The RBA cannot target level and growth of income (Wonkish)

John Quiggin recently wrote:

The first step should be a re-ordering of the Reserve Bank’s objectives to focus primarily on full employment rather than price stability. One way to implement this would be to target the level and growth rate of nominal income

April 1, 2020

APRIL FOOLS?! That’s what I first thought.

The following is a remix of a comment Tom Hickey made at The Economist in 2012.

MMT proponents argue is that there is a difference between money created by fiscal deficits and money created by bank lending. When the government issues currency into non-government it does so through the Treasury directing its bank, RBA, to credit non-government deposit accounts, e. g., to pay for submarines  or to pay the jobseeker payment or age or disability pension. The transmission from reserves to bank deposits is direct and does not depend on bank lending. Moreover, since there is no liability corresponding to the assets created in non-government in crediting these bank accounts, deficit disbursements inject net financial assets into non-government. Conversely, bank lending nets to zero since each asset has a corresponding liability, so non-government net financial assets remain unchanged no matter how much banks lend.

The reason that Nominal GDP targeting (NGDP) will not work is the flawed notion of the transmission mechanism from reserves to spendable bank deposits. When the RBA buys financial assets of whatever type, it simply increases bank reserves. The erroneous presumption about transmission is that that banks lend against reserves or lend out reserves. Neither is the case, as MMT points out. Rather, bank lend against capital based on demand from creditworthy borrowers willing to pay a rate that is profitable enough for the bank to risk it’s capital against. Increasing bank reserves does not spur banking lending and it does not affect the factors banks take into consideration in lending.

From this is simple to see why NGDP through increasing bank reserves, e.g., via quantitative easing (QE), will not increase effective demand and spur increased investment to meet it. The transmission mechanism is bank lending, which is in abeyance, and increasing reserves will not increase it as the failure of QE has shown. Unless the RBA would buy real assets like houses instead of financial assets like mortgage backed securities (MBS), it cannot not inject net financial assets into non-government, and there is no reason to expect an increase in effective demand due to increased bank reserves.

Australia is now in-effect at ZIRP (the support rate), as is the UK, Canada and the US and Japan have been for some time as have many others. This has done nothing either. MMT predicted the failure of these monetary policies around the world. It is time for fiscal policy to step up to the crease.

Ed: Thankfully that is what we are seeing in these Coronavirus time.

This has been remixed for an Australian audience. 


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