Must-read: Simon-Wren Lewis: “The Strong Case Against Independent Central Banks”

Must-Read: Simon Wren-Lewis: The Strong Case Against Independent Central Banks: “In the post war decades there was a consensus…

…that achieving an adequate level of aggregate demand and controlling inflation were key priorities for governments. That meant governments had to be familiar with Keynesian economics…. A story some people tell is that this all fell apart in the 1970s with stagflation. In the sense I have defined it, that is wrong. The Keynesian framework had to be modified… but it was modified successfully. Attempts by New Classical economists to supplant Keynesian thinking in policy circles failed…. The more important change was the end of Bretton Woods and the move to floating exchange rates. That was critical… allowed the creation of what I have called the consensus assignment. Demand management should be exclusively assigned to monetary policy, operated by ICBs pursuing inflation targets, and fiscal policy should focus on avoiding deficit bias. The Great Moderation appeared to vindicate this consensus.

However the consensus assignment had an Achilles Heel… the Zero Lower Bound…. Although many macroeconomists were concerned about this, their concern was muted because fiscal action always remained as a backup. To most of them, the idea that governments would not use that backup was inconceivable…. That turned out to be naive. What governments and the media remembered was that they had delegated the job of looking after the economy to the central bank, and that instead the focus of governments should be on the deficit….

Macroeconomists were also naive about central banks. They might have assumed that once interest rates hit the ZLB, these institutions would immediately and very publicly turn to governments and say we have done all we can and now it is your turn. But for various reasons they did not. Central banks had helped create the consensus assignment, and had become too attached to it to admit it had an Achilles Heel….

Economists knew that the government could always get the economy out of a demand deficient recession, even if it had a short term concern about debt. The fail safe tool to do this was a money financed fiscal expansion. This fiscal stimulus paid for by the creation of money was why the Great Depression could never happen again. But the existence of ICBs made money financed fiscal expansions impossible when you had debt-obsessed governments, because neither the government nor the central bank could create money for governments to spend or give away…