Rendering Corbynomics Safe

by George Hatjoullis

Jeremy Corbyn appears to be advocating monetary financing as a policy tool. Readers of my blog will know that I have advocated this for a long time. It is deemed an unconventional and unorthodox policy tool. Convention rather depends on historical context. It is deemed unsafe because it inevitably leads to dangerous and uncontrolled inflation. This is the stock response from those that have accepted the taboo without thought. Monetary finance can be a useful policy tool if used only in appropriate circumstances. It is open to abuse. So are all policy tools if there are no safeguards. How can monetary finance be introduced with appropriate safeguards that prevent abuse?

First a little refresher on monetary finance. In simple terms it amounts to the central bank printing some notes and handing them over to the government to spend, no questions asked. Quantitative easing does not do this. QE is where the central bank prints money and buys government (and other) debt in the open market. Indeed it need not only buy debt. The government debt still exists and must be repaid at some point. If the central bank were to announce that the government debt that it holds would not need be repaid then this would be monetary financing. If the central bank announces it will roll over the debt it has purchased indefinitely this is also a form of monetary financing. The important point is that the private sector obtains money for goods and the state acquires the goods to distribute as it please with no future state liability. 

It is not difficult to see how this might be abused. If the central bank is an arm of the state it can be instructed to print money to allow the state to acquire goods at will. If the economy is operating at potential then this will just generate inflation. Monetary financing in this context is just another way of taxing people on the quiet through inflation. What if the economy is not operating at potential? Potential output is defined as the capacity of the economy to produce without eliciting accelerating inflation. If the economy is operating at below potential then any demand will be reflected in greater output rather than accelerating inflation. In this context, monetary financing is rather useful. It provides an exogenous source of demand. It enables agents to exchange goods for money claims that can be held for future consumption. It raises output and employment and tax revenue. What is so wrong?

One problem is no one actually knows what is the potential output of an economy. The best indicator is the behaviour of inflation expectations but even this is hard to predict. The second problem is, of course, how to stop the state from misbehaving. In many countries the problem has already been solved; central bank independence. If the CB is made completely independent of the state then it cannot be made to print money beyond what it deems to be appropriate given its estimate of potential output. If it also has an explicit inflation target then the conditions for safe use of monetary financing are already in place. The CB can print money as it sees fit with no interference and , more important, stop doing so when it believes the economy is at potential. There may be errors of judgement but the CB is unlikely to abuse monetary finance as it has no incentive to do so. Sounds simple but it is not.

The periods in which the CB decides it is judicious to print money will coincide with a specific government of a specific complexion. The CB occasionally handing over largesse to the government of the day may be socially problematic even if the CB has good reason to do so. There needs to be an intermediary that like the CB is politically unattached. One possibility would be a publicly owned development bank (perhaps on the lines of the IBRD orEBRD). This bank could be initially capitalised by the tax payer and have a direct line of credit with the central bank as well as being allowed to raise loan finance in the open market. It could be even be owned by the public with every citizen getting shares which they can never sell but would entitle them to a dividend. The bank would periodically receive a gift of cash from the CB which would be part of its capital (not a loan). This is where the monetary financing would be deployed.

This well capitalised public bank would need a well-defined mandate and close scrutiny to ensure effective operation. It would not however need be set money profit targets. It must never go back to the state for recapitalisation but as periodically it would get an injection from the CB (during economic slumps) it should not need such taxpayer injections. The tricky part is the mandate. It could make loans, enter partnerships with the private sector and even take equity stakes in private sector business. It could finance hospitals, railways, roads, schools and housing. It could apply a social benefit criterion as well as a profit criterion. It could even increase its dividend in times of economic slump to boost demand. Perhaps this is what Corbyn has in mind?