On Eccles and QE in the 1930s

So last weekend I was at the Eastern Economic Association meetings, and I presented with Steve Bannister (on and off contributor to NK) a paper on Quantitative Easing in the 1930s. It's been a while since we looked at this work, which started long ago (4 years at least). One point worth noticing is that while most accounts of Eccles performance at the Fed suggest that he didn't do much (see Meltzer in his A History of the Federal Reserve), we suggest that he was crucial in pushing qualitative easing (the term first used by Buiter here), that is a shift in the composition of the Fed's balance sheet.

The figure shows that when Eccles assumed at the Fed, in 1934, QE, the increase of the balance sheet had already started, but the shift from short term government bills (blue ones) to long term bonds (green) had not. The dark line shows Eccles' policy, which had the objective of keeping long term interest rates at 2.5 percent, in order to allow for fiscal stimulus and sustainable expansion of public debt.

On the blogs

Graph For the Day: Is QE4 Far Away? -- Roger Farmer on why the Fed might be forced to intervene. This one is a bit old, but worth reading, even if you don't agree with Roger on the effect of the stock market on the unemployment rate

Lessons from the Crisis: Ending Too Big to Fail -- New head of the Minneapolis Fed, Neel Kashkari says that financial reform did not go far enough and some banks are still too big to fail

New Keynesian Orthodoxy and Hysteresis -- Robert Waldmann, at Angry Bear, on the Jerry Friedman versus establishment economists debate, and on the fact that with the Kaldor-Verdoorn law (he doesn't cite it, but that's the source of hysteresis), short run effects of macro stimulus have a more significant impact on growth

On Austerity and the Economic Outlook at the Rick Smith Show

Undocumented Immigrants pay a lot of taxes

I have discussed this before. I explicitly argued that this was one the GOP myths about taxes, and I lumped it together with the notion that poor people don't pay taxes (Myth #3: 50% don't pay taxes, including immigrants).  Now a report from the Institute on Taxation and Economic Policy (ITEP) seems to confirm this view.

The report claims that undocumented immigrants living in the United States collectively pay an estimated $11.6 billion dollars each year in state and local taxes. And if their situation was regularized, they would pay even more. Add that to the fact that it does not seem that immigrants reduce wages, and the whole anti-immigration position seems more like what it really is. Xenophobia exploited by a demagogues preying on people that have had a hard time and are willing to find someone to blame. A dangerous mix.

Brexit and Euroskepticism

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

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

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

Size of government

Source: WEO, IMF

Nothing earth shattering. Just the size of the average government spending as a share of GDP between 2001 and 2015 in a few developed countries, all of which, but one, have comprehensive health coverage. So it's reasonable to assume that if the US wanted that (healthcare for all), it would have to increase spending to something closer to 40% of GDP, for all levels of government, rather than the current 35% or so. Nothing implausible about that (wink, wink, nudge, nudge, say no more).

Frank Knight on unemployment equilibrium

Luca Fiorito, my sometimes co-author, and Carlo Cristiano have published (subscription required) class notes from Frank H. Knight's business cycle course in the fall of 1936, that used Keynes' General Theory (GT) as one of his references. Two quotes from the notes by Perham Nahal are reproduced below.

The main postulate of Keynes: the supply curve for labor should be drawn in terms of money, with no reference to the value of money (real vs. money wages). There is no tendency for the price of labor to adjust itself so as to clear the market.

It is not intelligent to take antithetical assumptions, as Keynes has done. There must be an enormous amount of inertia in an economic system to keep it from flying to pieces. Frictionless conditions are a fallacy. Because the classical assumptions did not work, they were not necessarily wrong. It is entirely possible that ‘frictions’ or undiscussed tendencies are responsible for deviations of actual conditions from what the classical economists believed would happen.
...
Unemployment is essentially the failure of the market to establish a clearance (FHK). Keynes seems to think that there is no such tendency toward clearance of the market. Keynes is wrong – this is FHK's criticism of Keynes. Keynes's talk of stable ‘equilibrium’ is ridiculous. How is this possible when there is unemployment? Competitive conditions tend to clear the market – if there is unemployment the ‘natural’ forces are working out too slowly, or there are obstacles. Any talk about stable equilibrium where the market is not cleared is nonsense. The fact that savings are sometimes not cleared does not invalidate a ‘law’ or tendency. If there were no tendency for prices to be set that would clear the market, there would be no system. [Emphasis added]

I do spend sometime with students emphasizing how important it is that Keynes suggested that the system was stuck in an unemployment equilibrium situation, and how contradictory that would be for neoclassical (classical for Keynes and Knight) theory.

Of course, while it seems clear that Knight dealt with chapter 3 of the GT, it seems evident from the class notes that he did not grapple with the issues in chapter 19, which explain how, even without frictions, without wage rigidities, the system remained below full employment.

Lord Eatwell in the Financial Times

A short Letter to the Editor, but worth reading. He clearly explains the policy failure since the global crisis and the reasons for the current problems in financial markets in developed and developing countries. He says:

The adage that, in the absence of the prospect of growing demand, cheap money amounts to “pushing on a string” has been once again confirmed in advanced economies by the slowest recovery from any modern recession. Instead of funding real investment, monetary expansion has resulted in a boom in asset prices — not just in real estate and equity markets, but in the flow of funds into emerging market corporate bonds in the search for higher return. All these asset markets are extremely unstable, as is now all too evident. And, as has been once again demonstrated in the last 7 years, financial instability leads to substantial real economic loss.

Yet in the face of evident policy failure, and of severe asset market distortions that can only lead to further financial instability, the response seems to be “more of the same”, or even, in the case of negative interest rates, “very much more of the same”. There was a significant fiscal expansion in the US in 2009 that had a clear positive impact. But the federal government lost its nerve and reined back on the expansion just as it was gathering pace. The quiet abandonment of severe austerity by the UK government in 2012 at least enabled something of a recovery, albeit fuelled by growing household debt. Fiscal policy works. 

Given that the cost of funds to most governments is today negative in real terms (and sometimes in money terms too) it is difficult to understand the failure to initiate a major expansion of investment in infrastructure and the other major components of “supply-side” strength. This failure is resulting not just in a loss of output today, but a long-term loss of competitive productive capacity (a particularly severe problem for the UK). Fiscal policy can provide the pull on the string required to validate the monetary push.

Read the full letter here (subscription required). Pushing on a string as an explanation for the inefficiency of monetary policy in a crisis was a term popularized by Marriner Eccles, by the way.

On the blogs

The Pious Attacks on Bernie Sanders’s “Fuzzy” Economics -- David Dayen at the New Republic on the Bernienomics debate

The TPP: Investor-State Dispute Procedures are a Threat to Democracy -- Mehrene Larudee at Triplecrisis on dispute settlement provision of the TPP agreement

Are US taxes progressive all the way to the top 1%? -- Branko Milanovic is not sure, in this slightly older, but relevant post

NYT Zombie Sighting -- James Livingston, who was last week at Bucknell, on an even older post, discusses the strange persistence of Monetarism (I discussed this before here and here)

Crazy as Adam Smith: the Media Discovers the Kaldor-Verdoorn Effect

So Kevin Drum at Mother Jones discovers the Kaldor-Verdoorn effect, and the fact that growing demand might be the main cause of rising productivity, and idea as old as Adam Smith in his vent for surplus model (chapter 3 of the Wealth of Nations says that the division of labor, that is, productivity, which is the basis for development, is limited by the extent of the market, that is, by demand). I posted extensively on that here (all post by date here), and produced, as far as I know, the only methodology to separate the Verdoorn effect (long term trend effect) from the Okun effect (cyclical effect) with one of my graduate students long ago (see here). And yes this is in part why a Bernie type policy would actually lead to significant changes in employment and productivity.

Getting history right: Krugman continues his disinformation campaign

So Krugman continues to argue that Friedman's calculations are implausible. Well sure. But that's the point to some extent as Galbraith discussed here. The Plan involves huge (read yuge; wink, wink, nudge, nudge) spending, and it should have almost by definition implausible results looking from the perspective of recent history. Imagine the implausible effect that Social Security had on old age poverty. Or the incredible reduction in inequality that the New Deal policies had.

If you were in the 1930s, the historical record would suggest that an improvement in income distribution based on higher taxes on the wealthy and cheap college access to the masses would be implausible, and yet by the 1950s things had changed (see graph below). The historical record would say this was not possible.

The guy that used the graph above said: "The middle-class society I grew up in didn’t evolve gradually or automatically. It was created, in a remarkably short period of time, by FDR and the New Deal. As the chart shows, income inequality declined drastically from the late 1930s to the mid 1940s, with the rich losing ground while working Americans saw unprecedented gains." Unprecedented, as in never done before, or implausible. Who said that? Bernie Sanders? Gerald Friedman? No, it was Paul Krugman of course.

What Friedman calculates is what would be the effect of Sanders transformative policies in the real world using fairly conventional assumptions. More spending should lead to higher output, and employment. For example, Krugman has correctly complained all through the recovery what little impact the fiscal package had on the employment-population ratio. A huge increase in spending would basically look like the figure below (not from Friedman's data; but same result).

So what Krugman calls implausible is the unprecedented fiscal expansion necessary to increase the employment-population ratio to the level he has been arguing it would need to be in a strong recovery. Krugman in the 1930s would have claimed that we shouldn't follow the pipe dreams of FDR and his implausible plans. We should probably stick with a Southern Dixiecrat that didn't rock the boat and implemented policies similar to Hoover. Electability is important after all.

PS: That there is nothing implausible about health care for all is shown by the number of developed countries that have something like that, with government spending not much higher than the US. A reasonable increase in government spending would be of about 15% rather than 40% to achieve that.

On Bernie Sanders and the Democratic Establishment Economists at the Rick Smith Show

Jamie Galbraith's response to the critics of Gerald Friedman's paper on the impact of Bernie Sanders policies

There has been a debate following the NYTimes piece on left of center economists against Bernie Sanders. Doug Henwood replied here and Dean Baker here. Henwood does not discuss the Gerald Friedman paper that led to the whole discussion. Now Jamie Galbraith provided a nice reply to the left of center economists that suggested that Bernie's plans are not realistic. He says:

"What the Friedman paper shows, is that under conventional assumptions, the projected impact of Senator Sanders' proposals stems from their scale and ambition. When you dare to do big things, big results should be expected. The Sanders program is big, and when you run it through a standard model, you get a big result.

That, by the way, is the lesson of the Reagan era – like it or not. It is a lesson that, among today's political leaders, only Senator Sanders has learned."

Read full letter here.