By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil
During the Great Depression and the war years monetary policy in Britain had proved largely ineffective. In the meantime it was shown that government spending could cure economic depressions and return the economy to full or even super-full employment. After the war most political parties in Britain were thus interested in using fiscal policy to generate full employment rather than rely on the vagaries of monetary policy. (This, it should be said, is the polar opposite of our rather more desperate situation today).
Wily conservatives, however, recognised that such policies would mean the expansion of government – which they didn’t like at all. So they tried to resurrect monetary policy as the government’s tool of choice. In 1951 Chancellor of the Exchequer Lord Butler raised interest rates half a per cent (from 2% to 2.5%). In the ensuing years further increases were initiated. While the wartime Keynesian policies were firmly entrenched and highly popular, the Conservatives nevertheless pushed back against them. Their attempts to strengthen the role of monetary policy was the first move in a strategic game that was to play out throughout the rest of the 20th century and beyond.
However, as is typical throughout history, the monetary policies did not work as intended. Bank advances carried on regardless of the rate increases. What was not so typical was that much of educated public opinion was now sceptical of monetary policy, so the Conservatives found themselves somewhat cornered when trying to defend it. As is usual when monetary mysticism fails, its proponents claimed that it was simply not being implemented in the correct way. So the Conservative government launched the Radcliffe Commission in 1957 to investigate monetary policy and how it could be more effectively implemented.
The Radcliffe Commission was in no way radical. It was set up to defend monetary policy against its detractors and allow it to better function to counter the highly successful Keynesian spending and taxation policies of the war years. It was chaired by Lord Radcliffe, a man of conservative disposition who was no fan of Keynesian taxation policies. However, in its very greyness the Radcliffe Commission remained a great leap forward for truth and common sense. This was because the commission was chaired by mostly sensible public servants and lawyers. There were few economists involved that could sabotage the commission, engage in obscurantism and generally muddy the issues.
It is worth noting here that this is, in fact, what many economists spend a great deal of their working lives doing. This often surprises people who have not read policy and research papers issued by central banks and think tanks. Of course, not all economists do this. But there are usually more than a few sitting around cooking up this sort of intellectual sewage which they use to bung up policy channels, confuse the general public and give incompetent and corrupt politicians excuses for their ineptitude. The idea, so far as I can see, is to debunk what should be common sense policy measures through highly theoretical (and often woolly) arguments. The economists then claim that most people are not qualified to understand these arguments and that those who are qualified to understand them and still say that they are garbage are incompetent and should be ejected from the debate.
Anyway, there were few sewer-intellectuals on the Radcliffe Commission who could sabotage the investigation and so it proceeded as would any inquiry: through detailed investigation, considered testimony and clear-eyed scrutiny of the facts. The commission took two years, a thousand pages of oral testimony and 750 pages of memorandum from institutions and individuals. The findings were clear as day: monetary policy was for the most part a dysfunctional lever with which to steer the economy.
We are driven to the conclusion that the more conventional instruments have failed to keep the system in smooth balance, but that every now and again the mounting pressure of demand has in one way or another driven the government to take action. We envisage the use of monetary measures as not in ordinary times playing any other than a subordinate part in guiding the development of the economy.
The report of the Radcliffe Commission was pessimistic in the extreme with regards monetary policy. The commission found that the central bank had little control over the expansion of the money supply and that the velocity of money was extremely variable. Basically, what the commission found was that the banking system was largely passive in relation to the economy. Central banks did not ‘drive’ the economy at all and any policies they did implement, if they were in any way effective at all, would be wholly subordinate to real economic variables such as levels of private investment, consumer demand and government spending and taxation policies.
Needless to say many economists were livid. From their armchairs they poured forth their ‘learned’ obscurantist gobble-dee-gook, pedantically nit-picking and complaining of terminological inconsistencies. In truth, they found that the report threatened their roles as High Priests of the economy as it undermined much of what they taught. Lesser mortals had investigated the banking system and had turned up results that debunked most of their models – including the ISLM models of the Neo-Keynesian School – and the economists did not like this one bit. So they did what any marginalised academic would do in such a situation: they criticised the report in abstract and obtuse terms while sitting in their lamp-lit studies, ignored by both sensible policymakers and the general public.
Before we move on we should note just how revolutionary a move it was for these public servants – Conservative public servants, no less – to peer into the banking system with a powerful torch without any intellectual devils whispering in their ear. Today, with our central banks populated by scores of trained economists, we could barely imagine such a thing. But the Radcliffe Commission shows that it can be done. Thus, when certain US Congressmen call for an audit of the Fed we should go further – much further. We should be calling for a public inquiry by people other than trained economists into the structure of the banking system and the effectiveness of monetary policy. If the economists and the central banks complain, we should simply ask what it is that they’re trying to hide. And if they claim that mere mortals cannot understand such intricacies, we should subject them to public ridicule for being priest-like fools.
Myths of the Money Supply
So much for the monetarists and their fixed supply of money driving the economy! What the monetarists had actually found, when their empirical research was even valid (which it often was not), was that national income – that is, the economy at large – drove the money supply and that this was why any correlations they found existed. If national income increased banks would lend in order to accommodate the economic growth taking place. This observation, as already stated, is today known as the endogenous theory of money and is associated with Modern Monetary Theory (MMT) and other Post-Keynesian economists, such as Steve Keen.
Funnily enough Milton Friedman actually realised this to some extent. In a response to Kaldor he admitted that causation could run both ways. In 1969 he wrote:
The feedback effect of business on money, which undoubtedly also exists, may contribute to the positive conformity and may also introduce a measure of inverted conformity.
Personally, I cannot understand how Friedman continued to make the case for monetarism after publishing this statement. His whole theory, together with the policy stances recommended thereby, rested on the supposed fact that the growth of the money supply and the national income were strongly correlated and that the reason for this correlation was because increases in the money supply led to increases in the nominal national income (i.e. increases in money could either generate economic activity if there was excess capacity or inflation if the economy was at full capacity). The moment that Friedman admitted that the causality might run the other way and that national income (and inflation) might drive the expansion of the money supply his whole doctrine falls apart. The correlations he found could then be explained in precisely the opposite manner – which is exactly what the Radcliffe Commission found and which, today, is exactly what the endogenous money theorists argue.
I found myself wrestling with Friedman’s ghost on this point. Was he being cynical or simply incoherent? Was he an ideologue pure and simple who fudged his argument to sell his politics or was he a rather witless thinker who had a tenuous grasp of basic causal logic? I wasn’t the first to ask this – many, Kaldor included, have questioned whether Friedman and the monetarists were really serious about what they were saying and doing. This was annoying me for quite a few days because I didn’t know what I was to write in this piece. After talking to some friends and emailing some economists I have decided that I must be wholly honest and admit that I am still not quite sure if Friedman was being cynical or just a bit dim. Perhaps, being part of the same tissue, we cannot really separate the two. Perhaps those who hide their ideology beneath the auspices of science really do reason in a different way people who do not. I will leave that to the reader to decide on their own. Whatever cannot be said, it is certainly clear that in making the above statement and continuing to peddle his doctrines, Friedman and those he counselled were undertaking a extraordinary leap of faith.
This is arguably where we are today. Quantitative easing is based on the same principles as the monetarist doctrine: increase the money supply and national income will increase with it because the correlations between these two measures can be explained through recourse to a simple, straight-forward channel of causation. And yet once again we have seen the failure of the doctrine – a failure which would have been obvious to Lord Radcliffe and his colleagues. QE has not done what it was supposed to. The banks are flooded with reserves and the money supply has increased drastically, yet national income has not followed suit.
Yet, at the same time, further rounds of QE are still spoken of in solemn tones by central bankers and the media (the markets, however, have been getting a bit sceptical recently…). What’s more, the old monetarist doctrines are still taught in economics departments across the world under the guise of the money multiplier.
What on earth is going on? Are central bankers and journalists being cynical or are they just misinformed? Again, I cannot pretend to answer that question; only to raise it. But the general public should be aware of these issues. It’s time to once again crack open the banking system and take a look inside.
People are sceptical of the system as it stands. They are sceptical of the strange operations that Bernanke, King and others are undertaking behind closed doors. Now is the time to allow policymakers and the educated public a look inside. Now is the time for a new Radcliffe Commission to investigate the effects of the QE programs. We can be sure that a bipartisan commission of non-economists who seek only the truth – and not confirmation of the biases with which they earn their crust – can tell us what all this monetary shamanism is actually about.
“Fresh air! fresh air!” wrote Nietzsche, “Keep clear of the madhouses and hospitals of culture! Away from the sickening fumes of inner corruption and the hidden rot of disease!” Nietzsche’s refrain can and should be applied today to the madhouses and hospitals of banking!