Labour's Bank of England problem

Despite Jo Michell’s criticisms of him, I fear that Richard Murphy raises an important point here.

To see it, let’s assume Labour were to take power today. There is a pressing need not just for more infrastructure spending but for more current government spending – on the NHS, local government, courts, prisons and so on. Let’s say that Labour does raise such spending, and therefore aggregate demand.

The Bank of England would regard this as inflationary. It raised rates last week because it believes “the UK economy currently has a very limited degree of slack”. A fiscal expansion would eat further into this slack thus prompting the Bank to raise rates to suppress demand.

Of course, the Bank of England might well be wrong to believe this*. But even if it is, rates will rise in response to a fiscal stimulus.

In this sense, Richard is right to say that “austerity will remain in place”, in the sense that we’ll suffer ongoing weak growth and continued mass unemployment – the difference being that it'll be due to tighter monetary rather than tight fiscal policy. And he’s right to say that, as things stand, Labour is leaving Carney & Co in charge.

In this context, the question of financing the extra government spending is a red herring: even if it were accompanied by higher taxes, there would be some rise in rates – remember the balanced budget multiplier?

The question is: what to do about this?

One solution would be to remove the Bank’s operational independence or, less radically, to raise its inflation target: doing so might be justified as a means of offsetting the Bank’s bias to over-estimating the Nairu.

It’s easy, though, to see why Labour might be loath to do this. Doing so would invite its critics to invoke folk memories of Labour’s failure to control inflation in the 70s.

It would also be only a temporary fix. Jo has a point when he says:

One doesn't have to sign up to a constant NAIRU to acknowledge that at some point higher demand is going to induce inflationary pressures. I sometimes get the impression this is not sufficiently acknowledged in MMT.

The constraint upon full employment is genuine – even if nobody knows for sure where exactly it is. Jo is therefore right to say that fiscal policy alone cannot achieve full employment.

He’s also right to say we need a progressive supply-side policy – ways of boosting productivity, capacity and competition to enable the economy to grow without generating so much inflation. It is here that Labour’s attack upon neoliberalism should lie: a national investment bank, worker democracy and even a citizens’ basic income.

But, but, but. It is unclear whether such policies really can do much to boost trend growth. In a famous paper (pdf) John  Landon-Lane and Peter Robertson argued that national policies can do little to affect trend growth, and Dietz Vollrath has shown that they can’t increase productive potential very quickly.

This is not to counsel despair. Getting rid of the Tory-Centrist fiscal squeeze would be a good idea; a little higher inflation or interest rates would be no disaster; and lots of supply-side policies such as better education, stronger competition policies and worker democracy are good ideas even if they don’t do much to raise growth.

Instead, we must remember the old Marxian question: how much can policy achieve within the constraints of capitalism? Yes, some of these constraints are illusory (such as capital flight). But some of them are not.  

Comments

[Luis Enrique]

What, I wonder, is Richard's prescription?

My guess is that it is:

1. Remove BoE independence and begin some direct money financing of government expenditure. (The extent to which he'd expect that to replace debt issuance, I cannot guess).

2. increase government expenditure (investment and current)

3. introduce a job guarantee

4. If it looks like you've over cooked it, raise taxes to 'remove money' from the economy.

If that's roughly right, how do you think it would pan out Chris?

(one concern that jumps out at me is that if you do overshoot and inflation rises too high, then raising taxes to tamp that down will be easier said than done).

[Peter K.]

I am more in favor of a UBI than a JG, but would support a job guarantee (which is just a basic income with a work requirement).

Here in the U.S. the MMTers argue that a JG is a crucial part of their macro program.

Say they institute a JG but still don't control the central bank (similar to your example.)

Everyone who wants a job can walk in and get a job and and income. Eventually inflation begins to edge up. The central bank raises rates.

People lose their jobs and go to the employment agency to get JG jobs. Rinse and repeat. Pretty soon the majority of jobs are JG jobs.

Current JG advocates don't say this, but Minsky and older ones touted the fact a JG could help control inflation.

If private employees who are above the JG wage scale threaten to agitate for higher wages, employers can threaten to replace them with JG workers who will work for more, thereby dampening wage demands.

[efcdons]

Peter K., Matt Bruenig has been telling everyone Minsky's beliefs about the mechanism by which JG controls inflation all over twitter and his PPI site. The JG people on twitter keep saying Matt's lying or misrepresenting Minsky or something.

This seems to be a political problem at its core. Capital owners want to maximize their share of national income and they control these "independent" bodies who have the power to impact the economy's direction. The idea CBs are "independent" is farcical.

But with inflation, what are the negative impacts on a "regular" person's day to day life? If there is wage-price inflation (from a tight employment market) then isn't the total impact a wage earner's standard of living close to neutral?

In the "old days" there was a physical problem caused by the need to increase the amount of cash one had to carry around (e.g. the famous "wheel barrow full of money" from Wiemar). But in our cashless economy that problem is solved. No one needs to increase the number of physical bills they carry around to buy stuff. Or reprint currency in higher denominations.

"Doing so would invite its critics to invoke folk memories of Labour’s failure to control inflation in the 70s."

Is this the strategic reason to avoid even trying to implement policies which might lead to more inflation than we have now?

Hopefully the political salience of that type of attack will decrease as the people who were adults at the time die off. The same way crying "socialist!" has become less effective as a political attack due to there being fewer voters who were alive during the cold war's peak.

[e]

Just bloody wonderful that what Labour can, may, or may not do gets a hearing – is being debated. Are we passing Tory-Centrist's madcap road blocks at last? Tory-Centrist: perfect descriptive term btw.

[Ed Seedhouse]

Well, I've been reading up on MMT for some years now and one thing they are at pains to say is that too much demand will indeed create inflation. And they have policy prescriptions to deal with it. Most obviously to reduce aggregate demand by running a fiscal surplus.

[Blissex]

Overall since 1980 per-head growth rates halved, as our blogger has reminded us many times; apart from that achievement, what thatcherism achieved was to redistribute upward trillions of wealth and income, from northerners and the working class and the poor, the the asset owning upper-middle and upper classes.

Perhaps a Labour government cannot improve per-head growth rates, but it can surely stop and reverse the policies that drove that enormous upward redistribution to a (significant) minority who have enjoyed booming living standards. "For the many, not the few".

«Getting rid of the Tory-Centrist fiscal squeeze would be a good idea;»

Ah the usual "conventional wisdom" lack of mention of the extremely loose monetary policy that has done much to deliver that enormous upward redistribution in favour of rentiers in the past 10 years (and much longer of course).

«a little higher inflation or interest rates would be no disaster;»

Unfortunately by doubling down on “fiscally conservative but monetarily active” (G Osborne said) something like that would involve a significant repricing of assets and rents.

That is badly needed, but the question is whether there is the political strength to push it through, and whether it can be done gradually.
After all Thatcher, Blair, Osborne did not quadruple or octuple asset prices and rents all at one, only gradually, by 7-12% a year for many years, "boiling the frog" (the frog being non-rentiers) so as to avoid provoking a reaction.
Shave the living standards and job security and social security of "losers" a bit every year, and they will adapt to it. I wonder whether a reversal can be achieved.

[UserFrIENDlyyy]

@ Luis Enrique
No need to end BOE independence. It really doesn't matter if the government prints pounds or bonds to finance itself.

@Luis Enrique, @Peter K., and @efcdons
There are several ways inflation can happen. A JG would reduce the likelihood of some and increase it with others.
E.G.
Demand-pull inflation.
Cost-push inflation.
Speculative inflation.
Exchange-rate inflation

There are ways to put in automatic safeguards against some types of inflation when implementing a JG too.

http://econintersect.com/a/blogs/blog1.php/the-job-guarantee-wage-price

http://econintersect.com/a/blogs/blog1.php/more-on-the-job-guarantee

[Nanikore]

I will leave the issue of "underestimating NAIRU: (something that does not even exist) for now.

In your links this question is asked, but not answered:

Why is the US different?

Put it this way; why is the US dollar different to the pre-Euro Greek Drachma. The reason is that the dollar denominates the trading system. Other countries have to buy dollars to import critical inputs. Countries with strong economies -eg competitive manufacturing sectors (eg Germany) are more able to do this than countries like Argentina, Greece, Spain or many African countries.

So if the US wants to it can simply print money. If pre-Euro Greece wanted to, it would suffer a devaluation. Neo-classical economists say this would help the competitiveness of Greek exports. But it would actually make imports more expensive, and actually increase the balance of payments problem.

The country gets mired in continual inflationary/Balance of payments/deflationary crises - which is why many countries such as Greece wanted to join the Euro. Do you remember all the zeros you had to add to Liras and Drachmas?

MMT has some things to say. But like neo-classical economics it does not mention power. "Printing money does not matter if you have your own currency" - only applies to powerful countries.

NK.

[Steven Clarke]

"Of course, the Bank of England might well be wrong to believe this*"

Was there meant to be footnote for this asterisk?

[chris]

@ Steven - yes. Evidence that the Bank might be wrong is that wage inflation has so far not risen in response to low official unemployment. The question of whether the Bank is wrong or not is a question of fact, not theory: you can reject MMT entirely and still think it wrong.

[Luis Enrique]

I'm not sure it's wrong, but I find the confidence that MMTers have that replacing debt financing of the expenditure-tax deficit with money printing will have no untoward effects really quite remarkable.

Here's how the last radical monetary experiment panned out:

https://link.springer.com/chapter/10.1057/9780230285583_7

[Calgacus]

Full employment can be very easily ensured by a job guarantee. And nothing else.
The idea that a job guarantee is inflationary is frankly insane. There is enormous real world experience with full employment policies, and they are if anything less inflationary than unemployment. Which makes perfect logical sense, unless one's head has been fuddled by nonsense for years and years.

The criticism is all idiotic, all dealt with decades ago, especially during the US's New Deal, all disproved by experience. And a JG is not a BIG with a work requirement. A JG is a totally normal, ordinary job. Do people with jobs here feel they have a basic income guarantee from the state with a work requirement? Basic income at best is a stupid way to spend on welfare. At worst and most probable it is an inflationary or stagflationary nightmare, as history shows.

So a JG or any other sort of prosperity might lower exchange rates. Whoop de doo. The thing that cures exchange rate depreciation "problems" etc - is to generally not give a damn about them. The cures (raising interest rates) are the problem, not the imaginary "disease" of balance of payments, CADs or trade deficits.

One of the worst problems of Europe is the mindless obsession people have with exchange rates and the foreign sector. Float your currency, spend enough domestically, have a job guarantee - and the government budget, the foreign sector takes care of itself, automagically, laissez-faire style.

I mean this is all provable and explained, but the ignorant critics have to actually read the explanations, not imagine that these dumb criticisms have not been made and refuted many, many times before, since the times of and by FDR, Keynes & Lerner.

[Calgacus]

Instead, we must remember the old Marxian question: how much can policy achieve within the constraints of capitalism?

It would really be nice if people remembered that the traditional Marxist and unequivocal position of Marx himself, and Trotsky (& probably/arguably Lenin haven't found the ideal quote yet) and many Marxists of 100 years ago was:

The JG goes outside the constraints of capitalism. A job guarantee is a "transition demand" that forces capitalism to become socialism. Capitalism + JG = socialism.

Only the plutocracy remembers this, which is why they fight guaranteed jobs and full employment so ardently for centuries.

[mariorossi]

I don't think there is much evidence that BoE would raise rates significantly after a significant change in fiscal policy. They would definetly wait for inflation to actually manifest itself...

If nairu is really significantly lower than currently expected, such inflation pressure would fail to materialize and interest rates would not need to be raised...

Even from a practical point of view, BoE would be very unlikely to be able to estimate the inflation effect of a loosening of fiscal policy and so very unlikely to substantially move from its current policies...

The idea that Labour should remove BoE independence because they might commit a mistake in the future seems like a pretty thin excuse...

[Robert Mitchell]

"folk memories of Labour’s failure to control inflation in the 70s."

Supply of oil was artificially and politically constrained in the 1970s. Demand was the same. 1970s inflation exemplifies the arbitrary nature of inflation. Inflation is psychological and the fix is to link incomes to price rises automatically, thus guaranteeing that real income purchasing power is maintained. Israel used this linkage mechanism successfully for decades. With today's bankcard technology, the manual adjustments can be automated and immediate, avoiding the strain that led Israel to suspend indexation in the 1980s in favor of wage and price controls.

Inflation is psychological. Fischer Black calls it noise in his 1986 speech, "Noise" (see https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.1986.tb04513.x ):

"I think that the price level and rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules. If people believe that certain changes in the money stock will cause changes in the rate of inflation, that may well happen, because their expectations will be built into their long term contracts."

[Blissex]

«The idea that Labour should remove BoE independence»

Here we go again: the BoE has zero independence, or if it has any it does not matter. Given a nominal rate of inflation as target, the government can "force" the BoE to adopt any monetary policy it wants by modulating fiscal policy to be less or more expansionary, as G Osborne pithily summarized some time ago:

“A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.”

Also central banks "independence" is a myth pushed by rightist Economists to take the attention away from the really important detail: that what matters is that the inflation ceiling is announced in advanced, therefore governments and their central banks cannot use a surprise rise of inflation to reduce the real value of their debts.
But they can use a "surprise" fall in "inflation" below the ceiling announced in advance to increase the real value of debts for people who don't get the special near-zero interest rate reserved by central banks to friends of right-wing parties.