The hidden conflict within the fascist state for control of economic policy (4)
I have been going through this process in order to clarify for myself the logic of the current discussion of so-called negative interest rates — an oxymoron if ever there was one. This is part four of the series; part one, part two and part three can be found here. I hope it also will have some use to readers.
Part Four: The desperate search for an exit from failed monetary policy
“I think we got the Recovery Act right. The primary objective of our policy is having more work done, more product produced and more people earning more income. It may be desirable to have a given amount of work shared among more people. But that’s not as desirable as expanding the total amount of work.” Larry Summers, Washington Post, November 8, 2009
“We didn’t think it would take that long.” Ben Bernanke, USA Today, October 5, 2015
The disappointment with the weak impact of counterfeiting the currency was admitted by Bernanke in a recent interview. This was not supposed to happen according to the dominant monetary theory, and Ben Bernanke in particular, where the prices of commodities are a function of the supply of currency in circulation. According to Bernanke’s “quantity theory of money”, the government had this technology, the printing press, which it could use to manage the US national capital. In fact, following the financial crisis, the policy rate went to zero without providing any real stimulus at all.
The chief economist of the Bank of England, Andrew Haldane, gave a speech in September on the problems faced by monetary policy. Although Haldane never mentions Larry Summers, his speech addresses the same concerns Summers raised in his own November 2013 “secular stagnation” speech. The problem is that monetary policy, on which the United States has relied since 1979, has run into a dead end, the zero lower bound. Had Washington not stepped in and provided a multi-year, multi-trillion dollar fiscal stimulus, capitalism likely would have collapsed. No one will admit it, but this is in fact what has happened after the 2008-2009 financial crisis.
The problem as defined by Haldane can be stated simply: Under the commodity money (gold) standard control the state had over its currency was constrained by a peg to the commodity serving as money. In reality, under the gold standard, there was no monetary policy at all to speak of. Leaving the gold standard freed the state from this constraint: “the cord connecting currency and monetary policy has been all but cut.” With the currency under its sovereign control since the Great Depression and especially since the collapse of the Bretton Woods agreement, Washington has been able to pursue monetary policy to manage the economy.
However, since the financial crisis, as interest rates have fallen to near zero, the effective difference between currency and credit has been erased. Currency, of course, pays no interest, but credit extended to many sovereigns and a few private capitalist firms is effectively at zero — and, in some cases, negative — as well.
Many economists judged this to be a short term problem. As conditions improved, they thought, interest rates would return to ‘normal’ and the distinction between currency and credit would reestablish itself. Despite the expectations of bankers, getting off zero interest rates is proving more difficult than previously thought and Haldane thinks the expectation may be misplaced. If zero interest rates are going to be around for some time as seems likely, monetary policy has to be rethought.
It is generally assumed interest rates cannot go below zero. No one in their right mind would lend you money on condition you pay them back less than they lent. However, as Haldane explains,
“The ZLB [zero lower bound on interest rates] problem is, in one sense, not new. It was discussed at the time of the previous largest and most damaging financial crisis, the Great Depression. Keynes warned of the ineffectiveness of low interest rates in his General Theory. It gave rise to his notion of the “liquidity trap”.”
For the most part, says Haldane, economists dismissed this problem — until the financial crisis when rates went to zero. Research now appears to support the conclusion the ZLB was always underestimated and, moreover, will not go away, i.e., monetary policy has reached a dead end. Further, the failure of monetary policy is not a recent development caused by the financial crisis, but may be a long term development. A look at this chart, taken from my last post, will show why: fed funds rate since 1985 shows a long downward trajectory.
According to data supplied by the Federal Reserve, the feds fund policy rate actually has been falling for thirty years and the Fed has been unable to reverse it. The policy rate reached zero after the financial crisis, but empirical data shows it was already heading there.
This raises an extremely important question no one in Washington really wants to talk about publicly: what happens when the economy tanks? According to Haldane very long term historical data suggests recession occur on average every three to ten years. It now has been seven years since the crash of 2008-2009. If a downturn occurred today, central banks likely would have no policy response except printing currency and that is, at best, only having a weak impact.
(Now we can debate whether QE is working like academics, but in the real world interest rates are still on zero and the Fed is having a difficult time raising them — which means it ain’t working. If QE was working interest rates would not be zero — simple as that.)
According to Haldane, in previous recessions, central banks have needed on average about three percentage point of monetary easing to stimulate sufficient private investment. Today, with policy rates near zero and six years into a ‘recovery’ of sorts, there appears to be little headroom for monetary policy.
“This suggests that the probability of policymakers needing 3 percentage points of interest rate headroom comfortably exceeds the likelihood of this headroom being available. Put differently, it is much more likely than not interest rates may need to return to ground zero at some point in the future. Although no more than illustrative, these estimates suggest the ZLB could exert a strong gravitational pull on interest rates for some time to come.”
In plain English, there is a high probability the world economy will go into a recession in the near future when, effectively, the fascists have no available policies to stabilize the economy?
Really? What does that look like?
Can you say, “Greece”? The depth and longevity of the depression in Greece is what happens when a country is plunged into a depression without any policy means to exit from it. Thus, it is very possible that in the coming recession Washington will have to rely solely on fiscal stimulus to exit it. Of course, deficit spending would expand the US trade deficit. (Hence, TPP negotiations and the like.) More importantly, however, being limited to QE in the next recession would essentially means the central banks would be limited to simply supporting fiscal policy — and that could spell the end of monetary dominance (and the Fed) in the setting of economic policy.
“Nonetheless, were QE to grow in scale and permanence, that boundary [between fiscal and monetary policy] would become fuzzier. QE then morphs into fiscal policy and monetary policy risks falling victim to so-called “fiscal dominance”. That would corrode another hard-won monetary prize over recent decades – namely, central bank independence. In short, as QE becomes permanent, monetary policy credibility heads down the most slippery of slopes.”
The stakes are high and, as Haldane explains, the prospect for continued control of economic policy by the central banking cartel is not looking good if some new approach to economic policy is not developed:
“This time may indeed be different, not just from the recent past (the 1980s and 1990s), but from the distant past (the 1930s). And if so, central banks may find themselves bumping up against the ZLB constraint on a recurrent basis.”
Desperate times call for desperate measures. The threat now arises not just from the potential (admittedly weak, but not zero) for a widespread movement for reduced hours of labor among the working class to counteract rising unemployment, but also from fiscal policy, which would effectively strip central banks of their control over economic policies in many countries hard hit by rising unemployment and bankruptcies.
Haldane has proposed three changes in the conduct of monetary policy to address the zero lower bound and weak impact of quantitative easing:
First, Haldane proposes to raise the inflation target from the present two percentage points to four percentage points:
“For example, raising inflation targets to 4% from 2% would provide 2 extra percentage points of interest rate wiggle room. That is roughly the order of magnitude researchers have suggested might be desirable. Simulations suggest a 4% inflation target gives sufficient monetary policy space to cushion all but the largest recessions historically.
Put another way, the optimal inflation target is likely to be state-dependent depending, among other things, on the likelihood of the ZLB constraint binding. That likelihood depends, in turn, on the level of equilibrium real interest rates. If equilibrium real rates shift, so too should the optimal inflation target. In other words, theory also would support a revision of monetary mandates.”
The obvious objection to this suggestion is that monetary policy has failed even to reach the two percent inflation target. Given this, how would increasing the target to four percent accomplish anything but further exposing the impotence of the central bankers? Haldane response might be that by raising the target, expectations of future inflation would rise. Expecting higher inflation in the future, firms would increase their prices, making the higher target possible.
Second, Haldane proposes to make quantitative easing a permanent fixture in the conduct of monetary policy:
“A second policy option would simply be to accept the ZLB constraint and allow currently “unconventional” monetary measures to become “conventional”. That might mean accommodating QE as part of the monetary policy armoury during normal as well as crisis times – a monetary instrument for all seasons.
This approach has some attractions. Unlike increases in inflation targets, it would not be a voyage into the monetary unknown. QE has been carried out by a number of advanced economy central banks over recent years. That has provided a fairly rich evidence base on which to assess its efficacy. Moreover, this evidence base suggests that the QE undertaken so far has, more or less, had its desired impact.”
In fact, the evidence quantitative easing has been effective policy is, at best, weak. Following the quantity theory of money, QE was supposed to increase inflation by increasing the supply of currency in circulation. Haldane would not be having this discussion if QE had been successful.
However, Haldane holds his boldest (perhaps insane) proposal for last: If the central banks cannot raise interest rates on loaned capital above zero, why not try imposing a negative interest rates on the currency itself?
“That brings me to the third, and perhaps most radical and durable, option. It is one which brings together issues of currency and monetary policy. It involves finding a technological means either of levying a negative interest rate on currency, or of breaking the constraint physical currency imposes on setting such a rate.
These options are not new. Over a century ago, Silvio Gesell proposed levying a stamp tax on currency to generate a negative interest rate. Keynes discussed this scheme, approvingly, in the General Theory. More recently, a number of modern-day variants of the stamp tax on currency have been proposed – for example, by randomly invalidating banknotes by serial number.
A more radical proposal still would be to remove the ZLB constraint entirely by abolishing paper currency. This, too, has recently had its supporters (for example, Rogoff (2014)). As well as solving the ZLB problem, it has the added advantage of taxing illicit activities undertaken using paper currency, such as drug-dealing, at source.”
Think of it this way: the problem with the zero lower bound is that credit becomes indistinguishable from currency. At the zero percent rate of interest there is no return on lent capital and the lender bears the additional risk of losing all or part of his lent capital. Once risk and overhead is factored into the loan, the real interest rate is negative. The lender would naturally see the advantage of sitting on his money capital than exposing it to a near 100% risk of losing money on the loan.
Haldane proposes that the way around this problem is by imposing negative interest rate not on credit money, but on the currency itself. If a way could be found to force the holders of currency to pay interest on the currency in their banks accounts, wallets, pockets — and even in their mattresses — the distinction between credit money and currency could be forcibly imposed on society by the state despite a zero interest rate environment.
The idea is obviously insane, and reflects the level of desperation measures to which the central banksters are now being driven in order to maintain their control over economic policy. I will turn to Haldane suggestion for how the central banks might be able impose negative interest rate on the currency in the next part of this series.