Yves here. This humble blog has regularly criticized central bank interventions, from Paul Volcker deciding that crushing labor was a key aid of his anti-inflation intervention to Greenspan losing his nerve when dot-com irrational exuberance was obvious in 1996 and then helping turbo-charge demand for risky assets by driving interest rates low for an unheard of nine quarters in the dot-bomb era, to the Bernanke Fed ignoring subprime risk and then doing too much, too late, particularly ZIRP. Yellen continued the Greenspan/Bernanke put.
The Fed has also damaged smaller economies by its indifference to how changes in its policy lead hot money to flow in and out of them, whipsawing their financial systems. Central bank governors, particularly India’s highly-respected Raghuram Rajan complained when the 2014 taper tantrum hit India and the other BRICs. And recently, we’ve taken the Fed and other central banks to task by acting as if they are in a position to address the current bout of inflation.
By Anis Chowdhury, Adjunct Professor at Western Sydney University and University of New South Wales (Australia), who held senior United Nations positions in New York and Bangkok and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Jomo Kwame Sundaram’s website
Central bank policies have often worsened economic crises instead of resolving them. By raising interest rates in response to inflation, they often exacerbate, rather than mitigate business cycles and inflation.
Neither Gods nor Maestros
US Federal Reserve Bank chair Jerome Powell has admitted: “Whether we can execute a soft landing or not, it may actually depend on factors that we don’t control.” He conceded, “What we can control is demand, we can’t really affect supply with our policies. And supply is a big part of the story here”.
Hence, decisionmakers must consider more appropriate policy tools. Rejecting ‘one size fits all’ formulas, including simply raising interest rates, anti-inflationary measures should be designed as appropriate. Instead of squelching demand by raising interest rates, supply could be enhanced.
Thus, Milton Friedman – whom many central bankers still worship – blamed the 1930s’ Great Depression on the US Fed. Instead of providing liquidity support to businesses struggling with short-term cash-flow problems, it squeezed credit, crushing economic activity.
Similarly, before becoming Fed chair, Ben Bernanke’s research team concluded, “an important part of the effect of oil price shocks [in the 1970s] on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy”.
Adverse impacts of the 1970s’ oil price shocks were worsened by the reactions of monetary policymakers, which caused stagflation. That is, US Fed and other central bank interventions caused economic stagnation without mitigating inflation.
Likewise, the longest US recession after the Great Depression, during the 1980s, was due to interest rate hikes by Fed chair Paul Volcker. A recent New York Times op-ed warned, “The Powell pivot to tighter money in 2021 is the equivalent of Mr. Volcker’s 1981 move” and “the 2020s economy could resemble the 1980s”.
Monetary Policy for Supply Shocks?
Food prices surged in 2011 due to weather-related events ruining harvests in major food producing nations, such as Australia and Russia. Meanwhile, fuel prices soared with political turmoil in the Middle East.
However, Boston Fed head Eric Rosengren argued, “tightening monetary policy solely in response to contractionary supply shocks would likely make the impact of the shocks worse for households and businesses”.
Referring to Boston Fed research, he noted commodity price changes did not affect the long-run inflation rate. Other research has also concluded that commodity price shocks are less likely to be inflationary.
This reduced inflationary impact has been attributed to ‘structural changes’ such as workers’ diminished bargaining power due to labour market deregulation, technological innovation and globalization.
Hence, central banks are no longer expected to respond strongly to food and fuel price increases. Policymakers should not respond aggressively to supply shocks – often symptomatic of broader macroeconomic developments.
Instead, central banks should identify the deeper causes of food and fuel price rises, only responding appropriately to them. Wrong policy responses can compound, rather than mitigate problems.
Appropriate Innovations
A former Philippines central bank Governor Amando M. Tetangco, Jr noted it had not responded strongly to higher food and fuel prices in 2004. He stressed, “authorities should ignore changes in the price of things that they cannot control”.
Tetangco warned, “the required policy response is not… straightforward… Thus policy makers will need to make a choice between bringing down inflation and raising output growth”. He emphasized, “a real sector supply side response may be more appropriate in addressing the pressure on prices”.
Thus, instead of restricting credit indiscriminately, financing constraints on desired industries (e.g., renewable energy) should be eased. Enterprises deemed inefficient or undesirable – e.g., polluters or those engaged in speculation – should have less access to the limited financing available.
This requires designing macroeconomic policies to enable dynamic new investments, technologies and economic diversification. Instead of reacting with blunt interest rate policy tools, policymakers should know how fiscal and monetary policy tools interact and impact various economic activities.
Used well, these can unlock supply bottlenecks, promote desired investments and enhance productivity. As no one size fits all, each policy objective will need appropriate, customized, often innovative tools.
Lessons from China
China’s central bank, the People’s Bank of China (PBOC), developed “structural monetary policy” tools and new lending programmes to help victims of COVID-19. These ensured ample interbank liquidity, supported credit growth, and strengthened domestic supply chains.
Outstanding loans to small and micro businesses rose 25% to 20.8 trillion renminbi by March 2022 from a year before. By January, the interest rate for loans to over 48 million small and medium enterprises had dropped to 4.5%, the lowest level since 1978.
The PBOC has also provided banks with loan funds for promising, innovative and creditworthy companies, e.g., involved in renewable energy and digital technologies. It thus achieves three goals: fostering growth, maintaining debt at sustainable levels, and ‘green transformation’.
Defying global trends, China’s ‘factory-gate’ (or producer price) inflation fell to a one-year low in April 2022 as the PBOC eased supply chains and stabilized commodity prices. Although consumer prices have risen with COVID-19 lockdowns, the increases have remained relatively benign so far.
In short, the PBOC has coordinated monetary policy with both fiscal and industrial policies to boost confidence, promote desired investments and achieve stable growth. It maintains financial stability and policy independence by regulating capital flows, thus avoiding sudden outflows, and interest rate hikes in response.
Improving Policy Coordination
Central bankers monitor aggregate indicators, such as wages growth. However, before reacting to upward wage movements, the context needs to be considered. For example, wages may have stagnated, or the labour share of income may have declined over the long-term.
Moreover, wage increases may be needed for critical sectors facing shortages to attract workers with relevant skills. Wage growth itself may not be the problem. The issue may be weak long-term productivity growth due to deficient investments.
Input-output tables can provide information about sectoral bottlenecks and productivity, while flow-of-funds information reveals what sectors are financially constrained, and which are net savers or debtors.
Such information can helpfully guide design of appropriate, complementary fiscal and monetary policy tools. Undoubtedly, pursuing heterodox policies is challenging in the face of policy fetters imposed by current orthodoxies.
Central bank independence – with dogmatic mandates for inflation targeting and capital account liberalization – precludes better coordination, e.g., between fiscal and monetary authorities. It also undercuts the policy space needed to address both demand- and supply-side inflation.
Monetary authorities are under tremendous pressure to be seen to be responding to rising prices. But experience reminds us they can easily make things worse by acting inappropriately. The answer is not greater central bank independence, but rather, improved economic policy coordination.
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The necessary levers are clear — industrial policy, credit guidance (differential interest rates by sector), capital controls and fiscal policy dominance.
All of which are anathema to neoliberalism, so good luck with that …
yep, its a lack of sovereignty and democratic control. since 1993 markets decide whats done, nafta billy clinton even declared it, the era of big government is over.
empty suit hollowman obama once said his job was to make sure their was no industrial policy any where.
so right now we are watching a futuristic hollywood movie, where corporations are warring on whats left of sovereign governments, russia, and china is next.
Oh, oh, what did he wrote! Controlling financial flows is a lesson to learn! Deadly sin! Deadly sin! My freedom to move money wherever and when I want not bothering with due taxes!
Mode /sarc on forever.
and as we see whats happening in sri lanka, they used to have some food security in whats important, grains. but since free trade cash crops rule.
so if the world did not free trade, less reliance on certain countries to raise basic food crops, so if there are droughts in major grain producing countries, it does not hit the world so hard with every countries ability to provide some food security for themselves.
Anyone who puts growth and ‘green transformation’ in the same sentence is kidding. IMHO what is needed is redistribution and de-growth at the top. But then that is a policy perhaps beyond any central bank. My 2¢.
Not so much “kidding” as dissembling…
Central banks was introduced for one thing, backstop bank runs.
Everything else is dependent on government counter cyclical policies.
But as of the 90s, Wall Street lobbyists managed to convince governments that they should be hands off as such policies cut into Wall Street’s boom time earnings.
>”Thus, Milton Friedman – whom many central bankers still worship – blamed the 1930s’ Great Depression on the US Fed. Instead of providing liquidity support to businesses struggling with short-term cash-flow problems, it squeezed credit, crushing economic activity.”
From my reading, nobody knows what caused the Great Depression. “There is no consensus among economists and historians regarding the exact causes of the Great Depression.”
https://www.britannica.com/story/causes-of-the-great-depression
Many economists have many theories which really only means that none of them has come up with one that works. One hundred years later, still no solid explanation, that says a lot about the practice of macro-economics.
don’t let economic nonsense blind you. most recessions, depressions are a lack of demand. two years before 2008, the trucking industry reported a lack of demand for goods and services was creating a recession in the trucking industry. the same warning lights are flashing now.
if there is curtailed demand, you get recessions or worse.
the great depression was a massive lack of demand.
https://aliveness.com/kangaroo/Timeline.htm
“1929
Herbert Hoover becomes President. Hoover is a staunch individualist but not as committed to laissez-faire ideology as Coolidge.
More than half of all Americans are living below a minimum subsistence level.
Annual per-capita income is $750; for farm people, it is only $273.
Backlog of business inventories grows three times larger than the year before. Public consumption markedly down.
Freight carloads and manufacturing fall.
Automobile sales decline by a third in the nine months before the crash.
Construction down $2 billion since 1926.
Recession begins in August, two months before the stock market crash. During this two month period, production will decline at an annual rate of 20 percent, wholesale prices at 7.5 percent, and personal income at 5 percent.
Stock market crash begins October 24. Investors call October 29 “Black Tuesday.” Losses for the month will total $16 billion, an astronomical sum in those days.
Congress passes Agricultural Marketing Act to support farmers until they can get back on their feet.”
read the entire thing, you will see what america became under woodrew wilsons free trade by 1920. it looks just like today.
I suspect Steve Keen is closer than most.
People in leadership that don’t understand that inflation destroys the financial base of the Proletariat have more money than brains.
They understand it right enough, and use that understanding to trash and loot and oppress the mopes. Since disparity of wealth and acceleration of end-game looting is, after all, their goal.
“central banks should identify the deeper causes of food and fuel price rises”
This is truly one of the real problems! Why should the central bank be responsible for this?
If we truly believe that expertise can be developed into highly disciplined experts AND the economy is very complex then why don’t you have a broad spectrum, and deep bench, of experts across many sectors to formulate a well defined and targeted policy for any desired economic activity.
And tangentially, why do we put economists in charge of our central banks? Most of them have ZERO actual understanding of how banking works. I’ve got a graduate degree in economics and I had to unlearn all of my education relating to money & banking to really understand money and banking as it actually works… and I say that after having worked for a banking institution for more than 15 years now.
I am ignorant of economic theory and have difficulty understanding complex notions so I would appreciate if someone can explain to me in carpenter’s terms how in a world of goods and money changing the quantity of one wont affect the other?
I get the supply chain issues but if the quantity of money had stayed the same, only some prices would go up not everything, where would money come from otherwise to pay for them?
Ignoring the trillions that were printed by Fed and government seems to be the elephant in the room imho.
Your assumption is incorrect. QE is not money printing. It’s an asset swap. The Fed buys bonds from investors, Treasuries or very high quality bonds like Ginnie Maes or Fannies. That gives them cash. But they don’t want cash (they are investors so they held securities for a reason) so they buy other securities. The effect is to increase the price of securities and lower the interest rate. Japan did QE to the moon and it still didn’t get Japan out of borderline deflation.
Moreover, you do need to increase money supply to reflect economic growth. But there is no fixed velocity of money, so there’s no relationship between money supply and inflation. Monetary experiments in the US (early Reagan) and Thatcher proved that. There was no relationship between money supply or changes in money supply and any macroeconomic variable.
What can overstimulate the economy is Federal government spending (more than it takes in in taxes) when the economy is already at full employment. Despite headline employment being low, the definition of employment has changed over time (there are still many un and under employed; indicators that more people could be working are that we are still below pre-Covid labor force participation rates and that most employers refuse to train new hires, they insist on someone who’s worked in a similar job, when 30 years ago, employers expected to train new hires).
See this seminal article that we reposted for why businesses underinvest and therfore government as a general rule needs to deficit spend: https://www.nakedcapitalism.com/2012/08/kalecki-on-the-political-obstacles-to-achieving-full-employment.html
thank you for taking the time to answer.
I see how QE might not have been money printing but 1.9 trillion in fiscal help and another trillion in PPP was clearly money printing imho that was sent directly to the people. That is a lot of cash.
Then, on the issue of QE, if the government issues a bond that primary dealers buy and collect a fee and immediately sell it to the Fed that deposits freshly printed dollars at the gov accounts, it looks like direct debt monetization with the primary dealers serving as a smoke screen only.
Majority of gov debt issues was purchased outright by the Fed lately, even the majority of Tips was bought by the Fed for reasons I don’t understand.
Then, investors that sold their treasuries for cash that didn’t want, what did they do with the cash (they weren’t forced into selling either)?
That might explain the huge home price increases we had and if we dont count that as inflation then its easy to say that QE doesn’t cause inflation.
Money has to be held by someone and if we narrowly define inflation as a limited basket of goods then its no wonder the relationship between quantity of goods and money supply doesn’t hold.
If printed money goes to stock market and other assets, does it really mean that its not causing inflation because our basket of goods isnt going up in price?
What happens when after 10 years of QE money going into assets it starts leaking out into everyday goods eventually, its hard to establish a cause and effect between QE and inflation but prices of goods cant go up if quantity of money doesnt increase ( I admit I dont get the velocity of money nor have I seen a coherent explanation of its dynamics).
I dont understand Japan, I heard that BoJ buys 100% of gov debt issues, it seems to me that time flows differently for asian countries so maybe its too early to say how the japan experiment will end up.
No, primary dealers bid at auction. There is no fee.
So this is a case in point regarding the effectiveness of “democracy.” Just too many foxes in the henhouse and, imo, it isn’t the Fed’s doing. The Fed is given its mandate for “independence” from Congress but there really aren’t any chickens left in that henhouse – it’s all foxes. When c. 2009 Bernanke testified before our dear leaders they seemed to chastise him for allowing the financial system to implode. Tsk tsk. He responded, politely, that it was more complicated than that and would Congress please allow him to make the necessary fiscal decisions? And to a person, they all began to stare at their fingernails. Clearly it is Congress’s decision to control every inflationary situation with high interest rates. The “independence of the Fed” is just cover for Congress. Congress made this ignorant decision – to cause a godawful recession that we are still trying to shake off – by not giving the Fed the means to adjust it. So, above, when Tetangco is quoted as saying, “…authorities should ignore changes in the price of things they cannot control” (supply side issues) it just goes to show that even a hick in the sticks knows more than Congress. Or is more responsible and moral. Or both. This remiss incompetence falls in Congress’s lap like a sack of potatoes. The quote from above is a keeper, “Central bank independence with dogmatic mandates for inflation targeting and capital account liberalization preclude better coordination between fiscal and monetary authorities and undercuts the policy space needed to address both demand and supply side inflation…… The answer is improved economic policy coordination.” Exactly what Bernanke asked for. We would be so much better off without Congress. They don’t even make sausage – just nasty little cocktail weenies. They are just too damn stupid.
This made me laugh our loud, “it’s all foxes”
Although I’d argue we’re up to the wolves eating the foxes in the henhouse.
That aside, Congress is not the place for short term fiscal decisions. They’re only capable of that on pure full out panic mode. The Treasury or some other related org needs to be able to dial up and down (within set parameters) certain taxes like a possible federal sales tax. I know way back in the 1950’s or 1960’s there was discussion of adjusting the soc sec tax to affect demand but that was lead balloon stuff. I get that, people want stable income so impact them on the expense side. I’m not saying a federal sales tax is a replacement for tax revenues, but it would be a demand targeted tax (and you could break it down more detailed in theory) that would be a possible level to use. And then give an agency like the Treasury the ability to move it up or down some without Congress approving – sort of like the power the FED has but on the fiscal side.
I agree that Treasury needs the power of the people, to act in behalf of everyone. We need something to offset the stranglehold Congress imposes on the Fed. Technically, Congress also imposes regulations on Treasury, “the purse”, but that becomes a battle of the branches – right out in the open. Whereas the Fed is a total captive of our dear leaders in Congress.
Where do the links get made and discussed between all these fiscal and monetary tools, relating to the “growth” thing (and what measure, mostly GDP, that shitforbrains confabulation of fraud, are used to measure “growth”), and the other aspect of consumption/demand that is killing the planet? What regulators/“policies” ever get applied by central banks as supragovernmental and supranational entities to foster large scale behaviors and capital flows that might keep humans from combustocide? “Disaster capitalism (sic)” only throws gasoline on the fire.
Just finished re-reading
Studs Terkel’s – Hard Times
Worth it to get a good perspective of what were headed for from his numerous interviews with people from the Great Depression.
I would say that it has some great lessons for today.
The depression does not appear to be due to a lack of demand but a huge oversupply causing prices to crash in the farm products. – You still had the market speculation, housing and land speculation, utility company speculation and all those other crimes and vulture-isms going on like today. You had company stores for the mine laborers to basically have yourself slave labor – you know – all that shafting of labor to make a buck at the top.
Guess that was the reason to put the in the Glass- Steagall Act from investopedia – Glass- Steagall Actwas passed in 1933 and separated investment and commercial banking activities in response to the commercial bank involvement in stock market investment. This mixing of commercial and investment banking was considered to be too risky and speculative and widely considered to be a culprit that led to the Great Depression.
if a worker does not have enough money to service their debts, consume, save a little and have leisure time, then yes, consumption falls and business are caught with to much inventory.
that’s part of what just in time tries to address. the capitalists know that squeezing workers till they have nothing under cuts their own consumption base, they are to sick with greed to care. so just in time is their answer to their greed.
https://aliveness.com/kangaroo/Timeline.htm
“1929
Herbert Hoover becomes President. Hoover is a staunch individualist but not as committed to laissez-faire ideology as Coolidge.
More than half of all Americans are living below a minimum subsistence level.
Annual per-capita income is $750; for farm people, it is only $273.
Backlog of business inventories grows three times larger than the year before. Public consumption markedly down.
Freight carloads and manufacturing fall.
Automobile sales decline by a third in the nine months before the crash.
Construction down $2 billion since 1926.
Recession begins in August, two months before the stock market crash. During this two month period, production will decline at an annual rate of 20 percent, wholesale prices at 7.5 percent, and personal income at 5 percent.
Stock market crash begins October 24. Investors call October 29 “Black Tuesday.” Losses for the month will total $16 billion, an astronomical sum in those days.
Congress passes Agricultural Marketing Act to support farmers until they can get back on their feet.”
read the entire thing, you will see what america became under woodrew wilsons free trade by 1920. it looks just like today.
Another mechanism for attacking inflation is invocation of the “credit control act”. The government limits the amount of credit for auto loans, credit cards etc, but allows full credit for productive investment. This is the action taken during war time.
So China can govern and we can’t.
One disagreement with the article: There is indeed wage inflation contributing to general inflation due outsourcing and technology hitting their limits resulting in the loss of productivity gains, which the Fed admits are strong headwinds for inflation.
So they could be trying to smash wage inflation like Volcker, even at the cost of generating more supply inflation.
It’s been a while since I checked in on Bill Mitchell’s blog but this might be a worthy companion read:
US inflation is moderating while a massive fiscal contraction is underway – recession looming
Speaking of full employment, the pandemic raises a question: what does full employment look like when a sizeable chunk of the population (except, again, in China) finds themself unwell due to the point or incapacitation due to Long Covid (although we can’t yet say the extent to which this will be the case, it is, I think, blandly realistic to say that this will be the case, to some extent)? Just yesterday, the Bank of England expressed serious concern about the ongoing LC crisis.