Mervyn King’s strange “paradox of policy” ideas.

I respect Mervyn King, the recently departed governor of the Bank of England. I’ve quoted him with approval more than once.

Unfortunately in this speech, he goes off the rails.

The national debt.

In one passage in reference to the UK national debt, he says, “In the long run, we will need to…. repay our debts…”.  Complete nonsense!!

National debt is just a form of private sector net financial asset, as every advocate of Modern Monetary Theory knows. And the size of PSNFA needs to be whatever induces the private sector to spend at a rate that brings full employment.

Keynes expressed exactly the same idea when he said, “Look after unemployment and the budget looks after itself”.  In other words aiming for any particular speed of debt reduction is daft. If the private sector has a fit of irrational exuberance, a surplus may be in order: it may necessary to confiscated some PSNFA (i.e. raise taxes) so as to calm things down, and the debt will come down. Conversely if the private sector goes into subdued or savings mode, the deficit will need to continue.

King has fallen for the argument put by many so called economists, namely that the debt is higher now than it used to be, ergo it should be brought down. Which is as ridiculous as saying that the temperature in your house is currently five degrees higher than it was an hour ago, therefor it ought to come down.

The CRUCIAL question in relation to the debt and the temperature in your house is: what’s the OPTIMUM size of the debt or temperature. And that’s about the five hundredth time I’ve seen a member of the so called intelligentsia having a problem with the concept “optimum”.

MMTers have SPECIFIC IDEAS as to what the optimum size of the debt ought to be. Other economists seem to have no such ideas. They don’t even asking the question: “what’s the optimum?” 

The balance of payments.

Next, King claims “In the long run, we will need to rebalance our economy away from domestic spending and towards exports, to reduce our trade deficit…  So you are probably puzzled by the fact that we seem to be doing exactly the opposite of that today.”

Whaaaaat?

So the UK is running an external deficit which we can leave in place for now, but which we’ll have to deal with in the long run?

The reality is that the Bank of England nowadays does not make a big effort to intervene to support the pound on foreign exchange markets. So if the UK has an external deficit (ignoring capital flows), market forces will immediately start rectifying that imbalance by devaluing the pound. So the idea that we are running an external deficit as long as the recession lasts is nonsense.

Moreover, even if a country’s central bank DID CONSIDER supporting its currency during a recession, that would be a questionable policy. That policy would of course temporarily support living standards, but the price would be a more violent adjustment for exporters and importers in the long run.

And finally, far from countries’ balance of payments tending to be in poor shape during a recession, the opposite is actually the case. That is, when demand in a country declines, that cuts imports which IMPROVES the balance of payments.

Combining monetary and fiscal policy.

Next, King tries to attack the idea that monetary and fiscal policy should be combined. (Helicopter drops in the form of central bank creating new money with government distributing that money in the form of extra public spending or tax cuts is an example of that “combination”).

His argument against the combination is that either government has the power to create new money in which case we’re just asking for inflationary booms before elections. Or else, the central bank creates new money and takes fiscal decisions (e.g. decisions as to how to allocate money to health, education, and so on).

As he puts it, “Not only is combining monetary and fiscal policies unnecessary, it is also dangerous. Either the government controls the process – which is “bad” money creation – or the Bank controls it and enters the forbidden territory of fiscal policy.”

The reality, as pointed out by Positive Money and others, is that we could perfectly well have some sort of independent committee of economists (much like the existing Bank of England Monetary Policy Committee) which would periodically decide HOW MUCH money to create depending on what inflation looked like doing. While the decision as to how to actually allocate that money was entirely in the hands of democratically elected politicians.

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P.S. (same day). King is also confused as to how monetary policy would operate if there was no government debt. The relevant passage reads, “For the same reason, the Bank could not countenance any suggestion that we cancel our holdings of gilts. The Bank must have the ability to reverse its policy – to sell gilts and withdraw money from the economy – when that becomes necessary. Otherwise, we run the risk of losing control over monetary conditions.”
The truth of course is that even if there was no government debt, there’d be nothing to stop central bank simply announcing it was willing to borrow at above the going rate of interest.
As to the money needed to pay the interest on that borrowed money, a central bank could simply print the money. But a better option would be for the central bank to agree with the treasury that it would be better if the money came out of taxation.