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UK Labour’s Fiscal Credibility Rule: Neoliberal Orthodoxy Dies Hard

Joe Emersberger interviews economics professor Bill Mitchell about the British Labour party’s fiscal credibility rule.

Under Jeremy Corbyn, the UK Labour party has, to an unprecedented degree for party with a real chance at taking office in an industrialized country, embraced a left wing platform. Corbyn’s shadow chancellor (finance minister) John McDonnell has recently provoked headlines like “Labour Party plots overthrow of capitalism” but Mitchell, in a recent meeting with McDonnell and his advisers, saw a troubling unwillingness to confront some neoliberal dogmas. Mitchell hopes grassroots pressure can turn that around.

Joe Emersberger: I was intrigued by a very detailed postof yours criticizing the British Labour party’s fiscal credibility rule. According to the rule, Labour is committed to closing the deficit on day to day spending over five years, and to making sure the government’s debt (presumably its gross debt to GDP ratio) is falling at the end of five years, and that it will only borrow to invest – so only for capital expenditures and not for so called expenses. You’ve criticized that.

Bill Mitchell (WM): Several times since it came out in 2016.

JE: And you met with McDonnell and his team very recently?

WM: I met with John McDonnell and a couple of his advisers in London in October.

JE: In a nutshell what is the big problem with the fiscal rule?

WM: Obviously a rule introduces inflexibility. When the rule is defined in its own terms and what I mean by that is in terms of just other financial aggregates, so in this case a rolling five year window on recurrent spending and revenue, a debt to GDP ratio…

JE: Is that that gross or net debt?

WM: That’s unclear but typically it would be gross. That’s the normal way of expressing these things and I haven’t seen anything in writing, nor did they tell me in person that it was nuanced in any way.

The problem is that when you just define these fiscal aggregates within their own financial terms you’re really losing the purpose and meaning of fiscal policy. The purpose of fiscal policy isn’t to achieve any particular fiscal outcome whether it be a balanced fiscal position, or a deficit of whatever percent or even a surplus of whatever percent. The purpose of fiscal policy as a tool is to advance wellbeing in the economy, to engage in government spending programs which are consistent with its electoral remit, and taxation to manage total expenditure in the non-government sector so that there is space – and what I mean by “space” is real resource space – for the government to basically buy those resources and conduct its programs. Taxation creates that space by depriving the non-government sector of the use of resources.

This is the purpose of fiscal policy. In a cyclical sense – in other words in the variation of economic activity – fiscal policy should play a very important role in being able to offset any fluctuations in non-government spending that would either cause unemployment if it were not offset, or would drive inflation if it were not offset. Fiscal policy has to be flexible enough to allow the government to meet that purpose. If you start imposing rules that are independent of purpose then you are likely to end up not meeting that purpose but also failing to meet your rules.

The example that governments get burned with over and over again in this neoliberal period of fiscal rules, is they say “we are targeting a surplus in the next year or two years”. Of course they go about doing that by cutting discretionary spending programs for example. That drives economic activity down. Tax revenue then falls. Welfare payments rise because there is rising unemployment and the fiscal position typically goes into higher deficit. It’s sort of counterproductive to try to target an aggregate that you don’t have complete control over anyway. That example shows that while the government has discretion over its policy settings the final fiscal balance will depend on the spending and saving decisions of the non-government sector. If the non-government sector cuts its spending and the government does nothing, then it is likely the fiscal deficit will rise anyway because of the fall in tax revenue and rise in welfare payments under current policy settings.

We just don’t need inflexible rules that are not related to the public purpose of fiscal policy.

JE: At one point in Labour ‘s fiscal rule documentit says that everyone’s personal finances are analogous to government finances: “everyone knows that if you’re putting the rent on the credit card month after month things need to change.”  Why are they afraid to challenge, rather than invoke, such a dumb analogy?

WM: This might be a dumb analogy and it is dumb once you understand it, but as I’ve said for years and years, for decades, this is one of the most powerful analogies – and the metaphors that flow from it  -one of the most powerful constraints that neoliberal economists have placed on government spending.  They don’t place it on government spending when it’s bailing out management or banker salaries, but when it is providing essential income support to the most disadvantaged in society then they challenge it.

The basic point is that the currency is issued by a government. Here we are excluding the Eurozone because nineteen member states all use foreign currency, the euro, but for the majority of governments around the world they issue the currency and they are the only entity that issues the currency. So this idea that China is bailing out the US government is just totally false. China doesn’t issue US dollars. The US government issues US dollars. Now households within the nation state use the currency. They don’t issue it, they use it. The important distinction then is that the government is not financially constrained because it issues the currency. Therefore you then have to then ask questions about “Why does it borrow money?”, “Why does it raise taxes?”  – and that’s a separate issue.

But for a household it uses the currency so every dollar, or whatever unit of currency we are talking about, that the household spends (or any entity in the non-government sector but the household is the analogy that’s used. And it issued by the way because it is trying to appeal to our personal experience.

They want to align the struggles that households have with their ‘budgets’ on a weekly basis – ‘making ends meet’ –  with the government’s fiscal policy positions).  But that alignment is flawed at the most elemental level.

For a household it is quite clear.  If we want to spend a dollar then we have to go to work to earn it, or we have to run down our savings, or we have to sell an asset, or we have to go to the bank and borrow. A household is financially constrained. That’s an experience we all understand and confront every single day. Where are we going to get our money? We don’t want to run out of money. We don’t want to max out the credit card. They’re all things we relate to as family members and individuals because we are financially constrained, so it’s a very powerful conservative discipline to get us to believe that the government is like us but just a bit bigger. Because if we believe that then we accept a whole range of notions that the government can run out of money. We can’t fund public infrastructure because we don’t have enough money.  We can’t fund pension schemes because we’ll run out of money. We’re maxing out the government’s credit card and so on. It’s continually thrust on us to think of the government fiscal situation as our own. So when a conservative tells us we’re spending too much money then from our experience we say “gosh we’ll go broke”.

JE: The analogy is flawed because the household doesn’t have a printing press in its basement.

WM: Oh I don’t use the term “printing money” because I think that invokes a whole lot of other negative things like hyperinflation and things like that – mad government bureaucrats down in the basement of the central bank running the printing presses until they can’t run any faster. That sort of metaphor has been exploited very often by conservatives. What I would say is that the analogy is flawed at the most elemental level because the government issues the currency and has no financial constraints which means that it can buy anything that it wants that is available for salein its own currency, including labor. A household can’t do that. It has to go and get some purchasing power in the ways I mentioned previously.

JE: So you think McDonnell and his team fear the media, fear that if they challenge the household analogy they’ll be depicted as irresponsible money printers who will drive the UK to hyperinflation?

WM: My assessment of progressive politicians around the world including in Canada (your country) the British Labour party and the socialists and social democratic parties everywhere is that they’ve been on the back foot for years about the capacity of financial markets to wreak havoc. That came out explicitly in my conversation with John McDonnell and I reported on that in a separate blog post. The left and progressive side of politics has this desperate and irrational fear that the financial markets will destroy a country’s currency if they step outside the neoliberal discipline. Part of the scare campaign that is used is the inflation one, the hyperinflation one. Almost everyone who has ever raised that one with me, when I followed up with a question “Do you really know what happened in Zimbabwe? “ or “do you really know what happened historically in Germany in the 1920s, the Weimar period? “ I can’t recall a single person who has ever really understood the detailed mechanisms through which those periods created hyperinflation. People who talk about inflation and hyperinflation have the most cursory and superficial understanding of the inflation process but also of the historical processes they invoke to justify their claim.

The reality is that every source of spending – whether it be government spending, household consumption, export revenue or private investment in capital formation – they all carry inflation risk. There is nothing exclusive about or particular about government spending. All spending carries an inflation risk if it tries to compete for real resources that are currently fully utilized. If there are spare resources available for purchase then there is a very low inflation risk, but if an economy is moving along at full employment – all the machines and capital equipment are working flat out –then any new spending that tries to push spending ahead of that capacity will create inflation whether it is government or non-government.  That’s the reality. The ultimate constraint on government spending is not financial but real – the actual resources that are available for sale.

JE:   The danger is therefore “overheating” the economy as they say, trying to drive it beyond its full employment potential when unemployment is a low as it can go and everything is running full tilt.

WM: That’s right. When nominal spending – the dollar flows going into consumption, investment and government spending, and coming in from the foreign sector via export revenue – when that spending outstrips the capacity of the economy to respond to that spending by producing goods and services, the only adjustment mechanism that’s left is to ration that growth in spending by pushing prices up. That’s the reality. Business firms have two adjustment mechanisms: prices and quantities. They will respond typically if they can to extra sales (demand) through quantity adjustments because that way they can maintain market share. But if they can’t respond that way, and if no firms can respond by increasing output then the only adjustment they have left is price adjustment. If that nominal spending continues to outstrip capacity and forces the issue then you’ll get accelerating price adjustments which is inflation.

JE:  I can’t see how these ideas you debunked are things that leftists should be afraid to take on. In UK Labour’s case, is it fear of the financial sector’s power to damage the economy, or is it mainly fear of the media that makes them shy away from it?

WM:  It’s both

JE: In equal proportion?

WM: Oh I don’t know what proportion you’d like to assign, but clearly they don’t have confidence in their own ability to provide leadership in the debate, so they default to using the language and framing of neoliberals. The work we’ve done and others have done on language and framing is that if you use the concepts you are really opposed to all you do is privilege those frames. If you use language and terms used by neoliberals then all you do is privilege that language and the concepts that lie underneath. The progressive side of politics has demonstrated a total lack of leadership. As you pointed out, even in the fiscal rule they are using neoliberal frames: “the credit card analogy” for example.

I also think they have an irrational fear – and we deal with this in my recent book “Reclaiming the State”with Thomas Fazi – which traces the way the left fell into this belief that the nation-sate was impotent and no longer able to tackle the power of global financial markets. The most obvious example in recent history that shows that the national government is all powerful is Iceland. It imposed capital controls and held the funds of some of the largest hedge funds in the world and no amount of legal battle could override the legislative capacity of the Icelandic government to do that.

The Left has fallen into believing is that there are these global financial powers out there that overpower the national state, and in our book what we demonstrate is that all of the neoliberal shifts going back to the 1990s (privatization, deregulation of financial markets, deregulation of labor markets, fiscal conservatism, austerity) have all been done through the state, not independent of the state because all of those things have to work through legislative and/or regulative changes. If the nation-state was powerless, why does global capital spend billions on lobbying politicians? It is quite clear that the nation-state rules the show, but it has been lobbied and corrupted to pursue neoliberal policies rather than progressive policies.  Once the left understands that then it can use legislative power itself. My view is that the state can bring financial and bond markets to their knees. They need the state.

JE: I wanted you to comment on the fact that UK Labour’s “fiscal credibility rule” documentsays that it can be suspended in times of emergency but only if the MPC (basically the Bank of England, its central bank) gives its approval.   You noted that judging by very recent history, it doesn’t look like the MPC would ever give its approval for an urgently required fiscal stimulus.

WM: This is John McDonnell’s get out clause: ”oh look if it gets to the stage where we really have to abandon this rule then we can”.  They have a clause in there that the Monetary Policy Committee of the Bank of England can make a decision that monetary policy (interest rate setting) is no longer capable of manipulating spending in the economy and is therefore no longer effective. So what they are saying is that if interest rates get to what is called the zero lower bound, therefore you can’t take them lower, so therefore the ability of the central bank to manipulate spending and respond to a cyclical emergency is gone.

First point is that central bank ability to shift interest rates has very little effect. It’s a very ineffective way to vary total spending in the economy. It’s very indirect and ambiguous, but that is a separate issue. That going to the monetarist mantra that fiscal policy should be mute and passive, and that monetary policy should be the key policy tool.  That’s because they don’t want politicians meddling with policy. They want technocrats meddling with policy which is the exemplar of the “neoliberal era”.

The thing is that even during the global financial crisis, the worst crisis since the Great Depression, the Bank of England dropped nominal interest rates to 0.25%, the lowest in several decades. Even at that low level of interest rate the central bank was still saying they could still drop interest rates further if they needed to stimulate spending.  That’s in their Monetary Policy Committee meeting minutes that they had that position – that they were not at the point where they would notify Her Majesty’s Treasury in Britain that the fiscal rule could be suspended. So even in the worst recession, where unemployment skyrocketed and banks started going broke and had to be nationalized, even in that chaos the fiscal rule would not be allowed to be suspended. So the question remains “what are they doing there in Britain as a progressive opposition with this fiscal rule?” It’s madness.

JE: McDonnell has also said in the past that he “absolutely guarantees central bank independence” which is the problem you just described – another neoliberal idea not challenged, so a real problem of public education and leadership that is not being filled.

WM: In our book Reclaiming the State we have a section on what we call “depoliticization”. What that’s about is a hallmark of the neoliberal era where elected governments invoke external factors for why they can’t do things.  For example, they appeal to the IMF. They say “the IMF is forcing us to do it” or “we have an independent central bank that’s doing it”. “It’s got nothing to do with us”. It’s a way of not taking responsibility and depoliticizing political activity. It’s a hallmark of neoliberalism and an affront to democracy.

JE: So UK labor members have a huge task in pressuring their leaders if they want a real break with neoliberalism. Not a great situation. You’d wish the leaders would require less pressure on them  – to actually lead.

WM:  In all of our countries where we want to maintain the viability of our democracies it is going to be a grassroots thing. Our political leaders are just mouthpieces for what they hear on the ground. In Britain I’ve urged (in talks I’ve given in the last speaking tour and the next one that is coming up) I urge British Labour party members to deselect any potential aspirant if they talk like a neoliberal, walk like a neoliberal, or act like one. It’s really up to us as individuals to become politically active, to ensure that people put up for office within our parties reflect our needs rather than the needs of capital, and that is the only way it is going to change.

With all this talk say in America of the Bernie Sanders revolution it was incredibly disappointing to see that hardly any of the new candidates in the midterm elections were what you could call Sanders-type Democrats. They were old neoliberal type Democrats. You can see that in the latest discussions about PAYGO there that Nancy Pelosi is pushing. The Democrats are going along with PAYGO and there are only a couple of Democrats who have dissented. That tells me they‘ve got a lot more grassroots work to do in the party structures. The British Labour party have a lot more work to do in the party structures expunging the likes of the Blairites. Same in Australia. We’ve got a massive task to refresh the Australian Labour party and get rid of all this neoliberalism because until we do that both sides in two party system are speaking the same language and using the same frames and distinguishing themselves marginally around the edges by how tough on law and order they are, and things like that.

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