Grabel: Ideology, Power and the Rise of Independent Monetary Institutions in Emerging Economies

I Grabel, “Ideology, Power, and the Rise of Independent Monetary Institutions in Emerging Economies,” Monetary Orders: Ambiguous Economics, Ubiquitous Politics (2003).

"Stated plainly, the effort to depoliticize financial policy via the creation of independent central banks and currency boards is ineluctably political" (26). The establishment of central bank independence in order to make monetary policy a-political was spurned on, so argues Grabel, by the power of the neo-classical theory of policy credibility. Grabel argues that this policy has been "elevated to a singular truth" and that it is unfalsifiable and must be taken on faith (26). Secondly, the policy-credibility theory overlooks and thus obscures potential different group interests that arise from distinct monetary policies; in other words, the theory is placed above and beyond the other social processes that may have distinct and differing opinions about policy recommendations.

Throughout the 1990s there was a move towards more central bank independence (CBI). Grabel argues that the goals of these newly independent banks were relatively well understood and standardized. However, the increasing independence also caused an increase in currency boards, which do not enjoy the same level of agreed upon practices. At their most basic level, currency boards issue local currency backed by reserve currency and fix exchange rates between local and foreign currency. "Currency boards complement the operations of independent central banks by providing an additional means by which the private sector can be assured that monetary management will proceed undisturbed by political pressures. Indeed, the credibility of currency boards is seen to exceed that of independent central banks because currency boards have the single responsibility of maintaining exchange rate fixity, while central banks...have a broad range of responsibilities. Currency boards help fill the 'credibility deficit' that confronts even independent central banks in countries where these institutions are new or where they have a poor track record" (28).

The issue of policy credibility became much more important after neo-liberal economic policies throughout the developing world were not universally successful throughout the 1970s and 80s. It was argued that the reason that some of these policies failed was because people acting in the markets did not believe that they were going to be followed through upon, or did not understand them to have the necessary credibility to be successful. This brought about a process of making monetary institutions independent so that the policy decisions that were made were given more credibility, as they were not going to be tampered with by political pressures.

"Against the new-classical economic explanation for the rise of independent central banks and currency boards, I argue that political factors chiefly explain the emergence of these institutions. Specifically, the creation of monetary and exchange rate institutions that are independent of elected governments stems from the widespread acceptance of the ideological aspects of the theory of policy credibility and from the exercise of political and economic power by influential actors" (35).

The ideological foundations of the policy credibility theory are two-fold: first, it is not falsifiable and secondly, the policy is solely reliant on faith in the power of neo-classical economic theory.

The remainder of the chapter explores how the role of ideology interacts with political power in order to justify the creation and establishment of central banks and currency boards that attempt to break the linkage between politics and economics.

Polillo and Guillén: Globalization Pressures and the State

Polillo, Simone, & Guillén, Mauro. (2005). "Globalization Pressures and the State: The Worldwide Spread of Central Bank Independence". American Journal of Sociology, 110(6), 1764-1802. http://www.journals.uchicago.edu/doi/abs/10.1086/428685

“We agree that globalization has shifted power around the state. The existing literature, however, has not empirically explored the mechanisms that account for such a shift…The goal of this article is to analyze theoretically and empirically the impact of globalization on specific state structures, controlling for domestic macroeconomic and political characteristics” (1766). Specifically, this article examines central bank independence and its role as a response to the effects of globalization.

This article then goes on to examine the role of the central bank, and why CBI is an increasingly important phenomena. “…we focus our theoretical analysis on the impact of global institutional forces on central bank independence. We examine two types of effects: 1.) international coercive pressures that affect countries, including their dependency on foreign trade, investment and multilateral lending; and 2.) cross-national international influences that operate through the network of bilateral trade ties in the form of cohesion and role equivalence effects” (1773).

Three hypotheses are then put forth: “the greater the exposure to foreign trade, foreign investment or multilateral lending, the more independent the central bank” (1776). “The more a given country trades with other countries with an independent central bank, the more independent its own central bank because of normative pressure” (1778). “The more a country competes in trade against third countries with an independent central bank, the more independent its own central bank” (1780)

They then deploy a quantitative method to try to answer these three hypotheses. The dependent variable is a measure of CBI. The independent variables are many. I fear they suffer from a problem of multicolliniarity.

“Our results indicate that international coercive, normative and mimetic pressures explain the adoption of central bank independence, lending support for each of our hypotheses” (1788).

“The purpose of this article was to examine the impact of globalization on the state, using the specific case of the central bank and its independence from the executive branch as the empirical setting…We argued that, be cause of cross-national economic, political, and cultural competition in a context of globalization, the state is subject to coercive, normative and mimetic pressures. In response to these pressures, the state reorganizes itself, with a strong tendency toward emulating the organizational forms and practices adopted by other countries…Thus, globalization is transforming the state structures that deal with monetary policy” (1793).

Posen: Why Central Bank Independence does not Cause Low Inflation

Posen, Adam. (1993). "Why Central Bank Independence does not Cause Low Inflation: There is no Institutional Fix for Politics". In R. O'Brien (Ed.), Finance and the International Economy (pp. 41-66). Oxford: Oxford University Press.

There is increased zeal to make central banks independent and inflation fighters. It looks like it is a free lunch with the possible benefit of long-term economic growth. Posen argues that, “…the causal linkage between central bank independence and low inflation is illusory” (41). His claim is that it is, as the title of his piece indicates, a problem of politics.

“The institutional fix of an independent CB is supposed to offer protection from inflation through three mechanisms—increasing the credibility of commitments to prices stability, assuring a higher priority on inflation fighting in the net preference of the public sector, and putting up barriers to the monetization of government expenditure” (42). The first isn’t played out by the facts. The second may be slightly true, but CBs are also concerned about exchange rates and growth.

“An empirically supported explanation of the association between CB independence and low inflation can only be arrived at through a proper understanding of politics” (46). Democratic politics is not a tool that is going to settle institutional problems (as per his sub title to this section: Nothing Contentions is ever Settled in Democracies). Politically important and influential interest groups will always be involved in the creation of caustic institutions in certain political systems. This he calls the “interests not institutions” thesis (47).

“Financial sectors having universal banking are expected to have stronger anti-inflationary sentiment than those without,” and, “…the less regulatory power of the CB over the financial sector, the more strength of opposition to inflation by the sector is to be expected,” and, “Where a country’s party system is more fractionalized, financial expert opinion is expected to be less influential,” and, “…financial opposition to inflation is expected to be more effective in federal systems of government” (48-9).

“The fundamental argument of this paper, that there is no institutional ‘fix’ for the redistributive struggle over monetary policy, implies that CBs designed with similar degrees of statutory independence will offer significantly differing degrees of protection from inflation over time as they political situation alters” (53).

Down: Central Bank Independence, Disinflations, and the Sacrifice Ratio

Down, Ian. (2004). "Central Bank Independence, Disinflations, and the Sacrifice Ratio". Comparative Political Studies, 37(4), 399-434. http://cps.sagepub.com/cgi/content/abstract/37/4/399

This study looks at CBI and the phenomena of disinflation to see if there are any costs to having an independent central bank that controls for inflation strictly. It had typically been seen that CBI controlling for inflation was a “free lunch”, and that there were no adverse economic costs. However, this study attempts to show that there are costs associated with CBI controlling for inflation, specifically in the realm of disinflation.

Disinflations are, “policy-induced reductions in inflation” (400). Down claims that, “the economic contraction that tends to accompany a disinflation appears to be more severe when a central bank is politically autonomous” (400). These periods of policy induced economic reverse can be associated with negative effects on societal welfare, increased unemployment, slow or negative economic growth and other explicitly distributional effects.

Down also deploys the sacrifice ratio, which measures, “the cost, in terms of either output or unemployment, of a point reduction in inflation. It thus measures the relative cost of a reduction in inflation: the higher the ratio, the greater the relative cost” (401). Down concludes that, “CBI is positively associated with the sacrifice ratio,” and that, “political and institutional factors play an important part in determining the costs of disinflations, particularly the unemployment costs” (401).

He finds that the inflation-output sacrifice ratio is highly and positively correlated to CBI disinflationary policies. More gradual disinflation is also more highly correlated to the sacrifice ratio. However, while there is a relationship, there is also no clear and universal relationship between either the inflation-output or the inflation-unemployment sacrifice ratios and Down claims that both must be investigated in more detail.

He then deploys a quantitative method for measuring the relationship between sacrifice ratios and disinflation. He creates four models and uses an OLS regression. He concludes that, “…the most striking result to emerge from the analyses is the robust positive relationship between CBI and the unemployment and output costs of disinflations” (430). “In sum, the relative inflation aversion of policy makers appears to increase the costs they are iwlling to impose on society to reduce inflation” (430). “Put simply, althought CBI may generate long-run gains for the economy, it does appear to be associated with greater short-run costs. This in turn suggests that CBI may not offer the unequivocal free lunch many believe accompanies greater independence” (432).

Watson: The Institutional Paradoxes of Monetary Orthodoxy

Watson, M. (2002). "The institutional paradoxes of monetary orthodoxy: reflections on the political economy of central bank independence". Review of International Political Economy, 9, 183-196. http://www.ingentaconnect.com/content/routledg/rrip/2002/00000009/00000001/art00007

“Academic studies of central banking typically divide into one of two traditions. For some, central bankers have shown that, once trusted to operate policy autonomously, they can consistently deliver low and stable inflation at no obvious cost in terms of output and employment…For others, however, this is to overemphasize the economic dimension of CBI” (183). CBI, in effect, is a tool derived from the political realm. Watson is here concerned with examining the literature on CBI, then showing that CBI can lead or promote problematic policy and then attempts to show that CBI was an effect of political pushing and pulling as opposed to economic drivers.

“The core of the intellectual case for CBI revolves around the assumption of a persistent inflationary bias built into politicians’ monetary policy preferences” (184). “There are two broad political economy challenges to this standard economic conclusion: one empirical, the other conceptual…The first…challenge suggests that CBI leads to superior inflation performance only when it is accompanied by labour market institutions that facilitate solidaristic wage bargaining…In contrast, the second…challenge suggests that the orthodox economics account of CBI mis-specifies the whole nature of monetary relations within contemporary capitalism” (185).

Watson then looks at the idea of path-dependency in the creation of CBIs, as well as the idea of a Grand Theory of CBIs. He finds that general theories of this sort are problematic. “…each time a general theory has been identified, it has been a different ‘general’ theory, which means that none of them have been actual, time-invariant, general theories at all” (189). While inflationary pressure has always been around, the nature and drivers of this pressure has changed as time progresses. On page 190 he provides a nice list of inflationary pressures by decade from the 60s to the 90s highlighting the different drivers that caused the pressure.

He looks then at the political logics for CBI. First, he highlights the issue of domestic distribution and finds that CBI is clearly a driver of distinct distributional policies, as credit is, in his words, “the sine qua non of distributional policies” (193). Additionally, he highlights how CBI is an “automatic pilot for policy” (193). This helps to shape the perspectives and expectations of market actors, and also provides for an outlet for unpopular policy interventions.

His first, economic conclusion, is that the assumption that CBI will create independent inflationary control misses the point that, “Money supply growth is determined as much by the actions of the private sector acting in its own interests as by the central bank acting in the public interest” (194). His institutional conclusion is that it is doubtful that CBI is the best institution to control for inflation. His political conclusion is that, “The decision to cede operational responsibility for the conduct of monetary policy should be seen as a statement of social intent” (195).

Maxfield: Gatekeepers of Growth (Chapters 1-4)

Maxfield, Sylvia. (1997). Gatekeepers of growth : the international political economy of central banking in developing countries. Princeton, N.J.: Princeton University Press.

Maxfield examines the rise of central bank independence in the 90s and attempts to outline some of the drivers of this change. Firstly, the rise of central bank independence may seem counterintuitive, especially for someone who deploys a rationalist framework: why would political leaders give up control of such a powerful took that could effect their future power to such a great degree? Maxfield argues that the increasing globalization of financial markets if, “of central importance” (4). The cause of financial market’s increasing control over the independent decision making of politicians is the attempt to, “signal their [the politician’s] nation’s creditworthiness to potential investors” (4). “Specially, this book argues that the likelihood politicians will use central bank independence to try to signal creditworthiness is greater 1.) the larger their country’s need for balance of payments support, 2.) the greater the expected effectiveness of signaling, 3.) the more secure their tenure as politicians, and 4.) the fewer their country’s restrictions on international financial transactions” (4).

She then goes on to briefly, and helpfully, outline some of the main functions of central banks. “To control inflation policymakers seek an anchor for prices. The exchange rate system devised in Bretton Woods…provided an exchange rate anchor” (7). This broke down after the move to fiat money. This is one of the reasons that there needed to be a new anchor for the international financial system: central bank independence with a mandate to control for price flux.

One reason that central banks need to be independent is because market actors can anticipate the policy moves of politicized government groups more easily (8). Another reason is the great power of finance in the age of increased economic interdependence (9). Another reason that this has become a more important issue is the Maastricht Treaty for conformity with EU rules (10). The increasing focus on rationalism as a social science methodology helped to promote the move to central banks (11). There are “normative” arguments for the move to central banks, like increased economic performance, policy coordination, democratic accountability, though I found these to be a bit problematic (12-7).

Maxfield then goes on, in chapter 2 to highlight the political source of central bank independence (also the title of the chapter). She highlights different studies that identify different sources of the independence of central banks. Some identify the need for highly trained and independent technocrats. Some believe that there is more independence if there is less political polarization in a country, others if there is more. Some that sectors of the economy will press for independence because it is in their interest. Another main group looks at how central bank independence is contingent on the need of governments to raise finance. Yet another group looks at ideology as a factor in determining whether or not the central bank is independent.

“A potential explanation for the contradictory findings reported above is that financier’s abilities to exploit a nation’s international economic vulnerabilities shape the effectiveness of financial sector demands on government to protect central bank independence” (33).

She then highlights the ways in which international finance can incentivise the move on the part of states to make their central banks independent. She looks at FDI, foreign equity shares, international bank loans and foreign government bonds. She finds that the first three are relatively not going to effect the move towards an independent bank. However, foreign government bonds do much to signal a country’s creditworthiness to international finance.

The final chapters of the book examine different case studies. I did not read these.

Kirshner: The Political Economy of Low Inflation

Kirshner, Jonathan. (2001). "The Political Economy of Low Inflation". Journal of Economic Surveys, 15(1), 41. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4374154&site=ehost-live

First, Kirshner claims that the politics of low inflation have been under theorized by IPE scholars. He is about to remedy this problem by looking at current literature on the politics of inflation generally and focusing on three themes: “the economic costs of inflation, the concept of monetary neutrality from economic and political perspectives, and the importance of disaggregating economic growth statistics” (41). He then goes on to map out his approach to looking at the political implications of low inflation.

The first perspective on inflation examined is the sociological perspective. This sees inflation as an escape valve for societies to release sociological tension. “Inflation is a ‘bad thing’, although perhaps at times a necessary evil, because it is the symptom of underlying social conflicts within society” (43).

The next perspective examined is the neoclassical. This perspective emphasizes the assumption that inflation has economic costs. Actors will change their behavior in response to the perceived actions of governments in the face of inflationary pressures. “In order to avoid the costs of inflation and the pain of subsequent disinflation, it is crucial that monetary policy be de-politicized, that is, insulated from short term political pressures emanating from both interest groups and the government itself" (44).

The third perspective is that of the modern political economist. From this point of view the bad-guy is the state, who is responsible for inflationary pressures. From here, the state is looking out for its own interests, as an egoistic rent maximizer. “Inflation can help the government by increasing its wealth and by affecting its ability to stay in power” (44). Inflation can act as a tax on “cash holdings” (45). This causes the need to depoliticize the monetary process, thus the need for a central bank.

Kirshner then goes on to claim that most economic perspectives claim that there is an economic cost to inflation, but that this cost has never been empirically verified. He looks at literature and models on the subject and finds them to be inconclusive. “In sum, the deductive arguments regarding inflation are indeterminate” (48). “Thus, there is no good reason to believe that moderate inflation has a significant effect on economic performance, or that moderate inflation should be met with aggressive anti-inflationary policies” (50).

Then, why are there so many central banks being depoliticized, especially throughout the 90’s? “The solution to this puzzle is that the opposition to inflation lies in its political effects, not in its economic ones” (51). Inflation affects different groups differently. “Unanticipated inflation…benefits debtors at the expense of creditors, one reason why financiers have always been strong proponents of price stability” (52). The emphasis on price stability can be best understood through a micro-politics perspective, claims the author. From here, it becomes possible to see that there are distributional effects to inflation policy, and that these effects have real political consequences.

From the micro-politics perspective, “The level of inflation is the outcome of an interest group conflict regarding the level of inflation. The economic effects of inflation are dwarfed by these political factors” (59).

Notermans: Policy Continuity, Poilcy Change, and the Political Power fo Economic Ideas

Notermans, Ton. (1999). "Policy Continuity, Policy Change, and the Political Power of Economic Ideas". Acta Poiltica, 34(3), 22-48.

Notermans argues that changes in economic policy stem not from ideational forces, but from material forces. Ideational forces are brought into the picture to simply justify the policy decision. Additionally, different theoretical frameworks can be manipulated in various ways to justify the needed policy response to the material drivers that a nation confronts.

“This article argues that the view that new economic ideas determine the character of new policies reverses cause and effect. More specifically, three hypotheses are advanced: 1.) Ideas exert n independent causal influence on policies by providing for continuity rather than change because economic policy-makers cling to the ideas and policies that were adopted in response to a traumatic event, even if the original constellation justifying such policies has long disappeared. 2.) The changes in macroeconomic policy regimes during this century have been driven by the need to correct cumulative price level disturbances… 3.) Because the timing and character of a regime change is determined by developments in financial and labour markets, it is largely exogenous to the political system” (23).

“In spite of fundamental theoretical differences between the two approaches, it is possible to derive Keynesian-type policies from neoclassical views and vice versa” (26). Notermans believes that, no matter what ideational approach you use, you will be able to manipulate that to produce any economic policy result. This means that people are just responding to material forces, and that ideational forces are tossed about. Eventually, this can be seen as securing economic policy that is more in line with neoclassical models, which tend to reflect reality more accurately. “Hence, policy convergence with the (long-term) neoclassical model is complete: macroeconomic policies need to prioritize price stability, and unemployment is to be tackled by supply-side policies” (27).

Notermans posits in section 4 of his article that ideas do not have a causal influence, even if different policy makers who hold different ideas posit different policies. This could simply mean that their interests diverge and that they are responding to material forces that they encounter. After making this claim, Notermans goes on to say that, since ideas are insufficient to explain macroeconomic change within the economic policies of Europe, he will propose a Darwinian approach. This approach claims that ideas are not of interest, and only policies that respond to price stability will have any worth.

Only firms who respond to the dictates of the market will survive. However, a Darwinistic approach must take into account the idea of path-dependency, as opposed to pure environmental determinism. “…because the behavior an individual market actor faces is largely determined by the behavior of the other market actors, the case for environmental determination of economic outcomes is much weaker than commonly assumed” (32).

However, this aside, the current nature of the market necessitates price stability as the mechanism of Darwinistic selection and adaptation. “In a world where money serves as a store of value, price flexibility no longer necessarily serve s as the device through which markets will quickly return to equilibrium Instead, excessive changes of the general price level may severely disrupt the willingness to engage in productive activity and hence precipitate rather than mitigate economic crises” (33). Therefore, price stability is the holy grail, and markets will orientate around that for material reasons.

“Whereas ideas play no significant role in explaining regime changes, they do play an important role in accounting for regime inertia” (37). “In sum, to the extent that ideas do influence the development of macroeconomic management their influence is generally moderate as they tend to perpetuate a given regime even if the conditions which gave rise to that regime have long disappeared” (37).

Notermans goes on to highlight this ascertain by looking at the cases of Britain, France and Sweden and highlighting how their transitions towards policies of price stability reinforce his theses. However, he also notes that these characteristics are not always going to necessarily be in play, and that a different set of material forces could come along and change the way that economic policy is made.