Multiplier-Accelerator and Business Cycles

 

 That would be long indeed (100 years or so for the US)

Keynesian theories of the business cycle start from the notion that the changes in income equilibrate savings to investment, and the level of activity is determined by effective demand. In that sense, the economy can fluctuate in the long run, with wage and price flexibility, around a normal position that is below full utilization of labor and capital. Unemployment is the norm. Keynes was not concerned in the GT with business cycles per se, even though he discussed the issue at the end of the book. His main concern was with what he referred to as unemployment equilibrium. It is clear in his terminology, unemployment equilibrium, instead of disequilibrium as Patinkin suggested would be more appropriate, that Keynes meant that unemployment was not the result of some type of imperfection, wage or interest rate rigidities, for example, which became the leading explanation for unemployment among the mainstream Neoclassical Synthesis or New Keynesian authors.

Keynes suggested that it was the cyclical changes in investment, which he associated with the marginal efficiency or productivity of capital, in marginalist fashion, that determined business cycle fluctuations. His correspondence with Harrod on the growth model, and Tinbergen's method, suggests that he disliked the accelerator, which was probably too mechanical for him. In that sense, cycles in Keynes own conception depended on shocks, which were associated to the state of long-term expectations, and the state of confidence.

Kalecki, which independently from Keynes advanced the Principle of Effective Demand (PED), developed an early theory of the cycle based on the interaction of Keynes’ multiplier process with the concept of the accelerator. Kalecki emphasized the role of time lags between the placing of investment, the demand for new equipment, and the delivery of the new equipment, indicating the dual role of investment as part of demand, but as creating productive capacity in the future. Further, Kalecki suggested that investment orders are a positive function of autonomous demand and a negative function of the existing capital stock.

Assuming that expectations about future demand are high, then investment would increase and through the multiplier effect it would have a reinforcing effect on income. The increase in income, in turn, would lead, according to the accelerator, to an increase in investment, leading to an economic boom. However, as investment increases, eventually new investment orders would exceed the replacement requirements, and the capital stock would also rise. This would have a negative effect on the rate of increase in investment, and new investment orders would slowdown first, and then decrease. The decreasing orders would have a negative impact on demand, and through the multiplier, lead to a reduction in the level of income, creating the conditions for a recession. The falling income would imply lower investment, following the accelerator, and even further collapse of income. In the depression, investment orders would collapse and at some point they would fall below the replacement requirements associated to depreciation, leading to a reduction in the stock of capital. Finally, the falling stock of capital would make the need for investment inevitable, and that would lead to more demand and a recovery.

The essential mechanism of the business cycle in the Kaleckian model was connected to the lags between the demand effect and the capacity effect of investment. Kalecki assumed that shocks would provide the initial spark for the business cycle, and the multiplier-accelerator mechanism would keep it going. He noted also that only under very specific circumstances would the cycle recur, and that additional shocks would be necessary to avoid a dampened cycle.

Kaldor developed a model, later formalized by Goodwin and Hicks, which allowed for the economic cycle to recur even in the absence of external shocks. The central difference in the Kaldorian model was the introduction of non-linear investment and savings functions. The idea was not to deny the existence of stochastic shocks or time lags, but to demonstrate that the economic system would also fluctuate in their absence, and that in a broad sense the capitalist system was inherently unstable.

This view of the cycle was dominant and basically accepted by the mainstream Neoclassical Synthesis in the 1950s and 60s. Yet, the notion of an endogenous cycle was one of the first victims of the attack on Keynesian economics in the 1970s. Eventually leading to the Real Business Cycles (RBC) school. Today most macroeconomic textbooks do not even mention the accelerator, even though the empirical evidence for it is overwhelming.

Crisis and Cycles in Economic Dictionaries and Encyclopaedias by Daniele Besomi

This is a review of this edited book that was just published in the Review of Political Economy.

This substantial volume provides an interesting and exhaustive discussion of the theories of business cycles as presented in the main economic dictionaries and encyclopedias over a period of almost two centuries. For the most part the content corresponds to the views of key authors who contributed to the development of the theories of fluctuations. Some major authors are nevertheless not directly covered, presumably because they did not write, or were not the subject of, encyclopedia entries. Joseph Schumpeter is one example of an important author who is not covered. Several chapters are devoted to schools of thought, e.g. Real Business Cycles, or to subfields like Political Business Cycles. The editor’s decision to focus on dictionary entries reflects his belief that these publications were authoritative and influential, and that the views expressed in them carried significant weight.

Part I, which is comprised of four chapters written by the editor, Daniele Besomi, provides an invaluable discussion of the history of economic dictionaries, and a useful analysis of the different terms economists have applied to what we now call the business cycle. The distinction between cycles proper and crises is central to the way Besomi classifies cycle theories, and again becomes relevant at the end of the volume when some alternative views are analyzed.

Part II discusses the so-called classical dictionaries, and covers a vast number of contributions from the early 19th century until approximately the late 1960s, including entries on crucial authors like Wilhelm Roscher, Clément Juglar, Adolf Wagner, Mikhail Tugan-Baranovsky, Arthur Spiethoff, Wesley C. Mitchell, Arthur Burns, Trygve Haavelmo and Jan Tinbergen. Dictionaries in French, German, Italian, Russian and Spanish are represented. The chapters explain the evolution of views on fluctuations, from a general discussion of unsystematic crises, to the analysis of more regular crises dependent on the state of confidence, and from Marxist crises of underconsumption, overproduction and disproportionality, to the development in the 1930s of the shock and propagation mechanism theories, which rely on more precise formal mechanisms to explain fluctuations.

The absence of some key names is unfortunate. Given the importance of the multiplier mechanism, Kalecki and Keynes deserve more attention than they get in this book. John Maurice Clark and the accelerator principle also get minor mention. More importantly, Besomi does not clearly distinguish theories that see the cycle as the result of external shocks from those that emphasize the endogenous character of economic fluctuations. There is a brief discussion on how Mitchell’s views rely in an informal way on the interaction of the multiplier and the accelerator, but no specific entry on the theories in which these two mechanisms are the key generators of fluctuations. Nor is there a full discussion of Richard Goodwin’s predator-prey model, which together with the multiplier-accelerator mechanism, provides one of the fundamental explanations of business cycles as endogenously generated phenomena. There is a brief discussion of the predator-prey mechanism in a chapter on nonlinear cycles, a field in which Goodwin formalized ideas developed by Nicholas Kaldor and John Hicks. Goodwin’s growth-cycle model was developed in the period of the classical dictionaries, but presumably was not discussed in any of them.

The last part of the book covers the period of the recent dictionaries. Nikolai Kondratiev and Long Wave theories of the cycle are discussed in this part, along with Real Business Cycles, political cycles and nonlinear cycles. There is no discussion of how the mainstream, which had accepted the multiplier-accelerator framework during the period when the Neoclassical Synthesis held sway, came to adopt optimizing models with imperfections and demand shocks as the main explanation of fluctuations. All we are told is that these models arose in reaction to Real Business Cycle theory. Aside from its discussion of long waves, the book offers no explicit chapter on heterodox views of the cycle (unless one classifies all nonlinear cycle theories as heterodox—a questionable view, to say the least). This seems to be due not to the failure of recent encyclopedias to discuss heterodox theories but to the choices Besomi and his contributors made regarding which dictionaries to consider.

To some extent this problem is mitigated by the thought-provoking last chapter on the return of crisis theory, also penned by the editor. Recent theories of crisis tend to emphasize the non-calculable, or qualitative, aspects of fluctuations, as against the more formal and mechanistic elements of cycle theories. In this chapter some entries that explicitly deal with Marxist and Post-Keynesian theories are discussed. The view of crises, particularly financial crises, as endemic within this context is also examined, although the work of Hyman Minsky, which is central to this topic, is not explicitly explored. There is only one brief mention of Minsky, in an early chapter by the editor on the taxonomy of fluctuation theories.

Most of the concerns I have raised about the coverage in this impressive volume are related to the choice to analyze the evolution of views on crises and cycles through the lens of entries in the most prominent dictionaries and encyclopedias. This provides a relatively easy way to determine the consensus view at a particular point in time; but it also precludes a more critical understanding of the limitations of conventional wisdom. This is by no means a disqualifying feature of the volume under review; it is merely an editorial choice that privileges certain views at the expense of others—a trade-off that, at the end of the day, is unavoidable. This volume is a tour de force, and will remain an essential resource for those interested in the history of business cycle theories.

Kaldorian and Sraffian supermultipliers: a clarification

This is a post for those interested in demand-led theories of growth. Not long ago I wrote a post on misconceptions about Sraffian economics. Marc Lavoie sent me a nice email about it, and a recent paper he published in Metroeconomica (subscription required), which comments on a paper I wrote with Esteban Pérez (working paper available here). In his discussion of supermultiplier models, which put the multiplier and the accelerator together to explain -- not fluctuations of the level of output around its normal position -- but the determination of trend or normal output. Lavoie says:

"Other post-Keynesians, also assume that non-capacity creating autonomous expenditures are the driving force, rather than investment. Serrano himself refers to Kaldor (1983, p. 9) to provide support for this reversal of causality. Fazzari et al. (2013) assume that there is some unidentified demand component that grows autonomously, in order to tame Harrodian instability; Godley and Lavoie (2007, ch. 11) and, as already pointed out Allain (2015), rely on autonomous government expenditures. Indeed, there is a large Kaldorian literature that relies on exogenous growth components other than business investment, most particularly the whole literature on Thirlwall 's law with its exogenous exports (McCombie and Thirlwall, 1994), as well as Godley and Cripps (1983), with both government expenditure and export sales."

And in a footonte to that passage he says:

"Thus, adding to the confusion over terminology, Pérez-Caldentey and Vernengo (2013) refer to the Kaldorian tradition when discussing models based on induced investment and non-capacity creating exogenous growth components such as Serrano's Sraffian supermultiplier analysis."

So let me clarify our use of Kaldorian, and also why I believe that it is a mistake to refer to the Sraffian supermultiplier as neo-Kaleckian, even though it does have evidently Kaleckian elements. As I understand the distinction that came to dominate demand-led models of growth, there are basically two* main traditions, one that is referred to as neo-Kaleckian, and one that is referred to as Kaldorian.

The first tradition developed from Bob Rowthorn's expansion of Joan Robinson's 1960s model. And because Joan Robinson was influenced by Kalecki, and  Rowthorn, a Marxist author, was seen as Kaleckian, the name stuck. The original model, one must note was wage-led. And causality basically determined whether the authors was Keynesian or Marxist, with Ed Nell famously referring to one author that suggested that causality went from income distribution to growth as Jean Baptiste Marglin. At any rate, Marxist and Keynesian closures, to use the term popularized in this context by Lance Taylor, were special cases of the neo-Kaleckian model. Later developments introduced changes in the independent investment function which allowed for a profit-led closure.

As I noted before, the term Kaleckian is a bit of a misnomer. The current version of the model allows for a profit-led closure, which is not clearly in Kalecki, and, besides its derived from Joan Robinson's model. The Kaleckian feature is that often it is assumed that workers do not save, and capitalists do not consume, for simplification, a classical political economy type of assumption really.**

The genesis of supermultiplier models is more convoluted. On the one hand, the combination of multiplier and accelerator was used to discuss economic cycles, not growth, including by Hicks, who first discussed the idea of the supermultiplier. By the late 1960s, Kaldor moved away from the differential savings or neo-Keynesian growth models (sometimes referred to as Kaldor-Pasinetti or Cambridge growth model), and adopted the supermultiplier model, formalized by Thirlwall in the 1970s. The model assumed as a simplification that exports were the only autonomous component of demand. In accordance with the accelerator, investment was seen as derived demand. That is the main difference with the so-called Neo-Kaleckian models, namely: there is no independent investment function.***

The idea of the supermultiplier was later, in the 1980s and 1990s, developed by Bortis and Serrano,**** both authors sharing a Sraffian perspective. In these versions, autonomous spending was not restricted to exports, and government spending was also relevant. The term Sraffian or classical-Keynesian has been used to describe these models. In essence, they are Kaldorian models, since investment is derived demand, as much as in Thirlwall's model. In this sense, even though the Kaldorian models a la Thirlwall are a special case of the Sraffian supermultiplier, as discussed here in my debate with Jaime Ros (in Spanish), and by definition more general than the export-led growth model, they came later, and can be seen as a development within this tradition.

So certainly the intention is not to create confusion. In my view, models with an independent investment function are broadly speaking neo-Kaleckian, while models in which investment is derived demand are Kaldorian. And there are differences between models within those broadly defined traditions.

* All taxonomies are somewhat arbitrary and one might see some sub-divisions from the two main branches discussed here as standing in the same footing, for example, some might argue for an explicitly Marxist tradition.

** Goodwin predator-prey models, which have become quite fashionable, can be seen as a variation of these neo-Kaleckian models.

*** I think these Cambridge models have been completely abandoned since the 1960s, and that is the reason why I don't have three types of models in my taxonomy. They are a historical curiosity, associated to a response to the Harrod instability problem, at a time when full employment seemed like a stylized fact in advanced capitalist economies. For a clear explanation of the implications of the different model closures see the paper by Franklin Serrano and Fabio Freitas here.

**** The Sraffian versions of the supermultiplier model also assume differential savings by workers and capitalists, as many other classical political economy inspired models, and in that sense have Kaleckain features. But they are not neo-Kaleckian, since there is no independent investment function.

IMF wants austerity and social security reform in the US

Blanchard presenting the WEO Report at the Spring Meetings

The new edition of the bi-annual World Economic Outlook is out (there is one in April and one in October). Olivier Blanchard, from MIT, and the IMF's Economic Counsellor since 2008, is the intellectual force behind the report. In the IMF's view, in the case of the United States:

"The next prominent policy challenge will be a smooth normalization of monetary policy. Building political consensus around a medium term fiscal consolidation plan and supply-side reforms to boost medium-term growth—including simplifying the tax system, investing in infrastructure and human capital, and immigration reform—will continue to be a challenge." [Italics added]

Fiscal consolidation is IMF speak for austerity. Austerity is really about less spending, and higher taxes, but fiscal consolidation should be about the results, meaning lower deficits and debt. Note that austerity is NOT the best way to get fiscal consolidation. Also, normalization of monetary policy can only mean higher interest rates. So for the IMF we are at the natural rate, or so it seems.

In the case of the US labor markets are seen as flexible enough, so immigration is seen as central for keeping real wages low, rather than further deregulation. Yes, supply side reforms are often about lowering real wages. They do not provide much in terms of what austerity would mean. Again from the report:

"Addressing the issue of potential growth will require implementation of an ambitious agenda of supply-side policies in a fractious political environment. Forging agreement on a credible medium-term fiscal consolidation plan is a high priority... [This] will require efforts to lower the growth of health care costs, reform social security, and increase tax revenues." [Italics added]

Reform social security is IMF speak for cutting and delaying benefits, and increasing payroll taxes. Not necessarily privatize it, although some might be in favor of that at the IMF. So supposedly in the US the priority is to promote austerity by reforming social security. The New IMF is great.

On the plus side, the IMF has rediscovered the accelerator (I checked a few older versions and have seen no trace of the accelerator in the last couple of reports) and the report shows:

"estimates of how much investment weakness can be explained by output dynamics based on investment models estimated at the individual-country level. The analysis is based on the conventional accelerator model of investment... A key assumption is that firms adjust their capital stock gradually toward a level that is proportional to output. In addition, firms are assumed to invest to replace capital that depreciates over time... The empirical literature has found strong support for this model, as in Oliner, Rudebusch, and Sichel 1995 and Lee and Rabanal 2010 for the United States, and, more recently, in IMF 2014a and Barkbu and others 2015 for European economies."

Funny, so supply responds to demand, that is, firms adjust their supply capacity to expected demand, but all reforms for growth are based on supply side factors. Yeah, way to use the right theory, but keep the wrong policy advice.

More on income distribution and growth (wonskish)

Kaldor and Kalecki

A few years back Sam Bowles presented a paper (Kudunomics: Property rights for the information-based economy) at the University of Utah. At dinner he reaffirmed his conviction that Arrow-Debreu General Equilibrium (GE) is compatible with different kinds of behavior and can be a force for progressive economics. Conventional marginalist theory suggests that income distribution is the result of relative scarcities, and, as a result, real wages should equal the marginal product of labor, i.e. labor productivity. When asked how he squares the belief in GE with the fact that wages in the US do NOT follow productivity since the 1970s, Bowles seemed puzzled. And the relation of income distribution and growth remains puzzling for the mainstream and its sycophants.

In the heterodox camp, the discussion has been centered, for the most part, between the so-called Kaleckian and Kaldorian models. First, I should note that from a history of ideas point, the Kaleckian name is a misnomer. Kalecki’s models where about the interaction of multiplier and accelerator, with shocks and lags, to produce fluctuations. In the various forms of his accelerator equation Kalecki included a trend, producing fluctuations around a trend. The so-called Kaleckian models derive from Harrod and Joan Robinson’s attempts to extent Keynes’ Principle of Effective Demand (PED) to the long run.

The PED says that an increase in investment is matched by an exact increase in savings, and that the level of income is the main adjusting variable (rather than the interest rate as in the Loanable Theory of Funds). The Kaleckian models basically normalize the IS identity by the capital stock, assume (in the extreme case) that the propensity to save out of wages is zero, and a propensity to save out of profits (s) between zero and one, and in Keynesian fashion have investment determine savings. The difference with the short-run story is that now accumulation (investment-to-capital ratio) determines income distribution (the rate of profits), a result often referred to as the Cambridge equation.

The various incarnations of the Kaleckian models are defined by the way the investment function is specified. For example, in the influential paper by Bhaduri and Marglin (B-M) (subscription required) they argue that investment and savings are functions of the profit share (h) and capacity utilization (z). In other words:

I(h, z) = shz

Solving for z and deriving with respect to h we have:

dz/dh = (Ih – sz)/(sh – Iz)

Where Ih is the response of investment to profitability and Iz to capacity utilization. Assuming stability, that is, that savings respond to profitability more than investment to capacity utilization and the denominator is positive, the sign of the equation depends on the numerator. If investment is strongly responsive to profitability (Ih > sz), then the system is profit-led (exhilarationist in B-M terms). If not we have the wage-led (stagnationist) regime.

As I suggested in my previous post, there are some theoretical problems with the type of model used to argue that the US economy is profit-led, besides the empirical ones alluded before. The independent investment function suggests that capacity utilization affects capital formation, if capacity is low there is more investment, and vice versa when z is high. In other words, firms would try to adjust capacity to demand. If that is the case you would expect that a normal relation between capacity and demand would be established in the long run (in the neoclassical view demand adjusts to capacity; that’s Say’s Law), which could be seen as the relatively stable output-to-capital ratio over the whole period for the US, in my previous post.

If that is the case, investment is determined by the adjustment of capacity to exogenous demand in order to reach the normal capacity utilization, and it is essentially derived demand (the accelerator principle). It is not instrumental in determining the normal level of capacity utilization, which must be determined by the exogenous components of demand. This is the basis of the supermultiplier models, first developed by Hicks, and then by Nicholas Kaldor, and referred to as Kaldorian in the heterodox literature (for more on that see this paper).

That is the essential difference between the Kaleckian and Kaldorian models, whether investment is partially autonomous and determined by profitability or it is derived demand. Of course income distribution in Kaldorian models might have ambiguous effects on growth, but firms would not investment more if profits went up, if there is no increase in demand. In this sense, worsening income distribution might lead to higher growth if demand keeps going for some reason (say more private debt stimulates consumption; or stimulates the consumption of a higher income group). But in general profit-led growth that stimulates investment, as in the M-B framework seems hard to explain from a theoretical point of view. Hence, the confusion it generates empirically (e.g. in the case of the US the notion that a debt-led consumption boom is a profit-led story).

PS: The typical Kaldorian model is based on Thirlwall's work, but the book by Bortis and Serrano's dissertation (or his paper; subscription required) are essential readings.

Is the American economy profit-led?

In a recent post I showed the evolution of real wages and long-term real rates of interest in the United States from 1950 until now. The figure below shows the real rate of output (GDP) growth for the same period. Between 1950 and 1973 the average (red line) rate of growth was 4.2% and in the subsequent period it was 2.7%. In other words, the change in income distribution dynamics, with a significant slower rate of growth of wages, was accompanied by a significant reduction in the pace of economic growth (we also saw in the previous post that it also went hand in hand with higher real rates of interest).

Many authors (e.g. the late David Gordon), in particular when looking at the evidence post-1970s, argued that the American economy is profit-led. In other words, as profits (some emphasized profit shares while others prioritized profit rates; the profit rate time the level of capacity utilization gives the profit share) expanded, it stimulated investment, and this, in turn, led to output growth. Growth was driven by profits.

The idea is that, even though the reduction in wages has a negative effect on consumption and output growth, this is more than compensated by the increase in investment. However, there are some empirical problems (there are some theoretical issues that I’ll deal with in another post) with this kind of model (often referred to as Kaleckian, even though it seems that their origin should be traced to Joan Robinson’s Accumulation of Capital and the influential formalization by Bob Rowthorn in the early 1980s).

For starters, growth actually fell significantly after real wages stagnated. Also, the output-to-capital ratio (shown from 1960 to 2008 using a OECD measure), as can be seen in the graph below, does not indicate a marked shift in the 1970s. The output-to-capital ratio goes up in the Johnson and Clinton booms, and falls otherwise. The Reagan boom was mild at best. This is consistent with the accelerator. As the economy moves closer to full employment, the output-to-capital ratio, a proxy for capacity utilization, moves close to its maximum. The accelerator would suggest that investment adjusts capacity to output. Investment is not the locomotive of the system, is the rear car (the idea behind the accelerator principle).

Since the 1970s the drivers of accumulation in the United States have been consumption booms driven by debt accumulation. In other words, as Barba and Pivetti have argued, increasing debt has allowed American families to continue to consume, in spite of stagnated wages. This has been mistaken in the empirical literature as a profit-led boom. The suggestion here is that the booms have continued to be driven by consumption (as in more traditional wage-led cases), and that the benefits for capital have been financial and associated to higher interest rates. The last three booms have been more Wall Street debt-led booms, rather than profit-led investment booms. Wall Street, not the Silicon Valley, defines the current American economy. After all, we all remember Gordon Gekko’s “greed is good” (uttered in real life by Ivan Boesky) and nobody remembers an iconic phrase by Bill Gates!

Investment Rate, Growth and Accelerator Effect in the Supermultiplier Model: the case of Brazil

A new paper by Julia Braga, that she will present at the next Eastern Association Economic Meeting in Boston. From the abstract:

"This paper investigates the role of demand in the productive investment evolution in the Brazilian economy. First, it assesses the long-run relationship between investment rate and GDP growth, taking annual data since 1962 until 2015. We then construct a “Final Demand” index and estimate its impact on productive investment growth rate, taking quarterly data since 1996q1 until 2017q2, highlighting a shift in the aftermath of the 2008 world economic crisis. The results support two hypotheses of the Supermultiplier model of Freitas and Serrano (2015) and Serrano, Freitas and Behring (2017) for the Brazilian economy: 1) non-capacity creating expenditures lead productive investment; 2) there is a very slow adjustment of the investment rate to demand growth, as described by the flexible accelerator process."

Read full paper here.

Causality and the new World Economic Outlook (WEO)

I often say that causality is the main, but not the only, difference between mainstream and heterodox approaches in macroeconomics. It's true for differences between Say's Law versus the Principle of Effective Demand, for discussions of exogenous/endogenous money, and also for interpretations of the relation between growth and productivity.

The new WEO is out (here). This one the first under Maurice Obstfeld, who substituted Oliver Blanchard. The explanation for lower growth in Obstfeld's intro says the following:

What underpins forecasts of moderating growth? First, the ongoing experience of slow productivity growth suggests that long-run potential output growth may have fallen broadly across economies. Persistently low investment helps explain limited labor productivity and wage gains, although the joint productivity of all factors of production, not just labor, has also been slow.*

So low productivity growth causes low output and employment growth, rather than vice versa. Further, lower investment is what causes low labor productivity, which is actually a plausible mechanism. No new machines, no increase in labor productivity.

But as the IMF has recently noticed, the accelerator is the mechanism that explains investment behavior (see here on the previous WEO rediscovery of the accelerator, and also Obstfeld says in the following line: "low aggregate demand... discourages investment"), and that implies that growth is what determines investment and, as a result, labor productivity. So low growth is caused by low growth. Good job!

* I'll leave out the problems with total factor productivity, which have been extensively discussed in the blog before.

On the blogs

Crowding In and the Paradox of Thrift -- Krugman praises Blanchard and the IMF research department. He too has rediscovered, but it was a few years back in his case, the accelerator. No word from him on why then all IMF policy advice is based on supply side reforms and why Blanchard thinks the priority in the US is fiscal consolidation. My take here. Note that here you have the typical organized hypocrisy story, the research department says reasonable things (accelerator), while the policy advice continues to be the same.

The economist's manifesto -- Tim Harford ask economists for policy advice. Often a terrible idea. Proposals are to abolish national insurance entirely (in my view the worst of all proposals) and replace it with higher rates of income tax, increase property taxes, to spend more on urban development, and R&D and infrastructure. Wren-Lewis proposes a rule for monetization of fiscal deficits when interests rates are at the zero bound. Not too bad.

What Causes Recessions? -- Noah Smith gives the traditional New Keynesian answer, shocks and price rigidities. No mention of endogenous cycles, meaning those that result from the normal functioning of the system. On that go here.

"The Question of Confidence" According to Marriner Eccles

From an address at a Conference on "Debt, Taxation, and Inflation" organized by the Wharton Institute of the University of Pennsylvania in May 8, 1936, and held at the Waldorf-Astoria in New York. In his words:

"Leaving aside plans which involved fundamental and far-reaching changes in our whole economic organization, the solutions offered to the country in 1933 were of two main types. On the one hand there were those who contended that all that was needed was the restoration of confidence. They insisted that it was essential to balance the budget... On the other hand there were those who, like myself, felt that recovery in the present situation could only be achieved by bold and aggressive intervention by the government, largely through underpinning the entire private credit structure which had collapsed, and undertaking to restore purchasing power through relief, public expenditures and other measures.
...
What businessman would have added to his plant, when he already possessed a great amount of excess capacity, merely because he read that the budget had been balanced? It is difficult to understand why people would be expected to invest money in new enterprise when existing investments were becoming less profitable every day. It should not require any great insight to understand that a reduction of government expenditures while everybody else as a matter of self-protection was being forced to reduce expenditures, could only accentuate the processes of deflation by reducing buying power.
...
A belief that industry would have voluntarily entered upon capital expenditures in 1933 if the government had restricted its expenditures and raised taxes is unrealistic to the highest degree. It displays an utter miscomprehension of the considerations that influence a business man in planning expenditures. There must be reason to believe that capital expenditures can be profitably made before they are undertaken."

Note that this argument builds on a clear comprehension of the accelerator mechanism. Firms buy machines when  they expect demand to increase and, hence, higher profits. In this sense, the empirical evidence on the accelerator should be relevant not just to show that low interest rates are not sufficient for expanding demand, but also to put a nail in the coffin of the confidence fairy. Austerity hurts confidence and private investment.

Mitchell and Clark on the business cycles

Starting my seminar on business cycles this week. Mainly theories and then a discussion of both Great Depression and Recession. In the US the original authority, and the intellectual driving force of the analysis of the cycle which started at the National Bureau of Economic Research (NBER), was undoubtedly Wesley Clair Mitchell. The figure above comes from an early analysis of global cycles published in the New York Times back in 1926 (subscription required). The Times quotes him saying that there was: "a trend in the direction of a world economy in which all nations will prosper or suffer together." In other words, a tendency to a global cycle.

In fact, Mitchell is often remembered more as a founder of the NBER and of the quantification of business cycles than his role as a disciple of Veblen and a founder of American Institutionalism.* His institutionalism, however, is often reduced to empiricism. In other words, Mitchell generally is not considered as a theorist. Howard Sherman suggests (subscription required), however, that: "embedded in his theory, but not made explicit in those terms, is a theory of the multiplier and the accelerator." In other words, a Keynesian approach to the cycle.**

This is consistent with the work we published with Luca Fiorito on another institutionalist from Columbia, namely: John Maurice Clark. As we noted then, the fact that the less mechanical, and also non-neoclassical version of Keynesian ideas, basically in contrast to the so-called Neoclassical Synthesis, was relegated to secondary status in the US in part explains how Keynesianism was reduced to a simple case of rigidities and imperfections. Not surprisingly the multiplier-accelerator interaction as the basis of the cycle, even though the empirical evidence for both components is strong, is not part of the mainstream macroeconomic textbooks.

* He was also one of the founders of the New School for Social Research in 1919.

** Mind you he did write with Arthur Burns, who eventually became a Monetarist associated with Milton Friedman and the chairman of the Fed, a famous NBER book on the cycle.

Investment, interest rates and the accelerator: more evidence for the US

Not that is really necessary. But the evidence continues to be overwhelming. Christian Schoder in a recent paper (here; subscription required), following in the steps of the classic paper on the subject by Fazzari et al. (1988) and looking at the micro data on investment concludes that:

"Overall, demand constraints seem to be crucial factors contributing to the slowdown of accumulation in times of economic distress relative to credit market conditions. In contrast to the prediction of the financial accelerator literature that credit constraints tighten in the downturn (relative to demand constraints) as net worth deteriorates, the cash-flow coefficient does not exhibit a clear counter-cyclical pattern.

We further find that the most tremendous declines in business investment which occurred in the contexts of the recessions in 1982, 1990, 2001 and 2008/09 were driven by the demand side of the capital market rather than the supply side since, during these times, an improvement of investment opportunities reflected by an expansion of sales growth and Tobin’s q, on average, induced firms to raise investment to a disproportionately large extent whereas an easing of credit constraints, on average, provoked only a disproportionately small expansion of investment."

In other words, cost of capital variables, that are measured at the firm level using a CAPM model and approximating by the ratio between interest payments and stock of debt, are not significant. Sales, i.e. demand, is what drives investment. And yes that means that more government demand was needed. In his words:

"The results suggest that investment tended to be driven by adverse demand rather than supply conditions during the most severe recessions. Especially, the decline of investment after the financial meltdown in 2007–2008 is associated with inferior demand conditions compared to supply conditions. This view is consistent with the chronicles of US fiscal and monetary policy stance regarding the management of aggregate demand and credit flow. Our policy evaluation implies that the policy attempts to stabilize demand were insufficient in order to stabilize investment in the recent economic crisis."

That's what the recent evidence suggests. No surprises here.

Wage and Profit-led Growth

New Working paper at the Levy Economics Institute with Esteban Pérez Caldentey. From the abstract:

We argue that a fundamental difference between Post-Keynesian approaches to economic growth lies in their treatment of investment. Kaleckian-Robinsonian models postulate an investment function dependent on the accelerator and profitability. Some of these models rely on the importance of profitability, captured by the profit share, to make the case for profit-led growth. For their part, Kaldorian models place the emphasis on the accelerator. More important, investment is a derived demand; that is, it is ruled by the adjustment of capacity to exogenous demand, which, in turn, determines the normal level of capacity utilization.

In our view, the Kaldorian approach is better equipped to deal with some of the issues relating income distribution to accumulation with effective demand in the long run. We develop a Kaldorian open-economy model to examine the conditions under which an increase in real wages can produce profit or wage-led growth, showing that the limit to a wage-led expansion is a binding external constraint. The role and limitations of wages as a determinant of growth are further examined through spectral techniques and cycle analysis for a subset of developed economies. The evidence indicates that real wages are positively related to growth, investment, and capacity utilization. It also highlights the role of finance in sustaining expansions, suggesting that debt-led growth should not be identified with profit-led growth.

Read the rest here.

Dude seriously, it's the accelerator

Once again I get to discuss on whether investment depends on 'animal spirits', Schumpeterian entrepreneurialism or other confidence fairies. The evidence, as I noted here before, is quite overwhelming in favor of a simple and logical empirical regularity, namely: the accelerator. Below the last results from the Fair Model.

KK is the capital stock, RBA is the bond rate, and Y is income. Note that the coefficient on bond interests is insignificant, both statistically and in economic terms. What drives the change in the capital stock are the contemporaneous and lagged changes in the levels of income (demand). This is not only in the data, but is also quite logical. It says that firms increase their capital stock when demand increases (note that firms have always some spare capacity, so they are looking for permanent increases in demand). If there is no increasing demand there is no need to invest.

Not a surprising result, unless you for some other reason need the Superman theory of investment, in which the firm, the entrepreneur, the job creator is the hero that will save humanity from its mediocrity [have you been reading Ayn Rand again?].

PS: Ray Fair model uses the old Cowles Commission approach to macroeconometrics, which is much better than the new Dynamic Stochastic General Equilibrium (DSGE) models, that rely more heavily on calibration rather than estimation. He discusses the issue here.

Goldman and Chinn discover the accelerator

Steve Bannister (where have you gone Joe Di Maggio?) pointed out this nice post by Menzie Chinn on the "puzzle" (sic) of the slow investment recovery during the crisis. Note that it is actually not a puzzle at all. Chinn cites a study by the Vampire-Squid (Goldman Sachs), that concludes that (wait for the surprise) "the accelerator model generally fits well." Chinn also finds that lending conditions and "slow GDP growth (attributable to fiscal drag) are important determinants of low nonresidential fixed investment." Is rain wet?

PS: Lending conditions (which is actually a measure of liquidity) might actually be caused by the level of activity and investment rather than the other way round.

What to expect from the incoming government in Argentina

The government in Argentina has less than two weeks at this point. It is too early to pass judgment. But we can look at the legacy of the Macri administration, and indicate a few things about the current strategy. A paper I have just received from Fabian Amico, that will soon be published in Circus, will be invaluable for my very brief comments here (the new issue of Circus and his paper will eventually be linked here, in Spanish).

The first thing that should be evident is that the 4 years of the Macri administration, that were supposed to restore economic growth, something that had faltered since 2011, essentially as a result of an external constraint, were a failure. Using IMF data, the average GDP growth in the period was -0.2 percent. Yep, negative. Amico uses a local activity index and the results are visibly not very different (his numbers give an overall decline of 1.7 percent for the whole period).

Macri's administration also lifted capital controls, paid the Vulture Funds more than US$ 9 billion, and open the doors to additional foreign borrowing. The Macri government had put all of their bets on the notion that growth would come from private investment and exports, rather than the combination of government spending and higher wages, which allows for higher consumption. Below you can see how well that worked out for them.

As it should be clear only exports grew (Amico calls, aptly, the Macri period an export-led stagnation one), and not as a result of the real devaluation, since they grew at about 2 percent per year, more or less in tandem with the growth of global GDP. So much for the notion that devaluation provides space for policy, and higher growth. The collapse of government consumption, and the fall in real wages were crucial to explain the poor performance. Investment followed the accelerator and collapses with the fall in GDP.

The real depreciation of the exchange rate, as is well-know, affects negatively the real wages, that fell approximately 30 percent during his government, and as I had noted back in 2015, that was the real objective of his government. In that sense, one can say that his government did achieve its main goal. The participation of wages in total income fell 8 percent, as shown below.

The worst mistake was the increase in foreign debt in foreign currency, of course, the currency crisis and the return of the IMF, which I've already discussed (here and here) so I'll not delve again into this.

The Fernández administration, and the new Finance Minister, Martín Guzmán, are doing what was expected, and what seems reasonable under the current circumstances. The increased the retentions, taxes on exports, mostly of the agribusiness sector, started to tax assets held abroad, and eliminated taxes on assets held domestically in pesos, which are measures to try to increase the reserves in dollars. This will certainly complemented with measures to alleviate hunger, and poverty, including the pensions of the elderly poor. They are most likely in negotiations with the IMF to avoid a default, and that is crucial for the success of the economic program.

As Fernández said, his administration inherited the chaos. But there are reasons for hope in the dark.

The inverted yield curve and the recession

The inverted yield curve, as it is well-known, indicates a forthcoming recession. I used it last year to suggest that the recession was not in the near horizon. The conventional explanation follows Wicksellian ideas (see this old post). In the Wicksellian story, one can think of the 10 year bond rate as a proxy for the natural rate of interest, and the Fed Funds for the monetary or banking rate. Hence, whenever the short-term rate (Fed Funds) is above the long-term one, it would be reasonable to assume that borrowing short-term is a bad idea, there is not enough borrowing, and investment falls short of savings. Lower investment would be the cause of the recession, and of deflationary forces.

Graph below show the difference between the 10-year bond rate and the Fed Funds, which I have noted I prefer to the more common 10-2 spread, since the Fed Funds is more clearly a policy variable, dependent on decisions of the FOMC.

And the yield curve has turned negative, which does indicate (look at the past in the graph) a high likelihood of a recession. But I remain skeptical, even though according to the BEA GDP growth slowed down a bit in the second quarter, and the trade deficit fell, due to lower imports (that decreased more than exports), both signs of a slowing economy.

First let me explain that you don't need to believe that the inverted yield curve would cause the recession because the monetary rate is above the natural rate of interest. You may very well think that there is nothing special or natural about the long-term rate. Post Keynesians often think in terms of uncertainty, and the role of expectations. Note that the fears of a recession in this case are related to a collapse of investment (this is the view of certain posties, for example, John Harvey here, that provides always reasonable and clear analysis; he claims to be skeptical about the yield curve).

In the Wicksellian story the high short-term rates (in comparison to the natural) discourage investment too. Here the idea of the marginal productivity of capital plays a central role, while posties would suggest that expectations are more important. But the mechanism is the same. Higher interest rates would lead, along an investment curve that is negatively sloped with respect to interest, to lower levels of investment. You could park your money in short-term securities, and avoid investment.*

But there is no reason to take a marginalist or Wicksellian version of the story. While for WIcksell the natural rate is not a policy variable, that might not be the case with the long-term rate (the 10 year government bonds). In fact, both rates can be influenced by the central bank, and the Fed has a history of switching to longer term securities after a crisis. After the 2008 Global Recession, the Fed increased its holdings of long-term government bonds, maintaining a low interest rate for government debt, and also bought significant amounts of Mortgage Based Securities. Buying long-term bonds pushes their price up, and reduces its remuneration. So lower tong-term rates have been a result of policy decision to some extent.

When the Fed decided to reduce its holdings of long-term securities it basically announced that the interest rate on the long-term bonds would go up. But last year the Fed announced that the program would slowdown and eventually end by this summer. So it basically reversed its previous policy stance, at the same time that it was increasing the short-term rate, presumably because the economy was beyond full employment (or the natural rate of unemployment, if you believe in Friedman's Wicksellian story; for the Fed description of its policies go here). And changes in interest rates and in the structure of rates should have significant effects on the balance sheets of agents spending, and affect the level of activity.

However, I wouldn't expect investment to be the key variable affected by higher short-term interest rates. Indebted agents would cut spending immediately if higher interest rates put pressure on their budgets, either because they have to pay higher interest or because they can borrow at less favorable terms. And sure lower consumption would then impact investment. Firms seeing that consumption is not too strong, would curtail investment, following the so-called accelerator. So I can live with the story that an inverted yield curve, because of a significant and fast increase of short-term rates, can lead to a recession.

And that might happen sooner than I think. But I'm still unsure about the reasons for expecting that immediately. Note that trade is more often than not blamed for the coming recession. See, for example, Greg Ip, from the Wall Street Journal, here, suggesting that trade and not the Fed would be the one blamed for the recession in the future. But as I noted before, I would expect the impact of tariffs to be stronger in China than in the US, and to be more on prices than on quantities. So expect more inflation, and some disruption of the production chains, but not a recession. And the government budget deal seems to inject some additional fiscal stimulus. Perhaps not enough, and perhaps other forces would be sufficient to throw the economy into a recession. But I still think the case for an immediate recession is still not a slam dunk. The slow recovery might continue for a while. But certainly things look worse now than when I wrote last year.

* Yes, that is open to the capital debates critique.

MMT and its Discontents: Again (Wonkish and Longish)

Modern Monetary Theory (MMT) has been in the news again, and for good reasons. I actually had a post with the same title back in February of 2012, hence the again in the title. But now, with the irruption of Alexandria Ocasio-Cortez in the political scene ,and with the discussion of a Green New Deal (discussed here 7 years ago) and the feasibility of higher taxes (here, also long ago, among the many on the topic) taking the center of the political debate, MMT has become trendy. The rise of democratic socialist ideas, since Bernie's 2016 campaign, has brought the fiscal feasibility or responsibility, in the more conservative terminology, of such progressive  plans into the center of economic policy debates. Also, the fact that Stephanie Kelton a prominent MMTer is an advisor to Bernie, has brought significantly more attention on their views.

I have discussed Modern Monetary Theory in this blog for years (going back to April 2011, when I first found use of the term, to the most recent earlier this year after Olivier Blanchard American Economic Association presidential address last January), and have known the main MMTers going back to at least the mid-1990s, when I was at the New School and working as research assistant to Wynne Godley at the Levy Institute. I guess, I can be seen, to use the term employed by Doug Henwood in his recent Jacobin piece, as a fellow traveller (like Jamie Galbraith), even though I've been critical of some aspects, in particular when applied to developing countries (more on both Henwood and MMT issues in developing countries below).

There are many critiques, which deal with both theoretical issues, mostly concerned with the Functional Finance aspects of MMT, and with the policy and political effects of MMT advising to the left of center Democratic presidential candidates. Note that I will not try to define MMT precisely, since it is a hybrid of economic theories and policy proposals. I would assume that at core it is composed by the ideas of Chartalist and Endogenous Monetary views, Functional Finance, and an Employer of Last Resort (ELR) program as suggested by Greg Hannsgen in his recent presentation at the Eastern Economic Association (EEA), in sessions we co-organized (with the presence of Randy Wray presenting Stephanie Kelton's slides and Josh Mason; Stephanie was with Bernie at the rally in Brooklyn).

My comments will be, for the most part, directed at issues that fall within the Functional Finance part of MMT, and mostly about developed economies like the US (although, I'll have something to say about developing countries like Argentina or Brazil). I might add that Randy suggested that Functional Finance was a late addition to MMT, since this ideas were not known by MMTers in the mid-1990s or so. I think that the original source for the Functional Finance story was Ed Nell, who organized a conference at the New School back in 1997, I think, with Bob Eisner, and many other Old Keynesians. I had read Abba Lerner and Evsey Domar foundational papers in Ed's classes, and I think his influence on MMTers in this area is reasonable to assume.

Let me start with Paul Krugman's critiques of MMT, which have been clear and perhaps the most widely read (but there are many, including critiques by Tom Palley and Sergio Cesaratto here in the blog). So Krugman, in one of his most recent posts, starts by showing that there are many levels of the fiscal deficits that are compatible with full employment (not sure who thinks that this is wrong; I would add the same is true about the rate of interest, and that there is no natural or neutral rate of interest, a point that Keynes made back in the 1930s, and that is coherent with the capital debates, and, hopefully, it will be clear why this is relevant below). Then he argues more problematically, in my view, that crowding out is a serious concern, in his words: "The question then becomes one of tradeoffs: would the things the government could buy with a higher deficit be worth the lost private investment due to a higher interest rate?" But he knows well that the crowding out effect is empirically (if not theoretically) irrelevant, since investment is not particularly responsive to interest rates (he knows it's all about the accelerator); then he moves to the issue of the natural rate itself.

He seems to think two things (he can certainly correct me if I'm wrong). One, that MMT requires that you use monetary policy in order to achieve full employment. Two, that if you are in a situation of like the zero-lower bound, then the central bank cannot bring you back to full employment. That is, her assume that, using his own graph, the economy would be in position A.

Note that by his own argument you can go back to a point like B, with full employment by pursuing expansionary fiscal policy (be that an ELR or something else like traditional fiscal policy to expand infrastructure spending, for example; on this I should say that Randy suggested that he thinks traditional fiscal policy might be inflationary, and that's something perhaps would be compatible with Krugman; he noted how Minsky suggested that an ELR can be used as a buffer to control inflation). That is the IS would move up.

So it's unclear what the fuss is all about. If it is because the Fed could, in the MMT story (not sure Functional Finance authors would say that), print money to finance the deficits and bring the economy back to full employment, then the concern might be that it would be inflationary, in a Monetarist sense that printing money might be the cause of inflation. But that does not seem to be his preoccupation (I dealt with the issue of monetization of debt back in May 2011 in a reply to Krugman, who was back then, not surprisingly, criticizing MMT). His concern seems to be that the rate of interest would not go up. But of course, there could be a flat interest rate close to zero, a horizontal monetary policy (MP) line, and the expansion of the IS could be achieved bringing the economy to full employment (right below the C and B points with a zero interest rate).

But that doesn't seem to be the issue either. My guess is that he thinks that the problems is more like the one below, from an older post by him, in which the natural rate of interest is negative (my discussion of that here), and the Fed cannot lead the economy to full employment.

So his point is that the Fed cannot make it because it cannot bring the economy to the natural rate of interest, the one that is compatible with full employment and stable prices. He then goes on to criticize Stephanie on her critique of the natural rate, and tells us that: "So what purpose does claiming that the natural rate is a meaningless concept serve? It looks to me like sophistry – word games intended to confuse what should be a simple issue."

I'm not sure what Stephanie said about the natural rate, but I think it is well-established that the natural rate concept is problematic (note that on this some MMTers have said things I would disagree;  e.g. Forstater and Mosler suggest here that the natural rate of interest is zero; my discussion of that here). So I think the position that Krugman attributes to her is correct. Paul Samuelson would agree, as he did when he admitted that the capital debates had shown that neoclassical parables cannot hold (on the capital debates read this old post). So let me explain it briefly. There is no sophistry, just pure logic.

The capital debates show that with factor price reversals, when one good can be said to be capital-intensive at one level of the wage-profit ratio, and labor intensive at another level of the same ratio, there is no monotonic inverse relation between investment and the rate of interest. The investment schedule could look like the one below (my graph), with portions that have a negative slope and some in reverse, and if savings (determined by the level of income as in Keynes' principle of effective demand, rather than a Ramsey inter-temporal model) is given as in the graph below, then there might be no natural rate of interest. Keynes was explicit about that in the General Theory. That means that the monetary authority can set the rate of interest, what Keynes referred to as the normal rate, that was conventional, and that fiscal policy can be used to bring the economy to full employment. Btw, I think that overall Krugman and Kelton agree on that. Krugman says he's defending the theory, not the policy proposals, since he thinks they agree on that.

The point is NOT that the state can do whatever it wants, even though it has a lot of space, but that at the end of the day monetary policy is central for the ability to pursue fiscal policy, and the monetary authority can keep (unless it's forced by law not to do it; and that would bring up the discussion about the rise of the neoliberal idea of independent central banks) interest rates low enough to allow for fiscal expansion without debt growing at a very fast pace. Think of Marriner Eccles during the New Deal (chairman of the Fed at that time; search the blog for more on that). This is the argument that Josh Mason did, in a different way in our session with Randy at the Easterns. Note, also, that even though politically it was acceptable for the Fed to keep interest rates low, at 2.5 percent during the Depression and World War II, by the 1950s political pressures by financial markets and rentiers forced the Fed-Treasury Accord, and things changed (even though rates remained relatively low).

I'll comment briefly on two additional critiques of MMT, the one by Larry Summers, the ex-Treasury Secretary and advisor to the Clintons and Obama, and the one by Doug Henwood, an influential Marxist (see my discussion of his comments, and others, on Marx for the New York Times here), and writer of a very good book on Wall Street. I am sorry to say that both have too many arguments of authority and ad hominem attacks on some MMT authors, which I'm not interested in discussing. But there are a few substantive issues. One is the danger of inflation (that I'm glad Krugman seemed less keen on) and the others are on MMT and developing countries, and the political relevance and practicality of MMT proposals (here most critics have in mind the Bernie/Ocasio agenda of Medicare for all, cheap or free college tuition in public institutions, a jobs guarantee, and a Green New Deal).

I'll start with Henwood. His major issue is inflation, I would say. He says: "That brings us to the next problem: inflation. When the printing presses run freely, it’s not only reactionaries who think that runs the risk of spiraling prices. As I was researching this piece, many people to whom I described MMT, from Democrats to Marxists, brought it up as a worry. MMTers are coy about the topic — they never say how much is too much, and they profess great confidence in their ability to control it." Let me start by saying that inflation has not been a problem in 40 years, while wage stagnation is a central one. But if one is concerned about it, at least one should get the correct analytical tools to discuss it.

He tells us that: "The standard view of the Weimer inflation is that the German economy, severely damaged by World War I and forced to make huge reparations payments to the victors, wasn’t up to the task — it just didn’t have the productive capacity, and its citizens were both unwilling and unable to pay the necessary taxes. So instead the government just printed money and spent it, not only to pay its own bills, but to support bank lending to the private sector." First, that's NOT the standard view of the hyperinflation in Germany. You can read here the standard story, and I cite even a conservative historian like Niall Ferguson admitting that the monetarist story embraced by Henwood is NOT the dominant view among historians. The notion that the economy was at full capacity (didn't have productive capacity) and that printing money caused inflation is what Cagan thought about it. A more refined and somewhat structural story is the dominant view actually. In my view, it is clear that debt in foreign currency (not domestic), and, hence, the external problems of the current account, that forced depreciation, together with wage resistance are at the core of the hyper., German and many others.

In addition, it's worth emphasizing that the US is not Weimar Germany, in the sense that even with much larger fiscal deficits, debt would still be in domestic currency, and no significant pressure for depreciation would arise. The role of the dollar as reserve currency is not really under significant jeopardy. Certainly, there might be questions of inflation if we reach full employment, and that's a different issue (I'll come back to the topic below when I discuss Summers and the political feasibility of MMT sponsored plans). But the kind of alarmism of even suggesting that the US would be on the verge of hyperinflation is not serious. I won't comment on other primary mistakes like the notion that the rise of Nazism is associated to the hyper, when it is clearly connected to the Depression and deflation a decade later.

Henwood is on firmer ground, actually, when he discusses the external limits. Yes, indeed, for most developing countries like Argentina or Brazil, the ability to pursue expansionary fiscal policy is severely limited by the balance of payments constraint. Considerably before full employment, the patterns of consumption and investment may require too many imports, particularly of intermediary and capital goods, and even with capital controls, interest rates might be hiked to avoid capital flight and depreciation. Depreciation does solve the external problem, often by throwing the economy in a recession, and not because it stimulates exports. There is extensive discussion of that in the blog about it. Sometimes MMTers sounded like New Developmentalists in Latin American suggesting that depreciation would solve the external constraint and that capital controls were not even necessary. I don't think Randy believes that (or Stephanie), but it was certainly something that Warren Mosler believed in the past (whether he changed his mind I can't tell). But again the debate seems to be about the feasibility of MMT in the US (that's why I didn't emphasize in my comments on the roundtable the differences of debt in domestic and foreign currency, something I always do, as noted by Josh).

So that leads me to the last critique, the one by Larry Summers in his recent piece in WAPO. Summers says that: "Modern monetary theory... is the supply-side economics of our time" and that "these new ideas [about the importance of fiscal deficits] are being oversimplified and exaggerated by fringe economists who hold them out as offering the proverbial free lunch: the ability of the government to spend more without imposing any burden on anyone." He also says in Monetarist fashion that printing money would lead to hyperinflation. In his words: "As the experience of any number of emerging markets demonstrates, past a certain point, this approach leads to hyperinflation. Indeed, in emerging markets that have practiced modern monetary theory, situations could arise where people could buy two drinks at bars at once to avoid the hourly price increases. As with any tax, there is a limit to the amount of revenue that can be raised via such an inflation tax. If this limit is exceeded, hyperinflation will result." Again, emerging markets, like Germany, borrowed in foreign currency, that they cannot print. It was often the depreciation of the currency, the increase in the prices of imported goods, and the wage resistance of workers that led to hypers, and the central bank printed money afterwards, with money being endogenous. A foreign debt or external problem, not a fiscal one.

But there might be a danger of inflation (not hyper) if Bernie wins the election and manages to pass Medicare for all, free college, a Job Guarantee and actually spend some money on infrastructure, and to do something about global warming, without significant reshuffling of spending. Here is where I think the question of the supposed naïveté  of MMTers comes to play, with Henwood suggesting that they shirk the question of fiscal choices, and with Summers saying they resemble voodoo economics, the supply-side of the left (mind you supply-siders are many things, but certainly not naïve). I think, first of all, that the dangers of inflation are exaggerated, for several reasons. First, the labor market is not as tight as normally suggested. The number of people discouraged and out of the labor force is relatively large. Second, there are positive effects of growth on productivity (the Kaldor-Verdoorn effect, search on the blog too), so the supply constraint is not fixed, rigid at one given level (people said the natural rate of unemployment was 5 percent or higher just a few years back; again check past blog posts). Third, the bargaining power of unions, and workers in general, is not particularly strong, and it would take sometime to pick up.

More importantly, there is no chance that a Bernie presidency (and that's in and of itself a big if) would have both houses and could implement even a little bit of the program presented. Mind you if it happened we would probably get to full employment in a couple of years, and get increases in wages, and perhaps some inflation. But some inflation might be good, in particular if it allows for higher real wages, something sorely needed. How much inflation? Difficult to say, but the structure of the Fed is not going to vanish, and higher rates would be used to discipline the labor class, with the support of many neoliberal Dems. The limit will come probably before full employment and the capacity limit of the economy is reached (yes inflation happens before the capacity limit, because it's often cost push, and the sort of demand pull stuff Summers and Henwood are afraid about is not that common). In other words, the limits to fiscal expansion would be political, not economic, and there is no reason for the left to be up in arms against an imaginary enemy. Hyperinflation is like the the windmills for the Quijote. The giants to attack are actually the ones pointed out in the progressive agenda, like lack of spending on health, education and the environment, and MMTers have been instrumental in getting these ideas in the political discourse, and moving the Dems to the left.

But taxes matter too. Here is where the MMTers refusal to acknowledge that taxes on the wealthy are necessary is a political mistake (not all I've been told, but some for sure, as I've heard that criticism). Note that from the logical point of view they are not incorrect in suggesting that causality goes from spending to taxes, like it goes from investment to savings. It's implicit in the Keynesian/Kaleckian model in which autonomous spending (government spending is in there) determines income through a multiplier process. And taxes, like savings, grow with income. But it is important to note that politically (again this is not analytically, but politically) countries that went for a more ample Welfare State opted to tax their citizens, particularly their more wealthy citizens, at a higher rate. Tax increases on the wealthy should be (and are) part of the progressive agenda. It has an important distributive effect, and it makes the spending politically acceptable. At this juncture, however, even Blanchard says that we should just borrow, since interest rates are low, and will remain low.

The crucial point is that overall MMTers have been helpful in moving the Dems in the right direction (the right direction is to the left), and that is a good thing. The problem with Dems is not the existence of a few social democrats or socialists in their midst. In fact, even being generous there will probably be just three democratic socialists in the presidential primaries (Bernie, and, perhaps, Warren and Tulsi). The problem is the vast majority of neoliberals that still dominate the party. The same could be said about MMT. The problem is not the exaggerated propositions of MMTers, but the excessive fear of inflation when there are too many relevant problems to be concerned with.

Economic Regularities and "Laws" and the Riksbank Prize too

I've been reading The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn by Avner Offer, Gabriel Söderberg, an interesting critique of the use of the Nobel Prize to undermine the Welfare State, essentially by conservative groups in Sweden, that were influential within the Central Bank (Riksbank), that disliked the Social Democratic policies in place in the 1960s. I have been critical of the Riksbank prize before (see, for example, here or here; check also Lars Syll's blog who often discusses the limits to the Nobel in economics), and this book is an interesting discussion of the socio-political forces behind the creation of the prize. I highly recommend it.

Having said that, I should note that the alternative to mainstream marginalist (neoclassical) economics is not Social Democracy. I guess one can actually be Social Democratic (Liberal in the US  New Deal sense of the word) and neoclassical. A good chunk of the Old Keynesians of the Neoclassical Synthesis sort were, and there are a few New Keynesians that are like that (many are simply Neoliberal). The alternative to marginalism, in my view, is a combination of the old surplus approach (classical political economy), particularly regarding value and distribution, and the Keynesian (and Kaleckian) analysis, regarding macro.

Also, I'm somewhat troubled by Offer and Söderberg tendency to read the Kuhnian ideas on the growth of knowledge in a nihilistic way, suggesting that economics cannot be seen as 'scientific' (surely a loaded term with more than one definition), and that there are no regularities in economics. They, for example, say that:

Feynman began by ‘looking for a new law’. But after three centuries, economics has yet to come up with a single non-obvious ‘law’, or universal regularity.

Don't get me wrong, regularities in economics are historically constrained, but there are more than a few. As any regular reader of this blog would know, I'm particularly fond of Okun's Law (and also of its inseparable fraternal twin Verdoorn's Law). I do think there is an important regularity behind the so-called Thirlwall's Law (that developing countries without a reserve currency face a balance of payments constraint more often than not), even if I don't think it is a "law" like the other two. In particular, I think that if one thinks of the persistent forces that operate within a particular mode of production, there are many other regularities that should (and to some extent are) part of economic analysis.

There are many mechanisms that capture the workings of those regularities in the economic system, like the multiplier and the accelerator. Theoretical constructs that are measurable, even if that is difficult and open to criticism. I guess I'm okay with the use of the term economic law, in a certain context. I suppose Marx also thought that capitalism, and other modes of production, were to some extent amenable of analysis on the basis of certain regularities, certain laws of motion, if one prefers (and, yes, that opens a discussion about determinism, but I'll leave that for another post).

Kindleberger (who I was lucky to see giving a talk in honor of Heilbroner years ago) wrote a little book on economic laws. The Iron Law of Wages, that Kindleberger discusses in his book, is very problematic (some discussion of that here), like the law of supply and demand, or the law of diminishing returns (they are not laws in my view, if that needs to be clarified). The other two Kindleberger discusses are much better, namely: Engel's Law and Gresham's Law. At any rate, for what is worth, I do think that there are many regularities that make economics scientific. Yes, sure social sciences are not like the hard sciences, but we do not live in post-modern world in which no regularities exist. But that does not undermine the authors' critique of the Riksbank prize, I might add.

On the blogs

Why You Should Never Use a Supply and Demand Diagram for Labor Markets -- by Peter Dorman at Econospeak. And you shouldn't, but the reasons given here are not the best (more on this on later post)

Declining US Investment, Gross and Net -- Tim Taylor just show the data really (nope, no accelerator story, or any for that matter). Particularly worrisome is the decline in infrastructure investment, even after a recession

What’s behind the decline in U.S. interest rates? -- Nick Bunker at the Center for Equitable Growth, a liberal (progressive?) think tank. Hey, if they endorse the nonsense about the natural rate of interest, there is little hope, I would argue (more on this later too)