Tag: monetary policy

I have a new piece up at Jacobin on December’s rate hike. In my experience, the editing at Jacobin is excellent. But for better or worse, they don’t go for footnotes. So I’m reposting this here with the original notes. And also for comments, which Jacobin (perhaps wisely) doesn’t allow.

I conveyed some of the same views on “What’d You Miss?” on Bloomberg TV a couple weeks ago. (I come on around 13:30.)

 

To the surprise of no one, the Federal Reserve recently raised the federal funds rate — the interest rate under its direct control — from 0–0.25 percent to 0.25–0.5 percent, ending seven years of a federal funds rate of zero.

But while widely anticipated, the decision still clashes with the Fed’s supposed mandate to maintain full employment and price stability. Inflation remains well shy of the Fed’s 2 percent benchmark (its interpretation of its legal mandate to promote “price stability”) — 1.4 percent in 2015, according to the Fed’s preferred personal consumption expenditure measure, and a mere 0.4 percent using the consumer price index — and shows no sign of rising.

US GDP remains roughly 10 percent below the pre-2008 trend, so it’s hard to argue that the economy is approaching any kind of supply constraints. Set aside the fundamental incoherence of the notion of “price stability” (let alone of a single metric to measure it) — according to the Fed’s professed rulebook, the case for a rate increase is no stronger today than a year or two ago. Even the business press, for the most part, fails to see the logic for raising rates now.

Yet from another perspective, the decision to raise the federal funds rate makes perfect sense. The consensus view considers the main job of central banks to be maintaining price stability by adjusting the short-term interest rate. (Lower interest rates are supposed to raise private spending when inflation falls short of the central bank’s target, and higher interest rates are supposed to restrain spending when inflation rises above the target.) But this has never been the whole story.

More importantly, the central bank helps paper over the gap between ideals and reality — the distance between the ideological vision of the economy as a system of market exchanges of real goods, and the concrete reality of production in pursuit of money profits.

Central banks are thus, in contemporary societies, one of the main sites at which capitalism’s “Polanyi problem” is managed: a society that truly subjected itself to the logic of market exchange would tear itself to pieces. But the conscious planning that confines market outcomes within tolerable bounds has to be hidden from view because if the role of planning was acknowledged, it would undermine the idea of markets as natural and spontaneous and demonstrate the possibility of conscious planning toward other ends.

The Fed is a central planner that dare not speak its name. [1]

One particular problem for central bank planners is managing the pace of growth for the system as a whole. Fast growth doesn’t just lead to rising prices — left to their own devices, individual capitalists are liable to bid up the price of labor and drain the reserve army of the unemployed during boom times. [2] Making concessions to workers when demand is strong is rational for individual business owners, but undermines their position as a class.

Solving this coordination problem is one of modern central bankers’ central duties. They pay close attention to what is somewhat misleadingly called the labor market, and use low unemployment as a signal to raise interest rates.

So in this respect it isn’t surprising to see the Fed raising rates, given that unemployment rates have now fallen below 5 percent for the first time since the financial crisis.

Indeed, inflation targeting has always been coupled with a strong commitment to restraining the claims of workers. Paul Volcker is now widely admired as the hero who slew the inflation dragon, but as Fed chair in the 1980s, he considered rolling back the power of organized labor — in terms of both working conditions and wages — to be his number one problem. [3] Volcker described Reagan’s breaking of the air-traffic controllers union as “the single most important action of the administration in helping the anti-inflation fight.”

As one of Volcker’s colleagues argued, the fundamental goal of high rates was that

labor begins to get the point that if they get too much in wages they won’t have a business to work for. I think that really is beginning to happen now and that’s why I’m more optimistic. . . . When Pan Am workers are willing to take 10 percent wage cuts because the airlines are in trouble, I think those are signs that we’re at the point where something can really start to happen.

Volcker’s successors at the Fed approached the inflation problem similarly. Alan Greenspan saw the fight against rising prices as, at its essence, a project of promoting weakness and insecurity among workers; he famously claimed that “traumatized workers” were the reason strong growth with low inflation was possible in the 1990s, unlike in previous decades.

Testifying before Congress in 1997, Greenspan attributed the “extraordinary’” and “exceptional” performance of the nineties economy to “a heightened sense of job insecurity” among workers “and, as a consequence, subdued wages.”

As Greenspan’s colleague at the Fed in the 1990s, Janet Yellen took the same view. In a 1996 Federal Open Market Committee meeting, she said her biggest worry was that “firms eventually will be forced to bid up wages to retain workers.” But, she continued, she was not too concerned at the moment because

while the labor market is tight, job insecurity also seems alive and well. Real wage aspirations appear modest, and the bargaining power of workers is surprisingly low . . . senior workers and particularly those who have earned wage premia in the past, whether it is due to the power of their unions or the generous compensation policies of their employers, seem to be struggling to defend their jobs . . . auto workers are focused on securing their own benefits during their lifetimes but appear reconciled to accepting two-tier wage structures . . .

And when a few high-profile union victories, like the Teamsters’ successful 1997 strike at UPS, seemed to indicate organized labor might be reviving, Greenspan made no effort to hide his displeasure:

I suspect we will find that the [UPS] strike has done a good deal of damage in the past couple of weeks. The settlement may go a long way toward undermining the wage flexibility that we started to get in labor markets with the air traffic controllers’ strike back in the early 1980s. Even before this strike, it appeared that the secular decline in real wages was over.

The Fed’s commitment to keeping unemployment high enough to limit wage gains is hardly a secret — it’s right there in the transcripts of FOMC meetings, and familiar to anyone who has read left critics of the Fed like William Greider and Doug Henwood. The bluntness with which Fed officials take sides in the class war is still striking, though.

Of course, Fed officials deny they’re taking sides. They justify policies that keep workers too weak, disorganized, and traumatized to demand higher wages by focusing on the purported dangers of low unemployment. Lower unemployment, they say, leads to higher money wages, and higher money wages are passed on as higher prices, ultimately leaving workers’ real pay unchanged while eroding their savings.

So while it might look like naked class warfare to deliberately raise unemployment to keep wage demands “subdued”, the Fed assures us that it’s really in the best interests of everyone, including workers.

Keeping Wages in Check

The low-unemployment-equals-high-prices story has always been problematic. But for years its naysayers were silenced by the supposed empirical fact of the Phillips curve, which links low unemployment to higher inflation.

The shaky empirical basis of the Phillips curve was the source of major macroeconomic debates in the 1970s, when monetarists claimed that any departure from unemployment’s “natural” rate would lead inflation to rise, or fall, without limit. This “vertical Phillips curve” was used to deny the possibility of any tradeoff between unemployment and inflation — a tradeoff that, in the postwar era, was supposed to be managed by a technocratic state balancing the interests of wage earners against the interest of money owners.

In the monetarist view, there were no conflicting interests to balance, since there was just one possible rate of unemployment compatible with a stable price system (the “Non Accelerating Inflation Rate of Unemployment”). This is still the view one finds in most textbooks today.

In retrospect, the 1970s debates are usually taken as a decisive blow against the “bastard Keynesian” orthodoxy of the 1960s and 1970s. They were also an important factor in the victory of monetarism and rational expectations in the economics profession, and in the defeat of fiscal policy in the policy realm.

But today there’s a different breakdown in the relationship between unemployment and inflation that threatens to dislodge orthodoxy once again. Rather than a vertical curve, we now seem to face a “horizontal” Phillips curve in which changes in unemployment have no consequences for inflation one way or another.

Despite breathless claims about the end of work, there hasn’t been any change in the link between output and employment; and low unemployment is still associated with faster wage growth. But the link between wage growth and inflation has all but disappeared.

 

This gap in the output-unemployment-wages-inflation causal chain creates a significant problem for central bank ideology.

When Volcker eagerly waited for news on the latest Teamsters negotiations, it was ostensibly because of the future implications for inflation. Now, if there is no longer any visible link between wage growth and inflation, then central bankers might stop worrying so much about labor market outcomes. Put differently, if the Fed’s goal was truly price stability, then the degree to which workers are traumatized would no longer matter so much.

But that’s not the only possibility. Central bankers might want to maintain their focus on unemployment and wages as immediate targets of policy for other reasons. In that case they’d need to change their story.

The current tightening suggests that this is exactly what’s happening. Targeting “wage inflation” seems to be becoming a policy goal in itself, regardless of whether it spurs price increases.

A recent piece by Justin Wolfers in the New York Times is a nice example of where conventional wisdom is heading: “It is only when nominal wage growth exceeds the sum of inflation (about 2 percent) and productivity growth (about 1.5 percent) that the Fed needs to be concerned. . .”

This sounds like technical jargon, but if taken seriously it suggests a fundamental shift in the objectives of monetary policy.

By definition, the change in the wage share of output is equal to the rise in money wages minus the sum of the inflation rate and the increase in labor productivity. To say “nominal wage growth is greater than the sum of inflation and productivity growth” is just a roundabout way of saying “the wage share is rising.” So in plain English, Wolfers is saying that the Fed should raise rates if and only if the share of GDP going to workers threatens to increase.

Think for a moment about this logic. In the textbook story, wage growth is a problem insofar as it’s associated with rising inflation. But in the new version, wage growth is more likely to be a problem when inflation stays low.

Wolfers is the farthest thing from a conservative ideologue. His declaration that the Fed needs to guard against a rise in the wage share is simply an expression of conventional elite wisdom that comes straight from the Fed. A recent post by several economists at the New York Fed uses an identical definition of “overheating” as wage growth in excess of productivity growth plus inflation.

Focusing on wage growth itself, rather than the unemployment-inflation nexus, represents a subtle but far-reaching shift in the aim of policy. According to official rhetoric, an inflation-targeting central bank should only be interested in the part of wage changes that co-varies with inflation. Otherwise changes in the wage share presumably reflect social or technological factors rather than demand conditions that are not the responsibility of the central bank.

To be fair, linking demand conditions to changes in the distribution between profits and wages, rather than to inflation, is a more realistic than the old orthodoxy that greater bargaining power for workers cannot increase their share of the product. [4]

But it sits awkwardly with the central bank story that higher unemployment is necessary to keep down prices. And it undermines the broader commitment in orthodox economics to a sharp distinction — both theoretically and policy-wise — between a monetary, demand-determined short run and a technology and “real”-resources-determined long run, with distributional questions firmly located in the latter.

There’s a funny disconnect in these conversations. A rising wage share supposedly indicates an overheating economy — a macroeconomic problem that requires a central bank response. But a falling wage share is the result of deep structural forces — unrelated to aggregate demand and certainly not something with which the central bank should be concerned. An increasing wage share is viewed by elites as a sign that policy is too loose, but no one ever blames a declining wage share on policy that is too tight. Instead we’re told it’s the result of technological change, Chinese competition, etc.

Logically, central bankers shouldn’t be able to have it both ways. In practice they can and do.

The European Central Bank (ECB) — not surprisingly, given its more overtly political role — has gone further down this road than the Fed. Their standard for macroeconomic balance appears to be shifting from the NAIRU (Non-Accelerating Inflation Rate of Unemployment) to the NAWRU (Non-Accelerating Wage Rate of Unemployment).

If the goal all along has been lower wage growth, then this is not surprising: when the link between wages and inflation weakens, the response is not to find other tools for controlling inflation, but other arguments for controlling wages.

Indeed finding fresh arguments for keeping wages in check may be the real content of much of the “competitiveness” discourse. Replacing price stability with elevating competitiveness as the paramount policy goal creates a convenient justification for pushing down wages even when inflation is already extremely low.

It’s interesting in this context to look back at the ransom note the ECB sent to the Spanish government during the 2011 sovereign debt crisis. (Similar letters were sent to the governments of other crisis-hit countries.) One of the top demands the ECB made as a condition of stabilizing the market for government debt was the abolition of cost-of-living (COLA) clauses in employment contracts — even if adopted voluntarily by private employers.

Needless to say this is far beyond the mandate of a central bank as normally understood. [5] But the most interesting thing is the rationale for ending COLA clauses. The ECB declared that cost-of-living clauses are “a structural obstacle to the adjustment of labour costs” and “contribute to hampering competitiveness.”

This is worth unpacking. For a central bank concerned with price stability, the obvious problem with indexing wages to prices (as COLA clauses do) is that it can lead to inflationary spirals, a situation in which wages and prices rise together and real wages remain the same.

But this kind of textbook concern is not the ECB’s focus; instead, the emphasis on labor costs shows an abiding interest in tamping down real wages. In the old central bank story, wage indexing was supposedly bad because it didn’t affect (i.e., raise) real wages and only led to higher inflation. In the new dispensation, wage indexing is bad precisely because it does affect real wages. The ECB’s language only makes sense if the goal is to allow inflation to erode real wages.

The Republic of the Central Banker

Does the official story matter? Perhaps not.

The period before the 2008 crisis was characterized by a series of fulsome tributes to the wisdom of central banking maestros, whose smug and uncritical tone must be causing some embarrassment in hindsight.

Liberals in particular seemed happy to declare themselves citizens of the republic of the central bankers. Cristina Romer — soon to head President Obama’s Council of Economic Advisers — described the defeat of postwar Keynesian macroeconomics as a “glorious counterrevolution” and explained that

better policy, particularly on the part of the Federal Reserve, is directly responsible for the low inflation and the virtual disappearance of the business cycle . . . The story of stabilization policy of the last quarter century is one of amazing success. We have seen the triumph of sensible ideas and have reaped the rewards in terms of macroeconomic performance. The costly wrong turn in ideas and macropolicy of the 1960s and 1970s has been righted and the future of stabilization looks bright.

The date on which the “disappearance of the business cycle” was announced? September 2007, two months before the start of the deepest recession in fifty years.

Romer’s predecessor on Clinton’s Council of Economic Advisers (and later Fed vice-chair) Alan Blinder was so impressed by the philosopher-kings at the central bank that he proposed extending the same model to a range of decisions currently made by elected legislatures.

We have drawn the line in the wrong place, leaving too many policy decisions in the realm of politics and too few in the realm of technocracy. . . . [T]he argument for the Fed’s independence applies just as forcefully to many other areas of government policy. Many policy decisions require complex technical judgments and have consequences that stretch into the distant future. . . . Yet in such cases, elected politicians make the key decisions. Why should monetary policy be different? . . . The justification for central bank independence is valid. Perhaps the model should be extended . . . The tax system would surely be simpler, fairer, and more efficient if . . . left to an independent technical body like the Federal Reserve rather than to congressional committees.

The misguided consensus a decade ago about central banks’ ability to preserve growth may be just as wrong about central banks’ ability to derail it today. (Or at least, to do so with the conventional tools of monetary policy, as opposed to the more aggressive iatrogenic techniques of the ECB.)

The business press may obsess over every movement of the Fed’s steering wheel, but we should allow ourselves some doubts that the steering wheel is even connected to the wheels.

The last time the Fed tightened was ten years ago; between June 2004 and July 2006, the federal funds rate rose from 1 percent to 5 percent. Yet longer-term interest rates — which matter much more for economic activity — did not rise at all. The Baa corporate bond rate and thirty-year mortgage, for instance, were both lower in late 2006 than they had been before the Fed started tightening.

And among heterodox macroeconomists, there is a strong argumentthat conventional monetary policy no longer plays an important role in the financial markets where longer-term interest rates are set. Which means it has at best limited sway over the level of private spending. And the largest impacts of the rate increase may not be in the US at all, but in the “emerging markets” that may be faced with a reversal of capital flows back toward the United States.

Yet whatever the concrete effects of the Fed’s decision to tighten, it still offers some useful insight into the minds of our rulers.

We sometimes assume that the capitalist class wants growth at any cost, and that the capitalist state acts to promote it. But while individual capitalists are driven by competition to accumulate endlessly, that pressure doesn’t apply to the class as a whole.

A regime of sustained zero growth, by conventional measures, might be difficult to manage. But in the absence of acute threats to social stability or external competition (as from the USSR during the postwar “Golden Age”), slow growth may well be preferable to fast growth, which after all empowers workers and destabilizes existing hierarchies. In China, 10 percent annual growth may be essential to the social contract, but slow growth does not — yet — seem to threaten the legitimacy of the state in Europe, North America, or Japan.

As Sam Gindin and Leo Panitch persuasively argue, even periodic crises are useful in maintaining the rule of money. They serve as reminders that the confidence of capital owners cannot be taken for granted. As Kalecki famously noted, the threat of a crisis when “business confidence” is shaken is a “powerful controlling device” for capitalists vis-à-vis the state. Too much success controlling crises is dangerous — it makes this threat less threatening.

So perhaps the most important thing about the Fed’s recent rate hike is that it’s a reminder that price stability and inflation management are always a pretext, or at best just one reason among others, for the managers of the capitalist state to control rapid growth and the potential gains for workers that follow. As the shifting justifications for restraining wage growth suggest, the republic of the central banker has always been run in the interests of money owners.

Some critics of the rate hike see it as a ploy to raise the profits of banks. In my opinion, this theory isn’t convincing. A better conspiracy theory is that it’s part of the larger project of keeping us all insecure and dependent on the goodwill of the owning class.

 

[1] The role of central banks in disguising the moment of conscious planning under capitalism and preserving the ideological fiction of spontaneous order is clearly visible in the way monetary policy is discussed by economists. From the concrete to the abstract. First, the “independent” status of central banks is supposed to place them outside the collective deliberation of democratic politics. Second, there is a constant attraction to the idea of a monetary policy “rule” that could be adopted once and for all, removing any element of deliberate choice even from the central bankers themselves. (Milton Friedman is only the best-known exponent of this idea, which is a central theme of discussion of central banks from the 18th century down to the present.) Third, in modern models, the “reaction function” of the central bank is typically taken as one of the basic equations of the model — the central bank’s reaction to a deviation of inflation from its chosen path has the same status as, say, the reaction of households to a change in prices. As Peter Dorman points out, there’s something very odd about putting policy inside the model this way. But it has the clear ideological advantage of treating the central bank as if it were simply part of the natural order of optimization by individual agents.

[2] The best analysis of the crisis of the 1970s in these terms remains Capitalism Since 1945, by Armstrong, Glyn and Harrison.

[3] The linked post by Peter Frase does an excellent job puncturing the bipartisan mythmaking around the Volcker and bringing out the centrality of his anti-labor politics. But it contains one important error. Frase describes the late-1970s crisis to which Volcker was responding as “capital refusing to invest, and labor refusing to take no for an answer.” The latter might be true but the former certainly is not: The late 1970s saw the greatest boom in business investment in modern US history; 1981 had the highest investment-GDP ratio since the records begin in 1929. High demand and negative real interest rates — which made machines and buildings more attractive than wealth in financial form — outweighed low profits, and investment boomed. (An oil boom in the southwest and generous tax subsidies also helped.) The problem Volcker was solving was not,as Frase imagines, that the process of accumulation was threatened by the refusal of unhappy money owners to participate. It was, in some ways, an even more threatening one — that real accumulation was proceeding fine despite the unhappiness of money owners. In the often-brilliant Buying Time, Wolfgang Streeck  makes a similar mistake.

[4] More precisely, it’s a return to what Anwar Shaikh calls the classical Phillips curve found in the Marxist literature, for instance in the form of Goodwin cycles. (The Shaikh article is very helpful in systematically thinking through alternative relationships between nominal wages, the wage share and inflation.)

[5] It’s worth noting that in these cases the ECB got what it wanted, or enough of it, and did aggressively intervene to stabilize government debt markets and the banking systems in almost all the crisis countries. As a result, the governments of Spain, Italy and Portugal now borrow more cheaply than ever in history. As I periodically point out, the direct cause of the crisis in Greece was the refusal of the ECB to extend it the same treatment. A common liberal criticism of the euro system is that it is too rigid, that it automatically applies a single policy to all its members even when their current needs might be different. But the reality is the opposite. The system, in the form of the ECB, has enormous discretion, and the crisis in Greece was the result of the ECB’s choice to apply a different set of policies there than elsewhere.