Geoff Crocker graduated in economics followed by an MA in philosophy of science. He worked internationally in technology strategy consulting for major multinationals, government institutes, and SMEs. From 1990-2006 he specialised in transition strategies in many sectors of Russian industry. Geoff is the author of ‘Basic Income and Sovereign Money : The Alternative to Economic Crisis and Austerity Policy’ (Palgrave 2020). His earlier book ‘A Managerial Philosophy of Technology’ (Palgrave 2012) explores the impact of technology on the economy, and is available as a free download. He is an advocate of basic income and edits the site ‘The Case for Basic Income’.
Governments rely extensively on monetary policy to seek to control the economy. The major policy instrument of monetary policy is the interest rate. The major constraint, which has morphed into a policy objective, is the accumulated level of government debt. The primacy of monetary policy derives from the turn to monetarism in economic theory attributed to Milton Friedman and Anna Schwartz, fired by a political kick back against Keynesian government oriented fiscal policy. The irrational claim was also that Keynesian policy had failed at the time of the 1970s OPEC price hike.
Interest rate policy
Monetary policy initially sought to control the economy via the quantity of money in circulation, following the ‘quantity theory of money’. But commercial bank money creation and elastic credit cards made this impossible. Hence the shift to try to control the quantity of money by its price, the interest rate. All very neo-classical. Independent central banks are now charged to control inflation with the interest rate as their sole instrument. The simple proposition is that inflation is caused by excess demand which should be dampened by interest rate hikes.
The interest rate however has both weak and contrary effects on inflation. Consumer disposable income may only be affected with a lag where people hold fixed rate mortgages. People may supplement any lost disposable income by drawing from savings, taking loans, or increasing working hours. The interest rate is powerless against exogenous imported inflation. Worse, interest rate hikes may actually raise inflation through their effect on business costs and investment decisions. The exchange rate is likely to inflate, causing lower import prices, but higher export prices with adverse balance of trade effects. Such counter-inflationary policy focuses exclusively on suppressing demand rather than on increasing supply and productivity. This would require investment which is deterred by high interest rates. Reduced demand will also deter investment, yielding a downward vicious circle. Current dominant service sector inflation requires yet more investment in service sector automation.
We need to recognise the limits of monetary policy, develop a synthesis with fiscal policy, and deploy productivity policies to enable the economy generally, and control inflation specifically. For example, commercial bank lending to business projects is too limited by conditionality imposed after the crisis. Typically risk averse bank loans require businesses to show current net assets > new loan value, and current EBITDA > the new loan interest payments. These stringent conditions limit lending to established businesses, and hugely restrict start up business funding. They should be moderated.
Debt policy
Governments fund their expenditure either from tax or borrowing, the latter creating debt and running into a supposed, but in effect an arbitrary, debt ceiling. The Maastricht 60% debt/GDP target has been eclipsed by debt/GDP ratios >100%, ranging from <50% for some economies to >250% for Japan. Curiously, whilst commercial banks are allowed to create money to fund business and personal loans, central banks are not allowed to do so.
Monetary policy specifically prohibits direct money financing of government expenditure. The justification for this common rule is to prevent governmental profligacy, a curious claim of irresponsibility when the same government is trusted with the nuclear button. It also derives from an accountancy theory that money must be balanced by an assumed debt at the point of its creation by a central bank. This assumption is ill-founded. Since money does not pre-exist, then at the point of its creation, it is not borrowed, but truly created, currently digitally with no production cost and therefore with 100% seigniorage.
The rule is however breached by a perverse practice which urgently needs reform. With the explicit aim of increasing bond prices in order to reduce interest rates and promote spending in the economy after the 2009 crisis, the Bank of England buys government debt in the secondary market, massively enriching primary market traders. Since government owns BoE, this becomes zero net debt, and is no argument for austerity. Even worse, BoE chose to buy fixed interest long term bonds. It funded their purchase by creating reserves to pay the pension funds and insurance companies for their bonds, on which it then pays variable rate interest. Interest rates increases have since caused huge losses in BoE’s bond portfolio value and any QT it implements, whilst BoE also pays out higher interest payments on the reserves it created, at a total loss estimated by BoE in evidence to the Treasury Select Committee at £130bn, and by Daniela Gabor of UWE Bristol at up to £230bn by 2033. This combination of mess and scandal needs reform.
As Adair Turner has pointed out, the end result of this process is equivalent to de facto direct money financing, which would be better enabled de jure. This would remove the delusion of unrepayable government debts in excess of GDP, and their interest payment burden. It would acknowledge the undeniable reality that debt/GDP ratios are arbitrary, empirically so, and are not a proper objective of government policy. Keynesian fiscal management should determine the constraint on government expenditure, not intermediate monetary balances. Moreover, if pension funds invested less in bonds, not only would they avoid highly leveraged LDI positions threatening their solvency, but would have funds released for investment into equities, which is rightly a current aspiration of government policy. Direct money financing of government expenditure ends up being a preferable option.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.
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