The Descent into Monetary Austerity: Announcing the new Monetary Policy Institute Blog
By Louis-Philippe Rochon
Full Professor of Economics, Laurentian University, Canada
Editor-in-Chief, Review of Political Economy
Founding Editor, Review of Keynesian Economics
With inflation nearing double digits in many countries, central banks have once again taken center stage. Their typical (and, one might say, completely predictable, response) has been to raise interest rates in the name of dampening inflationary pressures and expectations.
In doing so, central banks are trying to achieve two simultaneous goals:
- (A) Bringing inflation back down to a ~2% target,
- (B) Engineering a ‘soft landing’, i.e. ensuring that rate hikes don’t do too much damage to the overall economy and, more specifically, to the labour market.
But even within this short description, there is so much to discuss around this seemingly simple (or simplistic) approach to monetary policy and inflation. The Monetary Policy Institute blog aims to explore the ‘art of central banking’ and peel back the many layers of monetary policy, from its objectives and purpose, to its implementation and transmission mechanism.
Some questions and topics we seek to explore:
- How efficient is monetary policy in achieving an inflation target?
- Is monetary policy Class-biased? Gender-biased? Carbon-biased?
- Is monetary policy the best policy tool to fight inflation?
- Should inflation be the only goal of monetary policy? Or should it even be a direct concern of the monetary authorities?
- Is fine-tuning the best way of approaching monetary policy?
- Is a soft landing ever really possible?
- Does monetary policy have important income and wealth distributive effects?
- Does monetary policy have important income and wealth distributive effects?
- Is monetary policy suitable when inflation is caused by supply issues?
These are amongst the most urgent questions to answer, given current circumstances. But many more questions will reveal themselves in the next few years, as central banks force themselves on the consciousness of workers and households.
At the time of writing this (June 17, 2022), the Federal Reserve just announced an increase in interest rates by 75 basis points — mostly, I argue, to reinforce the notion that they are ‘credible’ when it comes to fighting inflation. But many commentators are now saying this is missing the point. Interest rates may be too low — certainly historically — and maybe they need to be raised to more ‘normal’ levels. If so, what constitutes a normal level for interest rates? Is there a Goldilocks rate? And just as important, who decides on what is normal? Workers and rentiers may indeed have a different answer to this question.
All of these questions need to be discussed and explored. We also need to understand
- What the sources of the contemporary surge in inflation are, and
- Whether changes in monetary policy are the appropriate way to dampen inflation
Specifically, is monetary policy appropriate when inflation is caused by supply-chain (bottleneck) issues, the war in Ukraine, and other factors like price gouging by corporations who don’t face serious price competition?
In a recent blog of his own, Servaas Storm lamented that, “a more acute assessment [of inflation] would recognize that interest rates are a socially very costly tool to ‘control’ inflation — especially when the sources of the inflationary surge lie in an unprecedented constellation of (mostly) supply-side bottlenecks which are driving up prices.”
In other words, we are not seeing demand-pull inflation, resulting from an over-heating economy or over-spending; we are also not at a true full employment. This is a cost-push mark-up for which monetary policy is inappropriate.
So, if increases in interest rates won’t solve supply-side or price-gouging causes of inflation, why raise them? Again, largely I think this is to convince markets that central bank(er)s are ‘credible’ and ‘acting responsibly’. But there may be a more economically destructive rationale at play, wherein interest rates are hiked to the point that they depress wages to compensate for stubborn supply causes outside of the reach of the Federal Reserve and other central banks
Moreover, we need to truly understand what inflation is, and more specifically what monetary policy is — or does. At its core, this blog offers an analysis of both inflation and monetary policy as income distribution.
There are always winners and losers when it comes to monetary policy, either in terms of changes in interest rates or the adoption of some more unconventional policies, like Quantitative Easing, which produced important income/wealth distributive issues. Indeed, when interest rates went to zero producing very little income for bond holders, central banks switched to a policy of buying various assets thereby increasing the value of those assets. Moreover, these low rates produced massive inflation in asset prices, both in the real estate market and the stock market. This then leads to the question, “Is monetary policy always about protecting financial interests?”
Moreover, monetary policy is not about raising rates a few times and hoping inflation somehow, miraculously, comes down. Rather, it is about repeated increases in interest rates until inflation finally comes down. It’s like using a jackhammer to kill a fly on a table. You may well kill the fly, but let’s hope you were not planning a dinner party that night! In other words, fighting cost-push inflation with monetary tightening is like treating COVID-19 with ivermectin.
For those who were educated on the traditional story of central banks and inflation (what we can safely call the ‘mainstream view’), what I just wrote may appear to be quite outrageous. Yet, this criticism is becoming increasingly widespread. Past attempts by central banks to control inflation have usually ended up in recessions, thereby creating unemployment. So here’s another question that begs an answer:
Is higher unemployment a necessary mean to control inflation?
Or better yet, why is unemployment a justifiable way of combatting inflation?
Whose interests are central banks defending? As I said above, there are always winners and losers, and repeated increases in interest rates can hurt labour markets while protecting the interests of bondholders and the uber-wealthy. Fighting inflation can come at great costs to society and workers. High rates can induce firms to forego long-term productive investment, since access to credit becomes expensive. The social cost in invariably the process of nominal wage suppression via unemployment. I am not the only one saying this: central bankers themselves are saying it.
Over the coming months and hopefully years, I will be inviting a number of observers and scholars from Canada and from around the world to contribute to this blog. In doing so, we hope to contribute to a rethinking or demystifying of the black box of monetary policy. At the heart of the analysis presented here, conflict dominates the discussion — conflict between workers, firms and bond holders. Who wins and who loses?
Oh, and what about the environment? Stay tuned.
