The Bond-Market-Power Fallacy

Abstract

This is a study about a deep-seated fallacy in modern Political Economy research. This myth emphasises the ability of the bond markets to discipline the actions of all states by demanding either higher interest rates on government bonds or by refraining from lending to governments they dislike. I call this assumption the bond-market-power narrative (BMPN) and demonstrate its popularity in both strands of modern Political Economy, namely international political economy and comparative political economy.

I prove that the BMPN must rely on a closed-systems-based understanding of economic theory in order to be internally coherent. Theoretical approaches founded on a closed-systems metatheory argue that the primary aim in the social sciences should be to detect geo-historical regularities between key factors. Relying on a critical-realist philosophy of social sciences I argue that such approaches are highly problematic because stable sequences cannot reliably be found in open systems such as human societies.

I suggest that the so-called Say’s law forms the exact mechanism of how the closed-systems approach is realised in BMPN-based studies. Say’s law says that supply creates its own demand – at least in the long run – which is why demand stimulation cannot have important positive long-term effects. This is crucial since the key argument in my study is that all governments enjoying relatively strong monetary sovereignty can mostly bypass bond market influence by using direct central bank financing of fiscal deficits if there is enough political support for such actions.

BMPN-based Political Economy literature, however, rejects this possibility – sometimes explicitly and at times implicitly. In economic theory, the risks of central bank financing of fiscal deficits are virtually always associated with the acceptance of some form of Say’s law. The idea is that fiscal deficits are possible in the long run only if government spending is financed through the central bank. However, since there is no output gap in the long run, the deficits primarily cause rising or even accelerating inflation rates. I conclude that BMPN scholars must have accepted, at least passively, such economic-theoretical views. BMPN-based studies could not otherwise be internally logical.

For me, BMPN scholarship includes only studies that clearly present the material structures of the world economy as sources of market discipline. So, by definition, BMPN scholars do not discuss bond market power as a political idea being promoted by certain fractions of the society. Rather, in BMPN scholarship, bond market power is predominantly something that has been connected to the crisis of the tax state and the deregulation of global finance which, consequently, have forced ostensibly sovereign governments to be at the mercy of bond market vigilantes.

I argue that the main schools of thought in economics compatible with the BMPN are neoclassical and classical-Marxian economics which both accept closed-systems theorising and some form of Say’s law. The major school of thought that most notably rejects such theorising is post-Keynesianism. Post-Keynesian theory argues that social reality is defined by fundamental uncertainty. Thus, there is no automatic adjustment towards any “natural” or “normal” rate (whether we are speaking of growth, capacity utilisation or unemployment) and therefore, the level of effective demand may differ, and output gap exist in all possible intervals. I further argue that the criticisms of post-Keynesians against the adjustment mechanisms at the heart of Say’s law are empirically convincing and therefore, the post-Keynesian depiction of the fiscal policy space is more accurate than neoclassical or classical-Marxian alternatives.

However, even though I argue that governments with relatively strong monetary sovereignty cannot be disciplined by bond markets, I also accept the existence of important external limitations on state-level economic policy. The most significant such limitation is the balance-of-payments (BOP) constraint which says that most countries are unable to run permanent current account deficits without risking a collapse of the exchange rate. Yet, in this study it is pointed out that BOP constraints have existed for as long as there has been a discrepancy between the open world economy and territorialised political authority. Hence, the structural power of capital is not a new phenomenon and the deregulation of global finance has not, principally, added important new layers to the disciplinary capabilities of the capitalist class – at least not in a material sense.

The most central finding of this study is that the acceptance, whether passive or active, of a closed-systems macroeconomic perspective is a necessary component of the bond-market-power narrative. Thus, the BMPN-based Political Economy studies do not primarily reveal much about the non-discoursive power structures of the world economy. On the contrary, these studies tend to be based on a replication of orthodox economic-theoretical views – and are often even unaware of this. Consequently, the argument put forward in this study is that the rejection of the BMPN is necessary for the progress of modern Political Economy research.

Tämä väitöskirja käsittelee moderniin poliittisen talouden tutkimukseen pesiytynyttä niin sanottua luottomarkkinavaltanarratiivia. Tämän narratiivin mukaan globaalit luottomarkkinat asettavat tiukat reunaehdot lähes kaikkien valtioiden finanssipolitiikalle eikä valtioilla ole mahdollisuutta kiertää tai sivuuttaa luottomarkkinoita.

Perinteisesti luottomarkkinavaltanarratiiviin on sisältynyt oletus siitä, että luottomarkkinoiden rakenteellinen valta vahvistui voimakkaasti 1970-luvulla, kun pääomaliikkeiden sääntelystä luovuttiin ja valtioiden kyky ylläpitää riittävän korkeita veroasteita heikkeni. Narratiivin mukaan valtioiden velkaantuminen on lisääntynyt näiden muutosten seurauksena ja valtioiden on pitänyt alkaa harjoittaa luottomarkkinatoimijoita tyydyttävää finanssipolitiikkaa. Niinpä poliittisen talouden tutkimuksessa toistuu usein käsitys siitä, että lähes kaikkien valtioiden on ylläpidettävä tiukkaa finanssipolitiikan viritystä ja vältettävä julkisen talouden velkaantumista, jotta valtionlainojen korkotaso ei nousisi kestämättömälle tasolle.

Tässä tutkimuksessa kuitenkin osoitetaan, että luottomarkkinatoimijoiden kyky asettaa valtioiden finanssipolitiikalle tiukkoja reunaehtoja on huomattavasti vähäisempää kuin luottomarkkinavaltanarratiiviin nojaavassa tutkimuskirjallisuudessa yleensä oletetaan. Ennen kaikkea valtioiden omaksumat institutionaaliset ratkaisut määrittävät keskeisesti sitä, kuinka merkittävästi luottomarkkinat voivat asettaa reunaehtoja valtioiden finanssipoliittisille ratkaisuille.

Tutkimuksessa todetaan, että luottomarkkinoilla on huomattavasti laajemmat mahdollisuudet vaikuttaa rahapoliittisesta suvereniteetistaan luopuneiden valtioiden politiikkaan kuin rahapoliittisesti suvereenien valtioiden ratkaisuihin. Rahapoliittisesti suvereeneilla valtioilla on niiden lainsäädännön niin salliessa mahdollisuus tarvittaessa kiertää luottomarkkinat ja rahoittaa julkista kulutusta suoralla keskuspankkirahoituksella.

Luottomarkkinavaltanarratiiviin nojaavassa kirjallisuudessa tätä vaihtoehtoa ei kuitenkaan pidetä realistisena, vaan sen yleensä odotetaan johtavan väistämättä hyperinflaatioon tai muuten katastrofaalisiin seurauksiin. Tässä tutkimuksessa kuitenkin esitetään, että keskuspankkirahoituksen ja hyperinflaation välillä ei vallitse mitään väistämätöntä tai edes todennäköistä kausaalisuhdetta.