Some notes on the political economy of central banking

EpsteinPolEconofCentralBankingI have just finished a very useful collection of some of the papers of economist Gerald Epstein, entitled The Political Economy of Central Banking. Epstein is Professor of Economics and Co-Director in the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst in the US, which is known for the progressive research agendas of its members.

Rather than write a lengthy review, this post sets out some of the key points made in the book and which stood out for me as being original and important. Epstein’s focus on central banks (CBs) remains especially relevant in today’s world of increased inflation and CB efforts to return it to target rates.

  • Epstein argues that CBs, especially the US Federal Reserve, are not as independent as they make out and tend to be captured by a variety of vested interests. In today’s financialised economies, many are predominantly influenced by the financial sector, particularly since its liberalisation, expansion and rising power and influence since the 1970s and 80s. Thus they tend to serve finance and support financial sector profits more than industry/industrial profits and workers/wages and employment.
  • Historically, CBs have often played a more developmental role at various times and in various countries, supporting industrial expansion and allocating credit to more productive sectors in order to encourage economic growth rather than financialisation.
  • Epstein argues that major reforms to CBs and the economy more broadly are needed today to democratise CBs and make them more accountable to society as a whole, so that they better serve the public good and not simply the financial sector. They need to play a larger role in supporting employment in the macroeconomy and industrial growth, especially in driving the green transition which is so vital to building a more sustainable economy.
  • CBs should be more accountable to society eg. to Congress in the US, and their boards and staff more generally should reflect the wider society and economy, including industrial and labour interests.
  • Monetary policy in the form of changes to interest rates have distributional impacts and are therefore political. Thus no CB can be truly ‘independent’ and free of partisan influences and political outcomes.
  • The financial sector, industry and labour (as classes or sectors in the economy) are impacted differently by monetary policy in terms of their respective income flows in the form of profits and wages, as well as their borrowing and servicing of their stocks of debt.
  • Lower interest rates may stimulate industrial investment, economic growth and employment, but can lead to a profit squeeze if the labour market becomes sufficiently ‘tight’. They may also inflate asset prices and boost financial profits. However higher interest rates can also boost financial profits and rentier incomes.
  • Epstein contrasts speculative finance with enterprise finance as two different sets of relations between the financial sector and industry. Speculative finance, more dominated by capital markets, may mean that the two sectors operate further apart and with more conflict between their respective economic aims, while enterprise finance means that banks and industry are more closely connected and cooperate in the service of expanding longer term productive investment and profitability. In a more financialised economy, industrial firms may themselves become more like financial institutions, with potentially detrimental impacts on economic performance. These varying relations, which can also be seen as different class coalitions, may alter their members’ preference for tight or loose monetary policy on the part of the CB. Varying degrees of conflictual and cooperative relations between industry and labour can do likewise.
  • Epstein questions the evidence that sustaining very low inflation, the remit of independent CBs, is a precondition for robust economic growth. He suggests that moderate inflation can be positively associated with growth and that overly tight monetary policy can damage growth performance over a significant period.
  • Quantitative Easing (QE) since the Great Recession of 2008-09 in the US has increased inequality through the inflation of asset prices, and despite some positive impact from increased employment, this has been offset by wage stagnation for many in work. However, an absence of QE and higher interest rates could also have increased inequality by reducing employment growth apart from its other effects. This paradox suggests that more wide-ranging progressive policy responses are needed to reduce inequality in the US and elsewhere, such as changes to labour market regulation and a higher minimum wage, as well as the effective use of fiscal policy.

Epstein’s contributions in the book are varied, original and interesting. His ideas are founded on a political economy approach, so that economics is necessarily seen as political. Particular class configurations in society therefore play a role in determining institutional and policy change, and for the author, CBs can never be ‘independent’ of them. This has major implications for the economy. In a more financialised world, the finance sector itself has become a more powerful influence on CB policy in many countries, and for Epstein, this has had detrimental effects on economic outcomes. The interests of labour in terms of employment and wages have in many cases been neglected in the service of finance and financial profits.

The reforms to CBs that the author proposes are an attempt to democratise aspects of finance and monetary policy so that they better serve the wider society and economy. The aim is to support employment and rising living standards for the majority, and this requires reforms that go beyond CBs alone, with changes made to the financial sector as a whole so that it better supports non-financial business investment. CBs and finance more broadly need to play a more developmental role, as they have done at certain times throughout history. Given the current need for massive investment in the transition to a green economy, there is a case to be made for a comprehensive progressive policy agenda which supports this.

CBs have been called upon to play such a role during episodes of national emergency, such as wartime. In these kind of situations, some of the ‘normal’ rules of capitalism have been suspended in order to focus on a huge collective effort. Repressed interest rates, the state-led allocation of credit to vital industries and price controls have all come into play when needed. A return to more peaceful conditions has tended to see such interventions set aside and a return to freer markets and a less regulated private sector.

Today the global economy faces multiple major challenges which have increasingly called for the state to play more of a role in securing the public good. These include, not least, maintaining political, social and economic stability as nations are battered by a variety of shocks, from the pandemic to war, climate change and inflation, as well as geopolitical instability and a global order under threat of fragmentation as a particular form of globalisation evolves in an uncertain fashion. In understanding and responding to all of this, CBs and their actions are a key part of the institutional and policy makeup. Epstein’s work on the political economy of central banking offers a richer, more comprehensive and more progressive contribution than a purer and narrower mainstream economic approach.

Many Middle Ways: stakeholder capitalism – recasting Keynesian political economy

Will Hutton is a political economist, author and journalist of the left, whose book from the mid 90s, The State We’re In, was a surprise bestseller in Britain. It was highly critical of the direction the economy, society and politics under conservative rule were taking at the time, and made a powerful case for an institutional revolution which he argued was essential to fundamentally improve the country’s economic performance alongside its social cohesion, in order to achieve ‘the good society’.

Tony Blair’s ‘New Labour’ came to power in 1997 and, while Blair himself had initially been drawn to Hutton’s ideas in the form of ‘stakeholder capitalism’, his new government was in the end politically to the right of this programme. Hutton is no socialist, but he has been arguing passionately for years for a comprehensive recasting of Keynesian economics and social democracy. In the spirit of my series of posts on the many middle ways possible under capitalism, Hutton’s progressive and leftist ideas are worth exploring. Continue reading

Michael Hudson on social progress and mythical stages of development

hudson-200x300Some more extracts in this occasional series from Michael Hudson’s J is for Junk Economics. Here he aims to take apart modern notions of progress and of financialized capitalism as somehow the most efficient form of socioeconomic system.

Progress: Today’s word “progress” has degenerated from its 19th- and 20th-century meaning of democratic reform. Every process of social decay euphemizes itself as progress, as if moving forward in time is invariably upward, not retrogressive. So there is “real” progress and false progress. The neoliberal ideology favoring rentier income over wages, deregulation, financialization and privatization over public investment is antithetical to classical political economy’s definition of social progress as replacing feudal privilege with progressive income tax and regulatory policy promoting greater equality of opportunity and income, mainly by taxing economic rent and windfall to property and financial gains.

Theories of progress treat the debt buildup as cumulative and irreversible, in contrast to ancient society’s idea of circular time with periodic financial clean slates to restore economic balance from outside “the market”. Without debt cancellations, economies evolve into oligarchies, which depict their takeovers as “progress” and thus as morally justified on the ground of its seeming inevitability.” (p.184)

Stages of Development: The idea that history has been moving inexorably toward the present distribution of wealth and income, assuming (by tautology) that today’s status quo must be the most efficient and hence “fittest”. The hypothesized stages of development usually are arrayed in sets of three, eg., from agriculture via industrial capitalism to “postindustrial” finance capitalism, culminating in today’s dominance by financial planners – as if this is the end of history, not a retrogression to feudalism.

Most concepts of “stages of development” get the actual sequence backward. Headed by the Austrian School, 19th-century monetary theorists speculated that economies evolved from barter via a money economy to a credit system. This misses the fact that the Neolithic and Bronze Age Mesopotamian economies were credit economies. As planting and harvesting developed in the Neolithic, credit became necessary to bridge the time gap for expenses incurred during the crop year (such as ale to drink and agricultural and public services, typically to be paid for at harvest time).

All three “stages” are usually found simultaneously. Economic historian Karl Polanyi’s (1886-1964) “three stages” of market development, for instance, distinguish reciprocity (gift exchange) and administered prices from market exchange at flexible prices. Even in today’s economies, individuals still reciprocate meals, gifts and other social obligations.

Money developed gradually as a means of denominating and settling crop debts, most of which were owed to the temples and palaces. Rulers set prices for grain, silver, and other key goods and services to enable debts to be paid to these large institutions in these commodities (“in kind”).

The volume of debt grew so large under Rome’s oligarchy that the fiscal and monetary system broke down for the vast majority of the population. Except for the narrow warlord-landlord layer, economic units were obliged to become locally self-sufficient. The Western Roman Empire deteriorated as silver and gold were drained to the East. Debt deflation, austerity and collapse are thus the final stage of debt-ridden economies. This makes the “credit” or “financial” stage a transition to economic collapse and reversion to barter, unless political decisions from “outside” or “above” the market check rentier power to create a more stable and equitable social arrangement. That requires debt cancellations to bring an economy’s debt overhead back within the ability to be paid.

Nearly all modern “stages of growth” theories deny the basic principle that defines “the final stage” of financialization: debts that cannot be paid, won’t be. Either a clean slate or a lapse into debt serfdom is needed to end the preceding cycle and inaugurate a new takeoff or recovery.” (p.213-4)

Productive versus unproductive labour: Michael Hudson on the creation of value

Where do we define the boundaries of productive activity in the economy? As Mariana Mazzucato argues in The Value of Everything, the ‘production boundary’ has changed over time throughout the history of economic thought until the present, in which mainstream neoclassical economics considers anything priced by the market to be a source of value, amended by the possible presence of market imperfections. She wants to rekindle the debate on the sources of value in economics, with the state as a potential co-creator of markets and innovative activity and, hence, economic value.

hudson-200x300I have already posted on Mazzucato’s book here, so here is Michael Hudson’s take on the issue, from his J is for Junk Economics (p.182-3):

Productive vs. Unproductive Labor: Defining productivity is fairly easy when the measure of output consists of uniform commodities: steel, crops or automobiles produced per man-year. But today’s National Income and Product Accounts (NIPA) define the productivity of labor by Gross Domestic Product (GDP) per work-year, regardless of whether it produces commodities, financial “services” or simply makes money by zero-sum speculation.

Goldman Sachs’s Lloyd Blankfein has bragged that his firm’s partners are the economy’s most productive individuals, as measured by the huge amounts of money they make. This reasoning is circular: it claims that people are paid according to their productivity as measured by their wages, salaries and/or bonuses – which are assumed to be paid in proportion to their productivity!

But what about economic activity that is merely extractive and predatory? Value-free economics abandons the classical definition of productive labor or investment as that which produces profit on “real” production. At issue is what is real and what is mere overhead.

Adam Smith and his followers defined labor as productive only if it produced commodities for sale. That was in an epoch when most services were performed by servants (maids, butlers, coachmen and other employees of the wealthy) as consumption expenses. This personal employment was deemed to be part of the rentier class’s overhead. Church officials, government workers, the army, tutors and teachers or other professionals in what today is called the non-profit sector also were deemed unproductive.

To Karl Marx, labor under industrial capitalism was productive to the extent that it produced a profit for its employer. He pointed out that even prostitutes were productive – of a profit, if employed by their madams, just as steel workers were productive of a profit to mill owners. His 3-volume Theories of Surplus Value reviewed the classical discussion of productive labor, value and price.

From the classical vantage point, rent extraction, debt leveraging and related financial overhead is not part of the economy’s necessary core, and thus would be viewed as a subtrahend from “real” output and productivity. Post-classical economists stopped distinguishing between intrinsic value and market price so as to avoid the critique of land rent, monopoly rent, and financial and other rentier charges as undesirable overhead.

After Russia’s 1917 revolution, Soviet statisticians reverted to Adam Smith’s definition of physical productivity: material output per worker. Their non-capitalist society had no rentier class, and the state did not charge interest or rent, so no implicit rent-of-location or cost of capital was measured in their national income statistics. These exclusions left Russia somewhat naïve when it opened its economy to the West in 1991, not realizing that the main aim of neoliberal investment was rent extraction from natural resources, land and monopolies.

The postindustrial epoch in the West itself has seen industry turned into a vehicle to extract economic rent and interest, and to make “capital” gains from asset-price inflation as a “total return” on equity. From the classical vantage point of the industrial economy at large, this is an overgrowth of unproductive investment. The quick collapse of Russian manufacturing after 1991 is an object lesson in the effect of replacing industrial productivity with rentier asset stripping.”

Michael Hudson on Wall Street

JisforJunkEconHere is another extract from Michael Hudson’s iconoclastic ‘dictionary’ J is for Junk Economics. This time he takes aim at Wall Street (p.243), though the following could be applied to some other major financial centres.

Wall Street: Replacing government as the economic planning center on behalf of the FIRE [Finance, Insurance and Real Estate] sector, Wall Street is the major source and sponsor of financial overhead. Its business plan is to load corporations, households, real estate, natural resources and government with enough debt so that all profit, all wages above basic and subsistence needs, and all rents will be paid to banks and bondholders as interest.

Financial short-termism is a distinguishing feature of junk economics. Corporate income is used for stock buybacks and higher dividend payouts instead of for new capital investment. Political contributions support politicians who vote to harden pro-creditor bankruptcy laws and sponsor regulatory capture to block prosecution of financial fraud. The resulting debt deflation slows economic growth, as debt service absorbs a rising proportion of personal and corporate income.

Wall Street’s business plan is thus inherently self-destructive. A financial crisis can be averted only by an exponential creation of new credit to fuel more asset-price inflation, enabling debts to be paid by borrowing the interest against collateral whose price is being pushed up by easier bank loans. To defend subsidizing the rising debt overhead and bailouts of banks and bondholders, Wall Street has become the major political campaign contributor, and also the major sponsor of junk economics that blames the victims (debtors, labor, immigrants and foreigners) instead of the debt creation and tax favoritism that increase the rentier wealth of the One Percent.”

Too much finance – misallocation, corruption and ideology

800px-A1_Houston_Office_Oil_Traders_on_Monday“[T]he financial sector has become much more profitable than the non-financial sector, which has not always been the case. This has enabled it to offer salaries and bonuses that are much higher than those offered by other sectors, attracting the brightest people, regardless of the subjects they studied in universities. Unfortunately, this leads to a misallocation of talents, as people who would be a lot more productive in other professions – engineering, chemistry and what not – are busy trading derivatives or building mathematical models for their pricing. It also means that a lot of higher-educational spending has been wasted, as many people are not using the skills they were originally trained for.

The disproportionate amount of wealth concentrated in the financial sector also enables it to most effectively lobby against regulations, even when they are socially beneficial. The growing two-way flow of staff between the financial industry and the regulatory agencies means that lobbying is often not even necessary. A lot of regulators, who are former employees of the financial sector, are instinctively sympathetic to the industry that they are trying to regulate – this is known as the problem of the ‘revolving door’.

More problematically, the revolving door has also encouraged an insidious form of corruption. Regulators may bend the rules – sometimes to the breaking point – to help their potential future employers. Some top regulators are even cleverer. When they leave their jobs, they don’t bother to look for a new one. They just set up their own private equity funds or hedge funds, into which the beneficiaries of their past rule-bending will deposit money, even though the former regulators may have little experience in managing an investment fund.

Even more difficult to deal with is the dominance of pro-finance ideology, which results from the sector being so powerful and rewarding to people who work in – or for – it. It is not simply because of the sector’s lobbying power that most politicians and regulators have been reluctant to radically reform the financial regulatory system after the 2008 crisis, despite the incompetence, recklessness and cynicism in the industry which it has revealed. It is also because of their ideological conviction that maximum freedom for the financial industry is in the national interest.”

Ha-Joon Chang (2014), Economics: The User’s Guide, Penguin Books, p.306-7.

Don’t Be Evil. Rana Foroohar on Big Tech

The FT’s Rana Foroohar discusses the ‘evil’ side of ‘Big Tech’. She is pushing her new book, but it is an interesting interview which touches on a range of issues relevant to the economics, business, politics, finance and culture of this increasingly all-pervasive phenomenon.

Foroohar has also written on the dangerous and distorting power and influence of ‘Big Finance’, which has become known as financialisation and has generated a large and growing literature among political economists, particularly those writing in the Marxist and post-Keynesian traditions.

Financialisation is a problem for capitalism. Is socialism the solution? (Part 2)

In this recent post I outlined some of the ideas in Grace Blakeley’s new book Stolen – How to Save the World from Financialisation. Her answer to the apparent political, social and economic problems with financialisation under capitalism is a transformation towards democratic socialism, starting in the UK and spreading across the world.

In the book she describes a range of policies that would, she hopes, encourage such a trend: a Public Investment Bank; a People’s Asset Manager to encourage the spread of public ownership; an ambitious Green New Deal; changes to corporate governance so that a much wider range of stakeholders are more closely involved in decision-making, not only in non-financial corporations, but also in banks and including the Bank of England. She also argues for the restoration of trade union power and influence, the refinancing of private debt and much tougher regulation of private banking, to encourage definancialisation domestically and ultimately globally. Continue reading

Financialisation is a problem for capitalism. Is socialism the solution? (Part 1)

GraceBlakeleyStolenThe rise of finance across the world economy in recent decades and its spectacular fall from grace as the crisis of 2008 unfolded has given birth to the notion of financialisation in academic circles, particularly among heterodox economists. Grace Blakeley, economics commentator for the New Statesman magazine, research fellow at the IPPR think tank and a rising star on the radical left here in the UK, has written an accessible book which attempts to make sense of this phenomenon and attempts to overcome it. Stolen – How to Save the World from Financialisation is aimed at the intelligent layman rather than being an academic work.

In the book, Blakeley explores the recent history of financialisation and the increasing power of finance in society and its damaging economic, social and political impact, focusing mainly on the UK. She also proposes a solution: democratic socialism. In two posts, of which this is the first, I explore some of the thinking in the book and elsewhere on financialisation and its consequences, as well as potential solutions which aim to mitigate or remove its deleterious nature. Continue reading

Inequality in the OECD: causes and policy responses

Inequality has become a ‘big’ topic in recent years, of concern both to economists and the public at large. This is exemplified by the popularity of Thomas Piketty’s Capital in the Twenty-First Century, and many other works. I have written on some of these studies here.

They continue to be churned out: in the July issue of the heterodox Cambridge Journal of Economics, Pasquale Tridico of Roma Tre University analyses the determinants of income inequality in 25 OECD countries between 1990 and 2013. He finds that ‘financialisation’, increased labour market flexibility, the declining influence of trade unions and welfare state retrenchment have been key to its rise.

When other factors such as economic growth, technological change, globalization and unemployment are taken into account, the above four causes remain important, and, to the extent that they can be changed as a matter of policy, they can mitigate inequality without harming economic growth. They are therefore not the full story but, for example, the negative effects of rising unemployment on inequality can be reduced if there is a strong social safety net in place. Continue reading