By Kindred Winecoff
Paul Krugman [1, 2] and Steve Randy Waldman are having an interesting exchange on why the wealthy support tighter monetary policy despite the fact that expansionary economic policy is good for them. This is often expressed as an aversion to lower central bank interest rates, quantitative easing programs, or other activist monetary actions. Krugman sums up the puzzle nicely:
I get why creditors should hate inflation, but aggressive monetary responses to the Lesser Depression have been good for asset prices, and hence for the wealthy. Why, then, the vociferous protests?
Krugman believes that this is false consciousness: “rentiers” oppose policies that benefit them because they adhere to a model of the world — in which loose monetary policy will lead to runaway inflation that will erode the value of their capital — that does not apply in our current circumstances. (Krugman does not mention that one reason why rentiers might believe this is because Keynesians like Krugman have been advocating for higher inflation partially for this reason for some time.) Waldman portrays this as simple risk-aversion: expansionary monetary policy will change something, and because recent circumstances have been favorable to rentiers that something is likely to negatively impact their station.
I prefer Kaleckian accounts that emphasize the general relationship between capital and labor. In Kalecki’s world, full employment gives bargaining power to workers because they have easy exit options. Conversely, underemployment gives bargaining power to capital. I believe that both Krugman and Waldman are sympathetic to this framework as well.
But I want to highlight another possibility that situates the U.S. macroeconomy within the context of the world economy. The simple Mundell-Fleming macroeconomic model, when combined with a Ricardo-Viner sectoral approach, tells us that when international capital mobility is high (as it is today) financial capital benefits from an exchange rate that is high and stable, while fixed capital and labor benefit from monetary policy flexibility and (often) a lower exchange rate. This relationship is discussed in detail in Jeffry Frieden’s 1991 International Organization article “Invested interests: the politics of national economic policies in a world of global finance”, from which the table below is taken:
The section of the article that begins on pg. 442 is especially relevant. There are several things to note. First, the preferences of financial capital diverge from those of fixed capital, which are divided in turn by whether it is engaged in export-oriented, import-competing, or nontradeable production. Second, the preferences of labor within these sectors will tend to side with capital within the same sector, and oppose capital (and labor) in other sectors. Third, the interests of financial capital will diverge from everyone else.
Why is this? Frieden notes that the interests of capital depend on how strongly tied that capital is for its specific current use. Financial capital is much more liquid and adaptable than an industrial plant. It can be deployed globally while fixed capital is must remain local. For this reason, exchange rate movements create an additional source of risk: a depreciation will negatively impact the value of local assets vis a vis foreign assets, while an appreciation will negatively impact the value of foreign assets vis a vis local assets. The point is that any exchange rate movement from the status quo will benefit some and negatively impact other status quo investments, which is why the interests of fixed capital are divided. But for financial capital, exchange rate movements are always bad for their status quo portfolio, at least inasmuch as an alternative portfolio created that anticipated the future exchange rate movement could have been constructed.
Why should finance support a higher exchange rate level in addition to low volatility when capital is mobile globally? Because, all else equal, a higher value in the local currency will increase purchasing power globally. This is particularly true if you have easy access to that currency via one’s central bank. It is probably true that U.S. banks have had greater access to dollar liquidity over the past five years than at any point in economic history; given that, they would prefer those dollars to be more valuable in exchange rather than less.
Frieden notes in his article that the distributional implications of the battle over exchange rate stability and interest rate levels would be especially severe among the European countries that were then debating joining a common currency, with finance preferring a high and stable exchange rate and low monetary policy flexibility. I would suggest that this expectation has been borne out exceptionally well, as the ECB has engaged in quite restrictive monetary actions despite suffering from a regional economic collapse that has few historical parallels. The story is a bit different for the U.S. because of its n-1 privileges, but it is unclear whether anyone in the U.S. — financial firms or even the Federal Reserve — really understands this. Even still the basic story works: high and stable exchange rates are better for finance capital than low and volatile exchange rates.
So from the perspective of financial capital the great risk of expansionary monetary policy is that it will impact exchange rates rather than interest rates, growth, employment, or even asset prices. Thus the Krugman-Waldman puzzle is not a puzzle at all. Financial capital wants restrictive monetary policy because it benefits them more than the alternatives.