Roth’s Monetary and Fiscal Framework for Economic Stability
Steve Roth over at www.asymptosis.com has a comment on my previous post ”Be right for the right reasons”, which in itself was a comment on Richard Williamson who had commented on one of my previous comments (“NGDP targeting is not a Keynesian business cycle policy”) so you might consider this as ponzi-commenting…Anyway, Steve’s comment deserves an answer. He has some intriguing ideas. What Steve suggests is what he calls “the MMTer’s guaranteed employment scheme”. For those who are not following the monetary debate in blogosphere it might be helpful to tell that MMT means Modern Monetary Theory – or what in the old days was known as Chartalism. I don’t want to use too much time explaining Chartalism (I am not really that strong on what they think), but lets just say that MMTer’s fundamentally think that monetary policy and fiscal policy is the same thing and that money enters circulation through government spending. Steve’s idea is the following: “My personal preferred stabilizer is to up the EITC bigtime, expand it up the income spectrum, pay it on weekly paychecks, and index its benefit levels to some measure of unemployment.” EITC for those who don’t know it means “Earned Income Tax Credit” and is a Federal tax credit given to low income families in the US. Steve does not say it directly, but I guess that his idea is that the Federal Reserve should fund this scheme. Or at least for a monetarist or a Market Monetarist this is crucial if the programme is going to “work”. Some would consider Steve Roth’s idea to be completely insane. I do not. However, I have a number of reservations, but most important I have serious trouble with Steve’s premise. I fundamentally think that recessions are always and everywhere a monetary phenomenon and hence monetary and fiscal policy should not be designed to be “countercyclical”. Monetary policy should be designed not mess with Say’s Law or said in another way monetary policy should not create recessions in the first place. If central banks where to engage in countercyclical policies then it basically end up fighting against it’s own past mistakes. This is also why I so strongly oppose when some Market Monetarists call for “monetary stimulus” as it exactly sounds as if we would like central banks to follow some kind of “countercyclical” policy. Therefore there is no need for an “employment scheme” if central banks stop messing with Say’s Law by introducing credible NGDP level targeting. That said, Roth’s scheme might not be in conflict with the idea of NGDP target. In fact if the Federal Reserve said that it in the future would say it would send each a American a cheque of the same size as the average EITC (hence doubling the EITC cheque) and that it would do so until NGDP had returned to the pre-crisis level then that in my view most likely would be a successful mechanism for returning NGDP to the pre-crisis trend. That does not mean that I endorse Steve’s scheme and and the fact that I think it would “work” does not mean that I in anyway agree with MMT theories – I don’t. The only thing it really means is that I think monetary policy is very powerful and that NGDP always can be increased by the use of monetary policy – then it is less important how you inject the money into the economy. Fundamentally I think it is a pretty bad idea to have the central bank funding government expenditure and given central banks exist I believe they would be made independent of political pressures. Finally, a comment on my headline. When I read Steve’s comment I came to think of a paper Milton Friedman wrote back in 1948 “A Monetary and Fiscal Framework for Economic Stability”. In the paper Friedman suggests something similar to Steve. Friedman’s suggestion is basically that the government should balance its budgets over the “business cycle”, but in downturns the central bank should print money to finance the public deficits. That in Friedman’s view creates a monetary-fiscal stabiliser of the economy. Friedman luckily became wiser as he aged. Here is a he said about in 1960 in “A Program for Monetary Stability” about his 1948 proposal: “I have become increasingly persuaded that the proposal is more sophisticated and complex than is necessary, that a much simpler rule would also produce highly satisfactory results and would have two great advantages: first, its simplicity would facilitate the public understanding and backing that is necessary if the rule is to provide an effective barrier to opportunistic “tinkering”; second, it would largely separate the monetary problem from the fiscal and hence would require less far-reaching reform over a narrower area.” So Steve, I don’t think we need to get the central bank involved in getting NGDP back on track and monetary policy should not be funding government programmes – especially not programmes that are not to great to begin with. PS Steve, you have one advantage in the debate with me. Friedman suggested in 1948 to use a monetary-fiscal stabiliser and the EITC is of course a (bad) variation of Friedman’s suggestion for a Negative Income Tax and I hate arguing against any of Friedman’s ideas. PPS Steve got my surname slightly wrong - it is Christensen and not Christiansen.