The conventional wisdom on monetary policy from the early 1990s through to the financial crises of 2007-2009 favored inflation targeting operated by an “independent” central bank. This approach to monetary policy was widely accepted by academics and central bankers, and widely implemented by the latter. In a relevant contribution, we questioned the effectiveness of this approach to monetary policy along many lines (Arestis and Sawyer, 2008). These included the weakness of the supposed link running from policy interest rate to the level of demand in the short run, and to the rate of inflation in the medium to long run; and hence that the central bank did not have an effective policy instrument to control inflation. Further, we questioned whether the lower inflation experienced during the late 1990s and early 2000s could be attributed to the adoption of inflation targeting, as non-inflation targetters appeared to do as well as targetters, if not better in some cases (see, also, Angeriz and Arestis, 2007, 2008). The promotion of inflation targeting was based on a flawed model of the economy (the “New Consensus Macroeconomics”).
Fiscal policy has not been taken seriously by policymakers since the Great Financial Crisis (GFC) of 2007-2008, with some exceptions over the period 2009-2010, notably after the G20 meeting in London (April 2009). The GFC prompted significant government and central bank interventions, both to restore confidence in the financial system and to contain the impact of the crisis on the real economy. Monetary and fiscal policy responses became very accommodative in many countries. Central banks responded by flooding the financial markets with liquidity, while fiscal authorities attempted to deal with the decline in the solvency of the banking sector. Those policies before 2010 had helped to avoid a complete collapse of the financial system and the real economy after the emergence of the GFC. Subsequently “unorthodox” monetary policies have been implemented, which have not been successful in terms of producing and maintaining healthy growth in the economy. Fiscal policy has increasingly been concerned with “balancing the budget” and “expansionary austerity” rather than being genuinely expansionary.
There are several reasons for such a change in terms of fiscal austerity going out of fashion. An important one being the failure of the austerity policies to bring about significant recovery despite the claims made for “expansionary fiscal consolidation.”
Alejandro Reuss is co-editor of Triple Crisis blog and Dollars & Sense magazine. He is a historian and economist. This is the first part of a two-part series. His article “An Historical Perspective on Brexit: Capitalist Internationalism, Reactionary Nationalism, and Socialist Internationalism” is available here.
In 2007–8, after the real estate bubble burst, the entire U.S. economy plunged into a deep recession, the worst since the 1930s. But the downturn hit some parts of the country harder than others. Overall, real gross domestic product shrank by just over 4% between the pre-recession peak and the trough. Meanwhile, Florida, for example, saw its state GDP decline by over 11%—so, more than 2½ times as much. The official unemployment rate for the United States as a whole more than doubled from a pre-recession low of 4.4% (May 2007) to a peak of 10.0% (October 2009). In Florida, it more than tripled, from 3.1% (March–April 2006) to 11.2% (November 2009–January 2010). Florida’s state and local tax revenues declined from nearly $37.5 billion in fiscal year 2006 to about $28.8 billion in fiscal year 2010.
Do you remember, then, how officials from Florida had to engage in protracted negotiations with the federal government—the Department of the Treasury, the Federal Reserve, etc.—to get federal assistance in dealing with the crisis? Do you remember the recriminations from the governors and legislators of other, less severely affected states, decrying Floridians for their profligate spending and lazy work habits? Federal authorities’ insistence on state tax hikes and deep spending cuts, as Florida’s just penance for a crisis of its own making? The mass marches in the streets of Miami, Tampa, and Tallahassee as Floridians resisted this painful austerity?
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.
Regular Triple Crisis contributor Gerald Epstein is a professor of economics and a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst. This is the concluding part of an interview in which he discusses the rise of “inflation targeting” around the world. The first two parts are available here and here.
Alejandro Reuss: In your view what would be a preferable approach to central bank policy—what priorities should central banks have and how should they go about achieving these aims?
Gerald Epstein: Central banks should be free and open, in conjunction with their governments, to identify the key problems facing their own countries, the key obstacles to social and economic development, and developing tools and targets that are appropriate to dealing with those problems. And these are going to differ from country to country. So, for example, in South Africa, my colleague Bob Pollin, James Heintz, Leonce Ndikumana, and I did a study a number of years ago: We proposed an employment-targeting regime for the central bank. The Reserve Bank of South Africa, in conjunction with the government of South Africa, would develop a set of policies and tools—such as credit allocation policies, subsidized credit, lower interest rates, capital controls to keep the capital in the country, more expansionary and targeted fiscal policy—so that monetary policy and fiscal policy would work hand-in-hand to lower the massively high unemployment rate in South Africa. That’s an example of an alternative structure for monetary policy and one that has worked for other developing countries. So, for example, in South Korea in the 1950s ,1960s, and 1970s, the central bank supported the government’s industrial policy—by lending to development banks that would lend to export industries, by subsidizing credit for export industries, and they would do this as part of the government plan to develop the economy. I call this developmental central banking, that is, central banking that in combination with the government is oriented to developing the country using a variety of tools—interest rates, credit allocation tools, etc..
Not all countries would do the same thing. It not only depends on the country, but also on the problems of the historical conjuncture. So take the United States for example. Right now we do have for the Federal Reserve a dual mandate, which some Republicans are trying to get rid of, for high employment and stable prices. But the financial intermediation system is broken because of what happened in the crisis. Interest rates are down to zero but banks aren’t lending to the real economy. People aren’t able to borrow from banks for small businesses and so forth. The Federal Reserve, through quantitative easing, bought a lot of financial assets but it’s probably time for the Fed to develop new tools, to give direct credit to small businesses, for infrastructure development, etc.
It is the case now, with the crisis and with negative interest rates, or very low interest rates, central banks are being much more experimental trying to develop new tools, new approaches. But they’re all doing it under the guise of inflation targeting. European central bankers were doing all these wild monetary experiments, but their goal was really just to get inflation up to 2%. In fact, what’s happening is that this inflation targeting is no longer the guiding post for central banks. They have to him have much broader sets of tools and targets to get out of this terrible slump that most of these economies are in.
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Regular Triple Crisis contributor Gerald Epstein is a professor of economics and a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst. This is the second part of an interview in which he discusses the rise of “inflation targeting” around the world. The first part is available here.
Alejandro Reuss: Hasn’t it been a central concern on the part of elites in capitalist countries, at least in those where there is representative government, that the majority could impose its will and force policymaker to prioritize full employment and wage growth (as opposed to, say, “sound money”)? Has the transition toward inflation targeting been accompanied by institutional changes to “wall off” monetary policy from those kinds of popular pressures?
Gerald Epstein: Yeah, I think that’s a very important point here. Inflation targeting ideas have also been often accompanied by the idea that central banks should be “independent”—that is, independent from the government. I think you’ll find that these two things go hand-in-hand. If you look at the whole list of central bank rules that the International Monetary Fund (IMF) and others have advocated for developing countries, the argument goes like this: You want to have an independent central bank. Well, what should this independent central-bank do?It should target inflation. Well, isn’t this anti-democratic? No, what we’re really saying is that central bankers should have instrument independence, that is, the ability to decide how they’ll achieve their target, The government should set the target, but what should target be? Well, the consensus is that the target should be a low rate of inflation. So that’s a nice little package designed to prevent the central bank from doing such things as helping to finance government infrastructure investment or government deficits. It’s designed to prevent the central bank from keeping interest rates “too low,” which might actually contribute to more rapid economic growth or more productivity growth, but might lead to somewhat higher inflation.
Regular Triple Crisis contributor Gerald Epstein is a professor of economics and a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst. In early May, he sat down with Triple Crisis co-editor Alejandro Reuss to discuss the rise of “inflation targeting”—the emphasis on very low inflation, to the exclusion of other policy objectives, in central bank policy-making—around the world. This is the first of three parts.
Alejandro Reuss: When we talk about central banks and monetary policy, what precisely is meant by the phrase “inflation targeting”? And how does that differ from other kinds of objectives that central banks might have?
Gerald Epstein: Inflation targeting is a relatively new but very widespread approach to central bank policy. It means that the central bank should target a rate of inflation—sometimes it’s a range, not one particular number, but a pretty narrow range—and that should be its only target. It should use its instruments—usually a short-term interest rate—to achieve that target and it should avoid using monetary policy to do anything else.
So what are some of the other things that central banks have done besides try to meet an inflation target? Well, the United States Federal Reserve, for example, has a mandate to reach two targets—the so-called “dual mandate”—one is a stable price level, which is the same as an inflation target, and the other is high employment. So this is a dual mandate. After the financial crisis there’s a third presumption, that the Federal Reserve will look at financial stability as well. Other central banks historically have tried to promote exports by targeting a cheap exchange rate. Some people have accused the Chinese government of doing this but many other developing countries have targeted an exchange rate to keep an undervalued exchange rate and promote exports. Other countries have tried to promote broad-based development by supporting government policy. So there’s a whole range of targets that, historically, central banks have used.
Across the developed world the persistence of a phenomenon that was initially seen as a freak occurrence—negative interest rates—is now a cause for concern. One form the tendency takes is for central banks to set their policy rates, which signal their monetary stance, below zero. The process was triggered by the European Central Bank (ECB). Under pressure to forestall deflation in the region, the ECB reduced its deposit rate to (minus) 0.1 per cent in June 2014. Since then, according to the Bank for International Settlements (BIS), till January 2016 four national central banks, from Denmark, Sweden, Switzerland and Japan, have moved the interest ‘paid’ on part of their deposits with them to negative territory.
After the Great Recession began in late 2008, there was a widespread trend observed for policy rates to be cut to stall and reverse the economic downturn. This process has now gone so far in some countries, that rates have breached the zero-barrier. The ECB itself has in three steps cut its deposit rate to (minus) 0.2, (minus) 0.3 and (minus) 0.4 in September 2014, December 2015 and March 2016 respectively (Chart 1).
Underlying this trend is a much more pro-active role for monetary policy in countering deflationary trends. Thus, in March 2016 the ECB reduced the interest it pays on deposits (or further lowered the negative rate from -0.3 to -0.4 per cent). In addition, it offered zero interest loans to banks, with the promise that if they use that money to lend 2.5 per cent or more than they were previously doing, then the ECB would pay them the equivalent of 0.4 per cent of what they borrowed from it as interest. In sum, the central bank is promising to pay banks that borrow from it, as long as they increase their lending to households and firms.
The long-awaited move is finally on the loose: The U.S. Federal Reserve (the “Fed”) had shown its intensions to start raising its policy interest rates for the first time since 2008. The “federal funds rate” has been increased by 0.25 to 0.50 percent in December 2015, with hints of further hikes coming in 2016. Just to put this decision in historical perspective, let’s just point out that this rate was on the order of 5.9% over 1971-2015, and climbed as high as 20% in 1980.
The decision to increase the interest rate came after three episodes of unprecedented monetary expansion over the last four years. The Fed had amassed–under the program dubbed with the esoteric name of “quantitative easing”—a total of 3 trillion dollars worth of assets from the finance markets, equivalent to roughly 20% of U.S. GDP.
Earlier this year, in a separate Triple Crisis blog on the Bretton Woods After 70 Years, I shared the outcomes of this massive expansion in liquidity: Interest rates fell all around the globe to virtually zero, but with barely a dent in the real sector. Unemployment barely fell to the pre-recent levels, and gross domestic product in U.S. and elsewhere remained stagnant.
This post is our second selection from “The Cracks Begin to Show: A Review of the UK Economy in 2015,” by Economists for Rational Economic Policies (EREP), sent to us by EREP co-convenor John Weeks. This installment is by Ann Pettifor, director of Policy Research in Macroeconomics, and author of Just Money. The full report, whose contributors include Weeks, Pettifor, Richard Murphy, Özlem Onaran, Jeremy Smith, Andrew Simms, and Jo Michell, is available here.
The British Prime Minister declared at Davos in 2012 that he (and his Chancellor) were “fiscal conservatives but monetary radicals injecting cash into the banking system and introducing credit easing measures to make it easier for small businesses to access finance.”
Doubt can be cast over the “fiscal conservatives” claim, as well as the claim that small businesses would benefit from greater access to finance. The major beneficiaries of the government’s lop-sided approach to monetary and fiscal policy are big corporations and the rich – owners of assets whose value are inflated by QE. But the biggest victim of the ‘fiscal conservative’ approach is the government itself. For as we argued in a paper written in 2010 – The Economic Consequences of Mr Osborne – “fiscal consolidation does not ‘slash’ the debt, but contributes to it, as the extent of economic recovery becomes increasingly uncertain.”