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The Genuine Progress Indicator

Published by Anonymous (not verified) on Fri, 01/07/2022 - 3:37pm in

The Genuine Progress Indicator Editor The previous article by David Shearman has alerted us to the fact that GDP is a poor measure of economo-socio-ecological…

The post The Genuine Progress Indicator first appeared on Economic Reform Australia.

Mainstream economics

Published by Anonymous (not verified) on Fri, 01/07/2022 - 2:24pm in

Mainstream economics: Sacrificing realism at the altar of mathematical purity – Extracted by Lars Syll from comments of Andrew Haldane “This critique goes beyond the…

The post Mainstream economics first appeared on Economic Reform Australia.

The Fed Tackles Kalecki

Published by Anonymous (not verified) on Fri, 01/07/2022 - 3:42am in

Ratner and Sim’s “Who Killed the Phillips Curve – A Murder Mystery”

“… the slope of the Phillips curve — a measure of the responsiveness of inflation to a decline in labor market slack — has diminished very significantly since the 1960s. In other words, the Phillips curve appears to have become quite flat.” Janet L. Yellen (2019)

A recent US Federal Reserve staff working paper written by David Ratner and Jae Sim (2022) has captured widespread attention, especially among economists, who, like ourselves, believe that a repeat of the anti-inflation policy scenario of the early 1980s of sharply raising central bank interest rates might prove inappropriate, if not catastrophic, as solution to dealing with the current inflationary environment. While inflation is hurting the poor disproportionally more because of their low incomes, a steep across-the-board rate hike may be a remedy that is worse than the disease, particularly since, as it has been well established (see, for instance, Storm 2022), we are not primarily facing with a demand-side inflation.

Indeed, not only might the inflation rate be quite insensitive to falling aggregate demand pressures, but sharp and persistent increases in interest rates could devastate many poor working households which would face the specter of increasing unemployment. This concern is amplified by the fact that, unlike the situation in the early 1980s, these poor households now tend also to be very heavily indebted as a proportion of their personal disposable incomes and may face even greater risk of insolvency both because of higher interest rates and because of the increasing unemployment (see Costantini and Seccareccia, 2020).

The US Fed as well as many other central banks internationally seem now to be united in favor of a steep hike in the Fed’s policy rate, as we witnessed with the most recent 0.75 percent jump on June 15. We are told, moreover, that there are many more increases to come since the Fed rate is, supposedly, still much below its “neutral” level. For a very recent plea in support of what may have been the “mother” of rate hikes in the United States, namely another “Volcker shock”, one has only to peruse the recent paper by Bolhuis, Cramer and Summers (2022) in which they suggest that, to get the current inflation rate down to align with the US Fed’s 2 percent inflation target, it would now “require nearly the same amount of disinflation as achieved under Chairman Volcker.” (2022, p. 1).

Given the nature of the current supply shocks affecting our weak Covid-battered economies, orchestrating another Volcker-style scenario by creating yet another deep recession is chilling. Besides, it would appear to be somewhat in conflict with the above assessment of former US Fed Chair Janet Yellen in 2019 as well as with the research of these two US Fed economists, Ratner and Sim, who suggest that the slope of the Phillips Curve is actually relatively flat and it has remained so for decades, for reasons that have little to do directly with the Volcker shock of the early 1980s.

While this was long established outside of the mainstream (for a review, see Seccareccia and Kahn 2019), numerous researchers in established circles have been writing recently about the flat Phillips curve. For instance, Engemann (2020), Del Negro, Lenza, Primiceri, and Tambalotti, (2020), as well as Del Negro, Gleich, Goyal, Johnson, and Tambalotti (2022), all recognize what had actually been obvious to many of us for a long time. The important implication is that, as Yellen (2019) recognized, the flatness of the relation implies an immensely high sacrifice ratio if pursuing a Volcker-style strategy (as recommended by Stanbury and Summers 2020), since it would require excessively high unemployment to get the inflation rate down by even a very small increment.

Yet, the conventional wisdom nowadays, which seems to willfully ignore this empirical evidence, still relies on some variant of the so-called New Keynesian Phillips Curve resting on the crucial assumption that the inflation rate responds to aggregate demand pressures as reflected in an economy’s rate of capacity utilization and/or the unemployment rate. If that were true, then this would advise the adoption of some “automatic formula” such as a return to some Taylor rule equation, as some conservative policy analysts are recommending, that would rest on an “inflation first” priority of central banking, which in the case of the United States would contravene its dual mandate.

However, evidence-based economics would suggest that the well-worn relation between unemployment and inflation does not actually exist, at least not in the form it is traditionally depicted by the mainstream. Since the 1980s, particularly during the disinflation era of the Great Moderation associated with falling unemployment and, even more so, when the US unemployment rate did fall significantly (as immediately after the Global Financial Crisis (GFC)), the inflation rate remained largely unresponsive and stayed close to the 2 percent inflation target even though the US civilian unemployment rate fluctuated a great deal from a double-digit level of 10 percent towards the end of 2009 to a low point of 3.5 percent just before the pandemic at the end 2019 and early 2020.

Apparently, for the mainstream, as it is now observable from recent central bank decisions to steer economies towards higher interest rates, what we have witnessed over the last four decades since the Volcker shock was some pure aberration. The current low unemployment rates, such as the US 3.6 percent unemployment rate in May, arising as economies recover from the pandemic, are now considered “unsustainable” low rates, even though the same central bank authorities deemed similar unemployment rates relatively sustainable in 2019 and early 2020. Now these low unemployment and high vacancy rates suddenly call for high interest rates and necessitate growing unemployment to prevent the acceleration of inflation.[i]

It is as if we have been abruptly thrust back to what were the confused arguments of the 1970s when economists like Milton Friedman had described those low unemployment rates resulting from the 1960s’ Keynesian expansionary macroeconomic policies as the cause of the accelerating inflation that had resulted during the 1970s. We now have reestablished a narrative with the same litany of arguments: governments have pumped too much money into the economy during the pandemic because of the massive deficit spending and because of the very loose monetary policy of quantitative easing and excessively low interest rates. These have now driven unemployment rates to unsustainably low levels that can only generate accelerating inflation. To prevent a galloping inflation, high interest rates have become an imperative.

The US Fed working paper on Kalecki’s economics, dated September 2021, but which appeared only recently, is a breath of fresh air. Ratner and Sim (2022) claim that the Phillips curve in the United States and the United Kingdom has been almost flat since the 1980s because of the significant erosion of the bargaining power of workers. This began during the Reagan and Thatcher years, and which was especially reflected in declining union density rates over the last four decades. Thus, the supposed triumph over inflation for roughly four decades, until the surge during this last year of Covid-19, cannot be fully attributed to the conduct of monetary policy by the US Fed and the Bank of England. The Fed working paper, therefore, casts serious doubt on the mainstream narrative, which posits that the policy of the late Fed Chairman Paul Volcker of large hikes in interest rates was responsible for taming the 1980s inflation. If the Volcker shock was actually not what caused the long-term change in the dynamics of the inflation rate since the 1980s, and until the current Covid-19 crisis, then what was the culprit that flattened the Phillips curve?

The main takeaway of their paper is clear: interest rate hikes could have helped but it was rather the class conflict — particularly the offensive against the working class — that stood behind the inflation debacle of the Great Moderation, which had long-term consequences. Putting it that way, this could sound quite subversive to many mainstream economists. Indeed, as Nick Peterson (2022) writes in the Financial Times: “coming from deep inside the Fed this is near heresy. After all, central banks have naturally long been in thrall to theories that made them the heroes of the story.”

However, the authors recognize that the ideas are not new at all. In an unusual display of openness to heterodox ideas, Ratner and Sim give credit to post-Keynesian economics, and especially to the famous Polish economist Michał Kalecki (1943, 1971), who was a contemporary of John Maynard Keynes and co-discoverer of the principle of effective demand, apart from advancing several of Keynes’ contributions. Indeed, Kalecki, along with such less well-known writers as Henri Aujac (1950), was the founder of the view that inflation is primarily an expression and the outcome of class conflict (or conflicting claims) over national output by the way firms price their products vis-à-vis workers’ wage setting.

As a tribute, the authors replace the New Keynesian Phillips curve with a more general “Kaleckian” Phillips curve, as they call it, in which they include an exogenously-determined parameter impacting on its slope that reflects the degree of bargaining power between workers and firms.

We believe that their main contribution is the introduction of the “Kaleckian” Phillips curve to the canonical Two-Agents New Keynesian (TANK) model with monopolistic competition (in this case, the two agents are workers and firms). This tweak implies that, apart from the usual bargaining over wages, there would be bargaining over the product price (or monopoly rents). Workers through labor unions would try to keep the markup as low as possible so that wages and the labor share would be larger, whereas firms would try to do the opposite. The degree of bargaining power would determine the winners and losers in the distribution of monopoly rents. It follows that the “Kaleckian” Phillips curve explains why the inflation and unemployment rates have been relatively low since the 1990s — without considering the recurrent crises and the most recent inflationary episode — because the bargaining power of workers has been extremely limited.

Apart from that, the model has additional interesting aspects, of course, within the obvious constraints of the DSGE framework, which, to many of us, is problematic (see Storm 2021). For instance, the fight over the share of monopoly rents involves two different and opposed channels that impact the level of output and the NAIRU. When the degree of bargaining power is roughly balanced, small increments in the bargaining power of firms have a very positive impact on output and employment since the investment incentives are higher, whence the job creation channel dominates. In contrast, when the bargaining power of firms is particularly high, firms prefer to increase their profits by selecting the highest markup at the expense of output and job creation; thereby the markup channel dominates. But there is no reason why the degree of bargaining power would vary over time because it is an exogenous parameter. Thus, within the model, involving the standard DSGE assumptions of “rational expectations,” a steady decline in the bargaining power of workers is unexplained (and conceivably “irrational”) from the point of view of labor unions since this simply goes against workers’ interests.[ii]

On the other hand, the authors contrast the “Kaleckian” Phillips curve with respect to the New Keynesian Phillips curve in response to a positive demand shock. The results are different because, in the former, the slope of the curve changes with the degree of bargaining power between firms and workers whereas, in the latter, it remains constant regardless of the degree of bargaining power. That is because in both models there is bargaining over the wage but, in the “Kaleckian” case, there is also bargaining over the markup and product price. As a result, a positive demand shock in the “Kaleckian” model would amplify the impact on inflation and diminish it on employment.

Finally, the paper presents some time-series and cross-sectional evidence for the United States and the United Kingdom that leads to a significant positive relationship between the bargaining power of workers and the slope of the Phillips curve, which would be supporting their model. Nevertheless, the econometric evidence does not discard the possibility that the respective monetary policies themselves did have a significant impact as well. In the authors’ own words: “The estimation results point to a possibility that both the post-1980s disinflation and the concurrent flattening of the Phillips curve owe as much to the labor market institutions of these two countries as to the monetary policies of these two countries.” (Ratner and Sim 2022, p. 26).

We appreciate their research findings and find ourselves broadly in agreement with their conclusions about the flatness of the Phillips curve. This is a view, however, that is somewhat inconsistent with the current hawkish position of the US Fed that seems now to believe that the short-run Phillips curve is more hyperbolic rather than flat, otherwise its whole current strategy of wringing the inflation out of the US economy through strong doses of higher interest rates would be futile, since we are not experiencing primarily a demand-side inflation. We have already argued above and have also discussed elsewhere (see Seccareccia and Khan 2019, Lavoie and Seccareccia 2021, and Seccareccia 2022) that the Phillips curve is quite flat for a very large relevant range of the unemployment rate.

As shown in Figure 1 below, cost factors, such as international oil price shocks, can shift the whole curve upwards, but if we are in the broad flat range, the central bank cannot act on it to influence the current inflation unless it believes that the economy has reached the extremities of the curve (in this case at the extreme left). Indeed, as US Fed chair Jerome Powell has quite candidly admitted: “What [the Fed] can control is demand, we can’t really affect supply with our policies…so the question whether we can execute a soft landing or not, it may actually depend on factors that we don’t control.” (Jerome Powell (2022) cited in Shapiro (2022)). Although the paper by Ratner and Sim does not look at very recent evidence during the pandemic, the burden of proof rests on central banks to show (rather than assume) that the current inflation is primarily a demand-side one, where the economy now finds itself within the extreme left in the upward-sloping section of the Phillips curve.[iii] If the economy is still in the relatively flat range, and that all that has happened recently is that supply-side shocks have shifted the whole flat range of the curve to a higher range as firms have been marking up these sustained cost changes, then these interest rate hikes will merely slow down the economy with minimal impact on the overall inflation rate. [iv]

Figure 1: Phillips Curve with a Significant Flat Range

While appreciating much of what Ratner and Sim analyze, we do, however, have some further concerns. Up to this point perhaps anyone with some knowledge of Kaleckian economics would notice that the Ratner and Sim model is far from representing the core ideas of the celebrated Polish economist. First, the model sticks to Say’s Law in the sense that it is saving that determines investment as in a pre-Keynesian loanable funds world. Kaleckian economics, on the contrary, sticks to the Keynesian principle of effective demand, whereby investment is autonomous, saving is endogenous, and the rate of interest depends on central bank policy (Kalecki 1943). Thus, profits are determined by consumption out of profits and investment, assuming workers spend all their income. This important theoretical departure from New Keynesian economics led to the famous Kaleckian aphorism (wrongly attributed to Kalecki): “capitalists earn what they spend, and workers spend what they earn.” (Lavoie 2022, p. 332).

Furthermore, the technology assumed by the authors’ model depicts constant returns to scale and diminishing returns to labor and capital, implying increasing marginal costs. By contrast, Kaleckian models assume constant marginal costs (up to full capacity) and so “higher real wages will not necessarily entail a reduction in production and employment” (Lavoie 2022, p. 314) such that the labor demand curve would be upward sloping. Ultimately, output is constrained by demand both in the short and long run. In contrast, the model of Ratner and Sim (2022) entails that steady-state output and employment is supply constrained by the level of saving, in turn determined by workers’ and firms’ preferences and a natural rate of interest that would pin down the value of the NAIRU.

Finally, we suspect that Kaleckians might be uncomfortable in calling the paper’s curve a “Kaleckian” Phillips curve. While it is true that the degree of bargaining power affects the Phillips curve in the authors’ model, the former is just a parameter exogenously determined, i.e., given the bargaining power of workers, the NAIRU and the natural rate of interest are pinned down and are unique, which is inconsistent with Kaleckian economics. Kaleckians, and more generally post-Keynesian economics, explicitly reject the existence of a NAIRU or a natural rate of interest. Therefore, a genuine Kaleckian Phillips curve would portray a horizontal segment that might depend on the bargaining power of workers, among other institutional factors but, as remarked by Kalecki (1943) in his “Political Aspects of Full Employment”, the bargaining power depends on the rate of employment and monetary policy, which is itself influenced by class conflict as well.

As we have already discussed above, the shape of a genuine Kaleckian/Post-Keynesian Phillips curve could depict a flat part but surrounded by downward-sloping segments or even an upward-sloping segment given by a hypothetical full-employment situation, as suggested by Seccareccia and Khan (2019). It is also very likely that the trends in the unemployment rate have affected the bargaining power of workers and the conflict over the distribution of income (Seccareccia and Matamoros Romero 2022). Last, partly as a result and since monetary policy is embedded in the class conflict, the Volcker shocks, and the subsequent high-interest rates policies — up to the financial crisis of 2008-09 — should be seen as part of the policies that eroded the bargaining power of workers and not as an independent phenomenon, as Ratner and Sim seem to posit. Central banks would themselves be taking sides in the class struggle.

But there is more going on than just the conflict between workers and firms. As suggested by Seccareccia and Lavoie (2016) and Seccareccia and Matamoros Romero (2022), there are also the rentiers, much analyzed by Keynesian economists who may have conflicting interests that have long been understood by post-Keynesian economists. Rentier interests have played an important role in what occurred historically. Owing to the growing importance of the financial sector, we have seen how the rentier perspective hijacked monetary policy through the adoption and framing of inflation-targeting monetary policy regimes since the last major inflation of the 1970s and 1980s. In fact, much of the current political pressure to revive the “inflation first” monetary policy commitment through some formal adoption of an official Taylor rule reaction function in the United States is part of this rentier revival in the macroeconomic policy agenda that waned after the financial crisis.[v] Ratner and Sim (2022) are completely silent on this matter of rentier interests, which has been also of great concern to many non-mainstream economists and which transcends the traditional two-class analysis discussed in their paper.


Aujac, H. (1950). Une hypothèse de travail : l’inflation, conséquence monétaire du comportement des groupes sociaux. Économie appliquée, 3(2) (avril/juin), 279-300.

Bräuning, F., J. L. Fillat, and G. Joaquim (2022), Cost-Price Relationships in a Concentrated Economy, Current Policy Perspectives, Research Department, Federal Reserve Bank of Boston, (May 23), 1-9, .

Bolhuis, M. A., J. N. L. Cramer, and L. H. Summers (2022), Comparing Past and Present Inflation, National Bureau of Economic Research, Working Paper 30116 (June).

Costantini, O., and M. Seccareccia (2020), Income Distribution, Household Debt and Growth in Modern Financialized Economies, Journal of Economic Issues, 54(2), 440-49, DOI 10.1080/00213624.2020.1752537

Davidson, K. (2016), Yellen Objects to Proposed Rule for Rate Formula: Discussion of Legislation Opposed by the Fed Crops up during Wednesday’s Testimony, Wall Street Journal (February 10),

Del Negro, M., A. Gleich, S. Goyal, A. Johnson, and A. Tambalotti (2022), Disinflation Policies with a Flat Phillips Curve, Liberty Street Economics, Federal Reserve Bank of New Your (March 2),

Del Negro, M., M. Lenza, G.E. Primiceri, and A. Tambalotti, (2020), What’s Up with the Phillips Curve?, Brookings Papers on Economic Activity, (Spring), 301-357;

Engemann, K.M. (2020), What Is the Phillips Curve (and Why Has It Flattened)?, Federal Reserve Bank of St. Louis, (January 14),

Kalecki, M. (1943). Political Aspects of Full Employment. The Political Quarterly, 14(4), 322–330.

Kalecki, M. (1971). Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge University Press.

Konczal, M., and N. Lusiani (2022), Prices, Profits, and Power: An Analysis of 2021 Firm-Level Markups, Working Paper, Roosevelt Institute (June),

Lavoie, M., and M. Seccareccia (2021), Going Beyond the Inflation-Targeting Mantra: A Dual Mandate, Max Bell School for Public Policy, McGill University (April 23): 5–40,

Lavoie, M. (2022). Post-Keynesian Economics: New Foundations (2nd ed.) Cheltenham, UK: Edward Elgar Publishing. Retrieved Jun 10, 2022, from

Peterson, N. (2022). Class War > Rate Hikes. Financial Times (June 7), Retrieved June 9, 2022, from

Powell, J. (2022), Inflation, Soft Landings and the Federal Reserve. Interview by Kai Ryssdal, Marketplace Business News Podcast, NPR, (May 12). Audio, 27:38;

Ratner, D., and J. Sim (2022). Who Killed the Phillips Curve? A Murder Mystery, Finance and Economics Discussion Series 2022-028. Washington: Board of Governors of the Federal Reserve System,

Seccareccia, M. (2022), Can the Pursuit of Fiscal and Monetary Policies Achieve a Meaningful Full-Employment Objective without Inflation? Learning from the Canadian Historical Experience, including the Recent COVID-19 Crisis, Paper presented at the XXII Seminar of Fiscal and Financial Economics, Public and Private Credit: National and Global Experiences in the Current Crisis, National Autonomous University of Mexico, Mexico City (March 30).

Seccareccia, M., and M. Lavoie (2016), Income Distribution, Rentiers and their Role in a Capitalist Economy: A Keynes-Pasinetti Perspective, International Journal of Political Economy, 45(3), 200-223, DOI:10.1080/08911916.2016.1230447

Seccareccia, M., and N. Khan (2019) The Illusion of Inflation Targeting: Have Central Banks Figured Out What They Are Actually Doing Since the Global Financial Crisis? An Alternative to the Mainstream Perspective, International Journal of Political Economy, 48(4), 364-380, DOI: 10.1080/08911916.2019.1693164

Seccareccia, M., and G. Matamoros Romero (2022). Is There an Appropriate Monetary Policy Framework to Achieve a More Equitable Income Distribution or Do Central Bank Mandates Really Matter? Interest-Rate Rules versus a Full-Employment Policy, Journal of Economic Issues, 56(2), 498-507, DOI 10.1080/00213624.2022.2061831

Shapiro, A. H. (2022), How Much Do Supply and Demand Drive Inflation?, FRBSF Economic Letter, Federal Reserve Bank of San Francisco, (June 21),

Stansbury, A., and L. H. Summers (2020), The Declining Worker Power Hypothesis: An Explanation for the Recent Evolution of the American Economy, National Bureau of Economic Research Working Paper No. 27193 (October),

Storm, S. (2021) Cordon of Conformity: Why DSGE Models Are Not the Future of Macroeconomics, International Journal of Political Economy, 50(2), 77-98, DOI:10.1080/08911916.2021.1929582

Storm, S. (2022), Inflation in the Time of Corona and War, INET Working Paper No. 185 (May 30).

Yellen, J. L. (2019), Former Fed Chair Janet Yellen on Why the Answer to the Inflation Puzzle Matters, Brookings Report (October 3),

[i] In fact, the model by Ratner and Sim (2022, p. 17) predicts that a low inflation-low unemployment environment would be consistent with high vacancy rates. This is because labor bargaining power would be particularly low, thereby firms would have much higher incentives to increase job postings. Hence, following the model, the current high vacancy rates in the United States would be in line with a low labor bargaining power, and the inflation surge would be unrelated to any supposed tightness in the labor market.

[ii] We are grateful to Servaas Storm for raising this point. Also, to be fair, Ratner and Sim (2022, p. 16) recognize that the degree of bargaining power is made exogenous for simplicity, but assert it could potentially be made endogenous in a more sophisticated DSGE model, despite being a challenging task. However, we have serious doubts that doing this in a DSGE framework would retain the Kaleckian insight that a long-run fall in the bargaining power of workers would be affected by monetary policies that are biased against workers’ interests.

[iii] A recent paper by Shapiro (2022) defending the Fed’s policy of raising rates suggests that, perhaps, about one third of the recent inflation arises purely from the demand side while the rest would be either “ambiguous” or of a supply-side nature, or to quote Shapiro (2022): “These results showing that factors other than demand account for about two-thirds of recent elevated inflation …” In our opinion, this methodology is somewhat flawed and highlights why understanding Kalecki’s model is important. Despite the complicated technique based on rolling regressions to generate predicted monthly values for quantity and price, his theoretical framework seems to rest on an elementary textbook division whereby, if the actual monthly values of price and quantity are both above or both below their predicted values, then it’s a “demand-driven” phenomenon, while if the values are of opposite signs, this would be a “supply-driven” outcome, analogous to the elementary textbook demand/supply analysis. Unfortunately, this binary distinction could easily confound a cost-push inflation arising from increasing business markups with a pure demand-side inflation, as might be the case in recent times as the economy is recovering from the pandemic, where presumably price and output would be moving upward in tandem vis-à-vis their predicted values as well as the price markup! By contrast, Ratner and Sim (2022) allow for this Kaleckian markup effect in their specific model. Many recent studies suggest that rising markups are ubiquitous and have been rising also because of growing industrial concentration. See, for example, Bräuning, Fillat, and Joaquim (2022), Konczal and Lusiani (2022), and Storm (2022).

[iv] This flat range is certainly well recognized at the US Fed, as Yellen (2019) points out about the importance of the “sacrifice ratio” along the flat range: “It’s important to point out, however, that a flat Phillips curve has a downside, which is that it raises the so-called “sacrifice ratio.” The sacrifice ratio measures the cost in terms of higher unemployment to lower inflation should it rise too high. With a flat Phillips curve, it’s necessary for monetary policy to create a good deal of slack in the labor market to return inflation to levels consistent with price stability. … Finally, even if the Phillips curve is quite flat over some range, it’s conceivable that it could become a lot steeper if unemployment is pushed to very low levels: that is, it may be nonlinear at very low unemployment. There is some evidence of such nonlinearity, so it’s a significant policy concern.”

We believe that this describes reasonably well what has been said for years by post-Keynesian economists. What at the US Fed may not be understood is that flat anchor is not governed only by inflationary expectations impacting on wage growth, but also other supply-side/costs that can shift the whole curve as shown in Figure 1 above.

[v] This well-known Taylor rule is discussed, for instance, in Seccareccia and Kahn (2019), and was rejected by former chair Janet Yellen for possible adoption at the US Fed (see Davidson 2016). This pro-rentier “rule” rests on three elements: (1) a “natural rate” of interest that central banks would sustain over time, (2) a deviation between current inflation and the 2% inflation target, and (3) an output gap. Since the output gap is of concern to policy makers uniquely as a predictor of future inflation based on some standard Phillips Curve model, then monetary policy becomes focused solely on how to get the inflation rate back on target through interest rate policy, while preserving a stable positive real interest rate over time. As we have said, this pro-rentier Taylor rule policy framework would actually contravene the US Fed’s dual mandate since the so-called output gap in the equation is only of concern to policy makers for inflation-fighting purposes. Instead, the minimization of the unemployment rate towards a full employment level is not directly of any concern since it is not an independent policy objective within the Taylor rule framework unless one defines the NAIRU as full employment, which it is not.

Why The Ukraine Crisis Will Make Little Difference to Dollar Supremacy

Published by Anonymous (not verified) on Sat, 25/06/2022 - 12:11am in

The depth of the U.S. securities market helps ensure dollar hegemony

1. The Ukraine Crisis and Dollar Supremacy

Since the collapse of communism in the early 1990s and the subsequent rise of the world economy as a single market-based operational totality, its monetary counterpart has been a unipolar currency system centered on the US dollar as the premier vehicle currency in the private sector, as well as the premier reserve currency in the official sector. The hegemony of the dollar has survived several global economic shocks, including that of the financial crisis of 2007-9. Whether the system can survive the seismic shocks stemming from Russia’s invasion of Ukraine in February 2022 is now under active debate.

Many prominent commentators argue that it will not, noting the ongoing attempts by Russia and her trading allies to circumvent the US-led imposed financial sanctions. Barry Eichengreen, for instance, observed that because of the Russian and other central banks’ increased diversification of their reserve holdings away from the dollar “we are seeing movement towards a more multipolar international monetary system."[1] James Galbraith sees a dual currency system in the making, as Russia and her trading allies “carve out… a significant non-dollar, non-euro” rival financial system.[2] In a wider context of innovations in technology and finance, the IMF also noted the possibility of a scenario where “the greenback could be felled not by the dollar’s main rivals but by a group of alternative currencies,” including crypto and digital currencies.[3]

This is not the first time that a geopolitical crisis has prompted musings, at various levels of the academia and the commentariat, about the coming end of dollar hegemony. Invariably, they turned out to be wrong. Given the rather long history of failed forecasts, current predictions about the dollar’s future tend to be given with more caution and hedged with various caveats and qualifications. Indeed, to be fair to Barry Eichengreen, he is careful to emphasize that dollar dominance will not end soon, even while the Ukraine crisis may have accelerated the ‘stealth erosion’ of that dominance. A more general qualifying refrain is that a multipolar currency system, while not yet here, is nevertheless in the cards.

Is it, though? Can the ongoing attempts to establish a non-dollar alternative amount to a serious challenge to the hegemony of the dollar? The contrasting answers to this question reflect two alternative visions of capitalism. The declinist school of thought on the dollar supremacy stems, as Susan Strange noted some 30 years ago, from academic traditions that have historically overlooked the importance of the financial system in shaping the balance of power. It was a result of a methodological choice: at best, they have proxied it with currency regimes that serve international trade relations. As such, the declinist school of US power (and hence the dollar) originates in the productionist vision of capitalism, where trade reflects the structure of production, and where monetary regimes of individual states reflect the position of a country in international trade flows.

An alternative approach, known as the money view of capitalism,[4] or capitalism of futurity, places the tradability of debt[5] as the core institutional setting that defines political economy generally, and, more specifically, the force that anchors major decisions and developments in production, trade, and investment. From the latter perspective, we see no end to dollar supremacy, whether rapid or gradual. As Susan Strange wrote in her seminal critique of a realist school of international relations:

“the error of the declinist school of American scholars lies in assuming that if the US has lost power, some other state must have gained it… The facts suggest that this zero-sum idea is far too simple. The US government has lost power mainly to the market.”[6]

Today, we can add, the financial market. Focusing on the trade flows and currency reserve tactics of the central banks, the declinist perspective on the global role of the dollar overlooks the central force that underpins not only the hegemony of the dollar but lies behind global financialized capitalism in general. That force is the gravitational pull of the dollar-denominated securities markets.

2. The Gravitational Pull of the Dollar

"As recent crises make clear, up to now the dollar-based order has been supported mainly by instability elsewhere and the lack of a credible alternative or compelling reason to create one, or where such reasons are felt, the ability to do so... The system has been held up, in short, by confidence in itself, and not, so far as one can see, by much of anything else."[7]

Galbraith is correct about the importance of the lack of alternatives to the dollar, yet the problem with his argument is his reading of the cause. He sees the confidence in the dollar as something highly fragile because it apparently lacks any material substance to back it. A lack that, presumably, comes down to the gap between the US share of world production on the one hand, and its share of world securities supplies, on the other.

Between 1986 and 2019, daily forex turnover had risen from about $0.4 trillion to $6.6 trillion.[8] During this period, the dollar’s share of this turnover has averaged about 44%.[9] In today’s terms, this percentage is roughly on a par with the US’s respective percentage contributions to the world’s equity stocks (40% of the $95 trillion outstanding in 2019) and to the world’s bond stocks (39% of the $106 trillion outstanding in 2019).[10] However, it is also far above the US’s percentage share of nominal world output (23% of the 2019 world GDP figure of $88 trillion). These numbers, taken in combination with the trend increase in the US trade deficits, underpin the widely held view, shared by Galbraith, that there will soon come a time when foreign investors will lose confidence in the dollar and thus abandon it due to mounting concerns about the US ability to meet its financial obligations in the face of its deteriorating macroeconomic fundamentals.

This scenario is realistic only if one assumes that there has been no structural change in the relationship between the financial sector and the macroeconomy. Yet, citing Strange again, the addition of credit has altered the balance of power in the world economy. But not in the way that Galbraith and others envisage it.

The expansion of financial markets, the explosion of debt and asset values, are typically associated with the phenomenon of financialization. Over the past few decades, financialization has evolved at an accelerated pace; the financial sector now completely dominates the real productive economic sector on which it rests. In 1980 the combined nominal value of the world’s equity and bond stocks stood at about $11 trillion, a figure on a par with that of nominal world GDP in that year. By 2020 the combined value of those securities stocks had grown over twenty-fold to $234 trillion, while world GDP had only registered an eight-fold increase to $84 trillion in that same period.[11] The growing scale disparity between the financial sector and the underlying real sector is what ultimately fuels narratives of an impending collapse, and the declinist school on the power of the dollar forms one of those narratives.

But financializaton is not a one-dimensional force. Its depth is just as important as an indicator of its historical significance, as is its speed of development because it reflects the structural role of finance in economic transformation. To be specific, the recent scale growth of the world’s equity and debt securities markets is an outcome of fundamental changes in both their supply and demand sides.

From a supply-side standpoint, this growth manifests the radical change in corporate and government dependence on financial security issuance. Previously that dependence may have been small, or, if large, always temporary (e.g., bond issuance to finance a large-scale project or to meet the costs of an emergency). Today, it has become both large and permanent, because of the new financial pressures on corporations and governments that are rising in tandem with the increasing size and complexity of modern economies. For increasing volumes of security issuance to be possible, there obviously must be investors with a correspondingly large enough demand capacity. Chief amongst those investors are the institutional asset managers, the pension and mutual funds, and insurance companies.

Once a small cottage industry catering to the wealthy, over the past four decades asset management has in many countries become a mass industry catering to the retirement and other welfare arrangements of large sections of the population. Along with this growth in asset management scale has come a corresponding growth in the need for investable assets - most notably, for equities and bonds. Although there are other types of assets that serve as stores of value for asset managers, the exigencies of their role as financial intermediaries mean that it is financial securities that necessarily comprise the majority proportion of their asset holdings. What sets these securities apart from other asset classes is their ability to combine a value storage capacity with a relatively high degree of liquidity. “In most countries, bonds and equities are the two main asset classes in which pension assets were invested at the end of 2018, accounting for more than half of all investments in 32 out of 36 OECD countries, and 39 out of 46 other reporting jurisdictions.”[12]

The new structural presence of the asset management sector has important implications for the financial system as a whole. The large absorption capacities of asset managers represent ample opportunities for corporate and government borrowers in having these investors on the buy side of the securities markets. However, at the same time, the industry is operating under new tight constraints regarding the disbursements of cash. As securities have no intrinsic value, their ability to serve as investables with a determinate value storage capacity depends entirely on the degree to which their prices are held firm and thus made tangible, a condition which, in turn, depends on the rate and regularity with which cash is returned.

Here lies the crucial significance of the transformation of asset management from a subsector of finance serving individuals, into an industry of wealth management populated by large institutional players. When households were the representative type of investor in the securities markets, borrowers had far more room for maneuver over cash disbursements. This was partly because households, as small investors, were less able to constrain security issuing organizations, but also because they had less motivation to do so, given that they themselves were under no obligation to invest any part of their savings in financial securities.

By contrast, institutional asset managers are always obliged to keep a substantial proportion of the portfolios that are marketed to the public in the form of liquid securities. It is this obligation that explains why these investors have been instrumental in the establishment of a whole new type of transparency and governance infrastructure in the financial markets that can help guarantee the regularity with which borrowers return cash.

In the final analysis, all understanding of what sustains the dollar’s supremacy in the contemporary era comes down to an insight into the remarkable transformation that securities have undergone in line with the new governance rules and constraints that are now binding on security issuers. Without these constraints, promises of returning cash are always in danger of remaining fictitious: promises filled with empty air. With the new regulatory and governance constraints, securities have been transformed from mere promissory notes into genuinely solid stores of value; from being particles without matter, they become particles filled with matter. What this means is that when all the securities of a country’s organizations are aggregated together, this aggregation endows that country’s financial markets with mass and a corresponding power of attraction for asset managers and other institutional investors: the greater the mass, the greater the power of attraction.

No facet of this power is greater than that exerted by the US securities markets.

Foreign investors currently have trust in the US and in its legal and governance infrastructure of tradability debt, or futurity. Far from there not being "much of anything else" underpinning this trust, there is, on the contrary, much of everything underpinning it. What the US offers, and what no other region can do at present, is a huge and varied abundance of securities (not only equities but also bonds, including corporate, financial, Treasury, agency, and municipal bonds) in which foreign investors can store large amounts of funds and across which they can also move these large amounts relatively easily according to any change in circumstances.

Given the need for dollars as a means of accessing the US securities markets, it follows that just as it is the sheer depth and liquidity of these markets that attracts foreign institutional investors in droves, this attraction serves, in turn, to further amplify the depth and liquidity of the market for dollars itself. This development helps to explain why the dollar remains the most widely used currency in the execution of various cross-currency transactions. For example, the dollar is the funding currency of choice in foreign exchange swap transactions that currently account for nearly a half of the $6.6 trillion daily forex turnover and that are mostly used by banks to hedge exchange rate risks and meet short-term liquidity needs. Similarly, the sheer depth and liquidity of the dollar market means that even when those institutional investors holding globally diversified portfolios transfer funds from one set of non-dollar securities to another non-dollar set of securities, they usually do so indirectly, via the dollar, to contain the costs of these fund transfers.

How will the financial sanctions currently imposed on Russia impact this situation? The answer is, hardly at all. Of course, these measures will see an increase in the amount of pairwise emerging market economy (EME) currency transactions. Yet to put this increase into perspective, there needs to be an estimate of the percentage share of the $6.6 trillion daily forex turnover that these transactions had prior to the Ukraine crisis. Even a cursory look at the figures makes it clear that this share was negligible.

In the first place, EME cross-currency transactions relate primarily to trades in goods and services, and these trades, taken in conjunction with all other real-sector-related currency transactions, account for no more than 8% of total daily forex turnover.[13] Once one strips out the real-sector-related transactions conducted between the advanced market economies (AMEs) themselves and those between the latter and the EMEs, it turns out that the remaining inter-EME currency transactions barely register as a meaningful percentage ratio.

The combined share of all EME currencies in daily forex turnover is just 13%. Even then, in most cases the counter currency was not another EME currency but an AME currency such as the euro, the yen, the Australian dollar but most notably the US dollar. China’s yuan, although the highest-ranked EME currency in 2019 at 8th place in daily forex transactions, accounted for just 2% of these transactions and no less than 45% of these in turn had the dollar as the counter currency.

In sum, the Ukraine crisis will certainly lead to an increase in "non-dollar, non-euro" currency transactions, just as James Galbraith has argued. But the pre-crisis volume of these transactions was so vanishingly small as to invalidate any suggestion that this increase portends a multipolar currency system in the making.

3. An emergent multi-polar reserve currency system?

The same conclusion holds regarding predictions about the dollar’s primacy as a reserve currency. When Barry Eichengreen recently argued[14] that the Ukraine crisis will accelerate the movement towards a more multipolar international monetary system, his line of reasoning was as follows:

  1. the share of dollars in globally identified foreign exchange reserves has been trending down so that they now account for 59% of these reserves as opposed to the 70% figure of 20 years ago;
  2. the principal cause of this downward trend has been central banks’ diversification away from dollars towards the currencies of smaller economies such as Australia, Canada, Sweden, South Korea, and Singapore;
  3. this diversification into smaller currencies has been facilitated by the liquidity of these markets and hence the low costs of transacting in them, developments that have been made possible by the advent of electronic trading platforms and other financial innovations; and
  4. the principal motivation for this reserve diversification has been the central banks’ attraction to the higher yields that the smaller currencies offer in contrast to those offered by the large currencies.

There is nothing wrong with this explanation as to why central banks are diversifying their reserve portfolios to include more smaller currencies. Nor is there anything wrong with the IMF’s observation that these reserve portfolios may now include alternative currencies such as cryptocurrencies and digital currencies. What is wrong is that these narratives are presented in entirely self-enclosed terms rather than in the broader context of what any increased diversification signifies for the overall composition of central bank reserve portfolios.

As with all institutionally managed asset portfolios, foreign exchange reserve portfolios are organized according to a core-satellite structure, where the core segment in this case typically comprises US treasuries and the satellite segments comprise the higher-yielding securities of other governments.

A key question, therefore, is whether dollar reserves in central bank allocations will fall far enough below 59% to warrant the claim about an emergent multipolar reserve system? The answer to this question, in turn, boils down to the question of whether the dollar core segment in reserve portfolios will shrink to a size comparable with the non-dollar satellite segments. The expectations are that it will not.

Recall that the reason why institutional asset managers must hold a significant, if not majority, proportion of their portfolios in the form of financial securities, is that these best combine liquidity with a value storage capacity. Now, while the huge growth of the stock of securities in recent years has provided these institutional investors with abundant supplies of safe and portable value containers, the flip side of this growth in financial value storage capacity is that it has also provided hedge funds and other speculative vehicles with massive financial firepower when targeting national currencies that are perceived to be vulnerable. As was pointed out in a Group of Ten report back in 1993:

"the growth in the size, integration and agility of international financial markets has greatly increased the scale of pressure that can be exerted against an exchange rate when market sentiment shifts."[15]

The European currencies felt the scale of that pressure in the EMS crisis of the summer of 1992, while all the Asian currencies (bar the yen) felt the scale of that pressure in the summer of 1997. Indeed, it was largely because of the unnerving experiences of these crises that there was a subsequent sharp increase in central bank foreign exchange reserves. From barely $0.5 trillion in 1995, the total amount of allocated reserves held by central banks had risen to $5.4 trillion by 2010, an amount that was more than doubled again to $11.8 trillion by 2020.[16]

In 2020, the dollar’s share of allocated reserves was indeed 59% as compared with its share of 70% in 2000. However, to say that there was a “trend decline” in the dollar’s share over this twenty-year period is misleading because it gives the impression of a continuous, year-on-year decline. Rather, while there was an initial downward adjustment of the dollar’s share to about 60% that occurred in the first few years following the introduction of the euro, from 2005 to 2020 that 60% share then remained stable, as did the euro’s share of 20%, and as did the remaining 20% collective share of several other smaller currencies.[17] The fundamental reason why the dollar has continued to maintain this 60% share of foreign exchange reserves even as these continue to grow exponentially in absolute terms comes down to the large mass of US Treasuries.

In today’s era, when the world’s capital markets are deep and highly integrated and when cross-currency capital movements accordingly combine huge scale with high mobility, central banks that are concerned to minimize the impact of these movements on their domestic currencies need to have in reserve financial securities that: (i) have a large and safe value storage capacity, (ii) are available in abundance, and thus (iii) are highly liquid. No other financial securities, and no other financial instruments including crypto and digital currencies, can match US Treasuries as regards these criteria.

If any EME-based central banks needed any reminder of this crucial fact, the events of early March 2020, provided it. By that time, the covid-19 pandemic’s negative impact on the global economy became clear to the world's institutional investors, and they quickly withdrew funds amounting to over $100 billion from the EMEs in the space of days. That withdrawal was catastrophic for many of these countries, but its impact would have been even more devastating had their central banks not quickly intervened in their domestic currency markets with huge sales of the US Treasuries kept in their reserves.

Central banks around the world may well add the higher-yielding securities of other smaller currencies to their reserve portfolios. But can we seriously believe that, at a time when the world’s financial markets continue to grow in scale and become ever more closely integrated, and the threats posed by sudden surges of cross-border portfolio investments grow accordingly, that these central banks will risk substantially shrinking their core holdings of US Treasuries in the search for higher returns? Of course not.

4. The Primacy of the Dollar as an International Currency

On April 1st, 2022, the Bank of International Settlements launched its 13th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets, the full results of which are due to be published in November. In the two full years between the 2019 survey and the current one, the world economy suffered its biggest shock since the great depression of the 1930s with the outbreak of the covid pandemic. In 2020, nominal world GDP fell from its 2019 figure of $87.4 trillion to $84.9 trillion, while the world’s combined bond and equity stocks increased by more than 15% from $200.9 trillion in 2019 to $234.3 trillion, an increase principally driven by the steep increase in government bond issuance on the one hand, and the increase in security prices fueled by monetary policy easing, on the other.

The story in 2021 appeared somewhat better, as nominal world GDP rose above its pre-pandemic level to $94.9 trillion, but the world’s combined equity and bond stocks again rose substantially, to reach over $241 trillion.[18] In both these Covid-impacted years, the US share of the world’s supplies of equities and bonds remained stable at around 40%. Thus, going by the observation that forex turnover volume is overwhelmingly driven by financial sector interests as distinct from those of the real sector, we can safely predict that the dollar’s share of the new 2022 figure for daily forex turnover will remain around 44%, while, at the other end of the spectrum, the combined percentage shares of all the EME currencies will stay around 13%, with China's yuan share at 2%. In other words, our prediction is that the Ukraine crisis that broke out just after the commencement of the latest BIS triennial survey of forex turnover will have had no discernible impact on the currency breakdown of that turnover.

As to the longer term, we also predict that there will be no serious challenge to dollar supremacy in the foreseeable future because there will be no other regional or national currency that will have a sufficient backing mass of equity and debt securities to enable it to mount such a challenge over that time span. To support this prediction, we need only invoke the experience of the euro.

When this currency was launched in 1999, it was widely assumed that, as the currency of the world’s largest single market and trading bloc, it would soon overtake the dollar as the world’s premier international vehicle currency. Chinn and Frankel, for example, argued that the dollar would relinquish that position by 2015 not only because ‘the euro now exists as a more serious potential rival than the mark or yen were’ but also because ‘the United States by now has a 25-year history of chronic current account deficits and the dollar has a 35-year history of trend depreciation.’[19]

This argument could not have been more wrong, because while the euro’s share of daily forex turnover hovered around an average of 19% between 2001 and 2010, it subsequently fell to an average of 16% between that year and 2019, the principal reason for this reverse movement being the eurozone's failure to supply the world's large institutional investors with sufficient amounts of euro-denominated securities in which to park their funds.

This insufficiency is even starker in the case of the world’s EMEs that today collectively account for about 20% of world equity stocks and about 15% of world bonds stocks.[20] Many EMEs have too small a domestic real economic base to support securities markets of any appreciable size. Those EMEs that do have large production bases nevertheless continue to have relatively small financial markets principally, if not exclusively, because of continuing weaknesses in their domestic legal and governance infrastructures.

China’s situation illustrates the point. Although China’s equity and bond markets are by far the largest of any EME, these are still small by comparison with those of the US, largely because its governance standards are currently of uneven quality, high in some sub-categories (e.g. law and order, crime prevention) and low in others (e.g. protection of minority shareholders). As for the period ahead, China, which is still a middle-income developing country, will find it difficult to move all its legal and governance institutions rapidly in the required direction.

5. Conclusion

Nothing that has been said above should be taken to mean that we favor a dollar-centered international monetary system. Far from it, for we believe that there are many sound reasons, ranging from the political to the economic, why a multipolar system is desirable.

Desire, however, is not enough. Nor is it enough to hope that the foundations of dollar supremacy are so fragile that it is only a question of time and of another shock or two to the world political and economic order for those foundations to come tumbling down. On the contrary, those foundations are strong, which means that any attempts to elevate rival currencies to a position where they can challenge dollar supremacy must start by recognizing the reason why its foundations do remain strong. That reason comes down to the hard stuff of the financial securities markets, their constituent solid matter. The chief purpose of this short contribution has been to explain the nature of that matter.


Arslanalp, Serkan, Eichengreen, Barry and Simpson-Bell, Chima, 2022, “Dollar Dominance and the Rise of Nontraditional Reserve Currencies”, IMF Blog, 1 June 2022,

BIS, 2019a, “12th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets”, November.

BIS, 2019b, Quarterly Review, December.

Chinn, M. & Frankel, J. 2008, “Why the euro will rival the dollar”, International Finance, 11(1), 49–73.

Commons, John, 2017, Institutional Economics. Its Place in Political Economy, London, New York: Routledge.

Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance”, Financial Times, 28 March 2022.

Galbraith, James, 2022, "A multipolar financial world is here", INET, May 5th 2022;

Georgieva, Katarina, 2022, “The Future of Central Bank Money”, 2 February 2022,

Group of Ten. (1993). International capital movements and foreign exchange markets: Report to the Ministers and Governors by the Group of Deputies. Basel, Switzerland: Bank for International Settlements.

IMF, 2017, Composition of Foreign Exchange Reserves, March.

IMF, 2021, Composition of Foreign Exchange Reserves, March.

Mehrling, Perry, 2010, The New Lombard Street, Princeton: Princeton University Press.

OECD, 2019, Pension Markets in Focus, p.29.

SIFMA, 2020, US Capital Markets Fact Book.

SIFMA, 2021, US Capital Markets Fact Book.

SIFMA, 2022, US Capital Markets Fact Book.

Strange, Susan, 1994, “Wake Up, Krasner! The World Has Changed”, Review of International Political Economy, 1:1.

UNCTAD, 2019, “Financing a Global Green New Deal”, Trade and Development Report.

UNCTAD, 2022, “Tapering in a Time of Conflict”, TDR Update, March.


[1] Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance”, Financial Times, 28 March 2022.

[2] Galbraith, James, 2022, "A multipolar financial world is here", INET, 5 May;

[3] Arslanalp, Serkan, Eichengreen, Barry and Simpson-Bell, Chima, 2022, “Dollar Dominance and the Rise of Nontraditional Reserve Currencies”, IMF Blog, 1 June 2022,

[4] Mehrling, Perry, 2010, The New Lombard Street, Princeton: Princeton University Press.

[5] Commons, John, 2017, Institutional Economics. Its Place in Political Economy, London, New York: Routledge.

[6] Strange, Susan, 1994, “Wake Up, Krasner! The World Has Changed”, Review of International Political Economy, 1:1.

[7] Galbraith, James, 2022, "A multipolar financial world is here", INET, May 5th 2022.

[8] BIS, 2019a, 12th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets, November.

[9] BIS calculates currency percentage shares out of 200%, to allow for the double counting of each currency pair. For simplicity, in what follows we halved the shares to give figures out of 100%.

[10] SIFMA, 2020, US Capital Markets Fact Book.

[11] SIFMA, 2021, US Capital Markets Fact Book.

[12] OECD, 2019, Pension Markets in Focus, p.29.

[13] BIS, 2019b, Quarterly Review, December.

[14] Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance,” Financial Times, 28 March 2022.

[15] Group of Ten, 1993, p.33.

[16] IMF, 2017, Composition of Foreign Exchange Reserves, March. IMF, 2021, Composition of Foreign Exchange Reserves, March.

[17] UNCTAD, 2019, “Financing a Global Green New Deal”, Trade and Development Report.

[18] SIFMA, 2022, US Capital Markets Fact Book.

[19] Chinn, M. & Frankel, J. 2008, “Why the euro will rival the dollar”, International Finance, 11(1), p.51.

[20] UNCTAD, 2022, “Tapering in a Time of Conflict”, March.

A Comment on Lysandrou and Nesvetailova

Published by Anonymous (not verified) on Sat, 25/06/2022 - 12:11am in

James K. Galbraith responds on the U.S. dollar system

I thank Philos Lysandrou and Anastasia Nesvetailova for their response to my essay on the dollar in a multi-polar world. Our conclusions are broadly similar, though a reader of the Lysandrou/Nesvetailova essay alone might be forgiven for thinking that sharp differences exist.

For instance, L/N characterize my view in these words: “He sees the confidence in the dollar as something highly fragile because it apparently lacks any material substance to back it.” I searched my text for the words “fragile” and “fragility.” They were not to be found. On the contrary, L/N quote the following passage but omit both a crucial intermediate sentence and also the conclusion, which are included in bold below:

“So, as recent crises make clear, today the dollar-based order is supported mainly by instability
elsewhere and the lack of a credible alternative or compelling reason to create one, or where such
reasons are felt, the ability to do so. With a large and liquid market for debt, the US Treasury bond remains the refuge of first resort even when a financial upheaval originates within the United States, as was the case with the sub-prime debacles of the 2000s and even today. The system is supported, in short, by confidence in itself, and not, so far as one can see, by much of anything else. This however does not necessarily mean that it will collapse on its own in the immediate or even foreseeable future.

A full rendering of that passage would, I think, have almost eliminated dispute. L/N themselves describe the basis of the dollar system thus: “Foreign investors currently have trust in the US and in its legal and governance infrastructure...” If there is a distinction between their use of the word “trust” and mine of the word “confidence,” I'm not sure what it is.

My essay went on to discuss at length why neither Russia, China, nor the larger group forming around them are likely to be able to fill the world's need for a “large and liquid market for debt” in the near future. So my conclusion is precisely the one that L/N judge correct, namely that a “non-dollar/non-euro” zone is coming into existence, for a certain fraction of world payments and capital flows – thanks to Western sanctions that threaten the liquidity, security, and trustworthiness of US and European assets. That is what happens when you seize another country's holdings of Treasury bonds. Whatever comes next, this is a remarkable own-goal by Western financial powers. It is a sign, to be blunt, of reckless incompetence in strategic leadership in the United States.

Booming entrepreneurship during the Covid-19 pandemic

Published by Anonymous (not verified) on Wed, 22/06/2022 - 6:00pm in

Saleem Bahaj, Sophie Piton and Anthony Savagar

Recessions typically discourage entrepreneurs from starting new businesses. During the Great Recession, a ‘generation’ of start-ups went missing which contributed to a slow recovery in employment.  Two years after the pandemic started, evidence for the UK suggests a very different story: the pandemic inspired many entrepreneurs to start new businesses and this supported the recovery in employment.

Figure 1 shows the contrast between the Great Recession and the Covid-19 pandemic. It draws the path of cumulative applications since the start of the crisis (March 2020 for the pandemic, September 2008 for the Great Recession, both starting dates being normalized to zero), relative to a reference pre-crisis period. During the Great Recession (left panel), we see that 12 months into the crisis there were 8% fewer business registrations at Companies House than pre-crisis (than over September 2006 to 2007). By contrast, one year into the pandemic (right panel), new registrations were 8% higher than pre-pandemic (than over March 2018 to 2019). This stark contrast between the Great Recession and the Covid-19 pandemic is not specific to the UK. There are similar trends in the US and in France.

In a new Staff Working Paper we study these new entrepreneurs and analyse the growth potential of their businesses.

Figure 1: Cumulative business creation relative to pre-crisis, Global Financial Crisis (GFC) vs Pandemic for the UK, US and France

Source: authors’ calculations using Companies House, US Census and INSEE.

A start-up boom in online retail and by first-time entrepreneurs

Business registrations exhibit a sharp decline followed by a rapid rise after the introduction of the first national lockdown in March 2020. Before the pandemic there were roughly 50,000 monthly registrations in total and this increased to 60,000 post March 2020. The online retail sector disproportionately contributed to this increase: despite the sector’s modest size in the total number of firms (2%), it contributed up to 2,000 of a total increase in 10,000 registrations per month. In other words, online retail accounts for 20% of excess entry during the pandemic.

We investigate who started firms during the pandemic. When registering to Companies House, firms have to provide information on their shareholders and respective stakes. Using this information, we can identify whether the firm is owned by another corporation or individual shareholders, and whether the shareholder has stakes in other companies as well.

Intuition might suggest that existing firms quickly adjusted to setup online retail subsidiaries or benefit indirectly from business support packages, but we do not find evidence for this. Using the ownership information we find that the rise in firm creation was driven by first-time solo entrepreneurs (Figure 2). First-time solo entrepreneurs are firms started by single individuals who had not started another business in the five years prior to the crisis or did not own a business when the pandemic started. This suggests that workers in lockdown pursued new ventures given more labour hours from reduced commuting or being furloughed.

Figure 2: UK business creation during the pandemic by ownership type

Source: Authors’ calculations using BVD-FAME.

Note: A new entrepreneur is an individual shareholder with no business active in Jan. 2020 or founded since 2016.  A serial entrepreneur is an individual shareholder who owns a business active in January 2020 or owned a new business founded since 2016. Solo entrepreneur refers to a firm with a single individual as a shareholder.

Entrepreneurs adjusted quickly to the collapse in retail footfall

The surge in business creation during the Covid-19 recession is surprising from a historical perspective. Entrepreneurship declined in most recessions over the past century in the UK, except in extreme event recessions, such as post world wars and the Covid-19 pandemic. These recessions share the feature that the economy restructures to substantial shifts in consumer demand and producer supply. The post-war recessions in 1919 and 1946 saw entry boom as wartime production declined and private enterprise restarted. Similarly, during the Covid-19 pandemic widespread lockdowns reallocated demand to sectors that complied with social distancing.

To understand the mechanisms behind the rise in business creation, particularly the rise in the online retail sector, we investigate the relationship between firm creation and retail footfall at the local level. Footfall is a good indicator of lockdown stringency and reflects changes in lockdown policies. We find that a decline in retail footfall in an area leads to a rise in firm creation in the same area. We interpret the result as a negative local demand shock to brick-and-mortar retail leading to reallocation of demand to other businesses, and a response in supply through firm creation. We show that it takes less than three months (10 weeks) for a firm to be created following a decline in footfall.

This result highlights the rapid self-correcting mechanism of the economy during Covid-19. There were no direct policies targeted at new firm creation, and policies such as furlough, eat-out-to-help-out, and the bounce back loan scheme all required firms to exist prior to the crisis. Despite this, we observe a quick reaction by entrepreneurs in the economy responding to demand changes and increasing supply in lockdown-compliant sectors.

Mixed evidence on the growth potential of these new businesses

Are the new firms seeking to hire workers and will they contribute to the recovery in employment? To answer this question, we match Companies House data with job posting data from Indeed. Posting a job signals a firm’s intention to become an employer-firm. We study the speed at which new firms post jobs and find that firms created during the pandemic post faster than firms created pre-pandemic. This is reflected in Figure 3, left panel. This figure shows the cumulative quarterly probability of a new business posting a job in Indeed relative to a pre-pandemic firm in its first quarter since incorporation (with respective 90% confidence intervals). Firms born during the pandemic are more likely to post a job within the first year of their existence than firms born in the two years prior to the crisis (the green line is significantly above the black line). Translating these numbers in economic terms suggest that firms born during the pandemic are four times more likely to post a job within the first quarter of their existence than firms born in the two years prior to the crisis. This result controls for the aggregate trend in job postings and its sectoral composition. In other words, the result does not arise mechanically because each year firms are posting faster or because the sectors that grow in importance during the pandemic, such as online retail, are sectors that typically post jobs faster.

Figure 3: Firms born during the pandemic both more likely to try to hire and to dissolve

Source: Authors’ calculations using Indeed and Companies House.

Are the new firms more likely to exit? We analyse the survival rates of new firms during the pandemic using dissolutions data from Companies House. We find that firms created during the pandemic are more likely to dissolve than firms born pre-pandemic firms. This is reflected in Figure 3, right panel. This figure shows the cumulative quarterly probability of a new business dissolving relative to a pre-pandemic firm in its first quarter since incorporation (with respective 90% confidence intervals).  Newly created firms during Covid-19 are more likely to dissolve within the first year than newly created firms pre-pandemic (the green line is again significantly above the black line). Translating these numbers in economic terms suggest that firms born during the pandemic are twice more likely to dissolve within the first year of their existence than firms born pre-crisis. We also find that firms created by solo entrepreneurs are more likely to dissolve than other types of ownership structure such as subsidiaries of larger groups or firms created by a group of individuals.

These results provide initial evidence that booming firm creation has helped the rapid recovery in the UK economy in the short run, but in the long run the implications are less clear. A rising number of dissolutions and entry concentrated among solo entrepreneurs who tend to dissolve more could negate the impact of the Covid-19 surge in firm creation.

Saleem Bahaj works in the Bank’s Research Hub, Sophie Piton works in the Bank’s Monetary Analysis, Structural Economics Division and Anthony Savagar works at the University of Kent.

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Climate and capital: some outstanding issues

Published by Anonymous (not verified) on Wed, 08/06/2022 - 6:00pm in

Marco Bardoscia, Benjamin Guin and Misa Tanaka

There is a lively debate about whether and how capital regulations for banks and insurers should be adjusted in response to climate change. The Bank of England will host a conference later this year to discuss the points in favour of and against adjustments to the regulatory capital framework to take account of climate-related financial risks. The call for papers asks for research on appropriate capital tools to address these risks, eg whether risks point to microprudential tools which are firm specific or rather macroprudential system-wide ones. Moreover, it asks for research on an appropriate time horizon over which the risks should be considered and how scenarios and forward-looking data should be used. This post will review the existing literature and identify some key gaps.

Measuring climate-related risks in asset portfolios

The main rationale for incorporating climate-related risks in capital regulation is to ensure that individual banks and insurers have sufficient capacity to absorb losses which could arise when these risks crystallise. Incorporating climate-related risks into the capital regime will require a reliable methodology to measure these risks. 

The existing literature proposes several approaches for estimating banks’ exposure to climate transition risks – ie risks associated with transitioning to a low-carbon economy. The first approach is to build climate stress testing around technologically plausible scenarios and carbon price paths which are consistent with climate goals (Batten et al (2016, 2018 – Chapter 10) and NGFS (2020)). The second approach is to estimate capital shortfalls for banks arising from the ‘stranding’ of specific sectors exposed to climate transition scenarios (Battiston et al (2017)). The third approach consists of building market-based measures of exposures to transition risks based on the sensitivity of banks’ equity prices to the excess return of fossil fuel firms (Jung et al (2021)). 

Physical risks – ie risks arising from climate change itself – are harder to quantify than transition risks. While catastrophe models can incorporate the increasing frequency and severity of extreme weather events in the future, they cannot predict which specific region will actually experience an extreme weather event (Leaton (2020)). BCBS (2021a) acknowledges that limited progress has been made in capturing banks’ exposures to physical risks, due to lack of data about the geographical locations of the physical assets underlying their financial exposures, and uncertainty about their ability to insure against prospective losses. Moreover, physical climate risks need to be estimated using non-linear, forward-looking models (BCBS (2021a) and BCBS (2021b)). But such models can give rise to radically different results and are hard to validate, as past data are unlikely to contain meaningful information about the future trajectory of key climate variables.

Setting capital requirements or buffers based on market-based climate risk measures is problematic for two reasons. First, these measures are likely to be directly influenced by the market reaction to regulators’ actions. Second, market-based measures provide reliable signals of transition risks only to the extent that investors price these risks. 

By contrast, setting capital requirements or buffers based on climate stress tests is conceptually similar to basing these on other types of stress tests, as long as all major banks and insurers have granular data to map the stress scenarios to losses. But there are practical challenges in mapping climate stress-test results to capital requirements. Further research in the following areas could potentially overcome these challenges.

First, more work is needed on how to approach risks that might materialise over a long-time horizon and how much capital should be held against these. At the same time, there is a need to develop methodologies to estimate climate risks over relatively short time horizons that are consistent with the current microprudential capital framework (BIS (2022)). Second, reliable methodologies need to be developed to help regulators validate firms’ data and models. Finally, there is a need to gauge the extent to which climate risks are already reflected in banks’ and insurers’ capital.

Ideas for new policy tools and macroeconomic considerations

Others have made the case of incorporating climate risks into capital requirements on macroprudential grounds: as climate-related risks can ultimately destabilise the financial system, and regulators should use capital requirements to incentivise an early and orderly low-carbon transition.

One proposal is to introduce lower risk weights for green assets (green supporting factors (GSF)) and higher risk weights for carbon-polluting assets (carbon penalising factors (CPF), also referred to as brown penalizing factor) in calculating capital requirements to incentivise green investment (eg Dombrovskis (2018)). Campiglio (2016) argues in favour of green supporting financial regulations, as a carbon tax might not provide enough incentive to stimulate low-carbon investment when banks face constraints in expanding credit. The implementation of these tools could be partially reconciled with a risk-based approach if green investments were consistently less risky. However, available evidence does not convincingly support this (see, for example, Chapter 5 in EBA (2022)).

Batten et al (2016, 2018 – Chapter 10) have argued that capital requirements are not the right tool for climate mitigation. Capital requirements for banks and insurers are designed to mitigate prudential risks, and hence adapting these to achieve climate mitigation objectives could undermine their primary purpose, or could give rise to undesirable effects. Moreover, unless those policies are implemented across major jurisdictions, carbon-polluting firms can bypass them by raising funds on international financial markets (Campiglio et al (2018)). Others have also questioned the usefulness of capital requirements as a climate mitigation tool using formal models. For example, Dunz et al (2021) develop a macroeconomic stock-flow consistent model and find that reducing risk weights for green loans to zero will result only in a small increase in the share of green capital goods in the economy and lead to an increase in the ratio of non-performing loans of carbon-polluting firms.

According to the ‘Tinbergen Rule’, policymakers must use multiple policy tools if they want to impact multiple policy targets. Several recent studies use agent-based models to analyse a combination of prudential and government policies. They typically conclude that green prudential policies can give rise to undesirable effects if they are not supported by other policies. Dafermos and Nikolaidi (2021) find that GSF and CPF reduce the pace of global warming and thereby decrease physical risks. At the same time, GSF increases bank leverage by boosting green credit and CPF increases loan defaults by reducing economic activity. A mix of green fiscal policies and CPF is potentially synergic, as the former reduce the transition risk brought by the latter. Lamperti et al (2021) investigate green capital requirements alongside green credit guarantees and carbon-emission adjustments in credit ratings. They find that a policy mix comprising all three policies allows the economy to enter a virtuous cycle. Lamperti et al (2019) find that climate-dependent capital requirements can counterbalance excessively high or low credit provision, as they account for the impact of climate damages on firms’ solvency. Such a policy could help address climate physical risks, even though it proves ineffective when damages surge.

In our opinion, an open question is whether capital requirements that are calibrated to imperfect measures of climate risks can achieve the intended aims of ensuring that banks and insurers have sufficient capital to absorb losses without giving rise to unintended side-effects. It is conceivable that imperfectly calibrated capital requirements could at worst interfere with climate mitigation. For example, suppose capital requirements against all oil sector exposure are raised without allowing for the fact that some companies within the sector are actively investing in renewable energy and are thus less exposed to transition risks. By raising the cost of finance for the entire sector it could end up discouraging investment needed for low-carbon transition. 


The literature has proposed ideas of new capital tools but we think that both conceptual and practical challenges remain. For example, as we transition to a greener economy, do climate-related risks increase system-wide or are they simply redistributed across firms pointing to microprudential requirements (EBA (2022))?

Moreover, the literature shows some progress documenting and sizing firms’ exposure to climate risks, eg via stress testing. However, further work is needed to explore the appropriate time horizons for capital requirements and how to use forward-looking information in the existing regime. More research is also needed on how to deal with the so-called model uncertainty, and issues around how to validate climate models using available data when certain risks have never materialised in the past.

New research that addresses those challenges can inform policymakers in developing their policy toolkit to tackle climate risks.

Marco Bardoscia and Misa Tanaka work in the Bank’s Research Division and Benjamin Guin works in the Bank’s Strategy, Policy and Approach Division.

Comments will only appear once approved by a moderator, and are only published where a full name is supplied. Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

If you want to get in touch, please email us at or leave a comment below.

Inflation in the Time of Corona and War

Published by Anonymous (not verified) on Tue, 07/06/2022 - 4:13am in

Are there alternative, less socially costly, ways to bring inflation down?

Inflation in a Time of Corona and War

Published by Anonymous (not verified) on Tue, 07/06/2022 - 4:12am in

Evidence-based answers to the main (policy) questions concerning the return of high inflation

A specter is haunting the US—the specter of stagflation

Financial TimesMartin Wolf (2022) is the latest influential voice sounding the alarm bell on ‘the threat of stagflation’ and calling for the Fed to drastically raise interest rates to bring inflation down to its target level. Published on May 24, Wolf’s diagnosis of where the stagflation in the US economy is coming from reflects current establishment opinion: nominal demand, fuelled by over-expansionary fiscal and monetary policies during the COVID-19 crisis, is exceeding US supply. To bring down inflation, these macroeconomic policy errors need to be corrected convincingly and as soon as possible. This is how Wolf puts it:

“US supply is constrained above all by overfull employment […] Meanwhile, nominal demand has been expanding at a torrid pace. [….] The combination of fiscal and monetary policies implemented in 2020 and 2021 ignited an inflationary fire. The belief that these flames will go out with a modest move in interest rates and no rise in unemployment is far too optimistic. Suppose, then, that this grim perspective is correct. Then inflation will fall, but maybe only to 4 per cent or so. Higher inflation would become a new normal. The Fed would then need to act again or have to abandon its target, destabilising expectations and losing credibility. This would be a stagflation cycle — a result of the interaction of shocks with mistakes made by fiscal and monetary policymakers.” (italics added)

Wolf hedges his bets and does not state how strongly the Fed should raise the interest rate in order to avoid the ‘grim’ prospect of a stagflation cycle. Wolf is in the good company of Lawrence Summers who voiced similar concerns already in February. Summers, however, does not hesitate to provide more explicit guidance to monetary policy-makers in the Fed:

“[….] we’re likely to have a need for nominal interest rates, basic Fed interest rates, to rise to the 4 percent to 5 percent range over the next couple of years. If they don’t do that, I think we’ll get higher inflation. And then over time, it will be necessary for them to get to still higher levels and cause even greater dislocations” (Klein 2022).

Summers’ and Wolf’s calls for action are echoed by many observers in the financial sector. Mohamed El-Erian (2022), for instance, argues that

“Also similar to the 1970s, the US Federal Reserve [….] is already dealing with self-inflicted damage to its inflation-fighting credibility. With that comes the likelihood of de-anchored inflationary expectations, the absence of good monetary policy options, and a stark choice for the Fed between enabling above-target inflation well into 2023 or pushing the economy into recession.” (italics added)

Goldman Sachs Group President John Waldron has just one piece of advice for the Fed: “…. bring back Paul Volcker” (Natarajan and Reyes 2022). Wolf, Summers, El-Erian, and Waldron are thus putting serious pressure on the Fed to hike up interest rates more strongly and quickly than it is already doing.

On March 16, 2022, the Fed raised the interest rate by a quarter percentage point, from 0.25% to 0.5%—the first interest rate increase since 2018. And on May 3, 2022, it raised its benchmark rate by another half-a-percentage point. “We have to reassure people we are going to defend our inflation target and we are going to get inflation back to 2%,” St. Louis Federal Reserve President James Bullard stated recently, adding that “our credibility is on the line here” (Egan 2022). Bullard doubled down on his view by recommending that the Federal Open Market Committee (FOMC) should shoot for a policy rate above 3% this year.

Not only the Fed, but central banks all over the globe are raising rates rapidly in the most widespread tightening of monetary policy for more than two decades, according to a recent Financial Times analysis (Romei 2022). To bring down inflationary pressures, central bankers worldwide have announced more than 60 increases in current key interest rates in the past three months. The recent increases are just the beginning of a global monetary tightening cycle (UNCTAD 2022). The Fed, pushed by the likes of Summers, Wolf, El-Erian, and Waldron, is expected to move to a policy rate around 2.5%-2.75% by the end of 2022, but statements in the minutes of the FOMC indicate that its members are prepared to raise interest rates more, if and when deemed necessary.

A soft versus a hard landing

Few doubt that the monetary tightening by the Fed will push the US economy into a recession. This means there is no free lunch: bringing inflation down comes with a considerable societal cost. Opinions are divided over how deep and long-lasting this recession will be. Establishment opinion is that “the time to throttle an inflationary upsurge is at its beginning, when expectations are still on the policymakers’ side,” as Wolf (2022) puts it. That is, the sooner and the more aggressive the Fed acts, the lower will be the collateral damage to the US economy and the more likely the US economy will experience a ‘soft landing’—which is Central Banker Speak for a relatively mild recession.

Channeling former Fed chair Paul Volcker, who has posthumously acquired a near-saintly status with the monetary policy commentariat, Summers adds that the cost of sharply increasing the interest rate to kill off inflation will be temporary increases in unemployment—and he opines that bearing this non-trivial (but temporary) social cost will be preferable to suffering from the permanent cost of inaction, which he predicts, rather ominously, will involve “stagflation and the associated loss of public confidence in our country” (Klein 2022). For Summers, a ‘hard landing’, a cherished euphemism for a deeper, bruising, recession, appears to be preferable to the long-run societal cost of a scenario in which the Fed does not act strongly and quickly enough, loses its inflation-fighting credibility, and cannot prevent the de-anchoring of expectations. Wolf concurs (again) and adds that “the political ramifications [of such a stagflation cycle] are disturbing, especially given a vast oversupply of crazy populists.”

The arguments of Summers and Wolf are fairly typical of the much broader macroeconomic debate within a select in-crowd of Very Serious Economists over how to respond to the recent surge in US inflation. The tone of this debate in newspapers and online fora is dire (“stagflation, after all, is a grim threat”); the arguments are abstract (“monetary tightening is crucial to maintain the Fed’s inflation-fighting credibility and keep inflation expectations anchored”); the analyses are surprisingly ahistorical (“today’s situation is a repeat of the 1970s” and “bring back Volcker”), the discussions are relatively tone-deaf to the very inegalitarian negative impacts of the sharp increases in interest rates, the (social engineering) policy solutions are mechanical and actionable (“raise interest rates to 5% and the inflation will go away”); and the underlying thinking remains firmly within the box of establishment macroeconomics (“the Fed is capable of controlling inflation without killing the economy in so doing”).

A more acute assessment would recognize that interest rates are a socially very costly tool to ‘control’ inflation—especially when the sources of the inflationary surge lie in an unprecedented constellation of (mostly) supply-side bottlenecks which are driving up prices. Similarly, a close look at the past record of monetary tightening shows that the Fed has hardly ever managed to guide the economy to a soft landing with interest rate increases.[1] A key reason is that small interest rate hikes do not reduce inflation (at all). It takes large interest rate hikes, but those come with massive collateral damage to the real economy—and this collateral damage might well be larger than the damage done by allowing inflation to remain high for some, while actively managing its consequences (especially in terms of the distribution of incomes). John Cochrane (2022, p. 9) sums it up rather well:

“The Fed likes to say it has “the tools” to contain inflation, but never dares to say just what those tools are. In recent U.S. historical experience, the Fed’s tool is to replay 1980: 20 percent interest rates, a bruising recession hurting the disadvantaged especially, and the medicine applied for as long as it takes. Will our Fed really do that? Will our Congress let our Fed do that? Can you deter an enemy without revealing what’s in your arsenal and whether you will use it?”

There are reasons to believe that the collateral damage wrought by substantially higher interest rates will be even higher today than in 1980. The key point is that more than a decade of extraordinarily low interest rates have led to a significant increase in corporate and public debts and an unsustainable bout of asset price inflation in the housing market, the stock market, and almost all other financial markets. A large interest rate hike will create a financial crash. The Federal Reserve (2022) recognizes these non-negligible downward risks of monetary tightening to the American economy in its Financial Stability Report of May 2022. Bringing back Volcker might, therefore, not be a good idea. What is to be done?

A new INET working paper on US inflation

In a new Working Paper for INET, I attempt to recover the lost plot, arguing that the recent inflation has mostly supply-side origins, caused by the COVID-19 crisis and the Ukraine war, and has been enabled by mistaken past and current macroeconomic policy choices. The paper takes a close look at the current inflation in the US, showing that it is not due to a generalized co-movement of (all) prices, but to a number of sector-specific price increases in industries strongly affected by global commodity-chain disruptions (Section 2). The corona crisis has been seriously stress-testing the resilience of the global supply chains that have developed during three decades of neoliberal globalization—and the system has been found wanting. Section 3 considers the global supply side of US inflation in more detail and investigates how global supply chain disruptions and higher global commodity prices have raised US import prices; I find that higher import inflation has been directly responsible for almost one-third of the increase in the PCE inflation rate during 2021-2022.

Section 4 presents data on accelerating inflation in the rest of the world. These data underline the fact that the rise in US inflation is by no means exceptional: almost all other economies are experiencing similar surges in (consumer price) inflation as the US. Inflation is running well above central bank inflation targets in all advanced economies. In most, central banks have so far reacted to the increase in inflationary pressures with a gradual response, tapering off unconventional monetary policy support introduced during the pandemic and raising policy rates. Interestingly, differences in the magnitude of fiscal relief responses to the corona-crisis between countries are not showing up in (statistically significant) differences in CPI inflation rates. This suggests that fiscal policy is not a key driver of inflation (differences).

The impacts of the global supply shock were amplified by supply-side bottlenecks within the US economy (Section 5), including inefficiencies in US ports and a shortage of long-haul truck drivers. However, the most important domestic supply constraint triggered by COVID-19 arose from the sharp decline in the (effective) labor force of the US: the employment-population ratio declined by 9 percentage points in early 2020 (Figure 1). The employment-population ratio steadily increased from 58.4% in January 2012 to 61.2% in February 2020, but it sharply dropped to 51.3% in April 2020 and 52.8% in May 2020 in response to the arrival of SARS-Cov-2 in the US. The average monthly employment shortfall was around 8 million persons in 2021.

Even though the employment-population ratio climbed up again to 60.1% in March 2022, it continues to remain below what it would have been without the COVID-19 shock. The estimated employment shortfall in March 2022 is 4 million workers (relative to the counterfactual). As elaborated in the paper, BLS data show that during the period May-December 2020, more than 40% of the estimated employment shortfall was caused by “persons not in the labor force, who did not look for a job in the last 4 weeks because of the coronavirus pandemic”. In 2021, around 28% of the employment shortfall must be attributed to persons dropping out of the labor force because of the coronavirus pandemic.

For many workers, the coronavirus outbreak was the main reason for quitting a job—directly, because doing the job had a high risk of getting infected, but also indirectly, because the job offered no or insufficient health insurance, lacked the flexibility to choose when to put in one’s hours, did not allow for working remotely, or did not offer adequate child care support. In Spring 2022, there are still around 1 million “persons not in the labor force, who did not look for a job in the last 4 weeks because of the coronavirus pandemic”, and around 3 million workers decided to retire (temporarily or permanently), primarily because of COVID-19.

As a result, in March 2022, the US labor force still has 4 million fewer workers than in the ‘no-corona’ counterfactual. The sharp decline in the effective labor force has led to a tightness of the US labor market which is showing up in a high vacancy ratio. As millions of workers disengaged from the labor force, by quitting or retiring, the number of job vacancies has risen sharply. The vacancy ratio, the ratio of job vacancies to official unemployment, has increased to 1.94 jobs per unemployed worker in March 2022, which is more than three times its long-run average level. This is what Martin Wolf means when he argues that “US supply is constrained above all by overfull employment.” But overfull employment is caused by the COVID-19 caused drop in the effective labor force of the US. It follows that, as long as COVID-19 continues to pose a significant health risk, the US labor market will remain ‘tight’.

Is there a wage-price spiral?

According to Wolf, Summers, and many other observers, US inflation is significantly driven by a wage-price spiral. The empirical case in support of this claim has been made by Domash and Summers (2022a, 2022b, 2022c) who argue that the vacancy and quit rates currently experienced in the US correspond to a degree of labor market tightness previously associated with below-2% unemployment rates. Such tightness, they warn, will make for “extremely rapid growth in nominal wages” (Domash and Summers 2022a, p. 32). Specifically, “nominal wage growth […] is projected to increase dramatically over the next two years, surpassing 6% wage inflation by 2023 ….” (p. 21). This is serious stuff—notice the use of the words “extremely” and “dramatically” in these sentences.
So, what is the evidence on nominal wage growth and its impact on US inflation? In response to the tightness of the labor market, nominal wages for the median US worker increased by 4.7% during April 2021 and April 2022 (Figure 2). This may look like relatively good news for US workers, whose median nominal wages increased by around 2.7% per year during 2010-2019 and whose real wages rose by only 1.1% per annum over the same period, but on a closer look, it isn’t. Nominal wage growth of American workers is not keeping up with accelerating PCE inflation, and hence, median real wage growth in the US became negative already in April 2021 (Figure 3). One year later, in April 2022, annual median real wage growth in the US is -2.1%. Real wage growth has been negative in almost all industries and occupations.

In Section 6 of the Working Paper, I identify various reasons why the evidentiary base of Domash and Summers’ (2022a) claim is not robust enough to substantiate their claim that the US is experiencing a wage-price spiral. A key point is that Domash and Summers assume that higher inflation is pushing up nominal wage growth. However, their own regression results show that inflation indexation is far from perfect: in 14 out of 21 regressions, the coefficient of lagged inflation on nominal wage growth in the US is not statistically significant. This means that in two-thirds of their regressions, higher prices are found to reduce real wage one-for-one. In the remaining 7 regressions, the coefficient of lagged inflation on nominal wage growth takes an average value of 0.35. Hence, even when US labor markets are extremely tight, US workers are unable to protect their real wages—as their nominal wages grow only one-third as fast as the general price level. Higher inflation is extremely costly to workers, therefore. To single out higher nominal wages as a main cause of the increase in US inflation is not just incorrect, because wage growth barely manages to partially follow (not leading) inflation, but it is quite a stark example of blaming the victim.

Finally, I estimate a more complete econometric model which also includes supply-side constraints (in addition to the vacancy ratio). The estimation results suggest that, on average, 20.5% of (rising) PCE inflation can be attributed to the (rising) vacancy ratio (as a proxy of labor market tightness). However, global commodity prices and capacity utilization play more prominent roles and account for 67% and 35% of PCE inflation. Hence, labor market tightness does contribute to US inflation indeed, but supply-side constraints play a more important role. Besides, the labor market tightness itself is caused by the fact that labor demand has recovered more quickly than the effective labor force (as I discuss below).

The problem that shall not be named: profit-driven inflation

US inflation is also being driven by the pricing power and higher profits of corporations—a claim that Lawrence Summers rejected on Twitter as a form of ‘science denial’. But there is more than just anecdotal evidence that corporations with pricing power are using the current inflationary environment as a pretext to raise prices more than necessary because they do not have competitors to drive them to keep prices down. For instance, Fed economists Amiti et al. (2021) highlight the importance of (what they call) the strategic complementarity channel, which captures how much US firms adjust their prices in response to changes in the prices charged by their foreign competitors. To illustrate, if the price of imported cars increases, domestic car producers can also increase their prices. The strategic complementarity channel has been estimated to account for circa 30 percent of the effect of higher import prices on US inflation (Amiti et al. 2021).

The strategic complementarity channel does help to explain the profiteering by large US corporations which have been able to raise their profit margins to the highest level in 70 years. Nominal growth of corporate profits (by 35%) during 2021 has vastly outstripped nominal increases in the compensation of employees (10%) as well as the PCE inflation rate (6.1%). Using inflation as an excuse and helped by algorithmic pricing and AI, mega-corporations are choosing to raise prices to increase their profit margins – and they hold enough market power to do so without fear of losing customers to other competitors.

Corporate profiteering is contributing to the inflation problem. According to The Wall Street Journal, nearly two out of three of the biggest US publicly traded companies had larger profit margins this year than they did in 2019, prior to the pandemic (Broughton and Francis 2021). Nearly 100 of these corporations did report profits in 2021 that are 50 percent above profit margins from 2019. Evidence from corporate earnings calls shows that CEOs are boasting about their “pricing power,” meaning the ability to raise prices without losing customers (Groundwork Collaborative 2022; Perkins 2022). Even the Chair of the Federal Reserve, Jerome Powell, has weighed in on this issue, stating that large corporations with near-monopolistic market power are “raising prices because they can.”

I estimated the inflationary impact of higher profits as well as higher nominal wages, using a simple model in which the producer price is determined by adding a profit mark-up to unit production cost which includes the unit cost of domestic and imported intermediate inputs and unit labor cost. Using BEA data, I find that higher nominal wages accounted for around 10% of the increase in the US producer price during 2020Q2-2021Q3, but the increase in net profits per unit of gross output accounted for more than one-third of the price increase (Figure 4).

These findings are similar to findings by Bivens (2022) who used a different approach. I have updated Bivens’ analysis to 2022Q1 and the results appear in Figure 5. More than 38% of the rise in the US inflation rate during 2020Q2 – 2022Q1 has been due to fatter profit margins, with higher unit labor costs contributing around 19% of this increase. Using Bivens’ approach, the contribution to inflation of higher profit margins is found to be two times as large as that of higher nominal wages. As Bivens (2022) notes, this is not normal: from 1979 to 2019, profits only contributed about 13% to price growth and labor costs 56.1%.
The historically high-profit margins in the economic recovery from the COVID-19 crisis are difficult to square with explanations of recent inflation based purely on macroeconomic overheating. We have already seen (in Figure 3) that real wages are declining. And what Figures 4 and 5 suggest, is that recent US inflation has been caused more by a profit-price spiral than by a wage-price spiral (as nominal wage growth is lagging behind profit growth).

The perversity trope: excessive nominal wage growth reduces real wages

Domash and Summers (2022c) take their wage-price spiral argument one step further, claiming that it is not in the interest of US workers to demand higher nominal wages as compensation for the sharply rising costs of living. Their argument is that claiming higher nominal wages is a self-defeating strategy because individual gains in nominal income will be eroded by the consequent increase in aggregate inflation. This claim is a clear instance of what Albert Hirschman (1991) called the ‘rhetoric of reaction’, and more specifically, of the ‘perversity trope’: the claim that some purposive intervention to improve some feature of the political, social or economic order only serves to worsen the condition one wishes to ameliorate (Storm 2019).

I have replicated the analysis of Domash and Summers (2022c) (see Figure 6) and obtain a similar parabolic—inverse U-shaped—relationship between lagged nominal wage growth and real wage growth in the US during 1965Q1-2019Q4. Domash and Summers use the annual growth rates of ‘average hourly earnings of production and nonsupervisory employees, total private’ as their measure of nominal wage growth; as shown in the Appendix, their measure gives much higher growth rates for nominal wages than alternative measures. Anyway, the fitted parabola has a turning point at a nominal wage growth rate of 5.6%; real wage growth peaks at 1.44%. If we take Figure 6 seriously (which we shouldn’t), this would mean that the average US real wage growth will decline from its peak level of 1.44%, the more US workers manage to push nominal wage growth above the threshold of 5.6%.

US workers be warned: nominal wage growth (calculated as the 4-quarter percent change in the hourly nominal compensation for non-farm employees from the BLS), running at 6.5% in the first quarter of 2022, has already passed the turning point of Figure 6, and hence, US real wage growth will only decline. To Domash and Summers (2022c) US workers act in a non-rational manner, hurting their own interests, by claiming excessively high nominal wage growth. It follows that rational workers would decide to restrain nominal wage growth (below 5.6%) and doing so, their private benefit (obtaining higher real wage growth) will lead, as led by an invisible hand, to a social benefit as well (because it helps cool down the overheated US economy).

The particular ‘perversity trope’ used by Domash and Summers (2022c) can only work, however, if higher nominal wage growth raises the growth of nominal unit labor cost (ULC) and firms shift the higher ULC on to prices. Nominal unit labor cost growth is, by definition, equal to the difference between nominal wage growth and labor productivity growth. It follows that an increase in nominal wage growth that is accompanied by a similar increase in labor productivity growth does not raise nominal ULC growth and inflation. Hence, the correlation between nominal wage growth and real wage growth in Figure 6 is somewhat misleading, because higher nominal wage growth will only impact inflation and real wage growth if it exceeds labor productivity growth and raises ULC growth.

In the Working Paper, I re-do the analysis of Domash and Summers using the 4-quarters lagged growth of nominal ULC instead of nominal wage growth. After all, nominal ULC growth is what matters for inflation. I obtain a (similar) parabolic relationship between ULC growth and real wage growth in the US during 1965Q1-2019Q4. The parabola has a turning point at a nominal ULC growth rate of 6.2%; real wage growth peaks at 2.5%.

What does my finding imply for nominal wage growth and the warning by Domash and Summers? Well, note first that labor productivity growth in the US during 1965Q1 and 2019Q4 was 1.9% on average per year. This implies that a nominal wage growth rate of 8.1% is consistent with a growth rate of nominal ULC of 6.2%. In other words, using nominal ULC growth instead of nominal wage growth, I find that the turning point after which nominal wage growth is associated with declining real wage growth is 8.1% rather than 5.6%. With US (quarterly) nominal wage growth running at 6.5%, it still makes good sense for US workers to push up nominal and real wages—a very different conclusion from the one obtained by Domash and Summers, but nevertheless completely in line with their logic.

Their logic, or rather the lack of any substantial logic, is the real problem concerning the parabolic relationship between nominal and real wage growth, put forward by Domash and Summers. Let it be said, the two authors duly acknowledge that the parabolic relationship is not meaningful in a causal way, because “nominal wage growth and real wage growth reflect a variety of economic forces.” But they nevertheless quickly proceed with their argument, treating higher nominal wage growth as a cause of lower real wage growth. Empirically, however, the relationship is not strong, as the parabolic relationships explain only around one-third of the variance in real wage growth—which means that two-thirds are left unexplained.
To see how this relationship performs out of the sample period (19651Q1-2019Q4), I used the estimated coefficients (reported in the notes to Figure 6) to calculate the ‘predicted’ real wage growth during the nine-quarters period 2020Q1 – 2022Q1, using actual (realized) 4-quarters lagged nominal wage growth. The out-of-sample prediction errors appear in Figure 7. Clearly, their ‘model’ does a very poor job of forecasting actual real wage growth during 2020Q1-2022Q2. Other factors—unprecedented lockdowns, labor market withdrawals and global supply-side shocks—did upset the US economy. The right conclusion is that past performance provides surprisingly little guidance to foretell the future.

However, ignoring the various empirical smokescreens, the greatest weakness of the argument put forward by Domash and Summers (2022c), is its a-historical nature. The wage-price-spiral claim presupposes that US workers have sufficient bargaining power to obtain higher and higher nominal wage increases. Structural evidence provided by Stansbury and Summers (one wonders whether this is really the same person as the co-author with Domash), shows that this presupposition is empirically incorrect. The reason is, of course, that US workers have suffered a long-term structural loss of bargaining power, due to declining unionization and globalization (outsourcing). As Stansbury and Summers (2020, p. 2) write, strong worker bargaining power “gives workers an ability to receive a share of the rents generated by companies operating in imperfectly competitive product markets, and can act as countervailing power to firm monopsony power.” Stansbury and Summers (2020a, p. 2) identify three main causes for the structural decline in worker power in the US:

“First, institutional changes: the policy environment has become less supportive of worker power by reducing the incidence of unionism and the credibility of the “threat effect” of unionism or other organized labor, and the real value of the minimum wage has fallen. Second, changes within firms: the increase in shareholder power and shareholder activism has led to pressures on companies to cut labor costs, resulting in wage reductions within firms and the “fissuring” of the workplace as companies increasingly outsource and subcontract labor. And third, changes in economic conditions: increased competition for labor from technology or from low-wage countries has increased the elasticity of demand for U.S. labor, or, in the parlance of bargaining theory, has improved employers’ outside option.” (Italics added)

Today, US workers almost completely lack the power to redistribute product market rents from capital owners to labor and, therefore, are in no position whatsoever to kickstart a wage-price inflation spiral. As a result, nominal wages are constantly chasing inflation, which is mostly due to higher import prices, higher energy prices, and higher profit markups—Alice’s Red Queen was wrong: even if workers do all the running they can do, their nominal wages keep lagging behind the inflation rate and their real wages are going down.

In sum: A fair assessment of what has happened during 2020-22 is that US inflation has been driven less by (lagging nominal) wage increases and more strongly by increases in profit mark-ups. Fears of a building wage-price inflationary spiral appear to be misplaced.

Can the Fed safely bring down inflation?

Section 8 of the Working Paper asks the question: can the Fed safely bring down inflation? The answer is a categorical no: the available empirical evidence is clear that small increases in the interest rate do not have much of an effect on inflation. First, the effects of higher interest rates come with a time lag and the gradual impacts (on PCE inflation) will not be felt during the three to four months. Second, an interest rate increase is a generic (blunt) intervention, which will affect inflation by depressing aggregate demand and economic activity but will achieve nothing in terms of lowering the price rises driven by supply-chain disruptions and/or geopolitical tensions, which are responsible for more than half of today’s PCE inflation. Third, empirically, the impact on inflation of an increase in the interest rate is quite limited.

To get a structural sense of how effective monetary policy is in changing the inflation rate, real GDP, and the unemployment rate, we can do no better than consider Figure 8, which presents recent econometric-model forecasts for the US economy of a one-percentage-point increase in the interest rate for the forecast period 2021Q2 – 2023Q4 by Ray C. Fair. Professor Fair finds that after 11 quarters, a one-percentage-point increase in the interest rate results in a decrease in the inflation rate by 0.5 percentage points, a decline in real GDP of almost 1 percentage point, and an increase in the unemployment rate by 0.35 percentage points. Fair (2021, p. 24) concludes: “The effects on inflation are [….] about a half percentage point fall for a percentage point increase in [the interest rate], but it takes about 5 quarters to achieve this.”

Suppose the Federal Reserve follows Summers’ advice and ramps up the interest rate from 1% to (say) 5% in the expectation that this will return the US economy to a stable-inflation equilibrium. Fair’s estimates tell us that this will not happen. Raising the interest rate to 5% will lower PCE inflation by only 2.25 percentage points—from 6.3% in April 2022 to around 4% in July 2022. The collateral damage of this failed attempt at inflation control will be non-negligible: after 11 quarters, real GDP will be lower by 4.5 percentage points and the unemployment rate will be higher by 1.5 percentage points.

There are reasons to believe that the collateral damage wrought by substantially higher interest rates will be even higher than predicted by Fair. The key reason is that more than a decade of extraordinarily low-interest rates has led to a significant increase in corporate and public debts and an unsustainable bout of asset price inflation in the housing market, the stock market, and almost all other financial markets. The Federal Reserve (2022) recognizes these non-negligible downward risks of monetary tightening to the American economy in its Financial Stability Report of May 2022. Ergo: Large—Volcker-like—increases in the interest rate are off the table, because the resulting collateral damage is prohibitively high.

Since inflation cannot be brought down by monetary tightening alone, calls are growing to tighten fiscal policy as well. The idea is that public spending has to be scaled down in order to reduce the excess aggregate demand and excess labor demand, created by the fiscal relief spending that was (arguably) larger than the COVID-19 crisis required. The million-dollar question is whether the collateral damage of renewed austerity is a price worth paying for lowering inflation. If the inflation is driven by supply bottlenecks not directly amenable to fiscal and monetary policy, and sector-specific (in origin), then the fiscal tightening needed to lower inflation will be large and will cause substantial collateral damage, particularly for low-income households and small businesses. Austerity is not a rational solution to rising inflation in a time of corona and war.

The strongest call for fiscal consolidation is coming from proponents of the ‘fiscal theory of the price level’, who argue that the current surge in prices represents ‘fiscal inflation’. In this account, inflation is due to an erroneously overly expansive fiscal policy, which will not be compensated by (promises of) higher tax revenues and/or expenditure cuts in the future. In Section 9 of the Working Paper, I offer a theoretical and empirical critique of the fiscal inflation hypothesis—arguing that it is a fallacious ‘theory’ and empirically empty.

In Section 10, alternative ways to bring inflation down are briefly discussed including the much-maligned strategic price controls, a tightening of position limits and an increase in margin requirements to eliminate commodity-market speculation, measures to remove some of the domestic supply-side bottlenecks in the US itself, and fiscal interventions to shield vulnerable households and firms from the negative impacts of high inflation.

Inflation in the longer run

Finally, in Section 11, I consider the longer-run context and focus specifically on the unavoidable inflationary impacts of global warming, ‘fossilflation’, and ‘greenflation’ (Schnabel 2022). I also discuss inflationary pressures originating from the long-run trends of rising transportation costs, rising commodity prices, fragmenting supply chains, and disorderly de-globalization. These trends are posing new—and daunting—challenges for monetary policymakers. The key issue facing macroeconomic policymakers is: how to deal with rising prices while also accelerating a green structural economic transition? When addressing this issue, central bankers appear to be stuck between a rock and a hard place.

This is because central bankers supposedly have to trade off safeguarding future financial stability (by keeping interest rates low today, supporting the climate transition but allowing for higher inflation in the short to medium run) versus bringing down inflation in the short to medium run (raising interest rates, but at the cost of slowing the transition to a net-zero economy and allowing for higher inflation in the longer run).

The trade-off is a false one, however. The reason is that slowing the climate transition is not an option: another decade of unmitigated global warming will lock the climate system into an unmanageable self-reinforcing process of climate change which risks putting us—humanity as a whole—on a one-way journey to Hothouse Earth (Schröder and Storm 2020). On that road, inflation rates will rise and become completely uncontrollable, while financial stability will be jeopardized.

In other words, in the face of the growing risk of catastrophic climate change, macroeconomic policy needs to be guided by only one principle: it is better to be safe than sorry. Hence, monetary policy should be made to support the transition to a net zero-carbon economy—and inflation control must be unconditionally subordinated to this overriding aim. Green fiscal policy and green industrial policies will have to do the heavy lifting—but these policies must be supported by (and not undermined by) a sufficiently accommodative interest rate policy. A supportive monetary policy will also include tightening risk and accountability regulations for banks and businesses so as to more rapidly phase out funding for fossil-fuel activities; dual interest rates (by offering a preferential discount rate for green lending); tighter regulation to eliminate commodity speculation; and some version of Green QE to help the decarbonization of the economy.

Monetary policy has to be reimagined to make it support the climate/energy transition—rather than obstruct it (as is the case now). Central bankers have to come down or be brought down, from their Olympus and act in alignment with the imperative of the net-zero transition. The clinical, social engineering approach to monetary policy-making that mostly favors financial markets (often at the cost of the rest of society) has to give way to more honest approaches based on the recognition that we are in all this together. One must recognize that a fair sharing of the inflationary and other burdens of the net-zero transition is critical to its viability (“distribution matters”) and acknowledge that the effectiveness of fiscal and monetary policies is overwhelmingly more important than whether their impacts are Pareto optimal or not. Financial markets need to serve the economy rather than live like parasites on it by means of speculation, socially useless regulatory arbitraging, and rent-seeking. There are no quick fixes and the longer macroeconomists continue to treat ‘the economy’ as a mechanical, ergodic, and closed system to which one can apply techniques of optimal control in order to identify some time-consistent monetary policy choice or optimal carbon tax trajectory, the more our economy and society will become locked into irreversible warming “heading for dangers unseen in the 10,000 years of human civilization” (Harvey 2022).

All this may well mean that inflation rates should be allowed to be higher (for some time) than the target of 2% and that alternative measures to control inflation and manage the societal and economic impacts of inflation (as discussed in Section 10 of the Working Paper) have to adapt. A reimagining of monetary policy-making in the face of global warming is long overdue.

Appendix: a note on measuring nominal wage growth

There are different measures of nominal wage growth in the US. Domash and Summers (2002a, 2002c) use the annual growth rates of ‘average hourly earnings of production and nonsupervisory employees, total private’. These two groups of workers account for approximately four-fifths of the total employment on private nonfarm payrolls. Other measures of nominal wage growth include the annual growth rates of ‘average hourly earnings of all employees, total private’ (which also include the wage increases of non-production workers and supervisory employees) and of ‘median hourly earnings of all employees’ (which concerns the growth of the wage ‘in the middle’ of the wage distribution, with 50% of wage earners earning less and 50% of wage earners earning more).

As is shown in Table A, the growth numbers differ depending on the measure of wages used. According to the wage growth measure for production and non-supervisory workers (W1) used by Domash and Summers, nominal wage growth in the US during 2021-Q1/2022-Q1 was 6.7%. But the growth rate of average nominal wages of all US workers (W2) was only 5.4% in 2021-Q1/2022-Q1. Median wage growth of all employees (measure W3), finally, was 4.3% over the previous year. Wage inflation exists, to some extent, in the eye of the beholder.

Table A

Nominal wage growth in the US: different measures




Average hourly earnings of production and non-supervisory employees, total private

(% change

from a year ago)

Average hourly earnings of all employees, total private

(% change

from a year ago)

Median hourly earnings of all employees

(% change

from a year ago)





















Source: FRED database.


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[1] According to Alan Blinder, a former vice-chair of the Federal Reserve, the Fed managed to achieve a soft landing in exactly two out of 11 tightening cycles since World War II: the first one occurred in 1966 and the more recent soft landing happened in 1994. That makes one success story in the past 50 years (Mason 2022).

Axel Leijunhufvud, Wide-Ranging Economist

Published by Anonymous (not verified) on Thu, 02/06/2022 - 4:31am in

An obituary for Axel Leijunhufvud (Sept 6, 1933 - May 5, 2022)

Axel Leijunhufvud’s sad passing on May 5th has rightly stimulated a round of tributes to a thinker of uncommon breadth. But there is perhaps reason to doubt how widely appreciated the diversity of his thinking really was. Leijunhufvud changed the colors of his economic reasoning in response to many strands of 20th-century discussion, repainting each one. He had an ample palette and his color mixes were always interesting – an artist of macroeconomics indeed. Never lacking confidence and blessed with understated charisma, he was a member of one of Sweden’s oldest aristocratic families. Lionhead is a literal translation of his surname. (Old Swedish noble names can be peculiar. For example, Oxstars and Swineheads still roam the land.)

Axel’s substantial contributions to economic thinking came in sequence. Each differed substantially from its predecessor. The first was his book On Keynesian Economics and the Economics of Keynes. Heavily influenced by Robert Clower’s “dual decision hypothesis” which can be summarized by his aphorism “Money buys goods and goods buy money but in a monetary economy goods do not buy goods.” Money is a form of financial institutions’ debt. It can be used to purchase goods but is not a good in itself. Axel’s book elaborated elegantly on this idea because it can lead to severe coordination problems between the financial and real sides of the economy.

A second major theme was developed in a very long and fascinating 1979 UCLA working paper on “The Wicksell Connection.” It exhaustively reviews 20th-century macro theories, all based on the class and payment structure underlying Knut Wicksell’s “cumulative process.”[1] Households lend to business to finance investment.

Around the turn of the 20th century, this flow of transactions may have been a plausible summary of the stylized facts but by the time Axel’s paper was written it certainly was not. It became more realistic to focus on lending and borrowing payments flows between households and/or the rest of the world and government, with each group financing its own capital formation with internal funding (a point emphasized by Michal Kalecki already in the 1930s).

Axel stuck with Wicksell and subsequent mainstream analysis. At the end of the paper, his 1979 avatar imposed Fisher arbitrage between the profit and real interest rates with full employment, thereby accepting Say’s Law and rejecting the General Theory’s determination of the interest rate in markets for stocks of securities. This Wicksellian loanable funds set-up is nowadays trumpeted by the American mainstream. It has nothing to do with Clower.

Meanwhile, Alex had another idea he called the “corridor hypothesis,” elaborated over decades. The idea is that the macroeconomy can be self-stabilizing if key variables stay within a range around a steady state. If they stray outside the corridor, disaster can follow. He wrote policy briefs for the Centre for Economic Policy Research which point to potentially destabilizing forces such as high leverage.

What he did not pursue is some degree of formalization about potential instabilities. Low dimension dynamical systems can be helpful. Consider for example real and financial dynamics as emphasized by Hyman Minsky. Firms have a debt/capital ratio (say D) and an investment/capital ratio or growth rate (g). If capital formation is at least in part debt-financed, then a higher level of D would be required to hold the time derivative Ḋ = dD / dt constant if g jumps up. At a given level of D, on the other hand, the time derivative of growth ġ will tend to rise because of animal spirits, leading to an upward swing in both variables. It may be braked if higher debt pushes up interest rates and stimulates bear speculation against business expansion. The firm would stay within the corridor. Or if initial conditions are not favorable, growth and debt would continue to rise accompanied by increasing leverage until investment mania leads to panic and a crash. Positive feedback of g into ġ is the source of Minsky’s danger.

In another example, global warming is to a large extent driven by rising atmospheric concentration of carbon dioxide (CO2). Emission of CO2 is roughly proportional to the level of economic activity but it can be reduced by higher spending on “mitigation.” Growth of CO2 depends on the level of output. Meanwhile, output itself is forced downward by a higher level of CO2. This feedback loop creates a cyclical form of instability over many decades.

As of the early 2020s, atmospheric CO2 concentration increased at one-half percent per year and output at two percent. The implication is that “business as usual” along with some climate deterioration could appear to be feasible for a few decades. But the illusion would vanish with accelerating CO2 growth. Output would swing up but then global warming would slam on the brakes.

On the down-cycle, the world would be hit with a climate crash involving drastic reductions in output and employment within a few decades more. Results from model simulations suggest that outlays of around five percent of world GDP ($5 trillion in the early 2020s) on mitigation would be needed to avoid climate disaster.[2] They would have to be implemented soon. Life would survive the crash, but it is not so clear about humans.

Axel was certainly correct about corridors when there is positive feedback, but perhaps he could have been a bit less literary in thinking through their implications. His work called attention to Clower, Wicksell, Minsky, and climate, enriching economic debate. It is too early to tell, but he is likely to be more than a footnote to the history of economic thought.


[1] UCLA Economics Working Papers 165, UCLA Department of Economics, 1979;

[2] See Armon Rezai et. al., “Economic Growth, Distribution, and Climate Change,” Ecological Economics,, 2018