The Declining Power of US Monetary Policy
‘Capital controls’ are regulations implemented by governments in order to manage international financial transactions. Recently these have been referred to as ‘capital flow management’ techniques (CFMs) or capital account regulations (CARs). There has been a sea change in recent years in the ‘official’ perception by economists and policy makers with respect to the desirability and viability of capital controls (CARs, CFMs). Whereas previously, capital controls were seen as a costly and inefficient intrusion into the free market allocation of global finance, now, capital flows are perceived to be highly variable – even ‘fickle’ – and capital account regulations are seen as a potentially useful tool to manage these flows. Empirical evidence on the efficacy, benefits and costs of capital account regulations is growing.
The ongoing Great Financial Crisis that began in 2007–2008 has dramatically called into question the previously dominant neoliberal approach to macroeconomic and financial policy. Unfortunately, these lessons are being learned in a highly uneven manner – and in some important circles, not at all. In light of this struggle to adopt developmentally friendly financial structures, it is critical that the history and practices of these policies, as well as their costs and benefits, be well understood. There is much rich history of developmental finance and central banking to draw from and many lessons to be found there. In this paper, we survey some of this history, focusing on the late twentieth century, including a discussion of policies undertaken following the Great Financial Crisis. The major lesson we draw is that developmental roles of central banks and related financial institutions have been the dominant approach in many periods since the mid twentieth century at least, and that the neoliberal approach to these policies is much more the exception than the rule. The way forward out of this crisis is to recognize the current policies for what they are – experiments in more developmental policy – and to build on them for the longer run, rather than see them as exceptional aberrations that should be abandoned at the first opportunity.
Modern financial markets and institutions have grown massively in relation to the economy in the United States and elsewhere, and there is little evidence that in recent years their contributions to economic and social output justify the resources they capture and the risks they impose on society. Many policy options exist to limit finance’s destructive excesses and to shrink its size. But while these efforts are important, more proactive measures to redirect financial activity is likely to be needed to achieve key social goals, such as employment generation and a successful transition to a fossil fuel limited economy. Refocusing financial institutions and financial activities toward providing investments in renewable energy and energy conservation provide an important example of reformed financial activity that both generate more and decent employment, while contributing to the production of key social goods. Abandoning the decades-long embrace of speculative finance and promoting socially efficient finance instead is a key imperative facing the United States and many other countries who adopted financial liberalization in the late twentieth century, with costly results.
Junji Tokunaga and Gerald Epstein
Global financing patterns have been at the center of debates about the global financial crisis in recent years. The ‘global saving glut’ (GSG) view, a prominent hypothesis, attributes the emergence of the global financial crisis to an excess of saving over investment, mirroring the current-account surplus, in emerging market countries. Crucially, according to this view, the financial crisis was triggered by an external and exogenous driver, not the shadow banking system in advanced countries which was the epicenter of the financial crisis. Instead, we argue that the global financial crisis was inherently caused by the endogenously dynamic process of balance-sheet expansion at a handful of large complex financial institutions (LCFIs) in the US and Europe. Importantly, this process was facilitated by the endogenous finance of the global dollar in the shadow banking system in the 2000s before the financial crisis. The endogenous finance of the global dollar became highly elastic during 2004–2006, accelerating the dynamically overstretched nature of balance sheets at LCFIs that contributed to the build-up of global financial fragility. Thus, the supreme position of the US dollar as a debt-financing currency in the shadow banking system, underpinned by the dominant role of the dollar in the development of new financial innovations and instruments, was an important, but underappreciated, driving force in this endogenously dynamic and ultimately destructive process.