People I admire were calling each other nasty names last week, so I cowered in the corner, put my hands to my ears, and hummed very loudly. I’m talking about the debate over money and banking that involved Steve Keen (1, 2, 3, 4, 5), Paul Krugman (1, 2, 3, 4, 5, 6, 7), Nick Rowe (1, 2, 3), Scott Fullwiler, and Randy Wray among others. Here are some summaries by Edward Harrison, John Carney, and Unlearning Economics. Anyway, although there were some good moments, this debate just made me unhappy. The mechanics of banking are straightforward and uncontroversial, although they are widely misunderstood.  Yes, some misunderstandings were expressed and then glossed over rather than acknowledged when corrected. But that is to be expected in a very public conversation in which people are not behaving cordially, but are instead playing “gotcha” with one another. When a conversation is framed with one group calling the other mystics and the other shouting “Ptolemy!”, that is not a good sign.
I don’t mean this as criticism of anybody. Humans have egos, and I’ve certainly behaved worse. But it is terribly frustrating to me. The protagonists in this debate have much more in common than they have apart, and I think some progress could be made intellectually, and perhaps in the governance of the real world, if they’d communicate with an eye toward finding where they agree. Though I get in trouble for saying so, I think that the heterodox post-Keynesians, mainstream saltwater economists, and uncategorizable market monetarists actually agree on a lot. I think they unnecessarily pick fights with one another for reasons that are more sociological than intellectual. I don’t mean to pretend that they don’t have important theoretical differences. They do. They will probably never agree on what sort of policy would be “optimal”. But if we move the goal posts from perfection to better-than-the-status-quo, they’d find a lot of room to join forces. I do my best to understand all of their models, and as imperfectly as I may have done so, I think I’ve learned from them all.
I’m going to switch gears a bit from the banking debate and talk about the fault lines over “fiscal” vs “monetary” policy, however you wish to define those words. We have identifiable groups of thinkers who agree on the most fundamental question — should the state act to stabilize “aggregate demand”? — but who have strong preferences over whether macro policy should be implemented via fiscal or monetary channels. If we frame this as a binary choice, all we have is a fight. But if we realize that we live in a “mixed economy” and are likely to do so for the foreseeable future, there is lots of room for conversation.
Market monetarists make excellent points about how cumbersome and unsuitable a legislature is to the task of managing high-frequency macro policy. They point out that fiscal interventions may have limited or even paradoxical effect if they are offset with countermoves or diminished activism by the central bank. They emphasize the nimbleness of monetary operations, their inexhaustibility and fast reversibility, and how those characteristics combine to make central banks extremely credible expectation-setters. They suggest that we rely upon consistent rule-oriented monetary policy, and argue that this can be implemented more by anchoring expectations (which become self-fulfilling) than by direct market intervention.
Mainstream saltwater economists are accustomed to operationalizing monetary policy as interest-rate policy, and pay great attention to the zero lower bound on nominal interest rates. They point out that regardless of your theories of central bank “ammunition”, as a matter of practice or politics, expansionary monetary policy seems to become difficult once the zero lower bound of conventional interest rate management has been hit. They suggest we rely upon monetary policy in “ordinary” times, but that we supplement it with fiscal policy at the zero bound. Conventional “neoclassical synthesis” models did not do a great job of foreseeing or predicting the crisis, but they have done a good job of explaining and predicting macro behavior during the crisis, in the context of “depression economics” or a “liquidity trap”.
Post-Keynesians did predict a crisis, on broadly the terms that we actually experienced. They argue that there are adverse side effects to using monetary policy to manage aggregate demand. Although in theory this might be avoidable, post-Keynesians point out that in practice monetary stabilization, even above the zero bound, seems to engender increasing indebtedness and financial fragility, and to distort activity towards overspecialization in finance and real estate. They pay much more attention to the details of financing arrangements than the other schools, and emphasize that vertiginous collapses of aggregate demand are nearly always accompanied by malfunctions in these arrangements. Aggregate demand, post-Keynesians argue, cannot be managed without concrete attention to the operation of financial institutions and the conditions that lead to their fragility. Post-Keynesians make the deep and underappreciated point that fiscal policy, even if it is conventionally tax-financed, can deleverage the private sector and reduce financial fragility in a way that monetary operations cannot. Monetary operations, if you follow the cash flows, amount to debt finance of the private sector by the public sector. The central bank advances funds today, in exchange for diverting precommitted streams of future cash from private sector entities to the central bank. Fiscal expansion is more like equity finance of the private sector by the public sector. Public funds are advanced, and captured by parties with weak balance sheets as well as strong. But taxes are not withdrawn on a fixed schedule. They are recouped “countercyclically”, in good times, when private sector agents are most capable of paying them without financial distress. Further, the private sector’s tax liability is distributed according to ex post cash flows realized by individuals and firms, while debt obligations are distributed according to ex ante hopes, expectations, and errors. So tax-financed fiscal policy acts as a kind of balance-sheet insurance. Both by virtue of timing and distribution, taxation is less likely than monetary-policy induced debt service to provoke disruptive insolvency in the private sector. Plus, during a depression, fiscal expansions may never need to be offset by increased taxation.  Never-to-be-taxed-back fiscal expenditures, if they are not inflationary, shore up weak private-sector balance sheets without putting even a dent into the financial position of the strong. They represent a free lunch both in real and financial terms.
When I think about these three groups, I don’t think, HIghlander-style, “There can be only one!”. I think “Cool! Let’s put these ideas together.”
The market monetarists are right. Having different agencies conduct fiscal and monetary policy without coordinating or setting expectations is a bad idea, it invites inconsistent and ineffective policy. If we can, as the market monetarists suggest, overcome the status quo inadequacy of monetary stabilization with more aggressive policy or by inventing better tools — new techniques for expectation setting, targeting NGDP futures, negative IOR, etc. — we should do those things!  But, the mainstream saltwater types may be right too. Monetary policy at the zero bound seems difficult to do in practice, even if it need not be in theory. So, to avoid having the central bank and fiscal policymakers work at cross-purposes, we can give the central bank fiscal levers it can use as part of its overall policy regime. Some post-Keynesians and market monetarists seem to like the idea of using payroll taxes as a fiscal lever (albeit with different rationales). The monetarist Scott Sumner has endorsed a proposal to use sales-tax surcharges and rebates as a supplement to monetary policy. We might find common ground even on more ambitious fiscal policy ideas, provided they are implemented in an expectations-consistent, rule-oriented way and integrated with monetary policy, rather than reliant upon ad hoc moves by a legislature in real-time. (We may have a harder time finding common ground on the MMT job guarantee, but once we get talking to one another on friendlier terms, who knows?)
There are lots of issues and controversies, but they strike me as far from insurmountable. A lot of people (like me!) distrust status quo central banks. I think central banks tilt the economic scales in favor of rentiers in general and financial industry cronies in particular. But central-bank cronyism is a governance issue. No one is particularly attached to the current governance structure of, say, the US Federal Reserve, which keeps the public and elected officials at a remove but gives the financial industry great influence (via formal ownership and enfranchisement but also via operational interdependence and “dependency corruption“, ht Matt Yglesias). It’s not just the leftish post-Keynesians who are upset about how central banks behave. Market monetarists like Scott Sumner and saltwater Keynesians like Paul Krugman constantly lament the bureaucratic caution of the real-world Fed, when the economic theory advanced by the guy who runs the place demands flamboyant commitment in order to anchor expectations. If there is a correct policy, if the managers of the central bank are competent and understand the correct policy, but it is politically or institutionally impossible to implement the correct policy, then we do not have an “independent central bank”. We have a governance problem that we should remedy. 
One nice thing about a monetarist / saltwater / post-Keynesian synthesis, the thing that has me most excited, is that it would be perfectly possible to give our nouveau central bank a mandate that explicitly includes restraint of private-sector leverage in addition to an NGDP target. I think that the post-Keynesians are right to identify financial fragility as a first-order macro concern. On its own, NGDP path targeting would help “mop up” after financial fragility and collapse, because it weds depressions to inflations, engineering wealth transfers from creditors to debtors when things go wrong. But we’d rather avoid the whole cycle of fragility, insolvency, and inflation, if we can. Monetarist David Beckworth has pointed out that stimulative monetary policy need not expand bank-mediated imbalances between creditors and debtors. Proper expectations could encourage creditors to spend (and, implicitly, debtors to save), reducing overall indebtedness. That could happen! But it has not been our experience with expansionary monetary policy in the recent past. Over the Great Moderation, wealth inequality and the indebtedness continually expanded while interest rates were pushed towards zero in order to sustain the pace of debt-funded expenditure. Under an NGDP-targeting regime, however, Beckworth’s view might be vindicated. NGDP-targeting would dramatically increase the vulnerability of creditors to inflation compared to the status quo price-stability commitment. Creditors might become less willing to accumulate large stocks of fixed-income assets, especially as indebtedness and perceived financial instability grows, for fear that a “Minsky moment” will require a path-targeting central bank to engineer a burst of inflation. In my view, nothing has distorted financial market behavior more egregiously than taking inflation risk off the table, which has guaranteed real rents to default-free debt holders, financed if necessary by the taxation of workers and the nonconsumption of the unemployed. Restoring inflation risk to its proper place (a bad economy means crappy real returns even to fixed-coupon debt) may be enough to shift private sector incentives and prevent unwanted accumulations of financial leverage. The market monetarists could be right, full stop.
But the post-Keynesians might be right that treating financial fragility as an afterthought is never sufficient, that the dynamics of endogenous instability identified by Minsky will not be thwarted by vague fears of inflation among creditors. If macro policy were to include a leverage cap as well as an NGDP path target, and if the central bank were empowered with a broadly targeted fiscal instrument, an unwelcome expansion in private sector leverage could be opposed with a shift towards tighter money but looser fiscal. This would reduce the pace of new borrowing, and accelerate repayment of existing private-sector debt, shifting creditors’ claims from fragile private-sector balance sheets to an expanded public sector debt stock. The NGDP path (with the occasional inflations it imposes) and the leverage cap (with the occasional deficits it engenders) would combine to shape the budget constraint faced by the political branches of government. Loose bank regulation would be paid for with automatic fiscal outflows to constrain leverage rather than via occasional crises and bailouts. The cost of borrowing would be related to the level of aggregate leverage and the government’s consolidated fiscal stance, and would be set reactively rather than actively by the central bank to maintain the NGDP path subject to an aggregate leverage constraint.
Maybe this is a terrible idea. I’m intrigued, but I’m kind of an idiot. The rest of you are very nice and smart and reasonable. You should talk with one another and stop picking fights over how many straw men can dance on the head of a DSGE model. Please.
 As Henry Ford famously noted, “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
 Many post-Keynesians would object to the phrase “tax-financed” as an incoherent descriptor for any government expenditure. But the claim that government expenditures sometimes need never be offset with tax increases is perfectly orthodox, when the cost of interest service is below the long-term growth rate of the economy, or when the present value of incremental growth in tax receipts engendered by the spending (under existing law) exceeds the cost of servicing the debt. Depressions are a time when government paper is sought after by the private sector, driving real debt service costs towards or below zero. If there are unutilized resources in the economy that would have generated no tax revenues absent government expenditure, or that would have elicited real transfers — negative tax revenues — via unemployment or other transfer payments, the incremental growth in real tax revenues engendered by government investment of fallow resources may be large, even if the investment is inefficient. In ordinary times, government expenditures do not “pay for themselves”, but in a depression, they very well might. Note there is no substantive symmetry here with “dynamic scoring” of tax cuts. In a depression, the private sector is leaving resources unutilized, foregoing potential consumption and investment in order to acquire government paper. Cutting taxes only generates incremental tax revenue if the distribution of tax cuts is to people who will invest by putting unutilized resources to work rather than bid-up the price of resources already in use or expand their holdings government paper. That’s a hard kind of tax cut to engineer. In good times, tax cuts may generate some incremental revenues by substituting efficient private-sector resource use for less efficient public-sector use and by sharpening incentives for private-sector production. But incremental revenue will be modest, as we’ve merely replaced a less efficient use with a more efficient use rather than bringing an entirely unutilized resource into service. And the cost of financing the tax cuts that generate this incremental revenue will be burdensome, as real interest rates are high and positive when the economy is booming. It is unlikely that tax cuts ever “pay for themselves”, but expenditures can when the economy is in depression. None of this conflicts with the market monetarists’ view that fiscal policy is unhelpful because depressions can be avoided with sensible monetary policy. If they are right that monetary policy is enough, then there never need to be unpleasant depressions where fiscal policy pays for itself because of inefficient nonutilization of resources by the private sector.
 There is some unconventional monetary policy to which we absolutely should object, “credit easing” targeted towards particular institutions or sectors, which is a form of directed subsidy. Fortunately, the market monetarists agree that this is a bad idea.
 Perhaps there is less of a tension between technocratic competence and democratic accountability than we once imagined.
- 9-Apr-2012, 12:25 a.m. EDT: Fixed broken link in Footnote #3; “future cash from
the private sector entities to the central bank”
- 9-Apr-2012, 3:10 a.m. EDT: Adopted consistent (non)hyphenation of “zero lower bound”.
- 11-Apr-2012, 2:30 a.m. EDT: Fixed broken link to Tcherneva job guarantee paper.