Why Philip Lowe is the Best Friend MMT Ever Had

If the central bank won’t do its job, politicians will

Governor Lowe’s speech yesterday was widely reported as ruling out monetary financing of fiscal policy, which goes under various names, including people’s QE, printing money, and helicopter money. Some even interpreted the speech as an attack on MMT, but MMT is a set of propositions that goes well beyond just the monetary financing of fiscal policy.

Lowe’s criticisms of monetary financing of fiscal policy are perfectly sound and they are criticisms I share. Note that the problem is not that monetary financing of fiscal policy would not work as intended. As I noted in my USSC report last year, if anything, monetary financing of fiscal policy would work too well. The problem is that it would break-down the institutional separation of monetary and fiscal policy that has been carefully built-up in Australia since 1982.

As Lowe also notes, monetary financing of fiscal policy simply relocates the debt servicing burden from explicit to implicit taxation, either via the inflation tax or the re-capitalisation of the central bank. This would be an undesirable outcome, but not necessarily from a politician’s standpoint. Indeed, the inflation tax, financial repression and directed lending were all part and parcel of the way in which Australia and even the US have funded deficit spending in the past. Cheerleading fiscal policy activism while reminding politicians that they have financing options other than explicit taxation may lead politicians to conclusions other than those the Governor intends.

More seriously, Lowe’s observation that monetary financing of fiscal policy would be inflationary somewhat undermines the notion that monetary policy cannot do more in the current environment to meet its inflation target and stabilise nominal demand.

If monetary policy is a spent force and fiscal policy needs to carry the burden of demand management, then Governor Lowe is effectively making a very good case for the fiscal theory of the price level (of which MMT is an institutionally-contingent special case). If politicians internalise this view, then an independent inflation targeting central bank loses much of its value to them.

As I have argued many times in the past, by failing to meet its inflation target, the RBA is not only discrediting the target, it is discrediting the notion of monetary policy effectiveness and an independent central bank charged with promoting nominal stability. The RBA is not alone in this, which is why ideas like MMT are gaining traction around the world. If central banks won’t do their job, politicians will step-in to do it for them.

The minutes of its July meeting show that the RBA Board considered a range of additional monetary policy measures, including a lower cash rate, or increased purchases of government bonds and other assets. The Board supposedly ruled these measures out on the basis that they would not be effective or would entail more costs than benefits. The authority for that claim seems to be little more than Governor Lowe’s speech in November last year, which showed little evidence that these costs and benefits had been carefully weighed and cited little or no empirical evidence to support his vaguely expressed concerns about them.

If the government internalises the proposition that monetary policy has no more to contribute and that fiscal policy is the only game in town, then the RBA may well find itself side-lined and monetary policy increasingly subordinated to fiscal policy, which was the RBA’s lived experience from 1960-1983. This is presumably not the outcome Governor Lowe intends, but the Board needs to consider the long-term risks to the RBA as an independent institution flowing from its current policy stance.