Thursday, August 1, 2013

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.


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:

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.


Anonymous said...


Unknown said...

Hi Ralph,

The problem seems to be that the Fed, an independent body of non-politicans, is also clueless.

Would Warren have done QE and ZIRP in response to the Great Recession? I doubt it.

Dan Kervick said...

I made some proposals along these lines for greater fiscal-monetary integration back in January:

Dan Kervick said...

Personally, I don't see why we should get rid of government bonds. Even Lerner didn't advocate that. He just stressed that it bond-issuance should be a policy choice, not a standing requirement for funding deficits. There is nothing inherently bad about the government providing a risk-free, interest bearing savings vehicle as a public service.

Most of the complaints about public debt, when you dig down into them, are not really about whether people should be able to earn risk-free interest on their savings - whether paid by the government or someone else - but are about the fact that the system is unfair because some people have far more savings than others. Because of that inequality, government debt is in effect a system that allows the wealthy investor class to own stock in the country and collect dividends on the general economic growth produced by others. (That growth is the reason the government can pump net positive interest income out into the private sector without.)

But suppose we had a more egalitarian society, and that the entire population was investing its discretionary savings in government instruments. Then I don't think there would be any problem with that government debt, as long as it was well-managed by monetary policy. The government could adjust the rate of interest as needed as a matter of monetary policy, dialing it up when a boost is needed and dialing it down when some tightening is needed. The bonds could then just be a kind of online postal bank system that everybody participates in. The bond system would give the government some greater monetary policy flexibility in comparison with a system that relies only on taxes and spending to control the net outflow or inflow.

There has been a a lot of populist mystification about debt and interest, again confusing old bigotries about usurers with real issues of justice and equality. For example, would anyone think that there was any problem at all about student debt if the bulk of higher education was subsidized and the typical debt after graduation was $500 - $1000? Not at all. It would be a perfectly enlightened system of having people buy an education at a very low price on time, and then pay for it after college once they begin to earn money. No different than buying anything else on time at a fair price. The reason people get all worked up about student debt is because the debts are so freaking large. And the largeness of the obligation would be a huge anger-causing problem whether people had to pay it all up front or over many years as a debt. And if only some people deserving can afford it and others can't, that's a problem too.

Unfortunately, this issue has been misconstrued into a whole mixed up philosophy and incomplete history about DEBT, combined with a lot of fantastical dreamwork about escapist lives in noble savage rainforest societies which allegedly have no debt. But it's the high cost and the inequality stupid, not the debts.

NeilW said...

Replace one cabal of the elite at the central bank with another cabal of the elite is no way to run a country.

The whole problem is cabals of the elite. They have no more idea about what to do than just asking a random selection of people on the street.

The simple rule that the government of the day gets their Finance Bill is enough. It has stood the test of time.

Here in the UK even the House of Lords doesn't question the government Finance Bill.

And as we've seen from the debt-limit fiascos in the US, it is no sort of control mechanism anyway.

The government is elected. They are permitted to blow up the country's economy if that is their policy and if they do they will be slung out at the next election by the people who elected them.

That is democracy.

Those who are elected take the decisions and stand or fall based on them. In taking that decision they can consult who they wish, but ultimately the buck stops with them.

Any attempt to limit the sovereign power of the parliament of the country is an attempt to subvert democracy and implement a form of autocratic rule by the 'betters'.

It's neo-feudalism.

NeilW said...

"That form of stimulus implies close cooperation between central bank and government."

No it doesn't - it requires auto-stabilisers that are powerful and work.

AKA a Job Guarantee into the public sector, alongside a scalable tax system that deals effectively with those who tend to be over-rewarded by the capitalist process.

Get the shock absorbers right and you can then set interest rates at the level required to promote the right sort of investment in your economy, and set government spending/taxation to make sure there is enough income.

Those settings then don't need to be moved as often.

Ralph Musgrave said...


The problem with interest rate adjustments is that they distort the economy towards producing investment goods when stimulus is implemented. Then the distortion has to be reversed come the recovery. I don’t rule out interest rate adjustments if fiscal stimulus is not enough, but fiscal is superior in that it can be made more or less distortion free.

That’s why I like Warren Mosler’s “permanent zero” rate of interest.


Governments these days have to make about a million decisions per day. It is plain straightforward impossible to have anything more than a MINUTE proportion of those decisions taken by democratically elected assemblies.

If you want politicians to take technical decisions like whether inflation is likely to rise in the near future, and what implications that has for stimulus, why not also have politicians design nuclear power stations or NASA rockets?

Moreover, as I pointed out above, the system I set out above leaves the MAIN POLITICAL DECISIONS (like what proportion of GDP is allocated to public spending, and how that spending is split between education, defence, etc) explicitly in the hands of politicians and the electorate. That is hardly amounts to “subverting democracy” as you put it.

Re automatic stabilisers, if those can be designed so as to bring PERFECT stability, I’m all for that.