It is not necessary, as suggested by Janet Yellen, to separate the central bank from the treasury in order to keep politicians’ hands off the printing press. Plus there’s a flaw in the “Yellen” or conventional way of keeping politicians away from the printing press: that “conventional way” gives power over stimulus to two arms of the state (central bank which does monetary policy and the treasury which does fiscal policy). That makes as much sense as a car with two steering wheels.
Janet Yellen recently said, “In normal times I think it’s very important that there be a separation between monetary and fiscal policy and its primary reason for independence of the central bank…….. We have seen all too many examples of countries that end up with high or even hyper-inflation because those in charge of fiscal policy direct their central bank to help them finance it by printing money.”
Yellen is not of course saying anything unusual there. Indeed, it’s me that’s going to be the oddball and argue below that there’s something wrong with that passage and with the conventional wisdom. So here goes.
Under existing or conventional arrangements, central banks (CBs) have the right to adjust interest rates and do QE, while treasuries / politicians have the right to borrow money and spend it and/or cut taxes. “Borrow and spend” is widely regarded by economists as stimulatory, as is cutting interest rates.
But what’s the point of two arms of government having a say on stimulus? What if they disagree? That all makes as much sense as a car with two steering wheels driven by a husband and wife having a row.
A second anomaly in the existing system is this. It’s widely accepted that measuring inflation and deciding how much extra stimulus the economy can take next year is a very technical job. Certainly you won’t get a job on a CB committee that makes that sort of decision unless you have first class qualifications in economics and about twenty years’ experience as a professional economist. Of course those committees make mistakes, but it’s widely recognised that it’s better to have those committees made up of economists rather than plumbers and bricklayers.
But as against that, politicians (most of whom don’t even have the most basic qualifications in economics) are allowed a say in fiscal stimulus.
Why demand tip top qualifications for those implementing stimulus one way, but require so such qualifications for those implementing stimulus a different way?
Privately owned central banks.
A possible objection to the above “arm of the state” point is that some CBs are PRIVATELY owned. The answer to that is that ownership is simply a series of rights over something, and ownership is normally a pretty INCOMPLETE series of rights. For example I own my house, but that wouldn’t stop government compulsorily purchasing it and knocking it down to build a road.
Same goes for CBs, but even more so. For example while some CBs are nominally in private hands, those private hands have almost no rights. Reason is that the rules or customs governing the CB force the CB to act in the public interest, not in the interests of those private so called owners.
So the above description of a CB as an “arm of the state” is fair enough even when the CB is nominally in private hands (assuming the above rules and customs force the CB to act in the public interest.)
To summarize so far, there two anomalies in having two arms of the state having a say on stimulus. First, that arrangement is like a car with two steering wheels. Indeed the latter arrangement contravenes the so called “Tinbergen principle”. Jan Tinbergen was an economics Nobel laureate and his principle stated roughly speaking that for each policy objective there should be one policy instrument and one only.
The second anomaly is that those working in one of the latter “arms” have to be highly qualified, while those working for the other arm need no qualifications.
So how can those anomalies be disposed of while still keeping politicians away from the printing press? Well it’s easy: just give OVERALL responsibility for stimulus (monetary AND fiscal) to the CB, while leaving clearly POLITICAL decisions with politicians. (To be more accurate, the body or committee that decides the TOTAL AMOUNT OF stimulus does not need to be based at the CB: the important thing is that it is kept at a distance from political influence.)
Now it might seem that separating the total amount of fiscal stimulus from POLITICAL decisions is near impossible: after all, if politicians decide for example to borrow more and spend it on say education, that is stimulatory plus it’s clearly a political decision. Certainly if more is spent on education, then all else equal, the proportion of GDP allocated to public spending rises, and that’s obviously a political decision.
In fact the latter “separation” can be achieved very easily and as follows.
The job of the CB should be to decide the TOTAL AMOUNT of extra spending or “aggregate demand” that is suitable during the next six months or year. And that includes private as well as public spending. As to politicians, they DO NOT have the power to spend more than they collect in tax because that is stimulatory. But they ARE FREE to raise or cut both taxes and public spending by the same amount.
So for example if politicians want to raise public spending by $X a year and raise taxes by $X to pay for that, they’re free to do so. They also have complete control over HOW that public money is allocated as between defence, education, road building, law enforcement and so on.
Central bank dominance.
It could be argued that the existing system is not so bad in that given an independent central bank, any excess stimulus deriving from those irresponsible politicians can be countered by interest rate increases imposed by the CB. But where that happens we get an artificially high rate of interest, and that does not make sense. Isn't it better to prevent excessive fiscal stimulus happening in the first place?
The system advocated above under which the CB controls the AMOUNT OF stimulus, while politicians retain control of strictly political matters is an eminently logical division of labor.
Of course that all represents a HUGE CHANGE to the EXISTING split of responsibilities as between CBs and politicians. And certainly persuading politicians to relinquish their freedom to influence the total amount of stimulus (aka “mess up the economy”??) would be difficult.
Still, I think we should have the latter split of responsibilities as a long term goal.
And what do you know? That split of responsibilities is advocated by Positive Money, the New Economics Foundation and Prof Richard Werner here. The latter work actually advocates full reserve banking as well, but FR banking is not NECESSARILY an ingredient in the above new split of responsibilities.