Must-Read: Simon Wren-Lewis: Brexit and Democracy

Must-Read: Some nice backup from the wise Simon Wren-Lewis. The frame of eurocrats vs. democrats is much, much, much too simple to be more than misleading. We want democracy where democracy belongs, with technocracy where it is needed–always acknowledging that circumstances alter cases, mechanism design is complex, and that democracy’s key benefits are as a legitimacy machine and an anti rent-seeking machine, not as a wise leader or wise policy selection machine:

Simon Wren-Lewis: Brexit and Democracy: “Germany… believed a union-wide demonstration of austerity was required…

…I strongly disagree…have thought a lot about why it happened, but a lack of democracy is not high on my list of culprits…. Democracy was overridden in Greece so cruelly… not [as] the result of actions of unelected bureaucrats, but of elected finance ministers… because of pressure from their own electorates. This exercise in raw political power worked because the Greek people wanted to stay in the Euro. The ‘bad equilibrium’ Evans-Pritchard talks about happens in part because of democracy…. Union governments should not lend money directly to other union governments, precisely because governments are democratic and so find it hard to accept write-offs…

Must-Read: Simon Wren-Lewis: Greece Under Troika Rule

Must-Read: Simon Wren-Lewis: Greece Under Troika Rule: “‘The repayment of foreign loans and the return to stable currencies…

…were recognized as the touchstones of rationality in politics; and no private suffering, no infringement of sovereignty was considered too great a sacrifice for the recovery of monetary integrity. The privations of the unemployed made jobless by deflation; the destitution of public servants dismissed without a pittance; even the relinquishment of national rights and the loss of constitutional liberties were judged a fair price to pay for the fulfilment of the requirements of sound budgets and sound currencies, these a priori of economic liberalism. — Karl Polanyi (1944), ‘The Great Transformation’ (p142)

This quote (HT Jeremy Smith) could almost be written today about Greece. I had once thought that the lessons of the interwar period and Great Depression had been well learnt, but 2010 austerity showed that was wrong…. The Greek government borrowed too much… the scale… meant default was pretty inevitable. But Eurozone leaders, worried about their banking system (which held a lot of Greek debt), first postponed default and then made it partial. The real ‘bailing out’ was for the European banks and others who had lent to the Greek government…. Nothing… obliged Eurozone leaders to lend their voters money to bail out these creditors…. If European leaders felt their banking systems needed support, they could have done this directly….

They convinced themselves that Greece could pay them back. It was a mistake they will do anything to avoid admitting. To try and ensure they got their money back, they along with the IMF effectively took over the running of the Greek economy. The result has been a complete disaster. The amount of austerity imposed caused great hardship, and crashed the economy…. The Troika wants 3.5% primary surpluses by 2018… to start getting their money back sooner… an absurd demand…. Right now Greece needs more aggregate demand not structural reform, yet the Troika insists on taking more demand out of the economy….

Despite Martin Sandbu’s optimism, the recent deal is essentially more of the same. The IMF, which knows it makes no sense to ‘extend and pretend’, has again capitulated. The reaction to the IMF’s paper on neoliberalism has generally missed the key point. It is not fanciful to believe that the paper is directed at those within the IMF like Poul Thomsen, the head of their European department. Falling GDP will continue to be blamed on the Greek government, even without its former finance minister. Of course one day the Greek economy will recover, just as the Irish famine came to an end. But history, as taught in Britain as well as Ireland, does not remember the British troops guarding the shipments of grain leaving Ireland during the famine as heroic upholders of the rules of law and contract. Nor will it do the same for the members of the Troika that keep Greece in poverty.

Must-Read: Simon Wren-Lewis: Helicopter Money and Fiscal Policy

Must-Read: What I often hear: “Expansionary fiscal policy increases the burden of the national debt. That’s the reason expansionary fiscal policy is too risky. Helicopter money–social credit–is expansionary fiscal policy. But expansionary fiscal policy is too risky. Hence helicopter money is too risky.”

Stupid or evil? Simon Wren-Lewis does some intellectual garbage collection:

Simon Wren-Lewis: Helicopter Money and Fiscal Policy: “John Kay and Joerg Bibow think additional government spending on public investment is a good idea…

…We can have endless debates about whether HM is more monetary or fiscal. While attempts to distinguish… can sometime clarify… ultimately… HM is what it is. Arguments that… use definitions to… conclude that central banks should not do HM because it’s fiscal are equally pointless. Any HM distribution mechanism needs to be set up in agreement with governments, and existing monetary policy has fiscal consequences which governments have no control over…..

At this moment in time… public investment should increase in the US, UK and Eurozone. There is absolutely no reason why that cannot be financed by issuing government debt…. HM does not stop the government doing what it wants with fiscal policy. Monetary policy adapts to whatever fiscal policy plans the government has, and it can do this because it can move faster than governments…. Kay… also suggests that HM is somehow a way of getting politicians to do fiscal stimulus by calling it something else. This seems to ignore why fiscal stimulus ended. In 2010 both Osborne and Merkel argued we had to reduce government borrowing immediately because the markets demanded it. HM… avoids the constraint that Osborne and Merkel said prevented further fiscal stimulus…. Many argue that these concerns about debt are manufactured… deficit deceit. HM, particularly in its democratic form, calls their bluff….

There is a related point in favour of HM that both Kay and Bibow miss. Independent central banks are a means of delegating macroeconomic stabilisation. Yet that delegation is crucially incomplete, because of the lower bound for nominal interest rates. While economists have generally understood that governments can in this situation come to the rescue, politicians either didn’t get the memo, or have proved that they are indeed not to be trusted with the task. HM is a much better instrument than Quantitative Easing, so why deny central banks the instrument they require to do the job they have been asked to do?

Must-Read: Simon Wren-Lewis: A General Theory of Austerity

Must-Read: Simon Wren-Lewis: A General Theory of Austerity: “I start by making a distinction… between fiscal consolidation, which is a policy decision, and austerity, which is an outcome where that fiscal consolidation leads to an increase in aggregate unemployment…

…Monetary policy can normally stop fiscal consolidation leading to austerity, but cannot when interest rates are stuck near zero…. I say that austerity is nearly always unnecessary… has nothing to do with markets: the Eurozone crisis from 2010 to 2012 was a result of mistakes by the ECB. If a union member’s government debt is not sustainable, there needs to be some form of default (Greece). If it is sustainable, then the central bank should back that government, as the ECB ended up doing with OMT in 2012…. None of this theory is at all new….

That makes the question of why policy makers made the mistake all the more pertinent. One set of arguments point to… austerity as an accident… Greece happened at a time when German orthodoxy was dominant…. [But this] does not explain what happened in the US and UK…. The set of arguments that I think have more force… reflect political opportunism on the political right which is dominated by a ‘small state’ ideology…. [But] how was the economics known since Keynes lost to simplistic household analogies[?]…. [And why] in this recession, but not in earlier economic downturns?… It does not have to be this way…. We cannot be complacent that when the next liquidity trap recession hits the austerity mistake will not be made again…

Must-read: Simon Wren-Lewis: “Can Central Banks Make Three Major Mistakes in a Row and Stay Independent?”

Must-Read: Simon Wren-Lewis: Can Central Banks Make Three Major Mistakes in a Row and Stay Independent?: “Mistake 1: If you are going to blame anyone for not seeing the financial crisis coming…

…it would have to be central banks. They had the data that showed a massive increase in financial sector leverage. That should have rung alarm bells, but instead it produced at most muted notes of concern about attitudes to risk. It may have been an honest mistake, but a mistake it clearly was.

Mistake 2: Of course the main culprit for the slow recovery from the Great Recession was austerity, by which I mean premature fiscal consolidation. But the slow recovery also reflects a failure of monetary policy…. Monetary policy makers should have said very clearly… that fiscal stimulus would have helped them do that job….

What could be mistake 3: The third big mistake may be being made right now in the UK and US… supply side pessimism. Central bankers want to ‘normalise’ their situation… writing off the capacity that appears to have been lost as a result of the Great Recession…. In both cases the central bank is treating potential output as something that is independent of its own decisions and the level of actual output. In other words it is simply a coincidence that productivity growth slowed down significantly around the same time as the Great Recession. Or if it is not a coincidence, it represents an inevitable and permanent cost of a financial crisis. Perhaps that is correct, but there has to be a fair chance that it is not…. What central banks should be doing in these circumstances is allowing their economies to run hot for a time….

If we subsequently find out that their supply side pessimism was incorrect (perhaps because inflation continues to spend more time below than above target, or more optimistically growth in some countries exceed current estimates of supply without generating ever rising inflation), this could spell the end of central bank independence. Three counts and you are definitely out?

Yes, in some (many) ways, our macro debate has lost intellectual ground since the 1930s. Why do you ask?

Last September, the illustrious Simon Wren-Lewis wrote a nice piece about the Bank of England’s thinking about Quantitative Easing: Haldane on Alternatives to QE, and What He Missed Out.

Simon’s bottom line was that Haldane was not just thinking inside the box, but restricting his thinking to a very small corner of the box:

[neither] discussion of the possibility that targeting something other than inflation might help… [nor] any discussion of helicopter money…

And this disturbs him because:

We rule out helicopter money because its undemocratic, but we rule out a discussion of helicopter money because ordinary people might like the idea…. Governments around the world have gone for fiscal contraction because of worries about the immediate prospects for debt. It is not as if the possibility of helicopter money restricts the abilities of governments in any way…. [While] it is good that some people at the Bank are thinking about alternatives to QE, which is a lousy instrument…. It is a shame that the Bank is not even acknowledging that there is a straightforward and cost-free solution…

It disturbs me too.

One reason it disturbs me is that a version of “helicopter money” was one of the policy options that Milton Friedman and Jacob Viner endorsed as the right policies to deal with the last time we were at the zero lower bound, stock Great Depression. Back in 2009 I quoted Milton Friedman (1972), “Comments on the Critics of ‘Milton Friedman’s Monetary Framework'”, quoting Jacob Viner (1933):

The simplest and least objectionable procedure would be for the federal government to increase its expenditures or to decrease its taxes, and to finance the resultant excess of expenditures over tax revenues either by the issue of legal tender greenbacks or by borrowing from the banks..

And Friedman continued:

[Abba] Lerner was trained at the London School of Economics [stock 1930s], where the dominant view was that the depression was an inevitable result of the prior [speculative] boom, that it was deepened by the attempts to prevent prices and wages from falling and firms from going bankrupt, that the monetary authorities had brought on the depression by inflationary policies before the crash and had prolonged it by “easy money” policies thereafter; that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms…. It was [this] London School (really Austrian) view that I referred to in my “Restatement” when I spoke of “the atrophied and rigid caricature [of the quantity theory] that is so frequently described by the proponents of the new income-expenditure approach and with some justice, to judge by much of the literature on policy that was spawned by the quantity theorists” (Friedman 1969, p. 51).

The intellectual climate at Chicago had been wholly different. My teachers… blamed the monetary and fiscal authorities for permitting banks to fail and the quantity of deposits to decline. Far from preaching the need to let deflation and bankruptcy run their course, they issued repeated pronunciamentos calling for governmental action to stem the deflation-as J. Rennie Davis put it:

Frank H. Knight, Henry Simons, Jacob Viner, and their Chicago colleagues argued throughout the early 1930’s for the use of large and continuous deficit budgets to combat the mass unemployment and deflation of the times (Davis 1968, p. 476)… that the Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure (Wright 1932, p. 162)….

Keynes had nothing to offer those of us who had sat at the feet of Simons, Mints, Knight, and Viner. It was this view of the quantity theory that I referred to in my “Restatement” as “a more subtle and relevant version, one in which the quantity theory was connected and integrated with general price theory and became a flexible and sensitive tool for interpreting movements in aggregate economic activity and for developing relevant policy prescriptions” (Friedman 1969, p. 52). I do not claim that this more hopeful and “relevant” view was restricted to Chicago. The manifesto from which I have quoted the recommendation for open-market operations was issued at the Harris Foundation lectures held at the University of Chicago in January 1932 and was signed by twelve University of Chicago economists. But there were twelve other signers (including Irving Fisher of Yale, Alvin Hansen of Minnesota, and John H. Williams of Harvard) from nine other institutions’…

“Helicopter money”–increases in the money stock used not to buy back securities but instead to purchase assets that are very bad substitutes for cash like the consumption expenditures of households, roads and bridges, the human capital of 12-year-olds, and biomedical research–could be mentioned as a matter of course as a desirable policy for dealing with an economy at the zero lower bound by Jacob Viner in 1933. But, apparently, central banks do not even want to whisper about the possibility. One interpretation is that, confronted with Treasury departments backed by politicians and elected by voters that have a ferocious and senseless jones for austerity even though g > r, central banks fear that any additional public recognition by them that fiscal and monetary policy blur into each other may attract the Eye of Austerity and so limit their independence and freedom of action.

If I were on the Federal Reserve Board of Governors or in the Court of the Bank of England right now, I would be taking every step to draw the line between fiscal policy and monetary policy sharply, but I would draw it in the obvious place:

  • Contractionary fiscal policies seek to lower the government debt (but with g > r or even g near r and hysteresis actually raise the debt-to-GDP ratio and possibly the debt).
  • Expansionary fiscal policies seek to raise the government debt (but with g > r or even g near r and hysteresis actually lower the debt-to-GDP ratio and possibly the debt).
  • Policies that neither raise or lower the debt ain’t fiscal policy, they are monetary policy.
  • Contractionary monetary policies reduce the money stock (and usually but do not have to raise the stock of government debt held by the private sector).
  • Expansionary monetary policies raise the money stock (and usually but do not have to lower the stock of government debt held by the private sector).

And if helicopter money leads Treasuries to protest that the money stock is growing too rapidly? (They cannot, after all, complain that the government debt stock is growing too rapidly because it isn’t.) The response is: Who died and put you in charge of monetary inflation-control policy? That’s not your business.

Must-read: Simon Wren-Lewis: “The Financial Crisis, Austerity and the Shift from the Centre”

Must-Read: Simon Wren-Lewis: The Financial Crisis, Austerity and the Shift from the Centre: “Think of two separate one dimensional continuums…

…one economic, with neoliberal at one end and statist at the other, and the other something like identity. Identity can take many forms. It can be national identity (nationalism at one end and internationalism at the other), or race, or religion, or culture, or class. Identity politics is stronger on the right…. For the political right identity in terms of class can work happily with neoliberalism, but identity in terms of the nation state, culture and perhaps race less so…. When neoliberalism is discredited, this potential contradiction on the right becomes more evident… [as] politicians on the right use identity politics to deflect attention from the consequences of neoliberalism…. Identity has always been strong on the right, so it is a little misleading to see it as only something that the right uses in an instrumental way….

None of this detracts from the basic point that Quiggin makes: the apparent drift from the political centre ground is a consequence, for both left and right, of the financial crisis…. One interesting question for me is how much the current situation has been magnified by austerity. If a larger fiscal stimulus had been put in place in 2009, and we had not shifted to austerity in 2010, would the political fragmentation we are now seeing have still occurred? If the answer is no, to what extent was austerity an inevitable political consequence of the financial crisis, or did it owe much more to opportunism by neoliberals on the right, using popular concern about the deficit as a means by which to achieve a smaller state? Why did we have austerity in this recession and not in earlier recessions? I think these are questions a lot more people on the right as well as the left should be asking.

Must-read: Jonathan Portes and Simon Wren-Lewis: “Issues in the Design of Fiscal Policy Rules”

Must-Read: Jonathan Portes and Simon Wren-Lewis: Issues in the Design of Fiscal Policy Rules: “The potential conflict in designing rules between the need to mimic optimal policy…

…where debt is a shock absorber and is adjusted only very slowly, and the need to prevent deficit bias…. It may therefore make sense to make different recommendations depending on… the nature of governments…. [In] governments… not… subject to deficit bias… simple debt feedback rules come close to reproducing the optimal fiscal policy… [if] the exchange rate is floating and there is little risk of hitting the ZLB…. [G]overnment[s] behav[ing] in a non-benevolent manner… need… operational targets… fixed for the end of the natural term of the government… [to] provide strong incentives… for cyclically adjusted primary deficits…. These targets should be set in cooperation with a fiscal council, which would monitor progress… [and,] in exigent circumstances… suggest that the target be revised….

These rules should not apply if interest rates have hit the ZLB. In that case, fiscal policy should focus on demand stabilization… the suspension of the rule while the ZLB constraint applies, and not its modification. This ‘knockout’ should be an explicit part of the rule…

Must-read: Simon Wren-Lewis: “A (Much) Better Fiscal Rule”

Must-Read: Simon Wren-Lewis: A (Much) Better Fiscal Rule: “Today the Labour Shadow Chancellor John McDonnell…

…will give a speech where he puts forward an alternative fiscal rule… a rolling target for the government’s current balance: within 5 years taxes must cover current spending. It leaves the government free to borrow to invest…. There is a commitment to reduce debt relative to trend GDP over the course of a parliament. No doubt we will hear the usual cries from the opponents of sensible fiscal rules: Labour plan to borrow billions more than George Osborne and they plan to go on borrowing forever. The simple response to that should be that it is right to borrow to invest in the country’s future, just as firms borrow to invest in capital and individuals borrow to invest in a house. Indeed, with so many good projects for the government to choose from, and with interest rates at virtually zero, it is absolute madness not to investment substantially in the coming years….

Recessions come and go, you might respond, but higher debt will always be with us. That ignores two key points. First, prolonged and deep recessions cause lasting damage. UK GDP per head is currently over 15% below pre-recession trends. Does none of that have anything to do with the slowest UK recovery from a recession in centuries? Second using fiscal policy to end recessions quickly does not mean higher debt forever. The key point is that debt can be reduced once the recession is over and interest rates are safely above their lower bound. Doing that will be no cost to the economy as a whole, as monetary policy can offset the impact on demand. Obsessing about debt during a recession, by contrast, costs jobs and reduces incomes, as every economics student knows and as the OBR have shown….

Some Labour MPs and commentators. They say, quite rightly, that one of the main reasons the 2015 election was lost was because Labour were not trusted on fiscal policy. But the basic truth is that you do not enhance your fiscal credibility by signing up to a stupid fiscal rule. Apart from getting attacked for doing so by people like me, your collective heart is not really in it and it shows. You get trapped into proposing to shrink the state as Osborne is doing, or hitting the poor as Osborne is doing, or raising taxes which makes you unpopular. And if by chance it ever looks like you might be getting that trust back, Osborne or his successor will move the goalposts again.

The far more convincing way to get trust back is to adopt a fiscal rule that makes sense to both economists and the public (‘only borrowing to invest’), and actively talking about it….

The Conservatives know they are vulnerable on public investment. Osborne tries to give the impression that he is doing a lot of it, but the figures do not lie. In the last five years of the Labour government the average share of net public investment in GDP was over 2.5%. During the coalition years it fell to 2.2%, and for the five years from 2015 it is planned to average just 1.6%. That is not building for the future, but putting it in jeopardy, as those whose homes have been flooded have found to their cost.

Must-read: Simon Wren-Lewis: “The ‘Strong Case’ Critically Examined”

Simon Wren-Lewis: The ‘Strong Case’ Critically Examined: “The deficit obsession that governments have shown since 2010…

… has helped produce a recovery that has been far too slow, even in the US. It would be nice if we could treat that obsession as some kind of aberration… but unfortunately that looks way too optimistic. The Zero Lower Bound (ZLB) raises an acute problem for… the consensus assignment… [of] leaving macroeconomic stabilisation to an independent, inflation targeting central bank) [and when you] add in [fiscal] austerity… you get major macroeconomic costs. ICBs appear to rule out the one policy (money financed fiscal expansion) that could combat both the ZLB and deficit obsession….

Many macroeconomists do see the problem, but the solutions they propose are often just workarounds… [q]uantitative Easing… NGDP targets… a higher inflation target… mean that in response to a sharp enough recession, we would still regret no longer having the possibility of undertaking a money-financed fiscal stimulus.

I also think there is a grain of truth in the argument that ICBs created an environment where deficit obsession became easier…. Ask the following question: in the absence of ICBs, would our deficit obsessed governments actually have undertaken a money financed fiscal stimulus? To answer that you have to ask why they are deficit obsessed. If it is out of ignorance (my Swabian syndrome), then another piece of macro nonsense that ranks alongside deficit obsession is the evil of printing money in any circumstances. I suspect a patient suffering Swabian syndrome would also be subject to this fallacy. If the reason is strategic (the desire for a smaller state) the answer is obviously no. We would simply be told it could not be done because it would open the inflation floodgates.