Saturday, May 22, 2010

Governments and central banks in a functional finance or MMT regime.

Most countries that issue their own currencies split economic and financial responsibilities between two organisations. First there is government, i.e. elected politicians. Second there are central banks.

Politicians have a tendency to act irresponsibility with the money printing press. So a central bank which can raise interest rates when inflation looms is good idea. This is an example of “checks and balances”.

But what set of rules would be appropriate in a functional finance scenario? I suggest the following (which are not vastly different to the current rules).

Rule No 1. Politicians must work on the assumption that they can spend slightly more than they collect each year in tax.

Rule No 2. The central bank shall be responsible for holding employment as high as is consistent with acceptable inflation. If unemployment is too high and there is room for reflation, the central banks shall inform government of what extra sums it (the central bank) will allow government to spend without any corresponding tax collection or borrowing. Conversely, if inflation is too high, the central bank may have to inform government that the latter rein in spending or collect more in tax. The central bank may even have to inform government that it must collect more in tax than it spends. This surplus money collected must be remitted to the central bank where it is effectively extinguished.

Rule No 3. However in most years there will be a small deficit, that is it will be appropriate for government to spend slightly more than it collects in tax. This is for reasons explained here – in particular see the calculations at the end.

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