Functional finance and fiscal rules – a synthesis (Part II)


A curious argument has broken out over the Labour’s proposed fiscal rule. Some advocates of functional finance, in particular, have been vociferous in their criticisms. There is scope for a considered and respectful debate, despite an inauspicious start. As I suggested in Part I, I think there is some sensible common ground between the two perspectives, and also some nuance which has been omitted so far. This second part is an attempt at synthesis and clarification.

Labour has announced what looks like a very sensible and flexible fiscal rule – and this should not surprise us. The rule has been devised in consultation with two of the country’s leading macroeconomists – Simon Wren-Lewis and Jonathan Portes – who have done decades of serious research on the subject. Much of the criticism they have received seems to reflect ignorance of their track record and the depth of their research. Google ‘Simon Wren-Lewis and fiscal rules’ and you’ll see how much reading is needed to get up to speed. At a minimum, read this.

Wren-Lewis and Portes are among the country’s pre-eminent public voices of reason from academia on fiscal policy, monetary policy, Brexit, and a great deal more. For example, no one to my knowledge has more incisively criticised unintended bias in the media and austerity. Wren-Lewis’s reputation rests on reasonableness, relentless appeal to empirical evidence, decency in exchange, a sense of public duty, deep rigour, and a lifetime’s work dedicated to macroeconomics. Shouting him down lessens our democratic process.

Both Wren-Lewis and Portes have been relentlessly consistent and rational, in their criticism of Britain’s post-crisis fiscal policy, and in their analysis of Brexit. And although they have advised the Labour Party, there is nothing I read in their work that needs to be seen as partisan. They are both resolutely empirical.

So what is this (in)famous fiscal rule and what is the nature of the criticism it has received? Deriving a relatively clear and simple rule for fiscal policy does not imply simplistic analysis. For full context on the depth of understanding on the complexity and difficulties this paper by Wren-Lewis and Portes is a good starting point.

Based on their extensive work, Wren-Lewis and Portes, together with the shadow treasury team, conclude that the government should balance current expenditure over rolling five year periods, with a knock-out operating at the lower bound on interest rates. The government should also aim to target a reduction in the ratio of public sector debt to trend GDP over the life of parliament.

This looks very reasonable – and clear. It is totally at odds with austerity in the face of a deflationary recession, because it advocates suspending the rule at the zero interest rate bound, and it permits borrowing for capital expenditure, because the rolling balance is only for current expenditure. It also imposes a constraint on public capex, because there is a long-term target for the ratio of net debt to trend GDP.

As the authors would be first to admit, none of these principles are cast in stone. An ‘optimal’ fiscal policy could diverge for a host of reasons. But the bar is not set at ‘optimal’ – we need something reasonable, flexible, explainable to the public, and something that can be used to hold the government to account.

Some caveats

Before returning to the specifics of the rule – there are some caveats. Institutional reforms, which I would advocate, may well render aspects of the rule redundant. There are two important ways in which our current macro-policy institutional framework needs reform. First, we clearly need to reduce central banks reliance on interest rates to manage demand. Simon Wren-Lewis, Mark Blyth, and I, argue in The Guardian, that the Bank of England should be given the power to make equal transfers to all households if needed to meet their inflation target. In addition, I would set up an independent capital expenditure commission to plan major 10-year public sector capital expenditure, and an independent sovereign wealth fund to create broader equity ownership (as outlined here with Mark Blyth, and here with Tristan Hanson). I would make borrowing to fund asset purchases and capital expenditure independent of the fiscal rule. Public sector capex should be determined by the available return on capital and its cost. The only difference between the calculus of the public and private sector in this regard is that the ‘return’ on public capex should incorporate externalities (as the private sector does in ‘impact’ and ‘social’ investing). If the return on investment exceeds the cost of capital it *always* makes sense, because it also improves debt sustainability. The main challenge is one of political economy, so the assessment of value created must be independent of the political business cycle and the vote-buying incentives of the political class. The balance sheet implications for the state of the sovereign wealth fund are described in detail here.

A cash-transfering central bank, a sovereign wealth fund to increase equity ownership, and an independent public capital expenditure commission, are long-overdue institutional innovations which tackle our major macro problems. This is the making of a credible radical agenda – far more interesting than a naive return to 1970s, or a ‘run deficits until there’s an inflation problem’ approach to fiscal policy..

None of these caveats is inherently inconsistent with the core of Labour’s fiscal rule, of course. Balancing rolling five-year current balances would remain very relevant. The knock-out should stay in place if the Bank of England needs help, although I suspect that a cash transfer-empowered BoE would not. This is another reason to empower it. If an effective BoE succeeds in reducing the frequency and severity of recessions, it will be transparently clear if the government is meeting its rolling five-year target of balance.

The ratio of public sector debt to trend GDP becomes less significant in this context because it will be determined by positive or negative trend growth shocks and the perceived return on public sector capex, and the cost of finance. Importantly for those who rightly reflect on the fact that fiscal targets imply private sector targets of the opposite sign, the reverse is also true – if the private sector sees huge investment opportunity at full employment and this drives up real interest rates, public sector investment will be lower than is otherwise the case due to a higher cost of capital. It is conceivable that a capital expenditure commission would recommend periodic shifts in the debt to trend GDP ratio, if deemed beneficial.

Ok, so I have outlined some institutional reforms which I think need to be on the table, which render some aspects of the Labour’s fiscal rule less likely to be relevant. The only substantive change would be to allow for variance in the debt/GDP ratio subject to the decisions of the capital expenditure commission. And serious innovations in the BoE’s tool box might render the ‘knock-out’ redundant.


So what are the more heated objections to Labour’s proposed fiscal rule? I think they come in two forms. One proposes an alternative rule – without calling it such – which is that fiscal policy should target inflation. Let’s call this ‘hard’ MMT in heterodox land, or The Fiscal Theory of the Price Level in hyper-orthodox land. One of the deep ironies in this debate is that the reasoning of some members of MMT is virtually identical to that of extreme orthodoxy – such as Chris Sims and John Cochrane. Both argue that inflation is always and everywhere a fiscal phenomenon (incorrectly, as it happens – yes, Friedman was fundamentally right, and monetary policy is distinct from fiscal policy). The other objection holds that targeting a public sector deficit is impossible – because a change in public sector behaviour has opposite consequences for the private sector. This follows from simple national income identities – if the public sector targets a surplus, the private sector, or balance of payments must go in to deficit. If the public sector mends the roof when the sun in shining, the rest of the economy burns it down! Let’s call this ‘soft’ MMT in heterodox land, in hyper-orthodox land, the closest analogue is Ricardian equivalence. Both are really attempts to understand fiscal policy targets in ‘general equilibrium’, or perhaps more accurately, at an holistic system level. This is entirely reasonable – even if the conclusions of Barro have the wrong sign (fiscal stimulus in a recession is likely to reduce the probability of higher future taxes), and ‘identity-defeatism’ appears empirically false – governments can hit fiscal targets and can have good reasons to.

Should fiscal policy target inflation?

Let’s consider ‘hard’ MMT – should fiscal policy target stable inflation or full employment, which some advocates appears to argue. Or to put it less forcefully, should the government run a deficit as large as it can until inflation starts rising, at which point it should tighten fiscal policy, which seems very close to what Stephanie is advocating?

We need to step back to unpick this. For a government which has the power to print money the fundamental constraint on fiscal policy is inflation. Stephanie Kelton, Simon Wren-Lewis and I agree on this. So when the threat is deflation, worrying about budget deficits makes little sense (let’s caveat the Eurozone, to which I will return). This may seem obvious – and it should do: if the government can finance itself by printing money, the only risk with state money-printing is inflation. So if there is deflation, a money-printing state has an unconstrained check book.

As Simon has pointed out, this is obvious, although he also acknowledges it has been periodically obscured in the debate, perhaps for political ends. Despite the self-evidence of this line of reasoning, many governments decided or were advised to tighten fiscal policy after the financial crisis despite the fact that deflation was a real and present danger. Nonsense about ‘household budgets’ and balancing the books was trotted out – arguably destroying the Liberal Democrats in the process. Households don’t have printing presses, and individual household’s budget decisions do not affect aggregate demand, employment and output. The government is simply not a household.

This set of observances seems very robust. But there are some very important nuances and less clear implications. Firstly, these statements are institutionally contingent. For example, in the Eurozone, national governments – as a matter of law – cannot print money. So this reasoning does not apply. In fact, we can not determine ex ante what a Eurozone government should do faced with deflation – although it is crystal clear what the ECB is mandated to do by law.

Also, although the Eurozone is institutionally unique, and renders many of MMT’s policy prescriptions redundant to this jurisdiction, as astute economists including Stephanie have shown, it is only at the extreme of a spectrum. The reality of political economy is that the population across the developed world does not trust its elected politicians with the printing press. Denial of this fact seems to run through a lot of MMT commentary and analysis I read. Central Banks are not independent across the developed world as a result of a quixotic hijacking of power by a spock-like subset of the technocracy. They are independent due to a democratic revolt against the abuse of the printing press by the political class. History suggests that democratic process is reinforced by an independent judiciary, an independent public service, and independent central banks. All, of course, are subject to law approved by legitimate legislatures. My objection to the Troika – one of the worst cases of institutional failure in the developed world in the last twenty years – is not ‘technocracy’, but illegality and dishonesty with catastrophic consequences.

Also, observing that inflation is a constraint on fiscal policy, does not give guidance on the right policy – it only tells you that people are talking nonsense when they say that policy *needs* to be tightened during deflation. If independent central banks are signalling a deflationary risk and hoovering up government bonds, a contraction in fiscal policy is a form of self-harm. But this in no way suggests that fiscal policy should either target full employment or stable inflation as seems to be suggested here, nor should it simply be eased until there is inflation, as suggested here. In fact, as I make clear below, reformed monetary institutions are likely to be far more effective at meeting these objectives.

Ok, so accepting that the obvious theoretical constraint on fiscal policy is inflation, is of limited use. Yes, it tells us that a combination austerity with QE is snake oil, but this neither amounts to a workable set of principles for fiscal policy, nor an answer to the policy dilemma of how to square a need to protect the printing press from politicians and make monetary policy fit for purpose.

The two major macro-policy issues which need to be addressed are: 1) how do we manage aggregate demand through the cycle, and 2) what do we do when faced with a major negative shock? The right policy when faced with a deflationary threat is in fact very complex and needs a lot more rigorous debate, which is oddly not really occurring. Changing targets for central banks is a complete distraction, as is handing these targets over to the fiscal authorities. The serious proposals on the table are Bernanke’s off-budget helicopter drop, cash transfers to households – or direct support for consumption as the Czech central bank has described it – or the Wren-Lewis/Portes proposal for a knock-out, where the fiscal authorities are called in by the central bank (in their suggestion, at the zero bound, but it could be earlier, in principle). These are serious institutional reforms which tackle monetary policy failure without compromising the democratic principles of central bank independence.

Who is responsible for inflation and managing aggregate spending?

In order to navigate these two questions, the first consideration is to understand the relative merits of monetary and fiscal policy – something I have discussed at length here and Simon Wren-Lewis has discussed here. The democratic legitimacy of decisions-makers, which I will return to, should be considered independently of the efficacy of policy.

The options available for counter-cyclical demand-management (or full employment or inflation-targeting, if you prefer) are: 1) fiscal policy only, 2) monetary policy only, 3) a combination of both, 4) reformed monetary and/or fiscal policy.

In my opinion (4) is clearly the best option, and it has received insufficient attention in public debate, despite the collective trauma of one of the most severe recessions in the post-War era. Counter-cycle fiscal policy needs reform of process, monetary policy needs reform of powers. What do I mean by this? Start by considering the pros and cons of monetary and fiscal policy, as counter-cyclical tools:

Fiscal policy. Pros: directly affects income and spending. Cons: gets hijacked by party politics, doesn’t take effect quickly or occur in a timely manner. Put bluntly: if one party is pro-deficits and the other anti- the severity of the recession will depend arbitrarily on which is in power. Consensus around inflation-targeting, given this alternative, is a godsend – whatever about its considerable limitations.

Monetary policy: Pros: Very timely, avoids party-political bickering and logjams in execution. Cons: only works – if it works at all – indirectly, by altering asset prices and/or leverage. Can be financially destabilising.

This quick inventory of the relative merits of fiscal and monetary policy points immediately to the areas in need of reform. If fiscal policy is to be helpful cyclically it needs to be set up so as to be implemented rapidly. In a sense, this is why the greatest counter-cyclical fiscal effects are the so-called ‘automatic stabilisers’. Perhaps there should be no changes in fiscal policy designed to balance over rolling five year periods, and the budget deficit/surplus would simply be caused by cyclical changes in revenue.

As regards monetary policy, the key area in need of reform is clearly the tools available to the central bank. Monetary policy would be optimal if it could change incomes directly. Intriguingly, Lars Svensson says as much (slide 10). And the Czech central bank has now outlined how to do this. So monetary reform is obvious – mandate central banks the power to target household income and spending directly. Arguably, the ECB already has this power – the European public should make clear that it expects it to be used.

The second question concerns the legitimacy of macro-economic policy-making. This area has become terribly confused. Just because a decision is made by public servant, and not an “elected” politician, does not render it illegitimate. Relatively well-functioning democracies have recognised: 1) There should be checks and balances on political power, we don’t want politicians, the executive, independent state agencies, the legislature, the judiciary, the army, the police, and the media – the essential institutions of democracy – to have too much power. All are subject to scrutiny and checks and balances; 2) We distribute power using diverse processes – we use majoritarian voting processes for the main legislative body, and a variety of non-electoral and electoral methods for other institutions and certain constitutional legal structures.

It follows that one cannot simply dismiss the actions of central banks as ‘undemocratic’ because they are ‘unelected’. Our laws are almost entirely implemented by unelected public servants. What matters are the legitimacy of the rules, mandates, and effective public scrutiny. Democratic process requires permanent vigilance.

For example, the ECB has been given a legal mandate to deliver price stability. This was granted by democratically-elected representatives of member states, which voluntarily joined the Euro. In order to fulfil this mandate, it has clearly defined monetary power – which includes, by the way, a monetary bazooka. It should be scrutinised. If it acts in breach of this mandate, it should be reprimanded through the courts.

Similarly, it would be entirely legitimate for the Bank of England to be granted the power by parliament to make cash transfers to households. Parliament should specify the rule.

In summary, democratic process can result in varying mixes of monetary and fiscal counter-cyclical policies, even if we all agree on how economies work. Different institutional arrangements are also likely to prevail in different jurisdictions. And ‘legitimacy’ is complex. Dismissing public servants as ‘unelected technocrats’ is trite.

My preference is to give more effective tools to central banks outside the Eurozone, as outlined above, and within the Eurozone to enforce and debate the law. The law is far more radical than realised. I do not think it is realistic to expect fiscal policy to ‘work’ for the well-rehearsed reasons outlined above. To a significant extent, central banks were given independence because finance ministries or treasuries were no longer trusted by the public to act in their interests. If reliance on fiscal policy is to increase, the emphasis should probably be on some form of automatic stabilisers that have cross-party support – otherwise our vulnerability to recession will vary once again with the political cycle.

Fiscal rules and accounting identities – inconsistency or choice?

Having a fiscal rule is also not inconsistent with the logic of sectoral accounting identities,- although thinking about these interrelationships reveals the inevitable complexity and why it is important to incorporate flexibility in the rule. The essential point here is that any sector of the economy’s spending is another sector’s income, so if any sector runs a surplus – spending less than it receives – another must run a deficit. In an open economy, if the private sector and public sector both run surpluses, as in Italy, the rest of the world runs a deficit. By this logic, I have argued that George Osborne’s catch-phrase that one should ‘fix the roof when the sun is shining’ implies that the private sector should simultaneously burn its roof down. Indeed after a financial crisis when the private sector is both mentally-scarred and attempting to repair its balance sheet – which neuters monetary policy – there is absolutely a case for running more persistent deficits.

Does this logic present an insurmountable problem for a fiscal rule? There are two points here. I have seen it argued that it is simply not possible for the government to hit its target because of changes in other balances. If a target is flexible, this hardline seems implausible, although in very unusual cases such as Japan, persistent and extreme savings behaviour by the private sector could make it very hard to meet even a very flexible rule – although the Japanese ‘debt problem’ now looks like an accounting error. Also, the knock-out option of the Wren-Lewis/Portes rule is really a permanent opt-out in Japan’s case.

The more fundamental point, I think, is that suggesting that Labour’s rule is somehow setting a fiscal objective independently of what the private sector is doing is disingenuous. In essence Labour’s rule is likely to be doing a version of responding to private sector behaviour. It is likely to be running surpluses, or smaller deficits, when the private sector is cyclically ‘optimistic’. Any ‘through the cycle’ rule, implicitly assumes behaviourally-driven cyclical attitudes by the private sector towards risk. Offsetting this optimism with public sector ‘saving’ seems wise.

The real question is whether running a surplus or reducing a deficit when the economy is growing above trend is destabilising in any way? If we believe that real interest rate structures are dangerous low -either for reasons of monetary policy efficacy, or financial stability – there is obviously a case for running looser fiscal policy to raise prevailing real interest rates, even during a phase of above trend growth. That is the intelligent defence of Trump’s deficit, which Stephanie side-steps, and Krugman and Summers ignore due to partisanship. Advocates of secular stagnation (I’m not), haven’t a leg to stand on objecting to Trump’s deficit – they can obviously dispute its composition, but that’s a totally separate argument). Stephanie Kelton is at least consistent on this point. She wants everyone to run a deficit.

Put more bluntly, could a fiscal rule reinforce the pro-cyclicality of private sector balance sheet dynamics? This is possible, but I suspect second order. Also, the emerging consensus that prudential regulations are the best means to target financial sector leverage – the most pernicious form of cyclical risk – seems right.

All of these considerations amount to viewing fiscal policy in ‘general’ rather than ‘partial’ equilibrium, which opens a large set of complexities. Indeed, the reality is extremely complex and the inter-relationships will change. We can add further complexity if we break the assumption of standard fiscal sustainability equations, that r (real interest rates) and g (real growth) are variables independent of policy – which they are not. What if fiscal stimulus affects trend g, and how should one respond to independent changes in r?

We must also distinguish between stocks of assets and liabilities and deficits and surpluses, something Wren-Lewis and Portes discuss but others typically ignore. We tend to simply assume that liabilities are the sum of deficits. But they aren’t. I have a major problem with the treatment of base money as a liability and conclude that stock of net debt in the UK is far lower than measured. In addition, the properties of government bonds are not static and private sector demand for them can shift dramatically for reasons completely independent of fiscal policy – such as regulatory shifts in demand for bonds by the financial sector and changes in correlations with other assets. John McDonnell’s point about the dollar as a ‘reserve currency’ is pertinent – I would not focus on its ‘reserve currency’ status, but I would acknowledge that Treasuries have very specific correlation properties, which make them act as safety assets. The huge change in the cyclical risk properties of government bonds, as a result of the elimination of inflation risk, could be exploited to great effect by an enlightened radical reforming government.

It is extremely important to remember that the risk properties of government bonds, actually hangs on assumed price stability, which is almost certainly a result of deregulated product and labour markets, and independent central banks. One of the ironies of some MMT arguments is that re-regulating labour and product markets would entirely neuter the role of counter-cyclical fiscal policy. The entire discussion about what markets will do is actually premised on whether or not markets perceive there to be inflation risk. Markets currently believe in price stability, largely because the evidence suggests – in the developed world – that whatever central banks do, inflation barely moves. This has provided the state with huge counter-cyclical policy powers. In heavily-regulated, ‘1970s’, economies there is no role for counter-cyclical fiscal policy – this is the risk-based definition of an emerging market.

All of these points merely suggest that reality is more complex than fiscal sustainability equations tend to assume, and that no fiscal rule will be perfect, or cover all eventualities. But that is not a reason to have no rule. It is a reason for flexibility and wisdom in the rule one adopts – criteria which labour’s rule meets. The alternative being proposed – that the fiscal authorities target full employment or inflation stability (and monetary policy does what?) seems to ignore all the evidence on institutional bias and failure, not to mention the democratic mandate for varying degrees of central bank independence. Give the monetary authorities the right tools, and legislate clearly on their mandate, and it becomes very clear that recessions can be either avoided or brief. Effective full employment – such as prevails now across much of the devloped world- combined with price stability, is demonstrably possible, but it likely depends upon competitive product and labour markets, and a legacy of sustained low inflation. Threatening any of these pillars would be ill-advised.

A synthesis and conclusion: rules help

It is worth reminding ourselves why we need a fiscal rule. Politicians are not trusted to always act in the interests of the public. At least one reason for the current global electoral revolt against mainstream politicians reflects the opposite belief – that our elected representatives are too often in it for themselves, or those connected to them. There is a long history of governments abusing the power of fiat money-printing, the result of which has been decades of institutional reform, including a global trend towards independent central banks. It should go without saying that ‘independence’ does not mean ‘illegitimate’. An independent judiciary underwrites democracy. To conflate independence with illegitimacy is to abandon thought. The laws governing independent central banks should be set by democratically legitimate legislatures, and their work requires constant scrutiny, and periodically evolving mandates.

Recognising that there is no constraint on fiscal policy when there is a threat of deflation – for example during a financial crisis and its aftermath – is in no way inconsistent with Labour’s fiscal rule. Beyond this, the truism that inflation is the ultimate constraint on the spending of a money-printing state, does not really help us much with designing a fiscal framework.

Wren-Lewis and Portes, perceptively quote Coen Teulings – director of the Dutch fiscal council – who observes that the absence of the equivalent of a Taylor rule left governments at sea when it came to fiscal policy after the financial crisis. This is very important. Pre-agreed rules give the public a relatively clear way of assessing what the government can do, and a highly flexible pre-agreed rule such as that proposed by Labour would also give them the confidence to be brave faced with another cyclical calamity.

So is Labour’s rule fit for purpose? As I have hopefully shown, an ‘optimal’ fiscal rule is extremely difficult to design. So the criterion cannot be perfection. Yes, there are lots of problems with any rule, and sets of circumstances where they will not be ideal. The real test is not perfection, but an assessment relative to the alternatives. On this basis, Labour’s rule definitively looks the best on offer.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

16 Responses

  1. Derek

    What I find difficult to understand with this analysis and many others on the left side of the spectrum is why there is a reluctance to address root causes and propose curative treatments rather than the patch-work palliative measures constantly being proposed. If you are truly looking for a radical policy platform, then why not put forward prescriptions that will address the foundational factors that are known causes of these economic downturns?

    As example, at this point we can comfortably observe that Debt Deflationary Cycles are fundamentally caused by non-indexed nominal liabilities. Fischer recognized in 1933 that the inefficiency of bankruptcy and credit restructuring – in particular of unsecured claims – was the fuel that drove the cycle and necessitated large reflationary efforts to stall it. Rather than squabble about the most effective reflationary mechanisms, we should at least first establish a set of policies that would eliminate this contagion to begin with! Whether or not we ultimately determine these to be politically infeasible, it is crucial for overall credibility that they be adequately parsed and explored. The most obvious such policy would be bankruptcy reform – again, in particular for unsecured claims.

    The best example of this is the Chrysler bankruptcy process in 2009, wherein Chrysler jettisoned much of its existing secured and unsecured debt and promoted its workers’ pension fund into a super-seniority position that took a control stake in the equity post exit. The entire process took 46 days. The relative speed and efficiency of the process preserved enormous value for both Chrysler as a going concern and its proximate industrial partners. It was also effectively done by executive fiat, which is not an ideal policy prescription. If we take the lessons from Chrysler and build a set of policy reforms that would make debt restructuring more efficient (and automatic), then we will have removed the catalyst for Debt Deflation at its source, and the need for these reflationary debates would be redundant.

    (I’ll just add that the other chief fuel for Debt Deflation has always been sticky nominal wages. It’s unclear whether wages are truly sticky or whether this is simply a byproduct of non-indexed nominal liabilities – workers won’t take wage cuts without reductions in their mortgage and car payments. If, however, wages persist at elevated nominal rates, then there are ample prescriptions to nudge nominal wages lower that do not have the blunt trauma of helicopter money.)

    • Eric Lonergan

      Derek, I actually think we have tackled many of the causes, through heavier regulation of the banks and price stability. Most of the measures I am recommending are insurance policies. I actually don’t see recession any time soon. But could be wrong!

  2. Derek Henry


    A very thoughful piece. Very fair and considerate and covers all bases.

    Do you know of any economist that has actually used the recent financial crash, as a barometer to determine which is the most efficent automatic stabiliser. Between the auto stabilisers in place today and that of a job guarentee ?

    If there are any could you please point me in the right direction.

    I think about it all the time – the what if question – it drives me nuts.

    What If a job guarentee was up and running for a few years and was in place in 2003. How would the job guarentee performance as an automatic stabiliser compare with the performance of the automatic stabilisers in 2007 when the crises hit ?

    Would the JG have performed better or the auto stabilisers ?

    Which one would have been more efficent ? When I use the word efficent I mean in which one would be more efficent in human terms.

    I would love to see a comparison using real data, before I go crazy thinking about it. That show the real costs and benefits to human lives. Human lives both in the private and public sectors so a total number of humans.

    For example using the auto stabilisers we have now when the crash hit

    How many humans were left unemployed

    How many humans lost their homes

    How many humans were left underemployed

    How many humans had to leave their friends and families to find work

    How many humans ended up on opitates

    How many humans got divorced

    How many humans ended up in jail

    How many humans will never work again

    How did it effect children.

    And so on and so on. Has any economist put a set of numbers against these humans and stepped away from the math and assumptions to look at it ?

    Then using the job guarentee as an automatic stabiliser when the crash hit

    How many humans were left unemployed

    How many humans lost their homes

    How many humans were left underemployed

    How many humans had to leave their friends and families to find work

    How many humans ended up on opitates

    How many humans got divorced

    How many humans ended up in jail

    How many humans will never work again

    How did it effect children.

    And so on and so on.

    Eric, there must be an economist out there that must want to produce these figures and the use the recent crash to find out which would have been the more effective auto stabiliser ?

    For me, it is just as an important question if not more than “if we increase the budget deficit by X will it cause inflation. ” The recent financial crash gives us the oppertunity to put numbers beside these humans and figure it out.

    I also think when Pavlina Tcherneva says the time to introduce a JG is now when the sun is shining. Introducing a JG when it rains is too late, is correct. Please correct me if I’m wrong, but these changes don’t seem to change any of that. The changes above feels and looks like a JG implemented when it is raining. The horse has already bolted and using the automatic stabilisers we already have will produce the same results.

    Again please correct me if I am wrong. It also looks like the changes above do not seem to change the fact that monetary policy will still be used to use a pool of unemployed to fight inflation.

  3. Jeff Powell


    Thank you for this and the previous very thoughtful and insightful contributions to this debate. I have learned a great deal.

    I want to take you up on one point however. I fear that in (rightly) critiquing one characterisation of the central bank independence debate, you are taking up another: “They are independent due to a democratic revolt against the abuse of the printing press by the political class.” I would argue that economists need to learn from political economy / political science / sociology in developing a more complex understanding of the many elements and vectors of independence. If you haven’t already, I would recommend (as only a few examples of what is a large, fascinating literature):

    Bibow, J., 2009. On the origin and rise of central bank independence in West Germany. The European Journal of the History of Economic Thought 16, 155–190.

    Bonefeld, W., Burnham, P., 1998. The Politics of Counter Inflationary Credibility in Britain, 1990-94. Review of Radical Political Economics 30, 32–52.

    Forder, J., 2004. Central bank independence: Economic theory, evidence and political legitimacy, in: Arestis, P., Sawyer, M. (Eds.), The Rise of the Market: Critical Essays on the Political Economy of Neo-Liberalism. Edward Elgar, Cheltenham.

    Lepers, E., 2018. The Neutrality Illusion: Biased Economics, Biased Training, and Biased Monetary Policy. Testing the Role of Ideology on FOMC Voting Behaviour. New Political Economy 23, 105–127.

    Mudge, S.L., Vauchez, A., 2018. Too Embedded to Fail: The ECB and the Necessity of Calculating Europe. Historical Social Research 43.

    • Eric Lonergan

      Thanks for those link! I’m with you. Very complex. Also, although I am an economist by training and profession, my specialisation was in fact moral philsophy and political theory. Some economists are poor on issue of political philosophy – but so are many of the commentators!

  4. Jerry Brown

    Once you accept the idea that the ‘economic’ constraints on the spending for a currency issuing government are the availability of real resources and the potential for inflation, then it is fair to question why you would advocate a ‘rule’ that really can only serve to limit that spending in certain situations (even if only rarely). Which kind of calls into question one’s confidence in the advisability of democracy, or at least the extent to which a government actually reflects the will of the people it represents. I think that is one of Bill Mitchell’s criticisms of the fiscal rule. Not that I can speak for him.

    Another is that by advocating a ‘rule’ you set yourself up for negative political consequences should you end up having to break that rule. So why expose yourself to that possibility if you don’t need to.

    And another is that by making the rule and advocating it in the first place, you are sort of reinforcing the mistaken idea that the currency issuing government faces spending constraints similar to a household or private business. Which is contrary if one’s goal is to educate and explain how the economy works. I mean it is contrary to the acceptance of the idea stated in my first sentence.

  5. MigT

    Great post – thx.

    Whatever the intent of the fiscal rule, it will likely have one very *un*progressive effect : It will reinforce the popular perception that the economy is just a big household with a household budget. And well-meaning people will vote Tory.

  6. JKH

    Why shouldn’t such a fiscal rule be implemented by Treasury?

    Is your objection the implicit bond financing requirement that goes with it?

    If this is the core issue, it might help to be more distinct regarding the characteristic of timely implementation of the rule versus the financing mode for it. Because I think these are quite separable characteristics, where the timing can be designed as institution-independent.

    E.g. I see no distinction between timeliness of central bank balance sheet mechanics versus Treasury balance sheet mechanics, provided the rule is established such that the timing is impervious to that choice.

    So your substantive issue seems to be a recommendation to use the central bank balance sheet in such a way as to avoid bond issuance.

    Do I have that right?

    • Eric Lonergan

      JKH, I think we’re in agreement. My only point about timeliness is that fiscal authorities never seem to act in a timely fashion. It is of course the case that the first sign of slowdown, they could send out checks. But there is no consensus and structure where they do this. The most timely measures are their automatic stabilisers. Of course, if a cross-party consensus emerges that the Treasury should do this, that would be great.

  7. Danny

    Very brief question, is it desirable or even feasible for a country with a persistent current account deficit to attempt to build a sovereign wealth fund?

  8. Matt Usselmann

    I would still think a functional finance discussion must include a job guarantee. Why not?

    The most effective demand management policy is the introduction of a job guarantee.

    Each £100 spent on job guarantee will lead to additional GDP of £140 to £200 (estimated).

    Each £100 spent on helicopter money will lead to additional GDP of £33. (Most of the additional money going to richer people who do not need it.)

    It is hard to set up, but surely a vote winner – further thoughts here:

    Let’s take Eric’s three proposals in turn, which he suggests should be considered by

    Labour to enhance its fiscal policy and its self-imposed fiscal rule.

    1. Bank of England (BoE) monetary transfers to households

    Eric has suggested that in case of a severe recession the Bank of England should transfer a sum equivalent of 3% of GDP in equal amounts to households, which should encourage them to spend. Eric estimates that an increase of 1% of GDP would result from that “helicopter drop”.

    So 3% of GDP works out at about £63bn, or about £1,000 per person in the UK. The additional one off growth would be about £21bn (1% of GDP), as not everybody would spend the extra cash.

    We should remember that at the height of the last recession annual GDP shrank by over 4%, so even with a successful BoE transfer it would have shrunk by 3%.
    (Incidently, something like that was thought about at the Treasury around 2009, but as there was no system in place it to pay this money out, it was decided to reduce VAT rates instead.)

    2. An independent capital expenditure commission

    A National Infrastructure Commission already exists. It would make sense for it to oversee a expanded range of projects and plan according to different projected growth rates. So a good idea.

    3. Independent Sovereign Wealth Fund

    My view on that would be that the UK does not really need one. For the UK government the whole of the UK economy and assets are its wealth and it can tax and transfer as it sees fit. Unlike oil states which have national wealth funds, the UK runs a current account deficit, so no need to invest abroad. And it would not help in a recession.

    Now what about a Job guarantee?

    No plans for a comprehensive UK job guarantee seem to exist, only a US version which is very, very ambitious – considering the total US labour market is about 150 million jobs.

    “… a generous JG program that employs between 11–16 million people at $15 per hour plus benefits will result in a net expenditure of 0.8 percent to 2 percent of GDP (Fullwiler forthcoming). These estimates include expected reductions in spending on other programs such as UI, Medicaid, and earned income tax credits (EITC).” (From Pavlina Tcherneva’s job guarantee FAQ)

    And it would increase US GDP by “$313 billion to $560 billion a year”, so that is about 1.6% to 2.8%.

    • Eric Lonergan

      HI Matt – thanks for the detailed thoughts and questions. I really dont see the JG and direct consumption support as comparable in function or effect. If you look at the pros and cons of fiscal policy I outlined in the post and also the link, a JG absolutely has the cons. Consumption support has the pros of fiscal pol and mon pol. If a system is set up in place (to you point about the Treasury considering this – they should legislate to make sure the bank has a system in place!), cash could literally arrive in household accounts tomorrow. Just like it effectively does when base rates are cut for those with variable rate mortgages. A rapid large set of transfers could stabilise demand almost immediately. You might want to look at the many previous posts I have done on this. I dont find the multiplier-based arguments compelling at all. Where I agree with Stephanie Kelton is that in these conditions there is no budget constraint. The speed and impact of consumption support is a huge advantage over all the alternatives (interest rates, job schemes, tax cuts, infrastructure), because if done quickly and powerfully it would actually prevent a significant increase in unemployment in the first place. Also, if arrange subject to existing CB mandates, there is no risk associated with what type of government is in power.


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