A estagnação que se explica por um capitalismo de benefícios exclusivos

Journal of Economic Issues

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Kicking Away the Ladder, Too: Inside Central Banks Matías Vernengo To cite this article: Matías Vernengo (2016) Kicking Away the Ladder, Too: Inside Central Banks, Journal of Economic Issues, 50:2, 452-460, DOI: 10.1080/00213624.2016.1176509 To link to this article: http://dx.doi.org/10.1080/00213624.2016.1176509

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Date: 27 October 2016, At: 13:24

JOURNAL OF ECONOMIC ISSUES Vol. L No. 2 June 2016 DOI 10.1080/00213624.2016.1176509

Kicking Away the Ladder, Too: Inside Central Banks Matías Vernengo Abstract: Central banks are evolving institutions. In developed countries, particularly in Britain, central banks were used as instruments of the state to finance government and to promote economic development. However, once they went up the economic ladder, advanced economies kicked it to preclude developing countries from climbing it, too. It is in this context that the modern independent central bank, concerned with inflation targeting alone, which harkens back to the Victorian era, should be interpreted. This paper analyzes the recent evolution of the Argentine central bank in this broad historical perspective. Keywords: central banks, economic history, Latin America JEL Classification Codes: E58, N20, O54

The history of central banks can be roughly divided in four periods: (i) an initial era, starting in the seventeenth century, in which central banks were used as instruments for development, essentially in England; (ii) a second period, roughly from the mid1840s to the Great Depression of the 1930s, in which Victorian sound finance principles and concerns with inflation dominated; (iii) a third period, between the Great Depression and the so-called Great Inflation of the 1970s, in which Keynesian views and the preoccupation with full employment were at center stage; and (iv) a fourth period, since the late 1970s, in which the rise of neoliberalism has led to the consolidation of the idea of independent central banks (ICBs), the increasing dominance of price stability as an objective of monetary policy, and inflation targeting (IT) as the main policy tool to achieve it.1 The four periods are often seen as following

Matías Vernengo is a professor of economics at Bucknell University. He served as a senior research manager at the Central Bank of Argentina (BCRA, in Spanish) at the time that some of the reforms discussed in this paper were carried out. These are the author’s personal views and do not reflect the opinions of any members of BCRA then or now. Previous versions of this paper have been presented at the central banks of Argentina and Ecuador, as well as at Bucknell University. The author thanks conference participants, Mercedes Marcó del Pont, and Arturo O’Connell for discussing the topics of the paper, without implicating any of them. 1 C.A.E. Goodhart (2011) suggests only three periods, disregarding the early period of central banking altogether. In part, his brief history of central banking is flawed, because that early history is fundamental to understanding what central banks can do in developing countries.

452 ©2016, Journal of Economic Issues / Association for Evolutionary Economics

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in a constructive progression, wherein central bankers have learned from the mistakes of the past and the central bank as an institution has adapted accordingly. This Whig interpretation of central banking history implies that central banks in developing or peripheral countries should adopt modern practices. The idea of an ICB and IT has become accepted as part of the set of institutional arrangements that are required for catching up with advanced economies. Also, sometimes it is suggested that, over the last period, central banks have become exceedingly concerned with macroeconomic management, meaning price stability questions, and that after the Global Crisis of 2008 more emphasis should be put on their regulatory role (Wachtel 2011). An alternative view would emphasize the complementary role of trade and financial institutions, including central banks, as instruments in the process of development. In particular, it seems that developed nations have used central banks as instruments to finance the developmental state,2 but once they reached the top of the ladder, so to speak — as Friedrich List famously quipped (in Chang 1999, 2002) — they kick it away to preclude developing nations from rising, too. In other words, the often discussed idea that trade policies have been used by developmental states is incomplete and must be complemented by discussing similar practices in financial markets, an environment in which central banks have been crucial (Epstein 2006). The remainder of this paper is divided into three sections. The first section deals with the historical evolution of central banks. The second discusses the use of central banks by advanced countries to promote development. The third section focuses on the more recent Argentinean experience of trying to promote institutional reform against the international consensus on central banking, and on the debate within the Argentine central bank on interest rates. The conclusion suggests that there is no single central bank structure valid for all countries, at all times. Central Banks in Historical Perspective3 The Bank of England (BoE) is the oldest continuously functioning central bank, having being preceded by the Stockholms Banco in the seventeenth century, and from the latter the Swedish central bank would eventually emerge. Both banks were emissions banks, which was a crucial difference from previous banks in western Europe that had been used as instruments of development by the rising merchant elites (e.g., the Bank of Venice and the Bank of Amsterdam). The Bank of England was explicitly created in 1694 to provide loans to the government in exchange for the right to issue banknotes.4 The position as a fiscal agent of the government throughout the eighteenth century — which brought more frequent wars with France over regional hegemony and expanded role of the state — put the Bank of England in a privileged position as the banker of the state. 2

On the concept of the developmental state, see Meredith Woo-Cumings (1999). This section is based on Matías Vernengo (2015). 4 The monopoly over the issue of banknotes came significantly later, only after Robert Peel’s Bank Charter Act of 1844. For the early history of the Bank of England, see John Clapham (1944). 3

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The emergence of a market for government bonds was central in the development of British financial markets. And government debt in England ballooned in the eighteenth century, reaching a peak of more than 260 percent of GDP during the Napoleonic Wars (Figure 1). The financial revolution in England preceded the industrial revolution (IR), and, to a great extent, it was made possible by the incredible accumulation of public debt that would be considered unsustainable or harmful to economic growth by modern standards (Dickson 1967).5 One crucial innovation was the possibility to borrow almost unlimited amounts of money with very low risk, since the state could not default in its own currency. Figure 1. British Net Debt as a Share of GDP (1692–2014)

300 250 200 150 100 50 0

Source: UK Public Spending (n.d.).

In all fairness, the pound was in a bimetallic standard and de facto on a gold standard since Newton mistakenly underpriced silver (Eichengreen 1996). That implies that, in contrast with a pure fiat system, in the absence of gold, the government could default, even if the gold standard was a pound system in reality. In these circumstances, England’s Treasury had to set aside several excise taxes to pay for specific parts of the debt. Taxing had to be authorized by Parliament, and such authorization was possible given the compromise between the Crown and the merchant and landed classes that led to the Glorious Revolution. Furthermore, the efficiency of the tax system was what allowed borrowing at relatively low interest rates 5

This would be, for example, the argument in the now infamous paper by Carmen M. Reinhart and Kenneth S. Rogoff (2010), who claim that public debt above 90 percent of GDP has a negative impact on economic growth.

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(Brewer 1989). The central bank was one of the institutions that were specifically developed to promote the new accumulation regime, which required significant expansion of the state, particularly in its military capacity.6 The rise of the so-called military-fiscal state, as noted by John Brewer (1989), was central to establishing British naval hegemony and, consequently, dominance over the trade routes to Asia, which was essential in providing markets for the British IR.7 The Bank of England was a central piece in the institutional framework that created the conditions for the state to finance the military machine which allowed (with the use of gunboat diplomacy during the infamous Opium Wars) for opening up markets in China and throughout the global periphery in the nineteenth century. However, as much as a certain degree of trade management was important for the rise of England in the eighteenth and nineteenth centuries, it was discarded once the economy had reached global manufacturing dominance by the mid-nineteenth century — the repeal of the Corn Laws in 1846 being the symbol of that change. The same change in strategy happened at about the same time with respect to the Bank of England, as well as with monetary and financial matters in general. It is at this point that the Victorian principles of fiscal discipline and the rules of the game of the gold standard were established as the seal of good management in the global economy. In the new international division of labor, not only did Britain export manufacturing goods and import from the periphery commodities, but the Bank of England became the center of the international financial system, acting as the conductor of an international orchestra (in John Maynard Keynes’s famous characterization). British banks borrowed short term and loaned long term, as well as provided the financial resources for new infrastructure — mainly railroads and ports — and military spending, thus reorganizing production on a global scale. The use of a central bank to finance the developmental needs of the national state was seen as technically inefficient since it disrupted the international division of labor. In addition, fiscal deficits, public debt, and central banks policies to finance them, were seen as inflationary and leading to lower international investment and less economic growth. The Victorian consensus on monetary policy was discredited by the collapse of the gold standard and the Great Depression of the 1930s. In the relatively long period between the 1930s and the Great Inflation of the 1970s, central banking was dominated by relatively heterodox ideas, influenced by the Keynesian revolution, which suggested that monetary policy had to be at the service of full employment, and the role of the government’s fiscal agent had to be the main focus of the central bank. Also, central banks had to manage capital flows in order to keep interest rates low and 6 Patrick O’Brien (2013) suggests that fiscal exceptionalism, related to the smaller and more urbanized polities of the west, explain why England and later western nations found it easier to tax their populations when compared to eastern empires with more extensive territories, larger populations, and less urbanized economies, even as the latter were in many respects more advanced than the former. 7 Some authors would suggest that external demand was less relevant than domestic demand for the IR, but this is of secondary importance for the purposes of this paper. Specifically on the role of public money for the development of the financial sector and the IR, see L.S. Pressnell (1953).

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to essentially allow cheap public and private borrowing (Vernengo and Pérez Caldentey 2013). This had been the case during the early history of central banking, but the process was undermined by high inflation and the Conservative Revolution, which signaled the return to Victorian ideas of central banking, now disguised as modern. The Central Bank of Argentina from Convertibility to Development The Central Bank of Argentina (BCRA, in Spanish) was created in 1935 in the midst of the Great Depression, and was one of the institutional innovations used to promote economic recovery. The path to economic growth was increasingly based on domestic markets and industrialization, which was seen as a necessary precondition for preventing the negative effects of recurrent international financial crises. Although the Argentine economy and the central bank went through several phases, and the governance rules of the bank were considerably more unstable than in developed countries, the possibility of using the BCRA as a tool for economic development was not abandoned until the 1970s. In the 1970s, the central bank — dominated by monetarist views — used the exchange rate to stabilize the economy. However, the debt crisis and the hyperinflationary process in the 1980s delayed a more significant reform. It was during the Convertibility period (1991–2002) that the BCRA returned to the Victorian principles that had dominated central banking before the Great Depression, essentially acting as a currency board. This was also the case in Argentina during the gold standard, when the country was able to issue currency tied to international reserves in dollars, with a fixed exchange rate of one peso for a dollar. The organic law that regulated the actions of the BCRA was changed in this period to promote the independence of the central bank, to commit it to maintaining price stability as its only goal, and to reduce the bank’s ability to finance the treasury. A small margin of flexibility nevertheless remained.8 The conventional view, supporting the new institutional arrangement, was based on the notion that stabilization required curtailing excessive monetary expansion, and that central bank independence was required to preclude the monetization of fiscal deficits. In this view, the fixed exchange rate component was a measure needed to import credibility from the United States’ central bank, since its Argentine counterpart had none. This view presupposes that Argentina’s inflationary process was caused by excessive demand.9 However, it is important to note that an inflationary

8 Domingo Cavallo, the Finance Minister behind the Convertibility Plan in Argentina, was explicit about his intention to emulate the currency board and the institutional arrangements of the Belle Époque (see Pérez Caldentey and Vernengo 2007). 9 In addition, the notion of demand-pull inflation in mainstream models hinges on the idea that the system tends to its natural rate of unemployment. The problems with this concept and its twin, the natural rate of interest — both logical, as highlighted in the capital debates, and empirical, as evidenced by its variability and path-dependency — suggest that the typical discussion of inflation in conventional models should be taken with a grain of salt.

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acceleration and hyperinflation took place in the midst of a significant collapse in the level of activity, in what became known in Latin America as the “lost decade.” In that sense, it seems more reasonable to understand the inflationary process as the result of external problems, which forced depreciation and higher import prices, combined with the effects of re-democratization and a stronger labor force demanding higher wages. A wage/foreign-exchange rate spiral drove prices up, and a fixed exchange rate and de-indexation became instrumental for stabilizing the economy. The austerity policies of the 1990s and higher unemployment levels were also instrumental in bringing wage resistance down. The combination of austerity policies and the complete and unilateral policy of external liberalization in the 1990s led to the accumulation of large current account deficits in Argentina, which were covered with the privatization of state assets and with international capital inflows. In contrast with the Bank of England during the rise of Britain to hegemonic power, the BCRA in the 1990s was an instrument for borrowing in foreign currency. In addition, the external indebtedness grew without any clear indication of growing prospects for Argentine exports, which should have indicated that the process was unsustainable. The system came tumbling down by the end of 2001, with a default on external debt in 2002. The collapse of the Convertibility experiment in Argentina led to skepticism about the Washington Consensus policies, as much as the debt crisis had called into question the state-led industrialization policies before. In the aftermath of the crises, a combination of factors allowed for fast growth from 2003 to 2008, and for a rapid recovery from the global financial crisis of 2008, with growth slowing down after 2011. A positive terms-of-trade shock lifted external constraints and allowed the new left-of-center government to pursue expansionary and redistributive policies. Growth fundamentally resulted from a substantial expansion of public spending, including transfers programs to address unemployment, which was reduced from about 22 to less than 7.0 percent before the onslaught of the global financial crisis. There was also a significant recovery in real wages that allowed the expansion of private spending. In spite of the large increases in public spending, the booming economy led to higher incomes, increasing revenues, and relatively balanced fiscal accounts, at least until growth decelerated starting in 2011. Inflation, having increased after the maxi-devaluation of 2002, stabilized at lower levels. But the combination of persistently crawling devaluation of the nominal exchange rate and higher wage resistance led to higher inflation, on the two-digit level, considerably above the international standards. The Central Bank of Argentina, while still formally committed to quantitative targets, adjusted the money supply to the real needs of the economy. Interest rates were maintained at low levels, which entailed real negative rates given the relatively high inflation levels. In addition, the BCRA was seen, together with other public banks, as an instrument to promote the expansion of credit for productive activities. A new organic law that consolidated the changes in role of the central bank was finally adopted in 2012 (Marcó del Pont 2013). One of the main preoccupations of the new government and its reformed central bank was to mitigate the external vulnerability of the economy and avoid a

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new crisis, hence the maintenance of a relatively competitive exchange rate, presumably to help maintain a positive current account, and the accumulation of external reserves. In particular, servicing foreign debt and preventing another default became priorities in Argentina. The depreciation of the nominal exchange rate, however, fed the inflationary pressures, while the fast recovery of the economy led to a significant increase in imports and the erosion of current account surpluses which, by 2011, had essentially vanished. The external constraint, in other words, had reasserted itself by that year. Argentina’s government had effectively reduced the risk of a new default by successfully renegotiating the external debt with approximately 93 percent of the bondholders and by reducing the export-to-debt-service ratio (Figure 2). However, the low rates of interest, which were seen by certain groups in the government and within the BCRA as central to the credit expansion policy, induced significant capital flight. International reserves essentially followed the behavior of the current account, increasing after the default and peaking in 2011, but consistently declining after that. The declining reserves in dollars and the small, but negative current account deficits meant that growth was constrained and that an external crisis could not be completely ruled out, even though there was no immediate risk of one.10 Figure 2. Argentine Foreign Debt Service as a Share of Exports (1976–2013) 70 60 50 40 30 20 10 0

Source: World Bank (2015).

10 For a discussion of the external vulnerability of Argentina in the context of the dispute with the Vulture Funds, see Vernengo (2014).

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Within the BCRA, one of the discussions that took place after the resurgence of the external constraint in 2011 was whether higher interest rates — which would be helpful for the accumulation of reserves — could be justified. The strategy of using higher domestic interest rates, even as advanced economies kept their interest rates low, has been used by several developing countries to attract capital flows, accumulate reserves, and reduce external vulnerability. Brazil — which has significantly larger current account deficits (compared to Argentina) and no external problem given the incredible accumulation of reserves — is a telling example of what the BCRA could have done in Argentina. The Argentine government gave two reasons for not hiking interest rates. First, it was the fear that higher interest rates would have the effect of further appreciating the peso in real terms, which, in turn, would have a negative impact on exports. Second, there was the concern that higher rates would have a negative impact on domestic credit. For those reasons, interest rates were kept on negative levels in real terms.11 The victory of the opposition in the 2015 presidential elections suggests that the chance of a new 180o-degree change in the structure of the BCRA is possible once the resurgent neoliberal development project reasserts itself in Argentina. Concluding Thoughts Central banks evolved historically and their structure and objectives are quite less stable than is often assumed. Central banks are institutions that adapt to the needs of the dominant political coalitions to serve specific accumulation regimes. That was true for the emerging central banks in the seventeenth century, as it was true for central banks in the periphery later, such as the BCRA in the mid-1930s. In this sense, the modern central bank structure, independent from the treasury and uniquely concerned with inflation, should be seen as a very specific historical development, associated with the neoliberal project. For that reason, the possibility of rethinking central banks and their objectives, particularly in peripheral countries, remains crucial. References Brewer, John. The Sinews of Power: War and the English State, 1688–1783. London: Unwin Hyman, 1989. Chang, Ha-Joon. “The Economic Theory of the Developmental State.” in The Development State, edited by Meredith Woo-Cumings, pp. 182-199. Ithaca, NY: Cornell University Press, 1999. ———. Kicking Away the Ladder: Development Strategy in Historical Perspective. London: Anthem, 2002. Clapham, John. The Bank of England: A History. Cambridge, UK: Cambridge University Press, 1944. Dickson, P.G.M. The Financial Revolution in England: A Study in the Development of Public Credit, 1688–1756. London: Macmillan, 1967.

11 There is little evidence that the external accounts react to changes in the exchange rate in a very significant manner. Also, higher central bank rates could be more than compensated by lower rates provided by other public banks, as the Brazilian experience with the national development bank (BNDES) shows.

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Eichengreen, Barry. Globalizing Capital: A History of the International Monetary System. Princeton, NJ: Princeton University Press, 1996. Epstein, Gerald. “Central Banks as Agents of Economic Development.” UNU-WIDER, Research Paper No. 2006/54, 2006. Goodhart, C.A.E. “The Changing Role of Central Banks.” Financial History Review 18, 2 (2011): 135-154. Marcó del Pont, Mercedes. “Introduction: The Role of Central Banks in Economic Development with an Emphasis on the Recent Argentinean Experience.” Review of Keynesian Economics 1, 3 (2013): 267272. O’Brien, Patrick. “Fiscal, Financial and Monetary Foundations for the Formation of Nation States in the West Compared to Imperial States in the East, c.1415–c.1839.” Journal of Chinese Economic and Business Studies 11, 3 (2013): 161-168. Pérez Caldentey, Esteban and Matías Vernengo. “A Tale of Two Monetary Reforms: Argentinean Convertibility in Historical Perspective.” Studi e Note di Economia 12, 2 (2007): 7-22. Pressnell, L.S. (1953). “Public Monies and the Development of English Banking.” Economic History Review 5, 3 (1953): 378-397. Reinhart, Carmen M. and Kenneth S. Rogoff. “Growth in a Time of Debt.” American Economic Review 100, 2 (2010): 573-578. UK Public Spending. Time Series Chart of Public Spending. Not dated (n.d.). Available at www.ukpublicspending.co.uk/spending_chart_1692_2016UKp_XXc1li111tcn_G0t. Vernengo, Matías. “Argentina, Vulture Funds, and the American Justice System.” Challenge 57, 6 (2014): 46 -55. ———. “Pateando la escalera también: Los bancos centrales en perspectiva histórica.” Circus 4 (2015): 75-97. Vernengo, Matías and Esteban Pérez Caldentey. “Heterodox Central Bankers: Eccles, Prebisch and Financial Reform in 1930s.” In Monetary Policy and Financial Regulation, edited by Gerald Epstein, Tom Schlesinger and Matías Vernengo, pp. 47-70. Cheltenham, UK: Edward Elgar, 2013. Wachtel, Paul A. “Central Banking for the 21st Century: An American Perspective.” In Post-Crisis Growth and Integration in Europe, edited by Ewald Nowotny, Peter Mooslechner and Doris RitzbergerGrünwald, pp. 121-135. Cheltenham, UK: Edward Elgar, 2011. Woo-Cumings, Meredith. The Developmental State. Ithaca, NY: Cornell University Press, 1999. World Bank. International Debt Statistics. Last updated December 16, 2015. Available at http:// data.worldbank.org/data-catalog/international-debt-statistics. Accessed December 16, 2915.