[Debate] Beware of Rule by Central Banks

Riaz K Tayob riaz.tayob at gmail.com
Thu Apr 5 12:17:43 BST 2012

Dan Kervick: Beware of Rule by Central Banks 

Posted: 04 Apr 2012 12:10 PM PDT

/*By Dan Kervick, who does research in decision theory and analytic 
metaphysics. Cross posted from New Economic Perspectives 

The recent exchange on the nature of banking among Paul Krugman 
Scott Fullwiler 
Steve Keen 
and others has been feisty and instructive. But some readers might be 
left wondering whether the whole exercise is too wonky by half. The 
anatomical details of banking systems might be juicy and interesting for 
the academics who like to dissect those systems and dig deep into their 
entrails. But how significant are the details for practical questions of 
public policy? They are in fact very significant.

The functional details of institutions matter, and without understanding 
how the banking system actually works it is impossible to distinguish 
causes from effects in our attempts to guide that system toward the 
service of the public good. Conventional textbook models of banking and 
monetary systems are responsible for widespread commitment to the money 
multiplier and loanable funds models of the relationship between central 
bank reserves and the volume of bank lending. Relying on these models, 
some prominent economists and pundits have been telling us throughout 
our recent economic crisis that we can address the problems of a 
stagnating economy and persistently high unemployment with the reserve 
management tools of monetary policy alone.

Even worse, some monetary policy hyper-enthusiasts seem to view the Fed 
has having vast powers to manage the nation's overall spending level and 
adjust the nation's money supply up and down though mysterious and 
occult mechanisms that extend well beyond the grubby plumbing of the 
credit system. The Wizard of Fed, it seems, can control the economic 
minds of Americans though imperious pronouncements on his expectations 
for the future. Hundreds of millions of Americans, one is led to 
believe, pay close attention to the Beloved Leader and await his 
determinative dicta, and then adjust their own behavior accordingly. 
L'État, c'est Ben. The nation's central banker is the glass of financial 
fashion and the caller of the economic tune.

Incongruously, this picture of an America enthralled under a slavish 
devotion to the oracular sayings of Chairman Ben is often brought forth 
as an instance of the "rational expectations" approach in economics. 
Allegedly, the lemming-like congruence of expectations precipitates its 
own self-generating rationality. Since we all know that we have all 
tacitly agreed to enslave ourselves to the nation's central banker, when 
we then proceed to conform to the general goose-stepping we are behaving 
quite rationally.

Now I ask you: speak to several of your neighbors tonight and ask them 
who Ben Bernanke is and what he does, and then consider whether this 
precious conceit of the court theorists of the financierati has the 
slightest grounding in empirical reality. I have no doubt that this 
picture describes the attitudes of some relatively small number people. 
My guess is that most of the people in question watch CNBC and Bloomberg 
all day, and manically shuffle their money hither and thither in the 
asset markets as the tipsters tip and the news items roll in. But down 
on Main Street where the real economy lives, and where people are too 
busy working all day -- or at least trying to get work -- to spend time 
playing games in the markets? Does the average citizen's step either 
quicken or slacken to the cadences called by the Fed chairman? Does the 
average consumer go to the store looking for a washing machine or an 
iPad on the Fed's say-so? It's doubtful.

This inordinate faith in and reverence for the power of the central bank 
and the Central Banker has had a profound effect on national policy over 
the past several decades. The US Congress has assigned to the Fed the 
"mandate" to achieve full employment, and many now routinely excoriate 
the Fed for failing to fulfill that mandate. And yet, while there may be 
more the Fed can do, there is little evidence that the Fed actually has 
any substantial degree of control over demand and employment in the real 
economy, at least in a circumstance in which interest rates have fallen 
as low as they can go. In fact, as various adventures in conventional 
and unconventional monetary policy have continued to fail, the evidence 
mounts that faith in monetary policy is misplaced, official mandates 
notwithstanding. We might as well assign to the Air Force a mandate to 
deliver pink ponies to every child in America. Just as there is no 
reason to think that Air Force brass and fighter pilots are particularly 
well-prepared for satisfying the equine needs of America's eager tots, 
it seems increasingly clear that the Fed is not the agency of government 
best suited to parachuting real jobs down across America.

The problem in America is not bankers who won't lend. Corporations are 
already sitting on record-setting amounts of profits and cash, but 
production and hiring are not booming. The problem is that ordinary 
people at the foundation of our economy, the people whose desires for 
goods and services drive the production that employs our resources, are 
lacking income. They do not want more credit and more debt. They want 
more income.

Yet it's not as though we don't know how to promote economic production, 
deliver income and boost unemployment when the private sector fails to 
deliver as much of these social goods as we need. As a monetarily 
sovereign country, the US government can finance an expansion in 
spending that does not require either new taxes or burdensome debts left 
to posterity. What people want the Fed to do -- somehow push new, 
spendable monetary assets into the real economy -- the political 
branches of the government can do better, and in a much more direct and 
effective way. What is called for is a renewed commitment to fiscal 
policy, not more exercises in conventional and unconventional central 
bank policy. We need to return fiscal policy to the front and center of 
our national discussion of economic policy.

Fiscal policy and the political branches of government are needed to do 
what the central bank can't, and to restore our sick economy to health. 
But there is another reason that we need to rediscover the power and 
capabilities of fiscal policy. The incessant debates about the virtues 
of monetary policy tend to encourage people to take an excessively 
technocratic and abstract view of our nation's economic policy needs, 
and to reduce those needs to the rubric of "macroeconomic 
stabilization." But our nation doesn't just need jobs in general; we 
have specific national needs for specific kinds of work. We don't just 
need more production and spending in general; we need to produce and buy 
specific kinds of things to advance urgent public purposes. The 
macroeconomist sometimes views spending on a bridge or a school as 
spending in the abstract; spending that is justified by the mere fact 
that we need more spending of some kind. But the citizen sees these 
actions mainly as spending on a bridge or a school -- something we do 
mainly to buy something we need. That's why monetary policy is a lame 
substitute for engaged fiscal policy in a democracy. A central bank can, 
at best, only concern itself with the public purpose of managing the 
flow of money and credit in general; but the public has very specific 
purposes in mind.

We are faced with imposing national problems of social decay, public 
underinvestment, incoherent and feckless national purpose and 
unconscionable underemployment of people and resources. These are 
problems that can't be fixed by Fed money management and expectations 
setting, and many of them are challenges of national scope that 
manifestly exceed what we can expect from the hurly-burly and hustle of 
private sector entrepreneurialism. Solving these problems is going to 
take an activist national government, and a politically engaged and 
committed public, directing serious resources toward unmet public 
purposes. We're way beyond the point where the only macroeconomic policy 
we need from the national government is the limited kind of 
"stabilization" that can be provided by the Fed. Our country is broken 
and our future prosperity is in deep jeopardy. We need to define large 
goals, set challenging tasks and get to work. It is time to get people 
to stop looking to the Fed to do the jobs that can only be accomplished 
effectively by the American people acting with purpose through their 
legislative representatives. There is no pure monetary policy cure for 
what ails us.

One prominent current enthusiast for monetary policy is Scott Sumner, 
who uses his blog The Money Illusion to promote an approach to monetary 
policy called "market monetarism". The core policy recommendation of 
market monetarism is that the Fed should target the aggregate level of 
dollar spending in the country, and maintain a stable rate of increase 
in that level, which includes engineering catch-up spending in 
subsequent years if spending in prior years false short. Sumner has no 
doubt at all that the Fed could hit this target if it truly sets its 
mind to it.

Sumner recently launched a blistering attack 
<http://www.themoneyillusion.com/?p=13715> on a new paper by J. Bradford 
DeLong and Lawrence Summers. DeLong and Summers argue in that paper that 
"discretionary fiscal policy where there is room to pursue it has a 
major role to play in the context of severe downturns that take place in 
the aftermath of financial crises." But Sumner is having none of it. 
Here is part of his tirade:

    So let's start over. The Fed is unwilling to provide enough monetary
    stimulus. OK, now what is the point of this paper? Is this to train
    our future econ PhD students? Are we trying to teach them the
    optimal policy regime? Obviously not. The optimal regime relies on
    monetary policy to steer the nominal economy, and fiscal policy to
    fix other problems. So we are going to defend the model how? A
    blueprint for failed states? For banana republics? Fair enough, but
    ask yourself the following question: In a failed state, which is
    more incompetent branch of government; the central bank or the

    Yes, the Fed is bad. But Congress is downright ugly. Deep down most
    economists are technocrats. They see the central bank as being the
    best and the brightest, the guys who are above politics, who will
    "do the right thing." And how do economists view our Congress? The
    terms 'stupid' and 'incompetent' don't even come close to describing
    the disdain. So are we supposed to change our textbooks in such a
    way that the fiscal multiplier is no longer zero under an inflation
    targeting regime (as the new Keynesians had taught us for several
    decades?) And on what basis? Because the Fed might be so incompetent
    that we need Congress to rescue the economy? In what world does that
    policy regime actually work? If you have a culture that has its act
    together, such as Sweden or Australia, the central bank will do the
    right thing. If not, then all hope is lost.

I find Sumner's assault on fiscal policy and Congressional action to be 
both economically misguided and politically disturbing.

First, it is hard to understand the practical difference between 
"steering the nominal economy" and "fixing other problems". The economy 
consists in the production and exchange of things of value, and one can 
measure those values in various ways. One way is to measure goods and 
services by their current market values as expressed in dollars. But 
economists have also devised various methods of abstracting away from 
the fluctuating current dollar as a measurement standard, so as to get 
at some more stable measure of value that allows for meaningful 
comparisons across times and places. They thus distinguish between 
nominal and real measures of value. But while one can distinguish 
analytically between nominal and real measures of economic activity, 
there is no such thing as the "nominal economy" that can be separated 
out for the "other things" and steered independently of those other 
things. It's all the same economy, whether its values are measured in 
nominal terms or real terms.

Perhaps what Sumner has in mind is not dollars as a nominal measure of 
value, but as a medium of exchange. We live in a monetary economy, and 
dollars are one of the things that are produced and exchanged in that 
economy. So the proposal might be that it should be left to the central 
bank to steer the part of the economy involved in the production and 
exchange of dollars, and leave it to fiscal policy to steer the part of 
the economy in which other things are produced and exchanged. But the 
fact is that almost every transaction that takes place in the United 
States takes place in dollars. The dollar economy is the real economy, 
and the real economy is the dollar economy. The economic system which 
consists of both money and the things money buys is an organic whole of 
integrated human activity. There is no plausible way of regulating or 
managing one without regulating or managing the other.

Nor is there a real-world way of institutionally separating the 
macroeconomic stabilization functions of government from public 
investment and redistributive operations of government. It's all part of 
the same job.

But what is really disturbing about Sumner's attitude is his haughty and 
unembarrassed contempt for democratic processes. Sumner actually 
believes the US should be seen as a failed state and banana republic if 
it fails to devolve responsibility for it economic fate onto the 
shoulders of an unelected, elite-governed and autocratic central bank, 
and away from its stupid and incompetent elected representatives. But my 
guess is that most Americans, schooled in reverence for democratic 
traditions and citizen responsibility of self-government, would view 
things from quite the opposite perspective.

Members of Congress might be corrupt, bungling and in some cases 
outright incompetent -- and these three traits make their sorry presence 
felt in some eras more than others. But as democratic citizens we know 
where our obligation lies in such circumstances: Throw the bums out, get 
a better Congress and then hold their feet to the fire to serve the 
public interest. If we simply pack it in instead, neglect our 
obligations, and dispose of our democratic institutions when they are 
not functioning properly, and then hand everything over to cadres of 
arrogant and aloof technocrats with minimal democratic accountability, 
we will have lost more than a few jobs.

Lately, in their zeal to defend to powers of the central bank, we have 
been getting some truly radical, and frankly dangerous, calls from 
central bank enthusiasts to allow the Fed to appropriate to itself all 
sorts of broad spending powers that every American schoolchild has 
learned are the prerogative of the United States Congress and the people 
who elect them. And sure, if we allow the central bank to become a 
second, unelected Congress that can conduct a second channel of fiscal 
policy by crediting bank accounts and buying things, without any direct 
democratic accountability or debate over its spending decisions, then it 
can no doubt have the same kind of macroeconomic impact that an 
unleashed Congress and Treasury could have. But if we do cross that 
Rubicon and go down that authoritarian road, turning the Fed into some 
kind of neo-Soviet Stroibank empowered to spend and command real 
national resources outside the normal democratic process at the behest 
of a technocratic elite, we will probably never get our democracy back.

People frequently rail against the pork barrel spending and earmarks 
that result from the legislative process. But the pork barrels don't 
worry me nearly as much as handing our economy over to another 
generation of theory-addled elitists like Alan Greenspan. As part of the 
democratic process, representatives come from all over the country to 
look for the resources to deliver the things their constituents want and 
need. They wrangle and haggle. And yes, in the process they land a few 
"bridges to nowhere." But most of what they get are bridges to 
somewhere. The people in New Hampshire might not like the way the people 
in Georgia use their share of our national resources, and the people in 
Georgia might feel the same way about the people in Oregon. But the end 
result is that things get built; people are hired; public goods are 
created; national and local needs are met; things get done.

My sense is that Americans are dead tired of a corrupt and aimless 
government that can't or won't do anything important anymore; that works 
energetically to deliver resources to its masters in the plutocracy, but 
then holds up its hands and says "Sorry, out of money!" when suggestions 
for the pursuit of major public purposes are advanced. It doesn't have 
to be this way. America hasn't always had a Congress full of can't-do 
seat-warmers, small thinkers and penny pinchers determined to castrate 
the national government and let bankers and CEOs run the world. There 
have been times in our history when we have actually managed to organize 
our vast resources to accomplish important things and invest public 
resources in our future.

We have an election this year. I suggest we use it to ditch the empty 
suits, the plutocratic shills and the small minds, and fill their spots 
with people ready to act.



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