More on MMT in the Tropics: or Can exchange rate instability, and zero interest rates, guarantee prosperity in the periphery?

 

Lance Taylor, Wynne Godley and myself in March 1999

Back in the 1990s (from late 1996 to early 1999 to be precise), I worked for Wynne Godley at the Levy Institute. Minsky, that I saw in Brazil once, had just passed away. Randy Wray was at the Levy at an office not far from Wynne's, where we worked on his model. I was, also, in Ed Nell's study group (Matt Forstater was a frequent visitor), that met regularly and discussed functional finance. In fact, one of the few topics that I was first exposed at the New School, rather than at my alma mater in Brazil.

Ed organized a conference on functional finance in 1997 (if memory doesn't fail me), then published as a book (see here), which in many ways was the beginning of what later would be called Modern Money Theory (note that at the core was Abba Lerner's functional finance). At dinner (at the Orozco Room) I sat at a table with Musgrave, Duesenberry, and, for a brief moment, Eisner, that had to leave early.* I think that was the first time I met Mosler.** Randy's MMT book came next year, in 1998 (I should note that I paid less attention to that book than his previous one, based on his PhD dissertation under Minsky, since I was at the time writing my own dissertation under Wynne and Lance Taylor, both pictured above on the day of my defense).

I start this, just to explain what should be obvious, that functional finance, endogenous money, and a preoccupation with full employment not only are part of my concerns, but that I learned, at least in part, some of these ideas more or less at the same time that they were being discussed and the MMT school was being formed. Mind you the notion of effective demand, and the perils of the external constraint, were things I already knew, but some of the issues with value theory and its importance for policy I also learned with Ed, and John Eatwell, at the New School. Further, on a personal note, I should clarify that while I worked for Wynne, who at the time was concerned with the growing external imbalances of the US, and the consequences for the international position of the dollar, I tended, on this topic to be closer to Randy's views, since it was clear for any one that came from the Federal University in Rio, and who had been influenced by Maria da Conceição Tavares, that the dollar was under no danger, and the US by definition didn't have an external constraint.

All of this to say, again, that in general, I do agree with the notion that autonomous spending determines income, and taxes being charged out of income, are the result of spending, and, as a result, the limit to fiscal policy is essentially political in nature. That is something that MMT has been instrumental in popularizing in the United States, and whenever I can, I do help on that (see my podcast with Stephanie Kelton, who was at Levy when I worked there, and started her PhD at the New School slightly after I did). She was here at Bucknell to discuss the documentary Finding the Money.

 

Stephanie at the Campus Theatre, Bucknell last March

This introduction, longish and winding, is to explain why it is somewhat weird to discuss this paper by Arturo Huerta, who I have met in Mexico, but do not know very well. This is difficult because it is a misrepresentation of the differences I do have with MMT. His paper is supposedly a rebuttal to some arguments that we have made with Esteban Pérez on Modern Money Theory (MMT). The paper is a mix of name calling (essentially that we are conventional or orthodox, read, neoclassical, and that we are neoliberals or aligned with them) and a series of arguments in defense of flexible exchange rate regimes as a solution for unemployment problems in peripheral countries. The title, "Exchange-Rate Stability Causes Deterioration of the Productive Sphere and Destabilizes Developing Economies," seems to go even further and advocate for exchange rate instability. For Minsky financial stability was destabilizing, for some MMT authors exchange rate stability causes underdevelopment and is also destabilizing.

In fact, this seems to be more a response to the critique, mine more than Esteban's, to Warren Mosler's proposal for Argentina (see below),* which would definitively cause more exchange rate instability,  inflation and a huge recession, than to our original discussion of MMT in developing countries. In fact, Huerta does not cite that paper, but our response to a poorly developed and somewhat misleading paper by Agustin Mario, that I discussed here, who said without any evidence that we defended supply side views of economic growth.

Mosler's plan consists of free float (which he says retains foreign reserves), a zero (yep, that is zero) interest rate irrespective of the rate of interest in the United States, and a Job Guarantee (JG) program. The rest is less relevant, at least for our purposes. I also assume some expansionary fiscal policy on top would be necessary for the JG.

 

Mosler's policy proposal for Argentina

Huerta's main point is that a flexible exchange rates would free the country to spend in domestic currency, very much like Mosler suggests, without loss of reserves, which developing should not be concerned with in the first place. He essentially argues along Wray's lines according to which: "a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate" (from Wray's Modern money theory: a primer on macroeconomics for sovereign monetary: p. 161. It is still exactly like that in the 2024 edition).

The notion is that: "a floating currency provides more policy space – the ability to use domestic fiscal and monetary policy to achieve policy goals. By contrast, a fixed exchange rate reduces policy space" (Ibid.). Of course, a fixed exchange rate is not necessarily the same that a stable one, and the notion that allowing big devaluations is counter-productive. MMTeers may say, as I'm sure they will, we do not defend big devaluations. Maybe not explicitly, but if you keep low (zero interest rates), and do not intervene in the exchange rate market, that is, unavoidably, the consequence. Doing that will not retain reserves, and central banks should be concerned about reserves. Btw, Milei was able to reduce inflation drastically because he did intervene both in the official and the parallel exchange rate markets (and the loan from the IMF is essentially about recomposing reserves; more on that in another post).

Then comes the question of why you should be concerned with reserves, and here Huerta's position is somewhat puzzling, particularly for someone coming from a developing country. I quote here, he says: "Vernengo and Pérez (2021) do not consider that purchases of imported goods are paid for in the importing nation’s currency, accepted by the exporters so that they can make investments, acquire financial assets, and make purchases in that nation." He suggests that they would accept pesos. In this view, a country that is an oil importer, that cannot function without energy, can import oil in domestic currency. Good luck with that!

But even if we leave the realm of Latin American magical realism, an the notion that developing countries can import in its own currency the basic capital and intermediary goods that they need to maintain normal levels of activity, his view is full of problems. He accepts very conventional views about the exchange rate (while claiming that I do have orthodox views, which I never did, on fiscal austerity; on that, note that The Guardian quotes me twice, here and here, as being against austerity when many heterodox economists, some even arguably MMTeers, I might add, have been for austerity in Argentina, saying that the mistake of the Kirchners was their fiscal excesses).

His main argument is that a "flexible exchange rates are important ... for increasing the competitiveness of national productivity and reducing pressures upon the external sector." He repeats it,  saying that: "A flexible exchange rate improves competitiveness and promotes economic growth, thereby reducing the current account deficit." In other words, the flexible exchange rate does solve the external problem (Randy is always more careful about that, and I have not seen that argument in his work).

He says that: "the reason for MMT’s advocacy of flexible exchange rates is so that the exchange rates may adjust to differences between domestic prices and those of the principal trading partners. By allowing those adjustments, a nation can avoid the relative-price distortions that would affect national production." *** He notes, as I suggested above, that they are not for depreciation per se (yeah, but with a zero interest rate...), but that: "the predominant exchange rate stability (achieved by maintaining high interest rates, in order to promote capital inflow) has led to exchange rate appreciation, which is detrimental to the competitiveness of national production." In this, as we noted in our original paper with Esteban, they are very similar to Bresser-Pereira's New Developmentalism. In the concern with a competitive exchange rate, but with a tolerance, if not a promotion of exchange rate instability, which is inevitable with very low interest rates.

There are many other issues, which again reveal actual use of marginalist thinking, for example, he says: "In saying that low interest rates generate inflation, these authors presuppose that low rates increase demand, and that the economy is in full employment. However, Vernengo and Pérez do not consider the fact that low interest rates favor the growth of investment, production, and productivity." First of all, that misrepresents our views. Low interest rates, leading to a negative interest rate differential (when the local rate is lower than the US rate adjusted for risk) leads to depreciation, and higher costs of imported goods, and inflation even if the economy is below full employment (I published the model in a book edited by, wait for it ... Forstater and Wray). Inflation comes from distributive conflict, and a depreciation, by affecting the costs of production and reducing real wages, stokes inflation. Second of all, his point is that lower interest rates lead to higher investment, which is a marginalist view that associates the intensity of the use of capital with its remuneration, a problem Huerta and many Post Keynesians share with Keynes.**** I follow Sraffians and prefer to abandon marginalist principles.

Huerta puts emphasis on the role of investment as central for growth, and in the need of very low interest rates for that, irrespective of their effect on exchange rate instability. He actually says several times that exchange rate stability is a problem, and argues that: "economies that give priority to exchange-rate stability cannot employ flexible monetary and fiscal policies to stimulate growth." On this, my views are closer to Ricardo Summa, that notes that investment is not so unstable, and follows the accelerator, and that autonomous demand (the non capacity generating part of it) is central for explaining growth.

So one needs a managed exchange rate, to avoid the inflationary pressures, and one needs to be concerned with reserves to be able to avoid the perils of not being able to import essential goods, that would cause bottlenecks an impede growth. But Huerta knows that, as a friend noticed (see below).

As he says in his tweets, what would Mexico do if it runs out of dollars to buy corn? Why not use pesos instead then? I mean, I get that Vernengo did not consider that, but he is an orthodox economist, isn't he?

In other words, sometimes, and certainly not always, developing countries cannot pursue expansionist fiscal policies because they do NOT HAVE DOLLARS (there is a reason every country, even China, accumulated humongous reserves of dollars after 2008-9). In order to be able to do it, sometimes, higher rates are needed in the periphery (not so much in the US). Then expansionary fiscal policy can be pursued even with higher interest rates, and the economy would be able to grow (as would investment that would respond, not to the higher interest, but to higher levels of demand). Exchange rate competitiveness is not central for growth, and Latin America did its State-led, import substitution industrialization (that Huerta cites all the time) during Bretton Woods with a stable nominal exchange rate (Mexico had a fixed rate from 1954 to 1976; they call it stabilizing development). It was a period of high growth, and relatively stable and appreciated exchange rate.

* I did co-edit a book, that had what I think was the last paper written by Eisner and can be seen as a follow up to that conference (ours what out of a few sessions we co-organized at the Easterns in DC in 2004, on functional finance issues.

** Mosler was in Argentina and presented this in several venues, including, at the University of Moreno, where someone questioned the idea that flexible rates with zero interested was feasible, and correctly noted that it would be inflationary and contractionary. He proceeded to ask if the person worked with me, as the story was related to me. As if my position on this is somewhat unique and someone that suggests that it doesn't make sense is my disciple.

*** Note that for Huerta exchange rates change relative prices and allow to fix distortions, in typical marginalist fashion. The emphasis is not on the effects on distribution and through that on quantities, as in structuralist views.

**** This blog is known for emphasizing the Sraffian critique of the marginalist theory of investment (very old post on that).

Lance Taylor (1940-2022) and his legacy

With Lance in Beijing (2001)

I took Lance’s macro class in the Fall of 1995 at the New School for Social Research (NSSR), and then was his Teaching Assistant for two years. The book we formally used was Income Distribution, Inflation and Growth: Lectures on Structuralist Macroeconomic Theory, in which the terms (not the concepts) for wage-led and profit-led economies were first used (at least that's what I think; profit-led does not appear in the index, I must note). But classes were based on his notes, on what became his next book Reconstructing Macroeconomics (he thanked me for all the input in my copy; I had to learn how to read his handwriting, which was not easy). In many ways, my thinking was influenced more by the Sraffian professors at the NSSR, both John Eatwell (I was also his TA in the micro class) and Ed Nell (who really was the first to discuss functional finance in my classes), in part because the blend of Cambridge left-of-center Keynesianism and Latin American Structuralism, that Lance exposed, was more familiar to me coming from Brazil.

My plan was to work on inflation theory (and I did write a conflict model, that can be seen as being in Lance’s tradition later on; in my view his best book is the one that is less formal, and is on inflation, his Marshall Lecture at Cambridge, Varieties of Stabilization Experience; at the time I first read it I didn't know that the title was a quote from Henry James; the other candidate is his book with Eatwell Global Finance at Risk. Both are more books than manuals). But I started working with Wynne Godley on his stock-flow model for the joint Center for Economic and Policy Analysis (CEPA) and Levy Economic Institute project. A year into the project I told Lance that it would make sense if I worked on something related to the project, namely the sustainability of the US external account. Lance was very nice about it, and not only went along, but also provided funding, since I received CEPA’s dissertation grant.

I ended up writing something that was very close to Massimo Pivetti’s monetary theory of distribution. The theory at least. Lance provided comments and feedback, and, at some point, told me that I was obsessed with this monetary distribution thing (I was, indeed). But he also provided support, and his criticism was always constructive. Lance was the best supervisor one could have. He guided the work with frequent conversations, read and criticized what I gave him to read, and, after it passed certain standards, approved it, even if it wasn't exactly a Lance Taylor dissertation. He never tried to mold my thinking, or force me to work on own his terms. Sadly, that isn’t the norm in academia. I think he had been lucky with his supervisor too. He once spoke fondly of Hollis Chenery (his supervisor; not his mentor, which I think was Rosenstein-Rodan; I might be wrong), because he protected the radicals, which were under pressure in the late 1960s at Harvard. His intellectual generosity, among several other qualities, is something that will be deeply missed.

Lance was open to alternative methods, and approaches, what he called closures (certainly more than I am), and his comparative method was influenced by other disciplines, the qualitative "thick descriptions" a la Clifford Geertz that he liked. I actually ended up reading a bit of Geertz because of my conversations with Lance, particularly when I was the assistant director at CEPA (he was the director) and he organized a book on several comparative studies of liberalization in peripheral countries (the one on Brazil, which was supposed to appear in a previous volume, and should have been written by Edward Amadeo, was eventually written by me; photo above is from one of the conferences that led to that book). Geertz saw anthropology, as he famously put it, "not [as] an experimental science in search of law but an interpretive one in search of meaning." The thick description was essentially the interpretive work of the ethnographer. Lance took that view, in some sense, of economics, blending the description of the historical and institutional features of peripheral countries, with relatively simple models in what Paul Krugman (a co-author; Paul's first paper was the one on contractionary depreciations with Lance) called the MIT or Solow type models (my only other model in that sense, is the currency crisis one that puts Krugman's one upside down).

 

I tend to think that this methodological stance is Lance most enduring legacy, and the one that had the most influence on my own work. Most discussions of his work emphasize the gap models (which I think are problematic, the savings and fiscal gaps in particular), or the stagnationist model of growth, which builds on Bob Rowthorn's seminal Neo-Kaleckian growth model (and also on Amitava Dutt's model, which I think was part of his dissertation work under Lance). Some might even think that it was the reversal of his views on the role of exchange rates in development, his paper with Roberto Frenkel on stable and depreciated exchange rates as engines of growth (which can be seen in line with Luiz Carlos Bresser-Pereira and Jaime Ros views, and as being at the center of New Developmentalism). Others might think it's his work on Social Accounting Matrices that prefigured, and went hand in hand with his appreciation for Wynne Godley's stock-flow consistent models (on Wynne's methodological stance, see this old post).

In a way, all these models, and others (I could have added the Minsky crisis one, that is often neglected), to some extent show the use of models for Lance. He was somewhat eclectic, and use them to illustrate some of the issues with developing countries. But for him that had to be complemented by the interpretive thick descriptions. In my view, the models per se were less relevant for Lance, who was an unorthodox lefty that remained so, as someone remembered recently, even as the whole world moved to the right in the 1980s, and 1990s (he told me that a director of research at the World Bank, that had become a neoliberal, told him in his last visit to that institution, if he wasn't ashamed for still defending those structuralist views). And he did leave MIT for the NSSR, which was a strong signal of his political views. The simple model allowed him to tell the stories.

I have a tendency to prefer greater consistency in the models, and I'm less keen on accepting some possibilities of neoclassical/monetarists closures for the real world. But his methodology, which in some sense contrasts with the large stock-flow models that my other mentor (Wynne) liked, is certainly something I think it is a more fruitful way of thinking about macroeconomic problems. But again the specific models per se are less relevant, and the thick description that they illustrate with simplicity matter more.

Fourth Godley-Tobin Lecture: Marc Lavoie on Godley vs Tobin on Monetary Theory

Part of the Eastern Economic Association Meeting, and sponsored by the Review of Keynesian Economics.

Some brief thoughts on the Great Shutdown

First GDP numbers of the Great Shutdown were out yesterday. As it can be seen in the graph, GDP shrunk by about 4.8%. The data reflects only the first weeks of the stay at home lockdown of the economy in March, as the BEA report points out. Numbers will get considerably worse.

You must add to this the increase in unemployment insurance claims, which since the crisis started has gone up by more than 26 million, as reported by the Labor Department. Note that the unemployment rate is still at 4.4% and that it would take a while for numbers to reflect the collapse in jobs. Also, the series are measured in different ways, so many that lost their jobs, and filed for benefits (and might not even have received them) will not look for jobs (what would be the point), and, as a result would not count as unemployed. Expect the participation rate to fall. At any rate, the true unemployment rate as we speak, 26 plus another 5 million or so unemployed before the crisis, would be closer to about 19%. This is a crisis of biblical proportions.

But that is not my main concern. There are many ways in which fiscal and monetary policy could mitigate the worst effects of the crisis. The problem for me is that almost nobody is talking about the size of the effort that would be required for the economy to get out of this deep hole. Imagine that unemployment does get to something like almost a third of the labor force, as suggested by some Fed officials.

I've been playing around with some scenarios. This is not forecasting, which I don't consider a particular useful approach. This scenario is based on very simple assumptions using a simple Keynesian (yes, as in Keynesian cross) model, and some simple stock-flow accounting definitions, even though I don't have a fully consistent accounting model (on that and Godley and stock-flow models see this old post). I also assume certain parameters and sizes of shocks (even though I played with different numbers; on Godley and his view of the role of parameter estimation and model architecture see this other old post). Other than the simple multiplier (in this scenario of 1.2) and Okun's Law (3:1 ratio in this case), there are only assumptions about autonomous spending (government in this case, with some assumptions for this year at least informed by current events), and my concerns are essentially about what those mean in terms of the political economy of fiscal policy.

So, in my scenario output falls by about 8% next year, and recovery starts immediately, but GDP only surpasses the previous level in 2022/23, in the third year of the crisis. That's with a lot of fiscal stimulus, by the way. And in part the result of that is that the debt-to-GDP ratio goes to, in this scenario, about 180%, after 9 years (I had others with considerably more). Japanese levels of debt. I see no problem, but not everybody agrees, and, of course, that's the problem. Since the social forces that push for austerity are still around.

The scenario also implies that unemployment spikes (less than the number I gave above; so I guess a lot of discouraged workers and disguised unemployment), and it takes almost a decade to come down to reasonable numbers.

As with Godley, my interest in this is NOT to make predictions. I have no clue if this is going to happen or not (most likely not). My point is that in all my scenarios, huge fiscal stimulus was followed by moderate stimulus (not austerity*), and yet in all the debt-to-GDP ratio would go considerably up. It shouldn't be a surprise. In a crisis with a collapse in demand, that destroys jobs and income, and that workers and corporations are heavily indebted, it is unavoidable that the federal government would be required to pick up the tab, run higher deficits, and accumulate debt.

But are we prepared for that scenario? Republicans already called for less government, less taxes, and reduction in all types of spending (particular social spending, which is frankly nuts in the context of a pandemic). More surprisingly, Mitch McConnell seems to want States and municipalities to go bankrupt, that is, not do the normal thing in federations, which is to make the only entity with ability to borrow in its own currency to borrow (at zero rates really) and transfer resources. He basically wants the US to look more like Europe, and not the more social spending part, but the absence of a federal fiscal pact part. That's dangerous. And a Biden presidency (oh man, this hurts!), if it happens (consider the alternative; is it too early for a beer?), would have to deal with that and discussions about the debt ceiling (am I glad a grabbed a beer?). Oh well.

* In my scenarios, austerity makes things worse, making the recovery slower, and tax revenue growth too, btw.

PS: The other post on Godley's approach to macro modeling here.

Why do we need a theory of value?

The theory of value and distribution is at the heart of economics. To be clear, when I say that it is at the center, it means that discussions of almost any topic in economics, in one way or another, depend on a certain theoretical position about the theory of value and distribution. However, most economists have no clue about it, about the centrality of value. Not only they don't understand the original and now infamous labor theory of value (LTV), that dominated between Petty and Ricardo (and Adam Smith too, even though that tends to surprise and puzzle most economists),* but also they misunderstand the dominant marginalist paradigm. Some economists actually think that you don't need a theory of value at all, and some don't even understand that they use a conventional (some vulgar form of supply and demand) theory of value. Hence, the reason of this post is to try to help clarify some very basic issues related to the necessity of a theory of value for proper theorizing in economics.

In a sense, this topic was discussed here before, in my post on Sraffa, Marx and the LTV. But it is worth revisiting, and thinking in broader terms, beyond the LTV, to understand why a theory of relative prices is needed in general, to understand almost everything in economics.

Let me start with the authors of the surplus approach. In fact, a bit earlier with the economists that would eventually be known as Mercantilists (if you can talk about a school). If we are allowed to generalize and simplify, the latter believed that the wealth of nations depended essentially on maintaining trade surpluses, and accumulating precious metals. Profits were essentially the result of buying cheap and selling dear, or profits upon alienation, which indicates that, for Mercantilists, profits were generated in the exchange process.

Classical political economy authors, starting with William Petty, emphasize the determination of profits in the process of production, as a residual of output, once the conditions for the reproduction of the productive system were satisfied. So profits are not the result of selling high and buying low, something that could result from the mere fluctuation of market prices, but from the ability to produce beyond what was needed for the simple material reproduction of society. Note that to obtain profits, part of the residual, the surplus over and beyond reproduction requirements, one needs to know the prices of the means of production. That is, one needs to be able to account for the normal prices of the goods that went into the production of all commodities. And these prices would include a normal profit. Again, not the extra gain that might occur from a high market price. So the normal rate of profit is needed to determine prices, and prices are needed to determine the normal rate of profit. This was well understood by both Ricardo and Marx.

Value (the relative prices of commodities) and distribution (the normal rate of profit) are intertwined. Smith knew that the simple LTV (amounts of labor incorporated) was not correct other than in very rudimentary economic systems, with essentially no produced means of production. His solution was to adopt the idea of labor commanded (more on that on my post on Sraffa, and the one on the standard commodity). Ricardo solved this problem, in his corn essay, by assuming that the surplus and the means of production advanced to produce output where all in physical quantities of corn, hence profits could be determined independently from relative prices, as a physical quantity. And Marx adopted the simple labor theory of value in volume one of Capital. Both believed, for slightly different reasons, that their main arguments would hold even if the LTV was not precisely correct.

I am not concerned with the problems with the LVT in Ricardo and Marx (worth noticing that the mathematical solution was not known in their time, and was essentially developed in the late 19th and early 20th centuries) or Sraffa's solution. It is worth insisting that the LTV does have an analytical solution that is unique, and stable (see my post on the standard commodity for the former, which suggests a Smithian, i.e. labor commanded, version of the LTV is perfectly fine).** That's good, btw. It suggests that the classical political economy notion that there are prices that guarantee the reproduction, and, beyond the the expansion (or accumulation), of the economic system do exist.

Here I want to emphasize the importance of the LTV for the analysis of other aspects of the economy. Ricardo saw the problems of the Smithian adding up theory. That's the notion that prices were composed by the sum of natural wages, profits and rent and that prices would go up if one of its components went up.  In order to determine the rate of profit properly, Ricardo noted the explanation of value was essential. The rate of profit was central because in his view the processes of accumulation depended on the rate of profit. Hence, proper discussion of accumulation and growth depends on a proper theory of value and distribution. Btw, all classical authors assumed that real wages were exogenously determined by institutional and historical circumstances (so there was a role for history and institutions in their theory; also, for accumulation that was seen as too complex to be theorized in the same level of abstraction that value). But even if one is less keen than Ricardo on the role of profits in accumulation, it is undeniable that distribution affects accumulation, and, hence, a proper theory of value and distribution is needed.

Note also, that other things that depend on relative prices are crucially affected by the theory of value and distribution. Classical authors assumed that the process of competition, by which they meant only free entry and not the size or the number of firms in an industry, would lead to a uniform rate of profit. In that sense, the forces of competition were central in forging the structure of production, and, hence, the determination of technological change or to understand the patterns of trade specialization, which cannot be understood without the determination of relative prices. In fact, perhaps the most famous and the most controversial issues coming out of Ricardian economics dealt with international trade and the effects of technical change (the so-called machinery question), and are directly connected to the theory of value.

Even the most crucial macroeconomic problem, the question of output determination (and employment, for a given technique) is affected by the theory of value. Note that classical political economists assumed output as given for the determination of the surplus. And Ricardo accepted Say's Law as a way of determining output and employment (not Marx, btw, so it's NOT a requirement of the surplus approach). But as much as for accumulation understanding of distribution is central for the determination of the level of output, as it is explicit in the Kaleckian effective demand model. the classical long term prices are compatible with levels of output that do not guarantee full employment. And the parametric role of distribution in affecting the size of the multiplier is crucial for output and employment determination. So unemployment is possible in the long run, as a regularity of market economies.

In other words, for a coherent theory of output, accumulation, international trade, technological change and more (taxation, etc.) you need a theory of value and distribution. That is also the case in the mainstream. Marginalism developed in the last quarter of the 19th century, both as a result of the lack of analytical solution in that period for the problems of the LTV and as a reaction to radical revival of the theory (Marxism). The important distinction is that while classical political economy authors dealt only with objective factors, and considered demand as given when determined value and distribution, marginalism incorporated subjective preferences as central for the explanation of long term normal prices, and prices and quantities were determined simultaneously.

Beyond the problems with the marginalist solution for the existence of long term prices (see this on the capital debates) and their switch to the intertemporal approach, which basically only deals with short term prices, their theory is also central for almost everything in economics. In a sense, given that in marginalist analysis distribution is determined by supply and demand, and by the relative scarcity of factors of production, the theory of value and distribution is even more central for other parts of their theory than in the surplus approach. Here the theory of distribution does not affect indirectly the level of output and the process of accumulation. Here the level of employment and, for a given technology, output determination is the same as the theory of distribution. Real wages and the level of employment are determined in the labor market simultaneously. Everything derives from that.

Before getting to the reason why the theory of value and distribution, central for everything, is often ignored, let me note briefly the possibility of a third alternative to value and distribution, beyond the surplus approach and marginalism. That would be the markup theories of pricing. Note that theories of markup pricing essentially describe how firms determine prices. Most of these theories were developed as a result of the imperfect competition literature sparked by Sraffa's famous (1926) critique of Marshallian price theory (see an old post on that here).

First, as it would be known for the readers of this blog (at least the ones that have been reading for a long while), markup pricing is actually dealing with a different set of issues, and Franklin Serrano suggested here that they are different than the classical political economy normal long term prices (the Marxist prices of production or Sraffa's prices), and that Fred Lee and Marc Lavoie were right about that. He argued that some Sraffians (I won't name names), and I would add probably Fred too, thought that Sraffian prices were compatible with the full cost pricing tradition, and I could have included myself in this group.*** Note that what I mean by that is simply that the behavior of firms must be compatible in the real world with the logic of gravitation in classical analysis. In other words, if prices of production imply a normal profit over the full cost for a given technique, then firms somehow must be trying to do that.

But it is clear that the full cost pricing of a particular firm might not be the long run equilibrium price around which market prices gravitate, with free mobility, that is, with competition in the classical sense. In a way, the same circularity suggested above reapers, costs depend on prices (and that involves the profit related to the markup), and prices depend on costs. The firm's individual prices might not be the prices that are required for the reproduction of the economy as a whole. In that sense, markup theories must be grounded on some surplus approach understanding of value and distribution, and they are essentially theories about market prices, meaning short run behavior. In that sense, they run into the same problem than the intertemporal marginalist models, the Arrow-Debreu type, that became more popular after the capital debates, and that led to what Garegnani famously referred to as the change in the notion of equilibrium (that is the abandonment by the mainstream of the notion of long run equilibrium). Some heterodox groups see this as a positive development, but again it implies that they cannot say anything clear about distribution and relative prices, and that has implications for almost any other theory.

I might add here, which is more concerning for some heterodox groups, is that many of these theories are also compatible with marginalist interpretations of the theory of value and distribution. Many imperfect competition theories just suggest simple inverse relations between markups and the price elasticity of demand. This again fall into the type of situation I discussed recently regarding Karl Polanyi, of well-meaning critics of the marginalist mainstream, using marginalist or neoclassical concepts w/o knowing they are doing it (if it's conscious acceptance of the mainstream model, then it's something different).

One last thing in this regard, while markup theories must be grounded on some theory of value and distribution, and my take is that the surplus approach is where it would make sense, the opposite is not true. There is no need for a theory of the firm, of individual behavior, to understand long term prices. Classical political economists certainly discussed behavior, but that essentially entailed some notion related to class, to general social norms, not about what is going on in someone's brain. Even Smith that was certainly concerned with the issue of the role of self-interest in determining the equilibrium outcomes in the market, cannot be assumed to be a precursor of the rational maximizing agents of the mainstream, or of methodological individualism. The same could be said of utilitarian views and Ricardo, who was, to some degree, close to many utilitarians including Bentham. Here too, many heterodox economists think that an alternative theory of behavior is central for economics, and that is why many see behavioral economics as somewhat heterodox.

Finally, getting, even if briefly, to the point of why most economists remain oblivious to the relevance of value and distribution. I would suggest that this is a recent phenomenon. It is the result of what I have discussed here before, the return of vulgar economics (for example, here or here), and that the mainstream has abandoned the long run, and provides only a theory of short run prices. But at the same time the mainstream must revert to the old model in order to promote economic policy. Note that only in that model you can guarantee that markets provide efficient allocation of resources (w/o imperfections), and the price system signals the direction of adjustment. It is often missed by the heterodox groups that resist old classical political economy (often for incorrectly assuming that it is a precursor of marginalism) that their theory of value and their long term prices provide something completely different, an understanding of the conditions for the reproduction of society. That notion, btw, is alive and well in other social sciences (see here or here). Not in economics.

* It survived in the fringes and it was rediscovered by Marx and then much later Sraffa, who actually provided a coherent solution to some of its logical limitations. But after Ricardo, the LTV was never dominant again.

** On the gravitation of market prices towards normal prices see the work by Bellino and Serrano here.

*** My fondness for the subject in part derived from having worked for Wynne Godley at the Levy for two years, who was a disciple of P. S. W. Andrews one of the key authors of the Oxford Economists' Research Group (OERG) behind full cost pricing theories.

The budget, the fragile recovery and the next recession

I'm not a forecaster. I do macro, and worked for Wynne Godley at the Levy, but I feel that there are too many dangers in forecasting. Wynne was also, btw, more concerned with what he called medium term scenarios, than pinpointing when a recession would take place. The obvious joke applies here. Economists have predicted 10 of the last 9 recessions. Having said that let me do the exact opposite and throw caution to the wind.

So I'm going out on a limb here. Everybody thinks the recession is around the corner. I'm more skeptical. Let me start by looking at what Martin Wolf has said in his last column, since he seems to be close to what consensus views would argue. He resuscitates old views about confidence cycles. For him: "Bull markets, it is said, climb a wall of worry... so much optimism was already in the prices of financial assets — in the US, above all — that once worry returned they had nowhere to go but down." He suggests that a "jump in risk aversion" might trigger the recession.

Worse, he suggests, following the IMF (that has changed its mind, according to many), that the US government has not helped by embarking on a highly irresponsible, pro-cyclical fiscal expansion on top of what the IMF labels 'already unsustainable debt dynamics'." In other words, expansionary fiscal policy will promote a crash by sapping the confidence of financial markets. Presumably we need sound finance.

The worst risk for him comes from populism, particularly in the US. He notes:

"The biggest shift of all is in the US. Last week, President Donald Trump broke a longstanding taboo by condemning recent tightening by the Federal Reserve. Under him, the US has also embarked on an assault on the World Trade Organization’s dispute settlement system and an open-ended trade war with China."

As I noted in my previous post on this, the biggest risk in my view comes from monetary policy in the context of a relatively fragile and slow recovery, even if it is a very prolonged one. The yield curve (see below; I use the Fed Funds and the 10 year bond rather than the 10-2 spread, since the Fed Funds is more clearly a policy rate, and gives you the result of policy actions) is closing, but if the Fed does not raise the basic rate too fast, there is a chance for the slow expansion to continue.

Note that there are other indicators that suggest that even though the recovery is not great, it may continue for a while. For example, if one looks at Gross Fixed Capital Formation, it is clear that an initial downturn seems to have subsided (like in the mid-1980s), and that the system got a second wind.

Capacity Utilization in Industry shows a similar picture. Note that this does not mean that the recovery is strong by any means. But last week the news, in spite of the unstable financial markets, were if anything indicating that the economy may continue on this path. I'm referring to fiscal news.

The budget deficit increased. That in and off itself says nothing, since the deficit is endogenous. In part the deficit went up as a result of tax cuts (a lot going to corporations and the wealthy). But also higher spending, quite a bit on defense. So there is a lot to complain about how money is being spent and how taxes are being collected. But that provides a modicum of stimulus. Trump, one should note, actually was more accurate on this than Wolf. He said that there is no fiscal danger, and that the US runs no risk of default (so why would financial markets be concerned with that), since the US can print money. Note that printing money might have consequences, but these are not the ones orthodox economists often suggest (see more here).

Contrary to Wolf I don't think that the trade wars would affect significantly the US economy. It might affect China, and certainly will have effects on the supply chains of US corporations. It might lead to higher prices, but it's implausible that it would bring the economy to a halt. The American economy depends on domestic demand. Nothing much will be affected by the trade war on that front. Also, while I think that student debt (and car loans too) are out of control, and will have implications, it's not clear that these, by themselves would cause a recession, in the way that mortgage loans did last time. They might not affect domestic demand to the same extent, at least not in the short run.

If there is a risk (besides monetary policy) is the persistence of financial speculation and the shadow financial sector, as represented by for example Collateralized Loan Obligations (CLOs), which have been going to high risk non-financial corporate firms (like Sears). But that does not mean that a recession is around the corner, and this weak recovery can (arguably) prolong itself for a few more quarters. Hey, conceivably it might go on until the 2020 election, giving Trump a serious shot at reelection (and that's not a happy thought).

The Godley-Tobin Lecture

Tobin and Godley

The Review of Keynesian Economics (ROKE) created of the Godley-Tobin Lectures, an annual lecture to be delivered at the Eastern Economic Association meetings. James Galbraith provided the first lecture, to be published in the first issue of 2019.

Wynne Godley and James Tobin represent the best among Keynesian economists. Both scholars insisted they were non-hyphenated Keynesians, meaning Keynesianism transcends the political disputes that often accompany economics. There is a deeper scientific validity to Keynesianism, something we reaffirmed in our inaugural statement of purpose for ROKE [see Palley, Rochon, and Vernengo, 2012].

Wynne Godley was an Oxford-trained economist, influenced by Philip Andrews and the views of the Oxford Economic Research Group on full-cost pricing. He was also a Treasury economist and Head of the Department of Applied Economics, University of Cambridge. He is remembered for the sophistication of his stock-flow consistent macroeconomic models that gave him a prescient sense of the unsustainability of the dot.com and housing bubbles in the 1990s and 2000s. Godley died in May, 2010.

James Tobin was educated at Harvard University and spent most of his career at Yale University. He was also a member of the celebrated Council of Economic Advisers (1961-62), during the Kennedy administration. His accomplishments and contributions to the profession are too many to cite, but it is specifically worth mentioning that he won both the John Bates Clark Medal (1955) and the Nobel Memorial Prize in Economic Sciences (1981). Tobin died in March, 2002.

Tobin and Godley shared an interest in stock–flow consistent macroeconomic modelling, a belief in the appropriateness of macroeconomic modelling based on aggregate functions rather than microeconomic parable models, and a belief in the importance and feasibility of full employment.

The Godley-Tobin lectures are intended to celebrate the intellectual achievements of Wynne Godley and James Tobin. We also hope the lectures will contribute to advancing their macroeconomic approach and interests, and help rescue macroeconomics from the narrow theoretical frame within which it is currently trapped.

The editors of ROKE [Tom Palley and yours truly] are pleased to announce that Robert Rowthorn has accepted to give the second annual Godley-Tobin lecture at the 2019 meetings of the Eastern Economic Association, in New York City. Professor Rowthorn is Emeritus Professor of Economics at Cambridge University and a life Fellow of King’s College.

He was also a long-time colleague of Wynne Godley at Cambridge University.

The Godley-Tobin Lecture by James K. Galbraith

Presenting the Lecture

Here is the audio file of Jamie Galbraith inaugural Godley-Tobin Lecture. Due to the weather he recorded the lecture before hand. The paper will appear in the Review of Keynesian Economics (ROKE) soon. Jamie presents a macro discussion of income distribution, which he correctly points out has been absent from most discussion of inequality in recent times.

Further, he connects his concern with the data (the UNIDO data that his team at UTIP has worked on for years now) to Wynne Godley's preoccupation with data consistency and accuracy. He also noted that James Tobin's preoccupation with the role of monetary variables, which Wynne certainly admired, is central to understand global inequality. We were very happy to have Jamie give the inaugural lecture, not just because we expected a great presentation, but more importantly because having interacted with both Godley, at the Levy, and with Tobin, at Yale and while he was in the staff at the US Congress, he was in a unique position to provide a thoughtful evaluation of their importance for what I referred (following Wynne) non-hyphenated Keynesianism to the understanding of economics.

The inaugural Godley – Tobin Memorial Lecture

The inaugural Godley – Tobin Memorial Lecture at the Eastern Economic Association meetings in Boston on Saturday March 3, 11.30am – 12.50pm. The lecture pays tribute to both Godley and Tobin's emphasis on being non-hyphenated Keynesians (more on that for a later post).

The lecture is sponsored by the Review of Keynesian Economics (ROKE) and will be delivered by Professor James K. Galbraith, whose talk is titled “A global macroeconomics – Yes, macroeconomics damn it – of inequality and income distribution.”

It will be held in Gardner A & B of the Boston Sheraton. If you are attending the EEA meetings, I hope you will attend.

Godley-Tobin Lecture at the EEA in Boston

James k. Galbraith on inequality at the EEA in Boston. Don't miss it!

The Godley-Tobin Lectures

The Review of Keynesian Economics (ROKE) is honored to announce the creation of the Godley-Tobin Lectures, an annual lecture to be delivered at the Eastern Economic Association meetings.

Wynne Godley and James Tobin represent the best among Keynesian economists. Both scholars insisted they were non-hyphenated Keynesians, meaning Keynesianism transcends the political disputes that often accompany economics. There is a deeper scientific validity to Keynesianism, something we reaffirmed in our inaugural statement of purpose for ROKE [see Palley, Rochon, and Vernengo, 2012].

Wynne Godley was an Oxford-trained economist, influenced by Philip Andrews and the views of the Oxford Economic Research Group on full-cost pricing. He was also a Treasury economist and Head of the Department of Applied Economics, University of Cambridge. He is remembered for the sophistication of his stock-flow consistent macroeconomic models that gave him a prescient sense of the unsustainability of the dot.com and housing bubbles in the 1990s and 2000s. Godley died in May, 2010.

James Tobin was educated at Harvard University and spent most of his career at Yale University. He was also a member of the celebrated Council of Economic Advisers (1961-62), during the Kennedy administration. His accomplishments and contributions to the profession are too many to cite, but it is specifically worth mentioning that he won both the John Bates Clark Medal (1955) and the Nobel Memorial Prize in Economic Sciences (1981). Tobin died in March, 2002.

Tobin and Godley shared an interest in stock–flow consistent macroeconomic modelling, a belief in the appropriateness of macroeconomic modelling based on aggregate functions rather than microeconomic parable models, and a belief in the importance and feasibility of full employment.

The Godley-Tobin lectures are intended to celebrate the intellectual achievements of Wynne Godley and James Tobin. We also hope the lectures will contribute to advancing their macroeconomic approach and interests, and help rescue macroeconomics from the narrow theoretical frame within which it is currently trapped.

As the Editors of ROKE, we are also pleased to announce that James K. Galbraith has accepted to give the inaugural Godley-Tobin Lecture, at the 2018 meetings of the Eastern Economic Association in Boston. Professor Galbraith will also join the Editorial Board of the journal.

James K. Galbraith was a colleague of Wynne Godley at the Levy Economics Institute and a student of James Tobin at Yale University.

Thomas Palley, Louis-Philippe Rochon and Matías Vernengo
Co-editors of ROKE

Noah Smith on heterodox models

As it is often the case when you've been blogging for a while, there is always a precedent, and one might have written about a particular topic. Noah Smith, which I think has been blogging for a shorter period of time than I've been, now comes up with another take down of heterodox economics (having difficulties of understanding the meaning of the mainstream, it's no wonder he gets heterodoxy wrong; on the definition of the latter go here).

He argues that "much of heterodox theory is non-quantitative." True, but so is the case with the mainstream. Not everything can be formalized. And there is qualitative knowledge. But, having said that, the point is that difference between the mainstream (marginalism, neoclassical economics) and heterodox approaches has nothing to do with the lack of formalization of the latter. His examples of heterodoxy are not the best, I would argue. He first deals with Hyman Minsky, which in my view accepted a good chunk of mainstream ideas in his interpretation of Keynes. And yes, he did not formalize his theory, but there are plenty of models (Lance Taylor, Alessandro Vercelli and Steve Keen have done it, to name a few).

The main critique of mainstream economics, or at least of its core theory of value and distribution, is presented in a very short, and formalized, little book called The Production of Commodities by Means of Commodities. The notion that supply and demand determine prices (long term equilibrium prices) and that the principle of substitution works is sketched there. And later Paul Samuelson (subscription required) admitted that neoclassical parables made little sense. I've dealt with this issues several times notably here. And the heterodoxy has formalized models of the determination of output, employment, inflation (see mine here), growth (in many varieties, but mainly demand-led) currency crises (see mine here), etc. So Noah is wrong when he suggests that "heterodox theory is non-quantitative."

Noah discusses essentially the so-called stock-flow models deriving from Wynne Godley's (my old mentor) work as examples of heterodox models that are formalized. His main critique is that there are problems with estimation of parameters. This is essentially one of the critiques raised against the Cowles Commission types of model that dominated the mainstream until the 1970s (before Lucas' critique). They are still around like Ray Fair's model at Cowles. Fair provides a response and comparison with modern methodology here, which is worth reading.  But the defense that Wynne would provide would be different in my view.

As I noted before, Wynne "was more concerned with what he referred to as 'model architecture' than with parameter estimation. The architecture, which was careful about stock-flow consistency, showing that everything came from somewhere and went somewhere so to speak, also imposed a clear causality structure, which determined most of the results. In fact, Wynne believed that significant variations of the parameters might not greatly influence the end result of the model, which was used for simulations and scenarios that helped to understand how the economy functioned, rather than for strictly forecasting purposes."

Simpler models, which do not provide the full accounting, as I suggested here, but that separate income and price determination, where output is demand determined, are in that sense also useful. Or just stated simply, of course there is a formal alternative to the mainstream. It's one that does not emphasize microfoundations and individual behavior as Noah would like, but that's another story.

A very brief comment on Brexit

I've been posting less frequently with the end of the school year. Will be going to the History of Economic Society Meeting this weekend. Posting will be even more limited. At any rate, hope to be able to say something more substantial on Brexit before the referendum. Let me say that I'm against Brexit, which is I suspect the view that Wynne Godley would take on the issue. He was firmly for Europe, but against the euro as it was shaped, but not in all circumstances. He correctly pointed out that a common currency requires a fiscal union.

It seems that more than a few heterodox Keynesians (post-Keynesians for the most part) have come in favor of Brexit. I think it is important to emphasize the difference between the common currency (the euro) and leaving it, for example, Grexit, and the European Union. Brexit, of course, refers to the last, since the UK has its own currency, the pound.

Mind you, I don't think that the problems with leaving the EU are essentially economic, and I think to emphasize these costs is a mistake. The real problem with Brexit is the political costs, associated to a more closed view of what Europe means. It would lend support to radical right wing views that reject a more culturally and ethnically diverse Europe, and it might, as Yanis Varoufakis suggested lead to the slow disintegration of the European project.

I have posted a few videos of 'Yes, Minister' before. The one below (h/t Ramanan) is apropos. Enjoy!

Brexit and Euroskepticism

British exit from the European Union (EU) is more radical than Grexit, which basically was exit from the eurozone (EZ), the currency area, but not the union. Wynne Godley, for example, was against the euro (see this), but he was not against the EU. Quite the opposite, he was pro-Europe, as were many progressive economists, several connected to Labor (Lord Eatwell being an example). The whole isue now became relevant, since David Cameron, the prime minister, set the date for a referendum on Brexit for June 23rd. Map below shows the degrees of euroskepticism (as in EU membership, not EZ) around Europe.

Note that in the UK there is a significant amount of euroskeptics, more than in the parts of Europe that have suffered from the problems with the monetary union (source here). The UK and the countries with more developed welfare systems in Northern Europe (Denmark, Sweden, Finland) tend to have a less favorable view of the European Union.

I'll discuss the pros and cons, from an economic perspective, of EU membership in another post. I do feel like Wynne that, while EZ membership is not necessarily good (at least with the current fiscal rules), EU membership is better than the alternative.

Thirlwall à la Godley

Short note on Thirlwall's Law by Lance Taylor available here. As he notes on Thirlwall's Law:  "Insofar as they [the conditions to generate it] are 'extreme,' the plausibility of (3) [Thirlwall's Law] is open to doubt," which is one of the points I raised in my recent debate with Jaime Ros. Causality here remains from exports to growth, which was reversed in Clavijo and Ros, but there is a healthy skepticism about the generality of the law.

Arguably Godley had a version of Thirlwall's Law in his model too. As noted by Zezza: "the ideas underlying the ‘New Cambridge Hypothesis,’ which assumed... that the private sector would adjust rather quickly to a shock, to restore its desired income/assets ratio." In this sense, in the long run in a steady state Godley assumed that the net acquisition of financial assets would be zero. This would be a stock version of the flow equilibrium between investment and savings, the private balance.

US Interstate Transfers and the Euro Crisis

by Nathaniel Cline and David Fields

It is recognized among heterodox economists that the fiscal crisis some Eurozone countries faced (and are facing) is the result not of internal fiscal excess but of fundamental imbalances made worse by the adoption of a common currency. Indeed, as Wynne Godley pointed out (in several pieces) long ago, European structural payment imbalances will not be automatically corrected by market forces. In this case a common currency without centralized fiscal powers will potentially exacerbate the balance of payments problems of member countries. Some countries will be permanently outsold, and under the current arrangements, are forced to make large income adjustments to resolve their balance of payments.

As a result, many (even in the mainstream) have suggested that a common fiscal union would resolve the problems these countries face. Comparisons have been made to the US whose member states enjoy a common currency with a substantial federal fiscal system that redistributes funds among the states. Residents of states pay taxes to the federal government and states receive government expenditures (through federal programs, grants, salaries, and other means). However the payments states receive are decided upon different ground than the taxes they pay. Thus a state like Mississippi pays very little in taxes, but receives a substantial amount of government spending. In contrast, states like Minnesota pay in to the system much more than they receive.

In normal times this prevents large balance of payments crises from emerging between states. Mississippi is thus permitted a higher average growth rate than would otherwise be implied by their balance of payments.

It is misleading however to assume from these large transfers that simple fiscal transfers between states would resolve Europe's fiscal problems. In a recent presentation to the Eastern Economic Association, Dave Fields and I argued that in fact, the US did not respond to the crisis by transferring large amounts of money between states as it does in normal times.

The key point was that US federal government went into deficit to transfer money to states as a whole. The relevant transfer in the crisis was then not among states, but between states and the federal government. What is needed then is a Euro deficit which would finance all member states, and not necessarily transfers between say Germany and Greece in the middle of a crisis.

The degree of interstate transfers in the US is shown below. Note that between 2004 and 2007 it appears that the federal government is actually a net drag on the states. This is likely not quite correct because the expenditures in the chart do not count expenditures which cannot easily be allocated among states (like for instance federal interest payments).

The Degree of Interstate Transfers 2004-1013

Source: Expenditures provided by the Pew Fiscal Federalism Initiative, tax data from the IRS, author's calculations

The issue can be seen clearly too if the transfers are broken down by state as is done in the chart below. One can see that by 2009, only a few states remained net contributors to the system while the others all became net recipients (including by the way both California and Texas). 

Fiscal Transfers Between the States 2008-2009

Source: Expenditures provided by the Pew Fiscal Federalism Initiative, tax data from the IRS, author's calculations

Mario Seccareccia on Greece and the European Crisis

Nice interview by Mario for INET. The main point in his words:

"In the medium term, Greece could create some form of parallel currency set at par with the euro, like Argentina did in the early 2000s. The government in Argentina used 'patacones' to buy things and pay employees and they became quite acceptable because ultimately regular people could pay taxes with this currency. The Greeks could have a parallel national currency without altogether abandoning the euro. 

So these various short-to-medium-term measures may well be available to prevent default, but, at the end, if the Greek government cannot renegotiate its crushing debt burden — without some form of debt forgiveness in however form it will be disguised — you could see a Greek default happen. If it reaches that point, I don’t think there’s anything in the Eurozone treaties that would prevent Greece from retaining the euro. In this case, it will have to learn from the experiences of dollarized countries such as Ecuador that have been surviving under very severe constraints on fiscal policy but without the oil revenues that until recent times have served well to replenish Ecuador’s coffers."[Italics added]

Not sure if Mario is against Greexit, meaning exit from the euro, but the suggestions is that even with default there is no need for exit. I am not against his perspective, and that was the view that Wynne Godley had about Europe and the euro, for the former, but against the way the latter was implemented without fiscal federalism, and significant transfers. I also noted before that devaluation or exit does not solve all the problems.

Independence and monetary unions

So, as the map above shows, independence from the UK is nothing new. And I personally have no particular opinion on whether independence is good or bad for Scots, although many on the left seem to think it's a good idea. However, it is undeniable that independence and maintenance of the pound is a terrible idea. Here is Wynne Godley, who I should add was in favor of the European Union, but not of the currency union as it was organized, in 1992 (from a previous post available here).

"the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates. As local authorities possess none of the instruments of macro-economic policy, their political choice is confined to relatively minor matters of emphasis – a bit more education here, a bit less infrastructure there."

So much for the possibility of a more social democratic Scotland after independence. A bit more spending on education, in exchange for a lot of austerity.  Mind you, these effects my take a long time. Wynne predicted the problems of the Euro in 1992.

Gennaro Zezza: Fiscal and Debt Policies for Sustainable U.S. Growth

New paper by Gennaro Zezza

From the abstract:

In our interpretation, the Great Recession which started in the United States in 2007, and propagated to the rest of the world, was the inevitable outcome of a growth trajectory based on fragile pillars. The concentration of income and wealth, which started rising in the 1980s, along with the stagnation in real wages made it more difficult for the middle class to defend its standard of living, relative to the top decile of the income distribution. This process increased the demand for credit from the household sector, while deregulation of financial markets increased the supply, and the U.S. economy experienced a long period of debt-fueled growth, which broke down first in 2001 with a stock market crash, but at the time fiscal and monetary policy managed to sustain the economy, but without addressing the fundamentals problem, so that private (and foreign) debt kept increasing up to 2006, when a more serious recession started. At present, the long period of low household spending, along with personal bankruptcies, has been effective in reducing private debt relative to income, and, given that the problems we highlight have not been properly addressed yet, growth could start again on the same fragile basis as in the 1990-2006 period. In this paper, adopting the stock-flow consistent approach pioneered by Wynne Godley, we stress the need for fiscal policy to play an active role in (1) modifying the post-tax distribution of income, which along with new regulations of financial markets should reduce the risk of private debt getting out of control again; (2) stimulate environment-friendly investment and technological progress; (3) take action to reduce the U.S. external imbalance, and (4) provide stimulus for sufficient employment growth.

Read the rest here.