Palley on the ELR in the UK

Thomas I. Palley

The following story, which appeared in The Guardian on Sunday 29 July, was forwarded to me by Malcolm Sawyer:

“Million jobless may face six months’ unpaid work or have unemployment benefits stopped”

In a sense, the UK, under Conservative Prime Minister Cameron, is looking to adopt a quasi-employer of last resort (ELR) scheme in which the ELR wage is set equal to existing unemployment benefits (Note: the Conservative scheme involves compulsory labor for benefits).

Read the rest here.

Kevin Gallagher on capital controls

Another interesting talk at the Central Bank of Argentina, this one by Kevin Gallagher from the University of Boston based to a great extent on his recent work with José Antonio Ocampo and Stephany Griffith-Jones on the regulation of capital flows (see here).

He has three main points to make. First, there is increasing and overwhelming evidence that there is no connection between capital account liberalization and economic growth. He cited the recent work by Arvind Subramanian, Olivier Jeanne and John Williamson (the latter of Washington Consensus fame) at the Peterson Institute, called "Who Needs to Open the Capital Account?," who argue (2012, p. 5) that "the international community should not seek to promote totally free trade in assets -- even over the long run-- because ... free capital mobility seems to have little benefit in terms of long run growth."

Second, it seems that the International Monetary Fund (IMF) has come to partially recognize the appropriateness of capital account regulations and has gone so far as to recommend (and officially endorse) a set of guidelines regarding the appropriate use of Capital Account Regulations (CARs), the new term for capital controls within the IMF. He warned, correctly I think, that changes within the IMF can be seen as a reform that tries to restrict the use of capital account regulations to emergencies, and situations approved by the IMF within article 4 consultations, when article 6 guarantees that countries can use them freely.

Finally, and more importantly, Kevin warned that Bilateral Investment Treaties (BITs) and Free Trade Agreements (FTAs) have regularly included very restrictive language on capital account regulations, and have a tendency to restrict the policy space in developing countries, exactly when a consensus that this restrictions do not provide any benefit in terms of growth.

A Critique of the Lucas Critique

The blogosphere, it seems recently, has been particularly rich in blogoyakking (sp?) concerning microfoundations. Wren-Lewis, Noah Smith, Krugman, Rowe, Plosser, and others just in the week prior to this post.

And this has caused a persistent itch of mine to clamor for scratching. Here goes.

The Lucas critique is fairly widely acknowledged to have at least exacerbated the trend toward insisting on microfoundations in macro theory, and thus the rise of New Keynesian Dynamic Stochastic General Equilibrium models. You know, representative agents showing rational expectations over generations, and all such things, reacting to policy changes. Which individual behaviors we can, more or less simply, just add up in order to understand the effects on the macro economy.

For those needing a brief review on "the" critique, Wikipedia is actually not bad, which I summarize. Lucas said:

"Given that the structure of an econometric model consists of optimal decision rules of economic agents, and that optimal decision rules vary systematically with changes in the structure of series relevant to the decision maker, it follows that any change in policy will systematically alter the structure of econometric models."

This is from his 1976 paper.

And the Wiki article summarizes the implications:

"The Lucas critique suggests that if we want to predict the effect of a policy experiment, we should model the "deep parameters" (relating to preferences, technology and resource constraints) that govern individual behavior. We can then predict what individuals will do, taking into account the change in policy, and then aggregate the individual decisions to calculate the macroeconomic effects of the policy change."

Thus, Bortis-style classical-Keynesianism was pretty much denuded: at best macro policy is effectively toothless, since that pesky agent will simply react to neutralize the policy actions;  and/or react so that the empirical regularities we were observing and making policy on will change. So we need to focus on micro and get that "right," the best we can do. The domination of Methodological Individualism on economic practice was on the rise.

I think Lucas got part of the diagnosis correct: individuals do react to macro policy changes but only indirectly. And he got most of it wrong. For the most part individual behaviors do not  directly change the  structure of the time series, but it is the change in the structure of the time series that changes individual behavior. Aggregate demand falls due to some shock - asset deflation, price shocks, war, pestilence, loss of income due to technology or offshoring. Producers then decrease output, and fire their workers.

This shock mechanism does induce individually optimizing behavior on the part of the business owner, given that what he optimizes is his profit function into which his production output enters.

For the newly unemployed person, since s/he no longer has a source of income, one can stretch and say that reducing consumption is individually optimizing at least of negative deviations from the budget. Of course this mechanism has it's own brutal zero lower bound - subsistence.  And does nothing to maximize utility.

Notice, no macro policy change is required here to start a recession or the recent depression; all we need is a sufficient shock to the system to start the negative feedback cycles rolling along.

We classical-Keynesian macroeconomists characterize these mechanisms as showing the fallacy of composition; the canonical principles of economics example is the paradox of thrift. You cannot use added-up individually optimizing behaviors to determine what is going to happen to the macro economy.

The reason is clear: emergent properties at the macro level have a life of their own. And its is these emergent properties like recessions and unemployment that directly affect the behavior of the economic person. I take here the strong version of emergent: a property or behavior at the aggregate level which cannot be observed or predicted at the individual level.

We do have methods that attempt to model this: the Keynesian aggregate expenditure model, but that is static. Dynamic macro econometric models, but those are difficult, and maybe it was because of these difficulties that the Lucas critique was so successful in attacking them.

I propose two things to restore the dominating importance of emergent macro properties on economic behavior. One is a recommitment to econometric modelling. Ever increasing data and increasingly better tools will continually improve modelling and forecasting results.

The other is a methodology that is vastly underused in economics, but widely used in various other sciences: network system analysis based on the mathematical theory of graphs. These methods lets us directly measure and model emergent dynamic behaviors from groups, like the individuals in an economy. No added up methodological individualism required; no agent-based model needed. Observe, model, and predict directly at the macro level.

While I believe empirical models, properly done, are fundamental to understanding and policy, network models provide us with a dynamic theory, emergent macro behaviors, that  support our correct Keynesian beliefs that it is the macro foundations of micro behavior that matter, not the other Lucasian way around.

More on MMT and ELR

Thomas I. Palley

Randy Wray and Mat Forstater, two leading contributors to the MMT School, have replied to my recent blog on the MMT controversy. Their replies warrant a brief response.

I agree that it does not matter very much who first identified the euro’s potential for failure. Along with other Keynesians, MMT-ers were early to identify the euro’s structural flaw – namely, its conversion of the financial status of national government into provincial government status via removal of government’s power to access money creation through a government controlled central bank. In many ways Warren Mosler (1995) is the godfather of interest in this issue.

Read the rest here.

In Defense of Post-Keynesian and Heterodox Economics

New book (and here) edited by Fred Lee and Marc Lavoie (there is a typo on the cover, Mark instead of Marc) forthcoming soon. The book is a response to critics of heterodox economics, mostly friendly critics, who suggest that heterodox economics should change its ways in order to be more respectable and to achieve more pre-eminence. The critics include J. Barkley Rosser, David Colander, John B. Davis, Giuseppe Fontana, Robert Garnett, Bill Gerrard and Richard C. Holt.

From the book jacket:

Post-Keynesian and heterodox economics challenge the mainstream economics theories that dominate the teaching at universities and government economic policies. And it was these latter theories that helped to cause the great depression the United States and the rest of the world is in. However, most economists and the top 1% do not want mainstream theories challenged—for to do so would mean questioning why and how the 1% got where they are. Therefore, numerous efforts have been and are being made to discredit if not suppress Post-Keynesian and heterodox economics. These efforts have had some success; this book is a response to them.

This book makes it clear that Post Keynesian/heterodox economics is, in spite of internal problems, a viable and important approach to economics and that it should resist the attempts of the critics to bury it. The reader will also find arguments that directly engage the critics and suggest that their views/criticisms are vacuous and wrong. As such, this will appeal to all who are interested in economic theory, economic history and who believe in challenging the orthodoxy.

The paper by Marc that started the book project is available here. Fred's paper which followed is here.

Why is neoclassical economics so resilient?

For non economists the Great Recession proved that economists are not serious. The Queen of England after a visit to the London School of Economics in 2008 asked how it was possible that economists failed to predict the crisis (yes, it is a bit ironic that woman that has only a decorative role essentially asks what is the role of economists if they cannot foresee crises). Her precise words were: "It's awful. Why did nobody see it coming?"

Many answers followed, some really bad, and others more to the point. And yes several economists, fundamentally heterodox ones, saw it coming. But the mainstream has remained, not only one step behind in the understanding of what has happened and why, but very reluctant in catching up with heterodox authors, which is not completely disconnected from the resilience of austerity as a policy to deal with the crisis.

Note that this crisis has been very different than the Great Depression, a period that became known for the revolutionary changes in economic theory as "The Years of High Theory," fundamentally as a result of a homonymous book published by G.L.S. Shackle in 1967. The question is why the previous crisis, during the inter-war period, led to a serious effort to rethink the discipline, but this time around nothing much happened.

In my view the only way to understand why the profession did not react to its own failure, by the way something that contrary to many others I did expect, is in light of the history of ideas, and the failures of the previous revolutionary changes during the years of high theory. First, it is important to note that Shackle himself, in ways that are very similar to the mainstream (even though Shackle was the missing link, if there is one, between Post Keynesians and Austrians), suggested that the revolutionary ideas of Keynes and Sraffa, that where at the core of the changes in the 1920s and 30s, basically meant that market imperfections imply that marginalism is a limited guide for the real world (for more see papers here and here). The point is that both Keynes' Principle of Effective Demand, and Sraffa's critique of Marshall, which led him to a revision of price theory and to the recovery of the old and forgotten theories of the surplus approach culminating with his 1960 book and the critique of the logical consistency of marginalist theories, were radical departures from neoclassical theory.

Also, it is important to note that back in the inter-war period, although the marginalist school was dominant in the UK, with Marshall reigning supreme in Cambridge, and Continental Europe, Austrians, Swedes and Italians (were Walrasian economics had more influence) at the front of the pack, in the US, which was then becoming the new hegemonic power, the predominance of marginalism was less clear. In fact, most institutions, like the American Economic Association, the National Bureau of Economic Research, and several universities were dominated by institutionalists. It is, in fact, only with the Keynesian Revolution, with Hicks, Hansen and then Modigliani (the one to introduce the fix wage model) that a certain version of Keynesianism, more neoclassical, that marginalism becomes dominant in the US. It is with the Keynesian Revolution that neoclassical economics became dominant in the US.

So the point is that a certain version of marginalism, that suggested that imperfections were at the heart of the problem, became dominant in the US, and that was a departure from the previous dominant school, but one that had significant problems. When those problems became evident in the 1960s in the midst of the capital debates, this sort of neoclassical synthesis Keynesianism came under attack, and the monetarist and New Classical counter-revolutions were possible. The return of vulgar economics was inevitable at that point. In this context, the profession lost capacity to understand reality, since it became, to a great extent, pure apologetics for free markets. Also, this counter revolution explains why authors like Krugman (which still learned his economics from old Keynesians) are surprised by the fact that the profession has forgotten basic things (the dark age of macroeconomics is his very apropos term).

Finally, the last reason why this time around the crisis did not lead to serious rethinking of the limitations of the dominant paradigm is that, while in the inter-war period Fascism and Communism were real threats (and the latter a threat to capitalism), this time around there is no significant alternative contender. Not only the US supremacy is uncontested in any serious way, but also the economic system itself is safe.

Note that vulgar economics, the shallow apologetic of markets, was dominant in the post-Ricardian period (from the 1830s onwards) and was not seriously contested until the inter-war period (Marxism, the only serious development within the surplus approach, and, hence, within scientific economics, was marginal of course). So this current state can, and most likely will, continue for a long while. Heterodox economists should prepare for the long winter. Teaching, maintaining serious and autonomous research (meaning that dialogue with the mainstream is less important that original research trying to understand the real world) and producing new heterodox economists (the production of heterodox economists by means of heterodox economists) are the tasks ahead.

Palley on the spurious victory claims of MMT

Thomas I. Palley (orginally posted here)

Led by Randy Wray (see this and this), supporters of so-called Modern Monetary Theory (MMT) are declaring that they were the first to identify the problems of the euro and that MMT has now proved itself to be the correct approach to monetary theory.

As regards these two claims, permit me to quote the following:

“5.3 Will capital still be able to veto policy?

…First, financial capital may still be able to discipline governments through the bond market. Thus, if financial capital dislikes the stance of national fiscal policy, there could be a sell-off of government bonds and a shift into bonds of other countries. This would drive up the cost of government borrowing, thereby putting a break on fiscal policy (Palley, 1997, p.155-156).”

MMT is a mix of old and new. In my view, the old is widely understood by old Keynesians and the new is substantially wrong. The above quote from my 1997 paper shows two things:

(1) MMT'ers were not the first to predict the structural flaw in the euro’s design regarding possibilities for conduct of fiscal policy.

(2) Old Keynesians fully understood that if you remove the national central bank, national government is reduced to the status of a province and may be unable to run deficit based fiscal policy if bond markets refuse to finance it.

With regard to theoretical weaknesses, MMT lacks a convincing theory of interest rates, over-simplifies the economy by assuming an L-shaped supply schedule that ignores the effects of sectoral bottlenecks and imbalances, lacks an adequate theory of inflation, and ignores expectations and exchange rates. These omissions lead it to overstate the powers of monetary and fiscal policy.

In this regard, I offered an early critique of MMT in the context of its twin policy proposal for an employer of last resort (see Palley, 2001). I am not necessarily against an ELR. However, because of their reliance on MMT, supporters of ELR tend to oversell the proposal and ignore problems that may be considerable. This illustrates how the theoretical short-comings of MMT can promote dangerous over-simplifications of important and complex policy issues.

References:

Palley, T.I., "European Monetary Union: An Old Keynesian Guide to the Issues," Banca Nazionale del Lavoro Quarterly Review, vol. L, no. 201 (June 1997), 147‑164.

Palley, T.I., “Government as employer of last resort: Can it work?" Industrial Relations Research Association, 53rd Annual Proceedings, 2001, 269 – 274.

PS: A previous post on the topic here.

Back to full employment

Robert Pollin has written a short and very important book titled as this post. Bob is correct in pointing out that the main obstacle to full employment has been political, and that there is no technical reason why we are not pursuing policies that would produce lower levels of unemployment. Note that, as I suggested before, the unemployment problem, as bad as it is right now, is actually worse than you might think.

The full employment goal was attacked almost from the beginning, when it was implemented as the result of the Employment Act of 1946 in the United States. Arguably the Fed-Treasury Accord of 1951 was the first bullet shot in the war against full employment policies. Intellectually, the notion of the natural rate of unemployment, developed by Milton Friedman, and still part of the box of tools of mainstream economists (including New Keynesians) gave theoretical respectability to the idea that full employment could not be a sustainable policy goal.

But it was the rise of conservatism in the 1970s, and the Volcker-Reagan economic policies, that effectively eliminated full employment from the policy agenda. Pollin's book is a plea to bring back the role of the State in promoting policies that would benefit society as a whole. Further, he argues that the same State capacity that has allowed the US to remain a military power can and should be used to promote industrial development with equitable income distribution. A must read!

PS: See also Bob Kuttner's article on Pollin's book at the American Prospect, and Bob's piece in the Boston Review on the topic of his book.

Global wealth inequality

Credit Suisse publishes a Global Wealth Report, and if you think that income inequality is bad, well you don't know anything about wealth (h/t Jorge Gaggero for the link). According to the report total wealth in 2011 was US$ 210 trillions. Figure below shows the distribution by deciles around the world.

The poor are fundamentally in Africa, India, and Asia-Pacific (mainly Bangladesh, Indonesia, Pakistan, and Vietnam), while the wealthy are in the US, Europe and Asia-Pacific (i.e. Japan). China has more people in the middle section of the wealth distribution than at the extremes. No big surprises there.

The distribution of global wealth is shown below in what the authors of the Report refer to as the Wealth Pyramid.

So 67% of the world's population (around 3 billion people) hold about 3.3% of total wealth at the basis of the pyramid. At the top of the pyramid, 0.5% of the population holds approximately 38% of the wealth. These are the dollars millionaires, which are overwhelmingly in the US, Europe and Japan.

Interestingly, in a different study, the Tax Justice Network has estimated that unreported offshore wealth held in tax havens has reached between US$ 21 and 32 trillions. That is, between 11 to 16% of all global wealth in 2010 (which was at US$ 195 trillions) is out of reach of taxing authorities. If you consider that this money comes fundamentally from the ones at the top of the pyramid, that hold wealth in more liquid forms, it is between 23 and 36% of the wealth of the top 0.5% of the wealthiest 1%. The global elites like Mitt Romney if you will.

Stock-Flow with Consistent Accounting (SFCA) models

Gennaro Zezza, student and co-author of the late Wynne Godley and currently responsible for the Levy Institute macroeconomic model, gave an interesting talk on the usefulness of Stock-Flow with Consistent Accounting (SFCA) approach to macroeconomic modeling. He refers to the models as stock-flow consistent (SFC), but I prefer to emphasize that the consistency is not just about the relation between stocks and flows, but also the fact that these models provide the full set of accounts (website for those interested in this approach here).

SFCA proved to be considerably more successful than conventional, in particular Dynamic Stochastic General Equilibrium (DSGE) models, in predicting the Great Recession (see here paper by Dirk Bezemer).

As noted by Gennaro, the fundamental principle of SFCA models is that:

"in the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: 'there are no black holes.' This obvious principle has relevant implications: one is that the debt of somebody is a credit for somebody else."

Note that this fundamental principle has more to do with the fully consistent accounting part of the model, than with the relation of stocks and flows. But stock-flow relations are also essential, since flow decisions of spending are tied to stocks. Private agents can spend if they have access to stocks of credit, of accumulated assets, that is, some stock of wealth. The State often has the power to spend and accumulate a stock of debt, since it can decide (Functional Finance and Chartalist approaches, which are implicit in Godley's work, become important here) the token in which debts are denominated.

One of the questions raised in the presentation was about the supposed lack of behavioral assumptions and expectations in the SFCA (as compared with DSGE models). First, it should be forcefully noted that there are behavioral assumptions, and those are strictly speaking based on Post-Keynesian (classical-Keynesian, I would say) principles. So agents autonomous decisions to spend create income, and in the models, I would add, investment follows an accelerator, so it tends to be derived demand, with the stock of capital adjusting to the flow of income (a relatively stable stock-flow relation, associated to the normal degree of capacity utilization).*

While DSGE models presume that an exogenous potential product (determined by supply side factors in a Ramsey/Solow/Lucas/Romer tradition) drives the economy, and deviations from it are corrected by price and wage flexibility, these models have an endogenous demand-driven output trend, which is really why they do better explaining the real world, including the Great Recession.

On the question of expectations Gennaro was clear, as a Post-Keynesian (PK) he is not particularly interested in expectations. He, however, suggested the possibility of using what Tom Palley refers to as model consistent expectations. That is, agents use expectations that are consistent with model (in this case the PK model, and, hence Lucas's problem is not that agents use all the available information, but that he has the incorrect model). Mind you the introduction of this expectational framework does little to improve the ability of the modeler to understand reality.

Finally, I want to note that while I do think that it is essential that these models, which are an alternative to applied DSGE models used around the world in Central Banks, international organizations, think tanks, and other institutions that managed to miss every single sign of the crisis, are developed and used more by economists, they should not be seen as the only modeling strategy available to heterodox economists.

In my view, the stock-flow and the demand driven (and I should say, the fact that price dynamics is orthogonal to the income flow determination structure)** is the essential characteristic of this approach. But the empirical, macroeconometric models that Gennaro and Wynne build have, more importantly, the full set of accounts, something that is essential for the empirical models, but sometimes too cumbersome for making a theoretical point. Hence, sometimes models that present the stock-flow dynamics (in a classical Keynesian perspective), without the full accounts (see here, for example), are necessary, useful and more directly relevant for the task of providing theoretical insight into a specific problem.

* This means that these are supermultiplier models in the Kaldorian tradition, which should not be a surprise since Wynne was a disciple of Kaldor. In fact, Kaldor was responsible for bringing Wynne to head the Department of Applied Economics at Cambridge in the late 1960s.

** Wynne was a student in Oxford of Andrews, one of the main authors of the Full Cost Pricing School.

Spot the difference

Here are two posts (here and here) that look very similar (same graphs). Both show that private indebtedness was the result of wage stagnation. The first was published the 18th, while the latter the 3rd of July. I'm glad he is reading it.

Toward an Understanding of Crises Episodes in Latin America

Conventional wisdom about the business cycle in Latin America assumes that monetary shocks cause deviations from the optimal path, and that the triggering factor in the cycle is excess credit and liquidity. Further, in this view the origin of the contraction is ultimately related to the excesses during the expansion. For that reason, it follows that avoiding the worst conditions during the bust entails applying restrictive economic policies during the expansion, including restrictive fiscal and monetary policies. In this paper we develop an alternative approach that suggests that fiscal restraint may not have a significant impact in reducing the risks of a crisis, and that excessive fiscal conservatism might actually exacerbate problems. In the case of Central America, the efforts to reduce fiscal imbalances, in conjunction with the persistent current account deficits, implied that financial inflows, with remittances being particularly important in some cases, allowed for an expansion of a private spending boom that proved unsustainable once the Great Recession led to a sharp fall in external funds. In the case of South America, the commodity boom created conditions for growth without hitting the external constraint. Fiscal restraint in the South American context has resulted, in some cases, in lower rates of growth than what otherwise would have been possible as a result of the absence of an external constraint. Yet the lower reliance on external funds made South American countries less vulnerable to the external shock waves of the Great Recession than Central American economies.

Read the rest here.

The real world vs. the confidence fairy

By Paul Davidson

Recently I went to a well-known restaurant in Evanston, Illinois. This restaurant has a reputation for providing excellent food and service. But the night I was there, it was less than half full. I asked the manager if he would he hire more waiters and chefs if his taxes were reduced and/or government removed the existing regulations controlling the way his restaurant could operate. His answer was that even if his taxes were reduced and regulations eliminated, he would only hire more staff if more customers came in for dinner. On the other hand, if there were twice as many customers for dinners than there were on this night (and there were many more customers before the recession began in 2007) he would gladly double the number of workers he employed even if his taxes were not reduced or regulations changed.

Read the rest here.

Heterodox and Mainstream Economics: The Great Confusion

Simon Wren-Lewis has a post on heterodox versus mainstream macroeconomics in which he seems surprised by what he calls the Great Divide between the two groups. He claims to be sympathetic to the heterodox project, at least along the lines of Steve Keen, but argues that the "rejectionist strategy is of course unlikely to win friends within the mainstream."

Wren-Lewis also suggests that a Minsky model developed by Keen (which according to Keen was rejected by several mainstream journals) is very similar to his ideas, but he fails to note that the Keen's model, as well as Minsky's theory, does not include a crucial characteristic of mainstream models, New Keynesian (NK), New Classical (NC), Real Business Cycle (RBC) and New Neoclassical Synthesis (NNS) alike, namely: Friedman's natural rate hypothesis.*

If you accept that cycles are just a shock (monetary or real) to an optimal trend and that the only thing that prevents the return of the economy to its optimal level is some sort of rigidity, then the obvious solution, at least in the long run, is to eliminate the rigidities. By the way, that is the reason why the NKs and NNSs authors end up believing in a confidence fairy, very much like NCs and RBCs authors. The NK and NNS fairy being about higher inflation expectations allowing for more investment demand, rather than directly about the less uncertainty allowing for more investment.

Wren-Lewis' confusion is to assume that the proximity of heterodox Keynesian groups and NKs like him on policy issues implies that on a deeper theoretical level there must be agreement too, and that this does not happen because of the sectarian nature of the heterodoxy.

Krugman's views, by the way, are very similar, in the sense that he seems to not quite understand why he is not seen as Keynesian by some heterodox economists. In a recent post, he argues that:

"Some devotees of Keynes claim that people like me aren’t really Keynesians – and while there are some serious grounds for the charge, part of the reason is precisely that we’ve treated Keynes as an inspiration to be modified in the face of evidence rather than as holy writ."

The confusion is incredible. Keynes himself accepted some neoclassical ideas that made his argument limited and heterodox authors actually have discarded a lot of Keynesian concepts (I myself believe that both the marginal efficiency of capital and liquidity preference are highly problematic, but that is material for other posts). The problem with Krugman is that he maintains (yes you guessed) the natural rate (a concept that a least Keynes wanted to drop from his theory), and suggests that unemployment and the recession are caused by the downward rigidity of the interest rate (a liquidity trap), propositions for which there is little evidence. Krugman is the one that treats neoclassical principles (the idea that a natural rate exists) as holy writ!

Both Krugman and Wren-Lewis seem to believe that economics (and science) is about convincing the others on a political level and are puzzled by the fact that heterodox do not fall in line with the NKs. That is why a less rejectionist, to use Wren-Lewis term, strategy is suggested (a similar view by Colander is criticized here). The problem is that evidence and logic (for the logical critique of the natural rate you must get the capital debates) suggest that the natural rate does not exist. Don't get me wrong, on political issues most heterodox authors are with Krugman, Wren-Lewis and company, against austerity, but science implies (as Krugman himself notes) adherence to facts.

So why don't NKs just renounce to the idea of a natural rate once and for all. For one they would make lots of friends within the heterodox community, which is way ahead in understanding the crisis (and foreseeing it too), and also would make their models more realistic.

* I have my own troubles with the kind of model presented in that paper by Keen, which are related to his profit driven investment function, but that is better discussed in another post.

Radical reforms at the Argentinean Central Bank

By Rick Rowden

Supporters say the changes will help Argentina address its diminishing fiscal and trade surpluses in the short term. But more importantly, it will allow for greater financial stability and the use of incentives and disincentives to steer investment capital and loans toward businesses and projects that increase jobs and boost domestic production. Critics say the reforms will lead to over-regulation that will constrain finance, and worry that the government will go too far with new spending.

The changes break a host of taboos in the dominant school of monetarism in neoclassical economics and conservative policy circles -- a bold effort to show that central banks can play more proactive roles by providing credit to promote productive investment and job creation, and doing so with an eye to ensuring greater socioeconomic equality.

Read the rest here.

Debt, wages and the fiscal cliff

It is well known that while real wages kept the pace with labor productivity up to the early 1970s in the United States, they have lagged ever since, as shown in Figure 1. The causes of the collapse of the so-called Golden Age of Capitalism that allowed for expanding wages in the advanced economies are complex and diverse, but it is clear that the demise of the Keynesian consensus and full employment policies was at center stage.

One of the important consequences of the stagnation of wages in the United States has been the increasing reliance on debt as a source of funds for spending. Pivetti and Barba (2009) have argued that rising household indebtedness should be seen essentially as a reaction to stagnant real wages and the cutbacks in the welfare state. In other words, financialization has been the counterpart of enduring changes in income distribution. A point that has also been raised by Jamie Galbraith in his new book Inequality and Instability.

Read the rest here.

Heterodox (Development) Bankers

Robert Skidelsky recounts how Victor Urquidi was instrumental in changing the future World Bank from a reconstruction to a development bank. In the words of Urquidi:

"With our chief delegate’s approval, and without any consultation with US delegation… we drafted an amendment to Article III, in order to lend more emphasis to development….Because my English was better than my fellow delegate’s I was asked to read it aloud…Keynes was characteristically quick to realise the ‘political’ significance of our amendment, which was…supported only by Peru and Norway…As he pushed his spectacles to the top of his nose and shuffled the various amendments that were upon the table, he picked out and expressed agreement with ours if we would accept a drafting change. The original text merely stated that ‘The resources and facilities of the Bank shall be used for the benefit of members’. In the amendment we submitted, we wrote a second paragraph as follows: ‘The Bank shall give equal consideration to projects for development and to projects for reconstruction…’ Keynes suggested ‘The resources and facilities of the Bank shall be used exclusively for the members with equitable consideration to projects for development and projects for reconstruction alike’. We were pleased with the word ‘equitable’ and that he put ‘development’ ahead of ‘reconstruction’. I quickly nodded…and the amendment was carried by consensus."

Urquidi then worked at the then Economic Commission for Latin America (ECLA, later with the addition of the Caribbean ECLAC), when Raúl Prebisch was the secretary general in the 1950s. For more on Urquidi go here.

The spurious victory of MMT

Sergio Cesaratto (Guest Blogger)

In a widely read blog aggregator Randy Wray has declared victory of MMT and that we are all MMTs by now. Victory on who? And I personally do not feel MMT, or better I feel MMT, Sraffian, Kaleckian, Marxist and many other things, each taken with a degree of salt. Fanaticism and over-excitement is not part of heterodox Economics, let alone of academic work, and the fact that Wray got so nervous after a initial critical comment by a reader is telling that we might be far away from a cold and equilibrate economic dialogue. MMT has provided a lot of important insights, as other approaches, about the European crisis. Also intellectual adversaries like Werner Sinn have contributed to our understanding of the crisis, in this case over the role of Target 2 (that for the first time or so Wray mentions). MMT has, indeed, missed the main feature of the EZ crisis: its nature of a balance of payment crisis. Anyway, I do not see the MMT explanation as alternative, but as complementary to the BoP crisis view. In this regard, more modesty would help everybody in our common scientific and political enterprise. While my own view of the EZ crisis as a BoP crisis is here (this WP is a longer version of an article in a book that will be published likely by Routledge, a blog version is here), below you can find some critical remarks on the MMT view of the EZ crisis part of a longer paper that will be published in Spanish. These remarks develop a bit further the post on MMT already published here which is also a section of the WP. Having said so, I am ready to acknowledge that along Godley 1992, De Grauwe 1998, Kelton and Wray (and few others like Barba and Pivetti) have provided prescient predictions of the forthcoming crisis, each emphasises one aspect of it.

Let us consider an economy in which a deficit of the public sector is accompanied by a current account deficit. Given full monetary sovereignty, the MMT scholars apply the same argument envisaged for a closed economy to an open economy: a public deficit corresponds to net private wealth desired either by the domestic private sector or by the foreign sector, so there are no limits to the foreign holdings of Government bonds “so long as the rest of the world wants to accumulate its IOUs”:

“a country can run a current account deficit so long as the rest of the world wants to accumulate its IOUs. The country’s capital account surplus “balances” its current account deficit…. We can even view the current account deficit as resulting from a rest of world desire to accumulate net savings in the form of claims on the country.” (Wray 2011 MMP26).

It is hard to believe that the proviso “long as the rest of the world wants to accumulate its IOUs” applies to the majority of the countries.

To sustain his view, Wray extends the Chartalist tax-theory of money – the currency issued by the State to finance its spending is accepted since the State itself accepts tax payments only in that currency – to the foreign sector, although this is not required to pay taxes in the deficit country:

“Any sovereign State obtains “something for nothing” by imposing a tax liability and then issuing the currency used by those with tax liabilities to meet the obligation. The only difference here is that the U.S. government has obtained output produced outside the U.S., by those who are not subject to its sovereign power—in other words, by those not subject to U.S. taxes. However, even within any nation there can be individuals who avoid and evade taxes imposed by the sovereign power, but who are still willing to offer their output to obtain the sovereign’s currency. Why? Because those who are not able to avoid and evade taxes need the currency, hence, are willing to offer their own output to obtain the currency. The U.S. dollar has value outside the U.S. because U.S. taxpayers need the currency.” (Wray 2006a: 22)

It does not seem that, however, the Chinese wish dollars to buy goods from the U.S. taxpayers (or to buy goods from those who would like to buy U.S. goods). Chinese do not export to the U.S. in order to import from them, but accept nonetheless U.S. dollars from complex reasons that make that currency unique that we do not consider here. A part the particular status of the US dollar as the favourite international currency, it may be argued that only the strong currencies of countries with persistent CA surpluses – that it is useful to denominate here mercantilist countries, say Switzerland or Germany – may have the status of international currencies. Liabilities denominated in the currencies of the non-mercantilist countries (with the exception of the US) do not have the unlimited acceptance that Wray pretends they would anyway have just on the basis of full monetary sovereignty that include the disregard of the foreign exchange rate (disregard that might discourage foreigners to accept IOUs denominated in that currency, as Wray (2011 MMP 11) pretends in passages like this:

“What is important for our analysis, however, is that on a floating exchange rate, a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate. Indeed, the government does not have to promise to make any conversions at all.”

However, precisely the lack of this promise, or its long run unsustainability (as in many examples of currency board), and the expectation of a depreciation of the currency that implies that the government of a non-mercantilist country might have to pay on its liabilities interest rates that would make the domestic and, symmetrically, foreign deficit and debts unsustainable. So, it is not so much the full monetary sovereignty of a currency that matters, but the underlying secular CA situation of a country that makes the difference in terms of sustainability of those debts (Frenkel and Rapetti 2009: 689). Floating exchange rates helps, of course, but not so much because they assure the acceptance of any amount of national liabilities at sustainable interest rates – how could they? - but because they may contribute to long-run balanced foreign accounts and (symmetrically) to the stabilisation of domestic stock and flow accounts. Unfortunately Wray (2011 MMP 25) seems to invite the countries “where the foreign demand for domestic currency assets is limited” to pursue the catastrophic road of foreign borrowing (for them “there still is the possibility of non government borrowing in foreign currency to promote economic development that will increase the ability to export”) which, by the way, presupposes a renunciation to monetary sovereignty.

Wray insists, however, on only one aspect of full monetary sovereignty, that we can define as ‘internal’, that is the possibility of the government to finance any amount of spending at the desired nominal interest rate, while conceding at most a benign neglect to the exchange rate role in securing the external balance, what we may define as the ‘external’ side of monetary sovereignty. If, for instance:

“it is believed that a budget deficit can raise demand and increase a trade deficit or cause inflation—either of which might negatively impact the foreign exchange value of the currency—the central bank might react by raising the target interest rate to increase rest of world (…) demand for the currency. Fiscal policy is also constrained by perceived pressures on exchange rates. To be sure, even nations on floating exchange rates formulate monetary and fiscal policy with some consideration given to possible impacts on exchange rates. However, with fixed exchange rate systems, there is very little room to maneuver ... What we might call sovereign power is severely reduced. It is no coincidence that countries operating with fixed exchange rates today strive for policy austerity—and that they are quickly punished when they adopt overly expansionary policy. The principles discussed above do not really apply to government finance in a nation on a fixed exchange rate. Effectively, government liabilities are “backed by” foreign currency and gold reserves as there is a promise to convert domestic currency at a fixed exchange rate. Adoption of flexible exchange rates increases independence of domestic policy. (Wray 2006b: 9)

But, once again, the difficulty does not seem that there is “a promise to convert domestic currency at a fixed exchange rate”: as long as a country has abundant foreign reserves this is not a problem at all. The true question is again the structural foreign account situation of a country. Fixed exchange systems or currency unions perfectly fit mercantilist countries, as the experience of Germany in the Bretton Woods, EMU and EMS regimes shows (Cesaratto and Stirati 2011). Of course, it does not fit non-mercantilist countries. With fixed exchange rates it not so much the limit to the possibility of debt monetization that cause high interest rates (as long as a country retains a sovereign central bank monetization is in principle always possible), but the fact that the exchange rate might be inconsistent with the foreign imbalances. This may lead at the same time to restrictive domestic policies, that negatively affect the GDP growth, and to higher interest rates in order to assure the external financing of the foreign/domestic debts. The higher interest rates worsen net foreign incomes balance of the CA (and symmetrically the interest costs of domestic debts). This, combined with the GDP stagnation, places the country on an unsustainable domestic debt/GDP path.[1] Non-mercantilist countries need floating regimes not to be able to issue any amount of foreign liabilities - as long as they are “backed by the national currency – as Wray pretends, but because the exchange rate flexibility is the necessary instrument, within many limits, to render consistent the support to domestic demand with balanced foreign accounts. (Controls of capital outflows might be also necessary to let the country to finance fiscal deficits at sustainable interest rates). [2] For a third kind of country, the foreign exchange regime is irrelevant: as the US Treasury Secretary Paul Polson once famously said: “The dollar is our money, but is your problem”. This is the “exorbitant privilege” famously denounced by the then De Gaulle’s finance minister Giscard D’Estaing.

Wray, however, if he does not neglect that the prerogative to let the foreign debt levitate is due to ‘dollar hegemony’, that is an American prerogative, it al least to downplay it as an ancillary problem. Indeed, where he explicitly discusses the point, he reluctantly (but openly) admits that the irrelevance proposition that any State “can run budget deficits that help to fuel current account deficits without worry about government or national insolvency” applies indeed only to the US: “precisely because the rest of the world wants Dollars. But surely that cannot be true of any other nation. Today, the US Dollar is the international reserve currency—making the US special”, and “the two main reasons why the US can run persistent current account deficits are: a) virtually all its foreign-held debt is in Dollars; and b) external demand for Dollar-denominated assets is high—for a variety of reasons. “ (Wray 2011 MMP 25).

So Wray is correct when he says that full money sovereignty is helpful to pursue national full employment policies, but not for the right reasons. It is not true that, a part the US, ‘normal countries’ can finance any amount of government (and even private) spending by issuing an internationally accepted currency (so without care for the foreign accounts). In particular, non-mercantilist countries typically experience the foreign constraint to their full employment policies. In their case full monetary sovereignty matters not so much in the ‘internal’ sense of being freely able to issue any amount of money – what is plainly impossible – but from the ‘external’ point of view of floating exchange rates that take care of the external equilibrium while the country pursue the desired policies. It is this external role of the sovereign monetary regime that frees (as well known) monetary policy to finance government spending at a sustainable interest rate (this may require also capital controls). A proof of why Wray is wrong is in the EZ periphery’s experience: in spite of the lack of national monetary sovereignty, during the EMU years private and government spending benefited of low nominal interest rates (and negative real interest rates): a sovereign central bank could not have done better from that point of view. The problems came form the external aspect of the lack of full monetary sovereignty: the impossibility of adjusting the growing foreign imbalances (due to strong imports and lose of price competitiveness). These imbalances are at the basis of the consequent growing sovereign spreads, not the ECB policy. Of course, a strong action by the ECB to abate the spreads (what it could do) would be enormously helpful once the spreads rose. But it would not solve the external imbalances that were at the origin of the crisis and that, indeed, matured when the sovereign spreads were at historically low level.

Of course, at the European aggregate level and with the backing of the ECB the financial imbalances would be perfectly sustainable, and indeed the EZ would a perfect MMT country that issue an international currency (and even with a balanced CA with the rest of the world). The institutional change required for the EZ to resemble the US would, however, be too challenging for a club of independent nations as real Europe is. This would require a transfer of many government budget functions to a federal government along the existing public debts, while local States would work as the American local States. Federal transfers from dynamic to troubled areas should dramatically increase while minimum standard welfare rights should be universally recognised to all European citizens. Labour mobility and infra-EZ direct investment should be incentivised. Beautiful but out of reach. Of course much less would be required to re-balance the EZ, but even that sounds utopia given that it entails a profound change in the mercantilist attitude of the dominant economy.

Returning to the criticism to Wray and his MMT fellows, full monetary sovereign, that is the power of a country to issue a non-convertible currency that is fully accepted for domestic and foreign payments, is not, with the possible exception of the US, a full prerogative of all countries and, therefore, the panacea MMT exponents envisage. The evident neglect of the foreign exchange troubles that a ‘normal‘ country would incur if a larger government deficit/debt are associated to an increasing foreign deficit/net debt, implies a neglect by the MMT of the foreign constraint that ‘normal’ countries meet in sustaining full employment demand even with flexible exchange rates. MMT exponents reflect too much the US unique position as issuer of the main international mean of payment.[3] The neglect of the foreign constraint – which can be expressed as the necessity for ‘normal’ countries to keep the CA in balance over the long run, i.e. a balance between revenues and leakages of international currencies – leads the MMT exponents to a one-sided interpretation of the European troubles. These do not straightforwardly depend on the abandonment of national monetary sovereignty as the power to monetise public (and domestic) debts, in particular the high sovereign spreads do not depend on this. It is rather the abandonment of the currencies flexibilities in a non optimal currency area in the context of financial liberalisation that has led first to the capital flows from the core to the periphery that typically develops in a fixed exchange setting. Later, the ensuing external/domestic imbalances were ultimately made unsustainable by the capital flow reversal (also typical) and consequent dramatic rise in the sovereign (and non sovereign) spreads. So the story in not precisely that told by the MMT scholars. The story must pass through the foreign imbalances that, however, are neglected by them, probably reflecting some American insularity.

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

C. Sardoni & L. Randall Wray, 2007. "Fixed and Flexible Exchange Rates and Currency Sovereignty," Economics Working Paper Archive wp_489, Levy Economics Institute,

Wray L.R. (2006a) Understanding Policy in a Floating Rate Regime, Working Paper No. 51, Center for Full Employment and Price Stability, University of Missouri-Kansas City

Wray L.R. (2006b) Extending Minsky's Classifications of Fragility to Government and the Open Economy by. Working Paper No. 450 The Levy Economics Institute.
Wray L.R. (2011 MMP 11) Modern Money Theory and Alternative Exchange Rate Regimes http://www.neweconomicperspectives.org/2011/08/mmp-blog-11-modern-money-theory-and.html

Wray L.R. (2011 MMP 25), Currency Solvency and the Special Case of the US Dollar http://neweconomicperspectives.org/2011/11/mmp-blog-25-currency-solvency-and.html
Wray L.R. (2011 MMP 26) Sovereign Currency and Government Policy in the Open Economy, http://neweconomicperspectives.org/2011/11/mmp-blog-26-sovereign-currency-and.html

Notes:
[1] That pegging is not a problem for mercantilist countries is partially recognised by Nersisyan and Wray (2010: 13): ‘Adoption of a peg forces a government to surrender at least some fiscal and monetary policy space—of course, constraints are less restrictive if the nation can run current account surpluses to accumulate foreign currency (or precious metal) reserves’.

[2] Sardoni and Wray (2007: 15-6) regards the flexibility of the exchange rate as a pre-requisite for full employment fiscal policy in so far as the state can finance spending not taking the external parities into account. Their only preoccupation is about the possible consequences on domestic inflation, while the positive effects of the trade balance are even regarded suspiciously (since a trade deficit is seen as sustainable and positive from a domestic welfare point of view). These arguments seem to reflect the unique U.S. position and do not look general.

[3] The EZ is in the same position, but it unfortunately does not take advantage of this opportunity.

Galbraith on the consequences of fiscal austerity

What would a significant fiscal adjustment, as the jumping of the so-called fiscal cliff would require next year, would be you ask? Jamie Galbraith has provided a timely answer in the Nation (here; hat tip Nathan Cedrus Tankus). In short: "a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis."

State of the World Economy: A South Centre's Perspective

During last Rio+20 Conference the South Centre organized a session with some local economists on the state of the world economy, which to a great extent reflects the views of their chief economist Yilmaz Akyüz (hat tip to Butch Montes for the link). Their views tend to be very pessimistic about the possibilities of sustained growth in the periphery and the continuity of the so-called double speed recovery, fast in the periphery and slow in the center.

For them the boom in the periphery in the New Millennium was caused by the commodity boom, and that, in turn, was dependent on China's exceptional growth record, which was heavily dependent on exports to developed countries. So the castle of cards is about to fall.

My views are slightly different (see here and here). I tend to think that Chinese growth may very well slow down, but may continue on the basis of domestic demand, and the structural transformation of the economy that will have to incorporate hundred millions in the next decades in the urban centers. Also, although the commodity boom eased the external constraint in other parts of the periphery, a lot of the growth was the result of the expansion of domestic demand too.

Also, as noted by the last Trade and Development Report by UNCTAD the expansion in several parts of the periphery has been based on higher rates of wage expansion, in other words, it has been based on an improvement of income distribution and higher domestic demand, in contrast to the stagnating wages in the center.

Finally, it is important also to note that commodity prices may also respond to speculation (as noted in the TDR report above), which explains the volatility of prices in the last decade, but also, as noticed in a recent paper by Franklin Serrano the supply conditions, and may for that reason be less vulnerable to a slowdown in China. In his view, part of the explanation of higher prices is the result of the revival of natural resource nationalism in a large number of developing countries, which has increased the state control of oil reserves and substantially raised the royalty rates and, the absolute rent component of the price of production of commodities.

So, perhaps China will still grow at a reasonably fast rate, and commodity prices might continue at relatively high levels, and there will still be some space for developing countries that do not decide, by doing fiscal adjustments of their own (yes I'm thinking about Latin Americans in particular), to cool down their economies to continue to grow. Sure enough a collapse of the euro, and of world trade, and a run for quality (towards dollars) might as well, as Abraracourcix feared, imply that the sky will fall on our heads, par Toutatis!