Author Archives: V. Ramanan

A New Handbook Of Post-Keynesian Economics

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This looks nice but will be released only in May 🙁

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

Link: 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

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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

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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

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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

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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.

Trade Elasticities, Floating Exchanges And Debt Sustainability

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[Although the following is a response aimed at one comment, it can be read in general]

In my post on the connection between balance of payments and debt sustainability, I got a “you are wrong” comment saying the analysis is based on the notion of trade elasticities which doesn’t exist (or is a chimerical notion) and that I ignore floating exchange rates. So a reply.

Trade Elasticities

A standard observation is that imports and exports depend on income – domestic and in the rest of the world. Exports depend on how competitive the producers are in the rest of the world and also the demand in the rest of the world. Similarly imports depend on foreign producers’ competitiveness compared to domestic producers as well as domestic demand. So in a simple Keynesian model one writes:

IM = ΟY

where Ο is the propensity to import. It measures imports as a proportion of domestic output. Relative propensities (between nations) measure relative competitiveness of producers. This is a very quick way to build a model for how stocks and flows change over time.

There is one simplification in this. Although it rightly captures the amount of imports during a period – such as a few years, it supposes imports rise one-to-one with output – i.e.,

ΔIM/IM = ΔY/Y

But in reality it could be worse – as the response of imports to a rise in domestic demand can be worse.

Also, it doesn’t capture the effect of prices. Producers across the world compete with each other on both the quality of their products and on price. So we have “non-price competitiveness” and “price competitiveness” . Now it is a Post-Keynesian observation that non-price competitiveness is much more important. So one has income elasticity of imports as well as price elasticity and the analysis can get a bit complicated. Some kinds of products have higher elasticities than others. For example manufactured products may have different elasticities as compared to raw materials, commodities etc. Also one can include nuances such as which is more important – income, expenditure, output etc.

Even more generally, the rest of the world consists of many nations and one has to be careful. So the rest of the world may be growing but it may happen that exports aren’t because exports are concentrated on one country or a group of nations which are not growing.

A good original reference is Joan Robinson’s article The Foreign Exchanges from her 1937 book Essays In The Theory Of Employment. 

Rather than going through the analysis, let me just show the plot of the United States’ imports to show that the concept of elasticity is far from chimerical as one observer claims.

The following is a scatter-plot of the logarithms of GDP and Imports for the United States since 1951 (quarterly). The data is from Federal Reserve’s Z.1 Flow of Funds Accounts.

US Imports Versus GDP

The thin grey line is the fit and in addition, there is a 45-degree line to show that the slope is different than 1.

The “elasticity” is supposed to capture the response of imports to a rise in expenditure/income/output. The above simple scatter-plot shows the relation is far from being random.

So much for the notion that trade elasticities don’t exist!

Of course, the elasticities can be improved and not god-given. A nation’s government can take some protection and/or invest in research and development because the elasticity is a supply-side concept. It can also be improved if producers learn how to improve their products and the quality of its sales force in marketing them in international markets. Still, the improvement depends on how well all these are carried out etc.

Now to floating exchanges.

Floating Exchange Rates

Now, it can be argued that a debt sustainability analysis is invalid because of floating exchange rates. If a nation’s currency floats, a depreciation of the exchange rate in the foreign exchange markets can improve the trade balance. While it is true that a depreciation can turn the balance in a nation’s favour because of price effects, it is doesn’t necessarily happen that way. Even if one assumes away J-curve effects, a nation can find itself in a balance worsening in spite of a depreciation. This is because non-price competitiveness is far more important than price-competitiveness. In fact there exists no reason how “market forces” miraculously resolve the imbalances by depreciating. In reality trade imbalances are kept from blowing up by adjustments to income.

It is one thing to say that depreciation can improve the trade balance (which has truth to it) and another to say it can do a miracle.

Now, coming to debt sustainability, one can still claim that this process can continue forever (i.e., net indebtedness to foreigners rising forever relative to gdp) without any trouble in the foreign exchange markets. That is something for another post but it is too much of a claim.

The Joan Robinson paper I quoted has the mechanism of how this ends up creating troubles in the fx markets.

Mario Draghi – Euro Saviour?

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Recently Mario Draghi, the European Central Bank President, has been going around telling everyone that “fiscal consolidation” is the absolutely essential to resolve the Euro Area crisis, given some positive developments. Although, this view of his is known and this has had a big influence on policy, he has become more and more vocal about it in recent weeks. He has also signalled a “positive contagion” – a phrase he seems to have coined.

Here is Mario Draghi talking at the recent annual conference at Davos to John Lipsky. (Link no longer works)

If Draghi is to be believed, “fiscal consolidation” is an absolute necessity for the Euro Area to come out of the crisis.

In a recent press conference from January 10, Draghi said the same:

Question: Could Outright Monetary Transactions (OMTs) lose their magical effect in the markets if no country asks for them?

Second question: Jean-Claude Juncker has said that too much fiscal consolidation could have a negative effect on countries like Spain, because unemployment is so high. What can you say about that?

Draghi: On your first question, you do not have to ask me, ask the markets.

On the second, many comments of this type have been made about several countries in the euro area. My answer to this is that so much progress has already been made, accompanied by so many enormous sacrifices. So reverting to a situation which has been found to be untenable would not be right. We should not forget that this fiscal consolidation is unavoidable, and we certainly are aware that it has short-term contractionary effects. But now that so much has been done I do not think it is right to go back.

[emphasis: mine]

Back in July 2012, when Spanish government bond prices were plunging, Mario Draghi came up with a plan to save the Euro Area by first announcing on July 26 in a conference in London that “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” and after a pause, “And believe me, it will be enough.”. In the monetary policy meeting on September 6, he outlined a plan by the Eurosystem to buy government bonds without any ex-ante quantitative limits, provided the nations asking this facility agree to terms and conditions – mainly on fiscal policy.

This was greeted with great optimism and the “state of confidence” of the financial markets greatly improved in the next few months. Mario Draghi eventually became the FT Person Of The Year. The fact that nations have a backstop meant that the financial sector has been more willing to finance the governments and the nations actually haven’t felt the need to use the facility so far.

At the time, there was an urgent need to do something and the European Central Bank responded positively to prevent a financial and economic collapse.

While the condition that governments asking for the ECB’s help have to meet is unavoidable for any such plan, Mario Draghi seriously misunderstands the nature of the problem. While it is true that there needs to be structural reforms so that struggling Euro Area countries become more competitive relative to their partners and aim to improve their exports to reduce imbalances within the Euro Area, a Euro-Area wide fiscal contraction will fail to achieve this in any sustainable way. Structural reforms aka wage cuts, will further deflate demand in those nations as Michal Kalecki taught us.

Take Spain for example. Its current account is coming back to balance but this has been the result of a huge deflation of domestic demand and no wonder its unemployment rate hit 26% recently. Statements such as “fiscal consolidation is unavoidable” put all the burden on weaker nations. The Euro Area actually needs a fiscal expansion in creditor nations and although a relatively tighter fiscal policy in the debtor nations compared to creditor nations, an expansion compared to the present state nonetheless. In the long term it needs to form a political union – not like the ones floated by European leaders.

The weaknesses of the Euro Area going forward has been highlighted by Charles Goodhart in a recent appearance in the Economic and Financial affairs session of the UK Parliament. Here is the link to the video.

Also, in December 2012, Draghi and the EU leaders presented a plan Towards A Genuine Economic And Monetary Union. Again this approach has the same errors as the plans floating around since decades and debunked by Nicholas Kaldor in 1971 in one of the most prescient articles ever written.  See this post Nicholas Kaldor On European Political Union. The European leaders are seriously mistaken to think of any of their plans as “genuine”.

Somehow, the Monetarist counterrevolution of the 1970s seems to have forever distorted the vision of economists and economic advisers to politicians even if they do not think they are Monetarists.

The Beggar-My-Neighbour Game

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How did Keynes and the Cambridge Keynesians (such as Joan Robinson, Richard Kahn, Nicholas Kaldor and Wynne Godley) think the world economy works?

A few important principles relevant here and of course not exhaustive:

First, real demand, output and employment is determined by the fiscal and monetary policies of the government with the former having a more solid impact on demand. Second, fiscal policy has constraints due to the capacity to produce, and inflation. High inflation – although also influenced by demand – needs to to tackled by direct political means as it is also (highly) dependent on costs. Third, economies have a balance-of-payments constraint and a nation’s success depends crucially on how its producers perform in international markets.

For neoclassical economists and their cousins, world demand and output is determined by the supply-side. It is fantasized that with economic scarcity (as if!) utility and profit maximising behaviour of economic agents will lead to the most efficient allocation of resources and attempts to regulate trade will only make everyone worse-off. The amount of resources is “given” and interference with markets only leads to a lower output for that “given” amount of resources. Fiscal policy is neutral – although it is conceded by them that it can have positive short-term effect. Over the long run, fiscal policy is strictly neutral in this view. The prescription is for the government to balance the budget – sooner the better, and for monetary policy to either “control” the stock of monetary aggregates and/or for interest rate to return to some vaguely defined normal. Further, at an international level, the free trade ideology is imposed on nations because it is thought that it will lead to a convergence of incomes and living standards and full employment.

For example the WTO page on tariffs says:

Customs duties on merchandise imports are called tariffs. Tariffs give a price advantage to locally-produced goods over similar goods which are imported, and they raise revenues for governments. One result of the Uruguay Round was countries’ commitments to cut tariffs and to “bind” their customs duty rates to levels which are difficult to raise. The current negotiations under the Doha Agenda continue efforts in that direction in agriculture and non-agricultural market access.

Unfortunately, free trade, has the opposite effect. Rather than leading to any convergence, it leads to some nations gaining more success and others failing. As Nicholas Kaldor said, “success breeds further success and failure begets more failure.”

How does this operate? A government which wishes its nation to grow faster can put up fiscal policy but sooner or later will be faced with a balance of payments because of the adverse effect on trade and rising indebtedness to foreigners. This constraint shows up as troubles in the foreign exchange markets. This constraint is strongest for a nation whose currency is fixed irrevocably (such as the Euro Area nations) but also is also strong for nations whose currencies are pegged and freely floating.

Now, a nation which has good exports sees good economic expansion via the “export multiplier”. Imports on the other hand are “leakages”. Let us think of a Nation X with a higher propensity to import. Faced with higher imports, X may try to use fiscal contraction to further contract demand and hence imports. This has negative ripples throughout the world as a whole. Exporters to X will see a lower demand for their products – even if they maintain market shares. Via lower multiplier than otherwise, this leads to a lower demand than otherwise in the rest of the world. This again has a contractionary effect on X because of lower exports again leading to a lower demand in the rest of the world than otherwise and so on. So fiscal expansion and investment are good for the world as a whole but free trade is damaging. This is not to deny the benefits of globalization but a world with free trade will be worse-off than with a system of regulated trade which will have higher output, income and world trade since allows more space for fiscal policy and via an accelerator process, allows investment to expand faster.

Now, till recently the United States was acting as the “demander of the last resort” because of its huge imports. Faced with a high balance of payments deficit (in the current account), the United States neither wants to be in this position nor is going to expand domestic demand. It is as if the engine of growth has been cut off.

Faced with so many constraints, nations try to play the beggar-my-neighbour game. Unfortunately this game is also played by the creditor nations. The phrase was first introduced by Joan Robinson in a 1937 article titled Beggar-My-Neighbour Remedies For Unemployment. This excerpt is from beginning of the article:

For any one country an increase in the balance of trade is equivalent to an increase in investment and normally leads (given the level of home investment) to an increase in employment.1 An expansion of export industries, or of home industries rival to imports, causes a primary increase in employment, while the expenditure of additional incomes earned in these industries leads, in so far as it falls upon home-produced goods, to a secondary increase in employment. But an increase in employment brought about in this way is of a totally different nature from an increase due to home investment. For an increase in home investment brings about a net increase in employment for the world as a whole, while an increase in the balance of trade of one country at best leaves the level of employment for the world as a whole unaffected.2 A decline in the imports of one country is a decline in the exports or other countries, and the balance of trade for the world as a whole is always equal to zero.3

In times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others. As soon as one succeeds in increasing its trade balance at the expense of the rest, others retaliate, and the total volume of international trade sinks continuously, relatively to the total volume of world activity. Political, strategic and sentimental considerations add fuel to the fire, and the flames of economic nationalism blaze ever higher and higher.

In the process not only is the efficiency of world production impaired by the sacrifice of international division of labour, but the total of world activity is also likely to be reduced. For while an increase in the balance of trade of one country creates a situation in which its home rate of interest tends to fall, the corresponding reduction in the balances of the rest tends to raise their rates of interest, and owing to the apprehensive and cautious tradition which dominates the policy or monetary authorities, they are chronically more inclined to foster a rise in the rate of interest when the balance of trade is reduced than to permit a fall when it is increased. The beggar-my-neighbour game is therefore likely to be accompanied by a rise in the rate of interest for the world as a whole and consequently by a decline in world activity.

The principal devices by which the balance of trade can be increased are (1) exchange depreciation, (2) reductions in wages (which may take the form of increasing hours ot work at the same weekly wage), (3) subsidies to exports and (4) restriction of imports by means of tariffs and quotas. To borrow a trope from Mr. D. H. Robertson, there are four suits in the pack, and a trick can be taken by playing a higher card out of any suit.

1 See below, p. 159, note, for an exceptional case. [Note on p. 159: When the foreign demand is inelastic a tax on exports (as in Germany in 1922) or restriction of output (as in many raw-material-producing countries in recent years) will increase the balance of trade, while at the same time reducing the amount of employment in the export industries, and increasing the ratio of profits to wages in them. In these circumstances, therefore, an induced increase in the balance of trade may be accomoanied bv no increase, or even a decrease, in the level of employment.]

2 Unless it happens that the Multiplier is higher than the average for the world in the country whose balance increases.

3 The visible balances of all countries normally add up to a negative figure, since exports are reckoned f.o.b. and imports c.i.f. But this is compensated by a corresponding item in the invisible account, representing shipping and handling costs.

Claims Economists Make

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Economists struggle with simple things. Two examples.

National Saving, Trade Deficits etc.

In a blog article Has Anyone Heard of the Trade Deficit?, Dean Baker uses the sectoral balances identity to make a claim which is presented like a no-go theorem.

Baker says:

Fans of arithmetic (a tiny minority among DC policy types) like to point out that a large trade deficit implies negative national savings. In other words, if we have a trade deficit then by definition the United States as a whole has a negative saving rate.

This means that we either must have budget deficits (negative public savings) or negative private savings, or both. There is no way around this fact.

Baker confuses saving with saving net of investment – just like the Neochartalists. (Confuses S with S minus I)

Without proof, the sum of saving of a whole economy is given by

S = I + BP

where (here) S is the sum of the savings of all resident sectors of the economy – the “national saving”, I is the total investment expenditure of the resident sectors of the economy (i.e., both private and public) and BP is the current account balance of international payments.

So it is possible for an economy to have a trade deficit and hence a negative BP (although it’s not always the case that the trade deficit translates into a current account deficit) and still have I + BP positive if investment is sufficiently high. So an economy can have positive national saving with a trade deficit.

Of course it must be said that the persons he is attacking are wrong. The claim (of the persons he is criticizing) is that the United States should save more (by a reduction in budget deficits brought about by a tightening of fiscal policy and/or higher propensity to save of the private sector achieved in some way). This is illegitimate as such a policy will induce a recession in the United States. Via the paradox of thrift, an increase in the private sector propensity to save can lead to lower saving of the private sector. Investment will fall because of lower sales expectations and the recession in the United States caused by the fiscal tightening will most likely lead to a recession in the rest of the world reducing its exports so that the only thing achieved is higher world unemployment.

Debt/GDP Ratio

In a series of posts aimed at showing something, Randall Wray claims the following:

… To simplify, if the interest rate is higher than the economy’s growth rate, then the debt ratio rises continuously…

Of course he also claims that if g>r, the debt ratio stabilizes.

Now, the debt sustainability conditions relating the interest rate and the growth rate of output are misleading. I showed this two posts back, where I showed that the claim that the condition that g>r ensures stabilization of the public debt/gdp ratio is incorrect. The above quote claims the opposite and is equally erroneous and misleading.

An economy can have the growth rate lower than the interest rate and still not have an exploding debt ratio.

A standard error in such analysis is to treat the budget deficit as exogenous. 

Consider an economy without a strong balance of payments constraint and with inflation less of a trouble. A fiscal expansion brings about an increase in output and this has the effect of stabilizing the debt ratio in two ways: the higher output itself and an increase in tax revenues of the government due to higher output. The budget balance may go into primary surplus automatically even though the government may not be targeting this.

In other words, if r>g, the sequence dn given by the relation

dt – dt-1 = λdt-1 – pbt

(where Ν is equal to (r-g)/(1+g) and  dt is the debt/gdp ratio at the end of time period t and pbt is the primary budget balance of the government in the period) would seem to explode because of the first time on the right hand side. But higher output will automatically lead to a dynamics for pbt ensuring sustainability.

How this works was shown by Wynne Godley in an article The Dynamics Of Public Sector Deficits And Debts written in 1994 written by his co-author Bob Rowthorn in J. Michie and J. Grieve Smith (eds), Unemployment in Europe (London: Academic Press), 1994 pp. 199-206 and which was originally a paper to the UK Treasury around ’92-’93.

For a demand constrained economy:

… Note that the primary budget balance adjusts automatically so as the stabilise the debt to GDP ratio. This spontaneous adjustment occurs through induced variations in GDP. The government cannot directly determine the primary balance. It can only control r, θ and G, and once the time path of these is fixed as above, the variable Y will evolve so as to stabilise the ratio B/Y. If this ratio is too large, Y will grow rapidly and generate sufficient tax revenue to bring this ratio down.

There is a standard proposition that the government cannot permanently maintain a primary deficit if the interest rate is greater than the growth rate (r>g) … even if true, the statement can be misleading. In a demand-constrained economy, the level of Y relative to G will automatically adjust so as to produce a primary balance (deficit or surplus) to stabilise the ratio B/Y …

[Emphasis mine]

(θ is the tax rate in the model in above paper). Also see this post Wynne Godley And The Dynamics Of Deficits And Debts

It is counterproductive to go around making statements about the conditions on interest rate and the growth rate without qualifications and care and considering a situation/history and future scenarios.

There is one place where this condition is useful. Consider a balance of payments constrained economy. In studying the sustainability of the external debt of a country, one can conclude that if r>g (where r is the effective interest rate paid on foreign liabilities), then the debt dynamics will lead to an exploding debt even if the trade balance is held constant. Of course that doesn’t mean if r<g alone ensures sustainability.

Platinumismatics

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I was very happy to have found a small mention in a recent Wired article on the “one trillion coin” – till the idea was killed by the U.S. Treasury and the Federal Reserve.

You may have certainly heard of the proposed $1T platinum coin even if you are not from the United States.

The United States government has hit the debt-ceiling, and will soon run out of other financial resources (asset-sales) to finance its expenditure and this may result in a default on its debt or almost complete freeze on expenditure (except interest payments on debt being financed out of taxes). Of course the simplest solution is to increase the ceiling or to completely do away with this. But it is not so easy.

Here’s Krugman aptly describing the situation in his New York Times Op-Ed piece Coins Against Crazies:

… Republicans go wild at this analogy, but it’s unavoidable. This is exactly like someone walking into a crowded room, announcing that he has a bomb strapped to his chest, and threatening to set that bomb off unless his demands are met.

So there’s an idea originally from Carlos Mucha, a lawyer from Georgia which became viral. The idea is for the U.S. Treasury to mint a $1T platinum coin and deposit it at the Federal Reserve. This sidesteps the debt ceiling because the coin doesn’t count in public debt!

Here is an article from the magazine Wired on him: Meet the Genius Behind the Trillion-Dollar Coin and the Plot to Breach the Debt Ceiling. The article mentions my name as the first to have understood Carlos’ idea and spread it 🙂 🙂

Ezra Klein of the Washington Post first reported two days back that the coin idea was killed by the US Treasury and the Federal Reserve.

What is it that gives the Treasury Secretary the power to mint a platinum coin of $1T?

According to § 5112 (k) of Chapter 51 of Title 31, Subtitle IV of the U.S. Code:

Platinum Coin Law

Now this alone was strong to make it go viral – thanks to the initiative of Joe Weisenthel of Business Insider who picked up the idea from Cullen Roche of Pragmatic Capitalism and Monetary Realism. Also Neochartalist bloggers were spreading the idea.

The trick was that the coin – although a liability of the government – doesn’t count in what the U.S. government calls the “public debt”.

Now there are several things. Since there are other laws to prevent the Federal Reserve from directly lending to the US Treasury, this raises the question of whether the Federal Reserve can accept the coin. Also, the U.S. Mint which is a part of the U.S. Treasury (as opposed to the Bureau of Engraving and Printing – which prints currency notes for the Federal Reserve) sells “circulating” coins directly to the Federal Reserve – depending on the demand for it from households, businesses and foreigners. There are however some types of coins such as numismatic coins (which coin collectors love) which are directly marketed by the Mint without the Federal Reserve entering the picture. So there are legalities around whether the Fed can directly buy the $1T coin from the U.S. Treasury. To avoid this, some people have proposed that the U.S. Treasury directly sell platinum coins of smaller denominations to the public to get funds in its account in order to make payments.

Another obstacle is that the U.S. Code isn’t straightforward on the “price theory” of the coin. For other coins there are some codes in the U.S. Code but apparently not for the platinum coin.

The coin was introduced in a bill H.R. 2018 (104th): United States Platinum and Gold Bullion Coin Act of 1995 which has the price theory (below) for the coin but the whole thing didn’t make it to the final law.

Platinum Coin Price Theory

I think this may have had a role in the Federal Reserve and the U.S. Treasury refusing it.

But it is a genie out of the bottle and won’t go back so easily!

Finally the ultimate authority on the platinum coin:

Carlos Mucha

(click to go to the New York Times’ Room For Debate)

“Free Trade Doctrine, In Practice, Is A More Subtle Form Of Mercantilism”

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Dani Rodrik has written a very interesting article The New Mercantilist Challenge for Project Syndicate. 

Perhaps it is the main aim of this blog to argue how the sacred tenet of free trade is devastating to the world as a whole and why a sustainable resolution of a crisis can only be achieved by new international agreements on how to trade with one another combined with coordinated demand management policies with an expansionary bias.

Joan Robinson was one of the fiercest critics of free trade. A good appreciation of her work is by Robert Blecker in the book Joan Robinson’s Economics (2005)

Joan Robinson's Economics

Blecker says:

Robinson’s critique of free trade had several dimensions, including her opposition to the comparative static methodology usually employed to “prove” the existence of gains from trade, as well as her scathing criticism of the actual practice of trade policy by nations proclaiming their fealty to free trade while seeking mercantilist advantages over their neighbors. Robinson also thought that international trade relations were far more conflictive than they were usually portrayed by free traders

[emphasis: mine]

In her 1977 essay What Are The Questions? (which is full of quotable quotes) Robinson says:

A surplus of exports is advantageous, first of all, in connection with the short-period problem of effective demand. A surplus of value of exports over value of imports represents “foreign investment.” An increase in it has an employment and multiplier effect. Any increase in activity at home is liable to increase imports so that a boost to income and employment from an increase in the flow of home investment is partly offset by a reduction in foreign investment. A boost due to increasing exports or production of home substitutes for imports (when there is sufficient slack in the economy) does not reduce home investment, but creates conditions favorable to raising it. Thus, an export surplus is a more powerful stimulus to income than home investment.

In the beggar-my-neighbor scramble for trade during the great slump, every country was desparately trying to export its own unemployment. Every country had to join in, for any one that attempted to maintain employment without protecting its balance of trade (through tariffs, subsidies, depreciation, etc.) would have been beggared by the others.

From a long-run point of view, export-led growth is the basis of success. A country that has a competitive advantage in industrial production can maintain a high level of home investment, without fear of being checked by a balance-of-payments crisis. Capital accumulation and technical improvements then progressively enhance its competitive advantage. Employment is high and real-wage rates rising so that “labor trouble” is kept at bay. Its financial position is strong. If it prefers an extra rise of home consumption to acquiring foreign assets, it can allow its exchange rate to appreciate and turn the terms of trade in its own favor. In all these respects, a country in a weak competitive position suffers the corresponding disadvantages.

When Ricardo set out the case against protection, he was supporting British economic interests. Free trade ruined Portuguese industry. Free trade for others is in the interests of the strongest competitor in world markets, and a sufficiently strong competitor has no need for protection at home. Free trade doctrine, in practice, is a more subtle form of Mercantilism. When Britain was the workshop of the world, universal free trade suited her interests. When (with the aid of protection) rival industries developed in Germany and the United States, she was still able to preserve free trade for her own exports in the Empire. The historical tradition of attachment to free trade doctrine is so strong in England that even now, in her weakness, the idea of protectionism is considered shocking.

[emphasis: mine]

Joan Robinson - What Are The Questions

Joan Robinson (1981)
What Are The Questions? And Other Essays