The continuum from monetary to fiscal

Simon Wren-Lewis says (in response to right-deviationist David Beckworth):

"Now this does not mean that Market Monetarists and New Keynesians suddenly agree about everything. A key difference is that for David this [fiscal policy at the ZLB] is an insurance against incompetence by the central bank, whereas Keynesians are as likely to view hitting the ZLB as unavoidable if the shock is big enough."

I want to try to clear up this last remaining difference.

At first I thought that David was right. Then I started building a little model, and convinced myself that Simon was right.

So then I changed the question, into one of more practical relevance: "How would we know in practice that the shock was big enough that Simon was right?". And I came up with Scott Sumner's answer: "If the central bank runs out of things to buy". (Maybe not Scott's actual words, but close enough.)

And then I thought to myself: "Hang on. If the central bank runs out of existing things to buy, it could always buy newly-produced things". Which is the same as Simon's answer. Because if the central bank prints money and it, or the government, uses that money to build a new bridge, that is definitely fiscal policy, as well as monetary policy.

We normally think of open market operations, where the central bank buys government bonds, as a purely monetary policy. But if a government just happened to have a very small debt/GDP ratio, the central bank would soon run out of government bonds to buy, even if the shock were very small, or even if there were no shock at all. And if the inflation target were lower, or if the NGDP level path growth target were lower, that would also mean the central bank would run out of government bonds to buy sooner. What then? Maybe the central bank should buy (an index fund of) commercial bonds as well, or/then commercial shares, or/then land, or/then existing capital goods, or/then newly-produced capital goods, like bridges.

Where exactly do you draw the line between monetary and fiscal? Does it matter?

It might matter on micro public finance/public choice grounds (is this the sort of asset we would want the government-owned central bank to own?). But if you don't want the government-owned central bank owning all that stuff, then maybe you need to increase the inflation target or NGDP level path growth target, so you get a smaller central bank. (Too dedicated a pursuit of low inflation and the optimum quantity of money leads to communism, with government ownership of everything.)

How much money should the central bank print and buy things with? As much as is necessary, to hit the NGDP target. And if it runs out of other things to buy, like government bonds, or commercial bonds, or......, then it should buy newly-produced things, if necessary. And if that means it is buying too much, and getting too big, then raise the NGDP target and the implied inflation rate and the implied tax on holding currency.

What particular things should be bought and held on the asset side of the consolidated balance sheet of the government plus central bank? That is a micro public finance question.

What particular things should be held on the unconsolidated central bank's balance sheet rather than on the government's balance sheet? That is a public choice question. If the central bank runs out of things to buy and needs to buy new bridges to hit its NGDP target, and if the government doesn't want the central bank owning bridges, the government should buy those bridges financed by issuing bonds, and let the central bank buy those bonds.

I don't think there's anything left to argue about. Except a lot of micro public finance and public choice stuff.

But I'm sure we will think of something.

Comments

[Steve Roth]

"(Too dedicated a pursuit of low inflation and the optimum quantity of money leads to communism, with government ownership of everything.)"

I think this may be the best line Nick Rowe has ever written. And that's saying something. Encapsulates so much -- economic, rhetorical, political, historical.

I've been trying to elicit a response from Scott Sumner to David's original helicopter post (which Steve Randy Waldman called a "fantastic piece") for better than a year now. Also to this from moi:

SSumner: Fiscal only works if the Fed is incompetent.

SSumner: The Fed is incompetent. (At least in not implementing NGDPLT).

Ergo: Fiscal works.

Maybe it's just too ideologically painful to admit that last. Hence the lack of response.

Which epitomizes the brick wall preventing implementation of a policy that pretty much every (ideological) branch of academic macro could endorse (hell, I think Wray, Keen, Lavoie, Kelton, et. al. would be right on board):

The NeoPaleos who populate the right side of our august legislative chambers (and some backwaters of econ) simply can't bring themselves to admit that any government action might be salutary. (Or to quote Nick Rowe, to admit that doing nothing is doing something, or "there's no such thing as doing nothing.")

By the NeoPaleo's standards market monetarism is already apostasy (reformocon territory), and this, well...beyond the pale. Heresy, Grounds for blanket excommunication.

Would be great to see Scott Sumner again leading the charge -- even if it meant abandoning some dearly held beliefs in favor of his thinking's logical conclusions.

[Steve Roth]

Also, wouldn't it be just as effective -- more so, by government-haters' standards -- to just give people money and let them decide what newly produced assets to buy? Even if they buy beer, it will spur beer producers to build bottling plants, right?

But that does sound suspiciously like redistribution, or...communism! Oh, wait.

[Jerry Brown]

Well you can always start arguing with the Austrian economics crowd. That would be entertaining.

[Jerry Brown]

Or argue with us knuckle-draggers about the money multiplier and loans creating deposits stuff. I always enjoy that.

[The Arthurian]

...Time spent figuring out whether a policy is monetary or fiscal would be better spent trying to understand the economic problem. But maybe that is your point, for you say: "Where exactly do you draw the line between monetary and fiscal? Does it matter?" It does not.

How much money should the central bank print and buy things with? As much as is necessary, to hit the NGDP target. And if it runs out of other things to buy, like government bonds, or commercial bonds, or......, then it should buy newly-produced things, if necessary.

No. If you have to say the central bank should buy "newly-produced things, if necessary" then I have to say you misunderstand the problem. Time spent figuring out whether a policy is monetary or fiscal would be better spent trying to understand the economic problem...

[Scott Sumner]

Nick, Great post.

Steve Roth, If you think that was a great sentence, how about this:

"But as I’ve argued many times, a bit of socialism might be the price you pay for a conservative monetary policy. The lower the inflation target, the greater the quantity of assets that must be purchased by the central bank (as a share of GDP.)"

http://www.themoneyillusion.com/?p=18606

Yeah, I like Nick's better too.

I'm not sure why you think I don't agree with Nick, I do.

You are a bit confused on the fiscal offset issue (which contrary to your claim I've addressed dozens of times.) An incompetent bank is required for fiscal policy effectiveness, but it must be incompetent in a very special way for the fiscal multiplier to be positive. I'm not convinced it is, and the evidence form 2013 suggests it isn't.

[Max]

At the ZLB there's little difference between:
(a) central bank buys assets with new money
(b) central bank sells short treasury bonds and buys assets with the (old) money

A monetarist might be inclined to say that (a) is monetary because it directly affects the quantity of base money and (b) isn't, despite the near equivalence. A New Keynesian might say that neither is monetary since neither directly affects interest rates. Perhaps we should be broadminded and say that monetary policy is anything the central bank does in pursuit of its legitimate objectives.

[Determinant]

Nick so eloquently writes:

"(Too dedicated a pursuit of low inflation and the optimum quantity of money leads to communism, with government ownership of everything.)"

This is not a theoretical or rhetorical question. It actually happened. NPR in the US did a fantatic series called "Toxie: The Toxic Asset". "Toxie" is a tranche of a junk-status mortgage backed security. The series dissects Toxie to show the real people, assets, home and businesses behind Toxie. In the course of the series, it came to light that the Federal Reserve owned a slightly-higher tranche of Toxie, though said tranche was still junk.

http://www.npr.org/series/124587240/planet-money-s-toxic-asset

One of the assets in question was a vacant mall in Arkansas.

Ownership of half-vacant malls in Arkansas is not the proper role for a central bank under any traditional understanding. And yet it happened. And that really sums up everything that went wrong with our economy, political life and society in the last ten years.

Comrade Bernanke has a lot to be proud of.

Perhaps the right-wing reactionaries need to get a new tune: "Inflation for Free-Market Freedom".

"We want eight (percent) and we won't wait!" ;)

[Min]

How much difference is there between a system in which the gov't owns the means of production and a system in which the owners of the means of production own the gov't? ;)

[Philo]

Steve Roth's argument directed at SSumner is an instance of the Fallacy of Affirming the Consequent.

[Frank Restly]

"Where exactly do you draw the line between monetary and fiscal? Does it matter?"

Prior to the introduction of the FOMC in the US in 1933, the line between monetary and fiscal policy was fairly well drawn. The federal reserve itself was created in 1913 (20 years earlier). And before that there were several other "central banks" of the U. S., though they were more closely aligned to fiscal policy (First and Second Bank of the United States). The charter for the Second Bank of the United States ended in 1836.

Where do you draw the line between monetary and fiscal policy? Monetary policy between 1913 and 1933 was defined such that the federal reserve could lend money at an interest rate. That interest rate and reserve requirements for banks that borrowed from the Fed was set administratively - there were no open market operations in the government bond market.

Fiscal policy during that time was not much different from what it is today - government collects taxes, government spends tax revenues. Congress was permitted to borrow at the time, however, debt held was required to paid back in gold or notes that were redeemable for gold on demand (gold certificates).

If a government borrows (issues bonds), what do those bonds represent a claim on? If they are nothing more than claims on a central bank's ability / willingness to buy that debt - then there is no distinction between monetary and fiscal policy. If government bonds represent a legal claim on gold / bridges / some other good or cash flow, then the distinction between monetary and fiscal policy is significant.

Suppose the government borrows money to build bridges and cannot generate enough revenue from bridge tolls to pay back the bonds. Do the bridges eventually become the property of the government bond holders?

[CMA]

"How much money should the central bank print and buy things with? As much as is necessary, to hit the NGDP target. And if it runs out of other things to buy, like government bonds, or commercial bonds, or......, then it should buy newly-produced things, if necessary. And if that means it is buying too much, and getting too big, then raise the NGDP target and the implied inflation rate and the implied tax on holding currency."

Why does the CB need to buy things? It can just issue money into peoples accounts and they will buy things. The only requirement to the CB issuing money into people's accounts is the provision of electronic deposit accounts by the CB. The CB should provide an efficient electronic means of pmt/deposits anyway if it is tasked with providing a money supply. Its not like we are in the 19th century and paper is the most effective pmt means.

[jonny bakho]

Correct. In the US, we call what the Fed does "Monetary Policy". The Fed is legally constrained by laws and Congress, which reserves what we call "Fiscal" powers for itself. It would be very stimulatory for the Fed to make medium to long term interest free loans for state infrastructure projects. Congress would throw and fit and look for ways to restrict/punish the Fed.

[Rajiv Sethi]

Nick, this is a great post, but why stop at newly-produced goods? If you are willing to let the central bank make accounting losses, why not create an account for every citizen, including minors, and simply credit these accounts in equal measure as needed? Not as a last resort, if there aren't enough financial assets to buy, but as the default transmission mechanism? This way, monetary (actually fiscal) policy would target the balance sheets of debtors directly, allowing them to pay down debt, instead of lowering rates to induce greater indebtedness. I proposed this a few months ago:

[Link here NR]

It's a pipe dream of course, even corporate bond purchases by the Fed are not permissible unless the "unusual and exigent circumstances" clause of Section 13(3) is invoked, and even then only indirectly, by accepting them as collateral. But that shouldn't stop us from contemplating alternative arrangements...

[Nick Rowe]

Thanks all for the comments.

Steve: "Also, wouldn't it be just as effective -- more so, by government-haters' standards -- to just give people money and let them decide what newly produced assets to buy?"

I should have included helicopter drops in the post. That was David's original proposal. I think that's a micro public finance/public choice question. One way to implement it: the central bank says to the government: "We have run out of (allowed) things to buy. Here's $1B cash. You now must give us $1B government bonds in return. And you must spend that $1B cash in the next month(?). You can buy a new bridge, school, shares, lend it to provincial government, or just give it away if you think that people can spend it better than you. Your call on how you spend it, but you must spend it."

Arthur: "But maybe that is your point,..."

It is my point.

"If you have to say the central bank should buy "newly-produced things, if necessary" then I have to say you misunderstand the problem."

Tell me why you think I have misunderstood the problem.

Scott: thanks! I figured you would be onside. Sometimes it's all just a question of translation.

Max: or we could think of it this way: there are some things the central bank, or government, can do, that affect the demand for base money, rather than the supply of base money (like changing the rate of interest paid on base money, or changing the rate of interest on other assets so that changes the opportunity cost of holding base money). Is that *monetary* policy? Well,...

"Perhaps we should be broadminded and say that monetary policy is anything the central bank does in pursuit of its legitimate objectives."

That's a tempting answer. But if a central bank went and bought a load of new bridges, or started handing out cash, to help hit the NGDP/inflation target, some might say "No! That's fiscal!" But yes, there comes a point where these semantic disputes just get in the way.

Frank: "Suppose the government borrows money to build bridges and cannot generate enough revenue from bridge tolls to pay back the bonds. Do the bridges eventually become the property of the government bond holders?"

Governments build bridges all the time, and only sometimes charge tolls. They pay the interest on the bonds from tax revenue. Or, if the central bank owns the bonds, it's a wash, because the government owns the central bank. The government pays interest to the central bank, which pays it back to the government, as profits.

CMA: "Why does the CB need to buy things? It can just issue money into peoples accounts and they will buy things. The only requirement to the CB issuing money into people's accounts is the provision of electronic deposit accounts by the CB."

We don't need E-money to do this. Paper works fine. Or bank accounts at commercial banks. The central bank lends the government the money, and the government mails out cheques. See my answer to Steve above.

[Nick Rowe]

Rajiv: Thanks!

Yes, I should have included helicopter money in my post. See my reply to Steve above.

I think that's a public finance/choice question. Sometimes a recession may be accompanied by balance sheet problems, but maybe not always. I expect I would be uncomfortable, on public choice grounds, letting the central bank make that call. But that's politics, more than macro. But the one practical difficulty is that it needs to be reversible. Can the central bank also tax people's balances? What happens if the balance is $0?

[Peter K.]

@ Bakho

Would you have said the same thing about quantitative easing and the government-backed mortgage market prior to 2008?

@ Sethi

What if we hit the next recession/financial crisis with inflation very low and QE isn't enough? Section 13(3) may be invoked again. What's Japan's experience?

[Steve Roth]

Scott Sumner:

Also a great sentence but yeah Nick's is a bit better. The ironies imparted in either case approach profundity.

"it must be incompetent in a very special way for the fiscal multiplier to be positive"

Would love to hear that special way characterized succinctly, or a link to same. I read your stuff a lot but not well enough to do so myself.

I've questioned the 2013 thinking a few times, suggesting that using 2012 as the counterfactual isn't convincing to me.

And to confirm: you think David's helicopter drop idea should be implemented as described?

Determinant:

Yes! Right wingers should really be printing the Gerald-Ford-inspired buttons I've been clamoring for for years:

Demand Inflation Now! (Make a DIN!) ;-)

[Philippe]

Nick,

"the one practical difficulty is that it needs to be reversible. Can the central bank also tax people's balances? What happens if the balance is $0?"

How about the government sells bonds to drain those balances, if needed?

[Steve Roth]

Oh and Nick: I have never agreed with your more wholeheartedly than your imagined letter from CB to government. Great stuff. One of those "that's exactly what I was thinking, in a somewhat muddled and incoherent way" kind of moments. Thanks.

I think Dems would totally go for this, right? Pubs never would. Shows where the real-world problem lies...

[Scott Sumner]

Steve, No, I'm strongly opposed to helicopter drops. I favor monetary stimulus when NGDP is too low. There is never any need for fiscal stimulus, even at the zero bound, and a helicopter drop is fiscal stimulus. It is wasteful and inefficient.

Suppose that there is a regime change when rates hit zero. The Fed goes from a 2% inflation target to a 1.5% inflation target. That's inefficient. And yet in that case fiscal stimulus may still be ineffective. I can also think of scenarios where it is mildly effective, but I don't find those scenarios very persuasive or important.

[ThomasH]

There is also a sense in which activist monetary policy is a back up against incompetent fiscal policy. As the interest rate declines and before it hits zero governments ought to find many more investment passing NPV tests: bridges to be built, research to be funded, asteroids to be tracked, land to be reclaimed. Governments however usually do not invest in this way so the ZLB is conceivable.

[Tom Brown]

Nick, Brad DeLong seems to be poo-pooing the Oxford-Bowling Green-Ottawa Kumbaya harmonic convergence! ... not only that, he invited Minsky to the party!... and Lloyd Meltzer too (whoever that is).

[Steve Roth]

Scott: "I'm strongly opposed to helicopter drops."

Well then, in answer to "I'm not sure why you think I don't agree with Nick, I do."

I guess my answer is, "because you don't agree with Nick."

I he uses the word "should" at least half a dozen times here regarding David's proposal.

But you say should not. I really don't understand how that constitutes agreeing. Confused.

[CMA]

"We don't need E-money to do this. Paper works fine. Or bank accounts at commercial banks. The central bank lends the government the money, and the government mails out cheques. See my answer to Steve above."

Thats like saying we dont need cars. We have horses. E-money is a more efficient means of transaction than paper. If the fed issues electronic deposits its independance wont be compromised when it conducts heli drops and the dep pmt system which is systemic will be risk free. No need to mail out cheques just electronically credit accounts.

[CMA]

"Steve, No, I'm strongly opposed to helicopter drops. I favor monetary stimulus when NGDP is too low. There is never any need for fiscal stimulus, even at the zero bound, and a helicopter drop is fiscal stimulus. It is wasteful and inefficient."

How is a heli drop wasteful?

If a heli drop performed directly by fed is fiscal then isnt a purchase of an asset fiscal? After all in a purchase you transfer money to seller and they transfer asset to you. In purchase there is two transfers, in a heli drop it is only one.

[Nick Rowe]

Lost in translation.

Can Scott think of circumstances where, on micro grounds, a $1B tax cut would be a good thing? Almost certainly yes.

Can Scott think of circumstances where, on macro grounds, a $1B increase in base money would be a good thing? Almost certainly yes.

Now suppose both those circumstances coincided.

[Min]

Scott Sumner: "a helicopter drop is fiscal stimulus. It is wasteful and inefficient."

It's wasteful and inefficient because it puts too much money in the hands of rich people, who may not spend it?

[Ralph Musgrave]

Min,

Market monetarism is also “wasteful and inefficient” in that it consists of the authorities printing money and buying assets which enriches the asset rich. I.e. MM is distortionary.

[Min]

Thanks, Ralph! :)

[Rajiv Sethi]

"I'm strongly opposed to helicopter drops... a helicopter drop is... wasteful and inefficient"

What's wasteful and inefficient is trying to stimulate aggregate demand by buying Treasuries, gifting capital gains to bondholders, and lowering interest rates to induce more debt-financed expenditure in an already over-leveraged economy.

Much less wasteful and inefficient is stimulating aggregate demand through equal per-capita transfers, allowing borrowers on the edge of insolvency to keep making payments to creditors, reducing the incidence of delinquency and default, and ensuring equal treatment of those who did not borrow heavily.

[CMA]

Rajiv Sethi

I totally concur. Check out this proposal of how to implement it if you like: cmamonetary.org

[The Arthurian]

Nick: The problem is that the liabilities became unsustainable. Central banks don't buy liabilities. Buying assets doesn't solve the problem.

[Philippe]

"What's wasteful and inefficient is trying to stimulate aggregate demand by buying Treasuries, gifting capital gains to bondholders, and lowering interest rates to induce more debt-financed expenditure in an already over-leveraged economy.

Much less wasteful and inefficient is stimulating aggregate demand through equal per-capita transfers, allowing borrowers on the edge of insolvency to keep making payments to creditors, reducing the incidence of delinquency and default, and ensuring equal treatment of those who did not borrow heavily."

I think Rajiv Sethi made an important point here, which has been generally glossed over by these technical model-based debates between NKs and MMs.

You guys seem to be missing the bigger picture...

[Ralph Musgrave]

Philippe,

I quite agree. The time-wasters and model builders in academia won’t like Rajiv’s point because it smacks of an actual SOLUTION to economic problems. Academic economists don’t like solutions to economic problems because that might put them out of work.

My only slight criticism of Rajiv’s point is that he advocates JUST “per capita transfers” which effectively means boosting JUST PRIVATE spending in a recession. I suggest that in a recession PUBLIC SPENDING should also be boosted, or at the very least should not be allowed to fall. Infrastructure spending in the US actually fell in the recent recession which was a total disgrace.

[CMA]

Ralph

Have you changed your mind about fed heli drops? Im pretty sure you were against them previously.

[Rajiv Sethi]

@CMA, thanks for the link, it's an interesting proposal. I don't think it should be restricted to adult citizens; accounts of minors can simply accumulate funds until they come of age. I also think all profits from open market operations should be credited to accounts instead of transferred to Treasury, but funds can be frozen and released incrementally as warranted by the policy target. More details in my post (linked above).

[Steve Roth]

SSumner answers at more length:

http://econlog.econlib.org/archives/2014/07/helicopter_drop.html

[Min]

Ralph Musgrave: "Infrastructure spending in the US actually fell in the recent recession which was a total disgrace."

And infrastructure spending in the US was already a disgrace. They told us growing up that the greatest danger to the US society was crumbling from within. I didn't know to take that literally.

[Innocent]

Okay how about this. Government stops taxing, Central Bank provides all the money. Viola instant stimulus to reach NGDP target. Model is clean and simple.

[Frank Restly]

Nick,

"We normally think of open market operations, where the central bank buys government bonds, as a purely monetary policy. But if a government just happened to have a very small debt/GDP ratio, the central bank would soon run out of government bonds to buy, even if the shock were very small, or even if there were no shock at all."

If you decide to count purchases / sales by a central bank as part of your GDP, then you only need a single good for the central bank to repeatedly buy and sell - the central bank can't "run out" of things to buy because it is repeated buying and selling the same good. Most countries (all?) tend to stick with newly produced goods as part of the GDP calculation. Obviously inventory adjustments need to be made in the GDP calculation to account for the time delay between when a new good is produced and when it is sold.