The IMF has released a couple of chapters from its upcoming World Economic Outlook. There is one chapter Are Global Imbalances At A Turning Point, which talks of not just “flow imbalances” (current account deficits/surpluses) but also “stock imbalances” (international investment positions).

There is a nice table with a lot of information (although it is interested in absolute indebtedness and misses out small countries with high indebtedness in the list but still good information).

IMF Largest Creditor And Debtor Economies

The article stresses that flow imbalances are not just enough to analyse the macroeconomics but stock imbalances also need to be studied. Of course, in reality deficits/surpluses are not the true measures of imbalances as Nicholas Kaldor stressed in a footnote in his 1980 article The Foundations Of Free Trade Theory And Their Implications For The Current World Recession (published in Collected Essays Vol. 9):

Morever, the actual surpluses and deficits are not a proper measure of the potential size of such imbalances (and of the deflationary force they exert) since the countries who suffer from an excessive import propensity tend, on that account, to suffer from an insufficiency of domestic demand as well so their aggregate output or income is demand-constrained; they may, in addition be forced to follow a deflationary fiscal and monetary policy, and for both of these reasons, will import less from the surplus countries than they would do under full employment conditions.

The same reasoning is valid for stock imbalances as well. The true solution to reverse the imbalances without hurting aggregate demand is to rein in free trade and expand domestic demand by fiscal policies, especially by creditor nations but with so much orthodoxy around — especially from the IMF, there still is a long way to go. The global imbalances problem itself is the result of neoliberal policies promoted by the IMF.

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Credit And Economic Growth

by Ramanan on 17 September 2014

In a new column for Bloomberg, Noah Smith questions the intuition that credit fuels economic growth.

Noah Smith's Tweet On Credit

He says:

It seems like the only people who don’t instinctively believe in credit-fueled growth are academic economists.

The academics have good reason for being skeptical.

His reason (in short) is the following:

It’s pretty obvious how credit drives my personal household consumption. If I borrow, I can get a nice big TV and a new car, but eventually I’ll have to skimp to pay it back. In a way, the consumption-fueled borrowing binge is an illusion of wealth — after all, borrowing doesn’t increase my salary. Pleasure today means pain tomorrow.

Notice how Smith’s argument uses a lot of national accounting and flow of funds concepts: consumption, borrowing, wealth, repayment (of loans) and so on. The interesting thing is that one can use the system of national accounts and flow of funds to create models which show precisely the opposite of what Smith is saying. The best place obviously to look out for is the book Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth by Wynne Godley and Marc Lavoie which has models called stock-flow consistent models or SFC models. It is however difficult to write down a simple SFC model in a blog post, so I will try to highlight how it works in words but refer the reader to these models.

Here’s how in a simple model:

  1. Consumers decide to borrow more and banks respond by granting them loans.
  2. Consumers spend the funds received on consumption goods.
  3. Since loans make deposits, it’s not as if someone forgoes consumption to lend as neoclassical textbooks say.
  4. Firms see their inventories go down and respond by increasing their inventories by producing more.
  5. For producing more, firms hire more labour and pay salary/compensation.
  6. People newly employed spend their income and there’s further rise in production as firms produce more when seeing a higher demand for their products.
  7. Higher production leads to a rise in productivity and wages/household incomes of the already employed rise in response (although not necessarily the case).

So we have a higher output than what we started with and higher national income.

One can take several issues with this and this is one reasons models are really helpful and pinpoint what’s going on. This is the reason I referred to the book by Godley and Lavoie above. So for example, one can ask: what if the rise in the national income and output is just a rise in the nominal value but that it’s possible that prices have changed and that the real output hasn’t changed. This of course needs a model of prices and inflation but a familiarity with stock-flow consistent models will make you realize that it is an extreme assumption to think that the real output hasn’t risen in the sequence of events highlighted above.

The second thing is the above “model” in words had just banks lending to households whereas in the real world, credit (as in any credit, such as firms borrowing) is via credit markets of which banks are only one part. This issue is not so simple to argue out, but it can be shown that it really doesn’t matter (in the first approximation). I do not know how to quickly argue it out in short here but will leave that for now.

Of course the above model can be misleading. For example, if households take a lot of debt, debt repayment burden will hit and cause a slowdown as households’ consumption will drop and this may lead to an economic slowdown. This point may look similar to what Noah Smith is saying, but that is not the case. One can imagine an economy starting with a GDP of 100 and growing to 120 in some time period and then slowing down to 118 because of the debt burden. Also the above model was implicitly a pure private sector model and in general one has both the government and the overseas sector adding more complications. Again more reasons why having a proper mathematical model for such things is important.

Another critique of Smith (in my mini-exchange of tweets with him on Twitter) was that SFC models do have behavioural assumptions. I agree, but my point was that there’s no reason to dismiss the argument “credit fuels growth” by purely theoretical arguments. If at all, the system of national income and flow of funds make it more convincing that credit is important.

Of course none of this means that policies should be promoted to ease credit conditions always and try to create a boom and what Smith says is somewhat true – there can be pain later, so it is important to consider fiscal policy, balance of payments and so on but the story told here is quite different from the one told by Noah Smith.

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Thomas Palley — The Theory Of Global Imbalances: Mainstream Economics Vs. Structural Keynesianism

26 August 2014

Thomas Palley has a new paper on global imbalances. It tells the story of how “the economics profession has been a gung-ho supporter of neoliberal globalization, using the rhetoric of free trade.” and how its narrative has changed over the years to keep the rhetoric intact. From the abstract: Prior to the 2008 financial crisis there was […]

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Thomas Palley — New Keynesianism As A Club

28 July 2014

Thomas Palley has a new blog post detailing how much recent new Keynesian theory is a rediscovery of ideas developed by old Keynesians and Post Keynesians over the past thirty years and that new Keynesians persistently fail to acknowledge that precedence. New Keynesianism as a Club Club, noun. 1. An association or organization dedicated to a particular […]

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ROKE Issue On Steve Keen’s Notion Of Aggregate Demand

22 July 2014

The new issue of ROKE (Review of Keynesian Economics) is online with a few articles available free for some time. Marc Lavoie, Thomas Palley and Brett Fiebiger comment on Keen’s notion of aggregate demand. Marc Lavoie’s article A comment on ‘Endogenous money and effective demand’: a revolution or a step backwards? is available here. Steve Keen’s […]

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Thomas Palley On The Phillips Curve

18 July 2014

Tom Palley has written a short note titled The Phillips Curve: Missing the Obvious and Looking in All the Wrong Places.  From the introduction: The Phillips Curve: Missing the Obvious and Looking in All the Wrong Places There is an old story about a policeman who sees a drunk looking for something under a streetlight […]

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Thomas Palley On Milton Friedman’s Shadow

7 July 2014

Thomas Palley has a new paper critiquing Milton Friedman’s influence on Economics: Milton Friedman’s economics and political economy: an old Keynesian critique Milton Friedman’s influence on the economics profession has been enormous. In part, his success was due to political forces that have made neoliberalism the dominant global ideology, but Friedman also rode those forces […]

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Marc Lavoie’s New Book

30 June 2014

Marc Lavoie is out with his new book Post-Keynesian Economics: New Foundations. (Publisher’s site for the book) As per the book’s website, The book is a considerably extended and fully revamped edition of the highly successful and frequently cited Foundations of Post-Keynesian Economic Analysis, published in 1992. It provides an exhaustive account of post-Keynesian economics and of the […]

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Greg Mankiw And Empirics

24 May 2014

Greg Mankiw wonders if teaching students empirics is feasible and answers in negative: Noah Smith says introductory economics needs to be more empirical. I understand his argument, and have some sympathy with it, but I wonder if the substantial change he seems to be proposing is practical. Economists usually do empirical work with statistical tools […]

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Steve Keen And Sectoral Balances

19 May 2014

Steve Keen has a new article on sectoral balances here. First apologies in advance for sometimes criticizing heterodox economists more but needless to say, such criticisms are of a totally different nature than criticisms of mainstream economists. Anyway, I am surprised at why Keen mixes accounting identities, especially when it involves banks in the analysis. […]

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