It’s the System Stupid!

By Hans Despain

On Thursday, December 13, 2012, The Guardian announced Queen Elizabeth finally received an answer to her question—“Did nobody see this coming?”—about the 2008 financial crisis.1 While she was touring the Bank of England, Sujit Kapadia, one of the bank’s economists, informed Her Majesty that financial crises are a bit like earthquakes and flu pandemics: rare and difficult to predict. An impressive answer indeed. Brilliant for its vagueness, spuriousness, and obtuseness. 

However, Kapadia is simply wrong not to have explained that many economists, financiers, and regulators anticipated and predicted the financial collapse. Additionally, metaphors of natural disasters are highly misleading. Financial crises are not inevitable occurrences, but historical, human-created, and contingent phenomena.

Her Majesty had asked: “Did nobody see this coming?” Perhaps she could have also asked three more questions: Does nobody see the suffering and socioeconomic injustices of oligopolistic-finance capitalism? Does no one see that the problems are structural and systemic? And is there no alternative to a system that generates continuous “quadruple crises”—the socioeconomic, political, environmental, and personal/psychological?

The conventional wisdom is “There Is No Alternative,” or TINA. For this reason most Americans simply acquiesce to capitalistic social relations and, like Sisyphus, are resigned to performing eternal tasks while enduring the “endless” quadruple crises generated by a pathological system. The most extraordinary aspect concerning the absence of an alternative is that it is fallacious. The capitalistic system itself must be transformed. To put it into a slogan: Capitalism Is No Alternative, or CINA.

Read rest here.

Steve Pressman on the origins of the Review of Political Economy (ROPE)

Of particular is Steve's discussion of the scope of the journal, and why it became dedicated to the old political economy tradition. In his words:

Someone suggested that we broaden the scope of the new journal. A first thought was to add institutional economics. I had long been an admirer of John Kenneth Galbraith, someone who bridged the gap between Post Keynesian and institutionalist thought, and supported the suggestion. Geoff Hodgson, who was there and slated to be the Book Review Editor of the new journal, had a strong institutional bent (Hodgson, 1988) and also supported this idea. Such a journal would overlap with both the JPKE and theJournal of Economic Issues to some extent. This suggestion had the benefit of not stepping on anyone's toes. It would provide authors with an opportunity to explore similarities and differences between these two schools of thought as well as to publish papers taking either perspective or criticizing either perspective. Still, there was considerable opposition to the idea. 

I then suggested something a bit different—adding Sraffian or neo-Ricardian economics to the scope of the journal. The publication of Eatwell & Milgate's (1983) critical book on Post Keynesian economics exacerbated the split between the American Post Keynesians and the European Sraffians. Even before publication of this book, there were tensions between these two schools, which surfaced initially at the annual Post Keynesian summer schools held in Trieste, Italy. My idea was to encourage a dialog between Post Keynesians and Sraffians, and to see if it were possible to repair some of the damage that had been done. This proposal also encountered considerable opposition. 

After rejecting a few other suggestions, someone (memory fails, I am not sure who it was) proposed something even more radical—a return to political economy. The idea was to bridge the gap among all the different heterodox traditions in economics, including some of the more market-friendly schools of thought, such as Austrian Economics. We would welcome papers that explored similarities between Post Keynesian and Austrian views of uncertainty, papers that examined the behavioral assumptions in the General Theory and in macroeconomics, papers that approached policy issues from different theoretical perspectives, as well as papers that addressed the overlap among some of the different non-neoclassical paradigms. Somewhat surprisingly, especially given what transpired earlier, this proposal won the endorsement of everyone there. We decided to make the new journal as open and as inclusive as possible. 

The result was a journal seeking to revive the grand tradition of classical political economy. It would publish in virtually every strand of political economy. The statement that is printed on the inside cover of the journal, and appearing on the journal's homepage, boldly proclaims this objective.

Pressman tells the whole story here.

Neoliberalism, neoclassical economics and the return of vulgar economics

The term Neoliberalism has been used with increasing frequency over the last few decades. But is often a confusing term, also used interchangeably with neoclassical economics by some authors (in fact if you look at the graph below you can see that as the use of neoliberalism increased, the use of neoclassical went down). I'm not necessarily against the use of the term, but I do think that semantic clarity is needed if the term is to be used with any propriety. I discussed some of these issues in my review of Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics, by Stedman Jones here.

As I noted before, in my exchange with Noah Smith, the term neoclassical is a bit of a misnomer. The term presupposes a continuity between the old classical political economy authors of the surplus approach -- the authors from Petty to Marx, including Quesnay, Smith and Ricardo, that assumed that real wages (distribution) were exogenously given -- and marginalists (the neoclassical ones), which assumed that real wages (equilibrium ones in the long run) are determined by supply and demand (endogenously) like any other price.

In that sense, Smith (Ricardo was a radical and his classification is more complicated, and Marx was a critical revolutionary socialist) was a liberal in the sense of wanting Laissez-Faire, but his theoretical framework was very different from neoclassical authors like Friedman, a modern champion of free markets. In other words, the policy stance in favor of non-intervention and freedom of markets is a poor guide for the underlying theoretical framework or the political views of the author.

The liberalism of the classical authors was based on the notion that the rising bourgeoisie had a revolutionary role (something noted by Marx in his Communist Manifesto), and was a reaction against Mercantilism and the remnants of the Ancien Régime. Neoliberalism, in contrast, should be seen as the resurgence of a free market ideology, after the onsloghut on neoclassical economics by the Keynesian Revolution. It was the ideology of the anti-New Deal, anti-Keynesian conservatives, which was finally victorious in the 1970s, when the marginalist ideas had already proven to be either incoherent or/and irrelevant by the capital debates.

In other words, while the old liberalism was a progressive ideology at the service of the nascent capitalist system radical transformation of the structure of production and the social relations associated with it, the modern resurgence of neoliberalism is a conservative ideology at the service of the maintenance of the status quo. It is fundamentally what I referred before as the return of vulgar economics.

PS: Note that many neoclassical economists are not neoliberals in the sense of radical defenders of the free market ideology. In fact, the majority, the so-called New Keynesians, are willing to accept significant amounts of government intervention to deal with market failures, even if by the 1990s they had accepted much of the more radical stuff (think of Larry Summers, which last week quite correctly noted that more government spending is needed to get us out of the recession, but back in the 1990s believed in expansionary fiscal contractions and financial deregulation. On the latter no word).

Lars Syll on Krugman as An Apologetic Defender of Esoteric Mathematization

By Lars P. Syll

Paul Krugman had a post up on his blog a while ago where he argued that “Keynesian” macroeconomics more than anything else “made economics the model-oriented field it has become.” In Krugman’s eyes, Keynes was a “pretty klutzy modeler,” and it was only thanks to Samuelson’s famous 45-degree diagram and Hicks’s IS-LM that things got into place. Although admitting that economists have a tendency to use ”excessive math” and “equate hard math with quality” he still vehemently defends — and always have — the mathematization of economics.

See rest here.

Krugman is Right for the Wrong Reasons on Dollar Hegemony

Paul Krugman argues (see here) that supposed threats of the US dollar losing its significance as the international vehicle currency are overblown (which I certainly agree with). He reaches his conclusion, however, from a mettalist perspective, suggesting that the dollar's role reflects self-sustaining increasing returns, that is, people use dollars because the markets are thicker (many buyers and sellers) and more liquid; i.e. it is 'confidence', not power, which rules the roost. For an analysis of the mettalist perspective, along with the alternative chartalist conception of dollar hegemony, see here.

New introductory heterodox macro textbook, "Principles of Macroeconomics: Activist vs. Austerity Policies"

New introductory heterodox macroeconomics textbook (see here) by acclaimed writers, Howard J. Sherman & Michael Meeropol (whom I was a student of). In similar vein as E.K Hunt and Howard J. Sherman's "Economics: An Introduction to Traditional and Radical Views," the authors stress the inherent instability of the capitalist macro-economy. Moreover, the entire book, as the subtitle indicates, centers on the debate between activist and austerity policies. Hence, it takes on many of the most important issues related to what has become known as the Great Recession.

Lars Syll on Krugman, Wren-Lewis and the New Keynesian apologetics

By Lars P. Syll

Is academic (mainstream neoclassical) macroeconomics flourishing? “New Keynesian” macroeconomist Simon Wren-Lewis had a post up not that long ago on his blog, answering the question affirmatively:

Consider monetary policy. I would argue that we have made great progress in both the analysis and practice of monetary policy over the last forty years … However, it has to be acknowledged that policymakers who look at the evidence day in and day out believe that New Keynesian theory is the most useful framework currently around. I have no problem with academics saying ‘I know this is the consensus, but I think it is wrong’. However to say ‘the jury is still out’ on whether prices are sticky is wrong. The relevant jury came to a verdict long ago… 

It is obvious that when it comes to using fiscal policy in short term macroeconomic stabilisation there can be no equivalent claim to progress or consensus. The policy debates we have today do not seem to have advanced much since when Keynes was alive… 

What has been missing with fiscal policy has been the equivalent of central bank economists whose job depends on taking an objective view of the evidence and doing the best they can with the ideas that academic macroeconomics provides…The contrast between monetary and fiscal policy tells us that this failure is not an inevitable result of the paucity of evidence in macroeconomics. I think it has a lot more to do with the influence of ideology…

And today another sorta-kinda “New Keynesian” — Paul Krugman — has a post up arguing that the problem with the academic profession is that some macroeconomists aren’t “bothered to actually figure out” how the New Keynesian model with its Euler conditions — ”based on the assumption that people have perfect access to capital markets, so that they can borrow and lend at the same rate” — really works. According to Krugman, this shouldn’t be hard at all — “at least it shouldn’t be for anyone with a graduate training in economics.”

Read the rest here.

Financial Masters & Slum Dwellers

If you read in Portuguese the book Conta de Juro Grande & Favela, rough translation would be Financial Masters & Slum Dwellers, can be bought here. The title is a play with the classic Masters & Slaves (Casa Grande & Senzala) by Gilberto Freyre.

Bresser-Pereira calls for the end of the euro

In his recent column on the European crisis Bresser suggests that in the absence of depreciation the Southern countries would be better off by abandoning the euro.

If the Southern countries had their own currencies, the adjustment would be simple: it would be enough to depreciate their currencies in relation to the German currency. Since they have a common currency, the solution is either a concerted discontinuation or the “internal devaluation”, that is, recession, unemployment, and a drop in real wages. It is this policy that is being adopted under the command of Germany, of the European Central Bank and of the IMF.

It is clear that the creation of the euro was a mistake for which European countries are paying dearly. The rational solution is the concerted discontinuation of the euro. Then the European Union will be saved. But for this we need courage in the Southern countries, particularly in their chief country, France, and Germany's willingness to come to an agreement. Neither one seems today available in Europe. The situation of the Eurozone countries reminds me greatly of the Argentinian situation and its “plan de convertibilidad”. A huge crisis was necessary to untie the peso from the dollar. Now we are seeing the euro of the Southern countries tied to the “German euro” and, apparently, only a huge crisis could lead the Europeans to get rid of this curse that is the common European currency.

Note that this is very different than the approach emphasized by Holland, Galbraith, and Varoufakis in their Modest Proposal, who argue for increasing public investment.

How fast has been the recent recovery? Faster than the Depression

But that is not really saying much in favor of the current crisis. Krugman has recently shown how bad the European crisis is comparing the index of industrial output in the Great Depression and the Great Recession. The same exercise for the US is shown below.

Note that the recovery was faster this time around (21against 43 months, incidentally both associated to changes in fiscal policy, in early 1933 and mid-2009 respectively). Further, due to the more active fiscal and monetary policy (besides specific policies like the rescue of the Big 3 auto makers) now we are at the same level than in late 2007, while back then 72 months into the recession industrial output remained some 25% below its previous peak.

The US cannot not run trade deficits, says James Galbraith

And he is right. If you're the provider of the global unit of account and main reserve currency, there is no other way than to run deficits. The hegemon must provide global demand, and the risk free asset to the global economy.

For the whole interview go here.

On the blogs

Robinson (unintentionally) tells us we should be worried Dean Baker

Having the backbone to set min. standards for health insurance Robert Reich

Actually, economists CAN predict financial crises Mark Thoma

Reforming economic education Lars P. Syll

Keynesian economics and the journals Paul Krugman

New Keynesian and Old Keynesian at the same time Simon Wren-Lewis

Dissecting the Republican brain Josiah Neeley

Speculating "financial gods" & …Star Trek (TOS)?! Erinc Yeldan

What can we learn from the Depression?

Free Exchange has discussed in a recent post the academic views on the Great Depression. They suggest that recent research (say the last 20 years or so) has produced a different view, and "that many traditional views about the causes of the Depression have been overturned by academics in recent decades." In particular, they suggest that neither protectionism nor the financial crash are seen as central anymore. They correctly note that the dominant view, associated to Barry Eichengreen and Peter Temin,* now puts an emphasis on the effects of the Gold Standard (note that Keynes also emphasized the role of the Gold Standard, to which he referred to as a 'barbarous relic'). 

And by the way that means that the consensus is that a demand shock caused the Depression. Note that a few authors have pushed the Real Business Cycle (RBC) story in recent times. For example, Prescott argues that:

“In the 1930s, there was an important change in the rules of the economic game. This change lowered the steady-state market hours. The Keynesians had it all wrong. In the Great Depression, employment was not low because investment was low. Employment and investment were low because labor market institutions and industrial policies changed in a way that lowered normal employment.”

In other words, the changes in incentives led to less supply of labor and less demand for investment goods by firms. Same ideas have been put forward by Cole and Ohanian, and by popularizers like Amity Shlaes in her The Forgotten Man. However, most of the New Deal regulations that the revisionists abhor, actually came to late to have caused the Depression. They generally try to explain the 'slow' recovery (growth averaged 8% in the first FDR term) as a result of the New Deal, and leave the question of what was the supply side shock that caused the Depression.

Lucas, who converted to RBC at some point in the 1980s, asked (cited here) poignantly: "Where is the productivity shock that cuts output in half in that period? Is it a flood or a hurricane? If it really happened, shouldn't we be able to see it in the data?" For that reason Lucas still believes, like Friedman, that the Fed did it. And if one is going to blame regulation for the duration of the Depression, one must deal with the fact that in the 1950s, if anything, labor and financial regulations were as stringent, if not more, than in the 1930s and unemployment was fairly low.

A more subtle critique of the conventional view, and its emphasis on the Gold Standard comes from Christina Romer. She suggests that the path of American output and unemployment before 1931 can be explained quite well with only domestic factors, and that even after 1931, international factors affected American economic conditions mainly through their impact on American policy decisions. Note that that this is not incompatible with Kindleberger's view that the US, in the process of becoming the hegemon, was central for the global economic collapse.

This should cast some doubts on FE's conclusion that:

"putting all the blame on Wall Street for the Great Depression -- or on bankers in the current crisis -- does not stand up to historical scrutiny. The responsibility may more properly lie in a complex combination of factors, like how global financial systems are structured."

Romer notes that in the US the collapse in consumption was more important than in other economies (harking back to Peter Temin's reply to Friedman that it was the collapse in consumption, not monetary policy, that caused the Depression). And the collapse in the demand for consumer durables, which depended on credit for their purchase, was affected by financial conditions. Romer argues:

“Both the initial recession in the United States in the summer of 1929 and the acceleration of the decline in late 1929 and 1930 are ultimately attributable to the stock market boom and bust of the late 1920s. The stock market boom is the prime explanation for why the Federal Reserve was pursuing tight monetary policy starting in 1928. The stock market crash is the prime source for the collapse in durable goods purchases starting in November 1929.”

So the financial bubble and the crash did matter, and John Kenneth Galbraith (among others) was correct about it. I would add that income distribution, which we know from Piketty and Saez, was as bad in the 1920s as now, did also play a role in the bubble and the expansion of private indebtedness. So Wall Street was to blame indeed, as much as it should be too in the recent Great Recession.

* Kindleberger, in his classic The World in Depression, goes further and suggests that it was the absence of an hegemon that acted as a source of demand in situations of crises (distressed markets), as a stabilizer of exchange rates, and as a source of international finance (an international lender of last resort) that caused  the Depression, since the UK was incapable and the US unwilling to assume that position. The Depression was essentially an hegemonic crisis.

PS: For further reading my forthcoming paper in the Cambridge Journal of Economics here.