More on the Indian Economy

By Suranjana Nabar-Bhaduri

Recent months have seen public concerns being voiced about the incipient slowdown in the Indian economy. Manufacturing output grew at only 0.1 per cent in April; the Indian rupee has been on a downward spiral since late 2011; exports have fallen; and capital inflows have been inadequate relative to India’s current account deficits. India’s GDP growth has declined to a nine-year low of 6.5 per cent in the financial year 2011-12.

The current situation draws attention to issues surrounding India’s services-led growth development strategy, and its persistent trade and current account deficits. It will hopefully provide a much-needed wake-up call to Indian policy-makers to undertake policies beyond “reforms”. A recent paper emphasizes that India’s services-led growth entails questions of long-run sustainability with respect to its balance of payments (BOP) and has a limited ability to raise the living standards of the population as a whole.

Read the rest here.

Has Econ 101 done just fine?

Krugman tells us that:

"huge government deficits could fail to raise interest rates in a depressed economy ... is what Econ 101 said – and it has been completely right. Basic IS-LM macro also said that under these conditions printing lots of money would not be inflationary, and that cutting government spending sharply would cause the economy to shrink. All of this has come true. So Econ 101 has done just fine ..."

Note, however, that Krugman basically believes that this is the case because the economy is in a liquidity trap, and the natural rate of interest for him is negative. That is, the rate of interest that would stimulate enough investment to bring about full employment savings is below zero. As I have argued here there are several empirical and logical reasons why one should doubt that kind of imperfectionist argument.

So, yes the Old Keynesians policy prescriptions do work, and have done quite well, even if their theories do fail miserably, as much as any other neoclassical approach that presumes that markets work by the magic of supply and demand producing optimal outcomes.

And that is also why what we need is not more monetary stimulus, or any hocus pocus to convince investors that inflation is going to be higher. We need more demand. And as Paul Davidson said in his reply to Tyler Cowen, only the government can do this now:

"if the government were to let contracts for, say, $1 trillion to private enterprise to rebuild our failing highways, bridges, and municipal water and sewage systems, and provide resources for our shrinking public and higher education systems, this would quickly restore companies’ confidence in the profit opportunities that are available if they hire workers and buy materials from other United States companies. When these newly hired workers go out and spend their wages, the confidence of United States retailers would immediately surge as these additional customers break down the doors to get at the merchandise on the shelves.  Nothing will build the confidence and trust of business and workers quicker than the continuous ringing of cash registers."

So Paul, that has complained about Econ 101 for a long time, is quite correct. We need spending and not the inflation expectations fairy.

PS: On my views on the ISLM go here.

This time is different, after all

It is well known, and it has been discussed in this blog, that the crisis has been to a great extent associated to the fact that wage stagnation has led to the accumulation of increasingly more unsustainable levels of private debt (echoes of both Godley and Minsky, from the Levy Institute). The graph below shows the percentage change in federal government, household and financial sectors outstanding debt. In other words, expansions have been associated to ever growing private debt.

Note that, in the 1990s, the federal debt growth rate turned negative when the dot-com bubble allowed for revenue to go up sufficiently, together with the reduction of military spending after the end of real socialism, and the Clintonian "end of welfare as we know it," to lead to significant fiscal surpluses.

Also, in every recession (shaded areas) when private debt (the blue and red lines for household and financial sectors) went down (the blue line does not go down in the Bush II recession, since mortgage debt allowed its continuous expansion), the green line of government debt goes up. More dramatically with every recession, since the fall in private debt is ever stronger.

The main difference between the current Great Recession with the previous two recessions is that private debt falls (negative rate of growth represented by the blue and red lines below the zero line) as a result of deleveraging (debt-deflation). And note that those two are still negative, so there is still need for more public debt, after all spending does maintain a relation with income and debt!

Jerry Epstein on the Argentinean Central Bank

Prevailing ideology has held that the only legitimate task for central banks is to control inflation, which often comes at the expense of broader goals such as employment creation, financial stability or economic growth. Now, in a bold and important move, the government of Argentina has fought against this neo-liberal “conventional wisdom” and broadened the mandate of the Argentine Central Bank to include economic growth and financial stability, and empowered it to use more tools to support credit allocation to promote productive investment and job creation (see Weeks).

Read the rest here (a slightly modified version published in Spanish by Página/12 here).

Two papers on the Indian economy

Two blog related papers on the Indian economy here and here suggest that there is less to the booming economy than you might think. Both suggest that the idea of the BRICS surpassing the US economy's global influence is an exaggeration, to say the least.

More on Heterodox Central Bankers

The Great Depression led to a need to rethink the principles of central banking, as much as it had led to the rethinking of economics in general, with the Keynesian Revolution at the forefront of the theoretical changes. This paper suggests that the role of the monetary authority as a fiscal agent of government and the abandonment of the view of the economy as self-regulated were the central changes in central banking in the center. In addition, in the periphery central banks changed to try to insulate the worst effects of balance of payments crises and the use of capital controls became more common. Marriner S. Eccles, in the United States, and Raúl Prebisch, in Argentina, are paradigmatic examples of those new tendencies of central banking in the 1930s.

Can we stop talking about inflation when we mean output growth?

Brad DeLong has a nice post on the euro crisis. Q&A session with himself (and yes he throws himself some soft balls, but hey those are relevant questions!). However, he says on the third question:

"(3) Q: How Should Greece Balance Its Spending on Imports and Its Exports Going Forward?
A: Borrowing to cover the gap between imports and exports that exists at current exchange rates and price and wage levels is not going to happen, so Greece has a choice between (a) deep prolonged depression to make Greeks too poor to afford imports, (b) Grexit, devaluation, and a subsequent export boom, and (c ) Germans opening up the monetary spigots to produce higher inflation in northern Europe and meanwhile giving Greece an additional fortune to keep the pain in Greece low enough for adjustment to take place within the Eurozone framework (emphasis added)."

If Germany actually went for fiscal expansion (or even monetary) and more demand for goods and services, including a few Greek ones (more olive oil, and a few more sunny vacations) it would not lead to inflation. Unless somebody thinks Germany is close to full capacity and growing fast. Why Keynesians have accepted the inflation expectations fairy is beyond me!

And here's to you, Mrs Robinson

Jesus loves you more than you will know (wo, wo, wo) ...I know, but I was going to talk about the other Mrs Robsinson, Joan Violet (née Maurice), the main disciple of Keynes,* as I had promised in a previous post. Joan Robinson's contributions to economics demand several posts. She has participated, as Maria Cristina Marcuzzo noted, in three Revolutions, namely: the imperfect competition, the Keynesian and the capital debates ones.

And to reduce her to those three one has to fit her contributions to growth theory into a subcategory of either the Keynesian Revolution (the extension of the Principle of Effective Demand to the long run) or the capital debates (the critique of mainstream growth theory), and omit her various other contributions to monetary theory (e.g. endogenous money and the circuit), methodology (e.g. history vs. equilibrium), Marxist economics and so on. She was prolific for sure.

There are several great reviews of her contributions in all of them, which would make my post irrelevant. But what I want to discuss is the point raised in Sergio Cesaratto’s presentation, that in the last one of those revolutions her contributions might have been seen as negative. In his exposition Sergio emphasized quite correctly her rejection, at least in certain contributions, of the notion of long term normal equilibrium positions, and, hence, the traditional method of economics.

This was done, for the most part, to emphasize the notion that history matters and that path dependency was important, since the process of reaching the equilibrium would affect the equilibrium itself. Arguably, the role of uncertainty, following Keynes and some post-Keynesians, played a role in her rejection of normal equilibrium positions.

Path-dependency is indeed an important feature of real economies, and Robinson was quite right in emphasizing its relevance.++ However, the fact that the normal or long run equilibrium positions might depend on the initial conditions and on the trajectory to its final position would render the very notion of equilibrium irrelevant for the analysis of real historical situations might not be granted.

In her view, the notion of equilibrium originated from a misleading mechanical analogy with movements in space, and shouldn’t be applied to movements in time.  However, nothing suggests that the long run position of equilibrium cannot be path dependent and actually represented by an equilibrium position. Let me suggest that the idea of the supermultiplier is, for example, a case in point. Output depends on the autonomous components of demand, and investment, as derived demand, behaves in a way which leads to the adjustment of capacity (supply conditions) to demand.  It is an equilibrating process, but not a unique one, or one that leads to a determinate path of accumulation, since alternative initial conditions (e.g. sizes of the relevant coefficients) lead to different outcomes.  Also, changes in several factors can affect the trajectory by which capacity adjusts to demand.

Further, uncertainty, or true, fundamental and non-probabilistic uncertainty was also a relevant component of Robinson’s critique of equilibrium positions. Uncertainty also suggests that historical processes are complex and could not be reduced to equilibrium analysis. This was also in line with the post-Keynesian developments in the 1970s, by Paul Davidson and others, that suggested that uncertainty was central for Keynes understanding of the functioning of the economy.

That is again true. Uncertainty was important for Keynes, and is central in the functioning of real economies. However, uncertainty does not preclude the use of equilibrium. Uncertainty implies that agents use conventions, rules of thumb in order to make decisions. In an uncertain world agents stick to social norms, and even if there is significant uncertainty on an individual basis, the institutional framework tends to reduce uncertainty. In that sense, for example, the New Deal reforms decreased to a great extent the degree of uncertainty in the functioning of the economy, and guaranteed a high degree of stability to workers.  Another example of how institutional framework would reduce uncertainty is the use of capital controls (and fixed but adjustable exchange rates) to reduce the pressures on interest rates during the Bretton Woods era. With that framework, fiscal expansion with low real rates of interest produced a normal equilibrium with low unemployment level. In other words, nothing implies that uncertainty suggests that the multiplier and accelerator processes are not operational or that normal positions of equilibrium cannot be achieved.

In my view, the two main problems to Joan Robinson’s critique of the equilibrium method in the latter part of her career are that, on the one hand, by emphasizing the independence of the investment function and of uncertainty it led to the development of a set of models (later incorrectly referred to as Kaleckian) that bring back the entrepreneur as the central figure in economic growth (the so-called profit-led regimes). On the other, and even more problematic, it took place at the same time that (as noted by Garegnani) the mainstream rejected the old notion of long term equilibrium, and started to use dominantly the intertemporal models (this ones in fact terrible mechanical analogies to movement in space).

The old classical (and indeed even the old Marshallian) notion of normal positions, which allowed for historical contingency and path dependency was abandoned by the mainstream, but that was seen by several heterodox authors as an improvement because now mainstream models were ‘capable’ of incorporating multiple equilibria and instability. In fact, Keynes point was that normal situations (and hence stable equilibrium positions) in capitalism were sub-optimal. And Joan Robinson, at least in part, is responsible for some of those heterodox (very confused) views of the development of the mainstream.

---

* Richard Kahn would be the other candidate, but his contributions to the Keynesian Revolution were considerably less visible, if admittedly incredibly important, with the formalization of the multiplier on the top of the list. Kalecki and Kaldor, although quintessential Keynesians, were not disciples of Keynes in a direct way, and Sraffa, although personally close, and contrary to what some think, very favorable to the idea of effective demand, was not a disciple proper either.

++ Note that path-dependency is not exactly the same as hysteresis, a point raised by Mark Setterfield. I’ll expand on this on another post.

PS: A paper in which some of the pros and cons of Robinson's approach to economics, in particular on money and growth, is available here (subscription required).

More on the debate on Germany’s beggar-thy-neighbour wages policy and the financial sector bubble

Here the rest of the debate with Robin Pope. Esteban Pérez responds to most questions.

The Overton Window for game changing exotic energy technologies

Political scientists invoke something called the Overton Window to describe the range of possible political conversations. Forget for the moment that the political right is trying to control this window.

I want to discuss a different 'Overton Window,' one which involves the possible conversations around truly radical, even exotic, energy sources. A small group of economists, including me, believe that much of what is to be understood in growth and development has a large energy component. So possibilities to radically change the supply and cost of energy causes great consternation. But moving the conversation window even a tiny bit will have great benefits.

Geographically for me, it is truly ironic that in 1989 Professors Pons and Fleischman were tarred and feathered and ridden out of town on a rail over their forced, though admittedly premature, assertion at a University of Utah press conference of low energy nuclear reactions, a.k.a. cold fusion, in their laboratory.

Well, some two decades later several very serious, very credible, scientists have come out of the closet in support of the so-called FP discovery. Scientists from MIT, NASA, and, especially, the US Naval Research and Development arm (SPAWAR), based in San Diego. If you have an open mind, some scientific aptitude, and a life-changing hour, try this. If you want to discuss it, I can follow some of it and guide you, especially around the implications of the high-energy neutron depositions. This is very good and careful science.

Further, at least a half dozen known commercial ventures are underway, one of which (Broullin) received $2 million in venture funding this week. Another, the Andrea Rossi E-Cat project, reports just this week self-sustaining 600C output from their current reactor. The implications of this, if supportable, are profound in two senses: self sustaining implies both electricity output and infinite over-unity possibilities.

Now this sounds all very speculative and even specious, and you may question why it even appears on an Econ blog. Fairly simple in an Overton way: as my research and dissertation leads me to believe there is no more important component of an economy than its energy availability and consumption, these discoveries are game changers, and Economists should try to understand, discuss, and even model the implications. I will leave it there for the moment.

So, if true, we are on the cusp of a radical energy transition. One which 'fixes' global warming and changes all of our Economic growth models. Not a bad time to be an economist. Or a human. Put away your tars, feathers, and rails.

A Latin American Perspective on the Greek Crisis

The election in Greece this weekend, and the possible victory of Syriza, the left of center party that is against the austerity measures that are attached to the bail-out program negotiated with the troika of the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF), but wants to remain within the euro, has prompted fears of a final collapse of the euro. Let me say that irrespective of whether Greece will be forced out or not of the euro, policies to reverse the austerity imposed so far will be needed. Latin America has extensive experience with external crises, and with defaults and devaluation, the Argentinean crisis of 2001-2 being the most recent and dramatic example. Here are some lessons and a short proposal based on these experiences.

Read the rest here.

Phrase for the weekend

"When you have convinced the world, that an established system ought to be corrected, it is not very difficult to persuade them that it should be destroyed."

Adam Smith, "The History of Astronomy" (p.71)

PS: And it wasn't about the euro. Hat tip to Japs for the reminder.

The Pope, Vernengo and Pérez-Caldentey Discussion

A debate on the euro crisis in another blog, which I forgot to report.

The nagging influence of energy prices

It's been a while since I have posted.  I have a few other things going on, mainly working on finishing my dissertation. I did successfully defend my topic on May 1 (!), and have an awesome committee that understands how to constrain the output in the right way. So, mea culpa, and here is the first in at least a couple of energy-related posts.

For the US economy, it is fairly widely recognized that each recession is preceded by a run up in energy prices. For the US consumer, the most relevant energy price is gasoline. The mechanism by which this price initiates the recession is the negative correlation with spending on consumer durables. Here is what has been happening in the last two years:

As gasoline prices spike, consumer durable spending decreases. And vice versa. The widely recognized soft spot in 2011Q1 is seen here as a run up in gas prices and a decrease in consumer durable spending. We seem to be seeing a similar pattern this year, though consumer durable spending appears already to be recovering. If I have any short term hope for this economy, this graph is its parents. If gasoline prices continue decreasing, PCEDG will increase and help the economy grow. And vice versa.

The mechanism operates because gasoline expenditures are very price inelastic in the short run, and consumers are budget constrained. More spending on gasoline, less on durables, and most of those are manufactured in the US, so it depresses economic performance. This is a very demand-oriented story.

And, this is probably the most fundamental short term dynamic for US growth and the November election. And it is largely out of the control of the politicians.

I will shortly update a post I did a while ago on radical energy solutions that are in the pipeline and promise to break this link between energy/gasoline prices and US economic performance. This post hints at why that break will be so important.

Graph of the Week: Unions and Inequality

If you were concerned about the defeat of the recall of Governor Walker in Wisconsin, well here is one more reason for you to panic. The Economic Policy Institute (EPI) has just published its Economic Snapshot.

The authors, Ross Eisenbrey and Colin Gordon, say:

“To a remarkable extent, inequality, which fell during the New Deal but has risen dramatically since the late 1970s, corresponds to the rise and fall of unionization in the United States.”

Nothing to add.

More austerity, more debt

How is that austerity working for you? According to a recent policy brief by UN-DESA, not so well. The authors (Oliver Paddison and Rob Vos) say that:

"Available evidence suggests that fi scal austerity is not helping restore economic growth or debt sustainability; countries that made the biggest spending cuts to reduce fiscal deficits have seen their debt-to-GDP ratios rise even further (see figure)."

The graph shows that higher primary surpluses (difference between revenue and spending, excluding financial payments) are correlated with higher level of public debt. The reason is that austerity reduces the level of activity and depresses revenues as you would expect according to Keynesian principles.

I think increasingly we have an analogy with evolution and creationism in the debate about the effects of austerity. Logic and evidence are clearly on one side, but belief, well that goes in any direction. The problem is that beliefs, ideology, and vested interests have an impact on policy.

Reagan was a pro-corporations Keynesian

Krugman notes today that Reagan was a Keynesian. And in a sense he is correct. The fact is that Republicans, at least since Ford, have been the Keynesians, or the party of Big Government if you prefer, while Dems since Carter have been the small government party. The problem is that Republicans are Big Government for the wealthy and corporations, and nobody wants government for the unions and the poor. See this debate between Barbara Bergmann, Jeff Frankel, Bill Niskanen, and Larry Seidman from 2004 (with a longish intro by Berglund and Vernengo) where the issue is raised. So if Obama wins you get sort of almost anti-Keynesian policies, between the Democratic timidity (let's call it that), and the Republican obstructionism (yeah, that's also a nice euphemism). And if you get Romney, you'll get conservative Keynesianism, tax cuts for the wealthy and spending benefiting certain corporations.

A few Galbraith talks you might have missed

Also, two more recent ones on C-Span Book TV taped his talk at MIT on May 7, and his appearance on Bloomberg talking about why need more than stimulus.

Phrase of the week: The Age of Lack of Innocence

"In this age of Leontief and Sraffa there is no excuse for mystery or partisan polemics in dealing with the purely logical aspects of the problem."

Paul Samuelson in "Understanding the Marxian Notion of Exploitation"

How bad is the unemployment rate?

Labor market numbers reported today by the Bureau of Labor Statistics are pretty bad. Only 69,000 jobs created last month, when we would need something more like 400,000 to be in a healthy recovery. But they are actually worse than it looks like, if that is possible. The key to understand why numbers are too rosy is the so-called participation rate. The labor force participation rate is the percentage of working-age persons in an economy who are employed or are unemployed but looking for a job, shown in the graph below. At the peak, from 1997 to 2000 the participation rate was 67.1%, but fell to 63.8% now.

If the number of employed and unemployed people that are looking for a job drops the participation rate drops too. If a few of the employed workers become unemployed, but  are still looking for a job, the participation rate does not change. But if the unemployed stop searching for a job they drop out of the labor force and the participation rate falls. So you see what is going on. More people are, since the prick of the dot-com bubble in 2000, leaving the labor force. The graph below shows the rate of unemployment and the adjusted rate of unemployment if the labor force participation rate had remained constant at 67.1%.

Instead of the current 8.2% rate of unemployment, the adjusted level would be 12.7%. It is also worth noticing that even with the housing bubble the labor market was not very strong during the Bush years, with the unemployment rate  never going below 6%.

Obama is not Carter

Interesting post by Nate Silver at Five Thirty Eight on Obama and Carter comparisons. The important point Carter went up for re-election in the middle of a worsening economy, and Obama is up in the middle of a very poor recovery. I add my 2 cents with the graph below.

The graph shows private employment growth in the four years of the Carter administration, and for Obama the three first years and the average of the first four months of 2012. Note that by 1980 private employment fell 0.2%, and is invisible in the graph. In the case of Obama the trend is up, but slowing down. Obama could increase public employment to help the lackluster private demand, but that is another story.

Parasites, vultures and other economic agents

The decision by Facebook cofounder, Eduardo Saverin, to relinquish his US citizenship led to a huge outcry, and to new bi-partiscan (a very rare event indeed) to tax him in advance and prohibit him from re-entering the country (the Ex-Patriot Act).  This is not a new phenomenon by the way. Kenneth Dart, inheritor to a styrofoam cup company and a few millions (billions?), renounced his US citizenship and became a citizen of Belize, a flight capital haven, in the 1990s for the same reason.

William McNeill differentiates between the micro-parasites and the macro-parasites, and Saverin and Dart are clearly in latter category. Macro-parasites also benefit from the host, and harm it in the process. And they evolve too. Dart is the owner of a Vulture Fund that made millions (700 or so) out of the Argentinean default back in the early 2000s.

Now, even though it has not received much attention, his Vulture fund has cashed US$ 400 millions out of the Greek payments after the last debt restructuring deal. Yep, there is where the money of Greek tax payers squeezed by the austerity programs of the EU and the IMF goes. Parasites and vultures exist, and will continue to thrive in capitalism, but there is no reason that governments should allow that to happen.

The impunite of parasites, vultures and other types of economic agents results from the lack of regulation with which corporations can act, and that has been the backbone of the neoliberal agenda. But I'll let the discussion of corporations for another post.

PS: Somebody reminded me that what Bain Capital and other private equity firms do is not very different from the parasitical behavior described above.

How big was the stimulus?

The figure shows the rates of growth of total federal government spending in three periods 1930-36, 1941-45 and during the last recession and after, that is 2008-11.

The longest series is 7 years, and you see that spending growth peaked in the third year, but is visible even in the last year. World War II saw a massive increase in government spending. By the standards of those previous stimuli the last one has been moderate in size, and even worse, not sustained in time. In the third year the rate of growth of government spending was negative. That is, after the 2009 stimulus government spending fell in comparison to the previous year.

And yes the comparison with the Great Depression and the War is okay, since the size of the shock was by almost any measure as big as the one  back then.

De Grauwe moment: an impressively prescient prediction of the Eurozone balance of payments crisis

Sergio Cesaratto (Guest blogger)

In an article in the Financial Times written one year before the onset of the European currency union, Paul De Grauwe presented a farsighted conjecture of what could follow, something most economists have only recently realised.[i] Indeed, with the benefit of hindsight, the European crisis appears now as the nth ‘this time is different’ episode of the financial liberalisation sequence cum fixed exchange rates, capital flows from the centre to the periphery, housing bubble, current account (CA) deficit and indebtedness, default. Although I find Reinhart and Rogoff (2009) to be a poorly organised account of the history and nature of defaults, their title really conveys the sense of a recurring pattern of unfortunate events. The title of a seminal paper ‘Good-bye financial repression, hello financial crash?’ (Diaz-Alejandro, C. 1985) also sums up the essence of those events. In order to better appreciate prof. De Grauwe’s insight I introduce his article with some notes from a just published WP of mine “Controversial and novel features of the Eurozone crisis as a balance of payment crisis”.

Popularized by Martin Wolf (2012), the interpretation of the European crisis as a balance of payment (BoP) crisis is becoming dominant. Accordingly, the cause of the crisis must be found in the easier access for a number of peripheral EMU countries to the European financial markets at low nominal interest rates. Financial liberalisation and the removal of the exchange rate risk encouraged massive capital flows from core to periphery countries in the ‘periphery’ (e.g. Merler and Pisani-Ferry 2012). Credit-financed autonomous consumption determined a growth both of domestic demand and of nominal wages higher than in core-EZ. Higher inflation rates in the periphery determined low real interest rates, a further support to domestic demand. The growth of domestic demand was associated to a housing bubble in Spain and Ireland, and to the growth of public spending in Greece. This sequel of events, and its consequences, foreign indebtedness and ‘sudden capital stops’ are basically not so different from those that typically took place in developing countries and ended in sovereign defaults (Frenkel, Rapetti 2009: 688-89; Reinhart 2011: 27-9).

A traditional objection to the interpretation of the EZ crisis as a typical ‘this time is different’ crisis is that there cannot be a BoP crisis in a currency union. The question is that the EZ is a hybrid between a full currency union (which also implies a fiscal union) and a traditional fixed exchange agreement. One main difference with the latter is that in a currency union capital flights are automatically compensated by the CB, in the EZ by TARGET 2 (T2) (Febrero et al. 2012). As everybody knows, assuming zero variation of foreign currency reserves, the BoP sheet would read: CA + KA = 0, where KA is the capital account. Normally, in a two countries world, if country A has (all magnitudes are balances) a negative CAA-, country B symmetrically shows CAB+, then KAA + and KAB- (country B is lending to country A). Suppose country B does not lend to country A (so the CA flow imbalance is not financed), and even worse that there are capital outflows from country A (so the stock of debt acquired by B in the past is not rolled-over as it expires). Then both CAA- and KAA-, so that CAA + KAA < 0. What happens in a currency union is that through T2: CAA + KAA + T = 0, where T > 0 means that country A is overdrawing from its CB account. It is as if the ECB were creating foreign currency reserves in a fixed exchange rate system (Leppanen 2012); or as if the deficit countries were creating the international reserves, like the U.S. in Bretton Woods (I or II) (Kohler 2012); or better still, it is as if the EMU worked in an ultra-Keynesian fashion as an International Clearing Union (ICU), with even less prudence than Keynes envisaged (I suppose I am the first to note this similarity).[ii] With T2, the EZ country A has indeed an infinite overdraft possibility (Milbrandt 2012 CESifo). What has happened in the periphery from 2007/8 is that CAA- and KAA -, T+ and symmetrically in the core: CA +, KA +, T- (core-banks receiving hot money from the periphery and reducing their overdraft at their NCB).

Not so paradoxically, given the hybrid nature of the EMU: ‘If, in the framework of a political union, the euro central banks were integrated as dependent branches of the ECB, the consolidation of the branches would dissolve the Target balances in thin air.’ (Neumann 2012; also Ulbrich & Lipponer 2012 CESifo Forum). This makes clear that through T2 the ECB is acting as a regular CB: normally banks rely on the interbank market to finance their imbalances (when they fall short of reserves); if, in exceptional circumstances, this does not work the ECB just fills the gap. As Eladio Febrero wrote to me: ‘If you move your savings from a deposit in Banca Intesa to Unicredit, and the former has no reserves deposited in the Banca d’Italia, the latter would create money and then credit the reserve account of Unicredit so your money would be there now. Then Banca d’Italia would acquire a claim on Banca Intesa. …It should be noted that if Banca d’Italia in the example just above, or the European System of Central Banks (in this discussion on T2) does not provide the banking system with liquidity, the latter would collapse: there would be a bank run and the whole economic system would have very serious problems.’ So, in this respect EMU is not like, say, the EMS. If the ECB interrupts T2 (i.e. it stops acting as a CB with the peripheral banks) this is the end of the EMU. Of course, T2 is not the cause of the problems, but it prevents the EMU from exploding as the EMS did in 1992.

In this regard one might think that if the EZ was a real Federal State, the financial crisis would be a ‘normal’ domestic crisis: if some local banks and some local governments (deprived of monetary sovereignty) are not solvent, nobody would talk of a BoP crisis. Even considering the grand scale of the EZ crisis, a ‘normal’ state would intervene by socializing part of the local government and banks’ debt, imposing austerity and balanced budgets on them; saved banks would be nationalised, restructured or shut down. The CB would cooperate by sustaining the sovereign/federal debt. At the same time the Federal administration would use fiscal transfers to attenuate the crisis. Fine, but this is not Europe! If it were, it would manage to solve the situation without too much hardship.

The question is that the EZ is a hybrid, in between a fixed exchange rate system among independent countries and a fully integrated economy, sharing the possibility of a BoP crisis with the former and national banking principles with the latter. In this spurious set up the ECB has acted somewhat similarly to the FED: through T2 and LTRO it is injecting liquidity and absorbing toxic assets as collateral, letting insolvent local banks and governments survive (although the lack of direct ECB intervention to sustain sovereign debts is putting the solvency of the Spanish and Italian governments in jeopardy by letting the sovereign spreads to explode affecting the in turn the solvency of domestic banks that carry plenty of their bonds).[iii] A fiscal pact has been imposed, but there is no Federal government assisted by a SCB on hand to heal the local states and banks. To sum up, the EZ crisis is not a classical fixed exchange rate crisis (as De Grauwe foresaw) ; it is not a domestic financial crisis; it is what it is: a BoP crisis in an imperfect currency union. If the union were perfected, the crisis could be solved in the same way as a traditional domestic crisis. If it is not perfected, it is an unedited BoP crisis with a still unwritten final.

References

CESifo (2012), Forum Volume 13, Special Issue January.

De Grauwe Paul (1998), The Euro and the Financial Crises, Financial Times, February.

Diaz-Alejandro, C. (1985)Good-bye financial repression, hello financial crash, Journal of Development Economics 19, 1-24.

Febrero E., Uxó J., Bermejo F. (2012), El funcionamiento del sistema TARGET2 desde la Gran Recesión. Una aproximación desde la óptica del circuito monetario, XIII JORNADAS DE ECONOMÍA CRÍTICA, Sevilla, February.

Frenkel R. and Rapetti M. (2009) A developing country view of the current global crisis: what should not be forgotten and what should be done, Cambridge. Journal of. Economics. (2009) 33 (4): 685-702.

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Notes:

[i] Hat tip Paolo Borioni and Ronny Mazzocchi.

[ii] Indeed Keynes regarded the ICU as an extension of the principles that govern a national banking system, the same principle that informs T2. In 1941 he even called it ‘Currency Union’. In famous passages, he wrote: ‘In short, the analogy with a national banking system is complete. No depositor in a local bank suffers because the balances, which he leaves idle, are employed to finance the business of someone else. Just as the development of national banking systems served to offset a deflationary pressure which would have prevented otherwise the development of modern industry, so by extending the same principle into the international field we may hope to offset the contractionist pressure which might otherwise overwhelm in social disorder and disappointment the good hopes of the modern world. The substitution of a credit mechanism in place of hoarding would have repeated in the international field the same miracle, already performed in the domestic field, of turning a stone into bread’ (CW 1940-44: 75). But he was also very cautious: ‘In only one important respect must an International Bank differ from the model suitable to a national bank within a closed system, namely that much more must be settled by rules and by general principles agreed beforehand and much less by day-to-day discretion. To give confidence in, and understanding of, what is afoot, it is necessary to prescribe beforehand certain definite principles of policy, particularly in regard to the maximum limits of permitted overdraft and the provisions proposed to keep the scale of individual credits and debits within a reasonable amount, so that the system is in stable equilibrium with proper and sufficient measures taken in good time’ (CW 1940-44: 45).

[iii] The Greek, Irish and Portuguese governments are already insolvent. Note also that the solvability of Spanish banks is anyway precarious after the burst of the housing bubble.

A leader for the ILO

Vijay Prashad writes on the very important election for the head of the International Labour Organization, and the need to support Jomo K.S. a progressive economist, in particular in the middle of the current global crisis. He says:

On May 28, a select group of delegates will enter a room in the International Labour Organization (ILO) in Geneva to elect the body's next Director-General. Nine candidates are in line for the post. The ILO's byzantine process revolves around a tripartite structure, with the employers (the International Organisation of Employers), the workers (largely the International Trade Union Confederation, ITUC) and the governments sharing the task of selecting the next Director.

Read the rest here.

Newspeak, Europe and economics

The German representative on the board of the European Central Bank (ECB), Jörg Asmussen, says that the debate on growth versus austerity is the "wrong debate" since "we [who?] need both." Of course what he means by growth measures is labor market reforms, meaning more flexibility to fire workers (yes with more than 20% of unemployment in Greece and Spain, and double digits for the eurozone it seems that firing workers is really hard in the old continent). That would supposedly reduce the cost of workers, i.e. lower wages, and, as a result firms will hire more workers, even if nobody is buying their goods. And you wonder why things are the way they are in Europe?

PS: For a debunking of the idea that labor market flexibility is necessary for full employment, or that labor market protections cause unemployment, read this paper.

A time to reap

Conceição Tavares worked hard and now is time to reap the benefits. From Marx21 (hat tip Tomas Rotta).

Renowned professor and economist Maria da Conceição Tavares received yesterday, May 17th 2012, the highest scientific prize granted by the Brazilian government. The national foundation for scientific research (CNPq) awarded Conceição Tavares for her lifetime theoretical and practical achievements. Tavares has influenced generations of students, scholars, and state officials. The significance of the award is that it goes to a female Marxist economist. Dilma Rousseff, Brazil’s first female president and herself a former student of Conceição Tavares, personally handed the prize. During the official ceremony Dilma made clear in her brief speech that “Conceição Tavares treated economics as it should be treated, as political economy.”

Read the rest here.

PS: By the way, while it's true that Conceição was certainly influenced by Marx, it's far from clear that one could call her Marxist rather than say Structuralist. Her famous 1978 full professor dissertation (you had to write one to get a chair at a public university then) is basically Kaleckian, and was clearly influenced by Keynes. And as any Brazilian economist she was heavily influenced by Marxist historian Caio Prado and by the quintessential Brazilian structuralist Celso Furtado, beyond several structuralists at ECLAC, like Prebisch and Anibal Pinto. A more detailed story here.

Central Bank Independence not so well intentioned failure

Chris Giles, the economics editor of the Financial Times, thinks, rather surprisingly, that central bank independence (CBI) has been a failure, in England at least. In his own words: "with the benefit of hindsight, the first 15 years of BoE [Bank of England] independence should be seen as a well-intentioned failure."

His views hinge on the question of public control of central bank behavior. For Giles a well informed public could have pushed the BoE to act more boldly after the 2007 financial crisis, and to be more prepared for the global crisis that started with the Lehman collapse in 2008.

While I agree that CBI has been a failure -- and not just in England (yep ECB is what I'm thinking) -- and also agree that there is no reason why fiscal policy is more directly scrutinized, than monetary policy, by the people's representatives in parliaments in most countries, I would disagree that the mistakes have all been well intentioned [that might also explain why the BoE is fighting reforms, something that puzzles Mr. Giles].

The problem actually lies in the fact that a CBI is by definition not coordinating with the Treasury on fiscal policy, and in some cases might be forbidden to do basic things like buying government debt. The justification is the fear of inflationary pressures, while the truth might be closer to Kalecki's view that fiscal and monetary policy are used to maintain a significant level of unemployment to keep workers in line. The intentions behind CBI are not so pure as Mr. Giles assumes.

CBI means that the objectives of monetary policy are not to be discussed by the public. In the case of England, as well as Europe (and even the US), the problem is that more fiscal policy is needed, and more support from their central banks should follow.

Letter of support for the new central bank law in Argentina

The prevailing ideology over the last thirty years has been that the only legitimate task of central banks everywhere is control of inflation. This has frequently been through the application of an "inflation target", a maximum rate of increase of some measure of aggregate price changes. The practical consequence of setting the "fight against inflation" as the primary objective has been to reduce substantially the policy options of central banks. Even more, this narrow approach prevents the coordination of monetary policy and fiscal policy, essential to successful countercyclical interventions.

In Argentina in the 1990s economic policy operated under the burden of an extreme form of this narrow approach, a "currency board" regime, involving a fixed exchange rate to the dollar and a monetary base strictly linked to foreign exchange reserves. During 1997-2002 the weaknesses inherent in this monetary policy created disaster, economic collapse and high inflation.

In March of this year, the Argentine government proposed a new central bank mandate, that would repeal the currency board rules and broaden the institution's mandate to multiple objectives including growth, more equitable distribution, sectoral credit allocation, and price stability. The Congress passed and President Cristina Fernandez signed it into law the new mandate.

We, economists working in the United Kingdom, applaud the Argentine government and the Congress for this farsighted approach to monetary policy. The new mandate allows the current and future governments to choose between wise and foolish economic policies, while the previous law institutionalized the latter.

George Irvin
Costas Lapavitsas
Terry McKinley
Jan Toporowski
John Weeks
(SOAS, University of London)

Ann Pettifor
(Prime Economics)

G. C. Harcourt
Ha-Joon Chang
Gabriel Palma
(Cambridge University)

Malcolm Sawyer
Gary Dymski
Annina Kaltenbrunner
(University of Leeds)

Guy Standing
(University of Bath)

Engelbert Stockhammer
(University of Kingston)

Ozlem Onaran
(University of Westminster)

John Grahl
(University of Middlesex)

Sarah Bracking
(University of Manchester)

Kalim Siddiqui
(University of Huddersfield)

Hulya Dagdeviren
(University of Hertfordshire)

Michael Burke
(Socialist Economic Bulletin)

Published in Spanish in Página/12 (thanks to John Weeks for providing the original English version)

Greeks pay their fair share

Krugman suggests that we might be close to the end, if Greece is unable to form a government and ends up out of the euro, which seems increasingly likely. One thing that everybody seems to agree is that in the Greek case fiscal issues did play a role. So here is some food for thought, are Greeks taxed at lower rates than citizens of other OECD countries?

The overall tax revenue as a share of GDP is actually a bit lower than the German, but not much, and is higher than the US, according to OECD data. There are differences on what kinds of taxes Greeks and Germans pay, with the Greek paying more on goods and services and less on income (i.e. a more regressive tax structure). But, for what is worth, tax revenues are not way off with respect to other countries.