Uncategorized

Don’t panic! (at least not about inflation)

As financial markets have been showing their panicky side in the last few weeks, we’ve been hearing various accounts of what’s driving the volatility. One of the key narratives goes something like this: 1) wages are moving up in the United States, and 2) inflation is starting to increase, which could well 3) produce a spike in inflation as was seen in the 1970s, which means that it’s likely that 4) central banks will start have to raise interest rates more quickly, potentially slowing the economy; ergo: 5) the sky is falling!

Although there are some reasons to be anxious (particularly if you’ve been betting on low stock market volatility or are having a hard time making your mortgage payments), the underlying narrative about the inevitability of a return to high inflation levels is highly suspect.

So, before we all start stocking up on gold and canned goods, let’s take a more careful look at each piece of this logic.

Yes – wages are finally starting to move up in the US, after almost a decade of stagnation. In January, US wages rose at a faster rate than they have since the recession, while the Federal Reserve predicts that inflation will continue to move up this year towards their goal. This is welcome news, given that the long recovery from the 2008 global financial crisis has not translated until now into reasonable wage gains.

In Canada, where I live and work, the story is more complicated: unemployment is lower than it has been since 1976, and inflation is moving slowly upwards towards the Bank of Canada’s 2% target, but wage pressures remain modest.

And in the UK, even though the Bank of England signaled its move into hawkish territory in February with inflation currently above the 2% target, inflation has started to slow again and wage growth is still tepid.

Yet, while the first two parts of the inflation narrative hold true, at least in the US, the next leap of logic, which warns of a sudden takeoff in inflation like that seen in the 1970s, is far less persuasive.

For those who are either too young to remember this decade (or aren’t quite as fascinated as I am by this period in economic history) it’s worth explaining that the 1970s are a bogeyman for investors and central bankers. Between 1971 and 1980, the post-war monetary order of fixed change rates was dismantled, the US dollar was delinked from gold, there were two OPEC oil crises that more than quadrupled the price of oil, and inflation rates got close to 15% in the US and Canada, and topped out over 25% in the UK.

At the end of this decade-long crisis, the central bankers decided to give monetarism a go—trying to slow the expansion of the money supply and raising interest rates dramatically. In the US, Federal Reserve Chairman Paul Volcker pushed the bank’s target rate close to 20%, while in Canada, mortgage rates went as high as 21%. Although the UK did push the bank rate up as high as 17% in 1979, Margaret Thatcher ultimately backed away from this particular strategy and turned to austerity as a way of squeezing inflation out of the economy through a painful recession.

While monetarism ultimately proved to be a failure, and there is still a great deal of debate about what caused and ultimately solved the 1970s’ “Great Inflation,” this traumatic experience paved the way to the current “new monetary consensus” in inflation-management policy, with its unwavering faith in central bank independence and very low inflation targets. Now, any sign that low inflationary expectations are becoming unanchored (i.e. people are receiving more reasonable wage increases), can produce panic.

Of course, no one wants to go back to the 1970s (and not only because of the dodgy haircuts). But how real is the risk that we might end up repeating history?

There several good reasons why we should be skeptical of such leaps in logic.

For one thing, inflation not only depends on people’s expectations of where prices are headed, but also depends on their ability to act on these expectations—by, for example, demanding wage increases. In the 1970s, workers had considerable power to make those demands, with roughly twice as many unionized in the UK and the US than today. As the recent recovery from the 2008 crisis has made very clear, employers now have far more power in determining wages than workers.

It is also worth remembering that the 1970s experience of high inflation was linked to a series of massive shocks—most notably the OPEC crises.

If we aren’t likely to see a return to the inflationary spikes of the 1970s, then what should we be looking for central bankers to do today? Should they double down on inflation targets as many hawks have suggested and move aggressively to pre-empt any jumps in inflation?

The short answer is no.

Just because inflation is finally moving towards the target after nearly a decade of trying to get it there doesn’t mean that inflation targets actually make sense—particularly the extremely low targets that have recently become the orthodoxy.

As I have argued in a Foreign Affairs article, making very low interest rates the only goal of monetary policy has considerable political costs—costs that become very apparent when even the most modest of wage increases for hard-working families becomes a sign that we need another round of monetary austerity.

Yet that doesn’t mean that we are quite out of the economic woods.

Although inflation isn’t likely to skyrocket, even a modest increase will tend to lead to higher interest rates, which will reduce the easy credit that has been making stock markets so bubbly of late. Since stock markets are prone to panics as well as manias, it’s likely to be a rough ride for some time.

A modest rise in interest rates will still pose some very real risks for those economies (like Canada’s) with significant household debt.

With interest rates still extremely low and government debt levels already high, we have fewer tools for coping with the next major bump in the economic road.

And, of course, Donald Trump is still the President of the United States and Brexit remains a source of seemingly boundless economic uncertainty.

So, feel free to panic—just not about inflation.

This blog was originally posted, in a slightly different form, on the CIPS Blog and on SPERI.comment.

Uncategorized

Bring Politics Back to Monetary Policy

The current battle over the liberal world order seems to be about trade, climate, and security policy. But monetary policy has also become an increasingly important arena of conflict. Populist leaders seem to love nothing more than denouncing central bankers and challenging the legitimacy of the current monetary order, as Donald Trump famously did during the U.S. presidential election campaign when he accused central bankers of “doing political things” by keeping interest rates low.

In responding to this challenge, it is tempting to point to central banks’ independence from politics as a defense against the dangers posed by erratic leaders. Yet that would be a risky move. It turns out that decades of appeals to technocratic exceptionalism — the idea that monetary policy should be shielded from democratic oversight — have had costs. Indeed, this exceptionalism can lead to the very politicization of monetary policy that it seeks to avoid.

Central banks play a paradoxical role in today’s liberal democracies. Their work is highly technical, yet the consequences of their actions are inevitably political, producing big winners and losers. They wield great power in democratic societies, and yet they are unelected — because of the fear that politicians tend to push up inflation to appease their bases unless interest rate policy is insulated from democratic pressures.

The underlying tensions in central banks’ technocratic exceptionalism became particularly evident in the aftermath of the 2008 global financial crisis. In recent years, the banks’ entire mission has become unclear: for decades, they have been focused on fighting inflation, yet since the crisis there has been no inflation to worry about despite massive central bank interventions. In fact, the opposite fear — this time, of deflation — has driven extraordinarily loose policies and a great deal of experimentation, ranging from massive bailouts to quantitative easing and ultra-low (even negative) interest rates. Although more normal conditions appear to be on the way at last, the decade of exceptional policies has taken its toll on the legitimacy of the current global monetary order.

The loudest critics of central banks have been on the populist right: Victor Orban’s regime in Hungary, pro-Brexit forces in the United Kingdom, Marine Le Pen’s Front National in France, Tea Party Republicans, and even President Donald Trump in the United States. Riding the growing wave of public skepticism about experts and elites, these illiberal populists have identified central bankers as among the worst offenders.

To save the current monetary architecture from such challenges — an absolutely vital task in a world in which the reliable circulation of money serves as the foundation for economic and political stability — monetary policy needs to have a more robust form of democratic accountability built in. Only then can nations ensure that central banks genuinely meet the needs of those for whom they work: the people.

Of course, with the forces of populist illiberalism on the rise, it is hard not to be relieved that at least some aspects of economic policy are insulated from political oversight. If central bank independence is supposed to protect monetary policy from excessive political pressure, then what better example of its merits than the fact that at least a little of the economy is off-limits to the Orbans and Trumps of the world?

Yet there is a peculiar irony at work here: this argument suggests that our best response to illiberal tendencies is an equally illiberal strategy of excluding monetary policies from democratic accountability. Although technocratic exceptionalism is tempting, especially in the face of the threat of illiberal democracy, it is also quite dangerous, since it reduces accountability even as it never quite succeeds in getting the politics out of monetary policy. This disconnect with the public ultimately fuels the kind of populist backlash the world has recently seen, further politicizing monetary policy with potentially very worrying consequences.

In the short term, we may well be relieved to know that the norms of central bank independence and rule-based policy provide a measure of protection from populist tendencies under the Trump administration and elsewhere. But when Trump ideologue Steve Bannon criticizes capitalism for its amorality and invokes the concerns of middle-class and working-class people, all the while defining the alt-right as their champion, we need to come up with a better answer than to encourage people to have faith in the two percent inflation target.

The feature-article-length versionof this blog was originally published by Foreign Affairson 6 December 2017. It is now also available as a chapter of the e-book A New Financial Geopolitics? The U.S.-Led Monetary Order in a Time of Turbulence.

Accountability, Canada, Inequality, Political economy

Scrooge in Paradise: Why Private Wealth is a Public Issue

Scrooge

As global inequality grows to “extreme levels” — as revealed in the just-released World Inequality Report — it is hard not to wonder what it bodes for the health of liberal democracy — around the world and here in Canada.

Even though our growing levels of inequality may not come close to those in the United States, recent conflict-of-interest stories about both Liberal and Conservative MPs, a growing reliance on tax havens, and cash for access scandals all raise serious concerns about the influence of the wealthy in Canadian politics.

If money talks, then the rich are now deafening the democratic system. As economist Branko Milanovic explains, “the higher the inequality, the more likely we are to move away from democracy toward plutocracy.”

One of my favourite recent New Yorker cartoons shows two men in business suits looking out from a lavish corner office, as one says to the other, “Part of me is going to miss liberal democracy.”

Although we’re not quite there yet, the dark tone of the cartoon reminds us that the economic “haves” can be just as likely to become disaffected with democratic politics as the “have-nots” often singled out as the source of populist pressures (in fact, elites have historically been the most important factor behind de-democratization, as Charles Tilly notes in a recent book).

Reading that New Yorker cartoon, it is hard not to imagine that at least one of those businessmen is likely to be a good friend of President Trump’s. He’s turning conflict of interest into performance art, talking up his daughter’s clothing line and getting national park gift shops to sell Trump branded wine.

Yet, while Trump and entourage demonstrate a particularly brazen willingness to blur the line between public office and private gain, the problem is a much wider one — with echoes here in Canada.

The Paradise papers revelations, the cash for access scandals, and the use of “loopholes” in ethics screens are all legal strategies for giving the wealthy an unfair advantage in a system where we are all supposed to be equal as citizens. Each of these strategies works in a different way to undermine the democratic culture that makes our political system work. In the process, they further blur the line between public good and private gain, eroding the trust that makes democratic politics viable.

Cash for access is the most straightforward. It takes the existing informal advantage that the wealthy have to ensure that their voice is heard politically and weaponizes it. Why bother voting as an ordinary Canadian when politicians will spend their time listening to someone paying $10,000 for a rubber chicken dinner?

The “loopholes” in ethics screens that various Liberal cabinet ministers have admitted to using, as well as the failure of certain Conservative MPs to disclose business ties to China, work more subtly. They create the possibility that public office holders will be swayed by their private assets as they make decisions designed to serve the public good. Why bother being an engaged citizen when you don’t know whether those making the decisions are pursuing their own interests or ours?

The Paradise papers tell us that many of the public figures who speak and act in the name of the public good use tax havens to avoid paying their fair share. Why bother buying into a democratic system requiring that we all do our part by paying taxes when those with the most power are actively avoiding doing so?

Of course, the line that we draw between public and private in a liberal democracy is always something of a fiction. Liberal political thought tells us that everyone is an equal citizen in the public domain, with an equal right to participate politically. Liberalism is also based on the premise that we should be free to pursue wealth accumulation in our private lives, meaning that we will often be quite unequal in economic terms.

In theory, this private inequality should not affect our formal public equality as voting citizens. In practice, things are rather different, as wealth often translates into a greater political voice — as any government that has tried to put a halfway house into an affluent neighbourhood or to reduce tax advantages for doctors incorporated as small businesses will tell you.

To keep a democracy alive, and to ensure that everyone has a meaningful voice and stake in the political system, we must do two things. We must work to keep those private inequalities from getting too large (via public education, social programs, a progressive tax system, etc.). And we must work to minimize the ways in which private inequalities translate into unequal influence (via election financing laws, conflict of interest provisions, etc.).

In Canada, we have made progress on some of these measures, but we have also fallen behind in many respects. As recent census data shows, earnings inequality has continued to grow in Canada over the last decade, while the top 1% increased their share of total income in 2015.

When trying to figure out how we got here, there is blame enough to go around. The Chrétien Liberals began the trend towards growing inequality when they gutted transfer payments for social programs in the 1990s. Inequality grew under the Harper Conservatives, who also eroded some of the other bulwarks against buying political influence, notably through reversing changes to election financing laws, making parties more reliant on private donors once again.

Although the Trudeau Liberals have clearly stated their desire to reduce inequality, and have begun to tackle some of these problems, their own recent conflict of interest scandals suggest a very long way to go before the political culture in Ottawa starts to change.

As that New Yorker cartoon reminds us, unless we start taking the problem of inequality much more seriously now, we may soon find ourselves thinking nostalgically of the “good old days” of liberal democracy.

This blog post originally appeared on the CIPS Blog on December 19, 2017.

Uncategorized

Why Trump’s recent actions should cause us all to rethink our policies

silent-majority-690x450As Donald Trump makes it clear that he is intent on pursuing his rash and racist agenda come what may, we might be tempted to stand back, count our blessings and try to minimize the damage.

We need to be bolder than that. Not only in the short-term, as we counter his hyper-nationalist rhetoric, but also in our longer-term thinking.

The fact of Trump’s victory, like the Brexit vote and the rise of the extreme right in Europe should for us to rethink many of our policies today. How did we let this happen? This is the kind of question that was asked over and over again after the Second World War, as scholars and political leaders tried to understand how populations could elect fascist leaders.

This time around, we need to ask ourselves these questions before things get any worse, and be open to rethinking our policies in significant ways. And, like those political leaders who sought to build a better world after the Great Depression and World War II, this means thinking holistically about the political and economic lessons that we can draw today:

1) Don’t be smug.

It’s far too easy to sit back and feel morally superior in the face of the growing racism and intolerance in the United States. We do moral superiority very well here in Canada. We played that card after the 2008 global financial crisis, and we’re quite likely to do it again. Yet, we need remember that Trump didn’t need (or get) a majority to be elected. He just needed enough support in the right places.

If we go back to the last Canadian election—or the current Conservative leadership race—we can find a lot of nasty, divisive rhetoric being bandied about. In fact, as Thomas Homer-Dixon argued very effectively, the debate about the niqab in Quebec played one of the most decisive roles in ensuring that the Liberals were elected, by making it clear that the NDP wouldn’t win Quebec, and allowing all of the anyone-but-Harper voters to coordinate their preferences around the Liberals.

That’s not a particularly strong mandate for smugness.

And that means that we have to work hard to make sure that we don’t go down the same xenophobic route that our American cousins are on right now.

2) Learn from history

There are no simplistic causal arrows linking the neoliberal economic policies of the past few decades to the rise of Trump, Brexit and the hard right in Europe—these events have complex origins.

Nonetheless, we would be foolish to ignore the parallels with the 1920s and 1930s, the last time in modern history that we saw the level of economic deregulation and inequality that we see today. The rise of fascism came hard on the heels of the Great Depression, making it abundantly clear to those who sought to rebuild after the Second World War that global and domestic political stability ultimately depend on economic stability and security—for everyone.

The results of those reflections were some of the most important changes in the way that we organize our economy on a global and domestic level, including the creation of multilateral financial institutions (the International Monetary Fund and World Bank—rather different creatures then than they are today), the regulation of financial flows, the development of the welfare state, and the broad commitment to full employment as the primary economic policy goal.

Fast-forward to today, and we find that many of the policies introduced in that post-war period have been eroded, dismantled or reversed. While the last few decades’ deregulatory binge may have afforded us a measure of economic growth, it was not without its costs. If the 2008 global financial crisis made the economic costs all too apparent, the rise of intolerance and protectionism should make its political consequences very clear.

3) Reduce inequality, and work to build a dynamic and inclusive economy

As we seek to respond to the challenges of a newly protectionist US and a still-lackluster economic recovery, we need to see the reduction of inequality and the creation of an inclusive economy as a key priority—not a luxury.

This means that we need to do better than we have in the recent past, when the Canadian government has given in too quickly to external pressures and accepted greater inequality as a necessary cost of economic survival.

The Conservative government’s response to the 2008 global financial crisis is a case in point, as stimulus measures gave way to austerity far too quickly (even in the face of IMF recommendations to the contrary).

The Chrétien Liberal government made a similar mistake, in the mid-1990s, when they found themselves at the mercy of bond markets that believed that the Canadian debt was too high and cut social transfers so severely that they started us on the current trend towards growing inequality.

Today, we know that the supposed trade-off between equality and growth is an illusion. There is a great deal of research out there that shows that inequality is bad for growth, and that reducing inequality can make growth oriented policies much more effective.

4) Prepare for the next crisis

When the next recession hits (as it is very likely to do in the next four years), the odds are that we will find ourselves in real difficulty. With our conventional monetary policy tools already mostly tapped out, and Canadian consumer debt levels at an all-time high, the pain of the next recession is likely to be more widely felt (as it was in the US and the UK last time).

Combine that with the kind of xenophobic rhetoric that we’re seeing in the current Conservative leadership campaign, and the risks of a rise of intolerance here is very real.

Which is why that we need to take the political and economic lessons from Trump’s election very seriously indeed, and start to think more creatively, bravely and inclusively about the kind of inclusive society that we can build in Canada.

This blog was originally posted on the CIPS blog.

Accountability, Banking, Economics, Measurement, Political economy, Uncategorized, Uncertainty

Why we need better central bank accountability

As pundits debate whether the US Federal Reserve will raise interest rates again this summer or fall, we are reminded of just how much of the economy’s direction hinges on central bankers’ decisions.

Since the 2008 financial crisis, the power of central banks has grown, as they have used unorthodox tools to stimulate the economy, taken a greater role in financial regulation, and put themselves in more politically sensitive positions, including the tough debt negotiations with Greece.

In spite of this powerful role, central bankers are remarkably insulated from democratic oversight. As a recent “Buttonwood” column notes in The Economist, “Janet Yellen and Mario Draghi are very important players in the world economy, arguably more important than the US President or the German chancellor. And yet they are not elected; if voters do not like the job they are doing, they cannot get rid of them.”

There is a great deal at stake in decisions about monetary policy, as I suggest in a recently published article in Ethics & International Affairs. Central banks not only define the broad direction of the economy but also create winners and losers. Consider, for instance, the disparate reactions of a prospective first-time home buyer and a retired couple living on their savings to the prospect of yet another drop (or increase) in the interest rate.

Central bank independence in its current form is relatively recent. Elected leaders exercised considerable influence over monetary policy in the post-war era, seeking to achieve the right “trade-off” between full employment and inflation. It was only in the 1980s that policymakers moved away from this kind of Keynesianism and embraced the ideas of Milton Friedman, who advocated the creation of an independent monetary authority.

Friedman and other economists believed that if governments were given any discretion over monetary policy they would adopt inflationary policies because these were more likely to be popular with the electorate. They argued that the only way to ensure price stability was to radically limit the government’s influence over monetary policy by making central banks autonomous and requiring them to stick to a simple rule, such as an inflation target. By the late 1990s, central banks in over thirty countries had gone down this path and were using some form of inflation targeting.

The current model of central bank governance does provide for a certain kind of accountability—but only a very narrow one. Ensuring accountability generally involves three elements: broadly-agreed upon standards, information on whether they are met, and sanctions if they are not. Because the principle of central bank independence involves a very limited set of standards—specifically, the achievement of an inflation target—and very few opportunities for sanction, the main mechanism for accountability is provided by publishing information about the bank’s activities. Hence we have seen the rapid expansion of central banks’ commitment to providing more and better information about their models and decisions in recent years.

Unfortunately, while this informational form of accountability may have worked during the stable years of the “Great Moderation” (from the mid-1980s to the 2008 crisis), it is no longer up to the task in the volatile post-crisis era.

Bank of Canada Governor Stephen Poloz and US Federal Reserve Chair Janet Yellen have both suggested that growing economic uncertainty has reduced the effectiveness of simple models and rules. What these bank governors have not acknowledged (unsurprisingly) is the challenges that this growing uncertainty poses for existing forms of accountability.

If uncertainty limits the effectiveness of rule-based policy, then it ultimately requires greater discretion on the part of policymakers. This is not a problem in itself (here I would disagree with those Republican lawmakers who would bind the Fed even further with more stringent rules). More discretion does, however, require a more robust form of accountability.

There are three basic principles that should underpin any such reforms.

1) Fostering more deliberation and dissent

While the informational model of accountability obligates decision-makers to explain their actions, it reduces this process to a simple publication of data. What is missing is the back and forth of question and answer—the process of genuine debate and deliberation. By the mid-2000s, central bankers were being treated like oracles, with Alan Greenspan as the most revered among them. There must be more room for dissent—both among those with the power to set monetary policy and in the wider society that is affected by those policies.

2) Ensuring that central banks are answerable to the wider public

Because financial issues are complex and their impacts are often diffuse, monetary policy questions rarely become salient enough to mobilize public action. In this context, the power of sanction actually shifts away from the two groups to whom central bankers should be accountable—the government and the public—and toward financial actors, who can impose very serious sanctions on central banks if they disagree with their policies. Without overly politicizing monetary policy, we need to find creative ways of ensuring that central banks are more accountable to the wider public.

3) Broadening the objectives against which their actions are judged

One way of ensuring that monetary policymakers are accountable to the public is to ensure that the issues that affect citizens are reflected in the standards that guide bank policy. At present, most of these issues are not officially on the agenda, which is constrained by the goal of achieving a very low level of inflation.

A number of commentators have recognized this dilemma and have suggested that today’s inflation targets may no longer be appropriate. A recent Federal Reserve working paper suggests that increasing the current inflation target and supplementing it with a nominal GDP target makes economic sense. Such moves to broaden the objectives used to guide central bank decisions would also go some way toward increasing their accountability.

As central banks take on an increasingly powerful role in our political and economic lives, it is time to find new ways of ensuring that they are more fully accountable.

This blog first appeared on the Carnegie Council’s Ethics & International Affairs website.

Banking, Economics, Exception, Finance, Political economy, Risk, Uncertainty

Central banks are facing a credibility trap

Quite a few commentators have noted that central bankers have become rather less boring of late. Since the 2008 financial crisis, central banks have taken on new roles and responsibilities. They have experimented with a whole range of unconventional monetary policies. And, in the process, they have gained considerably in power and influence.

There has been less attention to a key paradox underlying central bankers’ new roles on the world stage: they are being forced to govern through exceptions in an era in which rule-following (particularly the holy grail of the 2% inflation target) has become the ultimate source of policy credibility. Where central bankers are supposed to stick to the rules, they have found themselves endlessly making exceptions, promising that one day things will return to normal.

This paradox poses real challenges for efforts to foster a sustained global economic recovery. Governing through exceptional policies is always a politically-fraught undertaking, particularly over the long-term, but it is even more difficult in a context in which the dominant convention is one of strict rule-following.

Since the early experiments with monetarism in the late 1970s and early 1980s, most central banks have moved towards an increasingly rule-based approach to monetary policy, with inflation targeting becoming the norm in many countries in recent years.

Yet today we are faced with a situation in which the rules no longer apply but are still being invoked as if they did.

A recent Buttonwood column notes that the Bank of England has missed its inflation target “almost exactly half the time” since 2008. The European Central Bank (ECB) has effectively expanded its narrow mandate, which formally requires it to make price stability its top priority, by arguing that employment and other issues are crucial to achieving it. Yet the ECB and the Bank of England continue to act as if the old rules still apply.

If we look beyond the narrow rules that are supposed to be governing central bank actions and examine the wider changes in their recent policies, we find similar patterns. Scratch an unconventional monetary policy and you will find a kind of economic exceptionalism: an argument that the crisis that we face is extreme enough that it requires a radical but temporary suspension of economic rules and norms.

Most of the unconventional monetary policies that have been tried to date, and just about all of those that have been proposed as future possibilities if we face a renewed global recession, break quite radically with existing norms. Negative interest rates weren’t even supposed to be economically possible (until they were tried), while quantitative easing (a central bank’s buying up bonds by massively increasing the size of its balance sheet) still carries a whiff of irresponsibility linked to its past as a way for governments to avoid fiscal retrenchment by “printing money.”

More recent proposals include helicoptering money into the government’s or the public’s accounts, abolishing cash to make low interest rates effective, and even introducing a reverse incomes policy—a government-enforced increase in wages (as opposed to the wage controls of the 1970s) to try to get inflation going.

All of these existing and potential policies break with current economic norms, and all are being pitched as temporary, exceptional measures that are (or may be) necessary in the face of an extreme crisis.

Ironically, rule-following was designed precisely to avoid this problem. It came into its own as an influential approach to monetary policy in the wake of the destabilizing 1970s, with their stop-go economic policies and rampant inflation. Mainstream economists came to love rule-based monetary policy as did politicians—not just neoconservatives like Margaret Thatcher and Ronald Reagan who first championed the approach, but eventually the more centrist politicians who followed like Tony Blair and Bill Clinton, as well as today’s mixed lot.

A rule-governed approach to policy was designed to be both politically and economically stabilizing—to do away with the problem and even the possibility of exceptions by removing not only governments’ but even central bankers’ discretion: just stick to the rule, and everything will work out. A tidy, efficient, depoliticized (although certainly not apolitical) approach to monetary policy.

Yet rules only seem great until they don’t apply anymore. A rule that pretends it can always apply (or at least, as Colin Hay puts it in his introductory blog, in the 99.9% of times that seem relevant) inevitably runs serious problems when an exception becomes necessary.

Of course, as Alan Greenspan has noted, the victory of rules over discretion was never entirely true in practice. But it was an extremely powerful narrative—one that promised that central banks’ (and governments’) commitments to low inflation and economic stability was credible because they were constrained to follow the rules.

It was also a very effective narrative that has convinced markets that anything other that rule-following is likely to be destabilizing. As central banks begin to face the limits of those rules, their earlier persuasiveness has come back to haunt them: a recent paper from some Federal Reserve staff notes that although a higher inflation target would make sense in the United States, increasing it could well backfire if market actors believed that it would be too inflationary.

This fixation on rule-following has thus put central bankers into a credibility trap. If bankers admit that the rules no longer apply, then they risk losing their credibility as market actors have come to believe the mantra that rules—particularly low inflation targets—are the only way to ensure sound monetary policy. On the other hand if they don’t admit the limits of the rules, and continue lurching from exception to exception, they will eventually lose credibility as the gap between rhetoric and reality widens.

Central banks are damned if they do admit the limits of rules and damned if they don’t.

Of course, the most viable solution to this trap is for governments to stop relying so heavily on central banks in the first place and start taking some responsibility for economic recovery through concerted fiscal action (something that the Canadian government has at least started to do). Yet for that kind of fiscal action to work, governments have to convince the markets that they believe in it enough to stick to their guns and follow through—a rather unlikely scenario in today’s austerity-driven times.

As the potential for renewed economic crisis continues to grow, this credibility gap will only widen—as central bankers and governments find themselves lurching from exception to exception, refusing to question the neoliberal rules that no longer seem to apply.

This blog was first posted on the Sheffield Political Economy Research Institute’s website.

Canada, Economics, Inequality, Political economy, Theory

Rebuilding the middle class: The Liberals have a chance to rectify their past economic mistakes

As the new Liberal government starts to put its economic plan into action, its commitment to paying attention to the evidence (unlike its Conservative predecessors) should provide them with both comforting and cautionary tales.

On the one hand, there is ample evidence to support the Trudeau government’s plan to allow for short-term deficits in order to reinvest in infrastructure and rebuild the middle class. On the other, the data also points to a rather more inconvenient truth: the trend towards growing inequality actually started on the Chrétien Liberal government’s watch.

A recent report by TD Economics notes that while the top 20% of income earners have gained 30% since 1976 (most of that since 1994), the middle 20% have only seen an increase of about 5% in that time. More tellingly, the report suggests that it was only in the mid-to-late 1990s that the level of inequality in Canada began to take off “when governments stopped leaning against income inequality.”

During the campaign, Justin Trudeau demonstrated his willingness to take on board new economic thinking and break with the old Liberal Party’s obsession with paying down the debt at any cost. Although the Trudeau Liberals’ willingness to run a small fiscal deficit in the short-term was ridiculed by the Conservatives and challenged by the NDP during the election campaign, it is actually entirely consistent with much mainstream economic policy thinking today.

A recent discussion note by economists at the International Monetary Fund (not exactly known as a bastion of left-wing thinking) warned governments like Canada against imposing austerity measures in order to pay down their debts more quickly. The authors note: “While debt may be bad for growth, it does not follow that it should be paid down as quickly as possible.” In fact, “If fiscal space remains ample, policies to deliberately pay down debt are normally undesirable.”

Or, to borrow former NDP leader, Jack Layton’s, well-known phrase (as noted in a column by Andrew Coyne last March) there is little point in paying down your mortgage faster when your house is falling down from badly-needed repairs.

This reminder of Layton’s common-sense wisdom should tell us two things. First, and most obviously, the NDP lost its way in its efforts to seem economically credible enough to govern. While there is no question that the party had far less political leeway than the Liberals to challenge what has become a Canadian obsession with balanced budgets and debt-reduction, by setting aside the more hopeful ambitions of Layton’s NDP, Mulcair and his advisors ended up in the odd position of being more conservative than the IMF (not to mention Andrew Coyne).

Second, we need to remember that it was the Chrétien and Martin Liberals, not the Conservatives, who made debt reduction a centrepiece of their economic policy in the 1990s and early 2000s.

The first cuts made in the 1990s were designed to reduce what had become a genuinely unsustainable deficit. Back then, Canada faced a milder version of Greece’s recent dilemma, with bond markets increasingly suspicious of the government’s credit-worthiness.

Yet what started as a strategic response to external pressures soon became an end in itself: the running of surpluses to pay down the debt became a mantra—part of the brand of the Liberal Party itself.

As we now know, that policy had its own very serious human costs.

I remember well the moment when the Liberal government stopped leaning against inequality and started to dismantle the same social policies that Pierre Trudeau’s government had built. I was a parliamentary intern in the House of Commons from the Fall of 1994 to the Spring of 1995 (in fact, one of my fellow interns was Arif Virani, who has just been elected as a Liberal MP for Parkdale-High Park). I watched a Liberal party that had campaigned on the left move sharply right. I watched smart, progressive politicians like Lloyd Axworthy overseeing the erosion of our social infrastructure, and I tried to understand why.

That experience shaped the rest of my career. I decided to go back to university and become a professor of international political economy in order to try to understand why countries like Canada could believe that they had to destroy their social fabric in order to survive economically—and how we could prevent this happening again.

In the twenty-plus years since I first sought to understand how Canadians can foster a caring and just society in a competitive and often unstable global economy, I have not come up with any easy answers.

But I do know that a Liberal government that is genuinely open to learning from the evidence, and committed to paying attention to inconvenient truths, will not reproduce the same mistakes that it once made.

Rising inequality hurts all of us. Recent research has shown that more unequal societies don’t grow as quickly, as many members of society find themselves unable to invest in their education and training, decreasingly overall productivity.

As the TD Economics report notes, the factors that allowed us to avoid the more radical hollowing out of the middle class seen the United States in recent years can no longer be counted on, as the commodity boom comes to an end and the hot housing market starts looking increasingly like a bubble about to burst (or at best deflate). Without creative government action, we are at risk of falling into a vicious cycle of lower growth, cuts to programs, further inequality and even lower growth.

While some might argue that the Bank of Canada’s recent downgrades to the economic outlook should push the Liberals back into their old austerity mode, that zero-sum game no longer holds water. As middle-class jobs come under even more pressure, leaning against inequality can help us all.

This was originally posted on the CIPS Blog.