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.

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:

A Japanese Veteran’s Quest to Come Clean with His Service to His Nation

Introductory note from Kindred: This is a guest post by Dave Hackerson, one of my oldest friends and an American emigre to Japan since 2003. Nothing like the commemorations of Aug. 6, Aug. 9, and Aug. 15 exists in the United States. If it did we would also have to grapple with the consequences of Hiroshima, Nagasaki, and the fire-bombings of Tokyo, Dresden, and other cities. I have written previously in support of the position that the use of atomic weaponry was intended to signal to Moscow rather than Tokyo, which makes these anniversaries even more cruel. Of the World War II belligerents the United States may be most in need of honest reflection, but it is not the only one. I’ll now turn it over to Dave, who may or may not agree with the above.

Summer in Japan divides up nicely into two distinct stages. The first stage from the end of June to late July is the rainy season, with intermittent rainy weather filling the rice paddies with water and producing luscious hues of green that transform the mountains into verdant canvases. The second stage is where we get the “real” summer. That means hot and humid weather akin to my native Midwest in the United States, festivals and fireworks, and the national high school baseball tournament at Koshien Stadium in Osaka, one of the truly greatest events in all of baseball.

Yet in the midst of all this fanfare and excitement, each August the nation takes time to reflect on three dates: August 6, August 9, and August 15. The first two dates are the days of the Hiroshima and Nagasaki atomic bombings, while August 15 is the day on which the Emperor’s announcement of Japan’s decision to surrender was broadcast on public radio. There is a lot of questioning and soul searching at this time of year, with the nation seeking to make sense of a conflict that forever altered its destiny. Why did Japan continue to escalate the conflict in China? Was war with the United States truly inevitable? What lessons can be learned from Japan’s mistakes in the past? Each year these questions are rehashed and debated on TV and in the media. Scholars and writers pore over documents from the era and conduct interviews with veterans and other individuals who lived through the war, seeking to gain new insight to help make sense of this conflict. As the years pass, there is a growing sense of urgency as the numbers of these living witnesses to history dwindle.

This past week on August 14 the TV station TBS (Tokyo Broadcasting System) broadcast a powerful interview with a 94 year old veteran named Hajime Kondo. I have watched many of these interviews on TV and in NHK’s (Japan Broadcasting Corporation) online archives in my 11 years in Japan, but this particular interview with Mr. Kondo was especially powerful. Kondo’s story is unique in that he survived the war on two different fronts, spending over 3 and half years in China and then fighting on Okinawa in 1945 in Japan’s last ditch defense to prolong the invasion of the home islands.

Kondo first began to share his wartime experiences in the 1980s when a number of revisions were made to school textbooks. Some of these revisions stressed the negative face of the Japanese army’s defense of the island, such as using Okinawan civilians as human shields or ordering them to commit mass suicides. Kondo did not directly refute these allegations, but rather expressed his utter disgust at portraying all the Japanese soldiers who defended Okinawa in a highly negative light. “I just couldn’t take it,” he said reflecting back. “There were so many us determined to make a stand, for by defending Okinawa, we were defending Japan”. He recalled seeing troops with tears streaming down their eyes as they rushed forward in a final banzai charge towards the American lines. This desire to set the record straight and provide a more balanced account is what motivated him to speak out.

Kondo was one of the few Japanese soldiers who survived the battle. He was wounded and captured when he made a banzai charge against the American lines with two fellow soldiers, both of whom were killed. On Okinawa, Japanese soldiers not only had to battle their American foes, but also had to endure the hardships of a formidable environment and inadequate supplies. These harsh circumstances, combined with the massive loss of both combatant and civilian life, lend tragic overtones to the defense of Okinawa. “When we speak about Okinawa”, Kondo said, “We tend to portray ourselves as the victims (of poor military decisions and the circumstances of war). Yes, we may have been the victims there, but in my case I also spent 3 years and 8 months in Shanxi, China. There the story was the other way around. We were the assailants there, the people in the wrong. We soldiers did some horrific and unthinkable things to the Chinese while we were there.”

Burned out villages and crying orphans on Okinawa. Residential districts of Tokyo burned to the ground during the fire bombings of March 1945. The complete and utter devastation of Hiroshima and Nagasaki in the wake of the atomic bomb. Watching these images broadcast on television, it’s easy to see where the victim mentality Kondo alludes to comes from. But as scholar Kizo Ogura states in his Overcoming Our Perceptions of History (1), these tragic events are the end result of a war that Japan started by invading other territories. It was the instigator, the perpetrator, Japan’s inability to talk about this fact is one of the factors impeding historical dialog with China and Japan.

Kondo does not shy away from this fact, but is very open and direct. “I’m just telling it as is” he says. He states that some veterans have accused him of telling too much, but he insists they have an obligation to tell people about what they did. “We can’t be judge of our own actions. The people who hear our account are the ones who decide. It’s up to them to judge whether or not we acted accordingly”. Kondo admits that for years he did not feel much remorse for the things he did in China. It was only when he held his grandchild for the first time that the guilt swept over him. “Holding that child in my arms, I thought ‘good heavens, I have done some many terrible things, so many wretched things’. I knew then I had to tell people what really happened there.”

Though he is 94 years, Kondo remains active and committed to ensuring the historical account is complete. He has traveled back to Shanxi with a NPO that seeks out Chinese survivors of sexual abuse and other acts committed by Japanese soldiers, personally speaking with survivors he meets. He also continues to travel around Japan, holding lectures for young people and others willing to listen about his experiences in the war. He talks about being ordered to bayonet a captured Chinese prisoner in training after he first arrived in China, describing how that experience showed him how easily human life could be taken. He delivers a chilling account about how soldiers had their way with a young mother, and then threw her infant off a cliff only to see the mother run after the child and jump. Speaking with an interviewer from his home, he talks about how he and his fellow soldiers would line up prisoners, stand 30 meters back, and then see how many they could take down with a single shot from their standard issue rifle. Hearing him relate these accounts, it’s easy to imagine why other veterans condemned him for speaking out. They seemingly fear being viewed as monsters.

However, Kondo does not necessarily feel the responsibility for these horrific acts lies completely with the soldiers. Rather, he indicated that people should level blame at the military-dominated government of the time for plunging the nation into conflict and placing men in such desperate circumstances. His thoughts echo the sentiments of Jiro Horikoshi, the main engineer behind the Mitsubishi Zero Fighter. On August 15, 1945, Horikoshi penned the following entry into his diary:

“I can’t help but feel that the cause of that whole war was the fact that the military and politicians connected to them threw a fit, to the point that they tried to get their way by force rather than pursue a peaceful diplomatic solution”.

Next year marks the 70th anniversary of the end of World War II, and yet there are some who feel Japan may be heading down the same path again. The Japanese government’s recent decision to pursue the right of collective self-defense saddens Kondo. Standing before the memorial to the dead in Okinawa, he said “The struggle and sacrifice of these people is what the peace of our nation today is built upon. Now some 60, 70 years have passed, and here again we find our country being pulled along on the path to war. Looking at the names here, I feel so saddened and powerless.” We can only hope Kondo’s efforts to pass his account on to posterity will not have been in vain.

1) Kizo Ogura: Overcoming Historical Understanding: Determining the Obstacles that Inhibit Dialog between Japan, China, and Korea (the English is my own translation of the original Japanese title).

Defend Principles, Not People

Steve Salaita resigned from a permanent position at Virginia Tech to accept an appointment at the University of Illinois. Then, this week, his offer from Illinois was rescinded. Neither the university nor Salaita has divulged the reason for this reversal, but Inside Higher Ed has speculated:

The sources familiar with the university’s decision say that concern grew over the tone of his comments on Twitter about Israel’s policies in Gaza. While many academics at Illinois and elsewhere are deeply critical of Israel, Salaita’s tweets have struck some as crossing a line into uncivil behavior.

For instance, there is this tweet: “At this point, if Netanyahu appeared on TV with a necklace made from the teeth of Palestinian children, would anybody be surprised? #Gaza.” Or this one: “By eagerly conflating Jewishness and Israel, Zionists are partly responsible when people say antisemitic shit in response to Israeli terror.” Or this one: “Zionists, take responsibility: if your dream of an ethnocratic Israel is worth the murder of children, just fucking own it already.”

Salaita’s appointment to Illinois was thus apparently canceled because of the opinions he expressed concerning a current event. There are questions about whether this constitutes a violation of academic freedom — in the article linked above a professor at U of I suggests that protection is limited to academic work — but I am on record defending academics in similar cases from institutional reprisals. In other words, I think Salaita’s appointment should have gone through. The fact that I disagree vehemently with some of his expressed views, particularly the allegations of genocide and statements that Israel has earned any anti-Semitism it experiences, is immaterial. If the university was concerned with Salaita’s opinions, which were not a secret before this week, then they should not have given him the offer in the first place. Given that they did, and he gave up his previous (tenured) employment to accept this offer in good faith, it absolutely should be honored.

But I wonder on what principle folks like Corey Robin can object. Robin strongly protested the appointment of General David Petraeus to a temporary teaching position at his own university. While the content of Robin’s protests were primarily about the fiscal cost of hiring Petraeus, given Robin’s advocacy efforts (and the fact that he uttered not one word of disappointment when Paul Krugman was later given a permanent position at a higher salary for less work than Petraeus) it is difficult to believe that ideology wasn’t a part of it. Robin is also a visible proponent of the BDS movement and supported the American Studies Association’s proposed boycott of all Israeli academic institutions. It appears, in other words, that Robin believes in politicizing academic hiring and promotion decisions except when he does not, and that there is a perfect correlation between his political attitudes and his attitudes on such decisions.

This is the abrogation of principle. If the university is to be politicized, and Salaita seems to believe it should not be, then it is disingenuous to express outrage with a political outcome. The fact that university administrations appear to be reflexively pro-Israel is why actions such as those taken by the ASA are counter-productive and a defense of principles is so important.

Strategy and the Israel-Palestine Conflict

Tom Pepinsky cites some political science research on this and other conflicts, and concludes:

The most topical recent work on this is Anna Getmansky and Thomas Zeitzof’s forthcoming APSR piece, which finds that exposure to rocket attacks in Israel is associated with greater support for right-wing parties among Israelis. The core feature of the rockets fired from Gaza is that they cannot effectively target people or installations. They fall almost randomly. Looking back in history to an earlier insurgent war, Matthew Kocher, Stathis Kalyvas, and I findthat South Vietnamese villages exposed to aerial bombing from the United States and Republic of Vietnam forces were more likely to shift towards NLF (Viet Cong) control. Our argument also relies on the indiscriminate nature of this violence, which was simply incapable of separating true NLF supporters from neutrals or even RVN partisans within Vietnamese villages. …

If the goal is to compel civilians and non-combatants to change their minds about the conflict, to create a new kind of politics, then it will not. Most worryingly, if our findings are true, then this dynamic creates incentives for each side to make it harder for its opponent to discriminate between its own combatants and non-combatants. This is sad, and frightening.

We can actually say more about this. In a significant article in International Organization from 2002, Andrew Kydd and Barbara Walter (singular) notes that terrorist and insurgent violence is often a tactic used in order to mobilize support for extremist groups. In this case, in light of the quotes Brooks provides that I recount in my previous post, we could perhaps say that Hamas is hoping to provoke Israel into indiscriminate violence so that it will garner sufficient domestic and international support to force Egypt into ending its blockade.

Israel appears more than willing to play its part, and that’s more than a shame. But if this is an accurate assessment then Hamas’ actions are incredibly cynical. It would mean that if Gaza was not under an Israeli assault then Hamas’ international position would be undermined by Egypt’s (effective) economic sanction. Its domestic credibility might be negatively impacted over time as well. In other words, Israel is not the only thing standing in the way of Palestine being truly free.