The recent exchange on the nature of banking among Paul Krugman, Scott Fullwiler, Steve Keen and others has been feisty and instructive. But some readers might be left wondering whether the whole exercise is too wonky by half. The anatomical details of banking systems might be juicy and interesting for the academics who like to dissect those systems and dig deep into their entrails. But how significant are the details for practical questions of public policy? They are in fact very significant.
The functional details of institutions matter, and without understanding how the banking system actually works it is impossible to distinguish causes from effects in our attempts to guide that system toward the service of the public good. Conventional textbook models of banking and monetary systems are responsible for widespread commitment to the money multiplier and loanable funds models of the relationship between central bank reserves and the volume of bank lending. Relying on these models, some prominent economists and pundits have been telling us throughout our recent economic crisis that we can address the problems of a stagnating economy and persistently high unemployment with the reserve management tools of monetary policy alone.
Even worse, some monetary policy hyper-enthusiasts seem to view the Fed has having vast powers to manage the nationâs overall spending level and adjust the nationâs money supply up and down though mysterious and occult mechanisms that extend well beyond the grubby plumbing of the credit system. The Wizard of Fed, it seems, can control the economic minds of Americans though imperious pronouncements on his expectations for the future. Hundreds of millions of Americans, one is led to believe, pay close attention to the Beloved Leader and await his determinative dicta, and then adjust their own behavior accordingly. LâĂtat, câest Ben. The nationâs central banker is the glass of financial fashion and the caller of the economic tune.
Incongruously, this picture of an America enthralled under a slavish devotion to the oracular sayings of Chairman Ben is often brought forth as an instance of the ârational expectationsâ approach in economics. Allegedly, the lemming-like congruence of expectations precipitates its own self-generating rationality. Since we all know that we have all tacitly agreed to enslave ourselves to the nationâs central banker, when we then proceed to conform to the general goose-stepping we are behaving quite rationally.
Now I ask you: speak to several of your neighbors tonight and ask them who Ben Bernanke is and what he does, and then consider whether this precious conceit of the court theorists of the financierati has the slightest grounding in empirical reality. I have no doubt that this picture describes the attitudes of some relatively small number people. My guess is that most of the people in question watch CNBC and Bloomberg all day, and manically shuffle their money hither and thither in the asset markets as the tipsters tip and the news items roll in. But down on Main Street where the real economy lives, and where people are too busy working all day â or at least trying to get work â to spend time playing games in the markets? Does the average citizenâs step either quicken or slacken to the cadences called by the Fed chairman? Does the average consumer go to the store looking for a washing machine or an iPad on the Fedâs say-so? Itâs doubtful.
This inordinate faith in and reverence for the power of the central bank and the Central Banker has had a profound effect on national policy over the past several decades. The US Congress has assigned to the Fed the âmandateâ to achieve full employment, and many now routinely excoriate the Fed for failing to fulfill that mandate. And yet, while there may be more the Fed can do, there is little evidence that the Fed actually has any substantial degree of control over demand and employment in the real economy, at least in a circumstance in which interest rates have fallen as low as they can go. In fact, as various adventures in conventional and unconventional monetary policy have continued to fail, the evidence mounts that faith in monetary policy is misplaced, official mandates notwithstanding. We might as well assign to the Air Force a mandate to deliver pink ponies to every child in America. Just as there is no reason to think that Air Force brass and fighter pilots are particularly well-prepared for satisfying the equine needs of Americaâs eager tots, it seems increasingly clear that the Fed is not the agency of government best suited to parachuting real jobs down across America.
The problem in America is not bankers who wonât lend. Corporations are already sitting on record-setting amounts of profits and cash, but production and hiring are not booming. The problem is that ordinary people at the foundation of our economy, the people whose desires for goods and services drive the production that employs our resources, are lacking income. They do not want more credit and more debt. They want more income.
Yet itâs not as though we donât know how to promote economic production, deliver income and boost unemployment when the private sector fails to deliver as much of these social goods as we need. As a monetarily sovereign country, the US government can finance an expansion in spending that does not require either new taxes or burdensome debts left to posterity. What people want the Fed to do â somehow push new, spendable monetary assets into the real economy â the political branches of the government can do better, and in a much more direct and effective way. What is called for is a renewed commitment to fiscal policy, not more exercises in conventional and unconventional central bank policy. We need to return fiscal policy to the front and center of our national discussion of economic policy.
Fiscal policy and the political branches of government are needed to do what the central bank canât, and to restore our sick economy to health. But there is another reason that we need to rediscover the power and capabilities of fiscal policy. The incessant debates about the virtues of monetary policy tend to encourage people to take an excessively technocratic and abstract view of our nationâs economic policy needs, and to reduce those needs to the rubric of âmacroeconomic stabilization.â But our nation doesnât just need jobs in general; we have specific national needs for specific kinds of work. We donât just need more production and spending in general; we need to produce and buy specific kinds of things to advance urgent public purposes. The macroeconomist sometimes views spending on a bridge or a school as spending in the abstract; spending that is justified by the mere fact that we need more spending of some kind. But the citizen sees these actions mainly as spending on a bridge or a school â something we do mainly to buy something we need. Thatâs why monetary policy is a lame substitute for engaged fiscal policy in a democracy. A central bank can, at best, only concern itself with the public purpose of managing the flow of money and credit in general; but the public has very specific purposes in mind.
We are faced with imposing national problems of social decay, public underinvestment, incoherent and feckless national purpose and unconscionable underemployment of people and resources. These are problems that canât be fixed by Fed money management and expectations setting, and many of them are challenges of national scope that manifestly exceed what we can expect from the hurly-burly and hustle of private sector entrepreneurialism. Solving these problems is going to take an activist national government, and a politically engaged and committed public, directing serious resources toward unmet public purposes. Weâre way beyond the point where the only macroeconomic policy we need from the national government is the limited kind of âstabilizationâ that can be provided by the Fed. Our country is broken and our future prosperity is in deep jeopardy. We need to define large goals, set challenging tasks and get to work. It is time to get people to stop looking to the Fed to do the jobs that can only be accomplished effectively by the American people acting with purpose through their legislative representatives. There is no pure monetary policy cure for what ails us.
One prominent current enthusiast for monetary policy is Scott Sumner, who uses his blog The Money Illusion to promote an approach to monetary policy called âmarket monetarismâ. The core policy recommendation of market monetarism is that the Fed should target the aggregate level of dollar spending in the country, and maintain a stable rate of increase in that level, which includes engineering catch-up spending in subsequent years if spending in prior years false short. Sumner has no doubt at all that the Fed could hit this target if it truly sets its mind to it.
Sumner recently launched a blistering attack on a new paper by J. Bradford DeLong and Lawrence Summers. DeLong and Summers argue in that paper that âdiscretionary fiscal policy where there is room to pursue it has a major role to play in the context of severe downturns that take place in the aftermath of financial crises.â But Sumner is having none of it. Here is part of his tirade:
So letâs start over. The Fed is unwilling to provide enough monetary stimulus. OK, now what is the point of this paper? Is this to train our future econ PhD students? Are we trying to teach them the optimal policy regime? Obviously not. The optimal regime relies on monetary policy to steer the nominal economy, and fiscal policy to fix other problems. So we are going to defend the model how? A blueprint for failed states? For banana republics? Fair enough, but ask yourself the following question: In a failed state, which is more incompetent branch of government; the central bank or the legislature?
Yes, the Fed is bad. But Congress is downright ugly. Deep down most economists are technocrats. They see the central bank as being the best and the brightest, the guys who are above politics, who will âdo the right thing.â And how do economists view our Congress? The terms âstupidâ and âincompetentâ donât even come close to describing the disdain. So are we supposed to change our textbooks in such a way that the fiscal multiplier is no longer zero under an inflation targeting regime (as the new Keynesians had taught us for several decades?) And on what basis? Because the Fed might be so incompetent that we need Congress to rescue the economy? In what world does that policy regime actually work? If you have a culture that has its act together, such as Sweden or Australia, the central bank will do the right thing. If not, then all hope is lost.
I find Sumnerâs assault on fiscal policy and Congressional action to be both economically misguided and politically disturbing.
First, it is hard to understand the practical difference between âsteering the nominal economyâ and âfixing other problemsâ. The economy consists in the production and exchange of things of value, and one can measure those values in various ways. One way is to measure goods and services by their current market values as expressed in dollars. But economists have also devised various methods of abstracting away from the fluctuating current dollar as a measurement standard, so as to get at some more stable measure of value that allows for meaningful comparisons across times and places. They thus distinguish between nominal and real measures of value. But while one can distinguish analytically between nominal and real measures of economic activity, there is no such thing as the ânominal economyâ that can be separated out for the âother thingsâ and steered independently of those other things. Itâs all the same economy, whether its values are measured in nominal terms or real terms.
Perhaps what Sumner has in mind is not dollars as a nominal measure of value, but as a medium of exchange. We live in a monetary economy, and dollars are one of the things that are produced and exchanged in that economy. So the proposal might be that it should be left to the central bank to steer the part of the economy involved in the production and exchange of dollars, and leave it to fiscal policy to steer the part of the economy in which other things are produced and exchanged. But the fact is that almost every transaction that takes place in the United States takes place in dollars. The dollar economy is the real economy, and the real economy is the dollar economy. The economic system which consists of both money and the things money buys is an organic whole of integrated human activity. There is no plausible way of regulating or managing one without regulating or managing the other.
Nor is there a real-world way of institutionally separating the macroeconomic stabilization functions of government from public investment and redistributive operations of government. Itâs all part of the same job.
But what is really disturbing about Sumnerâs attitude is his haughty and unembarrassed contempt for democratic processes. Sumner actually believes the US should be seen as a failed state and banana republic if it fails to devolve responsibility for it economic fate onto the shoulders of an unelected, elite-governed and autocratic central bank, and away from its stupid and incompetent elected representatives. But my guess is that most Americans, schooled in reverence for democratic traditions and citizen responsibility of self-government, would view things from quite the opposite perspective.
Members of Congress might be corrupt, bungling and in some cases outright incompetent â and these three traits make their sorry presence felt in some eras more than others. But as democratic citizens we know where our obligation lies in such circumstances: Throw the bums out, get a better Congress and then hold their feet to the fire to serve the public interest. If we simply pack it in instead, neglect our obligations, and dispose of our democratic institutions when they are not functioning properly, and then hand everything over to cadres of arrogant and aloof technocrats with minimal democratic accountability, we will have lost more than a few jobs.
Lately, in their zeal to defend to powers of the central bank, we have been getting some truly radical, and frankly dangerous, calls from central bank enthusiasts to allow the Fed to appropriate to itself all sorts of broad spending powers that every American schoolchild has learned are the prerogative of the United States Congress and the people who elect them. And sure, if we allow the central bank to become a second, unelected Congress that can conduct a second channel offiscal policy by crediting bank accounts and buying things, without any direct democratic accountability or debate over its spending decisions, then it can no doubt have the same kind of macroeconomic impact that an unleashed Congress and Treasury could have. But if we do cross that Rubicon and go down that authoritarian road, turning the Fed into some kind of neo-Soviet Stroibank empowered to spend and command real national resources outside the normal democratic process at the behest of a technocratic elite, we will probably never get our democracy back.
People frequently rail against the pork barrel spending and earmarks that result from the legislative process. But the pork barrels donât worry me nearly as much as handing our economy over to another generation of theory-addled elitists like Alan Greenspan. As part of the democratic process, representatives come from all over the country to look for the resources to deliver the things their constituents want and need. They wrangle and haggle. And yes, in the process they land a few âbridges to nowhere.â But most of what they get are bridges to somewhere. The people in New Hampshire might not like the way the people in Georgia use their share of our national resources, and the people in Georgia might feel the same way about the people in Oregon. But the end result is that things get built; people are hired; public goods are created; national and local needs are met; things get done.
My sense is that Americans are dead tired of a corrupt and aimless government that canât or wonât do anything important anymore; that works energetically to deliver resources to its masters in the plutocracy, but then holds up its hands and says âSorry, out of money!â when suggestions for the pursuit of major public purposes are advanced. It doesnât have to be this way. America hasnât always had a Congress full of canât-do seat-warmers, small thinkers and penny pinchers determined to castrate the national government and let bankers and CEOs run the world. There have been times in our history when we have actually managed to organize our vast resources to accomplish important things and invest public resources in our future.
We have an election this year. I suggest we use it to ditch the empty suits, the plutocratic shills and the small minds, and fill their spots with people ready to act.