Seeking Stability

Central banking has been described as a “quest for stability” and with good reason. Nearly every major central bank today is charged with securing price stability. The Fed sees itself as responsible for securing price stability and maximum sustainable employment. The European Central Bank was created by the Maastricht Treaty in 1993 with a primary mandate to maintain price stability. The Bank of Japan “decides and implements monetary policy with the aim of maintaining price stability” which is important “because it provides the foundation for the nation’s economic activity.” And so on. Since 2008, most central banks have become responsible not just for securing price stability but financial stability as well. 

This commitment is not merely formal. Central bankers see themselves as doctors for the economy, charged with preserving the nation’s (or currency zone’s) economic health. As the former Governor of the Bank of England Mervyn King put it, “monetary or macroeconomic stability is like ‘healthy living.’”

Central bankers act to preserve the stability of the system, even when doing so requires massive structural changes to how they make policy or a revolution in how they model and conceptualize the economy. Their response to the global financial crisis made this particularly clear. Central banks like the Fed deployed a wide range of brand new and, in some economic circles, highly controversial policy tools aimed at preserving everything from insurance companies and banks to the Eurodollar market. This shift was solidified by the Fed’s choice to reopen and expand these facilities in the wake of the Coronavirus pandemic when the central bank deployed everything from an ersatz discount window for shadow banks to a junk bond buying scheme. All was done in the name of stability.

Securing macroeconomic stability, however, is becoming an increasingly difficult task. Persistent inflation, banking crises, and political crises have all come at a time when central bankers are less and less confident in their knowledge of how the economy or monetary policy actually work. As Jerome Powell put it, “we are navigating by the stars under cloudy skies.” 

Bagehot’s Dictum

Stability is foundational to modern life. Political theorists have long recognized the importance of stability to society. It was one of Hobbes’s great insights that people would enter political society so that controversies could be settled by the sovereign, thereby eliminating the constant threat to their lives posed by others in the state of nature. Achieving some semblance of stability, for Hobbes, was the root of political society. More recently John Rawls described a “well ordered society” as a stable equilibrium in which all citizens hold the same concept of justice, and society’s institutions conform to that conception. Discussing ancient Greek democracy Daniela Cammack argues that democracy was designed to sustain solidarity and thus stability of the political community over time. She writes, in contrast with the Greeks, “in modern states…coordinated and solidaristic mass action is more likely to be regarded as a threat to political stability than a preserver of it.”

While nearly all agree that stability is foundational to society, what exactly stability requires is less clear. We need to have a reasonably reliable understanding of what the future will look like so we can plan. Planning is essential for a functional society, not to mention a prosperous economy. Investment—in infrastructure, in business, in education—relies on our capacity to plan for the future. Stability contributes to our capacity to plan by offering a predictable future. As one Fed Governor put it recently, “price stability reduces uncertainty.” 

As politics, and especially democratic politics, are the means through which states change the world in which we live, it seemed intuitive to some that securing a stable financial and monetary system would require removing its governance from the political sphere. James Buchanan argued that stability is desirable for predictability and, as such, the best approach to monetary policy was one that was independent of politics at a constitutional level. Hayek agreed, writing that “our only hope for a stable money is indeed now to find a way to protect money from politics.” Advocates of just this view have promoted encasing democracy, thereby limiting its power over the economy.

While Buchanan didn’t get his dream arrangement, in which monetary policy was constitutionally independent and set by pre-determined rule, here we are, with independent central banks, insulated from day-to-day democratic politics that seek stability through the exercise of “constrained discretion.” Central bank independence is meant to facilitate a credible commitment to “good policy.” What constitutes “good” policy has changed over time. In the past, economists argued that good monetary policy would be the product of an insulated and constitutionally conservative central banker. As one scholar put it, “independence only guaranteed stability…if it was granted to a stable caretaker.” More recently, central banking has started to look more creative, even radical—intervening in markets, offering new purchase facilitates, backstopping international markets and more. What hasn’t changed is the driving intention: to preserve stability. 

Leon Wansleben describes central banks as “regime preservers” seeking to maximize predictability. Paul Tucker, the former deputy governor of the Bank of England writes, a “central bank has a special role in nurturing a stability-oriented culture in society.” As the Bank of England has itself described its current policy approach, “any asset sales would be conducted in a predictable manner over a period of time so as not to disrupt the functioning of financial markets.” In other words, don’t rock the boat.

The summary of Robert Hetzel’s recent book on the Fed puts it well, describing the central bank’s history as “the story of a century-long pursuit of monetary rules capable of providing for economic stability.” One such rule is known in central banking circles as the Bagehot dictum. First articulated by Walter Bagehot in 1873, the dictum is meant to guide the practices of central banks when they are acting as lenders of last resort. As Bagehot first put it, there are two rules for lending in the event of a panic:

First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it… Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them.

Or as one modern central banker describes it, “Walter Bagehot’s description of the ‘Lender of Last Resort,’ which (in essence) recommends stemming financial panics by lending freely, to sound institutions, against good collateral, and at rates materially higher than those prevailing in normal conditions.”

Bagehot encourages central bankers to lend freely in a panic to those who are willing to pay penalty rates and have good collateral because those are the firms who were solvent prior to the panic, and will be solvent after the panic, assuming the panic is nothing more than an irrational and random crisis of confidence. Bagehot writes:  

The great majority, the majority to be protected, are the “sound” people, the people who have good security to offer. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed.

In other words, Bagehot’s dictum asks central bankers to discriminate in their creation and allocation of credit between those who would have survived had the panic not ensued and those who wouldn’t have. If a panic is genuinely random then once it is staved off, underlying economic conditions should be the same pre- and post-panic. In that case, it makes sense for the state to protect firms that were solvent before the crisis, as they should be solvent after the crisis and the interim protection merely prevents society from suffering the transaction costs of rebuilding. 

According to Bagehot then, it is the job of the central bank to secure stability by preserving the macroeconomic state of affairs status quo ante. A (random) panic, in this view, is simply not an acceptable reason for a firm to suffer. Consequently, it is appropriate for the central bank to step in and prevent that suffering. The same reasoning persists today. In launching the Main Street Liquidity facility on April 9, 2020, Fed Chairman Jerome Powell said, businesses “didn’t close because of anything they did wrong. To the extent we have the ability to make them whole, we should be doing that as a society.”¹

Although it is presented and interpreted as a technical dictum that central bankers should apply in the case of a panic, Bagehot’s rule actually reveals something rather interesting and inevitably political. He suggests that central banks should only rescue firms that would have prospered, except for the random and unforeseeable circumstance of the panic, thereby preserving the “proper” macroeconomic state of affairs. But enacting this rule, securing stability through preservation, can have some rather odd and potentially perverse consequences. 

Bagehot in action

During the pandemic, the Fed opened up a panoply of emergency lending facilities to support the stability of the financial system. The industry that perhaps benefited the most from the Fed’s Secondary Market Corporate Credit Facility was the dirty energy sector. $432.1 million in Fed support went to the oil and gas sector directly, another $735.4 million was spent on the oil and gas sector via the Fed’s purchases of Exchange Traded Funds, some of which were rated as junk bonds. The Fed’s support of the market further fueled a private borrowing binge that enabled the oil and gas industry to raise $93 billion in newly issued debt. All this despite the impending climate crisis and the fact that the sector was financially floundering before the onset of the pandemic. 

Consider two examples: Diamondback Energy and Marathon Oil. In the wake of the Fed announcing its coronavirus relief efforts, Diamondback Energy issued $500 million in new bonds. $3 million of these were purchased by the Fed. The company spent $285 million in dividends in 2020, a 140 percent increase over 2019. In 2020 the company’s share price was 65 percent lower than its 2019 level. These trends are not independent of one another. A company can mitigate the negative effects of a dropping share price by increasing their dividend offerings. Investors may loose on share price, but the dividends compensate, ensuring shareholders break even, or maybe gain, despite the company’s poor performance. Diamondback Energy benefitted immensely from the Fed’s coronavirus relief efforts despite the fact that prior to the pandemic the company was “struggling mightily” with many fearing that it could fall into bankruptcy. Its net income was at an all-time low and net long-term debt at an all-time high. The borrowing the company was able to engage in as a result of the Fed’s actions, enabled it to kick the can down the road, “denying the eventual avalanche of debt payments.” 

Marathon Oil fired 2,000 people two months after it announced a $1.2 billion tax bailout from the federal government. It has paid $1.3 billion in penalties to the Environmental Protection Agency (EPA) since 2000. In the wake of the coronavirus, Marathon issued $2.5 billion in new bonds. $17.3 million were purchased by the Fed. In 2020, it paid out 11 percent more in dividends than it had in 2019 and its share price dropped 36 percent. Marathon is the thirty-third worst air polluter in the United States, has violated state emissions limits near Detroit fifteen times and once released 35,500 gallons of diesel into a river in Indiana. Prior to the Fed’s rescue efforts, Marathon’s share price has been in decline since 2018 and it had generally anemic financials with a net loss of $750 million in the second quarter of 2020.

Those who believe in the power of free markets see the Fed’s efforts to preserve as unjustified acts of market intervention. Those who see good reason for state intervention wonder why such intervention should be deployed in pursuit of preserving a status quo that is far from optimal—economically, socially, or ecologically. As one scholar describes it, “Today’s Fed officials are not aiming for radical change. They are trying to return to things as much as possible to the status quo ante, to the way things were before the summer of 2007. They are trying to preserve a system of globalized finance that their predecessors played a leading role in constructing and that imploded spectacularly fourteen years ago.” That being the case we must ask: why should we work to preserve that world? 

What are the alternatives? The Fed’s efforts in the wake of the coronavirus were merely one example of the larger trend in central banking: maintain stability by preserving, in other words, seeking stasis. But there are at least two types of stability: stability as stasis and stability as resilience. If secured, both forms of stability can deliver a measure of predictability. Stasis means tomorrow will look roughly like today, resilience suggests tomorrow will work roughly like today. Both assist in planning for the future. An institution that seeks stability as stasis aims to preserve a particular set of conditions—i.e. 2 percent inflation and the existing make-up of the macroeconomic environment. By contrast, an institution seeking stability as resilience is one that seeks to preserve the ability of citizens to plan, while allowing for the future to look different to the present. It means allowing things to change but ensuring they do so according to predictable, manageable processes. This is what democratic decision-making systems are designed to deliver. 

Stasis in crisis

Seeking stability as stasis, i.e. preserving, is limiting in two ways. First, because it limits the capacity of the state to make transformational change. If policymakers are focused on repairing rather than reforming then it’s hard to see how we can make the transformative changes required to address problems like climate change. In his recent book, Matthias Thiemann describes a tragic state of affairs in which central bankers recognize the need for structural change to the regulatory system to prevent financial crises but are unable to deliver it as they are not empowered to transform the system, but rather, merely to stabilize it.

Second, seeking stasis can (ironically) lead to volatility. Pursuing stability as stasis does not work when we are in a world that demands change. We have witnessed this in recent years both in the case of supply chains and in ‘populist’ politics. When the pandemic hit everything stopped. But it didn’t all stop at once. Countries shut down at different times, in different ways, and to different degrees. The global network of supply chains couldn’t handle it. We all became oddly familiar with the concept of the tanker ship during this strange period of life, watching from our closed-up living rooms as ports became bottle necks, bombarded with goods they couldn’t process fast enough, and then were left sitting empty for long periods of time. Our “just-in-time” supply chains were fragile. When the situation demanded they change, they couldn’t comply. The consequence was instability—in inventory, in prices, and in the delivery of essential goods. 

Many political systems are facing a similar challenge today in the form of “anti-system politics.” Anti-system political movements exist across the partisan spectrum. They are political movements organized around dissatisfaction with the contemporary political system, with the way in which politics is conducted, and in particular, with who holds the power. On the right, this tends to be cached out as a call to “take back control” and get rid of “experts.” On the left we see movements against corporate power, lobbying, and the influence of the wealthy. 

Attempts to preserve the stability of the political system by “sticking to the plan” or conducting “business as usual” have only made these political movements grow stronger. Stability, in this instance, is not served by an effort to preserve. If anything, attempts to do so are likely to lead to more radical volatility. If people cannot make their voices heard through the existing system, then it is no wonder we’re hearing louder and louder voices calling for the more radical notion of smashing the system altogether.

Stability as resilience: the political option

What would it look like to embrace stability as resilience rather than stability as stasis? How can we ensure that tomorrow will work like today, if not look like today? This is where a few thousand years of political theory can be helpful. Let’s return to Daniela Cammack’s point, “in modern states…coordinated and solidaristic mass action is more likely to be regarded as a threat to political stability than a preserver of it.” To rephrase: in modern states, democratic politics, and in particular  majority rule, is a mechanism for changing the status quo, and as such, is disruptive to stability understood as stasis–hence Buchanan and Hayek’s opposition to it. But it hasn’t always been that way. In fact, historically democratic politics was an agent of stability in its capacity to stabilize the political community by making change predictable. 

Under a democratic system, we cannot know what policy will be in three months, three years, or three decades time, but we can have confidence in how it will be decided. Recognizing the inherent uncertainty of the future, this view of stability is one that bakes in change. There is no attempt to guarantee any particular policy position or state of affairs will persist over time, rather, the stability of the system is achieved through its ability to facilitate stable change. 

The stability, or resilience, of the democratic system comes out of the very fact that no decision is ever permanent, and consequently, the belief that if one loses a vote today, she knows she’ll have the chance to win another tomorrow, on an entirely new topic, or simply a new vote on the same topic. Because decisions are provisional, nothing is ever fully settled. This provisionally offers institutional stability because it is a reason for citizens to buy into the system over time. If one lost a vote, say an immutable constitutional vote, and didn’t foresee any chance to change it going forward, this would surely put a dent in her desire to continue in good faith to abide by the existing system of government. If she were to feel that she had no chance to make her voice heard, why not tear down the system itself? 

Some call this loser’s consent. Helen Thompson explains the idea as follows, “exchanges of power via elections require tacit justifications for those who lose elections that enable them to accept the outcome without resorting to violence of secession.” We see this same idea, of institutional stability through policy instability, in the political theoretic literature about democracy and reciprocal sacrifice. Danielle Allen writes, “A democracy needs forms of responding to loss that makes it nonetheless worthwhile or reasonable for citizens who have lost in one particular moment to trust the polity—the government and their fellow citizens—for the future.”

“Losers do not forfeit the right to compete in elections, negotiate again, influence legislation, pressure the bureaucracy, or seek recourse to courts.” Their continued power, as a part of the collective body of citizens, to determine the rules they live by, is what undergirds the system’s stability. As Adam Przeworski writes, democracy is stable or “consolidated” “when all the losers want to do is try again with the same institutions under which they have just lost.” Stability, he writes, comes from “reducing the stakes of political battles.”

A more democratic approach to central banking, one dedicated not to seeking stasis but to preserving the resilience of the political community, would inevitably be more, well, political. It might empower the legislature to engage in credit policy, to determine who gets bailout support, to reassess and restructure the central bank, and to guide policy. That might sound destabilizing. But that’s only if we see stability as stasis. It’s true that more political central banking, more democratic central banking, would inevitably mean more uncertainty, and likely more policy churn. But it would also be more resilient because that change would happen according to predictable, manageable, democratic political processes. The alternative is to hold tight to stasis, and in doing so produce unpredictable volatility.

Employing expertise

Central banks are the poster boys (and they are often boys) of elite government. They are filled with highly educated experts that deploy complex and technical models, analyze vast swathes of data, and are insulated from traditional channels of democratic politics. This arrangement was designed to secure stability. Stability in prices, stability in financial markets, and as such, economic stability more broadly. From one perspective, that has completely failed: just see the recent inflation or the preceding financial crises. From another perspective, it has entirely succeeded: in the face of inflation, financial crisis, pandemics, and wars, the macroeconomic status quo has persisted. Central banks have channeled unfathomable amounts of public money and public power into preserving the private financial system, into maintaining a degree of stasis. 

But this insistence on stasis is now producing volatility. There was the Occupy Wall Street movement. There were protests at the European Central Bank. There was the Fed Up campaign. But these were small beans compared to what we are seeing now. There are now governments, left and right, across Europe, the US, and beyond that oppose the powers and structures of independent central banks in their entirety. Erdoğan has turned traditional central banking upside down in Turkey. Donald Trump tried to nominate someone to the board of the Fed who advocated a return to the gold standard. Liz Truss claims the Bank of England led a coup to remove her from power. We put central banks outside of traditional democratic channels to seek stability of the private financial system, but what we didn’t predict was that seeking stasis in the economy would produce instability in the political community. 

Political theorists have long touted the benefits of representative government in preserving political stability. Representative government creates the opportunity for the people to throw out the government, to make real change in who has power in society, without a revolution. It builds in the possibility of change and in so doing, secures stability. This is exactly what we lack with central banks.