Seeking “some education” Jared Bernstein recently asked some questions about MMT (Modern Money Theory).This series is my effort at some answers. Part I is about deficit spending, Part II covers inflation.
Where Does the Fed Fit?
Jared calls attention to the fact that the Fed exists and decides independently what their interest rate policies will be, and he wonders where its independence and ability to follow policies that run counter to “. . . all this money-printing and deficit spending advocated by MMTers”. . . fits into the MMTers advocacy for “self-financed government spending”. And then he says:
For all the MMTers logic around the privilege of sovereign, fiat currency, I don’t understand how they incorporate this reality into their model.
I don’t know how others do it, but I know how I do. I believe that most MMT writers believe as I do that the “independence” of the Fed is greatly over-stated and conditional on historical circumstances. Jared is not talking economics when he emphasizes its independence, but politics; and as far as politics is concerned, the independence of the Fed varies greatly with the political atmosphere of the times.
The Fed has appeared to be highly independent over the past four decades because Congress and the Executive have enabled that independence during the neoliberal period. But, the Fed was not nearly so independent during the 1930s, World War II, and the immediate post-war period. Then from the Fed –Treasury accord in 1950 until the days of Paul Volcker’s appointment in August 1979, it exercised moderate independence amidst occasional conflicts with the Executive. It was only during Volcker’s term that the modern seeming “independence” of the Fed from Congress and the President was firmly established.
So, the question is will the Fed’s “independence” continue? Don’t believe it for a second!
One needs to envision what the political atmosphere will be like when a Congress and an Administration committed to enacting a Green New Deal gets elected in order to answer Jared’s question about where the Fed fits. That atmosphere is likely to be celebratory and (after the behavior of the Obama and Trump Administrations) also extremely insistent on substantial change in the behavior of our institutions.
The Fed, in particular, will be a political target of a Green New Deal Administration. And the Congress and the Administration would be expected to exercise the levers of power in a way that ends neoliberal policies and ignores the “progressive” neoliberals ideal of the desirability of incremental change for the better, while the lives of the poor, the middle class, and the millennials suffer the cost of incrementalism.
As a first step, I expect that a Green New Deal Senate will immediately rid itself of the filibuster, an unacceptable impediment to rapid change. The next move for such a Congress would be to enact appropriations bills that provide for Overt Congressional Financing (OCF) of all appropriations and continuing resolution bills going forward, using language similar to that in the graphic below.
The effect of that language would be to order the Fed to provide reserves to the Treasury spending account sufficient to spend all appropriations and repay all debt subject to the limit, falling due during the fiscal year of that appropriation. The impact would be to end debt issuance by the Treasury as a general practice, and perhaps for any objective; and also, and most importantly to end the public perception within weeks or months that there is a “national debt” problem. The network of “debt terrorists” in Washington and New York, centered around the Peterson Foundation, would immediately have to become “inflation terrorists” to stay in business.
The Green New Deal appropriations bills would provide for handling all of the major problems accumulated by the United States during the nearly 40 years of dominance of the neoliberal paradigm. The Congress will then be faced with the further task of enacting tax legislation necessary to finish creating a full employment budget implementing both price stability and deficit spending for public purpose targets.
Its tax measures would be designed to achieve price stability and greater economic inequality, and other public purpose goals. They would incorporate automatic stabilizers increasing or lowering tax rates in various areas in response to signals based on indicators of what is happening in the economy in those areas.
Would the Fed rebel against all this and try to fight against this expansionary fiscal policy favored by the President and Congress? Here’s what Stephanie Kelton and Randy Wray think about the Fed responding with attempts to stop or slow the expansion:
Yes, the Fed could decide to hike rates to fight against expansionary fiscal policy. But it would not do so in order to teach Congress a lesson. The Fed has a dual-mandate, and it will not raise rates sharply in the absence of credible evidence that inflation is poised to accelerate. All the money-financed deficit spending in the world won’t provoke the Fed if inflation is subdued. And the explicit goal of Functional Finance/MMT is to allow the budget deficit to fluctuate, as needed, to maintain full employment and price stability. Why would the Fed fight its own dual mandate? Far better to sit back and take credit.
The Fed’s role and structure may or may not be changed by a Green New Deal Congress. There will be proposed legislation to diversify the Board of Governors to include representatives from sectors beyond the financial. There will be proposed legislation to re-organize the Fed by placing it directly within the Treasury Department. There will almost certainly be legislation passed to audit the Fed annually. And there could be an economist from the MMT community appointed to Chair the Fed.
In short, the legislative atmosphere will be hostile to the idea of Fed “independence”, and the view that its role in the economy has been merely technical, rather than overly and overtly supportive of Wall Street interests at the expense of public purpose. In this atmosphere I expect the Fed to be accommodative and to accept the direction of fiscal policy coming from the Congress and the Executive, as it did during the New Deal period and World War II.
If however, the Fed failed to be accommodative and collaborative, and adopted policies that ran counter to the general trend of the Government toward fiscal expansion, then I expect that Congress would move to restrict Fed independence quickly, and perhaps radically, since there is no public support for the independence of the Fed outside of Wall Street, institutions dominated by globalizing elites, and economics departments and business schools within academia. And, if the Fed continued to resist even after Congress made clear it opposed such interference then, the Fed might soon find that the conceptual consolidation of the Fed and the Treasury MMTers employ to simplify analysis of the realities of public finance in monetarily sovereign nations had become an actual institutional consolidation under the supervision of the Secretary of the Treasury.
End of Part III