Tag Archives: Job Growth

Why not give control of the fiscal deficit to the Bank of England?

In a democratic society, I would argue that decisions regarding interest rates, both long and short term, should be made by the elected government. They used to be. However, for nearly 20 years, short term rates in the UK have been set by the BoE. The level of short term interest rates is important and it can be adjusted to stimulate a slowing economy or slow an overstimulated economy. But there are other adjustments that can be made too.

Just as a pilot has all the control levers at his disposal when he’s flying a plane (if he, or she, does hand over to the co-pilot it would be all the controls not just one) then all the controls need to be either in the hands of government or the hands of the central bank.

But just who has the controls when it comes to controversial policy decisions like QE? Does an  independent Bank of England decide, all on its own, to buy up £375 billion of government securities from the private financial sector? I don’t think so!

QE is no big deal. That’s not a common view, I’ll agree, but from a scientific perspective, there seems to be no reason why the issue of government , or the BoE if you prefer, IOUs in the form of cash should be any more or less inflationary to the economic system than the issue of IOUs in the form of gilts (treasury bonds). If it is necessary to buy back gilts from the private sector to control longer term interest rates then that’s what needs to happen.

So why not give control of the fiscal deficit to the BoE too? The BoE could calculate the best combination of fiscal and monetary policy, including whatever level of QE is needed, and tell the government what it needs to do. Arguably the government could decide to raise income tax a bit here or reduce VAT a bit there , etc, but it would not have complete control of fiscal policy as it now does.

This is not my favoured option BTW. But, if the pilot is going to hand over the (macroeconomic) controls to his or her co-pilot it should be all the controls and not just one.

Never mind the deficit just vote for the recovery!

It’s difficult to know who to back in next month’s UK elections. Europe is a major issue which the most normally sensible parties, or at least the parties who the public normally consider to be the more sensible,  have largely chosen to ignore  in the run up. The events in the eurozone are highly significant, in particular the Greek crisis,  yet those in the most pro-EU parties don’t want to talk about them at all.

There’s next to nothing about it on Labour’s main website, Labourlist, for example.

Funny that!  Those who believe in a united Europe, as many of our more ardent EU advocates clearly do, should feel as strongly about unemployed young people in Spain or poverty in Greece as about hardship in the UK.  Yet, if they ever remember to make a critical comment, it is not because they wish to change anything. The just expired Parliament has seen a complete absence of Labour opposition to any new laws or powers for the EU.

If the UK today had 50% youth unemployment as the south of Euroland currently suffers, Labour would never let us all hear the end of it – and rightly so. If the UK had Greek levels of unemployment, and a Greek cost of living crisis which has depressed average real incomes by almost a quarter since 2007, again we would not hear the end of it, as Labour would rightly think it completely unacceptable. So why is it that these people who believe in pan European solidarity have nothing to say about the scandal of poverty and joblessness in large chunks of Euroland? Why are they not insisting on new policies for the EU?

The situation is far from ideal but it’s probably best to vote for the party who you feel will produce the best recovery. The recovery, when it happens, will fix all deficit problems. Firstly a healthy economy will mean increased taxation revenue. Secondly, if the economy is healthy no-one is going to worry about debts and deficit anyway. The US$ is surging at present as investors buy up $ securities. Are they worried about a $17 trillion (or is it $18 trillion by now?) debt?

I don’t think so. There are those in the USA who can’t make head nor tail of it all and are pushing for a balanced budget. I can’t see them getting anywhere but heaven help us all if they do!

The Half-Life of Money

We understand that money is an IOU of sovereign governments , or the State, as some prefer to say. When governments spend, they create money. When they tax they destroy it. Governments often like to pretend that the ideal state of affairs is to run a surplus, which means they are destroying more money than they are creating. This may be possible for a short time, but it is obviously impossible for governments to destroy more than they create overall. So, to that extent, they always have to be in debt in terms of their currency of issue. That’s the natural state of affairs.

Even if they are not running a surplus, Governments do seem to fret, usually unnecessarily, when a part of what they issue doesn’t come back quickly enough to be destroyed. Politicians are always worried that their deficits are too large. But why do they do silly things like raising taxes and cutting spending to shrink them? They are always surprised when that never seems to work but instead they end up with high levels of unemployment and business failure.

There’s a concept in Physics known as the half-life, which is commonly applied to the decay of radioactive materials. Say there are 1000 atoms of an unstable isotope, to start with, they will decay to 500 atoms after a time and release radioactive emissions in the process. Then, again after the same time, the 500 atoms will decay to 250. Then 125 and so on. The radioactivity is decaying over time, but never quite decays to zero. But mathematically we can say it tends to zero as time progresses. The shorter the half-life the quicker the decay.

This concept can be applied to the way taxes act on every financial transaction, starting when governments first spend their created money. If Income taxes are involved the rates can be very high. Up to 75% in France for example. On the other hand some transactions are tax free, (even in France!) and we have to consider a weighted average tax rate per transaction. If that average is 5% then it will take 14 transactions, per unit of issued currency, before half of it is returned to government and is therefore destroyed. Increase that to 7% and it becomes only 11 transactions. 10% takes 8 transactions, 20% takes just 5 transactions. 30% takes 3 transactions.

Providing the transactions keep occurring, governments will always get the same amount of revenue regardless of the level of taxes, so long as they are finite. Increasing taxes won’t therefore increase revenue in the way that may be initially supposed. Considerations by economists such as Arthur Laffer on what are the optimal level of taxes to maximise revenue can be seen to be unnecessary. Governments shouldn’t want all taxes to be optimised. Other, usually more social,  considerations should apply. For example, cigarettes could be optimally taxed to maximise revenue or they could be highly taxed to discourage smoking. The less than optimal tax which is then raised from sales of cigarettes leaves more money in the economy to enable extra transactions to take place. Those transactions then yield the extra revenue that may appear to have been lost.

So, from a government’s perspective, increasing taxation, and/or reducing spending, should be associated with the need to reduce the amount of financial transactions which occur overall in the economy. If there are too many transactions, the real resources to support them may be insufficient and higher than acceptable levels of inflation will occur. Conversely, reducing taxes, and/or increasing spending, should be associated with the need to increase the number of transactions occurring, so increasing business activity and therefore reducing unemployment levels.

Three Sector Balances Haven’t Gone Unnoticed by the Economic Mainstream

MMT incorporates the concept and emphasises the importance of the sector financial balances model of aggregate demand. It is a simple concept. The public sector, the private sector and foreign sector surpluses/deficits net to zero in any measured time period.

It causes neo-liberal types some problems. They probably do not like the idea of a public sector deficit being a necessary condition for a private sector surplus. They would like to pretend that the public account and private sector can be in strong surplus simultaneously. That’s impossible except for those countries who export much more than they import. So I wouldn’t expect to see three sector graphs offered up for public consumption by the mainstream media any time soon.

They are pretty good indicators of how the share market might perform though so naturally they can’t be totally ignored!


For what it’s worth I would agree that its a good time to buy shares. Watch that black line (the private sector) in the first graph. When it bottoms out, it will be a good time to sell!

If previous experience is anything to go by, the indicators will be completely misinterpreted for popular consumption. The reduced future public sector deficit will be hailed as a great success by various western  governments.  There won’t be any mention that this will mean the private sector will be overstretched. There won’t be any warnings of the next slump to come. The experts will be telling investors not to panic and prophesising soft landings etc.  You’ll know what I mean. You’ve heard it all before!

PS If anyone does really well from this advice I’m not too proud to accept tokens of appreciation!