Wednesday, August 21, 2019

The inverted yield curve and the recession

The inverted yield curve, as it is well-known, indicates a forthcoming recession. I used it last year to suggest that the recession was not in the near horizon. The conventional explanation follows Wicksellian ideas (see this old post). In the Wicksellian story, one can think of the 10 year bond rate as a proxy for the natural rate of interest, and the Fed Funds for the monetary or banking rate. Hence, whenever the short-term rate (Fed Funds) is above the long-term one, it would be reasonable to assume that borrowing short-term is a bad idea, there is not enough borrowing, and investment falls short of savings. Lower investment would be the cause of the recession, and of deflationary forces.

Graph below show the difference between the 10-year bond rate and the Fed Funds, which I have noted I prefer to the more common 10-2 spread, since the Fed Funds is more clearly a policy variable, dependent on decisions of the FOMC.
And the yield curve has turned negative, which does indicate (look at the past in the graph) a high likelihood of a recession. But I remain skeptical, even though according to the BEA GDP growth slowed down a bit in the second quarter, and the trade deficit fell, due to lower imports (that decreased more than exports), both signs of a slowing economy.

First let me explain that you don't need to believe that the inverted yield curve would cause the recession because the monetary rate is above the natural rate of interest. You may very well think that there is nothing special or natural about the long-term rate. Post Keynesians often think in terms of uncertainty, and the role of expectations. Note that the fears of a recession in this case are related to a collapse of investment (this is the view of certain posties, for example, John Harvey here, that provides always reasonable and clear analysis; he claims to be skeptical about the yield curve).

In the Wicksellian story the high short-term rates (in comparison to the natural) discourage investment too. Here the idea of the marginal productivity of capital plays a central role, while posties would suggest that expectations are more important. But the mechanism is the same. Higher interest rates would lead, along an investment curve that is negatively sloped with respect to interest, to lower levels of investment. You could park your money in short-term securities, and avoid investment.*

But there is no reason to take a marginalist or Wicksellian version of the story. While for WIcksell the natural rate is not a policy variable, that might not be the case with the long-term rate (the 10 year government bonds). In fact, both rates can be influenced by the central bank, and the Fed has a history of switching to longer term securities after a crisis. After the 2008 Global Recession, the Fed increased its holdings of long-term government bonds, maintaining a low interest rate for government debt, and also bought significant amounts of Mortgage Based Securities. Buying long-term bonds pushes their price up, and reduces its remuneration. So lower tong-term rates have been a result of policy decision to some extent.

When the Fed decided to reduce its holdings of long-term securities it basically announced that the interest rate on the long-term bonds would go up. But last year the Fed announced that the program would slowdown and eventually end by this summer. So it basically reversed its previous policy stance, at the same time that it was increasing the short-term rate, presumably because the economy was beyond full employment (or the natural rate of unemployment, if you believe in Friedman's Wicksellian story; for the Fed description of its policies go here). And changes in interest rates and in the structure of rates should have significant effects on the balance sheets of agents spending, and affect the level of activity.

However, I wouldn't expect investment to be the key variable affected by higher short-term interest rates. Indebted agents would cut spending immediately if higher interest rates put pressure on their budgets, either because they have to pay higher interest or because they can borrow at less favorable terms. And sure lower consumption would then impact investment. Firms seeing that consumption is not too strong, would curtail investment, following the so-called accelerator. So I can live with the story that an inverted yield curve, because of a significant and fast increase of short-term rates, can lead to a recession.

And that might happen sooner than I think. But I'm still unsure about the reasons for expecting that immediately. Note that trade is more often than not blamed for the coming recession. See, for example, Greg Ip, from the Wall Street Journal, here, suggesting that trade and not the Fed would be the one blamed for the recession in the future. But as I noted before, I would expect the impact of tariffs to be stronger in China than in the US, and to be more on prices than on quantities. So expect more inflation, and some disruption of the production chains, but not a recession. And the government budget deal seems to inject some additional fiscal stimulus. Perhaps not enough, and perhaps other forces would be sufficient to throw the economy into a recession. But I still think the case for an immediate recession is still not a slam dunk. The slow recovery might continue for a while. But certainly things look worse now than when I wrote last year.

* Yes, that is open to the capital debates critique.

Tuesday, August 20, 2019

ICAPE call for papers

Geoff Schneider sent a reminder that the deadline (9/4) for the ICAPE call for papers, for the San Diego conference next January 5 and 6, is just a couple of weeks away. See details for submitting a paper, panel or workshop proposal. in the following link. The main topic is Policy, Politics and Pluralism: Pluralistic economics for the post-Trump era.

As we approach the 2020 elections, it is an opportune time for heterodox economists to articulate their vision for modern economic policies that would better serve the interests of people and the environment. Already, heterodox ideas are gaining traction, from Modern Monetary Theory to the Green New Deal. Possible topics are:
  • What key theoretical and empirical issues should contemporary economists be confronting?
  • What are the best theories and policies that pluralistic economists have to offer to address the major problems facing contemporary society?
  • How do those theories and policies improve upon mainstream economic analysis?
All conference submissions must be completed using the following Google Forms:

Individual Paper submissions:

Complete Panel submissions:

Roundtable or Workshop submissions:

As you will see in the Google Forms, each participant must provide a name, professional title, affiliation, phone and email. Each paper/roundtable/workshop must include an abstract of up to 400 words (2800 characters), a short abstract of up to 100 words (700 characters), and 3 key words.

For additional information, contact

Friday, August 16, 2019

Thirlwall’s law at 40

Table of contents of the next issue of the Review of Keynesian Economics

Thirlwall’s law at 40
Esteban Pérez Caldentey and Matías Vernengo

Why Thirlwall’s law is not a tautology: more on the debate over the law
J.S.L. McCombie

Endogenous growth, capital accumulation and Thirlwall’s dynamics: the case of Latin America
Ignacio Perrotini-Hernández and Juan Alberto Vázquez-Muñoz

Thirlwall’s law and the terms of trade: a parsimonious extension of the balance-of-payments-constrained growth model
Esteban Pérez Caldentey and Juan Carlos Moreno-Brid

Thirlwall’s law, external debt sustainability, and the balance-of-payments-constrained level and growth rates of output
Gustavo Bhering, Franklin Serrano and Fabio Freitas

Growth transitions and the balance-of-payments constraint
Excellent Mhlongo and Kevin S. Nell

New Structuralism and the balance-of-payments constraint
Gabriel Porcile and Giuliano Toshiro Yajima

Is Indonesia’s growth rate balance-of-payments-constrained? A time-varying estimation approach
Jesus Felipe, Matteo Lanzafame and Gemma Estrada

Thoughts on balance-of-payments-constrained growth after 40 years
A.P. Thirlwall

Thursday, August 15, 2019

The return of populism or Argentina on the verge of collapse

The Argentinean primary elections, which are very peculiar and take place all at once with all parties, were last Sunday. The primaries made some sense when the Peronist party was all divided and that allowed the main candidate to proceed, but with the move of Cristina Kirchner to the vice-presidential spot next to Alberto Fernández, and the unification of a good part of Peronism (in particular Sergio Massa), the primaries become essentially an anticipated election. And Peronism won resoundingly, with 47 percent of the votes, considerably more than the 32 percent the neoliberal Mauricio Macri obtained.

After the election there was a run on the peso, with a depreciation of almost 30 percent, and no significant intervention from the Central Bank. To add to the problems, Macri, the incumbent president, blamed the run on the voters.  In his view, they basically do not know how to vote, and by bringing back the spectrum of populism, and the implication was default, they scared the markets. It's all about confidence.

There are many problems with his arguments, and the policies he proposed the following they, after he apologized (after all he still needs the votes of those that do not know how to vote in October, when the actual election takes place). First and foremost, the fact that the problems faced by this government are the result of their own decisions to increase significantly the amount of debt in foreign currency. As I noted before here, it doubled in this government, after having being significantly reduced in the previous one (and after the renegotiation of debt with 93 percent of bondholders in 2005 and 2010; I must insist that default was in 2002, before Kirchner, in spite of what the Wall Street Journal said recently).

Yes, it is true that by the time Macri was elected in 2015 the country had an external problem. Meaning that the current account was moderately negative, and there were no inflows of capital in a world awash in capital, and reserves were low. But most countries were able to attract flows with moderately higher rates than the international ones. I expected the depreciation and higher inflation in the beginning of Macri's government to bring down real wages. And fiscal adjustment was to be expected too, in order to increase unemployment and reduce the bargaining power of unions.

But he had space, after that, for borrowing in international markets in domestic currency, at higher interest rates, and in domestic markets, and he could have in the process obtained significant amount of dollars (locals buying high paying bonds in domestic currency) to prop up the reserves. That would have led to growth, possible stabilization of prices (with some appreciation of the currency), and accumulation of reserves, reducing the external vulnerability of the economy. The fact that they borrowed in dollars, allowed the depreciation of the currency, losing control of inflation, increased the obligations in foreign currency to a level that an agreement with the IMF was necessary, and that adjustment forced the recession (besides the contractionary effect of the devaluation) was unexpected, to say the least. It is almost impossible to fathom why he would pursue policies that would make his reelection very difficult.

To things should be said in this context. One is that the agreement with the IMF supposedly was in place to allow to maintain the exchange rate in the forty something level, and with that, perhaps, at least not accelerate inflation and help with reelection. A politicization of the IMF that the international organism should have resisted. Also, many people able to buy dollars at forty something (now that they are at around sixty) won significantly. So those that bet on a depreciation (and promoted capital flight) won. And financial markets certainly did. This government has many friends in the markets. The other is that the agreement with the IMF ties the hands of the next government. And in my view that's no accident.

The measures he announced to counter the crisis (see this FT story), essentially "increases in the minimum wage, loans for small and medium-sized businesses, student grants, subsidies for poor families with children and a floor for income tax, as well as a freeze on petrol prices" (the later freeze was, apparently, now eliminated) will not have an economic, and most likely also not an electoral effect. FT is correct, it's too little too late. Not only the size of the measures is small, but also the inflationary and contractionary effects of this massive depreciation will dwarf any possible benefit of a moderate stimulus.

So Fernández is the virtual new president, and Cristina his vice-president. And the left of center is most likely back in power in Argentina. The notion that the left was done in the region has been exaggerated. As I noted more than three years ago here it was a stretch to think that most people wanted a return of neoliberal policies in the region. I noted that Brazil was divided, and I think still is, with significant resistance to Bolsonaro, and that Macri had only won by a very a narrow margin. Note that the return of the left in Argentina comes with significantly less degrees of freedom than in 2003. Not only there's an IMF agreement that would need to be renegotiated (and they must do it to avoid a default), but also the international scenario is much less favorable. But my take is that the new government will be able to avoid default, and restore some degree of coherence to economic management, allowing for lower inflation, and moderate rates of growth (on the low end, but at least growth) and reduction of unemployment and poverty. More on that in another post the near future.

Tuesday, August 6, 2019

Class conflict, Economic Development and the Brazilian Crisis

Last summer readings

The issue of class conflict and its relation to accumulation of capital was central for classical political economists of the surplus approach. That tradition has survived in political science mostly through the work of Marxist authors. And in many recent discussions of the Brazilian crisis, that started with the 2013 protests, the 2015 turn in economic policy, the 2016 mediatic/parliamentary coup against Dilma, and the 2018 unlawful jailing of Lula and fraudulent elections of Bolsonaro, the theme of class and the role of the bourgeoisie has been widely discussed.

The book by Armando Boito Jr. (pictured above) is, perhaps, the best of those that analyze the role of class alliances and the anti-PT (anti-Workers' Party) backlash that led to the Brazilian economic collapse. The main argument is that PT had built an alliance with what he calls, following Poulantzas, the internal bourgeoisie, in particular after the fall of Palocci and the rise of Mantega in the Finance Ministry, and that this alliance fell apart in the end of the first Dilma administration. This internal bourgeoisie included many of the industrialist connected with the construction sector, the agro-business and the metal-mechanic complex, and was dependent on the internal market, while the external bourgeoisie, more favorable to the neoliberal policies of Fernando Henrique Cardoso and his social democratic opposition party (PSDB), was connected to financial markets and the international economy.

The reasons for the collapse of PT's coalition are complex, but essentially tied to the change in economic policies in 2011, the now infamous New Economic Matrix, referred to as the FIESP Agenda, by Laura Carvalho, in her useful book Valsa Brasileira, that promoted lower interest rates, a more depreciated currency, and tax incentives, rather than vigorous public investment in infrastructure, as the main tool for economic expansion. This was then exacerbated after Dilma's narrow win in 2014, when in 2015 she did a volta face on election promises and started a fiscal adjustment program.

As we discussed here before, the protests in Brazil started earlier, in 2013, and they came essentially from the left, with complaints about public transportation costs in São Paulo. But by 2015 the protests were clearly of a different nature. They were less about economic conditions, and more about corruption and the middle class was prominent among the protesters hitting pots (paneleiros) against the Workers' Party administration. In Boito's story is the break up of the coalition, and the abandonment of the Workers' Party by the internal bourgeoisie that marks the beginning of the crisis. In part, it seems, by the failure of the economic agenda (the FIESP Agenda, here this name is more revealing, since it marks that it was connected with industrialist interests) would be central for this.

Note that the policy turn precedes the protests. Note also that the complete turn in the economic policy, with the prioritization of austerity follows the electoral victory in 2014, and the nomination of Joaquim Levy to the Finance Ministry in 2015, arguably hoping to conciliate with a very hostile opposition that was vowing not to accept the electoral results the following day after the election (the defeated candidate, Aécio Neves, said so in the Senate in so many words). In many ways, like Vivek Chibber argued more generally about the State-led developmental phase, it is the national bourgeoisie that becomes the main constraint on growth.

While for the most part I agree with this analysis, I am not completely convinced about the break between a National or Internal bourgeoisie that is more industrialist, and an International or Neoliberal branch of the elites that is more financial, which is at the center of Boito's argument. For one, the differences between the internal and a more international one, and the industrial and financial one are less clear than suggested. The subdivisions might be exaggerated. Boito is careful and notes that FIESP supported both the more monetarist groups around Palocci, and also the Neo-Developmentalist groups linked to Mantega. A finger in every pie, so to speak. And that's a general problem with similar discussions within Marxism, and the whole division of financial capital and industrial capital. At the end of the day, capital is fungible, and even though one might have particular groups concentrated in one or other sector, it is relatively easy to diversify and move from one to the other. Jessé de Souza's book, also pictured above, provides a more direct critique of the role of the elites as a block (I have my issues with some of his critiques of certain Brazilian social scientists, but that's probably something for another post.

Boito, also, perceptively notes the role of the middle class. He does not emphasize it, but notes that it was particularly important in the use of the juridical system as a political element to bring down the Workers' Party. The prosecutors and the judges of the Car Wash (Lava-Jato), now increasingly less credible with all the revelations of abuse of power in their investigations as shown by The Intercept, are members of what he calls the upper middle class. I should note here the role of the United States, which trained some of these bureaucrats, including Sérgio Moro, then judge, not Attorney General of the Bolsonaro administration. Not just an elite that was committed to maintaining a backward system, the Elite of Backwardness in a possible translation of Jessé de Souza's expression, but a middle class of backwardness.

I see a parallel, with many caveats of course, to what happened in Chile with Allende. In that case, it seems that the causes for the demise of the state-led accumulation regime, as much as the retraction of the Keynesian welfare state in the advanced countries during that period, was related to its political limitations and what has been termed the Revolt of the Elites, by Christopher Lasch. In the Chilean case, the ideas of the so-called Chicago Boys were initially rejected even by the Conservative Party, and there was a significant consensus in society about the need to expand the welfare state. For example, the nationalization of copper, which had started during the Christian Democratic government of Frey, was passed in Congress with support not just from left-of-centre parties but also with support from centrist parties. In some respects, the Chicago Boys, with their ideas about liberalization and privatization, acted as a Leninist revolutionary vanguard.

In part, this was possible because the success of the state-led industrialization had created a middle class and an incipient industrial bourgeoisie that was susceptible to the fears of a communist takeover and was willing to support a violent coup to repress class conflict. It was the reaction to the political changes of the state-led industrialization period that increasingly led to the incorporation of marginal sectors of society that created the conditions for the neoliberal turn. Fears that were stoked by the United States, which provided support for the coup. In similar fashion, the success of the Workers' Party (sure there were mistakes in economic policy, but overall the economy grew, and inequality was reduced), and the improvement of the conditions in the bottom created sufficient fears in the upper and middle classes to provide support for a coup. And again the US seems to have played a role, now using other methods, with lawfare at the center of the strategy.

PS: If you want to know more about Brazil just click on the label below, and organize by date. There are posts going back to the beginning of the crisis in 2013.

The inverted yield curve and the recession

The inverted yield curve, as it is well-known, indicates a forthcoming recession. I used it last year to suggest that the recession was no...