Getting back to full employment: reconfiguring monetary and fiscal policy: Part One.


This chart is for the UK though the graph for the whole of the developed countries looks similar. If updated for the most recent times it would be gradually trending up by now, but not in any danger of returning to anywhere near the pre-crisis trendline.

The developed world is moving towards its eighth year of constant under-performance, though in both the US and the UK, a sufficient part of the hit has been in the form of lower than otherwise income growth (except for those at the top) enabling unemployment to fall to tolerably low levels. But everywhere the hit to income has been huge. And growth remains sluggish with governments committed not to expanding budgets but to repairing them and to repairing their legacy – government debt. Meanwhile monetary policy sits with overnight cash rates with central banks at or near zero. (Note, this post is not about Australia’s situation because our interest rates are positive. To avoid zero interest rates official macro-economic policy makers are pursuing a doctrine that targets higher unemployment. As I observed here, it’s a new idea that this could be the best we can do. Of course it could be. But call me old fashioned, but I thought that was to be demonstrated – you know with coherent economic models and that kind of thing – but then I’m not even invited into the Qantas Captain’s Club, so what would I know?).

Meanwhile central banks have tried one innovation – quantitative easing (QE). The hard money cranks think it’s a terrible idea. But plenty of thoughtful people are worried too. This argument is often put by people who think that – as Lady Bracknell said of statistics – markets are sent for our guidance. It’s hard not to see it as a theory that financial markets don’t really work. Ironically the ‘left’ Keynesian Hyman Minsky argued that too much prosperity eventually undermined itself as it fed the gradual infection of the market with speculation and more and more elaborate financial engineering and deception – what J.K. Galbraith referred to as the ‘bezzle‘. Meanwhile many scolds of keeping cash rates low argue that too little prosperity – too depressed a money market – leads to the same thing via the search for yield. Each seems to be arguing that private financial markets are pretty unstable things that are ill-adapted to promoting the common good.

Even without this, QE does seem to have some nasty bugs. It’s inefficient. If investment is being held down by depressed ‘animal spirits’ then lowering interest rates – including longer term interest rates which is what QE targets – can only address that very indirectly. Investment is usually depressed in recessions and depressions because of a lack of demand for final outputs – addressing that would be the direct way to get investment returning to a more normal share of economic activity. Meanwhile QE is funded by central banks creating money with which they support the price of assets owned by wealthy people and if the central bank is successful, one presumes it sells back the assets at lower prices – as growth resumes, interest rates return to more ‘normal’ higher levels and so the price of the assets falls. The public has used the money it’s manufactured to buy high and sell low! (This wouldn’t follow if QE involved buying shares which might well rise in such circumstances, but QE has hitherto involved the central bank purchase of high quality income bearing assets.) So QE unfair and inefficient – exactly the opposite of what we’re after here at Club Troppo.

The alternative is ‘helicopter money’ in which the central bank manufactures money – as it does with QE – but lavishes it on the ‘real’ not the financial economy. It could do it directly itself – sending out cheques (or in Milton Friedman’s original example dropping notes from a helicopter) – or more usually via the government – by funding some government outlay or a tax holiday. It’s always seemed to me that QE has been restricted to asset markets for the essentially arbitrary reason that it makes more sense given the historical development of central banking rather than because that restriction makes economic sense. The central bank is seeking to inject money into the system which state of affairs it believes will be temporary. But doing it through asset purchases is sufficiently indirect a way to act on the economy that the ‘temporary’ nature of QE could last an awfully long time (as we are discovering). Money created and directly spent in the economy seems much more likely to get things going.

Still if that’s the case, there’s a bug as I explained elsewhere:

In normal times it seems that ‘traditional’ ways of thinking of budget deficits might operate quite neatly to encapsulate the constraints on governments trying to optimise economic management. So printing more money might get you out of a recession, but then, once a recovery gets underway, you’ve got a lot of extra money sloshing around which you need to withdraw from the system – which you’d do by taxing more and/or reducing government spending. But that’s what you’d have to do if you’d debt financed your way out of a recession – loosening fiscal policy (borrowing to run a deficit) and then tightening fiscal policy (running a surplus and repaying some or all of the debt) after the event.

This perhaps explains why those proposing helicopter money seem to have been so tentative. One such has been former head of the Financial Services Authority, Adair Turner, Baron of Ecchinswell (why he was rejected for a knighthood by our former Prime Minister we can never know). Anyway, on the eve of his departure from the FSA Turner gave a lengthy speech which finally worked up the courage to say that maybe, in some circumstances, though not in these circumstances, we should entertain the idea of seriously considering money finance – sometimes called helicopter money. I haven’t looked it up but it was something of a cause célèbre at the time. Since then, unburdened by the position (though presumably with the interests of the kind people of Ecchinswell remaining firmly in his mind) and as a faculty member and now Chair of the governing board of George Soros’s (IAEIPNET) Institute for Already Extremely Important People engaging in New Economic Thinking he has written a book and plenty of columns on the idea.

He’s a smart guy whose writing I appreciate because he seems to wrestle with perhaps not knowing his subject as well as the best academics (it’s such an immense, technical and conceptually tricky area), but nevertheless has the courage to make proposals and risk making a fool of himself – not unlike your humble correspondent here at Troppo. However, though I’ve not read his book, I have read quite a few of the columns and the reticence remains. He concluded in a recent column that:

amid the confusion, the one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible.

As I’ve already half done the job, I’ll address the task Baron Turner has set in part two.

To be continued …



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Geo Bray
Geo Bray
8 years ago

Excellent, Lord Gruen.

derrida derider
derrida derider
8 years ago

Yep, its now eight years in which most professional macroeconomists have been arguing that, bluntly, we need a lot more money put into the economy by government spending – best directly but failing that by helicopter money. And eight years in which most of the Very Serious People in governments have been talking utter crap about “debt emergencies” and “when the people have to tighten their belts, government should too” and “hyperinflation risks”.

To me it has been deeply shocking that, aided and abetted by a press in the pocket of narrow financial interests (what Simon Wren-Lewis calls “mediamacro”), they’ve gotten away with it. Where their real motive is of course, on the one hand to shrink government, and on the other to maintain an overmighty financial sector. The class interest has been blatant.

And this bit about “monetary financing is used only in an appropriately moderate and disciplined fashion” is crap too; the big risk to our economies is in doing too little, not too much, as experience has shown. A burst of inflation a couple of percentage points above central bank targets is exactly what we need and will do far, far less damage than staggering along at sub-2% growth for a lost decade or more, which is what the alternative has been shown to be.