Monthly Archives: February 2013

So The Bank Of England And The UK Government Cannot Default On Its Bonds – Is It?

Always start macroeconomics with balance of payments 🙂


Moody’s Investors Service has today downgraded the domestic- and foreign-currency government bond ratings of the United Kingdom by one notch to Aa1 from Aaa.

It also downgraded the Bank of England:

In a related rating action, Moody’s has today also downgraded the ratings of the Bank of England to Aa1 from Aaa.

This has seen a lot of reactions – such as quoted here in an FT Alphaville blog post ‘This downgrade is nonsense!’

So let us get straight to scenarios which lead to defaults – in addition to ones purely voluntary.

Scenario 1.

The easiest is to think of a scenario where the Euro Area forms a political union and the UK is invited to join it and it joins it – such as in 2027. The UK government then gives up the power to make drafts on its central bank and becomes a state level government. UK government bonds will be redenominated in Euro and hence a possibility of default exists – including on debts in existence in 2013.

Scenario 2.

Suppose the UK pegs GBP to some currency such as the Euro or the dollar in 2024. Then surely the government and the central bank can default on debts in existence in 2013 and denominated in GBP in say 2037 isn’t it (like Russia in 1998)?

Now you may complain that it was the government’s mistake to have pegged its exchange rate – but whatever said, an investor holding a bond in 2013 would have been hurt in 2037.

Scenario 3.

Suppose the UK has a balance of payments crisis in 2030. It needs foreign exchanges and needs an international lender such as the IMF. Now suppose the IMF insists that the UK government and the Bank of England default on foreigners holding GBP denominated bonds including those in existence in 2013. Voluntary default?


Moody’s can be criticized for playing political games but a good critique cannot be that default is not possible.

You can come up qualifiers but won’t prove Moody’s rating change wrong.

Don’t get me wrong. I am trying to convince to come up with stronger arguments for critiquing the rating agencies instead of simple ridiculing. Usually the rating actions are defended by people arguing for fiscal contraction. Paradoxically the recovery of the world economy cannot come about easily with without at least a worldwide fiscal expansion.

A New Handbook Of Post-Keynesian Economics

This looks nice but will be released only in May 🙁

The Oxford Handbook Of Post-Keynesian Economics - Volume I - Theory And Origins

Links: OUP, Amazon

Table of Contents

Preface and acknowledgements

Introduction – G.C. Harcourt and Peter Kriesler

1. A personal view of the origins of post-Keynesian ideas in the history of economics – Jan Kregel

2. Sraffa, Keynes and post-Keynesianism – Heinz Kurz

3. Sraffa, Keynes and post-Keynesians: Suggestions for a synthesis in the making – Richard Arena and Stephanie Blankenburg

4. On the notion of equilibrium or the centre of gravitation in economic theory – Ajit Sinha

5. Keynesian foundations of post-Keynesian economics – Paul Davidson

6. Money – Randall Wray

7. Post-Keynesian theories of money and credit: conflict and (some) resolutions – Victoria Chick and Sheila Dow

8. The scientific illusion of New Keynesian monetary theory – Colin Rogers

9. Single period analysis and continuation analysis of endogenous money: a revisitation of the debate between horizontalists and structuralists – Giuseppe Fontana

10. Post-Keynesian monetary economics Godley-like – Marc Lavoie

11. Hyman Minsky and the financial instability hypothesis – John King

12. Endogenous growth: A Kaldorian approach – Mark Setterfield

13. Structural economic dynamics and the Cambridge tradition – Prue Kerr and Robert Scazzieri

14. The Cambridge post-Keynesian school of income and wealth distribution – Mauro Baranzini and Amalia Mirante

15. Reinventing macroeconomics – Edward Nell

16. Long-run growth in open economies: export-led cumulative causation or a balance-of-payments constraint? – Robert Blecker

17. Post-Keynesian precepts for nonlinear, endogenous, nonstochastic, business cycle theories – K. Vela Velupillai

18. Post-Keynesian approaches to industrial pricing: a survey and critique – Ken Coutts and Neville Norman

19. Post-Keynesian price theory: from pricing to market governance to the economy as a whole – Frederic S. Lee

20. Kaleckian economics – Robert Dixon and Jan Toporowski

21. Wages policy – John King

22. Discrimination in the labour markets – Peter Riach and Judith Rich

23. Post-Keynesian perspectives on economic development and growth – Peter Kriesler

24. Keynes and economic development – Tony Thirlwall

25. Post-Keynesian economics and the role of aggregate demand in less-developed economies – Amitava Krishna Dutt

Volume 2 website here

Table of Contents

Preface and acknowledgements

Introduction (from volume 1) – G.C. Harcourt and Peter Kriesler

1. On microfoundations of macroeconomics – Abu Rizvi

2. Post-Keynesian economics, rationality and conventions – Tom Boylan and Paschal O’Gorman

3. Methodology and post-Keynesian economics. – Sheila Dow

4. Critiques, methodology and the relationship of post-Keynesianism to other heterodox approaches – Gay Meeks

5. Two post-Keynesian approaches to uncertainty and irreducible uncertainty – Rod O’Donnell

6. The interdisciplinary applications of post-Keynesian economics – Wylie Bradford

7. Post-Keynesian economics, critical realism and social ontology – Stephen Pratten

8. The traverse, equilibrium analysis and post-Keynesian economics – Joseph Halevi, Neil Hart and Peter Kriesler

9. A personal view of post-Keynesian elements in the development of economic complexity theory and its application to policy – Barclay Rosser Jr.

10. How sound are the foundations of the aggregate production function? – Jesus Felipe and John McCombie

11. Marx and post-Keynesians – Claudio Sardoni

12. The L-shaped aggregate supply curve, the Phillips curve, and the future of macroeconomics – James Forder

13. A post-Keynesian critique of independent central banking – Joerg Bibow

14. The post-Keynesian critique of the mainstream theory of the state and the post-Keynesian approaches to economic policy – Richard Holt

15. A modern Kaleckian-Keynesian framework for economic theory and policy – Philip Arestis and Malcolm Sawyer

16. Classical-Keynesian political economy: genesis, present state and implications for political philosophy and economic policy – Heinrich Bortis

17. Post-Keynesian distribution of personal income and policy – James K. Galbraith

18. Environmental economics – Neil Perry

19. Theorising about post-Keynesian economics in Australasia: aggregate demand, economic growth and income distribution policy – Paul Dalziel and J. W. Nevile

20. The heterodox spiral and the neoclassical sink: reclaiming economic theory after neo-liberalism – Gary Dymski

21. Keynesianism and the crisis – Lance Taylor

Fake Trade-Offs

Elasticities for one last time for now.

Recently Tom Palley wrote a fine critique of the Neochartalist approach to solve the world problems with oversimplistic solutions. Among other things, Palley challenges the simplistic Chartalist solutions due to dilemmas posed by the external sector.

Bill Mitchell of Australia wrote a reply in which he states the following:

It is easy to see that a Job Guarantee model requires a flexible exchange rate to be effective. We can identify two external effects. First, given the higher disposable incomes that the Job Guarantee workers would have compared to if they were unemployed imports would likely rise.

With a flexible exchange rate, the increase in imports would promote depreciation in the exchange rate. We should expect the current account to improve and net exports increase their contribution to local employment. The result depends on the estimates of the export and import price elasticities. The body of evidence available suggests that import elasticities are small (around –0.5).

This is a typical oversimplistic and incorrect approach.

First, Mitchell incorrectly claims that import elasticities are low for Australia citing a “body of evidence”. The number he quotes is price elasticity. He hides away from income elasticity. I suppose he thinks that the numbers estimated are “low” enough not worthy of mention. Unfortunately it is not.

Second, he claims that as a result of running an employer of the last resort by the government, the Australian exchange rate would fall and this would actually lead to an improvement of the current account.

This is a primitive neoclassical argument. While it is true that a depreciation of the Australian dollar would act to reduce imports due to price effects, it is no guarantee to reduce the trade imbalance. This is because if incomes rise faster, the trade imbalance may be rising (i.e., imports are rising) even if the Australian dollar is depreciating. Note that is different from the J-curve effect. Exports on the other hand depend on the competitiveness of Australian producers and demand conditions in the rest of the world and hence improvement of exports is dependent on how the rest of the world grows which cannot be assumed arbitrarily.

[Incidentally, producers in other nations may be even less competitive than Australian producers – thereby implying a stronger constraint on those nations because exports may not be rising as fast]

Funnily, the blog posts claims in one place that imports reduce and later that it increases. In that discussion, Mitchell seems to be addressing imported inflation – a somewhat less important detail here in this post.

Third and the most important point is since the exchange rate is not under official control, there is no guarantee that the exchange rate will depreciate. It may appreciate and stay at appreciated levels for an uncertain period till the net indebtedness of Australia rises to alarming levels.

I suppose Mitchell believes there cannot be a crisis because according to a 2008 paper coauthored by him, There is no financial crisis so deep that cannot be dealt with by public spending. Ironically during the global financial crisis which started in 2007-8, Australian banks went into a heavy US dollar funding problem which had to be resolved by the Reserve Bank of Australia using its credit lines at the Federal Reserve (via swap lines). This puts his huge claim that crises can simply be solved by public spending into pieces.

Now, if incomes rise in Australia, this has the adverse effect of deteriorating the balance of payments which Mitchell denies reguarly. Of course in real life, Australian authorities won’t like a deterioration. Here is where the fake trade-off of the employer of the last resort proposal comes in.

If incomes are to not rise because imports have to be kept under check, then the ELR is simply a redistribution to the ELR employee out of taxes. This is because more people receive the disposable income due to production and if output is constrained from the external sector, so are incomes – thereby implying lower disposable incomes for others already employed and not in the ELR.

Incidentally I mention in the passing that Australian banks are subject to vulnerabilities due to funding from foreigners – something Chartalists (who are also Minskyians) would deny. The huge amount of external funding needs of Australian banks – both in domestic and foreign currencies is a direct result of the current account imbalances accumulated over the past.

Somehow a group of Keynesians think that simply deficit spending solves all our problems.

A Nation’s Net Indebtedness: An Example

Over this thread at Matias Vernengo’s blog Naked Keynesianism, I got into an exchange about current account deficits and sustainability with an anonymous commenter – a topic I had blogged on recently in 2-3 posts.

The commenter seems to not understand how this works or seems to believe that net indebtedness cannot keep rising relative to GDP in scenarios. I will present some scenarios below. The scenario presented below is not what literally happens but rather shows the absurdity of some types of growth.

Before this, let me give the expression for net indebtedness to foreigners. Ignoring revaluations, only current account transactions change claims on foreigners or claims by foreigners on residents. So

Change in Net Indebtedness to Foreigners = Current Account Deficit.

For simplicity, I will ignore other items in the current account – such as interest and dividend payments between residents and non-residents etc.

So start with GDP of £100, imports of £20 and exports of £15 and net indebtedness to foreigners of 20% of GDP.

Assume GDP grows at 5% annually. Imports as a percent of GDP is 20% and exports do not grow.

(In real life imports can be even worse when output changes but let’s just keep things simpler).

The numbers are nominal values.

So here is how it looks in Excel:

Net Indebtedness To Foreigners - Example

Now one can argue about the simplicity in the assumption that export was held constant. So here it is at 4% export growth.

To make it more realistic, I also use import elasticity of 1.5 – which means that for a 1% rise in GDP, imports rise by 1.5%.

Net Indebtedness To Foreigners - Example 2

Deteriorating in either case. If you were to extend the scenario to more rows in Excel, you can see how it rises forever.

It illustrates one thing: At sufficiently low growth of exports or a high propensity to import, a faster rate of growth of output comes with net indebtedness to foreigners rising relative to GDP which cannot be sustained for long.

Also if one assumes (although not always the case) that the private sector net accumulation of financial assets (NAFA) is a small positive number (such as 2% of GDP), then the current account reflects directly on the fiscal deficit because of the sectoral balances identity.

You can do this on your own sheet and see how these numbers change for different scenarios assumed.

The reason I have a numerical example is that it is easier to see how fast these stocks and flows change.

This example is an illustration of the balance-of-payments constraint nations face. Faced with rising current account imbalances, nations may be faced with little optimism – such as the ability to use of fiscal policy to improve demand and output. In a world of free trade, there is less one can do such as raising tariffs, import controls and so on. The trend in international political economy is actually tending toward reducing tariffs which makes the problem even worse. Subsidies to exporters can be provided but these lead to cries of foul at WTO. Even if subsidies are given to exporters, they are limited by how well they can compete with big firms in international markets. When this happens for everyone – such as at present – an international political economy game happens where muddled policy makers try to discuss something but in the end vow to continue free trade policies. Or they play games such as beggar-my-neighbour. Whatever said, a nation’s success crucially depends on how their producers do in international markets.

Back to stocks and flows. In real life things get more complicated and interesting. A nation may receive a lot of payments from abroad – even if its trade balance is worsening because of direct investments made in the past etc. Residents hold stock market securities abroad and these may make a killing – so analysing this becomes even more interesting! So high holding gains of assets held abroad may be sufficient to prevent net indebtedness from rising even if the current account balance is high. So there is an interesting dynamics here but finally, the current account balance wins over revaluations.

The example is motivated by one given in Wynne Godley and Francis Cripps’ book Macroeconomics.

The Production Function View Of The World

Recently FT published an interview with Adair Turner, chairman of the UK Financial Services Authority- who supposedly thinks of himself as heterodox!

Here is from the interview:

Lord Turner: Well, I think there is a challenge of macroeconomic policy which, for the last 30 years, we have largely, appropriately, located in central banks, which is the management of the pace of increase of aggregate nominal demand.

And we have had a philosophy, which I think is a right philosophy, that there is a macro challenge of making sure that aggregate nominal demand is growing at an appropriate pace, but all that can do is ensure price stability. And, within the constraint of price stability, the return of an economy to a full, or close to capacity level, and that there is no ability of those set of levers to change the trend growth rate of real output. And I think that was the shift in the orthodoxy, but this bit of the shift in the orthodoxy was absolutely right, I think, during the 1960s where there had been a previous tendency on the part of some economists to believe that you could call macro levers, fiscal and monetary levers, in a way that would increase the trend real growth rate of the economy.

So I think I’m clearly in the camp who believe the trend real growth rate of the economy is driven by a set of supply factors, the exogenous rate of technological growth, the growth of the labour market, the pace of capital formation, etc, and that the rejection in the 1960s of the idea that we could stimulate that by running large fiscal deficits or by monetary policy was quite correct.

Which is entirely inaccurate and super-neoclassical.

In the interview Turner also talks of “money-financed” stimulus – a crude and entirely misleading way of looking at fiscal policy. His interview summarized in another article Print money to fund spending – Turner seems to have irritated mainstream analysts as well 🙂

In Monetarism, fiscal policy is financed by the government and the central bank by issuing bonds and cash and this is decided by the two authorities by deciding on the proportions (as if the preference of the private sector’s portfolio allocation does not matter). A high proportion of issuance of cash leads to price rise with no increase in real output and the opposite case leads to a rise in interest rates. So fiscal policy is not only impotent but also has negative effects according to Monetarism.

Now mainstream economists have conceded that fiscal policy can have positive effects but tend to argue that it works in exceptional circumstances only and Turner’s view of the world is around that theme.

The notion of the production function seems to be the main point in Turner’s view of how the world works. In the interview he talks of “poison” when discussing fiscal expansion. Why do economists think of  the use of fiscal policy as immoral? One example below:

Production Function

In neoclassical theory, output is determined by a production function. Supply creates its own demand.

So one writes

GDP = C + I + G

assuming a closed economy and symbols with their meanings.

Now, in neoclassical theory, output [or GDP – although not the same thing because the latter excludes intermediate consumption for example] is determined by a production function. Unless you don’t understand Keynes, this seems to be a reasonable assumption but remember what Joan Robinson said – “The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists”.

Unfortunately it does not work that way and in (post-) Keynesian economics, demand creates its own supply. It has been difficult for economists to appreciate this because they would have to give up the concept of the production function. The aggregate production function is crucial to neoclassical economics. Without it, neoclassical economics cannot live.

Post-Keynesians have written the most devastating critiques of this fantastical object. In this post – humble compared to the critiques – I will just consider one aspect.

So the production function is

Q(t) = F(L(t), K(t); t)

This is a relationship which says that output is determined by factors of production. To simplify, only land, labour and capital are taken as inputs. To make it slightly more general, it is also assumed that the function is dependent on time – in order to allow technical change.

Since output and hence GDP is determined by this in this way of thinking, the left hand side of “GDP = C + I + G” is determined by the production function. It is then argued that since the left hand side is fixed, higher government expenditure can only work to reduce investment and consumption. Hence government should reduce its expenditure!

Also, since it supposed to hold inflation-adjusted as well, expenditures by the government can only increase prices – together with the earlier result of “crowding out”. Also further arguments – in discussions about interest rates etc. – this argument is further supported by the authors – with results such as increased government expenditures invariably leading to higher interest rates etc in the absence of “monetary financing”. So allegedly independent central bank does not “money finance” the deficit and the opposite case – central bank losing some independence leads invariably to higher inflation. This is connected with the notion of an exogenous stock of money and the standard neoclassical description is such that increased government expenditure leads to shortage of funds available for investment.

Such is the crude world of neoclassical economics. The concept of the chimerical production function goes hand-in-hand with the widely held damaging view that fiscal policy is not only neutral but also “poisonous”!

This is also presented another way. GDP is also equal to the sum of disposable incomes of all sectors of an economy. Since GDP is given by the supply side (the production function), a higher tax revenue for the government implies lower disposable incomes for the private sector. So the government should reduce taxes – by reducing the tax rates. In a demand-side description, although there is some truth to this – it is due to different reasons. A decrease in the tax rate leads to an increase in demand – as people will be left with more disposable incomes and will spend more and this acts to increase output but also brings in more tax receipts for the government because of the increase in total taxes due to higher economic activity.

Of course, supply-siders are misled by demand-side theories because they incorrectly tend to view them as if the theories assume that there is no supply-constraint at all. That takes one to “endogenous growth theory” but understanding the basic demand-led growth story is a Herculean task for most economists that such discussions rarely happen.