Central Bank Independency and the Idea of Neutrality Ulaş Şener

(first draft)

Abstract There is a strong consensus view in mainstream , that monetary institutions have to be depoliticized and independent from governments. A further economic conviction is that money could be mainly conceived as a neutral means of exchange. This paper argues that the consensus view, that central banks have to be independent, has its roots in the paradigm of neutral money. As I will show from a heterodox perspective that there is no such thing as money neutrality, the theoretical foundations and conceptual roots of central bank independence are controversial and its political economic narrative is shaky. To overcome these contradictions, pluralism in teaching is necessary. In order to grasp and understand the implications of the non- , the curriculum of monetary theory and policy has to consider heterodox theoretical approaches to money.

Keywords: Central bank independence; neutrality of money; de-politicization of monetary policy; , , pluralism

Research Assistant Chair of International Economics Faculty of Economics and Social Sciences University of Potsdam 14482 Potsdam Germany E-Mail: [email protected]

May 2018 Introduction ‘Apolitical monetary policy is a meaningless chimera, as are apolitical monetary policy institutions.’ (Frieden 2016, 34f) One of the most popular propositions in economics is Central Bank Independency (CBI) which is one of the central features of the New Monetary Consensus and the Modern Monetary Theory (Epstein 2009, 68). Many economists believe that monetary policy should be conducted by autonomous central banks in order to depoliticize monetary policy and maintain price stability. It is not only considered economic orthodoxy, but also a proliferated institutional policy. Over the past two decades several countries around the world endorsed the establishment of independent regulatory bodies for economic policy coordination and gave their central banks statutory independence.

A considerable amount of scholarly research has emerged on theoretical and empirical prospects of CBI. Despite a large body of orthodox literature favoring CBI, heterodox scholars remain skeptical. Critics point out, that CBI neither really excludes governments from intervening, due to the impossibility of depoliticizing monetary policy, nor does it secularly improve economic performance, as it is claimed. This controversy reemerged in the aftermath of the global financial crises 2007-09 (GFC), when leading central banks adopted highly accommodative and unconventional monetary policies. This development raised several crucial questions on the motives and effectiveness of monetary policy, its distributional and directional effects (Goodhart/Lastra 2018, 18f), as well as on the central bank- governments relationship and even on the future role of money itself. Especially the interventions of the ECB during the Euro-Crisis, which revealed the political power of monetary institutions and monetary policy to everyone, provoked harsh criticism from different political angles.1

Nevertheless, despite a growing controversy and a general questioning of mainstream economics (see Sheila Dow’s contribution in this book), the paradigm of CBI remains a strong normative principle in monetary theory and policy. The positive narrative on CBI is continuously reproduced in mainstream academia and politics. In September 2017, the ‘gains from independence’ were

1 End of 2012 Reuters reported on a worldwide growing pressure on CBI. Well-known economists, like Stiglitz, harshly criticized and rejected CBI; in several countries, from Japan to Turkey, CBI was challenged by governments (Şener 2016). The controversy reached a temporary peak in 2015, after the ECB blackmailed the Greek government to endorse austerity, by triggering a bank closure (Varoufakis 2017).

2 affirmed by politicians and economists at a commemoration of the 20th anniversary of the independence of the Bank of England and respected economists remain warning that ‘taking it [CBI] away would open the door to higher future inflation’ (Issing 2018, 30).

In order to advance the re-emerging debate, this chapter seeks to answer the question why CBI gains so much confidence in today’s political economy by focussing on the conjunction and mutual contingency of CBI and the neutrality theory of money (NTM). The latter states that money can be conceived as a neutral means of exchange, which has no lasting real impact on the economy. I will argue, that the paradigm of an independent and depoliticized monetary policy builds on the normative propositions of the NTM. Following the heterodox critic of neutral money, I will claim, that the theoretical foundations and conceptual roots of CBI are controversial and its political economic narrative is shaky. Neither money nor central banks can ever be impartial in political economic sense. This chapter reflects on recent debates and presents a non-technical discussion of the conceptual flaws of CBI and NTM, with an interdisciplinary look on elaborations from economics and economic sociology. Especially post-Keynesian as well as more radical approaches, question the conventional wisdom on CBI and NTM. Their case got some new evidence after the GFC.

The first section illustrates the concept of CBI and main theoretical arguments. Section two elaborates on the conceptual and meta-theoretical propositions of money neutrality. It examines the classical dichotomy and the Quantity theory of money, which construe the basic theoretical approach and framework for the NTM, and outlines the heterodox critic of the mainstream perception of money neutrality. Section three elaborates on the relation between CBI and NTM. The last section briefly concludes and explains why we need more pluralism in economics teaching on money.

The Case of Central Bank Independence

‘Capitalism is characterized by several related antinomies and contrasts, basic dualities that resemble the ancient paradoxes of Hellenic philosophy. Of these dualities, the most important are the distinction between politics and economics and the separation of the real from the nominal.’ (Nitzan/Bichler 2009, 25) A central bank is generally described as independent when formal channels for political influence on monetary policy have been cut. In such a case, the central bank takes no instructions from government or parliament, and monetary decisions are conducted only by a monetary policy

3 committee, which is an expert decision making body lead by the central bank governor. Accordingly, an ideal case for CBI is given, when a government does not interfere into monetary decisions, such as setting reserve requirements and interest rates, undertaking open market or foreign exchange operations.

The conventional way of establishing formal independency is to implement three constraints on monetary policy. First, to amend the central bank law by including an independency article into the bank statute, which legally forbids political interference - the so called de jure independence. Legal provision is flanked by a redefinition of the room for manoeuvre of monetary policy, which prioritises targets and instruments. Therefore, the second constraint addresses the mandate of the central bank and its goals. Price stability is declared as the primary objective of monetary policy. As a consequence, all other policy objectives are downgraded as arbitrary or secondary. A third constraint exists in a ban of monetary financing of public budget deficits. This has been legally secured by a prohibition of direct purchase of government bonds from the treasury, which is described in the literature also as ‘money printing’.2

Today, the case on CBI is a highly specific issue and a popular subject of interdisciplinary research in mainstream as well as in heterodox political economy. CBI is theoretically explained with several economic arguments (Cukierman 2007, 17), as well as a set of political motives (Maxfield 1997, 12). Scholars from different backgrounds elaborate on theoretical and empirical questions, different models and on the limits and prospects of CBI (Baimbridge et al. 2001, 122ff). In this regard the question under which specific political economic circumstances governments respect CBI, and under which they try to circumvent it become important. Recent research has been focused on the effectiveness of communication strategies as well as questions on accountability, legitimacy and transparency of independent central banks.

Many economists regard the 1990s as the heydays of CBI. Nevertheless, the issue is older and was raised by prominent figures of classical political economy, like Ricardo, Bagehot as well as later

2 It is not the aim of this article to dwell into the institutional features and details of independent central banks. A broad literature exists on the formal aspects and grades of independency, in which it is differentiated between institutional and functional independency, or further distinguishing between goal, policy, instrument (operational), personal and financial (economic) independence. For a review of the literature on CBI see Debelle/Fischer (1995), Eijffinger/Haan (1996), Fuhrer (1997), Forder (2001). For a critical elaboration of the literature on CBI see Şener (2016).

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Keynes. One of the first systematic arguments were put forward by followers of the Neo-Austrian School, who argued for CBI by relying on the axiom of ‘institutions interferes’. Their prominent representative Hayek wanted ‘to abolish an active monetary policy’ (Kindleberger/Aliber 2005, 86) and claimed, that the main reason for economic crises lies not in market dynamics, but, sui generis, in government intervention (Hayek [1976] 1990, 131). His core demand was the abolition of the ‘government monopoly of the issue of money’ (ibid. 14, 101f). Nevertheless, since Hayek regarded his claim as unrealistic, he conceded to the idea of an independent central bank (ibid. 121f).

The next generation of theoretical explanation emerged with New Political Economy and Institutional Economics. In this literature the conceptual notion shifted away from ‘institutions interfere’ to ‘institutions matter’, without abandoning the case for independent monetary policy making. CBI was advocated with new theoretical arguments and concepts, ranging from political business cycle, , to agency and behavioural theory (Forder 2004, 156; Şener 2016, 40f). Especially the so called time inconsistence problem became a popular argument under economists, and was put forwards to take away public control of monetary policy and gain a credible monetary policy (Kydland/Prescott 1977).3 This research strand follows the idea, that politics as well as democracy is ‘dysfunctional’ in economic terms (Forder 2004). When it comes to explain monetary policy, political objectives are termed as external and short-sighted interferences (Eijffinger/Masciandaro 2018, 2) and ‘politicization’ is regarded as an obstacle to price stability. This conclusion builds on the conviction that a sound monetary policy would not distort the real fundamentals of an economy.

The common denominator of old and new reasoning for CBI rests on three assumptions. First governments (politics) are prone to inflation, this has been called inflation bias in the literature; second, CBI depoliticizes monetary policy, transforming central banks to agents who are not inflation prone; third, CBI improves economic performance, which can be considered as the strongest argument. Latter builds on a further set of monetarist propositions. First, CBI serves low inflation, which is considered as an economic goal sui generis. Second, there is a certain level of unemployment, the so called natural rate of unemployment (NAIRU), which remains unaffected by monetary policy. Discretionary intervention would only lead to price increases without a

3 See Daunfeld/De Lunay (2008) and Bibow (2010) for a critic of time-inconsistency problem.

5 sustainable long-term positive effect on NAIRU. Third, CBI poses no adverse effects on economic output, i.e. no negative repercussions on employment and growth. This claim has been termed free lunch (Cukierman et al. 1992, 377f).4 Therefore, CBI is not only considered to be an institutional commitment and credible way to price stability but also a felicitous economic strategy, a conditio- sine-qua-non for ‘macroeconomic stability and financial stability’ (BIS 2016, 22). Last, in recent years it is claimed that CBI would also be beneficial for distribution effects in terms of inequality.5

Heterodox scholars have a much more sceptical approach to CBI. Independent monetary policy making is explained with concepts of ‘blaming’ (Epstein 2009, 69), ‘decoupling’ (Huffschmid 2002) and ‘privatisation’ of monetary policy (Mellor 2016). According to Watson, CBI was introduced ‘to provide a policy making context that tied the hands of governments by creating an external enforcement mechanism for counter-inflationary policy’ (2002, 190). One motive was to externalize monetary policy capacity to open the way for a restrictive monetary policy and moderate ‘popular pressure’ for wages increases (Bonefeld 2001, 90; Burnham 2001, 134). Burnham describes CBI as ‘politics of de-politicization’ and Bonefeld as the ‘politics of tied hands’, hinting at a neoliberal core and distributional effects of CBI. Another argument was that financial globalization triggered the shift to CBI, because vulnerable countries depending on international capital flows saw it as a way to gain monetary credibility (Maxfield 1997). These studies criticized CBI for its restrictive monetary policy message and austerity supporting practices, and rejected the argument that it would pose a free-lunch and neutral monetary policy. I shoved elsewhere, that monetary policy, irrespective of the formal independency of the central bank, can only have a ‘relative autonomy’ from politics and economic policy of governments (Şener 2016).

4 For a critic of the free lunch hypotheses see Şener (2016, 58ff). 5 This can be seen as a reaction to growing criticism over rising inequality. In his forward to the ECB Annual Report 2016, Mario Draghi stressed that independent monetary policy making ‘has positive distributional effects by reducing unemployment, which benefits poorer households the most. After all, bringing people into a job is one the most powerful drivers of lower inequality (https://www.ecb.europa.eu/pub/annual/html/index.en.html, accessed 1.3.2018).

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The Neutrality Theory of Money

‘The relations of commodities to one another remain unaltered by money; the only new relation introduced is their relation to money itself; how much or how little money they will exchange for; in other words, how the Exchange Value of money itself is determined. In this model money is just a neutral translator.’ (Mill [1848] 2009, 147) The relation between money and economic activity is one of the oldest questions that occupies the economics discipline and is even considered as the starting point for economic reasoning. In economics a neutral money means, when money that does not secularly increase and support employment, production or other productive activities (Asensio 2015, 366). Under such a perspective, money is understood mainly as a technical device, a ‘neutral translator’ (Mill), that facilitates exchange. In monetary economics the NTM finds it pendant in a neutral monetary policy and the concept of a neutral real interest rate, which is attributed to Knut Wichsell, who used the term natural rate of interest (1898). Monetary policy is described as neutral when it ensures mid- term constant inflation or price stability (Blinder 1998: 33). Theoretically this concept finds its expression in the (steady state) IS-Model, which displays different scenarios for the relation of real interest and output level (Sener 2014).

Usually the economic argument for NTM is construed with the concept of absolute and relative prices. While the former addresses the relation of commodities and money, expressed in nominal absolute prices, the latter describes the relations between commodities, calculated in relative prices. What economists understand under the neutrality of money is simply the notion, that monetary dynamics don’t change relative prices. This model has been established with the classical dichotomy, which sets the epistemological stage for the neutrality argument. This section elaborates on the qualitative and quantitative aspects of the NTM. We start with the meta- theoretical dimension

‘Classical Dichotomy’ and Money ‘And why this insistence on ‚neutrality‘? The reason goes back to David Hume‘s ‚classical dichotomy‘. (…) political economists follow this dichotomy to separate the ‚real‘ and ‚nominal‘ spheres of economic life. Of these two, the ‚real‘ sphere of production, consumption and distribution is considered primary; the ‚nominal‘ sphere of money and absolute prices is thought of mostly as a lubricant, a mechanism that merely facilitates the movement of the ‚real economy‘. And since money prices are ‚nominal‘ and therefore do not impinge on the ‚real‘, their overall inflation (or deflation) must be ‚neutral‘, by definition.’ (Nitzan/Bichler 2009, 368) The first step to neutralize money is establishing an analytical approach, known in the literature of political economy as ‘Classical Dichotomy’ (hereafter CD). This procedure persists in a division

7 of the economy into a real and a monetary sphere and construing two types of analysis, a real and a monetary analysis. This is what Nitzan and Bichler describe as the ‘second duality’ of modern (neoclassic) economics. Under this duality money exists as an epiphenomenon of the economy; while it displays nominal prices it does not express the real value of things. Latter is ascribed only to real analysis. In Schumpeters words, it ‘proceeds from the principle that all the essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them.’ ([1954] 2006, 264) Under such a perspective money is perceived as thing, a ‘technical device’ (ibid.), that serves the real economy This has two fundamental implications. As long as money follows its basic functions, playing its preassigned role, it is neutral and the real economy works ‘normally’. The message is straightforward, money can be analytically neglected in such an analysis of an ideal economy, which is understood here as barter (ibid.). Only in the opposite case, when money affects overall exchange relations it is a non- neutral source of disorder.

The so called real analysis, which emerge with the CD, is the central theoretical pillar of neoclassic economics, but the notion had been taken up before by classical political economists, who described money as a veil.6 The technique of real analysis implies that we can grasp a capitalist economy as a nexus of different markets and spheres, characterized by barter. On the one side we have the markets for inputs and outputs of production, which are labeled as real variables determined only by real factors. In this real sphere of ‘moneyless markets’ (Ganßmann 2012, 16), demand and supply, mediated through competition, leads to adjustment of real factors and goods markets, e.g. labor and capital market dynamics are determined by real wages and interest rates. On the other side there are the separate markets for money and finance, the monetary sphere. Money exists in this parallel universe and is supposed to have its own independent determinants, unlinked and unrelated to the real markets. In this economic model, every market follows its own distinct and unique principles and rules (Schelkle 1995, 22).

6 Ingham points out that the theoretical idea even goes back to antique Greek and Aristoteles who formulated that ‘the purpose of economic activity should be in gaining of utility through production and exchange. Money should be no more than a neutral medium for the attainment of this end’ (Ingham 2004: 199).

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The core proposition of real analysis is that the dynamics of real factors ‘do not depend on the quantity of money involved in payments. Hence, neither equilibrium quantities nor equilibrium relative prices involve money.’ (Asensio 2015, 366). That implies, as mentioned above, that nominal monetary prices don’t express real value. It is only relative prices which counts as real value and hence consulted for real economic analysis. Real values and quantities are determined on commodity, capital and labor markets, and as stressed by Marshall, by ‘factors such as production techniques; organization of business; the quantity and quality of labor, land, and capital; the social and political security of the citizenry’ (Humphrey 2004, 4). Money markets and monetary dynamics have no say in such an ideal economy.

This approach represents a neoclassic ‘stylist conception of a simple trading economy’ (Ingham 2004, 16) which narrows money to a dual state of absent presence. Despite the fact that we live in a time where money is omnipresent and we got confronted with money on daily basis, the most popular economic theory and its models can prevail by analytically excluding it. Consequently, money is absent in the founding models of neoclassic economics, the famous ‘Walrasian-Arrow- Debreu’ Model (Ingham 2004, 8; Rogers 2014, 303). Money is just perceived as a ‘means to facilitate transactions that can just as well take place in the absence of money’ (Ganßmann 2012, 14). Therefore, neoclassic theory has been described as a theory of perfect barter, where there is no reason for money. This holds also to newer versions of the standard model, the new classical, real business cycle and new-Keynesian models, where money has to be neglected (Rogers 2014, 301). All economic decisions, whether supply or demand, are taken on the basis of relative exchange ratios, not nominal absolute prices.7 Moneys main task in the standard models is to express and calculate real exchange rations, i.e. relative prices, and translate them into nominal money prices (Ganßmann 2012, 16).8

7 According to Rogers, this poses the core of the inconsistency of all mainstream models. All relative commodity prices, i.e. the real exchange ratios, are provided on the spot in an ‘time-0 auction’ (2014, 303). He argues that an introduction of money into the models even results in a loss of efficiency of barter, which contradicts one of the basic insights on the reason of money (ibid. 305). 8 Hajo Riese explains that the classical dichotomy goes back to Alfred Marshalls distinction between ‘principles and money’ (1995). He adds that the separation represents also a division between a theory of value and money as well as explains the separation of micro and macroeconomics (ibid. 46). Modern Macroeconomics, according to Riese, somehow integrated money theory and theory on income, therefore bringing money and commodities together, as Keynes claimed. But the theory of value is strictly banned into microeconomics, where money is absent (ibid.).

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The Quantity Theory of Money

‘[QTM] is a condensed formalization of the concept of the neutrality of money, which was strongly rooted in classical economic thought. Thus, prior to Keynesian monetary theory, money was considered as a veil cloaking real magnitudes without influencing them.’ (Mastromatteo/Tedeschi 2015, 419) A second step in construing the NTM consists in formulating a mathematical description of the nexus of money, prices and economic activity. The causality and interdependency between these magnitudes is expressed in the ‘exchange equation’ which depicts the quantity theory of money (QTM). The QTM has two basic conclusions: first, money and prices are positively correlated; second, there is no essential relation between money and economic activity. The initial mathematic equation, M·v=P·T, with the quantity of money, M, the velocity of money, v, the general price level, P, and the real value of aggregate transactions, T, goes back to Irving Fisher (ibid.). Later versions varied in the theoretical explanation of the proportional relation between money and prices and introduced other variable (Şener 2014). For our purpose it is suffice to look on a reduced version of the equation: dM=dP, since the remaining variables of the equation are usually taken as constant according to the NTM. The basic message of the QTM can be described in five core propositions: money-to-price causality and eqi-proportionality, the absolute/relative price and the short-run/long-run dichotomy, and the exogeneity of money (Humphrey 2004, 2). All propositions are criticized by heterodox economists.

The economic argument behind the QTM, namely that ‘abundance of money makes everything more expensive’ Cantillon (2010[1755]: 148) dates back several hundred years. The emergence of this insight has a long history and was first noticed by the Salamanca School (Navarro and Molina), and shortly later by Jean Bodin (Screpanti/Zamagni 2001: 29), who is considered to be the discoverer of the QTM (Schumpeter [1954] 2006, 296).9 The so called ‘Cantillion Effect’ describes that prices do not move in accordance and in proportional to a general increase of an aggregated money, as the QTM suggests. This emphasizes that price movements depend on how, where and by whom, as well as under which political economic circumstances money is spend (Cantillon [1755] 2010, 155f). Under conditions of real competition, we can observe that not all prices increase at the same pace. Only in a model of a total social planner, where all prices are controlled

9 These figures draw on historical experience with the so called ‘Price Revolution’, between the 16th and 17th century in Western Europe.

10 simultaneously, this would occur. However, uneven dynamic and development of productive forces is one of the basic features and ends of competition, and Nitzan and Bichler observe, that uneven price developments represent not a bias or distortion, but a normal functioning of capitalism (2009, 369). Their argument is, that price differentiation is not just an essential feature, but the condition in capitalism to prevail in competition and survive. Price changes at different speeds result in asymmetric and uneven development and have non-neutral economic outcomes.10

The temporal division of monetary effects in non-neutral short-term and neutral long-term by mainstream economists, has been fundamentally rejected, especially, by post-Keynesians (Rochon 2001, 292), not to mention the super-neutrality of money view of rational choice theory. The argument put forward is, that there is no reason why a long-term period cannot be understood as a consecutive chains of short-term events, which raises the issue of path dependency of economic developments. Therefore, there is also no reason why short-run non-neutrality cannot be extended and interpreted as long-run non-neutrality as well.

A further heterodox critic addresses the direction of causality in the quantity theory. Mainstream economists read the quantity equation from ‘left to right’, which means that money is conceptualized as the independent ‘explanan’ and prices as the dependent ‘explanandum’ in this causal relation. Heterodox economists, post-Keynesian as well as Marxists read the equation in the opposite direction, from right to left. Marxists economists acknowledge that the emergence of credit relations creates a higher need for cash (Shaikh 1980, 224). Marx himself concluded, that it is the sum of prices of commodities circulating, and the average velocity of money which determine the quantity of money, not the opposite way, as the quantity theory suggest (Marx [1887] 2015, 82). Marxist economists also emphasize that if credit growth increases effective demand an expansionary impact on production capacities would occur, which does not necessarily lead to inflation, because productivity gains can not only thwart inflationary pressure from the demand side, but can also cut prices due to improved supply side effects (Mattick 1980, 177).

10 Mainstream economists know quite well that in reality prices don’t increase simultaneously. This has been investigated in new-Keynesian Theory with the concept of menu-cost and imperfect competition, which tries to explain ‘price rigidity’. Price changes, as deviating from equilibrium prices, are declared as temporary fluctuations and explained with shifting consumer expectations and preferences as well as technological shocks or raw price volatility (Mankiw 1998). But it is claimed that these changes don’t result in inflation (Nitzan/Bichler 2009, 370), while distributive effects have been described as random (Şener 2014, 57).

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Post-Keynesians read the quantity equation from right to left, due to their notion of the endogeneity of money, which opposes the exogeneity view of money. The rejection arises from a more comprehensive understanding of what constitutes modern money and the fact that money cannot be reduced to coin or paper issued by the state. The focus lies especially on credit (fiat) money, that is created by banks and non-banks in the course of expanding credit borrowing and financialization. Minsky stresses that moneys main relevance is not its function as a means of exchange, but its constitutive role in the credit system and financial structure of capitalism, money ‘is a type of bond that arises as banks finance activity and positions in capital and financial assets.’ (Minsky [1986] 2008, 250).

Both theoretical schools do not conceptualize a capitalist economy as barter, but as a monetary production system in which money is endogenously created (Wray 2003, 264). Such an economy cannot be correctly described as a C-M-C’ cycle, where commodities (C) exchange each other via money (M), since the primary aim of capitalist activity is about realizing monetary profit, not collecting commodities (C’) in the end. In a capitalist economy, money is needed a-priori before any production can carried out (Bellofiore 2011, 321). This has been depicted by Marx’ known formulation of M-C-M’. In contemporary terms, an investor needs financing, mostly credit-money (M), in advance in order to be able to buy the factors of production, labor and capital goods, and produce commodities (C). The output then must be sold for more money (M’). Therefore, money stays at the beginning of the production cycle. This implies that the availability of money is an essential feature of capitalist production and affects real factors, such as ‘labor-force participation, immigration, population growth and, to some extent, labor productivity.’ (Hudson 2009, 56), from the very beginning. In this sense it is perfectly clear that money cannot be neutral (Bellofiori 2011: 321). 11

This leads us to the question how money is created and enter the economy? Post-Keynesians explain money supply not as a magnitude that is exogenously and independently set by a regulator. It is rather created endogenously through economic activity and demand for finance, which is translated into credit borrowing. When banks grant loans they create money, vice versa, when

11 Wray shows that the endogeneity of money perspective was already present in Marxist and later in circularist theory literature (2003: 264). Rochon emphasizes that Joan Robinson pioneered the post- Keynesian theory of the endogenity of money (2001: 304).

12 loans have been paid back, money disappears. In a fractional reserve system, banks do not even need (cash) money to lend, as Minsky famously formulated ([1986] 2008, 256). This explains why banks have such a constitutive role and political power in today’s monetary economies; they can privately produce money (Mellor 2016, 6). The credit they grant is accepted as money. Credit money becomes money, when states, i.e. the central bank accept it as money, and back the deposit accounts of the banks (ibid.). In a system of fractional reserve banking, where only parts of deposits are backed by money, there is no principle barrier for credit. This is why credit expansion is such a complex phenomenon under competitive capitalism, and historically repeatedly source of crises.12

Central banks usually accommodate the demand of money from banks. This means that the credit process is not under the full control of the state or the central bank, as the exogeneity view of monetarists suggests.13 Wray comments: ‘The mainstream view that central banks control the supply of money hides the fact that banks are essentially retailers of credit, not portfolio managers. Banks sell credit, and create deposits in the act of making loans. Like other retailers, the quantity of credit they sell depends on demand.’ (Wray 2003: 118). Central banks usually try to regulate this credit accommodation process, by employing interest rates or reserve requirements. But there is growing consent in the economics literature, that central banks cannot fully control this process, especially as over the last decades new forms of credit money issued by banks and non-banks entered the money markets (Lapavitsas 2001, 207).14 The endogenous money theory locates the creation of money in the real process of investment and production, emphasizing that it is demand and credit driven (Rochon 2001, 300) This leads us to the macroeconomic insight, that the supply

12 The debate on the quantity theory can be understood as a continuation of the historical controversy between the banking and the currency school. The former one sees prices determining the money supply, while for the latter the money supply determines the price (Dymski 2006, 54). 13 While mainstream economics explained credit creation with loanable founds theory, post-Keynesians presented a reverse explanation in the matter. Savings are not the cause, but the ends of a capitalist production cycle. This goes back to Keynes theory of effective demand, and the rejection of the Say’s Law (Hein 2005, 139). 14 Today mainstream economists accept different forms of money; the existence of several monetary aggregates (M1-3) document this. Mainstream theory also accepts that the state has limited control over monetary aggregates, expect high powered money M0. Some heterodox even say that the M0 highly depends on economic activity, whether productive or speculative nature (see Fontana/Palacio-Vera 2006: 50). Every credit granted increases the quantity of money.

13 and demand for money as well as the monetary and real sphere are interrelated (ibid. 292). As a result, the CD between the real and the monetary sphere became obsolete.

The neutrality theory of money and central bank independence

‘Money is political and any attempt to de-politicize it is even more political.’(Varoufakis 2014)15 The NTM and the QTM are is part of this liberal paradigm, and provide an ideal type explanation of money and its repercussions that fit market equilibria. The orthodox conception of money has its roots in the Walrasian type of general equilibrium theory (Ingham 2004,18). In order to make the equilibrium model work, i.e. markets clear all the possible exchange in an economy, money has to fit into it. Therefore, both theories present a theoretical case, in which money is construed as a neutral technical device, neglecting all other functions of money, as a store of wealth, as a means of final payment and as capital. But the problem lies not only in this narrow view and certain form of abstraction, but in the core assumption, that money is neutral and indifferent towards relative prices. This leads to an analytically misleading procedure that produces contradictory results.

The problem of the NTM and the QTM is that there is no economy in the theoretical explanation and equation. Streissler describes this theory as irrelevant and useless: when central economic issues such as nominal contracts, capital accumulation and income distribution is just overlooked, and all supplies and production capacities are taken as constant (Streissler 2002, 78f), we no longer engage in analyzing and describing a real market economy, but in creating an imaginary world. From a political economic perspective, it has to be added, that the NTM serves to ignore distributional effects of monetary changes. Money can only be regarded as neutral if ‘all changes in the nominal quantity of fiat money have to occur by varying the individual’s initial money holdings in the same proportion as changes in the stock of money’ (Mastromatteo/Tedeschi 2015, 420f) - a very strong assumption, that is highly unrealistic.

Money is neutral in so far, that it helps to make the division of labor work and enables the exchange of goods and services in an efficient manner. Schelkle emphasizes that this type of thinking leads to a paradox, because it turns money into a not negligible condition for the circulation of

15 Lecture at Berkeley in 2014.

14 commodities and goods, and exchange could be settled theoretically ‘without money’ (Schelkle 1995, 22). The NTM is neither a convincing analytical theory nor a discovery of a natural economic law (of money), but rather a normative assertion, a wishful thinking of the orthodox story of money (ibid.). Even Hayek confess that the NTM is a ‘is a wholly fictitious picture to which nothing in the real world can ever correspond.’ ([1976] 1990, 67f) It’s a necessary condition in order to trace the value of commodities back to the interplay of subjective preferences (Ingham 2004, 66).

But money is not just economically non-neutral, it is also in socio-economic sense a highly non- neutral device (Ingham 2004; Mellor 2016). This has been an established fact in economic sociology for a long time.

‘Money allows you to overbid and undersell, grant or refuse credit, withdraw your resources from a project, speculate, place your bets on innovation, punish and so on. Many of these moves create or react to unforeseen circumstances and have unintended consequences. That implies giving up the idea that money can be ‘neutral’, that is does not affect the play of ‘real’ activities underneath the ‘veil’ of money.’ (Ganßmann 2012, 16) The questions of why only certain people have access to money, under which circumstances, and what happens to those who lose their access to it, are usually ignored in mainstream economics. In advanced capitalist societies the access to the means of living is mediated and regulated almost exclusively via money. This is by no means a trivial insight, since it poses a question of life and death. The centrality of money to social provisioning makes monetary policy a highly relevant social, political and economic issue. Heterodox political economy does not abstract from the ‘social role of money’. 16 Since central banks have a constitutive role in a monetary economy, their mandate, priorities and implementations are of crucial importance to scholars of political economy, who focus on real questions of production and distribution of wealth. This brings us to the question of CBI and its relation to NTM.

The case for CBI is rooted in the neoclassic methodology of separating politics from economics. The theory of perfect competition suggests that economic forces look after a proper functioning of market relations. Politics is regarded here as an external factor. If politics stays out of economic and monetary policy, then competitive market forces bring out optimal and efficient equilibria in

16 The dominant role of money in capitalism was stressed by heterodox economists like Marx, Veblen and Keynes, who all pointed out that the main objective of a capitalist economy is not about satisfying needs, but appropriation of money wealth, which is why it is best understood as a monetary production economy (Jo/Todorova 2017).

15 all markets. In this story line, political intervention is accepted only in exceptional cases, and only temporarily. The same idea has been applied to money. If inflation is only a monetary phenomenon that occurs due to an oversupply of money over output, it must be due to ‘unsound’ monetary policy, which is explained with motives of politicians and governments and their interventions into monetary policy. In order to function properly, money has to be kept out of political considerations. After the source of irritation is identified, the remedy is close. The influence of politicians must be curtailed in order to enable sound monetary policy. This can be done, so the claim, only when monetary policy is freed from direct political interference and central banks are independent. An independent central bank with a primary price stability mandate is seen as an effective monetary regime to prevent fiscal profligacy as well as a discretionary monetary policy. In contrast, heterodox economists emphasize that the effects of institutional independence of central banks are mostly exaggerated and misplaced (Lapavitsas 2001) and ‘a central bank can never have complete control over money supply, irrespective of the extent of its independence’ (Watson 2002, 188).

The GFC led to a partial shift in the discourse on CBI. Proponents of CBI re-interpreted discretionary and expansionary monetary measures not as a weakness but this time as a pro argument for independent monetary policy making, especially in the case of the ECB. There are also other indicators and predictions that unfettered central bank independence might lose its hegemony in future due to implications of the crises of financialization. Due to recent involvements of central banks into macroprudential supervision and financial stabilization, some authors describe this engagement as a weak point of CBI, and even forecast an end of institutional independence (Goodhart/Lastra 2018, 20). Another recent development indicates that this shift of attention started to affect the dogma of CBI and may not be limited to rhetorics. The central bank of New Zealand recently promoted sustainable employment as an equal target of monetary policy, beside price stability. According to the strict rules of CBI, a double mandate represents a weakening of independency, since it became a political issue which ends should be prioritized in practice. Whether we can speak of a trend reversal towards a re-politicization of monetary policy in a progressive way, which might challenge the dominant paradigm, remains to be seen.

Conclusion

Independent monetary policy making continues to be seen as an optimal institutional setting for economic policy. But CBI does not mean a de-politicization of monetary policy. This is as Frieden

16 underlines ‘a meaningless chimera’. In this chapter, I argued, that the NTM serves as a theoretical reference to justify the de-politicization of money and respectively of monetary policy. If money has no economic impact, as it is claimed, then there would be no reason for the state to engage actively with monetary policy (Hudson 2009, 59f) and central banks could be given independency. I demonstrated, how money is theoretically conceptualized as a neutral medium and shoved the flaws of such theory efforts. A main point of the heterodox critic is, that the monetary sphere, i.e. the banks and the credit money system, is not off but in the center of the capitalist mode of production (Rochon 2001, 291; Hein 2005, 164f). For realistic analysis of the economy, the so called real analysis approach, based on the classical dichotomy as well as on the conventional insights presented by the quantity theory of money, are not suitable.

The heterodox analysis considers money as a non-neutral production force (Minsky), which is socially and politically construed and therefore constitutes a social relation (Ingham 2004, 58). You cannot really analyze political economy, while abstracting from the most critical and omnipresent factum of economic life, and treat money as a neutral, unpolitical and economically ineffective epiphenomenon. To overcome such a narrow understanding of money, pluralism in economics teaching is necessary. In order to grasp and understand the implications of the non- neutrality of money, the curriculum on money has to consider heterodox monetary theories, and insights from post-Keynesian, (post)Marxist and from economic sociology of money, which were addressed in this chapter. Only then students and scholars will gain a thorough understanding of recent political economic developments and crisis, how money and monetary policy has evolved over the last decades and assumed their present shape. Thus a wider pluralist and interdisciplinary perspective would surely help us to deal with contemporary and future contradictions of money and monetary policy.

There is reason to be optimistic in this sense. In recent years the controversy on the social value of money, monetary policy and CBI has reemerged. Especially younger economists seem to focus more on theoretical arguments and models, that partially overcome the dichotomy between the real and the monetary sphere, without leaving the neoclassic basic framework. New scenarios are discussed, which include the insight that money and fiscal policy matters and where the interrelation between the monetary, financial and the so called real sphere is acknowledged. This new attention can be interpreted as a reaction to growing critic and the developments in the aftermath of GFC, where it become obvious that money has fundamental effects not only on the

17 financial but also on the real sector. In this regard mainstream economists can learn from their heterodox colleagues, also methodologically, who already display a remarkable and substantial record on this issues.

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