Why Isn’t the Fed Tougher on Banks?

By Kindred Winecoff

I am live at The Washington Post‘s political science blog The Monkey Cage, writing about some of my recent research on the global financial system. One key bit:

[T]his result conforms to a simple logic: if you task central banks with financial stability, they will partially tailor monetary policy to make it so. If banks know that their central bankers have their interests in mind, they will behave with less prudence. It makes perfect sense why this would be the case. So long as banks do not violate their statutory capital requirements there is little that central banks can do to prevent this behavior even if they wished to do so. Economists refer to situations in which actors are able to shift the risk generated by their actions onto others as “moral hazard.” It is one of the greatest economic problems, which can cause entire markets to fail. Isn’t that what’s happening in this situation?

Read the rest here. The underlying research is available on my website here.

The Wizard of Oz Is an Anti-Finance Manifesto

By Kindred Winecoff

Somewhat apropos of my previous post is the following anecdote, which I’ve read a number of times and have always forgotten. I’m pasting it here for posterity’s sake. It is from Daniel Little’s review of David Graeber’s Debt: The First 5,000 Years:

There are many startling facts and descriptions that Graeber produces as he tells his story of the development of the ideologies of money, credit, and debt.  One of the most interesting to me has to do with The Wonderful Wizard of Oz.

L. Frank Baum’s book The Wonderful Wizard of Oz, which appeared in 1900, is widely recognized to be a parable for the Populist campaign of William Jennings Bryan, who twice ran for president on the Free Silver platform — vowing to replace the gold standard with a bimetallic system that would allow the free creation of silver money alongside gold. … According to the Populist reading, the Wicked Witches of the East and West represent the East and West Coast bankers (promoters of and benefactors from the tight money supply), the Scarecrow represented the farmers (who didn’t have the brains to avoid the debt trap), the Tin Woodsman was the industrial proletariat (who didn’t have the heart to act in solidarity with the farmers), the Cowardly Lion represented the political class (who didn’t have the courage to intervene). … “Oz” is of course the standard abbreviation for “ounce.” (52)

The symbolism of the “yellow brick road” needs no elaboration.

UPDATE: As was been pointed out by Thomas in the comments, this was discussed long ago in the Journal of Political Economy.

Understanding the Preferences of Finance

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.

La Guerre n’est Pas Finie

By Kindred Winecoff

I’ve been thinking about why the most recent flare-up of the Israel-Palestine conflict is happening now. Most off-the-shelf explanations of the relationship — ethno-religious animosities, long-standing rivalry, Western imperialism, etc. — only describe baseline characteristics even if they were fully acceptable as explanations (which they are not). There is a big gap between the long-running fundamentals and what is happening now.

I’ve had a nagging sense that all of this was somehow related to the revolutions, invasions, and civil conflicts that have been occurring in the Middle East for several years* but was having trouble filling in the picture. So I was happy to see David Brooks, who is not one of my favorite people, providing appropriate context:

Look at how the current fighting in Gaza got stoked. Authoritarians and Islamists have been waging a fight for control of Egypt. After the Arab Spring, the Islamists briefly gained the upper hand. But when the Muslim Brotherhood government fell, the military leaders cracked down. They sentenced hundreds of the Brotherhood’s leadership class to death. They also closed roughly 95 percent of the tunnels that connected Egypt to Gaza, where the Brotherhood’s offshoot, Hamas, had gained power.

As intended, the Egyptian move was economically devastating to Hamas. Hamas derived 40 percent of its tax revenue from tariffs on goods that flowed through those tunnels. One economist estimated the economic losses at $460 million a year, nearly a fifth of the Gazan G.D.P.

Hamas needed to end that blockade, but it couldn’t strike Egypt, so it struck Israel. If Hamas could emerge as the heroic fighter in a death match against the Jewish state, if Arab TV screens were filled with dead Palestinian civilians, then public outrage would force Egypt to lift the blockade. Civilian casualties were part of the point. When Mousa Abu Marzook, the deputy chief of the Hamas political bureau, dismissed a plea for a cease-fire, he asked a rhetorical question, “What are 200 martyrs compared with lifting the siege?”

The eminent Israeli journalist Avi Issacharoff summarized the strategy in The Times of Israel, “Make no mistake, Hamas remains committed to the destruction of Israel. But Hamas is firing rockets at Tel Aviv and sending terrorists through tunnels into southern Israel while aiming, in essence, at Cairo.”

Emphases added. This means, among other things, that John Kerry will be completely wasting his time in Cairo unless his trip is an attempt to reconcile the Muslim Brotherhood and its supporters with the Egyptian military. (Hamas’ rejection of the ceasefire negotiated by Egypt and Israel makes additional sense in this light.) That is so unlikely as to be hardly worth hoping for, and it isn’t even clear what such hope would mean, but that is the only mission with a chance for success. Of course it’s not even that simple: all of this is occurring within a broader regional conflict environment, as Brooks also notes:

This whole conflict has the feel of a proxy war. Turkey and Qatar are backing Hamas in the hopes of getting the upper hand in their regional rivalry with Egypt and Saudi Arabia. The Egyptians and even the Saudis are surreptitiously backing or rooting for the Israelis, in hopes that the Israeli force will weaken Hamas.

It no longer makes sense to look at the Israeli-Palestinian contest as an independent struggle. It, like every conflict in the region, has to be seen as a piece of the larger 30 Years’ War. It would be nice if Israel could withdraw from Gaza and the West Bank and wall itself off from this war, but that’s not possible. No outsider can run or understand this complex historical process, but Israel, like the U.S., will be called upon to at least weaken some of the more radical players, like the Islamic State in Iraq and Syria and Hamas.

It should be reiterated at this point that this is fundamentally a conflict over economics, not ideology. It is about control over the region’s resources at a time when those resources are dwindling and demographic pressures are mounting. Which is all to say that it isn’t 1967 anymore. Nor 1979 nor 1987 nor 2000.

None of this means that Israel’s response has not been disproportionate. It has been, and frankly it’s hard for me to believe that anyone could sincerely believe the opposite. Regardless of the tactics of Hamas, the Netanyahu government has shown a characteristic lack of maturity by lashing out with far less discrimination than it is capable of. It is, as the late Tony Judt put it, a sign of Israel’s inability to yet achieve its full height. Israel’s own blockade of Palestine only increased Egypt’s importance, it must be remembered. Still, Israel’s immaturity has a different flavor when half of Israel’s neighbors in the Middle East are supportive or indifferent, while much of the other half are engaged in their own domestic conflicts that are (in some cases) as severe as that in Palestine, or even much worse. It has a different feeling when ISIS is brutalizing Iraq while preparing to materially support Hamas.

The United States used to forestall Egyptian meddling in Palestine through military aid. It had a pacifying effect (pdf). Such aid had been frozen several times since the Arab Spring. Now the taps are open again, but it is much less clear if money will be able to soothe tensions if Egypt’s enemy is Hamas rather than Israel.

I am interested in this question in part because I cannot understand why Palestine remains cause célèbre for the left while support for Israel is de rigueur on the (American) right. This appears as a vestige of a Cold War mentality where imperialism was the primary concern of capitalists and socialists alike. Perhaps I’m thinking too much like a political scientist, but aren’t the stakes much lower today? Other than habit, why is Palestine’s struggle with Israel given so much more concern even than Iraq? Or this (h/t Dan Nexon)?

*On that point, briefly: neoconservative “domino” theories look a lot better today than they did in 2006, don’t they? But it’s more of a “be-careful-what-you-wish-for” situation than neoconservatives would’ve expected, and the much-maligned Cold War policy of maintaining relationships with authoritarians for the sake of stability is more understandable all the time.

Democracy Is Not Magic


Get used to hearing about Gilens and Page. The two political scientists — from Northwestern and Princeton, respectively — have a forthcoming article in the Fall 2014 of Perspectives on Politics*. The article reaches the conclusion that economic elites and interest groups representing business have greater policy influence than the mass public. In the Year of Piketty this finding has already attracted quite a lot of attention. That’s them on The Daily Show above, and Krugman discussed the article a few weeks ago. The BBC declares that article demonstrates that the “US is an oligarchy, not a democracy” and in the authors’ conclusion they argue:

Americans do enjoy many features central to democratic governance, such as regular elections, freedom of speech and association and a widespread (if still contested) franchise. But we believe that if policymaking is dominated by powerful business organisations and a small number of affluent Americans, then America’s claims to being a democratic society are seriously threatened.

I don’t find the overall message to be very surprising — although there are some possible issues with their empirical strategy — and because I don’t particularly care if the U.S. clears the bar of some technical definition of democracy. But I still take issue with this kind of conclusion. Democracy is not measured by policy outcomes and is not defined by where the balance of power in society lies at any particular moment. If a representative democracy represents some groups better than others that does not mean it is not a representative democracy. Or, as I put it a few years ago:

The fact is that “democracy” is a catch-all word that describes a host of political institutions which are similar only in that they aggregate the preferences of their citizens through some type of electoral process which is guided (and constrained) by previously established law. “Democracy” is decidedly not a description of a set of particular outcomes favored by the technocratic center-left … Given that, it is not completely clear to me that the U.S. has lost its ability to function; conflicting interests, partisanship, gamesmanship, interest group lobbying, rent capture, and vituperative campaigns are all par for this course, not evidence that things have gone horribly awry.

The desire to declare outcomes that we normatively prefer as “democratic” and outcomes that we do not prefer as “non-democratic” is ahistorical and, I believe, damaging. We need to accept the fact that no political regime is perfect. We need to accept the fact that economic inequality is not only possible but likely in a “true” democracy, as are plenty of other bad outcomes including war, slavery, patriarchy, discrimination, censorship, and environmental degradation. Among other reasons, this is why constitutions are so important.

The Gilens and Page results are interesting and useful. Folks should absolutely read the paper and take it seriously. But wild extrapolations from the results are not trustworthy. The true message of the paper is this: Democracy is not magic. I’ve said it before and I’m sure I’ll say it again. The U.S. is a democracy. If you don’t like certain outcomes in the U.S. then you don’t like democratic outcomes.

*Disclosure: Perspectives on Politics is edited by one of my colleagues at Indiana University, my academic home, and has published my work in the past.

By Kindred Winecoff

QOTD: From Summers to Keynes to Marx in One Step

By Kindred Winecoff

Today we’re calling that idea “secular stagnation”. Which of course sounds more impressive than plain old “abundance” and new enough to be able to distance itself from Marxist economics.

I know no one cares what I think, but I think Izabella Kaminska is one of the few intriguing writers on political economy these days. I know no on cares about political economy these days, even though they should.

No Work Makes Jack A Malcontented Boy

By Kindred Winecoff

In “Economic Possibilities for Our Grandchildren” John Maynard Keynes wrote that by 2030 or so humans could spend most of their time pursuing leisure:

For many ages to come the old Adam will be so strong in us that everybody will need to do some work if he is to be contented. We shall do more things for ourselves than is usual with the rich to-day, only too glad to have small duties and tasks and routines. But beyond this, we shall endeavour to spread the bread thin on the butter-to make what work there is still to be done to be as widely shared as possible. Three-hour shifts or a fifteen-hour week may put off the problem for a great while. For three hours a day is quite enough to satisfy the old Adam in most of us!

In many respects this echoed Marx nearly eighty-five years earlier, in The German Ideology:

For as soon as the distribution of labour comes into being, each man has a particular, exclusive sphere of activity, which is forced upon him and from which he cannot escape. He is a hunter, a fisherman, a herdsman, or a critical critic, and must remain so if he does not want to lose his means of livelihood; while in communist society, where nobody has one exclusive sphere of activity but each can become accomplished in any branch he wishes, society regulates the general production and thus makes it possible for me to do one thing today and another tomorrow, to hunt in the morning, fish in the afternoon, rear cattle in the evening, criticise after dinner, just as I have a mind, without ever becoming hunter, fisherman, herdsman or critic.

For contemporary treatments of similar ideas see John Quiggin and Ronald Dworkin. (Both of these are well worth reading in full.)

You may accept these goals or dismiss them. I would just like to note that we’ve basically achieved them, at the societal level. The Bureau of Labor Statistics reports that the average American spends 3.19 hours per day working. Obviously this mostly means that the distribution of working hours is highly unequal as is the renumeration from work. And the U.S. is hardly the world in this respect.

Still, if you squint hard enough from a high enough perch, we might be working about as much as we should be from a Utopian perspective. Even if you tack on the 1.74 hours per day we spend on “household activities” — from food preparation to lawn care — we’re basically in the realm that Marx envisioned. We spend 2.83 hours per day watching television. Marx really was a 19th century thinker whose outlook does not map easily onto 21st century realities but again: it’s worth knowing where we stand.

Our biggest crisis remains a jobs crisis, locally and globally. People seem to want to work even if their most basic needs are met. They want to work even if it means they would have to forego hunting in the morning or fishing in the afternoon or blogging in the evening. They seem to want to acquire and consume and improve their lives ever more. Keynes viewed this as avarice — a bit strange for him to say, given his relatively luxurious lifestyle — but maybe it isn’t. And if it isn’t then some basic planks of Utopian political theory might need re-thinking.