Is the United States the Champion of Global Finance or its Victim? A New Look at the Fed’s Low-inflation Policy

By Arie Krampf*

My article “Monetary Power Reconsidered: The Struggle between the Bundesbank and the Fed over Monetary Leadership”, recently published in International Studies Quarterly, contributes to the burgeoning literature that challenges the US-hegemony hypothesis in the global financial sub-order. It follows the path of several scholars, who question whether the shape of the international monetary and financial system has been consistent with the US interests and whether the US had the capacity to set rules for the world.  In his book Capital Rules: The Construction of Global Finance, Rawi Abdelal, one of those scholars, argues that the US-hegemony hypothesis is “the most important misconception of the conventional account” regarding the role of the United States. The United States, he argues, played an essential role in pushing for financial liberalization, however, “neither the U.S. Treasury nor Wall Street has preferred or promoted multilateral, liberal rules for global finance. The US approach to globalization has been neither organized nor rules-based, but rather ad hoc” (Abdelal 2007: 3). In my article, I demonstrate this general claim by tracing the struggle between the United States and its G5 allies regarding the consolidation of a particular type of rule: the rule of very low inflation targeting.
Rather than summarizing the argument—for a summary, one can have a quick look at the abstract and the conclusion of the article—I would like to take the opportunity here to invite the readers into the “editing room” and the research process, sharing with them the rejected hypotheses I had to leave on the floor before reaching a convincing argument, consistent with the historical findings.
The origin of this project is in a historical puzzle. While going over published and unpublished documents from the 1980s and the 1990s, I found that until 1989, there was no consensus among central bankers and economists regarding the desirability of very low inflation targeting. The lack of consensus was surprising, because since 1991 or 1992 economists at the International Monetary Fund (IMF), and the Bank of International Settlements (BIS) talk about a “consensus” on very low inflation targeting as fact of nature. The discursive change was radical, immediate and pervasive.
“Something” must have happened between 1989 and 1991, I thought, that caused this drastic discursive change. Nevertheless, I was not sure what kind of event to look for.

My first intuition was to follow a constructivist approach and search for the ideational entrepreneurs that changed the discourse. The first suspects were the central bankers and economists. It is not indisputable that, since the 1970s, academic economists had promoted the idea of independent and conservative central banking, so it was reasonable to assume that those ideas penetrated the circle of central banking practitioners. On that account, I searched for the traces of the process.
However, I could not find any evidence supporting this mechanism of change. The findings suggested, instead, that until 1989 the economists at the IMF and BIS advocated a more balanced approach to inflation. They believed central banks should watch for various economic indicator simultaneously: inflation, growth, employment, the exchange rate and the balance of payment. Also, the position of central bankers diverged: France and Japan favored an outward-oriented monetary policy, while the Fed, the Bundesbank and the Bank of England favored a more inward-oriented policy, focusing on the inflation level. There was no indication that before 1990 any of the key central bankers was influenced by the academic literature on independent central banking, besides perhaps in the United States.
Given the “heterogeneity” of the discourse, I had to rule out the constructivist mechanism. Central bankers, indeed, operated as an
epistemic communityas the constructivist theory often suggests—but until 1989 the community was far from sharing the same policy ideas. Those findings did not sit very well with the predictions of the constructivist theory.
Once I realized that the constructivist approach does not solve the puzzle, I resorted to a power-based mechanism of change. A power-based mechanism suggests that the consensus on low inflation emerged because powerful actors reformulated their interests and preferences. But why would they do that? One possible cause is the hierarchical structure of the international monetary system, with the US dollar at the top of it. Within the power-based literature, the common argument is that throughout the second half of the twentieth century, the United States—or the Fed—was the single most powerful actor in the international arena. Therefore, if a global consensus consolidated it must have been an outcome of the US power.
Two types of problems undermine the US-hegemony hypothesis. First, surprising as it might sound, there is no economic or political-economic theory that can explain why the United States would have liked other countries to target very low inflation. We have, rather, very persuasive rationales which explain why the United States benefited from operating in a global environment of weak currencies. During the 1980s, the interest rate differentials between the Fed and the other central banks enabled the United States to maintain its role as a monetary leader and to attract foreign capital which financed its domestic investment and trade deficit. The low inflation regime made it more difficult for the United States to attract foreign capital.

Moreover, the US was the single most powerful actor. Therefore, it had a preference for pragmatism and ambiguity, which enabled it to realize its power and to shift the burden of adjustment to its peers. Most notably, during the 1980 the United States made successful attempts to pressure Germany (and the Bundesbank) to exercise a more accommodative monetary policy (see the Plaza Accord). There is no reason why the United States would have liked to change this status-quo.
The second problem was more crucial: going over the archival material, particularly the minutes of the Federal Open Market Committee (FOMC), which is the decision making body of the Fed, I found “smoking gun” evidence that the United States—the Fed and the Treasury—were very clearly not enthusiastic, to say the least, about the tightening of monetary policies among the G5 partners. The documents show that Alan Greenspan, the Chairman of the Fed, who is known for its conservative monetary position, rather than encouraging other central banks to follow his legacy, was highly concerned by the global “conservative tide,” as he put it.
Fed Inflation BundesbankTherefore, if not the economists nor the United States, there was only a single other usual suspect to examine: the Bundesbank – the central bank of Germany.

The Bundesbank is well known for its preferences for tight monetary policy. Moreover, there is evidence that the Bundesbank—and Germany—was not happy with the not-conservative-enough policies of its peers in Europe and worldwide. Hence, it was reasonable to assume and not too hard to establish that the Bundesbank would have liked other central banks to embrace a more conservative approach. However, did the Bundesbank have the capacity to achieve this goal, given the opposition of the United States—the Fed and the Treasury—and of other powerful countries in the Groups of 5?
At that point, I needed a theory of monetary power, which could explain how the second most powerful country (or a central bank) in terms of monetary power—Germany—could force the single most powerful country—the United States—to absorb the burden of adjustment.

We need to roll back a little bit.
What is monetary power? The structural theory of monetary power, which is mostly associated with the work of Benjamin Cohen (2006), argues that the United States is by far the most powerful country in terms of monetary power, because of its size and the extensive use of the dollar as an international currency. Monetary power, in this context, implies that when two states face current account imbalances, the more powerful country can use its monetary power to shift the burden of adjustment to the less powerful one, which has to change it domestic policies accordingly. This theory does an excellent job in explaining the relative stability of the international monetary and financial system over the long-run, or in other words, the US monetary hegemony. But it fails to explain why, in certain circumstances, the single most powerful actor loses.
Contrary to Cohen, other scholars—for example, David Lake, Rawi Abdelal, Andrew Walter and Jonathan Kirshner—reminds us that the geopolitical hierarchy of money depends not only on the size of the economy, on trade and the current accounts, but also on capital flows. States compete over financial flows: capital flows can lift countries from the ashes, and they can also enslave them and make them addicted to foreign investment. When a country is able to divert financial flows to its own advantage, it has institutional monetary power.
Countries that have superior institutional monetary power can divert financial flows so as to shift the burden of adjustment to their peers. However, and this is the crucial point, institutional monetary power is much more susceptible to idiosyncratic historical events than the conventional structural monetary power. Therefore, institutional monetary power can explain “fluctuations” in the global hierarchy of money in the short-run.
The concept of institutional monetary power was the missing link that enabled me to explain how Germany (or the Bundesbank) could shift the burden of adjustment to the United States and make the latter accept the low inflation regime, despite its opposition to this idea and superior structural monetary power. During the period between 1989 and 1991 unique historical circumstances enabled the Bundesbank to take a go-it-alone move and raise the interest rate dramatically and rapidly (from 2 to 6 percent within less than two years), irrespective of the international repercussions. Given liberalized financial markets and rapid capital flows, the Bundesbank’s move triggered a cross-national sequence of events. First, the Bank of France started to follow the Bundesbank and then the Bank of Japan. By the 1990, the Fed found itself operating in a completely new environment. Rather than leading the G5 central banks, it had to follow them.
The conservative tide among the central banks was therefore interpreted by the Fed as an offensive move against the dollar. FOMC members complained about the “box we’re in with respect to the interactions between domestic interest rates, foreign interest rates… and the exchange rate.” The Fed was in a deadlock: it could not raise the rate and protect the dollar because of the sluggish domestic economy and it could not lower rate because of the international circumstances. The way out of the box required a fiscal reform: the Treasury had to make a drastic cut in budget deficit and public spending, which would lower the US “addiction” to foreign capital. After the administration failure to persuade the G5 to adopt a coordinated expansive fiscal policy, the US sitting president, George H. W. Bush, had to break one of his key election promises (“read my lips”), and implement a severe fiscal reform, cut the budget and raise taxes, a policy which was followed by his Democratic successor, Bill Clinton.
The article, therefore, makes two key contributions. The theoretical contribution lies in the distinction between structural monetary power and institutional monetary power. Whereas the former explains the stability of the international monetary and financial system, the latter explains how historical events, which affect financial flows, can lead to long-lasting institutional changes. The historical contribution is the claim that the United States, which is often perceived as the champion of financial globalization, was in practice of victim of it.
The theoretical and historical analyses as presented above are likely to be of interest to monetary aficionados. But the article has some broader implications for IPE scholars, who are interested in the bigger picture. What the article demonstrates, in broad brush strokes, is that the international regime, which emerged in the 1990s—the neoliberal regime—was not the result of the US power but rather the result of its relative weakness, of more precisely, its weakening. The United States had to accept an arrangement, which was not its first choice. This claim deserves some clarification.
A common argument is that the neoliberal order was internationalized by United States and that this process was consistent with its interests (Strange 2009; Helleiner 1994; Cohen 2006; Harvey 2005). However, we also know that during the 1980s the hegemonic position of the United States was declining (Keohane 2005). Therefore, as of the 1980s, the United States had to account for the preferences of its allies in the G7 and to coordinate its moves more closely with them. It means the United States capacity to set rules of the world was in decline.
From this perspective, the neoliberal regime was not consistent with the preferences of the United States. The neoliberal regime, as emerged in the 1990s, was a rules-based regime. The rules approach replaced the previous approach of coordination, characterized by pragmatism (Mügge 2011) and ambiguity (Best 2005). Pragmatism and ambiguity enabled the United States to exploit its superior negotiation power. The neoliberal rules, on the other hand, restricted the capacity of the United States to exploit its superior power
This somewhat counter-intuitive claim has the merit of clarifying recent puzzling developments in the international arena. In recent years the US, under President Donald Trump, has made significant steps, which have been interpreted as attempts to dismantle the global rules-based order. The new doctrine of the US raised questions among its traditional allies on the other side of the Atlantic. The President of the European Council Donal Tusk asked how come the international rules-based order is being challenged, “not by the usual suspects, but by its main architect and guarantor: the US”. Tusk, according to the US-weakening hypothesis, receives a very simple answer/reply: the United States challenges the rules-based order because it has never really wanted it.

— Abdelal, Rawi. 2007. Capital Rules: The Construction of Global Finance. Harvard University Press.
— Best, Jacqueline. 2005. The Limits of Transparency: Ambiguity and the History of International Finance. Ithaca, NY: Cornell University Press.
— Cohen, Benjamin J. 2006. “The Macrofoundations of Monetary Power.” Pp. 31-50 in International Monetary Power, edited by David M. Andrews. Ithaca, N.Y.: Cornell University Press.
— Gruber, Lloyd. 2000. Ruling the World: Power Politics and the Rise of Supranational Institutions. Princeton, N.J.: Princeton University Press.
— Harvey, David. 2005. A Brief History of Neoliberalism. Oxford: Oxford University Press.
— Helleiner, Eric. 1994. States and the Reemergence of Global Finance: From Bretton Woods to the 1990s. Ithaca, NY: Cornell University Press.
— Keohane, Robert O. 2005. After Hegemony: Cooperation and Discord in the World Political Economy. Princeton University Press.
— Mügge, Daniel. 2011. “From Pragmatism to Dogmatism: European Union Governance, Policy Paradigms and Financial Meltdown.” New Political Economy 16 (2): 185–206. 
— Strange, Susan. 2009. “The Persistent Myth of Lost Hegemony.” International Organization 41 (04): 551–74.
* Dr. Arie Krampf is a senior lecturer in Political Economy and International Relations at the Academic College of Tel Aviv Yaffo. He recently published the book The Israeli Path to Neoliberalism: State, Continuity and Change (Routledge, 2018). For his other publications see:

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  1. […] Against the hegemonic capitalist ideology that only states and labor cause economic decline (Blyth 2002), no ideas, laws,[3] policies, or institutions capable of moderating and directing capital for the public good could sustainably develop in the US, to become capable of moderating both regional and international capitalist strategy. This has diminished the US into a global capitalist playground headquarters (See Epstein 2019; Krampf 2019). […]

  2. Thank you for this contribution. It’s a great follow-up to Gerald Epstein’s presentation on the devastating costs of finance to the US and UK (Roosevelt Institute, 2019). In support of the critical thesis that US autonomy and capacity has been oversold, I would like to submit an additional piece of historical evidence to researchers: Schenk, Catherine R. 1998. “The Origins of the Eurodollar Market in London: 1955-1963.” Explorations in Economic History 35: 221-238.

    Schenk’s history shows that in the mid 20th century the ruling class in Great Britain used the City of London as a deregulation wedge, dislodging US capital from its semi-subordination to postwar US state power. In this way, the UK restored an international financial bloc with the capacity to coordinate capital, enforce disciplinary inflation against nation-states, and reduce the US to a capitalists’ playground. Far from autonomy, the US has not had nation-state integrity since 1971. Global finance, and its protective padding of comprador bourgeoisie both in American politics and managing putatively-nonfinancial corporations, have reduced the US to its shithole lined with military surplus. Predatory finance has been gutting the country the way they gutted Sears, the Simmons Bedding Company, and Lehman Bros.

    • mfridell, thanks for this response.

      You are right for bringing up the Eurodollar issue here as the emergence of the Eurodollar has weakened the monetary power of the United States. We have been just finalized an article about the Eurodollar market during the 1970s with Benjamin Braun and Steffen Murau. Hope it will come out soon.

  3. This is a very interesting thesis and it raises a lot of questions. I’m not completely convinced that the US as a whole opposes a rules based order, though I am convinced that at least some portion of US elites have always seen disadvantages in any kind of multi-lateral order. There’s a couple of other things you might consider: Monetary theory in the 80’s took a big turn towards rules based policies and a lot of this stems from the inflation of the 70’s. Once you get past Trump’s erratic rhetoric and action, it seems that he essentially channels the tropes of the “Old Right”-the crowd that wanted Truman to let MacArthur bomb China while unleashing Chiang Kai Shek and wanting to get the US out of the UN.

    • Thanks, Citizen Rat.
      In the United States, there was a turn towards a rules-based monetary approach. But the Fed did not see any advantage for the US to globalize this principle. This is the point I was trying to make in the article. Greenspan was happy to be the most conservative central bank in town. The Bundesbank, on the other hand, had an interest in globalizing the “sound money” approach.
      As for Trump, obviously, the thesis I put forward in the article shed a different light on his “America First” doctrine. It the US was forced into the rules-based regime, it makes sense that now it tries to demolish the regime.

  4. I must admit that I personally have almost stopped following modern and current Political Economy
    since around 2015, in favor of reading Classical Political Economics.

    However, after reading the above abstract, i could not help but be reminded of Brown’s research in her 2010 book.

    Have a look 🙂

    “The Web of Debt: the shocking truth about the money system and how we can break free”
    – Ellen H. Brown, JD [ 2010 ]

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