Why Isn’t the Fed Tougher on Banks?

I am live at The Washington Post‘s political science blog The Monkey Cage, writing about some of my recent research on the global financial system. One key bit:

[T]his result conforms to a simple logic: if you task central banks with financial stability, they will partially tailor monetary policy to make it so. If banks know that their central bankers have their interests in mind, they will behave with less prudence. It makes perfect sense why this would be the case. So long as banks do not violate their statutory capital requirements there is little that central banks can do to prevent this behavior even if they wished to do so. Economists refer to situations in which actors are able to shift the risk generated by their actions onto others as “moral hazard.” It is one of the greatest economic problems, which can cause entire markets to fail. Isn’t that what’s happening in this situation?

Read the rest here. The underlying research is available on my website here.

8 Hours in a Struggling School

Disclaimer: While I have an interest in education policy I am by no means an expert. My experience in this school probably won’t be shocking to anyone working in public education or studying education policy, and probably shouldn’t have come as as much of a shock to me as it did. I’ve read about failing schools, I’ve heard war stories from friends who teach in underfunded schools, but experiencing it firsthand was another matter entirely.

In search of a way to earn a bit of extra money while finishing my dissertation (without suffering the soul-crushing world of retail) I decided to try substitute teaching. In Michigan, the majority of K-12 institutions have outsourced their substitute hiring to staffing companies, so I signed on with one of the two in the area.

In order to substitute teach I had to send in official copies of my transcript, authorize a background check, go to the police department to have my fingerprints done (who knew they charged for that?), fill out a mountain of forms, go through several hours of online tutorials followed by quizzes that weren’t scored, and attend a torturously long in-person meeting. We spent approximately half of the meeting filling out forms together and another half hour being warned not to touch the children or use school computers.  The one interesting thing I learned in the meeting was that by the time students graduate, they have spent an entire year with a substitute teacher.

Classroom_desks_chairs_and_chalkboardI took this to heart, and was ready to lay down some serious knowledge at my first substitute teaching gig, filling in for a high school english teacher. It was the Friday of the first week of school. As recommended, I prepared a backup lesson plan, forced myself into dress pants for the first time since my last academic conference, and arrived at the school a full hour early to make sure I had time to find my classroom and prepare for the students’ arrival. It was still dark when I got to the school. The secretary at the front desk looked at me curiously then laughed when I told her I was a sub. She said I wouldn’t be able to get into my room for another 30 minutes at least.

When the secretary eventually handed me my assignment and asked me to sign in I noticed that I had been assigned to substitute for a Spanish class. I don’t speak a word of Spanish. I told the secretary as much, but she waved me off and picked up a walkie talkie, requesting a security guard to unlock my room for me. We had been warned at the sub meeting that we might be asked to fill in for another position occasionally, and that the staffing company recommended that in these cases we just “pitch in” and help out (and implicitly that we do so regardless of whether we’re equipped to teach in the subject area).

Following the directions of the secretary I made my way through the building, past the cafeteria and several banks of lockers. I paused at a bulletin board listing colleges students might want to apply to. Several were historically black colleges, the rest I had never heard of. Few if any had average ACT scores above 20. None of the major public universities in Michigan were listed. (more…)

The Wizard of Oz Is an Anti-Finance Manifesto

Somewhat apropos of my previous post is the following anecdote, which I’ve read a number of times and have always forgotten. I’m pasting it here for posterity’s sake. It is from Daniel Little’s review of David Graeber’s Debt: The First 5,000 Years:

There are many startling facts and descriptions that Graeber produces as he tells his story of the development of the ideologies of money, credit, and debt.  One of the most interesting to me has to do with The Wonderful Wizard of Oz.

L. Frank Baum’s book The Wonderful Wizard of Oz, which appeared in 1900, is widely recognized to be a parable for the Populist campaign of William Jennings Bryan, who twice ran for president on the Free Silver platform — vowing to replace the gold standard with a bimetallic system that would allow the free creation of silver money alongside gold. … According to the Populist reading, the Wicked Witches of the East and West represent the East and West Coast bankers (promoters of and benefactors from the tight money supply), the Scarecrow represented the farmers (who didn’t have the brains to avoid the debt trap), the Tin Woodsman was the industrial proletariat (who didn’t have the heart to act in solidarity with the farmers), the Cowardly Lion represented the political class (who didn’t have the courage to intervene). … “Oz” is of course the standard abbreviation for “ounce.” (52)

The symbolism of the “yellow brick road” needs no elaboration.

UPDATE: As was been pointed out by Thomas in the comments, this was discussed long ago in the Journal of Political Economy.

Understanding the Preferences of Finance

Paul Krugman [1, 2] and Steve Randy Waldman are having an interesting exchange on why the wealthy support tighter monetary policy despite the fact that expansionary economic policy is good for them. This is often expressed as an aversion to lower central bank interest rates, quantitative easing programs, or other activist monetary actions. Krugman sums up the puzzle nicely:

I get why creditors should hate inflation, but aggressive monetary responses to the Lesser Depression have been good for asset prices, and hence for the wealthy. Why, then, the vociferous protests?

Krugman believes that this is false consciousness: “rentiers” oppose policies that benefit them because they adhere to a model of the world — in which loose monetary policy will lead to runaway inflation that will erode the value of their capital — that does not apply in our current circumstances. (Krugman does not mention that one reason why rentiers might believe this is because Keynesians like Krugman have been advocating for higher inflation partially for this reason for some time.) Waldman portrays this as simple risk-aversion: expansionary monetary policy will change something, and because recent circumstances have been favorable to rentiers that something is likely to negatively impact their station.

I prefer Kaleckian accounts that emphasize the general relationship between capital and labor. In Kalecki’s world, full employment gives bargaining power to workers because they have easy exit options. Conversely, underemployment gives bargaining power to capital. I believe that both Krugman and Waldman are sympathetic to this framework as well.

But I want to highlight another possibility that situates the U.S. macroeconomy within the context of the world economy. The simple Mundell-Fleming macroeconomic model, when combined with a Ricardo-Viner sectoral approach, tells us that when international capital mobility is high (as it is today) financial capital benefits from an exchange rate that is high and stable, while fixed capital and labor benefit from monetary policy flexibility and (often) a lower exchange rate. This relationship is discussed in detail in Jeffry Frieden’s 1991 International Organization article “Invested interests: the politics of national economic policies in a world of global finance”, from which the table below is taken:



The section of the article that begins on pg. 442 is especially relevant. There are several things to note. First, the preferences of financial capital diverge from those of fixed capital, which are divided in turn by whether it is engaged in export-oriented, import-competing, or nontradeable production. Second, the preferences of labor within these sectors will tend to side with capital within the same sector, and oppose capital (and labor) in other sectors. Third, the interests of financial capital will diverge from everyone else.

Why is this? Frieden notes that the interests of capital depend on how strongly tied that capital is for its specific current use. Financial capital is much more liquid and adaptable than an industrial plant. It can be deployed globally while fixed capital is must remain local. For this reason, exchange rate movements create an additional source of risk: a depreciation will negatively impact the value of local assets vis a vis foreign assets, while an appreciation will negatively impact the value of foreign assets vis a vis local assets. The point is that any exchange rate movement from the status quo will benefit some and negatively impact other status quo investments, which is why the interests of fixed capital are divided. But for financial capital, exchange rate movements are always bad for their status quo portfolio, at least inasmuch as an alternative portfolio created that anticipated the future exchange rate movement could have been constructed.

Why should finance support a higher exchange rate level in addition to low volatility when capital is mobile globally? Because, all else equal, a higher value in the local currency will increase purchasing power globally. This is particularly true if you have easy access to that currency via one’s central bank. It is probably true that U.S. banks have had greater access to dollar liquidity over the past five years than at any point in economic history; given that, they would prefer those dollars to be more valuable in exchange rather than less.

Frieden notes in his article that the distributional implications of the battle over exchange rate stability and interest rate levels would be especially severe among the European countries that were then debating joining a common currency, with finance preferring a high and stable exchange rate and low monetary policy flexibility. I would suggest that this expectation has been borne out exceptionally well, as the ECB has engaged in quite restrictive monetary actions despite suffering from a regional economic collapse that has few historical parallels. The story is a bit different for the U.S. because of its n-1 privileges, but it is unclear whether anyone in the U.S. — financial firms or even the Federal Reserve — really understands this. Even still the basic story works: high and stable exchange rates are better for finance capital than low and volatile exchange rates.

So from the perspective of financial capital the great risk of expansionary monetary policy is that it will impact exchange rates rather than interest rates, growth, employment, or even asset prices. Thus the Krugman-Waldman puzzle is not a puzzle at all. Financial capital wants restrictive monetary policy because it benefits them more than the alternatives.


The annual meeting of the American Political Science Association was last week. Its scheduled time — the week before Labor Day every year — is terrible and should be changed, but given the centrality of this conference within the discipline it is almost required for advanced graduate students and new assistant professors to attend. The conference itself is frequently underwhelming. It is hot and crowded, and I always come away having learned less than I thought I should. That, coupled with my only-recent attempt to get back onto a normal human sleep schedule after a summer’s worth of research mania, left me tired and irritated.

So having the entire conference majorly disrupted for the second year out of three enhanced my irritability immensely. Two years ago, when I was entering the job market, the conference was canceled. You see, there are often hurricanes in the Gulf of Mexico this time of year. Notwithstanding this fact the organizers scheduled the flagship conference of the premier political science association in New Orleans. Going to New Orleans during August makes little sense even in the best of times: it’s muggy and hot, the city tends to smell bad in such conditions, and yet folks feel compelled to dress for business at the meeting. We should never blame victims, I agree, but planning to accommodate about 10,000 political scientists in this environment was unwise. So no one was surprised when Hurricane Isaac made his way up the Gulf. The conference was canceled in full. At least I got a meme out of it. In the end, #APSA2012HungerGames was probably more fun than #APSA2012 would’ve been, and some enterprising folks gave their presentations online (#VirtualAPSA2012) so a quasi-conference happened anyway.

Last was as uneventful — in the sense that means “not tragic” and also “pretty dull” — as you would expect and APSA meeting to be, so we were due this year. And we got it. First came the bombshell that there would be panels scheduled for 7:30 a.m. on Saturday. I was put on one of them. This is ridiculous. The whole reason most of us become political scientists in the first place was so that we wouldn’t have to do this sort of thing.

No worries! All those panels would be canceled once the meeting was attacked by suspected arsonists. Wait… what’s that? Yes, someone attacked the damn political scientists. Who? Who knows! (My guess is someone associated with Tom Coburn.) Why? Why ask why? All that matters is that all social order broke down at the Washington Marriott Wardman and, while we got some more decent snark, for the second time in three years the main conference in our discipline was mangled. And next year is in San Francisco where, well, you know.

As part of that, for the second time in three years I didn’t get to give my damn presentation. So here’s what I would have talked about had my venue not been torched: