Monetary and fiscal
policy makers in the UK seem to think they had a good recession. You
can tell that because neither group seem particularly interested in
learning any lessons. This is despite the fact that we had the
deepest recession since the 1930s, and the slowest recovery for
centuries. It is also despite the fact that the level of UK GDP is
almost 20% below the level it would be if it had followed
pre-recessions trends, and all previous recessions have had the
economy catch up with that trend.
You can tell from
this paragraph that I do think serious changes are required to how
monetary and fiscal policy are done. So does the IPPR, and their
detailed analysis and proposals are set out in a new report
by Alfie Stirling. The analysis is not too technical, well presented, well researched and I agree with a
great deal of what is said. I will look a monetary policy first, and
then fiscal policy.
What the Great
Recession showed us (although many macroeconomists already knew) is that
once nominal interest rates hit their effective lower bound (ELB) ,
monetary policy makers lose their reliable means of combating a
recession. The report is dubious about Quantitative Easing (QE) for
much the same reason that I have been for anything other than a last
resort instrument. In brief, the impact of QE is very uncertain
because it is not routinely used, and in addition there may be
important non-linearities. It is not a reliable alternative to
The report makes
much the same point about negative nominal interest rates: partially
or perhaps fully removing the lower bound. To quote:
“Like QE, the impacts of negative rates are uncertain and,
depending on the behavioural response from banks and savers, could
actually reduce spending in the economy, or else increase the number
of risky loans (see for example Eggertsson, Juelsrud and Wold 2017).”
I know some macroeconomists will disagree with that assessment, but I
think the point is valid.
The report also rejects helicopter money as a solution to the ELB
problem. Here I found their discussion less convincing, but they do
recognise that a form of helicopter money has already been undertaken
by some central banks through creating money to change the
relationship between borrowing and lending rates, a point that Eric
Lonergan has stressed.
The two reforms to monetary policy that have been suggested and which
the report does support are adopting unemployment or nominal GDP as either a
second target or as an intermediate target, and raising the inflation
target by one or two percent. I have argued strongly for a dual
mandate and also for using nominal GDP as an intermediate target, so
I have no objections here.
The report recognises, however, that none of their proposed reforms
to monetary policy eliminates the ELB problem completely. We have,
inevitably, to think about the other reliable and effective
instrument that we have to stimulate aggregate demand: fiscal policy.
Their proposed fiscal rule is very similar to Labour’s fiscal
credibility rule. It includes (a) a ‘knockout’ to switch to
fiscal expansion if interest rates reach their ELB, (b) 5 year
rolling target for a zero current balance (c) a 5 year rolling target for public investment (d) a similar target for debt to GDP.
The last in this list you will not find in Portes
and Wren-Lewis, in essence because it involves double
counting, and debt targets are less robust to shocks than deficit
If governments followed this fiscal rule, then the ELB would not be
the serious problem that it is, because reliable fiscal stimulus
would replace reliable monetary stimulus at the ELB. But the IPPR worry that
governments might not do what the fiscal rule, and with the knockout
what the Bank of England, tells them to do. They are concerned that
what they call ‘surplus bias’ might be so strong that the
government would not run the deficits that the Bank asks them to run.
To overcome this concern, they suggest an alternative to QE at the ELB: the Bank
should create reserves to fund projects that are part of a National
Investment Bank (NIB). The NIB would be independent of government in
terms of the projects it funded (but not its high level mandate), and
it would normally raise funds in the open market. (This makes it
different from proposals that the NIB be entirely funded by the Bank:
In an ELB recession, the Bank of England would ask the NIB to fund
additional projects, with the Bank providing the finance.
As public investment is particularly effective as a countercyclical
tool if undertaken immediately, and as it is usually possible to some degree to bring forward
investment projects, this proposal seems a superior alternative to
QE, as long as the link between additional purchases of NIB debt and
additional investment by the NIB was reasonably clear. The key point
here is that although conventional QE might try to stimulate private
investment by reducing firm borrowing costs, in a situation where
there is chronic lack of demand that can be like trying to push
on a string. The same problem should not arise with an NIB. In that
sense it just seems like a good idea.
Whether it would be enough alone to circumvent the problem of a rabid
surplus bias government during a recession I doubt. The kind of
public investment that is easy to ramp up quickly in a recession are
things like flood defences or filling holes in the road, rather than
the kind of things an NIB would fund. A government suffering strong
surplus bias could cut these things quicker than an NIB could fund
additional projects. Some form of QE would be more powerful in this respect. The
danger in either case is that you just encourage the government to
try and get down debt even faster: if QE gives money directly to
people, the government just raises VAT.
How seriously should we worry about (design policy for) a government
offsetting everything the Bank is able to do to stimulate demand in a
recession? The answer may be given by imagining the following
scenario. The government operates a fiscal rule that has an explicit
ELB knockout. The Bank of England, when rates hit the ELB, requests
the government undertake fiscal stimulus. If Cameron/Osborne had been
faced with both those things, would they have still cut back public
investment? I suspect the answer is no. That of course by implication means that
central bankers in Europe played a large part in facilitating (or
encouraging) austerity, which in the UK stemmed from a failure to
admit the problems of the ELB because of a naive faith in QE.
Which brings us to central bank independence and what I call the
conventional assignment (outwith the ELB, monetary policy deals with
macroeconomic stabilisation). The IPPR stay with the mainstream
macroeconomic consensus in wanting to keep both. People with a more
MMT type view, like
Richard Murphy, would reverse  the conventional assignment, and
have fiscal policy doing the macroeconomic stabilisation. I have
written a great deal on the distinction and will not repeat that
here. However it is worth making one point on independence.
The reasons for making central banks independent are not peculiar to
monetary policy. They are that if the complex task of macroeconomic
stabilisation is left in the hands of politicians who get secret
advice, they can mess things up for political ends.  Messing
things up can be minor (e.g. delaying necessary measures), structural
(e.g. time inconsistency) or explosive (e.g. hyperinflation). Austerity shows that this fear is justified. MMT’s
answer to the IPPRs concern about a surplus bias government is that this is just a cost of democracy or the good guys would always be in power,
which I suspect many might not find reassuring. Yet that is also why
European central bank’s encouragement of austerity was far from helpful to the case for the delegation of macroeconomic stabilisation.
 'Effective' because in practice it is up to the central bank to decide at what point they cannot reduce nominal rates further.
 Not strictly true. In the conventional assignment monetary policy
does inflation/aggregate demand and government looks after its debt,
while in MMT fiscal does inflation/aggregate demand and government
debt looks after itself.
 I hope time inconsistency can be subsumed under this broad