(Earlier this week, I gave a virtual presentation at an event organized by the Roosevelt Institute and the Green New Deal Network. Virtual events are inferior to live ones in many, many ways. But one way they are better, is that they are necessarily on video, and can be shared. Anyway, here is 25 minutes on why the economic situation calls for even more spending than the (surprisingly ambitious) proposals from the Biden administration, and also on why full employment shouldn’t be seen as an alternative to social justice and equity goals but as the best way of advancing them.)
Author: JW Mason
A Few Followup Links
The previous post got quite a bit of attention — more, I think, than anything I’ve written on this blog in the dozen years I’ve been doing it.
I would like to do a followup post replying to some of the comments and criticisms, but I haven’t had time and realistically may not any time soon, or ever. In the meantime, though, here is some existing content that might be relevant to people who would like to see the arguments in that post drawn out more fully.
Here is a podcast interview I did with some folks from Current Affairs a month or so ago. The ostensible topic is Modern Mone(tar)y Theory, but the conversation gave me space to talk more broadly about how to think about macroeconomic questions.
A pair of Roosevelt reports (cowritten with Andrew Bossie) on economic policy during World War II are an effort to find relevant lessons for the present moment: The Public Role in Economic Transformation: Lessons from World War II, Public Spending as an Engine of Growth and Equality: Lessons from World War II
Here is a piece I wrote a couple years ago on Macroeconomic Lessons from the Past Decade. Bidenomics could be seen as a sort of deferred learning of the lessons from the Great Recession. So even though this was written before the pandemic and the election, there’s a lot of overlap here.
This report from Roosevelt, What Recovery? is an earlier stab at learning those lessons. I hope to be revisiting a lot of the topics here (and doing a better job with them, hopefully) in a new Roosevelt report that should be out in a couple of months.
If you like podcast interviews, here’s one I did with David Beckworth of Macro Musings following the What Recovery report, where we talked quite a bit about hysteresis and the limits of monetary policy, among other topics.
And here are some relevant previous past posts on this blog:
In The American Prospect: The Collapse of Austerity Economics
A Baker’s Dozen of Reasons Not to Worry about Government Debt
Good News on the Economy, Bad News on Economic Policy
A Demystifying Decade for Economics
The American Rescue Plan as Economic Theory
So, this happened.
Some people are frustrated about the surrender on the minimum wage, the scaled-back unemployment insurance, the child tax credit that should have been a universal child allowance, the fact that most of the good things phase out over the next year or two.
On the other side are those who see it as a decisive break with neoliberalism. Both the Clinton and Obama administrations entered office with ambitious spending plans, only to abandon or sharply curtail them (respectively), and instead embrace a politics of austerity and deficit reduction. From this point of view, the fact that the Biden administration not only managed to push through an increase in public spending of close to 10 percent of GDP, but did so without any promises of longer-term deficit reduction, suggests a fundamental shift.
Personally, I share this second perspective. I am less surprised by the ways in which the bill was trimmed back, than by the extent that it breaks with the Clinton-Obama model. The fact that people like Lawrence Summers have been ignored in favor of progressives like Heather Boushey and Jared Bernstein, and deficit hawks like the Committee for a Responsible Federal Budget have been left screeching irrelevantly from the sidelines, isn’t just gratifying as spectacle. It suggests a big move in the center of gravity of economic policy debates.
It really does seem that on the big macroeconomic questions, our side is winning.
To be clear, the bill did not pass because some economists out-argued other economists. It was a political outcome that was driven by political conditions and political work. Most obviously, it’s hard to imagine this Biden administration without the two Sanders campaigns that preceded it. (In the president’s speech after signing the bill, Bernie was the first second person credited.) If it’s true, as reported, that Schumer kept expanded unemployment benefits in the bill only by threatening Manchin that the thing would not pass the House without them, then the Squad also deserves a lot of credit.
Still, from my parochial corner, it’s interesting to think about the economic theory implied by the bill. Implicitly, it seems to me, it represents a big break with prevailing orthodoxy.
Over the past generation, macroeconomic policy discussions have been based on a kind of textbook catechism that goes something like this: Over the long run, potential GDP grows at a rate based on supply-side factors — demographics, technological growth, and whatever institutions we think influence investment and labor force participation. Over the short run, there are random events that can cause actual spending to deviate from potential, which will be reflected in a higher or lower rate of inflation. These fluctuations are more or less symmetrical, both in frequency and in cost. The job of the central bank is to adjust interest rates to minimize the size of these deviations. The best short-term measure of how close the economy is to potential is the unemployment rate; at any given moment, there’s a minimum level of unemployment consistent with price stability. Smoothing out these fluctuations has real short run benefits, but no effects on long-term growth. The government budget balance, meanwhile, should not be used to stabilize demand, but rather should be kept at a level that ensures a stable or falling debt ratio; large fiscal deficits may be very costly. Finally, while it may be necessary to stabilize overall spending in the economy, this should be done in a way that minimizes “distortions” of the pattern of economic activity and, in particular, does not reduce the incentive to work.
Policy debates — though not textbooks — have been moving away from this catechism for a while. Jason Furman’s New View of Fiscal Policy is an example I often point to; you can also see it in many statements from Powell and other Fed officials, as I’ve discussed here and here. But these are, obviously, just statements. The size and design of ARPA is a more consequential rejection of this catechism. Without being described as such, it’s a decisive recognition of half a dozen points that those of us on the left side of the macroeconomic debate have been making for years.
1. The official unemployment rate is an unreliable guide to the true degree of labor market slack, all the time and especially in downturns. Most of the movement into and out of employment is from people who are not officially counted as unemployed. To assess labor market slack, we should also look at the employment-population ratio, and also at more direct measures of workers’ bargaining power like quit rates and wage increases. By these measures, the US pre-pandemic was still well short of the late 1990s. More broadly, there is not a well defined labor force, but a smooth gradient of proximity to employment. The short-term unemployed are the closest, followed by the longer-term unemployed, employed people seeking additional work, discouraged workers, workers disfavored by employers due to ethnicity, credentials, etc. Beyond this are people whose claim on the social product is not normally exercised by paid labor – retired people, the disabled, full-time caregivers – but might come to be if labor market conditions were sufficiently favorable.
2. The balance of macroeconomic risks is not symmetrical. We don’t live in an economy that fluctuates around a long-term growth path, but one that periodically falls into recessions or depressions. These downturns are a distinct category of events, not a random “shock” to production or desired spending. Economic activity is a complex coordination problem; there are many ways it can break down or be interrupted that result in a fall in spending, but not really any way it can abruptly accelerate. (There are no “positive shocks” for the same reason that there are lots of poisons but no wonder drugs.) It’s easy to imagine real-world developments that could causes businesses to abruptly cut back their investment plans, but not that would cause them to suddenly and unexpectedly scale them up. In real economies, demand shortfalls are much more frequent, persistent and damaging than is overheating. And to the extent the latter is a problem, it is much easier to interrupt the flow of spending than to restart it.
3. The existence of hysteresis is one important reason that demand shortfalls are much more costly than overshooting. Overheating may have short-term costs in higher inflation, inflated asset prices and a redistribution of income toward relatively scarce factors (e.g. urban land), but it also is associated with a long-term increase in productive capacity — one that may eventually close the inflationary gap on its own. Shortfalls on the other hand lead to a reduction in potential output, and so may become self-perpetuating as potential GDP declines. Hysteresis also means that we cannot count on the economy returning to its long-term trend on its own — big falls in demand may persist indefinitely unless they are offset by some large exogenous boost to demand. Which in turn means that standard estimates of potential output understate the capacity of output to respond to higher spending.
4. A full employment or high pressure economy has benefits that go well beyond the direct benefits of higher incomes and output. Hysteresis is part of this — full employment is a spur to innovation and faster productivity growth. But there are also major implications for the distribution of income. Those who are most disadvantaged in the labor market, are the ones who benefit most from very low unemployment. The World War II experience, and the subsequent evolution of the racial wage gap, suggests that historically, sustained tight labor markets have been the most powerful force for closing the gap between black and white wages.
I’m not sure how much people in the administration and Congress were actually making arguments like these in framing the bill. But even if they weren’t explicitly argued for, some mix of them logically follows from the willingness to pass something so much larger than the conventional estimates of the output gap would imply. Some mix of them also must underly the repeated statements that we can’t do too much, only too little, and from the recognition that the costs of an inadequate stimulus in 2009 were not just lower output for a year or two, but an extended period of slow growth and stagnant wages. When Schumer says that in 2009, “we cut back on the stimulus dramatically and we stayed in recession for five years,” he is espousing a model of hysteresis, even if he doesn’t use the word.
On other points, there’s a more direct link between the debate over the bill and the shift in economic vision it implies.
5. Public debt doesn’t matter. Maybe I missed it, but as far as I can tell, in the push for the Rescue Plan neither the administration nor the Congressional leadership made even a gesture toward deficit reduction, not even a pro forma comment that it might be desirable in principle or in the indefinite long run. The word “deficit” does not seem to have occurred in any official statement from the president since early February — and even then it was in the form of “it’s a mistake to worry about the deficit.” Your guide to being a savvy political insider suggests appropriate “yes, buts” to the Rescue Plan — too much demand will cause inflation, or alternatively that demand will collapse once the spending ends. Nothing about the debt. Things may change, of course, but at the moment it’s astonishing how completely we have won on this one.
6. Work incentives don’t matter. For decades, welfare measures in the US have been carefully tailored to ensure that they did not broaden people’s choices other than wage labor. The commitment to maintaining work incentives was strong enough to justify effectively cutting off all cash assistance to families without anyone in paid employment — which of course includes the poorest. The flat $600 pandemic unemployment insurance was a radical departure from this — reaching everyone who was out of work took priority over ensuring that no one was left better off than they would be with a job. The empirical evidence that this had no effect on employment is informative about income-support programs in general. Obviously $300 is less than $600, but it maintains the priority of broad eligibility. Similarly, by allowing families with no wages to get the full benefit, making the child tax credit full refundable effectively abandons work incentives as a design principle (even if it would be better at that point to just make it a universal child allowance.) As many people have pointed out, this is at least directionally 180 degrees from Clinton-era “welfare reform.”
7. Direct, visible spending is better than indirect spending or spending aimed at altering incentives. For anyone who remembers the debates over the ARRA at the start of the Obama administration, it’s striking how much the Rescue Plan leans into direct, visible payments to households. The plan to allow the child tax credit to be paid out in monthly installments may have some issues (and, again, would certainly work better if it were a flat allowance rather than a tax credit) but what’s interesting here is that it reflects a view that making the payments more salient is a good thing, not a bad thing.
In other areas, the conceptual framework hasn’t moved as far as I would have hoped, though we are making progress:
8. Means testing is costly and imprecise. As Claudia Sahm, Matt Bruenig and others have forcefully argued, there’s a big disconnect between the way means testing is discussed and the way it actually operates. When the merits of income-based spending are talked about in the abstract, it’s assumed that we know every household’s income and can assign spending precisely to different income groups. But when we come to implement it, we find that the main measure of income we use is based on tax records from one to two years earlier; there are many cases where the relevant income concept isn’t obvious; and the need to document income creates substantial costs and uncertainties for beneficiaries. Raising the income thresholds for things like the child tax credit is positive, but the other side of that is that once the threshold gets high enough it’s perverse to means-test at all: In order to exclude a relatively small number of high-income families you risk letting many lower-income families fall through the cracks.
9. Weak demand is an ongoing problem, not just a short-term one. The most serious criticism of the ARPA is, I think, that so many of its provisions are set to phase out at specific dates when they could be permanent (the child tax credit) or linked to economic conditions (the unemployment insurance provisions). This suggests an implicit view that the problems of weak demand and income insecurity are specific to the coronavirus, rather than acute forms of a chronic condition. This isn’t intended as a criticism of those who crafted the bill — it may well be true that a permanent child tax credit couldn’t be passed under current conditions.
Still, the arguments in support of many of the provisions are not specific to the pandemic, and clearly imply that these measures ought to be permanent. If the child tax credit will cut child poverty by half, why would you want to do that for only one year? If a substantial part of the Rescue Plan should on the merits be permanent, that implies a permanently larger flow of public spending. The case needs to be made for this.
10. The public sector has capacities the private sector lacks. While Biden’s ARPA is a big step forward from Obama’s ARRA in a lot of ways, one thing they have in common is a relative lack of direct public provision. The public health measures are an exception, of course, and the aid to state and local governments — a welcome contrast with ARRA — is public spending at one remove, but the great majority of the money is going to boost private spending. That’s not necessarily a bad thing in this specific context, but it does suggest that, unlike the case with public debt, the institutional and ideological obstacles to shifting activities from for-profit to public provision are still formidable.
My goal in listing these points isn’t, to be clear, to pass judgement on the bill one way or the other. Substantively, I do think it’s a big victory and a clear sign that elections matter. But my interest in this particular post is to think about what it says about how thinking about economic policy is shifting, and how those shifts might be projected back onto economic theory.
What would a macroeconomics look like that assumed that the economy was normally well short of supply constraints rather than at potential on average, or was agnostic about whether there was a meaningful level of potential output at all? What would it look like if we thought that demand-induced shifts in output are persistent, in both directions? Without the assumption of a supply-determined trend which output always converges to, it’s not clear there’s a meaningful long run at all. Can we have a macroeconomic theory that dispenses with that?
One idea that I find appealing is to think of supply as constraining the rate of growth of output, rather than its level. This would fit with some important observable facts about the world — not just that demand-induced changes in output are persistent, but also that employment tends to grow (and unemployment tends to fall) at a steady rate through expansions, rather than a quick recovery and then a return to long-run trend. The idea that there is a demographically fixed long-run employment-population ratio flies in the face of the major shifts of employment rates within demographic groups. A better story, it seems to me, is that there is a ceiling on the rate that employment can grow — say 1.5 or 2 percent a year — without any special adjustment process; faster growth requires drawing new people into the labor force, which typically requires faster wage growth and also involves various short run frictions. But, once strong growth does generate a larger labor force, there’s no reason for it to revert back to its old trend.
More broadly, thinking of supply constraints in terms of growth rates rather than levels would let us stop thinking about the supply side in terms of an abstract non monetary economy “endowed” with certain productive resources, and start thinking about it in terms of the coordination capabilities of markets. I feel sure this is the right direction to go. But a proper model needs to be worked out before it is ready for the textbooks.
The textbook model of labor markets that we still teach justifies a focus on “flexibility”, where real wages are determined by on productivity and a stronger position for labor can only lead to higher inflation or unemployment. Instead, we need a model where the relative position of labor affects real as well as nominal wages, and in which faster wage growth can be absorbed by faster productivity growth or a higher wage share as plausibly as by higher prices.
Or again, how do we think about public debt and deficits once we abandon the idea that a constant debt-GDP ratio is a hard constraint? One possibility is that we think the deficit matters, but debt does not, just as we now think think that the rate of inflation matters but the absolute price level does not. To earlier generations of economists, the idea that prices could just rise forever without limit, would have seemed insane. But today we find it perfectly reasonable, as long as the rise over any given period is not too great. Perhaps we’ll come to the same view of public debt. To the extent that we do care about the debt ratio, we need to foreground the fact that its growth over time depends as much on interest, inflation and growth rates as it does on new borrowing. For the moment, the fact that interest rates are much lower than growth rates is enough to convince people past concerns were overblown. But to regard that as a permanent rather than contingent solution, we need, at least, to get rid of the idea of a natural rate of interest.
In short, just as a generation of mainstream macroeconomic theory was retconned into an after-the-fact argument for an inflation-targeting central bank, what we need now is textbooks and theories that bring out, systematize and generalize the reasoning that justifies a great expansion of public spending, unconstrained by conventional estimates of potential output, public debt or the need to preserve labor-market incentives. The circumstances of the past year are obviously exceptional, but that doesn’t mean they can’t be made the basis of a general rule. For the past generation, macroeconomic theory has been largely an abstracted parable of the 1970s, when high interest rates (supposedly) saved us from inflation. With luck, perhaps the next generation will learn macroeconomics as a parable of our own time, when big deficits saved us from secular stagnation and the coronavirus.
The Natural Rate of Interest?
(A year ago, I mentioned that Arjun Jayadev were writing a book about money. The project was then almost immediately derailed by covid, but we’ve recently picked it up again. I’ve decided to post some of what we’re writing here. Plucked from its context, it may be a bit unclear both where this piece is coming from and where it is going.)
The problem of interest rates is one of the key fissures between the vision of the economy in terms of the exchange of real stuff and and the reality of a web of money payments. Like a flat map laid over a globe, a rigid ideological vision can be made to lie reasonably smoothly over reality in some places only at the cost of ripping or crumpling elsewhere; the interest rate is one of the places that rips in the smooth fabric of economics most often occur. As such, it’s been a central problem since the emergence of economics as a distinct body of thought. How does the “real” rate determined by saving and investment demand get translated into the terms set for the exchange of IOUs between the bank and its customer?
One straightforward resolution to the problem is simply to deny that money plays a role in the determination of the interest rate. David Hume’s central argument in his essay “On Interest” (one of the first discussions within the genealogy of modern economics) was that changes in the supply of money do not affect the interest rate.1
High interest arises from three circumstances: A great demand for borrowing; little riches to supply that demand; and great profits arising from commerce: And these circumstances are a clear proof of the small advance of commerce and industry, not of the scarcity of gold and silver… Those who have asserted, that the plenty of money was the cause of low interest, seem to have taken a collateral effect for a cause…. though both these effects, plenty of money and low interest, naturally arise from commerce and industry, they are altogether independent of each other.
“Riches” here means real, material wealth, so this is an early statement of what we would today call the loanable-funds view of interest rates. Similar strong claims have been taken up by some of today’s more doctrinaire classical economists, in the form of what is known as neo-Fisherism. If the “real” rate, in the sense of the interest rate adjusted for inflation, is set by the fundamentals of preferences and technology, then central bank actions must change only the nominal rate. This implies that when the central bank raises the nominal interest rate, that must cause inflation to rise — not to fall, as almost everyone (including the central bankers!) believes. Or as Minneapolis Federal Reserve president Narayana Kocherlakota put it, if we believe that money is neutral, then “over the long run, a low fed funds rate must lead to … deflation.”2 This view is, not surprisingly, also popular among libertarians.
The idea that monetary influences on the interest rate are canceled out by changes in inflation had a superficial logic to it when those influences were imagined as a literal change in the quantity of money — of the relative “scarcity of gold and silver,” as Hume put it. If we imagine expansionary monetary policy as an increase in the fixed stock of money, then it might initially make money more available via loans, but over time as that money was spent, it would lead to a general rise in prices, leaving the real stock of money back where it started.
But in a world where the central bank, or the private banking system, is setting an interest rate rather than a stock of money, this mechanism no longer works. More money, plus higher prices, leaves the real stock of money unchanged. But low nominal rates, plus a higher rate of inflation, leaves the real interest rate even lower. In a world where there is a fixed, central bank-determined money stock, the inflation caused by over-loose policy will cancel out that policy. But when the central bank is setting an interest rate, the inflation caused by over-loose policy implies an even lower real rate, making the error even worse. For the real rate to be ultimately unaffected by monetary policy, low interest rates must somehow lead to lower inflation. But it’s never explained how this is supposed to come about.
Most modern economists are unwilling to outright deny that central banks or the financial system can affect the rate of interest.3 Among other things, the privileged role of the central bank as macroeconomic manager is a key prop of policy orthodoxy, essential to stave off the possibility of other more intrusive forms of intervention. Instead, the disjuncture between the monetary interest rate observable in credit markets and the intertemporal interest rate of theory is papered over by the notion of the “natural” interest rate.
This idea, first formulated around the turn of the 20th century by Swedish economist Knut Wicksell, is that while banks can set any interest rate they want, there is only one interest rate consistent with stable prices and, more broadly, appropriate use of society’s resources. It is this rate, and not necessarily the interest rate that obtains at any given moment, that is set by the nonmonetary fundamentals of the economy, and that corresponds to the intertemporal exchange rate of theory. In the classic formulation of Milton Friedman, the natural rate of interest, with its close cousin the natural rate of unemployment, correspond to the rates that would be “ground out by the Walrasian system of general equilibrium equations, provided there is imbedded in them the actual structural characteristics of the labor and commodity markets, including market imperfections, stochastic variability in demands and supplies, the cost of gathering information about job vacancies and labor availabilities, the costs of mobility, and so on.”
The natural rate of interest is exactly the rate that you would calculate from a model of a rational individual trading off present against future — provided that the model was actually a completely different one.
Despite its incoherence, Friedman’s concept of the natural rate has had a decisive influence on economic thinking about interest in the 50 years since. His 1968 Presidential Address to the American Economics Association introducing the concept (from which the quote above comes) has been called “very likely the most influential article ever published in an economics journal” (James Tobin); “the most influential article written in macroeconomics in the past two decades” (Robert Gordon); “one of the decisive intellectual achievements of postwar economics” (Paul Krugman); “easily the most influential paper on macroeconomics published in the post-war era” (Mark Blaug and Robert Skidelsky). 4 The appeal of the concept is clear: It provides a bridge between the nonmonetary world of intertemporal exchange of economic theory, and the monetary world of credit contracts in which we actually live. In so doing, it turns the intertemporal story from a descriptive one to a prescriptive one — from an account of how interest rates are determined, to a story about how central banks should conduct monetary policy.
To understand the ideological function of R*, it’s useful to look at a couple of typical examples of how it’s used in mediating between the needs of managing a monetary economy and the real-exchange vision through which that economy is imagined.
A 2018 speech by Fed Chair Jerome Powell is a nice example of how monetary policy practitioners think of the natural rate. He introduces the idea of R* with the statement that “In conventional models of the economy, major economic quantities such as inflation, unemployment, and the growth rate of gross domestic product (GDP) fluctuate around values that are considered ‘normal,’ or ‘natural,’ or ‘desired.’” The slippage between the three last quoted terms is a ubiquitous and essential feature of discussions of R*. Like the controlled slipping between the two disks of a clutch in a car, it allows systems moving in quite different ways to be joined up without either fracturing from the stress. The ambiguity between these meanings is itself normal, natural and desired.
In a monetary policy context, Powell continues, these values are operationalized as “views on the longer-run normal values for the growth rate of GDP, the unemployment rate, and the federal funds rate.” Powell immediately glosses this as “fundamental structural features of the economy … such as the ‘natural rate of unemployment’.” Here again, we see a move from something that is expected to be true on average, to something that is a “fundamental structural feature” presumably linked to things like technology and demographics, and then to the term “natural”, which implies that these fundamental structures are produced by some quite different process than the network of money payments managed by the Fed. The term “natural” of course also implies beyond human control, and indeed, Powell says that these values “are not … chosen by anyone”. In the conventions of modeling, such natural, neutral, long-run, unchosen values are denoted with stars, so along with R* there is U* and a bevy of starred Greek letters.
Powell, to be fair, goes on to talk about how difficult it is to navigate by these stars in practice, and criticizes his predecessors who were too quick to raise interest rates based on hazy, imprecise ideas of the natural rate of unemployment. But there’s a difference between saying the stars are hard to see, and that they are not there at all. He has not (or, plausibly, assumes his audience has not) escaped the scholastic and tautological habit of interpreting any failure of interest rate changes to deliver the expected result as a sign that the natural rate was different than expected.
It is, of course true, that if there is any stable relationship between the policy rate controlled by the Fed and a target like GDP or unemployment, then at any particular moment there is presumably some interest rate which would move that target to its desired level. But the fact that an action can produce a desired result doesn’t make it “natural” in any sense, or an unchanging structural feature of the world.
Powell, a non-economist, doesn’t make any particular effort to associate his normal or natural values with any particular theoretical model. But the normal and natural next step is to identify “fundamental structural features” of the world with the parameters of a non monetary model of real exchange among rational agents. Indeed, in the world of macroeconomics theory, that is what “deep structural parameters” mean. In the usage of Robert Lucas and his followers, which has come to dominate academic macroeconomics, structural parameters are those that describe the rational choices of agents based only on their preferences and the given, objective production function describing the economy. There’s no reason to think Powell has this narrower meaning in mind, but it’s precisely the possibility of mapping these meanings onto each other that allows the “natural rate” and its cousins to perform their ideological role.
For an example of that next step, let’s turn to a recent report from the Centre for Economic Policy Research, which assembles work by leading European macroeconomists. As with Powell’s speech, the ideological understanding of the natural rate is especially striking here because much of the substantive policy argument being made is so reasonable — fiscal policy is important, raising interest rates makes public debt problems worse, the turn to austerity after great financial crisis was a mistake.
The CEPR economists begin with the key catechism of the real-exchange view of interest: “At its most basic level, the interest rate is the ‘price of time’ — the remuneration for postponing spending into the future.” R*, in other words, is a rate of interest determined by purely non monetary factors — it should be unaffected by developments in the financial system. This non monetary rate,
while unobservable … provides a useful guidepost for monetary policy as it captures the level of the interest rate at which monetary policy can be considered neutral … when the economy runs below potential, pushing actual real policy rates sufficiently below R* makes policy expansionary.
The notion of an unobservable guidepost doesn’t seem to have given the CEPR authors any pause, but it perfectly distills the contradiction embodied in the idea of R*. Yes, we can write down a model in which everyone has a known income over all future time, and with no liquidity constraints can freely trade future against present income without the need for specialized intermediaries. And we can then ask, given various parameters, what the going rate would be when trading goods at some future date for the same goods today. But given that we live in a world where the future is uncertain, where liquidity constraints are ubiquitous, and where a huge specialized financial system exists to overcome them, how do we pick one such model and say that it somehow corresponds to the real world?
And even if we somehow picked one, why would the intertemporal exchange rate in that world be informative for the appropriate level of interest rates in our own, given that the model abstracts away from the features that make monetary policy necessary and possible in the first place? In the world of the natural rate, there is no possibility for the economy to ever “run below potential” (or above it). Nor would there be any way for a single institution like a central bank to simultaneously change the terms of all those myriad private exchanges of present for future goods.
Michael Woodford, whose widely-used graduate textbook Interest and Prices is perhaps the most influential statement of this way of thinking about monetary policy is, unusually, at least conscious of this problem. He notes that most accounts of monetary policy treat it as if the central bank is simply able to fix the price of all loan transactions, but it’s not clear how it does this or where it gets the power to do so. His answers to this question are not very satisfactory. But at least he sees the problem; the vast majority of people using this framework breeze right past it.
The CEPR writers, for instance, arrive at a definition of the natural rate as
the real rate of interest that, averaged over the business cycle, balances the supply and demand of loanable funds, while keeping aggregate demand in line with potential output to prevent undue inflationary or deflationary pressure.
This definition simply jams together the intertemporal “interest rate” of the imagined non monetary world, with the interest rate target for monetary policy, without establishing any actual link between them. (Here again we see the natural rate as the clutch between theory and policy.) “Loanable funds” are supposed to be the real goods that their owners don’t currently want, which they agree to let someone else use. The “while” conjunction suggests that clearing the loanable-funds market and price stability are two different criteria — that there could in principle be an interest rate that keep output at potential and inflation on target, but failed to clear the market for loanable funds. But what could this mean? Are there any observable facts about the world that would lead a central bank to conclude “the policy rate we have chosen seems to be consistent with price stability, but the supply and demand for loanable funds are not balanced”? Where would this imbalance show up? The operational meaning of the natural rate is that any rate associated with the macroeconomic outcomes sought by the central bank is, by definition, the “natural” one. And as Keynes long ago pointed out — it is a key argument of The General Theory — the market for loanable funds always clears. There is no need for a market price balancing investment and saving, because any change in investment mechanically produces an exactly equal change in saving.
In practice, the natural rate means just this: We, the central bank, have set the interest rate under our control at a level that we hope will lead to our preferred outcomes for GDP, inflation, the unemployment rate, etc. Also, we can imagine a world in which rational agents trade present goods for future goods. Since in some such world the exchange rate between present and future goods would be the same as the policy rate we have chosen, our choice must be the optimal one.
“Has Finance Capitalism Destroyed Industrial Capitalism?”
(At the big economics conference earlier in January, I spoke on a virtual panel in response to Michael Hudon’s talk on the this topic. HIs paper isn’t yet available, but he has made similar arguments here and here. My comments were in part addressed to his specific paper, but were also a response to the broader discussion around financialization. A version of this post will appear in a forthcoming issue of the Review of Radical Political Economics.)
Michael Hudson argues that the industrial capitalism of a previous era has given way to a new form of financial capitalism. Unlike capitalists in Marx’s day, he argues, today’s financial capitalists claim their share of the surplus by passively extracting interest or economic rents broadly. They resemble landlords and other non-capitalist elites, whose pursuit of private wealth does not do anything to develop the forces of production, broaden the social division of labor, or prepare the ground for socialism.
Historically, the progressive character of capitalism comes from three dimensions on which capitalists differ from most elites. First, they do not merely claim the surplus from production, but control the production process itself; second, they do not use the surplus directly but must realize it by selling it on a market; and third, unlike most elites who acquire their status by inheritance or some similar political process, a capitalist’s continued existence as a capitalist depends on their ability to generate a large enough money income to acquire new means of production. This means that capitalists are under constant pressure to reduce the costs through technical improvements to the production process. In some cases the pressure to reduce costs may also lead to support for measures to socialize the reproduction costs of labor power via programs like public education, or for public provision of infrastructure and other public services.
In Hudson’s telling, financial claims on the surplus are essentially extractive; the pursuit of profit by finance generates pressure neither for technical improvements in the production process, nor for cost-reducing public investment. The transition from one to the other as the dominant form of surplus appropriation is associated with a great many negative social and political developments — lower wages, privatization of public goods, anti-democratic political reforms, tax favoritism and so on. (The timing of this transition is not entirely clear.)
Other writers have told versions of this story, but Hudson’s is one of the more compelling I have seen. I am impressed by the breadth of his analysis, and agree with him on almost everything he finds objectionable in contemporary capitalism.
I am not, however, convinced. I do not think that “financial” and “industrial” capital can be separated in the way he proposes. I think it is better to consider them two moments of a single process. Connected with this, I am skeptical of the simple before and after periodization he proposes. Looking at the relationship between finance and production historically, we can see movements in both directions, with different rhythms in different places and sectors. Often, the growth of industrial capitalism in one industry or area has gone hand in hand with a move toward more financial or extractive capitalism somewhere else. I also think the paper gives a somewhat one-sided account of developments in the contemporary United States. Finally, I have concerns about the political program the analysis points to.
1.
Let’s start with idea that industrial capitalists support public investments in areas like education, health care or transportation because they lower the reproduction costs of labor. This is less important for owners of land, natural resources or money, whose claim on the social surplus doesn’t mainly come through employing labor.
I wouldn’t say this argument is wrong, exactly, but I was struck by the absence of any discussion of the other ways in which industrial capitalists can reduce the costs of labor — by lowering the subsistence level of workers, or reducing their bargaining power, or extracting more work effort, or shifting employment to lower-wage regions or populations. The idea that the normal or usual result of industrial capitalists’ pursuit of lower labor costs is public investment seems rather optimistic.
Conversely, public spending on social reproduction only reduces costs for capitalist class insofar as the subsistence level is fixed. As soon as we allow for some degree of conflict or bargaining over workers share of the social product, we introduce possibility that socializing reproduction costs does not lower the price of labor, but instead raises the living standards of the human beings who embody that labor. Indeed, that’s why many people support such public spending in the first place!
On the flip side, the case against landlords as a force for capitalist progress is not as straightforward as the paper suggests.
Ellen Meiksins Wood argues, convincingly, that the origins of what Hudson calls industrial capitalism should really be placed in the British countryside, where competition among tenants spurred productivity-boosting improvements in agricultural land. It may be true that these gains were mostly captured by landlords in the form of higher rents, but that does not mean they did not take place. Similarly, Gavin Wright argues that one of the key reasons for greater public investment in the ante-bellum North compared with the South was precisely the fact that the main form of wealth in the North was urban land. Land speculators had a strong interest in promoting canals, roads and other forms of public investment, because they could expect to capture gains from them in the form of land value appreciation.
In New York City, the first subways were built by a company controlled by August Belmont, who was also a major land speculator. In a number of cases, Belmont — and later the builders of the competing BMT system — would extend transit service into areas where they or their partners had assembled large landholdings, to be able to develop or sell off the land at a premium after transit made it more valuable. The possibility of these gains was probably a big factor in spurring private investment in transit service early in the 20th century.
Belmont can stand as synecdoche for the relationship of industrial and financial capital in general. As the organizer of the labor engaged in subway construction, as the one who used the authority acquired through control of money to direct social resources to the creation of new means of transportation, he appears as an industrial capitalist, contributing to the development of the forces of production as well as reducing reproduction costs by giving workers access to better, lower-cost housing in outlying areas. As the real estate speculator profiting by selling off land in those areas at inflated prices, he appears as a parasitic financial capitalist. But it’s the same person sitting in both chairs. And he only engaged in the first activity in the expectation of the second one.
None of this is to defend landlords. But it is to make the point that the private capture of the gains from the development of the forces of production is, under capitalism, a condition of that development occurring in the first place, as is the coercive control over labor in the production process. If we can acknowledge the contributions of a representative industrial capitalist like Henry Frick, author of the Homestead massacre, to the development of society’s productive forces, I think we can do the same for a swindler like August Belmont.
More broadly, it seems to me that the two modes of profit-seeking that Hudson calls industrial and financial are not the distinct activities they appear as at first glance.
It might seem obvious that profiting from a new, more efficient production process is very different from profiting by using the power of the state to get some legal monopoly or just compel people to pay you. It is true that the first involves real gains for society while the second does not. But how do those social gains come to be claimed as profit by the capitalist? First, by the exclusive access they have to the means of production that allows them to claim the product, to the exclusion of everyone else who helped produce it. And second, by their ability to sell it at a price above its cost of production that allows them to profit, rather than everyone who consumes the product. In that sense, the features that Hudson points to as defining financial capitalism are just as fundamental to industrial capitalism. Under capitalism, making a product is not a distinct goal from extracting a rent. Capturing rents is the whole point.
The development of industry may be socially progressive in a way that the development of finance is not. But that doesn’t mean that the income and authority of the industrial capitalist is different from that of the financial capitalist, or even that they are distinct people.
Hudson is aware of this, of course, and mentions that from a Marxist standpoint the capitalist is also a rentier. If he followed this thought further I think he would find it creates problems for the dichotomy he is arguing for.
Let’s take a step back.
Capital is a process, a circuit: M – C – P – C’ – M’. Money is laid out to gain control of commodities and labor power, which are the combined in a production process. The results of this process are then converted back into money through sale on the market.
At some points in this circuit, capital is embodied in money, at other points in labor power and means of production. We often think of this circuit as happening at the level of an individual commodity, but it applies just as much at larger scales. We can think of the growth of an industrial firm as the earlier part of the circuit where value comes to be embodied in a concrete production process, and payouts to shareholders as the last part where value returns to the money form.
This return to money form just as essential to the circuit of capital as production is. It’s true that payouts to shareholders absorb large fraction of profits, much larger than what they put in. We might see this as a sign that finance is a kind of parasite. But we could also see shareholder payouts as where the M movement is happening. Industrial production doesn’t require that its results be eventually realized as money. But industrial capitalism does. From that point of view, the financial engineers who optimize the movement of profits out of the firm are as integral a part of industrial capital as the engineer-engineers who optimize the production process.
2.
My second concern is with the historical dimension of the story. The sense one gets from the paper is that there used to be industrial capitalism, and now there is financial capitalism. But I don’t think history works like that.
It is certainly true that the forms in which a surplus is realized as money have changed over time. And it is also true that while capital is a single process, there are often different human beings and institutions embodying it at different points in the circuit.
In a small business, the same person may have legal ownership of the enterprise, directly manage the production process, and receive the profits it generates. Hudson is certainly right that this form of enterprise was more common in the 19th century, which among other things allowed Marx to write in Volume One about “the capitalist” without having to worry too much about exactly where this person was located within the circuit. In a modern corporation, by contrast, production is normally in the hands of professional managers, while the surplus flows out to owners of stock or other financial claims. This creates the possibility for the contradiction between the conditions of generating a surplus and of realizing it, which always exists under capitalism, to now appear as a conflict between distinct social actors.
The conversion of most large enterprises to publicly traded corporations took place in the US in a relatively short period starting in the 1890s. The exact timing is of course different elsewhere, but this separation of ownership and control is a fairly universal phenomenon. Even at the time this was perceived as a momentous change, and if we are looking for a historical break that I think this is where to locate it. Already by the early 20th century, the majority of great fortunes took the form of financial assets, rather than direct ownership of businesses. And we can find contemporary observers like Veblen describing “sabotage” of productive enterprises by finance (in The Price System and the Engineers) in terms very similar to the ones that someone like Michael Hudson uses today.
It’s not unreasonable to describe this change as financialization. But important to realize it’s not a one-way or uniform transition.
In 1930s, Keynes famously described American capital development as byproduct of a casino, again in terms similar to Hudson’s. In The General Theory, an important part of the argument is that stock markets have a decisive influence on real investment decisions. But the funny thing is that at that moment the trend was clearly in the opposite direction. The influence of financial markets on corporate managers diminished after the 1920s, and reached its low point a generation or so after Keynes wrote.
If we think of financialization as the influence of financial markets over the organization of production, what we see historically is an oscillation, a back and forth or push and pull, rather than a well-defined before and after. Again, the timing differs, but the general phenomenon of a back and forth movement between more and less financialized capitalism seems to be a general phenomenon. Postwar Japan is often pointed to, with reason, as an example of a capitalist economy with a greatly reduced role for financial markets. But this was not a survival from some earlier era of industrial capitalism, but rather the result of wartime economic management, which displaced financial markets from their earlier central role.
Historically, we also find that moves in one direction in one place can coexist with or even reinforce moves the other way elsewhere. For example, the paper talks about the 19th-century alliance of English bankers and proto-industrialists against landlords in the fight to overturn the corn laws. Marx of course agreed that this was an example of the progressive side of capitalist development. But we should add that the flip side of Britain specializing in industry within the global division of labor was that other places came to specialize more in primary production, with a concomitant increase in the power of landlords and reliance on bound labor. Something we should all have learned from the new historians of capitalism like Sven Beckert is how intimately linked were the development of wage labor and industry in Britain and the US North with he development of slavery and cotton production in the US South; indeed they were two sides of the same process. Similar arguments have been made linking the development of English industry to slave-produced sugar (Williams), and to the second serfdom and de-urbanization in Eastern Europe (Braudel).
Meanwhile, as theorists of underdevelopment like Raul Prebisch have pointed out, it’s precisely the greater market power enjoyed by industry relative to primary products that allows productivity gains in industry to be captured by the producers, while productivity gains in primary production are largely captured by the consumers. We could point to the same thing within the US, where tremendous productivity advances in agriculture have led to cheap food, not rich farmers. Here again, the relationship between the land-industry binary and the monopoly-competition binary is the opposite as Hudson’s story. This doesn’t mean that they always line up that way, either, but it does suggest that the relationship is at least historically contingent.
3.
Let’s turn now to the present. As we all know, since 1980 the holders of financial assets have reasserted their claims against productive enterprises, in the US and in much of the rest of the world. But I do not think this implies, as Hudson suggests, that today’s leading capitalists are the equivalent of feudal landowners. While pure rentiers do exist, the greatest accumulations of capital remain tied to control over the production process.
Even within the financial sector, extraction is only part of the story. A major development in finance over the past generation has been the growth of specialized venture capital and private equity funds. Though quite different in some ways — private equity specializing in acquisition of existing firms, venture capital in financing new ones — both can be seen as a kind of de-financialization, in the sense that both function to re-unite management and ownership. It is true of course, that private equity ownership is often quite destructive to the concrete production activities and social existence of a firm. But private equity looting happens not through the sort of arm’s length tribute collection of al landlord, but through direct control over the firm’s activity. The need for specialized venture capital funds to invest in money-losing startups, on the other hand, is certainly consistent with the view that strict imposition of financial criteria is inconsistent with development of production. But it runs against a simple story in which industry has been replaced by finance. (Instead, the growth of these sectors looks like an example of the way the capital looks different at different moments in its circuit. Venture capitalists willing to throw money at even far-fetched money-losing enterprises, are specialists in the M-C moment, while the vampires of private equity are specialists in C-M.)
It is true, of course, that finance as an industry has grown relative to the economy over the past 50 years, as have the payments made by corporations to shareholders. Hudson describes these trends as a “relapse back toward feudalism and debt peonage”, but I don’t think that’s right. The creditor and the landlord stand outside the production process. A debt peon has direct access to means of production, but is forced to hand over part of the product to the creditor or landlord. Capitalists by contrast get their authority and claim on surplus from control over the production process. This is as true today as when Marx wrote.
There is a widespread view that gains from ownership of financial assets have displaced profits from production even more many nonfinancial corporations, and that household debt service is a form of exploitation that now rivals the work place as a source of surplus, as households are forced to take on more debt to meet their subsistence needs. But these claims are mistaken — they confuse the temporary rise in interest rates after 1980 for a deeper structural shift.
As Joel Rabinovich convincingly shows, the increased financial holdings of nonfinancial corporations mostly represent goodwill from mergers and stakes in subsidiaries, not financial assets in the usual sense, while the apparent rise in their financial income of in the 1980s is explained by the higher interest on their cash holdings. With respect to household debt, it continues to overwhelmingly finance home ownership, not consumption; is concentrated in the upper part of the income distribution; and rose as a result of the high interest rates after 1980, not any increase in household borrowing. (See my discussion here.) With the more recent decline in interest rates, much of this supposed finacialization has reversed. Contrary to Hudson’s picture of an ever-rising share of income going to debt service, interest payments in the US now total about 17 percent of GDP, the same as in 1975.
On the other side, the transformation of the production process remains the source of the biggest concentrations of wealth. Looking at the Forbes 400 list of richest Americans, it is striking how rare generalized financial wealth is, as opposed to claims on particular firms. Jeff Bezos (#1), Bill Gates (#2) and Mark Zuckerberg (#3) all gained their wealth through control over newly created production processes, not via financial claims on existing ones. Indeed, of the top 20 names on the list, all but one are founders and active managers of companies or their immediate families. (The lone exception is Warren Buffet.) Finance and real estate are the source of a somewhat greater share of the fortunes found further down the list, but nowhere near a majority.
Companies like Wal Mart and Google and Amazon are clearly examples of industrial capitalism. They sell products, they lower prices, they put strong downward pressure on costs. Cheap consumer goods at Wal Mart lower the costs of subsistence for workers today just as cheap imported food did for British workers in the 19th century.
Does this mean Amazon and Wal Mart are good? No, of course not. (Tho we shouldn’t deny that their logistical systems are genuine technological accomplishments that a socialist society could build on.) My point is that the greatest concentrations of wealth today still arise from the competition to sell more desirable goods at lower prices. This runs against the idea of dominance by rentiers or passive rent-extractors.
Finally, I have some concerns about the political implications of this analysis. If we take Hudson’s story seriously, we may see a political divide between industrial capital and finance capital, and the possibility of a popular movement seeking alliance with the former. I am doubtful about this. While finance is a distinct social actor, I do not think it is useful to think of it as a distinct type of capital, one that is antagonistic to productive capital. As I’ve written elsewhere, it’s better to see finance as weapon by which the claims of wealth holders are asserted against the rest of society.
Certainly I don’t think the human embodiments of industrial capital would agree that they are victims of finance. Many of the features of contemporary capitalism he objects would appear to them as positive developments. Low wages, weak labor and light taxes are desired by capitalists in general, not just landlords and bankers. The examples Hudson points to of industrial capitalists and their political representatives supporting measures to socialize the costs of reproduction are real and worth learning from, but as products of specific historical circumstances rather than as generic features of industrial capitalism. We would need a better account of the specific conditions under which capital turns to programs for reducing labor costs in this way — rather than, for example, simply forcing down wages — to assess to what extent, and in which areas, they exist today.
Even if it were feasible, I am not sure this kind of program does much to support a more transformative political project. Hudson quotes Simon Patten’s turn-of-the-last-century description of public services like education as a “fourth factor of production” that is necessary to boost industrial competitiveness, with the implication that similar arguments might be successful today. Frankly, this kind of language strikes me as more characteristic of our neoliberal era than a basis for an alternative to it. As a public university teacher, I reject the idea that my job is to raise the productive capacity of workers, or reduce the overhead costs of American capital. Nor do I think we will be successful in defending education and other public goods from defunding and austerity using this language. And of course, it is not the only language available to us. As Mike Konczal notes in his new book Freedom from the Market, historically the case for public provision has often been made in terms of removing certain areas of life from the market, as well as the kinds of arguments Hudson describes.
More fundamentally, the framing here suggests that the objectionable features of capitalism stem from it not being capitalist enough. The focus on monopolies and rents suggests that what is wanted is more vigorous market competition. It is a strikingly Proudhonian position to say that the injustice and waste of existing capitalism stem from the failure of prices to track costs of production. Surely from a Marxist perspective it is precisely the pressure to compete on the basis of lower costs that is the source of that injustice and waste.
There is a great deal that is interesting and insightful in this paper, as there always is in Michael Hudson’s work. But I remain unconvinced that financial and industrial capitalism can be usefully thought of as two opposed systems, or that we can tell a meaningful historical story about a transition between them. Industry and finance are better thought of, in my view, as two different sides of the same system, or two moments in the same circuit of capital. Capitalism is a system in which human creative activity is subordinated to the endless accumulation of money. In this sense, finance is as integral to it as production. A focus on on the industrial-financial divide risks attributing the objectionable effects of accumulation to someone else — a rentier or landlord — leaving a one-sided and idealized picture of productive capital as the residual.
This being URPE, many people here will have at one time or another sung “is there aught we have in common with the greedy parasites?” Do we think those words refer to the banker only, or to the boss?
UPDATE: My colleague Julio Huato made similar arguments in response to an earlier version of Hudson’s paper a few years ago, here.
On Negative Rates
Negative interest rates – weird, right?
In the five thousand years that interest rates have been recorded, they’ve never hit zero before. Today, there’s some $15 trillion in negative-yielding bonds — admittedly down from $17 trillion last year, but still a very substantial fraction of the global bond market outside the US. At first it was only shorter bonds that were negative, but today German bunds are negative all the way out to 30 years. What’s going on? Does this mean it would be profitable to bulldoze the Rockies for farmland? Will it cause the extinction of the banking system? And more fundamentally, if the interest rate reflects the cost of a good today in terms of the same good next year, why would it ever be negative? Why would people place a higher value on stuff in the future than on stuff today?
Personally, I don’t think they’re so weird. And the reason I think that is that interest rates are not, in fact, the price of goods today in terms of goods tomorrow. It is, rather, the price of a financial asset that promises a certain schedule of money payments. Negative rates are only a puzzle in the real-exchange perspective that dominates economics, where we can safely abstract from money when discussing interest rates. In the money view, where interest transactions are swap of assets, or of a stream of money payments, nothing particularly strange about them.
(I should say up front that this post is an attempt to clarify my own thinking. I think what I’m writing here is right, but I’m open to hearing why it’s wrong, or incomplete. It’s not a finished or settled position, and it’s not backed up by any larger body of work. At best, like most of what I wrote, it is informed by reading a lot of Keynes.)
The starting point for thinking about negative rates is to remember that these are market prices. Government is not setting a negative yield by decree, someone is voluntarily holding all those negative-yielding bonds. Or more precisely, someone is buying a bond at a price high enough, relative to the payments it promises, to imply a negative yield.
Take the simplest example — a government bond that promises a payment of $100 at some date in the future, with no other payments in between. (A zero-coupon bond, in other words.) If the bond sells today for less than $100, the interest rate on it is positive. If the bond sells today for more than $100, the interest rate is negative. Negative yields exist insofar market participants value such a bond at greater than $100.
So now we have to ask, what are the sources of demand for government bonds?
A lot of confusion is created, I think, by asking this question the wrong way. People think about saving, and about trading off spending today against spending tomorrow. This after all is the way an economics training encourages you to think about interest rates — as a shorthand for any exchange between present and future. Any transaction that involves getting less today in return for more tomorrow incorporates the interest rate as part of the price — at a high enough level of abstraction, they’re all the same thing. The college wage premium, say, is just as much an interest rate from this perspective as the yield on the bond.
If we insist on thinking of interest rates this way, we would have to explain negative yields in terms of a society-wide desire to defer spending, and/or the absence of any store of wealth that even maintains its value, let alone increases it. Either of those would indeed be pretty weird!
(Or, it would be the equivalent of people paying more for a college education than the total additional wages they could expect to earn from it, or people paying more for a house than the total cost of renting an identical one for the rest of their lives. Which are both things that might happen! But also, that would be generally seen as something going wrong in the economic system.)
Since economists (and economics-influenced people) are so used to thinking of interest as reflecting a tradeoff between present and future, a kind of inter-temporal exchange rate, it’s worth an example to clarify why it isn’t. Imagine a typical household credit transaction, a car loan. The household acquires means to pay for the acquisition of a car, and commits to a schedule of payments to the bank; the bank gets the opposite positions. Is the household giving up future consumption in order to consume now? No. At every period, the value the household gets from the use of the car will exceed the payments the household is making for it — otherwise, they wouldn’t be doing it. If anything, since the typical term of a car loan is six or seven years while a new car should remain in service for a decade or more, the increased consumption comes in the future, when the car is paid off and still delivering transport services. Credit, in general, finances assets, not consumption. The reason car loans are needed is not to shift consumption from the future to the present, but because use of the transportation services provided by the car are tightly bound up with ownership of the car itself.
Nor, of course, is the lender shifting present consumption to the future. The lender itself, being a bank, does not consume. And no one else needs to forego or defer consumption for the banks to make the auto loan either. No one needs to deposit savings in a bank before it makes a loan; the lent money is endogenous, created by banks in the course of lending it. Whatever factors limit the willingness of the bank to extend additional auto loans — risk; liquidity; capital; regulation; transaction costs — a preference for current consumption is not among them.
The intertemporal-exchange way of looking at government bonds would make sense if the only way to acquire one was to forego an equal amount of consumption, so that bond purchases were equivalent to saving in an economic sense. Then understanding the demand for government bonds, would be the same as understanding the desire to save, or defer consumption. But of course government bonds are not part of some kind of economy-wide savings equilibrium like that. First of all, the purchasers of bonds are not households, but banks and other financial actors. Second, the purchase of the bond does not entail a reduction in current spending, but a swap of assets. And third, the owners of bonds do not hold them in order to finance some intended real expenditure in the future, but rather for some combination of benefits from owning them (liquidity, safety, regulation) and an expectation of monetary profit.
From the real-exchange perspective, there is one intertemporal price — the interest rate — just as there is one exchange rate between any given pair of countries. From the money view perspective, there are many different interest rates, corresponding to the different prices of different assets promising future payments. Many of the strong paradoxes people describe from negative rates only exist if rates are negative across the board. But in reality, rates do not move in lockstep. We will set aside for now the question of how strong the arbitrage link between different assets actually is.
We can pass over these questions because, again, government bonds are not held for income. They are not held by households or the generic private sector. They are overwhelmingly held by banks and bank-like entities for some combination of risk, liquidity and regulatory motives, or by a broader set of financial institutions for return. Note for later: Return is not the same as income!
Let’s take the first set of motivations first.
If you are a bank, you may want to hold some fraction of your assets as government bonds in order to reduce the chance your income will be very different from what you expected; reduce the chance that you will find yourself unable to make payments that you need or want to make (since it’s easy to sell the bonds as needed); and/or to reduce the chance that you’ll fall afoul of regulation (which presumably is there because you otherwise might neglect the previous two goals).
The key point here is that these are benefits of holding bonds that are in addition to whatever return those bonds may offer. And if the ownership of government bonds provides substantial benefits for financial institutions, it’s not surprising they would be willing to pay for those services.
This may be clearer if we think about checking accounts. Scare stories about negative rates often ask what happens when households have to pay for the privilege of lending money to the bank. Will they withdraw it all as cash and keep it under the mattress? But of course, paying the bank to lend it money is the situation most people have always been in. Even before the era of negative rates, lots of people held money in checking accounts that carried substantial fees (explicit and otherwise) and paid no interest, or less than the cost of the fees. And of course unbanked people have long paid exorbitant amounts to be able to make electronic payments. In general, banks have no problem getting people to hold negative-yield assets. And why would they? The payments services offered by banks are valuable. The negative yield just reflects people’s willingness to pay for them.
In the national accounts, the difference between the interest that bank depositors actually receive and a benchmark rate that they in some sense should receive is added to their income as “imputed interest”, which reflects the value of the services they are getting from their low- or no- or negative-interest bank accounts. In 2019, this imputed interest came to about $250 billion for households and another $300 billion for non financial corporations. These nonexistent interest payments are, to be honest, an odd and somewhat misleading thing to include in the national accounts. But their presence reflects the genuine fact that people hold negative and more broadly below-market yield assets in large quantities because of other benefits they provide.
Turned around this way, the puzzle is why government debt ever has a positive yield. The fundamental form of a bond sale is the creating of pair of offsetting assets and liabilities. The government acquires an asset in the form of a deposit, which is the liability of the bank; and the bank acquires an asset in the form of a bond, which is the liability of the government. Holding the bond has substantial benefits for the bank, while holding the deposit has negligible benefits for the government. So why shouldn’t the bank be the one that pays to make the transaction happen?
One possible answer is the cost of financing the holding. But, it is normally assumed that the interest rate paid by banks follows the policy rate. There’s no obvious reason for the downward shift in rates to affect spread between bank deposits and government bonds. Of course some bank liabilities will carry higher rates, but again, that was true In the past too.
Another possible answer is the opportunity cost of not holding positive-yield asset. Again, this assumes that other yields don’t move down too. More fundamentally, it assumes a fixed size of bank balance sheets, so that holding more of one asset means less of another. In a world with with a fixed or exogenous money stock, or where regulations and monetary policy create the simulacrum of one, there is a cost to the bank of holding government debt, namely the income from whatever other asset it might have held instead. Many people still have this kind of mental model in thinking about government debt. (It’s implicit in any analysis of interest rates in terms of saving.) But in a world of endogenous credit money, holding more government debt doesn’t reduce a bank’s ability to acquire other assets. Banks’ ability to expand their balance sheets isn’t unlimited, but what limits it is concerns about risk or liquidity, or regulatory constraints. All of these may be relaxed by government debt holdings, so holding more government bonds may increase the amount of other assets banks can hold, not reduce it. In this case the opportunity cost would be negative.
So why aren’t interest rates on government debt usually negative? As a historical matter, I suppose the reasons we haven’t seen negative yields in the past are, first, that under the gold standard, government bonds were not at the top of the hierarchy of money and credit, and governments had to pay to access higher-level money; in some contexts government debt may have been lower in the hierarchy than bank money as well. Second, in the postwar era the use of the interest rate for demand control has required central banks to ensure positive rates on public as well as private debt. And third, the safety, liquidity and regulatory benefits of government debt holdings for the financial system weren’t as large or as salient before the great financial crisis of 2007-2009.
Even if negative yields aren’t such a puzzle when we think about the sources of bank demand for government debt, we still have the question of how low they can go. Analytically, we would have to ask, how much demand is there for the liquidity, safety and regulatory-compliance services provided by sovereign debt holdings, and to what extent are there substitute sources for them?
But wait, you may be saying, this isn’t the whole story. Bonds are held as assets, not just as reserves for banks and bank-like entities. Are there no bond funds, are there no bond traders?
These investors are the second source of demand for government bonds. For them, return does matter. The goal of making a profit from holding the bond is the second motivation mentioned earlier.
The key point to recognize here is that return and yield are two different things. Yield is one component of return. The other is capital gains. The market price of a bond changes if interest rates change during the life of the bond, which means that the overall return on a negative-yielding bond can be positive. This would be irrelevant if bonds were held to maturity for income, but of course that is not bond investment works.
For foreign holders, return also includes gains or losses from exchange rate changes, but we can ignore that here. Most foreign holders presumably hold government bonds as foreign exchange reserves, which is a subset of the safety/liquidity/regularity benefits discussed above.
To understand how negative yielding bonds could offer positive returns, we have to keep in mind what is actually going on with bond prices, including negative rates. The borrower promises one or more payments of specified amounts at specified dates in the future. The purchaser then offers a payment today in exchange for that stream of future payments. What we call an interest rate is a description of the relationship between the promised payments and the immediate payment. We normally think of interest as something paid over a period of time, but strictly speaking the interest rate is a price today for a contract today. So unlike in the checking account case, the normal negative-rates situation is not the lender paying the borrower.
Here’s an example. Suppose I offer to pay you $100 30 years from now. This is, formally, a zero-coupon 30-year bond. How much will you pay for this promse today?
If you will pay me $41 for the promise, that is the same as saying the interest rate on the loan is 3 percent. (41 * 1.03 ^ 30 = 100). So an interest rate of 3 percent is just another way of saying that the current market price of a promise of $100 30 years from now is $41.
If you will pay me $55 for the promise, that’s the same as an interest rate of 2 percent. If you’ll pay me $74, that’s the same as an interest rate of 1 percent.
If you’ll pay me $100 for the promise, that is of course equivalent to an interest rate of 0. And if you’ll pay me $135 for the promise of $100 30 years from now, that’s the equivalent of an interest of -1 percent.
When we look at things this way, there is nothing special about negative rates. There is just continuous range of prices for an asset. Negative rates refer to the upper part of the range but nothing in particular changes at the boundary between them. Nothing magical or even noticeable happens when the price of an asset (in this case that promise of $100) goes from $99 to $101, any different from when it went from $97 to $99. The creditor is still paying the borrower today, the borrower is still paying the creditor in the future.
Now the next step: Think about what happens when interest rates change.
Suppose I paid $135 for a promise of $100 thirty years from now, as in the example above. Again, this equivalent to an interest rate of -1 percent. Now it’s a year later, so I have a promise of $100 29 years from now. At an interest rate of -1 percent, that is worth $133.50. (The fact that the value of the bond declines over time is another way of seeing that it’s a negative interest rate.) But now suppose that, in the meantime, market interest rates have fallen to -2 percent. That means a promise of $100 29 years from now is now worth $178. (178 * 0.98 ^ 29 = 100.) So my bond has increased in value from $135 to $178, a capital gain of one-third! So if I think it is even modestly more likely that interest rates will fall than that they’ll rise over the next year, the expected return on that negative-yield bond is actually positive.
Suppose that it comes to be accepted that the normal, usual yield on say, German 10-year bunds is -1 percent. (Maybe people come to agree that the liquidity, risk and regulatory benefits of holding them are worth the payment of 1 percent of their value a year. That seems reasonable!) Now, suppose that the yield starts to move toward positive territory – for concreteness, say the current yield reaches 0, while people still expect the normal yield to be -1 percent. This implies that the rise to 0 is probably transitory. And if the ten-year bund returns to a yield of -1 percent, that implies a capital gain on the order of 10 percent for anyone who bought them at zero. This means that as soon as the price begins to rise toward zero, demand will rise rapidly. And the bidding-up of the price of the bund that happens in response to the expected capital gains, will ensure that the yield never in fact reaches zero, but stops rising before gets much above -1 percent.
Bond pricing is a technical field, which I have absolutely no expertise in. But this fundamental logic has to be an important factor in decisions by investors (as opposed to financial institutions) who hold negative-yielding bonds in their portfolios. The lower you expect bond yields to be in the future, the higher the expected return on a bond with a given yield today. If a given yield gets accepted as usual or normal, then expected capital gains will rise rapidly when the yield rises above that — a dynamic that will ensure that the actual yield does not in fact depart far from the normal one. Capital gains are a bigger part of the return the lower the current yield is. So while high-yielding bonds can see price moves in response to fundamentals (or at least beliefs about them), these self-confirming expectations (or conventions) are likely to dominate once yields fall to near zero.
These dynamics disappear when you think in terms of an intertemporal equilibrium where future yields are known and assets are held to maturity. When we think of trading off consumption today for consumption tomorrow, we are implicitly imagining something equivalent to holding bond to maturity. And of course if you have a model with interest rates determined by some kind of fundamentals by a process known to the agents in the model — what is called model-consistent or rational expectations — than it makes to sense to say that people could believe the normal or “correct” level of interest rates is anything other than what it is. So speculation is excluded by assumption.
Keynes understand all this clearly, and the fact that the long-term interest rate is conventionally determined in this way is quite important to his theory. But he seems never to have considered the possibility of negative yields. As a result he saw the possibility of capital gains as disappearing as interest rates got close to zero. This meant that for him, the conventional valuation was not symmetrical, but operated mainly as a floor. But once we allow the possibility of negative rates, conventional expectations can prevent a rise in interest rates just as easily as a fall.
In short, negative yields are a puzzle and a problem in the real exchange paradigm that dominates economic conversation, in which the “interest rate” is the terms on which goods today exchange for goods in the future. But from the money view, where the interest rate is the (inverse of) the price of an asset yielding a flow of money payments, there is nothing especially puzzling about negative rates. It just implies greater demand for the relevant assets. A corollary is that while there should be a single exchange rate between now and later, the prices of different assets may behave quite differently. So while many of the paradoxes people pose around negative rates assume that all rates go negative together, in the real world the average rate on US credit cards, for example, is still about 15 percent — the same as it was 20 years ago.
In the future, the question people may ask is not how interest rates could be negative, but why was it that the government for so long paid the banks for the valuable services its bonds offered them?
Money and Cryptocurrencies
(This is an edited and expanded version of a talk I gave in Trento, Italy in June 2018, on a panel with Sheila Dow.)
The topic today is “Digital currencies: threat or opportunity?”
I’d like to offer a third alternative: New digital currencies like bitcoin are neither a threat or an opportunity. They do not raise any interesting economic questions and do not pose any significant policy problems. They do not represent any kind of technological advance on existing payment systems, which are of course already digital. They are just another asset bubble, based on the usual mix of fraud and fantasy. By historical standards, they are not a very large or threatening bubble. There is nothing important about them at all.
Why might you conclude that the new digital currencies don’t matter?
– Aggregate size – the total value of all bitcoin is on the order of $200 billion, other digital currencies are much smaller. On the scale of modern financial markets that’s not much more than a rounding error.
– No articulation with the rest of the financial system. No banks or other important institutions rely on cryptocurrencies to settle transactions, or have substantial holdings on their balance sheets. They’re not used as collateral for loans.
– Not used to structure real activity. No significant part of collective productive or reproductive activity is organized by making payments or taking positions in cryptocurrencies.
Besides that, these currencies don’t even do what they claim to do. In practice, digital currencies do depend on intermediaries. Payment is inconvenient and expensive — as much as $14 per transaction, and accepted by only 3 of top 500 online retailers. And markets in these currencies are not decentralized, but dominated by a few big players. All this is documented in Mike Beggs’ wonderful Jacobin article on cryptocurrencies, which I highly recommend.
Compare this to the mortgage market. Total residential mortgages in the US are over $13 trillion, not far short of GDP. The scale is similar in many other countries. Mortgages are a key asset for the financial system, even when not securitized. And of course they play a central role in organizing the provision of housing (and commercial space), an absolutely essential function to social reproduction.
And yet here we are talking about cryptocurrencies. Why?
Partly it’s just hard money crankery and libertarianism, which have a outsized voice in economics discussions. And partly it’s testimony to the success of their marketing machine. One might say that the only thing that stands behind that $200 billion value, is the existence of conversations like this one.
But it’s not just cranks and libertarians who care about cryptocurrencies. Central bank research departments are earnestly exploring the development of digital currencies. This disproportionate attention reflects, I think, some deeper problems with how we think of money and central banking. The divide over whether crypto-currencies represent anything new or important reflects a larger divide over how we conceive of the monetary system.
In the language of Schumpeter — whose discussion in his History of Economic Thought remains perhaps the best starting point for thinking about these things — it comes down to whether we “start from the coin.” If we start from the coin, if we think of money as a distinct tangible thing, a special kind of asset, then bitcoin may look important. We could call this the quantity view of money. But if we follow Schumpeter — and in different ways Hyman Minsky, Perry Mehrling and David Graeber — and start from balance sheets, then it won’t. Call this the ledger view of money.
In the quantity view, “money” is something special. The legal monopoly of governments on printing currency is very important, because that is money in a way that other assets aren’t. Credit created by banks is something different. Digital currencies are a threat or opportunity, as the case may be, because they seem to also go in this exclusive “outside money” box.
But from the Minsky-Mehrling-Graeber point of view, there’s nothing special about outside money. It’s just another set of tokens for recording changes in the social ledger. What matters isn’t the way that changes are recorded, but the accounts themselves. From this perspective, “money” isn’t an asset, a thing, it is simply the arbitrary units in which ledgers are kept and contracts denominated.
The starting point, from this point of view, is a network of money payments and commitments. Some of these commitments structure real activity (I show up for work because I expect to receive a wage). Others are free-standing. (I pay you interest because I owe you a debt.) In either case money is simply a unit of account. I have made a promise to you, you have a made a promise to someone else; these promises are in some cases commitments to specific concrete activities (to show up for work and do what you’re told), but in other cases they are quantitative, measured as a certain quantity of “money.”
What does money mean here? Simply whatever will be accepted as fulfilment of the promise, as specified in whatever legal or quasi-legal provisions govern it. It is entirely possible for the unit of account to have no concrete existence at all. And in any case the concrete assets that will be accepted are never identical; their equivalence is to some extent a fiction enshrined in the terms of the contract, and to some extent the result of active interventions by whatever authorities are responsible for the payments system.
In short, the fact that some particular asset that serves as money in this or that case is not very interesting. What matters is the balance sheets. Money is just a means of recording changes on balance sheets, of making transfers between ledgers. If we take the ledger view, then there’s no difference between physical currency and an instrument like a check. In either case the social ledger maintained by the banking system has a certain credit to you. You want to transfer a part of that to someone else, for whatever reason. So you give that person a piece of paper with the amount written on it, and they take it to their bank, which adjusts the social ledger accordingly. It makes no difference whether the piece of paper is a dollar or euro bill or a check or a money order, any more than it matters what its physical dimensions are or whether it is one sheet of paper or two.
And of course the majority of transactions are made, the majority of obligations, are settled without using pieces of paper at all. In fact the range of transactions you can carry out using the pieces of paper we call “money” is rather limited.
To put it another way: At the train station there are various machines, which will give you a piece of paper while debiting your bank account. Some of those pieces of paper can be used in exchange for a train ride, others for various other purposes. We call one a ticket machine and one an ATM. But conceptually we should think of them as the same kind of machine. Both debit your social ledger and then give you a claim on something concrete — a paper from the newsstand, say, or a train ride, as the case may be.
In the quantity view of money, there is some special asset called money which the rest of the payments system builds off. So the fact that something else could “be” money seems important. It matters that the government has a legal monopoly on printing currency, so it also matters that something like cryptocurrency seems to evade that monopoly. In the ledger view, on the other hand, that legal monopoly doesn’t matter at all. There are lots of systems for making transfers between bank accounts, including many purely electronic ones. And there are social ledgers maintained by institutions that we don’t officially recognize as banks. New digital currencies introduce a few more of each. So what?
In the quantity view, money and credit are two distinct things. We start with money, which might then be lent. This is how we learn it as children. In the ledger view, money is just anything that settles an obligation. And that is constantly done by promises or IOUs. The fact that “banks create money” in our modern economy isn’t some kind of innovation out of an original situation of cash-on-the-barrelhead exchange. Rather, it is a restriction of money-creation from the historical situation where third-party IOUs of all kinds circulated as payment.
Related to this are two different views of central banks. In the quantity view, the fundamental role of the central bank is in some sense setting or managing the money supply. In the ledger view, where money is just an arbitrary subset of payments media, which is constantly being created and destroyed in the course of making payments, “the money supply” is a nonsense term. What central banks are doing in this view is controlling the elasticity of the credit system. In other words, they are managing the willingness and ability of economic units to make promises to each other.
There are a variety of objectives in this; two important ones today are to control the pace of real activity via the elasticity of money commitments (e.g. to keep the wage share within certain bounds by controlling the level of aggregate employment) and to maintain the integrity of the payments system in a crisis where a wave of self-perpetuating defaults is possible.
In either case the thing which the central bank seeks to make more scarce or abundant is not the quantity of some asset labeled as “money”, but the capacity to make promises. To reduce the level of real activity, for example, the central bank needs to make it more difficult for economic units to make claims on real resources on the basis of promises of future payments. To avoid or resolve a crisis the central bank needs to increase the trustworthiness of units so they can settle outstanding obligations by making new promises; alternatively it can substitute its own commitments for those of units unable to fulfill their own.
Now obviously I think the ledger view is the correct one. But many intelligent people continue to work with a quantity view, some explicitly and some implicitly. Why? I think one reason is the historical fact that during the 20th century, the regulatory system was set up to create a superficial resemblance to the quantity theory. The basic tool of monetary policy was restrictions on the volume of credit creation by banks, plus limits on ability of other institutions to perform bank function. But for various reasons these restrictions were formalized as reserve requirements , and policy was described as changing quantity of reserves. This created the illusion we were living in world of outside money where things like seignorage are important.
Axel Leijonhufvud has given a brilliant description of how regulation created this pseudo quantity of money world in several essays, such as “So Far from Ricardo, So Close to Wicksell.”
Now this structure has been obsolete for several decades but our textbooks and our thinking have not caught up. We still have an idea of the money multiplier in our head, where bank deposits are somehow claims on money or backed by money. Whereas in reality they simply are money.
The fact that money as an analytic category is obsolete and irrelevant, doesn’t mean that central banks don’t face challenges in achieving their goals. They certainly do. But they have nothing to do with any particular settlement asset.
I would frame them the problems like this:
First, the central bank’s established instruments don’t reliably affect even the financial markets most directly linked to them. This weak articulation between the policy rates and other rates has existed for a while. If you look back to 2000-2001, in those two years the Federal Reserve reduced the overnight rate by 5 points. But corporate bond rates fell only one point, and not until two years later. Then in 2003-2006, when the Fed raised its rate by 4 points, the bond rates did not rise at all.
Second, neither real economic behavior nor financial markets respond reliably to interest rate changes. It’s a fiction of the last 25 years — though no longer than that — that this one instrument is sufficient. The smugness about the sufficiency of this tool is really amazing in retrospect. But it’s obvious today — or it should be — that even large changes in interest rates don’t reliably affect either the sclae of concrete activity or the prices of other assets.
Third, there is no single right amount of elasticity. A credit system elastic enough to allow the real economy to grow may be too elastic for stable asset prices. Enough elasticity to ensure that contracts are fulfilled, may be too much to avoid bidding up price of real goods/factors.
People who acknowledge these tensions tend to assume that one goal has to be prioritized over the others. People at the Bank for International Settlements are constantly telling us that financial stability may require accepting persistent semi-depression in real activity. Larry Summers made a splash a few years ago by claiming that an acceptable level of real activity might require accepting asset bubbles. From where I am sitting, there are just competing goals, which means this is a political question.
Fourth, the direction as well as volume of credit matters. In discussion like this, we often hear invocations of “stability” as if that were only goal of policy. But it’s not, or even the most important. The importance of crises, in my opinion, is greatly overrated. A few assets lose their values, a few financial institutions go bust, a few bankers may go to jail or leap out of windows — and this time we didn’t even get that. The real problems of inequality, alienation, ecology exist whether there is a financial crisis or not. The real problem with the financial system is not that it sometimes blows up but that, in good times and bad, it fails to direct our collective capabilities in the direction that would meet human needs. Which today is an urgent problem of survival, if we can’t finance transition away from carbon fast enough.
For none of these problems does some new digital currency offer any kind solution. The existing system of bank deposits is already fully digital. If you want set up a postal banking system — and there’s a lot to recommend it — or to recreate the old system of narrow commercial banking, great. But blockchain technology is entirely irrelevant.
The real solution, as I have argued elsewhere (and as many people have argued, back to Keynes at least) is for central banks to intervene at many more points in financial system. They have to set prices of many assets, not just one overnight interest rate, and they have to direct credit to specific classes of borrowers. They have to accept their role as central planner. It is the need for much more conscious planning of finance, and not crypto currencies, that, I think, is the great challenge and opportunity for central banks today.
The Coronavirus Recession Is Just Beginning
(A couple days ago I gave a talk — virtually, of course — to a group of activists about the state of the economy. This is an edied and somewha expanded version of what I said.)
The US economy has officially been in recession since February. But what we’ve seen so far looks very different from the kind of recessions we’re used to, both because of the unique nature of the coronavirus shock and because of the government response to it. In some ways, the real recession is only beginning now. And if federal stimulus is not restored, it’s likely to be a very deep and prolonged one.
In a normal recession, the fundamental problem is an interruption in the flow of money through the economy. People or businesses reduce their spending for whatever reason. But since your spending is someone else’s income, lower spending here reduces incomes and employment over there — this is what we call a fall in aggregate demand. Businesses that sell less need fewer workers and generate less profits for their owners. That lost income causes other people to reduce their spending, which reduces income even more, and so on.
Now, a small reduction in spending may not have any lasting effects — people and businesses have financial cushions, so they won’t have to cut spending the instant their income falls, especially if they expect the fall in income to be temporary. So if there’s just a small fall in demand, the economy can return to its old growth path quickly. But if the fall in spending is big enough to cause many workers and businesses to cut back their own spending, then it can perpetuate itself and grow larger instead of dying out. This downward spiral is what we call a recession. Usually it’s amplified by the financial system, as people who lose income can’t pay their debts, which makes banks less willing or able to lend, which forces people and businesses that needed to borrow to cut back on their spending. New housing and business investment in particular are very dependent on borrowed money, so they can fall steeply if loans become less available. That creates another spiral on top of the first. Or in recent recessions, often it’s the financial problems that come first.
But none of that is what happened in this case. Businesses didn’t close because there wasn’t enough money flowing through the economy, or because they couldn’t get loans. They closed because under conditions of pandemic and lockdown they couldn’t do specific things — serve food, offer live entertainment, etc. And to a surprising extent, the stimulus and unemployment benefits meant that people who stopped working did not lose income. So you could imagine that once the pandemic was controlled, we could return to normal much quicker than in a normal recession.
That was the situation as recently as August.
The problem is that much of the federal spending dried up at the end of July. And that is shifting the economy from a temporary lockdown toward a self-perpetuating fall in incomes and employment.
One way we see the difference between the lockdown and a recession is the industries affected. The biggest falls in employment were in entertainment and recreation and food service, which are industries that normally weather downturns pretty well, while construction and manufacturing, normally the most cyclical industries, have been largely unaffected. Meanwhile, employment in health and education, which in previous recessions has not fallen at all, this time has declined quite a bit.5
If we look at employment, for instance which is normally our best measure of business-cycle conditions, we again see something very different from past recessions. Total employment fell by 20 million in April and May of this year. In just two months, 15 percent of American workers lost their jobs. There’s nothing remotely comparable historically — more jobs were lost in the Depression, but that was a slow process over years not just two months. The post-World War II demobilization was the closest, but that only involved about half the fall in employment. So this is a job loss without precedent.
Since May, about half of those 20 million people have gone back to work. We’re about 10 million jobs down from a year ago. Still, that might look like a fairly strong recovery.
But in the spring, the vast majority of unemployed people described themselves as on temporary layoff — they expected to go back to their jobs. The recovery in employment has almost all come from that group. If we look at people who say they have lost their jobs permanently, that number has continued to grow. Back in May, almost 90 percent of the people out of work described it as temporary. Today, it’s less than half. Business closings and layoffs that were expected to be temporary in the spring are now becoming permanent. So in a certain sense, even though unemployment is officially much lower than it was a few months ago, unemployment as we usually think of it is still rising.
We can see this even more dramatically if we look at income. Most people don’t realize how large and effective the stimulus and pandemic unemployment insurance programs were. Back in the spring, most people — me included — thought there was no way the federal government would spend on the scale required to offset the hob losses. The history of stimulus in this country — definitely including the ARRA under Obama — has always been too little, too late. Unemployment insurance in particular has historically had such tight eligibility requirements that the majority of people who lose their jobs never get it.
But this time, surprisingly, the federal stimulus was actually big enough to fill the hole of lost incomes. The across-the-board $600 per week unemployment benefit reached a large share of people who had lost their jobs, including gig workers and others who would not have been able to get conventional UI. And of course the stimulus checks reached nearly everyone. As a result, if we look at household income, we see that as late as July, it was substantially above pre-recession levels. This is a far more effective response than the US has made to any previous downturn. And it’s nearly certain that the biggest beneficiaries were lower-wage workers.
We can see the effects of this in the Household Pulse surveys conducted by the Census. Every week since Mach, they’ve been asking a sample of households questions about their economic situation, including whether they have enough money to meet their basic needs. And the remarkable thing is that over that period, there has been no increase in the number of people who say they can’t pay their rent or their mortgage or can’t get enough to eat. About 9 percent of families said they sometimes or often couldn’t afford enough to eat, and about 20 percent of renters said they were unable to pay the last month’s rent in full. Those numbers are shockingly high. But they are no higher than they were before the pandemic.
To be clear – there are millions of people facing serious deprivation in this country, far more than in other rich countries. But this is a longstanding fact about the United States. It doesn’t seem to be any worse than it was a year ago. And given the scale of the job loss, that is powerful testimony to how effective the stimulus has been.
But the stimulus checks were one-off, and the pandemic unemployment insurance expired at end of July. Fortunately there are other federal unemployment supplements, but they are nowhere as generous. So we are now seeing the steep fall in income that we did not see in the first five months of the crisis.
That means we may now be about to see the deep recession that we did not really get in the spring and summer. And history suggests that recovery from that will be much slower. If we look at the last downturn, it took five full years after the official end of the recession for employment to just get back to its pre-recession level. And in many ways, the economy had still not fully recovered when the pandemic hit.
One thing we may not see, though, is a financial crisis. The Fed is in some ways one of the few parts of our macroeconomic policy apparatus that works well, and it’s become even more creative and aggressive as a result of the last crisis. In the spring, people were talking about a collapse in credit, businesses unable to get loans, people unable to borrow. But this really has not happened. And there’s good reason to think that the Fed has all the tools they need if a credit crunch did develop, if some financial institutions to end up in distress. Even if we look at state and local governments, where austerity is already starting and is going to be a big part of what makes this recession severe, all the evidence is that they aren’t willing to borrow, not that they can’t borrow.
Similarly with the stock market — people think it’s strange that it’s doing well, that it’s delinked from the real economy, or that it’s somehow an artificial result of Fed intervention. To be clear, there’s no question that low interest rates are good for stock prices, but that’s not artificial — there’s no such thing as a natural interest rate.
More to the point, by and large, stocks are doing well because profits are doing well. Stock market indexes dominated by a small number of large companies, and many of those have seen sales hold up or grow. Again, so far we haven’t seen a big fall in total income. So businesses in general are not losing sales. What we have seen is a division of businesses into winners and losers. The businesses most affected by the pandemic have seen big losses of sales and profits and their share prices have gone down. But the businesses that can continue to operate have done well. So there’s nothing mysterious in the fact that Amazon’s stock price, for instance, has risen, and there’s no reason to think it’s going to fall. If you look at specific stocks, you see that by and large the ones that are doing well, the underlying business is doing well.
This doesn’t mean that what’s good for the stock market is good for ordinary workers. But again, that’s always been true. Shareholders don’t care about workers, they only care about the flow of profits their shares entitle them to. And if you’re a shareholder in a company that makes most of its sales online, that flow of profits is looking reasonably healthy right now.
So going forward, I think the critical question is whether we see any kind of renewed stimulus. If we do, it’s still possible that the downward income-expenditure spiral can be halted. At some point soon that will be much harder.
“Monetary Policy in a Changing World”
While looking for something else, I came across this 1956 article on monetary policy by Erwin Miller. It’s a fascinating read, especially in light of current discussions about, well, monetary policy in a changing world. Reading the article was yet another reminder that, in many ways, debates about central banking were more sophisticated and far-reaching in the 1950s than they are today.
The recent discussions have been focused mainly on what the goals or targets of monetary policy should be. While the rethinking there is welcome — higher wages are not a reliable sign of rising inflation; there are good reasons to accept above-target inflation, if it developed — the tool the Fed is supposed to be using to hit these targets is the overnight interest rate faced by banks, just as it’s been for decades. The mechanism by which this tool works is basically taken for granted — economy-wide interest rates move with the rate set by the Fed, and economic activity reliably responds to changes in these interest rates. If this tool has been ineffective recently, that’s just about the special conditions of the zero lower bound. Still largely off limits are the ideas that, when effective, monetary policy affects income distribution and the composition of output and not just its level, and that, to be effective, monetary policy must actively direct the flow of credit within the economy and not just control the overall level of liquidity.
Miller is asking a more fundamental question: What are the institutional requirements for monetary policy to be effective at all? His answer is that conventional monetary policy makes sense in a world of competitive small businesses and small government, but that different tools are called for in a world of large corporations and where the public sector accounts for a substantial part of economic activity. It’s striking that the assumptions he already thought were outmoded in the 1950s still guide most discussions of macroeconomic policy today.6
From his point of view, relying on the interest rate as the main tool of macroeconomic management is just an unthinking holdover from the past — the “normal” world of the 1920s — without regard for the changed environment that would favor other approaches. It’s just the same today — with the one difference that you’ll no longer find these arguments in the Quarterly Journal of Economics.7
Rather than resort unimaginatively to traditional devices whose heyday was one with a far different institutional environment, authorities should seek newer solutions better in harmony with the current economic ‘facts of life.’ These newer solutions include, among others, real estate credit control, consumer credit control, and security reserve requirements…, all of which … restrain the volume of credit available in the private sector of the economy.
Miller has several criticisms of conventional monetary policy, or as he calls it, “flexible interest rate policies” — the implicit alternative being the wartime policy of holding key rates fixed. One straightforward criticism is that changing interest rates is itself a form of macroeconomic instability. Indeed, insofar as both interest rates and inflation describe the terms on which present goods trade for future goods, it’s not obvious why stable inflation should be a higher priority than stable interest rates.
A second, more practical problem is that to the extent that a large part of outstanding debt is owed by the public sector, the income effects of interest rate changes will become more important than the price effects. In a world of large public debts, conventional monetary policy will affect mainly the flow of interest payments on existing debt rather than new borrowing. Or as Miller puts it,
If government is compelled to borrow on a large scale for such reasons of social policy — i.e., if the expenditure programs are regarded as of such compelling social importance that they cannot be postponed merely for monetary considerations — then it would appear illogical to raise interest rates against government, the preponderant borrower, in order to restrict credit in the private sphere.
Arguably, this consideration applied more strongly in the 1950s, when government accounted for the majority of all debt outstanding; but even today governments (federal plus state and local) accounts for over a third of total US debt. And the same argument goes for many forms of private debt as well.
As a corollary to this argument — and my MMT friends will like this — Miller notes that a large fraction of federal debt is held by commercial banks, whose liabilities in turn serve as money. This two-step process is, in some sense, equivalent to simply having the government issue the money — except that the private banks get paid interest along the way. Why would inflation call for an increase in this subsidy?
Miller:
The continued existence of a large amount of that bank-held debt may be viewed as a sop to convention, a sophisticated device to issue needed money without appearing to do so. However, it is a device which requires that a subsidy (i.e., interest) be paid the banks to issue this money. It may therefore be argued that the government should redeem these bonds by an issue of paper money (or by an issue of debt to the central bank in exchange for deposit credit). … The upshot would be the removal of the governmental subsidy to banks for performing a function (i.e., creation of money) which constitutionally is the responsibility of the federal government.
Finance franchise, anyone?
This argument, I’m sorry to say, does not really work today — only a small fraction of federal debt is now owned by commercial banks, and there’s no longer a link, if there ever was, between their holdings of federal debt and the amount of money they create by lending. There are still good arguments for a public payments system, but they have to be made on other grounds.
The biggest argument against using a single interest rate as the main tool of macroeconomic management is that it doesn’t work very well. The interesting thing about this article is that Miller doesn’t spend much time on this point. He assumes his readers will already be skeptical:
There remains the question of the effectiveness of interest rates as a deterrent to potential private borrowing. The major arguments for each side of this issue are thoroughly familiar and surely demonstrate most serious doubt concerning that effectiveness.
Among other reasons, interest is a small part of overall cost for most business activity. And in any situation where macroeconomic stabilization is needed, it’s likely that expected returns will be moving for other reasons much faster than a change in interest rates can compensate for. Keynes says the same thing in the General Theory, though Miller doesn’t mention it.8 (Maybe in 1956 there wasn’t any need to.)
Because the direct link between interest rates and activity is so weak, Miller notes, more sophisticated defenders of the central bank’s stabilization role argue that it’s not so much a direct link between interest rates and activity as the effect of changes in the policy rate on banks’ lending decisions. These arguments “skillfully shift the points of emphasis … to show how even modest changes in interest rates can bring about significant credit control effects.”
Here Miller is responding to arguments made by a line of Fed-associated economists from his contemporary Robert Roosa through Ben Bernanke. The essence of these arguments is that the main effect of interest rate changes is not on the demand for credit but on the supply. Banks famously lend long and borrow short, so a bank’s lending decisions today must take into account financing conditions in the future. 9 A key piece of this argument — which makes it an improvement on orthodoxy, even if Miller is ultimately right to reject it — is that the effect of monetary policy can’t be reduced to a regular mathematical relationship, like the interest-output semi-elasticity of around 1 found in contemporary forecasting models. Rather, the effect of policy changes today depend on their effects on beliefs about policy tomorrow.
There’s a family resemblance here to modern ideas about forward guidance — though people like Roosa understood that managing market expectations was a trickier thing than just announcing a future policy. But even if one granted the effectiveness of this approach, an instrument that depends on changing beliefs about the long-term future is obviously unsuitable for managing transitory booms and busts.
A related point is that insofar as rising rates make it harder for banks to finance their existing positions, there is a chance this will create enough distress that the Fed will have to intervene — which will, of course, have the effect of making credit more available again. Once the focus shifts from the interest rate to credit conditions, there is no sharp line between the Fed’s monetary policy and lender of last resort roles.
A further criticism of conventional monetary policy is that it disproportionately impacts more interest-sensitive or liquidity-constrained sectors and units. Defenders of conventional monetary policy claim (or more often tacitly assume) that it affects all economic activity equally. The supposedly uniform effect of monetary policy is both supposed to make it an effective tool for macroeconomic management, and helps resolve the ideological tension between the need for such management and the belief in a self-regulating market economy. But of course the effect is not uniform. This is both because debtors and creditors are different, and because interest makes up a different share of the cost of different goods and services.
In particular, investment, especially investment in housing and other structures, is mo sensitive to interest and liquidity conditions than current production. Or as Miller puts it, “Interest rate flexibility uses instability of one variety to fight instability of a presumably more serious variety: the instability of the loanable funds price-level and of capital values is employed in an attempt to check commodity price-level and employment instability.” (emphasis added)
The point that interest rate changes, and monetary conditions generally, change the relative price of capital goods and consumption goods is important. Like much of Miller’s argument, it’s an unacknowledged borrowing from Keynes; more strikingly, it’s an anticipation of Minsky’s famous “two price” model, where the relative price of capital goods and current output is given a central role in explaining macroeconomic dynamics.
If we take a step back, of course, it’s obvious that some goods are more illiquid than others, and that liquidity conditions, or the availability of financing, will matter more for production of these goods than for the more immediately saleable ones. Which is one reason that it makes no sense to think that money is ever “neutral.”10
Miller continues:
In inflation, e.g., employment of interest rate flexibility would have as a consequence the spreading of windfall capital losses on security transactions, the impairment of capital values generally, the raising of interest costs of governmental units at all levels, the reduction in the liquidity of individuals and institutions in random fashion without regard for their underlying characteristics, the jeopardizing of the orderly completion of financing plans of nonfederal governmental units, and the spreading of fear and uncertainty generally.
Some businesses have large debts; when interest rates rise, their earnings fall relative to businesses that happen to have less debt. Some businesses depend on external finance for investment; when interest rates rise, their costs rise relative to businesses that are able to finance investment internally. In some industries, like residential construction, interest is a big part of overall costs; when interest rates rise, these industries will shrink relative to ones that don’t finance their current operations.
In all these ways, monetary policy is a form of central planning, redirecting activity from some units and sectors to other units and sectors. It’s just a concealed, and in large part for that reason crude and clumsy, form of planning.
Or as Miller puts it, conventional monetary policy
discriminates between those who have equity funds for purchases and those who must borrow to make similar purchases. … In so far as general restrictive action successfully reduces the volume of credit in use, some of those businesses and individuals dependent on bank credit are excluded from purchase marts, while no direct restraint is placed on those capable of financing themselves.
In an earlier era, Miller suggests, most borrowing was for business investment; most investment was externally financed; and business cycles were driven by fluctuations in investment. So there was a certain logic to focusing on interest rates as a tool of stabilization. Honestly, I’m not sure if that was ever true.But I certainly agree that by the 1950s — let alone today — it was not.
In a footnote, Miller offers a more compelling version of this story, attributing to the British economist R. S. Sayers the idea of
sensitive points in an economy. [Sayers] suggests that in the English economy mercantile credit in the middle decades of the nineteenth century and foreign lending in the later decades of that century were very sensitive spots and that the bank rate technique was particularly effective owing to its impact upon them. He then suggests that perhaps these sensitive points have given way to newer ones, namely, stock exchange speculation and consumer credit. Hence he concludes that central bank instruments should be employed which are designed to control these newer sensitive areas.
This, to me, is a remarkably sophisticated view of how we should think about monetary policy and credit conditions. It’s not an economywide increase or decrease in activity, which can be imagined as a representative household shifting their consumption over time; it’s a response of whatever specific sectors or activities are most dependent on credit markets, which will be different in different times and places. Which suggests that a useful education on monetary policy requires less calculus and more history and sociology.
Finally, we get to Miller’s own proposals. In part, these are for selective credit controls — direct limits on the volume of specific kinds of lending are likely to be more effective at reining in inflationary pressures, with less collateral damage. Yes, these kinds of direct controls pick winners and losers — no more than conventional policy does, just more visibly. As Miller notes, credit controls imposed for macroeconomic stabilization wouldn’t be qualitatively different from the various regulations on credit that are already imposed for other purposes — tho admittedly that argument probably went further in a time when private credit was tightly regulated than in the permanent financial Purge we live in today.
His other proposal is for comprehensive security reserve requirements — in effect generalizing the limits on bank lending to financial positions of all kinds. The logic of this idea is clear, but I’m not convinced — certainly I wouldn’t propose it today. I think when you have the kind of massive, complex financial system we have today, rules that have to be applied in detail, at the transaction level, are very hard to make effective. It’s better to focus regulation on the strategic high ground — but please don’t ask me where that is!
More fundamentally, I think the best route to limiting the power of finance is for the public sector itself to take over functions private finance currently provides, as with a public payments system, a public investment banks, etc. This also has the important advantage of supporting broader steps toward an economy built around human needs rather than private profit. And it’s the direction that, grudgingly but steadily, the response to various crises is already pushing us, with the Fed and other authorities reluctantly stepping in to perform various functions that the private financial system fails to. But this is a topic for another time.
Miller himself is rather tentative in his positive proposals. And he forthrightly admits that they are “like all credit control instruments, likely to be far more effective in controlling inflationary situations than in stimulating revival from a depressed condition.” This should be obvious — even Ronald Reagan knew you can’t push on a string. This basic asymmetry is one of the many everyday insights that was lost somewhere in the development of modern macro.
The conversation around monetary policy and macroeconomics is certainly broader and more realistic today than it was 15 or 20 years ago, when I started studying this stuff. And Jerome Powell — and even more the activists and advocates who’ve been shouting at him — deserves credit for the Fed;s tentative moves away from the reflexive fear of full employment that has governed monetary policy for so long. But when you take a longer look and compare today’s debates to earlier decades, it’s hard not to feel that we’re still living in the Dark Ages of macroeconomics
Marx on the Corporation
(I wrote this post back in 2015, and for some reason never posted it. The inspiration was a column by Matt Levine, where he wondered what Marx would think of the modern corporation.)
Let’s begin at the beginning.
Capital, for Marx, is not a thing, it’s a social relation, a way of organizing human activity. Or from another point of view, it’s a process. It’s the conversion of a sum of money into a mass of commodities, which are transformed through a production process into a different mass of commodities, which are converted back into a (hopefully greater) sum of money, allowing the process to start again. Capital is a sum of money yielding a return, and it is a mass of commodities used in production, and it is a form of authority over the production process, each in turn.
When we have a single representative enterprise, managed by its owner and financed out of its own retained profits, then there’s no need to worry about where the “capitalist” is in this process. They are the owner of the money, and they are the steward of the means of production, and they are master of the production process. Whatever happens in the circuit of capital, the capitalist is the one who makes it happen.
This is the framework of Volume 1 of Capital. There the capitalist is just the personification of capital. But once credit markets allow capitalists to use loaned funds rather than their own, and even more once we have joint-stock enterprises with salaried managers in charge of the production process, these roles are no longer played by the same individuals. And it is not at all obvious what the relationships are between them, or which of them should be considered the capitalist. This is the subject of part V of Volume 3 of Capital Vol. 3, which explores the relation of ownership of money as such (“interest-bearing capital”) with ownership of capitalist enterprises.
For present purposes, the interesting part begins in chapter 23. There Marx introduces the distinction between the money-capitalist who owns money but does not manage the production process, and the industrial, functioning or productive capitalist who controls the enterprise but depends on money acquired from elsewhere. “The productive capitalist who operates on borrowed funds,” he writes, “represents capital only as functioning capital,” that is, only in the production process itself. “He is the personification of capital as long as … it is profitably invested in industry or commerce, and such operations are undertaken with it … as are prescribed by the branch of industry concerned.”
The possibility of carrying out a capitalist enterprise with borrowed funds implies a division of the surplus into two parts — one attributable to management of the enterprise, the other to ownership as such. “The specific social attribute of capital under capitalist production — that of being property commanding the labour-power of another” now appears as interest, the return simply on owning money. So “the other part of surplus-value — profit of enterprise — must necessarily appear as coming not from capital as such, but from the process of production… Therefore, the industrial capitalist, as distinct from the owner of capital [appears] … as a functionary irrespective of capital,… indeed as a wage-labourer.”
So now we have one set of individuals personifying capital at the M moment, when capital is in its most abstract form as money, and a different set of individuals personifying it in the C and P moments, when capital is crystallized in a particular productive activity. One effect of this separation is to obscure the link between profit and the labor process: The money-owners who receive profit in the form of interest (or dividends) are different from the actual managers of the production process. Not only that, the two often experience themselves as opposed. In this sense, the division between the money-capitalist and the industrial capitalist blurs the lines of social conflict.
Marx continues:
Interest as such expresses … the ownership of capital as a means of appropriating the products of the labour of others. But it represents this characteristic of capital as something which belongs to it outside the production process… Interest represents this characteristic not as directly counterposed to labour, but rather as unrelated to labour, and simply as a relationship of one capitalist to another. … In interest, therefore, in that specific form of profit in which the antithetical character of capital assumes an independent form, this is done in such a way that the antithesis is completely obliterated and abstracted. Interest is a relationship between two capitalists, not between capitalist and labourer.
We might read Marx here as warning against an easy opposition between “productive” and “financial” capital, in which we can with good conscience take the side of the former. On the contrary, these are just shares of the same surplus extracted from us in the labor process. It’s important to note in this context that Marx speaks of a “productive capitalist,” not of productive capital. The productive capitalist and the money capitalist are, so to speak, two human bodies that the same capital occupies in turn.
Once the pirates have burned your fields, seized your possessions and carried off your daughters, it shouldn’t matter to you how they divide up the booty: I think this is a valid reading of Marx’s argument here. Or as he puts it: “If the capitalist is the owner of the capital on which he operates, he pockets the whole surplus-value. It is absolutely immaterial to the labourer whether the capitalist does this, or whether he has to pay a part of it to a third person as its legal proprietor.”
But while the development of interest-bearing capital obscures the true relations of production in one sense, it clarifies them in another. It separates the claims exercised by ownership as such, from the claims due to the specific labor performed by the capitalist within the enterprise. With the owner-manager, these two are mixed together. (This is still a big problem for the national accounts.) Now, the part of apparent profit that was really payment for the labor of the capitalist appears in a distinct form as “wages of superintendence.”
Marx’s analysis here seems like a good starting point for discussions of the position of managers in modern economies.
The specific functions which the capitalist as such has to perform, … [with the development of credit] are presented as mere functions of labour. He creates surplus-value not because he works as a capitalist, but because he also works, regardless of his capacity of capitalist. This portion of surplus-value is thus no longer surplus-value, but its opposite, an equivalent for labour performed. … the process of exploitation itself appears as a simple labour-process in which the functioning capitalist merely performs a different kind of labour than the labourer.
As Marx later emphasizes, one consequence of the development of management as a distinct category of labor is that the profits still received by owners can no longer be justified as the compensation for organizing the production process. But what about the managers themselves, how should we think about them? Are they really laborers, or capitalists? Well, both — their position is ambiguous. On the one hand, they are performing a social coordination function, that any extended division of labor will require. But on the other hand, they are the representatives of the capitalist class in the coercive, adversarial labor process that is specific to capitalism.
The discussion is worth quoting at length:
The labour of supervision and management is naturally required wherever the direct process of production assumes the form of a combined social process, and not of the isolated labour of independent producers. However, it has a double nature. On the one hand, all labour in which many individuals co-operate necessarily requires a commanding will to co-ordinate and unify the process … much like that of an orchestra conductor. This is a productive job, which must be performed in every combined mode of production.
On the other hand … supervision work necessarily arises in all modes of production based on the antithesis between the labourer, as the direct producer, and the owner of the means of production. The greater this antagonism, the greater the role played by supervision. Hence it reaches its peak in the slave system. But it is indispensable also in the capitalist mode of production, since the production process in it is simultaneously a process by which the capitalist consumes labour-power. Just as in despotic states, supervision and all-round interference by the government involves both the performance of common activities arising from the nature of all communities, and the specific functions arising from the antithesis between the government and the mass of the people.
In one of those acid asides that makes him so bracing to read, Marx quotes an American defender of slavery explaining that since slaves were unwilling to do plantation labor on their own, it was only right to compensate the masters for the effort required to compel them to work. In this sense it doesn’t matter that the Bosses are performing productive labor. Their claims are just a version of the German nihilists’: It’s only fair that you give me what I want, since I’ve gone to such effort to take it from you. Or Dinesh D’Souza’s argument that equality of opportunity would be unfair to him, since he’s gone to great effort to give his kids an advantage over others.
But again, the industrial capitalist is not only a slave-driver. They do have an essential coordinating function, even if it is performed by the same people, and in the same activities, as the coercive labor-discipline that extracts greater effort from workers and deprives them of their autonomy. The ways these two sides of the labor process develop together is one of the major contributions of Marxist and Marx-influenced work, I think — Braverman, Noble, Marglin, Barbara Garson. It seems to me that, paradoxical as it might sound, it’s this positive role of managers that is ultimately the stronger argument against capitalism. Because the development of professional management fatally undermines the supposed connection between the economic function performed by capitalists, and the economic form of property ownership.
Marx makes just this argument:
The capitalist mode of production has brought matters to a point where the work of supervision, entirely divorced from the ownership of capital, is always readily obtainable. It has, therefore, come to be useless for the capitalist to perform it himself. An orchestra conductor need not own the instruments of his orchestra, nor is it within the scope of his duties as conductor to have anything to do with the “wages” of the other musicians. Co-operative factories furnish proof that the capitalist has become no less redundant as a functionary in production… Inasmuch as the capitalist’s work does not … confine itself solely to the function of exploiting the labour of others; inasmuch as it therefore originates from the social form of the labour-process, from combination and co-operation of many in pursuance of a common result, it is … independent of capital.
The connection Marx makes between joint-stock companies (what we would today call corporations) and cooperative enterprises is to me one of the most interesting parts of this whole section. In both, the critical thing is that the work of management, or coordintion, is just one kind of labor among others, and has no neceessary connection to ownership claims.
The wages of management both for the commercial and industrial manager are completely isolated from the profits of enterprise in the co-operative factories of labourers, as well as in capitalist stock companies. … Stock companies in general — developed with the credit system — have an increasing tendency to separate this work of management as a function from the ownership of capital… just as the development of bourgeois society witnessed a separation of the functions of judges and administrators from land-ownership, whose attributes they were in feudal times. Since, on the one hand, … money-capital itself assumes a social character with the advance of credit, being concentrated in banks and loaned out by them instead of its original owners, and since, on the other hand, the mere manager who has no title whatever to the capital, … performs all the real functions pertaining to the functioning capitalist as such, only the functionary remains and the capitalist disappears as superfluous from the production process.
This, to me, is one of the central ways in which we can see capitalism as a necessary step on the way to socialism. Only under capitalism has large scale industry developed; only the acid of the market was able to break the bonds of small family productive units and free their constituent pieces for recombination on a much larger scale. So the only form in which the organization of large-scale enterprises is familiar to us is as capitalist enterprises. (At least, this is Marx’s argument. Arguably he understates the ability of states to organize production on a large scale.) But just because large industrial enterprises and capitalism have gone together historically, it doesn’t follow that that capitalism is the only institutional setting in which they can exist, or that the conditions required for their development are required for their continued existence.
In fact, as capitalist enterprises develop, their internal organization becomes progressively less market-like. Markets exist only at the surfaces, the external membranes, of enterprises, which internally are organized on quite different principles; and as the scale of enterprises grows, less and less economic life takes place on those surfaces. So while capital continues, nominally, to be privately owned, relations of ownership play less and less of a role in the concrete organization of production. The “mere manager” as Marx says, “has no title whatever to the capital”; nonetheless, he or she “performs all the real functions” of the capitalist.
When Marx was writing this in the 1870s, he thought the trend towards the separation of ownership from control was clearly established, even if most capitalist enterprises at the time were still directly managed by their owners.
With the development of co-operation on the part of the labourers, and of stock enterprises on the part of the bourgeoisie, even the last pretext for the confusion of profit of enterprise and wages of management was removed, and profit appeared also in practice as it undeniably appeared in theory, as mere surplus-value, a value for which no equivalent was paid.
That’s as far as the argument gets in chapter 23.
The next few chapters are focused on the other side of the question, interest-bearing capital — that is,capital that appears to its owners simply as money, without being embodied in any production process. Chapter 24 is an attack on writers who reduce both to money capital, and imagine that the accumulation of capital is just an example of the power of compound interest. (Among other things, this chapter anticipates the essential points of left critiques of Piketty by people like Galbraith and Varoufakis, and by me.) Chapter 26 attacks the opposite conflation — the treatment of money as just capital in general, and of interest as simply a reflection of the physical productivity of capital rather than a specifically monetary phenomenon. This is today’s orthodoxy, represented for Marx by Lord Overstone. Chapter 25 anticipates Minsky on the elasticity of finance, and takes the side of the credit-money theorists like Thornton and banking-school writers like Tooke and Fullarton, against quantity theorists and the currency school. Marx’s debt to Ricardo is well known, but it’s less recognized how much he learned from this group of writers — the best discussion I know is by Arie Arnon. When Tooke died, Marx wrote to Engels that he had been “the last English economist of any value.”
Marx returns to the industrial or functioning capitalist in chapter 27, which is focused on joint-stock companies. Marx credits stock companies with “an enormous expansion of the scale of production and of enterprises, that was impossible for individual capitals.” And critically these new enterprises are public in both name and substance (the “public” in “publicly-traded corporations” is significant.)
The development of joint stock companies continues the sociological transformation that begins with the development of interest-bearing capital and the ability to operate on borrowed funds — that is, the
transformation of the actually functioning capitalist into a mere manager, administrator of other people’s capital, and of the owner of capital into a mere owner, a mere money-capitalist. Even if the dividends which they receive include the interest and the profit of enterprise, … this total profit is henceforth received only in the form of interest, i.e., as mere compensation for owning capital that now is entirely divorced from the function in the actual process of reproduction, just as this function in the person of the manager is divorced from ownership of capital. … This result of the ultimate development of capitalist production is a necessary transitional phase towards the reconversion of capital into the property of producers, although no longer as the private property of the individual producers, but rather … as outright social property. … the stock company is a transition toward the conversion of all functions in the reproduction process which still remain linked with capitalist property, into mere functions of associated producers.
In short, the joint stock company “is the abolition of the capitalist mode of production within the capitalist mode of production itself.”