Brad DeLong has coffee with Stephanie Kelton:
“As of January 1, 2016, enough time will have passed for us to be able to judge whether the Federal Reserve’s policy shift to the Evans rule plus an open-ended $1 trillion a year of balance sheet has been a success or not.
Stephanie Kelton is almost certain it will not be a success. I think it might well work. Mike Woodford is almost certain that it will work. It seems to me that there is an opportunity here for me to lock in a profit of some sort here…
The first stage of this is crafting a bet that Stephanie Kelton would accept for what states of the economy on January 1, 2016 would qualify as success for the Fed, and what states of the economy would qualify as failure. She does expect a better economy in three years–She expects private sector deleveraging to continue at its slow pace And as a result the forces making for balance sheet recession to ebb. Success would, for her, have to count as stronger than expected improvement in the economy given this positive underlying trend.
How should I phrase the bet? And then what bet should I offer Mike Woodford when I run into him by accident in San Diego?
This would be a bet between monetary policy and fiscal policy, between two people who are very smart, co-ordinated by a person who is also very smart. But the bet is a not a smart setup, because all three of them lose by entering into this wager – and we lose too. They would all become less informed by participating in this wager. Everybody is worse off with this wager.
Here is reason #1 Monetary Realism Matters: Monetary Realism recognize both monetary and fiscal policy will work.
We know a few things. We know Monetary Policy can work. We know Fiscal policy works when we let it. So this is a bet between two things that work, two very different policies we know will work if we do them semi-correctly!
So this bet Brad DeLong proposes, it seems like the wrong bet, or a wrongish bet if you can stand the word “wrongish”.
Monetary policy isn’t perfect, but it can work. It’s worked in the past, when it has promoted or destroyed credit. Monetary Policy will probably work if the fed does $1T of QE for a few consecutive years. It will probably work even though it’s primary channel of influence – that’s real estate – seems broken for a generation.
But here is something else - Fiscal policy works, even though some people deny it works.
Here is where fiscal policy can really, really help. Yes, we could use endless years of trillion dollar QE to end the recession – but why when we have another choice the market is begging us to use?
Right now, the market is voting – via the bond market – for massively increased government spending. Negative real yields have been going on for years, so it’s not ablip or accident – we can assume the markets are fairly valued at some negative real yield. If we should trust non-existent NGDP futures to tells us how much QE to use, why can’t we trust one of the largest and most liquid markets on the planet to tell us when to spend more money? Why not use fiscal policy when the market is literally begging us to do use fiscal policy?
A good question is “Do we WANT monetary policy to work in todays economy?” The lending monetary policy helps to stimulate is mostly real estate lending. Real Estate is the channel of monetary policy. If monetary policy works, real estate prices will go up, private credit will increase. Private citizens will leverage their balance sheets further, and we will use more real estate as collateral than we do today.
We want the economic growth that will result from these activities. But do we want to stimulate through credit creation? No, probably not, because Real estate collateral is fairly valued now.
So even if monetary policy wasn’t having such a hard time getting traction due to the market problems in real estate, we wouldn’t want to use it to stimulate our economy! We don’t really want Monetary Policy to work, considering the other true facts about our current economy! Expanding credit would mean real estate would go back into overvalued levels! We would further leverage the private sector.
Cullen Roche likes Richard Koo because he talks about balance sheet recessions, even if Mr. Koo doesn’t get about inflation. Here is a good way to think about monetary policy and balance sheet recessions: Don’t use monetary policy to end a balance sheet recession, because it recreates the conditions for another finance-driven crash.
Here is where the Austrians have a series of good points – the fed can distort the economy by creating too much credit. Making more credit to end the pain caused by too much credit is foolish.
But their cure of reducing credit without any offsetting expansion is worse than the disease. Their plan results in an economy guaranteed to make a significant portion of the population absolutely miserable, and frequently ends up starting shooting wars due to massive unemployment.
This is the kind of thinking that results from not knowing the accounting.
Fiscal policy has limits too. We can’t just spend money forever, without limit, without thinking about the real resources we have available to use. Today, those limits on spending are far beyond our current levels of spending, but that does not mean these limits do not exist. Those limits exist.
Not only do they exist, but there is a point long before we hit the inflation limits where we would no longer want to use fiscal policy to stimulate the economy – even if there was still slack, even if there is still unused capacity. It’s a matter of choice and of balance. We can use also monetary policy to stimulate our economy, because monetary policy works.
Yes, we can make the government spend until we get to full employment – but shouldn’t the private sector be doing some or much of this work when the situation warrants it? Yes – Hell Yes!
Big Reason #3: Monetary Realism Bridges a Gap
There are not many people in the world who are arguing for a reasonable blend of monetary and fiscal policy even when the economy is doing well. There are very few people even thinking about this idea.
In fact, some of the brightest people out there are engaging in wagers where we all end up losing. If Michael Woodford “wins”, yay! We get started on another housing bubble! Great news, right? If Stephanie Kelton wins Yay! We’ve been in a semi-recession for 3 years!
This is why I write for MR, why I spend time on it. We’re doing real work here. We need a pragmatic approach to our world.
This Central Treasury Bank structure has some important abilities:
“The entire liability structure of the CTRB is now intra-convertible, in terms of the fluidity with which reserves, currency, bills, and bonds can be issued or redeemed according to a fused and seamless fiscal and monetary machine.”
A fused and seamless fiscal and monetary machine requires a fused and seamless fiscal and monetary policy regime. Here is something to note about todays world - we require fused and seamless fiscal and monetary policy regime today, right now.
We are bridging the gap, slowly but surely here at MR. I made the Strong Economy Rule (aka the TC Rule), and beo has proposed a series of fiscal rules to help guide our fiscal policy. These are not enough – we need a more seamless policy guide than these rules.