Development Central Banking, Part 2

Answering the Questions about Development Central Banking

Gerald Epstein

This is part 2 of a two-part series by regular contributor and Political Economy Research Institute (PERI) co-director Gerald Epstein, adapted from his recent International Labour Office (ILO) working paper “Development Central Banking: A Review of Issues and Experiences.” Part 1 is available here. The full paper is available here.

In both the developed and developing world, countries face significant transformational challenges. According to the International Labour Organization (ILO), global unemployment is over 200 million, with vulnerable employment being almost 50% of the total; among youth the unemployment rate stands at 13.1% but, in some places, such as the southern European countries, it is significantly higher. If current trends continue, these levels of unemployment and unemployment rates are unlikely to decline appreciably (ILO, 2014). In fact, in some respects, current trends are virtually guaranteed to get worse. Specifically, climate change, which is already creating considerable economic dislocations in many parts of the world, is predicted to accelerate over the next decades. It will especially harm poor and economically vulnerable communities (IPCC, 2014).

Historically, central banks have often been part of the policy apparatus that has helped to guide and provide financing for important development and transformational projects. (Bloomfield, 1957; Brimmer, 1971; Chandavarkar, 1987; Epstein, 2007). However, with the rise of the “Washington Consensus”, the global drive toward financial liberalization and the elimination of so-called “financial repression”, central banks were instructed or chose to follow the increasingly prevalent norm of the “inflation targeting” approach to central banking. This approach eschews virtually all goals other than keeping inflation in the low single digits. Its tool-kit was limited to just a few and ideally only one instrument – a short term interest rate (Bernanke et al., 1999; Anwar and Islam, 2011).

This approach to goals and instruments was accompanied by a drive to change the governance structure of central banks. Hitherto, they had tended to be integrated into the government’s policy apparatus but were also potentially subject to inappropriate influence by government officials. Now, they were able to “independently” implement inflation targeting policy structures and, especially, resist excessive financing of government expenditures.

If inflation targeting is not the best monetary policy framework for achieving broad economic and social goals, then what kind of central bank frameworks—goals, governance and instruments—are likely to best help developing countries address the key problems they face? Important lessons can be learned from history with respect to the kinds of central bank frameworks that have been tried and those that have been successful in achieving macroeconomic stability and economic development (Epstein, 2007, 2013).

Read the rest of this entry »

Development Central Banking, Part 1

What’s Wrong with Inflation Targeting?

Gerald Epstein

This is part 1 of a two-part series by regular contributor and Political Economy Research Institute (PERI) co-director Gerald Epstein, adapted from his recent International Labour Office (ILO) working paper “Development Central Banking: A Review of Issues and Experiences.” This post focuses on the “inflation targeting” central-bank policy pushed on developing countries under the “Washington Consensus” and what is wrong with it. Part 2, next week, will follow with answers to the principal mainstream objections to a broader “development central banking.”

In its strict form, “inflation targeting” posits that central banks should have only one objective—low and stable inflation—and should utilize only one policy instrument—usually a short-term interest rate. As a corollary, the conventional wisdom usually promotes the idea that central banks should be “independent” of the government, in order to enhance their ability to reach the inflation target. This is usually justified on the basis of avoiding time inconsistency and resisting pressures from governments to finance fiscal deficits. No matter how much policy makers such as Olivier Blanchard question inflation targeting in the rich countries, as they have in recent years, it is still widely seen as the current “best practice” for developing countries.

Even if one believes that this general approach is a good one, a key question arises: what is the appropriate inflation rate? The standard practice is that countries should try to maintain inflation in the low single digits (Anwar and Islam, 2011). Where does this number come from? One might expect that a number designed to guide the making of monetary policy in many parts of the globe would come from rigorous research and a broad consensus that the optimal rate of inflation for developing countries is in the low single digits. However, nothing could be further from the truth.

Read the rest of this entry »

Quantitative Easing and The Great Recession: Who Wins? Who Loses?

Gerald Epstein

The Federal Reserve (“the Fed”), the central bank of the United States, is at the center of a big political fight, once again. Ron Paul, former libertarian congressman, says we should “End the Fed” and reinstitute a gold standard; Rick Perry, former governor of Texas, said the Fed policy of low interest rates is “treasonous” and Fed officials should be sent to Texas where they know how to “deal with” such people; Senator Rand Paul (Ron’s son) has put forward a bill to “Audit the Fed” and establish more Congressional control over monetary policy; and progressives from Senators Bernie Sanders and Elizabeth Warren to the Occupy Movement are highly critical of the revolving door between Fed officials and Wall Street, but oppose Paul, Paul and Perry’s “hard money” policies that would make life harder for debtors.

This fight over monetary policy happens now and again in U.S. history. In the Great Depression of the 1880’s the populist movement of indebted farmers rose up to demand a looser monetary standard that would make it easier for them to pay their debts; the financial panic of 1907 ushered in a 7 year struggle that culminated in the establishment of the Fed; and the great inflation of the 1970’s and the draconian increases in interest rates that Fed Chairman Paul Volcker engineered in the late 1970’s instigated widespread protests against the Fed.

Such enduring conflicts have real causes; in its founding and very structure, the Fed is a creature of the financial industry, yet the Fed has enormous economic power that affects everyone in the U.S. economy (and indeed, the world). Most importantly, it has enormous public power – to print legal tender (the U.S. dollar) – yet it has a political structure that to varying degrees insulates it from democratic control. And with the demise of fiscal policy as a strong tool of macroeconomic policy (conservatives have blocked the use of government spending and taxation as tools of economic policy), the Fed’s power to set interest rates has become the most important and flexible tool of macroeconomic policy.

Read the rest of this entry »

Can “Abenomics” Revive Japan’s Economy? Part 1

Junji Tokunaga, Guest Blogger

This is the first part of a two-part post on the economic policies of Japan’s prime minister, Shinzo Abe, and on alternatives to neoliberal “Abenomics.” Junji Tokunaga is an Associate Professor in the Department of Economics, Dokkyo Univeristy, Saitama, Japan. He is the co-author, with regular contributor Gerald Epstein, of a multi-part series for Triple Crisis on “Global Dollar-Based Financial Fragility in the 2000s” (Part 1, Part 2, Part 3, Part 4).

Japanese Prime Minister Shinzo Abe won a landslide victory in the snap election for the lower house of parliament on December 14, 2014. Abe’s Liberal Democratic Party (LDP), the leading conservative political party, and its partner party in the ruling coalition have won 326 of 475 seats, which enabled the coalition to secure a two-thirds supermajority in the lower house.

Why did Abe win the election? Since the end of 2012, the Abe government has carried out an economic revitalization program, called “Abenomics,” consisting of “three arrows”: more aggressively quantitative monetary easing, massive fiscal stimulus, and structural reforms. The main reason of his emphatic victory is that Abe  succeeded in persuading the electorate to stay the course, with slogans like “Abenomics is progressing” and“there is no other way to economic recovery,” while shifting the electorate’s attentions from more delicate political matters such as restarting Japan’s nuclear power plants and bolstering its military forces.

Read the rest of this entry »

Bretton Woods After 70 Years

“The End of (Monetary) History”

Erinç Yeldan

As we are about to wrap up 2014, it may prove worthwhile to celebrate the 70th anniversary of one of the most innovative and exciting episodes of homo economicus: The Bretton Woods Monetary Conference. Convened in 1944 at the Mount Washington Hotel in New Hampshire, the conference established the World Bank and the IMF (later referred to as the “Bretton Woods Institutions”) and set the gold standard at $35.00 an ounce with fixed rates of exchange to the U.S. dollar.

Based on John Maynard Keynes’s famous dictum, “let finance be a national matter,” and on the productivity advances of Fordist technology and institutional structures, the global economy expanded at a fast rate over the postwar era, from 1950 to the mid-1970s. Per capita global output increased by 2.9% per year over this period, which later came to be referred to as the “Golden Age of capitalism.” (In contrast, the average rate of per capita growth over the whole century has been estimated at 1.6%.)

The conditions that created the Golden Age were exhausted by the late 1960s, however, as industrial profit rates started to decline in the United States and continental Europe due to increased competition, particularly from the Asian “tigers” or “dragons” (Republic of Korea, Taiwan, Hong Kong, and Singapore). In the meantime, Western banks were severely constrained in their ability to recycle the massive petro-dollar funds and the domestic savings of the newly emerging baby-boomer generation. Trumpets for the “end financial repression” intensified with the so-called McKinnon-Shaw-Fama hypotheses of financial deregulation and efficient markets. A global process of financialization was commenced, lifting its logic of short-termism, liquidity, flexibility, and immense capital mobility over objectives of long-term industrialization, sustainable development, and poverty alleviation with social-welfare driven states.

Read the rest of this entry »

Has the Euro Been Saved?

Philip Arestis and Malcolm Sawyer

A number of changes have been taken or proposed as a result of the financial crisis of August 2007 and the “Great Recession” that are worth discussing in terms of the euro crisis. Most important, though, are the changes of the period between late 2011 and 2012: strict budget rules, banking oversight stripped from national governments might make the European Central Bank (ECB) become “lender of last resort.” We concentrate on the most recent ones at some length before we reach conclusions as to whether the euro has been saved from the euro crisis.

The European Union (EU) summit meeting, 28/29 June 2012, took a number of decisions: banking licence for the European Stability Mechanism (ESM) that would give access to ECB funding and thus greatly increase its firepower; banking supervision by the ECB; a “growth pact,” which would involve issuing project bonds to finance infrastructure. Two long-term solutions are proposed: one is a move towards a banking union and a single euro-area bank deposit guarantee scheme; another is the introduction of eurobonds and eurobills. Germany has resisted the latter, arguing that it would only contemplate such action only under a full-blown fiscal union; not much has been implemented in any case.

Read the rest of this entry »

What Happened to the Recovery, Part II

Gerald Friedman, Guest Blogger

This is the second part of a two-part series on the reasons for the sluggish U.S. economic “recovery” since the Great Recession, by Gerald Friedman, professor of economics at the University of Massachusetts and author of Microeconomics: Individual Choice in Communities. This post, from Friedman’s “Economy in Numbers” column in Dollars & Sense magazine, focuses on the failings of various government policy responses to the crisis.

Government Policy and Why the Recovery Has Been So Slow

The recovery from the Great Recession has been so slow because government policy has not addressed the underlying problem: the weakness of demand that restrained growth before the recession and that ultimately brought on a crisis. Focused on the dramatic events of fall 2008, including the collapse of Lehman Brothers, policymakers approached the Great Recession as a financial crisis and sought to minimize the effects of the meltdown on the real economy, mainly by providing liquidity to the banking sector. While monetary policy has focused on protecting the financial system, including protecting financial firms from the consequences of their own actions, government has done less to address the real causes of economic malaise: declining domestic investment and the lack of effective demand. Monetary policy has been unable to spark recovery because low interest rates have not been enough to encourage businesses and consumers to invest. Instead, we need a much more robust fiscal policy to stimulate a stronger recovery.

Read the rest of this entry »

As the Wage-Profit Conflict Sets In, Troubles Deepen for Global Capital

Erinç Yeldan

As the recession in Europe painfully proves all attempts at austerity to be dead-ends, the search for the miraculous “silver-bullet” continues. The European Central Bank (ECB) has initiated a negative “nominal” interest rate. That means the ECB, the first monetary authority to ever take such an action in a common currency zone, will be charging commercial banks for the funds they deposit (overnight) rather than paying them interest.

The ECB is pursuing an inflation target of 2% with a dogmatic belief that “this is he rate at which agents [read this as financial speculators and the rentiers] will not be affected in their economic decisions.” To this end, it utilizes three sets of interest rates: (1) the marginal overnight borrowing rate of the banks from the ECB; (2) the basic rate for their re-financing operations; and (3) the rate that is applied to the banks’ deposits at the ECB. In order for the monetary interventions of the ECB to have any effect, the rates on these interests ought to be differentiated. Until very recently, the ECB rate on deposits was set to zero, and the rate on the re-financing operations was 0.25%. The decision of the ECB has now been to reduce the latter rate to 0.15% and  the deposit to negative 0.10%. The textbook explanation for this unusual negative interest rate on money deposited by banks rests on the expectation that they should be now motivated to lend their funds instead of keeping them in reserves. Hopefully, this will restore eurozone economic growth by encouraging more lending for “real” investment.

Read the rest of this entry »

Are We All Post Keynesians Now?!

Philip Arestis and Malcolm Sawyer

Within two weeks in March, two publications came from the Bank of England which overturned the conventional wisdom of monetary policy and macroeconomic thinking of the past few decades. Yet the key elements of the contents of these two publications have been common knowledge in the post Keynesian community for many years.

The first came with the publication in the Bank of England Quarterly Bulletin of articles on the nature and endogeneity of money (and a video). The second came with the Mais Lecture delivered by the Governor of the Bank of England Mark Carney in which he argued that the narrow view of central banks as guardians of stable inflation as “fatally flawed,” as he unveiled a “transformative” overhaul of the Bank of England.

The endogeneity of money has been long known to post Keynesian economists and has formed the bedrock of their macroeconomic analyses for at least three decades. The practice of Central Banks has in effect similarly recognized endogeneity and the new consensus in macroeconomics did not mention money—money for this framework is a “residual.” The Bank of England was (not surprisingly) well aware of the endogeneity of money when it was instructed by the monetarist Thatcher government to pursue the task of controlling the money supply, which proved impossible since the money supply is endogenous!

Read the rest of this entry »

Turkey's Hot-Money Problem

Bilge Erten and José Antonio Ocampo, Guest Bloggers

The ongoing financial volatility in emerging economies is fueling debate about whether the so-called “Fragile Five” – Brazil, India, Indonesia, South Africa, and Turkey – should be viewed as victims of advanced countries’ monetary policies or victims of their own excessive integration into global financial markets. To answer that question requires examining their different policy responses to monetary expansion – and the different levels of risk that these responses have created.

Although all of the Fragile Five – identified based on their twin fiscal and current-account deficits, which make them particularly vulnerable to capital-flow volatility – have adopted some macroprudential measures since the global financial crisis, the mix of such policies, and their outcomes, has varied substantially. Whereas Brazil, India, and Indonesia have responded to surging inflows with new capital-account regulations, South Africa and Turkey have allowed capital to flow freely across their borders.

Read the rest of this entry »