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.

Opening up Keynesianism – the implications for economic policy

keynesAt its simplest, Keynesian economics makes the case for the role of aggregate demand in determining output and employment in the economy as a whole. Government policies should therefore attempt to achieve low levels of unemployment through the management of aggregate demand, or the growth of expenditure. A crude form of this emphasises fiscal policy, the balance between tax revenues and public spending. A weak economy with rising unemployment may need an expansionary fiscal policy, with public spending increases or tax cuts to boost demand, while an overheating economy may need the opposite, to reduce demand and lower inflation.

This is a crude characterisation of a major school, or truthfully what has given rise to many schools, of economic thought. It is unfortunate since, in the wake of economic crises in recent decades, particularly that of 2008-09, commentators proclaimed the return of Keynesian ideas as governments across the world responded to recession with degrees of expansionary fiscal policy, as the use of monetary policy alone was deemed to be inadequate. But it didn’t last, and the turn to austerity and ‘tighter’ fiscal policy quickly followed. Alongside a return to reliance on monetary policy and the adoption of Quantitative Easing (QE), this played a role in the weakness of the recovery.

Following the global pandemic and the advent of war in Ukraine, many countries now face the prospect of stagflation, the combination of weak growth and rising unemployment alongside high inflation. Policymakers are now tightening monetary policy by raising interest rates, even as recent fiscal expansions come to an end. Crude Keynesianism appears to have little to offer, echoing its abandonment during the stagflation of the 1970s.

But genuine Keynesianism does have far more to offer public policy than expansionary fiscal policy during a deep recession. It may start with a focus on aggregate demand, but can be used to illustrate the importance of industrial policy, the reduction of inequality and the reform of the global monetary and trade system. This post intends to explain how. Continue reading

Quote of the week: Warren Buffett on how we all benefit from the past actions of others

WarrenBuffettThis week’s quote is particularly short, and comes from the financial investor Warren Buffett. Rather than simply let it speak for itself, I thought I would briefly consider its implications for economics and political economy.

“Someone is sitting in the shade today because someone planted a tree a long time ago.”

Buffett is saying that it is important to take the long view in any venture worth pursuing. It can be seen to be intended for investors but for me it speaks to a far broader set of issues, particularly the notion that we all benefit from the past actions of others and so should be humble and socially and historically aware when it comes to individual success, not least in the field of wealth. Continue reading

Considering the work of a maverick economist: introduction to a new series

AndrewSmithersI recently happened upon the work of economist Andrew Smithers, whose books and articles portray an unconventional and original thinker, and one who is unafraid to challenge the conventional wisdom in economic theory and policymaking. He could be classed as heterodox, while not falling easily into any particular political or ideological category. He studied at Cambridge in the 1950s, and was taught by, among others, the distinguished post-Keynesian Nicholas Kaldor, as well as Brian Reddaway. While he is now retired he continues to contribute to economic debate, via the Institute for New Economic Thinking, the Financial Times and elsewhere.

He has many years experience in international investment and has written extensively on financial economics, bringing together the spheres of finance and the real economy. His latest book is The Economics of the Stock Market, which is on my current reading list. However, I decided to start with his 2013 work The Road to Recovery, written in the wake of sluggish global growth following the financial crisis, followed by Productivity and the Bonus Culture, published in 2019, which tackles more comprehensively phenomena described in the earlier book.

The global economy has more recently been hit by shocks arising from a pandemic and war, but one of Smithers’ main contributions to economic debate is his argument that poor growth in output and productivity in the US and UK is largely down to the ‘bonus culture’ that has arisen in recent decades. Continue reading

Quote of the week: Paul Samuelson on the essential contribution of Keynes’ General Theory

paul samuelsonPaul Samuelson was the high priest of the post-war “neoclassical synthesis” in economics, which combined a particular interpretation of Keynesian macroeconomics with mainstream microeconomics. He was the author of two influential textbooks which were widely used by students on the US side of the Atlantic and, as time went on, on the UK side as well. Keynes’s disciples at Cambridge University, and many of their students, tended to be politically to the left of their American counterparts, and were critical of Samuelson’s approach to Keynesian economics. But fast forward to today, and the left Keynesians, or post-Keynesians, are sadly confined to a heterodoxy with limited influence on the dominant mainstream of the subject.

This week’s quote, by Samuelson, is another from the 1947 collection of essays The New Economics, published not long after Keynes’ death the previous year. It provides a fascinating snapshot of how some of the influential (mostly American-based at the time) voices in academia assessed Keynes’ contribution to economic theory and public policy. It includes essays by Keynes himself, as well as Joan Robinson, one of the founders of the post-Keynesian school at Cambridge. Continue reading

The political economy of the current inflation

Contando_Dinheiro_(8228640)Today’s inflation is leading to calls for mitigating policy responses. The distributional outcomes of higher inflation are necessarily uneven, creating winners and losers across society and the economy. I outline some of the likely impacts on households, businesses, government, and the wider economy, as well as the effects of changes in economic policy.

In recent months rising inflation, termed ‘the cost of living crisis’ by the media, has become a major issue for households, businesses and, increasingly, governments and central banks, who are tasked with policy responses. Caused by a combination of bottlenecks in global supply chains and recovering demand as many economies emerge from severe pandemic-induced downturns, it has hit rates not seen for decades in countries such as the US and UK. What are the likely impacts on the various elements of the economy? It is important for decision makers across the economy, from ordinary workers to policymakers, to understand how higher inflation can affect livelihoods and behaviour. Continue reading

The “high wage economy” in theory and practice

JohnsonSunakThe UK’s conservative government has declared that it wants to achieve a “high wage economy”. Part of this involves its stated policy of “levelling up” so that the poorer regions of the country, many of which voted for the conservatives at the last election, are given improved economic and social opportunities. The recent spate of supply-chain problems, which has given rise to shortages of certain goods and categories of worker, and which is in part a global problem, but also partly a consequence of Brexit, was recently spun on the hoof by Prime Minister Boris Johnson into a deliberate act of policy. In short, he claimed that mass immigration from the EU had held wages down for lower paid workers, and that shortages of these workers would drive wages up, and give their employers incentives to invest in improving workforce skills and technology, in order to increase productivity. So the aim of a high wage economy seems now to be a key aim and slogan of policy. But what is it, and what can economics tell us about how it can be achieved? Continue reading

Thomas Palley and the ‘vampire squid’ economy

800px-A1_Houston_Office_Oil_Traders_on_MondayPost-Keynesian economist Thomas Palley has written a new paper on financialization which can be downloaded for free here. Palley has long argued that rising inequality across the capitalist world has produced sluggish growth in aggregate demand, undermining GDP growth. Growth has been maintained to some extent through rising public and private debt. These trends have been building for the last forty years, since the shift towards a neoliberal policy regime and ideology. Mainstream economics has recently tried to account for sluggish growth with an appeal to ‘secular stagnation’, and arguing that with interest rates now at historically low levels, there is room for public borrowing to stimulate growth, at least until interest rates begin to rise once more. Continue reading

Michael Pettis on China’s latest economic prospects and the difficulty of reform

For some years now I have found Professor Michael Pettis’ analysis of the Chinese economy and its relationship to the rest of the world to be original and compelling. Here is a short interview with him on China’s growth prospects for this year, and the difficulty for policymakers in rebalancing the economy away from investment and towards household consumption. He has long argued that a substantial redistribution of income and wealth from businesses and the state towards ordinary households is vital to this end, for the good of China and the world. He also argues that this still remains largely undone.

Capitalism, socialism and innovation – the role of soft budget constraints

DSC00236Since I was a student, industrial policy and its key historical role in promoting prosperity under capitalism have been among my main interests in economics. An article by Max Jerneck in the December issue of the journal Industrial and Corporate Change explores the role of so-called soft and hard budget constraints (SBCs and HBCs), how they differ under capitalism and socialism, how they promote or hinder innovation, and their role in successful industrial policy.

Jerneck refers to the work of Janos Kornai, who developed the ideas of SBCs and HBCs in relation to different economic systems and policies. The budget constraint is part of the external environment faced by firms. Under SBCs, which for Kornai are typical under socialism, the state will support producing firms however they perform, which hinders innovation, as firms lack the incentive to improve products, processes and efficiency in response to market pressures. Organisations “can avoid making internal adjustments to changing conditions” which is “an expression of market power”. External financial support is sustained, leading to general expectations among all firms that this is the norm. This goes beyond the occasional bailouts and rescues that occur under capitalism. Under socialism, “the survival and growth of an organisation is not decided by market forces but by bureaucratic coordination and bargaining”. Continue reading