Jane D'Arista on Asset Inflation and Wealth Effects

Jane D'Arista, sharp as always, argues that the recovery in asset prices cannot be expected to lead to a strong recovery, in particular becuase the positive wealth effects are too small when compared to the negative distributive effects. In her words:

"By March 2013, rising asset values succeeded in filling the $12.5 trillion hole in households’ net worth that developed in 2008. Quantitative easing appears to have played a major role in spurring that recovery. As in the period leading up to the recession, some think this rapid increase in household net worth is a clear sign that monetary ease is producing asset inflation rather than price inflation. But, unlike the previous period, the distribution of these gains primarily benefits upper and upper-middle income households. The largest increases were in their holdings of corporate stocks, mutual fund shares and pension funds, while growth in the values of residential real estate and households’ equity in non-corporate (small) businesses remains below pre-recession levels. Thus, what seems a resurgence of the potential for the so-called “wealth effect” to increase confidence and stimulate demand may be undermined by the further boost this uneven appreciation in asset values gives to inequality.

The benefits of the rise in households’ net worth are far weaker than in the past because there is no clear connection to employment. In addition, the fact that inflated capital market assets held in pension funds are not easily used to back new borrowing may have limited the effect on spending."

Read the rest here.

PS: On a related topic, the negative effect that higher bond prices might have on income distribution and the level of activity, see Tom Palley here.

Should the AER retract Reinhart and Rogoff's paper?

The case of Dutch social psychologist Diederik Stapel fraud, now in the news, which led to the retraction of several of his papers by academic journals suggests that this might be the right course of action for the American Economic Review (AER). Even if Reinhart and Rogoff's (RR) results do not necessarily amount to fraud, something that I'm sure could become a matter of dispute, it's still a fact that they are incorrect, as admitted by the authors. So the AER should clear the record and retract the paper that suggests that growth collapses when a country has a debt-to-GDP ratio of more than 90%.

PS: As the NYTimes notes there is a blog about scientific papers that are retracted here. The blog dealt with RR case here.

Commodity Prices

The Economist has posted a chart with some evidence of falling commodity prices, noting that since last September their index has fallen by 12%. The most discussed fall in recent times had been that of Gold, but others are relevant too.

Note that this masks significant variation in commodity price dynamics. For example, soybean prices fell from US$ 615 in August to 536 last March. Still high by historical standards, but considerably lower. The same is true for copper, with a fall from US$ 8,087 last September to 7,652 in March. Natural gas, on the other hand, went from around US$ 70 in March 2012 to about 136 last March, which is not the highest from a long term perspective. This suggests that commodity producers will be hit very unevenly by variations in prices, as will importers.

PS: All data available here.

When were we Keynesians?

From a policy point of view, in the United States, the two common periods associated with the ascendancy of Keynesianism are right after the so-called Roosevelt recession in 1937-38, when Currie and Eccles and other fiscal expansionists got the upper hand in the dispute with Morgenthau and the deficit hawks, and the Kennedy-Johnson tax cut in 1964, when the New Economics became dominant in the Council of Economic Advisors (CEA), during Walter Heller's chairmanship, when James Tobin (among others) was a staff member.

And it is correct that in both periods expansionary fiscal policies, which are broadly Keynesian, were actually pursued. But it would be a mistake to think that Keynesian ideas actually won the day, and became common sense among policy makers and the political elites in the US. In fact, while Keynesian ideas and Keynesian economists became dominant for short periods, for the most part political elites remained firmly conventional and remained wedded to sound finance ideas. Without World War II and then the Cold War, which allowed for some type of Military Keynesianism, Keynesian ideas would not have had a chance.

In theory too, while Keynesian ideas associated to the possibility of unemployment in the short run became dominant, the reason was not Keynes' own explanation that this would be the normal, long term situation, associated even to a situation with wage and price flexibility. Unemployment was seen as an imperfection, something that required in the short run a brief stimulus, but that did not have significant long term effect. Hence, by the 1950s if small deficits in recessions or war periods would be acceptable for politicians, they were certainly not seen as desirable as a longer term instrument for economic development.

Domar, Lerner and other Functional Finance authors, that took Keynes' fiscal ideas to their logical conclusion never became dominant. In a sense, we can say that we were never truly Keynesian. Only by the 1970s a sort of perverse Keynesianism would eventually prevail within one of the wings of the Republican Party. Supply-siders would argue that lower taxes, not as a result of its multiplier effects, but as a result of the incentives to invest, would lead to higher growth, hence deficits were not a problem. This was embraced by some more mainstream Republicans also, as a way of promoting the 'Starve the Beast' strategy, i.e. cut taxes in a boom, and force welfare cuts in a crisis (any similarity with current events is totally not a coincidence).

On the other hand, most Democrats, which were never particularly Keynesian, moved away even from a short term defense of anti-cyclical fiscal policy. For that reason we should not be surprised that austerity, and sound finance ideas have gained so much traction in recent debates about the Great Recession, and why we should continue to have a very slow recovery.

PS: The significant victory of Keynesians was less about the consensus on anti-cyclical fiscal policy than the implementation of programs that established automatic stabilizers, like unemployment insurance.

PS2: Krugman today says that the austerian's position has imploded with the Rogoff-Reinhart debacle. Also, he shows that most Americans actually are not concerned about deficits, but the wealthy are. I guess politicians respond to the wealthy then. Like in gun control, what the majority wants does not necessarily translate into policy.

Harry Dexter White on Austerity and Confidence Fairies

There is a fantastic and incredibly modern quote from White in Benn Steil's book on Bretton Woods:

"The cry of “loss of confidence” is largely a smokescreen let loose by certain conservatives who are traditionally opposed to almost any Government expenditure, who object to any increase in taxes, and are too shortsighted to know that the perpetuation of the present level of unemployment constitutes de most dangerous threat to their own interests ... The statement that the bond market could not absorb Government bonds has been made ever since the first unbalanced budget, yet today Government bond prices in the United States are higher than ever. ... If [companies] do not employ the potential purchasing power [of the unemployed], the Government can do so at virtually no expense to the community."

Of course several would dismiss White as a commie spy, even though the best evidence is that we do not know if he was a spy at all. But it's easier to blacklist Keynesians as commies than to deal with their arguments.

Rogaine and Braveheart on Austerity

More on the Reinhart and Rogoff debacle. It says a lot about the state of mainstream economics.

Eatwell on Garegnani again

I linked to Eatwell's lecture in honor to Garegnani at the University of Rome. The text has been published in Contributions to Political Economy (full text here, subscription required). It is important to note how central Garegnani's PhD dissertation was for his following work.

As Eatwell notes:

"Key elements in the life's work of Pierangelo Garegnani (9th August 1930–14th October 2011) derive from the analytical results first developed in his 1958 PhD dissertation at Cambridge University. The critique of Walras's theory of capital articulated in the dissertation was extended in later years to the identification of the implications of the change in the concept of equilibrium in the works of Hicks and Debreu."

Further, the essential element in the dissertation was the clear anlytical stance, which, in Eatwell's words, shows how economics should be done. Again in his words:

"First, he specified the problem clearly: the determination of natural/normal prices, i.e. the solution to the problem of value and distribution.

Secondly, he clarified the structure of the competing theories, classical and neoclassical, by defining the data of the theory, i.e. the propositions taken as given. In the case of classical theory these were the social product (its size and composition) the technique or techniques of reproduction and (sometimes) the real wage. In the case of neoclassical theory the data were preferences, endowments, and the technology (constrained to constant returns to scale by the requirements of perfect competition).

Thirdly, he defined the analytical problems faced within each theoretical construct in terms of measurement: in classical theory measurement of the social product independently of its distribution; in neoclassical theory the measurement of the endowment of reproducible means of production in a manner compatible with the determination of normal prices, i.e. with a uniform rate of profit on all capital goods."

The limits of the mainstream approach, and the open possibilities of the alternative classical-Keynesian approach can still be derived from his seminal work.

Health spending and life expectancy

A brief follow up on the post on Baumol's Disease and healthcare costs. It's obvious that something else is also going on in the US, since the costs are much higher than in other countries with similar results. Graph below show spending on health as a share of GDP and life expectancy in 4 countries.

Note that the US spending almost 7% of GDP more than the next, and does not do better as a result. A broader public healthcare system as in the other 3 is part of the explanation. Data comes from Index Mundi.

Does High Public Debt Consistently Stifle Economic Growth?

Thomas Herndon, Michael Ash and Robert Pollin show in this new paper that the studies by Carmen Reinhart and Kenneth Rogoff which correlate national debt-to-GDP ratios over 90% with sharp declines in growth are not correct. They find that when properly calculated, meaning using the full data set not just part of it, the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90% is actually 2.2 percent, not -0.1 percent as published in Reinhart and Rogoff (RR). That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90% is not dramatically different than when debt/GDP ratios are lower. Reinhart and Rogoff claim the mistake resulted from a technical error involving a spreadsheet, and say that they “do not, however, believe this regrettable slip affects in any significant way the central message of the paper.” You would think that growing at 2.2% rather than a recession of 0.1% would make them think that their results are incorrect.

Keynes and Prebisch

The journal Estudios Críticos del Desarrollo has a new issue (in Spanish) on Raúl Prebisch. Below the abstract for the paper co-authored with Esteban Pérez Caldentey on Prebisch and Keynes.

Keynes had a profound influence on Prebisch, not only in terms of his diagnosis of the main failures of market economies, but also on the need to pursue pro–active and anti–cyclical policies. However, Prebisch was critical of Keynes’ most important publication, The General Theory of Employment, Interest and Money (1936). He viewed this work as being removed from the reality of capitalist economies. He also argued that it was inconsistent and did not represent at all a break with conventional wisdom. Prebisch’s criticisms focused on the theory of interest and the multiplier. Prebisch’s attitude in relation to Keynes can be explained by a difference in the object and method of analysis. The former’s interests focused on dynamics and cycles, themes that were peripheral to the central message and analysis of The General Theory. Notwithstanding Prebisch’s criticisms, there are several similarities between his analysis and that of Keynes.

Europe’s crisis without end: The consequences of neoliberalism run amok

By Thomas Palley

This paper argues the euro zone crisis is the product of a toxic neoliberal economic policy cocktail. The mixing of that cocktail traces all the way back to the early 1980s when Europe embraced the neoliberal economic model that undermined the income and demand generation process via wage stagnation and widened income inequality. Stagnation was serially postponed by a number of developments, including the stimulus from German re-unification and the low interest rate convergence produced by creation of the euro. The latter prompted a ten year credit and asset price bubble that created fictitious prosperity.

Postponing stagnation in this fashion has had costs because it worsened the ultimate stagnation by creating large build-ups of debt. Additionally, the creation of the euro ensconced a flawed monetary system that fosters public debt crisis and the political economy of fiscal austerity. Lastly, during this period of postponement, Germany sought to avoid stagnation via export-led growth based on wage repression. That has created an internal balance of payments problem within the euro zone that is a further impediment to resolving the crisis.

There is a way out of the crisis. It requires replacing the neoliberal economic model with a structural Keynesian model; remaking the European Central Bank so that it acts as government banker; having Germany replace its export-led growth wage suppression model with a domestic demand-led growth model; and creating a pan-European model of wage and fiscal policy coordination that blocks race to the bottom tendencies within Europe.

Countries, particularly Germany, can implement some of this agenda on their own. However, much of the agenda must be implemented collectively, which makes change enormously difficult. Moreover, the war of ideas in favor of such reforms has yet to be won. Consequently, both politics and the ruling intellectual climate make success unlikely and augur a troubled future.

Read the whole paper here.

Baumol's cost disease and healthcare

Since the classic work by William Baumol (Baumol and Bowen, Performing Arts: The Economic Dilemma, 1965), serious doubts have been raised about the possibility for services to lead to significant increases in productivity. Baumol and Bowen argued that “the output per man-hour of the violinist playing a Schubert quartet in a standard concert hall is relatively fixed, and it is fairly difficult to reduce the number of actors necessary for a performance of Henry IV, Part I” (1965, p. 500).

That should not be confused, obviously, with lack of productivity in the service sector as a whole, but it should be noted that the quality of the services often improves as a result of higher productivity in manufacturing. For example, improvements in the phonographic, cinematographic, electronic, and telecommunications industries imply that more people have access to Schubert’s quartets and Shakespeare’s plays at lower cost. While the cost of downloading a digital version of Schubert's quartets might be incredibly low, the relative costs of maintaining a full orchestra tend to increase over time, since musicians must be paid.

Note that the problem is not that musicians are paid too much (they aren't believe me), but that their wages tend to grow more or less together with the wages of other workers. That means that the relative costs of orchestras, that cannot reduce the number of musicians per presentation, when compared to car producers, that can reduce the numbers of workers per car produced, must grow over time. The same is true for other services that cannot reduce substantially the number of workers per unit produced without affecting the quality of the product, like education and healthcare. Baumol's new book deals with the effects of the eponymous disease on healthcare, and suggests that there is no problem in spending more on health. Worth reading.

The Politics of Accounting

To anyone familiar with basic balance of payments accounting, it will come as no surprise that income from foreign investments are included under current account transactions. To students learning balance of payments accounting however, this can be quite confusing. Why should the foreign investment be considered part of the financial account, but the income from the investment be included in the current account? After all, a capital gain or loss will be recorded in the financial account, why not interest and dividend income?

The typical answer provided in most textbooks is that the supply of capital can be thought of as the provision of a service (a very contentious proposition in the history of economic thought one might add!). But if “supplying capital” is a service, why is not included in services? 

I have recently been reading Cheryl Payer’s (old) book, “The Debt Trap: The International Monetary Fund and the Third World” (available from Monthly Review Press here). She offers another suggestion as to why investment income is included among the items in the current account. She argues that:

“Placing investment income firmly in the ‘goods and services’ section of the balance of payments ensures that restrictions on payments to foreign investors cannot legitimately be imposed under IMF rules, while its inclusion in the capital account would allow them.”

Payer is referring here to the well known “asymmetry” in the regulation of current and capital transactions as written into the IMF Articles of Agreement. While there are options available for countries to place controls on capital, “no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions” (Article VII, section 2). This reflects the view that the control of capital was central to the maintenance of international economic stability, a view held by both Keynes and White at Bretton Woods. Since then of course, the IMF has made attempts to resolve this asymmetry by encouraging countries to not exercise controls on the movement of capital (recent changes in tone aside).

In Payer’s view then, the placement of investment income in the current account functions to protect this income from possible regulation or restriction. And of course,  for many of the low and middle income countries net interest payments have been increasingly negative:

Income payments and Receipts for low and middle income countries: