Structural Defects

The Bank for International Settlements issued its annual report yesterday.  Perhaps the central banks are feeling a little insecure, or perhaps they are a little more sensitive to economic reality, but the BIS felt compelled to use one third of its report to tackle inequality.  Here’s the summary as given in the report:

“Key takeaways

• The long-term rise in economic inequality since the 1980s is largely due to structural factors, well outside the reach of monetary policy, and is best addressed by fiscal and structural policies.
• Monetary policy can most effectively contribute to a more equitable society by fulfilling its mandate, which addresses two key factors causing inequality at shorter horizons. This requires keeping inflation low and limiting the incidence and duration of macroeconomic and financial instability, which disproportionately hurt the poor.
• Central banks can also help mitigate economic inequality wearing their “non-monetary hats”, notably as prudential authorities, promoters of financial development and inclusion, and guardians of payment systems.”

Fairly bland stuff.

First:  That opening conclusion that the long term rise in inequality is more due to structural defects than monetary policy is spot on.  Sort of.  The near perpetual low interest rates maintained for the past decade and more have surely supported asset holders more than the rest.  In fact going some way back the prevailing focus of monetary policy seems to have had a decided bias towards the credit side of the ledger.  Rightly so, you might argue.  I suppose the central banks can argue that the seemingly bottomless willingness to support the financial system in moments of crisis is a necessity.  After all the general public benefits from a working payments system and access to credit.  That the financiers are never held accountable for the rest of what they do is left aside.  I will get to that in a moment.

Second: I think we can all agree that the avoidance of major economic cyclical damage is in the public interest.  So the BIS’s point about central bank mandates — to avoid inflation and limiting instability — are well made.  But insufficient.  That such instability hurts the poor more than the wealthy is surely blazingly obvious.  The evidence from the long slow recovery form the Great Recession is all we need in support of that argument.  What if, however, the central banks consistently undershoot their inflation target?  Who benefits from that?  Does too low a level of inflation benefit the poor?  No, it doesn’t.  The wording the BIS uses is carefully chosen: it elides the responsibility central banks have towards the support of labor markets.  Their recent record is not so strong on that front.  Labor market conditions are presumably subsumed into the “instability” fighting responsibility.  The recent record indicates that other aspects of instability prevention take precedent.  Like the endless focus on banking.

Third: I love that the BIS then adds a non-monetary policy factor: the regulation of finance.  Guardians of the payment system? Yes I get that.  Prudential authorities and promotion of financial development?  I don’t think the BIS ought crow too much about this.  The ease with which the banks manipulate and coax the regulators into a pro-bank stance was all too well evidenced by the crash.  Much financial innovation appears to be destructive and adding to that instability the BIS mentions.  Why is it tolerated?  The laxity and ineffectiveness of regulation has been exposed for all to see even in recent weeks here in the US, where the big banks all passed their “stress tests” and are now planning to shovel billions of dollars back to their shareholders.  This will deplete capital and divert resources to the wealthy, thereby exacerbating inequality.  This contradicts the feel-good story the BIS wants to convey.  The weakness with respect to regulation is in stark contrast to the devotion to duty displayed in the fight against inflation.  Consequently the central banks appear to be less neutral in their role than they would like us to believe.

For the record I have always advocated the separation of bank oversight from the implementation of monetary policy. The lines between the banks and their overseers blur all too easily.  The career carousel between overseer and the overseen is too easily ridden.  The intellectual independence that the central banks pride themselves on in their monetary policy making is hard to find on the regulatory side.  But this all might simply be me extrapolating from personal experience, so you can dismiss it is bias if you like.  It’s just that the heavy handed threat of rising interest rates to head off inflation contrasts rather starkly with the delicacy with which the big banks are treated.  Is that to do with the too frequent mingling of staff?  I leave it you to decide.

Back to structure.

I mentioned a little while ago that I had been reading Jan Eeckhout’s book “The Profit Paradox”.  I recommend it.  Whilst it might not be stunning news that market power has grown significantly in the past few decades, it is useful to keep its impact in mind when evaluating things like the BIS annual report.  Indeed the report lays it out there right at the beginning: “structural factors”, it says, are largely to blame for rising inequality.  Eeckhout’s data and analysis provide the justification for that statement.  What the BIS doesn’t say is that structural defects affect the efficacy of monetary policy.  It takes a lot more effort, and for longer, for policy to have the desired effect when its transmission is through a sticky mechanism.  Contra to the pristine economies that the policy makers model when making their decisions, the real economy is riddled through with jamming devices that slow down or contradict the messaging intent of policy.   Oligopolies work to rig the labor market, they limit output in order to manage revenue, and they over-price in order to maximize short term profit.  The consequent effects on employment and consumer welfare are all negative and create a downdraft backdrop for monetary policy.  Surely the BIS ought note this in its comments.

Nowhere is the impact of market power more obvious than in the banking industry itself where a few ultra-large organizations now dominate most markets.  Since the steady consolidation of banking has taken place right under the noses of the central banks armed with regulatory oversight of that consolidation, I think the BIS might usefully reflect on the role its members have had in allowing those structural defects to accumulate.  It is one thing to palm the rise in inequality off on non-monetary policy issues like structural factors.  It is another to be complicit in the formation of those factors.

Perhaps the BIS can opine on how to untangle the finance industry and break up the big banks in its 2022 report?  After all, the central banks oversee the industry.  Don’t they?