Financial Stability News

News about financial stability, central banking and theory of money

Category Archives: Fiscal policy

EU’s unemployment continue to increase

Unemployment continue to increase, as reported by Eurostat yesterday. Depressing figures; should be of greater concern for everybody! For a good review of the situation, see this blog from Professor Bill Mitchell, University of Newcastle, NSW Australia.

End of central bank independence?

Former PIMCO economist Mc Culley has issued a new WP with former IMF economist Poszar called Does Central Bank Independence Frustrate
the Optimal Fiscal-Monetary Policy Mix in a Liquidity Trap? Well worth reading! (50 pages)

Martin Wolf  devoted a long blog post to the paper in April, and the issue is sure to be high on the policy agenda as the discussion of economic policy in Europe continues.

Randall Wray has an interesting reflection on Wolfs post here, and you can read here for a very opposite view form Bundesbank chief Weidmann.

One thing is sure, as Ron Paul noted, central bank management and policy will surely be hot topics ahead.

You can watch a Bloomberg interview with Mc Culley here

Brad DeLong on FT’s call for austerity

The FT’s editorial today with a balanced call for austerity in Europa was surprising and disappointing, given all the writings of Martin Wolf and others in the paper before. Today Brad de Long take charge at the ed and discuss why it is that people who should know better fall in the “austerity trap”. He points out that even Milton Friedman would have to to stabilize nominal GDP and buy stuff for until inflation and growth are reestablished on a sustainable path.Well written.

Also included are the response from Paul Krugman which is even better, and probably well to the mark (still scary):

My best theory here is that it’s political and sociological: conservative-leaning economists who should know better are driven by peer pressure to suppress their better instincts.

Think about Greg Mankiw and inflation. Early on in the Lesser Depression Greg came out for inflation — fairly high inflation! — as the solution, to give us negative real interest rates. But he encountered a firestorm of criticism from his political allies — and went silent.

The point is that even among academics with tenure and established reputations, there is apparently enough leverage in the hands of the enforcers of right-wing orthodoxy that they end up bowing to the reign of error.

As for Rachman: I think this is a subtler form of peer pressure. And for what it’s worth, Ryan Avent has already written the devastating reply to Rachman I haven’t had time for because I’m on Reddit!

Making finance servant, not master of the economy

This heading seems like a good companion post to the previous one on hedge funds speculation against the euro countries. It is the title of a presentation by Ann Pettifor at a conference on Just Banking (for program, see here). She gives a good overview of the problems in Europe and then draw extensively on Keynes in her proposal for a radical alternative to the current austerity approach:

Keynes’s six tools for recovery:

First, independent monetary policy: liquidity created by both public and private financial institutions should be directed towards sound public and private investment in productive, job creation activity. Any attempt to divert liquidity/credit into speculation had to be curtailed.

Second, fiscal policy: Keynes understood that it was not enough simply to create liquidity. That money had to be spent, and spent wisely. Today economists and politicians like David Cameron (“.. a fiscal conservative and a monetary activist”) rely simply on monetary policy to inject liquidity into zombie banks. This helps the banks, but does precious little to direct lending to firms and to stimulate recovery.

Third, managing debt de-leveraging: Keynes understood that the vast bubble of debt had to be de-leveraged in a managed way. Some debts inevitably have to be written off, with debtors granted a jubilee – as Steve Keen argues – simply because a high proportion of private debts are ultimately unpayable.

Fourth: regulation of credit creation. To ensure that credit created by the private banking system was aimed at the real economy, and not speculation, Keynes advocated wise regulation of the credit creation powers of private banks (‘tight money’). In other words loans had to be carefully assessed for their ability to generate income to finance repayment; and for their ability to generate sound employment and economic activity.

Fifth: permanently low interest rates. This was one of the central pillars of the Keynesian revolution. It was also the one that invited the greatest hostility from private bankers – whose profits and capital gains depend on exacting high rents from the effortless activity of creating new loans, and from speculative activities.

Six: capital controls are important for a number of reasons. One of the most important reasons for control over the mobility of capital is that management of financial flows gives democracies the freedom and autonomy to conduct their economic policies in the interests of society and the economy as a whole. In the absence of capital control, democracies are subject to the whims and interests of unaccountable global financial elites.

Bernanke on the dual mandate

Chairman Bernanke was responding to questions in the Senate Banking Committee today. Most of the Q&A were on fiscal matters, especially on the need for budget consolidating in the medium term, including the big three entitlement programs Medicaid, Medicare, and Social Security.

Federal Reserve Chairman Ben Bernanke urged senators to resolve differences over payroll tax cuts that expire this month saying uncertainty could slow the economy down. He testified before the Senate Budget Committee on the U.S. economic outlook for this year. Chairman Bernanke told the committee that the labor market still has a “long way to go” and unemployment levels remain “troubling.”

At around 1:27 Bernanke gives some interesting reflections on the dual mandate and the ongoing policy of quantitative easing.

At around 1:40 he gives a strong defense for the ZIRP policy and oppose the recent views from Charles Swab in WSJ and Bill Gross of PIMCO in FT

Throughout, many senators commended Bernanke on his new policy of increased transparency, including the posting of an inflation target.

Central bankers of the 30s

Interesting policy statement from Fed officials in the 30s; quite relevant for situation today (from Naked Keynes):

“At the present time we are still in the depths of a depression and, beyond creating an easy money situation, there is very little, if anything, that the Reserve organization can do toward bringing about recovery. One cannot push a string. I believe, however, that if a condition of great business activity were developing to a point of credit inflation, monetary action could be very effective in curbing undue expansion. That would be pulling a string.”

Marriner S. Eccles,Chairman, Federal Reserve Board, March 4-20, 1935.
“The factor of unutilized capacity appears to furnish the decisive answer to the argument that if the budget had been balanced the resulting restoration of confidence would in itself have led to recovery. There is nothing in balancing the budget that would lead to an absorption of excess capacity and hence make it profitable for business to increase its disbursements for plant and equipment. On the contrary, balancing the budget, by curtailing the incomes of people receiving money from the Government and by reducing buying power through increased taxes, would heve been expected to decrease demand and hence increase excess capacity.”

Marriner S. Eccles, Chairman, Federal Reserve Board, June 8, 1936


“Our national debt we will owe to ourselves. The cost of interest service and gradual repayment that is collected in taxes from one generation will be paid to the same generation. The debt will be held wholly within the United States and by our citizens. It will present none of the impossible problems that accompany an external debt. If we fail in the future to make democracy worth while, it will not be the size of the public debt that defeats us. It will be because we have not learned how to use these great resources – human and material – to provide full employment and a high standard of living for all our people.”

Chester C. Davis,President, Federal Reserve Bank of St. Louis,November 14, 1942



Central bank independence and the 1951 Accord

Gavyn Davies have an interesting post in the today about “How the Fed defeated president Truman to win independence”. I have been reading several articles recently about the Accord, and I agree fully with Davies that the Fed – Treasury Accord is important in understanding the rationale behind central bank independence today.

However, reading here about the key actors in the drama, especially Governor Eccles, who fought the main battle before being sidelined by Truman, it becomes clear that their view of CB independence was more relative to the needs of the day. During the depression both Eccles and his famous assistant Lauchlin Currie were rather skeptical to central bank policies as a way out of the crisis, and they both favored strong fiscal stimulus. I therefore note in a blogpost to the article that

… when inflation became an issue after the war, they both felt the need for a more flexible interest rate policy, which required a break with the Treasury’s low rate policy. Thus the need for central bank independence.

Governor Eccles has been accused of turning with the winds, whereas I would rather see him (and the rest of the Chicago school for that manner, including Henry Simons and Jacob Viner) as being pragmatic economists who understood that the central bank’s policy tools and governance structure are relative to the situation at hand. Therefore, central bank independence and inflation fighting cannot be seen as a holy grail to be defended at all cost and all times.

What is needed now, as in the 30s, is forceful monetary stimulus, both through fiscal and monetary means. The ECB has been doing this reluctantly, partly with reference to this misconceived notion of independence. And the fiscal stimulus seems even further away, due to an even stronger intellectual straightjacket of “balanced budgets”. In due course there will hopefully be some reconciliation between the ideology and what is constructive polices to resolve the crisis.