in then James? How will you pay VAT on your barter transactions? How will you buy anything when everyone else accepts £s, like I don't know FOOD? You first.
      You can give all that worthless currency to me if you want ;)

      Delete
    2. Perhaps I wasn't clear. I was just thinking of the classic "hot potato" theory of inflation. In an inflationary situation people don't want to hold any cash they receive for very long, as rapidly rising prices devalue the cash quickly. Hence, they spend it (ie don't hold on to it) for very long. We all do this.

      Delete
    3. That doesn't happen in PQE James.
      To have inflation you have to have people chasing the same resource *at the same time*. That means you need to have time sensitive projects.

      PQE projects are 'shovel ready'. So you set the price for the job and await bids. If there are no bids (because there is a boom on) then the project stays on the shelf. They are 'time insensitive' and therefore operate in a countercyclical manner providing a rudimentary limited Job Guarantee.

      Serialise projets by any mechanism and you won't get inflation. Price competition is just the most primitive mechanism. Delays or planning rules can similarly serialise things and avoid price pressures.

      Delete
  27. My experience relates to policy-making in government and business but not in macro-economics. However, central bank (CB) independence is just a governance issue and governance is part of almost any policy making.

    Here are four steps in policy making:

    Decide basic policy i.e. WHAT and WHY.
    Decide governance i.e. WHO and HOW.
    Build consensus i.e. assess options dispassionately and agree best option.
    Communicate consensus widely amongst all interested parties including politicians, media and general public.

    How do these four steps look in terms of current macro-economic issues? I will assume that mainstream (MS) and MMT are two options and that Market Monetarism (MM) and austerity are two further options.

    First, basic policy. MS, MMT and MM all believe that we should stimulate the economy while austerians do not. The first three options are all on the same side against austerity. However, a non-economist would never realise this from reading about MS, MMT or MM. This is because economists, like all technicians, prefer to focus on the interesting disagreements between technicians rather than the big picture. This is one of the main reasons why the austerians win despite having poor arguments, and this is why many non-economists think that academic economists are useless.

    Second governance. Governance should just be about determining the best way to achieve the basic policy. However for some reason, in macro-economics, governance has been raised to something resembling a religion. The first rule of effective governance is to answer the question ’who is the one person or institution who is accountable for delivering the policy’? This is where MS, MMT and MM diverge.

    MM has a clear answer to this question. The CB is accountable. It points to the fact that CBs can use ‘monetary offset’ to counteract reckless spending by governments. However, there are two problems with the MM view of governance. First, the CB can use positive interest rates as a brake on the economy. However, from what I can see, there is little evidence that the CB can use an accelerator to counteract an underspending government. Second, while the CB may act independently of the government it can do so only with the ACTIVE CONSENT of the government. Even if the CB is independent of the government, the government is also always independent of the CB.

    MMT also has a clear answer to my question. In a democracy, the elected government is accountable. The central bank is just an agency of the government. I don’t want to get involved in the technical rights and wrongs of MMT so I’ll leave it there.

    (continued below)

    ReplyDelete
  28. MS, on the other hand, does not have a clear answer to my question. This is incoherent. For example, MS economists argue that CBs should be independent. However, in current circumstances where MS, MMT and MM all agree that governments are not stimulating the economy sufficiently, MS economists then disapprove of independent CBs independently deciding to independently raise interest rates. The problem here is that the independent CBs are independently acting against the basic policy agreed by MS, MMT and MM economists that stimulus is required. However, this is exactly the sort of over-zealous behaviour that many independent agencies exhibit. Independent CBs are the macro-economic equivalent of over-zealous traffic wardens. For example, an average two percent target is re-interpreted as a maximum two percent target as this gives the independent CB more room for error. Soon, the merest hint of inflation is regarded as a reason to increase interest rates just in case inflation might possibly hit 2%.

    The problem here is that economists view governance as being more important than the basic policy being pursued. This is a schoolboy error.

    The final two steps of my model are building consensus and communicating it widely. This is impossible when the three pro-stimulus economic tribes want different governance models, and even more impossible when they use different vocabulary and different models to describe the same topics to the rest of society. No wonder politicians, the media and the general public are all confused.

    Governance (and targets) should always be viewed in terms of the problem being tackled. Different problems may require different governance and different targets. Just because it is good policy for independent CBs to oppose over-spending governments doesn’t mean that is good policy for independent CBs to oppose sensible government stimulus.

    A final point. Independent CBs were introduced to prevent (mostly left-wing) governments from overspending. Without an independent CB targeting 2% inflation, governments might over-stimulate the economy prior to elections and cause inflation to rise to 3%, 4% or even 5%. Almost laughably, many of the economists who supported this policy (including Paul Krugman) now say that a 4% inflation target should be standard while others argue for a completely different NGDP target which would create even greater inflation when RGDP is not increasing. As far as I can see, that means that this type of revised policy would require politicians and CBs to be more reckless than the governments whose ‘reckless’ spending was the reason for introducing independent CBs in the first place. You couldn’t make this stuff up.

    ReplyDelete
    Replies
    1. The UK set up is different from elsewhere. There is no evidence before or after 2008 of the kind of over-zealous behaviour you talk about. Keeping interest rates at 0.5% in 2011 took a lot of courage, and many politicians would have raised rates in those circumstances.

      Delete
  29. “Government delegates technical decisions all the time, and as long as there is strong accountability (which in the UK there is), the right people are on the MPC and they are truly independent (from government or the financial sector) this works well.”

    Yes.

    All organizations face challenges in the design of structure and the delegation of responsibilities.

    Simplifying, the management of the budget and the management of the ground zero interest rate are quite different.

    It’s difficult to imagine the operational responsibility for both of these functions falling under one individual, which is what would happen at some level with institutional consolidation.

    Otherwise, as is the case now, the operational responsibility for the rate is naturally independent of the responsibility for the budget.

    There may be one exception – where the policy rate is “euthanized” by setting it to zero permanently. That happens to be one version of MMT. It makes the combination of the two functions somewhat moot.

    ReplyDelete
  30. This post misses the point. The reason why MMT is becoming fashionable is because it addresses the elephant in the room: the pernicious political and economic impact of the Bond Market. The rationale for austerity is the fear of sovereign default. Thus it is the size of the national debt that is driving the debate, yet the real problem is the trade balance, or more specifically the current account.

    MMT on the other hand represents a completely internalised system of government financing which therefore frees the state from external economic interference. It is therefore the only system of financing that is compatible with national sovereignty, democracy and fiscal autonomy.

    The issue of CBI is secondary. For a start it is just "goal independence" anyway. However, even with MMT such independence can be incorporated into any model simply be giving the BoE additional targets such as maintaining full employment in periods of growth, or maintaining RGDP in a recession, while also meeting a variable inflation target. Thus MMT and CBI are not mutually exclusive or incompatible.

    ReplyDelete
    Replies
    1. "yet the real problem is the trade balance, or more specifically the current account."
      No it isn't.

      Delete
    2. I think the idea that MMT frees the state from external interference is very odd. If fear of sovereign default drives austerity, then it does not come from mainstream macroeconomics.

      Delete
    3. "I think the idea that MMT frees the state from external interference is very odd."
      How is that odd? EXPLAIN please Simon! But before you do let's get a few thing straight. MMT is not about permanent money printing, unlimited money printing or arbitrary levels of money printing so please do not try to move the goalposts of the debate by referring to any of these in your critique. MMT as I understand it merely involves replacing conventional borrowing with borrowing from the central bank. As such it represents a closed (quasi-)isolated system. Therefore it operates without the need for external funding. Hence no external interference. What is so difficult to understand about that?

      And yes, I know that no economy is ever totally isolated. But when you model a system you start by considering it in its idealised state and then built in complexity as required. The idealised state in this case is a closed system, so let's use that as a starting point.

      "If fear of sovereign default drives austerity, then it does not come from mainstream macroeconomics."

      No-one is saying it does. It comes from realpolitik because the general public does not understand economics and neither do most bond traders. Nor do they (the traders) have a set of priorities that generally coincide with those of the citizens of the country whose bonds they buy. Either way mainstream macro is irrelevant because the politicians that set the budget are listening to either the electorate/press or the Bond Market, not to you. In which case, why not remove the bond traders from the equation entirely? After all, the Bond Market is just an anachronism that dates from the days of yore, the Napoleonic wars and the Gold Standard. It is time economics moved on.

      Delete
    4. Reply to Random

      Yes it is the current account that matters, not the size of the government debt. It is a country's debts to overseas creditors that force it to run a primary surplus (as in Greece and the Weimar Republic) and ultimately tip it into debt deflation and a depression. The economic crash in Spain was also the result of excessive capital inflows as Paul Krugman and others have pointed out.

      Then there is the strong correlation between government borrowing from overseas and the current account deficit. So if governments didn't borrow from outside their currency zone their current account would be more likely to balance.

      Delete
    5. "If fear of sovereign default drives austerity, then it does not come from mainstream macroeconomics."

      It does. Because MMT shows that there can be no 'sovereign default' and the state can engage whatever resources are available for sale in its currency. Functional Finance just adapts dynamically to any reduction in private spending and borrowing.

      If foreign suppliers decide they want to blow up their own economy by refusing to supply ours, then that is their choice. It can happen, has happened, and probably will again. You can't do anything about it other than move suppliers (because the foreign market is still *competitive* and they don't all act with one mind), making sure you have multiple suppliers, and otherwise adapting the economy to cope - by rationing import goods and services to needed supplies where necessary.

      Delete
  31. I think the deeper issue at stake here is a claim implicit in CBI, namely that the implementation of a CB mandate, whatever it is, can somehow be considered an apolitical act. in other words, is management by rule compatible with democracy? Is there such a thing as 'the right rule'? A natural rate of interest? Who changes the rules if they turn out to be wrong?

    Personally, I find the idea of a politicised CB without a strict mandate dangerously naive. But what I do think should be questioned regularly, as part of the political process, is the mandate, i.e. the rules themselves. And with that I don't mean where to set the interest rate, which, if conseidered a legitimate tool, should rightly be set independently by the CB, but rather whether setting an interest rate is actually the right or the only right thing for a CB to do?

    Where I find MMT to be somewhat muddled is when they mix the above framing, in which they take a more or less strong stance against CBI, with their other strong claim that interest rates have little to no effect on the (real) macro economy. If it's so economically unimportant, why fight it?

    The MMT view on monetary policy can also be explained by its Chartalist heritage. In this view, monetary policy (that is, setting a base interest rate) is the logical counterpart to the constrained way in which government spends high powered money, namely by borrowing from the public. The politically imposed constraint that borrowing imposes is necessarily offset by the a CB with an interest rate mandate. What is desiged to be a constraint turns out not to be a constraint at all. If one then consolidates CB and government, the supposed CBI vanishes and government is trump. On this point, I think I'll agree with JKH above that such a consolidation is hard to imagine in practice.

    And while one can quibble over whether the above accurately characterises the role of the CB as government banker ( I personally find it relies too stronly on views of national sovereignty), the main citique I would add is that CB actions should be viewed wrt the whole financial system and not only government spending. One shouldn't deduce from one's own view that changing interest rates is an ineffective tool by which to manage an economy, that a CB should have no other function than to accomodate government spending. That does not logically follow.

    Oliver (not the same Oliver as above)

    ReplyDelete
  32. One last remark from me, although I don't imagine anyone is reading this far down.

    I was asking myself last night why this issue is so important to some people, on either side and including me, when part of my point, at least, is that independence is more nominal than real.

    I think it's because what seems to be behind it is the idea that you should separate the management of fiscal policy from monetary policy. In other words, the power to create deficits should be wielded by different people and institutions from the power to create money.

    Why is this? Wouldn't it make more sense, a priori, to have the control of monetary and of fiscal instruments in the same hands, or at least guided by the same brains? Is it because one side is dealing with what's really important, and the other with simple numbers (and if so which is which)?

    I still want to see both theoretical justification and practical demonstration that CBI is genuinely beneficial to an economy, or polity, ceteris paribus.

    ReplyDelete
    Replies
    1. There is an interesting intermediate stage, which is represented by the OBR. It recommends to the Chancellor what aggregate fiscal stance he needs to take to meet his targets. You could in principle make CBI advisory, or make OBR advice mandatory. These are interesting issues, and as a result there is a large literature (not just straight econ) on this.

      Delete
    2. 'Not just straight econ'. Indeed, when expressed in these terms the issue is analogous to the separation of powers logic that supports independent decision making by the judiciary. However the independence of judges is derived from their tenure, whereas CBI is contingent on a cultural group think that renders it meaningless.

      Delete
    3. "You could in principle make CBI advisory, or make OBR advice mandatory."

      You could. But why should the advice of these people be binding on a democratically elected chamber?

      There are 650 people in parliament. There are select committees and numerous stages to the decisions they make - all open and recorded. The idea of democracy is that together and taking on board the advice all of them can receive they collectively reach the optimal decision for society.

      Suggesting that a group of 'betters' should be able to override the choice of the 'commons' in financial matters is to return us to the state before the 1910 constitutional crisis which removed the House of Lords veto over financial matters and lead to the Parliament Act. All of which asserted the supremacy of the Commons.

      What you are suggesting is a new House of Lords that can bind the hands of parliament - but consisting of only half a dozen individuals.

      This is all about embedding the philosophy you believe in permanently in the system. And that is anti-democratic.

      Delete
    4. «both theoretical justification and practical demonstration that CBI is genuinely beneficial to an economy, or polity, ceteris paribus.»

      That's ridiculous because there is no such thing as "polity", there are usually interest groups that fight over the pie quite hard. Never mind "ceteris paribus", which is a joke.

      But I'll try to describe one important angle of the consequences of CBI. CBI was designed to make long term interest rates lower and steadier by removing from the government the ability to make unannounced rapid changes in the wage-inflation rate, which has two consequences from both aspects of the means:

      #1 That the bank of England has to hit the target wage-inflation rate regardless of everything else can mean that monetary policy may have to be far more extreme than desirable to compensate for changes in that "everything else". But this of course is intended: to compensate for overtight fiscal policy monetary policy has to be extremely loose, generating huge asset price booms, as "trickle down" effects are weak.

      #2 That the target is expressed in terms of wage-inflation only (even if thinly disguised with an index with a different name) means that monetary (and fiscal) policy can be indeed free of constraints unless wage-inflation is involved, so the bank of England can either be indifferent or actively participate in policies that boost property inflation, for example.

      By having as fixed-target the wage-inflation rate thus CBI may result in greater instability in everything else. Indeed in recent years because of that medium-term wage-inflation rates have been allowed to significantly depart from the target for some years, under the excuse that what matters is the long term average.

      But overall since CBI and wage-inflation targeting has enabled huge swings in government policy in other areas, and in monetary and credit policy. As a result M King has remarked that the current setup may make the bank of England come to be perceived as an upward-redistributive tool of the rentier classes, but that's why the whole setup was designed like that.

      Delete
    5. The government delegates decisions about what drugs to provide on the NHS to NICE. Do you think everyone of those decisions should be taken by politicians?

      Delete
    6. «The government delegates decisions about what drugs to provide on the NHS to NICE»

      This under the assumption that what matters with the CBI idea is that the BoE can choose the merely-technical means to reach the wage-inflation target.

      But what really matters with CBI is that increases in target inflation rate have to be announced in public and well before the BoE make up their mind on how to reach that target. The main effect is that governments are effectively prevented from shafting low-rate long-term debt holders with a sudden increase in inflation; they have to use a sudden devaluation instead :-).

      Plus that in order to reach that target the BoE is implicitly constrained to consider even pretty extreme monetary policies, so that if the government is «fiscally conservative» (that is uses "austerity" to push down wage-inflation) then the BoE has to overdo the «looser monetary policy than would otherwise be the case» to boom asset prices so that spending funded by capital gains (a rather leaky transmission channel) compensates.

      The actual "independence" aspect of BCI is a red herring, even if likely the wise and fair philosopher-kings at the BoE are very happy indeed to enjoy less meddling from the mere civil servants at the Treasury. :-)

      Delete
    7. Simon, what the hell does this have to do with this? Wren Lewis, master of the strawman.
      If NICE was doing a terrible job and had control over NHS policies generally, with a NHS Governor that embedded a certain philosophy of bleeding patients, then hell yes.
      Come up with an actual argument rather than sophistry.

      Delete


  33. It is no disrespect to officials to note that testomonies by the people directly involved are not generally regarded as definitive proof of neutrality as even honest people can interpret their own actions in ways others might not. Regardless of Richard Murphy, the letters to the Govenor from Darling 29th January 2009, and from Osborne 6th Oct 2011 do seem to read that the Asset Purchase Facility was at least a partnership government intitiative with the BoE and that both Darling, and then Osborne, clearly DID instruct the BoE on the sums that could be used for QE and their direction for asset purchase, even if the day to day operation was directed by the BoE.

    If the distinction in practice between needing HM Treasury authorisation and instuction is already so thin,particurlarly if QE made gilts more saleable so much of it was a form of indirect 'People's QE' anyway, then it behoves officials who should be seen to be politically neutral to be very careful not to exaggerate how radical or unprecedented, or read for tabloids 'madly reckless', the suggestion of the new leader of the opposition was. Particularly as the general election was clearly won on the issue of economic competence and a spurious portrayal of Labour's economic record.

    On the MPC and interest rates I largely agree with Simon ( a most excellent economist), but the use of BoE debt for fiscal spend is not purely monetary, it is also fiscal and so government has a legitimate interest in how and when it should be enacted. It is Article 123 that has been used to hobble such desirable fiscal action in Europe, action that I thought Simon had been rightly calling for.

    What is clearly wrong is a Governor of the Bank of England showing in his recent comments on Corbyn's suggestions and and a skewed analysis on this and the perils of inflation that he is NOT himself neutral. Does he think that Corbyn would not read a private letter from the Governor of the Bank of England or not meet with him? Officials have plenty of opportunity to provide their advice in more discreet ways, especially the Governor of the Bank, but Carney has chosen to go straight to a public attack on a newly elected opposition leader. Some independence!

    ReplyDelete
    Replies
    1. I have no wish to defend Carney, but we are in a strange - possibly quite short - period where policy decisions are being made. So perhaps he just wanted to fire a warning shot, but did not feel that a 'private' approach was appropriate. Or maybe not!

      Delete
    2. «Carney has chosen to go straight to a public attack on a newly elected opposition leader. Some independence!»

      * CBI happens within the bounds of the establishment consensus.
      * The establishment consensus is of course "non-partisan" :-).
      * Corbyn apparently is outside the establishment consensus, so fair game.

      USA readers: "establishment consensus" -> "Overton window". Even if not quite the same.

      Delete
  34. Prof Wren-Lewis, thanks for this interesting post. You might find this comment of interest
    http://www.economonitor.com/blog/2015/09/helicopter-money-central-bank-independence-and-the-unlearned-lesson-from-the-crisis/

    ReplyDelete
  35. Don't ignore the financial crisis that at some point a Corbyn/McDonnell government will face.

    Some reduction in asset values would be rational but markets will overshoot. Worse, we can assume – given the record in everything from money laundering to market manipulation – that there will be deliberate attempts to bring down the government, including through foreign oligarchs and criminal conspiracies.

    Central bankers cannot be trusted to support a Labour government through such a crisis. Carey proves it every time he comments and Draghi suspended ELA to blackmail Syriza. So the Treasury will have to seize control to get us through.

    ReplyDelete
    Replies
    1. It can just ignore the governor, and then appoint a new one. But if they say they will scrap CBI, that seriously diminishes the chances they will ever be in government, because most people will assume - not without reason - that this will mean higher inflation.

      Delete
    2. «But if they say they will scrap CBI, that seriously diminishes the chances they will ever be in government, because most people will assume - not without reason - that this will mean higher inflation.»

      More precisely (as I have been arguing in other comments):

      * "most people": lenders.
      * "higher inflation": higher interest rates.

      Of course many voters in marginals in the South East are terrified of higher interest rates, as they are engaged in high leverage margin speculation, and they by now understand well that lenders will demand higher interest rates if wages rise, but not if asset prices rise, so they want lower or at least non-rising wages too.

      Delete
    3. «Draghi suspended ELA to blackmail Syriza»

      That seems to be a wide misrepresentation, as ELA was not suspended, just the credit limit was not increased; existing lending was even rolled over.

      The Greek finance minister had repeatedly stated that the greek government and the greek banking system were bankrupt, and the ECB is forbidden by international treaties (that the greek government signed enthusiastically, even if fraudulently) from lending to bankrupt entities unless the lending is somehow likely to be repaid, for example by being endorsed by solvent entities.

      When SYRIZA refused the endorsement of the other 18 euro governments and broke off negotiations the ECB probably should have called in all that debt immediately instead of simply keeping it in place and rolling it over.

      Two members of the ECB board have resigned in protest at the extraordinarily generous lending that the ECB management has kept giving to Greece, at the expense of the other ECB members, even if technically it is still within the treaties under a very loose interpretation.

      Delete
    4. The immediate problem with Greek banks was a run created by the Troika's negotiating stance. Central banks should always provide cash in the case of a bank run. The fact that the ECB, as part of the Troika, can first create a run, and then refuse to provide cash, means that it acted in a highly political way.

      This should worry anyone who wants to support democracy. As a completely unelected body, it has the power to hold any individual EZ country to ransom, and in the case of Greece used that power. I had previously been pretty critical of the ECB, but even I was shocked by that.

      Delete
    5. «Central banks should always provide cash in the case of a bank run.»

      Well, the well established Bagehot principles are that central banks should provide cash only to solvent banks, against good collateral and at punitive rates.

      None of these applied to greek banks, or the greek government that used them as a money-grabbing tool.

      Regardless of the Bagehot principles, lending to insolvent entities including banks is anyhow explicitly forbidden by the ECB treaties, bank run or not. it is after all a fiscal operation, and the fundamental principle of all EU activity is that fiscal operations can only be authorized by heads of government (not even their finance ministers), because of political accountability to their voters.

      Plus the Troika is merely a figleaf for the governments of the 18 euro countries. Using the "Troika" name and concept is misleading: the greek government negotiated with the other 18 euro governments as the discussions were about fiscal support, and none of those 18 governments wants to delegate authority for fiscal operations to unelected bodies,. or the to whim of the greek parliament alone.

      No taxation without representation!

      Delete
    6. The ECB declared Greek banks solvent on one hand, but refused liquidity.

      Delete
    7. "This should worry anyone who wants to support democracy. As a completely unelected body, it has the power to hold any individual EZ country to ransom,"
      God what a load of total arrogant tosh.
      Greece can exit the euro at any time it wants and chose to enter voluntary. What a load of nonsense. They signed up and knew at a the time it was a "completely unelected body."

      Delete
    8. "Central banks should always provide cash in the case of a bank run. "
      Then why should they not do the same to governments?

      Delete
    9. "The immediate problem with Greek banks was a run created by the Troika's negotiating stance. Central banks should always provide cash in the case of a bank run. The fact that the ECB, as part of the Troika, can first create a run, and then refuse to provide cash, means that it acted in a highly political way."

      It looks like you're contradicting your own argument here Simon. The quote suggests that you acknowledge that CBI is a means to promote the politics of TINA; institutional misdirection to mask the real instruments of government action. I think the broader issue within the larger Keynesian community is scepticism over the effectiveness of monetary policy. There are a range of views but there is a broad desire for an institutional framework that is more favourable to fiscal policy.

      Delete
  36. As I understood it, Labour introduced CBI only to reassure the electorate (and media presumably) of their economic competence - in fact, it's almost an admission of the latter in demonstrating that politicians can't be trusted with oversight. In any case, you can argue successfully that there never has been any CBI. Being able to argue it both ways shows how unimportant CBI is. Take it or leave it, no difference.

    ReplyDelete
    Replies
    1. You cannot argue successfully there has never been any CBI. Nor do I understand where this wish to comes from.

      Delete
    2. You can't argue successfully that there ever has been. Until the Central Bank successfully prevents a government decision to spend, bounces a cheque, or does some other action that shows that it has decided something against what the politicians wanted, then you just have a facsimile and an illusion.

      You would need a 1910 style constitutional crisis to show that there is any independence.

      The independence of the central bank is the same independence the department of Work and Pension has to determine who gets tax credits and who doesn't - which of course then increases government spending without budget limit.

      It's an elaborate political illusion. The standard political processes would take place in all cases to ensure that those running the bank were in lock step with the political philosophies of those running the currency area.

      Delete
    3. «Labour introduced CBI only to reassure the electorate (and media presumably) of their economic competence»

      Don't believe all that you read in government press releases :-).

      The real constituency of the CBI was lenders and in particular long-bond lenders, a promise to them that the BoE would choke wage-inflation and thus keep nominal interest rates low, or they would be told in advance they would not.

      What lenders are scared of is sudden increases in nominal rates: raising rates from 2% to 4% would wipe out half of their investment. CBI in essence means that changes in wage-inflation targets have to be announced in public by the government well ahead of them being implemented by the BoE.


      PS of course long-bond lenders have been screwed regardless, because the low long-term interest rate enabled by the promise to keep wage-inflation low in the long-term have been used to boom asset prices. So a long-term lender when they are paid back can buy with that money the same amount or more of wage-hours they could at the beginning, but a lot less real or financial assets, which is what lenders tend to do when they don't lend. But lenders still look at wage-inflation to set the interest rates they demand, rather than at asset-inflation, so clever governments screw them on the difference.

      Delete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.