I am typing some of this on the train from Brighton back to London, after a day of speaking events in Brighton, where the British Labour Party conference is currently being held. I spoke at two events: (a) the GIMMS event on MMT and the Green New Deal and a video will be available soon; and (b) at an event alongside British Labour MP Chris Williamson, where were talked about how an Modern Monetary Theory (MMT) understanding can enhance the progressive policy cause and advance a transformation towards a ‘socialist’ (whatever that might be) state. It was great to see everyone at the events. The second event was attended by many people involved in the Labour Party itself and I hope that being exposed to new ideas will activate further grassroots resistance to the neoliberal system that undermines our material prosperity. So this two-part series is a reflection on the state of economic policy thinking within British Labour in the context of the paradigm shift that is going on now, around the world, in macroeconomic policy thinking. As I noted in – Part 1 – we are now seeing economists and policy makers, lining up, to tell us that a reliance on monetary policy has run its course and a new era of fiscal policy dominance is the only viable way ahead. That means that New Keynesian economics is over. That means that fiscal credibility rules that reflect an adherence to neoliberal constructs will need to be abandoned. And it seems that British Labour are lagging behind these major shifts that have been going on in economic policy thinking. Only Modern Monetary Theory (MMT) offers a consistent and credible path for Labour to make the shift into this era.
Just yesterday, in between writing Part 1 and this Part, ECB boss Mario Draghi addressed the European Parliament.
The Introductory Statement was published in full for the – Hearing at the Committee on Economic and Monetary Affairs of the European Parliament – on September 23, 2019.
I will write more about that speech in another blog post when the full transcript is available.
But Mario Draghi said that the ECB should “be open to ideas such as Modern Monetary Theory” (Source):
“When you look at them closely, you realize the task of distributing money to one subject or the other subject, that’s typically a fiscal task … It’s a government decision, not the central bank … It’s the political governance of these ideas that needs to be addressed.
Yes, the pattern of government spending is a political decision but the statement that a currency-issuing government is not revenue-constrained in its spending is factual.
And Mario Draghi’s intervention in the debate shows how far it has come.
Fiscal dominance will dominate the period ahead.
Which once again demonstrates how misguided British Labour Party policies and the advisors, who convince the politicians to adopt these policies, are.
Which is the theme of this two-part series.
The Fiscal Credibility Rule – a neoliberal construct that should be abandoned
In – Part 1 – I focused on the language of the Fiscal Rule.
In this part, I want to reiterate the mechanics of it, especially its privileging on central banks over the democratically-elected fiscal authority.
The privileging of monetary policy over fiscal policy – is reflective of the old paradigm.
There has been a lot of talk about the so-called suspension of the Fiscal Rule.
The Fiscal Rule states that:
When the Monetary Policy Committee decides that monetary policy cannot operate (the “zero-lower bound”), the Rule as a whole is suspended so that fiscal policy can support the economy. Only the MPC can make this decision …
We will reserve the right, for as long as monetary policy is unable to undertake its usual role due to the lower bound, suspend our targets so that monetary and fiscal policy can work together.
… Rather than an arbitrary cut off for GDP forecasts, we will give the Bank of England’s Monetary Policy Committee the authority to suspend the rule in the circumstances when it is clear that fiscal policy needs to work together with monetary policy to get the economy moving again.
1. It talks about monetary policy (in general) – which in modern parlance refers to the full array of interventions at the command of the central bank.
It does not differentiate between conventional and unconventional monetary policy. Certainly the Bank of England in its official statements considers the full array of policy tools to be part of its concept of monetary policy.
The Rule makes it clear that the rule can be suspended when the MPC “decides that monetary policy cannot operate” any longer.
What that means in the parlance is the MPC determines that decisions it might make about rates or other interventions at is behest can no longer provide any leverage on overall spending in the economy and that, as a consequence, it has exhausted its effective policy capacity.
2. “Only the MPC can make this decision” is definitive.
The Rule, as published, says that the 9 members of the MPC together, are the sole group that can declare that monetary policy has reached the point of ineffectiveness (using their logic).
3. The MPC has “the authority to suspend the rule” – no-one else is given the authority to do that. Back to point (2). The Rule doesn’t say that the democratically-elected Chancellor has that authority.
These procedures are clear and reflect the New Keynesian orthodoxy that was behind the design and wording of the Fiscal Rule – that monetary policy should be the primary counter-stabilisation force and that decisions should be ‘independent’ of the political process.
The subordination of fiscal policy (accountable and elected representatives) to monetary policy (unelected and unaccountable technocrats) is one of the classic ‘Monetarist’ coups over the last several decades.
I know the mainstream economists like to dismiss this issue as simply a choice or preference for ‘monetary assignment’ over ‘fiscal assignment’ but there is deeper ideological issues operating as well including claims (noted above) that politicians (our representatives) cannot be trusted.
But while it is clear that the MPC is the sole arbiter of whether the rule was to be suspended, there is a question about what constitutes the zero-lower bound.
As a matter of evidence, Britain recorded its peak real GDP prior to the GFC in the March-quarter 2008. It dropped rapidly in the subsequent five quarters and by the June-quarter 2009, the British economy was 5.1 per cent smaller.
The Bank of England policy rate at the peak was 5.25 per cent (having been adjusted downward from 5.5 per cent on February 7, 2008).
The Bank then made a series of small cuts to the Bank Rate as production was collapsing – they clearly misunderstood the severity of the recession that was unfolding.
The proponents of Labour’s ‘Fiscal Rule’ have claimed in the past that when the Bank Rate fell to 0.5 per cent on March 5, 2009 it had hit the effective zero lower bound.
But, this just shows out of touch the mainstream macroeconomists were.
The Bank of England clearly did not think it was at the zero lower band.
In the 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 – which accompanied that day’s Monetary Policy Committee decision, the Bank noted that its decision to cut rates to 0.25 (from 0.5 per cent) was in response for the need for monetary policy “to provide additional support to growth” – which means they believed that policy rate manipulation was still performing as an effective counter stabilisation role.
It also noted additional policy changes designed to stimulate growth including “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” which would be “financed by the issuance of central bank reserves”.
The Bank asserted that its intervention would “help to eliminate the degree of spare capacity over time” by lowering “borrowing costs for households and businesses”.
The Bank noted that the MPC “can act further along each of the dimensions of the package by lowering Bank Rate” (and the QE and lending initiatives) and if the new inflation data (to be released in the “August Inflation Report forecast”) was ratified by the “incoming data”, then:
… a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year. The MPC currently judges this bound to be close to, but a little above, zero.
So by the MPC’s own estimate a Bank Rate of 0.25 per cent was not yet at the effective zero lower bound.
Thus, it is clear that even with its policy rate at 0.25 per cent, the Bank of England’s MPC would not have informed the British Chancellor that he could suspend the Fiscal Rule.
And thinking retrospectively, this means that over the entire course of the GFC, the MPC would never have decided:
… that monetary policy cannot operate (the “zero-lower bound”) …
Which given that the Fiscal Rule says that “Only the MPC can make this decision”, means that there was no way that the Fiscal Rule would have been “suspended so that fiscal policy … [could] … support the economy”.
So history tells us that despite the worst recession in decades, British Labour Party would still have been forced to follow its Fiscal Credibility rule.
Moreover, recent history tells us that the Bank of England’s Monetary Policy Committee continued to believe (and state) that they had effective policy capacity, even when they cut the Bank Rate to 0.25 per cent.
For example, the – Monetary Policy Summary and minutes of the Monetary Policy Committee meeting ending on 20 June 2018 (published June 21, 2018), stated that:
The MPC continues to expect to maintain the stock of purchased assets until Bank Rate reaches a level from which it can be cut materially, reflecting the Committee’s preference to use Bank Rate as the primary instrument for monetary policy. Since the previous guidance, the Committee has reduced Bank Rate from 0.5% to 0.25% in August 2016 and has noted that it could lower it further if required.
1. It specifies the Bank rate (interest rate adjustment) “as the primary instrument for monetary policy” not the only instrument.
2. It believes they can lower the rate below 0.25 per cent “if required”, meaning they do not believe they have reached the point where even the primary instrument of monetary policy is ineffective.
Further, in oral evidence to the House of Commons Treasury Committee – on February 23, 2016, Bank of England governor, Mark Carney told the Committee members:
What we have done as the MPC … is to think more carefully about where the effective lower band is for interest rates. Back in 2009‑10, the MPC stopped at 0.5% and then began to purchase assets because, at the time, the feeling was that, given the balance sheets, particularly building societies’, lower interest rates would be counter‑productive. It would undercut the capital position of building societies and further restrict access to credit. A more effective way to provide that stimulus was through asset purchases.
In the intervening years, building societies have, by and large, rebuilt their capital positions. We gave a judgment, as the MPC in the past year, that we felt that we could, if necessary, go below that 0.5% towards zero. We did not give a judgment that we felt that it would be appropriate or productive to go negative, given the importance of building societies to this financial system and the economy, and given the capital position.
The point is that the British Labour Party remains locked into a paradigm that even central bankers are saying is untenable into the future.
The paranoia about the ‘City’
When I met with the Shadow Chancellor last October, it was clear that they believe that the financial markets in Britain (the ‘City’) will crucify a government that runs a progressive policy campaign without the fiscal rule.
It means that British Labour has not advanced much since the mid-1970s when Dennis Healey mislead the British people by claiming that the government had run out of money and had to borrow from the IMF.
Amorphous sorts of claims about destroying a currency etc abound but the fact is that if the government brings its legislative capacity to bear the financial markets are the losers not the power brokers.
Iceland, a tiny little country with a huge financial system (relatively), has demonstrated exactly how that legislative capacity can overpower even the most powerful foreign banking interests.
The point is that Labour’s Fiscal Credibility Rule is really a document designed to appease the financial markets.
It is some mumbo jumbo that British Labour naively thinks will placate the currency traders and others who might bear malice against its undoubted progressive policy agenda.
The problem is that this reinforces the narrative that deficits and public debt are in some way ‘bad’.
I think this degree of paranoia is misplaced and reflects a fundamental failure to understand the financial markets and what they require.
I had meetings in Paris and Berlin last week with some of the largest investment managers in Europe and the world. These are the people who the Shadow Chancellor and his advisors are fearful of.
But, they have fundamentally misunderstood the situation.
First, austerity around the world and a reliance on monetary policy has generated financial market outcomes that are unsustainable for financial investors.
All around the world, interest rates and yields on assets are falling and we are now seeing negative interest rates on long-term bonds becoming the norm.
The pension funds and insurance funds are also facing a major – Asset-Liability Mismatch – as a result.
And to resolve the mismatch, they are seeking to generate higher returns on their assets, which means they are taking on higher risk and exposing themselves to higher probabilities of insolvency in the face of any new crisis.
It is an unsustainable position.
And it is making life very difficult for the large investment funds who seek stable returns.
What they are hankering over is an end to the neoliberal era of passive fiscal policy and monetary policy interventions that are driving yields into negative territory.
They are getting on board the shift to fiscal dominance that Mario Draghi talked about today and many others are now echoing.
They are becoming increasingly attracted to MMT because they can see that we have consistently articulated the case for fiscal dominance.
After many years of monetary policy dominance, which has failed to deliver on its promises, the game is up.
That is why these investment bankers have been talking to me about policy choices etc.
So if the British government forgets about stupid fiscal rules and just uses its fiscal capacity to improve service delivery, invest in nation building infrastructure that will crowd-in private investment, then also given that Britain enjoys the rule of law (provides contractual certainty and enforceability), has a skilled labour force, etc. then far from selling off the currency, I would expect FDI to be flooding in.
This is also in the context of the world being awash with savings which are just sitting in unproductive deposits somewhere because there are insufficient investment opportunities available as a result of the austerity bias.
So the very people that the British Labour politicians think would destroy the currency if they break out of the neoliberal framing and rules, would, in fact, be shifting massive flows of investment into Britain – and pushing sterling up.
This is another reason why British Labour is lagging behind current trends.
As the discussion is moving quickly towards the basic MMT approach to macroeconomics, British Labour will be left behind if it keeps taking advice from neoliberals (New Keynesians)..
I hope they see that sooner rather than later. John McDonnell has my phone number!
European-UK-US Speaking Tour September 2019 – Where am I today?
I have one event today.
1. September 24, 2019 – Training the Trainers (GIMMS – 18:30 start, 21:00 finish) – public event.
The location will be the Springer Nature – Stables Building, Trematon Walk, Kings Cross, London.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.