There Is No Technocracy: Stop Worrying About Aggregate Demand

Is "aggregate demand" really what anyone cares about? I don't think so. We care about the quality of peoples' lives. And new research is starting to look at what sorts of fiscal policies matter for improving well-being whatever the macroeconomic aggregates say. Evan Soltas describes some of this work and interviews the authors:

Tax revenues fall automatically in recessions, and governments back that up with lower tax rates and/ or new credits and deductions. On the spending side, extra outlays on unemployment benefits and other transfers greatly exceed extra outlays on infrastructure and other purchases. This modern kind of fiscal stimulus is supposed to work by stabilizing disposable income. Stabilize that, the thinking goes, and you stabilize output and employment. 

But is that right? In a new working paper, Ricardo Reis of Columbia University and Alisdair McKay of Boston University say no. They find that stabilizing aggregate disposable income plays a “negligible role” in stabilizing the economy as a whole. Transfer payments can indeed stabilize output, they find, but mainly through a different channel -- not by changing disposable income in the aggregate, but by changing its distribution. Fiscal policy, in other words, is all about inequality.

“It’s the redistribution that has a lot of kick,” Reis said in an interview. “The usual argument for transfers is basically Keynesian. We find that has very low impact in our model.”

More on the fiscal side here. What about the monetary side? Marc Chandler, a Wall Street manager writing in the Jacobin, describes the relationship between monetary policy and distribution.

Central bank independence was never what it was cracked up to be. During “normal” times, central banks protected the interests of the owners of capital. Paul Volcker is often cited as the epitome of the independent central banker, but surely his tight monetary policy, justified in terms of some technocratic money supply target created winners and losers. The owners of capital were among the winners, while those who did not own capital were losers (through such things as higher unemployment and downward pressure on real wages). ... 

The setting of monetary policy was never simply a technocratic exercise as the [central bank independence theory] pretends. There were always those interests that benefited and those who did less well. Few cried of a loss of central bank independence, for example, when the Bundesbank would threaten tighter monetary policy in reaction to unions seeking a sharp increase in wages.

Much more here. Both the commentariat and academia have focused too long on the supposed technocratic features of policy: whether unemployment is at its "natural" rate, whether output is at "potential", whether central banks are "independent", whether inflation is "low and stable". None of these concepts exist in nature. None of them are even definable quantitatively, although they may be described quantitatively. Hence, they are not scientific concepts but terms of art with important distributional ramifications.
 
I have a paper forthcoming which looks at how banks respond to monetary arrangements. It turns out that monetary politics goes well beyond central bank independence. I'll post a link when it's available.

There. Is. No. Technocracy. Dammit.

Felix Salmon is one of my favorite journalists, but he routinely makes a common error: forgetting that there is such a thing as politics. Take this reflection on Tim Geithner in which Salmon wonders what made the former Treasury Secretary "change his mind" on how to deal with financial crises:

[T]he most obvious case in which Geithner has done a complete U-turn from his former views is that of Indonesia. The great Australian financial journalist Peter Hartcher explained this very well back in 2009, when Geithner took over as Treasury secretary. He quoted former Australian president Paul Keating explaining in a nutshell exactly what Geithner did wrong: “Tim Geithner was the Treasury line officer who wrote the IMF program for Indonesia in 1997-98, which was to apply current account solutions to a capital account crisis.” With hindsight, Geithner did the exact opposite of what he is now prescribing in the event of a crisis... 

Indonesia in 1998 had a problem not dissimilar to what we saw in the US 20 years later: a sudden credit crunch afflicting a country whose government finances were fundamentally sound. Geithner’s solution, now, is for the government to “be very aggressive” spending money, and for the central bank to provide its own monetary support, all in the service of “compensating for the huge collapse in private sector demand”. But that’s not what he thought in 1998, when he forced the Indonesian government to cut spending and raise interest rates — precipitating a recession much larger than anything the US saw during the financial crisis.

Now that Geithner is going to write a book, I very much hope he goes as far back as Indonesia, and covers his two-year tenure at the IMF as well, rather than glossing over those episodes on the way to the juicy stuff about the more recent crisis. For one thing, it will be fascinating to see when and how his mind changed on such issues. And for another thing, it’s conceivable that the book might shed light on the how this consummate career government technocrat thinks — and thereby shed light on much of the system of global governance.

This type of commentary bothers me because it is so common (which is why I keep harping on it). Isn't it possible, just possible, that an American public official might respond to a crisis in the United States differently than to a crisis in Indonesia for political reasons? Isn't it possible, just possible, that the reason why the IMF pushed Asian (and Latin American) countries into austerity in exchange for emergency finance is because the IMF's creditors cared more about getting their money back than about finding the most optimal solution to the problem? Isn't it possible, just possible, that an American central banker or Treasury Secretary might care more about American interests (and interest groups) than those of, say, Thailand? Of course those things are possible. So why doesn't Salmon mention them as a possibility?

There is quite a lot of political economy research on the IMF. None of it concludes that it is an impartial technocratic institution. It is involved in power politics, generally in ways which benefit US interests. It lends in a way that benefits the American financial sector. It trades lax conditionality for UN votes on the Security Council and in the General Assembly. It adjusts conditionality requirements based on the recipient's geopolitical importance, and enforces conditionality more or less strictly based on a country's ties to major powers. This is but a small sampling of the literature demonstrating that the IMF is a political, and politicized, institution. It acts in the interests of the major stakeholders in the major powers, especially the United States (which is the only country which possesses an effective veto on IMF funding decisions). The IMF is not on a relentless pursuit for the Most Optimal Policy as determined by the economists' imagined technocratic Benevolent Social Planner. (Needless to say, the US Treasury Department and Federal Reserve are even more political.)

In other words, when parsing Geithner's career we do not need to make an assumption that he has been on a quest to find technocratic nirvana. We don't have to assume that he's had a Road to Damascus moment which caused him to change his mind on key issues. All we have to note is that an American policymaker, when faced with very different crises in very different countries with very different levels of geopolitical importance reacted... very differently. That makes sense! That is what we should expect from an interested government official.

There Is No Technocracy: Bank of Japan Edition

From the Telegraph:

"Its very rare for monetary policy to be the focus of an election. We campaigned on the need to beat deflation, and our argument has won strong support. I hope the Bank of Japan accepts the results and takes an appropriate decision," he said.

The menace behind his words did not have to be spelled out. He has already threatened to change the Bank of Japan’s governing law if it refuses to comply.

Political economists have not done a very good job of analyzing the political role of central banks and other "technocratic" institutions. We've spent most of our time looking for central bank independence how that conditions inflation outcomes, with a bias in favor of low inflation. But central bankers respond to the political environment in which they operate, have preferences of their own, and should therefore be treated as political actors.

Via Scott Sumner, who also notes:

In 2001 Argentine fans of the “currency board” learned that their policy regime was not as impregnable as they’d assumed. And in 1933 American supporters of the gold standard found that even the world’s largest monetary gold stock couldn’t prevent a devaluation under duress. The reason was the same in both cases—voters get the last word.  

On the 1930s see Beth Simmons, who persuasively argues that differences in political regimes conditioned choice of policies during the Depression. On Argentina I like Paul Blustein's account, which is journalism (not social science) but there's more real social science in it than many academic books.

There Is No Technocracy, Still

Another Fed entry. This time peer-reviewed! Hint: Fed economists like Republicans.

How the Fed Is Constrained

Blogging has been light as Real Work has pressed, but there is something I don't want to let go. Dan Nexon linked to this post and asked:

The question remains, however, what mechanisms translate [the] pressure [on Bernanke] into constraint [preventing more aggressive monetary policy]?

It's a very good question. I think I've answered it over the past few years, but spread across a number of posts. So it's worth spelling out the mechanisms that could be operating. Some of these are supported by academic literature, some of them are more speculative. I could go into much greater detail on each of these, and have in the past, but I'll try to keep each point brief for now. So:

1. One constraint comes from the Fed itself. That is, Bernanke is not a dictator... he's a chairman of a corporation. This gives him quite a lot of latitude, but not omnipotence. The Fed has a Board of Governors, not all of whom are academics, and the strong norm is to operate by consensus at least as much as is possible. In addition, there are Presidents of the twelve regionals banks that constitute the Federal Reserve System and they also have influence. Remember: a big function of the Fed is to not freak everybody out. If major disagreements within the institution become public, everyone could get freaked out. So Bernanke, as the leader of this institution, may be willing to accept a somewhat sub-optimal outcome if he believes than an even more sub-optimal outcome is likely to obtain if he chooses to hold no prisoners. Central bankers aren't like op-ed writers (or bloggers)... their decisions actually matter. I imagine there is a strong bias against killing the patient that may sometimes preclude aggressive treatment.

2. Another pressure comes from Congress, an institution which has recently blocked the appointment of a Nobel Prize winning economist because he (supposedly) lacked sufficient qualifications for the job. This pressure has, in turn, hamstrung the White House. For much of the last few years the Fed has been understaffed at senior levels, as the Obama administration tried to figure out who they could nominate that would a) be approved by Congress; b) not attract the ire of the progressives who were already upset that the neoliberal wing of the Democratic party -- Summers, Geithner, etc. -- held such sway. This led to the Fed Board of Governors to have persistent vacancies until this past May. Keep in mind that Congress oversees the Fed, and right now the committee charged with that task is helmed by Ron Paul, who wants to abolish the institution and has passed a law through the House to audit the Fed. As I mentioned in my previous post, Republicans in Congress oppose further stimulus by the Fed and Democrats are quiet on the issue. Bernanke's last reappointment vote was the most contentious since three decades, and that was before the Tea Party's 2010 electoral success. In short, the Fed is in a principal-agent relationship with Congress, and this fact is salient. All else equal, the Fed would like to protect its autonomy. (Although, ironically, this discussion suggests that it has no real autonomy.)

3. Much is said about the Fed's dual mandate -- to maintain low and steady inflation while promoting full employment -- but the Fed actually has a triple mandate: those two plus regulation of the commercial banking system. Previous research has shown that locating regulatory authority in the central bank biases monetary policymaking in favor of banks. To some extent, both the Tea Party movement and the Occupy Wall Street movement arose in direct protest against this dynamic, although it wasn't articulated very well. More recently, the Fed has come under fire over the JPMorganChase losses and the LIBOR scandal. Faced with populist opposition from both the right and the left, one could understand why the Fed might choose to shoot for the middle: prevent unemployment from skyrocketing but don't risk any spike in inflation; stabilize the banking sector but don't do much to help repair household balance sheets via an erosion of the real value of household liabilities -- which are, of course, bank assets.

4. Additionally, in an important sense the Fed is the central bank of the world. It acted as a global lender of last resort during the crisis, it injected liquidity into the global monetary system by opening up swap lines with every major central bank, and it's quantitative easing programs have reverberated through the global economy. The Fed, therefore, may be constrained by needing to maintain global stability. In pursuit of this, perhaps, the Fed is willing to accept a somewhat slower recovery in the U.S. in exchange for a reduction in international economic (and political) volatility.

5. The Fed has intellectual biases of its own. This is related to #1 and #3, but deserves its own point. The Fed's experience in the 1970s and 1980s was that it is better to keep inflation low over the long term than to try to correct every uptick in unemployment. The Fed's experience in the 1990s was that if it prevented collapses in the financial sector than than full employment would come more or less naturally. The result is that the Fed knows how to keep inflation low, and can stabilize a faltering financial system, but it's not as good at keeping unemployment low. Moreover, it's only tool to do so is indirect: pump cash into the banking system in the hopes that they'll lend. Not only do politicians on the right and left oppose this for ideological reasons, some members of the Fed appear to believe that many of the economic problems in the country are structural rather than cyclical. If the Fed believes that the economy needs to adapt structurally, it might not pursue policies that could help lower unemployment even if they thought they would be successful. Better to manage the needed adjustment than to prevent it from occurring. Folks like Krugman and Sumner have been arguing vehemently against this view for years, but that doesn't mean that some Fed members don't feel that way. (Keep in mind, too, that Fed policy tends to be more relaxed during Republican administrations.)

To my knowledge there is no good literature on #1. David Singer has done a good work on #2, including this book, and on #3 with this article (with Mark Copelovitch). I'm also doing some research on #3, currently R&R. I don't know of much recent published work describing #4 (although I know some folks are researching it now), but Charles Kindleberger described the dynamic in The World In Depression. I've also blogged about it a lot over the years [e.g. 1, 2, 3, 4, 5]. As linked above, Christopher Gandrud is doing some research with Cassandra Grafstrom on Fed partisanship.

There Is No Technocracy, a.k.a The Fed Is Still Political

Not that they've taken any notice at all, but for a long time now I've been yelling at economists who have been disappointed in the Fed's relative complacency that they are not evil or stupid or timid or felons. Rather, they are constrained politically. Pretty highly constrained, in fact. So I was happy -- well, not happy exactly, but satisfied -- to see this story in the NY Times:

House Republicans pressed the Federal Reserve chairman, Ben S. Bernanke, on Wednesday to forswear additional actions to stimulate growth, warning that the results would be counterproductive. ... 

Democrats made no similar effort to convince Mr. Bernanke that he should take additional action. They congratulated the Fed chairman in the manner of people confident that they are speaking with an ally.

The GOP says no more monetary stimulus. The Democrats think the Fed is doing just fine. Their bosses don't want them to do any more. Financial markets and economic conditions have both stabilized. Is it any wonder the Fed is sitting on its hands? Isn't this exactly what we'd expect if we believed that the Fed was responding to their political incentives?

There Is No Technocracy: China Central Banking Edition

David Daokui Li -- former member of the Bank of China's Monetary Policy Committee -- has an op-ed in the FT in which he says that central bankers are subject to political constraints:

First, central bank independence is an unhelpful superstition. In theory, independence is a good defence against pressures from politicians facing re-election. The PBoC is under the control of the state council, and not run under by autonomous bank staff. This may suggest that Chinese officials are subject to strong political whims. ... 

Knowing this, I was nevertheless shocked when the Chinese premier recently said that only two factors had the potential to undermine his government: corruption and inflation. He does, of course, have some influence over these factors.

No surprise to regular readers of this blog, I hope, but this is even more interesting in light of the fact that China's government is supposedly comprised of wise bureaucrats whose insulation from political pressures allows them to pursue optimal policy.

Guess not.

There Is No Technocracy: Partisan Bias at the Fed

These are a few months old now, but Christopher Gandrud -- a recent LSE PhD -- has a cool project going. It's spread out over several posts [1, 2, 3] but here's the gist:

So, I have two questions:

1. Have Fed inflation forecast errors been different during Democratic and Republican presidencies?
2. Are Fed inflation forecast errors different for election periods and non-election periods? ...
Question 1: The Fed did tend to overestimate inflation during Democratic presidencies and underestimate it during Republican presidencies (an Error/Actual score of 0 means that the forecasters perfectly predicted actual inflation). Admittedly we have a pretty small sample of Democratic presidencies (only Carter and Clinton), but it is striking how all of the big underestimates were during Republican presidencies and almost all of the big overestimates were when Democrats had power.

Maybe, Federal Reserve staff anticipate--to an incorrect degree--that Democratic presidents will pursue expansionary policies and vice versa.

Question 2: It is not as clear that forecasts systematically differ in election periods as opposed to non-election periods. Though the spread of the errors across parties does shrink very close to the election. I wonder why this might be?

And:

The partisan effect is less obvious than in the earlier graph, but is is clear that during this time period the big over estimations are during Democratic presidencies and the big (actually almost all) underestimations are during Republican ones. The effect would be even stronger if we took out the end of Reagan's first term and his second one, where Fed staff may not have fully adjusted their forecasting to reflect the Volker-Greenspan era of moderate inflation.

Parsing Bernanke

I've just now been able to read Roger Lowenstein's profile of Ben Bernanke in The Atlantic. There's a lot of good stuff in it, but I want to highlight a few parts:

Rising to his own defense, he told me, “I would argue that everything we have done has been in the interest of the American public and, broadly, of the global economy. A lot of people get that.” (Privately, Bernanke and Timothy Geithner, the treasury secretary, have shared mutual wonder that the financial rescue, which they consider a success, has been so widely panned. Geithner told me that recently, when he informed Bernanke that yet another officeholder had asked for each of their resignations, Bernanke wryly quipped, “Well, that’s a step up from being accused of treason.”) 

A bit later Bernanke references Bagehot and Lowenstein observes that “Bernanke has a sense of history uncommon among public officials”. I should hope so, since in his academic life Bernanke was a scholar of the Great Depression. But this confirms two things that I've long suspected but that have no been confirmed in print until this point: that Bernanke seems himself as the world's central banker, not just the U.S.'s central banker, and that he feels constrained by American politics.

The first is important for a host of reasons, and helps explain many of the less-discussed Fed actions. It's important because Bernanke seems to understand that because the U.S. banking system is central to the global banking system, a disruption here leads to disruptions elsewhere. Financial disruptions everywhere leads to political instability, and political instability can lead to conflict. Bernanke thus took all the actions that the Fed either could not or would not take in the 1930s to make damn well sure that whatever happened this go 'round we wouldn't get that again. Bernanke, i.e., was willing to go to whatever lengths he had to make sure this time was different, at least politically. This means removing the objects of political contention, and that in turn means opening up swap lines with every major central bank in the world. That means direct lending to important foreign firms.* To stabilize a global banking system you have to act like a global central banker. Bernanke did that.

The article actually questions Bernanke's international role:

Nor has he exploited the natural leadership role of the Fed chairman on the world stage, for instance during the crisis in Europe. When Alan Greenspan showed up at international meetings, he got star treatment. Bernanke, says one former White House official, is just “another guy at the table.” 

Greenspan's previous cult of personality notwithstanding, there are very good reasons for Bernanke not to showboat, particularly when he's involved in extending billions – perhaps trillions – in loans to foreign firms. The chairman of the House committee that oversees the Fed famously wants to abolish the institution; Bernanke's re-confirmation vote was the closest in the history of the Fed; the Fed's regulatory authority has come under attack; a former GOP presidential front-runner threatened to lynch him if he showed up in Texas; the Occupy movement seems to believe that Bernanke exists only to serve the banking sector. Etc. Bernanke is very politically constrained right now. To advertise that he is running the global economy – and not entirely for the benefit of the U.S. – would exacerbate those who oppose him. He is also constrained by his own committee. As the article notes, Bernanke has had more votes against his proposals than any Fed chief in 20 years.

Lowenstein claims that the Fed has a “dual mandate” – to promote full employment and low inflation – but in actuality the Fed has a triple mandate: the first two plus regulation of the banking sector. These goals are sometimes in tension, and when they are the Fed must choose which to privilege. This is a highly political decision, and one can certainly understand why Bernanke would feel a need to be protective of himself and his office. Particularly when it's pretty clear that he broke the law or came close to it:

Under the Federal Reserve Act, the Fed is authorized to make loans under “unusual and exigent circumstances” as long as the loans are “secured to the satisfaction of the Federal Reserve banks,” meaning, as long as the Fed does not expect to suffer any losses. A fair argument can be made that in the depths of the crisis, some of the Fed’s emergency loans violated this dictum. 

The political pressures Bernanke is facing comes up again when Lowenstein discusses the debate over whether the Fed should increase it's targeted inflation rate and quotes Mankiw as saying that no central banker would do it because "the political reaction would be too severe".

It's a good article in general, and there's a lot of detail both about the Fed's policies since the crisis and the fallout from them.

*Someone on Twitter snarkily remarked that it was disingenuous of Bernanke to invoke Bagehot because he didn't follow Bagehot's advice to lend freely, but only to solvent firms and only at penalty rates. I obviously can't speak for Bernanke here, but there's no reason to be doctrinaire on this point; the goal is to stabilize the banking sector at any and all costs. If that means relaxing some rules that a journalist made up nearly 150 years ago, well then do it. Now I think this can have some pernicious effects, as some of my research is pretty skeptical of the priorities of central banks with mandates that extend beyond stabilizing the macroeconomy, but crises are crises. Every other concern goes out the window until later.

There Is No Technocracy, Bank of Japan Edition

Scott Sumner:

My view (and that of many other market monetarists) is that the Bank of Japan acted as if it didn’t want inflation, tightening policy in 2000 and 2006, despite no inflation. In my view the press and many economists were somewhat naive in accepting the BOJ’s claim that there was little they could do to end deflation. After all, the yen is a floating fiat currency. ... 

I used to wonder why the BOJ tightened so much in late 2006, raising interest rates and reducing the monetary base by 20%. Another Financial Times story gives us the answer: 

In recent years, the bank has tended to shrug off overt political pressure. A 1998 revision of the BoJ law strengthened its operational autonomy by removing the government’s authority to dismiss the governor and deputy chiefs.  

Only under prime ministers with very solid popular support, such as Junichiro Koizumi between 2001 and 2006, has the BoJ appeared to bend to the government’s will. It has put up a particularly strong defence of its independence under Mr Shirakawa, promoted from deputy governor in 2008.

This is a common theme on this blog. Hopefully others are starting to internalize it. For some reason this particular post and discussion reminded me of this old article (pdf) of Oatley's on the politics of central banks. For my money the best articles on the politics of "technocratic" institutions have yet to be written. There's a good bit of fruit still to be harvested from there.

The IMF Isn't Technocratic Either

The title of a recent post at The New Republic is "How the IMF Got It's Keynesian Groove Back". I don't want to pick on author, Jared Vary, too much as he appears to be an intern at TNR, but I see this line of reasoning proffered from more credentialed folks all the time and it drives me crazy. It basically goes like this: originally, the IMF was a fairly kind, generous, technocratic "Keynesian" institution, which was corrupted over time by a "Chicago school" ideology that made crises worse rather than better by insisting on harsh austerity. After the IMF botched up 1990s crises, they started to return to their postwar Keynesian roots.

This type of narrative relies on a view of the IMF that is, I think, inherently flawed. IMF actions have varied along with the geopolitical issues of the time. More specifically, it has always taken actions that the major Western powers, particularly the U.S., wanted. (The U.S. is the only single country with an effective veto, since it has always controlled over 15% of the voting rights and actions must be approved with an 85% majority.) These preferences were not consistent across countries or time, and there is no reason to expect that they would be. During the Bretton Woods period, the IMF was used to used to balance the fixed exchange rate system that embedded the U.S. at the center of the international economic system. In the 1970s and 1980s, the IMF was used as a sort of bailout device for commercial banks in the U.S. and Europe, which owned too much emerging market debt. Harsh conditionality was tied to these loans because the purpose of them was to help the banks, not the indebted countries. In the 1990s the IMF behaved differently depending on the geopolitical context. Loans to countries undergoing post-communist traditions had fewer conditionalities attached to them than loans to East Asian countries or the Latin American countries in the 1980s.

The above paragraph draws from a fairly long string of research on these questions. While the ideational view has some support from folks like Chwieroth, materialist explanations of the IMF's behavior are more prevalent in the literature. Strom Thacker wrote about the "high politics" of IMF lending, and showed how countries that "move toward the political space of the U.S." -- for example by voting with the U.S. in the U.N. -- have a greater chance of receiving loans. Oatley and Yackee extend this further, showing that countries with a lot of indebtedness to U.S. financial firms receive larger IMF loans, as do countries that are allied with the U.S. Randall Stone finds that conditionality is enforced less on countries that are important to the U.S., and can offer the U.S. something valuable in return. Finally, Grigore Pop-Eleches argues that the size of IMF loans and type of conditionalities attached to them varies according to geopolitical, rather than economic, concerns. Indebted Latin American countries in the 1980s had more strings attached than transitioning Eastern European countries, because the major Western powers had an interest in a smooth transition away from communism towards capitalism, and towards greater integration of the European continent.

The point of all of this is to say keep reiterating that there is no technocracy. Institutions like the IMF are inherently political, and act accordingly. The constituent members of these institutions are also political, and will use the institution to suit their ends when they are capable of doing so. Often this will involve issue-linkages and quid pro quo arrangements, so it may not always be transparent, but that doesn't mean it isn't happening.

Update: See also this previous post from Thomas.

There Is No Technocracy QOTD

From Daniel Davies, talking about the new EU deal:

The ‘technocrats’ (which is apparently what they want to be called, although frankly I am seeing a lot of ideology and not much technical ability) want to reorganise the whole of Europe on neoliberal lines.