Toward Monetary Enlightenment: An Integral Approach to Macroeconomic Policy

By Dan Kervick

One staple of economic policy debate is the running conflict between those who lean toward a reliance on fiscal policy and those who lean toward a reliance on monetary policy. Fiscal policy is concerned with the use of government spending and taxation to achieve desired changes in economic activity. Monetary policy concerns actions by monetary authorities that seek to affect the quantity of money in circulation, or its rate of increase or decrease, in order to achieve economic ends that are believed to be influenced by monetary phenomena. The debate over the relative effectiveness of the two approaches is, as I say, standard fare. But it also tends to be carried on in ways that I believe are both misconceived and outmoded.

1. The Perspective of the Consolidated Balance Sheet

In the modern era, many national governments are both the issuers of the national currency and the regulators of the national money of account. The governments of countries such as Australia, Japan, the United States and Canada are not mere users of monetary instruments produced and regulated by others. They are the monopoly issuers of these instruments. These governments combine the traditional taxing and spending role of a sovereign fiscal authority with the currency issuing role of a sovereign monetary authority. But while these facts are broadly understood, many people seem not have made the conceptual leap or shift of perspective that is needed to crystallize the consequences of these facts into a fully modern and integrated view of economic policy. We can begin the move toward a more enlightened economic policy by adopting a more integral view of government operations, one in which fiscal and monetary policy are reinterpreted as just two different aspects of the same operations.

One thing that has prevented a more rapid shift to a more enlightened and integral approach to economic policy, I believe, is that we continue to rely on outmoded institutional structures that predate the monetary system under which we now live. These antiquated structures influence the way we perceive our economic world. They foster an artificial conceptual division between fiscal and monetary affairs, and institutionalize this awkward division in the operational responsibilities assigned to different departments of the government. The resulting anachronisms harmfully limit the range of policy options that come up for public consideration. They also perpetuate the privileges of economic and political elites who are stakeholders in the old, anachronistic order. As we develop a clearer understanding of the way established institutions function, we naturally begin to think about ways in which they might be changed.

Part of the power of Modern Monetary Theory, or MMT, is that it adopts an analytic perspective on economic activity and economic policy that derives from taking a consolidated view of government operations. All payments from national government agencies, branches or departments and all receipts by these agencies, branches or departments are viewed from the perspective of a single abstract balance sheet. Similarly, all debts owed by any part of the national government and all debts owed to any part of the national government are considered with respect to the same consolidated balance sheet. Crucially, both the central bank and the various arms and accounts of the public treasury are seen as sharing the same balance sheet.

Of course, MMT recognizes along with everyone else that the national government in any country is actually divided into many interacting component parts, each acting with various degrees of dependence on or independence from the other parts, and each with its own operational responsibilities and prerogatives established by law. But the consolidated balance sheet view provides a powerful abstract framework that simplifies the analysis of the economy and economic policy, and helps lead to important realizations about the policy options that are actually available to us. Once we view government policy from this consolidated perspective, we quickly realize that what is important to the impact of government policy on the private economy, and on the lives and economic welfare of individuals, households and businesses, is not the various labyrinthine transactions or operations that take place inside and among government agencies, but the transactions that take place between branches of the government, on the one side, and economic actors in the non-governmental sectors on the other side.

Every kind of payment from a government account to a non-government account, whether for the purchase of a piece of equipment, the delivery a social welfare payment, the purchase of a debt instrument or the payment of interest or principle on a debt instrument, can be viewed as a way in which the government injects money into the private economy. Every such injection increases the net financial asset holdings of the non-governmental sectors of the economy. And every time a payment is made from a non-government account to a government account, whether for payment of a tax bill, the purchase of a postage stamp, the purchase of a debt instrument or the payment of interest or principle on a debt instrument, money has been extracted from the private economy. Every such extraction decreases the net financial asset holdings of the non-governmental sectors of the economy.

It doesn’t really matter for the purpose of analyzing monetary operations whether the branch of the government in question is the central bank or the public treasury. Ultimately we have payments to government and payments from government – they are all the same from the point of view of their effect on net financial assets. The only differences that are significant lie in (i) who outside the government is making the payment to the government or receiving a payment from the government, (ii) how much money they are surrendering or receiving, or (iii) whether the side of the transaction making the payment is receiving some real good or service in exchange or not.

So, the government cannot make a decision about how to tax and spend which is not at the same time a decision about how to extract money from or inject money into the private economy. And the policy-maker cannot make a decision about how to extract or inject money from the private economy which is not at the same time a decision about whom to give money to or to take money from. Fiscal policy is monetary policy; monetary policy is fiscal policy.

Because a monetarily sovereign government is the issuer of the nation’s fundamental monetary instruments, and not a mere user of those instruments, it is also useful to view the operations that generate payments from the private economy to the government as conceptually and operationally separate from the operations that generate payments from the government to the private sector. The national government does not need to collect its own money, whether via taxes or borrowing, in order to spend, since the government can create or destroy money, and is not limited to conveying existing money from one account to another. Under current arrangements, these distinguishable government operations might be institutionally and legally linked in various ways. A government might institute laws governing its own operations that create constraints and divisions of responsibilities applying to its own internal branches and departments. But any such linkages are themselves policy choices, subject to change by either legislation or bureaucratic initiative, and are usually not part of the deep constitutional structure of the government. We can then pertinently ask ourselves how well those laws and institutions perform, and realistically consider whether they should be reformed , or even abolished altogether and replaced by other institutions.

Because the government is always free to issue or destroy money as a policy decision, nothing important should ever depend on how much money the government itself has. All that matters is how much money is injected or extracted from the private sector; which households, individuals or firms are involved; and the terms of their transaction with the government. To get a grip on what is ultimately important in these operations, there are two different heuristic models we can apply, each of which serves just as well to bring out the really significant elements of the government’s role. One approach is to regard the government as never having any money. When the government spends, it creates new units of money on non-governmental accounts out of thin air. And when it receives a payment, it deletes monetary units from a private sector account and these units disappear into thin air. Every payment the government makes creates money. Every payment it receives destroys money.

Another way to view matters is to think of the government as always having an infinite amount of money. There is an infinite well of monetary assets into which the government can dip. When it spends it creates additional monetary assets in the private sector, but its own infinite stock of money doesn’t shrink. When it receives a tax payment, the non-governmental stock of money shrinks, but the government’s stock does not grow, since that stock is already infinite.

Of course, neither the no monetary stock model nor the infinite monetary stock model captures the way governments currently do their bookkeeping. The various branches and departments of the national government are all attributed a net balance of money according to the established accounting practices. When they spend, the money they possess is depleted. However, my contention is that these usual practices are mere conventions that could be changed without affecting the government’s real role in the real economy. We might typically think of some country’s Department of Schools, for example, as having a certain quantity of money X in its account, and being authorized to spend that sum, so that as it spends, the stock of money it has is depleted. But we could just as easily think of the Department of Schools as having no having no money at all, but being authorized to create the sum X by spending it into existence. Money attributed to government accounts, then, can be thought of as a kind of abacus for keeping track of its money injections via spending or money extractions via taxation. These operations are carried out in accordance with pre-selected policy choices, and so some way is needed of keeping track of them. But the money in those government accounts doesn’t represent a stock of wealth possessed by the government.

Governments traditionally classify the currency they issues as liabilities. But these liabilities are of a very different order from the debt liabilities private sector firms and households possess. For private sector agents, a debt liability represents negative value. It is a legally binding commitment to make a future payment out of one’s finite stock of assets, thus diminishing that stock. It is a claim against one’s finite assets. It is thus hard to see the government’s issue of currency as the creation of any kind of genuine liability at all. It is true that the holder of the government’s currency can always use it to discharge tax obligations, and so private sector firms or households who possess money possesses a credit on their tax accounts with the government. But these credits are for obligations that the government itself establishes by sheer legislative fiat, and so the fact that the government has issued credits for those obligations does not mean that the issuance of these credits represents negative value for government. Nor does the currency issued by governments in modern fiat systems represent a redeemable promise for the delivery by the government of some other objects or services of value. The only thing the possession of a US dollar entitles you to is another US dollar. When the government collects the currency it has issued, it doesn’t get richer. And when the government issues additional currency, it doesn’t get poorer. These so-called liabilities are thus something like a bookkeeping fiction. While they represent positive value to holder, they do not represent negative value to issuer.

Because of the unique role of monetarily sovereign governments in the creation and destruction of net private sector financial assets, these governments have the option of doing something that non-governmental currency users cannot do. They can run what I have called elsewhere a pure deficit. That is, they can simply spend more into the private economy that they extract from it, without negatively affecting the stock of public sector wealth. In doing so, they create money. They can also run a pure surplus that destroys private sector money, without building the stock of public sector wealth. Private sector firms and households can only run financial deficits and surpluses. If they spend more than they receive in income, they must either draw down their stock of assets by surrendering some of them to the payees, or issue debts that represent a commitment to surrender assets in the future.

MMT argues that running a pure deficit of this kind should be recognized as the normal operating condition of an intelligent national government pursuing public purposes in an effective way, at least when that government is a sovereign currency issuer that lets its currency float freely on foreign exchange markets. If the government is running a deficit in its currency, then the non-governmental sectors of the economy are running a surplus in that currency and their net stock of financial assets in that currency is growing. If the government is running a surplus, on the other hand, then the net stock of financial assets in the non-governmental sectors is decreasing. We expect a growing economy to be increasing its financial asset stocks, and so we should expect government deficits as a matter of course. Furthermore, in some circumstances the non-governmental sectors will experience a sudden surge in desire to add to their financial asset stocks, which includes the desire to pay down existing debt. If the government does not accommodate that desire by increasing its deficit, the result will be a drop in spending and an increase in unemployment.

2. Against Central Bankism

I have claimed that there is no fundamental macroeconomic difference between fiscal policy and monetary policy. The customary distinction between these two types of policy somewhat arbitrarily separates into two distinct categories the various operations by which the government injects money into the private sector and extracts money from the government sector. Nevertheless, despite the fact that the customary distinction between monetary and fiscal policy is due more hoary convention than principled theory, there is no denying that different branches of government are usually tasked with carrying out these different categories of policies: central banks carry out most of the operations customarily regarded as falling under the heading “monetary policy” and treasury departments or finance ministries carry out the most of the policies customarily regarded as falling under the heading “fiscal policy”. So instead of focusing on the distinction between monetary policy and fiscal policy, we can take an institutional perspective and distinguish treasury operations from central bank operations. Both central banks and treasuries make payments to the private sector and thereby inject money into the private sector. And both central banks and treasuries receive payments from the private sector and thereby extract money from the private sector. But the payments involved are of different kinds. The central banks operate through the banking channel or financial sector. They are permitted to do things like pay interest on reserves, provide direct loans at interest to banks, purchase financial securities from various kinds of securities dealers, and resell the securities they have previously purchased. Treasuries collect taxes that have been imposed by the legislative authorities on businesses, individuals and households, and they also dispense payments of many kinds to businesses, individuals and households. Sometimes these payments are direct gifts of money to designated recipients; sometimes they are payments for goods or services provided to the national government in exchange.

Note also that in democratic countries virtually all of these operations are carried out under authorization provided by the national legislature. In the United States, for example, the US Congress possesses the power of the purse, and the US Treasury spends only pursuant to congressional authorizations and appropriations. The Federal Reserve carries out operations with more day-to-day independence. But the Fed was created by the US Congress through a delegation of authorities specifically granted to Congress. The Fed is independent only to the extent that Congress allows it to operate independently. At any time it wishes, through further acts of legislation, Congress could assume a more direct supervisory role in central bank operations. Congress could direct the Fed to carry out the operations Congress prefers. It could even dismantle the Fed entirely and shift its operations to other agencies – either existing agencies or newly created ones. So the independence of the Fed is a relative independence only, reflecting the results of past policy choices that have not been undone.

Now it should be fairly obvious that when it comes to the potential impact of government on the economic life of the country – on its millions of ordinary people, households and businesses – conventional treasury operations are much more important than conventional central bank operations. The legislature can choose to spend money on virtually anything it wants, and direct payments to virtually anyone it wants. Similarly, it can choose to tax almost anyone it wants. Its scope of operation is vast. The central bank operates through the much more narrowly constrained channel of the banking sector. And as the present crisis should have made plain by now, monetary interventions in that sector alone cannot spur the real economic demand and productive activity that drives the economy.

A yet, in the United States at least, a very strange ideological phenomenon and theoretical bias has taken root among many pundits and professional economists. Many are deeply committed to the notion that the central bank is the institution of government charged with, and possessing the power to control, the entire macroeconomic policy of the country. They are convinced that the central bank, all by itself and acting within the scope of its established authority, can determine the aggregate demand for goods and services across the whole economy. They even think the central bank can control the level of total spending in the economy. Sometimes they are convinced that the central bank can control the level of the money supply, despite an earlier record of manifest failure by central banks to do just that, no matter how we measure this money supply. Not only do they think the central bank can do all these things, they also seem to think that it is the institution best suited to carrying out these jobs, despite the all-too-evident limitations on central bank powers in comparison with the legislative branch. Sometimes this embarrassing secular theology goes so far as to attribute to the central bank the power to determine these grand macroeconomic results through the sheer power of its mighty words. I call this tendency “central bankism”.

Note that central bankism goes well beyond the economic doctrine referred to as “monetarism”, a doctrine that claims that a variety of crucial measures of economic performance are at bottom monetary phenomena. Whatever strengths or weaknesses traditional monetarism possesses, we have already seen that monetary policy and fiscal policy are not deeply distinguishable. Central bankism is an outgrowth of monetarism, but also an elephantine extension of it. It is an irrational fixation on the powers, social importance and macroeconomic sufficiency of the central bank itself as an institution, and on the role of the banking system that the central bank superintends.

Of course, if you are convinced that your neighbor possesses magical powers, and could transform your modest home into a spectacular castle with a wave of his wand, then you will grow increasingly frustrated each day that the wand is not waved. Central bankists rail daily at the Fed for its failure to fix the economy, accelerate spending and growth and restore full employment. For some, the belief that central bank policy and monetary policy are identical seems almost a matter of definition. As a result, we have seen increasingly mysterious calls by central bankists for the Fed to engineer large-scale macroeconomic changes by engaging in operations that are only vaguely described and by working through transmission channels of dubious reality.

Even very sane and very intelligent thinkers have been afflicted by the mind-clouding fevers of central bankism. For example, in this recent essay, the economist and blogger Paul Krugman wonders what has happened to the Ben Bernanke who argued earlier in his career, when considering the economic problems facing Japan at the turn of the 21st century, for aggressive monetary policy responses to a crisis similar to the one we face now.

These arguments are contained in Bernanke’s 1999 paper, “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” In that paper, Bernanke argued that monetary policy was not powerless at the zero bound, and then went on to propose various unconventional policies that Japan might pursue. However, he prefaced these proposals with the following remarks:

… I am aware that several of the proposals to be discussed are either not purely monetary in nature, or require some cooperation by agencies other than the Bank of Japan, including perhaps the Diet itself. Regarding the concern that not all these proposals are “pure” monetary policy, I will say only that I am not here concerned with fine semantic distinctions but rather with the fundamental issue of whether there exist feasible policies to stimulate nominal aggregate demand in Japan. As to the need for inter-agency cooperation or even possible legislative changes: In my view, in recent years BOJ officials have—to a far greater degree than is justified—-hidden behind minor institutional or technical difficulties in order to avoid taking action.

So Bernanke was quite clear in recognizing that he was using “monetary policy” in a very broad sense to include policies that fall outside the permitted operations and actions of the central bank and require the participation of other branches of government. The proposals for Japan included (i) money-financed transfers (ii) depreciation of the yen, and (iii) non-standard open market operations.

Now consider the case of the United States since 2008. The non-standard open market operations have been employed. We have had two major rounds of quantitative easing as well as “Operation Twist.” How about depreciation of the dollar? The exchange rate of the dollar is regarded as the prerogative of the Treasury Department, and a dollar depreciation strategy cannot be executed by the central bank alone. Also we are in a crisis that afflicts a large share of the globe, and not everyone in the world can depreciate at the same time, especially given the acute problems in Europe and the high resulting demand for dollars. But what of the money-financed transfers? These would be the famed “helicopter drops” Bernanke is noted for having supported in theory. A government can indeed always carry out a plan of massive spending by creating the money it spends. It can either buy things with the money, or simply give the money to people. But here’s the thing: the Fed cannot do a helicopter drop! Only Congress possesses the power to authorize that kind of spending. Of course, the Fed could always try doing a helicopter, and leap one hundred giant steps beyond what most people would understand to be its established permissible exercise of authority. I take it that Congress would not stand still for the Fed overstepping boundaries in this way. Nor should they. An unelected central bank taking over responsibility for spending of that scope would be a manifest threat to democratic government. It would be the economic policy equivalent of Julius Caeser’s crossing of the Rubicon.

So what happened to Bernanke once he became Fed chairman? I would say nothing other than that once on the job, he developed a keener concern for what the job actually permits, and what aspects of “monetary policy” fall within the Fed’s ambit.

So what forces contribute to the obsession with central banks and fuel the religion of central bankism in the United States? I would point to four main drivers:

One is the strong ideological opposition to an activist and engaged government playing a large role in the economic sphere. The financial crisis of 2008 and its aftermath have created a strong fear among the Western world’s ownership elite about the potential rise of popular democratic government, and the calls for the redistributive policies and broad-based public investment that would likely result from democratic revival. Central bankism provides mainstream and establishment pundits with a vehicle for calling for “action” that nevertheless holds the great democratic masses and bay, and protects prevailing property arrangements and existing stakeholder privileges. Like the current US President, central bankists might see themselves as standing between established power and the people with the pitchforks.

A second motivator of central bankism is the sheer pathetic desire to believe that there is a simple answer to a very large social problem, an answer whose solution lies at the policy desk of a single omnipotent individual, a Wizard Banker whose inaction can be blamed as the main source of government failure, and who could heal our sicknesses and fix most of what is wrong with us all by himself. Such beliefs are comforting. If the Wizard would only wave his wand, that would save us from the challenging democratic task of getting 535 members of the US Congress to do something significant about the plague of stagnation, unemployment, rising inequality and declining living standards!

A third motivator of central bankism is that it appeals to those who are attracted by clean, elitist, technocratic approaches to governance, and repelled by the squalid disorder and messy results of democratic struggle and legislative policy-making.

A final factor motivating central bankism is political cowardice. Frankly, many people whose hearts are otherwise in the right place seem utterly terrified of the malevolent right-wing demagogues and the corrupt plutocratic tools from both parties who now run the US Congress. The seeming intention of much this gang is to protect the privileges of the very wealthy and the rent-collectors who live off the income that comes purely from ownership stakes in the productive work of others; to replace the America of democratic and egalitarian ideals with a Social Darwinist dystopia of interpersonal aggression, hierarchy and domination; to dismantle a century of achievements of progressive government; and to elevate the demented and radically individualistic narcissism of people like Ayn Rand to established public doctrine. The rise of this kind of thinking, and the brazen aggression of the Washington and Wall Street war on ordinary Americans and their democracy is so shocking, and even frightening, that good people seem determined to turn their attention elsewhere and look for saviors where they can find them rather than accept the political risks and burden of a political war on the enemies of equality and broad democratic prosperity.

3. Toward the Future

I argued earlier that we should begin the process of moving to a more integral approach to macroeconomic policy that dissolves the conventional distinction between monetary policy and fiscal policy. What would an integral macroeconomic policy look like? The answer depends on the kind of government that runs that policy. But in a democratic country, macroeconomic policy like everything else should be in hands of the people and their legislative representatives. There is no one single way of implementing an integral economic policy, but we can imagine some broad outlines. The legislature would set spending priorities for the country. It would also recognize that part of the normal functioning of government should be to run a pure deficit – a deficit that accommodates the savings desires of the public while also permitting spending compatible with full employment. It would estimate the needed size of that deficit, and attempt to hit that deficit as a target. And it would enact tax policies that were designed, given the size and types of the spending it planned, to generate revenues compatible with its deficit target. In other words, the legislature would actively seek a deficit of a specific targeted size, and enact spending and tax policies that were designed so that the excess of spending over revenues came as close as possible to the target.

It would not have to borrow from other sources to fund the budget shortfall. A monetarily sovereign government is a currency issuer, not a currency user. It can simply spend more than it taxes, inject more money into the private sector than it extracts, and thereby create additional net financial assets. It can create money by spending it into existence. Money creation is generally seen as an expression of monetary policy, and so as something that only the central bank can do. But once we understand that there is no fundamental difference between monetary policy and fiscal policy, and have turned away from the seductions of central bankism, we can see that the tasks monetarist set for monetary policy can be carried out by a democratic legislature in the course of its spending, even more effectively than by a central bank.

If the deficit grows too large, demand-pull inflation might threaten. At that point the policy makers should enact new legislation that directs the treasury either to collect more taxes more or to spend less. It could also prepare for inflation ahead of time by enacting tax-raising or spending-cutting triggers that kick in automatically if established measures of price instability reach certain thresholds.

Of course, some people are horrified by the suggestion that a legislature, responding directly to voters, might carry out monetary policy. Some people seem convinced that money is a kind of economic uranium, a substance so deadly and volatile that it is too hot for ordinary mortals to handle, and whose careful manipulations must be left to a few expert technicians. There is something to be said for this attitude, but it is overwrought. One might have heard a few centuries ago that parliaments could not control national budgets, and could not set tax policies and spending policies without creating economic disaster. But the era of legislatively controlled taxing and spending policies has been an era of unprecedented prosperity. I see no reason to think that legislatures cannot assume the same responsibilities for monetary policy. The passing of monetary policy from the secluded private conclaves of a few central bankers into the public sphere, where it will become a matter of spirited and engaged public debate and activism, will be salubrious for our democracy.

I have claimed that a government doesn’t need to borrow in order to spend more than it taxes. However, it might be held that public borrowing performs several valuable functions, even granted that the public doesn’t need to borrow to fund its expenditures. The buying and selling of treasury securities in central bank open market operations is a tool for interest rate management. Also, those securities provide their owners with a low-risk, low-yield savings vehicle for those who hold the publicly-issued currency. That in itself might be seen as an important and stabilizing public service. Finally, the existence of several varieties of securities with different maturities and coupon payments provides the government and the public with some flexibility in accomplishing these goals. While I believe the first task, interest rate management, could probably be accomplished through other means such as adjustments to the interest rate on reserves, the availability of a government-provided savings vehicle might be important. That is fine. But what the public should be in no confusion about is that the savings vehicle is not provided because the government needs to “borrow” money to fund its spending. The issue for public debate will then become, as it should have been all along, who receives the interest payments provided by these savings vehicles, and whether it best serves public purposes to continue to provide them, or would instead better fulfill those purposes to force the savers out into other markets in search of investment vehicles that might be riskier, but also more productive.

A macroeconomic policy determined by the political wrangling of a democratic legislature will frequently be messy and ungainly. Economists seem to dislike instinctively this approach to economic policy. They dream of the perfect “policy rule”, some mathematical formula that is applied with technocratic precision in a politically controlled and detoxified environment. But economic policy is always engaged in the pursuit of multiple, sometimes conflicting goals: full employment, equity, price stability, national progress and development. Perhaps it is a mistake to think all of these goals can be captured in a single rule. Might it not be better for the policy to emerge from the struggle for conflicting aims among engaged democratic citizens?

An integral macroeconomic policy approach should be organic, democratically accountable, nimble, responsive and flexible. It should be forged by broad public debate and discussion, and will no doubt require the messy contention of political factions and regions. But elitism and technocracy have not served us well. Let’s try democracy.