Winner of the New Statesman SPERI Prize in Political Economy 2016


Tuesday 11 June 2019

Is Labour’s fiscal policy rule neoliberal?


That is the charge some on the left, particularly followers a movement called MMT, have laid against Labour's Fiscal Credibility Rule (FCR). MMT stands for nothing very informative, but it is a non-mainstream left-wing macroeconomic school of thought. Bill Mitchell, one of the leading lights of MMT, has run a relentless campaign against the FCR through his blog. As my own work with Jonathan Portes helped provide the intellectual foundation for the FCR, I will try and explain why I find the neoliberal charge nonsensical.

Although MMT has had its biggest impact in the US, it is increasingly discussed by those on Labour’s left (e.g. pro and con). Here I will give a lay person’s guide to only the aspects of MMT that lead to its dislike of Labour’s rule. MMT’s key idea is that fiscal policy (changing taxes and government spending) is better suited to stabilise the macroeconomy than a central bank setting interest rates.

Almost without exception, advanced economies use interest rates set by an independent central bank to control output and inflation. In the UK the Bank of England’s mandate (the inflation target and how quickly it has to be reached) is determined by the Chancellor. If the Chancellor wants to raise the inflation target or scrap it altogether they can do so. But the month to month task of actually choosing what interest rate is most likely to meet the Chancellors mandate is left to the Monetary Policy Committee (MPC), who are either Bank insiders or outsiders appointed by the Treasury.

Why is the choice of setting interest rates delegated to the MPC? Getting this choice right is a highly technical task, requiring detailed discussions of different forecasts and macroeconomic models. If the MPC is working well, they bring strong expertise to the table to help make a decision.

These experts could just give their advice in secret to the Chancellor, leaving the Chancellor to accept or reject their advice. The danger in doing that is the Chancellor will allow party political motives to influence what they do, to the detriment of the economy. As one Treasury insider once told me in the years before the Bank of England (BoE) became independent, the Chancellor recognised that rates had to rise but there is no way it was happening before the party conference.

A fundamental problem with today’s way of doing things occurred during the Global Financial Crisis. Interest rates fell to a level that became their lower bound. Central banks thought that cutting rates any further was ineffective and risky. When that happens, something else needs to step in to stimulate the economy. The BoE tried various measures (like Quantitative Easing), but they were all rather hit and miss because they had not been used much before.

Under the Labour government in 2009 fiscal policy was used to provide the stimulus that monetary policy could no longer reliably give. But in 2010 the Coalition government was elected and decided fiscal stimulus had to become austerity, with disastrous results in the UK and other countries that adopted it. Most macroeconomists rejected austerity in 2010, and their number increased steadily as the impact of austerity became clear.

It is now received wisdom among academic economists that when interest rates hit their lower bound, fiscal policy needs to provide a large stimulus to the economy. Labour’s fiscal credibility rule is the first in the world to formalise this. If interest rates hit their lower bound, the normal rule is suspended and a fiscal stimulus occurs that is sufficient to end the recession. Labour’s rule is therefore designed to prevent austerity happening again.

MMT wants to go one step further. It wants to use fiscal policy to stabilise the economy at all times, and not just when monetary policy is out of action. This is not a ridiculous proposal. The question is whether it would work as well as the current regime. Most macroeconomists prefer using interest rates when possible because rates can be moved quickly. It also allows this decision to be easily delegated to experts, which avoids party political influence getting in the way of macro stabilisation. However an obvious drawback of the current regime is that it cannot work when rates hit their lower bound, so in a bad recession you have to switch to fiscal policy. Labour’s fiscal rule hardwires that switch into policy.

If you are still reading you have probably decided by now that the debate between MMT and mainstream macro about whether to use fiscal policy all the time or just when interest rates hit their lower bound is pretty technical and best left to macroeconomists. I think that conclusion is correct. But why do many MMTers, as they are known, call Labour’s rule neoliberal? To understand this, you have to understand that MMT is far from just another school of macroeconomics.

MMT is also a political movement of the left. Mitchell himself supports Lexit. They are therefore naturally indignant that a Corbyn led government has adopted a rule that is derived from mainstream economics rather than adopting MMT. Their aim is to win a political as well as an economic battle. Pretty much anything is fair game in this political battle, including describing those like myself who defend Labour’s fiscal rule as neoliberal. (To see how ludicrous this charge is, see here.)

These attacks do however raise a legitimate issue. Why the need for a fiscal rule at all? Why not let the Chancellor choose the deficit depending on the economic circumstances? The answer is provided by something called deficit bias, which preoccupied economic policy before the global financial crisis (GFC). In the 30 years before this crisis, the ratio of OECD government debt to GDP almost doubled for no justifiable reason.

Deficit bias happens because politicians like cutting taxes or raising spending through borrowing, because it puts off any obvious economic pain. But if deficit bias does substantially raise the debt to GDP ratio, as it did before the GFC, then more debt requires paying more interest which in turn requires higher taxes or lower spending. Deficit bias does not avoid the downside of cutting taxes or increasing spending, it just puts it off until a later date. Deficit bias has not gone away. Donald Trump cut taxes for the rich, but he avoided a lot of political flack by doing this through borrowing.

Contrary to many alarmists in the City, the world does not come to an end if you have deficit bias. Deficit bias just makes life harder for future governments. So it is good practice, and a sign of fiscal responsibility, for governments to follow a fiscal rule. Nothing about this good practice need be neoliberal.

You can certainly make a fiscal rule neoliberal through asymmetry (deficits matter, but surpluses do not) and saying the only spending should be cut and not taxes raised to reduce an excessive deficit. Labour’s fiscal credibility rule does neither of these things. It targets the current deficit, leaving public investment free to meet public needs and benefit from low borrowing costs. The target only needs to be met in 5 years time and this period rolls forward. As a result the rule is compatible with the Chancellor enacting a modest stimulus during a mild recession. In a severe recession a fiscal stimulus is mandatory, making austerity impossible.

MMTers like to suggest that government spending could be higher under MMT than under the FCR. This is simply false if the MPC is doing its job. Indeed if higher interest rates reduce demand, as most empirical evidence suggests, for given taxes government spending will be higher under the FCR than under an MMT policy.

MMTers might argue that leaving interest rates decisions to a central bank is neoliberal. That charge has less force for the UK, where the Chancellor has complete control of the Bank’s mandate, than in the Eurozone for example. Delegation of decisions to experts is hardly neoliberal. Is the UK organisation that decides whether drugs are cost effective, NICE, a neoliberal organisation? There is a legitimate issue of what happens when experts fail to do their job, but that is an issue for UK monetary policy that has nothing to do with Labour’s fiscal rule.

MMTers over the top criticisms of Labour’s fiscal rule do however raise some serious questions about MMT. MMT has been important in the US in helping to counteract excessive concern among many Democrats about budget deficits, and in fighting nonsense that says we cannot afford to tackle climate change. However both points can be made using entirely conventional macroeconomics, as my article on the Green New Deal showed. Yet MMT also wants to be a revolutionary movement that overthrows mainstream macroeconomics.

There have been two revolutions in macroeconomics in the last 100 years, but both have brought major and radical new ideas to the table. As yet, MMT only offers ideas that can easily be expressed as part of the mainstream. For example using fiscal rather than monetary policy was a big debate when I was studying as an undergraduate more than 40 years ago. That does not make MMT’s ideas wrong, but they are certainly not revolutionary and they will certainly not replace the mainstream, even if MMTers call all their opponents neoliberal.









16 comments:

  1. Your mistake is in thinking that "neoliberal" means anything other than "not sufficiently Communist".

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  2. A light riposte...

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  3. With all due respect, your criticisms of MMT are based on your misunderstanding of how the fiscal monetary systems work with a sovereign that issues, borrows in, and floats its own currency. These continued misunderstandings are evident in this article as outlined below:

    RE: "... Bill Mitchell, ..., has run a relentless campaign against the FCR ... ..."
    • The reason for the nonacceptance of the FCR is that it is wholly inadequate and is based on fundamentally false assumptions.

    RE: "... Labour’s fiscal credibility rule is the first in the world to formalise this. If interest rates hit their lower bound, the normal rule is suspended and a fiscal stimulus occurs that is sufficient to end the recession. ... ..."
    • The truth is interest rates are a very ineffective tool in modulating economic activity. It's like pushing on a string. Increased rates have both stimulative and contractionary effects. Why rely on an ineffective tool and wait until you hit the lower bound to switch to fiscal policy? Bad idea. The solution is a JoB Gty as part of a Full Employment Fiscal Policy and incorporate counter inflationary taxes UP FRONT so they kick in immediately after inflation hits certain monthly inflation targets.

    RE: "... Deficit bias happens because politicians like cutting taxes or raising spending through borrowing, because it puts off any obvious economic pain. ...then more debt requires paying more interest which in turn requires higher taxes or lower spending. ...Deficit bias does not avoid the downside of cutting taxes or increasing spending,...Deficit bias just makes life harder for future governments. .... "
    • In plain sight: a demonstration of the misunderstanding of the flexibility of a sovereign that issues, borrows in, and floats its own currency.
    • The only downside is affects on inequality and potential inflation if things are overdone.
    • The truth is, the level of Federal Debt is totally irrelevant. It doesn't have to be measured much less reported. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.
    • Deficits/debt have no negative affect on future governments. See the blurb: https://fflorescpa.wordpressDOTcom/2018/07/28/the-kids-are-not-alright-the-truth-about-the-federal-debt-and-intergenerational-equity/

    RE: "...You can certainly make a fiscal rule neoliberal through asymmetry ... ..."
    • The entire issue is that the Fiscal Credibility Rule is totally measuring the wrong thing --> Deficits and Debt. That is the reason for the hostility of MMTers towards it. It's like making policy based on reading tea leaves. And in the meantime the things that DO matter: unemployment and national priorities are left to suffer. Labour should prioritize: FULL EMPLOYMENT, Green New Deal, Free Education. By adopting the Fiscal Rule, Labour is tying its own hands on not accepting the real flexibility afforded once one understands MMT. Kinda like Speaker Pelosi adopting the "Pay-For" rules in the US. Sad.

    RE: "... That does not make MMT’s ideas wrong, but they are certainly not revolutionary and they will certainly not replace the mainstream ... ..."
    • Mainstream economics' FUNDAMENTAL assumptions are wrong as outlined above and in the blurb here: https://fflorescpaDOTwordpressDOTcom/2018/07/28/financing-economic-solutions-to-unemployment-and-accompanying-social-problems/

    ReplyDelete
  4. POSTED AGAIN WITH NO LINKS.

    With all due respect, your criticisms of MMT are based on your misunderstanding of how the fiscal monetary systems work with a sovereign that issues, borrows in, and floats its own currency. These continued misunderstandings are evident in this article as outlined below:

    RE: "... Bill Mitchell, ..., has run a relentless campaign against the FCR ... ..."
    • The reason for the nonacceptance of the FCR is that it is wholly inadequate and is based on fundamentally false assumptions.

    RE: "... Labour’s fiscal credibility rule is the first in the world to formalise this. If interest rates hit their lower bound, the normal rule is suspended and a fiscal stimulus occurs that is sufficient to end the recession. ... ..."
    • The truth is interest rates are a very ineffective tool in modulating economic activity. It's like pushing on a string. Increased rates have both stimulative and contractionary effects. Why rely on an ineffective tool and wait until you hit the lower bound to switch to fiscal policy? Bad idea. The solution is a JoB Gty as part of a Full Employment Fiscal Policy and incorporate counter inflationary taxes UP FRONT so they kick in immediately after inflation hits certain monthly inflation targets.

    RE: "... Deficit bias happens because politicians like cutting taxes or raising spending through borrowing, because it puts off any obvious economic pain. ...then more debt requires paying more interest which in turn requires higher taxes or lower spending. ...Deficit bias does not avoid the downside of cutting taxes or increasing spending,...Deficit bias just makes life harder for future governments. .... "
    • In plain sight: a demonstration of the misunderstanding of the flexibility of a sovereign that issues, borrows in, and floats its own currency.
    • The only downside is affects on inequality and potential inflation if things are overdone.
    • The truth is, the level of Federal Debt is totally irrelevant. It doesn't have to be measured much less reported. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.
    • Deficits/debt have no negative affect on future governments.

    RE: "...You can certainly make a fiscal rule neoliberal through asymmetry ... ..."
    • The entire issue is that the Fiscal Credibility Rule is totally measuring the wrong thing --> Deficits and Debt. That is the reason for the hostility of MMTers towards it. It's like making policy based on reading tea leaves. And in the meantime the things that DO matter: unemployment and national priorities are left to suffer. Labour should prioritize: FULL EMPLOYMENT, Green New Deal, Free Education. By adopting the Fiscal Rule, Labour is tying its own hands on not accepting the real flexibility afforded once one understands MMT. Kinda like Speaker Pelosi adopting the "Pay-For" rules in the US. Sad.

    RE: "... That does not make MMT’s ideas wrong, but they are certainly not revolutionary and they will certainly not replace the mainstream ... ..."
    • Mainstream economics' FUNDAMENTAL assumptions are wrong as outlined above.

    ReplyDelete
  5. I think this article in fact proves MMT's point.

    Money is issued as debt through the private Banks, why is that necessary?

    In truth it is not, but is a Neo-Liberal policy allowing the private banks to make money for doing nothing.


    What is public debt.


    It is in fact an expression of people's and the nations savings.

    That debt could of course be wiped out at a single stroke of the Bank of England's pen.


    Most all of our money according to the Bank of England is created on a key board of a computer in private banks and did not exist before it was issued.


    We have trade deficits that stretch back all the way to Thatcher's reign so money is not increased by our trade with the rest of the world, until recently we averaged £4 billion each month, month in month out, meaning our so called exports have little impact on our economy other than not making the deficit even worse.


    Fiscal responsibility is a Neo-Liberal myth, when we allow the banks to issue money as debt, instead of investing in the needs of people.


    There is absolutely no need for the government to only issue money as debt. It can of course issue it directly into the economy where and when it's needed, and regulate the economy - yes by raising interest rates and also taxation.


    The idea of a government creating a fiscal surplus is also nonsense as it means that the private sector automatically has to go into deficit as it pays back money in taxation.

    What is ridiculous about the whole Neo-Liberal premise of fiscal responsibility is that it allows capitalists to extract as much profit out of the system it likes without any concern as to what happens to it after extraction, or why they need such levels of profit in the first place.

    Positive Money wants restrict private banks from issuing money as debt as a means of getting it into the economy, and only issue debt from it's own existing profits. With a commission issuing government investment directly where it is needed, presuming that all governments are spendthrifts, when it wasn't public expenditure that caused the crash, but those very private banks that issue money willy nilly.


    Neo-Liberal policies attack the very foundations of government and presume that the private sector knows best, which is of course a proven fallacy, and why Neo-Liberals never ever admit to being Neo-Liberal.











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  6. Thanks for this clear explanation.

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  7. “Why is the choice of setting interest rates delegated to the MPC? Getting this choice right is a highly technical task, requiring detailed discussions of different forecasts and macroeconomic models. If the MPC is working well, they bring strong expertise to the table to help make a decision.”

    Yes we all remember how Carney gave expert advice in Aug 2013 that interest rates wouldn’t rise until unemployment fell below 7 percent and how nine months later he ditched that guidance. I wasn’t surprised because I was aware that the school leaving age was in the process of being raised from 16 to 18. Apparently no one told the BOE and their economic modellers. There was a long period when the Bank’s inflation forecasts were consistently too low and they maintained low emergency levels of interest rates leading to damaging levels of house price inflation. The BOE and Carney predicted a recession and rising unemployment in the aftermath of a vote to leave the EU. Gove is right there is no evidence that so-called experts have any actual expertise.

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  8. In my experience, few MMTers consider the theory to be 'revolutionary', and the ones that do don't really understand MMT, or any other economic theory. Most MMTers simply state that it makes it much clearer how the economy really works than the neoliberal doctrine ever will, and that there is far more freedom-of-action available to a Government, especially in the Digital Age, to influence the economy positively than the "How-are-we-ever-going-to-pay-for-all-this?!?!?!?" brigade will ever admit.

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  9. Whats missing from this post is a statement at the start that says the economy of a nation issuing it's own free floating currency can be treated as a corner shop.

    "MMT is also a political movement of the left." No it's not.

    "As yet, MMT only offers ideas that can easily be expressed as part of the mainstream." No it doesn't, please read the literature.

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  10. Deficit bias meet financial repression

    A zero real pin on pub safe rate

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  11. Well, taking economic advice from experts is back in again.

    Now down here, we not so distantly had a British born (Lambeth), British educated (Queen's College, Oxford after a Rhodes Scholarship) chap who became Prime Minister and who declared: "we sub-contract too much out to experts already".

    No wonder the Australian economy is doing so very, very well. We might even have to provide a tax cut to the wealthy so that we can boost our debt even more.

    Best you should emigrate, Simon; a new world awaits you.

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  12. MMT has emphasized the reserves-adding function of government interest payments. However, it is open to a stimulating effect of low interest rates on debt-financed purchases of consumer durables. I am an MMTer myself, and I think that ultra-low-priced credit contributed to the ill-fated mortgage debt boom of the 2000s. For a while, the net effect was probably stimulative. However, one has to be clear about the nature of the stimulus, because high household indebtedness has implications for consumer balance sheets and economic performance in the medium term. Randy Wray agrees to my recollection.

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  13. Things Neo-Liberals have no answer to:

    1. Neo-Liberals never admit to being Neo-Liberal.

    2. Why would any sovereign government that issues its own currency ever need to borrow its own money?

    3. Why does a sovereign currency issuer need to tax people before it spends into the economy or on public services?

    4. Isn't it a red herring to talk in terms of levels of interest in a debate about a spending boost, meaning a sovereign currency issuer does not have to just issue money as debt?

    5. Why in the 21st century are we still talking about debt issuance, when we should only be talking about human and raw material resources?

    Just a few things real economists should be addressing.



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  14. Not an economist but my understanding of MMT is that it is a 'lens' through which the operational reality of economies becomes more clear. Specifically as regards monetary sovereign nations such as Britain and the US. As a result of this view, fiscal policies take precedence over monetary ones. Legislatures spend new money into existence and tax money out of existence. Debt is not a requirement in this set up and taxes play a different role too, particularly when it comes to financing federal spending. The correct fiscal balance then is whatever creates full employment and stable pricing. Positing a five year goal is putting the cart before the horse, in other words. MMT does not reject orthodox economics so much as it acknowledges the operational realities.

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  15. "Does this blog still have a comments section?". Six weeks now

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  16. I like the way as a non economist myself that Mervyn Hyde is able to summarise and clarify these blogs as I understand and believe that he should be chancellor. Where can I read more as sometimes Simon is too technical and then a few weeks ago it worsened when reference was made to Bill Mitchell and I started reading that blog and someone praising the Australian PM and his right wing views. We have had right wing and austerity for over 10 years in UK with more proven deaths among the poor and even a UN report. Now we are facing a Monty Python PM modelling himself on Trumpism and all its worst forms and a risk of Labour becoming labelled as still mixed up on Brexit.
    I watched some idiot last night assure the newsreporter that there is a "Wall of money waiting to be invested in UK " when we leave EU!!! What a load of manure. We are going down hill fast and we are already coz of Brexit in recession and we havent even got there yet.
    This is a sad period for the young of UK that is all I can say.

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