Jonas Elvander – Interview with Costas Lapavitsas and Nicolás Águila: Central banks at the heart of economic activity

There have been major changes in some economic paradigms. What are these, why did they occur, and what are the consequences?

Costas Lapavitsas is a professor of political economy at the SOAS University of London

Nicolás Águila is an economist affiliated with the Centro Interdisciplinario para el Estudio de Políticas Públicas (CIEPP) in Buenos Aires

Jonas Elvander is a Brussels-based journalist and editor of the Swedish left-wing weekly newspaper Flamman

This is the first part of a lengthy interview. The rest will follow.

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Jonas Elvander: Vast changes have taken place in the international economy in the past year, not least in monetary policy. In the third week of March last year the Federal Reserve spent $1m every second on securities to stabilize the financial markets, leading to a total of $5.25tn. At the same time the ECB has, through its €750bn PEPP program, lowered the yield on Greek ten year bonds to almost zero. How should these changes be interpreted from a left-wing perspective?

Costas Lapavitsas: These changes began in full earnest with the crisis of 2007-2009. What we are seeing now is the acceleration of that process, it is not new. It is a process that places the central bank at the heart of economic activity. The central bank can do that because it commands the creation of money, of fiat money, as a monopoly. This monopoly power is of enormous importance in contemporary capitalism. It is basically state power because the central bank is a public institution at the heart of contemporary financialized capitalism. And what has been happening with the pandemic crisis is the demonstration of the importance of state power to capitalism. The use of monetary power in this way aims to defend the interests of the oligarchic layer of the capitalist class, the layer that has made vast profits during the last decades of financialization. But monetary power also transforms the functioning of the credit system in unprecedented ways. It drives the rate of interest down to zero, and by doing so it completely warps the functioning of credit and financing. It puts the state at the heart of the financial system and stops money markets from working in the traditional supply-and-demand way. Everything now pivots on the state in terms of how credit works. This creates all kinds of strange and problematic outcomes, not least among which are speculation and economic bubbles. That is the kind of diseased capitalism that we live in.

Nicolás Águila: As Costas said, what happened in March and April last year was that the fear of the coronavirus led to some liquidity issues. Everyone wanted to have [American] treasury bills because it is the safest asset in the world. And then even treasury bills were not enough, they wanted cash instead. So what the Fed did was basically to absorb the money market onto its own balance sheet by buying a lot of treasuries, taking the interest rates down to zero, and then also to try to provide support with new facilities to actors who do not generally have access to the Fed, like the Main Street Lending Program, the Municipal Liquidity Facility, Commercial Paper Funding Facility and so on. That was the biggest moment of stress, around March and April. Later the situation calmed down, and what we saw was that capital markets recovered and even reached historical highs in a moment when the economy was collapsing and unemployment was exploding in the US. So we have to think about this. What is the direction of state involvement? It was definitely directed at supporting big business and the functioning of the markets, instead of any sort of action that would lead to a transformation in a direction to the benefit of the people.

JE: So, the monetary state interventions have mainly helped rentiers and big businesses, but also poor and vulnerable people in the short term. What should one make of this? Is it bad or good, or is that question irrelevant?

CL: It is contradictory in the way that capitalism is, in ways that people often do not appreciate. The reason why the central bank can do this is that it commands public credit and has the backing of the state. People often think the central bank is some kind of regular bank. It is not, it is a state institution, and behind it is society itself. The people running the central bank command public credit because of their position in the financial system, and they deploy it for the purposes of capitalism. They mobilize a social resource – the credit of society – to further the interests of a small capitalist minority and thus create further problems down the line. And the peculiarity of the credit system is that it does this in ways that are difficult to see, in ways that appear technocratic, scientific, detached. At bottom, however, all these are class questions.

Is it a good thing or a bad thing that they are intervening in this way? Well, it is a bit of both. On the one hand, it is society intervening using its own resources and mobilizing a vital public institution. On the other, the central bank does not do so in a publicly minded way, but in a capitalistic way, aiming first and foremost to help the big banks. And as it does that it creates all kinds of other problems, not least encouraging financial speculation. To give you an example, driving the interest rates down to zero seems good, right? You lessen the burden on borrowers and so on. Yes, but at the same time speculators take advantage because money is free, and they start creating stock-market bubbles. That is what capitalism is all about. That is what it means to take advantage of social resources and power to foster private interests and end up creating paradoxical and contradictory outcomes.

NA: I think this is an important point. Let me point to another manifestation of this contradiction, in both the short and long term. If you create money out of thin air and you allow some unprofitable firms that are facing liquidity problems to survive, that is great in the short term because you are avoiding unemployment and so on. But if you do that at the expense of worsening their structural position, for example, leading to the formation of so-called “zombie firms”, that will only lead to a bigger bubble that will explode in a few years’ time with deeper consequences. The questions is how to allow those firms to go bankrupt and stop speculation, while at the same time ensuring that employment is sustained and that investment is going in a socially useful direction. The answer to that cannot be found only looking at the central bank. For Neoclassical Economics, fiscal policy is forbidden so everything depends on the power of the central bank. But it is not; we need broader state intervention, the central bank cannot address all the problems.

JE: That leads us neatly to the question of fiscal policy, where there have been perhaps even more spectacular changes. The ramping up of central bank spending has been accompanied by a turn to fiscal spending that was until recently unimaginable. A case in point is the Biden administration’s $1.9tn package, which even moderate Democrats like Larry Summers described as the “least responsible fiscal macroeconomic policy we’ve had for the last forty years”. What explains this sudden lack of fiscal constraints?

CL: Indeed, the fiscal side of things in the pandemic crisis is even more spectacular, because the radical monetary interventions began already in 2007-2009. And at that time we also witnessed austerity. Now austerity has been shelved, it has been eliminated, especially in the USA. This is interesting and very important. It points again to the crucial role of the state at the centre of contemporary capitalism. We talk about neoliberalism and the market, right? What market? What neoliberalism? At the heart of things is the state, particularly when crisis hits, it is clear.

The first thing to say is that monetary and fiscal policy are interconnected, and we must not lose sight of that. The reason why the state can so easily spend is that the central bank buys the bonds. The state can in the first instance increase its deficits enormously in the US, in Britain and in Europe, because the central bank buys the debt, and therefore the two policies go together. To a certain extent the spending in the US is monetized in that way.

The second thing is that fiscal policy, despite the austerity of the last decade, has always been used in times of crisis. It does not mean some kind of return to Keynesianism as some people might imagine. In times of crisis capitalist states have always sought recourse to Keynesian policies. But having said that, the magnitude of the intervention this time is indeed gigantic. It makes a difference and signifies a point of inflection in the direction of capitalism. It is a kind of re-balancing of financialized capitalism, with the state more firmly at the heart of it, even fiscally. Part of it is due to the realization that years of suppression of aggregate demand through austerity had actually created deep structural problems which were leading to a social explosion in the USA and possibly to the collapse of the monetary union in Europe. This forced a retreat, and that is why we see this kind of resurgence of fiscal policy.

Another thing that is also very important, however, is the global struggle for hegemony, particularly for the USA. It seems that large sections of the US ruling class have realized that much of the infrastructure of their economy is no longer up to scratch. Which, of course, is true. All you have to do is take an airplane and land in New York. It is obvious that, if this is the capital of the Western world, then the Western world needs some help. A section of the American ruling class has realized that if they are to continue to be hegemonic, they have to do something about aggregate demand and the infrastructure of the domestic economy. That is a sign of intensified hegemonic struggle and it will also take on military dimensions in the period ahead, because a lot of the money due to be spent is tied to the military needs of the US. Microchips and other things that are needed for the military strength of the US. It is a more aggressive and fiscally flexible financialized capitalism. Will they be able to maintain it? That is a different story.

NA: An interesting thing at the beginning of the crisis was that the main central bankers were publicly saying that monetary policy was not enough and that fiscal policy was needed. That in itself expresses a shift in the direction of things. And indeed, the fiscal spending has been enormous. It has mostly been discretionary and the level of the deficit is now the highest ever recorded, even exceeding that of World War II. So it is a shift, at least in terms of the size of the intervention. However, it is not so certain that there is a change regarding the direction of the spending. If you look at who have been the main beneficiaries of this spending, it is the same winners as always: mostly big firms, at least in advanced economies. In this context an opportunity opened up for more progressive state intervention in the production and distribution of commodities in a moment where there were severe disruptions in international trade, people were locked in their homes, there were shortages in supermarkets – all of this gave the state the opportunity to take a more active and progressive role, planning production and distribution. But it did not do so. Instead it just focused on sustaining the old state of affairs and allowing big corporations to keep profiting from the situation. The best example is in pharma. The state could have produced vaccines and distributed them for free. And the same with face masks and ventilators and so on. But it did do any of that. It just pumped a lot of money into the pockets of big companies, which are now charging high prices on all of these things that should be free and available for everyone.

On the question of whether austerity will return or not, the development in the US seems to suggest that it will not. Biden has already announced an additional $3tn infrastructure spending package added to the $1.9tn package. But in other countries the same old deficit hawks are still flying high. Especially in developing countries which are facing huge levels of external debt. So it is yet to be seen if this fiscal spending constitutes a shift or if it was just a temporary thing. I tend to think that there will be a shift, but the scenario is still open.

JE: The Fed has also modified its inflation target, declaring that it will not raise interest rates if inflation goes above the 2% threshold. Has the establishment’s view of inflation and unemployment fundamentally changed since the 2008 crisis, or is this merely a blip in the neoliberal hegemony?

NA: The Fed actually has not changed the target, it is still 2%. The framework has not been changed either. The only difference is that they think that the Philips curve, which measures the relationship between unemployment and inflation, is considered to be flatter now. What this means is that they fear deflation more than inflation. So they are willing to allow a higher rate of inflation and a lower rate of unemployment without immediately acting (increasing the interest rate), but they are not willing to let deflation happen. So if there has been any change at all it is very small. It is not even a change of framework, because the same old Taylor rule and the Philips curve still underlie the whole thing, and the target has not been changed.

CL: We have to wait before drawing conclusions. There is a debate in the USA, a very lively debate within the elite, which indicates the difficulty of the issue. After the 2007-2009 crisis the Fed and other central banks went in the direction of greater discretion. They stopped applying the usual rules and adopted a policy of greater discretion, which meant more intervention, more regulation, which they shaped as they went along. But, of course, inflation remained a major fear. And it is logical in a financialized regime for inflation to be the biggest fear, because inflation is the biggest enemy of the lender. If inflation goes up, it destroys debt and that is the last thing the financiers and lenders want. However, if you try to keep inflation down at all costs then you run the risk of social explosions. Permanent suppression of demand damages productive ability and employment.

Clearly the hegemonic section of the US ruling class has decided that the risks from a deep depression of accumulation is greater than that of inflation. It is not a bad guess on their part, because demand has been suppressed for a long time. The blow of the pandemic has been very severe and there is certainly scope for the state supporting aggregate demand to boost growth. Equally however, you can see why their opponents worry, particularly as there is no strong evidence that the side of production in the USA will be able to increase output significantly, meeting demand and preventing inflation from rising. It is possible that we might get inflation ahead, though the risks are low.

The answer is clear from a socialist perspective: it is necessary to have intervention not only on the side of aggregate demand but also of aggregate supply. If there is a risk of inflation and supply not responding, then intervene with industrial policy, intervene on big business which has not been investing, have programs of public employment, have programs of public production, alter property rights over large areas of production. In short rejuvenate the production side but on a social basis. That is what should happen if there is concern about inflation. Not, as Larry Summers argues, suppress demand by curbing spending. We should think creatively and go beyond the poverty and misery that working people have lived through the last several decades.

JE: Even if the changes in the view of for example inflation might not be as big as they are sometimes described, the view of the deficit has clearly changed since the last crisis. Why is that? And why is someone like Larry Summers suddenly out in the cold?

CL: I think that in a peculiar way the easiest way to understand the changes in the USA is by looking at Europe. Even in Europe we have had a relaxation of austerity after the outbreak of the pandemic crisis. Europe was far more rigid on austerity in the previous decade. In the USA policy was conservative, but still the government maintained a deficit for large parts of the decade, which is why the economy registered better growth. In Europe austerity ruled the roost, emanating from policy decisions taken fundamentally in Berlin. So why has even Europe changed? I think the answer is clear, and casts light on the USA. With another bout of austerity, the economic and social conditions within which European capitalism has operated for the last 20 years would have been blown apart. There is no way that the southern periphery of the monetary union would have survived within the common currency, if austerity was again the name of the game, stopping countries from increasing their fiscal deficits. Unemployment would have gone through the roof, production would have collapsed, and there would have been a gigantic social crisis.

The EU suspended austerity very early, as also did the USA. The threat of mass unemployment in the USA in the early months of the pandemic was enormous, the number of new unemployment claimants was unprecedented. The state intervened by essentially nationalizing the wage bill of enterprises, mostly big but also small and medium ones. They saw the writing on the wall and took immediate action. Which is what they always do. They remember Keynes whenever things get difficult, they have never forgotten him.

NA: I think that part of the explanation is that we are facing a crisis of a different nature. The global financial crisis and the coronavirus crisis are very different and require different interventions. In a way, I think the Fed learned some lessons from the financial crisis. This time it acted faster and more decisively. It implemented many of the so-called unconventional policies that were relatively new in 2008. But they are also more aware of the limits of their policies. Interest rates were already low so there was not that much space to lower them. Fiscal policy was needed among other things because of what Costas just mentioned: unemployment in the US went to 14% in April, which is unprecedented. The reason is because, in contrast to the global financial crisis – which was not actually global, it spread from developed countries to developing countries –, the coronavirus crisis is in traditional terms a “real” crisis, not a “financial” one, and it is truly global. Employment has been hit, industries have closed, and so on everywhere. The financial system needed support initially, but throughout the corona crisis banks have stood up very well, at least so far. The capital markets quickly recovered and went to historic highs while the rest of the economy was collapsing. That is what changed, requiring to put on hold the austerity nonsense.

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