Opinion: It’s time for a change in monetary policy

A few years ago my son got a clock for Christmas. It functions anti-clockwise. One o’clock is on the left of twelve. Five to one is really five past one. Are you with me?

The thing is, you have to change completely the way you read and interpret the data on the clock face.

The Coalition leadership is proud of its management of the economy because it sees the interest rates on gilts historically low and continuing to fall. It reads this as a sign that ‘the markets’ have confidence in its stewardship of UK plc.

But suppose they are reading the clock incorrectly. Suppose what low and falling yields are actually telling us is that aggregate demand is low and falling (which we know it is).

If so, everything that is encouraging them to persist with their policy should be telling them to desist.

You are probably sick and tired of me contributing pieces here that say that monetary policy is too tight and needs to be loosened.

“No but,” I hear you say, “interest rates are low – historically low – so monetary policy must be loose.”

But have a look at this graph provided by Lars Christensen on his blog, The Market Monetarist 


I am not clever enough to superimpose the figures and the turning points for UK Gilts, but they won’t be far off the same plot.

As Christensen explains: “Every time either the ECB or the Federal Reserve have moved to tighten monetary policy long-term US bonds yields have dropped and when the same central banks have moved to ease monetary policy yields have increased.”

QED: low yields occur when monetary policy is too tight and yields reflect the market’s expectation of aggregate demand – money or nominal Gross Domestic Product – PY or indeed MV – however you want to describe it.

What the Quad interprets as a sign of success is a sign of failure. And it puts the low rates on gilts as a sign of market confidence in austerity and its management of public finances.

Hence, full steam ahead.

They are not alone.  The same thinking dominates the German Chancellery, the Bundesbank, the European Central Bank and, closer to home, the Opposition benches.

Reading the clock this way means that we shouldn’t worry about rising yields in the bond market. Rising yields would be a sign that the market was expecting an increase in aggregate demand. Exactly what we want.

And similarly, the continuing falls in NGDP (aggregate demand) tell us that the Bank of England’s monetary policy is too tight.

Why are they not loosening it?

Because it is keeping monetary policy tight to achieve its 2% inflation target.

The Coalition is running out of time to change course; to loosen monetary policy, to introduce NGDP targeting.

Each day sees more permanent damage caused; more lives blighted; more life chances lost for ever, and, as Nobel prize winning economist Paul Krugman said on Monday, an establishment of politicians held fast to their policy by no more than their ambition and vanity.

As Nick Clegg says, the Establishment is broken and there is no better proof of this than the Establishment’s determination not to admit that monetary policy has been wrong since at least the mid-Noughties and remains the fundamental cause of the continuing recession – too loose when rates were high, too tight when, as now, rates are low.

What better cause could Liberal Democrats have?  What better opportunity to show distinction, wisdom and leadership?

Is Nick Clegg part of the broken Establishment or part of the Anti-establishment?

It’s time for a change.

* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams

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  • Professor Nick Crafts has said something similar in his recent CentreForum paper on lessons from the 1930s: http://centreforum.org/index.php/mainpublications/274-lessons-from-the-1930s

    And I said the same in the Financial Times in 2009: http://www.ft.com/cms/s/0/224ae9f2-fb95-11dd-bcad-000077b07658.html

  • Bill le Breton 30th May '12 - 9:56am

    1,000 apologies Lars. With a surname like mine in the UK I know just how irritating my error can be.
    Thank you for contributing here.
    I was looking at those figures on Monday. For others they can be found here: http://www.bankofengland.co.uk/statistics/Documents/bankstats/2012/Apr/TabA2.1.1.xls
    Whenever I mention M4 as a ‘speedo’ for the economy I get some MMs telling me that base money is what is most indicative – and non-MMs say that M4 targeting in the early 1980s undermined its credibility.
    It is good to see you referring to its measure in this way – given the paucity of other monetary published by the B of E.

  • Matthew Huntbach 30th May '12 - 10:29am

    The crazy thing is that the criticisms of the Conservatives’ economic policy we made at the time of the general election are increasingly being shown to have been sound, and the line we were saying we would have taken at that time is getting increasing backing from many who were firmly backing the Conservatives then. So we should be getting the benefits now, we should be saying “We were right, they were wrong”.

    I don’t think the existence of the coalition should be stopping us from saying that. We should be making it clear – and we should have been making it clear from day 1 of the coalition – that the coalition exists because it was the only viable government option arising from the way the people of this country supported the Conservative Party more than us and more than Labour in 2010, and also from the distortions of the electoral system which favour the largest party and weaken third parties (which the people of this country backed in the 2011 referendum). Now is the time we should be asking the people “Do you still support what you voted for in 2010 and 2011? Because if you don’t, we can offer a very different alternative”.

    If we believed what we said in 2010 – and I do, does Mr Clegg? – we should have planned our actions from then forward in the basis that the Conservatives’ economic policies would fail to deliver. That is, we should have made it absolutely clear that we were not signing up to a coalition of equals – how could that be when they have five times as many MPs as us? – we were, as good democrats, accepting the democratic will of the people. That is why I go on about the 2011 referendum because the result put properly places gives us the big tactical advantage of saying “We gave you the chance to change the electoral system to one which would not have been so distorting in favour of the Tories, but you turned that down after a “No” campaign which explicitly put that distortion as its main virtue. Therefore our participation in the coalition on its current terms really is just accepting what you the people voted for”.

    Anyone with any political experience of these sorts of things would know junior coalition partners always get torn to pieces, with both sides blaming them for anything that goes wrong in government. Therefore a defensive strategy should have been played from the start, doing what it could to reduce the impact of this. I, like many other party members, have argued in favour of the coalition from day 1, not because I agree at all with what it is doing but because I recognise it was something we were forced into by the 2010 general election situation. Although I may have been quite outspoken in my criticisms of the leadership, I hope that actually that makes my support of the coalition more credible. It would be nice if that underlying loyalty I am prepared to give were repaid in loyalty back to the party’s members from its leaders.

  • Mark Valladares Mark Valladares 30th May '12 - 10:38am


    On behalf of those with ‘interesting’ surnames, I’m delighted to correct the spelling mistake…

  • Bill le Breton 30th May '12 - 10:55am

    Thanks Mark,

    @Tim, isn’t Craft in favour of price level targeting, not NGDPLT?

    Speaking of antecedents; I too was making this point in 2009. When Centre Forum published ‘Tackling the Fiscal Crisis’ I said it should then have been commissioning and publishing ‘Tackling the Monetary Crisis’.

    @Matthew, please remember that Clegg prior to the Party Conference in 2009 was calling for ‘savage cuts’, when the money supply was contracting alarmingly and NGDP had plunged.

    However, we are where we are, and there is a wonderful opportunity for Lib Dems to lead on monetary policy reform.

    FDR’s Executive Order 6102 http://en.wikipedia.org/wiki/Executive_Order_6102 saw an astonishing recovery in aggregate demand.

  • I listened to the Nobel Prize winning economist Paul Krugman talking to Evan Davis about austerity and growth this morning. I don’t know if he’s right but there should be more to the coalitions reponses, to the demands of opponents of their policy, than hearing the ‘mantra’ from Cameron, Osborne Clegg and Alexander that “There’s no alternative”.

  • Matthew Huntbach 30th May '12 - 1:00pm

    Mark Valladares

    On behalf of those with ‘interesting’ surnames,

    The rest of you think you have it hard ….

  • Daniel Henry 30th May '12 - 2:00pm

    As usual I agree with all of Matthew’s comments, even that last one about Mark’s surname.

    (I decided to stick to first names in that sentence! 🙂 )

  • Bill,

    There has been much debate since the banking and financial crisis concerning the role of money in the economy.

    There are perhaps four schools of thought worthy of attention. Firstly, current orthodoxy based on rational expectations which holds that the economy will grow steadily if central banks keep inflation low and stable, and that there are no great gains in the offing from fiscal expansion, nor any great cause for concern over financial instability.

    Secondly, neo-chartalism, sometimes called “Modern Monetary Theory”. The neo-chartalists believe that because paper currency is a creature of the state, governments enjoy more financial freedom than they recognise. The fiscal authorities are free to spend whatever is required to revive their economies and restore employment. They can spend without first collecting taxes; they can borrow without fear of default. Budget-makers need not cower before the bond-market vigilantes. In fact, they need not bother with bond markets at all. This views has its origins in “A Treatise on Money,” where Keynes asserted that “all modern States” have had the ability to decide what is money and what is not for at least 4,000 years.

    Thirdly, “Market monetarists” who favour more audacity in the monetary realm. Tight money caused the Great Recession, they argue, and easy money can end it. They do not think the government can or should rescue the economy, because they believe the Central bank can. Market monetarists, diametrically see exaggerated fear of inflation as an obstacle to economic recovery. Market monetarists argue that fiscal stimulus should be redundant, because a central bank can always revive spending—if it sets its mind to it. They do not fret about the side effects of the activism they seek, which can misdirect capital, inflate bubbles and seduce people into over-borrowing.

    Fourthly, there is the “Austrian” school of economics. The Austrians see the bogeyman as deflation, the fear of which inflates bubbles. Its adherents believe that part of the economy’s suffering is necessary, an inevitable consequence of past excesses. They do not think the central bank can rescue the economy. They seek instead to rescue the economy from the central bank. They would end the central bank’s monopoly in setting the price of credit and the supply of government money, replacing central banks with “free banking” in which private institutions take deposits and issue their own banknotes without government permission or protection.

    My own view is closest to that expounded by the neo-chartalists and based on the work of Hyman Minsky. Using the fiat currency reality of MMT, we know that an issuing government can, at will, create and destroy money. The most common method for creating it is by spending it into existence on goods and services (or giving it to people who are incapable of providing goods and services). The most common method of destroying it is by taxes.

    I favour the idea of NGDP targeting as a means of ensuring that monetary policy works to support and not blunt the effect of expansionary fiscal stimulus undertaken by the government or fiscal tightening when the economy is overheating.

  • Bill le Breton 30th May '12 - 7:24pm

    Tommy, please have a closer look at what is being argued before you dismiss it so cavalierly.

    Greece is not a currency issuer. Those lending to Greece, Spain etc are taking a risk of default and people can and are taking positions endeavouring to force them out of a fixed system and so gain on the subsequent depreciation/devaluation.

    This does not apply to Japan, the UK, the US and the ECB.

    And did you bother to look at the M4 figures? They are truly dreadful.

    If you don’t believe in MV=PY=NGDP=Aggregate Demand, please explain why? If you do, then, you will know why the sustained fall in M4 is so worrying.

    Joe, I agree that at this stage in the cycle a change in the PSBR or the way that the PSBR is funded is probably the way to start the process. Along with the following: a concerted communications campaign explaining what is being proposed, how it will operate and what the target is. An improved means of gauging expected NGDP. Reduced taxes on employment, a jobs guarantee as part of a national negotiation along the lines of that conducted at Vauxhall.

    All of which adds up to a legitimate alternative policy to austerity and one that the Liberal Democrats should propose.

  • Crafts (not Craft, and come on, his name is hardly difficult, unlike mine, yours, etc!!) is arguing for a price level target, but in the short run it is little different to NGDP, given that real GDP growth is zero…

  • That sounds like a decent plan, Bill.

    A communications campaign on the mechanics of monetary policy can get a little obscure. I think a focus on the economic benefits of utlisation of the country’s real resources – like the one million unemployed youth and millions more under-employed is the key. The Job guarantee and reduced taxes on employment are easily understanable benefits for all.

    The government should offer anyone (of legal age and not disabled) a job at minimum wage. This should be limited only by the person’s eligibility to work in the UK. The jobs being offered should include a certain amount of time to allow these transient workers to look for employment in the private sector (through job training, searching, etc.).

    The only real problem with “creating” money to pay government expenditures and fund tax reductions is the possibility of inflation. Thus, we need to have a flexible tax policy designed to maintain a stable rate of inflation. Taxes take money out of the system. That is one of their only purposes (at least when the money is a fiat, non-exchangeable currency). The other purpose is to set value (since one needs the sovereign currency to pay one’s taxes), so all other values become related to the tax base.

    As Keynes once noted ‘take care of employment and the budget will take care of itself’.

  • Stephen Donnelly 30th May '12 - 8:58pm

    In private the Labour leadership admit that in practice their fiscal policy would differ very little from coalition policy. The timing may be slightly different, and the cuts in different places, but it would amount to much the same thing overall because they would be under the same constraints. Don’t kid yourself that anyone in mainstream politics would be following policies that were very different from the coalition. As we have found out, opposition is a lot easier than government, and that seems to be the main complain by some Lib Dems.

  • The government has staked its credibility on the repeated claim that the low yield on gilts is proof of the confidence that investors have in “UK PLC”. It would require an economic disaster to make the party leadership change its position. However at this moment that appears to be a real and present danger.

    If Greece exits, Spain implodes, Italy follows and France starts to implement Hollande’s manifesto then the Germans will either have to leave the Euro or else they will have to let the ECB print to infinity. I suspect they’ll choose the latter.

    Under those circumstances anything might happen in the UK – even plan A and a half.

  • Bill le Breton 31st May '12 - 7:58am

    Stephen, the piece is quite clear that these ideas are distinct from those of the Coalition and HM Opposition. That is the point. That is why adopting this would give the Liberal Democrats a distinct and sustainable economic policy that they should publically negotiate with their coalition partners.

    As someone who began his political career ‘in power’, I have never accepted the caricature that Liberals, then the Alliance and now Liberal Democrats preferred opposition to power. Over the last thirty years actually more Liberal Democrat elected representatives have experienced power than have not. The last team to experience that responsibility was the Parliamentary Party in the House of Commons.

    Governance is not about making ‘hard’ decisions, it is about making ‘smart’ decisions. Breaking free from out of date conventions. Questioning accepted wisdom. Pursuing Liberal Democrat values.

    It is wrong to see governance as ‘management’. It is an inherently unmanageable process, best undertaken with the compass of political principle. That compass now reads that it is time to give monetary policy centre stage.

    Recovery is not going to occur whilst the Bank of England operates tight monetary policy in pursuit of a 2% inflation target, so successfully that the supply of money is declining at a rate of 5% a year – it is deliberately deflationary.

    We can campaign for this and we should.

  • Bill le Breton 31st May '12 - 8:01am

    Tim, certain types of Liberals like to tease their teachers 😉

    Yes we could advocate an increase in the Bank’s target from, say, 2% to 4% but that does not allow the differentiation for the source of the inflation (the supply side or the demand side).

    The behaviour of the Bank surely suggests that it is already being guided by NGDP rather than the price level – it ‘gets’ the need to be able to differentiate the source of an inflationary stimulus.

    Our Central Bank needs two ‘permissions’ and one structural change. These are first, to increase the NGDP target substantially until the trend level is regained and secondly to come out publically with what it is doing.

    The structural change requires the removal of the inflation hawks from the decision making process. They have been wrong since 2007 and oversaw the collapse in NGDP at that time.

    Because this new monetary policy requires the Bank to communicate in a way that is alien to it (and to Central Bankers) and may jeopardises its effectiveness when recovery takes grip, I believe that this job should be returned to the Chancellor and the Chief Secretary, supervised by the Cabinet until NGDP is firmly back on trend.

    It makes sense economically and it makes sense democratically. The wielders of power over monetary policy should be directly accountable to Parliament.

  • Bill le Breton 31st May '12 - 8:23am

    Paul, the leadership is rattled. ‘But it wasn’t meant to happen like this,’ was the impression given to the last Parliamentary Party Meeting.

    You can characterise its present state of mind as depressed. This is either a prelude to inaction, to frantic but unguided action or to clear purposeful change.

    Clegg recently spoke of Europe needing its “central banks (sic) to intervene aggressively to support demand.”

    We have not been told by him what this means, what it would entail if applied at home. Was it something that someone else put into the speech alongside his call for fiscal action or is it something genuinely significant?

    I think a clear piece on what he meant published here at this Liberal Democrat Forum would be very useful to him and to us.

  • Matthew Huntbach 31st May '12 - 11:00am

    Bill le Breton

    @Matthew, please remember that Clegg prior to the Party Conference in 2009 was calling for ‘savage cuts’, when the money supply was contracting alarmingly and NGDP had plunged.


    Clegg recently spoke of Europe needing its “central banks (sic) to intervene aggressively to support demand.” We have not been told by him what this means, what it would entail if applied at home.

    I’m not convinced he does know what it means. All along my view of Clegg is that he’s someone who has managed to get places due to his social background and ability to pick up and say whatever he feels from those surrounding him is the right thing to say – without ever really deeply thinking about it or even knowing what it means. I’m sorry, but so much of what Clegg comes out with sounds like the student essays from diligent plodders I mark in my day job – you can tell they’ve mugged up on it, they are using words in sort of the right context, but you really are not convinced they know what those words mean, and there’s no sense of original thinking whatsoever, just a rather too obvious “this is what I’m expected to say here” feel.

  • Good points Bill,

    Fiscal policy is concerned with the use of government spending and taxation to achieve desired changes in economic activity. Monetary policy concerns actions by the central bank 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.

    From a macroeconomic perspective there is very good reason why these policy levers should be closely integrated and co-ordinated by government.

    You note in your comments that “the behaviour of the Bank surely suggests that it is already being guided by NGDP rather than the price level” Until the crisis, Bank of England monetary policy appears to have been remarkably successful in keeping nominal GDP growth close to 5 per cent. It almost appears to be the target the Bank was following UK nominal GDP

    Maintaining this target did not, however, do anything to curtail the house price bubble, the explosion in private sector debt levels or the stagnation of real wages in the decade preceding the crash.

    Similarly, Tim Leunigs piece in the FT in 2009 Co-ordinated inflation could bail us out argued for a 4% inflation target as a means of spurring economic activity. Although inflation has run above this level for most of 2011, we have yet to see the resurgence in investment anticipated and living standards continue to fall.

    These actual results highlight the importance of not relying solely on monetary policy, or worse still a single policy lever such as the impact of price level expectations, in managing demand in the economy.

    I have yet to see a better policy prescription than the job guarantee that you advocate. At a minimum wage level this can provide the means to stabilise wages, prices and aggregate demand that in turn furnishes the basic foundation for the value of the currency, both domestically and internationally. It goes directly to the heart of the economic issues we face and is easily within our present means, as a country, to deliver.

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