Talking of elephants – plain old, garden variety fiscal policy

If there were two lessons that can be taken from the GFC among others then we should know, once and for all, that, first, monetary policy (in all its glorious forms these days) is not a very effective tool for influencing the level of economic activity nor the price level, and, second, that fiscal policy is very effective in manipulating total spending and activity. Of course, those lessons provided the evidence that turned macroeconomics on its head because for several decades, as the Monetarist surge morphed into all manner of variants, tried to eulogise the primacy of monetary policy and rejected the use of fiscal policy. There were all sorts of justifications – time invariance, lags, politicians cannot be trusted, etc – but at the heart of the shift towards supposedly independent central banks was the political desire to neuter the capacity of governments to use their currency capacity to advance the well-being of the many, while at the same time, using that same capacity to advance the interests and real income shares of the few. Depoliticisation worked a treat for the top-end-of-town. The problem is that the lessons have not been learned and all manner of commentators still think that monetary policy is the king. Eventually, we will move beyond that but the pain of holding on to the myth is damaging for people, especially those who are without work, are underemployed or have been forced into early retirement by the poor economic performance in this austerity-biased era.

CNBC published an article (May 28, 2019) – The next downturn could see a ‘radicalization’ of the policies used during the financial crisis – where plain old fiscal policy is constructed as a “radicalization” and as a sort of desperation among policy makers.

The same article says that we will see:

… a turn towards more extreme versions of stimulus.

They are talking here about plain, garden-variety fiscal policy – governments spending and taxing – as some sort of new dimension in policy intervention.

That is how deep the neoliberal psychosis has penetrated the public debate.

The same article says that because the current policy tools are clearly inadequate (doesn’t that tell you something) that:

… next time around policymakers will go even further. That means the use of “Modern Monetary Theory” – in which even more government debt is used to spur growth …

Which tells you that the author doesn’t know much at all.

Quote apart from the ridiculous claim that Modern Monetary Theory (MMT) promotes “even more government debt … to spur growth”, this claim invokes the further misrepresentation that Modern Monetary Theory (MMT) is about switching to a new regime.

We should always make it clear that policy makers have been operating in a MMT world all this time and clearly didn’t gain an MMT understanding of the way the monetary system operates and the capacities of the currency-issuing government within it.

Otherwise they would have been able to anticipate that all the monetary policy tweaks that have been going on would not be particularly stimulatory.

How hasn’t it sunk in that the ECB, for example, which has expanded its balance sheet many times since the crisis as it buys up all sort of debt (including a large proportion of government debt), hasn’t been able to hit its inflation target.

Inflation still lingers well below its stated price stability level, after a decade or so of trying to push it up, yet people still believe monetary policy is effective and expanding bank reserves will be inflationary (because they claim banks will go on a lending frenzy and so on).

The CNBC article referred to some “chief economist” who claimed that:

… policymakers are running out of ammunition, though he concedes that the current batch of tools is losing its effectiveness.

See the dissonance.

The policies (“ammunition”) were largely blanks anyway, although I hate that militaristic metaphor.

They are not “losing … effectiveness”, they were never particularly effective in the first place.

Importantly, the article acknowledges, without clearly understanding the implications of the acknowledgment that:

That model “looks tired overall,” as households are increasingly less inclined to take on excessive debt and low rates lose their effectiveness.

The point here is that the only way fiscal austerity can avoid creating stagnation is if the non-government sector takes on increasing debt burdens through credit growth.

For a nation running an external deficit, that debt burden increase has to be borne by the private domestic sector.

With increasing financial market deregulation, the conditions were ripe for households, and, to a lesser extent, firms, to take on that debt increase.

But that type of growth cycle is finite because the non-government sector (particularly, households and firms) cannot take on increasing burdens.

Even with extremely low interest rates, the non-government sector reaches a limit beyond which it will not increase its borrowing.

At that point, if fiscal policy is not used to maintain spending growth as the non-government sector withdraws to contain its debt exposure, then economies start to slow and we get this sort of discussion.

I did an interview about Japan yesterday for Bloomberg. MMT is getting a lot of attention in the Japanese media at present and this is the third interview I have done within a week.

I referred to some of this attention in the blog post – Japan Finance Minister getting paranoid about MMT (May 21, 2019).

The latest interview covered a lot of ground but we got onto the effectiveness of the Bank of Japan in generating inflation. History tells us that it is not effective at all, contrary to the mainstream fear that the various bouts of QE would lead to an accelerating price level.

The emphasis on the role of the Bank of Japan was front-and-centre of the recent Financial Times article (May 28, 2019) – Japan’s dormant central bank may have to rouse itself once more

The FT article starts with the plaintiff:

What more can the Bank of Japan do? This is the question economists in Japan have long grappled with.

The article could have finished a sentence later – something along the lines of “Haruhiko Kuroda should get on the phone to Taro Aso and tells him to abandon his plans to raise the sales tax in October and resist calls from neoliberal economists, who never get anything correct, to wind back the fiscal deficit”.

Those economists are “grappling” with the wrong questions because they have the wrong lens.

The FT article outlines how the Bank of Japan’s low interest rate policy is squeezing profit opportunities for the private banks who have “demanded that the policy be rolled back”.

Meaning: they want policy to be designed to allow them to make profit. Which should not be the primary role of economic policy.

When I was asked by Bloomberg whether Japan demonstrated a sound approach to policy, I answered by noting that we can only assess the policy stance in the context of things that matter – employment, inequality, etc. Japan’s unemployment rate is 2.5 per cent, which puts most of the rest of the world to shame.

Its Gini coefficient (for income) is relatively low.

So whether its fiscal deficit is around 6 per cent of GDP is beside the point. Trying to cut it to, say 2 per cent, and push up unemployment as a result, would be destructive.

The challenge facing Japan at present is that exports are slowing (as world trade declines) and domestic demand is following suit – “both private consumption and business investment in Japan contracted in the first quarter of 2019”.

The article tries to conjure up all sorts of monetary policy gymnastics as a response to this very straightforward situation.

We read that the Bank of Japan could “intervene in foreign exchange markets by selling the yen, but past forex interventions proved ineffective” – so why bother suggesting it?

We read that if the Bank of Japan lowers interest rates further it will possibly destroy “the viability of Japan’s banking system”.

So more corporate welfare is encouraged – “start a Japanese version of “TLTRO”, the European Central Bank’s so-called targeted longer-term refinancing operations.”

But the Bank is already providing “financing to banks at zero cost in order to support the provision of loans to companies and households.”

So that suggestion is redundant other than to further “effectively subsidise … banks” so they “provide credit to the rest of the economy”.

But they admit that will not provide sufficient profits to the banks anyway and that no matter how low rates go (and free the credit is to banks from the Bank of Japan):

Banks will also find it difficult to increase their loan books in a recession.

Get the picture. The banks are finding it hard to make loans, which generate their profits, because people do not want to borrow.

They don’t want to borrow because they want to save and spend less.

The picture should be very clear.

Another suggestion is for the Bank of Japan to just bolster the capital of the commercial banks – which they admit would “certainly set the BoJ up for criticism”.

This would represent a denial of capitalism and the creation of a special class of capital that lived on the largesse of government funding (effectively).

But the FT article thinks that would be okay because:

… desperate times should call for desperate measures

Apparently, TINA.

Yet, the whole article makes no mention at all of fiscal policy.

That is how far the neoliberal psychosis has permeated the public debate.

Further south, the Australian press was rehearsing the same arguments about the Reserve Bank of Australia “”running out of bullets”.

Fairfax journalist Ross Gittins’ article (May 28, 2019) – Morrison’s new economic worry: Reserve Bank running out of bullets – was a case in point.

The point of the article was that the Government, newly re-elected, has been banging on how they will record a fiscal surplus next financial year even though it also promised as part of its election campaign to deliver “the most expensive tax cuts we’ve seen”.

But that the promise of surpluses will come to grief because the RBA is running out of interest rate cut space.

Gittins asks:

What happens if all the shots have been fired, but they’re not enough to keep the economy growing?

The fact is that the low interest rates have not provided much support to growth anyway. The economy will still contract even if interest rates are cut a further 1.25 percentage points to 0.25 percentage points (this is Gittins’ “only six shots left in its locker” shift).

At that point, he says that “all that’s left” is “increased government spending or tax cuts”.

The election campaign promises about fiscal surpluses were fraudulent because the Government knew the economy was slowing dramatically:

1. Real GDP growth came in at 0.2 per cent in the December-quarter 2018 (trend growth is about 3.2 per cent per annum) – so annualised growth is less than 1 per cent at present – Australia national accounts – growth plummets, per capita recession (March 6, 2019).

2. Wages growth remains low, see – Australian workers enjoy modest real wage rises (May 28, 2019).

3. Annual CPI inflation is at 1.3 per cent, well below the RBA’s lower inflation targetting band (2 per cent), and falling.

4. Today, the ABS announced that “The trend volume estimate for total new capital expenditure fell by 0.6% in the March quarter 2019 while the seasonally adjusted estimate fell by 1.7%.” (Source).

Taking together the data is pointing to one thing – Australia is heading for recession unless policy settings change.

Last week, the RBA governor gave a speech to the Economic Society of Australia in Brisbane (May 21, 2019) – The Economic Outlook and Monetary Policy – where he itemised the dimensions of the slowdown in Australia.

His take-away message was that:

My judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below 5 per cent without raising inflation concerns. This would be consistent with the experience overseas, with many other advanced economies sustaining lower rates of unemployment than previously thought possible without leading to a noticeable uplift in inflation …

In the event that the unemployment rate does not move lower with current policy settings, there are a number of options. These include: further monetary easing; additional fiscal support, including through spending on infrastructure; and structural policies that support firms expanding, investing and employing people. Relying on just one type of policy has limitations, so each of these is worth thinking about.

The point of his central-bank speak was that the ability of monetary policy to make the shift necessary to bring the unemployment rate down further (and, certainly, to stop it rising) was limited.

At present, the parlous GDP growth rate is being supported by some rather large State government infrastructure projects (mostly transport-related) in Sydney and Melbourne.

The RBA governor noted that:

This investment is important. It is not only supporting demand in the economy at a time when this is needed, but it is also adding to the supply capacity of the economy and directly improving people’s lives, including through a reduction in transport congestion.

But it is state government stimulus not federal.

The problem with the Gittins’ approach is that he maintains the myth that fiscal policy is subordinate to monetary policy. That fiscal policy can only be turned on when monetary policy reaches the “zero lower bound”.

This is the problem worldwide.

It is a central proposition in the British Labour Party’s Fiscal Credibility Rule, for example. That the government only gets fiscal discretion fully when the MPC of the Bank of England declares there is not room to cut rates further and that monetary policy has lost its effectiveness.

The question that is avoided is the extent of effectiveness of monetary policy in the first place. The lessons from the GFC should have disabused us of the notion that it was an effective policy tool.

But the inherent neoliberal ideology is proving hard to throw.

I note that the Gittins article also pointed out the failure of the Opposition Labor party in the campaign – “Why didn’t Labor make more of these signs of weakening economic growth during the campaign?”.

The reason is, as Gittins himself notes, is that the ALP were “intent on proving that its budget surpluses over the next four years would be bigger than the government’s”.

Who was giving them that ridiculous advice? No-one who knows anything about macroeconomics that is for sure.

The final point that keeps cropping up when we talk about fiscal policy is that politicians cannot be trusted so we need to have independent policy institutions run by so-called apolitical technocrats.

I have always found this argument wanting.

We can apparently trust politicians to have their fingers on the missile button, to be able to command military machines to inflict war on nations, and other responsibilities, but we cannot trust them to run economic policy, unless, of course, things get tight in the corporate sector and public handouts are required (at a larger level than flow from the normal corporate welfare settings).

It is such a vapid type of smokescreen to hide what is going on that I am surprised more people do not see through it.

And even progressives advocate this sort of depoliticisation! But then you know my view on that.


Until we learn those lessons from the GFC we will be having these ridiculous discussions about what strategies the central banks can come up with to avoid disaster.

They always ignore the elephant in the room – plain old, garden-variety fiscal policy – which is effective, transparent and can be spatially targetted by design.

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.

This Post Has 20 Comments

  1. Hi,
    Even my 16yr old, has been able to work out from our discussions about MMT, spending, income etc, that we could be heading towards recession. And then to ask the important question, what happens to him when he wants to start working, and our family when in a recession? And what can the government do to stop it or fix it?

  2. I am constantly shocked by the poverty of economic debate in Australia. But then again I shouldn’t be as the MSM only parrots the views of mainstream economists who endlessly predict/speculate about when and how much interest rates will be cut by the RBA. Fiscal policy is barely mentioned.

    And yes Bill if it wasn’t for Victorian and NSW governments spending the nation would probably already be in recession?

  3. I’ve sent this to the author of the FT article and posted it on the FT website. The author is engaging with commenters, so let’s see if he can ignore you;o)

  4. Bill, do you use the concept of “money in circulation” (as distinct from net financial assets)?

    For example, when a sovereign government net spends, it increases bank reserves and bank deposits held by the public, boosting the public’s net worth. The net financial assets of the non-government sector increase and the increase in bank deposits represents (potential) new money in circulation.

    When the government then issues bonds to the public (“to cover its deficit”), there is no change in the non-government’s sector’s net financial assets – just a change in the portfolio holdings of the public, from non-interest-bearing deposits to interest-bearing bonds. But the public has now “spent” the new income (on buying the bonds), so there is a reduction in (potential) money in circulation and the multiplier can’t work its magic.

    To the extent that governments issue bonds to fully “cover their deficits”, doesn’t this mean that net financial assets may increase but all of the increase is diverted into “savings” (bonds), nullifying the effect on money in circulation and the benefits of the multiplier?

    In that case, the only source of new money in circulation for the economy would be bank lending?

    As a novice (who rarely gets 3 out of 3 on the quiz), I’m probably misunderstanding things. Any illumination gratefully received.

  5. I know I sound like a broken record, but I continue to repeat that the fundamental problem with people accepting the truth of MMT is philosophical, not economic. What has yet to sink in is the CONCEPT of fiat money, created ex nihilo, unlinked to debt–money called into existence purely by the spending decisions of a currency-sovereign government, which need not utilize the awkward and obfuscating mechanism of a central bank (and bonds) to infuse that money into a national economy. And behind this current inability of people to grasp the concept of fiat money lies an even deeper philosophical problem: the neoliberal TINA conditioning of people to instinctively close their minds (and hearts) to the extraordinary (though not unlimited) scope of human agency that fiat money entails. We CAN create the money to build a better, more beautiful world, and MMT can keep inflation under control. But so many remain unable (ideologically incapacitated) to believe that all of this is even remotely possible. THAT is the tragedy that must, I submit, be philosophically–indeed, spiritually–addressed before MMT can break through like a burst of sunlight into widespread public awareness.

  6. Bill. Good Post. Are your interviews in Japan available with subtitles?

  7. @Newton Finn

    A worthwhile insight. I become convinced that a solution may lie in stressing the “scoreboard” aspect of “money”. If anyone suggested the money system as a scoring mechanism for a sport they would be laughed out of town.

    “You get to hold over your score from the last game and use it to buy the referee?”

    “Your goals only score if someone is willing to buy them using their accumulated points?”

    A money system designed to properly recognise and encourage winning the economic game would look very different.


    Bond issue moves reserve currency into bonds, but does not affect bank deposits. The bank deposit increase enacted by government spending is not erased by issuing bonds, only taxes affect bank deposits.

    This is why monetary policy is such a weak mechanism for controlling the money supply. When you add that the money supply is not really a strong contributor to inflation levels….

    The main effect of the bond mechanism is sit down money for corporates to not invest in real economic assets. This contributes to unemployment and increases the power of those with large fiscal holdings.

  8. Bill
    I know you have to defend yourself and MMT from absurd attacks but as a long time viewer of CNBC I can assure you that their level of economic analysis is at best classical/monetarist. But what would you expect from a network that regularly features Rick Santelli, who famously wagged tea bags on air in 2010 to help spur the notorious Tea Party “revolution”? Today he was again featured and railed against U.S. deficits and debt ( and unloaded on Elizabeth Warren in a supposedly non political economics segment). It is hard to watch this rubbish but I think it gives a good read of where the conventional – neo-liberal- view is at the moment. Still a hurdle to overcome… but the message is starting to get out. AOC in particular but Sanders and Warren not too far behind.

  9. Norman

    Government spending multiplies through the economy depending on the marginal propensities to save/consume taxation rates and level of spending on imports. A teacher gets an extra $100 per week from the government after strike action, spends $70 on local wine per week to cope with the stress, the wine shop owner spends 0.7 X 70 on flowers for his wife etc…. The savings rate will effect the size of the multiplier of course.

    The bond issuance is perhaps best thought of as a savings vehicle for money that is already saved and was not going to be spent anyway. It is one vehicle for saving. It pays interest on reserves left in the system from prior deficit spending. As I understand it, bond issuance should not really be thought of as a way to “prevent people from spending”. Though if they do suddenly go on a massive spending spree then the size of the deficit might need to be rethought. Bonds were issued in WW2 to encourage a higher savings rate as I understand it – as one way of controlling inflation by discouraging spending. Also remember a bond can be sold for cash very easily so if you do want to spend the money tied up in a bond you can.

    Brendanm – I believe that if a member of the public buys a government bond with their money directly their bank deposit would go down.

  10. Hi Bill
    Here in New Zealand we have just had our budget yesterday and it was all the standard talk about how big the budget surplus will be. Our finance Minister is determined to get the governments debt level below 20% of GDP as if it’s some sort of a badge of honour. We had all the usual crop of orthodox economist’s being interviewed afterwards and agreeing on what a fine job the government is doing. We also have just had a cut in the OCR as the economy is starting to slow.

  11. @ Norman,
    I’m not Bill and I rarely get more than 1 out of 3 right. But for what it is worth —
    US bonds to totally liquid. If you have one you can borrow with it as colateral, hold it or sell it on any/every business day.
    This means that if you want to buy something with that money you can. Others will want to save and will buy it.
    To me this means that they are little different from cash in a bank savings account.
    And, so they can contribute to GDP growth and maybe inflation at some point.

  12. A thought I have had is —
    The rules should be written to encourage the powers that be to do the right thing.
    . . 1] For example if the changes in the top income bracket were pegged firmly to the CPI than the rich would want the CPI to go up faster. And then, if the poverty level and therefore the wage paid by the JG or the minimum wage were also firmly tied to the CPI then, there would be 2 groups that want the CPI to more closely follow the real price rise and maybe it therefore would more closely follow it.
    . . 2] Again, if the interest rate (coupon rate?) on US bonds was not fixed but instead set at the CPI rate plus a fixed small additional percentage rate, for example CPI rate plus 0.05%; then again the CPI would more closely follow the real rate of price rises. It would do this because the rich would like their interest incomes to go up faster.
    It would not matter that much if the interest payments went up because the Gov. can always pay unlike the people who often come to a point that they can’t pay more.
    . . 3] OTOH, would pegging the bond rate to the CPI and the JG wage to the CPI undo the counter-inflationary effects of the JG?

  13. Steve Keen’s recent interesting debate with Peter Switzer on Australian house prices (available on youtube) includes Keen\’s comment that “spending is turnover of money PLUS credit. The RBA incorrectly believe CREDIT contributes nothing to GDP, they are on another planet”.

    [Listen to the video for the full explanation of terms; Keen says that virtually no other economist believes this, but he can prove it is correct].

    Not surprisingly, Switzer – in a refreshingly honest and open debate – farewells Keen (an old sparing partner) with the comment that “I hope you are wrong” (re Keen’s dire forecast of Oz house prices).

  14. I believe that if a member of the public buys a government bond with their money directly their bank deposit would go down.

    From my reading of Bill’s blogs my understanding is that only reserves can be exchanged for bonds. So your member of the public would need to get a bank/agent to purchase the bond, then buy it off them.

    The main point is that her bank deposit would transfer the the agent and the aggregate of banking deposits would remain unchanged. Only the aggregate of reserve deposits changes.

    Taxation on the other hand, removes both reserve and Bank deposits, fully reversing previous spending operations.

  15. @ Newton Finn
    @ Brendanm

    I don’t believe that MMT can be successfully got over just by this or that simplification. After all, Warren Mosler’s “Seven Deadly Innocent Frauds…” has been around for getting on for two decades now, and its core messages (such as “govt spends first then taxes”) are being explicitly rubbished every day by politicians and an army of mainstream-spouting wise-guys.

    Imagine if MMT was being routinely taught to 12-year-olds. A fairly high proportion, I would surmise, would grasp at least the basic essentials without much if any trouble. Having done so they would as adults have little or no difficulty in relating the theory they had been taught at school to the social and economic issues of their day. That’s the process, I suggest, which most (all?) of us who read Bill’s blog have been obliged – much more laboriously – to put ourselves through as mature adults (none of us having been taught it in school or university), because we were self-motivated to do so.

    MMT is a body of theory, the object of which is itself an abstraction – namely our monetary system. To understand it you first of all have to want to understand it, and before you get to that stage you have (for some peculiar reason) to have become interested in this esoteric subject. Those two preconditions filter out nine-tenths or more of the adult target population (including a fair proportion of economics graduates) before the process of elucidating the theory to the remaining one-tenth (on the hopelessly-optimistic assumption that you’d been lucky enough to gain the attention of that large a fraction) can even start.

    Education of the young is the first prerequisite for changing an entrenched paradigm. As an absolute minimum, exposition of the working of a fiat floating-exchange-rate monetary system ought to be an essential ingredient in *all* undergraduate courses in economics. MMT would be the perfect vehicle for that though (let’s not be parochial) not the only conceivable one.

  16. Brendanm, cs, Steve_American – Many thanks for your help. I think Brendanm’s 15.57 explanation probably answers my question perfectly (if he’s right!).

    One of the sources of confusion for me in trying to understand MMT is that some new economists focus mainly on bank lending and private debt (Steve Keen, Richard Werner etc.) while Bill and MMT seem to focus on government spending as the financial motor of the economy. Both provide valuable new ways of looking at the world but a novice can get a bit lost in the undergrowth if s/he’s not careful.

  17. Brendanm, you write:

    “.. Bond issue moves reserve currency into bonds, but does not affect bank deposits. The bank deposit increase enacted by government spending is not erased by issuing bonds, only taxes affect bank deposits…”

    No, bank deposits are reduced also when a Gov Bond is purchased. Otherwise, a liability of the bank would remain to the bank’s customer when a Bond purchase instruction is implemented.

    Gov Bonds are highly liquid in the aggregated funds finance sector where they are used. Their only real lack of ‘moneyness’ is in the overnight interbank market which is limited to reserves balances only.

    Hence as Warren Mosler explains, Tsy Securities (aka Gov Bonds) are also part of the ‘net money supply’, or Net Financial Assets of the Non-Gov sector as MMT states it.

  18. The wet dream of the neoliberal of course would be to have control of both monetary and fiscal policy, handed over to their chosen technocrats..

  19. “They are not “losing … effectiveness”, they were never particularly effective in the first place”

    And to the extent that monetary policy is the preserve of the central bank, a sentiment echoed by John Kenneth Galbraith.

    “Nevertheless, it is thought good to have an uncontroversial, politically neutral institution headed as in all recent times by an informed, confident and respected figure of no slight theatrical talent. How agreeable decisions taken in reputable surroundings beneath the portraits of the financially celebrated of the past. It is thus that economic policy should be decided. That nothing important results is overlooked.”

    The “politically neutral” bit of course would have to be tongue-in-cheek.

  20. @Mike Hall

    No, bank deposits are reduced also when a Gov Bond is purchased. Otherwise, a liability of the bank would remain to the bank’s customer when a Bond purchase instruction is implemented.

    I am certainly interested in exactly what your version of the bond purchase transaction involves in terms of the banks reserve account and the private purchaser’s bank account.

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