This work is a translated and revised version of the third edition of my German book Zentralbankkapitalismus. The English edition has been expanded to keep pace with the complex challenges of our times and their implications for global finance and central bank policy, notably the resurgence of inflation since 2022, and the worsening climate crisis compounded by so many other dilemmas facing the world today in a multiplicity of interrelated emergencies aptly referred to as the polycrisis of capitalism (World Economic Forum 2023).
In 2022, inflation made a spectacular comeback on a global scale. After having largely disappeared for fifteen years, at least in Western industrialized countries, it returned with an unexpected vengeance. Indeed, until very recently, the focus was rather on deflation, as Western central banks struggled to prevent prices from falling. But then, in a matter of mere months, prices rose to levels not seen for forty years, and central bankers came under pressure to react. The plea for central bank intervention was not surprising, considering the high priority accorded to price stability as a stated objective of monetary policy. After some hesitancy, central banks around the world heeded the call to hike key interest rates in the most comprehensive tightening of monetary policy in decades (Romei and Stubbington 2022; Tooze 2023a). There was good reason for their initial reluctance: Only a few months after raising key interest rates in 2011, the European Central Bank (ECB) was forced to reverse its decision because of the euro crisis. In 2019, just a year and a half after moderately increasing its benchmark interest rate to 2.5%, the Fed was similarly required to backtrack and cut interest rates when the US money and capital markets began to stumble. More important still, central bankers were well aware that the problem they were facing was not one which could be solved by raising key interest rates. Such a measure makes sense in an overheated economy and when a wage-price spiral leads to inflation. This was not the case in 2022 and 2023. On the contrary, most economies were still struggling with the effects of the COVID-19 pandemic and overall wage developments were modest.
The rise in prices in 2022 and 2023 can rather be attributed to supply-chain problems caused by the pandemic and the high cost of fossil energy, especially in the wake of, but not solely owing to, Russia’s war of aggression in Ukraine. Other factors include extreme events such as crop failures due to the climate crisis (Weber and Wasner 2023) and the practice of price gouging that has led to record profits for corporations in a variety of sectors (Schnabel 2022). Even the president of the European Central Bank, Christine Lagarde, called attention to this type of exploitation, known as “greedflation”: “In some sectors, firms have been able to increase their profit margins on the back of mismatches between supply and demand, and the uncertainty created by high and volatile inflation” (quoted in Allenbach-Ammann 2023). Key interest rate hikes have no influence over such factors. Instead, they can very likely stall the recovery of economies from the COVID crisis, because when key interest rates increase, loans become more costly for businesses and households. They therefore borrow and invest less. In addition, because central bank bond-buying programs (called quantitative easing) have also been scaled back, debt has become more expensive for the state, which, in turn, has tightened public budgets (austerity policies).1 This has made the fight against inflation even more difficult: In order to bring down energy prices and suppress the increase in prices due to climate-related crop failures in the medium term, it is absolutely necessary for governments to invest extensively in green and sustainable transformation. Higher borrowing costs caused by an increase in the key interest rates, however, reinforce the reluctance of states, but also of private actors and households, to make the necessary investments. Finally, just to touch briefly on an issue that will be discussed later in the book in greater detail: High interest rates combined with the scaling back of quantitative easing destabilize the shadow banking system, and therefore the global financial system as a whole. Short-term funding markets are particularly sensitive to this type of change (Pozsar 2022). The UK gilt market turmoil of September 2022 was the first crisis to become visible after these policies were adopted (Plender 2022). The regime of rising rates, however, was felt most severely in the traditional banking sector. The beginning of 2023 marked the failure of the US banks Silvergate Bank, Silicon Valley Bank, and Signature Bank, followed by the implosion of First Republic Bank, which was taken over by JPMorgan. In Europe, Credit Suisse collapsed (Jenkins 2023; Masters et al. 2023).
Calls for central banks to intervene to control rising prices are based on the hope of returning inflation to tolerable levels. Central bank intervention, however, comes at a huge price. To produce the intended effect, the increase in key interest rates must be high enough to slow down investments and the overall economy. As a result, fewer jobs are created, less people are hired, and more employees become redundant. This can lead to an economic recession, or even worse a recession accompanied by high inflation; in other words, stagflation (IMF 2022). Instead of leaving it up to central banks to fight this very special form of inflation, governments themselves can address the problem far more directly and in a more differentiated and effective way than is possible via key interest rates: They could, for example, launch large investment programs that would greatly reduce dependence on fossil fuels and overall energy consumption (Neuhoff 2022). In the medium term, such an investment policy would already reduce inflation by half. They could introduce a windfall profits tax to siphon off excessive war earnings and impose price controls to prevent companies from making high and undeserved gains from supply shortages. This would further significantly reduce inflation. In the short term, they can protect the most vulnerable social groups from rising prices by introducing price caps (Weber 2021; Ehrhart, Schlecht, and Wang 2022; Editorial Board New York Times 2022). Indeed, countries such as France, Italy, Spain, and Norway that have subsidized retail energy and food prices experience significantly lower inflation rates than countries that have not (Sandbu 2022a; Arnold and Jopson 2023).2 Many more policy options exist to combat inflation. However, they are not being exploited, or only very hesitantly.
Instead of taking action, governments and political parties in most Western countries have rejected responsibility for economic developments. They prefer to leave economic matters to market forces while remaining committed to austerity. Indeed, virtually all advanced economies have cut public spending for investments over the past two decades by an annual amount equivalent to almost two trillion US dollars (Sandbu 2022b). Except for a brief interruption when fiscal aid was provided during the first two years of the COVID pandemic in 2020 and 2021, this trend has only worsened (Mackenzie 2023). With governments shying away from strong fiscal policies and the market unable on its own to restore stability shaken by financial and economic crises, central banks are left to fix the problem. Welcome to the world of central bank capitalism!
1. Strictly speaking, government debt has only been rising in nominal terms. However, the much more important debt-to-GDP ratio is falling because inflation has been rising faster than interest rates, and inflation leads to higher government revenues through taxes. Nevertheless, there has been a cut in spending in most countries.
2. Energy prices are also the main reason why inflation in the United States has fallen much faster and more sharply than in the euro area. Greater dependence in the eurozone on Russian gas that also affected electricity prices, especially in Germany, meant that expensive alternatives had to be used after the decision to impose sanctions on Russia over its war of aggression against Ukraine (Koester et al. 2022; Giles, Arnold, and Smith 2023). Also, while companies are quick to pass on increased input costs, they are far more reluctant to make downward price adjustments to reflect decreased costs, which, according to ECB board member Isabel Schnabel, leads to persistent inflation (Schnabel 2023).
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