The week before last, Thomas Fazi and I had a response to a recent British attack on Modern Monetary Theory (MMT) published in The Tribune magazine (June 5, 2019) – For MMT. In effect, there were two quite separate topics that needed to be discussed: (a) the misrepresentation of MMT; and (b) the issues pertaining to British Labour Party policy proposals. The article we were responding to – Against MMT – written by a former Labour Party advisor, was not really about MMT at all, as you will see. Instead, it appeared to be an attempt to defend a policy approach, that I have previously criticised as giving to much back to the neoliberals. Whenever, progressives use neoliberal frames, language or concepts, it turns out badly for them. Anyway, the published article only allowed 3,000 words, which made it difficult to cover the two topics in any depth. In this three-part series, you can read a longer version of our reply to the ‘Against MMT’ article, and, criticisms from the elements on the Left, generally, who think it is a smart tactic to talk like neoliberals and express fear of global capital markets. In this final Part, we focus explicitly on Labour Party’s Fiscal Credibility Rule – which uses these neoliberal frames – and we show that it would fail in a deep recession, causing grief to a Labour government should it be in office at that time.
The series so far:
1. Seize the Means of Production of Currency – Part 1 (June 11, 2019).
2. Seize the Means of Production of Currency – Part 2 (June 12, 2019).
Labour’s Fiscal Credibility Rule
I have written extensively about the Rule and by dint of the sorts of discussions that are going on over the Internet, the penny still hasn’t dropped for those trying to defend it.
You can find links to many blog posts I have written about the Fiscal Rule in this blog post – The British Labour Fiscal Credibility rule – some further final comments (October 23, 2018).
It should be clear by now that MMT has absolutely nothing in common with mainstream economics.
If anything, it is the likes of James Meadway that are worryingly wedded to the kind of neoliberal economic thinking that got us into the mess we’re in.
This becomes evident when looking at Labour’s ‘Fiscal Credibility Rule’ (FCR), which Meadway claims is consistent with “ending austerity”.
The FCR, which Meadway helped to design in his position as former advisor to Shadow Chancellor John McDonnell, comprises “a strict set of rules [that Labour has adopted] for how a future government will manage its finances”.
In Meadway’s own words, the FCR means that:
Labour will commit to removing the deficit on day-to-day government spending at the end of a five-year period. will be free to borrow to invest in capital, like new schools and hospitals, infrastructure like renewables and railways, and scientific research. Second, that Labour will commit to seeing the level of government debt relative to the size of the economy lower at the end of five years than at the start. Third, if some sort of adverse shock hits the economy, this rule will be suspended to allow government to spend as required.
His summary leaves out some technical details but we do not have to dwell on them to make the next point.
The problem is that the FCR would fail in a deep recession and discredit any Labour government that tried to defend its record.
For starters, there is confusion about recurrent and capital spending. The FCR says that day-to-day (current) spending, which includes the salaries of public workers, welfare expenditure, etc., should be ‘funded’ from taxes presumably because the Labour Party thinks it doesn’t deliver longer term returns, while capital expenditure (investment) can be financed through debt because it will ‘pay itself back’.
Of course, spending on teachers and health care does deliver enduring benefits, which highlights the difficulties in recurrent/capital demarcation.
But more importantly, and leaving aside the aspect of the rule where recurrent spending and taxes will balance over some rolling 5-year window, the FCR requires that “at the end of every Parliament, Government debt as a proportion of trend GDP is lower than it was at the start”.
Imagine that the Labour Party had have been elected in 2007 when the public debt ratio was 41.7 per cent of GDP.
By the end of 2012, the public debt ratio had actually risen to 84.1 per cent reflecting the earlier attempts by the Labour Government to fight the threat of recession and the role of the automatic stabilisers pushing out the deficit, which then, under current (unnecessary) institutional arrangements increased the outstanding debt.
We know from what actually happened that the expansion of fiscal policy was not sufficient and was not maintained for long enough.
If we use trend GDP (calculated from a de-trended regression), the public debt ratio at the end of 2012 was 81.8 per cent of GDP.
Based on that experience, it would have been impossible for the Labour government (assuming it was elected just before the GFC) and had remained in office for a full five-year term to have satisfied the FCR without engineering a dramatic austerity turn with devastating consequences.
Meadway claims that this scenario would not have arisen because:
… if some sort of adverse shock hits the economy, this rule will be suspended to allow government to spend as required.
The FCR stipulates that the rule can only be suspended if the Monetary Policy Committee of the Bank of England determines that “monetary policy cannot operate” in an effective way (hit the “zero-lower bound”).
The FCR says that “Only the MPC can make this decision”.
That, in itself, is giving privilege to the unelected officials on the MPC over the accountable politicians (the Chancellor), which is the exemplar of the characteristic depoliticisation of neoliberalism.
But the practical matters are more pertinent here.
After the GFC hit, the Bank of England dropped the interest rate in several steps until it reached 0.5 per cent on March 5, 2009.
Many mainstream economists were claiming that the rate had reached the ‘zero-lower bound’ and monetary policy was no longer effective.
Meadway has claimed elsewhere that this would have triggered a suspension of the FCR.
But history shows us that the MPC had other ideas.
In a Bank of England Press Release (August 4, 2016) – Bank of England cuts Bank Rate to 0.25% and introduces a package of measures designed to provide additional monetary stimulus – they announced that:
The MPC voted unanimously to cut Bank Rate to 0.25%. The Committee also voted for a package of measures designed to provide additional support to growth and to achieve a sustainable return of inflation to the target …
This package comprises: a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion. The last three elements will be financed by the issuance of central bank reserves …
… the MPC judges it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation …
All members of the Committee agreed that policy stimulus was warranted at this time …
This was a very significant decision in British monetary history, which the likes of Meadway, Simon Wren-Lewis, Jonathan Portes, appear to have overlooked.
What it means is that the MPC believed that policy rate manipulation (and other monetary components) were still performing as an effective counter stabilisation role.
So despite their acknowledgement that with “interest rates are close to zero, it is likely to be difficult for some banks and building societies to reduce deposit rates much further”, they did not believe that monetary policy had reached the point of being ineffective – the essential condition for triggering a suspension of the FCR.
In other words, they would not have allowed the FCR, had it been in place, to be suspended.
This was the worst crisis since the Great Depression. What would constitute an “adverse shock” in Meadway’s world?
But the overwhelming point is that such a Labour government, in these circumstances, would be forced to impose fiscal austerity or abandon the FCR, neither of which would do its electoral chances much good.
The other thing to note is that the Rule doesn’t really bind in a growth phase, which is why I have never claimed that British Labour is pro-austerity.
Only in a recession would the shortcomings of the Rule be exposed and compromise the Labour Party’s credibility.
Of course, if a future Labour government abandoned the practice of issuing debt to match its fiscal deficits, it would flush out a lot of debt-related paranoia, however unfounded it may be.
It would also eliminate the provision of debt to the financial sector, which in its essence is an elaborate corporate welfare program.
The amorphous global capital threat
The technical justifications offered by James Meadway for such binding fiscal rules are even more puzzling.
He seems to believe that “clear and credible [fiscal] targets” for are necessary to keep government borrowing rates down and the “bond vigilantes” at bay.
This is simply false.
First, the government could simply stop issuing debt altogether if it wanted. Then the bond market investors would be begging the government to issue debt because they see it as corporate welfare.
I wrote about this sort of situation in this blog post – Direct central bank purchases of government debt (October 2, 2014).
Second, the standard crowding out story, whereby government borrowing is claimed to push up interest rates and squeeze out private spending is false.
Irrespective of the fiscal state, credit-worthy borrowers can always gain access to funds from the banking system to finance investment projects.
Further, there is no finite pool of saving that government debt issuance soaks up, and, in doing so, forces increased competition for the funds and higher interest rates.
Fiscal deficits increase income which, in turn, expands the pool of saving.
Third, the central bank can always control yields in the bond markets. Japan, for example, has over the last three decades accumulated the highest gross public debt-to-GDP ratio in the world (around 250 per cent), run continuous and substantial deficits, yet has maintained interest rates and bond yields at around zero (in some cases, the bond yields have gone negative) and has been fighting deflation rather than inflation.
Meadway’s irrational fear of financial markets is particularly evident when he talks of current account (balance of payments) deficits.
In the article, he repeats the oft-stated claim that:
Countries running a deficit on their current account (meaning, broadly, that they import more than they export, counting goods, services, and flows of income) like the UK — which has a deficit funded from abroad — will always be vulnerable to demands for foreign currency that they cannot immediately meet. This is a significant impediment to sovereignty.
Apparently, this situation arises when speculators lose faith in the policy settings of the nation and sell off the currency – causing its value to collapse.
So, he believes that countries should eschew current account deficits and “MMT-like prescriptions” although Meadway doesn’t actually tell us what those policies would be.
He prefers ambit scaremongering.
How does he explain, for example, Australia’s currency history?
It has run sizeable external deficits for the last 50 years and fiscal deficits in most of those years. It trades in primary commodities which highly volatile in price. Yet it is among the wealthiest nations and its currency fluctuates up and down.
Why haven’t the amorphous currency speculators dumped the Australian dollar?
In our book – Reclaiming the State – we dedicate an entire chapter to the balance of payments issue.
Modern Monetary Theory (MMT) does not deny and has never denied that crises, particularly pertaining to currencies, can occur.
Indeed, it is fully cognisant that a currency can become, under certain extreme conditions, worthless. There are many reasons why this could happen.
However, running a fiscal deficit is not one of them: there is simply no robust statistical result linking fiscal deficits to currency crises.
A well-governed country with a government committed to building and maintaining a first-class infrastructure, high quality public services (energy, transport, health, education, training, etc.) and a highly skilled labour force, would be a magnet for productive investment.
It is of course entirely possible that capital markets may decide to dump the pound to put pressure on a radical Labour government.
But that has nothing to do with following ‘MMT-like prescriptions’ or not, nor is a tight fiscal stance going to avoid that, if the underlying motive is political.
Furthermore, if that should occur, MMT shows that the government has the capacity to insulate the economy from those effects. Look at Iceland, which endured the worst financial collapse in history in 2008.
It has successfully locked up the funds of some large international hedge funds using capital controls and its currency has strengthened as a result.
Ultimately, progressives should understand that financial markets are not as all-powerful as they would have us believe.
However, the true problem with the FCR is not technical but political.
It is the fact that by embracing the macroeconomic neoliberal framing about ‘fiscal responsibility’, Labour is setting up a deadly trap for itself.
Meadway states that:
Seeking to close a government deficit is not in itself ‘neoliberal’.
Which might be true under certain circumstances.
However, there are two considerations here. The first relates to framing and language. The second relates to the context.
The framing used by him and even by McDonnell himself – and encapsulated in the FCR – is core neoliberal.
In the – FCR document – we learn that:
While there are exceptional times when shocks from the private sector mean that government has to step in to help, everybody knows that if you’re putting the rent on the credit card month after month, things needs to change.
A currency-issuing government does not have a credit card. Invoking the household budget analogy is a core neoliberal construction.
It pretends that the government faces an intrinsic financial constraint, like a household which uses the currency the government issues, and has to access credit to spend beyond its tax revenue.
Further, the – Labour Party Manifesto – reminds us that:
To maintain good fiscal health, we will have a firm rule in place to guide all our taxation and spending decisions. Our Fiscal Credibility Rule is based on the simple principle that government should not be borrowing for day-to- day spending, but that future growth depends on investment. It was designed in conjunction with world-leading economists. It also means we are committed to ensuring that the national debt is lower at the end of the next Parliament than it is today.
This is the language of neoliberals – “fiscal health” as if there is a ‘patient’ involved that can become sick; “should not be borrowing for day-to-day spending” – why not?; and the implication that without such a rule “investment” will be damaged and along with it “future growth”.
Furthermore, Shadow Chancellor John McDonnell went on record saying that Labour accepts that (Source):
We accept we are going to have to live within our means and we always will do – full stop … We will support the charter. We will support the charter on the basis we are going to want to balance the books, we do want to live within our means and we will tackle the deficit.
Making such a public statement indicates that John McDonnell was receiving very poor strategic advice at the time. This is pure neoliberal framing and neoliberal metaphorical language. Which begs the question: if Labour is trying to break out of the neoliberal narrative, why use this language?
The statement is also incoherent.
Even within its own logic, if a government spends more than its tax revenue today (beyond “its means”), it will enhance future growth, which means its “means” (using the flawed logic) expand.
But, using correct logic, government spending is not financially constrained and the only means that the government is constrained by are the available real resources that are for sale in that currency. The FCR does not address that question at at all.
It is thus a ridiculous (neoliberal) statement for a Labour Chancellor to make.
James Meadway claims that one of the main reasons for adopting this framework is that it:
… allows Labour to put together a coalition of support for its programme from across the economics profession. The party can’t expect every economist to agree with every dot and comma, but the impact of having well-respected experts onside for at least some of that programme is significant. If we want to not only form a government, but make a difference in government, these alliances are essential.
This is highly disingenuous.
Firstly, the support of mainstream economists and financial operators for certain theories and policies doesn’t stem from a sincere belief in their virtue, but from the fact that they promote the interests of the dominant forces in society.
The idea that a socialist government could guarantee itself the support of the economic establishment simply by adhering to the ideological framework that its members claim to believe in, with the aim of deploying mainstream theories and policies for progressive ends (even if this were technically possible, which it is not, as we have seen), is terribly naïve, to the say the least.
More in general, Meadway doesn’t seem to understand that the power of the capitalist establishment derives as much from its command of the state and means of production as it does from its capacity to frame the narrative.
The primacy of these fiscal rules is a key part of the way in which the economic establishment censures governments that might be intent on redistributing national income or improving welfare services and the like.
Ultimately, the ideology of scarcity of money is integral to the maintenance of our deeply unequal relations of power in society.
If there’s anything the establishment fears more than the working classes seizing the means of production, it’s the working classes seizing the means of production of currency. You would think that socialists would understand that.
The Overton window
It follows that British Labour should first and foremost strive to build a narrative that will advance the socialist cause for the decades to come.
It should reject the ideology of ‘sound money’ outright and educate the public about the capacities of a currency-issuing government and the opportunities those capacities provide.
It should explain to citizens that the purpose of fiscal policy is to advance broad welfare concerns, which pertains to wages, employment, equity, price stability, environmental sustainability, and the like, not to achieve financial balance between revenue and outlays, whether recurrent, capital or total, or to achieve a particular debt or debt ratio dynamic.
In other words, Labour should strive to shift the Overton window – what is accepted in public discourse – rather than passively submit to it for perceived (and highly dubious) short-run political purposes.
Shifting the – Overton window – is precisely what MMT is doing, and why a growing number of people on the Left find it so empowering.
MMT gives us the power to imagine truly transformational politics, without getting caught up in meaningless debates about whether we can ‘afford’ it or not.
This is also why it is being attacked so fiercely.
Not because of its theoretical foundations, but because of the range of economic and political possibilities that it opens up. The bottom line, however, is that MMT is here to stay.
The UK Labour Party can choose to stick to the old neoliberal fiscal paradigm – or it can join the revolution.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.