Yves here. Richard Murphy has summarized an important paper by James Galbraith, which discusses two different, but actually somewhat related, central bank fixings. One is the loanable funds theory, which is the long-debunked and false notion that banks lend pre-existing savings. In fact, banks create new deposits each time they lend; they do not need to tap into an existing savings/investment pool.
Galbraith then turns to why central banks pursue high interest rates. The answer is not pretty.
By Richard Murphy, Chartered Accountant and Political Economist. He was described by the Guardian newspaper as an “anti-poverty and tax activist”. He is Professor of Practice in International Political Economy at City University London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economics Forum. Originally posted on UK tax research
I must thank those who brought to my attention a new article published by James Galbraith in the past few days. The blurb from the Levy Economic Institute of Bard College in the United States says:
In the paperJames Galbraith first demolishes the case for the loanable funds banking model, still favored by most macroeconomists and so absurdly wrong that it is shocking that they can still teach this nonsense to most undergraduates.
What he then argues is that there is no such thing as a market interest rate. First, he says it’s because there is no free market in money given the barriers to entry that the banking sector has. More importantly, it is because of the power of central bank regulations on this matter.
Accordingly, he suggests that the objective of any interest rate policy should be to keep rates as low as possible. This was, he argues, Keynes’ preferred option. As Galbraith sums it up:
The interest was the return to the funder, generally the idle annuitant. Thus, a low interest rate and a high investment rate would yield, in long term, a “euthanasia of the rentier” – leaving capitalist society in the hands of its active elements, namely businesses, their workers, consumers and the government—perhaps requiring a “socialization of investment”.
Galbraith specifies that he is on the side of this euthanasia of the annuitant. He argues that regulation must provide the active economy we need.
As he then notes, since Keynes’ death everyone has recoiled from this critical idea. After reviewing the resulting failures, Galbraith asks:
The above analysis leaves an open question. Apart from the illogical and the illusory, is there solid, if not necessarily defensible, reasons why the Federal Reserve would raise interest rates?
He offers two. The first is this:
Two possibilities come to mind. The first is venal. The Federal Reserve works, essentially, to the largest banks, and since 2008 it pays interest directly on their reserves. Thanks to the “quantitative easing”, the policy of purchasing risky assets such as private sector mortgage-backed securities and store them in special purpose vehicles, the big banks are full of reserves. Paid interest provides them with income; pay more interest gives more income. In exchange for this, nothing is required. As small banks with unstable deposits bases are hit by runs, the biggest banks can (and do) come up to the rescue, consolidating their hold on the banking system as a whole. All this should be very well appreciated by major bankers.
I think that’s most likely true.
His second explanation is as follows:
The other possible reason is global and strategic. Although the legal liability of the the dollar belongs to the treasury, not the federal government Reserve, the power over the dollar exchange rate rests largely with the central bank, its interest rate, and their effect on capital flows. Although the subject rarely surfaces in public, there is no doubt that preserve the centrality of the dollar as a global currency reserve asset is a primary goal of American policy. So that when Paul Volcker took office in 1979, returning from an IMF meeting in Belgrade to announce the first “Volcker shock”, and so it remains today.
American hegemony is therefore at the heart of interest rate policies. It is, again, very difficult to disagree.
As Galbraith notes, the first of these problems is relatively easy to solve. The second is much more difficult. It would amount to, as Galbraith puts it, “shattering the illusion of American prosperity.”
How does he conclude? Like that:
In short, there is no alternative, compatible with minimum economic functionality, to a policy of low interest rate. Keynes was right. … But such a policy cannot be effective, in fact no policy can be effective, without radical restructuring the US economy as a whole. For that, definancialization, effective control of speculative/predatory elements in classes, and the acceptance – which is inevitable – of a multipolar financial world are the essential first steps. There is little doubt at this stage that the the adjustment will be quite hard at first. Adjustments usually are. But after forty years in pursuit of a failed strategy, an easy path is not realistic.
Once again, I agree. As I said here recently, to survive we need to break away from the economic model we have that has been driven by the power of advertising to promote consumerism, which exists for the ultimate purpose of first making us unhappy and then keeping us in debt.
This model has always been bad for well-being.
Now this model is also destroying the planet.
We really have no choice but to change. But as it becomes very evident, politicians are finding it very difficult to meet this need due to their own debt to big business and the financial hierarchy of power.
There can only be one winner here. The problem is that power is on the losing side.