On Money and the Interest Rate

David Fields (guest blogger)

A capitalist economy is a monetized production system, that is, economic activity is predicated upon the extent to which financial institutions extend credit to enterprises. Consequently, output expansion is mediated by the mechanisms of banking. The ability of firms to acquire necessary labor and material inputs, essential for fulfilling profit expectations and enabling wage disbursements to workers, is contingent upon the scope of debt obligations. Credit, thus, functions as a social technology of deferred payment and settlement, establishing a relatively secure contractual claim that enables entrepreneurs to address uncertainty and facilitate long-term operational expansion, as determined by the level of aggregate demand. Restrictions on credit invariably nullify attempts at increased production. Banks facilitate the prepayment of firms for capital goods and labor costs, sustaining production and distribution prior to the realization of profits from projected consumer goods sales.

Proportional shares of accumulated profits are transferred to the banking sector. Firms are obligated to deduct interest payments from their collateralized deposit schedules of future revenue. This is called the reflux mechanism, or monetary circuit, which can be represented by the following Marxian schema:

                                                           M* – M – C’ – M’ – M*’

where M* denotes bank loans to firms that enable the production process (M – C’ – M’), ultimately converted into M*’, representing interest payments to the financier from realized profits, M’. The difference (M' - M), profit, is regulated by the financial provisions offered by banks , which are subject to the interest rate is set by a nation's central bank. Hence, the interest rate is a conventionally determined distributive variable that ultimately determines the proportional allocation of income.

Consequently, should the central bank implement and sustain elevated interest rates over extended duration while aggregate demand remains subdued due to insufficient fiscal policy, a decline in real wages will ensue, unless there is effective labor resistance. In this sense, what can be defined as monetary austerity sacrifices long-term productive investment, unless there is an effective counter-cyclical fiscal space, which is limited for states that faces balance of payments constraints.

On the GDP data and the risk of a recession

For the most part what I suggested here, a month ago or so, seems to be essentially correct [the video is not very good, and it continued sharing the previous PowerPoint rather than mine]. What I said was that the objective or actual data on government spending, consumption and imports did not suggest a recession. I noted that the Atlanta Fed GDP Now prediction of a massive recession (2.8% of GDP) was probably incorrect and all predicated on the increase in imports, which were most likely an anticipation as a result of the announced tariffs, and that the economy would probably slowdown, as it was already slowing down, but that a recession was (at least immediately) unlikely. This is essentially what happened.

As I noted, these imports (say imported cars in a parking lot) are actually inventories, and more akin to investment. Jason Furman noted that if one looks at what he calls core GDP, then the economy grew at a more normal 2.4% in the first quarter. Note also, as I said in the above talk, that imports are pro-cyclical, and the rise in imports is NOT a sign of a recession.

Again, that does NOT mean that a recession should be ruled out. But the two mechanisms by which it would happen, if it does, should be properly understood. Uncertainty, per se, is not the central story. One channel as I noted in the presentation is the effect of possible higher rates (or simply no reductions) of interest on the housing market and from that on consumption. The Fed has been moved to a more hawkish stance, and even the possible new chairman, Kevin Warsh, seems even more hawkish. The other channel is in my view the big surprise of this report. Government spending fell, in particular a pronounced fall in defense spending. How much of that is caused by DOGE is unclear. The GDP tracker, when one looks at the monthly data, suggests a decrease, after February, even if overall spending since the beginning of the year is up when compared to 2024. But that seems to be the norm, and if they keep on track it should go up soon. Certainly no marked anomalous decline yet.

 

If the Trump administration takes a hawkish fiscal stance, then for sure we can expect a recession. I am somewhat skeptical that this is the case. Trump himself is not particularly concerned with fiscal issues beyond making his previous tax cut permanent. Republicans, except a tiny minority are not fiscal hawks. Actually, it is most likely to find fiscal hawks among Dems these days (and that is their problem; or one of them). But those would be the two channels that might cause a recession. To be seen.

Recession, Stagnation, Inflation, Debt Crises and more (with Franklin Serrano, Ricardo Summa, and Nathalie Marins)

Slow at posting. This should have been uploaded before, but it wasn't on my Zoom account. At any rate, I think the panel holds well even after a couple of months (from late February).

More on manufacturing and trade policy

There has been, and there will continue to be a lot of speculation about manufacturing and tariffs. Tariffs started to increase with Trump in 2017, and were kept by Biden. But among the differences between Trumponomics and Bidenomics (for more go here and here) was the smarter use of industrial policy, in the latter case.

The figure below shows Total Private Manufacturing Construction in the United States. Essentially how much firms spent on constructing of manufacturing installations. A poor proxy for manufacturing output (or potential), if not employment. Actual manufacturing output didn't grow much (a discussion on re-industrialization here; a very old post on deindustrialization here).

As it can be seen, it is flat during the first Trump presidency, and takes off at some point towards the middle of 2021. This in part reflects the CHIPS Act and the Inflation Recovery Act, both from well into 2022, but given the timing, it also shows that simply the expansion of spending, that occurred as soon as Biden assumed the presidency, with the $1.9 trillion package of March 2021, may have been instrumental. By about mid-2024, the boom had lost steam.

I think there are good reasons to be skeptical about Peter Navarro's manufacturing boom (see last post here).

Tariffs and the return of Made in America!

Trump's tariffs look less and less like an instrument for negotiation, of whatever they would allow to negotiate (some stuff is simply ludicrous, like the discussion on reducing fentanyl entry through Canada), and, at least rhetorically, he is using the language of bringing back manufacturing jobs to the United States. That would actually strengthen his populist credentials. Many trade union types were very happy, contrary to what most media outlets would make you believe, and certainly it should worry Dems.

However, whether this tariffs will bring back manufacturing jobs is far from clear. There have been a lot of jokes about the back-of-the-envelope calculations used to determine the level of the tariffs. At the end of the day, it seems that the actual decision was somewhat arbitrary, and mostly concerned with punishing countries with higher trade surpluses with the US.

I don't think this is clear yet, but average tariffs may go back to the levels of the 1930s, if these stick (which again, nobody knows, since some might negotiate side deals with the Don). And while there is a lot of debate about the effects that they will have in the economy in the short run (inflation, stagflation and so on), there has been little discussion of the historical precedent, and whether tariffs were instrumental for American industrialization, and whether the claim that they will bring back good jobs makes sense. Certainly, on the progressive side that is the common understanding, and a lot of that is associated to Alexander Hamilton, and his followers, less well-known figures like Mathew and Henry Carey, Friedrich List, and later Progressives like Simon Patten, during the Gilded Age. And tariffs were definitely high in the post-bellum period, when the US industrialized (see below, from Douglas Irwin's massive history of US trade policy).

It is certainly true that the bulk of industrialization happened when tariffs where high, even if some industrialization did happen in the ante-bellum period, when tariffs fluctuated quite a bit. The official economic historiography, Taussig, North and Irwin himself, to cite some of the more prominent authors, are somewhat skeptical of its role. Irwin, in particular, is very forceful in his views about the fiscal nature of the ante-bellum tariffs, and even, in terms of intellectual history, the notion that Hamilton was not a protectionist defending import substitution industrialization. I have problems with that interpretation, and I think a reading of Hamilton's Report on Manufactures shows that he is incorrect.

However, it is true that tariffs alone did not cause industrialization. Just as an example, tariffs by the end of the 19th century were higher in Latin America, on average, than in the US, and even though there was some increase in manufacturing in some countries in the region, they remained mostly commodity exporters during this period (see graph below from Coatsworth and Williamson).

So, if not tariffs, what allowed for the industrial boom in the post-bellum period, one may ask. First and foremost, the railroad boom, and the finishing of the transcontinental railroad in 1869,  the "Golden Spike" at Promontory Summit, Utah (I visited, and they do a recreation of the famous photo below), created a national market, that was only possible because of the Federal government. Republican governments in that era had an industrializing project, were protectionist, but more importantly provided subsidized land to railroad corporations, which otherwise would not have been able to finance these massive infrastructure projects. Land grants were central for the expansion of the economy, and suggest that the role of the government was much larger than if one looks simply at the level of spending in this period, which was modest, by modern standards.

In other words, protection did play a role, but it was not sufficient to explain the industrialization boom of the late 19th century. Government support for the expansion of the domestic market was key. I do not expect, and so far that has been the case, that the Trump administration will cut significantly spending. A lot of the money that they will spend, will certainly go to contracts for big corporations. In that sense, American corporations will continue to benefit from government largess, but I doubt jobs will come back in great quantities. Note that manufacturing jobs were constant up to the entry of China in the WTO, and then even when they collapsed in the early 2000s (explaining the Tea Party and Trumpism itself to a great extent), at least for a while, it went hand in hand with the expansion of manufacturing output. Only in the last 15 years, in the aftermath of the Great Recession did manufacturing production stalled, and that was during a period of relative modest government spending growth (the Obama-Trump lackluster recovery).

In my view, and this is admittedly impressionistic, cost of production in the US will remain too high, and alternatives will still be more attractive than moving production back to the US. Also, while I do think that the new Republican coalition is fractious, and some may really want to bring back manufacturing jobs, neither Trump, nor his main backers (mostly wealthy billionaires) are pro-workers or really concerned with bringing back good manufacturing jobs. He is dismantling unions (in the Federal bureaucracy) and has a very pro-business, anti-labor set of policies. Even in immigration that could strengthen labor to some extent, he has not deported more than Biden, at least not yet.

On the critical, progressive side, the most common critique is that tariffs will lead to a collapse of the global economy, like the Smoot-Hawley Tariff of the 1930s, and a significant acceleration of inflation. Perhaps even stagflation. I, obviously, think that fears (or hopes) here are also exaggerated. Smoot-Hawley did not cause, and did not even exacerbate the Depression (even if it did not help either), the latter a view that is probably in the minority these days. And as I noted repeatedly, while tariffs will have a short run effect on inflation, since they will affect the level of prices, they will not lead to persistent inflation, which will come down fast, as did it after the pandemic. The problem will be that workers this time will not have higher wage increases. In other words, tariffs will hurt some people in the economy for sure. But that is a matter for another discussion.

Policy Parlor with Franklin Serrano

My conversation with Franklin during his visit to Bucknell University. We talked about the supermultiplier and its applications to understanding real economies. The quality of the sound is better than I had expected, even if the camera is moving somewhat, and could be distracting.

On the coming American Recession: Some skeptical notes

Everybody, including Trump, is talking about the forthcoming recession. In Trump's case, he suggests that while painful in the short run, it would be good in the long (when possibly will be dead). At any rate, I did comment (mostly on social media and podcasts) that most of that is based on subjective perceptions of what might happen, which is certainly not impossible if government spending is truly slashed by the Department of Government Efficiency (DOGE). But again, most evidence so far has been based on impressions, things like consumer confidence.

Most of the objective data, at least for now, does NOT suggest a recession, but rather a slowdown at worst. The new data that came out last week suggests still the same. The personal income and outlays report of the Bureau of Economic Analysis (BEA) suggests that real personal consumption remains more or less steady, a little below December, but with a minimal increase in February.

On the other hand, spending seems to be still on target to continue to grow at the same pace (in fact faster so far) even if many of the categories have changed, and winners and losers should be expected. If you cut Medicaid spending, and delay payments on Social Security while expediting government contracts to Space-X this might have distributive consequences, even if the level of activity does not fall.

The Brookings Institution real time federal spending tracker suggests that spending is higher in 2025 than in 2024, at least so far. Something that has been reported by several other outlets. Sure enough the Fed kept interest rates up, but there is no evidence that this has affected the housing market yet. Maybe the key word is yet. But there is a reasonable scenario that this Trump presidency, at least on this, will look like that previous, a slow expansion pushed by regressive tax cuts and higher spending on military/space contracts, with negative social consequences.

By the way, the Post indicated that on deportations, something similar is happening. Numbers are not up, with respect to Biden, even if the targets and methods have changed (and are certainly nastier). No doubt in other areas, the second term might be more problematic.