Central Bank Independence and Fiscal Rules in the Periphery

 

Reading Keynes in Buenos Aires

This week I participated (virtually) in a conference in Colombia organized by the finance ministry, alongside a remarkable group of participants, including Rafael Correa, Isabella Weber, and Daniela Gabor. The focus of the discussion was the ongoing dispute between the government of Gustavo Petro and the Colombian central bank over the persistence of relatively high interest rates, and the broader question of central bank independence.

None of this, of course, is new. Variants of this conflict have played out repeatedly, including in the United States, where Donald Trump has openly criticized the Federal Reserve for maintaining interest rates he considers too high, and has clashed with Jerome Powell, as I have discussed here. But the Latin American context adds an important layer that is often missing from these debates.

The first point worth stressing is historical. The notion of an independent central bank is a relatively recent invention. Central banks have existed for centuries, but their functions have evolved significantly. Early central banks, even before institutions like the Bank of England (see here and here), were deeply intertwined with the fiscal needs of the state. They acted as fiscal agents, helping to finance public debt, often at levels that would alarm today’s orthodox commentators. In Britain, public debt during the Industrial Revolution exceeded 100 percent of GDP, with significant portions effectively absorbed by the central bank.

In this context, I suggested an analogy with Ha-Joon Chang’s argument about kicking away the ladder. Chang shows that today’s advanced economies relied heavily on protectionism and industrial policy during their own development, only to later promote free trade as the universal path, effectively denying developing countries the same tools. Something similar can be said about central banking. Historically, advanced economies used their central banks as instruments of development and as fiscal agents of the state, helping to finance large public debts and support economic transformation. Once they achieved development, they moved toward promoting central bank independence as a general principle, thereby limiting the ability of developing countries to use similar financial tools. In that sense, one could say that they also kicked away the financial ladder.

The idea that central banks should operate according to fixed rules, insulated from political pressures, is more closely associated with the gold standard era and the late nineteenth century. Even then, this rule-based framework reflected specific historical conditions rather than a timeless principle. And, as is well known, it broke down in the interwar period, when governments, faced with high unemployment, and the crisis of British hegemony, abandoned orthodoxy in favor of more active coordination between central banks and treasuries.

The US experience is illustrative. Under Marriner Eccles during the New Deal and World War II, the Federal Reserve worked closely with the Treasury, including maintaining low interest rates on government debt. It was only with the Treasury–Fed Accord of 1951 that the modern notion of central bank independence took shape. Even then, the separation was never as clean as the textbooks suggest.

This is because, at a more fundamental level, the central bank and the Treasury cannot be meaningfully separated. The central bank still acts as the fiscal agent of the state. Government spending creates money, whether through keystrokes in digital accounts, as emphasized recently by Modern Money Theory authors, or more traditional mechanisms. The idea that governments can run out of money (domestic issued money) in a technical sense is a useful fiction, one that obscures the real constraints, which are not financial but material. As John Maynard Keynes famously suggested, if it can be done, financing can be arranged.

This brings us to the present conjuncture. The recent inflationary episode in the United States was not primarily the result of excessive demand, but of supply-side disruptions, pandemic-related bottlenecks and energy price shocks (I wrote many posts on that; see this one). As these factors subsided, inflation fell. The Federal Reserve’s aggressive interest rate hikes were, at best, incidental to this process, and at worst risked pushing the economy into recession. What prevented that outcome was not monetary policy, but fiscal expansion, particularly the initial stimulus enacted by the Biden administration, the one that Larry Summers referred to as the worst economic mistake of the last 40 years (it's worth remembering).

If this is the case at the center, the implications for the periphery are even more significant. In Latin central bank independence is even more recent than in the US. It results from institutional arrangements that have evolved particularly in the wake of the debt crises of the 1980s and the imposition of the Washington Consensus, but that have been fully accepted by left of center governments in the region (note that most central banks in the region were created to deal with development issues in the aftermath of the 1930s crisis; this is represented by Prebisch, reading Keynes in Buenos Aires, in the figure above*).

The debate in Colombia mirrors similar tensions in Brazil, where Luiz Inácio Lula da Silva has criticized high interest rates maintained by the central bank under the previous chairman, appointed by Jair Bolsonaro, Roberto Campos Neto.  Interest rates, which remain high with the current president of the Brazilian Central Bank, Gabriel Galípolo, have not precluded growth, which depended on fiscal expansion and higher wages. True, Brazil has returned to growth, but it has done so more slowly than it could have, but not as a result of the interest rate policy. Instead, the slower pace of growth results from the self-imposed fiscal limits (see this by Haluska, Serrano and Summa).

Here is where the Colombia and Latin America, more generally, diverge from the US case. In the periphery, central banks do not operate in a vacuum. Their policies are constrained by the global financial environment, particularly by the stance of US monetary policy. Higher interest rates in the United States put pressure on developing countries to maintain relatively high rates of their own, in order to stabilize nominal exchange rates and avoid capital outflows and depreciation. Currency depreciation is not only inflationary but also contractionary, making macroeconomic management far more difficult.**

This is why the question of central bank independence, while important, is ultimately secondary to the issue of fiscal rules. Even countries without severe external constraints, such as Colombia or Brazil, face self-imposed limits on their ability to use fiscal policy to expand demand and promote growth. These constraints are not natural. The challenge, then, is not simply to debate whether central banks should be independent or not and from whom (certainly from financial markets). It is to rethink the broader framework within which monetary and fiscal policy operate, particularly in the periphery.

The discussion in Colombia, therefore, is not just about the appropriate level of interest rates or the degree of central bank independence. It is about the broader question of how much room governments have to use fiscal policy as a tool for development.

* Yes, the figure is AI; and the 9 of July monument, the obelisk, which was completed in 1936, was designed by Raúl's brother, Alberto Prebisch.

** Hélène Rey refers to this as the dilemma (instead of trilemma), since countries, with fixed or flexible (and, I guess, anything in between) exchange rate regimes, loose monetary policy autonomy with greater capital mobility.

Robert Skidelsky and the Many Lives of Maynard Keynes

Keeping up with the Keyneses

The death of Robert Skidelsky last week marks the passing of one of the most important interpreters of John Maynard Keynes. He will be remembered above all for his monumental three-volume biography of Keynes, widely regarded as the definitive account of Keynes’s life and times. That work, written over several decades, drawing on the Collected Writings edited by Donald Moggridge, did much to reposition Keynes as a historical figure. It also humanized him in ways that earlier accounts, such as Roy Harrod’s, had not. In that sense, Skidelsky’s contribution helped bring Keynes back into the conversation at a time when Keynesian economics itself was in retreat.

Skidelsky was also, importantly for us, a member of the editorial board of the Review of Keynesian Economics (ROKE), and a supporter of its broader intellectual mission. As I noted in my short piece on Robert Solow, the journal was conceived as a counter-cultural project, aiming to reestablish Keynesian economics, understood broadly, and without hyphens, as a central framework for macroeconomic analysis. Skidelsky understood that mission and supported it, at a moment when such a project was far from obvious or widely accepted.

At the same time, Skidelsky’s interpretation of Keynes was not without its limitations. In his own critique of Roy Harrod’s biography, he rightly argued that it sanitized Keynes and obscured important aspects of his life and work. Yet his own work, written in the context of the dominance of the Neoclassical Synthesis and the broader retreat of Keynesian ideas, often did not fully break with that framework. Skidelsky’s biography, while more historically accurate and richer in detail, remained in important respects defensive, accepting the view that Keynes’s theory rested on imperfections rather than representing a fundamental break with orthodox economics.*

This matters because the interpretation of Keynes is never neutral. The postwar Keynesianism associated with the Neoclassical Synthesis reduced Keynes to a theory of market failure, wage rigidities, and short-run stabilization, leaving intact the core of marginalist theory and Say’s Law in the long run. In that reading, Keynes becomes a useful supplement to an essentially self-correcting market system, rather than a critic of it. Skidelsky did much to restore Keynes the person, but less to fully recover Keynes the theorist.

None of this should detract from his achievements. Skidelsky was a serious scholar, a prolific writer, and a public intellectual engaged with the issues of his time. He consistently defended a moderate, pragmatic Keynesianism, what he himself sometimes described as a middle way between the excesses of unregulated capitalism and the failures of central planning.

For those of us working in the Keynesian and heterodox traditions, his legacy is therefore a mixed but important one. He helped keep Keynes alive during decades in which the profession largely moved in other directions. He supported efforts, like ROKE, to rebuild a broad (pluralistic) Keynesian consensus in the profession. But his interpretation also reflects the limits of the period in which it was developed, a period in which Keynesianism was often reframed in more conventional, and less radical, terms.

Each generation, gets its own Keynes. Skidelsky gave us one that was richer, more human, and more historically grounded than the sanitized versions that preceded it. The task remains to recover, more fully, the theoretical and political implications of Keynes’s work.

* See the more recent work by Zachary Carter that connects Keynes' biography with the ideas of Joan Robinson and John Kenneth Galbraith, and the development of heterodox views based on Keynes thought. 

Milei, Markets, and Mirage: Why Argentina’s “Success” Is Not What It Seems

There is a growing narrative in the international press, and among those who consume it, that Javier Milei has turned Argentina into a success story. Inflation is supposedly down, poverty is falling, growth is rebounding, and the long-standing problems of fiscal excess and state overreach are said to be finally resolved. For some, this is taken as vindication of “free market” principles.

 

But before we rush to declare ideological victory, it is worth pausing. If one is willing to infer from Argentina that markets work, why not infer from Scandinavian welfare states that intervention works just as well? The answer, of course, is that these simplistic conclusions misunderstand how economies actually function. There are no single-policy experiments in macroeconomics, and certainly none that can be reduced to slogans about the "free market” versus “the state.” As I will argue below, the apparent successes of the current Argentine administration are far more fragile, and far more misleading, than commonly portrayed.

Yes, inflation has come down from the extremely high levels reached at the end of the Alberto Fernández administration. But context matters. Those peak inflation rates, above 200% annually, were largely the result of massive exchange rate depreciations, including one induced under pressure from the International Monetary Fund (IMF) during the election of 2023.

Crucially, the current government itself triggered a sharp devaluation at the outset, accelerating monthly inflation from roughly 12% to 25% in December of 2023. The subsequent decline in inflation is not the result of laissez-faire policies, but rather of exchange rate stabilization, made possible by external financing. This includes a swap line with China and a substantial IMF agreement (around $14 billion disbursed), alongside additional support linked to political ties with the United States, again close to the midterm elections last year.

In other words, inflation came down not because markets are free, and fiscal spending was contained -- that caused a slowdown of the economy (more on that below) -- but because the exchange rate was actively managed with the help of international financing. So much for free markets. Even now, inflation remains around 30% on an annual basis, higher than during much of the period under Cristina Fernández de Kirchner. If this is success, it is a rather modest one.

The claim that Argentina is booming is equally misleading. What is improving is not the domestic economy, but the external sector. After several years of drought that depressed agricultural exports, favorable weather and higher commodity prices, especially for soybeans, have boosted export revenues. Additionally, infrastructure projects initiated under previous administrations, such as energy investments linked to Vaca Muerta, have reduced energy imports and improved the trade balance. None of this has much to do with current policy. It is largely the result of exogenous factors and past investments.

Meanwhile, the domestic economy is stagnant, and this is the direct result of the draconian cuts of government spending, including investment and spending on crucial areas like Research & Development that will hurt growth, and exports in the future. Capacity utilization collapsed in December 2025, when he assumed the government (as can be seen below), as much as real wages did (as I have shown before here).

 

Poverty has indeed declined from its recent peak. But here again, the explanation is more mechanical than structural. Poverty in Argentina is highly sensitive to inflation. The spike in prices, partly triggered by the initial devaluation under the current administration, pushed poverty sharply upward. As inflation stabilized, poverty naturally declined from those elevated levels. This is less an achievement than a reversal of a self-inflicted shock, even if poverty was increasing at the end of the previous government. And it remains higher than it was with Cristina. And it is higher than what his government claims (as is inflation; note that the head of the statistics office resigned for issues with inflation measurement, something that the right always criticized about the Kirchners).

On further note, part of the reduction in extreme poverty is due to the continuation of transfer programs, ironically maintained under pressure from the IMF. Without these policies, indigence would be significantly worse. This underscores a basic point often ignored in market triumphalism, markets do not solve poverty. In any functioning society, that responsibility falls to the state.

 

This is not a story of market-led success. It is a story of short-term stabilization underpinned by external support, which has increased indebtedness significantly,making Argentina by far the biggest debtor to the IMF (see above; the other expansion was with Macri, that had the same economic team; yeah he is also an outsider, wink, wink, say no more), combined with policies that risk undermining long-term productive capacity and the external sustainability of the country's foreign obligations. In other words, Milei makes a crash much more likely.

ROKE's New Clothes

A first look at the new ROKE cover, launching next year for the journal's 15th anniversary.

A little bit of the history of the journal appears in Robert Solow's obit, who was a member of the editorial board.

On Schumpeter as an economist, sociologist and prophet

I guess we are on a history of thought week. I wrote about Adam Smith being misinterpreted. Now it is about Schumpeter, who is often celebrated as the great theorist of innovation, the dynamic force behind capitalism according to him, being overrated. In this longer post (link to substack below), I argue that this reputation is largely overstated. While Schumpeter offered an influential narrative centered on entrepreneurs and technological change, his economics remained firmly within the marginalist tradition and added little analytically beyond earlier authors like his teacher Böhm-Bawerk. His real insights lay elsewhere, particularly in fiscal sociology in his famous essay on the tax state, but not much of a sociologist of technology. I discuss Schumpeter as economist, sociologist, and prophet (his approach to Marx in Capitalism, Socialism and Democracy), showing that he was a conventional theorist of growth, an interesting but limited sociologist, and ultimately a failed prophet about the fate of capitalism, especially when contrasted with Keynes, whose more modest proposals for managing capitalism proved far closer to historical reality. Read the whole thing here.

Development by invitation: a short digression on the concept

 

Development? Be my guest 

The concept of development by invitation, as far as I know, and most of my knowledge comes from Esteban Pérez's paper in a book we co-edited long ago,  originates with Arthur Lewis and refers to a development strategy in which small developing economies attract foreign capital to initiate industrialization. For Lewis, the problem of many small developing economies, particularly in the Caribbean, was that they lacked several key elements required for industrialization, namely: domestic capital, entrepreneurial skills and large domestic markets. Because of these constraints, industrialization could not easily emerge through domestic investment alone. Lewis therefore proposed industrialization by invitation, meaning that governments should invite foreign firms to establish manufacturing activities in the country.

Immanuel Wallerstein refers to a path of development in which a peripheral country advances economically because the multinational corporations from central countries actively expand into the world economy. This development occurred not through autonomous national transformation, but through external investment resulting from political and economic cooperation with central countries. For Wallerstein, the concept referred to a structural process within the capitalist world-system. In his framework, central countries allowed limited industrialization in some peripheral areas as multinational firms relocated production. That was, in fact, to some extent the phenomenon in a good part of the Latin American periphery, In other words, development by invitation was not a development policy, but a mechanism of global capitalism that reorganized production.

In the work of Carlos Medeiros (published with Franklin Serrano; he is pictured above), the notion of development by invitation refers to a historical process in which peripheral or late-industrializing countries accelerate their development because the leading powers of the international system actively support or tolerate their industrialization for geopolitical reasons. The concept is embedded in their analysis of international monetary regimes and growth dynamics. Growth is demand-led, and based on the supermultiplier, if that wasn't clear.

For Medeiros, the starting point is that capitalism naturally generates divergence between countries due to structural asymmetries in military power, technological capabilities, and monetary hegemony. All three are interrelated. Because of these asymmetries, most peripheral countries face a balance-of-payments constraint that limits growth. However, in certain historical periods, some countries can overcome these constraints when the dominant power facilitates their development.

For Medeiros,  development is not simply the relocation of production associated to multinational or transnational firms, be that as a policy strategy or an endogenous process of integration within the capitalist system. It involves state-led industrialization and strategic geopolitical support from the hegemonic power. Hence, development by invitation can produce successful industrial catch-up, not merely integration into the world economy.

Note that Esteban's discussion implicitly highlights a critique of the early concept from a structuralist perspective. Even though Lewis viewed the strategy as a path to development, in practice it often led to enclave industrialization and persistent dependence on multinational firms. The outcome sometimes resembled the type of dependent integration emphasized by Wallerstein. In a sense, Medeiros version is a further critique, suggesting that the interaction of political coalitions, behind the developmental state, and the geopolitical context matter.

Note that one might be correctly skeptical  of the notion that a country develops simply because the hegemonic power invites it to do so. Even acknowledging that favorable geopolitical contexts existed, such as those of Japan, South Korea, or several European countries in the postwar period, one might argue that development was ultimately the result of internal strategies, that is, strong states pursuing active industrial policies of technological catch up. In this view, the invitation may have constituted a favorable external framework, but it was never the decisive factor.

However, this critique appears to address a somewhat simplified interpretation of Medeiros’ concept. In his framework, development by invitation was never presented as a purely external process or as a microeconomic explanation based on private decisions. The concept was formulated in macroeconomic and geopolitical terms, placing emphasis precisely on the role of the state. The question was not whether Japan or Korea developed simply because the United States invited them, but rather why certain developmental states were able to industrialize so rapidly through manufactured exports. The answer highlights that these states benefited from exceptional external conditions. First, the unilateral opening of the US market, financial transfers,  very often facilitated technological transfers, beyond tolerance toward aggressive industrial policies, and strategic support within the context of the Cold War. This was not diplomatic magic, but rather a combination of an internal developmental state and a relaxation of the external constraint facilitated by American hegemony.

In other words, Medeiros’ concept does not attempt to explain development exclusively through external factors, but rather to illuminate why certain developmental states faced fewer external constraints, had greater access to financing, and enjoyed broader access to strategic markets than others. This allowed for a particular mix of export promotion and import substitution and helps explain why several Asian countries not only avoided the lost decade that followed the debt crisis of the 1980s, but also managed to accelerate their process of industrialization as a good part of the center, and other peripheral regions deindustrialized.

If the discussion is brought to the current Argentine case (I wrote a short note on this in Spanish), the most important point may not be to deny the relevance of the concept but to recognize that Argentina today lacks a developmental state capable of taking advantage of any potential invitation. If the government dismantles industrial, technological, and financial policy instruments, then whether a country is invited or not becomes almost irrelevant. The issue is not whether Washington extends a diplomatic invitation, but whether there exists a national strategy capable of transforming a favorable geopolitical context into productive accumulation.

Ultimately, the debate should not revolve around whether development arrives mechanically by invitation, but rather around the interaction between internal state strategy and external conditions. Development has never been automatic or purely external, but neither has it been independent of the geopolitical order and the decisions of the hegemonic power.

The Wealth of Nations at 250! Misunderstood icon of free markets

Today, March 9th, marks the 250th anniversary of the publication of The Wealth of Nations (WN) in 1776. Adam Smith may also be one of the most misunderstood thinkers in the history of economics. Smith is not the father of modern economics, neither of capitalism, a term he never used.

In modern discussions Smith is often portrayed as a precursor of contemporary economics, something like an early version of the Arrow-Debreu model of competitive equilibrium. I remember Sam Bowles suggesting that (he actually said something to the effect that Smith, Marx and Arrow, all said the same thing) at a talk at the University of Utah. In that interpretation, Smith supposedly discovered that self-interested individuals interacting through markets generate optimal outcomes, the infamous “invisible hand.”

Many books, including most classics on the topic suggest that interpretation. For example, yesterday WAPO had an op-ed (actually two; the other was much less problematic) by Jesse Norman, who will be publishing a book titled, you guessed, Adam Smith: Father of Economics. He correctly notes that the: "250th anniversary is not a moment for hagiography. It is an opportunity to recover a way of thinking that is directly relevant, indeed urgent, to the economic, social and political challenges we face today." He goes on to analyze essentially the question of tariffs with modern economic notions. Note that back in the 1790s, just after Smith passed, Alexander Hamilton, using Smithian ideas and method achieved very different policy conclusions.*

These readings of Smith as a father of modern economics and a champion of free market capitalism tells us far more about modern neoclassical economics than about Smith himself. The conceptual universe of modern economics is fundamentally different from that of classical political economy, the tradition to which Smith belonged.

Smith should be understood as part of a broader intellectual tradition that begins not with him but with William Petty, and continues through Cantillon, the Physiocrats, Ricardo, and ultimately Marx, what later came to be called the surplus approach. This tradition was concerned with the material conditions for the reproduction of society, the generation of surplus, and the process of accumulation.

In that framework, economics was not primarily about individual choice or utility maximization. It was about the reproduction of society. Seen in this light, Smith’s analysis was fundamentally about social conflict and the distribution of income, not about harmonious equilibrium among optimizing individuals. The core problem of political economy was explaining how societies generated and distributed the surplus that allowed accumulation and growth.

Another common myth is that Adam Smith founded economics. In reality, Smith was the great systematizer of a body of ideas of the surplus approach. Political economy emerged gradually during the Scientific Revolution and the early modern period. Petty, Cantillon, and the Physiocrats had already developed crucial insights about value, production, and economic reproduction before Smith wrote the WN. Smith’s real contribution was to organize these insights into a coherent framework and to place them at the center of his critique of the mercantilist system he saw as dominant. His book certainly helped establish political economy as a distinct intellectual discipline.

Nor was Smith the theorist of capitalism in the modern sense. The term itself was not part of his vocabulary. Smith spoke instead of commercial society, a stage in historical development characterized by the expansion of markets, manufacturing, and exchange.** He was certainly against the mercantile system, and believed that Physiocracy had incorrectly limited the creation of wealth to agriculture. But his defense of the system of natural liberty was not a defense of free markets in the modern sense.

Modern defenders of free markets often claim Smith as their intellectual ancestor. But the relationship between the liberalism of classical authors (not classical liberalism, which brings another series of confusions) and neoliberalism is far more complicated. Smith’s defense of laissez-faire was largely a reaction against the mercantilist system and the remnants of feudal regulation that constrained economic activity in the eighteenth century. The liberalism of Smith and Ricardo was historically progressive; it aimed to dismantle the privileges of the Ancien Régime and promote economic development.

Neoliberalism, by contrast, emerged in the twentieth century as a reaction against the Keynesian and welfare-state reforms of the New Deal era. Its central objective has been to limit the ability of democratic governments to regulate markets or redistribute income. In that sense, neoliberalism is better understood as a revival of what Marx called “vulgar economics”, rather than a continuation of the classical tradition.

Perhaps no concept has been more abused than Smith’s invisible hand. In modern economics it is often interpreted as a general theorem about markets producing optimal outcomes. But in Smith’s text the metaphor appears in a very specific context: merchants preferring domestic investment for reasons of security, which incidentally supports domestic employment. That is a far cry from the sweeping claim that all self-interested behavior leads to socially optimal results.***

Smith was also deeply skeptical of concentrated economic power. His famous warning that “people of the same trade seldom meet together… but the conversation ends in a conspiracy against the public” reflects a profound concern with monopoly and collusion. Competition, not the invisible hand, was the mechanism that restrained self-interest. He was anti-monopoly, not anti-state. In fact, he was for taxes to fund public education, a radical proposition back then (and now if you believe libertarian views that education is not a public good).

If you want to understand more about Smith ideas I recommend Tony Aspromourgos' The Science of Wealth: Adam Smith and the framing of political economy. For a book that puts in perspective how the legacy of Smith evolved in the 19th century read  After Adam Smith: A Century of Transformation in Politics and Political Economy by Murray Milgate and Shannon Stimson.

* On the distortions on Smith's views within the American context see my comments on  Glory M. Liu's book Adam Smith's America: How a Scottish Philosopher Became An Icon of American Capitalism. 

** On Smith's views on history and the four stages of development see the classic paper by Ronald Meek.

*** On that see the revised entry on the Invisible Hand by Tony Aspromourgos for the New Palgrave Dictionary of Economics.

PS: He also did not build up on the ideas of Ibn Khaldun, who, in turn, cannot be seen as a precursor of classical political economy or of Smith. On that see this post.

 

The macroeconomic perspectives: The GDP and employment numbers and the war in Iran

The new GDP and employment numbers are out, and they confirm something I have been arguing for a while, namely: the US economy is slowing down, but it is not in a recession, and the tariffs did not cause the stagflation that so many commentators confidently predicted.

Real GDP growth slowed again in the most recent quarter, but it still expanded at about 1.4 percent. Real GDP growth is slower than in 2024, but it was still above 2 percent (see below). That is clearly below the pace we saw in the immediate aftermath of the pandemic, when fiscal expansion and the reopening of the economy generated unusually strong growth. But it is still positive growth. As in previous quarters, consumption remains the central driver of the economy, which should not be surprising in a country where household spending accounts for roughly seventy percent of GDP.

The more worrisome component in the GDP report is actually government spending, which fell significantly. This decline reflects the wave of layoffs of federal workers and the broader push toward fiscal restraint that has accompanied the current administration, including falling nondefense spending. In other words, a certain degree of austerity has been quietly introduced into the federal budget, with a negative bias with respect to social spending. That matters because the rapid recovery of the US economy after the pandemic owed a great deal to fiscal expansion. As that support fades, or is actively reversed (although I doubt that) the economy naturally settles into slower growth.

On the labor market side, the most recent BLS employment report shows a decrease of about 92,000 jobs. That is certainly weak by the standards of the last few years, but it is not yet consistent with a recession. A lot of this was caused by a major, four-week, strike involving over 30,000 nurses and health care workers. Unemployment remains relatively low, and the labor market appears to be softening rather than collapsing. In other words, what we are seeing is broadly consistent with what macroeconomic theory would predict: when growth slows, job creation also slows. Okun’s law still works.
 
The decline in federal employment is part of that story. But here again there is an interesting political twist. While civilian federal jobs have been cut, the administration has promised a significant increase in military spending, which is likely to offset some of the contractionary effects of austerity elsewhere. This is not exactly a new strategy. Economists used to call it military Keynesianism, using defense spending to sustain demand when other forms of public spending are politically difficult.
 
All of this confirms something that was widely disputed last year. The tariffs did not trigger the recession that so many analysts predicted. Nor did they produce a surge in inflation. They also did not bring back manufacturing jobs, but that isn't a surprise either (on that see this post). As I argued repeatedly, tariffs might produce a one-time increase in the level of prices, but that is very different from generating persistent inflation. And the effect was small, with CPI increasing by less than it did in 2024 (see figure above). The data have borne this out. Inflation has remained relatively subdued, and the economy, while slowing, continues to grow.
 
That does not mean the risks have disappeared. In fact, the risks may now be higher than they were earlier in the year, but for reasons that have little to do with tariffs. The most important new development is the war with Iran and the sharp increase in oil prices. Since the beginning of the conflict, oil prices have risen by more than 25 percent (see below). Energy shocks have historically played an important role in US inflationary crises, including the Pandemic. Higher oil prices increase production costs,  push inflation and squeeze household budgets. The affordability issue (like the Epstein files) might not go away.

But the key channel here is not simply inflation. The real issue is the Federal Reserve’s reaction to these cost pressures. Throughout last year I have argued that the main recession risk comes from monetary policy, not trade policy (and to a lesser extent fiscal policy). The Fed kept interest rates relatively high for a prolonged period in order to combat inflation after the pandemic. Those high rates have already slowed residential investment and put pressure on consumption through higher mortgage rates and credit costs. If oil prices push inflation slightly higher again, the Fed may become even more reluctant to reduce interest rates further. Kevin Warsh was a hawk before he wasn't. 
 
In other words, the oil shock could reinforce the Fed’s cautious stance and delay the easing of monetary policy. That would prolong the period of tight credit conditions and increase the risk that the slowdown eventually turns into a recession. Ironically, this means that the biggest macroeconomic danger today comes not from tariffs, not from supply chains, and not from the uncertainty that commentators love to invoke. It comes from the interaction between energy prices and monetary policy.
 
PS: My view has been more or less in line with the results of the Fair model forecasts. He sees a slowdown of growth and a small increase in inflation (last one was before the Iran war). 

Naked Keynesianism at 15!

A day like today, back in 2011, I wrote the first post on Naked Keynesianism. I was at the University of Utah then (that was still an heterodox place). I had been blogging for a while (at Triple Crisis, a joint effort), but nothing quite captured the kind of heterodox economics that mattered to me. The Review of Keynesian Economics (ROKE) did not yet exist. There were few spaces where the conversations many of us thought were essential were taking place openly and consistently. More than 2,000 posts and roughly 9 million views later, the blog has clearly passed its peak in terms of traffic, but it has taken on a life of its own.

As I noted 5 years ago, the blog is less of a teaching instrument for me now than it was at the beginning. I post some of that on the substack. I post less, but it still has some value added, I hope. Thanks to all my co-bloggers over the years, and to the readers who have made these fifteen years possible.

The John Jay-New School Conference on Contemporary Political Economy

Since the Easterns will not be in the US this year (in the Dominican Republic in May), John Jay and the New School Econ departments are organizing a conference on the traditional date (last weekend of February) in New York. I'll be in a table on international finance and development. More info here, including link for registration and the program.

The General Theory at 90: The reconstruction of macroeconomics

On February 4, 1936, Maynard Keynes published The General Theory of Employment, Interest and Money (GT). I'm off by a few days. ROKE did notice it, but I had no time to post. I recently presented on the social policies discussed in the last chapter of the book at the ASSA Meetings in Philly (photo above; paper soon, hopefully).

Ninety years later, the book remains perhaps the single most important book in twentieth-century economics. The work that most decisively changed the direction of the discipline. And yet, much of what people think about the book is wrong.

The first thing to understand is that the GT is not a book about economic policy. Keynes says so explicitly at the outset. It is a theoretical work, written for fellow economists. It is not a blueprint for government spending programs. It is not a political manifesto. It is not a defense of deficit finance in simple terms. It is a theoretical reconstruction of how a monetary economy actually works.

The popular image of Keynes as the prophet of fiscal stimulus obscures this. Ironically, the book itself says very little about fiscal policy. There are some vague remarks about what Keynes calls the “socialization of investment,” but there is no systematic discussion of fiscal policy, for how to pursue expansionary fiscal policy or the construction of the welfare state, which is also often associated with Keynes. The policies we associate with Keynesianism, deficit spending, expansionary fiscal policy, tolerance for deficits and debt, at least in times of crisis, are not the core contribution of the book.

Another important historical irony, the GT arrived relatively late, both politically for the New Deal, but also in Keynes' own trajectory as a policy wonk. By 1936, Franklin Delano Roosevelt and the New Deal had already reshaped American politics. The Wagner Act had strengthened unions. The CIO was organizing industrial labor. Sit-down strikes in Detroit had forced General Motors to negotiate with the United Auto Workers. Figures like Frances Perkins, the first woman to hold a cabinet position, were central to labor reforms. Obviously Marriner Eccles (see my paper on him here), and his advisor Lauchlin (not Laughlin) Currie (and on him here) had not yet won the battle for fiscal activism, but they were entrenched in the New Deal environment. The shift toward a more interventionist state was already underway.

In that sense, Keynes’ theoretical revolution did not initiate policy change. It provided a new framework for understanding an economic world that was already politically transforming. So what was truly new in the GT, you may ask? After all, many still claim that the Treatise on Money, his previous work, with endogenous money, and more institutional discussion was a better book (Schumpeter, for example; Friedman preferred his Tract on Monetary Reform, more aligned with the Quantity Theory of Money). The revolutionary core of the GT is the principle of effective demand.

Neoclassical economics rested on Say’s Law (and so did classical economics, properly defined, but in a different way; without full utilization of labor), the idea that supply creates its own demand. Production generates income, and income automatically generates sufficient demand to purchase output. Persistent unemployment, therefore, could only be temporary. Keynes turned that logic upside down in the GT. Demand generates income. Output and employment are determined by the level of effective demand. There is no automatic mechanism guaranteeing full employment.

This idea was not fully developed until 1932, during intense discussions in Cambridge among the group known as “the Circus,” which included: Joan and Austin Robinson, Richard Kahn, James Meade and Piero Sraffa. Their critiques of Keynes’ earlier Treatise helped push him toward the insight that defines the book. That theoretical shift, not fiscal activism, is the true intellectual rupture.

Another misconception is to assume that Keynes needed the GT to defend fiscal activism. Theory and policy would be tied up together. In fact, he had already been advocating public works and expansionary measures since the mid-1920s, especially after Britain’s return to the gold standard created severe deflationary pressures. The 1926 General Strike and the electoral victories of the Labour Party in 1924 and 1929 occurred in this context of economic stagnation (see my paper on this here). Keynes’ policy activism predated his theoretical breakthrough. In other words, the policy ideas were not new. The theory that justified them, and explained why unemployment could persist, was.

It is also worth dispelling another myth. Keynes was not a socialist bent on expanding the state at all costs. He remained, throughout his life, a liberal in the classical sense, though one deeply critical of laissez-faire orthodoxy. His goal was to save capitalism from its own instability, not to replace it.

The “socialization of investment” he envisioned was pragmatic, not revolutionary. It reflected a recognition that private investment decisions were volatile and insufficient to guarantee full employment, not a desire to abolish markets or even for economic planning.

Ninety years on, The General Theory still matters, but his views have been in retreat since the 1930s, and only succeeded, during the so-called Golden Age of Capitalism, because they could be incorporated within the mainstream of the profession. The irony is that the book most associated with fiscal stimulus is fundamentally about something deeper: a reconstruction of macroeconomic theory. That task is still ahead.

The bridge to austerity and stagnation

I have always emphasized in the blog the importance of  the Principle of Effective Demand and the pitfalls of Say’s Law, as central to understand Keynesian economics. Keynesianism is about that and NOT about the rigidity of wages, or the interest rate, or even fundamental uncertainty (something to which Keynes had to appeal to defend his ideas from 1937 on, as a result of retaining the marginalist notion of the marginal efficiency of capital). Very often that is an abstract discussion, hard to follow for students. I'm in the middle of teaching this again this semester (first time I taught Intermediate Macro was in 1993 at the Universidade Federal Fluminense, UFF).

A recent paper by Guilherme Haluska, Franklin Serrano, and Ricardo Summa (2026) provides a good empirical look at these theories in action. The authors analyze the period from 2015 to 2022 in Brazil, a phase marked by a radical shift toward fiscal austerity, labor reforms, and a rigid constitutional cap on government spending. This policy shift, famously dubbed "The Bridge to the Future," was predicated on the neoclassical belief that cutting public spending would boost confidence and reduce interest rates, thereby triggering an explosion of private investment and export-led growth.

The results, as the authors demonstrate, were exactly the opposite: the bridge led straight to stagnation. By utilizing a demand-led growth framework, they show that the sharp contraction in public investment and social spending actually dragged down aggregate demand. Far from being crowded in, private business investment fell as a share of GDP because firms, facing a shrinking domestic market and stagnant consumption, had no incentive to expand capacity. In other words, the accelerator works. As often emphasized in this blog.

The paper serves as a powerful contemporary reminder that, as Keynes argued and as we have noted in many prior posts (too many to link), when the state retreats from its role in managing demand, the market often fails to find a natural path back to prosperity, leaving the economy trapped in a low-growth equilibrium.

PS: A version of that, linked in the blog before, here. For a few similar posts suggesting Brazil has no fiscal problems, see this from 2024, or this one, this one from 2019, and this one from the beginning of the Brazilian stagnation period in 2015 (check how correct, in your view, my predictions were).

On the Language of Economics on NPR's Marketplace

Last December, I spoke with Sean McHenry for a segment on NPR’s Marketplace about the meanings behind the words economists use. While only a short excerpt aired today, the full exchange dove into the philosophical, historical, and political layers that underlie economic language, especially through the lens of Adam Smith and the evolution of economic thought.

We began with Smith, not the pop-icon version who supposedly preached markets above all else, but the Smith who drew from Newtonian mechanics to describe economic processes. Smith’s idea that market prices gravitate toward natural prices wasn’t just a metaphor, it was grounded in his belief that economic laws were as natural and immutable as the laws of physics. This analogy wasn't poetic fluff; it was the intellectual architecture of 18th century economics.

This matters because metaphors shape how we understand the world. Terms like natural rate of unemployment or neutral interest rate don’t just describe, they legitimize. They imply inevitability, naturalness, and neutrality, even when real-world consequences (job loss, mortgage spikes) are anything but neutral.

Smith's project was a materialist science concerned with the accumulation of wealth. For him the natural functioning of the economy did not lead to optimal outcomes. Still, the intervention of the mercantilist and feudal institutions impaired the natural process of wealth accumulation. After the marginalist revolution of the late 19th century, interventions affected the natural tendencies of the market to produce optimal outcomes. That is the world in which we still live, when it comes to economists metaphors. Meaning a world in which markets do produce optimal outcomes, unless there imperfections.

We also discussed the ideological undertones of terms like churn in labor market language. While economists may use it as a tidy description of movement in and out of jobs, for someone who's lost work, the term can feel like a euphemism that sanitizes real economic pain. It's this kind of language, precise, clinical, but emotionally distant, that can obscure the lived experience behind the data. The notion is that there might be pain, but in the long run that will not be a problem (Keynes was reacting to this notion with his famous quote about all being dead in the long run).

In my history of thought course at Bucknell, I walk students through how economic terminology evolved, from classical theories of value to modern utility and preference-based models. We interrogate the shift from political economy to economics, and what gets lost when we strip politics (class conflict) from the analysis. Even terms that seem neutral, like neutral interest rate or natural rate of unemployment, are packed with assumptions about how markets work, very often skewing issues of power, and distributional conflict.

Economics has long striven to present itself as a hard science, borrowing the language and posture of physics. But unlike physics, economics deals with entrenched political structures and it is harder to separate the ideological and analytical elements in a particular theory. The profession’s reliance on technical jargon and tidy models sometimes masks the messy, contested, and deeply political nature of the economy itself.

As one of the editors of the upcoming fourth edition of The New Palgrave Dictionary of Economics, I’m part of a team trying to decolonize the dictionary, bringing in voices from underrepresented regions, grappling with the absence of concepts like power, and reassessing the dominance of certain Western-centric assumptions. I also it requires a return to some of the forgotten ideas of the classical political economy authors that made the political or socially conflictive element of the reproduction of society central to their analytical inquires (see my Palgrave lecture here).

Language is never just descriptive. It is to some extent normative. It tells us what to value, what to question, and what to accept as given. Political economy, at its best, can be a powerful tool for understanding and improving social conditions. But that requires constant reflection, not just on models and data, but on the words economists use, the histories economists tell, and the blind spots economists perpetuate.

You can catch the edited interview on NPR’s Marketplace with Sean McHenry here.