The Legitimacy of Central Bank Power

Adam Tooze confessed to me (it was probably in a shared cab ride to Brooklyn) that, although more fashionable than ever, when he sees the word “neoliberalism” in the title of an article, it kills his appetite for reading. I had noticed a similar response in my own foraging behavior online. Like capitalism, neoliberalism is one of those words that, when you see it in the titles of articles, it immediately shut off your brain. Still, I’m less unsympathetic to it than Adam, I suppose. But I hate the way it is thrown around to mean anything and everything that the author has a beef with.

What I understand by the term is the reproduction of certain scripts of the self, as in Curtis’s “century” of the self; as certain configurations of power over the economy that obtained in response to the stagflation crisis of the 1970s, as in Dumenil and Levy’s counterrevolution, manifest in the 1979 coup; and, above all, as certain disciplinary mechanisms put in place during the 1990s, as in Alasdair Roberts’s Logic of Discipline. I am compelled to say, somewhat esoterically, that the wages of neoliberalism are best looked at, not through Case and Deaton’s Deaths of Despair and the Future of Capitalism, although that is definitely a good place to start, but through the lens of Natasha Dow Schüll’s extraordinary intervention, Addiction by Design: Machine Gambling in Las Vegas. It is, ostensibly, a study of the economics and psychology of the neoliberal subject in the microworld of machine gambling. In reality, it is a mediation of the phycho-analytic subject of neoliberalism in general. And it remains the most important intervention on the subject.

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But this essay is not about Schüll or machine gambling. It is about high finance. If there is any content in neoliberalism as large-scale socio-economic reality it is, above all, in the evacuation of regulatory power over the economy from elected officials to the unelected technocrats who man the central banks. On the periphery, this is experienced as the practically imperial power of the center country central banks, the Fed above all. In the core, this is experienced as the extraordinary power of the monetary authorities.

But identifying the location of power tells us very little indeed. In particular, it tells us nothing about the legitimacy of that power. After all, power over the economy was willingly surrendered — Dumenil and Levy’s “coup” was less of a coup and more of a capitulation — the central banks acquired the reigns of the world economy legitimately.

As Tooze notes on the pages of Foreign Policy, in his most important intervention since Crashed, what is being debated in the German Constitutional Court is nothing less than the ‘regime of justification‘ of central bank policy [emphasis mine]. Adam lays out the disciplinary logic through which supreme regulatory power over the economy was handed to the central banks in Dumenil and Levy’s ‘1979 coup’. Put simply, the logic of discipline was that elected officials could not be trusted to be fiscally responsible, therefore controlling inflation required empowering, as Tooze puts it, ‘the countermajoritarian institution‘ of the central bank [emphasis mine].

Liane Hewitt, a trusted friend, recently wrote about the war analogy on the pages of Foreign Policy. She seems to have put her finger precisely on the nub of the problem. The point of war time controls over the economy was not just to channel resources into the war effort, she says. It was also, perhaps even more significantly, to manage elite-mass relations: ‘Rationing in both world wars had two purposes,’ she writes, ‘to manage real shortages and [more importantly] to establish a sense of fairness and mitigate discontent among those who suffered disproportionate economic hardship [emphasis mine]’. It is the management of elite-mass relations that is coming under severe stress as the official response to the COVID crisis systematically secures the fortunes of wealth holders and the professional-middle class, but not the working class majorities in the West and beyond. At the center of the brewing storm is central banking.

The central banks delivered on the mandate they were entrusted with in the late 20th century. But that was the last war. Since the global financial crisis, if not, indeed, since 2000, a crisis has been brewing in central banking practice. As I wrote on Facebook (send me a friend request):

Basically, the Phillips curve model of inflation (‘domestic slack –> inflation’) was so wildly successful in the postwar era that inflation came to be seen as the measure of economy-wide slack. Central banks came to rely exclusively on this one measure to tell them whether their economies were running too hot or too cold. But this relationship between domestic slack and the rate of underlying inflation broke down and disappeared with the ‘second unbundling’ of global production [Baldwin]. Borio (2007, 2017) explained that ‘global slack’ had replaced ‘domestic slack’ as the driver of inflation in the core of the world economy. (See in particular https://ideas.repec.org/p/ces/ceswps/_6387.html.) Unfortunately, once-successful theories die hard. Macroeconomists, even those who have read Borio and checked the numbers themselves (eg Yellen), continue to cling to outmoded models of the inflation process, largely because global slack has not been integrated into full-scale workhouse models of the economy, particularly New Keynesian ones. …

There is now a giant black hole in macroeconomic theory. Central bankers are flying blind. Their cherished indicator of economy-wide slack (core inflation) is now all noise and no signal. Worse, inflation expectations, key to the New Keynesian models, keep threatening to get deanchored, not on the upside, but on the downside! Basically, central bankers are war veterans: they all made their bones in the central bankers war against inflation in 1979-2000. That war was won a generation ago. And now we are stuck with experts who know how to fight the last war. But do not know how to fight this one. Within the central banking discourse, the struggle between the inflation hawks and doves has largely been won by the doves. For reality has spoken in their favor. However, the old guard has not been neutralized. They’re still there; ready to pounce at the first sign of the return of ‘a sane world’ (where inflation was a predictable consequence of loose monetary policy).

But a bigger problem than the survival of the old guard plagues central banking in the core economies. Pressing the accelerator seems to elicit a weak response in economic activity (and none in inflation) and a strong response in asset prices. Bernanke’s idea was that pumping up asset prices should shore up economic activity through ‘the wealth effect’. That seems to work. But very weakly. It’s now been tried for a decade. Central banks are at the end of their tether. No one knows what to do. There’s almost a panic among the central banking cognoscenti.

The problem cannot be solved without an integration of a more credible model of the inflation process into workhorse macroeconomic models. A process that has yet to begin. But underlying it all is the great explanadum of the modern world economy: Why, oh why, is the world plagued by such gargantuan industrial overcapacity? How can it persist? Here too, there is a problem with the ‘high saving strategies of the emerging manufacturing powers are responsible’ view. See my https://policytensor.com/2019/05/16/brenners-hypothesis-revisited-or-the-logic-of-discipline-in-us-manufacturing/.

The problem of the legitimacy of central banking power is intrinsically connected to the crisis of central bank policy, and thence to the deeper crisis of macroeconomic thought. Simply put, central banks no longer have the power to restore the fortunes of Main Street. They can press the peddle, but it does nothing beyond buoying up asset prices. Economic activity responds very weakly to ‘extraordinarily accomodative monetary policy’. Meanwhile, Bernanke’s ‘wealth effect’ can prop up the stock market and the fortunes of the class that owns stocks. This is what center-country central banks have been doing for a decade. But now it has become a recipe for the de-legitimization of central bank power itself.

In the COVID crisis of 2020, hard-currency issuing central banks, the Fed above all, have managed to crush volatility and stabilize the financial system. As Tooze puts it, ‘[l]iquidity provision is the slogan under which central banks now backstop the entire financial system on a near permanent basis.’ Or as Pozsar put it in his Global Money Note,”US dollar Libor and War Finance”:

[C]ore assets like Treasuries are backstopped; core institutions like banks and dealers are backstopped; and core funding markets likes repos and FX swaps are backstopped too. Money is hierarchical … and during crisis, rules are flexible at the core and rigid at the periphery. [Emphasis mine.]

This is the not-so-secret recipe of the obscene spectacle of a financial boom in the midst of the greatest economic catastrophe of our lifetimes. How long can this last? More precisely, How long can the legitimacy of central bank power last under present conditions?

Someone wondered whether Liane had gone too far in advocating wartime levels of government intervention. I’m wondering whether she went far enough. Not in the sense of responding more aggressively to the economic crisis, but whether that is what the object of government policy should be in the present crisis. There will never be a better time to reconsider how we organize our societies. This is clear to all concerned. But no one knows what comes next. As Gramsci wrote in an earlier world crisis: ‘The crisis consists precisely in the fact that the old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear.’

 

 

 

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