The Italian crisis in historical perspective

In one graph. Source is this twitt from Gennaro Zezza. Real consumption per capita, not GDP (just making sure nobody gets confused).

Note that while the crisis is considerably less profound (right axis for the current one), it is already going to be considerably more prolonged. Not sure what's worse really.

Austerity and the weak recovery

From Papadimitriou, Nikiforos, and Zezza's new Levy Strategic Analysis:

"over the last 25 years policymakers in Washington have become increasingly fiscally conservative. The current recovery is the only one in the postwar period during which government expenditure has decreased in real terms. Fiscal austerity, together with weak foreign demand, has put the entire burden of supporting aggregate demand on the private sector spending in excess of its income and borrowing. This has led to a rapid increase in the private sector debt-to income ratio in the United States."

Read full report here.

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.

What will happen in Greece?

That's the question everybody is asking. And no, I don't have the answer. But we do know that Tsipras promised to renegotiate the debt, and that Yanis Varoufakis, who has been suggested as the probable finance minister has said that the current policies are a: "kind of fiscal waterboarding policies that have turned Greece into a debt colony." You may want to read Yanis Modest Proposal, co-authored by Jamie Galbraith and Stuart Holland and linked here too. Also, this paper by Dimitri Papadimitriou, Michalis Nikiforos and Gennaro Zezza might be of interest to understand the possibilities and constraints Greece is currently facing.

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.

Ramanan and Zezza on Europe

Even though pundits at the World Economic Forum in Davos have proclaimed the end of the Global Crisis, the European crisis continues to unfold. Ramanan correctly notes that Draghi suggests that fiscal consolidation [that's Doublespeak for fiscal contraction] is essential for the recovery. Meanwhile Zezza shows that Italy increasingly looks like Greece and other countries that have committed to contractionary policies.

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.