A Clarification of the clarification of supermultipliers

After my post I got an email and post below by Franklin. Mind you, I still would refer to supermultiplier models as Kaldorian, and the models with autonomous investment as neo-Kaleckian. As Franklin notes Bortis, a Kaldorian and Sraffian, makes the transition to exogenous distribution, even if Kaldor himself didn't. Below the email and the post.

Dear Matias:

Great Post.Your use of the phrase “no independent investment function” to refer to induced investment models is unfortunately quite confusing.

This phrase since the classic survey of Hahn in Matthews has been used to refer to models in which full employment (or full capacity in Lewisian and neo-Marxian models) saving determines investment.

I am sure that what you mean is that in supermultiplier models there is no autonomous component in the (capacity creating) investment function. It would be much better to all of us if you changed that at no cost for you. If you do this , please omit this part from my uninvited guest post.
...

The Sraffian supermultiplier (Serrano, 1995) , as the name says is,well... Sraffian. That means that its key feature is that distribution is exogenous. In fact the original title of my 1995 PhD dissertation was going to be “demand led capacity growth under exogenous distribution”. That is why it can and recently it has been adopted/discovered by a few eminent neo-Kaleckians , as the key feature of their approach is also the exogenous profit share, determined separately from output (although along different lines through the degree of monopoly).

Kaldor himself never moved away completely from some version of the Cambridge theory of distribution, either of the “competitive” (prices are flexible relative to Money wages ) or “managerial” (there is mark-up pricing but the mark-up is function of the desired induced investment share and thus of the rate of growth of the economy (a la Wood, Eichner, etc.) . See chapter three of my PhD thesis and chapter two of my 1988 Master´s thesis for a critique of both [in Portuguese].

In both (totally unrealistic )versions of the Cambridge mechanism, it is accumulation that determines distribution endogenously, unlike the separation between distribution and accumulation we find in Sraffa , Kalecki and their modern followers.

In fact, Kaldor´s paper that I quoted in my thesis and that Lavoie (2015) mentions, called “conflict in national economic objectives” is the only one in which (although without using equations) he does not mix the harrod balance of payment equilibrium condition X/m=Ybp ,which shows a balance of payments constraint with a proper supermultiplier , say Y=G+X/(c(1-t)+m-gv ) which is the level of output determined by effective demand

In all his other works Kaldor makes Y=Ybp and this occurs because Kaldor arbitrarily assumes that G=t.Y and that vg =(1- c(1-t)) via some Cambridge mechanism that makes the aggregate marginal propensity to consume adjust itself to the marginal propensity to invest vg. See Fabio Freitas (2003) and Bhering & Serrano (2013) for details here and here.

(Palumbo ROPE 2009 also mentions these assumptions by Kaldor but unfortunately fails to note that the endogeneity of distribution that is the problem and not the induced investment function as she claims)

The inconsistency of having a proper aggregate demand led growth model with endogenous Cambridge distribution is the reason why I say in chapter two of my Ph. D. thesis that “It seems then that the only reason why Kaldor did not get to point of producing a explicit model of the industrial economy identical to our Sraffian supermultiplier must be attributed to

His reluctance to abandon completely his own version of the Cambridge theory of distribution. In fact , a consistent supermultiplier analysis requires the distribution of income  (and the aggregate marginal propensity to save) to be treated as an exogenous parameter, being therefore incompatible with the idea that distribution is somehow endogenously determined via the Cambridge equation.”

And it is then also no surprise that it was Heinrich Bortis, supervised by Kaldor that first got to the idea of an exogenous distribution supermultiplier, that he calls “Classical-Keynesian” in his 1979 Cambridge PhD (though his book was published only in 1997).

But note that , again as I demonstrated in chapter 3 of thesis, that in Cambridge models whatever the initial level of capacity there will always be enough aggregate demand for as distribution will change so that aggregate consumption changes to fill the gap (see Serrano & Freitas, 2015).

Of course you may ask: but then what is the point of having induced investment growing at the rate the autonomous part of demand grows if there is never lack of aggregate demand? The only consistent answer to this last question is: please just drop the endogenous distribution Kaldorian supermultiplier and use either the neo-Kaleckian or Sraffian ones, according to the theory of exogenous distribution you find more reasonable. In other words, if you like the idea of an autonomous demand supermultiplier , don´t be Kaldorian (in this specific sense). The exogenous distribution supermultipliers are not just more general as Vernengo correctly argues but most importantly , they are more consistent.

Kaldorian and Sraffian supermultipliers: a clarification

This is a post for those interested in demand-led theories of growth. Not long ago I wrote a post on misconceptions about Sraffian economics. Marc Lavoie sent me a nice email about it, and a recent paper he published in Metroeconomica (subscription required), which comments on a paper I wrote with Esteban Pérez (working paper available here). In his discussion of supermultiplier models, which put the multiplier and the accelerator together to explain -- not fluctuations of the level of output around its normal position -- but the determination of trend or normal output. Lavoie says:

"Other post-Keynesians, also assume that non-capacity creating autonomous expenditures are the driving force, rather than investment. Serrano himself refers to Kaldor (1983, p. 9) to provide support for this reversal of causality. Fazzari et al. (2013) assume that there is some unidentified demand component that grows autonomously, in order to tame Harrodian instability; Godley and Lavoie (2007, ch. 11) and, as already pointed out Allain (2015), rely on autonomous government expenditures. Indeed, there is a large Kaldorian literature that relies on exogenous growth components other than business investment, most particularly the whole literature on Thirlwall 's law with its exogenous exports (McCombie and Thirlwall, 1994), as well as Godley and Cripps (1983), with both government expenditure and export sales."

And in a footonte to that passage he says:

"Thus, adding to the confusion over terminology, Pérez-Caldentey and Vernengo (2013) refer to the Kaldorian tradition when discussing models based on induced investment and non-capacity creating exogenous growth components such as Serrano's Sraffian supermultiplier analysis."

So let me clarify our use of Kaldorian, and also why I believe that it is a mistake to refer to the Sraffian supermultiplier as neo-Kaleckian, even though it does have evidently Kaleckian elements. As I understand the distinction that came to dominate demand-led models of growth, there are basically two* main traditions, one that is referred to as neo-Kaleckian, and one that is referred to as Kaldorian.

The first tradition developed from Bob Rowthorn's expansion of Joan Robinson's 1960s model. And because Joan Robinson was influenced by Kalecki, and  Rowthorn, a Marxist author, was seen as Kaleckian, the name stuck. The original model, one must note was wage-led. And causality basically determined whether the authors was Keynesian or Marxist, with Ed Nell famously referring to one author that suggested that causality went from income distribution to growth as Jean Baptiste Marglin. At any rate, Marxist and Keynesian closures, to use the term popularized in this context by Lance Taylor, were special cases of the neo-Kaleckian model. Later developments introduced changes in the independent investment function which allowed for a profit-led closure.

As I noted before, the term Kaleckian is a bit of a misnomer. The current version of the model allows for a profit-led closure, which is not clearly in Kalecki, and, besides its derived from Joan Robinson's model. The Kaleckian feature is that often it is assumed that workers do not save, and capitalists do not consume, for simplification, a classical political economy type of assumption really.**

The genesis of supermultiplier models is more convoluted. On the one hand, the combination of multiplier and accelerator was used to discuss economic cycles, not growth, including by Hicks, who first discussed the idea of the supermultiplier. By the late 1960s, Kaldor moved away from the differential savings or neo-Keynesian growth models (sometimes referred to as Kaldor-Pasinetti or Cambridge growth model), and adopted the supermultiplier model, formalized by Thirlwall in the 1970s. The model assumed as a simplification that exports were the only autonomous component of demand. In accordance with the accelerator, investment was seen as derived demand. That is the main difference with the so-called Neo-Kaleckian models, namely: there is no independent investment function.***

The idea of the supermultiplier was later, in the 1980s and 1990s, developed by Bortis and Serrano,**** both authors sharing a Sraffian perspective. In these versions, autonomous spending was not restricted to exports, and government spending was also relevant. The term Sraffian or classical-Keynesian has been used to describe these models. In essence, they are Kaldorian models, since investment is derived demand, as much as in Thirlwall's model. In this sense, even though the Kaldorian models a la Thirlwall are a special case of the Sraffian supermultiplier, as discussed here in my debate with Jaime Ros (in Spanish), and by definition more general than the export-led growth model, they came later, and can be seen as a development within this tradition.

So certainly the intention is not to create confusion. In my view, models with an independent investment function are broadly speaking neo-Kaleckian, while models in which investment is derived demand are Kaldorian. And there are differences between models within those broadly defined traditions.

* All taxonomies are somewhat arbitrary and one might see some sub-divisions from the two main branches discussed here as standing in the same footing, for example, some might argue for an explicitly Marxist tradition.

** Goodwin predator-prey models, which have become quite fashionable, can be seen as a variation of these neo-Kaleckian models.

*** I think these Cambridge models have been completely abandoned since the 1960s, and that is the reason why I don't have three types of models in my taxonomy. They are a historical curiosity, associated to a response to the Harrod instability problem, at a time when full employment seemed like a stylized fact in advanced capitalist economies. For a clear explanation of the implications of the different model closures see the paper by Franklin Serrano and Fabio Freitas here.

**** The Sraffian versions of the supermultiplier model also assume differential savings by workers and capitalists, as many other classical political economy inspired models, and in that sense have Kaleckain features. But they are not neo-Kaleckian, since there is no independent investment function.

Multiplier-Accelerator and Business Cycles

 

 That would be long indeed (100 years or so for the US)

Keynesian theories of the business cycle start from the notion that the changes in income equilibrate savings to investment, and the level of activity is determined by effective demand. In that sense, the economy can fluctuate in the long run, with wage and price flexibility, around a normal position that is below full utilization of labor and capital. Unemployment is the norm. Keynes was not concerned in the GT with business cycles per se, even though he discussed the issue at the end of the book. His main concern was with what he referred to as unemployment equilibrium. It is clear in his terminology, unemployment equilibrium, instead of disequilibrium as Patinkin suggested would be more appropriate, that Keynes meant that unemployment was not the result of some type of imperfection, wage or interest rate rigidities, for example, which became the leading explanation for unemployment among the mainstream Neoclassical Synthesis or New Keynesian authors.

Keynes suggested that it was the cyclical changes in investment, which he associated with the marginal efficiency or productivity of capital, in marginalist fashion, that determined business cycle fluctuations. His correspondence with Harrod on the growth model, and Tinbergen's method, suggests that he disliked the accelerator, which was probably too mechanical for him. In that sense, cycles in Keynes own conception depended on shocks, which were associated to the state of long-term expectations, and the state of confidence.

Kalecki, which independently from Keynes advanced the Principle of Effective Demand (PED), developed an early theory of the cycle based on the interaction of Keynes’ multiplier process with the concept of the accelerator. Kalecki emphasized the role of time lags between the placing of investment, the demand for new equipment, and the delivery of the new equipment, indicating the dual role of investment as part of demand, but as creating productive capacity in the future. Further, Kalecki suggested that investment orders are a positive function of autonomous demand and a negative function of the existing capital stock.

Assuming that expectations about future demand are high, then investment would increase and through the multiplier effect it would have a reinforcing effect on income. The increase in income, in turn, would lead, according to the accelerator, to an increase in investment, leading to an economic boom. However, as investment increases, eventually new investment orders would exceed the replacement requirements, and the capital stock would also rise. This would have a negative effect on the rate of increase in investment, and new investment orders would slowdown first, and then decrease. The decreasing orders would have a negative impact on demand, and through the multiplier, lead to a reduction in the level of income, creating the conditions for a recession. The falling income would imply lower investment, following the accelerator, and even further collapse of income. In the depression, investment orders would collapse and at some point they would fall below the replacement requirements associated to depreciation, leading to a reduction in the stock of capital. Finally, the falling stock of capital would make the need for investment inevitable, and that would lead to more demand and a recovery.

The essential mechanism of the business cycle in the Kaleckian model was connected to the lags between the demand effect and the capacity effect of investment. Kalecki assumed that shocks would provide the initial spark for the business cycle, and the multiplier-accelerator mechanism would keep it going. He noted also that only under very specific circumstances would the cycle recur, and that additional shocks would be necessary to avoid a dampened cycle.

Kaldor developed a model, later formalized by Goodwin and Hicks, which allowed for the economic cycle to recur even in the absence of external shocks. The central difference in the Kaldorian model was the introduction of non-linear investment and savings functions. The idea was not to deny the existence of stochastic shocks or time lags, but to demonstrate that the economic system would also fluctuate in their absence, and that in a broad sense the capitalist system was inherently unstable.

This view of the cycle was dominant and basically accepted by the mainstream Neoclassical Synthesis in the 1950s and 60s. Yet, the notion of an endogenous cycle was one of the first victims of the attack on Keynesian economics in the 1970s. Eventually leading to the Real Business Cycles (RBC) school. Today most macroeconomic textbooks do not even mention the accelerator, even though the empirical evidence for it is overwhelming.

A periodization of Latin American development in the Robinsonian tradition

New Working Paper available here. From the abstract:

This paper analyzes Joan Robinson’s growth model, and then adapted in order to provide an exploratory taxonomy of Growth Eras. The Growth Eras or Ages were for Robinson a way to provide logical connections between output growth, capital accumulation, the degree of thriftiness, the real wage and illustrate a catalogue of growth possibilities. This modified taxonomy follows the spirit of Robinson’s work, but it takes different theoretical approaches, which imply that some of her classifications do not fit perfectly the ones here suggested. Latin America has moved from a Golden Age in the 1950s and 1960s, to a Leaden Age in the 1980s, having two traverse periods, one in which the process of growth and industrialization accelerated in the late 1960s and early 1970s, which is here referred to as a Galloping Platinum Age, and one in which a process of deindustrialization, and reprimarization and maquilization of the productive structure took place, starting in the 1990s, which could be referred to as a Creeping Platinum Age.

Kaldor-Verdoorn's Law for Latin America

The Kaldor-Verdoorn’s Law (KVL) suggests that the rate of growth of labor productivity is determined by the expansion of demand. In other words, KVL suggests that there is a strong correlation between the growth of labor productivity and the rate of growth of economic activity.

The graph shows KVL for 7 Latin American Economies between 1950 and 2006. For similar analysis for the US see this paper.

The US Net International Investment Position (IIP)

The graph below shows the Net International Investment Position (IIP) as a share of GDP for the US, since 1976. The last report by the Bureau of Economic Analysis (BEA) is available here. Note that by the first quarter of the year the IIP corresponded to US$ 5.5 trillion, or slightly more than 30% of GDP.

The IIP position has been negative since the late 1980s, which is the reason why economists argue that the US is a debtor country. The negative position follows as a result of the persistent current account (CA) deficits, which imply that foreigners accumulate dollars and dollar denominated assets. A negative IIP means that foreigners have more financial claims on residents than vice versa, and is seen often as a problem for most countries.

The conventional view also suggests that CA deficits are not dangerous if they finance domestic investment, which leads to growth, and presumably higher exports, even though this is often not explained by mainstream authors that tend to forget that most countries borrow in foreign currency. In this case, in which the CA deficits allow for higher exports in the future, a negative IIP is seen as sustainable. On the other hand, if the CA is used to finance consumption, then the negative IIP would be unsustainable. Many analysts think that the US IIP is not sustainable and from time to time someone suggests that a run of the dollar is possible. For example, Paul Krugman famously predicted that a run on the dollar would eventually occur, what he termed a 'Wile E. Coyote moment,' in which agents holding dollars would finally get that the floor was gone, and the dollar would depreciate sharply (this was before the Lehman's collapse and the run for dollar denominated assets, and the appreciation of the dollar; subsequently the gradual depreciation of the dollar returned, but so far no Wile E. Coyote moment).

Some mainstream authors are also puzzled by the fact the US, in spite of having persistent CA deficits and a large and negative IIP, has consistently had a positive net investment income position. In other words, interest and profits resulting from holding foreign assets has exceeded the payments of income to owners of US assets. Hausmann and Sturzenegger argued creatively (let's call it that) that the reason for this 'paradox' is that the CA does not measure well the net international investment position, since insurance and liquidity services go unaccounted. Their adjusted measure to add those invisible services, which they refer to as 'dark matter'* would explain the paradox, and why the US IIP is sustainable after all.

Note, however, that once one takes into account that the US holds the reserve/vehicle currency much of the discussion about the dangers of the CA deficits, the sustainability of IIP and the paradox of the positive net investment income position sort of vanishes. US debts are in dollars, which implies that there is no possibility of default in a fiat system. Chartalism holds in the open economy too.

The US does not need to export to obtain dollars, and how it uses the accumulation of financial claims on the US by foreigners is not crucial for sustainability. Holding the key currency does NOT come without consequences, but those are not the ones often suggested by the mainstream. Certainly given US policy choices there has been a loss of industrial jobs in the Rust Belt, yet as noted in another post, not with a significant loss in terms of technological advantage for US corporations. The consequence, thus, of the hegemonic position of the dollar, together with other policy choices (e.g. financial deregulation, lower taxes for the wealthy, deregulation of labor markets, etc.) has been one that affected the balance between labor and capital domestically.

Also, there is no need for dark matter, or other neologisms, to understand why the US has positive net investment income flows. By definition, the key currency is the risk free asset, and hence investments denominated in other currencies must pay a risk premium. Yes, sure BOP accounts are imperfect, like NIPA or any other measure of the economy. But there is no need to revamp the BOP accounts to get that the US CA deficit and the negative IIP are not really unsustainable.

* Hausmann has a flair for coining terms for ideas or problems that were well known by heterodox authors, and to incorporate them inconspicuously in the mainstream discourse. He refers to the notion that developing countries cannot borrow long term in their own currency as "the original sin." Note that the original sin is exactly the notion suggested by Prebisch, Kaldor, Thirlwall and others, that argue that since these countries cannot borrow internationally, and must pay with exports in the long run, then the CA becomes a constraint for economic growth.

Daniele Tavani on Endogenous Business Cycles

Daniele's website is all revamped, and here is a new post, which is based on Goodwin 'Marxist' or Class Conflict business cycle. At some point I should post something about it, since this is one of the seminal profit-led  models, which I have criticized somewhere else. Notice also that Goodwin model suggests that the inflation barrier is at full employment.

As noted by Daniele, an important feature of the model is that cycles are endogenous, something uncommon in mainstream models of the cycle. In his words:

"The key point is that the model generates endogenous cycles, that is fluctuations that are independent of shocks (such as monetary policy, fiscal policy, or supply shocks)."

Kaldor (1940) and Goodwin (1951) non-linear multiplier-accelerator models would also fall into that category, by the way.

Bank of England on Endogenous Money

This paper by McLeay, Radia and Thomas from the Bank of England has been making the rounds in heterodox circles. In particular because it admits that the conventional story about money creation is simply wrong. For them:

"rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks."

Yes, finally the monetary version of Say's law is seen as incorrect. And for a change they do cite heterodox authors contributions. In a footnote they say:

"There is a long literature that does recognise the ‘endogenous’ nature of money creation in practice. See, for example, Moore (1988), Howells (1995) and Palley (1996)."

Interestingly they do get the reflux principle of the old Banking School (of Thomas Tooke and others). They say:

"There are two main possibilities for what could happen to newly created deposits. First, as suggested by Tobin, the money may quickly be destroyed if the households or companies receiving the money after the loan is spent wish to use it to repay their own outstanding bank loans. This is sometimes referred to as the ‘reflux theory’."

In this context, they refer to the contributions of Nicholas Kaldor, one of the fiercest critics of Monetarism and exogenous money views. Finally, they also note that the central bank determines essentially the rate of interest, and that there is no money multiplier per se. In their words:

"While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates."

Mind you, it is weird that they think it is useful for teaching, and also it's not just 'today', but since their inception that central banks controlled the rate of interest. When they did try to control money supply in the late 1970s, central banks were unable to do so, and Goodhart's law that suggests that as soon as the central bank tries to control a particular quantitative target the very measure becomes unreliable.

Note, however, that endogenous money, while relevant and part of the usual set of ideas used by heterodox economists can be perfectly accommodated in a mainstream neoclassical framework, like the New Keynesian three equation model or the old Wicksellian model. And that is the way in which this paper by the Bank of England should be interpreted. Still nice that they do cite Kaldor and Moore, the quintessential endogenous money authors, and Howells and Palley of the younger post-Keynesian school.

PS: On a different note, this paper by the European Central Bank (ECB) cites my work with Esteban Pérez on the European crisis as one of the few that suggests that capital flows (after the convergence of interest rates) that allowed for spending in peripheral countries in part explains the current account imbalances in the region.

Bernard, Gervorkyan, Palley, Semmler: A Review & Critique of Long Wave Theories

In a previous post (see here), I had argued that the capitalist world economy can be conceived as resting on the dependence of historically-specific hegemonic institutions, whose rise and fall follow the trajectory of long waves, what Giovanni Arrighi defined as systemic cycles of accumulation (SCA's), periods of approximately 40-60 years, separated by A phases and B phases (see here). Lucas Bernard, Aleksandr V. Gervorkyan, Thomas I. Palley, and Willi Semmler, however, offer a penetrating critique of this central tenant of the world-systems tradition.

From the abstract:

This paper explores long wave theory, including Kondratieff’s theory of cycles in
production and relative prices; Kuznets’ theory of cycles arising from
infrastructure investments; Schumpeter`s theory of cycles due to waves of
technological innovation; Goodwin`s theory of cyclical growth based on
employment and wage share dynamics; Keynes – Kaldor – Kalecki demand and
investment oriented theories of cycles; and Minsky’s financial instability
hypothesis whereby capitalist economies show a genetic propensity to boom-bust
cycles. This literature has been out of favor for many years but recent
developments suggest a reexamination is warranted and timely. 

Read rest here.

Prabhat Patnaik - Finance and Growth Under Capitalism

By Prabhat Patnaik

Once we reject Say’s Law and recognize that capitalism is prone to deficiency in aggregate demand, we have to accept that sustained growth in this system requires exogenous stimuli. By exogenous stimuli I mean a set of factors which raise aggregate demand but are not themselves dependent upon the fact that growth has been occurring in the system; that is, they operate irrespective of whether or not growth has been occurring in the system. Moreover, they raise aggregate demand by a magnitude that increases with the size of the economy, for instance with the size of the capital stock. They are in other words different from “erratic shocks” on the one hand, and “endogenous stimuli”, such as the multiplier‐accelerator mechanism, on the other: the latter can perpetuate or accelerate growth only if it has been occurring anyway.

Read rest here.

Wage and Profit-led Growth

New Working paper at the Levy Economics Institute with Esteban Pérez Caldentey. From the abstract:

We argue that a fundamental difference between Post-Keynesian approaches to economic growth lies in their treatment of investment. Kaleckian-Robinsonian models postulate an investment function dependent on the accelerator and profitability. Some of these models rely on the importance of profitability, captured by the profit share, to make the case for profit-led growth. For their part, Kaldorian models place the emphasis on the accelerator. More important, investment is a derived demand; that is, it is ruled by the adjustment of capacity to exogenous demand, which, in turn, determines the normal level of capacity utilization.

In our view, the Kaldorian approach is better equipped to deal with some of the issues relating income distribution to accumulation with effective demand in the long run. We develop a Kaldorian open-economy model to examine the conditions under which an increase in real wages can produce profit or wage-led growth, showing that the limit to a wage-led expansion is a binding external constraint. The role and limitations of wages as a determinant of growth are further examined through spectral techniques and cycle analysis for a subset of developed economies. The evidence indicates that real wages are positively related to growth, investment, and capacity utilization. It also highlights the role of finance in sustaining expansions, suggesting that debt-led growth should not be identified with profit-led growth.

Read the rest here.

Robert Skidelsky on Hayek, Keynes and Common Sense

Robert Skidelsky at a Liberty Fund event, not too long ago. Note that in the opening remarks he says: "I'm going to talk about the conditions of liberty, which seems a good topic of conversation for a Liberty Fund event. Owing to the hazards of the weather, I find myself the sole representative of common sense this afternoon." Not sure what the weather conditions had to do with it, but I must agree, given the venue.

The whole thing here. My only major disagreement is that I really do not think that Hayek is the great rival of Keynes, or even one of the major economists of the 20th century, given his contributions. On the neoclassical front, Hicks, Modigliani, by bringing neoclassical results in the long run, but opening space for Keynesian policies in the short run, associated to rigidities an imperfections, and even Friedman, with the return of the concept of the natural rate, were more relevant than Hayek.

Who was Keynes great rival? While he was alive his debates were with his Cambridge peers, Pigou and Robertson, more than with Robbins, Hayek and the LSE economists. In fact, a good chunk of the younger LSE economists became, in different degrees, Keynesian (e.g. Hicks, Kaldor, Lerner, and even Shackle). But if I had to say, his great rival was himself, which would probably fit his very elevated sense of self-worth. In particular, his inability of getting rid of marginalist (neoclassical) elements of his theory is what ultimately opened the door for the Neoclassical Synthesis.

Hydraulic Krugman on Wynne Godley

Paul Krugman commented on the NY Times piece on Wynne. There are many little incorrect interpretations, which derive from his lack of understanding of the history of ideas. First, he equates Wynne's model with the old hydraulic Keynesianism (i.e. Neoclassical Synthesis) of Phillips (of Phillips curve fame, but also of the hydraulic model of the British economy). Nothing further from the truth.

Wynne came to economics via P. S. W. Andrews, one of his two most influential teachers at Oxford (the other being being Isaiah Berlin). Andrews and the full cost price authors that were part of the Oxford Economists' Research Group (OERG), under the leadership of Roy Harrod, and were in general more concerned with practical applications than with theoretical first principles. That influenced the way Wynne developed his skills as a modeler at the British Treasury, before being taken by Nicholas Kaldor, to head the Cambridge Department of Applied Economics (DAE), where he built together with Francis Cripps the Cambridge Economic Policy Group (CEPG).

Note that conventional hydraulic models, including the sort of Cowles models like the Klein-Goldberger model of the US economy, put great emphasis on the estimation of parameters based on certain simplistic macro behavior. Wynne took a very different approach to modeling than Klein-Goldberger. He 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.

Krugman then says these models were abandoned because they failed in the face of the Great Inflation of the 1970s, and because they did not deal with consumption in a coherent way. Here again he is wrong. First of all, Wynne's models had no trouble dealing with the inflation of the 1970s, correctly pointing out the effects of oil prices, devaluation, and wage pressures from the cost side rather than demand pull views, and he was one of the few that correctly foresaw the big recession that the Thatcher policies would cause.

On consumption the notion that Friedman somehow is better than Duesenberry and the relative income approach of other old Keynesians goes to show how limited is Krugman's understanding of his own tradition in the field (for more go here). Note that he believes that New Keynesians are just grafting a more sophisticated behavioral decision making approach to old Keynesian stories, without owing up to the limitations that the Old and New Keynesian models, based on rigidities and imperfections to avoid the tendency to the natural rate.

Wynne's model, in the Kaldorian tradition, with a supermultiplier determining growth, and with the Oxford pricing tradition determining prices, was free of the main limitations of the Hydraulic tradition to which Krugman belongs, whether he understands it or not. That is why Jonathan Schlefer, from the NY Times, is correct in suggesting that rebuilding macro on the basis of Wynne's work would make more sense.

On a funny note at the end, Krugman reveals his misconception about the role of old ideas in the history of science, and economics in particular. He says: "it is kind of funny to see a revival of old-fashioned macro hailed, at least by some, as the key to a reconstruction of the field." In his view, old ideas are only relevant if you can formalize them in modern garb, but are not a source of forgotten and incorrectly discarded knowledge that are better prepared to understand how the economy works. The limitations of the 'great economists' of today, make the loss of economists like Wynne all the more painful.

PS: Full disclosure, I'm quite biased on this topic, having worked for Wynne at the Levy Economics Institute for two years in 1997-98.

PS': Two additional posts by Unlearning Economics and Philip Pilkington and a link by Lars Syll (h/t for the link to Unlearning).

Economists with K, or rediscovering something never lost

So there is a certain buzz about the two old Ks, Keynes and Kalecki, and what Krugman and Konczal, the new Ks, have been saying about their theories. Mike is more of a journalist, and it is certainly good that journalists get Keynes right. And even better if they get Kalecki. On Krugman I said enough. He should take a page from Keynes and learn that by 1936 he was:

"no longer of the opinion that the concept of a 'natural' rate of interest, which previously seemed ... a most promising idea, has anything very useful or significant to contribute to our analysis."

In all fairness, for heterodox economists this rediscovery of Keynes/Kalecki is both welcome and a bit frustrating (check the comments in Quiggin post; someone thinks that DeLong was the first to point the relevance of Kalecki's "The Political Aspects of Full Employment").

But here is my advice to recovering neoclassical economists, check these other economists with K, you might learn something: Kahn, Kaldor, Keyserling, Klein, Knapp,  and Kondatriev. Kuznets is often remembered, so no need for rediscovering him, I think. And you can always go back to Gregory King, if you're so inclined. A good active economist with K, that understands both Keynes and Kalecki and how their theories are related to the old classical economists and Marx is Heinz Kurz. I have a list with the Ms and Ss for you to 'rediscover' too.

PS: Just three books on Kalecki published a few years after he passed away that you may want to check out are George Feiwell's The Intellectual Capital of Michal Kalecki: A Study in Economic Theory and Policy, Malcolm Sawyer's Macroeconomics in question: the Keynesian-monetarist orthodoxies and the Kaleckian alternative, and The Economics of Michał Kalecki. For a discussion of Kalecki's views on economic development see this paper by Jayati Ghosh.

Houthakker-Magee effect and the US external position

The Houthakker-Magee (HM) effect is one of those empirical regularities, like Okun's Law, that suggests that Kaldor was correct when he talked about stylized facts, and that indicates that economics might actually aspire to be a more serious scientific endeavor (in spite of economists, of course). The HM effect says that the income elasticity of imports in the US tends to be about double the size of the income elasticity of exports, and as a result the US has a tendency to run trade deficits if it grows at the same pace than the rest of the world.

Several more recent estimates of the HM (the original Houthakker and Magee paper is from 1969*; subscription required) confirm the persistence of the phenomenon. Peter Hooper and Jaime Marquez are responsible for more than one of those more recent estimates (see, for example, here with Karen Johnson), which also suggest that income elasticities are considerably larger than price elasticities. In particular they note that, at least for G7 countries, imports are not responsive to changes in the real exchange rate. They estimate that US export and import income elasticities are 0.8 and 1.8 and that everything else constant, and, if the US grew at the same pace than the rest of the world, a depreciation of 2.8% in real terms per year would be necessary to maintain the trade balance.

Mind you, the question of whether the US needs the depreciation (at the point they wrote the paper, actual depreciation had been more like 1.1% per year) is a different question. The role of the dollar allows the US to run deficits that other countries could not, so the external constraint does not play a role in this case. But that was discussed before (here).

* Note that Houthakker and Magee cite in their paper the previous work by Neisser and Modigliani done at the New School, which was, as far as I know, the first estimation of the US trade elasticities.

PIGS in Madrid

This is the introduction by Sergio Cesaratto at the Meeting in Madrid Economy4Youth held 22-3 November 2012. Press coverage includes here, here, here, here and here, so far. The videos are here, but some better quality videos will likely be posted.

PIGS in Madrid

By Sergio Cesaratto* (Cesaratto@unisi.it)

Dear students and colleagues, ladies and gentlemen, companeros y companeras (if I am allowed to say so), I wish first of all to thank the organisers and the supporters of this event. I believe this is a beautiful opportunity to work side by side with the young people who are fighting against the present state of things and the critical economists. This is not a conference against Europe, or of one part of Europe against the other. As people of “troubled Europe” we feel perhaps more concerned than the majority of our northern fellows. But I think that the message of this meeting should arrive especially at your young northern fellows not just asking for solidarity (a word that I personally look suspiciously at), but because the dismantlement of the social rights in our countries might be the premise to the reduction in their own. I believe that they would defend the idea of their countries being part of a peaceful and prosper continent, and be outraged by the idea of their countries as islands in the midst of deprivation and resentment. I also believe that youth is the time of hope and generosity, the time in which the outrage for social injustice is felt the most. So I hope that our messages, the messages from the young people here, will arrive at the most sensible ears of northern Europe, those of the young people there (let us not forget here the young socialists massacred by the crazy Nazi guy in Norway). It is particularly important that, through any possible channel, more information about the situation in our countries be directed at the likely victims of disinformation, be they youths of Germany, Austria, the Netherlands etc,. We should take some initiative in this direction.

The story of the crisis
The story of this crisis is the story of an imperfect currency union. It is not yet clear to me which political processes led to the European Monetary Union (EMU). Unfortunately economists tend to neglect the analysis of the political processes, and indeed our aim is also to reform the way Economics is done and taught. From a rational point of view, the national leaders and their economic advisors certainly knew that the European Union was not a so-called optimal currency area. Various considerations possibly led to this imperfect union. France and Italy were not happy with the European Monetary System (EMS), the fixed exchange-rate that preceded the EMU: they though that a monetary union could be less German-dominated than the EMS. The German unification in 1989 and the fall of the iron curtain possibly accelerated the process (Germany has traditionally looked east, and the monetary unification was perhaps seen as a way to lock it west, but I cannot judge if this is a legend). Finally, through the common currency the elites in the periphery wanted to import the German renowned labour discipline. Be that as it may, the monetary union lacked the institutions that could make it work, in particular the significant federal budget with regional redistributive functions recommended by earlier unification plans (see also the prescient analysis by Kaldor and later by Godley). The union was designed in negatives, so to speak. To prevent national governments to take too advantage of lower interest rates, the Maastricht Treaty created the famous Maastricht fiscal constraints; the ECB was assigned a monetarist statute with the sole objective of controlling inflation (so that it inherited the Bundesbank function to keep German wages in check). The objective of full employment was assigned to national labour-market flexibility policies, that is to competitive internal devaluation strategies. No to a wider federal budget, no coordination of fiscal and monetary policies, no banks crisis resolution mechanism.

As we know, at the beginning the Euro seemed a success, particularly if judged from the point of view of Spain, Ireland and also Greece. Not much so for Portugal and Italy: the former country already had its demand-led boom in the years before the monetary unification and joined the currency with a negative current account, which explains its later stagnation. Portugal and Italy - but of course this partially also concerns the other southern countries - likely began to suffer from a loss of competitiveness due to more than one factor: an over-valued real exchange rate, the competition from the EU new entrants and from the emerging economies, the stagnation of domestic aggregate demand that depressed productivity growth In Portugal and Italy. As is well known, in Spain, Ireland and also Greece domestic demand was indeed sustained by a construction boom fed by foreign capital flows. The story has been usefully compared to that of the financial crises in the emerging economies: financial liberalisations and fixed exchange rates can easily lead to foreign capital flows that sustain a residential investment-led growth, ending later in a balance of payment crisis. This happens when foreign financial investors stop the refinancing of the peripheral foreign debt and begin to withdraw their investment (what is named “sudden stops and capital flows reversal”).

The peculiarities of the Eurozone (EZ) payment system, the famous and arcane TARGET 2 system, have impeded the eruption of the standard foreign debt crisis, with attendant debt restructuring and currency devaluation, which has been typical of the emerging economies. In this kind of crisis, typically the IMF intervened to assure that the indebted countries could continue to repay the interest and the principal of their foreign debt (so the IMF “saved” the banks of the north); normally the debt was renegotiated; fiscal austerity measures were imposed to obtain a current account surplus necessary to assure the future ability to serve and repay the debt (including that to the IMF); the currency devaluation relieved a bit the country in this effort. Notoriously, Argentina by refusing to repay 75% of her debt avoided the IMF austerity measures and, also helped by a buoyant price of her exported commodities, could manage a demand-led recovery. What has happened in Europe is that, through TARGET 2, the foreign debt of the peripheral countries has “changed hands”: from a liability towards private lenders (who withdrew their loans) it has become a liability towards the Eurosystem (the German conservative economist Werner Sinn has not been wrong in calling it a “stealth bail-out” of the periphery, although he missed to point out the German responsibility in this story. I also agree with him that this re-shuffling of liabilities has not made the German credits safer, contrary to the initial opinion by De Grauwe). In a sense TARGET2 helped to gain time, but this time has so far been wasted by the EZ governments. While no reforms of the institutional architecture of the EZ have been endeavoured, the EZ followed a wrong diagnosis of the crisis that, through austerity, made things much worse.

The peripheral governments have indeed basically backed the German interpretation of the crisis as caused only by the borrowers ( although the SPD also vaguely accuses the deregulation of the financial sector) and by the fiscal profligacy of the peripheral governments. This interpretation overlooks that the peripheral current account deficit financed by the northern capital flows sustained imports from core-Europe. Moreover, it forgets that the fiscal crisis was the result, in Ireland and Spain, also of the bailout of private banks, while the Italian public debt was much older and Italy before 2008 violated the fiscal pact much less than Germany and France. While the Greek centre-right government might have relied too much on an endless cheap foreign support to its public debt, it should not be forgotten that Greece has also been a excellent market for German exports (and possibly still is for the German and French armaments). Be that as it may, lenders are as much responsible as borrowers. But core-Europe is responsible for the crisis in an even more important way: its neo-mercantilist behaviour. The financial liberalisation and the fall in the devaluation risk (the ‘convertibility risk’ as Draghi calls it) and the consequent indebtedness of the periphery have indeed been functional to this behaviour.

This is an old story, indeed. Since the early 1950s Germany took advantage of fixed exchange rates to pursue an export-led mode. The three institutional pillars of the German low-inflation model were

- a paternalistic State, both with regard to the general welfare of the working class (the famous Bismarkian social state) and to trade (the German government has clearly foreign trade and foreign investment policy as its top priority, as the resignation of one President of the Federal Republic reminded to us: he candidly confessed that Germany sent troops to Afghanistan for commercial reasons).

- an accommodating labour movement;

- the Bundesbank as the watchdog of German labour discipline.

Wage moderation, the relative compression of the domestic market and the other countries’ Keynesism made the model successful: it has guaranteed a high standard of living in a self-fulfilling model in which the pursuit of trade surpluses promoted domestic labour discipline. The model was reinforced at the inception of the Euro by the SPD-inspired labour reforms. Although the model assured relatively high wages, following Kalecki we can regard it as a way for capitalists to maximise the level of the “internal surplus” - that is of what remains to them of the social product after having paid wages - and get rid of it (or realize it in Marxian terms) in foreign markets.

Note the parallel here between the U.S. and the EZ crises. In both cases residential investment bubbles (and more in general autonomous consumption financed by consumer credit) within a currency union sustained aggregate consumption from a middle class otherwise impoverished by decades of real wages stagnation. The internal geography, so to speak, changed, but the logic is similar. What is different is, of course, that the U.S. as a complete Federal Union had the will and means to deal with the crisis through monetary and fiscal policies and by implementing bank crisis resolution mechanisms, while the EZ as an imperfect Union retreated back to nationalistic behaviours.

There is a lot of things we must imitate from Germany – and the German people should in no way be regarded here as an enemy. There is a ‘benign’ form of mercantilism (quotation here) that consists of a developmental state promoting welfare and productive capacity. This form of economic nationalism is not at odds per se with a domestic demand-led growth and international economic cooperation. But the German hyper-nationalistic economic model has always constituted a problem for the world economy, and it is basically incompatible with the working of the EZ. This has been defined as malevolent mercantilism (quotation here). The suggestion that all the EZ countries should imitate Germany is a zero-sum game: a suicidal competitive deflation strategy. As Soros summed up, Germany has to lead or to leave.

As I said, I believe that we should decide here a strategy of communication with the German new generations, the only ones that perhaps have not yet suffered for too long from the Build, FAZ, BuBa etc. brain washing. Our student organizations should ask their German twins to be invited in the German Universities to explain the dramatic situation in our countries and the importance of a collective responsibility to bring Europe away from this self-destruction. A specific open letter might be prepared in this meeting in this direction and addressed to the main German Youth organisations (including the SPD’s Jusos, LINKE, Grunen etc.) The rich and generous German progressive foundations might be asked to finance this initiative: one hundred delegations from PIIGS countries to visit one hundred German universities. Germany has to decide if she wants to lead a prosperous Europe or if she just wants a backyard of impoverished countries, possibly a pool of unemployed labour for her ageing population. We must be competent enough to explain the terms of the situation to our German fellows, and so it is important that the interaction with the critical economists continues. It is also important that the European dimension of the crisis is fully endorsed by the movements.

In view of the German neo-mercantilist behaviour, a debate about the causes of the EZ trade imbalances has developed: one thesis emphasizes the structural lack of southern competitiveness often attributed to an unsustainable wage dynamics; more plausibly, another thesis argues that the trade imbalances are mainly due to the combination of the repressed German domestic market and wage moderation, and of the residential-investment demand-led growth in some peripheral countries. This led to higher inflation in the latter and to their loss of competitiveness. In this view, real wages are not the cause of the higher inflation and real exchange rates losses, rather the service/non-tradable sector, protected from external competition, appears to be the cause. Spain seems the typical example (the PIIGS families, as the Anna Karenina unhappy families, are each miserable in her own way, so it is always difficult to generalise). This debate is important to focus on – also in view of some discussion that has taken place on the manifesto of the meeting (I particularly sympathize with the comments by Jorge Uxo). What Europe seems to need is not so much a structural change in the periphery, but rather a German-led aggregate demand growth. This would help to rebalance the EZ. Inspired by an analysis of the periphery problems as due to too rigid labour market institutions and too high real wages – again a wrong diagnosis of the crisis – the widespread labour market reforms and wage deflation have negatively affected consumption demand, thus aggravating the crisis.

All in all, the way Europe has dealt with the crisis has been too little and too late (to kick the can down the road, as it has often been said). But even worse: the austerity imposed on the EZ has made the crisis worse. It may well be said that at present austerity is the main cause of the crisis.

The policies
The main policies so far have been:

a) Bail out packages (ESFS; ESM): used to bail-out Greece, Ireland and Portugal. They have a basic problem: the troubled countries also put the money, so Italy and Spain “loaned” money to their smaller troubled fellows to save the German banks (note that Germany lends at very convenient rates, and borrows also at very profitable rates, the opposite is true for Spain and Italy). Anyway, Spain and Italy cannot save themselves in case they need to be bailed out (it would be a vicious circle, somebody drowning cannot help herself): so the only real money would be from Germany: too much even from this mighty country. To make things worse, the bailed-out countries have been imposed a counterproductive austerity that made the crisis and public finances worse. Presently, everybody is realizing that Greece will not able to redeem the official loans it received (used to save the French and German banks). OSI (Official Sector Involvement) is the new EZ-acronym.

b) The ECB intervention has been limited to the early summer 2011 when the central bank bought about €200bn of peripheral sovereign bonds, without any persistent effect on the sovereign spread. Only an unlimited guarantee can obtain this result.

c) The liquidity made available by the Eurosystem assured that the banking system in the periphery did not collapse in view of the capital flights to core-Europe. As said, the liabilities of the periphery towards the private core-European investors have been substituted by the “official” TARGET2 liabilities towards the Eurosystem. Since most of the capital flights consisted of previous investment in peripheral sovereign debt that foreign investors progressively refused to refinance (roll-over), banks used the liquidity to sustain their respective domestic sovereign debts (In Italy, for instance, the share of foreign-held public debt has fallen form 60 to 30 per cent. This does not mean, however, that the Italian foreign debt has fallen: private loans have just been substituted by TARGET2 loans). What all this produced is that fragile banks sustain fragile states, and fragile states back fragile banks. What we would instead need is an ECB support to sovereign debts and a bank resolution mechanism: a European bail out of banks and deposit insurance (measures that cannot be left to national governments). Both measures would not hit the core-countries tax-payers as far as the intervention of the ECB keeps the sovereign interest rates at bay. The results of the European summit held at the end of June 2012 have been disappointing in this regard: no European banking crisis resolution mechanism seems to be in view.

d) From Summer and Autumn 2011 also Italy and Spain were inflicted various austerity packages. Italy was imposed a change in government with the implicit promise of an ECB intervention that never materialised. In addition, in Spring 2012 the EU approved the six-pack and the fiscal compact directing the EZ countries to balance their budget and to reduce the sovereign debt/GDP ration at 60% by year 2020. The logic of the austerity policy is as follows, austerity leads to credibility, which leads to lower interest rates on sovereign bonds and thus to recovery.

As a mounting evidence is showing, this option simply does not work and will not work.

e) Following his famous August declaration (“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”) in Sept. 2012 Draghi launched his OMT plan [Outright Market Transactions is the way the ECB defines the open market operations (OMO); in the ECB’s jargon OMO means bank refinancing operations]: the ECB cold intervene in the secondary markets buying, in principle, an unlimited amount of sovereign bonds (the big bazooka, although restricted to up-to 3y bonds); the countries asking for assistance should, however, subscribe to an austerity memorandum with the EU surrendering their national fiscal sovereignty. The idea of OMT is that lower interest rates will render austerity a bit less tough, so that unsustainable social unrest (so-called “austerity fatigue”) can be avoided, credibility regained, and maybe - the trust of financial markets being restored - some growth will appear, etc. The ECB will not pre-commit a given interest rate (or a given level of the spreads), so as to be able to blackmail in any moment governments, and anyway the reduction should not be too much, with a view to avoiding moral hazard, that is the temptation of dodging the “structural reforms”, cuts in public spending and labour market reforms. So the OMT does not really break with austerity policies asking the peripheral countries to surrender further national sovereignty to Bruxelles.

As known, the mere announcement by Draghi of this measure determined a fall in the Spanish and Italian sovereign spreads of some 150 basic points. This made plain to the public that the interest rates are determined by the central bank and not by the market, unless the central bank does nothing. It also showed that it is not necessary for the central bank to intervene and buy: the deployment of the big bazooka is enough to intimidate the markets.

We should finally mention the blah blah going on in Bruxelles on a European Federal Budget, nothing very serious, some bland anti-cyclical fund, nothing to do with a real redistributive Federal Budget (in fact, the existing small EU budget has been cut!). Indeed when Germany thinks of a European fiscal policy, it is just proposing the assignment of a pro-austerity power on national sovereign budgets to a fiscal authority in Bruxelles.

Alternative policies
Alternative policies have also been proposed and discussed.

Eurobonds
In my opinion Eurobonds are not an ultimate solution since by putting all sovereign debts in the same pot, the “credibility” of the German sovereign debt would be negatively affected and the political support by Germany undermined. A pan-European sovereign central bank that guarantees a European sovereign debt is the necessary measure to avoid this result. But if the ECB provides this guarantee, do we still need the Eurobonds? Perhaps yes, if the change in the statute of the ECB is deemed to be accompanied by a centralization in Bruxelles of fiscal policies. But this should not be done along German lines, however. The old French proposal (not of shy Hollande, tough) of a stronger Eurogroup that should be transformed from an informal club into the institutional fiscal counterpart of the ECB would be a good compromise to avoid an EZ fiscal Kaiser (the Germans have always refused this change because a political body would be stronger than a technical body like the ECB).

An alternative proposal
My favourite proposal is of an ECB intervention to calm markets down (the big bazooka) conditioned by a fiscal rule; this should consist of the stabilisation of the public debt/GDP ratios (not their reduction). This will be consistent with deficit spending policies. I would call it an “expansionary conditionality” or “Keynesian conditionality”. The rationale is that the savings obtained from the reduction in the interest rates should be used not to reduce sovereign debt/GDP ratio, but to sustain aggregate demand; the larger fiscal revenues will help the stabilization of the ratio. This is the most practical, politically reasonable proposal I can think of.

In addition we need:

- a solution to the banking crisis and a separation of sovereign and bank crises (this would be easier if the European state intervention is backed by the central bank)

- a looser wage and inflation policy, so to let wages rise especially in core-Europe in order to sustain aggregate demand. To this scope we need the right institutions, first of all a cooperative ECB that tolerates a higher inflation target and stops for good being the watch-dog of German wages. Instead of destroying the Trade Unions, the EZ south needs strong TU and income policies, plus measures to modernise the non-tradable sector, the source of the core-periphery inflation gap.

Many other things we need to do, but I do not like endless shopping lists. Let us focus on the macroeconomic measures first.

There are at least two further, opposite alternatives to be briefly discussed, a Federal Europe and a Euro break-up.

A Federal Europe
Optimistic Europhiles are thinking of the crisis as an opportunity to create a Federal Europe. The US could be a good example for a working Federal State from the point of view of fiscal and monetary policies, although less for social policy. We may, of course, dream of a progressive Europe, with social fairness and full employment. Of course Treaties in this direction should be re-written (including the ridiculous EU “Constitution” that says that the ECB must be independent and pursue price stability first). A Federal Budget should progressively be created, perhaps along the lines of the McDougall report of 1977. But I suppose this is not for this generation. The Spanish experience with Catalonia shows how much even old and consolidated states are fragile once exposed to external shocks (the austerity has clearly generated the Catalan resentment against the rest of Spain – that is, by the way, a market for Catalonia, as the Italian Mezzogiorno is for the Italian north).

A Euro Break-up
I am not able to assess how dramatic this event could be, there are different opinions. What is sure is that there should be a preliminary European political agreement, and a lot of peaceful financial negotiation later. The EU must be saved. A German exit might be easier, but do not underestimate the governance problems of a Southern Euro. We must study this, and our governments should study it to have a card to play to deal with Germany. It is clear that Spain, Italy and the other smaller southern fellows cannot endure this situation any further. We must therefore accompany our “reasonable” pro-European proposals with the option that we might go “our way” (a Mercosur with preferential ties with Latino-America and North Africa?).

Our duties
We have a difficult future ahead. But our fathers and grandfathers also had a difficult future ahead. I thought I belonged to a lucky generation that did not suffer hunger and wars, and the same I expected for my sons. It is not anymore true (at least we have not wars, yet). I assumed to be living in a situation in which any single individual was cared by society. It is not true anymore: we see a cynical ruling class, that includes Rajoy and Monti, literally destroying the lives and hopes of entire generations, old and young people alike. But we must fight and resist. Our specific duty as students of Economics and critical economists is to put the European question at the centre. The current European leaders must decide if they want to save Europe or not. They are the anti-Europeans, not us. We must explain to our fellow citizens that austerity is a policy choice and not a compelling fate, that different policies that would save Europe and prosperity are feasible. You must talk also to your young core-European fellows. If I am sceptical about solidarity, youth is the time for solidarity and change. I am sure they will listen. To do this, we must also fight to defend the space for critical economic thought in our universities. The Italian students of LINK have in this regard launched a petition that they will explain. We must defend critical Economics so as to be better trained in view of the tremendous challenges we have ahead. Good luck to all of you, and thanks.

* I thank Jorge Uxo for preliminary comments and Giancarlo Bergamini for valuable help in improving the exposition.

Stock-Flow with Consistent Accounting (SFCA) models

Gennaro Zezza, student and co-author of the late Wynne Godley and currently responsible for the Levy Institute macroeconomic model, gave an interesting talk on the usefulness of Stock-Flow with Consistent Accounting (SFCA) approach to macroeconomic modeling. He refers to the models as stock-flow consistent (SFC), but I prefer to emphasize that the consistency is not just about the relation between stocks and flows, but also the fact that these models provide the full set of accounts (website for those interested in this approach here).

SFCA proved to be considerably more successful than conventional, in particular Dynamic Stochastic General Equilibrium (DSGE) models, in predicting the Great Recession (see here paper by Dirk Bezemer).

As noted by Gennaro, the fundamental principle of SFCA models is that:

"in the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: 'there are no black holes.' This obvious principle has relevant implications: one is that the debt of somebody is a credit for somebody else."

Note that this fundamental principle has more to do with the fully consistent accounting part of the model, than with the relation of stocks and flows. But stock-flow relations are also essential, since flow decisions of spending are tied to stocks. Private agents can spend if they have access to stocks of credit, of accumulated assets, that is, some stock of wealth. The State often has the power to spend and accumulate a stock of debt, since it can decide (Functional Finance and Chartalist approaches, which are implicit in Godley's work, become important here) the token in which debts are denominated.

One of the questions raised in the presentation was about the supposed lack of behavioral assumptions and expectations in the SFCA (as compared with DSGE models). First, it should be forcefully noted that there are behavioral assumptions, and those are strictly speaking based on Post-Keynesian (classical-Keynesian, I would say) principles. So agents autonomous decisions to spend create income, and in the models, I would add, investment follows an accelerator, so it tends to be derived demand, with the stock of capital adjusting to the flow of income (a relatively stable stock-flow relation, associated to the normal degree of capacity utilization).*

While DSGE models presume that an exogenous potential product (determined by supply side factors in a Ramsey/Solow/Lucas/Romer tradition) drives the economy, and deviations from it are corrected by price and wage flexibility, these models have an endogenous demand-driven output trend, which is really why they do better explaining the real world, including the Great Recession.

On the question of expectations Gennaro was clear, as a Post-Keynesian (PK) he is not particularly interested in expectations. He, however, suggested the possibility of using what Tom Palley refers to as model consistent expectations. That is, agents use expectations that are consistent with model (in this case the PK model, and, hence Lucas's problem is not that agents use all the available information, but that he has the incorrect model). Mind you the introduction of this expectational framework does little to improve the ability of the modeler to understand reality.

Finally, I want to note that while I do think that it is essential that these models, which are an alternative to applied DSGE models used around the world in Central Banks, international organizations, think tanks, and other institutions that managed to miss every single sign of the crisis, are developed and used more by economists, they should not be seen as the only modeling strategy available to heterodox economists.

In my view, the stock-flow and the demand driven (and I should say, the fact that price dynamics is orthogonal to the income flow determination structure)** is the essential characteristic of this approach. But the empirical, macroeconometric models that Gennaro and Wynne build have, more importantly, the full set of accounts, something that is essential for the empirical models, but sometimes too cumbersome for making a theoretical point. Hence, sometimes models that present the stock-flow dynamics (in a classical Keynesian perspective), without the full accounts (see here, for example), are necessary, useful and more directly relevant for the task of providing theoretical insight into a specific problem.

* This means that these are supermultiplier models in the Kaldorian tradition, which should not be a surprise since Wynne was a disciple of Kaldor. In fact, Kaldor was responsible for bringing Wynne to head the Department of Applied Economics at Cambridge in the late 1960s.

** Wynne was a student in Oxford of Andrews, one of the main authors of the Full Cost Pricing School.