DeLong’s False Dichotomy

By Dan Kervick

Brad DeLong proposes that there are, broadly speaking, two camps among economists with respect to what a central bank is and the purposes it should serve: the Banking Camp and the Macroeconomic Camp:

One camp, call it the Banking Camp, regards a central bank as a bank for bankers. Its clients are the banks; it is a place where banks can go to borrow money when they really need to; and its functions are to support the banking sector so that banks can make their proper profits as they go about their proper business. Above all, the central bank must ensure that the money supply is large enough that mere illiquidity, rather than insolvency, does not force banks into bankruptcy and liquidation.

The other camp, call it the Macroeconomic Camp, views central banks as stewards of the economy as a whole. A central bank’s job is to uphold in practice Say’s Law – the principle that output is balanced by demand, with neither too little demand to purchase what is produced (which would cause unemployment) nor too much (which would cause inflation) – because Say’s Law certainly does not hold in theory. In other words, a central bank’s primary responsibility is not to preserve the health of the firms that make up the banking sector, but rather to maintain the robust functioning of the economy as a whole.

Paul Krugman agrees with DeLong, and puts himself in the Macroeconomic Camp.  he also complains that the President is in the wrong camp.

I believe this is a false dichotomy. The central bank has a macroeconomic role, but that role is constrained by its institutional powers and responsibilities. And failure to appreciate those constraints has led a number of economists to chase monetary policy wild gooses over the past four years, when they should have been helping the American people bring heavy political pressure to bear on the Congress and the President, who have behaved both incompetently and corruptly.  Here, it seems to me, is a better and more accurate way to look at the institutional role of the central bank:

1. The nation’s credit and monetary system is primarily administered through its highly centralized banking system.

2. Since monetary exchange, monetary saving and credit are vitally important functions in every modern economy, the efficient and stable functioning of the centralized monetary and credit system is an essential element of the nation’s economic health.

3. As the institution established by Congress to centralize the nation’s monetary and credit system, and govern it in the public interest, it is the role of the central bank to promote the efficiency and stability of that system, which means properly regulating and managing the banks which comprise the system, and infusing them with the appropriate flow of US government money, which only the central bank issues, and which is the backing asset of all important broader forms of money.

4. It is not the role of the central bank to attend directly to either the solvency or the liquidity of any individual bank.  Bank solvency and illiquidity are only relevant to the extent that they are pose systemic risks for the banking system and economy.  If a bank is so large that its illiquidity or insolvency would pose a systemic risk, the existence of such a bank is in itself a systemic risk.  If the central bank has been granted the power to break up such banks, it should use it.  If the central bank has not been granted such power, it should ask the legislature to grant it.

5. It is not the role of the central bank to maximize the profits of its member banks. Bank profits are only relevant to the extent that they are one component of national income. If the optimal functioning of the monetary and credit system in the public interest, in a given contingent set of historical circumstances, includes banks operating with very low profit margins, then the central bank’s role is to govern the banks in that optimal way.

6. It is not the role of the central bank to attempt to exercise powers that the central bank does not possess at all.

7. It is not the role of the central bank to attempt to control macroeconomic phenomena that it can’t control.

8. It is not the role of the central bank to attempt to control the behavior of economic agents throughout the economy by fraudulently conveying myths and misconceptions about its own powers, and making grandiose behavior-modifying statements about how it plans to exercise those mythical powers.

9. It is not the role of the central bank to exercise latent powers that it might indeed possess, but that it was never the intent of Congress or the American people that the central bank should exercise, and the exercise of which would subvert democratic government.

10. It is the role of the US Congress, such as it is, to define the public interest and the economic policy direction of the nation, and to enact legislation pursuant to those definitions. It is the role of the central bank to defer to those legislative judgments, and to accommodate them to the fullest extent that is compatible with all other policy choices Congress has already made and assigned to the central bank.

11. It is the role of the President and the Treasurer to execute the spending projects authorized by Congress, and to propose useful projects to Congress for enactment.

12. The most important macroeconomic and microeconomic policy body in the US system of government, by far, is the US Congress, since not only does Congress enact all laws governing the central bank, but it has vast powers to spend, tax, regulate, plan, mobilize and organize in any manner consistent with the Constitution. In the economic realm, Congress’s constitutional powers are quite expansive.  As Justice Holmes said, “The Fourteenth Amendment does not enact Mr. Herbert Spencer’s Social Statics.”

13. It is the role of US citizens to make sure that the US Congress legislates polices that advance the public interest.

14. It is the role of US citizen economists to advise the public on what policies would best serve the public interest, and to assist the public in getting those policies enacted by Congress by offering their expertise, prestige and persuasive powers to the effort.

15. It is the responsibility of all Americans, economists included, to resist and struggle against corruption, cronyism, incompetence and anti-democratic usurpations throughout the political system, wherever they reside or occur.

Cross-posted from Rugged Egalitarianism

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