Guest post: MMTers need to think about how to merge monetary and fiscal policy

Guest post by Ralph Musgrave.

Advocates of Modern Monetary Theory keep making the point that a monetarily sovereign government can create and net spend any amount of money, the only constraint being inflation. I agree.

Moreover, MMTers have little to say about interest rates, although Warren Mosler argued that the interest rate should be permanently set at zero. (See item No.3 under his heading “Proposals for the Federal Reserve”). That virtually amounts to saying that governments should not borrow at all, and that the only liability they should issue should be money (monetary base to be exact). Indeed, Warren says as much in his second last paragraph.

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And Warren is in good company. Milton Friedman advocated the same “money but no debt” policy (see p.250, paragraph starting “Under the proposal..”). Plus I’ve argued that none of the conventional arguments for government borrowing make sense. Link to my paper: http://mpra.ub.uni-muenchen.de/23785/

So let’s assume that in the ideal MMT economy, stimulus is implemented only or primarily by creating new money and spending it (and/or cutting taxes).

So who decides how much stimulus is required?

That form of stimulus implies close cooperation between central bank and government. For example, if it’s decided that $Xbn of stimulus is in order, then the central bank would have to create and $Xbn and government would have to spend the money on roads, the military, education or whatever (or alternatively, a right of centre government would probably cut taxes).

And that all needs to be done fairly QUICKLY: the lags between monetary and fiscal adjustments and the desired effect are long enough as it is (roughly a year).

And not only would government and central bank need to cooperate, but the mere fact of creating new money and net spending it is clearly part fiscal and part monetary policy. That is, there is an inevitable money supply increase involved (monetary policy), plus there is the actual spending of said money (fiscal policy).

To summarize, the distinction between central bank and government becomes blurred.

So what exact institutional arrangements would exist in this ideal MMT world? For example when deciding how much stimulus to apply and deciding exactly how that money is net spent would there be a committee made up partly of politicians (for the fiscal bit) and partly of central bank economists (for the monetary bit)?

That question has already been answered.

Well an answer to that little problem has already been set out by a trio of authors who, while they are not MMTers, nevertheless take a dim view of interest rate adjustments and, like MMTers, do believe in implementing stimulus simply by creating new money and net spending it. Their solution is to have the amount of stimulus decided by an independent committee of economists, much like various such committees around the world which already have a big say in stimulus decisions. The Monetary Policy Committee at the Bank of England is one example.

 As to strictly political decisions, like what proportion of GDP should be allocated to public spending, that remains ENTIRELY with politicians and voters. So if the latter committee decided and extra $Xbn should be net spent in the next year, it would inform Congress, and Congress would then get on with deciding how to net spend the money. But note that it would only be the DIFFERENCE between tax and public spending (i.e. the deficit) that the committee could influence. In contrast, if Congress decided to raise taxes AND SPENDING by $Ybn, that would be entirely their business.

The above committee would have no powers to influence that decision. Politicians are economically illiterate. An additional advantage of that system is that it disposes of a glaring nonsense in the existing system, which is that most countries have two bodies with a say over stimulus: government and central bank. That makes as much sense as a car with two steering wheels each controlled by a different person. Worse still, one of the “drivers” in existing economies (i.e. elected bodies like Congress) are composed of a bunch of people who are WHOLLY UNQUALIFIED to estimate what inflation is likely to do in the next year, and hence what amount of stimulus is in order.

So called professional economists are bad enough. But Congress and similar elected bodies of politicians in other countries are a bunch of economically illiterate buffoons. And finally, the latter buffoons in a number of countries will doubtless not want to give up their right to have a say on stimulus. Or to put it more bluntly, they won’t want to give up their right to wreck economies. But I’ve simply set out above what I think is the ideal system. That system may well be politically impossible in some countries, at least for some time yet.