By Gerald Epstein, Professor of Economics at the University of Massachusetts, Amherst. Originally published at Triple Crisis, published by Dollars & Sense
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.
And now the crash of 2008 has led to the biggest fight in 75 years. We got into this fight because Alan Greenspan’s Fed failed to sufficiently regulate the banks that drove the economy into the ditch, and the Fed subsequently bailed out these same banks without punishing the guilty parties (we only know about this thanks to journalists and activists; the Fed has tried to block oversight). Central to the current fight is the battle over the Fed’s interest rate and monetary policy. Since late 2008, the Fed has undertaken a variety of unusual policies – it massively increased credit by buying a range of financial assets, and it has held short term interest rates close to zero in an unprecedented set of policies referred to as Quantitative Easing (QE). It was this policy that Rick Perry called “treasonous.”
And to be sure, there is a lot to be concerned about with the results of these policies. They have been accompanied by massive increases in the value of the “stock market”, record levels of profits of non-financial corporations, and the rebound of bonuses on Wall Street. By contrast, there have been much slower and limited gains for workers. The unemployment rate has been trending downwards, but wages have barely budged and many workers have given up looking for jobs. And yes: evidence indicates that virtually all the economic gains since the depths of the recession have been captured by the top 1%.
These inconvenient facts have created a paradox in our attempts to understand the relationship between monetary policy, worker’s well-being and inequality. Paul Volcker was roundly criticized in the 1980’s because his massive increases in interest rates threw workers out of work, raised profits for banks, and dramatically increased inequality. For decades the Fed has been criticized by progressives and heterodox economists for keeping interest rates too high, and for padding the profits of bankers while making it more difficult for businesses to invest, expand and create jobs. But now, the Fed is being accused of raising inequality by doing the opposite: by lowering interest rates.
Can both of these be true? Has the world been turned upside down? What can economic analysis tell us about who gains and who loses from the Fed’s recent Quantitative Easing (QE)?
A recent study by the IMF looked at the impact of Fed policy on income inequality in the U.S. in the period between the Second World War and 2008, just prior to the recent financial crisis. (Innocent Bystanders: Monetary Policy and Inequality in the United States.) Their study supports the long-held view of progressives and heterodox economists: more restrictive monetary policy, which generates higher interest rates, leads to MORE inequality. It helps the wealthy and the “creditors” who lend money by raising interest rates and raising the returns on their wealth, keeps inflation in check so it preserves the value of their wealth, and hurts workers by slowing job creation and harming debtors by raising the interest rates they have to pay.
Has there been a change since 2008? Recent research by Juan Montecino, a UMass-Amherst graduate student, and myself has identified some clear winners from the Fed’s QE policy. We found that the initial round of QE in 2009 did increase bank profits, especially among those large banks that held large quantities of toxic financial assets (Juan Antonio Montecino and Gerald Epstein, “Have Large Scale Asset Purchases Increased Bank Profits” ). But we found little evidence that these policies increased lending to businesses. In a related study (“The Political Economy of Quantitative Easing: Who Stood to Gain?”), Montecino and I studied the impact of the full period of QE on the expected profits of all sectors of the U.S. economy. We found once again that the large financial firms stood to gain from the policy; these were joined by companies in construction and autos. But the expected benefits from these policies faded for most sectors by the last round of QE in 2012-2013. This might explain why the Fed abandoned the policy soon thereafter.
So we have clear evidence that the big banks gained from the policy. But the impacts on wages and employment for the bulk of the population have been much more muted. Does this mean that a better policy would be to do as Paul, Paul and Perry propose? Doubtful. High interest rates and an inflexible monetary standard such as the “gold standard” would only bring us back to the days of costly credit, slow job growth, and new ways for lightly regulated Wall Street banks to crash the economy again.
But at the same time, it is clear that current monetary and macro policy more generally is not working well for the bulk of the population. Until it does, political pressure will keep focusing on the Federal Reserve, as it should. But don’t forget the Wall Street banks and corporations that stand to gain from the Fed’s policies, and the missing-in-action fiscal policy that places way too much pressure and responsibility on the Fed.
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Does this mean that a better policy would be to do as Paul, Paul and Perry propose?
Ron Paul and the gold standard – No
Rick Perry – Yes. Give the Fed a taste of Texas justice.
Rand Paul – Audit the Fed – Yes. Everything should be up for audit, and the inspection should extend to the broom closets, and the skeleton closets.
High interest rates and an inflexible monetary standard such as the “gold standard” would only bring us back to the days of costly credit, slow job growth, . . .
High interest rates would certainly put a crimp in million dollar home sales, but then that million dollar home might only be $100K if interest rates were 10%, and the incentive to get the sucker paid for, would be priority one.
. . . and new ways for lightly regulated Wall Street banks to crash the economy again.
It is news to me that there is any connection between interest rate levels and regulation of Wall Street, but what do I know? I am not an economist.
And now the crash of 2008 has led to the biggest fight in 75 years. We got into this fight because Alan Greenspan’s Fed failed to sufficiently regulate the banks that drove the economy into the ditch, and the Fed subsequently bailed out these same banks without punishing the guilty parties.
See Rand Paul, above.
And yes: evidence indicates that virtually all the economic gains since the depths of the recession have been captured by the top 1%.
The fact that the 99% have gotten practically zero of any gains since 2008 is of no real concern to anyone at the Fed. It is all hot air. See Rand Paul above.
The root cause of these problems is G L O B A L I Z A T I O N. When a company threatens it’s employees to move production to China, unless employees take a huge pay cut and then afterwards move production anyway, it destroys the value of labor, but no less than the “smartest guy in the room” Ben Bernanke crowed about how inflation was subdued by the use of Chinese slave labor.
The results are in, and it is an ecological disaster in China, and an economic disaster everywhere else. Thanks for nothing.
Very good points, for the most part. The post does put the blame where it belongs – on congress. Referring to the dereliction of duty practiced by our congress for 40 years and acutely adhered to for the last 10 years in what can only be called “austerity” and abdicating responsibility to the Fed to actually keep the USA on economic life support and etc. Referring to congress as “missing in action”. In lock step, comrades. Must wonder whose vision we are marching to.
Why only congress to blame?
Don’t forget the Supreme Court.
And the third branch.
It’s…teamwork.
Putting them all together, you have…the government.
Yes, and the three branches of that government work for Wall Street and corporations, especially the war profiteers with all their subsidiaries in every congressional district.
Government by corporatocracy, especially with massive flag-waving, militarism, militarized police, repression of peaceful protests, a domestic surveillance state and an imperialist foreign policy amounts to one thing: fascism.
“When fascism comes to America, it will be wrapped in the flag and carrying a cross” – Sinclair Lewis
I don’t see how to break the immense (and growing) power of big finance without a systemic collapse and reboot (with gold playing a major role, whether under an exchange standard or otherwise). I just can’t see any other scenario. Can anyone here? Does anyone here really think that rallying around Elizabeth Warren will make a dime’s worth of difference?
Everything has become too centralized. Not only at the Fed, but globally with coordination of all the central banks. As a gradual process, centralization has made it easier and easier for the elite to seize control of the whole system and operate it for their own benefit. You see this with monetary policy, you see it with “trade” policy in the TPP, you see it with regulatory capture on Wall Street, you see it as events unfold in Greece, you see it with corporate control of the press. I could go on and on. If you have eyes to see, look for yourself and you will see democracy eviscerated everywhere you look, and the culprit is centralization.
The only way to change course is to let the financial system collapse, to start rebuilding economies locally, and to build a new monetary system based on something other than accumulated debts (which lend themselves much too easily to centralization and deja vu).
Agreed! This system has become parasitic on 99% of the population. It is beyond fixing and must be destroyed. Those who want to apply band aids to make it less bad are just pushing even more burden on future generations. Seeing that we’ve benefited most from this racket, we should pay the price of fixing it.
The important thing is what comes after a collapse. Unless a gold standard is adopted we will simply be giving the 1% a free hand to repeat the financial crimes they’ve been committing. You cannot allow financiers and politicians such power as they’ll only abuse it. The only way to avoid that is with a gold standard. set rules they must abide by. Otherwise you get this Wild West show.
The progressives leave a lot to be desired. Typical of them to oppose something but offer no solution to actually fix the problem. Just liberals doing the only thing they know how to do: appear to care. Don’t get me wrong, I’m not looking to ruin anyone’s life. The 1% are doing a very through job of that right now. If a debt jubilee could be combined with a gold standard I’d be all for it. Many people have been forced into debt just to make a living. Others are likely living beyond their means with debt(check out the Canadian middle class) but I don’t resent them for it, even though I’ve been more responsible – and had the luck to have that luxury. We’re at a point now that the system must be changed. It must be a drastic change, even if it brings down every bank in the global economy. It’s just a shame most of the 99% wallow in willful ignorance and will never have the courage to even attempt such a financial revolution.
I think that what all this proves is that when the powerful get to write the rules, they can come out winners with any policy. High interest rates, low interest rates, it doesn’t matter as long as they can act freely without any concern for regulation. Lack of regulation isn’t the only necessary condition, though. Active government rescue of the powerful and the quashing of the less powerful is needed when things turn sour. If they can’t steal from us one way, they find another way.
Seams to me that if 40% or so of all profits exist in the financial sector, a sector that derives it’s profit by creating renter income/extractive income/non-productive income that therefore, puts an extra cost upon everything akin to a levy of a private tax. Combined with this extraction is the privatization of the commons, the largest of which is this planet, then infrastructure sorely in need of improvement….and the list goes on. It would make sense to me to tax the non-productive extraction by the financial sector into public use, the commons. In supporting that view…the currency issuance should be from the sovereign and therefore, the recapture of this financial levy, in a just revenue system, would go back to the people and the commmons.
The largest commons is earth and, if you haven’t noticed…..it is in trouble and could use some sprucing-up.
Consider this analogy: In a hypothetical casino card game the house takes 5% of every pot. If 10% of the money at the table is on average played on each hand, then the house takes 0.5% of the money in the game on each rake. After 200 hands, 100% of the money that is on average at the table has been taken by the house. The only way the game may continue is to have new money come to it. The winners, of course, smell the new blood and even anticipate it greedily. And the biggest winner over a time is always the house. Until the free market ideologues took over, the biggest difference between a casino bank and finance was that the gaming house took a bigger cut of the handle.
So what does this have to do with the FED and interest rates? It demonstrates that whatever the rate of financial profits, wealth is inevitably concentrated. The only way to avoid that economic damage to the human race is to minimize the cost of finance. Non profit finance, of, by and for the people begins with the confiscatory taxation of individual and corporate wealth over some acceptable maximum allowable limits.
No usury is sustainable. No financial profits above actual costs can be tolerated if we are to survive.
This is a very interesting and insightful analysis!
And it certainly seems true to me – if more and more of your economy is finance, and more and more of it becomes rents, than only those who have income from rents will prosper.
The IMF study appears flawed. it does not include wealth in asset prices, only includes income. As far as I can tell hence, …….
That isn’t a flaw. The purpose was to look at effects of monetary policy on income inequality, not wealth.
Seems to be missing quite a lot, then, in terms of true inequality. Making $25,000 a year is quite different, in terms of quality of life, for a person with a $1,000,000 trust fund in comparison to a person with no assets.
Also, how would the data look if the 1% weren’t excluded? Seems like a big oversight to me.
One gets into real problems when attempting to estimate wealth — what does one count as such, how does one determine its value, etc. There’s hard data on incomes so you get a cleaner analysis. You’re right that a lot is missed, though.
There’s also another, fairly obvious conclusion: the money always flows up to the top in the US economy regardless of whether or not interest rates are high, low, or somewhere in between. Furthermore, setting the interest rate never had a damn thing to do with combating inequality in the first place. Maybe that’s what no one wants to hear, past a certain point the Fed really isn’t in control. Don’t get me wrong, monetary policy matters and affects a wide range of things, but wealth distribution isn’t one of them.
When I hear Paul jr. and sr. talking about the Fed, all I can think is how entirely besides the point their argument is. Going back to the gold standard would be terrible for the average American, but then again pretty much every idea pushed by the hardcore neoliberal crowd is. That isn’t to say that high inflation would be either, but they were never going to offer their constituency anything but snake oil from the jump. The only things that will help them were off the table to start with and most of those voters are delusional enough that they wouldn’t take policies which benefitted the middle class if you handed them to them on a silver platter.
Most voters don’t realize that throughout U.S. history, middle classes were products of government intervention, via massive spending, direct employment, legalized labor unions, homestead land…Middle classes are never “natural” products of “markets”.
True, and corporate media will never inform most voters about that history. When was the last time you saw a documentary about the labor movement?
This graph shows private debt/ GDP and income share to the top 5%
if increases in private debt/ GDP increase incomes to the top, that would imply loose easy credit increases inequality
http://www.voxeu.org/sites/default/files/image/FromApr2012/coibion%20fig1%2028%20jan.png
this shows economy wide leverage and pay in finance
http://static.businessinsider.com/image/4f2ac559ecad04385000000c/image.jpg
and this as well
http://www.marketoracle.co.uk/images/2014/May/household-incomes-mean-real.gif
If anyone can explain the tighter credit of these graphs and the IMF paper please do, it just doesn’t seem to fit if you ask me
In ecology, ‘primary productivity’ is a measure of the conversion of solar energy into biomass, which can be consumed by successive prganisms. The Verhulst Equation is illustrative. A rate ({r} of growth less than 1 will crash the system. If r increases over 3, there are stable cycles. If r increases further, there is chaotic destabilization, and ultimately a crash at r=4.
Greer (the Archdruid) has investigated the system of externalities, the dumping of bads outside the system of interest. Every living thing does this. Odum looked at how money undersells the value of the stored energy. The price is uncoupled from the underlying value. This also describes the effect of ZIRP on stock buybacks.
This issue has been well-covered here at NC: the semantics of saying asset inflation increases ‘productivity.’
Amazon loses a half-billion dollars a year. Taxing Amazon on profits is meaningless. A waterhole in a drought can lead to one enormous crocodile that eventually starves to death. But the incentive structure means that Bezos can sequester the cash before the crash (IBGYBG).
Greer (“collapse now and avoid the rush”) effectively advocates a permaculture methodology. Develop the skill set and perennial agriculture to uncouple from the vagaries of the financial system and rigged interest rates. Depending on circumstances, it can be an energetically efficient local strategy. “35 million families (70% of Russia’s population) working 8 million [hectares] of land and produc[e] more than 40% of Russia’s agricultural output…”
However, this strategy can be undercut by more than one means. When oppressors salt the soil and knock down thousand-year-old olive trees, it fails by force.
When speculation can drive up land values, and taxation is assessed on the speculative price, the cash needed to pay the taxes cannot be produced by local real productivity.
“Local government exists for one reason and one reason only: to decide how land gets used. Everything, and I mean everything, that local government does deconstructs to a decision about which landowners will win, and which will lose.” (Gregory Travis) But it is national level powers that have access to ZIRP and its secondary profits. Yves: “Michael Lind provided the best single analysis I’ve seen so far in a piece that describes it as the “newest right” which promotes the interests of “local notables” who are wealthy leaders in their communities but second-tier nationally.”
Energy is conserved. Land is conserved. Fiat money, like entropy, is not conserved. I do not have the resources to hop on the fiat train. I’m just trying to adapt to circumstances, sort of like learning how to grow warmer-weather crops.
So, the questions: Am I being oversensitive to a fiat-fueled, speculative tax-increase land grab? Can a coalition with ‘local notables’ work, somewhat like the Magna Carta? Or is Ostrum-style regulation doomed by the immense leverages now built in to the financial system. Bueller?
Please forgive the lengthly post and rough transitions. One last quote:
“So do I,’ said Gandalf, ‘and so do all who live to see such times. But that is not for them to decide. All we have to decide is what to do with the time that is given us.'”
edits:
successive organisms. The Verhulst Equation is illustrative. A rate {r}
to the financial system?
Bueller?
global permaculture would be a giant step for mankind
If the TPP and its insidious siblings pass local government will have lost its reason for existence.
edits:
successive organisms. The Verhulst Equation is illustrative. A rate {r}
to the financial system?
Economics is a hard science – without any scientists. Bankrupt U Bernanke caused the world-wide Great-Recession all by himself, thru his incredibly bad judgment/mistakes. There is a Gospel, a Holy Grail, and it has been inviolate and sacrosanct -for over 100 years.
I’m beginning to think that 50 years ago the seeds of our current depression were sown and decisions were made. People could see the mess capitalism would get into because growth would be stopped by a lack of resources and a malthusian population explosion. Because we began outsourcing in the 70s. Slowing down our own growth. And all the books about the problems we would inevitably face, etc. Ecology became a new religion that long ago too. One I adhere to. Because what is the alternative? My question is Why? Why couldn’t we control this runaway freight train sooner?
Soddy, Frederick M.A., F.R.S.. Wealth, Virtual Wealth and Debt (Kindle Locations 1883-1884). Distributed Proofreaders Canada.
I wonder if Paul and the hard money crowd have ever heard of petro-dollars? It seems clear that Henry Kissinger, Wall Street and this country’s ‘financial diplomats’ have. What their apologists euphemize as ‘efficiency of capital’, Soddy called “double counting” (of money). Creating more money than there was wealth for it to purchase has always been a fraud on the money-holding public, a form of embezzlement leveraged investors and their money-creating banker buddies managed to conceal by creating the missing wealth in the interval between the commission of their crime and its discovery.
In the era of industrial capitalism, that wealth came from harnessing inanimate energy sources to machinery to do what human labor could do thousands of times ‘faster, better, cheaper’. But for people with more money than they could ever need, real wealth creation wasn’t the point. The only thing of interest to them is the ability of money to create more money. This all boils down to
(Thanks Lambert!) Or as a lay person would translate it ‘the value of a claim on tomorrow’s income stream today’, AKA debt / ‘money’.
Pretty much the whole of the last century has been given over to a system of political economy obsessed with piling up more money one way or the other, employing for example world wars, conspicuous consumption, waste of finite resources, etc so those who have more money than they need already could pile up an even larger claim to the wealth and labor of present and future generations or, from the perspective of the host society, more debt.
It should come as no surprise that the ultimate outcome of this process would be bankruptcy (both literal and moral) as the Lords of Finance in the West deploy their financial engineers to pile debt upon debt upon debt. That’s what the Fed is all about – keeping this system of debt creation afloat – not just for the US but for international capital as far as the US ‘dollar system’ can reach. For the Lords of Finance what matters is protecting the debt of society to the system they have constructed, even if it means ‘destroying that society to save it’; hence, QEs, ZIRP, Greece, TTPs, etc.
One more Soddy quote…
Soddy, Frederick M.A., F.R.S.. Wealth, Virtual Wealth and Debt (Kindle Locations 1089-1091). Distributed Proofreaders Canada. If you want to be on the winning team, make sure your team mates use it (energy) wisely.
It has been fun watching (true) conservatives and progressives converge – while of course resisting it all the more as they find themselves drawn together in some ways.
Both realize that the Fed is the tool of tiny elites, and that ceding economic policy to the bankers (in the form of the Fed) is good for neither liberty nor the nation’s broad economic well-being. Both agree that using government power to enrich the wealthy as we are doing today – a kind of reverse Robin Hoodism – leads only to catastrophe. But while the conservative see using official power (the Fed) as bad in principle, the progressives think official power (the government) should be used to manage the economy, but for the benefit of the poor and not for the rich as is happening now (wake up, Paul Krugman).
I would split the difference. The GOP is right on debt and printed money. Sorry libs, but the problem in the world today is too much debt, and creating still more debt does not erase existing debt. So yes, painful as it would be, a gold standard is the only way to avoid governments’ natural tendency to print money.
On the other hand, 2008 proved the need for government regulation if it proved nothing else. Wall Street shysters, if left alone, will drive us off the cliff. They have no conscience or morals – that is their job! So they must be regulated.
Governments can prevent bad behavior – the commonest law against stealing or murder prove this – but all experience shows they are bad at guiding economies to prosperity.
Government should be a cop, not a managing director.
Public debt is not the same animal as private debt, the amounts can also be attributed to poor risk management which is a feature and not a bug of the free market posse.
Per your cop – director missive you might want to check as to whom government is most responsive towards i.e. industry lobbyists, think tanks, wads of cash or citizen voters.
IIUC, one thing that the Fed deliberately did not do as part of QE, but which they could legally have done, was to buy municipal bonds. Doing so might have allowed cities to borrow money and actually do something for Main Street instead of Wall Street.
As it is rightly mentioned about the impact on wages and employment, interest rates and standards can be fine tunes considering the situation of working population. The policy measures should ideally cover all classes of society and sectors of the economy. If the measures affect large financial institutions in such a way that they can generate and sustain employment, they are fairly adoptable. – Via http://www.synechron.com
The missing piece in this discussion is the impact technology is having on decoupling the cost of labor from the cost of production. This accelerating structural change enables globalization, the replacement of human labor with capital labor, automated (including high frequency) trading and the list goes on and on. As long as science continues to expand the boundaries of Moore’s Law, we will continue down the path of needing fewer and fewer people to make all the stuff we want to consume. The inevitable result is the transfer of wealth from the owners of labor (individuals) to the owners of capital (1%).
Current economic and political theory is ill equipped to provide an answer. Both liberal and conservative thinking looks at the problem through the prism of the past. The seed of the solution can be found by answering the following….
When the value of human labor becomes a declining factor in the production of goods and services, what changes to economic and political policies are needed to avoid the resulting inevitable inequality? A livable wage doesn’t help when the aggregate number and quality of jobs is shrinking. A livable income…. perhaps.
A central bank enacts quantitative easing by purchasing—without reference to the interest rate—a set quantity of bonds or other financial assets on financial markets from private financial institutions.[8][24] The goal of this policy is to facilitate an expansion of private bank lending; if private banks increase lending, it would increase the money supply. Additionally, if the central bank also purchases financial instruments that are riskier than government bonds, it can also lower the interest yield of those assets.
This was taken from wiki.
Here is the problem. We are at record levels with Quantitative Easing. Why is there no money for small businesses? The Fed is doing its part. So where is the money going? We all agree to the 1%. My suggestion would be to cut the current primary dealers out of the loop and go straight to the regional banks. The current primary banks use the Fed money to make their own gambles knowing Fed will bail them out. How can small businesses compete against this insanity.