Nearly a year and a half ago I wrote a post about encouraging
dialogue between economists and other social scientists. I concluded
with the following three paragraphs:
“Let
me take a real world economic problem: the response to the financial
crisis. Some have suggested that banks have become too large and need
to be broken up, or that the activities of high street banking need
to be separated from the activities of the casino. Your economic
analysis tells you that networks of many small entities can be as
subject to crises as networks involving a few large banks. You are
also able to devise a system of Chinese walls that mean that the
activities of the casino can be separated from those of the high
street even within the same company, and your political masters seem
to prefer this approach. You recognise that different assets differ
in their liquidity, and so you devise complex weighting algorithms
for computing capital ratios. Your suggestions form the basis of
negotiations between officials and bankers, and a set of rules and
regulations are agreed.
Over
the next few years you watch in dismay as your complex system begins
to unravel. The CEOs of the large banks seem to constantly have the
ear of politicians, who in turn gradually compromise your elaborate
controls to render them less and less effective. Those in charge of
administering the rules find it much more lucrative to work for the
banks, and so regulators gradually lose expertise and resolve.
And
you realise that right from the start you made the wrong choice. You
decided to focus on what you knew, which was how to design systems
that worked well as long as those systems remained unchanged, but
which were not robust to intervention by self-interested parties. In
short, they were too open to rent-seeking. You realise that actually
the best thing to have done was to break up the banks so that their
political power was forever diminished. And you recall a conversation
with your social science colleague when this all started, who might
have been trying to tell you this if only you had understood the
words he was using.”
I was afterwards asked whether I had one particular UK economist,
John Vickers, in mind when I wrote this. He chaired, at the
government’s request, a commission on banking reform. He has become
increasingly vocal
about how his original commission’s proposals (pdf)
are being watered down and how the Bank of England appears to be
putting public money at risk once again. (For his detailed
assessment, see this paper.
And here
is what another commission member, Martin Wolf, thinks about the
financial sector. Adam Barber details
how the attitude of the UK government has changed. In the US this very issue became an important point of difference between Clinton and Sanders.)
The honest answer is that I did not have him in mind. It was a
fictional account designed to make a point, and so I took elements
from different debates which together apply to no one country or
individual. The point is that in finance good reforms are those that
can best resist political or economic manipulation by banks, and
perhaps economists in general have been slower to see that than some
of their colleagues in other social sciences..
It would probably be fair to say that before the financial crisis
economists got on pretty well with the financial sector. There was a
common interest in monetary policy (although the motivation for that
interest might have been different) and the sector was a useful
source of funds for conferences and (for a few) consultancy. Most
economists did not look too hard at what the financial sector was
actually doing, although those that did often raised serious
questions. Behind this nice piece
by Ben Chu is an army of academic research which suggests that fees
paid to manage funds are a waste of money.
The situation changed after the financial crisis, for obvious
reasons. Since then economists have increasingly questioned whether
the whole business model behind banking is sound. In particular they
have questioned
why banks should be so different from other companies in terms of the
amount of equity capital they hold in relation to their assets. These
economists include
the previous governor of the Bank of England, Mervyn King. They have
also questioned
whether one of the side effects of current regulation is to maintain
the monopoly power of big banks.
If all that was not bad enough, we have the influence that the
financial sector has on monetary policy. Mainstream macro has put a
lot of emphasis on the importance of day to day monetary policy being
independent of politicians, and far too little on it being
independent of the influence of finance and bankers. Paul Krugman has
talked
about the links between interest rates and bank profits and how that
might ‘guide’ the views of bankers. If you want to see a clear
case of that, read this
FT op-ed by David Folkerts-Landau, chief economist at Deutsche Bank.
The article could not be more wrong. The reason the Eurozone has
performed so badly compared to the US, Japan and even the UK is not
because of lack of structural reform, but because of the relative
reluctance of the ECB to stimulate the economy. Rates were raised in
2011, and Quantitative Easing delayed until 2015. The article is full
of hopeless lapses in logic. If there is any sense here at all, it is
that high unemployment is required as a political incentive to
undertake structural reform. So the ECB “has become the number one
threat to the eurozone” because it has allowed politicians to put
that reform off.
Here I can do no better than quote
Adair Turner. “Vague references to “structural reform” should
ideally be banned, with everyone forced to specify which particular
reforms they are talking about and the timetable for any benefits
that are achieved. If the core problem is inadequate global demand,
only monetary or fiscal policy can solve it.” In the Eurozone the
core problem is lack of aggregate demand, as below target inflation
shows.
Why this hostility from German bankers to low or negative rates? What
the author does not tell you is that the profits of German banks,
and the viability
of other parts of the German financial system, are particularly (IMF
pdf,
box 1.3) vulnerable to low rates. (For those that can access it,
Wolfgang Münchau in the FT provides
an excellent summary.) And also that the profitability of Deutsche
Bank is not great right now, as Frances Coppola notes.
In the UK or US if this kind of nonsense from bankers appears in the press it gets
a lot of kick back from economists - in Germany perhaps less so.
So who cares if economists have crossed swords with bankers? It
matters because finance gets away with so much partly through a
process of mystification. Mystification is how banks can perpetrate
widespread
fraud on consumers and businesses. When bankers say that being forced
to ‘put aside’ more capital keeps money out of the economy it
sounds plausible to many, even though it is completely false. (Admati
and Hellwig (pdf)
list 30 other similar false claims.) There is also a belief that
because bankers are involved in financial markets, they must know
something about how the macroeconomy works, a belief which the FT
op-ed shows is clearly false. In all these cases, economists can provide demystification.
If we are ever to cut finance down to size (metaphorically, and
perhaps also literally), economists are going to be vital in the
battle to do so.
