Writing off the Reserve Bank’s government bonds

From time to time I’ve been asked about the idea that the government bonds the Reserve Bank is now buying, and will most likely be holding for years to come, might be written off.   I thought I’d written an earlier post on the idea but I can’t find it –  perhaps it was just a few lines buried somewhere else – and the question keeps coming up.

The Reserve Bank’s own answer to the question –  I’ve seen it recently from both the Governor and the Chief Economist (the latter towards the end of this) – is to smile and suggest that, since they are the lender, it really isn’t up to them.    That, of course, is nonsense.  It is quite within the power of a lender to write-off their claim on a borrower, and that doesn’t require the borrower first to default or to petition for relief.   To revert back to some old posts, that is how ancient debt jubilees worked.

I guess that, in answering the way the do, the Bank is simply trying to avoid getting entangled in controversies that they don’t need.  I have some sympathy for them on that, and so just possibly it might be a tactically astute approach.  A better approach would be for them – as the specialists in such things, unlike the Minister of Finance – to call out the idea of that particular debt being written off for what it is: macroeconomically irrelevant.

In reality, of course, if the debt held by the Reserve Bank were to be written off, it would only be done with the concurrence of the government of the day.    Apart from anything else, if the Governor (or the Board, when the new Reserve Bank legislation is enacted) were to write off the Bank’s claims on the government, it would render the Bank deeply insolvent (very substantial negative equity).  You can’t have management of a government agency just deciding – wholly voluntarily – to render the agency deeply insolvent.

And that is even though the Reserve Bank is quite a bit different than most public sector entities, in that life would go –  operations would continue largely unaffected –  if the Reserve Bank had a balance sheet with a $20 billion (or $60 billion) hole in it.   The Bank isn’t a company, its directors don’t face standard penalties and threats, and –  critically – nothing about substantial negative equity would adversely affect the Bank’s ability to meet its obligations as they fall due.   The Reserve Bank meets its obligations by issuing more of its own liabilities (notes or, more usually, settlement cash balances).  People won’t stop using New Zealand dollars, and banks won’t stop banking at the Reserve Bank, just because there is a huge negative equity position.

(This isn’t just some hypothetical.  Several central banks have operated for long periods with negative equity; indeed I worked for one of them that had so many problems it couldn’t even generate a balance sheet for years at a time.  It also isn’t materially affected by arguments that seignorage revenue –  from the issuance of zero interest banknotes –  means that “true” central bank equity is often higher than it looks (much less so when all interest rates are near zero, and not at all if other interest rates are negative).)

The big reason why writing off the claims the Reserve Bank has on the government through the bonds it holds wouldn’t matter much, if at all, for macroeconomic purposes is that the Reserve Bank is –  in substance – simply a branch of the government.  Any financial value in the organisation accrues ultimately to the taxpayer, and the taxpayer in turn is ultimately responsible for the net liabilities of the Bank.  Governments can –  and sometimes do – default, but having the obligation on the balance sheet of a (wholly government-owned and parliamentarily-created) central bank doesn’t materially change the nature of the exposure.  If anything, governments have tended to be MORE committed to honouring the liabilities of their central bank –  their core monetary agency, where trust really matters –  than in their direct liabilities (thus, in New Zealand  –  as in the US or UK – central and local governments have –  long ago –  defaulted, but the Reserve Bank has never done so).

It is worth remembering what has actually gone on in the last few months.  There are several relevant strands:

  • the government has run a huge fiscal deficit, (meeting the gap between spending and revenue by drawing from its account at the Reserve Bank, in turn resulting in a big increase in banks’ settlement account balances at the Reserve Bank, as bank customers receive the net fiscal outlays),
  • the government has issued copious quantities of new bonds on market (the proceeds from the settlement of those purchases are credited to the Crown account at the Reserve Bank, paid for by debiting –  reducing –  banks’ settlement account balances at the Reserve Bank,
  • the Reserve Bank has purchased copious quantities of bonds on market (paying for them by crediting banks’ settlement accounts at the Reserve Bank).

In practice, the Reserve Bank does not buy bonds in quite the same proportions that the government is issuing them.  But to a first approximation –  and as I’ve written about previously – it does not make much macroeconomic difference whether the Reserve Bank is buying the bonds on market or buying them from the government directly.   In fact, it would not make much difference from a macroeconomic perspective if the Reserve Bank had simply given the government an overdraft equal to the value of the bonds it was otherwise going to purchase.     There are two caveats to that:

  • first, under either model the Reserve Bank has the genuine power to choose, and
  • second, that the fiscal deficit itself is not altered by the particular mechanism whereby the funds get to the Crown account.

But that seems a safe conclusion for now under our current institutional arrangements and culture.

From a private sector perspective, the net effect of the various transactions I listed earlier has been that:

  • private firms and households have been net recipients of government fiscal outlays, (which, in turn, boosts the non-bank private sector’s claims on banks)
  • banks have much larger holdings of (variable rate) settlement cash balances at the Reserve Bank.

Those settlement cash balances are the (relevant) net new whole-of-government debt.

By contrast, quite how the core government and the Reserve Bank rearrange claims between themselves just doesn’t matter very much (macroeconomically) at all.

Suppose the Minister of Finance and the Governor did get together and agree no payment needs to be made in respect of the bonds that Bank holds at maturity.  What does it change?   It doesn’t change is the appropriate stance of monetary policy –  determined by the outlook for the economy and inflation.  It doesn’t change the nature and extent of the Reserve Bank’s other liabilities –  which still have to be met when they mature.   And it doesn’t change anything about the underlying whole-of-government fiscal position.

I guess what people are worried about is that the government might feel it had to raise  taxes –  or cut spending –  more than otherwise “just” to pay off those bonds held by the Reserve Bank.  But remember that the Reserve Bank is just another part of government.  What would actually happen in that scenario is that settlement account balances held by banks at the Reserve Bank would fall (as, say, net taxes flowed into the government account at the Reserve Bank) –  and those are the new claims the private sector currently has on the government.    In other words, the higher taxes or lower spending still extinguish net debt to the private sector.   And if the government didn’t want to raise taxes/cut spending, it could simply issue more bonds on market.  In the process they would (a) repay the bonds held by the Reserve Bank, and (b) reduce settlement cash balances at the Reserve Bank, but (c) increase the net bonds held by the private sector.    Total private claims on whole of government aren’t changed.

(Now it is possible that at the point where the bonds mature, the Reserve Bank still thought that for monetary policy reasons settlement cash balances needed to be as large as ever.  If so, then of course they could purchase some more bonds on-market, or do some conventional open market operations. Neither set of transactions will change the overall claims of the private sector on the government sector –  net fiscal deficits are what do that.)

And what if the bonds were just written off?   As I noted earlier, write off the bonds and the Reserve Bank has a deeply negative equity position.   I don’t really think that is a sustainable long-term position.  It is a bad look in an advanced economy. It is a bad look if we still want to have an operationally independent central bank.  And we can’t rule out the possibility that, for example, risk departments in major international financial institutions might be hesitant about continuing to have the Reserve Bank of New Zealand as a counterparty, including for derivatives transactions, if it had a balance sheet with a large negative position –  even though, as outlined above, the Bank could unquestionably continue to pay its bills.  So at some point of other, the Bank would have to be recapitalised. But again that has little or no implications for the rest of the economy –  or the future tax burden.   The government subscribes for shares…and settles them by issuing to the Bank…more bonds.  The government, of course, pays interest to the Bank –  whether on bonds or overdrafts –  but, to a first approximation, Bank profits all flow back to the Crown.

This post has ended up being quite a lot longer than I really intended, as I’ve tried to cover off lots of bases and possible follow up questions.  Perhaps the key thing to remember is that what creates  the likelihood of higher taxes and lower spending (than otherwise) in future is unexpected/unscheduled fiscal deficits now.

Those deficits might be inevitable, even desirable (as many, perhaps most, might think of those this year as being), but it is they that matter, not  what are in effect the internal transactions between the core government and its wholly-owned Reserve Bank.   That is true even in some MMT world, provided one takes seriously their avowed commitment to keeping inflation in check over time.  You could fund the entire government on interest-free Reserve Bank overdrafts and the consequence would be explosive growth in banks’ settlement cash balances at the Reserve Bank.  But real resources are still limited (see yesterday’s post).  Over time, if you are serious about keeping inflation in check, you still have to either pay a market interest rate on those balances, or engage in heavy financial repression of other sorts, imposing additional imposts on the private sector just by less visible means.

Perhaps the other point worth remembering is the relevance of focusing on appropriately broad measures of true whole-of-government indebtedness, not ones dreamed up from time to time for political marketing purposes.



So-called Modern Monetary Theory (MMT) has been attracting a great deal more attention than usual this year.  I guess that isn’t overly surprising, in view of (a) the severe recession the world is now in, and (b) the passivity and inaction (and the ineffectiveness of what actions they do take) of central banks, those with day-to-day responsibility for the conduct of monetary policy.

Until about three years ago I had had only the haziest conception of what the MMTers were on about.  But then Professor Bill Mitchell, one of the leading academic (UNSW) champions of MMT ideas, visited New Zealand, and as part of that visit there was a roundtable discussion with a relatively small group in which I was able to participate.  I wrote about his presentation and the subsequent discussion in a post in July 2017.   I’d still stand by that.  (As it happens, someone sent Mitchell a link to my post and he got in touch suggesting that even though we disagreed on conclusions he thought my representation of the issues and his ideas was “very fair and reasonable”.)  But not many people click through to old posts and, of course, the actual presenting circumstances are quite a bit different now than they were in the New Zealand of 2017.  Back then, most notably, there was no dispute that the Reserve Bank had a lot more OCR leeway should events have required them to use it.

Among the various people championing MMT ideas this year, one of the most prominent is the US academic Stephanie Kelton in her new book The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (very widely available – I got my copy at Whitcoulls, a chain not known for the breadth of its economics section).   Since it is widely available –  and is very clearly written in most places – it will be my main point of reference in this post, but where appropriate I may touch on the earlier Mitchell discussion and this recent interview on interest.co.nz with another Australian academic champion of MMT ideas.

As a starting point, I reckon MMT isn’t particularly modern, is mostly about fiscal policy, and is more about political preferences than any sort of theoretical framework (certainly not really an economics-based theoretical framework).     But I guess the name is good marketing, and good marketing matters, especially in politics.

The starting proposition is a pretty elementary one that, I’d have thought, had been pretty uncontroversial for decades among central bankers and people thinking hard about monetary/fiscal interactions: a government with its own central bank cannot be forced –  by unavailability of local currency –  to default on its local currency debt.  They can always “print some more” (legislating to take direct control of the central bank if necessary).  So far so good.  But it doesn’t really take one very far, since actual defaults are typically more about politics than narrow liquidity considerations and governments may still choose to default, and the actual level of public debt (share of GDP) maintained by advanced countries with their own currencies varies enormously.

A second, and related, point is that governments in such countries don’t need to issue bonds –  or raise taxes – to spend just as much as they want, or run deficits as large as they want.  They can simply have the central bank pay for those expenses.  And again, at least if the appropriate legislation was worded in ways that allowed this (which is a domestic political choice) then, of course, that is largely true.  That means governments of such countries are in a different position than you and I –  we either need to have earned claims on real resources, or have found an arms-length lender to provide them, before we spend.    Again, it might be a fresh insight to a few politicians –  Kelton spent a couple of years, recruited by Bernie Sanders, as an adviser to (Democrat members of) the Senate Budget Committee, and has a few good stories to tell.  But to anyone who has thought much about money, it has always been one of the features –  weaknesses, and perhaps a strength on occasion – of fiat money systems.

Kelton also devotes a full chapter to the identity that any public sector surplus (deficit) must, necessarily, mean a private sector deficit (surplus).  Identities can usefully focus the mind sometimes in thinking about the economy, but I didn’t find the discussion of this one particularly enlightening.

It all sounds terribly radical, at least in potential.  One might reinforce that interpretation with Kelton’s line that “in almost all instances, fiscal deficits are good for the economy. They are necessary.”

But in some respects –  at least as a technical matter –  it is all much less radical than it is sometimes made to sound.   As a matter of technique and institutional arrangements, it is mostly akin to “use fiscal policy rather than monetary policy to keep excess capacity to a minimum consistent with maintaining low and stable inflation”.    Supplemented by the proposition that advance availability of cash –  taxes, on-market borrowing –  shouldn’t be the constraint on government spending, but rather that the inflation outlook should be.

Quoting Kelton again “it is possible for governments to spend too much. Deficits can be too big”.

What isn’t entirely clear is why, as a technical matter, the MMTers prefer fiscal policy to monetary policy as a stabilisation policy.    In the earlier discussion with Bill Mitchell, it seemed that his view was the monetary policy just wasn’t as (reliably) effective as fiscal policy.  In Kelton’s book, it seems to reflect a view that using monetary policy alone there is inescapable sustained trade-off between low inflation and full employment (a view that most conventional macroeconomists would reject), and that only fiscal policy can fill the gap, to deliver full employment.    Kelton explicitly says “evidence of a deficit that is too small is unemployment” –  it seems, any unemployment, no matter how frictional, no matter how much caused by other labour market restrictions.

I can think of two other reasons.  The first is quite specific to the current context.  Some might prefer fiscal policy because they believe monetary policy has reached its limits (some effective lower bound on the nominal policy rate).   Kelton’s book was largely finished before Covid hit –  and US rates at the start of this year weren’t super-low –  but it seems to be a factor in the current interest in MMT.     The other reason –  not really stated, but sometimes implied by Kelton – is that central bankers might have been consistently running monetary policy too tight – running with too-optimistic forecasts and in the process falling down on achieving what they can around economic stabilisation.  Since 2007 I’d have quite a bit of sympathy with that view –  although note that in New Zealand prior to 2007 inflation was consistently too high relative to the midpoint of the target ranges governments had set.  But it is, at least initially, more of an argument for getting some better central bankers, or perhaps even for governments to take back day-to-day control of monetary policy, than an argument for preferring fiscal policy over monetary policy as the prime macro-stabilisation tool.

But in general there is little reason to suppose that fiscal policy is any more reliably effective than monetary policy.  Sure, if the government goes out and buys all the (say) cabbages in stock that is likely to directly boost cabbage production.  If –  in a deep recession – it hires workers to dig ditches and fill them in again that too will directly boost activity.  But most government activity –  taxes and spending (and MMTers aren’t opposed to taxes, in fact would almost certainly have higher average tax rates than we have now) –  aren’t like that.  If it is uncertain what macro effect a cut in the OCR will have, it is also uncertain how  –  and how quickly – a change in tax rates will affect the economy, and even if governments directly put money in the pockets of households we don’t know what proportion will be saved, and how the rest of the population might react to this fiscal largesse.  In principle, there is no particular reason why fiscal policy should be better, as a technical matter, than monetary policy in stabilising economic activity and inflation.  But Kelton just seems to take for granted the superiority of fiscal policy, and never really seems to engage with the sorts of considerations that led most advanced countries –  with their own central banks, borrowing in local currencies –  to assign stabilisation functions to monetary policy, at arms-length from politicians, while leaving longer-term structural choices around spending and tax to the politicians.

These probably shouldn’t be hard and fast assignments. In particular, there are some things only  governments (fiscal policy) can do.  Thus, if an economy largely shuts down –  whether from private initiative or government fiat –  in response to a pandemic, monetary policy can’t do much to feed the hungry.  Charity and fiscal initiatives are what make a difference in this very immediate circumstances –  just as after floods or other severe natural disasters.    And we consciously build in some automatic stabilisers to our tax and spending systems.  But none of that is an argument for junking monetary policy completely, whether that monetary policy is conducted by an independent agency, or whether such agencies (central banks) just serve as technical advisers to a decisionmaking minister (as, for example, tended to be the norm in post-war decades in most advanced countries, including New Zealand).

The MMTers claim to take seriously inflation risk.  This is from the Australian academic interest.co.nz interviewed (Kelton has very similar lines, but I can cut and paste the other)

“They should always be looking at inflation risk. Because when we say that our governments can never become insolvent, what we are saying is that there is no purely financial constraint that they work under. But there is still a real constraint. So New Zealand has a limited productive capacity. Limited by the labour and skills of the people and capital equipment, technology, infrastructure and the institutional capacity of business organisations and government in New Zealand. That limits the quantities of goods and services that can be produced there is a limitation there. Also it depends on the natural resources of a country,” says Hail.

“If you spend beyond that productive capacity it can be inflationary and that can frustrate your objectives, frustrate what you’re trying to do. So it’s always inflation risks that’s important. Within that productive capacity, however, what it is technically possible to do the Government can always fund. So yes, you can fund any of those things but there’s always an inflation risk and that inflation risk is not specific to government spending. It’s specific to all spending.”

There is a tendency to be a bit slippery about this stuff.  Thus Kelton devotes quite some space to a claim that government spending/deficits can’t crowd out private sector activity.  And she is quite right that the government can just “print the money” –  so in a narrow financing sense there need not be crowing out –  but quite wrong when it comes to the real capacity of the economy.  Real resources can’t be used twice for the same thing.  When the attempt is made to do so, that is when inflation becomes a problem –  and the MMTers aver their seriousness about controlling inflation (and I take them at their word re intentions).

Partly I take them at their word because Kelton says “the economic framework I’m advocating for is asking for more fiscal responsibility from the federal government not less”.     And it certainly does, because instead of using monetary policy, the primary stabilisation role would rest with fiscal policy.  That might involve easy choices for politicians flinging more money around to favoured causes/people in bad times, but it involves exactly the opposite when times are good, resources are coming under pressure, and inflation risks are mounting.  Under this model, a government could be running a fiscal surplus and still have to take action to markedly tighten fiscal policy because –  in their own terms –  it isn’t deficits or surpluses that matter but overall pressure on real resources.  And they want fiscal policy to do all the discretionary adjustment.

Maybe, just maybe, that is a model that could be made to work in (say) a single chamber Parliament, elected under something like FPP, so that there is almost always a majority government.  Perhaps even in New Zealand’s current system, at a pinch, since to form a government the Governor-General has to be assured of supply.

But in the US, where party disciplines are weak, different parties can control the two Houses, and where the President is another force completely.     What about US governance in the last 30 years would give you any confidence in the ability to use fiscal policy to successfully fine-tune economic activity and inflation, while respecting the fundamental powers of the legislature (no taxation without representation, no expenditure without legislative appropriation)?   In a US context, I’m genuinely puzzled about that. [UPDATE:  A US commentator on Twitter objected to the use of ‘fine-tune” here, suggesting it wasn’t what the MMTers are about.  Perhaps different people read “fine-tune” differently, but as I read MMTers they are committed to maintaining near-continuous full employment, and keeping inflation in check, and even if some like rules –  rather than discretion –  it seems to me frankly no more likely that preset rules for fiscal policy would successfully accomplish that macrostabilisation than preset rules for monetary policy did.  “Successfully managed discretion” is what I have in mind when talking about “fine-tuning” in this context.]

But even in a relatively easy country/case like New Zealand using fiscal policy that way doesn’t seem at all attractive.    It takes time to legislate (at least when did properly).  It takes time to put most programmes in place, at least if done well –  and don’t come back with the wage subsidy scheme, since few events will ever be as broad-brush and liberal as that, especially if fine-tuning is what macro-management is mostly about.   And every single tax or spending programme has a particular constituency –  people who will bend the ear of ministers to advance their cause/programme and resist vociferously attempts to wind such programmes back.  And there are real economic costs to unpredictable variable tax rates.

By contrast –  and these are old arguments, but no less true for that  – monetary policy adjustments can be made and implemented instantly.  They don’t have their full effect instantly, but neither do those for most fiscal outlays –  think, at the extreme, of any serious infrastructure project.   And monetary policy works pretty pervasively –  interest rate effects, exchange rate effects, expectations effects (“getting in all the cracks”) –  which is both good in itself (if we are trying to stabilise the entire economy) and good for citizens since it doesn’t rely on connections, lobbying, election campaign considerations, and the whim of particular political parties or ministers.  And what would get cut if/when serious fiscal consolidation was required?  Causes with the weakest constituencies, the least investment in lobbying, or just causes favoured by the (at the time) political Opposition.     Perhaps I can see some attraction for some types of politicians –  one can see at the moment how the government has managed to turn fiscal stabilisation policy into a long series of announceables for campaigning ministers, rewarding connections etc rather than producing neutral stabilisation instruments –  but the better among them will recognise that it is no way to run things.  It is the sort of reason why shorter-term stabilisation was assigned to monetary policy in the first place.

Reverting to Kelton, her book is quite a mix.  Much of the first half is a clear and accessible description of how various technical aspects of the system work, and what does and doesn’t matter in extremis.   But do note the second half of the book’s title (“How to Build a Better Economy”): the second half of the book is really an agenda for a fairly far-reaching bigger government – (much) more spending, and probably more taxes.    There is material promoting lots more (government) spending on health, welfare, infrastructure, and so on –  all the sort of stuff the left of the Democratic Party in the USA is keen on.

That is the stuff of politics, but it really has nothing at all to do with the question of whether fiscal or monetary policy is better for macro-stabilisation.   I guess it may be effective political rhetoric –  at least among the already converted –  to say –  as Kelton does –  “cash needn’t be a constraint on us doing any of this stuff”.  But –  and this is where I think the book verges on the dishonest (or perhaps just a tension not fully resolved in her own mind) – the constraint, or issue, is always about real resources, which  – per the quote above –  can’t be conjured out of thin air.    Resources used for one purpose can’t be used for others, and even if some forms of government spending (or lower taxes?) might themselves be growth-enhancing in the long run, that can’t just be assumed, and almost certainly won’t be the case for many of the causes Kelton champions (or that local advocates of MMT would champion).

I can go along quite easily with much of Kelton’s description of how the technical aspects of economies and financial systems work, but the really hard issues are the political ones.   So, of course, we needn’t stop government spending for fear that a deficit will quickly lead to default and financial crisis, or because in some narrow sense we don’t have the cash available in advance.   But we still have to make choices, as a society, about where government programmes and preferences will be prioritised over private ones –  the contest for those scarce real resources, consistent with keeping inflation in check.    And we know that rigorous and honest evaluation of individual government tax, spending and regulatory programmes is difficult to achieve and maintain.  And we know that programmes committed to are hard to end,  And that government failure is at least as real a phenomenon as market failure –  and quite pervasive when it comes to many spending programmes.    And so while Kelton might argue that, for example, balanced budget rules (in normal circumstances, on average over the cycle) are some sort of legacy of different world, something appropriate and necessary for households but not a necessary constraint for governments, I’d run the alternative argument that they act as check and balance, forcing governments to think harder –  and openly account for –  choices they are making about whose real resources will be paying for the latest preferrred programme.

Kelton tries to avoid these issues in part by claiming that “outside World War Two, the US never sustained anything approximating full employment”,  and yet she knows very well that real resource constraints still bind –  inflation does pick up, and was a big problem for a time.  Hard choices need to be made –  not by the hour (government cheques can always be honoured) but over any longer horizon.

There are perfectly reasonable debates to be had about the appropriate size of government. but they really have nothing to do with the more-technical aspects of the MMT argument.  Even if, for example, one accepted the MMT claim that there was something generally beneficial about fiscal deficits, we could run deficits –  presumably still varying with the cycle –  with a government spending 25 per cent of GDP (less than New Zealand at present) or 45 per cent of GDP (I suspect nearer the Kelton preference).

This post has probably run on too long already.  Perhaps I will come back in another post to elaborate a few points.  But before finishing this post I wanted to mention one of the signature proposals of the MMTers – the job guarantee.  There is apparently some debate as to just how central such a scheme is –  that is really one for the MMTers to debate among themselves, although it seems to me logically separable from issues around the relative weight given to fiscal and monetary policy.   I covered some of the potential pitfalls in the earlier post and I’m still left unpersuaded that the scheme has anything like the economic or social benefits the MMTers claim for it, even as I abhor the too-common indifference of authorities (fiscal and monetary to entrenched unemployment.  In the current context, one could think of the wage subsidy scheme as having had some functional similarities, but it is a tool that kept people connected to (what had been) real jobs, and which works well for identifiable shocks of known short duration.  That seems very different from the sort of well-intentioned job creation schemes the MMTers talk about. From the earlier post

It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the private market?

And much of Kelton’s idealistic discussion of the job guarantee rather overlooked the potential corruption of the process –  favoured causes, favoured individuals, favoured local authorities getting funding.  It is a risk in New Zealand, but it seems a near-certainty in the United States.

A radical alternative to macro policy?

Last Friday, an outfit called Strategy2040 New Zealand, together with Victoria University’s School of Government, hosted a lunchtime address by an Australian academic, Professor Bill Mitchell of the University of Newcastle.   He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

Mitchell attracted some interest on his trip to New Zealand.  He apparently did two substantial interviews on Radio New Zealand and attracted perhaps 150 people to the lunchtime address –  a pretty left-liberal crowd mostly, to judge from the murmurs of approval each time he inveighed against the “neo-liberals”.    In fact, the presence of former Prime Minister Jim Bolger was noted –  he who, without apparently recanting any specific reforms his government had put in place, now believes that “neo-liberalism has failed New Zealand”.     Following the open lecture, 20 or so invitees (academics, journalists and economists –  mostly of a fairly leftish persuasion) joined Mitchell for a roundtable discussion of his ideas.   Perhaps a little surprisingly, I didn’t recognise anyone from The Treasury or the Reserve Bank at either event.

Mitchell has it in for mainstream academic economics.   Quite probably there is something in what he says about that.  Between the sort of internal incentives (“groupthink”) that shape any discipline, and the inevitable simplifications that teaching and textbooks require, it seems highly likely there is room for improvement.   If textbooks are, for example, really still teaching the money multiplier as the dominant approach to money, so much the worse for them.   But as I pointed out to him, that was his problem (as an academic working among academics): I wasn’t aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously.  He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand.    And if very few people correctly diagnosed what was going on just prior to the financial crises in some countries in 2008/09, that should be a little troubling.  But it doesn’t shed much (any, I would argue) light on the best regular approach to macroeconomic management and cyclical stabilisation.  Perhaps especially so as (to us) he was talking about policy in Australia and New Zealand, and neither country had a US-style financial crisis.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were reamrkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit.    It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.