I have been travelling for most of today so I have to keep this post…
The conservative forces including those ‘Tories’ that are within the British Labour Party (aka New Labourites) continue to gather their forces to counter the growing threat posed by Jeremy Corbyn to their secure world as neo-liberal, Tory-lite hopefuls. They are part of a phalanx of critics, including mainstream economists who seek to diminish his credibility. At the extreme end of this bunch are the evil ones who have accused Corbyn of being antisemitic and a friend to Islamic terrorists. I am reliably informed that the same tactics have been deployed against Bernie Sanders in the US. It tells us that desperation has replaced any sense of decency or reason. It also tells us that the Tory-lites are finally seeing the evidence that their day in the sun has gone and they are being cast into irrelevance. Not before time, I should add. But all is not clear on the Corbyn front either. Today, I want to discuss what appears to be a major economic policy proposal – the so-called People’s Quantitative Easing (or PQE). There are elements of a good idea in this proposal but the QE reference and the resulting language is all wrong, in that it betrays as lack of understanding of the difference between a monetary
policy operation and a fiscal policy intervention. The concept should be re-framed so that a consistent narrative can be provided and that a good policy proposal gains the wings it needs. PQE is a wealth generating policy which is in contradistinction to QE which just shuffles wealth portfolios.
By way of background, please read the blogs:
Jeremy Corbyn’s proposal is outlined in his PQE plan in his manifesto – The Economy in 2020.
In a discussion about “rebalancing” the British economy to drive innovation in hi-tech industries with the requisite infrastructure, the ‘Plan” proposes PQE:
One option would be for the Bank of England to be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital projects:
Quantitative easing for people instead of banks.
The funds would establish a “‘National Investment Bank’ to invest in the new infrastructure we need and in the hi-tech and innovative industries of the future.”
PQE as enunciated is thus quite simple in conception.
The idea that the central bank, which is one part of the consolidated government sector, the other being the Treasury, would use the currency-issuing capacity of the government to facilitate the purchase of real goods and services to build productive infrastructure is sound.
I dealt with the otherwise named Overt Monetary Financing option for governments at length in my current book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).
This blog also considers the policy option – OMF – paranoia for many but a solution for all
However, the proposal has been attacked by all and sundry as being “bad economics”, as compromising the so-called “independence of the central bank”, as putting elected officials in charge of monetary policy, as being the path to hyperinflation or for others deflation, and more.
Such a simple idea has invoked an hysterical backlash and it is more than just a dislike/fear of a Jeremy Corbyn victory in the British Labour leadership contest that is driving the negative reaction.
The concept of Overt Monetary Financing is a taboo in mainstream economics. Please read the blogs cited above to learn more.
But if we cut through all the sophistry disguised as ‘economic theory’, which seeks to demonstrate that such a policy would be inflationary at least, the real reason the policy option is taboo is because:
1. It cuts out the private sector bond traders from their dose of corporate welfare which unlike other forms of welfare like sickness and unemployment benefits etc has made the recipients rich in the extreme.
Welfare provision at the bottom of the income and wealth distribution is so partial that those on unemployment benefits in Australia, for example, are not only deprived of a chance at a job by deliberate government policy (failing to increase the fiscal deficit sufficiently), but are then forced to live below the poverty line while jumping through a ‘hoop’ of pernicious compliance obligations.
2. It takes away the ‘debt monkey’ that is used to clobber governments that seek to run larger fiscal deficits.
The language is important. The conservatives (including most economists) know that the public doesn’t understand these concepts but have a visceral response that ‘too much debt’ is bad and that the government will force them to pay for it in the form of higher taxes etc.
That message is continually rammed homeand thus metaphors like the ‘debt mountain’ and ‘debt explosion’ etc are all readily deployed at the political level to discipline government spending (unless, of course, it is benefiting the well-to-do or bailing out banksters).
These conservatives know that if the government just spent (as it can any time it likes given it issues the currency) and didn’t match that spending with any debt issuance or tax revenue increase, then it would be harder to mount a case against the fiscal intervention.
People would soon see the benefits in the form of better schools, hospitals, public transport, green energy innovations, more jobs, more diverse cultural events etc and there would be no ‘negative’ association.
So the conservatives prevent that sort of realisation from occurring by mounting these spurious claims about inflation, and compromising central bank independence etc to try to stop governments from using real resources to improve the well-being of the people.
Conclusion: PQE is an excellent strategy for the British government to introduce. It exploits the currency-issuing capacity of the government directly and uses it to increase the potential of the economy to improve well-being.
But, the policy proposal should never have been called PQE because it is not similar at all to Quantitative Easing and the false analogy only opens the proposal to further, unwarranted criticism.
So the language is all wrong because the underlying economics is not fully articulated.
None of the commentators I have read in the mainstream media understand the point I am about to make.
Larry Elliot’s article in the UK Guardian (August 14, 2015) – Is Jeremy Corbyn’s policy of ‘quantitative easing for people’ feasible? – thinks that PQE is not necessarily “bad economics” but because the Bank of England’s monetary policy committee “is toying with the idea of tightening policy by raising interest rates rather than adding to the amount of stimulus” it would seem not to be a policy for the current period.
Elliot thinks that Quantitative Easing (QE) was a way of giving banks more money to loan out.
He also think that in the “current circumstances”, more QE should be avoided because it would be inflationary in the current economic circumstances and would have “risks – including giving the impression that the government is indifferent to inflation”.
All claims are false.
Then there was the article in the Financial Times by its economics editor Chris Giles (August 13, 2015) – People’s quantitative easing – no magic.
He wanted to disabuse his readers of the idea that PQE would work. He uses the loaded metaphor – “a magic solution” – to discredit the concept through language abuse.
He seeks to compare PQE to QE. What do we learn? Answer: not a lot.
1. Who decides when “to instigate QE – the creation of additional central bank money”. He concludes that “Between 2009-12, that was clearly the role of the BoE’s Monetary Policy Committee, although it required Treasury authorisation”. Note the intrinsic link between the central bank and treasury, which Giles does not tease out.
Whether he understands the import of that link is one thing, but if he did he wouldn’t want to tease it out because it would totally undermine his next point.
2. He wrote “People’s QE is definitively different: the government would order the central bank to print money and determine the quantity of QE.”
“In both ordinary and people’s QE, the BoE “prints money”. This is shorthand for saying it creates electronic money – a liability on its balance sheet – which can then be used. There is no difference between the two.
First, the term “printing money” is not just “shorthand”. It is loaded language, which is not descriptive of the actual process that underpins government spending and invokes irrational emotional responses about hyperinflation with the Weimar Republic or Zimbabwe immediately entering the conversation, and reasoned debate then becomes impossible.
Second, there is a huge “difference between the two” proposals, such that if we want QE to have meaning, then PQE should be abandoned as terminology to describe the idea that governments should deficit spend without issuing debt whether it be on infrastructure or something else.
Giles clearly doesn’t understand the intrinsic monetary and fiscal operations involved in each policy (QE and PQE) or if he does he chooses to mislead his readership for the sake of indoctrinating them against the Corbyn proposal.
In his final assessment, Giles’ main point is:
The distinction between people’s QE and ordinary QE boils down to whether the government or officials at the central bank have control of the monetary printing press, and whether the assets are cancelled after purchase.
There is no doubt that people’s QE ends the operational independence of monetary policy as the government, not the BoE. would decide whether to pump more money into the economy to stimulate demand.
We will come back to this point because it is made by most of the critics.
Further, apparently, the “risk is rampant inflation or deflation” because of the indivisibility of large infrastructure projects. If the commitment to Project X was such that it pushed nominal spending above the capacity of the economy to absorb it by way of a real production response then there would be inflation.
The opposite is that there would be deflation because an output gap would be left.
This assumes that there are no other spending or tax initiatives that can be invoked to trim the net position of the government to the output gap. Of course, there is considerable flexibility in government fiscal policy parameters.
The introduction of a Job Guarantee would increase this flexibility. Please see the range of blogs under the category – Job Guarantee
Both Giles and Elliot claim that the government can always borrow to fund infrastructure spending so why discuss PQE.
This view is being pushed by so-called progressive commentators who are claiming that there is a huge “unsatisfied demand for government debt” as evideced by low government bond yields and so governments could easily fund their infrastructure spending by increasing public debt with low “costs”.
First, why would any progressive commentator advocate expanding corporate welfare. Public debt issuance is just that. It provides a risk-free, guaranteed annuity to the financial markets to allow profit-seeking traders to benchmark their risky products and to use as a haven to alleviate uncertainty.
The debt issuance is entirely unnecessary and if the private markets were efficient they would create their own low risk benchmark asset.
Second, underlying the recommendation is a flawed understanding of the inflation process. I have dealt with this on several occasions and will summarise it again below.
A truly progressive policy platform would wipe out corporate welfare and stop issuing public debt. In that sense, Overt Monetary Financing is the preferred Modern Monetary Theory (MMT) policy option.
Then there was the article by the British New Keynesian academic economist Simon Wren-Lewis (August 16, 2015) – People’s QE and Corbyn’s QE – which is being used by many commentators on the progressive side of the debate to attack Corbyn’s position.
The claim is that Wren-Lewis is a “respectable economist” and so his view carries weight.
The essence of the article rests on this paragraph:
With an independent central bank, that means that they, not the government, get to decide when helicopter money happens. In contrast, if your goal is to increase either public or private investment (or both) for a prolonged period, then its timing and amount should be something the government decides. While QE is hopefully going to be something that is unusual and rare, the goal of an investment bank is generally thought to be more long term, and not something that only happens in severe recessions
Note the use of the term “helicopter money”, which I will come back to.
But this also avoids the main question – who should be in charge of economic policy – the democratically-elected members of the government who are fully accountable every electoral cycle or a group of unelected and unaccountable technocrats in the central bank?
Of course, even that dichotomy is strained because the treasury and central bank arms of governments have to work closely together on a daily basis to ensure the monetary system functions effectively.
For example, the treasury makes it clear to the central bank what the daily implications of their spending and taxation patterns are for the state of liquidity in the banking system, which allows the central bank to design liquidity management strategies each day which are necessary if it is to achieve its target cash rate (the statement of monetary policy).
In this way, the idea that the central bank is ‘independent’ is a ruse that allows politicians to divert responsibility for unpopular interest rate decisions onto the faceless central bank board.
Please read my blog – The sham of central bank independence – for more discussion on this point.
There are also deep political links between the central bank and the treasury in most countries – for example, in Australia, the elected government appoints the central bank governor and can override interest rate decisions if they choose.
There is also the question of relying on an unelected, unaccountable (to the people) central bank board to make key decisions with respect to economic policy.
The evidence is that in advanced nations this semblance of separation of interest rate decisions from the daily government business has delivered poor outcomes.
The late Franco Modigliani, the famed Italian economist (who was hardly anything but mainstream – he coined the term NAIRU) saw it very clearly when he was reflecting on the legacy he had created in 2000:
Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies … [the decisions of Central Banks] … inspired by an obsessive fear of inflation, … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies.
[REFERENCE: Modigliani, F. (2000) ‘Europe’s Economic Problems’, Carpe Oeconomiam Papers in Economics, 3rd Monetary and Finance Lecture, Freiburg, April 6]
The points they are all missing
First, Quantitative Easing is a monetary operation that can be distilled down to being asset swap – bank reserves for a government bond.
Please read my blog – Quantitative easing 101 – for more discussion on this point.
By bidding up the price of government bonds in the secondary markets, the central bank forces yields (interest rates) down, given the inverse relationship between the effective yield and the price of the bond in fixed coupon assets.
Therefore, the only way it can impact positively on aggregate spending is if the lower interest rates it brings in the maturity range of the bond being bought stimulates borrowing and spending.
The problem is that borrowing is a function of aggregate spending itself (and expectations of where demand is heading) and if unemployment is persisting at high levels and governments are imposing harsh net spending cuts, the sentiment that might lead to increased borrowing is absent – lower interest rates notwithstanding.
But QE was based on a false premise – that the banks need reserves before they can lend and that quantitative easing provides those reserves.
Mainstream macroeconomics create the illusion that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
This is clearly an incorrect depiction of how banks operate in the real world. Bank lending is not ‘reserve constrained’. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards.
If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.
Please read the following blog – Building bank reserves will not expand credit – for further discussion.
The major formal constraints on bank lending (other than a stream of credit worthy customers) are expressed in the capital adequacy requirements set by the Bank of International Settlements (BIS) which is the central bank to the central bankers. They relate to asset quality and required capital that the banks must hold. These requirements manifest in the lending rates that the banks charge customers. Bank lending is never constrained by lack of reserves.
Second, QE does not change the net financial asset position of the non-government sector at all. It is an asset swap. The non-government sector just rearranges is wealth portfolio – more cash, less bonds. No net change.
That is the essence of a – monetary policy operation – which alters the liquidity in the economy. It does it by portfolio swaps and in doing so influences the interest rates and the term structure.
Third, PQE is not QE because it is a fiscal operation – as is any so-called ‘helicopter drop’. Keep the helicopters on their pads and just spend
What does that mean?
PQE (like a helicopter drop) would increase the net financial assets in the non-government sector because it would increase national income (via spending on infrastructure).
That is the hallmark of a fiscal operation.
Vertical transactions – such as government spending, taxation – create national income changes which change the net financial position.
PQE as envisaged is a fiscal operation, not a monetary operation, whereas QE as practiced by the Bank of England, the Federal Reserve Bank of America, the Bank of Japan etc are not fiscal operations.
That is why I would not have called PQE, PQE.
PQE would involve the government instructing the central bank to credit some account so that the National Investment Bank could put in purchase orders for contractors etc
The accounting to support this operation is largely irrelevant – it could be a simple instruction to expand the treasury overdraft, for example. At any rate it is just one government hand putting liquidity into the other and then pushing that liquidity out into the non-government sector.
The spending would boost the contractor’s bank deposits (which increases their net financial assets or net worth) and the bank now has more reserves and matching liabilities (the contractor deposits).
That is the hallmark of a fiscal operation.
In QE, the central bank would buy a bond and exchange it for a bank deposit. The Assets of the bond holder would be unchanged but altered in composition (more cash less bonds). For the bank of the bond holder, deposits rise (liabilities) as do assets (reserve balances).
The essential difference is in terms of the impact on the net wealth of the non-government sector. QE leaves that position unchanged, whereas PQE increase net wealth via the net spending effects.
Another way of thinking about this is to ask the question: What would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a fiscal deficit without issuing debt? That is engaged in Overt Monetary Financing?
First, governments spend in the same way irrespective of the monetary operations that might follow. There is no sense in the claim that the government gathers money from taxes or bond sales in order to spend it.
If they didn’t issue debt to match their deficit, then like all government spending, the Treasury would instruct the central bank to credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.
The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet).
Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.
This means that there are likely to be excess reserves in the ‘cash system’ which then raises issues for the central bank about its liquidity management. The aim of the central bank is to ‘hit’ a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.
When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target.
Alternatively, the central bank can offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.
There is no sense that these debt sales have anything to do with ‘financing’ government net spending. The sales are a monetary operation aimed at interest-rate maintenance. So M1 (deposits in the non-government sector) rise as a result of the deficit without a corresponding increase in liabilities. It is this result that leads to the conclusion that that deficits increase net financial assets in the non-government sector.
What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.
The only difference between the Treasury ‘borrowing from the central bank’ and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If private debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the long-time Bank of Japan solution).
There is no difference to the impact of the deficits on net worth in the non-government sector.
Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend and restrains the growth in the money supply. This is claimed to reduce the inflation risk.
However, the reality is that:
- Building bank reserves will not expand credit
- The money multiplier process so loved by the mainstream does not describe the way in which banks make loans – Money multiplier and other myths
- Building bank reserves is not inflationary. Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.
So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.
This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand – government and non-government – carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and available productive capacity. The FT articles clearly recognise that point.
The ‘stock of money’ can expand by some percent per month without there being any additional inflation risk if real productive capacity is also expanding at a rate sufficient to absorb the extra nominal aggregate demand.
The idea that debt-issuance to the private sector in some way is less inflationary (for a given injection of government spending) is totally fallacious.
I covered the inflation risk argument in more detail on Monday – Governments do not need the savings of the rich, nor their taxes!
I am clearly in favour of governments no longer issuing any debt and ending the practices that are legacies of the fixed-exchange rate, convertible currency world we (mostly) abandoned in 1972.
In that sense, PQE is not “bad economics”. It is the obvious extension of the government’s currency-issuing capacity in a floating exchange rate environment.
It might be inflationary but that risk is inherent in the spending side not the particular monetary operation that might accompany that spending.
In fact, all spending – non-government or government – carries an inflation risk.
But the aim of government fiscal policy is to ensure that nominal spending growth keeps pace with the real capacity of the economy to produce goods and services and if that aim is managed well then there is little risk of inflation arising from PQE.
I am aware of the political considerations that might have led to the terminology “Peoples’ Quantitative Easing”. But in my view it is a case of being too cute and it leaves what is an otherwise sound policy open to spurious criticism.
Once again, progressives have to be mindful of language.
Upcoming Event – Reframing the Debate: Economics for a Progressive Politics, London, August 27, 2015
The organisers have changed the location to accommodate the increased demand for places at this event.
The NHA is very pleased to be able to present an evening with Professor Bill Mitchell, Professor of Economics and renowned proponent of Modern Monetary Theory, during his visit to the UK at the end of this month.
Come and join Professor Mitchell in conversation with Richard Murphy (Tax Research) and Ann Pettifor (Prime Economics), both currently economic advisors to Jeremy Corbyn’s campaign.
How can the debate on the economy be re-framed around the things that really matter – people and the environment? Does MMT hold the key?
The Event will be held on Thursday, August 27, 2015 from 18:30 to 20:30 (BST).
John Snow Theatre
London School of Hygiene and Tropical Medicine
WC1E 7HT London
WWW site for Registration.
The event is free and all are welcome.
Upcoming Event – Book Launch Maastricht, August 31, 2015
The official book launch for my new book – Eurozone Dystopia – Groupthink and Denial on a Grand Scale – will be held on Monday, August 31, 2015 at the Maastricht University, the Netherlands.
The Launch will be held at the SBE Building, Tongersestraat 53, Maastricht University.
The event will run from 13:15 to 14:30 (drinks to follow).
There will be two excellent speakers:
1. Dr László Andor, former Commissioner for Employment, Social Affairs and Inclusion in the Barroso II administration of the European Commission.
2. Professor Arjo Klamer, Professor of Economics of Art and Culture at Erasmus University in Rotterdam, The Netherlands. He “holds the world’s only chair in the field of cultural economics”.
The public is welcome to the event. I hope to see a lot of people there in Maastricht on August 31.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.