The debt-ceiling limit: a guide for the bewildered

It is very difficult to explain American politics to those that are not Americans and/or have not lived here long enough. Add to that the confusion over basic economic principles, and it becomes almost impossible to explain the debt-ceiling debate to rational people.

As noted by James Galbraith, this is not a fiscal crisis, which should be obvious, since it was a Wall Street driven bubble.  Also, contrary to what you think the Republicans are the big government party. The graph below shows total federal government spending as a share of GDP (in black), and some spending categories as a share of government spending (in colors). As it can be seen total spending goes up in 1981, 1989, 2001, when Republicans assumed the administration, and down in 1993, when Clinton did.  Also, note that even if spending went up in 2009, as a result of the crisis, it did come down in 2010 (which is not a good thing, by the way) with Obama.

Read the rest here.

15 minutes of fame

Andreu Mas-Colell, author of the famous micro text used in most graduate programs, and specialist in General Equilibrium, suggested a solution for Spanish unemployment.  After wage reductions, his advise is to go for "marginal adjustments" like increasing the working day of public workers by 15 minutes. Working more for less money, would help balance the budget and maintain credibility. The hilarious proposal is described here (in Spanish). Nough said.

Sensible theory and economic predictions

Yes, that's Wynne's bust.
 

Economists are well known for having predicted nine of the last five recessions.  Or so goes the joke.  The fact that economists cannot predict and that forecasters are always wrong is not new, and I would suggest less important than often understood.  The problem is not so much that economists cannot predict particular events, but that the dominant theory is an ineffective tool for understanding real economies. And that is true for both the New Classical/Real business Cycle types that believe that markets are efficient immediately, or the imperfectionist New Keynesian, that think that they are too, but only in the long run (this view should lead you to believe that the main solution is to reduce imperfections). As a result, the mainstream always provides unreasonable predictions.

But let me give an example of what I mean. Rudiger Dornbusch was a well respected mainstream economist.  He said back in 1999 that the euro would:

"reinforce financial deregulation (national and cross border) in Europe to create a broad and deep capital market. Europe comes from a dinky and segmented national, bank-based financial structure. It is on the way to a US-style capital market where households hold funds and companies issue paper and stocks, intermediation margins are small and governance significant. European companies will benefit from the transformation, the most significant supply side influence we will see. … the Euro is a thoroughly modern institution, well-adapted to a highly integrated and trigger-happy international capital market."

Not only deregulation was something good for Europe, but also giving up the currency would allow for lower interest rates and higher growth.  For him:

"Having a national money is expensive … It offers little flexibility and year after year an interest cost is paid for what is the illusion of independence. … Monetary sovereignty nowadays means only the right to bad money.  How can the periphery get out of the self-inflicted historical curse of a central bank and a national money. Do what Argentina did ... Give up the national money and create a hard link to a world class currency."

It goes without saying that this does not sound like good advice these days.  And before you say that hindsight is always 20-20, I want to remind you that yes some people that were in favor of the European project actually saw the limitations of the euro.  The economists that did not believe in the efficiency of markets (at least not for allocating resources, including labor) argued that giving up a tool (like the exchange rate) would imply the need for other tools.  Here is Wynne Godley in 1992, about the project of a common currency for Europe:

"It needs to be emphasised at the start that the establishment of a single currency in the EC would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. … the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates. As local authorities possess none of the instruments of macro-economic policy, their political choice is confined to relatively minor matters of emphasis – a bit more education here, a bit less infrastructure there."

And colonies are exactly what the countries of the European periphery have become.  And the options have been a lot less education, retirement, employment and infrastructure.  Further, Godley was concerned that the European project, that he supported, was incorrectly based on the notion:

"that economies are self-righting organisms which never under any circumstances need management at all ... It is a crude and extreme version of the view which for some time now has constituted Europe’s conventional wisdom … that governments are unable, and therefore should not try, to achieve any of the traditional goals of economic policy, such as growth and full employment."

Hence, sensible theory did allow, not to get the timing of the euro crisis (or wouldn't allow now to know exactly when Greece is going to default), but to get reasonable understanding of how economies work, and to provide fitting advice.  Of course almost nobody got the message.

Global Monetarism Strikes Back



Olivier Blanchard, the chief economist at the International Monetary Fund (IMF) announced in a triumphalist tone that “earlier fears of a double-dip recession—which we did not share—have not materialized” and defended the need for “fiscal consolidation that is neither too fast, which could kill growth, nor too slow, which would kill credibility.” For Blanchard fiscal expansion has done its job, since “private demand has, for the most part, taken the baton.” The risks are associated to the higher prices of commodities and inflation. The Bank of International Settlements (BIS) has added to the IMF’s view that inflation is the main risk on an otherwise recovering world economy. In their recent Annual Report they argue that: “spread of inflation dangers from major emerging market economies to the advanced economies bolsters the conclusion that policy rates should rise globally.” That is, add monetary contraction to the policy mix.

Read the rest of the entry here.

Wouldn't it be nice if ...



Nope, not the Beach Boys song.  Ronald Dworkin reminder that Obama is not FDR (here).  From FDR's Madison Square Garden's speech:

"For nearly four years you have had an Administration which instead of twirling its thumbs has rolled up its sleeves. We will keep our sleeves rolled up. We had to struggle with the old enemies of peace—business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering. They had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob. Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me—and I welcome their hatred. I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said of my second Administration that in it these forces met their master."

These days that would be called class warfare.  And you know that's not acceptable. There are no social classes in the US.  There are only winners and suckers!

Devastating Labor Market Backslide

According to Heidi Shierholz, from the Economic Policy Institute (EPI) regarding the last Employment Situation report by the Bureau of Labor Statistics:

"Virtually every single measure was devastatingly weak: only 18,000 payroll jobs were added, average hours declined, nominal wages fell, unemployment was up in almost all age groups, more than 250,000 workers dropped out of the labor force altogether, and the public sector continued to bleed jobs. Furthermore, a downward revision to last month’s data means that this is the second month in a row with job growth at 25,000 or less. This is a remarkable, across-the-board backslide. The President and Congressional leaders need to stop talking about deficit reduction and start talking about job creation."

Meaning, they need to talk about more fiscal stimulus. The whole thing here.

The debt ceiling limit: Dean Baker vs. Matt Rognlie

So I have been having a back and forward with Matt Rognlie on his blog about Dean Baker’s proposal to destroy the 1.6 trillion dollars in the Fed balances as a way of avoiding the debt ceiling limit.  Note that, as Dean says, this debt is owed by one branch of government to the other (although the Fed is a hybrid part public, part private), and is basically owed to itself.  The point is that nobody loses if the Fed just shreds the bonds.  Dean then discusses the risks of doing it, which are fundamentally associated with the loss of the bonds (which the Fed could sell to the public to reduce liquidity) and the effects that it might had in future monetary policy.  The fear was (although I doubt that was Dean’s concern) the Fed would have its ability to curtail liquidity limited and that inflation pressures might not be contained.  Dean simply noted that reserve requirements could be used in that case.

Not a difficult point to make.  Rognlie suggests somehow that this is both confusing and not serious.  To prove it he assumes that the Fed would need to reduce liquidity by the same amount of the bonds destroyed (and, hence reducing almost the whole increase in liquidity that the Fed was forced to do as a result of the crisis), which he notes would be impossible.  The question is why would someone assume something like that, and the only explanation is that he must believe that there is a fixed relation between liquidity and prices (a fixed velocity of money) and that to avoid inflation the same amount of money that was created will have to be destroyed.  But that seems to be a very strong assumption to make.  Since there is a lot of unused capacity it is far from clear that the Fed needs to increase the reserve requirements at all.  So in all fairness there are NO consequences of destroying those bonds.  And, as noted by Dean, yes it is just an accounting gimmick to get around the accounting stupidity of the debt-ceiling. It might not have a chance in the current policy debates (since Democrats have a tendency to cave on almost anything), but is a perfectly logical solution.

The end of the New Deal as we know it?

So it seems that Obama is willing to play ball with Republicans on the debt-ceiling issue.  Meaning cut Medicare and Social Security in exchange of an increase in the debt limit, increasing planned cuts for the next ten years from somewhere around two to closer to four trillion dollars.  This was reported by the Washington Post, and seems to be in accordance with, not just Obama’s politics, but of the mainstream democrats since Carter and including Clinton, who notoriously ended welfare as we knew it.

It’s incredible that Obama would cave without putting a fight (he says that the WaPo story is overhyped apparently, but suggests that Social Security should be a means tested program!).  This basically implies that the long fight that started with Reagan’s presidency to dismantle the basic achievements of the New Deal will finally succeed under a democratic presidency.  But, on the other hand, it is part of the democratic move to the right, at least on economic issues, since Carter.

The graph shows the rate of growth of median income since 1948.  The average rate of growth until 1979, before the Volcker shock, was 2.4 per cent.  Since the Reagan administration it has been 0.5 per cent.  That is the miracle of trickle down economics.  And it is because the economic performance is so poor that fiscal problems have taken place.  It is ironic that conservatives managed to sell the failure of their policies as the reason why those very same policies should be pursued.

Well trained but poorly educated

David Ruccio's post on Brad DeLong confessions about his past favoring financial deregulation is not far from what I wanted to say.  I am, however, more impressed by the a-critical acceptance in the mainstream of whatever their teachers tell them. I agree with Minsky, who said that:

"If I had my way the standard American course in economics would be eliminated and economics would be introduced in the context of social sciences and history. The current American way of teaching economics leads to American economists who are well trained but poorly educated" (Minsky,6 2009, p. 194)

The only question is well trained in what?!!!

The wageless recovery and the two-speed recovery

Is this a wageless recovery? No doubt in the United States, and also in a good part of the rest of the developed world (e.g. Europe and Japan).  In the case of the US real wages have stagnated since the 1970s.  The recovery may very well be wageless, but in all fairness that has been a perennial characteristic of the American economy.  In Europe there were marked differences between Greece and Iceland, where real wages were growing until the crisis, and Germany, where they have basically stagnated.  So the wageless recovery is basically an American, German and Japanese story.

In developing countries, however, the story is quite different.  The graph below shows real wages in advanced, Latin American and Asian economies (there are also significant variations between and within the two sub-regional groups).  The graphs come from the International Labour Office's Global Wage Report 2010/11 (available here).



Note that both in Asia and Latin America real wages did not fall in 2008, and started to recover in 2009.  In Latin America, according to ECLAC (in the Preliminary Overview Statistical Annex Table A-18, p. 150) in 2010 real wages increased on average 1.7 per cent.  Essentially at the same pace than the previous years.  Also, it seems that wages continue to grow in Asian countries (particularly in urban China).  Perhaps, the reason for the so-called two-speed recovery is associated to the different patterns of real wage dynamics, and not just about commodity prices.  Expansion of domestic demand in the periphery (or at least in some countries) might be relevant too. Just saying.

Profit-led stagnation?

So a new paper published by the Center for Labor Market Studies shows that the recovery in the US has been wageless and jobless.  The graphs below which show the variation of the Dow Jones Index, Corporate Profits, and Average Hourly Earnings in the Private Sector (from figure 14 in the paper), and Real GDP , Investment and Payroll Employment (using BEA data) illustrate the point.

It is clear that conservative calls for tax cuts for the wealthy do NOT work.  Profits go up, but jobs do not increase.  Wealthy corporations are not ncessarily job creators. Also, any heterodox story about profit-led growth seems also incorrect.  Again, why would firms invest if there is no demand?  The increase in demand is not robust enough to lead to investment or employment creation.  In fact, while corporate profits increased 39.6 per cent between the second quarter of 2009 and the first of 2011, investment only increased 7.6 percent.  This recovery is just for the rich.

Eclecticism, Complexity and Hypocrisy in Economics



In some of my posts there is an open critique of what I referred to the best in the mainstream, people like Krugman and Brad DeLong (and even Larry Summers), that have been in favor of fiscal stimulus, QE, and against tax cuts for the rich.  The critique is not about the soundness of their policy advice or even about their political views, which are liberal in the American sense of the word.  My trouble is the same that Joan Robinson had with the neoclassical synthesis, that is, that their policy propositions do not follow (logically) from their economic models.

Some people may think that this is just splitting hairs, an irrelevant exercise in taxonomy, to determine who is or is not heterodox. And that would certainly be a complete waste of time and energy. But the problem is that this inconsistency between reasonable policy advice and coherent economic theory is at the heart of the problems with the mainstream, and not just the crazy ones that believe in extreme versions of market efficiency (see for example Lucas’ Milliman Lecture; as I suggested these views could be referred to as the Intelligent Design version of economics. Krugman calls it the Dark Ages of macroeconomics).

As I argued somewhere else (subscription required, or preliminary version free here), there is a symbiotic relation between the best in the mainstream (what David Colander refers to as the cutting edge), that sound reasonable and provide rational policy advise particularly in times of crises, and the hardcore fundamentalists that stick to neoclassical/marginalist principles (despite logical problems). The problem is not a trade off between relevance and coherence in general, as Mark Blaug tried to argue with respect to Sraffians (his point being that Sraffians are rigorous and cannot be relevant for that reason; see the reply by Kurz and Salvadori here).  The trade off is a particular problem for the mainstream (that's why Blaug's argument is preposterous).

Rigorous arguments are NOT detrimental for empirical relevance, and they are essential for coherent policy advice. Part of the problem with the current state of the economics profession, what Alessandro Roncaglia has called the cultural roots of the crisis, is that the reasonable so-called New Keynesians, like Larry Summers and Ben Bernanke, were for deregulation and did not see (or didn’t want to see) the crisis coming. There is no intention to revise the foundations of economic analysis.

The whole argument of the best in the mainstream (and even some heterodox economists) is that conventional models are too simplistic and we need more sophisticated models.  In this view, the problem is the complexity of the real world.  Also, the mainstream is not monolithic, and there are several strands, some better some worse, with a high degree of eclecticism. I find the argument disingenuous, at best.  Sure the real world is complex, but the increase in the number of complex models have served since the 1970s as a way of introducing more realistic and often more relevant policy results while maintaining the respectability of the mainstream defense of the sanctity of market efficiency.  Some of these models are not even compatible among them, and, it is true that the mainstream is fragmented or eclectic.  In this sense, I borrowed the use of the term organized hypocrisy to describe, not the behavior of individual economists per se, but of the profession as a whole.

Organized hypocrisy implies that the mainstream can still maintain that markets are efficient, and that General Equilibrium models are a coherent proof of that (which allows the Tea Party version of the profession to go around and preach Real Business Cycles and Supply Side Trickle Down Voodoo Economics), while at the same time say that there are more sophisticated models, with imperfections, and alternative patterns of behavior, that explain reality.  Hence, whether Krugman and other cutting edge authors understand it or not, they have a role within the mainstream which actually serves to perpetuate their hold on the profession.  They are there to make the mainstream sound reasonable without the need to rethink the foundations of the subject.  Eclecticism is not a good feature of the mainstream, it reflects their lack of coherence and the inability to provide a theory that is both realistic and logically sound.

PS: Eclecticism should not be confused with pluralism. One is the result of incoherence, the other of tolerance with different approaches to economics.  For example, institutionalists take a different starting point than Sraffians, but say relevant and coherent things that add to understanding of the real world.  A pluralistic approach that encompasses some of the contributions of both schools is, therefore, quite reasonable.  The same could be said about other heterodox schools.

Lindsay Lohan is a monetarist



Via Jason Linkins; the joke of the day.  So Lohan twitted the following:

"Have you guys seen food and gas prices lately? U.S. $ will soon be worthless if the Fed keeps printing money!"

Apparently she was paid by a group called the National Inflation Association (with that name I'm sure they are in favor of inflation).  Forget that the causes of inflation had nothing to do with the Fed printing money, what is really hilarious is that conservative/monetarists chose Lohan as the speaker of their cause.  It must be a question of credibility!