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Thomas Palley — Monetary Policy And The Punch Bowl: The Case For Quantitative Policy And Wage Growth Targeting

Thomas Palley in his new paper:

In a famous 1955 speech, William McChesney Martin, the legendary Chairman of the Federal Reserve, declared that the Federal Reserve “is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.” Martin’s characterization of the Fed and monetary policy is brilliant and enduring. It explains why the stock market celebrates when the Fed stays on “hold”, and why the market is prone to a tantrum when the Fed raises interest rates. Staying on “hold” means more punch, while raising rates may mean sobering up.

This paper uses the punch bowl metaphor to explore and illustrate monetary policy, to show what the Fed has been doing with the punch bowl, and to suggest how it might do things better in the future. The essence of the argument is that, for thirty years prior to the financial crisis of 2008, the Federal Reserve ran the economy with too much unemployment and slack, contributing to wage stagnation and income inequality. That undermined the aggregate demand generation process, necessitating monetary policy fueled debt and asset price bubbles to fill the demand shortage. The combination of inequality and debt bubbles has proven disastrous, creating mountainous debt burdens. We need a new model for monetary policy (i.e. a different way of managing the punch bowl) that delivers full employment with wage growth, while restraining excessive debt accumulation.

[The title is the link]

Two Hundred Years Of Ricardian Trade Theory

Ingrid Kvangraven has a nice article200 Years of Ricardian Trade Theory: How Is This Still A Thing? on the blog, Developing Economics. In that, she asks how “the observation of persistent imbalances (and recurring debt crises in the deficit countries) appears to have little impact on the popularity of Ricardo’s theory.”

It’s a nice article going into details about the assumptions of the trade theory, but let me just add another perspective. New Consensus Economics is based on the assumption about the magic of prices and market forces acting to resolve imbalances. Government “intervention” (a loaded word), supposedly spoils this magic and economists are trained to think that this is the reason for crisis. So a New Consensus economist doesn’t find this to be contradictory. “Hey government, why did you interfere with the workings of the market”, an economist is likely to say.

The role of the government in this model is mainly about law and order and is supposed to balance its books. Whenever a crisis arises, economists tend to blame “fiscal profligacy” and recommend contraction of fiscal policy and “economic reforms”.

Of course, since the financial crisis started about ten years back, economists have conceded that they have been wrong about several things. Fiscal policy is one major area where this is so. But the “learned intuition” is so deeply ingrained and ramified into every corner of their minds—borrowing words from Keynes—that it is difficult for them to escape old ideas.

It’s unfortunate that Keynes didn’t stress much about this problem, which is huge. In his GT, he did have a chapter on mercantilism and discussed how the mercantilists behaved the way they behaved because of their distrust in the role of market forces in resolving imbalances. Keynes also had a plan called the Keynes Plan, before the Bretton Woods established. Keynes proposes a fine on creditor nations as well (page 23-24):

from page 23 of IMF’s document on Keynes’ Plan

Usually one only hears of this in Post-Keynesian literature but this was not all. He also proposed other responsibilities for creditors:

from page 24 of IMF’s document on Keynes’ Plan

Of course, the idea of a Bancor sounds crazy because of its similarity to the Euro. The trouble with the Euro is that there is no central government with large fiscal powers, such as in a federation like the United States. Bancor would need a world government. Nonetheless, we can still embrace Keynes’ genius that creditors should take responsibility in the rules of the game and reject Bancor. So apart from the principle of effective demand, this is one of Keynes’ biggest contribution to the history of humankind—that creditor nations have a responsibility.

Unfortunately, the world is still stuck with Ricardo’s ideas!

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Thomas Palley — Trumponomics: Neocon Neoliberalism Camouflaged With Anti-Globalization Circus

Thomas Palley:

A key element of Trump’s political success has been his masquerade of being pro-worker, which includes posturing as anti-globalization. However, his true economic interest is the exact opposite. That creates conflict between Trump’s political and economic interests. Understanding the calculus of that conflict is critical for understanding and predicting Trump’s economic policy, especially his international economic policy.

As part of maintaining his pro-worker masquerade, Trump will engage in an anti-globalization circus, but the bark will be worse than the bite because neoliberal globalization has increased corporate profits, in line with his economic interests.

Trump also expresses neocon unilateralist tendencies that play well with much of the US electorate. His neocon unilateralism is not a one-off temporary political aberration. Instead, it reflects intrinsic and enduring features of the current US polity. That has profound implications for the international relations order, and is something many Western European governments may not yet have digested.

Read more by clicking the link (header of this page).

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Levy Institute’s Strategic Analysis On The US Economy

Michalis Nikiforos and Gennaro Zezza of the Levy Economics Institute Of Bard College have published their strategic analysis report for the U.S. economy.

They discussion two scenarios — baseline scenario and scenario 1. Growth in either scenario is low. The authors argue that while equity markets have risen in recent times on expectations of a fiscal stimulus, it is unlikely. In scenario 1, it’s assumed that equity markets fall and this leads to a fall in private expenditure relative to income and this causes a fall in growth by 2020 and a rise in the budget deficit to 8.3% because of it.

It looks more likely that the Trump administration isn’t going to relax fiscal policy. Donald Trump had promised in his campaign to reduce taxes for even the middle class but is now saying that it’s dependent on numbers in the Republican healthcare plan.

At any rate, the report has a chart showing how tight fiscal policy has been since the recession. This is how real government expenditure changed after the crisis. The red line is the current recovery (2009Q2-) and other colours are for previous recoveries post recession trough.

Source: Levy Institute

[the title is the link]

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INET Interview With Anwar Shaikh On His Work

Recently, Institute For New Economic Thinking (INET), interviewed Anwar Shaikh in their New York office. It’s like a short autobiography of his work and his life and a background to his book, Capitalism: Competition, Conflict, Crises. Shaikh starts off describing his personal background and what led to him ask the questions he asks. He then talks about his work, from the humbug production function to the theory of international trade to the responsibilities of the heterodox.

An interesting story is about his association with Joan Robinson while writing the paper on the production function. Shaikh tells us that he was at Columbia University at the time and the professors there told him, “Joan Robinson is not an economist”!

[the header of this article is the link to the INET page which has the video and a brief description]

The Paradox Of Costs And Other Macro Paradoxes

In the last postEffective Demand And The Labour Market, I argued how the effect of raising minimum wages on employment is straightforward—it’s beneficial. This seems contradictory to the “intuition”—which it is not really, it’s learning to think like an economist—which suggests that raising wages will lead to unemployment.

Economists have been struggling to find answers to analysis which do not find empirical support. But they needn’t, as explanations are already available. You just need to take the Keynesian principle of effective demand more seriously.

Keynes highlighted the paradox of thrift — reduction in the propensity to consume (or rise in the propensity to save) leads to a fall in output. This goes against intuition, which considers saving as only positive. Of course the solution is to not promote a policy in which consumers spend like crazy. So fiscal policy has to be relaxed if consumers want to save a lot.

And there are other paradoxes such as the paradox of costs, which is related to the discussion on wages, profits, output and employment in the previous post. Here’s a table from Marc Lavoie’s fantastic book, Post-Keynesian Economics: New Foundations.

Marc Lavoie’s list of macro paradoxes

Intuition derived out of learning New Consensus Economics will lead one to believe that raising real wages will lead to a fall in profit rates. Michal Kalecki highlighted that this isn’t the case. As Marc Lavoie says, “what seems reasonable for a single individual or nation leads to unintended consequences or even to irrational collective behaviour when all individuals act in a similar way.”

Further, Marc Lavoie says:

The paradox of costs, in its static version, says that a decrease in real wages will not raise the profits of firms and will instead lead to a fall in the rate of employment. This was explained by Kalecki in a Polish paper first written in 1939, where he concluded that ‘one of the main features of the capitalist system is the fact that what is to the advantage of a single entrepreneur does not necessarily benefit all entrepreneurs as a class’. Its dynamic version has been proposed by Robert Rowthorn. It says that rising real wages (relative to productivity) can generate higher profit rates. This flies in the face of a microeconomic analysis that would demonstrate that lower profit margins generate lower profit rates. But if higher real wages generate higher aggregate consumption, higher sales, higher rates of capacity utilization and hence higher investment expenditures, profit rates will be driven up.

So while it may be beneficial to an individual firm to reduce wages and get a higher profit rate, it will be the reverse if everyone tries to do it.

For a fantastic discussion of these paradoxes, refer to the book Post-Keynesian Economics: New Foundations. Chapter 1 can be accessed for free at the publisher’s website.

Effective Demand And The Labour Market

Noah Smith asks, “Why the 101 model doesn’t work for labor markets”.

He realizes the answer but attributes it to Nick Hanauer. Smith says:

And with labor markets, it’s very hard to find a shock that only affects one of the “curves”. The reason is because almost everything in the economy gets produced with labor. If you find a whole bunch of new workers, they’re also a whole bunch of new customers, and the stuff they buy requires more workers to produce. If you raise the minimum wage, the increased income to those with jobs will also boost labor demand indirectly (somehow, activist and businessman Nick Hanauer figured this out when a whole lot of econ-trained think-tankers missed it!).

So Smith indeed concedes that the profession missed it out. But the attribution is incorrect. All this was figured out by Michal Kalecki in the 1930s.

Economists use supply-demand curves all the time without realizing that the diagram really doesn’t have time in it. Also, supply demand analysis crucially misses out the fact that supplies and demands are brought into equivalence not only because of “price clearing” but also quantity clearing. So while the supply-demand analysis is correct, it should be used more carefully.

So increases in real wages raises consumption and this leads to higher production plans which requires more labour. So because of the principle of effective demand, the reverse of what the New Consensus Economics says is true.

And also—without proof—it should be easy to see this in a stock-flow consistent model. Raise the wage rate and see the effect on output and employment. As simple!

But may be not. If say only the minimum wage is raised, although unemployment will fall in the short run, medium and long run effects can still be either way. So if fiscal policy is not relaxed, i.e., say, the growth rate of government expenditure is not increased, a rise in output will result in a rise in tax flows to the government and this may cause a slowdown in the rise of private sector wealth, resulting in a fall in output in the medium run. So fiscal policy also needs to be relaxed. Moreover, in the case of an open economy, faster rise in the wage rate may result in a fall in “price competitiveness”, and result in a fall in exports. A rise in a minimum wage in one region—say a state in the United States—may lead to a transfer of business operations to another state or even offshoring. So a global policy response is needed in the long run.

At any rate, we are far from the simplification of New Consensus Economics which starts off with a rise in unemployment due to a rise in real wage rises. The short run effect is completely the opposite.

Anthony Thirlwall’s Lecture At Kaldor Conference

There was a conference in honour of Nicholas Kaldor on 30th September last year at the Cornivus University in Budapest, Hungary 🇭🇺. Kaldor was born in Budapest. Anthony Thirlwall gave the keynote lecture at the conference. The video has been made available now.

click to see the video on YouTube

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Thomas Palley — Fixing The Euro’s Original Sins: The Monetary – Fiscal Architecture And Monetary Policy Conduct

Thomas Palley’s new paper:

The euro zone (EZ) was created in January 1999. Its weak economic performance is significantly due to the euro’s neoliberal monetary architecture and the design of monetary policy. Those features undermine national political sovereignty and consign the EZ to severe economic under-performance, which in turn fosters political demands for exit from the euro. Escaping this dynamic requires restoring fiscal space to EZ countries, and also changing the design of EZ monetary policy. The paper shows how this can be done. It decomposes the challenge of reform into generic problems related to the neoliberal construction of monetary policy, and specific problems concerning the euro as a currency union. The currency union problems are further decomposed into “money – fiscal policy” architecture problems and specific monetary policy conduct problems.

[The title is the link]

Article 50 To Be Triggered. Nicky Kaldor Would Have Been Happy

The UK Prime Minister’s Twitter account tweeted this picture of Theresa May signing the letter to trigger Article 50 tomorrow, starting the process for the UK 🇬🇧 to leave the EU 🇪🇺.

click the picture to see the Tweet on Twitter

Nicholas Kaldor wrote a lot on this in the 1970s before the United Kingdom European Communities membership referendum in 1975. In his Collected Economics Essays, Volume 7, he wrote (Introduction, page xxvi, October 1977) :

The final section of this volume, Part III, reproduces papers written in the course of the “Great Debate” on the question of British Membership of the Common Market in 1970 and 1971, and includes as a postscript a lecture on Free Trade written in 1977. As this debate came to an end when Britain entered the market, a decision which was later confirmed in popular referendum with a 2:1 majority, the reproduction of these papers may strike as otiose and serving little purpose other than somewhat ignoble one of self-vindication in the eyes of future historians. However, if the long-run effects of our membership turn out to be as disastrous as I feared they would be in 1971—and nothing that has happened has caused me to change my views—I think it is of the utmost importance that the true arguments against membership should be accessible to successive generations of students, the more so since the political debate continues to be dominated by issues (such as our effects of membership on the cost of food, on our agriculture, or the net budgetary cost of membership) which I regard as secondary and which could be brushed aside if the long-run effects on Britain’s manufacturing industry and on our capacity to provide employment were favourable.

 

So Nicky Kaldor would have been happy, had he been alive today.

Economists’ predictions about leaving the European Union (“Brexit”) went wrong. Real GDP in the H2 2016 rose faster than H1, while they were predicting a recession. Not that the road will be simple ahead for Britain. Let’s see!