Greece on the verge

Jean François Ponsot, Jonathan Marie and @NakedKeynes

I'm in France for a talk at the Université de Paris XIII, invited by Jonathan Marie and Dany Lang. The Greek crisis looms large in everybody's minds. I gave a talk based on two papers, one published here, and the other (specifically on the Spanish crisis) just finished, which will soon come as a working paper. But I discussed to a great extent the debate between Sergio Cesaratto and Marc Lavoie on the nature of the European crisis, that is, whether it is a balance of payments crisis or a monetary sovereignty one.

Cesaratto argues that a balance-of-payment crisis is possible in a currency union, and that the financial crisis of the Eurozone is indeed such a balance-of-payment crisis. Arguably Pérez and Vernengo (2012; the one linked above) suggest the same, even though the paper was written to argue that the crisis was not fiscal, as per the mainstream hypothesis, and the actual policies pursued by the Troika, which require fiscal adjustment as a solution (presumably because the problem was fiscal).

In the balance of payments or Cesaratto hypothesis, the problem would be that there are no federal transfer payments from the surplus to the deficit countries to help compensate the negative impact of CA deficits on GDP and budget balances. Or to make it more correct, it would be that there are no fiscal transfers from a federal government to the federated units, as has been shown is the case by Nate Cline and David Fields here for the US case.

Yet, as noted by Lavoie, the Eurozone crisis seems to have been mainly caused instead by a banking problem, which transformed itself into a public debt problem. In other words, the currency issue, and the functioning of the monetary union seem to be at the core of the crisis, not a balance of payments one. The monetary union clearly eliminates exchange rate risk, but not country risk, which might explain the interest rate differentials between euro countries. So some countries remain more vulnerable than others.

Marc suggests that the interbank payments system, the so-called TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer System), used by the European Central Bank (ECB) can be seen as being at the heart of the problem. In his example, if a Spanish firm imports cars from a German firm, the ECB credits the German firm in a German bank and debits the Spanish one in his correspondent bank. There is no limit to the debit position that the Banco de España, the Spanish central bank, can incur at the ECB. The overdraft capacity of the ECB is unlimited.* So in this view the solution would be for the ECB to use its overdraft capacity to create the conditions for the euro periphery to continue to function without austerity.

Alternatively, this could be solved if the ECB bought bonds from the member countries. However, the rules of the euro imply that the ECB cannot purchase sovereign debt, and, hence, the mechanism by which a risk free asset is normally created is precluded to function. The creation of the risk free asset is the essential function of the central bank in relation to financial stability. According to Lavoie the Eurozone setup should have incorporated a central bank that holds and purchases large amounts of securities issued by the participating national governments. Something that was done in the US by the Fed after the crisis.

My argument, discussed briefly here before, is that the Cesaratto and Lavoie hypotheses are one and the same. The balance of payments and the monetary sovereignty views of the European crisis are two sides of the same coin. The fact that overdraft facilities involved in the TARGET2 system could be used to create credit to finance euro imbalances, or that the ECB could buy government bonds in the secondary market does not preclude the fact that the actual crisis is, in the absence of these policies, the result of the inability to manage a CA deficit. In his example, the origin of the debit position of the Banco de España is an import of German cars, which presumably corresponds to a current account deficit position.

In this sense, the European crisis is caused by the failures of the euro design, but it is also one that forces countries with banks that over-borrow, or that have firms that over-import, to adjust by reducing its imports through austerity, and, hence, increasing its ability to repay. Note that leaving the euro (in particular for Greece, i.e. Grexit), which would imply some degree of depreciation of the newly created currency, might not be sufficient (or even necessary) to solve the crisis. I discussed this here before. Yanis Varoufakis, the Greek finance minister, has also been skeptical about depreciation and Greexit.

* Marc compares TARGET2 to Keynes bancor, and suggests that Keynes might be, more than Mundell, the father of the euro. Two things come to mind. I think in principle, the adjustment rules based on austerity, are closer to Mundell than Keynes (poor Keynes, this institutional mess should not be pinned on him). Second, Keynes' plan also implies that there is a need for surplus countries to finance deficit ones. What really matters in this is who creates the overdraft, who has the power to create money, so to speak. Normally that has nothing to do with having surpluses. National governments are not in surplus against its subunits. Globally the US is a deficit country, and is still the one issuing the global currency.

Stiglitz and Krugman on Troika’s Attack On Greek Democracy

By Joseph Stiglitz

The rising crescendo of bickering and acrimony within Europe might seem to outsiders to be the inevitable result of the bitter endgame playing out between Greece and its creditors. In fact, European leaders are finally beginning to reveal the true nature of the ongoing debt dispute, and the answer is not pleasant: it is about power and democracy much more than money and economics. Of course, the economics behind the program that the “troika” (the European Commission, the European Central Bank, and the International Monetary Fund) foisted on Greece five years ago has been abysmal, resulting in a 25% decline in the country’s GDP. I can think of no depression, ever, that has been so deliberate and had such catastrophic consequences: Greece’s rate of youth unemployment, for example, now exceeds 60%.

Read rest here.

By Paul Krugman

It has been obvious for some time that the creation of the euro was a terrible mistake. Europe never had the preconditions for a successful single currency — above all, the kind of fiscal and banking union that, for example, ensures that when a housing bubble in Florida bursts, Washington automatically protects seniors against any threat to their medical care or their bank deposits. Leaving a currency union is, however, a much harder and more frightening decision than never entering in the first place, and until now even the Continent’s most troubled economies have repeatedly stepped back from the brink. Again and again, governments have submitted to creditors’ demands for harsh austerity, while the European Central Bank has managed to contain market panic.

Read rest here.

Bielschowsky on Furtado's "Economic Growth of Brazil"

Celso Furtado (1920-2004)

The International Journal of Political Economy, edited by Mario Seccareccia, had a special issue on Celso Furtado. There were articles by Ricardo Bielschowsky, James Cypher, and Rosa Freire d'Aguiar, Furtado's widow, among others. Below Bielschowsky's paper on Furtado's opus magnus, titled "Furtado's Economic Growth of Brazil: Masterpiece of Structuralism."

From the abstract:

This survey article reviews Celso Furtado’s most famous book and argues that he convincingly used the central elements of the Prebisch-ECLAC analytical construct—strucuturalism—to organize and study the economic history of Brazil from its discovery until the mid-twentieth century. Furtado shows how, throughout Brazilian history, successive cycles of economic growth before industrialization (mainly, the production of sugarcane in the Northeast in the seventeenth century, the gold cycle in Minas Gerais in the eighteenth century, and coffee production in the Southeast in the nineteenth and early twentieth centuries) have created, and thereafter perpetuated, some major characteristics of Brazilian underdevelopment: low production and lack of export diversity, as well as structural heterogeneity, specifically, a vast underemployed sector existing side by side with a high productivity modern sector.

Read rest here.

Greece Has Made Tough Choices. Now It's the IMF's Turn

By James K. Galbraith

The International Monetary Fund's chief economist, Olivier Blanchard, recently asked a simple and important question: "How much of an adjustment has to be made by Greece, how much has to be made by its official creditors?" But that raises two more questions: How much of an adjustment has Greece already made? And have its creditors given anything at all?

In May 2010, the Greek government agreed to a fiscal adjustment equal to 16 percent of GDP from 2010 to 2013. As a result, Greece moved from a primary budget deficit (which excludes interest payments on debt) of more than 10 percent of GDP to a primary balance last year -- by far the largest such reversal in post-crisis Europe.

Read rest here.

On Keynes and the Quantity Theory

Slow posting will continue for quite a while. Backlogged with work. At any rate, I've been reading (almost done now) Richard Davenport-Hines new book on Keynes, Universal Man: The Lives of John Maynard Keynes. Nothing new really. And that should not be a surprise after the biographies by Skidelsky and Moggridge.

There are many little issues here and there, which is inevitable, given Keynes' own contradictions, and the overwhelming number of interpretations of his work. There is one point, which is repeated by Davenport-Hines, based on a monetary interpretation of the development of the Principle of Effective Demand (PED), which I think is completely misguided. He says that: “Keynesian economics developed from its progenitor’s rejection of the quantity theory of money [QTM].” Not really. The theory developed from the rejection of Say's Law. The rejection of the QTM is a side effect.

In fact, in terms of the monetary views, Keynes had moved from the QTM in his Tract in 1923, to a Wicksellian model in his Treatise in 1930, with endogenous money, to having exogenous money, and, in that respect being closer to the QTM, in the General Theory (GT) in 1936. Many posties like the Treatise more than the GT for that reason. I prefer the GT, since it has investment and savings being adjusted by income (PED), rather then the rate of interest. And he at least tries to get rid of the notion of a natural rate of interest in the GT.

Davenport-Hines gets closer to the real contribution of the GT, and the reasons for its development, when quoting Austin Robinson, who said in 1947:

“a great step forward in economic thought when Keynes insisted that we should have a general theory – a theory which was valid not only with full (or near-full) employment, but also with unemployment – and that we should know clearly which of the propositions of economics were universally valid, and which were valid only in conditions in which it might be true that an increase of one activity was possible only at the expense of another activity. In the Cambridge thought of my time I believe that no single forward step has been so important.”

The real revolutionary thing in the GT is that the system does not have a tendency to full utilization of resources, no natural rate.* Full employment is one possibility. That's why his theory was general. What Keynes was trying to reject is the neoclassical version of Say's Law, that implies that changes in the rate of interest guarantee that investment equilibrates to full employment savings.

In fact, changes in aggregate demand, and that would include increases in the exogenous supply of money, would have inflationary consequences with full employment. Keynes' views on inflation remained very conventional, as they had been during the German hyperinflation, based on excess demand.

* To do that requires getting rid of the marginal efficiency of capital, but that's another story.

Inequality, the Financial Crisis and Stagnation

By Thomas Palley

This paper examines several mainstream explanations of the financial crisis and stagnation and the role they attribute to income inequality. Those explanations are contrasted with a structural Keynesian explanation. The role of income inequality differs substantially, giving rise to different policy recommendations. That highlights the critical importance of economic theory. Theory shapes the way we understand the world, thereby shaping how we respond to it. The theoretical narrative we adopt therefore implicitly shapes policy. That observation applies forcefully to the issue of income inequality, the financial crisis and stagnation, making it critical we get the story right.

Read rest here.

Beyond Laissez-faire? Seriously?

As I noticed, posting will continue a bit slow for a while. So this is a bit old. Noah Smith suggests that the profession is leaning in a liberal, meaning moderately lefty, direction. He tells us, however, that:

"although there’s a growing consensus that something about U.S. economic policy needs to be changed in a more liberal direction, there isn't any consensus on what. Laissez-faire may have reached the end of its shelf life, but we don’t yet know what is going to replace it."

He praises Reagan-Thatcher's policies for their simplicity. I guess Occam's Razor is the criteria here. Not uncommon, as I noted before, that was Krugman's defense of free trade not long ago. He might be right on the lack of consensus on what to do, even though his minimal program from the discontented seems plausible enough, more fiscal expansion, less free trade agreements, higher wages (start with the minimum) and more regulation of finance.

Note, however, that this policy consensus, is open to a lot of dissensus, and not only on details of policy (e.g. more fiscal expansion where, infrastructure, health, defense? Do we increase the taxes on the wealthy too? And so on). The vast majority of those that now defend these policies do it from an essentially unreconstructed marginalist view (mostly New Keynesians). So the policy defense does not stem from different models (Mankiw, a New Keynesian as much as Krugman and DeLong would not endorse any of these 'left' policies), but from their policy preferences. I would suggest that left leaning economists using mainstream models have a harder time showing that their policy prescriptions are coherent with their theory (they need all kinds of imperfections, and ad hoc assumptions).

But that's not the surprising thing in Noah's piece, at least to me. He's nonchalant about the assumption that the shelf life of laissez-faire policies has somehow expired. It is true that Keynes had suggested that laissez-faire was dead long ago, in 1926. But that proves exactly the policy resilience of laissez-faire. In fact, I would argue that the theoretical persistence of misguided (illogical and lacking evidence) mainstream positions often results from the advantage that these models provide for defending laissez-faire.

So laissez-faire is doing fine. And note that austerity is doing fine, in the US, in Europe, in Latin America, and is still being pushed by the IMF in their actual programs (forget the research department suggesting that sometimes it doesn't work; these views never apply to the real world). FTAs are also doing fine, and pushes for increasing the minimum wage or for more regulation of finance continue to be contested and fought back fiercely. We're far from the end of laissez-faire.

More on the War on Tenure

From Inside Higher Ed:

It’s been a tumultuous year for faculty members within the University of Wisconsin System, from threats to the Wisconsin Idea to a proposed $300 million budget cut to Governor Scott Walker’s suggestion that professors do more work to compensate for the slash. But many professors and other observers said the roller coaster hit a new low Friday afternoon when the state Legislature's powerful Joint Finance Committee approved, by a vote of 12-4, the elimination of tenure from state statute, along with adding new limits to the faculty role in shared governance and procedures for eliminating faculty members in good standing outside of financial exigency.

Read rest here.