Neo-Wicksellian macroeconomics

Modern macro has more to do with Wicksell's Interest and Prices than with Keynes' General Theory. For one, the idea of a natural rate of unemployment derives directly from Wicksell's natural rate of interest, as Friedman noted. So here is a brief explanation of Wicksell's main argument in that book.

Wicksell distinguished between the natural rate of interest (R*) and the monetary or bank rate of interest (R). The former was determined by the marginal productivity of capital (I) and the intertemporal decisions of consumption (leading to savings S), along the lines of what became known as the loanable funds theory. The monetary rate was determined by bank decisions. That is, banks supplied credit (Ms) at the chosen rate of interest (R), according to money demand (Md). Monetary equilibrium occurred when the two rates coincided (see figure below). The natural rate is the gravitational center around which the bank rate fluctuates. Real and monetary shocks could cause deviations of the bank rate from equilibrium.

Wicksell assumes that a positive productivity shock raises the natural rate of interest, and that banks maintain the initial monetary rate. Thus, with a low bank rate, investment exceeds savings and once the system reaches full employment prices would go up. However, continuous lending would reduce bank reserves, and as a result banks would be forced to increase the monetary bank until a new equilibrium was reached. Inflation resulted from a bank rate that was too low, as much as deflation (and temporary unemployment) from a bank rate that was too high.

The low bank rate implies overinvestment, and the need for additional savings. The inflationary process by reducing the ability of consumers to spend provides the additional 'forced savings.' Inflation acts as a tax that provides the additional resources needed to finance investment. The business cycle can be explained by exogenous shocks to productivity (the I curve), changes in consumers preferences (shocks to S), or by the misconduct of the banking sector (shocks to Ms). Wicksell, as much as the modern Real Business Cycle (RBC) School, favored the former.

Walk out on Mankiw

As has been reported in some blogs (Robert Viennau and Daniel McDonald) students were planning to walk out of Mankiw's class to protest the type of economics he teaches and in solidarity with the Occupy movement (Adbusters has had a campaign for a while here). That's right on the mark. The teaching of economics is a central part of the process by which the mainstream and the liberalization and deregulation policies that led to the crisis have been perpetuated. The Harvard Crimson reports on the protest here. The anti-Mankiw blog is here.

More old debates on the euro

Someone pointed this link on the The Economist site, about British economists (on the left and right of the political spectrum) that were against the euro. Vicky Chick, a very good post-Keynesian monetary economist, appears here.

"Just as the political opposition to a single currency spans both socialists and the free-market right, says Victoria Chick of University College, London (a self-described “left-wing anti”), so the economic Noes contain both old-style Keynesians and Marxists on the one hand, and monetarists on the other. However, says Ms Chick, left and right have different reasons for opposing a single currency. For instance, she and economists like her think that the ECB has an in-built bias towards being too tough on inflation—which is unlikely to concern the right.
That said, the two wings have some objections in common. The left-wingers say that the ECB lacks democratic accountability. So, from the other flank, does Patrick Minford, a monetarist at Cardiff Business School. “The idea that credibility requires unaccountable central bankers is wrong,” he says. “Central bank independence has been oversold.” Far from making the ECB an exact copy of the German Bundesbank as is often supposed, he says, the new bank’s designers forgot how much the Bundesbank relied on its political legitimacy.
Besides this, the anti camp—left, right and centre—have two main objections to joining the single currency. First, they say, monetary union has imposed a “one-size-fits-all” monetary policy on the euro-zone: in booming Ireland and slumping Germany alike, interest rates are 2.5%. To complicate matters, thanks to variations in the structure of economies, a given change in interest rates may have quite different effects in two different countries. Britain’s housing market, says Andrew Hughes Hallett of Strathclyde University, is dominated by variable-rate debt, making British consumption and housing expenditure far more sensitive to changes in interest rates than elsewhere in Europe. Meanwhile, German corporations’ reliance on debt rather than equity finance makes the supply of capital more sensitive to interest rates than, say, in Britain.
On top of this, there is little scope for fiscal policy to cushion the effects of economic shocks affecting different countries in different ways. The stability and growth pact limits national budget deficits to 3%. And the EU budget is not big enough for international transfers to take the strain instead.
This leads to the second objection: that Europe’s labour and product markets are too inflexible to deal with the strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called on to deal with economic shocks, then wages and prices will have to do the job. “The consequence of one-size-fits-all”, says John Flemming, warden of Wadham College, Oxford (and a former chief economist at the Bank of England) “is that the strain is likely to be taken by unemployment.”"

The whole thing is worth reading to remember the 1999 mood, and those that actually saw it coming.

Reuters on Greece's tiny debt load

Pedro da Costa, from Reuters, in their Macroscope blog, says that:

"No, that is not a typo in the headline. Greece has long been the focal point of Europe’s crisis. It was the first country to reveal some cracks in a monetary union that lacks a fiscal authority to back it. Indeed, Greek politics were dominating the headlines on Friday, with news that the prime minister had survived a confidence vote in parliament restoring a momentary sense of calm to a still very dramatic situation.

However, Greece’s actual debt load is only large relative to its own small and struggling economy. In the larger context of the euro zone, the actual amount of debt being haggled over is rather puny."

The rest of the post here. I can't but agree with him, in particular taking in consideration the expert he cites.

John Cassidy on Wynne Godley

On my way to the euro conference in Austin. Just read this nice piece on Wynne Godley (for whom I worked back in the 1990s) in the last issue of the New Yorker. Indeed Wynne was for the European Union, but skeptical about the way the common currency was being pushed. Must read. I have also a post here.

The Crisis in the Eurozone

A conference on the euro crisis at the University of Texas, Austin, organized by Jamie Galbraith, will be held this Thursday and Friday, and a live webcast will be available here. The program is here. The event will focus on “A Modest Proposal for Overcoming the Euro Crisis” by Yanis Varoufakis and Stuart Holland, a plan which would combine the innovation of the Eurobond with a “New Deal” approach to European development.

Nominal output targeting

Christina Romer wrote this Sunday about the necessity for the Fed to target nominal output. The implication seems to be that so far the Fed had been targeting inflation, which is obviously incorrect. That would be the ECB. Krugman (here) for some reason liked it. By the way the idea is not new, Samuel Brittan had argued for that not long ago (here), and as noted by David Beckworth so have two other prominent FT columnists (Clive Crook and Martin Wolf).

First of all, Romer calls this a Volcker moment, which is from a historical point of view (and she is a macroeconomic historian) preposterous. Volcker is the guy that tried to use nominal monetary targets, as in Milton Friedman's monetary growth rule (now he is much better and is against de-regulation and too big too fail among other things).

Further, it's not clear how a nominal GDP target would be different from what the Fed is already doing, namely acting as a lender of last resort, and keeping interest rates (short and long, the latter through QE) low. Worse, her argument smells to the confidence fairy stuff you hear from the crazies serious people, and that correctly Krugman deplores. She says:

"By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth."

Sure as objective targets come, nominal GDP is better than inflation,  but since the Fed does not target inflation what is she fighting? Ben Bernanke is fine, Super Mario (Mario Draghi), the new president of the ECB needs whatever is the reverse of a Volcker moment. The US (and Europe) need more fiscal expansion.

The political economy of flat taxes

The GOP has revived this season the ghost of the flat tax. Cain is for the 999 plan (whatever that is) and Perry for a 20% flat income tax (see here, for example). I haven't seen any particular analysis of the Perry plan so far, but it won't be much different from the Cain breakup. For example, the Tax Policy Center (here) shows that Cain's plan would increase the federal taxes of the lowest quintile by 18.3% while reducing that of the top 0.1% by 17.9%.  And that's not class warfare! You don't need to be a rocket scientist to know that when you hear flat tax it's all about reducing the taxes of the rich.

Taxation was, by the way, always a key concern of classical political economy (it's there in the title of Mr. Ricardo's Principles). One of the most famous tax proposals of the 19th century, Henry George's single land tax, was in fact based on the 'Ricardian' theory of the rent. That is, the idea that landowners derive their income (rent) from ownership, and that their income (for a given level of output) detracts from profits and the possibilities of accumulation, required a tax to transfer income against wealthy landowners.

The interesting thing is that since the old classical surplus approach makes it clear that class conflict is essential for understanding the functioning of the economy, it does not try to disguise the issue of taxation as not having distributive consequences.

Utah is number 1

A graduate student brought to my attention the study here that classifies universities according to economic freedom (liberty). The Econ Dept at the University of Utah is number one (if you exclude Canadian universities) in the liberty-reducing (see graph below; click to enhance) index. We hate freedom here!

If you read the paper you'll find out that the liberty-enhancing and liberty-reduction indexes depend on what types of petitions the faculty signs. So if you sign a petition for free trade and against protectionism (a Club for Growth thing), to oppose tax hikes (the so-called Death Tax; yes they do use that term in the paper), to warn against the risks to Social Security (i.e. want to cut benefits) then you're for liberty. But if you sign a petition against the Bush tax cuts, to increase the minimum wage, or to show concern about global warming (they call it climate change; I know) then you're against liberty.

I'm proud to be against liberty then. By the way, we beat other heterodox depts, like UMass Boston and Amherst, right after the U, and the New School and UMKC that don't register at all.

PS: I just noticed that they are color blind. The liberty hating lefties should have been blue not red!

Historians and the surplus approach

An interesting feature of the literature in history, particularly when related to ancient history, is that ideas that are clearly in the tradition of classical political economy, that is the developments from William Petty to Marx including mainly, but not uniquely Quesnay, Smith and Ricardo, are often used in contrast with the dominant supply and demand approach of the literature in economics. The typical discussion of development presumes that it was the surplus obtained with the domestication of plants and animals, and the transition from hunter/gatherer to agricultural societies, that allowed specialization (the division of labor) and the development of social classes.

The figure below comes from William McNeill's classic The Rise of the West, and the essential concept of surplus is at the center of the stage.

In that sense, historians, contrary to economists (even economic historians) do not tend to fall into the trap of describing markets as autonomous institutions that are disconnected from society. Also, historians tend to think in terms of classes, and restrict individual behavior to the kinds of actions that are related to the underlying social class. That is true in several popular books like Jared Diamond's Guns, Germs and Steel.

Galbraith on long term growth

Link to the interview here, where he says that we need to spend ourselves out of the stagnant economy.

PS: Here link to his upcoming conference on the European crisis.

G20 Meeting

Yep nothing much will happen. My take here on TripleCrisis.

Commercial Policy in Latin America

Last week I taught my Raúl Prebisch class, in my Latin American Economic History and Development course, dealing with Import Substitution Industrialization (an annual thing now). The classic paper in English was published in the American Economic Review of 1959. The masters' students have to read the original paper. This follows my two previous posts (here and here) on trade. A few things that are important to notice.

Prebisch clearly says that industrialization (and hence the expansion of domestic production) is an inevitable part of the process of development, something that has been often forgotten as if strategies based on services or intensive agriculture are alternatives to industrialization. We still live in industrial societies (not post-industrial ones), and industry remains the main source for productivity growth (something that was referred to as Kaldor's Second Law of development).

Second, even if there is strong growth of productivity in the primary sector, these tend to be passed to prices and benefit the consumers, mostly in developed countries, whereas at least part of the increases in productivity in the other two sectors are retained by workers in the form of higher wages. So the problem of industrialization is associated to the ability to keep in the developing countries the fruits of technological progress, and not with protectionism for the sake of domestic special interests. Further, the workers expelled from the primary sector (if productivity is to grow there) must be incorporated in the other sectors, and as a result a preoccupation with what he calls (following Lewis) 'surplus manpower' (p. 255).

Last but not least, it's worth again emphasizing on the question of protection (since Prebisch is seen often as the Devil by Free Traders*), that Prebisch (p. 259) notes clearly that: "protection by itself does not increase productivity."

* The typical attitude is I did not read it, and I did not like it. The aversion of the mainstream to Prebisch is so strong that Dani Rodrik confesses in his Prebisch Lecture (see the irony?!) that a month before he had not read any of his works. Basically he found out that Prebisch: "did not favour indiscriminate protection. He anticipated his later critics by recognizing that trade protection on its own would not lead to increased productivity in manufactures, and that it might even resuit in the opposite."