These points will be old hat to economics cognoscenti, but they need repeating because of how the debate about ‘Corbynomics’ has been conducted.
I’ll single out Richard Murphy, Corbybn’s economics advisor, as an example, citing points he made in his discussion of the proposed ‘People’s Quantitative Easing’ [PQE] with myself and others.
But the views addressed here have surfaced many times in recent months, so RM is not the only rhetorical offender.
One is that ‘central bank independence is an illusion’. Being so, PQE or any other policy that seems to intrude on central bank independence is not a problem, because there is nothing lost by dispelling an illusion. In fact, the ‘illusion’ analogy suggests, PQE or similar may allow us to see things how they really are.
It’s certainly true to say that, in functioning democracies what central banks do follows from choices made by electorates, or at least by politicians on electorates’ behalf. In the UK, for example, the electorate chose a Labour Government in 1997, and on its behalf it delegated to the Bank of England the task of wielding monetary policy instruments, but in pursuit of a goal it would determine. [Lately finessed to express this as stabilising a combination of inflation and real activity].
So what the BoE actually does with interest rates and asset purchases from month to month traces back to decisions voters made in May 1997.
That being the case, Mr Murphy’s arguments imply, there’s no problem voters choosing Jez’ manifesto, and, along with it, instructions for the Bank of England to buy bonds issued by a new Government infrastructure investment vehicle.
However, there IS a problem, deriving from the fact that, despite this ultimate democratic control over the monetary authorities, there IS a form of central bank independence, which we might more revealingly call ‘curtailment of government control over monetary policy’ and put there not by accident, but purposefully, to solve a pre-existing problem.
The curtailments of government control are twofold. First, the BoE has control over the instruments on a month to month basis. This gives confidence that the government won’t say one thing [‘price stability!’] and do the other [‘cheap mortgages!’] with the instrument. This is known in the trade as the BoE having ‘instrument independence’]. Second, by passing the BoE Acts, in which the broad terms of the BoE’s goals are set out, the government restricted its day to day freedom to change the goals of monetary policy. For sure, new Acts could be passed, and the goals re-written. But this would cost the government, in reputation, Parliamentary time and even political favour.
The Acts themselves contain clauses allowing for the government to take back control over monetary policy instruments in times of national crisis. But if these were used lightly, the benefits flowing from passing the Acts in the first place would evaporate. So, despite the existence of those clauses, the Government’s month to month control over monetary policy goals and instruments is curtailed.
This begs the question what those benefits are. Having established that central bank independence [read curtailment of government control over monetary policy on a month to month basis] is not ‘an illusion’, we still have to remind ourselves why such curtailment is a good thing. A second line of attack adopted by Richard Murphy in some of his media encounters, inconsistent with the first ‘central bank independence doesn’t exist’ strategy, is the line of attack that central banks should simply do what governments want them to (sounds reasonable, put like that, doesn’t it) and if they don’t like it they can go and take a running jump.
The reason curtailment of government month to month control is a good thing is that politicians themselves proved that they could not be trusted to set good monetary policy themselves.
Governments have horizons limited by the electoral cycle, and, in a tight race for re-election, will be unable to resist pressing the economic accelerator to create a boom that they can then take credit for. Only later, after the election, putting on the brakes again. Subjecting the economy to damaging ‘political business cycles’. A related problem with government control is the issue of time-consistency. When it starts out, the government promises low inflation, hoping to be rewarded with muted wage settlements and low bond yields. However, once the advantages of that promises are pocketed, the temptation to renege and generate higher inflation is irresistible, because it will boost employment [by eroding real wages] and lower the real value of government debt.
The way out of this was for the government to make it more costly for itself to change the inflation rate from period to period. Which is just what the complicated legislative infrastructure of monetary policy does.
In a Twitter exchange, responding to my ranting about how PQE erodes central bank independence [why it does this I explained in previous posts], Richard Murphy said ‘you hate democracy, don’t you’. Hopefully if you read this far you can see what my answer to this is: Of course not. But governments acting on behalf of electorates in democracies face time-consistency problems. And have to devise solutions to them to make their electorates better off [in this case by generating low and stable inflation]. The particular solution discussed here [central bank independence] was itself chosen by the electorate, pretty much. Or at least, plenty of time has elapsed for the electorate to have a pop at overturning it.
So defending central bank independence is not anti-democracy. On the contrary, it’s campaigning for a democratically chosen institution. And one that makes the economy in a democracy function better. Perhaps, ultimately, allowing the institution of voting to endure. If you think that sounds overblown, think of the examples of Weimar and Zimbabwe, and wonder if better designed and more resilient institutions might have made the outcomes there more favourable.