I was a signatory to a letter published in the Financial Times on Thursday (March 26, 2015) – Better ways to boost eurozone economy and employment – which called for a major fiscal stimulus from the European Central Bank (given it is the only body in the Eurozone that can introduce such a stimulus). The fiscal stimulus would take the form of a cash injection using the ECB’s currency monopoly powers. A co-signatory was Robert Skidelsky, Emeritus Professor, Warwick University, renowned Keynesian historian and Keynes’ biographer. Amazingly, Skidelsky wrote an article in the UK Guardian two days before the FT Letter was published (March 24, 2015) – Fiscal virtue and fiscal vice – macroeconomics at a crossroads – which would appear to contradict the policy proposal we advocated in the FT Letter. The Guardian article is surrender-monkey territory and I disagree with most of it. It puts the progressive case on the back foot. What the hell is going on?
For those who do not have access to the Financial Times, here is the text of the letter:
Sir, The European Central Bank forecasts unemployment in the eurozone to remain at 10 per cent even after €1.1tn of quantitative easing. (FT View, March 25). This is hardly surprising: the evidence suggests that conventional QE is an unreliable tool for boosting GDP or employment.
Bank of England research shows that it benefits the well-off, who gain from increasing asset prices, much more than the poorest. In the eurozone, where interest rates are at rock bottom and bond yields have already turned negative, injecting even more liquidity into the markets will do little to help the real economy.
There is an alternative. Rather than being injected into the financial markets, the new money created by eurozone central banks could be used to finance government spending (such as investing in much needed infrastructure projects); alternatively each eurozone citizen could be given €175 per month, for 19 months, which they could use to pay down existing debts or spend as they please. By directly boosting spending and employment, either approach would be far more effective than the ECB’s plans for conventional QE.
The ECB will argue that this approach breaks the taboo of mixing monetary and fiscal policy. But traditional monetary policy no longer works. Failure to consider new approaches will unnecessarily prolong stagnation and high unemployment. It is time for the ECB and eurozone central banks to bypass the financial system and work with governments to inject newly created money directly into the real economy.
The Bank of England research we referred to in the letter was published on July 12, 2012 – The Distributional Effects of Asset Purchases.
The intent expressed in the FT Letter is straightforward.
I wrote about Overt Monetary Financing (OMT), which is the latest terminology for central bank fiscal action in this blog – OMF – paranoia for many but a solution for all – and it features in my soon to be published book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.
OMF recognises that the usual monetary policy changes which involve variations in interest rates are relatively ineffective in stimulating a recessed economy.
When households are worried about losing their jobs and firms declining to invest in new productive capital because the sales outlook is depressed, cutting interest rates will not stimulate a large demand for credit.
Further, those who rely on fixed incomes are disadvantaged by a reduction in interest rates.
It is also clear that fiscal policy is very effective – it introduces spending capacity directly into the economy, which stimulates sales, employment and allows households to save more if they are exposed to large debt levels.
OMF breaks the link between fiscal deficits and the common voluntary practice in the neo-liberal era where governments match their deficits with debt issuance to the non-government sector.
It is clear that there is a significant misunderstanding of the debt issuance process. But even though increased public debt levels are of little relevance to the health of the economy, given that a currency issuing government can always meet its liabilities denominated in the currency it issues and that debt issuance is just tantamount to the government borrowing back past deficits, there is still massive public hysteria surrounding this matching process.
The Eurozone is different, in the sense that at the Member State level, the matching of fiscal deficits to debt issuance is not voluntary but a required outcome of surrendering their currency sovereignty.
Further, a Member State of the Eurozone can clearly become bankrupt if it cannot issue debt at times they are running fiscal deficits. The corollary of that observation is that any debt they issue is subject to credit (default) risk, which is not a problem besetting nations that maintain their own currencies.
So, within the logic of the Eurozone, there is some sense to the debt hysteria. Too much debt will stampede the bond markets, which will then not be prepared to absorb any further credit risk at going yields and the debt issuance process for the single Member State becomes problematic.
That is, as long as the central bank (the ECB) refuses to take on the responsibilities that a central bank in a currency-issuing state assumes in order to ensure the economy is not subject to entrenched stagnation and the financial sector (banks etc) are not at risk of insolvency.
But the ECB, like any central bank, can create currency units (in this case, euros) at zero marginal costs – that is, out of thin air – and can never go broke, not even if all its ‘assets’ were degraded in value to some negative value.
Please read my blogs – The US Federal Reserve is on the brink of insolvency (not!) and The ECB cannot go broke – get over it – for more discussion on this point.
So even though the flawed design of the Eurozone places restrictions on the Member State governments with respect to fiscal policy latitude, which are compounded by the voluntary fiscal rules known as the Stability and Growth Pact (SGP), the central bank (the ECB) has all the latitude it needs to issue currency (and buy as much government debt as it likes in the secondary bond markets).
Even though the Treaty governing the common currency prohibits so-called ‘direct’ bailouts of struggling governments, there is nothing in the Treaty that says the ECB cannot issue currency and make it available to whomsoever it chooses.
Of course the idea that the central bank would just create liquidity which could be used to purchase goods and services is considered taboo by most nearly everyone. All of which who do not fully understand what would be involved anyway – and if they did the taboo would be gone immediately.
I raised the following question in my forthcoming book: how can a relatively simple monetary operation between a central bank and its corresponding treasury department (both part of what we can call the ‘consolidated’ government sector) possibly be considered a taboo?
‘Overt Monetary Financing’ (OMF), simply means that in some form or another, the treasury arm of government tells the central bank it wants to spend a particular amount and the latter then ensures those funds are available in the government’s bank account for us.
Various accounting arrangements might accompany that action. For example, the treasury might sell the central bank debt some government bonds which match the value of the funds put in the government’s bank account.
In the FT Letter we propose OMF in this form as well as just giving out a demogrant (a payment of a certain sum to every citizen) for a period. No holds bars. Just get the credit in the bank account and spend it if you like.
Almost certainly a significant portion would be spent. Governments could also use the funding to offer job creation programs (human infrastructure development) and fix degraded public infrastructure.
It is a win-win.
Abba Lerner clearly understood this. Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.
His second law of Functional Finance advocated the central bank using OMF to match government deficit spending sufficient to achieve and sustain full employment. The idea is very simple and does not involve any printing presses at all.
While the exact institutional detail can vary from nation to nation, stylistically, governments spend by drawing on a bank account they have with the central bank. An instruction is sent to the central bank from treasury to transfer some funds out of this account into an account in the private sector, which is held by the recipient of the spending.
A similar operation might occur when a government cheque is posted to a private citizen who then deposits the cheque with their bank. That bank seeks the funds from the central bank, which writes down the government’s account and the private bank writes up the private citizens account.
All these transactions are done electronically through computer systems. So government spending can really be simplified down to typing in numbers to various accounts in the banking system.
When economists talk of printing money they are referring to the process whereby the central bank adds some numbers treasury’s bank account to match its spending plans and in return is given treasury bonds to an equivalent amount in value.
That is where the term ‘debt monetisation’ comes from. Instead of selling debt to the private sector, the treasury simply sells it to the central bank who creates new funds (or financial assets) in return.
This accounting smokescreen is, of-course, unnecessary. The central bank doesn’t need the offsetting asset (government debt) to function given that it creates the currency ‘out of thin air’.
So the swapping of public debt for account credits is just a convention.
The taboo element relates to what Lerner said is an “almost instinctive revulsion … to the idea of printing money, and the tendency to identify it with inflation” but that:
… we calm ourselves and take note that this printing does not affect the amount of money spent. That is regulated by the first law of Functional Finance, which refers to inflation and unemployment.
In other words, it is spending that creates the inflation risk. And as long as total spending is at the appropriate level specified above, then “printing money” will be an appropriate accompaniment to total government spending.
The point to note is that the inflation risk lies in the spending not the monetary operations (debt-issuance etc) that might or might not accompany the spending.
All spending (private or public) is inflationary if it drives nominal aggregate demand faster than the real capacity of the economy to absorb it.
Increased government spending is not inflationary if there are idle real resources that can be brought back into productive use (for example, unemployment).
Related propositions include the claims that issuing bonds to the central bank, the so-called ‘printing money’ option, devalues the currency whereas issuing bonds to the private sector reduces the inflation risk of deficits. Neither claim is true.
First, there is no difference in the inflation risk attached to a particular level of net public spending when the government matches its deficit with bond issuance relative to a situation where it issues no debt, that is, invests directly.
Bond purchases reflect portfolio decisions regarding how private wealth is held. If the funds that we used for bond purchases were spent on goods and services as an alternative, then the budget deficit would be lower as a result.
Second, the provision of credit by the central bank (in return for treasury bonds) will only be inflationary if there is no fiscal space.
Fiscal space is not defined in terms of some given financial ratios (such as a public debt ratio).
Rather, it refers to the extent of the available real resources that the government is able to utilise in pursuit of its socio-economic program.
Further, hyperinflation examples such as 1920s Germany and modern-day Zimbabwe do not support the claim that deficits cause inflation. In both cases, there were major reductions in the supply capacity of the economy prior to the inflation episode.
So if the ECB takes our advice, the Eurozone malaise would disappear very quickly and much of the current angst about Greece and other depressed economies would be over. Instead, there could be a genuine dialogue about growth and job creation and renewed prosperity.
What has this to do with Robert Skidelsky?
Well despite his name appearing on the FT Letter alongside my own (and others), just two days before our letter was published he wrote an extraordinary article in the UK Guardian – Fiscal virtue and fiscal vice – macroeconomics at a crossroads – claiming that:
Keynesians have to face the uncomfortable truth that the success of stabilisation policies may depend on the business community having Keynesian expectations. They need the confidence fairy to be on their side.
Which is an astounding retreat for Skidelsky, who in the sentence before admitted that he was as a “Keynesian”, he “firmly … [believes] … that market economies need to be stabilised by policy.”
The article’s logic is this:
1. “After the financial crisis of 2008 erupted, we got the Great Recession instead. Governments managed to limit the damage by pumping huge amounts of money into the global economy and slashing interest rates to near zero.”
2. Then “they ran out of intellectual and political ammunition.”
3. Why? Because the “Keynesian remedy … ignored the effect of fiscal policy on expectations.”
4. Which means? “If public opinion believed that cutting the deficit was the right thing to do, then allowing the deficit to grow would annul any of its hoped-for stimulatory effect.”
Logic point 4 is referring to the mainstream notion called Ricardian Equivalence.
For more discussion on this point, please read my blogs:
In a bizarre reversal of logic, neoliberals talk about an ‘expansionary fiscal contraction’ — that is, by cutting public spending, more private spending will occur.
This assertion comes with the fancy name of ‘Ricardian Equivalence’ but the idea is simple: consumers and firms are allegedly so terrified of higher future tax burdens (needed, the argument goes, to pay off those massive deficits) that they increase saving now so they can meet their future tax obligations.
Increased government spending is therefore met by reductions in private spending—stalemate.
But, neoliberals argue, if governments announce austerity measures, private spending will increase because of the collective relief that future tax obligations will be lower and economic growth will return.
In the literature, the economic models that make these bizarre predictions rely on some tight assumptions, which have to hold in entirety for the logical conclusions to follow.
Should any of these assumptions not hold (at any point in time), then the Ricardian models cannot generate the predictions and any assertions one might make based on this work are groundless – meagre ideological statements.
First, capital markets have to be ‘perfect’, which means that any household can borrow or save as much as they require at all times at a fixed rate which is the same for all households/individuals at any particular date. So totally equal access to finance for all.
Clearly this assumption does not hold across all individuals and time periods. Households have liquidity constraints and cannot borrow or invest whatever and whenever they desire. People who play around with these models show that if there are liquidity constraints then people are likely to spend more when there are tax cuts even if they know taxes will be higher in the future (assumed).
Second, the future time path of government spending is known and fixed. Households/individuals know this with perfect foresight. This assumption is clearly without any real-world correspondence. We do not have perfect foresight and we do not know what the government in 10 years time is going to spend to the last dollar (even if we knew what political flavour that government might be).
Third, there is infinite concern for the future generations. This point is crucial because even in the mainstream model the tax rises might come at some very distant time (even next century). There is no optimal prediction that can be derived from their models that tells us when the debt will be repaid. They introduce various stylised – read: arbitrary – time periods when debt is repaid in full but these are not derived in any way from the internal logic of the model nor are they ground in any empirical reality. Just ad hoc impositions.
So the tax increases in the future (remember I am just playing along with their claim that taxes will rise to pay back debt) may be paid back by someone 5 or 6 generations ahead of me. Is it realistic to assume I won’t just enjoy the increased consumption that the tax cuts now will bring (or increased government spending) and leave it to those hundreds or even thousands of years ahead to “pay for”.
Certainly our conduct towards the natural environment is not suggestive of a particular concern for the future generations other than our children and their children.
If we alter the assumptions to reflect more real world facts then the Ricardian models break down and deliver very different predictions. In that sense, we would not consider the framework to be reliable or very useful.
Further, in an empirical sense, the Ricardian Equivalence theorem has been shown to be a dismal failure regularly and should not be used as an authority to guide any policy design.
So what is Skidelsky thinking about?
He claims that after the initial fiscal stimulus packages in 2008-09:
Economic advisers assured their bosses that recovery would be rapid. And there was some revival; but then it stalled in 2010. Meanwhile, governments were running large deficits – a legacy of the economic downturn – which renewed growth was supposed to shrink. In the eurozone, countries such as Greece faced sovereign-debt crises as bank bailouts turned private debt into public debt.
But he admits that the governments “committed themselves to fiscal tightening” shortly after the stimulus packages were introduced.
He doesn’t seem to make the connection to the stalled growth.
Once beliefs and expectations are introduced into economics, as is surely reasonable, the results of fiscal policy become indeterminate. Too much depends on what people think the results of the policy will be. In the economists’ lingo, policy results are “model-dependent.”
But to show that actual policy made things worse does not mean that a better policy was actually available. The right policy’s success may depend on the public’s expectations of its effects. The unanswered question is why the public should have the wrong expectations
Expectations are important in driving economic behaviour. That point is correct but hardly justifies his claim that fiscal policy becomes ineffective because people are led to believe it is ineffective.
That is the nonsense that mainstream neo-liberal economists sprout.
So here are some examples of fiscal stimulus measures. Ask yourselves what you expect the impacts to be.
The national, currency-issuing government facing entrenched high unemployment and increasing poverty in an environment of depressed sales and poor income support measures announces that it will introduce a – Job Guarantee.
It tells the citizens, all of who are skeptical of government deficits, that it will offer a job at a reasonable wage (a socially viable and inclusive minimum) to anyone who cannot find work elsewhere.
This job offer is unconditional and permanent and the wage will be protected in real terms over time.
The difference between the wage and the income support payment is not insignificant.
1. Will there be a reduction in unemployment? Definitely. Not entirely, because some higher skilled workers may eschew the Job Guarantee opportunity and hang out for a better job. They might also have redundancy payments. So they will stay in what we call ‘Wait Unemployment’. But most of the unemployed would take the jobs.
2. Will the newly employed workers who were facing poverty spend more as a result of the Job Guarantee position? Almost certainly. The propensity to consume for someone in poverty is almost 1, which means for every dollar they get extra they spend that amount.
Some newly employed workers will clearly lift their saving rates as well.
But there will be a solid increase in aggregate spending.
3. Will that extra spending induce further spending? That is, are expenditure multipliers above 1? Even the IMF admits that expenditure multipliers might be around 1.7 in a recession. So not only will the Job Guarantee workers spend their extra income but that spending will stimulate sales throughout the economy which will induce further production and employment and wage payments, which lead to further spending overall.
4. Will workers worry about the fiscal deficit and not spend the extra incomes? Not a chance. Even if they are right-wing neo-liberals in their ideological swing, they will spend more – poverty is harsh, consuming is better.
5. What will firms do? They suppress investment in recessions because the existing capital stock (machinery and equipment) is sufficient to meet the depressed sales levels.
As spending increases, they will find they need extra productive capacity to maintain market share and this will induce further investment spending, especially as they realise the Job Guarantee will be permanent and the incomes paid to workers will be on-going.
As more economic activity occurs, the Job Guarantee pool would shrink and workers would transit into other higher paying jobs and by then the recovery is entrenched.
Example Two – the government places a major order for new public mass transit systems or new educational or health infrastructure. The contracts for building etc will offer payments over the next two to three decades.
1. Do you think construction and infrastructure contractors will refuse to tender for these opportunities because they are worried about higher tax rates?
2. Do you think successful tendering firms will refuse to increase production and employment – even the most conservative business firms (politically) take advantage of government contracts to expand their businesses.
There is zero evidence that such stimulus measures will hit an ‘expectations’ wall and cease to underpin economic activity.
It is only when governments introduce uncertainty into policy making by claiming austerity is needed when the economy is not yet fully recovered – and confidence remains low – that pessimism mounts and private thrift dominates.
You can see the contradiction between the UK Guardian article by Skidelsky and the FT letter he signed.
I won’t attempt to speculate on what was in his mind in either case.
But the ECB should follow our advice and the Eurozone malaise would end very quickly.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.