Will taxes have to rise?

That is the question addressed in this debate between Jonathan Portes and Bill Mitchell. I found the discussion very frustrating, because it is really a debate about medium term inflation forecasts dressed up as something more fundamental. Both Mitchell and Portes agree that there is no need for taxes to rise to ‘pay for’ the fiscal costs of the pandemic. In an age of ultra-low real interest rates, shocks to the debt to GDP ratio like the Global Financial Crisis and the pandemic should be allowed to gradually wither away as growth outstrips interest rates on that debt. Trying to reduce debt by running deficits close to zero, or even surpluses, as Osborne tried to do, threatens to derail a full recovery.

I think it would be fair to say that the argument from Jonathan Portes is that we should increase the share of current public spending in GDP in various ways over the next few years, and without higher taxes, or substantially higher interest rates, that will at some point lead to a permanent rise in inflation above target. To prevent that, taxes should rise. Bill Mitchell would agree that public spending should rise, but he doesn’t think inflation will rise as a consequence. If inflation did rise, it is standard MMT (at least according to Stephanie Kelton) that fiscal policy should be the “primary tool for macroeconomic stabilisation”. Thus the debate between the two on whether taxes should rise is essentially a disagreement about medium term inflation forecasts.

This point is illustrated in the final statement from Bill Mitchell. He writes:

“Should the government seek to command a far bigger share of productive resources—say, for a green transition—then, yes, perhaps tax rises would have a role in offsetting the extra spending and warding off inflation.”

Jonathan Portes might well respond that his argument is premised on just such a situation. In his opening statement he writes:

“And as well as more on the NHS and social care, structural economic shifts—from the aftermath of Covid-19 to decarbonisation—will mean more is needed for education and training. We don’t need higher taxes to pay for the virus; but the virus has exposed, economically, socially and politically, that we need them to build a better future.”

This illustrates that there is no disagreement in principle here, but just a disagreement about what levels of public spending increase would tend to lead to above target inflation. Indeed as these quotes suggest, there may not even be a disagreement here, but just a distinction between what should happen to public spending (Portes) and what is likely under current or prospective governments (Mitchell).

I want to argue that the whole debate about whether taxes should rise to pay for additional public spending is unnecessary. We can afford to wait and see. If inflation does appear to be permanently rising above target, you can be sure that the central bank will raise interest rates to bring inflation back down. Exactly when central banks should act is a live issue right now in the US, where the Federal Reserve has decided it will allow inflation above target for some time to ‘make up’ for inflation being below target in the past. But important though this change is, it remains the case that no independent central bank worth its salt is going to allow inflation to permanently rise above the inflation target.

It is only when central banks start raising interest rates in earnest that governments need to think about raising taxes. By raising taxes they reduce the pressure on aggregate demand and inflation, and therefore moderate the extent to which interest rates need to rise. It would be foolish for governments to make the same mistake that central banks made before the pandemic hit, and try and anticipate what might happen to inflation based on outdated ideas about the NAIRU. [1].

What about deficits? Isn’t good fiscal policy all about trying to achieve sustainable deficits (deficits that stabilise the government debt to GDP ratio)? As Jonathan Portes and I have argued, those rules should not apply when interest rates are stuck at their lower bound. When interest rates are at their lower bound, fiscal policy should become the primary tool for macroeconomic stabilisation. When interest rates are at their lower bound, standard academic macro and MMT should be on the same page.

While academic macroeconomists now generally accept that fiscal consolidation is a bad idea when interest rates are at the lower bound, the UK Treasury appears to think otherwise. There is much talk of tax rises or spending cuts to 'pay for the (fiscal) costs of the pandemic'. No doubt this will be justified by OBR forecasts and talk of structural deficits, just as it was in 2010. But whether its spending cuts or tax rises, fiscal consolidation coming out of a recession where interest rates are at the lower bound risks turning what should be a temporary downturn into a permanent fall in output.

[1] The changes at the Fed are welcome, because they address an error that central banks have been making since the Global Financial Crisis (GFC). Before that crisis, they tried to guess where inflation would go in the future by looking at forecasts and indicators like unemployment, and they were pretty successful at that. But, as some of us argued at the time, after the GFC it was foolish to continue in the same way, because the crisis had fundamentally changed the way the economy worked and because the risks of getting it wrong were asymmetric.

Bill Mitchell's fantasy about Labour's fiscal rule

My last post about outlandish attacks from some MMTers on Labour’s Fiscal Credibility Rule (FCR) was designed to be read by non-economists, and I didn’t want to bore them or waste space with all the fantasies Bill Mitchell has spread about the rule. But as I’ve had one of those fantasies tweeted back to me many times in response, I want to lay it to rest here.

That fantasy is that the Bank of England somehow has control of when the knockout happens. The knockout is when the rule is suspended and instead you have as much fiscal stimulus as is necessary to get the economy out of recession. It is triggered when interest rates hit their lower bound. At that point all monetary policy has left are unconventional policies, which are less reliable than fiscal policy, so it makes sense to go for a full fiscal stimulus. 

The way this simple rule has been spun by some is that it gives the Bank of England control over when the knockout is triggered. In reality the rule does no such thing. The Bank will have announced beforehand where the lower bound for rates is, and when a recession happens such that the Bank cuts rates to this lower bound the knockout is triggered. This is simple, unless of course you hate the rule because it is not MMT.

To see how MMters spin this as the Bank being in control of the knockout, you have to construct a fairy tale where the Bank is evil. Although they are supposed to do everything to end a recession, in this fantasy they have a higher calling, which is to impose austerity. So what the evil Bank does is announce that the lower bound is X, but when a severe recession hits they cut rates to X+0.25% and no further. They undertake all kinds of unconventional monetary stimulus but insist that rates are not at their lower bound, just because they do not want any fiscal stimulus.

What the fairy tale requires is that all 9 members of the Monetary Policy Committee (MPC), who actually set interest rates, collude to deceive the Chancellor and the public. In reality the M in MPC does not stand for Masonic - 4 of their members are external members. They would have to swear in public that the real lower bound is X and have to explain to parliamentary committees why rates have not been cut to X despite being in a major recession with rapidly rising unemployment and falling output.

I know many more past and current MPC members - both from the Bank and from outside - than I suspect Bill Mitchell does. What always impresses me is how seriously they respect the mandate they are given. They might have their individual views on fiscal policy, as Mervyn King did, but there is just no way they would collude to harm the economy because of those views. Most of those I have met are quite positive about the contribution fiscal policy can make in a severe recession, so they wouldn’t even want to deceive the public on this score even if they felt able to.

But let’s put all that to one side. After all I am sure MMTers would just say this shows I’m too much part of the elite, or I am incredibly naive, or whatever. Let’s just suppose this conspiracy happened. Each member of the MPC swore blind that rates were still not at their lower bound, and had concocted some kind of story about why rates should be kept above their lower bound despite rapidly rising unemployment and falling output etc etc.If all that happened, what would a Labour Chancellor do?

The Chancellor, together with much of the non-partisan press, would see what was going on. They would observe that in the middle of a recession the MPC were deliberately not cutting rates to the stated lower bound for no good reason other than a nefarious motive. The Chancellor would first embark on a temporary (less than 5 years) fiscal stimulus, which he is free to do under the FCR rule even without the backstop. If rates stayed at the same level for months as the recession continued, and the Bank embarked on all kinds of unconventional stimulus measures, the Chancellor would conclude, as any reasonable observer would, that the lower bound had been reached. The Chancellor would then invoke the FCR backstop, allowing him to expand on their original fiscal stimulus. Once the recession was over, I doubt very much that the current monetary framework would survive, which is yet another reason why no MPC would never embark on this fairytale.

MMters sometimes retort that the Chancellor would get political flack for triggering the backstop in this situation. In the middle of a recession with unemployment rising I doubt there would be much flack at all, besides the usual nonsense from the Tory press. But I find it supremely ironic that MMTers are prepared to use media reaction as an argument, as if the media reaction to any Chancellor adopting MMT would be all sweetness and light. Just imagine how abolishing the MPC, and saying taxes do not help finance spending, would go down with most journalists. People in glass houses shouldn’t throw stones.

Mike Norman Economics, commenting on my earlier post, says compared to Bill Mitchell I’m out of my league. That would be the league for telling fairy tales I assume. While one part of the left indulges in polemic and spinning fantasies against Labour policy, thankfully we have another part that is getting on with the serious business of preparing for a transforming government that will finally reverse what neoliberalism really is.

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.

MMT and Labour’s fiscal rule

I’m afraid this will probably only interest those familiar with MMT, but in its favour it has to me at least a surprising end. Bill Mitchell has been criticising Labour’s fiscal rule for some time, and my work that lay behind it (with Jonathan Portes) in particular. In one posts he says “Wren-Lewis just should stick to Twitter. He seems to like that. It would save us the time reading the other stuff.” In his latest post on the subject, after he met John McDonnell and his team, involves general assertions that the rule is neoliberal, but he does have two concrete criticisms. He has the following objection to a current balance target.

“But as I’ve written many times in the past, if a nation encounters a serious recession that results in a significant deficit, and then within the last years of the rolling window, it may have to introduce major cuts in recurrent outlays in order to move the recurrent balance towards zero.”

Now that is a cogent criticism of a fixed date rule, which does suffer from the danger of a recession just before its time period ends. The only problem is that Labour’s current balance target involves a rolling window. It is a target for the current balance (what Mitchell calls the recurrent balance) over the next five years. One year later it remains a target for the next five years. That is what ‘rolling’ means. So you never get caught out by an event ‘just before the target date’. With a rolling target this criticism makes no obvious sense.

Incidentally, this rolling window allows the government to pursue a countercyclical policy if it wishes to do so. The standard assumption is that mild booms and downturns are reversed by monetary policy within 5 years, so as long as the fiscal stimulus was not planned to last more than 4 years it is quite consistent with a rolling target. Whether government would want to when interest rates are doing the stabilisation is another matter.

What about a more major recession, where rates hit their ZLB. The rule’s knockout then applies, and fiscal policy becomes the primary stabilisation tool. This brings us to his second criticism.

“I noted that this was another neoliberal aspect of the approach. The reason for that conclusion is that the rule as stated requires the Monetary Policy Committee of the Bank of England to indicate to the Treasury that its monetary policy instruments are no longer effective. So in effect, the elected and accountable Chancellor can only enjoy fiscal freedom when the technocrats in the Bank of England handover the imprimatur to him. That is a basic Monetarist tenet – that monetary policy has primacy over fiscal policy. That is neoliberal central. Moreover, the MPC may not indicate monetary policy ineffectiveness, even if the target interest-rate is at zero (the so-called zero bound). As we have seen in the recent years, central banks have been willing to explore all sorts of weird and wonderful policy interventions to remain relevant in the macroeconomic policy sphere.”

Again its a cogent criticism. But this time Bill must know he is not talking about Labour’s rule, because he talked to Labour’s team. The MPC is asked to indicate when interest rates have reached their lower bound, not when they think all monetary policy instruments are ineffective.

MMTers on twitter tried to defend this line by saying the Bank might deliberately deceive. But think what that would have to involve. In a major recession the MPC would keep rates deliberately high and claim that they could cut them if they wished, but they do not wish to do so. I think the concern in that rather fantastical scenario is whether the MPC is any longer fit for purpose.

For much of the time I was arguing with MMT twitter about all this Bill Mitchell was copied in, but he did not respond to my criticisms of his post. But at one point he did send me this about a particular tweet I wrote

“Stop slandering me or you will face the legal consequences. I have nothing to do with the way others behave on Twitter.”

This is a first for me at least. Given this threat I cannot tell you what I wrote that provoked that, or give you a link to it, because I cannot afford a court case. Of course Bill Mitchell is not responsible for what his twitter followers say, but he is responsible for his distortions about what Labour’s fiscal rule says. I have criticised the way he argues his case in his defence of Lexit here.

After that threat I did then take the opportunity of asking him why he distorted his description of the ZLB knockout in the way I describe above, but he never replied. I wrote this about MMT and its followers, and these events only confirm this view.

How to spot fraudulent economic arguments: an example from Lexit

When I last talked about Lexit, I said Lexiter arguments had “many structural similarities to right wing arguments for Brexit.” In this post I want to go further and suggest ways you can spot when economic arguments are fraudulent, using an article by Thomas Fazi and William Mitchell advocating Lexit as an example. To show how generic the tactics are, I will demonstrate how exactly the same techniques were used by those who argued for austerity.

The first sign that the wool is being pulled over your eyes is wildly exaggerating your opponents case. It is so much easier to attack a straw man. This particular article talks about the “Left’s anti-Brexit hysteria” i.e anyone who disagrees with us is acting hysterically. They talk about those opposing Brexit predicting “Brexit Armageddon”. The tactic works particularly well if you can find an example of someone who did exaggerate their case, and focus on how their fears have not come to pass.

I am very familiar with this tactic from the UK in 2013. From 2010 to 2012 growth was very low, and the expected recovery from the Great Recession did not materialise. People like myself blamed austerity, and we were quite right to do so. But some in 2012 made the foolish claim that the economy will never start growing again unless austerity came to an end. So when growth returned to trend in 2013, proponents of austerity used those claims to announce the critics were wrong and austerity had been vindicated. The example that Lexiters and Brexiters alike use is of course the Treasury short term post Brexit forecast.

That forecast was not about the longer term impact of Brexit, but uncertainty about the prospect of Brexit. It overestimated the immediate impact of Brexit. But the real question is not whether forecasts were wrong, but whether the Brexit announcement and subsequent uncertainty has damaged the UK economy. The article says the economy is still growing, and quotes some other selected statistics, implying all is fine. They do not mention that we have gone from the top to the bottom of the international growth league. Of course they cannot avoid acknowledging that sterling fell sharply on announcement. However they say but this has not destroyed the British economy: another straw man (who ever seriously said the depreciation would destroy the economy?!), and no mention of what the depreciation did do, which is cut the real incomes of workers. The debate over whether Brexit uncertainty has harmed the economy is over, as no one seriously thinks it has not. 

A second sign of a fraudulent argument is to focus on a single study that supports what you want to say, and ignore all the rest. The Brexiters have Minford of course, but Lexit have the study by Coutts, Gudgin and Buchanan (CGB) published by the Centre for Business Research (CBR) at Cambridge. Those advocating austerity had two well known papers: one suggested there was empirical evidence that high government debt reduced growth, and the other that austerity was expansionary. In all these cases the studies are outliers, so you need some reason why the majority of academic work can be discredited.

This leads to a third tactic: tar academic work that goes against what you say with some broad assertions that have only a grain of truth. If your audience has a political bias, play to it. With austerity it was that those against austerity were old fashioned Keynesians who just wanted a larger state. (Some were, but most were just using a much more modern Keynesian framework and its macroeconomics implications.) The way this paper does the same with the many studies that have suggested Brexit will be harmful in the longer term is so laughable I have to quote it:

“The neoliberal biases built into these models include the assertion that markets are self-regulating and capable of delivering optimal outcomes so long as they are unhindered by government intervention; that “free trade” is unambiguously positive; that governments are financially constrained; that supply-side factors are much more important than demand-side ones; and that individuals base their decision on “rational expectations” about economic variables, among others. Many of the key assumptions used to construct these exercises bear no relation to reality.”

It will be news to most trade economists whose work is the basis of the long term case against Brexit that they are assuming things like governments being financially constrained and rational expectations. A key part of why Brexit is a bad idea is the gravity equation, which says trade is more likely to take place with neighbouring countries. It is a robust empirical relationship that makes no assumptions about governments or markets at all. [1] The article pours scorn on the ‘neoliberal’ idea that openness to trade is good for the economy, and again neglects to say that the relationship linking openness to productivity growth is also empirical, not theoretical.

Another tactic that if you see being employed you should start to worry is to impugn the motives of your opponents. That may be a common enough tactic in political discourse, but not if you are trying to make a serious economic argument. It is notable how academic economists who have criticised the Brexit work of Minford for example do not try and suggest he is ideologically motivated. Being good academics they instead question the model he uses (e.g. no gravity) and how he uses it. That is what should be done. But this article tries to discredit the current government’s analysis of the impact of Brexit by implying the results have been fiddled to produce large numbers for the long term costs of Brexit. They write:

“The models are notoriously unreliable and easily manipulated to achieve whatever outcome one desires. The British government has refused to release the technical aspects of their modeling, which suggests they do not want independent analysts examining their “black box” assumptions.”

Apparently the current UK government do not want us to see their workings because if we did we could see how they had fiddled results to make Brexit look bad. The attempt in this case is again laughable, because this government is pro-Brexit so any fiddling would go the other way.

All these four signs are easy to spot. The fifth is less obvious to the non-expert, which is to inconsistently use lots of broad brush statistics that do not get the heart of the issue, or which are problematic for other reasons. For example in arguing that Brexit has had as yet little impact on the economy they quote unemployment data, just as the government did from 2013 to argue that the economy was strong as a result of austerity. It is problematic because strong employment growth coupled with weak output growth means poor productivity. As I noted here, current productivity growth performance in the UK is worse than it has been for centuries.

In terms of broad brush statistics, they argue that GDP growth has been weaker rather than stronger than post-war trends as a result of EU membership, as if nothing else had been going on in all these years. The reality is that we joined the EU in part because our post-war growth and particularly productivity was worse than most other countries, and from the 1980s onwards it has if anything been better than other major countries. But why look at GDP rather than exports, where you would expect the impact of EU membership to be clearer. In fact the CGB study they quote from extensively does exactly this, and the following chart shows the results.

The benefits for UK exports of being in the single market are clear from this data. (To see how the CGB study erroneously avoids this conclusion, see here.)

There are of course plenty of Brexit specific points as well (the article does not even mention the Irish border), but this post is long enough already. I wrote it because it struck me when reading the Fazi and Mitchell article how similar its rhetorical devices were to those of many who tried to sell austerity. So if you read anything that wildly exaggerates the opposing position, focuses on a single academic study and ignores the rest, particularly if it suggests that there is some generic problem with these other studies which may include the motives of those who did them, and if it uses broad brush statistics when it could have used data that was more relevant, beware that you may be reading a piece of political persuasion rather than serious analysis.

[1] The confusion is compounded when they quote Paul Romer’s criticism of macroeconomics, and then drop the macro bit to pretend that Romer was talking about the whole of economics.

The dangers of pluralism in economics: the case of MMT

MMT (Modern Monetary Theory) is a ‘school of thought’ in economics, by which I mean that it deliberately sets itself apart from the mainstream. I like a lot about MMT as a set of ideas. On the key issue of whether monetary or fiscal policy should be used as the main stabilising tool, although I go with the mainstream in looking to monetary policy outwith the lower bound, I think that issue should always be kept open, and too many mainstream economists just presume that monetary policy must be better. I am also attracted to the idea of some version of a Job Guarantee type scheme, and the mainstream has often failed to recognise the amount of autonomy the banking system has to create demand. I could go on but you get the idea. As I result, I have tried probably more than most mainstream economists to engage with MMT ideas.

As far as I can see there is nothing in MMT that cannot be presented using standard mainstream tools. But I also know that the microfoundations hegemony in mainstream macro excludes many, like MMT economists, who would prefer to do macro in different ways. I dislike the microfoundations hegemony for reasons I have set out elsewhere. For that reason I cannot argue that MMT, or any other school of thought, should be part of the mainstream, because right now it would be impossible because of the microfoundations hegemony. [1]

Having said all that, I think MMT sometimes demonstrates many of the dangers of a school of thought. It tends to be antagonistic to the mainstream, and some (not all) of its leading lights give their followers the idea that the only truth is to be found within MMT, and everything the mainstream says has to be wrong. That proposition is so absurd but I can understand why it can be believed. It was a long time ago, but I was told as a student that neoclassical economics was fundamentally flawed, and would soon be replaced in some kind of Kuhnian revolution. I know how easy it is to follow your political instincts and thereby miss out on so much important and useful knowledge.

It is very difficult not to come across MMT followers (MMTers) if you write a blog on macroeconomics. Most recently this happened when I wrote this on Trump’s tax cuts. Now unusually this post examined how to discuss these tax cuts split into two parts: one which followed the mainstream view where monetary policy controlled inflation, and another that described an MMT view where fiscal policy controls inflation.

My post was criticised by some MMTers on twitter. Not because I had got the MMT part wrong, but because I had argued in the mainstream part that a deficit generated by a tax cut could alter the intergenerational distribution of income. Now this idea is standard, but it can confuse, because you cannot transfer real resources (output) through time in a closed economy. I show how it can be done in an overlapping generations framework here. It is much easier to see how it can happen in an individual open economy, because a generation can consume overseas goods as well as domestically produced goods.

If that all seems a bit abstract, it is also important. I have argued in the past that one of Margaret Thatcher’s failures was to give taxes from the North Sea back to consumers (who spent rather than saved them) instead of following Norway in creating a sovereign wealth fund. Subsequent generations have therefore been deprived of the benefits of North Sea oil. By giving tax cuts funded by borrowing, governments can do the opposite of creating a sovereign wealth fund: future generations inherit more government debt which they have to service.

Those MMTers criticising my blog said such intergenerational transfer was impossible. I tried the best I could to explain why it was possible, but the responses I got ranged from intelligent denialism to simple insults along the lines that I was neoliberal, I didn’t care about the working class and so on.

I’m used to that kind of interchange as a result of Brexit. But there was an important difference here. I was not attacking MMT, but outlining how things work in a mainstream view. So I was not attacking their school or their politics. They had no reason to be defensive. But it was clear to some that I was the enemy simply because I was not an MMTer. This very tribal attitude reflects one of the dangers of plurality in economics. Another is language. MMTers have their own way of describing things, so if you say something like a ‘tax financed increase in government spending’ you are jumped on: according to MMT tax never finances spending, but follows it, or something like that. I don’t mean to make fun, and I can see what they are trying to do, but talking separate languages is a key problem when you have different schools of thought, particularly if you insist that only your language is the right language.

Another problem is that schools of thought also tend to be political. As a result, to use Paul Romer’s phrase, all too often scientific discourse is replaced by political discourse. To some of these MMTers because I was a mainstream economist I had to be neoliberal, as if those two things had to go together. The idea that deficits could redistribute income between generations moved from being an economic statement to a political one. Presenting models that showed how it could happen meant those models had to be unrealistic, without specifying why that lack of realism mattered to the issue in hand.

It is a shame, because these MMTers are clearly interested in economics because of their political interest, so I would love them to be discussing both mainstream as well as MMT ideas. I probably spent too much time on twitter with them as a result. Those that tell them the mainstream is neoliberal and a waste of time are in my view almost criminal because that attitude leads to such a waste of enthusiasm and interest.

It does not have to be like this. I have had plenty of good discussions with MMT academics and some supporters which I have found interesting. They have been courteous and not aggressive. But not all the leading lights in MMT encourage these things. Such as those who write

“Wren-Lewis just should stick to Twitter. He seems to like that. It would save us the time reading the other stuff.”

He wrote that, and worse still which I will not repeat, because he is angry that Labour have adopted a fiscal rule based on my own work with Jonathan Portes rather than MMT’s ideas. Actually I didn’t enjoy the conversations he is referring to at all, and I should have stopped much earlier because it was a waste of time, but as I said above it is a shame to see people who have closed themselves off to so much interesting and, for them, politically useful knowledge.

As I said, I do not blame anyone being in a macroeconomic school of thought because the current mainstream is exclusionary. Many MMTers are open and my discussions with them have been interesting for me at least. But unfortunately some in MMT appear to want to make it a kind of cult, where only MMT sees the truth and everything in the mainstream is neoliberal and wrong. They attract followers because of their politics, but then they turn their followers into converts with closed minds. Which I think is a real shame and completely unnecessary, because MMT is strong enough to stand on its own feet and encourage open minded thinking, not dogma.

[1] I do not think that is the only aspect of the mainstream that excludes other schools. There is too little room in mainstream journals to discuss policy or history in a discursive, holistic way. I happen to like the way most mainstream economists use models to discuss issues, but sometimes it is useful to make sure we are not abstracting from what is really important.

Some thoughts about the Job Guarantee

Mainly for economists

The idea of the state stepping in during a recession to offer some group of the unemployed a job was selectively adopted by the UK Labour government in 2009: see here by Paul Gregg. Richard Layard has proposed it for the long term unemployed. We can think of both schemes as providing a partial insurance policy against the failure of countercyclical stabilisation policy to completely do its job in a downturn/recession. But MMT (Modern Monetary Theory) economists go beyond that to suggest that it could be a permanent feature, which would eliminate involuntary unemployment (IU) without creating inflation.

Given our recent experience, the use of a Job Guarantee as an insurance policy for all unemployed people during a recession seems like a good idea. Unwanted leisure is replaced by labour producing useful output, and paying a wage greater than unemployment benefits would add to automatic stabilisers. The devil is of course in the detail: JG jobs need to be setup to allow job search (many jobs are created even in a recession) or (if necessary) retraining and the JG jobs would need to involve an output that was socially useful [1]. The main problem that Gregg discusses in his paper is the ‘Lock-in’ effect, where those in a JG job reduce their search activity. To combat that and for other reasons it also seems helpful to provide detailed individual advice along the lines of the Swedish scheme described here.

MMT economists have suggested extending such a scheme so that it operates at all times. As I understand it any worker without a job would be offered a JG job. It can be refused with no consequences in terms of unemployment benefit, so it that sense it is not workfare. Many people who were confident of getting another job quickly might want to focus all their spare time on job search, and so might decline a JG job. Anyone who wanted a job could receive one, so the scheme would largely eliminate involuntary unemployment (IU). [2] In the rest of this post I’m going to focus on this idea of JG as being a permanent feature of an economy, rather than just something put in place during an economic downturn.

A key issue is what the JG wage would be. In most MMT literature I have seen, the JG wage would be the minimum wage or better: see Mitchell here for example. There seems to be an obvious consequence of this. Unfortunately many private and public sector jobs are paid the minimum wage. These jobs are risky whereas JG jobs are by definition permanent. Minimum wage non-JG jobs may have compensating advantages like a career structure, but still it would seem probable that the existence of JG jobs paying the minimum wage would attract some workers from private sector minimum wage jobs.

The obvious response would be for private and public sector employers paying minimum wages to increase their pay sufficiently to stop this happening, which in turn would often lead private sector firms to raise prices. How far this ripples through the economy is not certain [3], but it is quite possible that the overall price level rises by a noticeable amount. This higher aggregate price level would reduce the real value of the JG wage. If this reduced wage differentials in the economy as a whole this process might be regarded by some as beneficial, but it is an implication that JG advocates need to acknowledge.

A perhaps more serious concern is the impact of the JG on inflation. What is conventionally believed to prevent policy makers expanding demand sufficiently to eliminate all IU is that to do so would embolden workers to ask for greater pay increases, generating an inflationary spiral. The existence of IU, and the possibility of joining their number. becomes a threat that keeps inflation stable. In a JG economy that threat is greatly reduced, both because an alternative job is always available and it will pay more than unemployment benefit. (JG and the lock-in effect will also reduce geographic mobility, although the other side of that coin is that joblessness would not be a feature of deindustrialisation.)

Suppose we start with an economy with stable inflation, implying unemployment was at the NAIRU, and introduce JG.. As this puts upward pressure on inflation because the costs of losing a job are reduced. the only way of keeping inflation stable is to deflate demand, which of course would reduce output, labour demand and therefore increase the number of people on JG jobs. So if we were to compare two economies where inflation was stable, one with IU and one with JG, the number of JG jobs would exceed IU in the other economy.

That does not mean that output would necessarily be lower in the JG economy, because JG workers are producing some kind of socially useful output while the IU workers are not. In welfare terms you have also eliminated any non-pecuniary costs associated with spells of unemployment, and the distribution of income in the JG economy is more equal than in the IU economy. However in practice the productivity of JG workers will be pretty low, as they need to be allowed time for intensive job search and the turnover in JG jobs is likely to be high. We have a trade-off, and if anyone can point me to any analysis of this particular trade-off I would be very grateful.

Can I end with a personal plea. When I write things like this it is often assumed by MMTers that I am being critical for the sake of it. In other words they think all I want to do is attack the JG or MMT. I don’t. I have far better things to do with my time. I actually find the idea of JG appealing at an intuitive level. More generally I agree with MMT on many things, although not all. But I am also fed up with policy makers implementing bad policies just because they sound good to those policy makers, so I want to subject any policy I intuitively like to rigorous analysis.

[1] JG jobs could be as assistants in police stations, schools and other public sector institutions. Or they could be jobs in social enterprises.

[2] Keynes defined involuntary unemployment as those seeking a job at the going real wage. As JG jobs would be at the minimum wage it would not eliminate all involuntary unemployment defined in this way: as I noted those looking for a higher than minimum wage job who chose to stay unemployed would still technically be classed as involuntarily unemployed. But this is being a little pedantic.

[3] Mosler and Silipo (section 7) talk about the JG wage as a nominal anchor. This captures the idea that movements in the JG wage would influence other wages. However nominal anchors, like the money supply or the exchange rate, are often talked about as being able to control the aggregate price level in the longer term on their own. The JG wage would not be able to do this. As the authors note, active stabilisation policy would still be required to do this, although the number of JG jobs could be a useful indicator of what action was required, just as the unemployment rate is now. Another way of saying the same thing is that the JG does not supplant the need for active macroeconomic stabilisation.

Japan and the burden of government debt

I don’t write enough about Japan, and now that some of my posts are very kindly being translated into Japanese I should try to remedy that. In fact there is currently a very good reason to write about the Japanese economy, and that is a very strong 2017 Q2 performance. Annualised growth was 4%, compared to 1.2% in the UK. What is particularly heartening about recent Japanese growth is that it is led by domestic demand rather than trade. In the past Japan seemed to have the opposite of the UK’s problem: growth was often led by trade, while domestic demand was weak.

This recent growth is not just making up for poor past performance compared to other countries. Comparisons of GDP growth are misleading for Japan because (unlike the UK and US) it has relatively little inward migration, so it is better to use GDP per head for such comparisons. (As Noah Smith points out, even this my bias comparisons against Japan because its population is aging.) Between 2006 and 2016, Japan increased GDP per head by a total of about 5.5%, compared to around 5% in the US and about 3% for the UK. Good compared to other countries, but all these countries should have had stronger recoveries from the recession.

Strong growth is good news because inflation is so low (around 0.5%): way below the 2% inflation target. The government is trying to stimulate growth using a modest fiscal stimulus and large scale quantitative easing (short and long interest rates are exactly zero) as well as implementing various structural reforms. But the striking thing about all this is that their net government debt to GDP ratio is 125% and rising (OECD Economic Outlook measure). This is higher than any other OECD country except Greece and Italy.

Does the conjunction of relatively strong growth and high government debt confound economic theory, as Bill Mitchell suggests? Like high powered money and inflation, any relationship between government debt and growth just does not work when interest rates are stuck at zero. High government debt could crowd out private investment (although some dispute this), but not when real long term rates are zero and inflation is near zero. Servicing high debt could discourage labour supply, but again not when interest rates are zero. Nor is debt a burden on future generations when the real rate of interest is well below the growth rate.

Of course most people think such high debt levels are a real concern because of ‘the markets’. But the markets will only stop buying this debt if they expect default or rampant inflation, and there is no way a government with its own currency can be forced to default. There is also no way it will choose to default with interest rates so low. This is the basic truth that our leaders in the UK choose not to tell us (and pretend otherwise).

But what happens when growth finally raises inflation, and interest rates rise. Will debt not be a problem then? Maybe, but only in the long term, so the government will have plenty of time to fix that roof when the sun shines. [1] Right now Japan does worry about its high levels of government debt, but it rightly worries about the combination of low growth and low inflation much more. In that sense it sets a good example to other countries.

[1] Fixing the roof while the sun shines is one of the Cameron/Osborne little homilies I approve of. The problem when they used it was the UK economy was actually in pretty poor shape, as we could tell because interest rates were so low.