British House of Lords inquiry into the Bank of England’s performance is a confusing array of contrary notions
On November 27, 2023, the Economic Affairs Committee of the British House of Lords completed…
As part of the paradigmic turmoil that is confronting mainstream economists, we are witnessing some very interesting strategies. Imagine you establish a set of principles that are seemingly inviolable. They are the bedrock of the belief system, even though it is not called that. These principles then offer all sorts of predictions about, yes, the real world. They are without nuance. The predictions are so worrying, that politicians, whether they are knowing or not, proceed with caution in some cases, and, in other cases, openly damage the well-being of citizens because they have been told that shock therapy is better than a long drawn out demise into ‘le marasme’. The authority for all the carnage that follows (unemployment, poverty, pension cuts, degraded public infrastructure and services, etc) is these ‘inviolable principles’. Economists swan around the world preaching them and bullying students and others into accepting them as gospel. The policy advice is hard and fast. Governments must stay credible. Except one day they completely change tack and all the policy advice that established certain actions to be totally taboo become the norm. We observe things are better as a result. Does this mean those ‘inviolable principles’ were bunk all along? Not according to the mainstream economists who are trying to position themselves on the right side of history. Apparently, their optimising New Keynesian models can totally justify fiscal dominance and central bank funding fiscal deficits when yesterday such actions were taboo. Which leg are they trying to pull?
So this set of principles is held out as a science – a body of principles embedded in an understanding of human psychology and incentive systems. Except, the practitioners forget to tell you that they are not sociologists and psychologists, nor are they anthropologists.
And they ignore the fact that those social sciences actually are built on establishing a clinical and social understanding of human behaviour, motivation and organisation.
And so these ‘principles’ create an image of humanity that no other social scientist or medical scientist, for that matter, can identify as being human.
Never mind. Continue. Who are they to tell us what it right anyway?
These principles then offer all sorts of predictions about, yes, the real world.
The principles are abstractions but are held out as being of fundamental relevance to the real world.
As a result of the nature of the discipline, the predictions have manifest consequences for human well-being, physical, mental, and material.
And these predictions also condition the way our governments design and implement policy interventions, which link the world of thought to humanity.
It turns out at some point, the predictions are so worrying that politicians, whether they are knowing or not, proceed with caution in some cases, and, in other cases, openly damage the well-being of citizens because they have been told that shock therapy is better than a long drawn out demise into ‘le marasme’.
And all manner of damage is inflicted on communities around the world by governments who follow the advice of economists based on these inviolable principles.
Anyone who dares contest them is summarily dismissed as being unknowing, ideological, dangerous leftist, stupid, and all manner of slights that I, personally, could document over my career to date.
The principles are typically expressed in abstract mathematical language that even the true mathematicians find rather simplistic and naive.
Never mind. Continue. Who are they to comment?
The predictions and the abstractions sit uncomfortably next to each other.
In fact, while the defenders of these principles dwill never admit it openly, the predictions are not directly derivable from the principles.
The logic says they cannot be because in order to ‘solve’ the mathematical representations the ‘models’ (their abstract depiction of reality) are so simplified that they are incapable of ‘tracking’ the real world data.
Which means in English that without further ad hoc manipulation, the theoretical models have no empirical application.
So to satisfy some semblance of statistical congruency (using the established diagnostics of mathematical statistics and distribution theory), the operational frameworks deployed depart from the starting principles and framework.
If that doesn’t make sense, try this.
They justify the principles as being ground, for example, in optimising behaviour by humans. The so-called ‘micro-founded’ macroeconomic models.
They harp on to their students about the beauty and authority of these ‘micro-founded’ approaches.
But as soon as they have to apply those models to the real world, they introduce all sorts of ad hoc manipulations, which help the statistical expression of the models ‘fit’ the data.
There are two problems for them as a result:
First, the predictions systematically fail to account for real world developments.
Fiscal deficits rise and interest rates or bond yields do not.
Central banks buy massive quantities of government bonds, effectively financing fiscal deficits, and inflation rates hover at low levels and price expectations follow.
Government debt rises but bond markets keep queuing up for more except in the Eurozone where they start pushing up demands for higher returns to accommodate the increased risk because they know the governments do not have their own currency any more.
Except, even then the ECB steps in an absorbs all the yield pressure using keystrokes in computers to buy huge amounts of government debt.
The Treaties are written to prevent the ECB doing that and the economists talk relentlessly about maintaining credibility (one of those principles that are allegedly inviolable) but still the ECB breaks taboo because they know without them the common currency collapses fairly quickly such is the dysfunctional nature of the monetary architecture the economists insisted was put in place – following their ‘principles’.
Second, and moreover, no-one owns up to the fact that once the highly abstract, simplified mathematical models, that are constructed following the application of these optimising assumptions, are tampered with in order to get any semblance of a statistical fit to the real world data, the users can no longer say that the results (the predictions) flowed from the principles (the micro-foundations).
Once the ad hoc changes are made (lags added to relationships etc) then we are sailing in unknown waters – certainly not in any waters that their so-called optimising principles can apply to.
They don’t tell you that though.
If they did, their cover would be blown. They would lose their own perception of rigour or technical authority.
The reality is they have none.
Please read my blog post – Mainstream macroeconomic fads – just a waste of time – (September 18, 2009) – for more technical discussion on this point.
So humanity suffers and none of these characters lose their jobs, go to prison for professional incompetence, or lose their pensions when they decide to depart the scene.
They wander around appearing at conferences, write Op Eds that just repeat and repeat, in some cases receive huge speaking fees from organisers who represent segments of society that are the winners of the application of these principles, and that has been the world for some decades now.
As time passes, we start to put two and two together. We get four.
We realise that the outcomes that these professionals promised us, if only we sacrificed and pulled our belts in, haven’t transpired.
We realise that our wages haven’t grown much yet incomes at the top-end of the distribution have gone through the roof.
We realise that the quality of our jobs, if we are able to keep one, have deteriorated.
More of us are forced onto contracts without the old protections.
More of us are ‘casualised’. They tell us that this helps us achieve work-life balance – which sounds beautiful – but is, in reality, a road to a low-wage, precarious life with little balance being evident – split-shifts, zero-hour commitments, capricious and bullying bosses.
We realise that the investment in our public education and health systems is falling and services are deteriorating yet profits in the privatised health care and educational sectors are booming.
We learn that private education providers are receiving massive contracts from government in the ‘competitive’ educational sector and provide students with libraries that consist of one shelf in a sparsely occupied office in a back street of our cities.
I was approached this week by a student from some private college in Australia which boast it offers the No 1 on-line MBA in Australia. He wanted me to send him a published article I authored in one of the top Australian economics journals last year – a totally mainstream journal at that – because his college does not provide access!
Anyway, then the tide turns.
There is a commercial property collapse in Japan that leads the government to break ranks with the neoliberals and increase fiscal deficits, see the Bank of Japan buying up massive quantities of government debt.
Interest rates stay zero for decades.
Bond yields fall towards zero and into negative space.
Inflation struggles to record positive numbers.
But that is Japan – ‘cultural’. It doesn’t apply to us.
Then there is the GFC.
Bank of England, the ECB, the Federal Reserve all start looking very Japanese.
The treasuries (Ministries of Finance) all start looking very Japanese.
Big deficits, big central bank bond buying.
No interest rate or bond yields breaking through any roofs.
Then comes the pandemic.
The whole world goes Japanese.
And guess what, the economists start shifting ground.
They have to because even they know how stupid they have looked over these various crises.
How stupid did Olivier Blanchard look when he had to apologise in 2012 for overseeing the IMF recommendations to impose harsh austerity onto Greece and then to discover the underlying modelling they had used to justify that program was deeply flawed?
Not a little bit flawed. Deeply flawed to the extent the applying it would have generated exactly the opposite outcomes to what the IMF claimed would follow from the bailout program.
How stupid did Reinhardt and Rogoff look when, after swanning around gaining world-wide attention for their debt threshold study (‘this time is different’) it was discovered by a postgraduate student that their spreadsheet calculations were wrong?
We will never know whether this was deliberate or just incompetence but policy makers took heed of their initial claims as part of the justification for imposing harsh austerity onto citizens.
How stupid did Paul Krugman look when he claimed in 2017 that “Deficits Matter Again” only to change his mind again when nothing happened according to his script, which in his own words “didn’t come out of thin air … [but … was based on well-established macroeconomic principles.” (Source)?
How much time have I got?
I could document these idiocies for days on end and still not get close to the end.
But the point is that now we are witnessing papers and Op Eds coming out from various economists and groups which now claim that the fiscal dominance we are witnessing with central banks effectively keeping the private bond investors at bay, while governments continue the unnecessary act of issuing public debt to match their fiscal deficits is fine and they knew it all along.
Just a short time ago, they were arguing that it was not.
Then they said that counter-stabilisation (macroeconomic policy) had to be the domain of ‘independent’ central banks at arm’s length from government and that fiscal policy had to concentrate on reducing public debt, which meant it had to be biased towards surplus.
Where did they get those recommendations from?
Their inviolable principles of course.
Apparently, assigning policy precedence to monetary policy and eschewing fiscal policy was the outcome of their modelling logic following the application of their ‘micro-founded’ New Keynesian frameworks.
A reasonable person would then ask such an economist this sort of question.
If your micro-founded principles and resulting analytical framework so strongly established this macroeconomic policy mix yesterday and today you are advocating quite the opposite, does it mean your underlying analytical framework that you used yesterday was wrong and that you have abandoned it?
Quite a reasonable question.
You wouldn’t have to know anything about economics to ask that question.
Well it turns out that it seems that the underlying analytical framework still applies but because it is obvious that fiscal dominance is the only way to save capitalism, which is now on state life support systems, the framework can be tweaked to justify the abandonment of the old policy recommendations, which, as we all know were presented more as taboos than preferences.
That is where the mainstream is at now.
Totally confused. Adrift. Hanging on to their security blankets (the principles) but trying to convince us that they are on top of things.
A good example of this sort of sophistry was released by the Centre for Economic Policy Research in partnership with the International Center for Monetary and Banking Studies (ICMB), under their so-called “Geneva Reports on the World Economy” (No 23) on December 15, 2020.
The CEPR are funded by their membership base and the “financial sector currently makes up two thirds of the membership base”. They claim that they are “broadening the membership base” and cite “for example, the support of most European Union Central Banks as well as the ECB, World Bank, IMF, EBRD and the BIS.”
I would not call that broadening. I would call that deepening the Groupthink base.
Anyway, their paper – It’s All in the Mix: How Monetary and Fiscal Policies Can Work or Fail Together – notes that “the notion of the monetary-fiscal policy mix has made a spectacular come back” because of “the COVID-19 pandemic”.
They claim that:
To deliver the required macroeconomic stabilisation, monetary and fiscal authorities had to join forces and pull together, blurring the traditional boundaries between monetary and fiscal interventions.
The policy mix, long forgotten in the public debate as well as in economics textbooks, is back with a vengeance, and with it the impression that the conventional wisdom about the respective roles of monetary and fiscal authorities is seriously outmoded.
So they ask whether this shift:
Are we witnessing a policy revolution that will shatter the decades-old consensus on the respective roles of central banks and treasuries?
The answer to the question is that what we are observing now should definitely “shatter” the New Keynesian ‘consensus’ once and for all.
But they couldn’t bring themselves to reach that obvious conclusion because then they would have to make further admissions along the lines of what have they been doing all these years while taking good salaries.
That wouldn’t be a very comfortable exercise.
Which is why Groupthink is so hard to, dare I use their word again “shatter”.
So to save face we get the usual tripe.
This new policy mix – fiscal dominance/central banks basically funding the deficits and more – is only possible – “can only work”:
… if the credibility of their commitment to desirable long-term goals – healthy growth under price stability and public debt sustainability
And that means that policy makers have to start moving back to the old policy mix.
Which means that austerity is back in town even though governments are doing exactly the opposite.
I don’t recommend you read their report – it is 181 pages of standard guff.
I read this stuff every day – it is sort of a rod I took on when I became an economist unfortunately. I suspect you all have much better things to do with your time.
The issue is clear enough.
Apparently, they now believe that:
… successful stimulus requires fiscal and monetary authorities to create policy space for each other. With high debt, monetary stimulus creates fiscal space by determining favourable borrowing conditions for the treasury. But for this space to be effective, the central bank must also provide a credible monetary backstop to government debt – essentially shielding the debt markets from belief-driven surges in sovereign risk. With rates at their lower bound, the treasury creates space for monetary stimulus via QE and unconventional measures by offering a contingent backstop to the central bank balance sheet, so that monetary authorities do not face the risks of losing control of money creation and inflation even in the case of large losses.
So, it’s all there. The myths.
1. Governments have to issue to debt to spend above taxation revenue.
2. Private bond markets rule but occasionally they don’t.
The question they can never answer is when it is optimal for the switch to be made from private markets determining the bond yields to central banks determining the yields?
It is obvious that central banks can always keep yields at whatever level they desire. Why don’t they always do that?
3. Central bank can go broke if they buy too much public debt and markets crash so the treasury has to guarantee that won’t happen.
Of course, central banks are not corporations that can become insolvent. They could operate with negative capital forever and no-one would be the wiser.
They could also just type a zero against all the public debt they currently own as a result of their various bond-buying programs and nothing else would happen.
Other than, the public debt ratios would dramatically fall.
When would it be optimal to do that? Always, but the New Keynesians have no analytical capacity to answer that question even though they claim lower public debt ratios are preferable.
4. QE could lead to money creation getting out of control and inflation accelerating – taboo taboo taboo.
They just cannot get over the fact that central banks have been doing this for years now and inflation has gone the other way.
They just cannot comprehend that the central banks have been telling us they are trying as hard as they can to get their inflation rates back up towards their so-called (arbitrary) price stability levels and they have failed.
But, undaunted, the CEPR authors continue to invoke the old principles:
1. “a ‘fiscal backstop’ to central banks’ unconventional policy cannot work if public debt sustainability is in jeopardy” – how can the public debt be unsustainable if central banks hold increasing proportions of it and control yields over the rest of it?
This is a scare-type threshold that has no meaning. The dramatic shift in policy mix that they acknowledge has demonstrated that once and for all, even though they cannot seem to comprehend that.
2. “What the two authorities cannot do is fall into a regime where optimal temporary actions turn into a permanent situation, leading to disaster.”
Taboo doesn’t apply now. But it will later logic.
3. “the budget should tend to be in surplus in booms to create a fiscal buffer for rainy days.”
A ridiculous proposition. Why would that ever been sensible.
What if the boom (high employment) was accompanied by high overall saving from the non-government sector according to preferences?
Then the boom would only have been possible with fiscal deficits of a size commensurate to offset the overall non-government saving.
And if we decompose the non-government sector, what happens if the boom was accompanied by an external deficit, and a desire to save overall by the private domestic sector, which one might offer is a pretty normal situation for a nation to be experiencing?
Then the fiscal deficit would have to even bigger and continuous.
So these context-free claims that the fiscal position has to ‘save’ up currency for rainy days is preposterous and unfounded.
Governments that issue there own currency can always increase deficits no matter what they were doing yesterday or the day before.
They can always respond to declines in non-government spending to protect jobs and incomes.
And their central banks can always ensure bond yields (if debt is issued) are low, irrespective of how much debt is currently outstanding.
There is never a situation where a currency-issuing government can go broke.
So the question remains: if all this talk of credibility and sustainability and the rest of it justified austerity in the past, how can it now justify a diametrically opposite approach to policy?
The answer is that it cannot.
The inviolable principles are bunk.
Which is why the sky hasn’t fallen in on Japan.
Which is why central banks cannot really push up inflation rates despite trying.
Which is why bond yields are low and have been in, say Japan for years despite high, continuous fiscal deficits.
Which is why the New Keynesian paradigm in economics is breaking down.
This lot will eventually die out.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.