It was the last day of the 12th Path to Full Employment Conference/17th National Unemployment Conference in Newcastle, which I host. The papers were interesting all day and I will report on some of them another day. But overnight, the big news was that the US Senate has finally succeeded in forcing the US Federal Reserve Bank to release details of more than 21,000 transactions it made as a reaction to the rapidly escalating global financial crisis. The lending rose to $US3.3 trillion at its peak and dwarfs the volumes involved in QE1 and QE2 amounts. This is relevant to a debate in the banking literature about the separation of monetary policy functions (setting interest rates) and the broader monetary interventions we have been witnessing in this crisis, which bear close similarity to fiscal policy functions. The question is which macroeconomic policy functions should be accountable to the ballot box. My view is all of them!
The UK Guardian wrote in the article (December 2, 2010) – US Fed lent $3.3tn to multinationals, billionaires and foreign banks – that:
The global credit crunch of 2008 ran deeper and wider than previously disclosed, forcing the US government to fund firms including General Electric and Toyota, along with banks and billionaire investors, according to documents released by the Federal Reserve. As well as its well-publicised support of the banking system, the Fed’s aid reached far beyond Wall Street, offering finance to the motorbike manufacturer Harley-Davidson, the industrial equipment maker Caterpillar, the telecoms company Verizon and even the computer billionaire Michael Dell as it struggled to keep the economy going. The lending reached $3.3tn (£2.1tn) at its peak.
The disclosures show that UK banks were major beneficiaries of the Fed’s extensive support for foreign banks. Barclays was the biggest borrower under one scheme, the term auction facility, taking loans totalling $232bn, which it has since repaid. Royal Bank of Scotland, Bank of Scotland (now part of Lloyds), Abbey National and HSBC also received billions in loans.
The “only self-described socialist” in the US Senate – Bernie Sanders – has been running a one-man attack on the secretive Federal Reserve released a statement coinciding with the release of the information (December 1, 2010).
Almost two years ago I asked Chairman Bernanke to tell the American people which financial institutions and corporations received trillions of dollars as part of the Wall Street bailout. He refused. Today, as a result of an audit-the-Fed provision I put into the financial reform bill, we finally learn the truth – and it is astounding.
These revelations have invoked all sorts of Wall street sentiments and xenophobic worries that the Federal Reserve has “become the central bank of the world?”
It is clear that the “loans” are examples of corporate welfare and look to be fiscal in nature. The question is why is the central bank becoming a fiscal authority (and escaping the scrutiny of the legislature and the political process in general). Further, were these the best places to extend fiscal largesse? Would the US gained more from widespread public sector job creation programs?
At least these issues might have been discussed more if the legislature had have been involved. So the question generalises to a matter of appropriate governance.
As an aside, perhaps it is lucky that the US legislature was not involved given how chronically debilitated it has become!
The US Federal Reserve announcement is interesting in light of research that the Bank of International Settlements has been publishing recently. In a recent BIS working paper – Minimising monetary policy – there was discussion of “non conventional monetary policy” exposing central banks to what the BIS call “central bank fiscal risk”. The point that emerges is that the central banks have been acting as “quasi-fiscal” agencies (BIS terminology) which appears to violate the neo-liberal, inflation targeting consensus which have hamstrung treasuries in their use of fiscal policy.
The BIS is worried about potential losses from such central bank interventions but even more worried about “how monetary policy independence may be preserved through a shrinking of the monetary authority balance sheet and transfer of market intervention responsibilities to an alternative governance structure”.
The BIS paper said that:
Prior to the crisis, monetary policy in the advanced countries was undertaken almost exclusively through indirect influence on short term money market rates. Financial market interventions requiring the injection of large amounts of central bank liquidity had become rare. Confronted with the “zero lower bound” on interest rates, central banks during the crisis have resorted to unconventional policies or balance sheet management to achieve policy goals. Financial market stress has also been remedied by historically large interventions by central banks. Even in those cases where the monetary base has not expanded, central banks have expanded their role in financial intermediation.
Note that the pursuit of these “non-conventional” interventions beg the fiscal capacity that is always available to a sovereign government and can provide sufficient demand support to prevent a financial crisis becoming a real crisis. The fact that the global financial crisis morphed (fairly quickly) into a full-blow real crisis is due to the inadequate and delayed fiscal responses from treasuries rather than any limitations imposed by zero lower bound monetary policy.
The other point that should be borne in mind is this faux concept of “central bank independence”. This is a neo-liberal construct that attempts to de-politicise macroeconomic policy and thus promote monetary policy ahead of fiscal policy as the optimal tool of intervention. While this might satisfy conservative political sensibilities the underlying reality is that the central bank and the treasury are part of the consolidated government sector in the Modern Monetary Theory (MMT) parlance.
Please read my blogs – Central bank independence – another faux agenda and The consolidated government – treasury and central bank – for more discussion on this point.
The transactions conducted by both components of the consolidated government sector with the non-government sector can be “vertical” in nature (changing net financial asset positions in the non-government sector). Transactions conducted between agents (institutions etc) in the non-government sector can never change the net financial position of that sector. That is a crucial difference and needs to be a starting point for anyone seeking to understand the way the monetary system operates.
But as we will see in terms of what the BIS call central bank fiscal risk – there is no independence of the central bank – even if the BIS would not put it in this way.
So what is this concept of central bank fiscal risk?
The BIS say that:
In their unconventional operations, central banks have taken on greater risk of a fiscal nature than had heretofore been the case and exposed themselves to potential losses. The question discussed in this section is whether the size of potential losses could take on a macroeconomic dimension, ie become so large that losses must be financed with money creation beyond what is compatible with the monetary authority’s inflation target.
The claim is that macroeconomic stability is threatened if the central bank loses what they call “financial strength” which they suggest is related to being able to “achieve its policy objectives without recourse to treasury financial resources”. Note that in the US the treasury has the power to issue the currency which is not the usual arrangement in the advanced world where the central bank has this capacity vested in it. Either way, the central bank cannot become insolvent in any meaningful way.
Please read my blog – The US Federal Reserve is on the brink of insolvency (not!) – for more discussion on this point.
What the BIS seem to be worried about – which reflects its ideological dislike of base money creation. In relation to this, the Paper explicitly says the issue is not that a central bank might have negative capital. The Paper notes that in several nations (Chile, Czech Republic) central banks have kept operating “successfully” with negative capital. So they claim if the US central bank sought currency input from the US treasury it would signal a lack of financial strength. I find that demarcation or construction artificial and unnecessary.
MMT would suggest that the government issues the currency and it is largely irrelevant how this is administratively organised. The fact is that the currency-issuing capacity provides a tool for government to advance its socio-economic aims. The question should be how to ensure the government uses that capacity appropriately rather than to either deny it has that capacity or that the “tool” should be kept hidden and not used (and saved for emergencies).
There is no sense in the idea that the currency issuance capacity of the government sector should be an emergency operation.
The BIS Paper constructs the central bank as a “business” in saying that:
It is evidence that for the central bank intertemporal budget constraint to hold, the revenue obtained in the steady state from net interest-earning assets must be sufficient to finance central bank operational expenditures at the target inflation rate. If interest revenue is consistently inadequate to cover operating expenditures, any of five outcomes is possible: currency issuance is increased in order to generate additional seigniorage, thereby jeopardising the attainment of the inflation target; the inflation target is relaxed for similar reasons; an injection of capital is obtained which may impair central bank independence; operational expenditures are reduced to bring the central bank budget back into a sustainable equilibrium; or more risk is taken in the management of central bank assets, which may not be prudent.
So the ideological bias is evident. It is automatically assumed that expansion of the monetary base will be inflationary. What is underpinning that result? Two erroneous concepts: (a) the Quantity Theory of Money; and (b) the money multiplier.
Both theories/concepts are plain wrong and I have covered them in detail in other blogs – for example – Money multiplier – missing feared dead – Money multiplier and other myths – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.
Further biases are revealed in the claim that a added “treasury” capital “may impair central independence”. Note the use of the qualifier “may”. The point is that the central bank is not independent from the treasury despite all the political assertions to the contrary. In Australia, for example, the elected parliament can overrule an RBA decision and the government appoints the central bank board.
Finally, the “business approach” is reflected in the statement that the central bank might engage in even riskier behaviour if it is facing losses. Why would it do that given that it knows that it is part of the government sector and cannot be made insolvent.
You get the feel for how compromised the paper really is when after discussing ways in which loss exposure might arise they say:
Even in this incredibly high-loss scenario, in only the case of the Bank of England (BoE) is there reason to be concerned with the macroeconomic level of losses. However, the BoE is largely indemnified by the UK Treasury for potential losses; thus, it is not plausible that it would have to assume losses of that magnitude.
QED. So the issue is just that they have an ideologically-based problem with the fact that the central bank is really part of the government sector and that means it enjoys access to the currency-issuing capacity of the economy.
Then we get to the nub of the paper which claims that:
The second important dimension of fiscal risk is political. That is, the issue is not that central bank losses would directly interfere with the attainment of monetary policy goals, but that political pressure might be brought to bear on operational independence as a consequence of the central bank straying into what would appear to be expenditures of a fiscal nature. Therefore, even if central bank operations are fully collateralised and generate ex post profits, legitimate questions may be raised as to why, for example, the housing market was supported and not automobile manufacturers, airlines or farmers. Similarly, why were certain institutions perceived to have been “rescued” and others allowed to fail?
So the BIS has an objection to the workings of democracy and the currency-issuing capacity of the government being used to reflect the political debates. Advocating structures that compromise the capacity of the government sector to respond to fluctuations in aggregate demand in a meaningful manner is a typical neo-liberal position but should be exposed for what it is – an ideological dislike of government intervention rather than a technical issue of financial solvency or macroeconomic stability.
The use of public funds should also be subject to intense scrutiny from the citizens and the current reluctance of the US Federal Reserve to release all its transactions is consistent with the “independence” mantra but destructive of democratic outcomes.
The problem then becomes one of the blurred boundaries between a monetary operation and a fiscal intervention. The former are not typically restricted by the parliament whereas the treasury operations are always scrutinised by the normal process of governance (the budget process). But the situation becomes more complicated because the distinction between “monetary and quasi-fiscal operations” (both central bank operations) may become blurred.
In situations where the central bank is acting in a quasi-fiscal manner, the argument is that “legislatures may, with some justification, wish to bring central bank operations under their control, much as they govern fiscal policy”. The BIS believe this “may lead to an unintended and undesired constriction of monetary policy operational independence”.
In an address to a Conference co-hosted by the People’s Bank of China and the Bank for International Settlements in Shanghai (August 8, 2009) the Governor of the Bank of Japan said:
The fourth issue is the fine line between monetary policy and fiscal policy … when central banks try to create “productive” policy measures, in an environment where the effectiveness of traditional monetary policy is constrained, they naturally come close to the area of fiscal policy. As a result, the policymakers need to face up to the issue of who should be responsible for such policy actions in a democratic society.
In my view any aggregate policy instrument should be the responsibility of an elected official for democracy to have any meaning. Any policy change that can affect the standard of living of a citizen should be able to be traced back directly to an elected person. The monetary policy arrangements now violate that principal.
The neo-liberal agenda – pushing the primacy of inflation-targeting monetary policy and eschewing fiscal interventions has progressively undermined the connection between policy settings and their outcomes and the ballot box. I stand for a close link between the two.
I also do not see this in terms of being able to split monetary and fiscal policy neatly. So it is not a matter of blurred boundaries – it is all macroeconomic policy.
The BIS paper claims that typically it is “not difficult to separate monetary and fiscal policies” especially now that central banks set interest rates. But in the current crisis:
… the previously broad line between fiscal and monetary policies in the advanced economies became extremely thin and in some cases invisible, when financial stability concerns led to the adoption of unconventional central bank operations.
The Paper considers fiscal policy to be about “resource allocation at the micro level” which just demonstrates how blinkered the view is. The macroeconomic dimensions of fiscal policy are eschewed along with mainstream reasoning (allegedly because it is “ineffective”) and so tax and spending policy is about microeconomic reform.
It is clear that the central banks have changed the way they operate during the current crisis. In 2009, the US Federal Reserve “did not conduct a single conventional repurchase operation in 2009, whereas prior to 2007 this was virtually the only actively used instrument”.
Several other central bank operations have moved it closer to being a “fiscal” authority which have “allocative” implications. The BIS are less concerned with the “potential quasi-fiscal cost of the operations”. They argue that “credit policies” (government lending whether by Fed or Treasury) are a form of fiscal policy because they use “public sector’s balance sheet to alter the allocation of resources”.
The BIS paper differentiates between central banking and monetary policy functions and governance structures. It says that:
… we may think of monetary policy as “interest rate policy”: the process by which an operational interest rate target is set and liquidity conditions managed to achieve a close correspondence between a market rate and the target rate so as to meet an inflation objective. Central banking may be thought of as intervening in identified markets or institutions to affect relative prices or to provide liquidity, thereby improving market or institution functioning.
They argue that the controversy is not about monetary policy but about central banking. They provide an extended discussion of how the mainstream monetary literature has not developed the difference between the two concepts very well.
But once you differentiate then the issue of “the possibility of different governance structures with different degrees of independence” arises.
This is the main point of the paper. They say:
we can conceive of a “third” governance structure operating in the grey area between monetary and fiscal policies. We can also begin to differentiate among the different policy instruments that may be assigned to those governance structures, the corresponding financial resources with which they may be endowed and their accountability frameworks.
So the monetary policy operations should be vested in an “independent” institution. But they argue that there should be a separation of the monetary policy authority and the central banking decision-making structures to allow financial stability experts to guide the latter body and monetary specialists to guide the former.
The “market intervention authority (MIA)” would not have currency issuance capacity but could issue government-guaranteed debt with the aim “to preserve market stability through interventions in financial markets”. It would become the lender of last resort and could take credit and interest rate risk.
Where would this organisation sit – within the central banking structure or as a role for treasury? In terms of the functions described, various countries have adopted various arrangements within that choice.
They note that:
In Norway, the principle that operations implying a fiscal or quasi-fiscal risk must be financed by the central government was affirmed during the current crisis, when the government assumed the risk onto its own balance sheet: “… funding support for banks came from the government’s balance sheet, not as loans from Norges Bank. This provided transparency … The Norwegian measures were designed in such a way that Norges Bank’s balance sheet has not increased to the same extent as that of a number of other central banks
This is closer to my conception. The central banks should not be engaged in “fiscal” type transactions although these transactions are more effective in manipulating aggregate demand than interest rate (monetary) policy.
The paper concludes that “limiting the risk to monetary policy independence requires that those central bank assets and operations not intimately related to conventional monetary policy be removed rapidly from the monetary authority balance sheet and placed with national treasuries” or a separate authority in between the two.
The underlying motivation of the paper is to preserve “independent monetary policy” but when “fiscal resources are placed at risk outside the national budgetary framework” the case for independence is less clear.
They say that:
In the light of contentious political debates over fiscal policy it is not evident that the political champions of central bank independence intended to provide central banks with “fiscal” independence … Should political authorities find current central bank activism an affront to their legislative authority, a backlash might ensue which could lead to a curtailing of monetary policy independence. For this reason, it may be wise to develop an alternative governance structure to handle the “banking” or, in the modern financial system, “market-making” roles that central banks have taken on during the current crisis, and thereby preserve monetary policy independence.
I reject the mainstream case that there have been benefits from independent monetary policy which really translates into the benefits of inflation targeting.
In this blog – Inflation targeting spells bad fiscal policy – I demonstrate that the empirical case for inflation targeting has not emerged. There has been very little difference in the outcomes for targeting and non-targeting nations.
The real damage of inflation targeting (monetary policy independence) has been the way in which fiscal policy has been subjugated and rendered passive.
Monetary policy independence is mainstream-speak for passive fiscal policy and that has been a major contributor to the current crisis and the drawn out nature of it. We should abandon that mindset and recognise that the government has a range of macroeconomic tools available to it which includes setting interest rates, net spending and an array of other policies (for example, margin limits, etc).
Once we achieve an understanding of how the government can utilise its tools to advance public purpose (maximise the potential of its citizens etc) then we soon realise that the “independence” agenda is a smokescreen to reduce the capacity of the government to use these tools.
A tool is not intrinsically evil or dangerous – which is how the mainstream economists tend to cast fiscal policy. The array of macroeconomic tools that the government has available to it are very powerful. That is their attraction and value.
The task is to ensure the politicians we elect use them appropriately to advance our collective interests.
In that context, artificial distinctions between monetary policy agencies, broader monetary intervention agencies and treasury agencies are irrelevant and counter-productive. All functions should be directly related to ballot box accountability. Yes, the government might stuff up through incompetence or chicanery. But we should be able to kick them out in the not so distant future.
Important macroeconomic policy functions should never be vested in unaccountable, unelected bureaucracies.
I have had a full day hosting the Conference and so I will leave it at that.
The Saturday Quiz will be available some time tomorrow.
That is enough for today!