Helicopter money and the tyranny of fiscal pessimism
Thankfully, FT Alphaville's Matt Klein and macro fund manager Eric Lonergan's two pieces are firmly in the former camp. And they warrant a more substantive response than Richard Murphy's own attempt to explain his "Green QE" idea that Corbyn has so enthusiastically seized upon.
So here it is.
I don't want to go over ground that has been well-trodden before so if you want an excellent explainer as to why forcing a central bank to finance fiscal spending directly I would read Frances Coppola here and if you want a concise summary of why it could undermine "the social usefulness of money" read former Bank of England economist Tony Yates.
Instead I want to focus on to key criticisms of PQE that both Klein and Lonergan touch upon, but I don't think are sufficiently worried about.
Firstly, the coordination problem.
I am persuaded by many brighter minds that the shibboleth of central bank independence as defined as the rigid compartmentalisation of monetary and fiscal policy is largely a concept devoid of meaning. However, the practical separation of political and technocratic arms of government remains meaningful in practice even if it isn't in theory.
By this I mean, it is clearly within the government's power to alter the mandate of the central bank at its discretion — thereby shaping what targets central banks must meet and the tools they have at their disposal to hit them. But the manner in which they go about doing so is up to the appointed technocrats and their teams of researchers.
In other words, the mandate binds in both directions.
The reason for this separation was to establish the credibility of monetary policy in preventing it from exclusively serving the various budgetary whims of each successive government (or the same government in each successive year of its term).
I would agree with the criticism that the lack of fiscal and monetary coordination during the Great Recession has been one of the factors behind the developed world's sluggish recovery from the downturn and its persistent failure to take advantage of ultra-low government borrowing costs to invest in critical infrastructure for the future.
At least a part of those low rates were "bought" by central bank's Quantitative Easing (QE) policies and as such its relative lack of impact on the real economy can be attributed to fiscal failure (e.g. the impact of the portfolio balance, bank lending and expectation channels on the real economy proved underwhelming).
In response to this, however, Klein says there's a simple way to improve the power of the policy:
"Cutting out the middle men is the most obvious way to improve the transmission of central banker desires into economic reality. If policymakers want people to spend, they shouldn’t try to juice share and home prices, or fiddle about with borrowing costs at the margin, but actually give people money."
It's hard to disagree that direct transfers, or in the case of PQE direct financing of infrastructure, would increase the potency of QE. But if you're forcing the central bank to undertake these policies then you're not so much papering over the coordination problems highlighted above — you're sending a bulldozer over them.
Once you've demolished the facade of central bank independence my question is: What then?
If it's a government-led policy, why imagine they will turn off the money taps once the central bank's inflation mandate is hit? Or, if central bank led, why imagine they would return fiscal levers back to parliament if they deem them necessary to meet their mandate (as it increasingly looks as if they do).
To put it another way, the coordination problems are a significant barrier to optimal policy but overcoming them by force majeure poses even bigger accountability problems that the current institutional set-up.
At any rate, these coordination problems raise another, and equally troubling issue. And that is the reliance of PQE and its ilk on highly uncertain estimates of the amount of available slack in the economy (otherwise known as the output gap).
Neither Klein nor Lonergan believe that the lack of reversibility of PQE should be a major barrier to its implementation.
One argument goes that an increase in household spending that caused an overshoot of the inflation target could be brought back by increases in tax rates to soak up the demand — alongside the credible commitment that the government would not themselves use the taxes for additional spending. I think Frances Coppola deals adequately with government track records in this regard (it's not very promising).
Alternatively, the central bank could attempt to raise the base rate sufficiently high to dampen inflationary pressures — but if the scale of the programme is poorly calculated the interest rate hikes might need to be large and could have significant negative spillover effects on the wider economy (see for example the Bank of Russia's recent experience attempting to halt the rouble rout).
(To be fair, Lonergan does suggest alternative tools such as the introduction of bank reserve and/or capital ratio limits — though the experience of China with these tools suggests they too have problem containing large swings in sentiment on banks' credit functions.)
My problem with this is that it all relies on highly uncertain estimates of exactly how much spare capacity there is in the economy when you launch the programme. Here is the FT's Chris Giles on the problem:
"Measuring output is difficult enough in a modern economy. Distinguishing changes in the value of many services from changes in their volume is even harder. It is impossible to know the sustainable volume of goods and services that the economy can produce."
What PQE's advocates are effectively saying is that you can overcome some of the lag in feedthrough of monetary policy into the real economy, but even direct transfers would still shift in their impact depending on sentiment and desired savings. In other words, the impact of monetary policy would still be variable.
Add that onto huge uncertainties over the amount of available slack and the limits on the tools at your disposal to counter significant overshoots (not to mention the possible risks of erosion of trust in the currency) and I think you have some significant problems. Overcoming these will require more than wishing away, or worse legislating away, the difficulties of convincing politicians of sound counter-cyclical policies.