Wednesday, 23 November 2016

Ed Balls’s ideas on central banks are no match for Positive Money / Richard Werner ideas.

Ed Balls is a former economic secretary to the Treasury in the UK. He recently co-authored a paper entitled “Central bank independence revisited: after the financial crisis, what should a model central bank look like?” The other co-authors were two Harvard economists.

I like Ed Balls: he has a sense of humour. But this paper is just a dreary and very long regurgitation of the conventional wisdom or something very near the conventional wisdom. I’ve tried to make the review of the paper below interesting, but I’ve struggled.

According to the 1,400 word summary, the first main idea in the paper is that what it calls “operational independence” (the ability of a CB to choose which instruments to use on control inflation etc) “has been associated with significant improvements in price stability”. In contrast what they call “political independence” - the freedom of CBs to choose their “goals and personnel” - is NOT CORRELATED with price stability.

Well now that’s a big of dog’s dinner, isn't it? For example the main new “instrument” used by CBs since the 2007/8 crisis has been QE, but the Bank of England chose not to exercise any “operational independence” it had in that it sought and got permission from the then UK finance minister (Alistair Darling) before embarking on QE.

As for the other main instrument used by CBs to control inflation, namely interest rate adjustments, most CBs have been using that instrument for decades. So what does “operational independence” amount to? Nothing much!

Second, and as regards “political independence” and “goals and personnel”, the basic “goal” of CBs has for decades been to keep inflation near the 2% target. Or put another way, the aim has been to maximise employment (by cutting interest rates) in as far as that is compatible with acceptable inflation, which of course is one of the main aims of ANY government, whether it has an independent or totally non-independent CB. So there again, what does “political independence” amount to? Not much, far as I can see.

The authors then say they want to “locate new powers inside the central bank, while minimizing potential conflicts with monetary policy and limiting political threats to the legitimacy of central banks’ operational independence.” And the first element of that policy consists of the now very conventional idea that existing arrangements for monetary and fiscal policy are OK when interest rates are well above zero, but at the zero bound, monetary / fiscal coordination is needed.

Also that conflicts with the policy advocated by supporters of Modern Monetary Theory (MMT) which in turn is much the same policy advocated in the submission to the UK’s Vickers commission by Positive Money, Prof Richard Werner and the New Economics Foundation (PM/RW/NEF). And that consists of implementing monetary / fiscal coordination ALL THE TIME: i.e. the idea is that demand should be controlled all the time simply by adjusting the amount of money that the state prints and spends.

So who is right there?

Well I suggest it’s MMTers and PM/RW/NEF. Reason is (as I explained here) that in order to be able to cut interest rates, the state first has to artificially boost them. But that amounts to a clear and unwarranted interference with market forces: that is, the normal assumption in economics is that prices should be at free market prices, unless there are obvious social reasons for thinking otherwise. To that extent, interest rate adjustments are a nonsense (which is not to say they should NEVER be used, e.g. where there is a need for a DRASTIC dose of deflation or the opposite, i.e. stimulus).

In addition, PM/RW/NEF provide plenty of other evidence and reasons for thinking that interest rate adjustments are a defective tool.

Ergo the best role for the state is (as suggested by PM/RW/NEF) to simply print and spend money as required (and/or cut taxes). As to how that job is split between central banks and politicians / treasuries, there again, the Pos Money / Werner solution has all the beauty and simplicity and E=MC2.

That is, the basic principle should be to have TECHNICAL decisions taken by technicians and POLITICAL decisions taken by politicians. Thus PM/RW/NEF advocate that the decision as to how large the TOTAL SIZE of a stimulus package (i.e. the deficit) should be should be up to technicians (e.g. some committee of economists at the central bank). Though as PM/RW/NEF point out, whether that committee is a CB committee is base somewhere else is unimportant: it could be based at the treasury, as long as it is reasonably independent of political influence.

In contrast, the decision as to what proportion of GDP is allocated to public spending and how that is split as between education, infrastructure, defence, etc is clearly a POLITICAL decision, which should thus be taken by politicians.

In short, the fiscal/monetary split which economists have argued about for about a century is one big red herring, to put it politely. Or to put it less politely, it’s a system under which two separate bodies, central bank and “treasury / politicians” each have a say on the total amount of a stimulus package and that makes as much sense as car with two steering wheels controlled by a man and woman in the middle of a marital row.  A much more important split is between technical and political decisions, a distinction which the existing system makes a compete hash of.

And finally it should be noted that while PM/RW/NEF advocate full reserve banking in their paper, the above new split of responsibilities as between treasuries and CBs is perfectly compatible with the existing or “fractional reserve” bank system as it is sometimes called.

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