The 2017 Labour Manifesto contains a section on “Balancing the books”. It commits the party to “eliminating the current deficit” and “ensuring that the national debt is lower at the end of the next Parliament”. This looks like a concession to the misleading rhetoric of “sound finance”, at the very least. For many post-Keynesians, notably followers of Modern Monetary Theory (MMT), these commitments signal no less than a capitulation to neoliberalism and austerity. They claim that Labour is painting itself into a corner, placing unnecessary limits on public spending and setting itself up to make the next crisis even worse than it need be.

However, these commitments have been defended by Labour Party advisers like James Meadway and by the academics behind Labour’s Fiscal Credibility Rule (FCR). They view them not as a tactical concession but as a policy that is actually progressive, allowing Labour to oppose austerity without restraint.

In this article, I hope to clarify what the FCR actually says. I also hope to take things a step further, however, because I believe that while the FCR does not lock us into austerity, it does little to ensure that macroeconomic policy is actually progressive. It leaves rather open the question of how macroeconomic tools are used, to which ends, and by whom. This is a problem of institutional settings and the class interests expressed within them.

Macroeconomic policy is about more than crisis management. Through its influence on unemployment, it can be used to protect the economic power of capital, or to support the structural transformation of the economy. The manifesto sets out many institutional reforms that aim to reverse the disastrous decline of real wages in the last decade, and to build an economy that “works for the many” – reforms such as a living wage, the repeal of the Trade Union Act and the ban on zero-hours contracts. Such measures would be swimming against the tide in the context of mass un- and underemployment, propagated by macroeconomic management that actively sought to keep labour cheap and weak.

The next manifesto may not be the place to set out a detailed macroeconomic policy position, but it may be useful to set down some more markers about the kind of policy Labour in government would pursue. To see this, we need to begin with what the FCR actually does, and does not, permit.

Labour’s Fiscal Credibility Rule

“Everybody knows that if you’re putting the rent on the credit card month after month, things need to change.” Such “sound finance” tropes in Labour’s briefing on the rule are clearly a tactic. Unfortunately, they have also spread confusion about a rule that is actually quite nuanced, but not well explained.

The basic rule is that the government should plan its spending so that, at any one time, it is on course to reduce the deficit to zero within five years, according to independent forecasts. This is what is meant by a “rolling five-year target”.

There are two important exceptions to this basic rule. One is that it does not apply to borrowing for investment. Instead, Labour commits to reduce public debt as a proportion of trend GDP over the span of a parliament. This still allows for large-scale public investment if the economy is growing, particularly because public investment tends to raise GDP growth itself.

The other exception is the “knock-out clause”: the whole FCR is suspended when interest rates approach zero and the Bank of England “runs out of ammo” for further stimulus. Then, the government is free to borrow as needed to maintain full employment. This clause is meant to ensure that the rule could never force the government to implement a programme of austerity that would only make a bad crisis worse.

Its supporters thus claim that the FCR would allow Labour to end austerity and implement its Manifesto. Up to a point, I think they are right. Many MMTers appear to be responding to the soundbites rather than the small print. Yet there is a danger implicit in the rule as it stands, and one that does justify some of the MMT concern.

Deficit bias vs. rentier bias

Much of the debate between MMT and mainstream Keynesians boils down to a dispute over whether macroeconomic stabilisation (keeping employment up and inflation down) should be assigned chiefly to monetary policy or fiscal (see a recent article by Mason and Jayadev). The FCR is clearly intended to embody the mainstream view that central banks should do stabilisation in normal times, with deficit spending used only as a fallback. One of the main arguments for this “consensus assignment” is that monetary policy may be easily delegated to “experts”, while governments cannot really be trusted to do fiscal stabilisation responsibly.

Governments, it is claimed, are prone to “deficit bias”. Driven by the short-term electoral cycle, they tend to overspend and overstimulate, forcing central banks to raise interest rates to dampen growth and control inflation, and leading to an unsustainable rise in public debt in the long term. In this way, monetary and fiscal policy end up working against each other in a way that is unnecessary and harmful, and blame is put at the door of the fiscal authorities.

Many post-Keynesians, by contrast, are deeply sceptical about central banks. They charge them with consistently overreacting to inflation and underreacting to unemployment, as some research has suggested. They are sceptical about whether employment is ever actually that near to a level that should be called “full”. Thus, post-Keynesians tend to see the economy as permanently “in crisis”, with employment much less than full, requiring interest rates near zero and much larger deficits.

In fact, the deficit bias of governments could equally be viewed as the “rentier bias” of central bankers – it is just a matter of perspective. The members of rate-setting committees are notoriously well-connected with the financial sector. They may be driven by rentier interests (in high interest rates, low inflation and the suppression of real wage demands) to under-stimulate, raising rates at the first excuse, long before any strong wage growth that might signal an economy at the limits of capacity. This forces governments – who are actually accountable to the public via elections – to run deficits to sustain growth and employment. Monetary and fiscal policy end up working against each other in a way that is unnecessary and harmful, but the blame, from this point of view, can be put at the door of the central bank.

Mainstream macro is keen to see the choice between monetary and fiscal policy levers as a purely technical one, as if all the actors were trying to achieve the same thing. But they may not be, and this makes it a question of political economy. It is about the trade-off between class interests and about the institutional frameworks that allow one or other of those interests to prevail. So does Labour’s Fiscal Credibility Rule advance the interests of workers or enshrine the interests of capital?

Does the Fiscal Credibility Rule enshrine rentier bias?

The short answer is “no”, but neither does it ensure that macroeconomic policy is implemented in a progressive way. It actually leaves rather a lot open.

What we should want, from the perspective of “the many”, is a regime that keeps interest rates low to ensure debt sustainability, to minimise the share of income going to wealthy savers, and to control asset-price volatility. It should thus use fiscal policy, not interest rates, to maintain full employment. Moreover, it should regard moderate inflation as a price worth paying for a very low level of unemployment that actually gives workers the leverage to push for higher wages. This is basically what MMT and other post-Keynesians propose. It is achievable, even with uncontrolled movement of capital, as long as the current appetite for UK gilts (government bonds) is sustained.

At first sight, however, this is not the vision of the FCR. This is because the presentation of the rule seems to assume that the government will want higher employment than the Bank of England (i.e. that the government will be deficit-biased, or the Bank of England rentier-biased, depending on your point of view). The stance of the Bank of England is taken as given, and the government is expected to adjust its fiscal policy accordingly.

Even in this case, however, it is actually within the power of the government, under the FCR, to stop the Bank of England from ever raising interest rates, by giving it no cause to do so. The government merely has to run a fiscal policy that is sufficiently tight that the Bank of England cannot justify a rate rise (this is more or less what recent Tory austerity has done). But such an approach rules out pushing for very low unemployment to shift market power to workers, if that is not what the Bank of England wants. The problem is not that the FCR restricts fiscal room for manoeuvre, but that it lets the Bank of England do so. If we assume that the Bank of England also wants to target the same level of employment as the government – or is instructed to do so – then there is no problem. The government can then pursue its desired employment target and is free to choose fiscal policy as the primary stabilisation tool, simply by avoiding overstimulation, thus giving no cause for a contractionary interest rate rise.

So the FCR is not in itself regressive, but neither does it do anything to overcome the problem of the rentier bias of monetary policy makers. As long as that bias is given free reign, there is little scope for fiscal policy to do anything progressive, with the FCR or without. This is clearly a potential weakness in the Labour position.

A “Monetary Credibility Rule”

Should we abolish the independence of the Bank of England? Actually, this is not something I would propose for Labour’s next Manifesto. The tactical need to “not to scare the markets” is real. Moreover, to have monetary decision-making disappear into the dark recesses of the Treasury is not quite the point. The problem is not that a policy is implemented by experts tasked to interpret economic data; it is that it is not clear whose policy they implement. We need their deliberations to be as transparent as possible, and we need accountability to ensure that the policy implemented is the democratically chosen one.

This is why we need to look at governance and guidance for the Bank of England. On governance, it might be pragmatic to give a role to the UK regions, the unions and non-financial sectors of industry in the selection of the experts on the Monetary Policy Committee (MPC), to dilute the influence of the City. On guidance, we need something like a “Monetary Credibility Rule” that goes beyond a simple inflation target, to guard against rentier bias by setting exactly the progressive policy we want the MPC to implement.

The exact parameters of a monetary credibility rule need to take account of changing contexts, including with regard to the international position of a post-Brexit, socialist-run Britain. We should not be complacent about this. However, as an example, we can say that an effective, progressive monetary credibility rule might be similar to the following:

1. The inflation target is exceeded when the Consumer Price Index (CPI) and wage inflation both exceed 5%.
2. The rate of interest should track the CPI, to the extent compatible with debt sustainability, and unless the inflation target is exceeded.
3. When the inflation target is exceeded, interest rates should be raised to help get back to the target.

This means, firstly, that the MPC is instructed to tolerate a level of inflation higher than the current two percent target, but still essentially harmless. It is instructed to tolerate even higher CPI inflation caused by factors such as changes in the exchange rate and oil price, that are anyway of transient effect. It is also instructed not to act against any rise in wages, relative to inflation. Only when significant wage increases (signalling a tight labour market) are accompanied by significant price rises (signalling a danger of a wage-driven inflationary spiral) is the bank of England instructed to step in to dampen economic activity.

At all other times, the Bank of England is instructed to aim for real interest rates of zero (i.e. nominal interest rates track the CPI). This protects the value of non-index-linked pensions and savings and promotes the stability of asset prices such as house prices, relative to earnings. Nominal interest rates may be lower, however, if this become necessary for debt sustainability. The MPC is instructed not to raise rates in supposed anticipation of inflationary pressures, but to wait, giving fiscal policy a chance to act.

Macroeconomic policy – the bigger picture

It is also important to see monetary and fiscal demand management as part of a wider programme of complementary measures to bring about economic transformation. The changes already set out in the “Rights at work” section of the last manifesto are very important in this regard, in strengthening the institutional bargaining power of labour.

Looking beyond how to support the rise of wages at the bottom of the scale, we also need to cap the rise of wages at the top. Being able to do so could make a big difference because it could have a counter-inflationary effect, slowing nominal salary increases at the top and making it easier for real pay at the bottom to increase. In the 2017 manifesto, the Excessive Pay Levy and the maximum pay ratios of 20:1 proposed for the public sector and companies bidding for public contracts are relevant in this regard. What we really need, however, is such a maximum pay measure for the whole private sector. This is an idea that Corbyn trailed in early 2017, but that did not fully make it into the manifesto.

If fiscal policy is to be the main tool for macroeconomic stabilisation, then there is a need to do better at delivering deficit spending directly to people who are likely to spend the money on into the economy – and also to reduce these transfers as needed. This is because it is not so easy to increase and decrease public investment and service provision – and hence public employment – in a timely and counter-cyclical way. If we need more public goods and services for their own sake, its better just to provide them, regardless of demand management concerns.

Instead, there is a clear macroeconomic rationale for expanding social security, particularly unemployment benefits, which act as an automatic stabiliser. We should also look at developing other transparent and reliable direct transfer approaches – sometimes dubbed “helicopter money” – to facilitate fiscal policy.

Finally, we should realise that macroeconomic policy does not have to mean maximising employment at all costs. The goal is stable full employment, not employment that is as high as possible. Indeed, if we can create the conditions for everyone to work less, for the sake of a better quality of life and a lower ecological impact, or just to take advantage of advances in automation, this would be a good thing. Macroeconomically speaking, we do not just need to stimulate labour demand (from employers); we can also look at gradually reducing labour supply. The TUC’s proposal for a shorter working week is one way to approach this challenge. As I have discussed in a previous piece for New Socialist, we should also look at how a shift to greater needs-based redistribution of income – more child benefit and parental leave, earlier retirement, longer free education, better unemployment benefits, and so on – can facilitate a move away from the maximisation of work and growth.

Macroeconomics in the manifesto

It is important that the next Labour manifesto sets out a clear vision for how the party in government will create an economy that “works for the many”. The 2017 manifesto already made important contributions in this regard, not least through pledges on reforms that would strength the institutional position of workers in the labour market. The role of the Fiscal Credibility Rule is more complex. There is certainly a danger in playing on ill-informed notions of fiscal probity, but the rule itself is not un-progressive, and does not tie Labour to a policy of continued austerity.

Nonetheless, the manifesto leaves wide open the question of how macroeconomic policy can be used strategically to support – or thwart – economic transformation, through its influence on unemployment and the bargaining power of labour. It does not address the apparent “rentier bias” of monetary policy-makers, or the institutional setting that promotes it. I have proposed governance changes and more detailed guidance for the Bank of England, in the form of a “Monetary Credibility Rule”, that could go far to address this issue.

The next manifesto may not be the best place to set out a detailed monetary policy position. On the other hand, given the Salisbury-Addison convention – that the House of Lords doesn’t try to wreck the legislative implementation of manifesto pledges – and the similar influence that the inclusion of policies in the manifesto may have on the Parliamentary Labour Party, it may be worth using the next manifesto to set down some markers of the Labour Party’s monetary policy intent.