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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.

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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.