The IPPR Commission’s plan for a new economy

The final report of the IPPR’s Commission on Economic Justice is released today, with the full title of Prosperity and Justice: A Plan for a New Economy. [1] I was lucky enough to get an advance copy, and it is a very impressive document: very well researched and well argued. It is nothing less than a blueprint for a new progressive government. Of course there are some proposals I have doubts about, but it is sufficiently authoritative that in future anyone should ask of any progressive economic programme how does it relate to the recommendations of this report.

As far as my own area of monetary and fiscal policy is concerned, I’m not sure I have seen in one place as clear and comprehensive a summary of the lessons of the recent past and a better set of proposals for the future. I wrote about an early draft of this chapter in April, so I will be brief here. Their proposed fiscal rule separates current and investment spending, but suggests the ONS and OBR look to obtain a measure of spending that helps future generations that is better than the national accounts definition of public investment. They suggest a substantial increase in public investment, while current spending in constrained by a rolling five year target for balance. However they suggest that if interest rates are stuck at their lower bound, the focus of fiscal policy (current spending and taxes as well as investment) should be stimulus. Readers familiar with this blog will know this is very similar to the proposals in Portes and Wren-Lewis, 2015 and the Labour Party’s fiscal credibility rule.

For monetary policy they suggest ending the primacy of inflation, and adding underemployment and nominal income as primary targets. In addition, they suggest that QE involve creating money directly to expand the activities of a National Investment Bank (NIB) when a large macroeconomic stimulus is required. Note that, unlike a fleeting proposal by Corbyn, money creation to expand the NIB remains a call made by the independent Bank of England in a recession rather than by the NIB itself or anyone else. I would go further on the Bank’s mandate, but otherwise the IPPR’s proposals look eminently sensible.

The chapter on industrial policy seems sensible, with some ideas from Mazzucato (e.g. public sector led missions) clearly evident. Beside the NIB already mentioned, there is an emphasis on direct support rather than via the tax system (e.g. patent box) which often have large deadweight losses. They argue an industrial strategy should not just be about helping and adding to innovation clusters based around universities, but also in increasing productivity in what they call the ‘everyday economy’. In my view it is higher productivity and not greater union bargaining power that will raise real wages in a sustainable way, although in other areas a greater union presence can be helpful (see below).

For many one of the most interesting ideas - of course not new - is to end the shareholder model, and replace it with a stakeholders model where workers have an influence on the board and executive pay. It represents a move from a US to a more European model. While I find this argument fairly convincing, the idea under reforming the financial system that the Financial Policy Committee (FPC) of the Bank should target house price inflation is misconceived. What the economy needs is falling house prices, and once you make house prices a target the pressure will be to stop that happening.

The idea of a citizen’s (social) wealth fund is interesting, but I’m not sure a strong case for it is made here. Why should a government hold assets and issue debt, for example? If you want to redistribute wealth from the wealthy old to the poorer young, why not do so directly? On tax the proposal to combine income tax and national insurance seems sensible, as is the idea of a replacing bands with a formula based system (as in Germany). The same goes for a lifetime gifts tax to replace inheritance tax, and a land value tax.

There is so much else in the report, but let me end by talking about one issue: executive pay. There is a cute chart in the report that I reproduce below.

The report starts, quite rightly in my view, by emphasising the dangers of inequality. It also suggests that this cannot just be tackled ‘after the fact’ i.e. by tax and welfare measures. But will the stakeholder measures talked about above, or greater union influence, be enough to reverse runaway corporate pay? The rise of the share of the 1% starts with the advent of a neoliberal US and UK, and it has made the rest of us noticeably poorer. The report involves reversing many aspects of neoliberalism, but an interesting question is whether that is enough to achieve a decline in the 1% share, or whether other measures like higher top taxes are an essential part of doing that?

It is a fascinating report for anyone interested in a progressive economic policy. Do read it.

[1] This is a personal nostalgic footnote, which I am only writing because I could not easily see this information online. New Economy also happened to be the title of the IPPR’s journal in the early 1990s, which is now called Progressive Review. I remember it well because between 1993 and 1995/6 I wrote a number of articles for it based around simulations of the macroeconometric model I had developed with Julia Darby and John Ireland. The idea to do that came from IPPR’s Economic Director Dan Corry, with Gerry Holtham as overall Director at the time. Apart from members of the modelling team, Rebecca Driver helped write a number of the articles. The first article over that period had the title “What’s so Bad about Borrowing?” (plus ça change), and the last “Avoiding Fiscal Fudge” which proposed an independent fiscal institution or fiscal council for the UK. That took 14 years to come to fruition, and I hope many of the proposals in this report do not have to wait so long.

Macroeconomic Policy Reform the IPPR way

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) [1], 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 interest rates.

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 targets.

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: see here.) 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 [2] 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. [3] 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.

[1] 'Effective' because in practice it is up to the central bank to decide at what point they cannot reduce nominal rates further. 

[2] 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.

[3] I hope time inconsistency can be subsumed under this broad definition.

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. 

People's QE and Corbyn’s QE

Politicians can be adept at co-opting attractive sounding terms to their own cause, even when they distort their meaning while doing so. Osborne announced what was in reality a partial but large increase in the minimum wage, but he called it a ‘living wage’. This was especially devious, as calculations of the actual living wage take into account the tax credits that Osborne was at the same time cutting.

Is Labour leadership contender Jeremy Corbyn’s ‘Peoples QE’ an example of the same thing? It is certainly true that the way that some macroeconomists, including myself, have used the term is different from Corbyn’s idea. For us Peoples QE is just another term for helicopter money. Helicopter money was a term first used by that well known radical Milton Friedman. It involves the central bank creating money, and distributing it directly to the people by some means. It is a sure fire way [1] for the central bank to boost demand: what economists sometimes call a money financed fiscal stimulus.

The idea has been recently revived, most prominently in the UK by Adair Turner, because of the failure of conventional monetary policy (changing interest rates) to bring a quick end to the Great Recession, which in turn is because governments were undertaking fiscal austerity (a bond financed fiscal contraction) rather than fiscal stimulus. In contrast central banks in Japan, the US and UK, and now the Eurozone, have been creating money to buy financial assets (mainly government debt), which is called Quantitative Easing (QE). Hence the term People’s QE for helicopter money: instead of the central bank creating money to buy assets, it creates money and gives it to the people.

The genesis of Corbyn’s QE seems rather different. Corbyn adviser Richard Murphy had previously suggested what he called a Green Infrastructure QE, which is that a “new [QE] programme should buy the new debt that will be issued in the form of bonds by the Green Investment Bank to fund sustainable energy, local authorities to pay for new houses, NHS trusts to build new hospitals and education authorities to build schools.” This in turn is related to two ideas: first a near universal view among macroeconomists that public sector investment in infrastructure should be rising not falling when interest rates are low and labour is cheap, and second that a National Investment Bank (NIB) might be useful in helping to encourage private sector investment. (See, for example, the recommendations of the LSE growth commission.)

The main difference between helicopter money and Corbyn’s QE therefore seems to be where the money created by the central bank goes: to individuals in the form of a cheque from the central bank, or to financing investment projects. I think that is wrong, and to see why we need to ask an obvious question: what is this policy innovation designed to achieve. I think it is here that confusion has arisen.

As I noted above, the idea behind helicopter money is to provide a tool for the central bank to use when interest rate changes are no longer possible or effective. With an independent central bank, that means that they, not the government, get to decide when helicopter money happens. In contrast, if your goal is to increase either public or private investment (or both) for a prolonged period, then its timing and amount should be something the government decides. While QE is hopefully going to be something that is unusual and rare, the goal of an investment bank is generally thought to be more long term, and not something that only happens in severe recessions.

For that reason, Corbyn’s QE looks like one of those ideas that is superficially attractive because it seems to kill two birds with one stone, but on reflection turns out to be a bad idea. If we want to keep an independent central bank we do not want the government putting the bank under pressure to do QE because the government wants more investment, and if that does not happen we do not want the central bank deciding whether extra investment happens. Indeed some of those who dislike the idea of helicopter money have already been using Corbyn’s QE to say ‘I told you helicopter money was a slippery slope that would lead to the end of central bank independence’.

However I think it is unfair and unproductive to leave it there. Suppose that a NIB is created, not on the back of QE but using more conventional forms of finance. (If the government wants to encourage it, just directly subsidise that finance with conventional borrowing. Don’t be put off doing so by deficit fetishism.) Suppose we also like the concept of helicopter money - not for now, but for the next time interest rates hit their lower bound and the central bank wants more stimulus. In those circumstances, it might well make sense for helicopter money to be used not only to send cheques to individuals, but also to bring forward investment financed by the NIB, or public sector investment financed directly by the state. If those investment projects could get off the ground quickly, and crucially would not have happened for some time otherwise, then what I have elsewhere described as ‘democratic helicopter money’ would make sense. [2] This is because investment that also boosts the supply side is likely to be a far more effective form of stimulus than cheques posted to individuals.

So one day, this form of Corbyn’s QE could happen. But we need to get the idea of helicopter money, and the need for public investment and a National Investment Bank, accepted in their own right first. Putting the two ideas together right now is misconceived, and is in danger of discrediting two potentially good ideas.

[1] Unless you believe in complete Ricardian Equivalence

[2] When I put forward the idea of ‘democratic helicopter money’ here to Tim Harford, Tim responded that he thought it was probably the most radical and politically infeasible idea of those he had canvassed. If Corbyn wins, I will have pleasure in reminding him of that!