Do “Unconventional” Monetary Policies Work?

Philip Arestis and Malcolm Sawyer

The “unorthodox” Quantitative Easing (QE) monetary measures, along with another “unorthodox” monetary policy, namely negative interest rates, have been implemented by a number of countries in the years following the global financial crisis. This is as a result of the normal policy monetary instrument, the rate of interest, being reduced to nearly zero by a number of central banks. We discuss these measures but most importantly we discuss the extent to which they have been successful in terms of their targets.

QE includes two types of measures: (i) one is “conventional unconventional” measures, whereby central banks purchase financial assets, such as government securities or gilts, which boost the money supply; (ii) another is “unconventional unconventional” measures; in this way central banks buy high-quality, but illiquid corporate bonds and commercial paper. The purpose under both measures is not merely to increase the money supply but also, and more importantly, to increase liquidity and enhance trading activity in these markets.

A number of QE possible channels can be identified. There is the liquidity channel, whereby the extra cash can be used to fund new issues of equity and credit; thereby bank lending is influenced positively, which potentially can affect spending. The purchase of high-quality private sector assets, which aims at improving the liquidity in, and increase the flow of, corporate credit. There is also the portfolio channel, which changes the composition of portfolios, thereby affecting the prices and yields of assets (and thus asset holders’ wealth); the cost of borrowing for households and firms is also affected, which influences consumption (also affected by the change in wealth) and investment. Additionally, there is the expectations-management channel: asset purchases imply that, although the Bank Rate is near zero, the central bank is prepared to do whatever is needed to keep inflation at the set target; in doing so the central bank keeps expectations of future inflation anchored to the target.

The success of QE depends on four aspects: (i) what the sellers of the assets do with the money they receive in exchange from the central banks; (ii) the response of banks to the additional liquidity they receive when selling assets to the central banks; (iii) the response of capital markets to purchases of corporate debt; and (iv) the wider response of households and companies, especially so in terms of influencing inflation expectations.

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The Vote for Brexit: Reykjavik-on-Thames, Redux?

Nina Eichacker

Nina Eichacker is a lecturer in economics at Bentley University. She has written previously for Triple Crisis on German financialization and the eurozone crisis and on financial liberalization and Iceland’s financial crisis.

On October 8, 2008, the British Chancellor issued the “Landsbanki Freezing Order 2008,” freezing the assets of Landsbanki, one of Iceland’s three largest banks, after the Icelandic Finance Minister’s statement that Iceland would not guarantee UK citizens’ deposits in Landsbanki’s retail banks, after it had gone into receivership. The British Treasury and Financial Supervision Authority (FSA) froze billions of pounds sterling in Landsbanki’s assets in Britain. Icelandic banks had been badly overleveraged: In 2007, Icelandic GDP was $16.3 billion dollars; Icelandic banks held $176 billion in assets, $166 billion in liabilities, and owned three times as many foreign assets as domestic ones (Buiter and Sibert, 2011, Aliber, 2011). Consequences of this crisis included billions of dollars in banks’, firms’, and households’ losses on bank shares, economy-wide recession, austerity policies and international pressure for the Icelandic government to guarantee banks’ liabilities with taxpayers’ money.

On November 13, 2008, Willem Buiter wrote a post sub-titled “Is London Really Reykjavik-on-Thames?” arguing that the UK should consider the risk of similar financial events occurring. The UK was also a small global economy with an outsize financial sector relative to total GDP, though UK banks’ balance sheets were only 450% of UK GDP, compared to Icelandic banks’ 900% of GDP (Buiter, 2008). External assets and liabilities of UK banks were large: 400% of GDP in gross external assets and liabilities, compared to Iceland’s 800% and the United States’ 100% (Buiter, 2008). Buiter argued further that most UK banks in 2008 were very vulnerable to a banking crisis, followed by sovereign-debt and currency crises (Buiter 2008). UK banks had the potential to set off another triple crisis. This didn’t come to pass: banks like Lloyds and HBOS received large bailouts, the government oversaw mergers of smaller banks into larger banks, and mandated banks’ sale of shares to raise capital, and improve overall bank resilience, while the Bank of England engaged in expansionary monetary policy.

Could Brexit or the vote to leave bring about that potential crisis?

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Seed Sovereignty and Climate Adaptation in Malawi

Timothy A. Wise

You wouldn’t have known from the farmers gathered in Lobi, in the Dedza area of central Malawi, that drought had seriously depressed harvests. To be sure, they hadn’t suffered the worst of the country’s devastating heat and dry spell. Farmers to the south saw crops wither in their baked fields; some never even bothered to plant. An estimated 8 million people – fully half the country’s people – are now at risk of hunger, according to the World Food Program.

The farmers in Lobi were surprisingly upbeat, enthusiastically calling out the crops they were growing to a project manager leading a community meeting. One reason they were happy is that the list of crops didn’t begin and end with maize, the staple for which Malawi is known because of the country’s government-subsidized program to boost local production through the provision of hybrid maize seeds and fertilizers.

Under the Malawi Farmer-to-Farmer Agroecology Project (MAFFA), the farmers in Lobi grow a diversity of food crops, for sale and home consumption. Maize is still their staple, but the list of other crops seemed endless: rice, millet, common beans, soybeans, groundnuts (peanuts), Bambara nuts, potatoes (of many varieties), sweet potatoes (white and orange), cassava, pigeon peas, and even two types of tobacco, a local cash crop.

Maize yields were down, as a blackboard chart of local production from the just-concluded harvest showed. That’s not surprising. Maize is a relatively water-intensive crop. Still, all the farmers in Lobi wanted to talk about was their orange maize, which had performed well.

Rich in Vitamin A, the native local variety was taking off faster than the project could promote it. Farmers seemed particularly to like its drought resilience, taste, high conversion to edible grain for the local staple, nsima, and how well it grows even without the doses of expensive – or subsidized – inorganic fertilizer required by government-supported hybrid maize varieties. They mostly use compost to fertilize their crops.

What seemed more worrisome than the drought, at least for these farmers, were the government’s draft seed policies, which threatened to declare these small-scale farmers’ coveted orange maize seeds unworthy of commercial sale, or possibly even exchange with fellow farmers.

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What Next for the EU?

Jayati Ghosh

Even before the results of the UK referendum, the European Union was facing a crisis of popular legitimacy. The result, especially in England and Wales, was certainly driven by the fear of more immigration, irresponsibly whipped up by xenophobic right-wing leaders who now appear uncertain themselves of what to do with the outcome. But it was as much a cry of pain and protest from working communities that have been damaged and hollowed out by three decades of neoliberal economic policies. And this is why the concerns of greater popular resonance across other countries in the EU – and the idea that this could simply be the first domino to fall – are absolutely valid. So the bloc as a whole now faces an existential crisis of an entirely different order, and its survival hinges on how its rulers choose to confront it.

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In Finance, Even Business as Usual Comes at Too High a Price

Gerald Epstein

A healthy financial system is crucial to a stable and productive market economy. But after decades of deregulation, the U.S. financial system has turned into a highly speculative system that has failed spectacularly at doing its job. My new report, Overcharged: The High Cost of High Finance,” written with Juan Montecino and published by the Roosevelt Institute, describes in detail the massive costs of this failed financial system.

The evidence of overcharging is all around us. The most obvious, of course, is the catastrophic financial crisis of 2007-2008 that wiped away $16 trillion—24 percent of household net wealth, led to more than 5.5 million home foreclosures, and caused skyrocketing, hope-crushing unemployment rates. When the government picked up the pieces and committed more than $20 trillion of taxpayers’ money to bail out the largest financial institutions, millions of Americans were left high and dry, angry and frustrated.

But the failures of our financial system don’t just arrive in one big bang. They occur on a daily basis, in more mundane ways, often hidden from sight. Asset managers overcharge and underperform. Private equity (PE) general partners earn massive incomes but pay low returns to pension funds and other investors while enjoying unjustifiable tax breaks such as the carried interest exclusion. They do this while, at times, breaking companies and laying off workers for no other reason than their pursuit of short-run capital gains. Payday lenders charge upwards of 400 percent annual interest because many poor people have nowhere else to turn. Meanwhile, many of these payday lenders themselves are tied to the major Wall Street banks.

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Taking the Blinders Off, Part 3

Susan Schroeder is a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). This is the final part of a three-part article, originally published in the July/August 2016 issue of Dollars & Sense magazine. See parts 1 and 2 here and here.

Susan Schroeder

Beyond Credit Rating

The beauty of mainstream economics, which assumes the inherent stability of markets, is that, if markets work well, the public interest aligns with the interests of private agents. In this view, then, the key policy objective is to improve the efficiency of markets. But if markets are inherently unstable, the interests do not align. In this context, increased government presence to promote a more stable economy and financial system is what promotes the public interest.

A Minskian basis for credit risk-assessment and a public credit-rating agency would be a good start, but they will not be enough to thwart the ups and downs in ratings over the course of the business cycle. To do this requires reducing the cyclical patterns of the economy as a whole. This will likely require an industrial policy focused on civilian industries that promotes the sale of output by firms (often referred to as “supply support” or “demand management”). One way to facilitate the absorption of some firms’ output by other firms is to create an insurance scheme to protect the accounts receivable of firms from the risk of non-repayment, focusing particularly on small and medium-sized firms as their failure rate is higher than for corporations. That way, if one firm owes another one money, but does not pay on time, the latter firm does not find itself short on cash to meet its own obligations. (That is, one firm’s default on its debts does not set off a chain reaction.) The “trade credit insurance” enjoyed by export banks is a precedent for this kind of scheme.  Stabilizing their cash inflows strengthens their ability to absorb goods and services from other firms and to employ workers.  With this mechanism in place, banks will be more willing to supply short-term financing during bouts of instability. Living wages that reduce consumers’ reliance on credit would also reduce debt-service burdens and support consumption. Robust consumption and strong cash-flow for firms, in turn, stimulates investment.

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The UN and Global Economic Stagnation

Jomo Kwame Sundaram

When the financial crisis preceding the Great Recession broke out in late 2008, attention to the previously ignored UN Secretariat’s analytical work was greatly enhanced. This happened as the UN and the Bank of International Settlements (BIS) had been almost alone in warning, for some years, of the macroeconomic dangers posed by poorly regulated financial sector developments.

In contrast, most other international organizations – the IMF, World Bank and OECD – which monitor developments in the world economy have failed to see the crisis coming. Until the third quarter of 2008, they were still predicting continued robust growth of the world economy, and, ‘soft landings’ in the unlikely event of financial turmoil, including in the US.

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Taking the Blinders Off, Part 2

Susan Schroeder is a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). This is the second part of a three-part article, originally published in the July/August 2016 issue of Dollars & Sense magazine.

Susan Schroeder

Instability in Capitalist Economies

A market economy is not completely unpredictable—it does have gravitational tendencies, such as a tendency towards a falling rate of profit. Those tendencies are created by the day-to-day activities of firms and consumers, and are further shaped by the contexts in which they are embedded, such as institutional configurations and social norms.

What is the source, then, of instability in capitalist economies? It emanates from firms’ quest for profit. Capitalism runs on profit. To enhance their profits, firms adopt production techniques that lower their per-unit production costs. As this occurs, each firm’s structure of production changes relative to industry norms. Firms that use lower proportions of labor relative to other inputs are deemed to be more efficient and will earn a better rate of return on their capital than firms that do not adapt.  Firms also switch from one industry to another, or enter new industries, in a quest for higher returns. Firms must change in these ways in order to survive, and thrive, in a competitive market economy.

Changes to productive conditions within an industry and capital flows between industries, however, are major sources of instability. The mechanization of the production process, for example, increases the presence of capital relative to labor. This process is also facilitated by mergers and acquisitions. As each firm changes its production process, the average conditions of production for each industry change. Capital flows between industries will also affect the industry averages as weaker firms exit.  Firms can never be exactly sure how they compare against the industry average at any point in time. The best they can do is try to lower the unit cost of output faster than their competitors. Moreover, economists have demonstrated that these activities create a third source of instability—a tendency towards a falling profit rate for the entire economy.

Debt exacerbates this instability. Firms use debt, supplementing their own retained profits, to finance investment that improves their structures of production. However, improvement comes at the expense of the increasing weight of debt service. As firms become increasingly fragile, collectively, the economy becomes less resilient, and more vulnerable to a debt-deflation process.

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Taking the Blinders Off, Part 1

Susan Schroeder is a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). This is the first part of a three-part article, originally published in the July/August 2016 issue of Dollars & Sense magazine.

How private credit rating agencies reinforce global economic instability—and what we can do about it.

Susan Schroeder

The role that credit rating agencies played in the global financial crisis is no secret. One memorable scene in The Big Short depicted an employee of Standard & Poor’s (S&P)—one of the “big three” rating agencies, with Moody’s and Fitch—as being blinded by conflict of interest in her evaluation of mortgage-backed securities. In a visual gag, she is depicted as having just come from the eye doctor, wearing literal blinders as she is quizzed by the film’s protagonists about how S&P could give the highest ratings—AAA—for securities based on bundled subprime mortgages. “If we don’t give the ratings, they’ll go to Moody’s, right down the block.”

In the wake of the financial crisis, rating agencies have faced growing public concerns about their ability to evaluate credit risk. Investors who lost large sums on investments involving structured financial products, such as mortgage-backed securities (MBSs), have sued the rating agencies. The agencies had assessed MBSs as having very low levels of risk prior to the crisis. But this is not the first instance when the products of the ratings industry have come under suspicion. In the Penn Central crisis of the 1970s, the financial instrument involved was commercial paper. In the Latin American debt crisis of the 1980s, it was sovereign debt. In the early 2000s, at Enron and Parmalat, it was corporate bonds. In the most recent financial crisis, it was collateralized debt obligations and, in some countries, sovereign debt as well.

The role of credit in an economy is a double-edged sword. During a business-cycle upswing, credit facilitates investment and economic growth. As a cycle matures, credit becomes a burden and debt servicing becomes more problematic. If firms are forced to sell assets en masse to obtain the means to service debts, the economy is exposed to “debt deflation”—a fall in the level of prices, contraction in the profits and net worth of firms, and a reduction in output and employment. Changes in credit ratings over the course of a cycle have a tendency to exacerbate both the upswings and downswings.

How should credit risk be evaluated in the context of an ever-changing macroeconomic environment? One way is to assume a market economy is inherently stable and self-regulating. Credit risk is evaluated in the context of recent experience, with that context occasionally revisited for possible revision.  Another way is to assume the economy is inherently unstable and not self-correcting. This is something that economists John Maynard Keynes and Hyman Minsky understood well, but that mainstream economists now treat as heretical. Although assuming instability seems more plausible, assuming stability makes it easier to use quantitative techniques and computing power. When rating agencies are processing information on thousands of credit issuers, speed matters. But it comes at the cost of accuracy and ability to foresee crises.

A public credit rating agency could support the development of better credit risk-assessment by using Minsky’s “Financial Instability Hypothesis” to create more sensitive methods of detecting changes in the overall economy, particularly instability generated by risk-taking behavior of individual firms and investors. By more accurately evaluating changes in the macroeconomic context, such an agency could do a better job of assessing firms’ levels of risk, and thereby reduce the danger they pose to the broader economy.

Why Can’t Private Credit Rating Agencies Solve the Problem?

Credit ratings are a form of credit risk-assessment—an opinion about the ability of a borrower to service its debt. These opinions, however, have the ability to destabilize financial markets and economies like no other. The three largest credit-rating agencies—Moody’s, Standard & Poor’s, and Fitch—dominate the global market for this service. Taken together, their global market share, in terms of the value of all rated securities, is more than 95%. They issue opinions on the liabilities of governments, non-financial corporations, financial firms like insurance companies and banks, and even universities. They are separate from credit reference or consumer reporting agencies, sometimes referred to as “credit bureaus,” which issue assessments about individual consumers.

Credit ratings are supposed to address the imbalance (or, in economic lingo, “asymmetry”) of information that exists between borrowers and lenders. Borrowers are thought to hold the most complete information about changes in their ability to service debt, whereas lenders only become aware of this after a time lag. Ratings may shorten the lag, even if they do not eliminate it. Credit risk-assessments are conducted in a way that borrowers and financial instruments can be compared and ranked according to their relative riskiness.  This way, the ratings refine the process by which different firms’ cost of raising capital is established and improve market efficiency and liquidity. At least that’s how it’s supposed to work.

Flaws in the rating methods arise from conflicts of interest, lack of transparency, and changes that coincide with and amplify the business cycle (“pro-cyclicality”). For instance, the agencies’ very business model, in which issuers pay the agencies for assessments of creditworthiness (known as the “issuer-pays” model) generates conflicts of interest. Such conflicts are thought to have contributed to the overly rosy ratings of structured products prior to the financial crisis (e.g., the highest, or “AAA,” ratings for residential mortgage-backed securities), as the agent from S&P in The Big Short made clear. The lack of information about the agencies’ methods and processes made it hard for investors to scrutinize their decisions. The pro-cyclicality of rating changes is striking, as credit risk-assessments are intended to be “through-the-cycle” or impervious to cyclical behavior of the economy. Why is this?

A key flaw with many credit-assessment methods is that the assumptions they make to process data from thousands of borrowers—to make their own quantitative techniques work—are the same assumptions that envision a market economy as inherently stable. For instance, assessment methods often employ traditional statistics that rely on the notion of stable relationships between possible outcomes and their probability of occurrence. That is, the purchase of a security is seen as similar to placing a bet at a roulette table. All the different possible outcomes, and their relative probabilities, are fixed. In real life, the probability distributions describing the riskiness of different securities are not necessarily stable if the broader market economy is inherently unstable. And, given the recent global financial crisis, not many people would be easily convinced that market economies are inherently stable.

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Looking for Food in All the Wrong Places

Timothy A. Wise

I spent another week in Mozambique looking for ProSAVANA, the much-touted, much-reviled Japanese-Brazilian-Mozambican agriculture project that has spectacularly failed to turn Mozambique’s savannah-lands in the Nacala Corridor into a giant soybean plantation modeled on Brazil’s Cerrado region. I was there doing follow-up research for a book.

I hadn’t found much evidence of ProSAVANA two years ago (see my previous articles here and here) and I didn’t find much now. Government officials wouldn’t talk about it. Japanese development cooperation representatives spoke only of pathetically small extension services to a few small-scale farmers. Private investors were scarce. Civil society groups debated whether it is worth cooperating in the wholesale redesign of the program.

I wondered why anyone would bother. Like many of the grand schemes hatched in the wake of the 2007-2008 food price spikes, this one was a bust, by any measure. Still, ProSAVANA remains the Mozambican government’s agricultural development strategy for the region. While farmers defend their hard-won land rights, it seems they will have to look elsewhere for agricultural development.

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