The Monetarist fantasy is over

Published by Anonymous (not verified) on Wed, 19/02/2020 - 10:11pm in

The forced resignation of the United Kingdom’s Chancellor of the Exchequer, Sajid Javid, is the latest sign that macroeconomic policy is being upended, and not only in the UK. In addition to completing the ritual burial of the austerity policies pursued by UK governments since 2010, Javid’s departure on February 13 has broader significance.

Prime Minister Boris Johnson is determined to overcome Treasury resistance to his vast spending ambitions. The last time a UK prime minister tried to open the government spending taps to such an extent was in 1964, when Labour’s Harold Wilson established the Department of Economic Affairs to counter Treasury hostility to public investment. Following the 1966 sterling crisis, however, the hawk-eyed Treasury re-established control, and the DEA was soon abolished. The Treasury, the oldest and most cynical department of government, knows how to bide its time.

But Johnson’s latest coup also is indicative of a global
shift from monetary to fiscal policy. After World War II, stabilization policy,
the brainchild of John Maynard Keynes, started off as strongly fiscal. The
government’s budget, the argument went, should be used to balance an unstable economy
at full employment.

In the 1970s, however, came the monetarist
counter-revolution, led by Milton
Friedman
. The only stabilizing that a capitalist market economy needed,
Friedman said, was of the price level. Provided that inflation was
controlled by independent central banks and government budgets were kept “balanced,”
economies would normally be stable at their “natural rate of unemployment.” From the 1980s until the 2008 global financial
crisis, macroeconomic policy was conducted in Friedman’s shadow.

But now the pendulum has swung back. The reason is
clear enough: monetary
policy failed to anticipate, and therefore prevent, the Great Recession of
2008-09, and failed to bring about a full recovery from it. In many countries,
including the UK, average real incomes are still lower than they were 12 years
ago.

Disenchantment
with monetary policy is running in parallel with a much more positive reading of
US President Barack Obama’s 2008-09 fiscal boost, and a much more negative view
of Europe’s post-slump fiscal austerity programs. A notable turning point was
the 2013 rehabilitation
of fiscal multipliers by the International Monetary Fund’s then-chief economist
Olivier
Blanchard
and his colleague Daniel Leigh. As Blanchard recently put
it
, fiscal policy “has been underused as a cyclical tool.” Now, even
prominent central bankers are
calling
for help from fiscal policy.

The theoretical
case against relying on monetary policy for stabilization goes back to Keynes. “If,
however, we are tempted to assert that money is the drink which stimulates the
system to activity,” he wrote,
“we must remind ourselves that there may be several slips between the cup and
the lip.” More prosaically, the monetary pump is too leaky. Too much money ends
up in the financial system, and not enough in the real economy.

Mark Carney, the
outgoing governor of the Bank of England, recently admitted
as much, saying that commercial banks had been “useless” for the real economy
after the slump started, despite having had huge amounts of money thrown at them
by central banks. In fact, orthodox theory still struggles to explain why
trillions of dollars’ worth of quantitative easing, or QE, remains stuck in
assets offering a negative real rate of interest.

Kenneth Rogoff of Harvard recently argued
that fiscal stabilization policy “is far too politicized to
substitute consistently for modern independent technocratic central banks.” But
instead of considering how this defect might be overcome, Rogoff sees no alternative
to continuing with the prevailing monetary-policy regime – despite the overwhelming
evidence that central banks are unable to play their assigned role. At least
fiscal policy might in principle be up to the task of economic stabilization; there
is no chance that central banks will be.

This is due to a technical reason, the validity of
which was established both before and after the collapse of 2008. Simply put,
central banks cannot control the aggregate level of spending in the economy, which
means that they cannot control the price level and the aggregate level of
output and employment.

A less skeptical observer than Rogoff would have looked more closely at
proposals to strengthen automatic fiscal stabilizers, rather than dismissing
them on the grounds that they will have (bad) “incentive effects” and that
policymakers will override them on occasion. For example, a fair observer would
at least be open to the idea of a public-sector
job guarantee
of the sort envisaged by the 1978 Humphrey-Hawkins Act
in the US, which authorized the federal government to create “reservoirs of
public employment” to balance fluctuations in private spending.

Those reservoirs would automatically be depleted and refilled
as the economy waned and waxed, thus creating an automatic stabilizer. The
Humphrey-Hawkins Act, had it been implemented, would have greatly reduced
politicians’ discretion over counter-cyclical policy, while creating a much
more powerful stabilizer than the social-security systems on which governments
now rely.

To be sure, both the design and implementation of such
a job guarantee would give rise to problems. But for both political and
economic reasons, one should try to tackle them rather than concluding, as
Rogoff does, that, “with monetary policy hampered and fiscal policy the main
game in town, we should expect more volatile business cycles.” We have the intelligence
to do better than that.

Copyright: Project Syndicate, 2020.
www.project-syndicate.org

Photo credit: Flickr/sr hostil.

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