The Brave New World of Central Banking, Monetary Policy and Economic Inequality
Let me start with an important empirical observation. Europe is the richest region in the world. Private wealth and private capital is equal to 6-7 times national income in most Euro area countries, even 8 times national income in some countries, such as Italy. Yet at the same time the public sector and European governments are poor, youth unemployment is at an all time high, and economic inequality is rising.
Europe has the highest capital/income ratio in the world yet economic growth is stagnant. To improve this we are being told that we need to reduce public sector deficits and that government debt is the problem. This is what we call austerity. Let’s think about that for a moment, as it is rarely commented upon. It’s indirectly discussed in Robert Reich’s new book: Saving Capitalism for the Many, not the Few.
In the richest region of the world there is serious under investment in public infrastructure, housing, research, public transport, telecommunications, childcare and education (societal goods that the private market is not very good at providing). Funding per student at third level is down 25% in those countries that radically embraced austerity, such as Ireland, Spain, Italy, Greece and Portugal. In responding to this crisis of investment and growth, the Euro area chief executive – Mario Draghi at the ECB – has radicalised monetary policy (QE) as a complement to fiscal austerity. This is the first big public policy problem in the study of contemporary macroeconomics and international political economy: how to tackle what Larry Summers calls secular stagnation and associated unemployment effects.
- But remember; ask yourself, why is this the case if countries are so rich? I will suggest that the economic growth problem is a distribution problem. The rich are getting richer but societies are getting poorer.
The policy response to weak growth and unemployment has been to provide free money, in the form of quantitative easing (QE), to the private financial banking sector (in addition to structural reform of product and labour markets). The ECB has provided, on average, 60 billion a month to the private financial sector, in the hope that banks will lend to governments and increase investment into the economy, thereby bringing down government debt indirectly.
Providing free money to banks is considered efficient yet providing finance (fiat money) to governments is considered a moral hazard. Think about that. Private banks, whom we have no democratic control over, are trusted more than public sector agencies. This is despite the fact that there is a near consensus in the macroeconomic profession that the Eurozone crisis can be traced to reckless behaviour in private financial markets. The crisis was an outcome of private debt (rising credit) not government debt. This problem of relying on private credit-debt has not gone away.
In the US, QE has provided around 4 trillion to the financial market sector. In the UK, the BoE has pumped around 1 trillion into the private banking sector. The implication is that capital/income ratios are increasing, the stock market booming, corporate executive salaries rising and private wealth rapidly expanding. This has increased the R>G inequality, whereby the rate of return on capital assets (the wealthy) has outstripped economic growth (society).
The R>G inequality is the macro phenomenon that Thomas Piketty introduced with analytic parsimony in his international bestselling book, Capital in the 21st Century. His research suggests that when the pure rate of return on capital exceeds the economic growth rate wealth inequalities will grow. It is what Robert Solow calls the rich get richer dynamic. This is not difficult to understand. It points out an intuitive reality: if you own capital assets (such as several houses or apartment blocks) the income (interest) you receive from owning these assets (rent), tends to outstrip the income growth rate of the vast majority of people whose income depends on wage labour.
But think about this radical shift in monetary policy that has exacerbated wealth inequality for a moment.
Rather than central banks providing funding to households and/or the government to reduce deficits created by dysfunctional finance markets they give it to those same unaccountable private banks in the hope they will lend to government (with interest), rather than just hoard cash to improve their balance sheets. There is now substantial evidence to suggest that QE in the USA, the UK, and Europe has increased wealth inequality whilst only marginally improving growth and employment. We have rising profit share and weak investment.
Quite simply, monetary and fiscal policy has benefited the 1%. This is the second big problem in macroeconomics and International Political Economy: the brave new world of central banking and the distributional impact of monetary policy on the real economy (as opposed to stock market and asset-price valuations).
Until Piketty’s bestseller, Capital in the 21st Century, the rise in income inequality was considered an outcome of skills based technological change. First it was assumed that technology was displacing the bottom, and then it was assumed to hollow out the middle. Meanwhile top incomes (the 1%) soared. Evidently this had little to do with education or skills. Hedge fund managers have no more formal training than high school teachers. Something more basic was happening. To put it simply, capital was thumping labour. Even the IMF acknowledges this basic observation. Most evidence would suggest that weak unions and collective bargaining is an important factor behind rising levels of economic inequality. Economists tend to suggest, however, that weaker unions and changing labour markets is a reflection of technological change. Economists generally prefer to talk about technology than political power.
It is beyond the scope of this commentary to go into detail on the political decisions affecting income and wealth inequality but here are just some policy choices; weakened anti-trust laws, changes to top corporate and income taxes; depressed fiscal policies; priority accorded to speculative trading rather than real investment; the rise of contingent and temporary labour; pension and insurance changes. The general point is that from a political economy perspective it is market power that explains rising economic inequality, rather than changes to modern technology. Piketty and the R>G inequality has very little to say about this. But those who study labour market institutions and comparative capitalism have a lot to say about it.
Furthermore, rising market power is intimately linked to political bargaining power; lobbying; donations; threats of capital flight. From a political economy perspective, governments don’t ‘intrude’ on the market. They create the market. Politics and economics are inseparable, and reflected in the diverse cross-national variation in fiscal policy regimes within the OECD. This is the third big problem in macroeconomic and International Political Economy: explaining the causes and consequences of growing wealth and income inequality. This is what I call the distribution problem. There are no shortage of economic resources. The problem is that those who own them all, control all the investment.
Why are we not talking about the distortion of public policies that clearly benefit the few over the many? I don’t think it is necessarily an outcome of a right wing conspiracy (although corporate interests clearly matter). Nor do I think it is an outcome of politicians intentionally acting in the direct interest of capital-asset holders (although this is probably the case in the USA where regulatory capture by Wall Street is endemic, or in countries where governments are trying to increase the price of housing after the collapse of asset price bubbles, such as Ireland). I think it is an outcome of the complete failure of our economic models to address the core public policy problems facing society today. Our toolkits are outdated.
The underlying ideational assumptions that are implicitly contained within most economic models provide an instruction sheet to governments about the policies choices available to them. Certain public policy choices are ruled out, such as implementing a coordinated wealth tax in Europe as a mechanism to pay off public debt, rather than asking governments to borrow from the wealthy at high interest rates. The call for the ECB to directly re-finance government debt (which in most countries, with the exception of Greece, was caused by the folly of the private financial sector) is consider a ‘pact with the devil’. We are told it will lead to moral hazard and runaway inflation. Yet lending to private banks is somehow considered unproblematic, despite the impact on asset-price (housing) inflation. Monetary and fiscal policies are a politicised process because of their distributional implications. They never purely technical decisions. The political question is in whose interest is monetary, fiscal and labour market policy designed: wealthy capital-asset holders or real people in the real economy?
What does all of this imply about the development of economics?
It suggests a fundamental rethink of the assumption of market economics, along the lines of the CORE project, developed by the Institute for New Economic Thinking. The economic and public policy community must let go of their ideological presuppositions and engage in a conversation with the broader political and social sciences. Mathematical models are useful for reducing complexity in the world but there is always an empirical trade off. If this trade off implies giving up ‘explanation’ of the really existing economic world, in the interest of ‘logical clarity’, then economics becomes a dubious and dangerous science. The policy implications of these simplistic models are too great to be ignored. Social science is more than economics.
To conclude, the three big economic problems I have outlined here are a) secular stagnation, b) wealth and income inequality and c) the brave new world of central banking and monetary policy. All three are interconnected and presently public policy is ill equipped to deal with them. Government debt, fiscal deficits and the public sector are not the problem. Governments need to recognize this. The core economic problem is financial oligarchy and rentier capitalism for the few.
This is based on a talk I have at the Young Professionals Network at the Institute for International and European Affairs.
Brussels Insider 2021-2022 