Contested terrain

The question "Why do central banks do what they do?" seems like an obviously impor- tant question, especially considering that political straitjackets limit countercyclical fiscal policy, leaving central banks as the dominant macroeconomic policy-making institution in most countries. Yet, mainstream macroeconomics has given very little thought to ana- lysing the economic and political sources of central bank goals and conduct.

Rather, the implicit assumption of most mainstream analysis is that central banks try to make policy in the general interests of society as a whole. From this perspective, "poor" monetary policy stems from failures of theory, judgment or forecasting rather than from a lack of concern for the public interest.

By contrast, the contested-terrain approach to the analysis of central banking - which borrows the term from Richard Edwards's (1979) book on the fight over corporate labour processes - suggests that central bank behaviour, like that of other important institutions of capitalist governance, can usefully be analysed as a struggle among key classes (and class-fractions) over economic policy (Epstein and Schor, 1990). Building on Kalecki (1943) and Boddy and Crotty (1975), Epstein and Schor developed a three class model in the spirit of Keynes (1936), arguing that in advanced capitalist countries, central bank policy is determined by a struggle between industrial capital, financial capital, and labour. This contest over policy, in turn, is shaped and constrained by key structural factors, including the relations between finance and industrial capital, the structure of labour markets, the position of the domestic economy in the world economy, and the dynamics and contradictions of capital accumulation itself. From this perspective, policy that fails to operate in the public interest can often be explained by looking at the narrower interests - often financial interests - that dominate the central bank those policies are designed to serve. Since the configuration of these four factors may vary across countries and over time, central bank policy is likely to vary as well. For example, building on the work of Hall (1984), Epstein and Schor (1990) show that variations in the relationships between finance and industry in European (close) versus Anglo-Saxon (arm's-length) countries, together with different labour bargaining systems, can help explain differences in monetary policy among these countries. The institutional structure of the central bank itself is also crucial. Where central banks are "independent" of the executive branch of government, they tend to be dependent on the financial sector for political support, and therefore tend to make policy with "finance coloured" glasses (Epstein, 1981).This framework helped to explain, for example, the US Federal Reserve policy in the 1930s (Epstein and Ferguson, 1984), and in the Paul Volcker period (Epstein, 1982).

Epstein (1994) formalized these ideas, building and empirically estimating a highly stylized three class model based on a Marglin-Bhaduri framework. This model shows how differences in industry-finance relations ("enterprise finance" versus "speculative finance"), labour market relations ("Kaleckian" versus "neo-Marxian") and the degree of central bank independence ("independent" versus "integrated") could help explain monetary policy. He showed, for example, that independent central banks, which tend to be most influenced by inflation-averse financial sectors, in countries with weak ties between finance and industry (like the United Kingdom and the United States), and with more flexible labour markets tend to pursue tighter monetary policy.

Because of its emphasis on the role of class relations and structural factors in deter- mining the political economy of central banking, the framework must be updated with changes in institutional and economic relationships. For example, in more recent work, Epstein (2002) argued that, in the 2000s, changes in the structures of industry-finance relations and labour markets led to a change in the orientation of monetary policy in many countries. Increased financial orientation of non-financial firms (that is, "finan- cialization"), and increased importance of capital gains for both financial actors and financialized "industrial" firms prompted central banks in the United States, United Kingdom and elsewhere to lower interest rates to support asset price appreciation. Meanwhile, the reduced bargaining power of labour resulting from key changes in the global competition and domestic political institutions kept wage inflation in check. This change in political economy structures helps to explain the shift by the US Federal Reserve and other central banks to a low interest rate environment in the first decade of the twenty-first century.

The contested-terrain approach has been criticized for paying insufficient attention to the question of central bank control over monetary policy in a world of endogenous credit and financial innovation. Indeed, this framework could be enriched by more research work along these lines.

See also:

Asset price inflation; Central bank independence; Endogenous money; Financial innovation; Monetary policy objectives; Volcker experiment.