Jeremy Corbyn’s proposal for ‘Peoples’ Quantitative Easing’ – public investment paid for using money printed by the Bank of England – has provoked criticism, including an intervention by Labour’s shadow Chancellor Chris Leslie. It seems the anti-Corbyn wing of the Labour party has finally decided to engage with Corbyn’s policy agenda after several weeks of simply dismissing him out of hand.
Critics of the plan make two main points: that the policy will be inflationary and that it dissolves the boundary between fiscal policy and monetary policy. It would therefore, they claim, fatally undermine the independence of the Bank of England.
The first point is inevitably followed by the observation that inflation and the policy response to inflation – interest rate hikes and recession – hurts the poor. As ever, the first line of attack on economic policies proposed by the left is to claim they will hurt the very people they aim to help. Leslie falls back on the old trope that the state must `live within its means’. It is well-known that this government-as-household analogy is nonsense. But what of the monetary argument?
Inflation is not caused by printing money per se. It is instead the result of a combination of factors: wage increases, supply not keeping pace with demand, and shortages of commodities, many of which are imported.
By these measures, inflationary pressure is currently low – official CPI is around zero. Since this measure tends to over-estimate true inflation, the UK is probably in deflation. There is finally evidence of rising wages – but this comes after both a sharp drop in wages due to the financial crisis and an extended period in which wages have grown at a slower rate than output. The pound is strong, reducing price pressure from imports.
More importantly, the purpose of investment is to increase productive capacity and raise labour productivity. Discussion of monetary policy usually revolves around the ‘output gap’ – the difference between the demand for goods and services and the potential supply. Putting to one side the problems with this immeasurable metric, the point is that investment spending increases potential output as well as stimulating demand, so the medium-run effect on the output gap cannot be determined a priori.
The issue of central bank independence is more subtle – certainly more subtle than the binary choice presented by Corbyn’s critics. That central banks should be free from the malign influence of democratically elected policy-makers has been an article of faith since 1997 when the Labour government granted the Bank of England operational independence. But, as Frances Coppola has argued, central bank independence is an illusion. The Bank’s mandate and inflation target are set by the government. In extremis, the government can choose to revoke ‘independence’.
More relevant to the current debate is the fact that the post-crisis period has already seen significant blurring of the distinction between monetary and fiscal policy. In using its balance sheet to purchase £375bn of securities – mostly government bonds – the Bank of England has, to all intents and purposes, funded the government deficit. The assertion that the barrier is maintained by allowing debt to be purchased only in the secondary market is sleight of hand: while the government was selling new bonds to private financial institutions the Bank was simultanously buying previously issued government bonds from much the same financial institutions.
At this point, critics will object that the Bank was operating within its mandate: QE was enacted in an attempt to hit the inflation target. This is most likely true, although during the inflation spike in 2011, there were suggestions the Bank was deliberately under-forecasting inflation in order to be able to run looser policy; as it turned out, the Banks’ forecasts over-estimated inflation.
None of this alters the fact that quantitative easing both increases the ability of the government to finance deficit spending and has distributional consequences; QE reduced the interest rate on government bonds while increasing the wealth of the already wealthy. Crucially, there won’t be a return to ‘conventional’ monetary policy any time soon. At a panel discussion at the FT’s Alphaville conference on ‘Central Banking After the Crisis’ featuring George Magnus and Claudio Borio among others, there was consensus that we have entered a new era in which the distinction between monetary and fiscal policy holds little relevance; there will be no return to the ‘haven of familiar monetary practice‘ in which steering of short-term interest rates is the primary mechanism of macroeconomic control.
The issue which has triggered this debate is the long-term decline in UK capital expenditure – both public and private. An increase in investment is desperately needed. Corbyn isn’t the first to suggest ‘QE for the people’ – a number of respectable economic commentators have recently called for such measures in letters to the Financial Times and Guardian. Martin Wolf, chief economics commentator at the FT, recently argued that ‘the case for using the state’s power to create credit and money in support of public spending is strong’. Former Chairman of the Financial Services Authority, Adair Turner, has made similar proposals.
I agree, however, with the view that it makes more sense to fund public investment the old-fashioned way – using bonds issued by the Treasury. Where I disagree with Corbyn’s critics is on the sanctity of `independent’ monetary policy; the Bank should stand ready to ensure that these bonds can be issued at an affordable rate of interest.
Why has Corbyn – supposedly a throwback to the 1980s – proposed this new-fangled monetary mechanism? Rather than some sort of populist gesture, I suspect this reflects a status quo which has elevated the status of monetary policy while downgrading fiscal policy. This, in turn, reflects the belief that the government can’t be trusted to make decisions about the direction of the economy; only the private sector has the correct incentive structures in place to guide us to an optimal equilibrium. Monetary policy is the macroeconomic tool of choice because it respects the primacy of the market.
Given that the boundary between fiscal and monetary policy has broken down at least semi-permanently, that status quo no longer holds. It is now time for a serious discussion about the correct approach to macroeconomic stabilisation, the state’s role in directing and financing investment and the distributional implications of monetary policy. It is to Corbyn’s credit that these issues are at last being debated.