 today's lecture is about the history of central banks and the philosophies which guide the actions of central banks. معایدوں میں تو یہ سوچ BETA لی ہے لیکن سب کل ابل ہے سب کل شاہت کو بتاکار کرنے کے لئے ساتھ سکتا ہے سب سے سے جمعی 這 مدنہ حق45یی دیگی دے وہ دوسری کل کے لئے مدنہ اور سب سے دیکھنے کونی کل کے لئے اور بیسکت پرپرس of دیز بینکس were that people could trade across countries without having to carry money with them they would be able to transfer money from their bank to overseas to buy things from or to other countries to buy things without having to go and without having to carry money which would be a risky transaction so these so called exchange banks so these were allowed people to send money and to bring back money these eventually became central banks and we will use the term high finance which is also called both finance or french and this has been called the money lenders so these were very powerful institutions because they had access to a huge amount of money so I'm going to teach you today about the bank of England which is the mother of all central banks which was formed in 1694 this is a very strange and interesting story very few people know first in 1600 money lenders were driven out of England and out of most places Queen Elizabeth basically the money lenders were in a way in control of the money supply because they would be able to provide gold to anybody who wanted so by providing these loans they created the money supply so they were driven out and Queen Elizabeth actually issued metal coins which were made of metal which was itself worth less or worth very little and she said that this is legal tender all other coins were cancelled that you can't use any other coin this action was challenged in the courts and the court ruled that it was the sovereign's right to create money and nobody else had that right so they supported Queen Elizabeth and it was treason for anyone else to create it but the merchant classes the goldsmiths and the financiers they did not like this at all because the privilege of money creation was taken away from them so basically they worked to get rid of this so one way to do this was that they funded revolts against the kings and in particular the Cromwell succeeded in carrying out a successful revolution which was financed by these money lenders many lenders gave the loan to the parliament Cromwell basically it was a battle between the king and the upper classes who were in the parliament and this has always been the case that the kings are against the upper classes because the upper classes are always trying to take the kingship away from him and so the king has a natural alliance with the poor and that is why attempts at privatization the so called commons this was large amounts of forests and rivers and lakes which were common property everybody could use them and for a long time aristocrats had been wanting to acquire this this is our own personal right the whole village belongs to us and the kings had prevented this from happening because they did not want more power being given to the aristocrats but anyway so the money lenders exploited this natural split and they provided financing to the parliament in return for two conditions that the loans would be guaranteed they would receive repayment for them and that the finances would be allowed to operate once again when they had been banned so Cromwell carried out a successful revolution and then Charles was actually captured and the king tried and executed so that he would not to make sure that he doesn't return to power because he had come to power then he would have not allowed all of this to happen after Cromwell died there was no particular head of that revolution which had been launched so the parliament and the financiers offered to give him back the kingship but in the process they made sure that his hands would be tied in many different ways one of the things was that the privilege of issuing money was given to the parliament as well as the taxation privilege there was the free coinage act of 1666 which made that anybody who brought in gold or silver to the mint that would be converted into money so that anybody could create money out of the gold and silver this was very powerful because basically it gave the power of money creation to the private sector and of course it's only to the rich that it makes a difference so king William 3 is an important figure in this he started out as a Dutch aristocrat the most powerful of the exchange banks was the Amsterdam whistle bank and this was the one which financed king william Dutch money lenders first they arranged his marriage to prince Mary princess Mary of York then James was removed from power and William and Mary became the joint rulers in 1689 and then soon it was the nine years war with France for this purpose he needed money which he got in return for giving creating the bank of England so basically England was defeated by France which who had the bigger navy in 1690 and so England had to borrow money in order to build a new new navy but king William had no money and so it could not borrow the 1.2 million pounds that they wanted basically the powers of the king at that point were through the parliament in order to raise this he would have had to put in taxes and that was not really feasible and the parliament was not very much going along with him in fact denied him funds when he asked them the bank of England was formed to provide 1.2 million pounds to the king to allow him to carry out this war and how this was done this is very important to understand we are going to form a company which is the governor and company of the bank of England anybody who is a stock holder in this company basically you buy stocks in this company that is the money that the king will get that's the loan and anybody who buys stocks he will earn the 8% return that the king is offering actually there was so now so far so good but the bank that is going to be created will be allowed to issue money basically they said okay you give us paper saying that I owe you the king will give us a paper I owe you 1.2 million pounds and I promise to pay 8% per annum on it and the bank said that you don't have to pay it back all you do is you pay me the 8% and also you don't need to raise 8% I will do it on your behalf by collecting taxes but the key thing is that this money this I owe you of the government I will be able to write notes on it I will say this I have 1.2 million pounds of the king's money and I can use this as notes to do whatever I want so if I say that okay I have 1 million pounds here I am going to buy this company here are my notes what is this note this note is an I owe you by the king so actually it was not the I owe you by the king but it was a note which was backed by the I owe you of the king so basically they got the money this is called monetization of the debt they got the power to create money the money that was created by the word of the king that was on so these Bank of England will issue bank notes that would circulate as the national paper currency the bank would create bank notes out of nothing and only a fraction of them would be backed by gold actually but basically it would mainly be backed by the government I owe you now so if you circulate these notes and people say that okay give me I want to get gold well it's not technically backed by gold but the but it's backed by a king's promise to pay gold so it should have some value so the bank said that okay yes we will redeem these notes in gold so even though it's backed by the kings I owe you the king doesn't have money but we will act as the intermediary that is what what is meant you see the king technically what happened was what should have happened was that the banks gave 1.2 million gold to the king but they did not they just said okay whenever you need we will give you the gold as required now they have they have 1.2 million pounds and they have promised to redeem this debt for gold as required so whenever somebody came in and said okay I want to get gold for this pound they would give him the gold but they didn't need as much gold as 1.2 million pounds because if people are confident that the gold is there then they don't demand it the lender would be allowed to secure payment on the national debt by direct taxation of the people so the 8% not the principal 1.2 million but the 8% per annum that was due that they collected by putting taxes on the people and goods this is the model in which most central banks have been based it was privately owned by stock holders from its foundation in 1694 until it was nationalized in 1946 so basically the bank of england which seemed to everybody to be a government bank is actually owned by financiers it's not owned by the government of england and this is the case for most central banks so how did the bank of england provide one point did they have 1.2 million pounds in gold no actually what is very strange if you think about it technically is it makes no sense i mean your head becomes very puzzled the bank of the king writes an IOU to bank of england saying that IOU 1.2 million dollars and now the bank prints 1.2 million pounds as in bank notes which are backed by this IOU and these he says okay has your 1.2 million pounds basically the bank is providing the money that the king the king on the basis of the IOU that the king so basically it's giving back to the king what the king gave to the bank it's very puzzling transaction but we will see why this how this happened so now the bank provided bullion so as needed I will provide you gold this is part of the but not 1.2 million gold bars to sit in your castle gold bars are with me but I will provide them as needed so technically the king can ask for 1.2 million in gold but the king doesn't want 1.2 million gold he wants to make sure that any payments that he makes are honored so the bank now the king can write checks or can give these notes as these notes have the property that in principle anybody can take these notes to the bank and get gold for them so this is something that the king cannot do he does not have any gold but the bank can so that's why this trade can be done it is now authorized to issue currency backed by gold or by government debt it can redeem the liability of the government now modern state bank words the government writes a check and anybody can present it to the central bank and the central bank will cash it by actually of course there's no gold involved anymore but it will deposit an electronic entry in your bank account if you present it with the government obligation and it can also collect taxes on behalf of the government if the government owes the bank so this is not true anymore for our banks so the central bank was established at the end of 17th century and basically over the period in 1800 actually the bank of france was established and then basically all of the European powers acquired these central banks over this period of the 19th century and this became what was known as high finance and this was a century of unusual peace in Europe among the European powers these were not in the world in the world there were huge numbers of wars going on but these were all wars of colonization the European powers did not fight among themselves and Karl polanyi says that this was because the high finance they had very strong linkages across the capitals and it was not in their interests to have wars between the powers so whenever there was an equation for war they exerted their invisible power to make sure that some peace was negotiated so in this period in the 19th century Disraeli said that the world is governed by very different people from what is imagined by those who are not behind the scenes and he was not a child who was one of the billionaires and he controlled the bank of england and he said I don't care who is on the throne of england the man who controls the money supply controls the empire and I am the man who controls the money supply ایک ساقی دیکھتے ہیں۔ باہمہ بھی کامپین پرمیسز کی محبت کرنا ہے۔ ایک ایک ایک ایک دن آپ کو بھی سکتے ہیں اور آپ کو پر کیسے نہیں کرتے ہیں۔ کیونکہ آپ کا ہمہارا مرمانتی مدہت کیا جلو ہے۔ اور جب میں وہ بھی اس جو ایک کیا آپ کو پرمیس پرمیس سے چیز کرتے ہیں۔ یہاں سے چیٹ ہے ، انہوں میں پہنچ یہاں ہیں اگر کبھی آپ کو آپ پر تک اس کسی عمد کر گیا ہے میں ملیریہ سال پر سال ہے کیسا جمہ ملیریہ ہے اسی جو ساری کس ہے لیکن اس پرو نہیں good ہونے سے 10 Lau ڈالیت کیا میں پر ملیریہ درہنے کیا ہے اور سے ملیریہ کس ہیں امام کسی اعمالے میں مزہد ہوجا جو ملیریہ کس ہے مدیشن جب خواہی چیبہ اور اسی اقلہ سے محاولے سے کچھ گئے اور پہلے آئیت پیس ہی اور ایسیлей بہت پہلے بہت دارے جائے گا جس بہت ہی بہت مصدر خالد کی احوالے میں آتا ہی اس سے بہت حالہ بہت مصدر ہی دلی سے مصدر خالد کی قوانات ہوتا ہے اسی بکتورین آرہ سمجھ لئے جو اہمیابن آرہتے ہیں۔ اسی بخرح پرمانیش لیتا ہے۔ سمجھ لے کے بارے میں اہمیابن آرہتے ہیں۔ اسی بخرح پرمانیش لے کے بارے میں کوئی محطصی دیتا ہوں۔ یہ because these were true multinational the finances they had interests in multiple nations and so that's why they were trying to prevent wars and they wanted to make sure that the trade takes place at stable prices and that انہوں کے لئے جانتے ہیں لیکن انہوں کے لئے جانتے ہیں لیکن انہوں کے لئے جانتے ہیں انہوں کے لئے جانتے ہیں now as we have discussed this means that the money supply is fixed by international considerations and therefore it cannot adjust to domestic market so that was no problem i mean allowing large amounts of unemployment in the domestic market was also something that was favorable and desirable for these high finance international so the domestic concerns were sacrificed or in preference for the international concerns so at that time also there were many tourists victorian era monetists and they were many philosophies about how the central bank should function one important position was the debate was the bullionists versus anti-bullionists so though the bullionists said that the money should be backed by gold and anybody who wants to demand gold for his money should be given gold the anti-bullionist said that no money should be backed by the real bills the assets in the economy not necessarily gold one of the concerns was of the banks central banks was to that the gold standard how can this be reconciled with financial stability financial stability means mainly meant prevention of panics and runs and banks because everybody understood that and the gold standard was actually a fractional reserve standard there was never 100% reserve so in such a situation panics are always possible and at any point in fact the banks could anytime all the people who had claims on the banks would show up at the same time the bank would be unable to provide them with the gold because they were just not enough so one of the tactics that was used by banks was the large old established banks they could gang up on new entrants if there's somebody who has started a bank because banks was a profitable business what they could do and what was actually done on occasions was that the banks would issue bills and it would issue checks and the other big banks would just hold them and then when they had accumulated enough they would all in collaboration present them to the bank at the same time and the law said that if you are presented with the law was designed to prevent fractional reserve actually it was and it said that if you get a bill you must pay it right away you should not delay so this would cause the banks to collapse so then there was a law which was passed saying that you can have a moratorium you can say that okay I will pay but for a certain after a certain period of time so this was one of the ways to prevent the panics in that time also there were some rules which were made for setting interest rates it was kind of a prototype of a tailor rule and the badge it badge it rule the issue was that it was debated that central banks should bail out banks which are in trouble like if they are under attack so it was clear to everybody that this bail out should not be given to everybody at all times otherwise the banks can do anything on the other hand it was also clear that sometimes especially like in this situation where the bank is under attack the bank is fundamentally sound but it has been so in that case the central bank should step in to bail out so the rule for when should when should you ask act as a lender of last resort was discussed and some guidance was Providing one of the important doctrines which was used to carry out central bank business was the real bills doctrine that basically just like you see the bank the initial transaction was that the government provide an IOU to the bank and then the bank monetize this debt it would create money on the basis of this so similarly the checking account that we use is a monetization of debt when the when I deposit money than the bank the bank acquires well not like that when the bank gives a loan to somebody they create account for him and in this account they say that any lie checks that is written by this person or written by somebody else on the basis of what this person receives we will pay money for so somebody comes in with a check for a thousand rupees the bank gives them cash which is today's gold now this is a loan so this cash where is it coming from well it is backed by this IOU that the man has promised that he will pay us in the future so on the basis of this promise I'm giving money to third parties and the backing of this money is the real build the promise of this person to pay so the real bills doctrine says that any asset you can issue money against that but you should not create money out of nothing as opposed to this so basically the theory the real bills doctrine says that if you follow this principle that for every money that you issue you have some real asset backing it then this will not be inflationary but that is actually false theory but this is the reason that in the great depression era banks did not undertake expansionary policy because they said well yes obviously economy needs money but where will we get the money from we have no real assets against which we can issue money so the real bills doctrine was wrong basically it assumes that the full equilibrium or so once you are at full employment equilibrium all the resources are available so they would always be enough assets that you could issue loans against them but if you are at unemployment then you are in trouble because there are real assets which are lying unused and so this assumption that they will always be enough real bills to monetize to keep output is false and when there was not enough money to go around then there was deflation prices started falling this is the debt deflation cycle so in 1914 so up to 1914 there was this victorian monetary theories which were used to guide central banks but in real bills doctrine was the mainstream view but they were opposed people who were arguing in fact Thornton was an early Keynesian and he argued that the real bills is wrong and that you can print money he was like basically took position of Keynes that in a recession you should use expansionary monetary policy you can issue money without any backing so after in 1914 it was clear that the real bills doctrine is not correct you need more money than can be backed by assets in order to create full employment so over the period 1914 to 1944 between the two wars there was massive confusion in both philosophy and practice the central banks were all trying to go back to the gold standard because there was this concept that the gold standard had brought us a huge amount of prosperity and so the way to get back is to go back to this but now as we have studied the same policies which worked very well in the pre war period failed to work in the inter war period and we have gone through this in detail so from the global depression in 29 to the Nixon shock in 71 is an era in which basically in 1929 you had this great crisis this crisis was caused by basically banking sector expansions in the from 1914 to 1918 the world war lasted one and basically then after that there was a period of prosperity in the USA because the USA had survived without any damage to the economy and so there was a great boom in demand for their products by Europe which was completely devastated by the war and in addition there was this plan which was said that basically will provide money to Europe to help them to rebuild so large amounts of huge amounts of money went into Europe creating deficit financing boom and this printing of money also created huge amount of demand for American products which created a boom in the American economy and so you had what was called the roaring 20s where the economy was doing very well and as we have studied from minsky that there was huge amounts of credit creation because the economy was in a boom so the property values rose and the real estate prices rose and so there was a lot of stock market rose and so there was lots of people who were ordinary people started investing in stocks by being encouraged they would take loans to invest because they could make a lot of money so then there was this collapse and we have now studied why booms collapse that's a very important part of the analysis by minsky that basically the loans that are taken are transformed from hedge loans to speculative loans to Ponzi loans it sort of happens automatically without and so once you get into a Ponzi loans then that's unstable and that can collapse and once one collapse happens then that has a effect of multiplying because people are borrowing and then people are these this loan the IOU is being used as a collateral for credit creation so now once one loan collapses then a lot of money that was created with the backing of this loan that also collapses and then that causes further ripple effects that's why you have this the bursting occurs very suddenly so after this bubble burst in the banking crisis then you had in 1933 the massive regulations came into place and there was this glass teagle federal deposit insurance the Fannie Mae corporation this was actually a very important innovation which basically private banks are not equipped to make 30 year loans that's such a long period risk that the private banks cannot afford it so the in order to make this possible the government created an organization which provided guarantees on mortgages so the banks could make mortgages and if as long as they satisfied certain rules they would get covered by this Fannie Mae which would ensure them against the possibility of loss once this was established then this allowed the creation of a large amount of credit for the purchase of homes and this was a major contributor to prosperity because people can finance homes over a period of 30 years installments and so lots of 30 year loans were given banks were restricted to be local no bank could operate across states there was an interest rate ceiling to make sure there is no competition among the banks to offer more and more interest banking became the most boring profession on the planet there was the 363 rule borrowed 3% landed 6% and on the golf force at 3pm nothing to do so the boring system is also a very safe system there were no crisis no efforts by central banks to control crisis there is this periodization table which shows the crisis frequency so in the 1945 to 1971 period you have zero banking crisis this is the post world war 2 to the nixon shock 71 is exactly nixon shock there were currency crisis exchange rate crisis that happens for different reasons twin crisis when you have both a banking crisis and currency crisis basically the key thing is that then there is 73 to 97 97 is the east asian crisis and then so during this period of time 44 to 71 there was this issue of the central bank what it is supposed to do and the treasury what they are supposed to do so basically through trial and error and experiment and experience these were the general rules that were adopted in most places although there were individual variations from country to country so the treasury was in charge of monetary policy and the central bank was in charge of foreign exchange and implementation of banking regulations and liquidity management making sure that the government has enough money to spend and handling the debt of the government and the treasury established monetary policy it also established the budget so how much the debt is going to be the bank managed the payment of the debt and fiscal policy of course that also needed to be financed but that was not the central bank role and of course creation of rules and regulations regarding banks these were jobs of the treasury implementation of these rules was the central bank job so nixon shock occurred in 1971 again the same dynamic the war vietnam war needed to be financed and so i think that i have omitted something which is yeah one more slide here basically in this period from 44 to 71 we have Bretton Woods in 1944 it became clear to everybody that gold standard cannot be restored they met and they said what's going to be the post war World War II was winding down and it was going to end soon and so people said that after the war we are going to have a trading system so what's it's going to be it cannot be the gold anymore so at that point they said that let us actually canes had come in with a very nice plan for international trade but that plan was not accepted because it didn't give any favor to the powerful countries and the alternate plan that was put into effect was that okay some countries have gold principally the USA and so we will use instead of the gold standard what was called the gold exchange standard so we will use currencies which can be exchanged for gold so the countries like USA and some other so called hard currencies promise to redeem their currencies for gold but under strict conditions first of all one of the things was that it was not freely and first of all in the USA they banned the public from using gold or even from converting to gold and they even banned private parties could not go to the central bank and ask for gold but the governmental transactions could be done in gold basically that was the thing that if the central bank of some countries says that I have a lot of pound sterling and I want gold for that so then the government and a government to government basis the UK would supply gold so all the other people they would use pounds or dollars and so these are the countries that could be exchanged for gold and these could be held as reserve currencies so instead of gold especially the poorer countries of the world they would use the currencies of the hard currencies and mainly they would use the hard currencies of their principal trading partners so in the British colonial era actually the pound was king but in the interval period the dollar took over as the central currency and so all over the world basically the dollar started being used as the reserve currency but the idea was that dollar is just a symbol of the gold that is behind it so this gave an enormous power to USA in the sense of it would be able to print dollars and when you print dollars it's basically printing gold so in the Bretton Woods also there was an agreement that the governments would be responsible for not printing over many dollars but basically in the Vietnam war the USA had enormous amount of budget deficit and they printed lots of dollars and then General De Gaal threatened to cash some of these dollars and so to prevent that Nixon announced that dollar would no longer be converted for gold and suddenly we were in the free floating era currencies are not tied to anything so in this period then monetarism of freedmen was tried and basically it failed the basic theory of monetarism is that the money supply in the economy is a multiple of the reserves this was actually introduced by freedmen freedmen restated the basically monetarism had been discredited by Keynes and Keynes was the dominant philosopher his economic theory was the dominant philosophy Keynes himself had a very radical philosophy in economics which was suppressed in favor of the new classical synthesis but even in the new classical synthesis money has a short term impact on the economy but in the long run money is neutral so and that was all based on quantity theory that the level of prices in the economy is a multiple of is just proportional to the money supply and money is proportional or multiplier of the reserves so basically that means that the central bank controls the reserves so this is called a theory of exogenous money as opposed to this there is endogenous money which means that money is created by the private sector according to the demands of the economy so you don't have any control over money so the freedmen rule was that since money is the multiple of reserves we just keep the reserves growing at a fixed amount this should be first of all you need to make sure that money grows at least at the rate of growth of the economy technically if the economy is growing at 3% and you grow the money supply at 3% then you have zero inflation and you have exactly enough money for the needs of the economy so that would be perfect but because of price rigidities some prices cannot go down so if you allow inflation to happen then what will happen is that the real price will automatically go down even though the nominal price is fixed and so that will allow the economy to equilibrate so a certain low amount of inflation is good for the economy so freedmen said that keep the reserves going at 6% the economy will go at 3% and the inflation will be 3% also and this will create a fixed and known rate of inflation this was based on what we have already discussed a misunderstanding of gains that unemployment is caused by many illusion so this fixed growth rule will create price stability financial stability and growth by ensuring full employment because of lack of many illusion so this was the idea of the freedmen rule so wocher announced that I am going to follow this rule for the moment and this failed because it created the greatest depression it did bring down the inflation rate but it also caused a huge amount of depression wocher kept thinking that this is a short run phenomena and it will wipe out but it did not also wocher could not control the money supply he tried to control the reserves but the ratio between the reserves and the actual money was very erratic and that is because credit creation by banks is not regulated by the central bank and when the economy is booming they create lots of money when it is going into freefall they contract the money supply so after the freedmen rule failed there was a search for new ways to conduct monetary policy obviously the freedmen method does not work by the way freedmen gave an interview in 2000 something and he was asked what did we learn from the so called monetarist experiments in the US and UK in the start of 1979 wocher was in 1979 he came in and basically in early 80s we had monetarist experiments everywhere which failed so what did freedmen say in response to this so he freedmen said that the monetarist experiment was in 1979 when wocher announced that he was going to take the quantity of money and not the interest rate as his guide but he didn't do it we look at the monetary aggregates they are more variable during the wocher period than any of the previous time in history so he did not follow the monetarist course so according to him because the money supply was not growing constantly at 6% so wocher did not follow freedmen's rule and so if you look at 1980, 1980, 1985 you say that the aggregate monetary growth has come down and with it has come inflation so basically he says that inflation is purely monetary and that's proven by the data so this is a very perverse way of looking at what happened actually but the reason to say this is that this is one reason why text book continue to teach this failed theory of the multiplier I was going to give you the 2014 reference here but again I failed to do that the Bank of England has published finally admitted that this is the multiplier is wrong so even though what I am saying is that the monetary experiment was a spectacular failure this was something that was known to all central banks they understood that this things don't happen this way but this knowledge did not make it from the experience and policy to the text books for some reason it was misunderstood and misinterpreted so the idea that the world has confirmed the inflation is monetary is actually exactly the opposite of what has happened in that period because over that period all the monetary equations failed and there was a huge amount of discussion as to why this relationship the money demand which was stable up until the 70s has become unstable and finally because nobody could get a money demand equation to fit this was quietly dropped and as I said Richard Werner has alternative theory called the quantity theory of credit it says that basically if you take this credit creation by banks into account then you can make the quantity equation work and that fits in with the story that we have been saying that the reserves by themselves are not enough because the reserves are used to do credit creation and credit creation is a very important part of the story and if you take that into account then you can make the quantity equation work also you have to take into account the prices of stocks and the prices of land this is omitted from the standard consumer price level does not include the stock prices and does not include land prices usually so that's why the inflation index doesn't capture all of the places where the money is going and the money quantity does not capture all of the places where the money is being created so once you take both of those into account then you can get back into the quantity equation fit which is not available otherwise so once it became clear that the freedmen rule doesn't work then there was a search all over the banks for a way to do alternative method to do monetary policy and basically Roger Douglas was minister of finance and he said to the New Zealand central bank that he wanted the inflation to be brought down to between 0 and 2% now the New Zealand bank was actually quite happy because they had brought it down from 16% to 5% and that was a good accomplishment but Roger Douglas said that no that's not good enough and so New Zealand said ok let's see what we can do and they created this idea of inflation targeting that ok we want the inflation to 2% how can we do it they succeeded by using the discount rate actually the interest rate was in widespread use all over because it became clear that the interest rate is not enough sorry the reserves are not enough but still the goal seem to be to control the money supply that is the banks you were trying to achieve monetary targets that let the money increase at 6% as per freedmen rule so New Zealand said why control the money why not control directly the goal the object is the inflation rate so instead of controlling the money supply in order to control the inflation rate which is what freedmen says which doesn't work let's directly go for inflation targeting and so they managed to succeed in bringing the rate and that made clear to everybody that this is a goal which can be pursued and which works because the MMT idea is that even if you can announce it and even you can make it work by crippling the economy that doesn't mean it's a good thing that's because you can announce an inflation target and achieve it doesn't necessarily and to achieve it if you have output losses and employment losses so this is not a good idea once inflation targeting became the standard then this question of operational independence for the central bank became important there are many reasons why independence of central bank is just impossible because central bank provides money to the government it has the monetary policy fiscal policy has to be coordinated many decisions of the government have to be supported by the central bank but if the central bank is seen as a part of the government then there is no credibility for inflation targeting and one thing that was realized over the decade of the 80s was that public expectations are very important and one has to manage these expectations so if the central bank is not independent then the minister of finance has a lot of pressure on him especially prior to elections there is always a demand for lots of spending and that will lead to inflation also the national debt is very high and payments on the national debt depend on the interest rate and so there is a pressure on the minister of finance to keep the interest low that will give him more fiscal space so central bank operations in public sector debt and in setting the rate have a direct impact on the fiscal space of the government so if you have a central bank under control of the treasury then they will have this conflict of interest so what to do something for the which is good for the inflation might be harmful to the budget balance of the government itself so if you want to use inflation targeting then you have to have operational independence because otherwise that bank will not be able to announce credible targets now when financial deregulation took place in the 1980s then one thing that happened was that the bank started issuing more and more credit and so the capital ratio declined by a lot which means that basically what is the backing that you have for the credit that you are extending so in that regulated times the ratios were quite high because they were kept high by law but once you deregulated the banks the banks started to issue credit with very little backing and that obviously led to more and more crises because if you have small amount of reserves and large amount of obligations then any time that a lot of obligations are coming in then you enter into a banking crisis so as we saw there were no banking crisis until the Nixon shock but after the 70s, 80s, 90s we have had lots of banking crisis and increasing number there was an IMF paper listing more than 300 banking crisis so you have to actually define exactly what a crisis is and there are many ways to count but basically you can show that as deregulation has increased the number of crises have also increased there was one big crisis MAB, Mexico, Argentina and Brazil in which there were major defaults on these sovereign debts and that led to the realization that we need to have some rules and especially rules for international lending because these crises would occur in across countries and would have effect across borders the Mexico crisis led to the savings and loan crisis in USA the savings had deposited money in Mexico to earn high interest so when Mexican debt collapsed there was a so there was the Basel Accord of 1988 that was the first meeting of the international bankers and they set up some capital requirements at least you have to have so much capital in order to make loans and many other rules and regulations and then an attempt by banks to self-regulate this was the standard Freedmanian theory in operation that instead of government regulations what we need is that the private sector has incentive to self-regulate to make sure that it doesn't go into crisis since then this didn't prove very successful there have been a lot of more crisis and accordingly this agreement has been revised to Basel 2 and Basel 3 I think they are going for Basel 4 in the near future but self-regulation doesn't seem to work for obvious reasons reasons which are obvious to those who have studied Minsky so from 1988 after Basel 1 to 2007 the central banks were in self-congratulation mode they said that we have now solved the problems inflation is under control as Freedman said and that was the main problem so we have price stability because of price stability we are having a natural rate of unemployment so yes it's high but that's what the economy is supposed to be like we have the great moderation business cycles have been tamed and Lukas said that we have learned to prevent recessions it all came apart in the global financial crisis of 2007 Bernanke said that we know how the great depression happened he was speaking in absentia to Freedman and said we won't let it happen again because we know the reason so he did follow his master's voice and injected trillions of dollars into the system basically Freedman's diagnosis was that the great depression happened because of insufficient liquidity so liquidity was there but unfortunately it didn't work the great recession happened anyway so basically all of the central monetist positions were rejected by the experience although macroeconomists still haven't learnt this lesson just like we have discussed so now what is supposed to happen after the global financial crisis what should we be doing there is a lot of disturbance in central banks it's clear that basically one of the things and I think the article that I read now central banks have become philosophers previously they were just short term managers now they are thinking what's our role in life what's our goal and purpose but it's clear that short term management is not enough we just prevent make sure that the stock markets don't decline tomorrow which is the green span put and let the private sector self regulate just make sure that no crisis happens today so first one thing we saw that price stability does not guarantee financial stability the private sector can blow up even though inflation is under control and there is the great moderation all prices are predictable so the idea was that when you have a predictable economy then the private sector now only the problems that arise in the private sector management come from unpredictability and unpredictability comes from these shocks and these shocks also include government policy shocks so the whole source of the problem is outside inside the system is sable so we saw that all the outside shocks were not there but the private sector by itself blew up the economy and that's exactly the Minskian theory so now everybody understands that there's need to manage the long term risk to the system and perhaps inflation targeting is not the goal although the current consensus is that inflation targeting is fine that's what's needed but we also need what is called macro prudential regulation we need to have basically more of the basal accord we need to make sure that the banks don't misbehave so that crises don't happen but otherwise inflation targeting is the right goal so modern monetary theory offers solutions but rather different from what the mainstream macro is by the way I gave a talk on these ideas at the state bank on Thursday so I said that after teaching this course I've changed my mind about these because at the beginning I was a skeptic I was just studying MMT to understand what it is without having in fact I wasn't sure I thought that it had some good things and some bad things mixed in it but now I've become a convert this is a good approach so what are the solutions that modern monetary theory offers us well the key thing especially I was talking at the central bank so I tried to isolate those things which would be easily understood by people who are generally hostile to the idea so I didn't focus on the idea that government deficits equals private surplus which is actually the central idea and very important but that is really exactly the opposite of what is thought so you don't want to when you want to change ideas you don't want to attack at the heart and you want to chip at the periphery where you won't meet such strong resistance so the most important idea is that the deficit hawks don't want to spend too much money so that's the operational implication of the idea that deficits don't matter so that case can be made separately and logically and cleanly so I focused on this as a strategy and I'm telling you this because you will also need to use strategy if you want to discuss MMT in hostile environments and today actually environment is very hostile there is a big debate taking place on MMT and I think that Stephanie Kelton who is a major MMT here is advisor to Bernie Sanders and so the debate is taking place precisely because there is some danger that if they come into power they will implement these policies big names have taken part shots at MMT so here is where we say that suppose that government has balanced budget or some level of deficit now we spend some more money so what's the standard theory which comes from the supply side perspective that the amount of output is fixed and so when you spend more money by deficit spending then inflation will happen but suppose you spend money on a project which creates more output suppose you hire people and you have them plant trees then these trees can be fast growing and they can be harvested and that will create wood so it creates output so if you have more money and more output then you can't say that it's inflationary if you look at the equation mv equals pq the idea is the velocity and quantity is fixed so if money goes up then prices must go up but suppose that as money goes up quantity also goes up then there is no implication for prices so the real business cycle thinking is this is called the classical dichotomy that the real sector is divorced from the monetary sector so what happens in the monetary sector is just that it affects the prices and in the real sector things are separate money is a veil if you increase the money you can't increase output this is what prevents classical economists from thinking along the lines that I'm saying and why because you're automatically at full employment so there are no unemployed resources what I'm saying is that let's print some money and give it to the unemployed and make them produce something all of this is inconceivable in the classical and new classical framework because everything is already fully employed so you're already at full output so the quantity cannot increase so this is exactly what Keynes said in the general theory that the classical theory is a special theory which applies to the case of full employment economies and his general theory applies to a case where you have unemployment and employment so there are these projects which self finance in the sense that you spend money on them then they create output and the output pays back for the money that you spent so this is a practical implication so basically the idea is that in Pakistan we have millions of people who are unemployed so there is a huge output gap if these people could be employed so the question arises let's give them all jobs so the question arises where will the money come from so we say that well you see the government issues an IOU and we print money on the base strength of this IOU and we give this in jobs and when they earn money when they produce output this will pay back the loan this is actually to convince the deficit hawks so not necessarily the correct line of argument in fact the correct line of argument comes from your model where these people do nothing but the printing of the deficit money leads to raised aggregate demand and that also leads to increased aggregate output which also pays back for the money so it's a strange mechanism it's not obvious I mean the obvious mechanism job guarantee is that you give money to people and they work and they produce more output but actually they buy when they spend money that raises the aggregate demand and when you raise the aggregate demand then the producers produce more and so the money ends up leading to additional output but not in the way that one might think so the key recommendation which comes out of the MMT framework is that we should use unemployed resources to add to output and we can print money to do whatever is necessary we are not constrained by lack of money so this is the main thing that the fiscal people all over Asid Umar وقار مصود and everybody else says that there is no fiscal space our budget is we have a revenue which comes from to the government and now we are spending so much on interest and so much on army and there is very little money left for us to do developmental projects so this argument is wrong because you can print more money and so people say well if you print more money then that will lead to inflation we say you know you print the money in a smart way we print money in such a way that it leads to more jobs for more people and that will create more output so if you have more output then you can't say that you have more inflation but in order for this to work you have to make sure that the people that you hire actually add to output so in the steel will it is said that it was got destroyed because the popular government gave jobs to everybody and they didn't have to do any work they just showed up to get the money so if you do that then you might create inflation what you need to do is to create productive jobs so once you do that it's possible to create massive increase unemployment without the concern that deficit will rise most important among these tasks is to build infrastructure, roads, houses lay grid lines how did Dubai develop our unemployed laborers who have no skills we can do exactly the same thing in Pakistan we don't have money but actually we need to build million houses we need to build roads and all of this can easily be done by an employed unskilled laborer we need to give them a small amount of training and then they can so all of these jobs are there all of these laborers are there and why it's not happening we don't have money this is a silly macro theory but this is widely believed in addition to these there are today green jobs planting trees retrofitting houses we have all of these geezers outside the house which are very cold and all you need to do is to cover them up to make sure that they are insulated so that you don't spend heat to heat up the atmosphere and then these pipes are running outside the houses and so they are ice cold and so the first thing that happens is that these ice cold pipes become hot and if you run the pipes properly through the inside of the house they will not get so cold there are many things that you could do so basically any re retrofitting to make the houses more energy efficient something which is being done in Switzerland and it can also be done here so there are all of these jobs that are available which are productive which will save the and so just financing this job training people to do these jobs and getting them to do is a win-win proposition it will massively improve the economy but there is no fiscal place to do this so now actually that's the big picture but to actually implement this requires a lot of detailed work so suppose I give I pump trillion rupees into the economy by providing jobs to millions of people and launching enterprises and many other things that can be done so what will happen you need to do the calculations who will get the money and then what will they demand so one of the things that they will demand is food so you want to make sure that some of this labor is going into the agriculture they should be able to plant foods there are many projects like people have done like in cities they ask people to give part of their land people have large lawns to produce vegetables so people come from the outside plant vegetables and take them I was in my neighborhood there was some Chinese people who rented the house and in front of the house you have a very small square plot of land and they grew enormous amount of vegetables of strange types in a very small space because apparently they know how to do this in China so you can grow a lot so basically it's easy to do to create more food so that will be one of them but what you need is actually what is called input output tables if you produce one ton of steel this feeds into some sectors and it requires some inputs from some other sectors so basically when you pump money into a sector you have to see what are the linkages with the other sectors where will this money go so this money will go into demands for certain types of goods and it will also create supplies so this will unbalance your economy now you need to make sure that you can take care of these things so you have to anticipate the demands that requires basically detailed knowledge detailed knowledge of the linkages of the economy what we have seen from Minsky is that in order to stabilize the economy you need a big government so what's going on here actually Russian economy the command economy was working like this they had these plans and they had these input output tables and they said ok we are going to produce so much steel and so much cotton so much corn and so on all of the things that were determined by the state and it collapsed because the state did not have right level of knowledge and information about the demands in the economy so it was decided correctly that they should move towards private sector methods of production because that creates the right incentives but actually what is needed is a mix suppose you want to create a million jobs the government simply does not have the capacity to do so it can say ok everybody we will hire everybody in the steel mill but it will not be able to put them to work so what you need is private public partnership you can't get rid of the government the government will finance and can't get rid of the private sector either and the government has to collaborate you have to look at where in the private sector there is excess capacity if there is none as the people say then you have to look at where you can build the capacity and all of this can be done provided that you have the right mindset the problem is that people don't have the right mindset but the mindset is that first we must get growth when we have growth then we have lots of money when we have lots of money then we will hire the people and we will feed the people so this is exactly the opposite of what is needed and with this mindset you can never get anywhere and the basic obstacle and the problem in the path of doing all of this is political if you give jobs to all the people if you have prosperity the power will shift dramatically today actually is very much and in a drawing room conversation people were talking about educating the poor so one of the ladies said that where will we get our servants if everybody gets educated this was a serious concern so this is true that there are no private servants except for millionaires in the USA if everybody is educated everybody has jobs then the upper class will suffer they will have to make their own chai now it's very interesting that south came and gave me the chai normally it would be a naib khasid I have been trying to get rid of naib khasid when nobody agrees because they said that who will make our chai so we say we can put in a naslai machine and everybody can go and that's how when I was in the US there was a coffee machine and you go to the coffee machine you put in your styrofoam cup and you make your own cup it doesn't take any effort but people are so this kind of the problem is this is a joke but the problem is the political one that there is an elite upper class they have power if you devolve power this is why all efforts at devolution have failed many people have realized it and they have been many efforts so this devolution is meaningless going from federal to province doesn't mean anything devolving power to the people means that you go to the communities and you give them budgets and you give them their own projects and you let them do things so today you get lots of multi million rupee projects which fail at the planning commission and the main reason for failure is that there is no ownership who writes up the project the secretary of the bureaucrat they say this place needs a hospital so we have a hospital project but the project needs to be driven by the community if there is a community they say that we want a hospital and they should go and design the project and they run the project then it will be successful and it will be very ownership there will be people who want to make it work and they will try to get around the obstacles so this kind of thing requires public-private partnerships the community doesn't have the money to carry out big projects the government has the money but not the skills nor the incentives so this is what is needed