Tuesday, March 21, 2017

How Capitalism is Killing Itself

Short documentary on the limits of capitalism mostly based on an interview by Richard Wolf. I find the simplistic explanation of exploitation at the end (around minute 27:30) based on the time of work (prices proportional to labor incorporated) to be problematic (for a discussion of the Labor Theory of Value, LTV go here). At any rate, worth watching whether you agree with Wolf's interpretation of Marx and capitalism or not.

Monday, March 20, 2017

Latin America’s Crisis: The End of the Commodity Super-Cycle, or the Return of Neoliberalism?

From this announcement about my talk at Keene State College today at 7pm.

"Professor Vernengo will offer a public lecture and discussion of the recent slowdown in economic growth. The talk will consider the degree to which these events reflect the fall in primary commodity prices, particularly oil, or are instead the result of a return to neoliberal policy prescriptions.

Dr. Vernengo is currently Full Professor of Economics at Bucknell University. He is the former Senior Manager of Economic Research at the Central Bank of Argentina, and has acted as an external consultant for the International Labor Office (ILO), United Nations Development Program (UNDP), the Economic Commission for Latin America and the Caribbean (ECLAC), and the United Nations Conference on Trade and Development (UNCTAD)."

Sunday, March 19, 2017

Latin American corner: Neo Fisherism, New Keynesianism and monetary policy in Latin America (II)

By Naked Keynes (Anonymous Guest Blogger)

The positive relationship between nominal interest rates and inflation is not a new stylized fact in economic theory. In the 19th Century Thomas Tooke (1774-1858) considered it a general rule illustrated by the data presented in his History of Prices and the State of Circulation, 1792-1856 (published over the period 1838-1857).

Tooke rationalized the positive relationship between inflation and interest rates by postulating that the interest rate is part of the cost of production of commodities As a result when interest rates rise so does the cost of production and hence prices. As he put it in his Inquiry into the Currency Principle (1959 (1844) p.81: “A general reduction in the rate of interest is equivalent to or rather constitutes a diminution in the cost of production…the diminished cost of production hence arising would…inevitably cause a fall of prices of all the articles into the cost of which the interest of money entered as an ingredient.” Tooke dismissed the existence of a negative relation between interest rates and commodity prices. A fall in interest rates may be synonymous with liquidity but as Tooke remarked (Ibid, p.79):“A power of purchase might thus doubtless be created; but why should it be directed to the purchase of commodities if there was nothing in the state of supply, relatively to the rate of consumption, to afford the prospect of gain on the necessary eventual resale?..The error is in supposing the disposition or will to be co-existence with the power. The limit to the motive for the exercise of the power is in the prospect of resale with a profit.” By the way the assumption of equating the disposition with the power of purchase is a fundamental tacit assumption underlying the monetarist, New-Classical and New Keynesian monetary transmission mechanisms. It´s the whole story behind real cash balances and the transactions demand for money. Tooke went further he assimilated the effect on interest rates on asset markets (Ibid, p.86):“A low rate of interest is almost synonymous with a high price of securities…”

Tooke´s views were challenged by Knut Wicksell (1851-1926): “Tooke´s thesis is certainly wrong…The argument is based on the inadmissible, not to say impossible, assumption that wages and rent would at the same time remain constant, whereas in reality a lowering of the rate of interest is equivalent to a raising of the shares of the other factors of production in the product” (Wicksell, Lectures on Political Economy, II, p. 183). Wicksell´s criticism of Tooke and his disciples led him to explain the rise in prices and inflation by the gap between the natural rate of interest (“the rate of interest at which the demand for loan capital and the supply of savings exactly agree”, Ibid, p. 193 and which depends on real as opposed to monetary factors including “the efficiency of production…the available amount of fixed and liquid capital, on the supply of labour and land…” Wicksell, Interest and Prices (1936 (1898) p. 106)) and the money rate of interest. Assuming full employment, a pure credit system and that banks respond endogenously to the demand for credit Wicksell showed that when the natural rate of interest exceeded the money rate of interest an inflationary process ensued. The inflationary process led eventually to an increase in the money rate of interest to match the natural rate of interest at which point inflation would stop. In this way Wicksell was able to resurrect the positive relation between the money rate of interest and inflation while rejecting Tooke´s theses.

The Wicksellian distinction between the natural and money rate of interest is at the heart of the New Keynesian model. It appears in the aggregate demand equation (IS) and in the Taylor rule and in fact the Central Banks that have explicit inflation targeting regimes (as well as some that do not) must obtain estimates of the natural rate for their models to be operative. Without the natural rate there would be no New Keynesian monetary models. However, it is odd, that the relation they postulate between the money rate of interest and inflation is exactly opposite to that of Wicksell.

Needless to say, New Keynesian inflation targeting models do not have scope or space to include the type of causality between interest rate and asset markets envisage by Tooke (which is an essential component of Keynesian economics). These models do not include the banking system or asset markets. This is due to their firm commitment to the upgraded “divine coincidence”: price stability (equating the market and natural rate) is equivalent to full employment and to financial market stability.

To be continued

Friday, March 17, 2017

Trump's budget

The figure from the New York Times shows the changes in spending by category. More defense and less social spending. Not a surprise there. Schumpeter long ago (in his The Crisis of the Tax State) suggested that it is the fiscal history of a society that explains the spirit of the people and the character of the government, since it is there plain to see by those that can read it what they are trying to achieve.

The surprise to me, at least so far, is that the increase in defense seems to be more or less cancelled by the cuts in social spending. I suppose the stimulus part of his fiscal plan will come just from the tax cuts. If that is the case, I would not be too optimistic about the Trump boom.

Thursday, March 16, 2017

Latin American Corner: Neo-Fisherism, New Keynesianism and monetary policy in Latin America (I)

By Naked Keynes (Guest Blogger)*

Since the 2000s, like other countries in the region, Brazil adopted inflation targeting. The results are not encouraging. Brazil has, without doubt, the highest interest rate levels of Latin American economies. Brazil also has probably the widest interest rate spread in the region. In the first months of 2017, the monetary policy rate stood at 12.25%. Available data for interest rates for the year 2016 show that the deposit rate is around 12.43%, while the lending rate nears, 50 %. In addition, between 2013 and 2016 the Central Bank steadily raised its monetary policy rate bringing it to the highest level in seven years.

The stylized fact that is even more disturbing is that at least since the beginning 2010, the monetary policy rate is positively related to the rate of inflation (Figure 1).
This stylized fact contradicts the very basis on which Brazil´s inflation target regime is founded and has sparked an important debate in monetary policy involving well known Brazilian economists including, among others, Lara Resende  Eduardo Loyo, and Luiz Carlos Bresser-Pereira. At the conceptual level the debate centers around New Keynesianism and Neo-Fihserianism. 

The inflation targeting framework is founded upon New Keynesian principles (rational expectations plus market rigidities) rests on three simple equations (in its reduced and essential form), aggregate demand and supply equations (IS and Phillips curve) and a Taylor rule. These are shown below.

(1) Yg=f(rn-rt, et), where Yg is the output gap and rn and rt are the natural and current interest rates.

(2) πt=f(Ett+i),Yg, vt), πt=inflation rate; Et=mathematical expectation formed in t.

(3) it=f(Ett+i), θπ πg, θY Yg, ut), where it=policy rate of interest, θπY=policy parameters associated with the inflation and output gaps, and et, vt, ut are random errors, independently distributed with mean zero and constant variance.

The aggregate demand equation (1) specifies a negative relation between the real interest rate (or to be more precise the gap between the real and natural rate of interest) and the output gap (the difference between the actual level of output and the potential, i.e., natural, level of output). The aggregate supply equation (2) specifies a positive relation between inflation (or the difference between actual inflation and the target inflation rates) and the output gap. Finally, the Taylor Rule (3) introduces the policy reaction of the Central Bank by postulating a positive relationship the nominal policy rate of the Central and the inflation and output gaps.

The logic of the model is simple: an increase in the output gap brings about a rise in the rate of inflation (aggregate supply equation, (2)) which triggers an increase in the policy rate (Taylor rule, (3)) by the authorities and this reduces the output gap (aggregate demand, (1)). In turn, the reduction in the output gap narrows the inflation gap. Thus the model is stable.

However, stability (and uniqueness) require two conditions. First, it requires adding to the above three equation model, the Fisher equation ((4) rt=it-Et(πt+i)). Second it requires that the parameter on the inflation gap in the monetary policy reaction function (3) be greater than one (θπ>1). That is, when the inflation rate increases and is off target, the increase in policy rates should be greater than the rise in the inflation rate.

Only in this way can the nominal interest increase bring about a reduction in the output gap (aggregate demand equation). If θπ<1 a nominal increase in the rate of interest would not do the trick: aggregate demand responds only to variations in the real and not in the nominal rate of interest. Thus, within the logic of New Keynesianism the reason why the nominal policy rate and the inflation rate move positively together is due to the simple fact that Brazil has a “dovish” Central Bank (θπ<1).

To be continued.

* Naked Keynes is a generic name used for bloggers that for professional reasons must remain anonymous

Kalecki: Forgotten Genius

A documentary about Kalecki can be seen here (no way to embed, sorry). H/t to Franklin Serrano.

Wednesday, March 15, 2017

What economists do?

Nothing more profound here on the perils of being an economist. And nothing (not in this post, at least) on the interest rate hike (more on that later; it will be announced at 2pm). Just a table I came across from a paper by Card and DellaVigna (see here) on the fields of papers published in the five top mainstream journals.*
The authors suggest that "the relative shares of the different fields are fairly constant over time: theory is the largest field, accounting for about 30 percent of all articles; macro is next (about 20 percent of papers); labor and microeconomics are tied for third (16–17 percent each); and econometrics, IO, and international each account for about 10–12 percent of papers)." However, you can notice (or so it seems visually) that the Lab Experiment field now appears clearly, and that Development, Health, Finance and IO have grown over time. I would prefer to have the graph with the shares of fields.

Perhaps more interestingly the authors note that "papers in Development and International Economics published since 1990 are more highly cited than older (pre-1990) papers in these fields, whereas recent papers in Econometrics and Theory are less cited than older papers in these fields." More experiments, less citation of theory and more citations of development and and international. That's what mainstream economists have been doing. It would be interesting to see what the heterodox ones have been up to in the same period.

* The top five mainstream journals according to the authors are the American Economic Review, Econometrica, the Journal of Political Economy, the Quarterly Journal of Economics, and the Review of Economic Studies.

Wednesday, March 8, 2017

Quantitative Easing (QE), changes in global liquidity and financial instability

New paper by Esteban Pérez. From the abstract:
This paper argues that QE led to significant changes in the global financial system, which, are not conducive to greater financial stability. Through a policy of reserve accumulation, QE disconnected base money from the money supply and deposits from loans. Jointly with the deleveraging process of global banks, QE contributed to restrain the supply of bank credit growth throughout the world. Also global banks continued to expand their trading on the basis of opaque instruments such as derivatives. Moreover, by altering the relative profitability of investing in different assets, QE exerted a positive effect on the performance of the international bond market. This not only spilled into emerging market economies expanding the debt of both the financial sector and the non-financial corporate sector but also has reinforced the role of the asset management industry in financial markets. Due to its concentration and interconnectedness, illiquidity, and pro-cyclicality the asset management industry poses important risks to financial stability.
Read full paper here

Tuesday, March 7, 2017

The theory of endogenous money and the LM schedule

By Tom Palley. From the abstract:
Money is at the center of macroeconomics, which makes understanding the money supply central for macroeconomic theory. this paper presents the Post Keynesian theory of endogenous money supply and shows how it is fundamentally different from the conventional money supply theory. the conventional approach relies on the money multiplier and bank lending is invisible. Post Keynesian theory discards the money multiplier and focuses on bank lending which drives money creation. the paper emphasizes the structuralist version of Post Keynesian theory which retains Keynes’ liquidity preference theory of long term interest rates and also recognizes banks are subject to nancial constraints that limit their lending activities. the paper then shows how to derive the Lm schedule in an endogenous money economy, which is a necessary prelude to reconstructing the IsLm model.
Read full paper here

Thursday, February 23, 2017

The “Natural” Interest Rate and Secular Stagnation: Loanable Funds Macro Models Don't Fit Today’s Institutions or Data

By Lance Taylor

Can America recover ideal rates of growth through interest-rate policies? This important analysis suggests that most economists misunderstand the issue. Updating Keynes, the analysis suggests that fiscal stimulus, labor union bargaining power, and more progressive income taxes are needed to support growth. (The article includes some algebra, which some readers may choose to skip.)

The main points of this paper are that loanable-funds macroeconomic models with their “natural” interest rate do not fit with modern institutions and data. Before getting into the numbers, it makes sense to describe the models and how to think about macroeconomics in the first place.

Today’s “New Keynesian” orthodoxy says that short- to medium-run performance is determined by interest-sensitive “loanable funds.” Unimpeded interest-rate adjustment should support robust macroeconomic equilibrium. Examples of this thinking include the (visibly nonexisting) “zero lower bound” on rates, which allegedly holds down saving and contributes to secular stagnation, the global “savings glut” keeping market rates near zero, and the “dynamic stochastic general equilibrium” (DSGE) models beloved by freshwater economists and central banks in which investment is determined by saving as a function of financial return.

Loanable-funds doctrine dates back to the early nineteenth century and was forcefully restated by the Swedish economist Knut Wicksell around the turn of the twentieth (with implications for inflation not pursued here). It was repudiated in 1936 by John Maynard Keynes in his General Theory. Before that he was merely a leading post-Wicksellian rather than the greatest economist of his and later times.

Macroeconomic models are built around assumptions about behavior imposed upon accounting relationships such as value of output (or demand) equals cost of output (which generates income), and value of assets in a balance sheet equals value of liabilities plus net worth. Keynes said that changes in income dominate in making sure that the first accounting balance is satisfied. He switched Wicksell’s assumptions about macro causality—or, in the jargon, the “closure” of the model—to fit his understanding of the system. New Keynesian economists reswitch the closure back to Wicksell.

Institutions have evolved since Wicksell and Keynes were writing—the welfare state materialized and international trade expanded. Both thought, correctly for their times, that most saving comes from households and that most investment is done by business. Unlike Keynes, Wicksell argued that “the” interest rate as opposed to the level of output adjusts to ensure macro balance. If potential investment falls short of saving, then, maybe with some help from inflation and the central bank, the rate will decrease. Households will save less (and possibly also run up debt to buy into a financial bubble as prior to 2007), and firms seek to invest more. The supply of loanable funds will go down and demand up, until the two flows equalize with the interest rate at its “natural” level.

In New Keynesian thinking, demand for investment can be so weak and the desire to save so strong that the natural rate lies below zero. The “distortion” imposed by the zero lower bound short-circuits the adjustment process, leading to calls for central banks to raise their inflation targets to reduce the “real” interest rate (nominal rate minus inflation). More straightforward interventions—such as restoring American labor’s bargaining power so that rising wages can push up prices from the side of costs, expansionary fiscal policy, or redistributing from the top 1 percent to households in the bottom half of the income size distribution whose saving rates are negative—are apparently impossible for “political” reasons.

Read the rest here.

Wednesday, February 22, 2017

Crisis and Cycles in Economic Dictionaries and Encyclopaedias by Daniele Besomi

This is a review of this edited book that was just published in the Review of Political Economy.

This substantial volume provides an interesting and exhaustive discussion of the theories of business cycles as presented in the main economic dictionaries and encyclopedias over a period of almost two centuries. For the most part the content corresponds to the views of key authors who contributed to the development of the theories of fluctuations. Some major authors are nevertheless not directly covered, presumably because they did not write, or were not the subject of, encyclopedia entries. Joseph Schumpeter is one example of an important author who is not covered. Several chapters are devoted to schools of thought, e.g. Real Business Cycles, or to subfields like Political Business Cycles. The editor’s decision to focus on dictionary entries reflects his belief that these publications were authoritative and influential, and that the views expressed in them carried significant weight.

Part I, which is comprised of four chapters written by the editor, Daniele Besomi, provides an invaluable discussion of the history of economic dictionaries, and a useful analysis of the different terms economists have applied to what we now call the business cycle. The distinction between cycles proper and crises is central to the way Besomi classifies cycle theories, and again becomes relevant at the end of the volume when some alternative views are analyzed.

Part II discusses the so-called classical dictionaries, and covers a vast number of contributions from the early 19th century until approximately the late 1960s, including entries on crucial authors like Wilhelm Roscher, Clément Juglar, Adolf Wagner, Mikhail Tugan-Baranovsky, Arthur Spiethoff, Wesley C. Mitchell, Arthur Burns, Trygve Haavelmo and Jan Tinbergen. Dictionaries in French, German, Italian, Russian and Spanish are represented. The chapters explain the evolution of views on fluctuations, from a general discussion of unsystematic crises, to the analysis of more regular crises dependent on the state of confidence, and from Marxist crises of underconsumption, overproduction and disproportionality, to the development in the 1930s of the shock and propagation mechanism theories, which rely on more precise formal mechanisms to explain fluctuations.

The absence of some key names is unfortunate. Given the importance of the multiplier mechanism, Kalecki and Keynes deserve more attention than they get in this book. John Maurice Clark and the accelerator principle also get minor mention. More importantly, Besomi does not clearly distinguish theories that see the cycle as the result of external shocks from those that emphasize the endogenous character of economic fluctuations. There is a brief discussion on how Mitchell’s views rely in an informal way on the interaction of the multiplier and the accelerator, but no specific entry on the theories in which these two mechanisms are the key generators of fluctuations. Nor is there a full discussion of Richard Goodwin’s predator-prey model, which together with the multiplier-accelerator mechanism, provides one of the fundamental explanations of business cycles as endogenously generated phenomena. There is a brief discussion of the predator-prey mechanism in a chapter on nonlinear cycles, a field in which Goodwin formalized ideas developed by Nicholas Kaldor and John Hicks. Goodwin’s growth-cycle model was developed in the period of the classical dictionaries, but presumably was not discussed in any of them.

The last part of the book covers the period of the recent dictionaries. Nikolai Kondratiev and Long Wave theories of the cycle are discussed in this part, along with Real Business Cycles, political cycles and nonlinear cycles. There is no discussion of how the mainstream, which had accepted the multiplier-accelerator framework during the period when the Neoclassical Synthesis held sway, came to adopt optimizing models with imperfections and demand shocks as the main explanation of fluctuations. All we are told is that these models arose in reaction to Real Business Cycle theory. Aside from its discussion of long waves, the book offers no explicit chapter on heterodox views of the cycle (unless one classifies all nonlinear cycle theories as heterodox—a questionable view, to say the least). This seems to be due not to the failure of recent encyclopedias to discuss heterodox theories but to the choices Besomi and his contributors made regarding which dictionaries to consider.

To some extent this problem is mitigated by the thought-provoking last chapter on the return of crisis theory, also penned by the editor. Recent theories of crisis tend to emphasize the non-calculable, or qualitative, aspects of fluctuations, as against the more formal and mechanistic elements of cycle theories. In this chapter some entries that explicitly deal with Marxist and Post-Keynesian theories are discussed. The view of crises, particularly financial crises, as endemic within this context is also examined, although the work of Hyman Minsky, which is central to this topic, is not explicitly explored. There is only one brief mention of Minsky, in an early chapter by the editor on the taxonomy of fluctuation theories.

Most of the concerns I have raised about the coverage in this impressive volume are related to the choice to analyze the evolution of views on crises and cycles through the lens of entries in the most prominent dictionaries and encyclopedias. This provides a relatively easy way to determine the consensus view at a particular point in time; but it also precludes a more critical understanding of the limitations of conventional wisdom. This is by no means a disqualifying feature of the volume under review; it is merely an editorial choice that privileges certain views at the expense of others—a trade-off that, at the end of the day, is unavoidable. This volume is a tour de force, and will remain an essential resource for those interested in the history of business cycle theories.