Why I think we should change the macroeconomic assignment

In the great MMT wars of economics twitter I learned a rather helpful term from Simon Wren-Lewis: “the macroeconomic assignment”. MMT advocates were, as is their want, being somewhat vague about what they meant and Wren-Lewis suggested that what they were suggesting was an alternate macroeconomic assignment from the current one. I won’t be arguing for their plan today but I also won’t be arguing for the status quo either. The status quo here may be taken to mean a government that acts separately from the central bank and raises taxes and issues liabilities to match its spending. The central bank meanwhile pushes up and down overnight interest rates on bank reserves so as to restrain or expand bank lending into the economy. This, in turn, pushes up and down inflation to hit a target.

How well this works is somewhat debated but my understanding is that most economists believe the evidence is strong that it works when interest rates are firmly above zero and it works considerably less well as we go towards the point of zero or negative rates. What Wren-Lewis was pointing out was that MMT appeared to be reversing this. Spending and deficits, fiscal policy, controls inflation rather than the central bank. This is where I think things are interesting. The point with MMT is often that it is either saying something unbelievably mundane that’s not actually new, or else it’s being incredibly vague, but if this description is correct (who knows if it is, MMT changes whether this sort of thing is true or not on a moment by moment basis!) then we can talk about whether it would work and what it’s problems are. What I read Wren-Lewis’ reply to mean was that it is possible to push inflation around with fiscal policy but it makes fighting inflation politically extremely difficult as it would rely on tax rises and/or spending cuts. An independent central bank solves this problem.

My experience is more in politics than in economics but this problem rings true to me, however, I think it’s clear that the problem we have been facing recently is the reverse: now that we have hit the zero lower bound on interest rates we need governments to spend more to push inflation up and they won’t. They won’t because the current macroeconomic assignment requires government deficits to be covered via debt issuance. Now we can say (correctly) till we’re blue in the face that it matters not one iota that the government debt is at the zero lower bound but politicians are scared of and will use it to their advantage if in opposition, high government debt. In short, I think the current macroeconomic assignment is broken for the same reason the MMT one is- it relies on governments doing something politically damaging at a key moment. They don’t do that thing and consequently, the system breaks down. That is the problem I would like to see solved.

This is where I’d like to go rogue and using my complete lack of qualifications in economics disagree with both the Professor of Economics at Oxford and also MMT. I do actually believe there should be a change in the assignment and that we should move away from the current model of loan based Monetarism. I do not, however, agree with the MMT crowd that the central bank should just set rates at zero and let the elected government manage inflation through tax and spend. What I want to see happen is limited fiscal powers transferred to the central bank with a clear and tight mandate. This can be seen as a move away from monetarism where an independent central bank alters the money supply purely via interest rates with every £ created matched by a debt obligation to one where some £s are simply created and injected into the economy. This is analogous to the difference between a private company borrowing capital or issuing equity.

This is a subtle departure from something like a fiscal council used to moderate government debt levels or a fiscal rule, much like the Wren-Lewis/Portes rule Labour is currently using. That’s because if a government follows the fiscal rule, fine, but if it doesn’t we’re back at square one. I don’t believe that solves the problem in the way central bank independence does. I’m more arguing for something like what Frances Coppola argues for in “The Case for People’s Quantitative Easing”. It’s a very good book and I heartily recommend you read it.

This is far more satisfying to me than the vagaries of MMT but ideally, I would actually go further. Certainly, there is a fairly simple route of more or less sticking with the status quo but adding in people’s quantitative easing for a UBI, as in Coppola’s book, but one big opportunity that we currently have, and I think is being missed, is the opportunity to use the shift from monetary to fiscal policy to anchor inflation mildly above risk-free interest rates. That sounds mundane but it represents a monumental shift if we can go from a system where high-interest rates create rentier income for investors, dropping interest rates raises asset prices… creating rentier income for investors and quantitative easing injects cash into the financial system… creating rentier income for investors, to a system where there is no risk-free return to capital. Indeed you would lose money in real terms if you did not invest in productive assets that carried some risk. That’s how capital markets are supposed to work and yet currently they don’t.

I’ve had a go at this problem before, and it was a pass I don’t mind, but clearly not a viable alternative. At the moment you’d be hard pushed to argue I have a better solution than the experts. However, I don’t think this is an unsolvable problem. It may be that Coppola’s system could be enough by itself but I think we can and should go further and I’d like to have a go at redoing my previous proposals to make them better. We can, and should, in my view, also look into incorporating the ideas from Roger Farmer around the utility of overall stock market stability, even if individual firms are allowed to fluctuate as normal. Having lived through the 2008 financial crisis, austerity, and then the Coronavirus recession while more or less obsessively trying to learn about economics and finance during that decade has left me absolutely fascinated and excited to try and find an effective and powerful solution for what we’ve seen these past ten to fifteen years that could also cope in a 1970s style inflationary crisis. So I hope I’ve laid out the very start of an argument here for why we should be trying to do that, what the starting point for ideas are and why I’d like to push a little further. I’ll let you know how that goes!