Central Banks As Agents of Employment Creation Gerald Epstein Professor of Economics and Co-Director, Political Economy Research Institute (PERI) University.

Central Banks As Agents of Employment Creation

Gerald EpsteinProfessor of Economics and Co-Director,

Political Economy Research Institute (PERI)University of Massachusetts, Amherst

How Can Central Banks Contribute to Employment Creation?

• Under the current dominant practice of central banking, the answer is that they contribute very little

• Indeed, in some cases, they put up obstacles to employment creation

Neo-liberal Approach to Central Banking

• “Inflation Targeting” or “Inflation Targeting Lite” – primary or ONLY objective of Central Bank should be to keep inflation low, in the LOW SINGLE DIGITS

• Financial Liberalization, both external (eliminate capital controls) and internal, de-regulate finance, eliminate quantitative controls

Source: IMF

16 Emerging Market Countries

Source: IMF

14 More Countries Expected to Become Formal

Inflation Targeters within next 5 years

Source: IMF

Poor Countries Subjected to Low Inflation TargetsAs Part of Poverty Reduction Strategy Conditionality

(Inflation targets: less than 5%)

Maintaining Moderate Inflation:

An Important Goal of Central Bank Policy

The Problem:

When Moderate Inflation Becomes the ONLY Goal of Monetary Policy, other goals

suffer

Problems: High Real Interest Rates

Drag on Aggregate Demand Growth

High Real Interest Rates

Also Associated with increases in inequality

Current Paradox of Tight Monetary and Credit Policy and Falling Real

Interest Rates

High Real Interest Rates Currently Masked by Falling Global Interest Rates

Source: IMF

1960 20041976 1990

Source: IMF

forecast1970

Includes Developing

Countries

Paradox Resolved

• Austere Monetary and Fiscal Policies Reduce Global Demand for productive loans

• Unstable Capital flows force countries to accumulate reserves increase supply of loans to Wealthy countries – driving down interest rates

Global Employment Problem:

• Quantity of Jobs inadequate

• Quality of jobs need to be improved

• Both of these are key to reducing global poverty

In Principle: What role for Central Bank Policy?

• Central Bank policy does or can affect many of the key factors determining both the quantity and quality of employment.

Some Key Factors Affecting Employment

• Demand for products– Exports

• Affected by the Real Exchange Rate

– Domestic Demand Growth• Affected by cost and availability of credit

Some Key Factors Affecting Employment

• Productivity Growth determines sustainable growth in real wages and quality of jobs.

– Affected by:» Investment – affected by credit» Economies of scale provided by exports – by

exchange rate» Public Investment and infrastucture (affected by

allocation of credit to)» Education and opportunities (affected by public

investment and credit)

Many of these affected by Central Bank Policy

• Real Exchange Rate

• Cost and Availability of Credit

• Allocation of Credit to different sectors, including the government

Thought Experiment

• Industrial policy to create employment

• Where is the aggregate demand going to come from to create market for products?

• Monetary policy can have a critical role to play.

Central Bank Policy For Employment Creation

• Enable expansion of aggregate demand

• Make credit available for sustainable investment

• Maintain a stable and competitive real exchange rate

But Neo-Liberal Central Bank Ideology

• Presents a set of obstacles to Central Banks contributing substantially to employment creation.

Central Bank Operations

• Switch from direct instruments, such as credit allocation, to indirect instruments, primarily short term interest rates as main tool of monetary policy

• Financial liberalization reduces central bank leverage over the financial system in terms of quantitative controls

Reduced Targets and Instruments

• Targets: inflation

• Instruments: Short-term interest rates

• Eliminates capital controls, exchange controls and capital management techniques generally

Neo-liberal Approach:

Departure From historical Practice

Central Banks historically have used many tools of monetary policy to reach

multiple objectives

• Including credit allocation to develop social sectors of the economy,

• Credit allocation techniques to develop dynamic industries,

• Capital management techniques to manage inflows and outflows of international capital.

Arthur Bloomfield

• Prominent Historian and Adviser of the New York Federal Reserve

• In 1957, wrote a report on Central Banks in Developing Countries:

Bloomfield goes on to say:

Arthur Bloomfield, 1957

Central Banks should have TWO roles:

• Stabilization

• Developmental

Currently they have only one:

• Stabilization

Problems with Current Financial Regime

• Focus on Inflation Targeting Means Real Interest Rates are Too High

• Capital Account Liberalization + Unstable Financial Flows Means Countries have to Keep too many Reserves as Protection

• Financial Liberalization misallocates credit away from Employment generation

The Result:

• Investment in Employment Generating Activities of high quality jobs is too low in many countries

• Aggregate Demand growth too low

• Real Exchange rates go through cycles of appreciation and depreciation that are destabilizing and harmful.

Alternatives to “Inflation Obsessed” Central Banking

How to Create Central Banks to Be ALSO Focused on Creating more and better Employment

Central Banking Goals:

• Create More and Better Jobs while

keeping inflation at moderate levels.

With more goals (employment, moderate inflation)

• Need More Instruments

• Jan Tinbergen, Dutch Nobel Laureate: You need to have as many instruments as targets

UN-DESA Co-Sponsored Research Project on:

• Alternatives to Inflation Targeting

• Goal is to Develop Country Specific Targets and Instruments for Central Banks and related institutions that can make macro-policy contribute more to employment generation and other social goals

Country Case Studies

• South Africa• India• Viet Nam• Mexico• Brazil• Argentina• Turkey• The Philippines

Thematic Topics

• Impact of Inflation on the Poor

• Impact of Inflation on Economic Growth

• Impact of Anti-inflation monetary policy on women’s employment

Some Over-all Consensus of the Researchers:

• Central Bank policy and inflation targeting in particular must broadened or replaced to include other important social goals such as:

• Employment generation

• Investment Promotion

• Productivity Enhancement

Targets of Central Bank Policy

• Stable and Competitive Real Exchange Rate

• Employment Generation

• Investment Promotion

One Size Does NOT Fit All

• As our project shows, one main target for central bank policy is NOT appropriate. This is a fundamental flaw in the mainstream/neo-liberal inflation targeting approach.

“New Tools” for Central Bank Policy

• To reach multiple targets various country studies proposed a variety of monetary policy tools.

All Authors Agree

• Attaining “moderate” inflation, in the 10-15% range or less is a desirable goal for monetary policy

• But other goals, a stable and competitive real exchange rate, employment, or investment and economic growth, must be pursued as well.

Problem of the So-Called“Trilemma”

• Policy makers can pick at most TWO out of the following three

1. Open international capital markets

2. Autonomous central bank policy

3. Fixed Exchange Rates

Tinbergen + Trilemma

• For both the Tinbergen Targets and Instruments constraint and the Trilemma constraint it is useful and even necessary to expand the tool-kit of central banks to achieve these social and macroeconomic stabilization goals.

“New Tools” for Central Bank Policy

• “Capital Management Techniques”: help control de-stabilizing inflows and outflows of capital (“HOT MONEY”) so that countries can maintain “stable and competitive real exchange rates” while moderating inflation or generating more expansionary monetary policy.

Country Targets Instruments

Argentina Competitive and Stable Real Exchange Rate

-interest rates

-capital management techniques

Mexico Competitive and Stable Real Exchange Rate

-interest rates

-capital management techniques

Central Banks: Targets and Instruments

Country Targets Instruments

South Africa Employment -Credit allocation tools

-Capital management

India -Exchange rate

-Investment and More Rapid Economic Growth

-Interest rate-Credit allocation--capital management

Central Bank Targets and Instruments

Cases where broader Central Bank Targets and Instruments have

worked:

• China

• India

Two Cases: Argentina and South Africa

South Africa

• Government has stated goal to reduce unemployment by half by the year 2014.

• This Central Bank policy is part of an integrated program of credit allocation, and fiscal policy designed to achieve that goal.

Real Target for South Africa

Employment Target

Subject to inflation constraint

Elements of an Employment Targeting Program For South Africa

1. Fiscal stimulus

2. Public Credit Allocation and Development Banking

3. Capital management techniques

4. Mechanisms of inflation control, possibly including Scandinavian style tri-partite agreements on wages and prices.

5. Government Tax Policy: mechanisms, such as an enhanced securities transactions tax, to raise more revenue to finance employment policies.

6. Other sectoral policies, eganti-trust and competition policy

Role of Monetary Policy

1. Policies

2. Institutional Commitments

Institutional Commitments

• New research program on relation between instruments and employment

• Work with financial institutions and borrowers to develop new tool of credit allocation for employment

• If not enough employment generated, CB will work to develop new tools

Argentina

• Roberto Frenkel and Martin Ripetti

• Goal: more rapid economic growth, productivity growth and employment generation

Central Bank Policy

• Maintain and Stable and Competitive Real Exchange Rate

Capital management Techniques

• Strengthen controls on inflows to be used when necessary to help maintain a stable and competitive real exchange rate.

In conclusion:

Balance Stabilization and Developmental Roles of Central

Banking to support more and better Employment