Category Archives: Economic Thought: History & Criticism

Yep, This Is What A Liquidity Trap Looks Like

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People, businesses, and banks simply aren’t investing in the sense of putting financial wealth to work in productive purposes with the intent to produce goods and thereby produce profits.  Instead, folks, the ones who have financial wealth that is, are just sitting on cash.  They’re putting it in the bank at record low interest rates. The banks don’t want the extra deposits and are trying to discourage it.  Meanwhile the banks are just turning around and putting the money on deposit at The Federal Reserve where it sits idle. This is called a liquidity trap.

Calculated Risk directs us to this report:

From Scott Reckard at the LA Times: Bank deposits soar despite rock-bottom interest rates

Americans are pumping money into bank accounts at a blistering pace this year, sending deposits to record levels near $10 trillion …

In the last three months, accounts at U.S. commercial banks have increased $429 billion, or 10%, almost double the increase for all of last year.
…
The large amount of cash only adds to expenses such as paying for deposit insurance premiums. … [banks] have slashed interest payments to discourage customers. Wells Fargo & Co. … halved its payments on one-year certificates of deposits to 0.1%; Citigroup … dropped its payment to a paltry 0.3%.
…
[Some banks are] stashing it in a safe but unrewarding place: Federal Reserve banks, which are paying them an interest rate of just 0.25% to tend the funds. Such deposits rose to more than $1.6 trillion at the end of August from about $1 trillion a year earlier, according to the Fed.

So why is this really significant?  Simple. Neo-classical/neo-liberal macro theories, the theories that conservatives have been relying on, basically say this can’t happen. It’s irrational and according to those models, people and firms never act irrationally.  So who or what theories say a liquidity trap is possible?  Keynesian theory.  Yes, the whole idea of a liquidity trap in which macro circumstances are such that firms and households would rather hold cash than put it to some productive investment purpose comes from Keynes.

A liquidity trap is also significant because it means that monetary policy, the raising/lowering of interest rates and the purchase/sale of bonds by the central bank, isn’t very effective in a liquidity trap. The Federal Reserve can make funds available for investment, but it can’t force banks to lend or firms to invest or households to spend.  Monetary policy in times of a liquidity trap has been likened to pushing on a string.  The string doesn’t really move much.  Again, neo-classical models don’t allow for the possibility of a liquidity trap.  Indeed they start with assumptions that pretty much exclude the possibility of there ever being one.  Models and theories that start with the assumption that “A” can never happen aren’t of any use in trying solve “A” when it really does show up.

Why do people seek money instead of useful investment in a liquidity trap?  Simple. There are two reasons why firms and people would seek to hold financial wealth as money instead of useful, profitable investments.

  • First, profitable investments require a growing economy and expectations of a growing economy.  If firms and people have no confidence that the economy will grow or that any growth will last, then they don’t invest. No need to expand capacity at the business if you won’t need the extra capacity.
  • Second, if you expect the economy to get worse and/or have deflation happen, then it makes enormous sense to be cash instead of things.  Cash actually is profitable and gains in real purchasing power when deflation happens.  So I would interpret from the above data that people, banks, and firms are expecting more deflation and not expecting inflation.

What to do in a liquidity trap?  Theoretically (and Krugman/Delong push this idea)  you could have the central bank (Federal Reserve) make some sort of commitment to higher future inflation.  But that’s in theory only.  It’s not been proven.  What’s experience say?  We have a choice.  Suffer through it, experience a prolonged depression that could easily last a generation, and make do with lower living standards for the vast majority but see the really wealthy become even more wealthy.  This is the story of the Long Depression in the late 1800′s.   Or, we could turn to aggressive fiscal policy. Keynesian style spending for job creation.  That’s been proven.  It worked in the 1930′s until it was abandoned in 1937, it worked in 1939-1940 with the start of WWII (not my choice of spending priorities), and it worked quite well in the 1950′s through the 1970′s in achieving a higher average annual growth rate in GDP than has been achieved since.

Unfortunately, too many economists, and the politicians that follow them, are so married to their ideologically-based models that they persist in the theory even when the facts contradict it.

Politics and Job-Creation Policies – Disagreements and The Theories Behind Them

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Blogging time has been in short supply lately.  To compound things, I’ve had a bunch of inter-woven ideas bouncing around in my head that I want to explain, but  I’ve been struggling to figure out how to do it.  I’ve been stuck in the “can’t explain this until I explain that which in turn needs this explained” circle.  Uggh.  So I’m going to just start taking a shot at it and write some posts that all relate one way or other.

What I want to talk about is why there’s so much disagreement among economists about policies, particularly when it comes to macroeconomic policies.

Few people, regardless of political ideology, dispute the idea that the U.S. economy needs to create more jobs.  It’s obvious to nearly all that persistent unemployment rates over 9% and an economy that month after month fails to create enough net new jobs to keep pace with population growth is problem in need of solution. Likewise, few dispute the idea that the solution will rely upon some sort of policy change.  Even the far-right wing, conservative economists and Austrian school economists argue for policy change. Virtually nobody argues that current policies are ideal.  The issue, then, is how to change policy.  In what direction should policy change so that the government can encourage job creation?

Like many things in political economy, there’s a range or spectrum of recommendations.  I personally don’t like the simple “right vs. left-wing” or “conservative vs. liberal progressive”* terminology. I think things are more complex and positions are richer than that.  But, for purposes of exposition here, I’ll go with it today.

If there are n politicians, there are probably at least n+1 different specific proposals of what to do to change policy to encourage job creation.  But today I’m not looking at specific proposals. Today I want to look at patterns, types, or categories of proposals.  I’m interested in the essence of the logic and economic models/ideas behind the proposals, the thinking that leads people to believe they’ll work.

Right now let’s say there are 4 different categories or generalized views, ranging from what might be called extreme right-wing or libertarian views through conservative views through mildly progressive views and finally a more radical or activist progressive view.  Let’s look at each one, the types of policies advocated and some comments on the economic thinking behind them.  I’ll offer my views afterward.

First, let’s take what we can call the far-conservative view or libertarian (economic libertarian, not necessarily social libertarian).  In the U.S. today, this is represented by the Tea Party positions.  The view here is that it’s  government interference with the free market, private property, and private wealth that causes unemployment in the first place.  Therefore, what’s needed, they argue, is for minimal government with minimalist taxes and as little regulation as possible.  They argue that only the private economy creates jobs at all and that the government cannot by it’s nature create any jobs.  Their proposals will typically take the form of calls for tax cuts, government spending cuts, and repeal of regulations. They will oppose any government programs they see as “welfare” or “redistributionist” such as Social Security or Medicare. Their rhetoric will typically include phrases about “unleashing the private sector”.  In terms of economic theory, supporters of this view find support from what we call Austrian-school economists and the more strict Neo-classical macroeconomists (think University of Chicago school).   These schools of macroeconomics in many ways aren’t about macroeconomics at all.  The theories are heavily based on microeconomics, in particular, the models of pure utility-maximizing rational people interacting in unrestricted markets.  Much of this view in macroeconomics has been called rational expectations school, efficient markets theory and real business cycle theory.

Next is a the conservative view.  Until the last few years, the milder conservative view was what was espoused mostly by Republican candidates such as both Bushes and Reagan.  In more recent years the Republicans (in general) have moved further toward the far-conservative/libertarian view.  The conservative view is likewise grounded in traditional microeconomic-based neoclassical models.  In many ways, the conservative view is very similar in thinking to the far-conservative libertarian.  They both derive their conclusions from a reliance and embrace of pure-utility maximizing rational micro models of markets.  Both will tend to advocate tax cuts, especially for high-income earners and for corporations. The idea is that high-income earners and corporations would normally create enough new jobs but that taxes discourage them from creating jobs by making business and investment look unprofitable.  The assumption is that if you eliminate or reduce the taxes, investment will naturally look profitable and attractive.  Private sector investment spending will then drive growth in the economy.  This view has also been called supply-side economics. The conservative view typically relies upon rational expectations, efficient markets, and real business cycle theory also, but it also takes a lot from the monetarist views of Milton Friedman and his disciples.

The major point of disagreement between regular conservatives and the far-conservative/libertarian views is really in the area of monetary policy.  Far-conservatives or libertarians dislike central banks (seen as government agencies) and often call for a return to some form of commodity-based money such as gold.  The regular conservative view instead believes that an independent central bank, like the U.S. Federal Reserve Bank, if it follows anti-inflation policies, can usually manage monetary policy and interest rates to encourage growth when needed.  In effect, far-conservative/libertarians believe that no type of government or central bank actions can achieve high employment and high growth by policies.  In effect, recessions are simply events we have to live through -they can only be made worse, not better by government policy.  Regular conservative-types favor using monetary policy, in particular interest rates, to manage the economy. And, if monetary policy is ineffective, then they advocate using tax cuts to stimulate the economy.  They have a strong bias against government spending, or at least spending that is used to stimulate the economy (spending for military and wars is usually OK though).

Next we move to views that owe a greater heritage to John Maynard Keynes, though Keynes is far from the only theorist contributing to the views.  We’ll call the next group of policy recommendations Keynesian.  Not surprisingly, this view owes a lot to Keynes.  But Keynesian theory and models have evolved a lot since Keynes’ time.  Some historians of economic thought have argued that, were he alive today, Keynes might not agree with what much of what today’s “Keynesians” argue.  Nonetheless, standard Keynesian models/theories differ from classical/neo-classical/supply-side theories (the ones that conservatives like) in that it focuses on aggregates in the economy like total demand and total spending.  Keynesian models also try to explain why in aggregate, the total economy doesn’t always behave as if it were a simply made of purely rational micro-markets.  Keynesian theory allows for more situations where markets don’t behave rationally all of the time.  Even more significantly, Keynesian theory observes that if we simply assume the economy is the sum of whatever happens in a bunch of micro-markets, we can commit the fallacy of composition.  Keynesian theory points out the cases where the paradox of thrift takes over or when monetary policy is not likely to be effective.

Despite the allegations of many critics, standard Keynesian theory allows for monetary policy to be effective.  But typically standard Keynesian theory says that when the crisis is big or when interest rates are very, very low, then only fiscal policy, increased deficits, will do the job.  Those deficits could be created by either tax cuts or increases in government spending. But, they won’t be equally effective in creating jobs. Basically what’s needed is more spending (demand for goods) in the economy. People need to be motivated to spend more money.  Tax cuts provide money for households and firms to spend, but they do so weakly.  First, people might not spend all the tax cut – they might save some.  Increased savings won’t increase total demand and therefore won’t create the need for new jobs. Further, firms will only spend if they expect future increases in demand.  They won’t spend and invest just because they have more cash in their hands.  Since we have no assurance that a tax cut will result in enough new spending in the economy, Keynesians are more likely to argue for increased government spending because government spending directly creates demand for goods and services.  Contrary to critics’ claims, Keynesian policies are not based upon any ideological desire for socialism or government control.

So what do Keynesian policy proposals for creating more jobs look like?  Increased government spending is the answer.  In particular, while any spending will help, the most desirable forms of spending are public goods, things like infrastructure and schools, and also on social safety nets, things like unemployment compensation, social security, and Medicare. If a proposal calls for more infrastructure spending or extensions/increases in unemployment compensation, it is clearly inspired by theories/models with Keynesian roots.

Finally, there’s proposals that are inspired by the most progressive branches of modern macroeconomics.  Let’s call these proposals the Progressive proposals. Proposals in this area would involve would build upon the ideas of Keynesian group, but go further.  The spending would be greater and on a larger scale. Proposals in this area would call for programs where the government doesn’t just fund projects and buy goods, it actually creates programs that directly hire the unemployed.  Typically such programs are proposed to be temporary or designed in a way to only hire when the private sector won’t (see Bill Mitchell & Randy Wray’s Jobs Guarantee proposals).  These are not socialist or communist proposals.  That’s a whole different thing.  Often Progressive jobs-creation proposals include having the government initiate and fund large-scale infrastructure projects during periods of high unemployment.   This group, which has little popular voice among modern U.S. politicians, is inspired by what’s called Post-Keynesian and Modern Monetary Theories.   In many ways, the original Keynesian proposals for dealing with unemployment are closer to this group than to what we call Keynesian today.  Today’s Keynesians are actually pretty conservative when compared to historical policies.

So there we have it.  Four schools of thought and proposals for how to create jobs in the economy.

Despite the labels attached and misused by politicians, the reality is that the political discussion and policy recommendations of today, the ones with supporters in Congress or the White House, are actually quite conservative.  Franklin Roosevelt and the New Deal in the 1930′s was actually rather Progressive.  In the 1950′s, 60′s, and 70′s, the dominant thinking in Washington was Keynesian.  In fact  a”centrist” politically in that era would have still been somewhat Keynesian on our scale above.  In the 1980′s though today, the “center” of mainstream politics has increasingly moved towards conservative thinking.  Today, for example, President Obama is actually pretty conservative.  He is certainly more conservative than the Republican Richard Nixon was in the 1970′s.

Let’s look at the latest proposal from the Obama administration for stimulating the economy to create jobs. It’s actually quite conservative and it’s not very Keynesian at all.  In fact, of the proposed $447 billion effort, less than 1/4 involves more spending for infrastructure or unemployment benefits.  That’s less than 1/4 of the proposal is basic Keynesian.  Instead, it’s overwhelmingly focused on tax cuts and business tax credits/incentives.  These are the policy proposals of a conservative.  Even the original 2009 “stimulus bill” was heavily oriented towards tax cuts and tax incentives.  Despite what critics said, less than half of it was traditional Keynesian stimulus. It’s a sign of how the U.S. political dialogue has shifted towards the conservative/far-conservative end that the Obama proposals have been challenged as “Keynesian” and Obama himself accused of being “socialist”.

* The word “liberal” is particularly problematic. The positions argued by today’s “conservatives” in the U.S. are in fact the positions that were historically identified as “liberal” going back to the 1800′s.  In the 1800′s “liberal” meant anti-government and pro-free market.  Yet, thanks to the power of talk radio and Republican presidential campaigns since the 1980′s, the word liberal has come to be used an epithet to describe opponents of conservatism.  I’ll stick with progressive to label this more left-wing end of the political spectrum to avoid the emotional taint that liberal carries these days.

The Famine in Horn of Africa and Political Economy Failure

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The study of economics starts with recognition of the economic problem: we (humanity) have unlimited wants but limited resources to satisfy those wants, so something has to give. Famine is perhaps the starkest reminder of the economic problem. People die simply because they cannot get enough food to eat.  Yet while there have been famines throughout history, famines today are different.  The reason is because the problem with modern day famines isn’t the stark reality of the physics of too many people, not enough food grown.  Instead there’s no natural reason for famine today with the increases in productivity of agriculture and food preservation in the 20th century.  We (the planet) now grow enough food to feed everybody.  Today when there’s famine, it’s a failure of political economy.

Today we are seeing a major famine in the Horn of Africa, in Somalia, parts of Ethiopia, and Eritrea. The famine threatens the lives of millions of people. It is a human tragedy on a massive scale.  Yet it was avoidable as Maude Barlow, National Chair of the Council of Canadians, writes (bold emphasis is mine):

Most Westerners see the crisis in the Horn of Africa as a combination of a large population, chronic poverty, corruption on the part of African government officials, failed states and no rain, and that none of this will ever change so giving money to this self perpetuating crisis is throwing it away. But I offered another narrative that I believe is closer to the truth.

I believe the water and food crises in the Horn of Africa are the direct result of old-fashioned colonial exploitation: land grabs by foreign hedge and investment funds and wealthy countries setting up large foreign-based agribusinesses that are guzzling the lion’s share of the water resources and using them to grow crops and biofuels for export and drive up speculation. Ethiopia, for instance, has already leasedseven million acres of land at $1 an acre for 100 years and has put another seven million on the market. Lake Naivasha in Kenya (where the movie Out of Africa was filmed) provides most of the cut flowers (88 million tons every year) for Europe. As a result, the local Masai population has no access to its traditional water source, and the lake, like hundreds of others in the region, is dying.

Foreign acquisitions are forcing small farmers and peasants off the land depriving them of access to food and water. The food and water of the region is being used for export for profit and not being used for local people. As a result, food prices in the region have gone up 200 per cent in less than a year and the price of water has risen 300 per cent. The foreign minister of Ethiopia defends his government’s actions with the neo-liberal explanation that these foreign “investments” will make the country wealthy enough that it can stop producing food and start buying it on the world market. But exactly the opposite is happening when you drain the land of its water, as is being done by this agribusiness industry, and the rains stop coming. The drought is directly related to both climate change and the resulting desertification of a land stripped of its water sources.

In my remarks, I pointed out that there is enough food and water for all in that region, (as there is for every region on earth) if they moved to a set of policies based on respect for the land, water and people, instead of the greed and raw power of global food interests increasingly entrenched in global and regional trade agreements.

Here is what is essential to know: deserts can arise because humans treat land and water badly. Desertification is taking place in over 100 countries in the world, as we strip the land of land-based water from aquifers and rivers, sending it to thirsty mega-cities (who dump it untreated into oceans), or using it to grow food and other goods for the world market, where it is transported out of local watersheds in the form of “virtual water exports.”

Water-retentive landscapes, conservation, watershed restoration, rainwater harvesting, small, local and sustainable farming, poverty reduction, and the human right to food and water: these are the guideposts to a sustainable, just and full recovery for the Horn of Africa.

It’s the Political Economy That Must Change.

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Peter Dorman at Econospeak has an excellent post on the real challenges facing the U.S. today.  It’s the political economy that must change.  It no longer serves the interests of the vast majority of Americans. We need more discussion and action at these levels>

It’s the Political Economy, Stupid!, by Peter Dorman: Sometimes living in the world of ideas makes it harder to understand the real one. If you happen to be an economist, and the time is now, that is true in spades. Take Paul Krugman, for instance. After bemoaning the terrible policy choices of the last two years, he writes, “I’m still trying to make sense of this global intellectual failure.” It’s as if the core problem is that political leaders didn’t learn their macroeconomics well enough.

But Keynes was wrong about the power of “academic scribblers”. Idea-smiths provide language, narratives and tools for those in control, but the broad contours of policy depend on who the controllers happen to be. We are not living through an epoch of intellectual failure, but one in which there is no available mechanism to oust a political-economic elite whose interests have become incompatible with ours.

This is not some sudden development, much less a coup d’etat as is sometimes claimed. No, the accretion of power by the rentiers has been systematic, structural and the outcome of a decades-long process. It is deeply rooted in modern capitalist economies due to the transformation of corporations into tradable, recombinant portfolios of assets, increasing concentration of and returns to ownership, and the failure of regulation to keep pace with technology and transnational scale. Those who sit at the pinnacle of wealth for the most part no longer think about production, nor do they worry very much about who the ultimate consumers will be; they take financial positions and demand policies that will see to it that these positions are profitable.

The rapid and robust global restoration of profits post-2008 was not an accident. Public funds were used to bail out exposed creditors and shore up asset values, while the crisis was used to suppress wages and postpone meaningful regulatory reform. Indeed, I can predict with some confidence that many of the profits, particularly in the financial sector, that have been reported in official filings and blessed by the accounting firms will later be found to be illusory—but not before those who have claims on the revenues have cashed in to their own personal advantage. The institutions will be decimated, but those who owned, lent to or bet on them will be rich. This is not a failure, at least not for them.

You could make a case that, collectively, the interests of the financially endowed ultimately require a rescue of the real, nonfinancial global economy. Surely, when we take our painful plunge into the second dip of the Great Recession, their wealth will be at risk. But the ability to see it at a system level presupposes either a system-level organization of the class or the existence of individual interests that are transparently systemic. Neither appears to be the case today. From what we (you and me) can see from our vantage point, the ruling demands are to make sure my bonds are serviced, my counterparties pony up, the markets I invest in stay liquid, and expenditures for public welfare (i.e. the losers and chiselers) are slashed.

The first principle of political economy is that the scope of democracy depends on the range of views and interests (typically tightly linked) of the owning and controlling class. Genuine public debate and decision-making extends only to those issues on which the elites are divided. In what country today is there a significant division among political-economic elites over core economic questions? How would our situation be different if Obama, Cameron, Merkel, Sarkozy et al. had been on the losing side of their elections?

So, the current mess is not the result of a failure by intellectuals—although clearer, less ideologically-driven thinking by economists would certainly be a good thing and might make a small dent at the margin. As long as there are even a few economists who proclaim the virtues of austerity and deregulation, however, their views will dominate. They haven’t won a battle of ideas; they are simply the ones who have been handed the microphone.

The real problem is political, and it is profound. Unless we can unseat the class that sees the world only through its portfolios, they may well take us all the way down. Unfortunately, no one seems to have a clue how such a revolution can be engineered in a modern, complex, transnational economy.

There were also some excellent comments in the discussion:

PQuincy said…

I’m a historian, and I think the past confirms your assessment of elite behavior and priorities, not only in the last 2 centuries of mass-based polities, but since the rise of large-scale states altogether. Political contention is almost always limited to a narrow range of issues on which those with power disagree, meaning that significant change (and there has been significant change in the political sphere, as well as the economic one) generally results from elite conflicts, not from ‘popular’ pressure. In fairness, elite contention does open gaps for genuinely ‘progressive’ change, and that’s an important lever for intellectuals to remember…but as you say, academics, thinkers, et al. are as a rule never in a position to have more than a marginal effect.

It’s not a promising situation now, structurally: a series of positive feedback loops in the political sphere are actually concentrating the influence of what I am forced to call a “reactionary clique”, at a time when the policies pursued by that clique are, at least on a larger time-frame, seriously destabilizing. But the narcotic effects of power are such that those who drive the dynamics of elite conflict rarely see the larger picture — behave, for all practical purposes. as though they were incapable of seeing the larger picture (call it, if you like, discursive hegemony), and those who believe they see a larger picture are structurally excluded from bringing about changes in response to their perception.

And…

Re-Considering …. said…

Thanks for the very well thought out reasoning in you post.

While you correctly identify the problem and its solution (current “ruling class” and its unseating), you are shy in suggesting how a solution might come about. While I do not advocate violence, history has shown us that fundamentally there are two ways by which subjugated classes improve their position. A traumatic way and less traumatic one.

Revolutions (most egregious examples are the French, Bolshevik, Chinese, and Cuban revolutions), whereby the ruling class, along with its interests, are eliminated by the subjugated classes. A traumatic event indeed, but, in my opinion, not sustainable in the long run unless the entire world adopts those political and economic paradigms.

Less traumatic and, more sustainable in the long term, are the outcomes of strong labor and student movements like the ones that took place in Europe in the 60s and 70s. Those movements made sure to convey to the ruling classes the message that a more equitable wealth distribution and effective social safety net were needed to avoid the extremes and dispossession that a revolution would involve. Reluctantly, the ruling class complied and the social safety nets and income distributions typical of Western Europe emerged.

In the same light, one must interpret the recent unrests in Western European countries (UK, Greece, France) (and most recently in Israel) as a response to the austerity measures taken by conservative governments of these countries to protect rentiers and capitalists. The austerity movement is trying to undo at least some (ideally, all) of the achievements of the 60s and 70s and redistribute wealth away from the “ruled classes”, when it is clearly the “ruling class” that should bear most of the cost of its disastrous, reckless, and self-serving policies. While the current message in Western Europe is still not of the same intensity of the 60s and 70s due to a current better wealth distribution than that of the 60s, the message is similar in content and direction. Its intensity may increase if the rentiers and capitalists will insist with their policies.

So, why the US labor and student movements do not materialize or are active to the same extent of the ones in Europe? The answer is very simple… while in Europe the “ruled classes” realized a long time ago that there will never be cooperation between them and the “ruling class”, in the US people still believe and pursue the American dream, which is fueled by the once in a while admission of few “mortals” on Mount Olympus. Let’s also not forget that constant sense of guilt passed on by the Pilgrims that, somewhat, it is exclusively the individual’s fault if his/her life is not better… and, maybe, the Pilgrims they were right given that US citizens keep electing the same (type of) people over and over to lead them. After all, wouldn’t you rather have a beer with a nice guy from Texas or Hawaii than protesting in some square?

And…

TheTrucker said…

I stand fittingly chastised for my indictment of the economists.

The Tea Party may well have hit upon a method to overcome the current problems. A constitutional convention to propose particular modifications to federal government structure might seem to be the way out. But that is a holdover from the time when people rode a horse to the nation’s capital in order to be seated in the discussion chamber. The problem is best resolved buy an incorruptible on line polling system of direct democracy in which various policies are proposed and tested for consensus. I do not trust the pollsters and I do not feel that they ask the right questions. At present we have the “super committee” approach which goes in the wrong direction totally. This election of Dems or Pugs who then decide what is the best way to maintain their own power has got to go.

I know that the public is easy to fool. The Republicans prove it every day. Yet there is no acceptable substitute for self governance. When we look at the polls we find that taxing the rich is the majority opinion and that social welfare is a high priority. Yet there is no way to act upon this consensus because the rich own the government. That must change, and it cannot change from the top. Surely there must be a peaceful means of revolution.

If a policy and polling system can be created that is impervious to tampering and corruption then it is entirely possible to supplant the current system or to dramatically improve the current system’s performance. I see no other way.

A Contagion of Bad Ideas. Not Only Slaves to Defunct Economists, but Slaves to Bad Ideas.

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I’m still away on the road (which is why comments and questions in the last week have gone unanswered).  However, while I’m away, here’s a point made by Joseph Stiglitz at Project-Syndicate.org.  John Maynard Keynes famously said that today’s policy-makers are the slaves of defunct economists.  Joseph says, and I agree, that today’s policy makers are really the slaves of not only defunct economists, but some very bad and discredited ideas from those economists.  It’s these bad ideas that are hurting us the most.

Stiglitz observes the urgency with policymakers on both sides of the Atlantic are eagerly pursuing contractionary policies at a time when growth is negligible and unemployment persists at a very high level. In the U.S., the Republicans threatened a government shutdown and/or default if the government didn’t significantly cut spending while refusing to raise taxes even on the very rich who have benefitted so much in the last decade. President Obama surrendered to the Republicans’ desire for contractionary policy, taking the Democrats with him.  All of this in a mistaken belief that somehow cutting spending, balancing the government budget, and reducing government debt (which leads to increased private debt) would somehow help the economy.  The problem is that while there are economic theories and economists who argue that such policy will work, these policies were discredited a long, long time ago.  Further these failed theories have never shown that they would work.  The historical evidence refutes the austerity position.

In Europe, it’s worse.  European leaders, having set  up a currency union (Eurozone) that stripped member nations of valuable fiscal policy tools, are convinced that cutting spending (which slows an economy) will balance their budgets and calm bond markets.  Unlike the U.S., which has it’s own central bank and therefore ends up paying very low interest rates on government debt (there’s no risk of default), Greece, Italy, Ireland, Spain, and the others are all paying significant and rising interest rates on government debt.  Without their own central bank and wearing the Eurozone-imposed fiscal strait jackets, these countries continue to cut, their economies weaken and shrink, and their deficits just get bigger.  Why?  Because you can’t cut spending faster than tax revenues drop from the slower economy that the spending cut produced.  Nonetheless, the European leaders persist.

Stiglitz concludes in A Contagion of Bad Ideas:

The end of the stimulus itself is contractionary. And, with housing prices continuing to fall, GDP growth faltering, and unemployment remaining stubbornly high (one of six Americans who would like a full-time job still cannot get one), more stimulus, not austerity, is needed – for the sake of balancing the budget as well. The single most important driver of deficit growth is weak tax revenues, owing to poor economic performance; the single best remedy would be to put America back to work. The recent debt deal is a move in the wrong direction.

There has been much concern about financial contagion between Europe and America. After all, America’s financial mismanagement played an important role in triggering Europe’s problems, and financial turmoil in Europe would not be good for the US – especially given the fragility of the US banking system and the continuing role it plays in non-transparent CDSs.

But the real problem stems from another form of contagion: bad ideas move easily across borders, and misguided economic notions on both sides of the Atlantic have been reinforcing each other. The same will be true of the stagnation that those policies bring.

Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.

Copyright: Project Syndicate, 2011.  Excerpts republished with permission.

 

You might also like to read more from  or go to Project-Syndicate  home page.

Bankers vs. Democratic Finance at The Constitutional Convention

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I’m cross-posting the following with permission from New Deal 2.0.  This should be of particular interest to students of American history. Our current struggles and political battles over the relative power and influence of banks and the monied class vs. ordinary citizens, workers, and small businesses, most of whom are dependent on sources of financial capital for their livelihoods are not new.  Indeed, they were foundational to the creation of the republic.  This piece also sheds a new light on the period of the Articles of Confederation (1776-1788) vs. the Constitution (1789 onward).

Hogeland’s article also puts the actions of today’s Tea Party movement in a new light. The forefathers weren’t universally in favor of democracy. Rather, they viewed it as an enemy of finance.  The article is long so please follow the more button.

Constitutional Convention Delegates Had Common Goal: Ending Democratic Finance

by William Hogeland

Economic struggles played a huge role in the founding of our country, despite some attempts to revise that history.

Edmund Randolph of Virginia kicked off the meeting we now know as the United States constitutional convention by offering his fellow delegates a key inducement to forming a new U.S. government. America lacked “sufficient checks against the democracy,” Randolph said. A new government would provide those checks.

Randolph’s listeners in Philadelphia in the spring of 1787 knew what he meant by “the democracy.” And readers of this series probably will, too. He was talking about the 18th-century American popular finance movement, whose supporters agitated for policies to obstruct concentrated wealth and to give regular folks access to political power and economic equality. Amid depressions and foreclosures, ordinary people had long been rioting — they called it “regulating” — to pressure assemblies to restrain the merchant creditors, whose command of scarce gold and silver let them acquire immense wealth by lending at high, even predatory rates to the needier.

Then, with revolution against England, the popular finance movement turned its attention to changing the economic terms of American society. The 1776 Pennsylvania constitution, based in large part on ideas expressed by Thomas Paine in “Common Sense,” smashed the ancient property qualification for voting and holding office. In Pennsylvania, new political leaders like the preacher Herman Husband, the weaver William Findley, and the farmer Robert Whitehill entered the assembly and began passing laws shutting down elite banking and requiring government to operate, for the first meaningful time anywhere, on behalf of ordinary people.

Democracy in Pennsylvania sent chills through elites of every kind throughout the newly independent country. Rioting for popular finance was bad enough, but rioting was temporary, spasmodic, and traditional. Debtors wielding legitimate political power to equalize economic life — that was tantamount to a new kind of tyranny of the mob, hardly what Whig revolutionaries had fought England to gain. Neither Edmund Randolph nor other delegates of the Philadelphia convention, meeting in secret sessions in the Pennsylvania State House, felt any need for subtlety in seeking to suppress the political and economic equality burgeoning everywhere in America among “the democracy.”

Present at the Philadelphia convention was the fabulously wealthy Pennsylvania financier and speculator Robert Morris, America’s first central banker, no doubt licking his ample chops over the fulfillment, at long last, of his plan to wed nationhood to high finance. Yet it was the planter Randolph, not the financer Morris, who referred to “the plague of paper money,” and he meant just what Morris meant. State legislatures’ currency emissions and legal-tender laws depreciated the merchants’ income from their loans; paper, the people’s medium, built debt relief into money itself. Randolph also rued the country’s difficulty in paying the investing class its interest on federal bonds. With those bonds, Morris had made private creditors into public creditors as well, swelling the domestic U.S. debt to vast proportions in an effort to connect national purpose to high finance.

Hence the need, Randolph said, for a national government with laws acting on all the people throughout the states. It’s no coincidence that he also charged the delegates with repairing the federal government’s military weakness. A debtor uprising in western Massachusetts known as Shays’ Rebellion had marched on the state armory. That wasn’t just a riot. It showed how far ordinary people might go in rejecting regressive taxes and policies giving investors huge paydays with public money. The United States, Randolph said, must be empowered to put down insurrections anywhere in the country.

So Randolph did indeed know what he meant by “the democracy,” and his fellow delegates knew too. Why are historians typically so coy about the constitutional convention’s financial purposes?

The fight over those purposes is almost 100 years old. In 1913, the historian Charles Beard published “An Economic Interpretation of the Constitution of the United States.” There Beard argued that because delegates of the convention came overwhelmingly from the bond-holding class, the government they put into effect represents less a glorious triumph of republican philosophy than a rearguard action of money elites to assure their own payoffs. Beard’s startling contention was that the framers acted at least as much on financial self-interest as on principle.

If that contention remains startling, we can thank an immense effort, carried out over generations, to throw out not only Beard’s particular economic interpretation of the convention, but along with it any suggestion that struggles between elites and ordinary Americans over public and private finance played a role in framing our Constitution. It’s not surprising that many of the popular founding father biographers routinely avoid the issue. But entire careers in academic history — major ones, like Edmund Morgan’s — have been largely dedicated to depicting a founding generation acting with perfect intellectual consistency almost entirely on principle. Wherever self-interest did arise, Morgan suggests (in his popular book “The Birth of the Republic” and elsewhere), the nature of the founding mission was such that it enabled even greed to inspire the founders to good. In that kind of history, everyday political struggles over money between ordinary Americans and American elites just don’t play.

Continue reading →

‘Ism’s, Rhetoric,and the Branding of Ideology in the 21st Century

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The following is a reflection I’m sharing with my online Introduction to Political Economy (it has a different name, but that’s what it is) course. It’s long and therefore continued after the jump.

Textbooks and politicians make frequent use of labels for socio-political-economic systems. Typically these labels identify some particular ideology as an “ism”.  Thus we have capitalism, socialism, communism, fascism, and probably several others I’ve missed. For those that grew up in the 20th century or have been educated by those who grew up in the 20th century, it seems natural. We talk about the merits of socialism vs. capitalism for example as if we were discussing the merits of alternative selections from a menu.  It hasn’t always been this way, though.

In the middle and dark ages people did not discuss or promote “feudalism”.  In fact, the term itself is an invention of scholars in later centuries. (see fascinating article on how feudalism as we think of it didn’t really exist).  The term, “feudalism”, is a construct, a rhetorical device, created to guide us into thinking about the socio-political-economic system of that era. In earlier times, those people who discussed political and economic policy issues focused primarily on the specifics of the issues in front of them at the time.  Policy decisions were made on an ad hoc, practical basis.  They essentially are today also, but since the 19th century, we don’t always think of policy that way.  There is a tendency to think there is a master plan or grand design or some kind of over-arching principles which can be used to guide our specific decisions.  We think that policy makers are (or should be) guided by these principles in making policy.

The Role of Media in Creating Manifestos, Platforms, and Slogans

Part of the reason, perhaps the major reason, why we think this way is because popular elections have made it necessary. In the pre-democratic past, back before the French or American revolutions and before the franchise was expanded in England, only a few people, the power elites such as kings, lords, landed gentry, their advisors, high clergy, and some academics need be concerned with policy. They were the only ones whose views mattered. But as popular elections and democracy began to spread, starting in the 18th century and continuing into the 20th century, the views of the populace at large began to matter. It became increasingly important for policy questions to be debated and understood by larger and larger numbers of people.  Increasingly, these people had less background and less time to understand the “nuances” or specifics of policy.  A farmer on the frontier or a worker in a factory may have been smart and literate, but they had little time or resources to spend researching and considering policy options before voting.  Even for the well informed, they had little influence beyond the voting for particular candidates. Their specific views on particular subjects were (and still are) irrelevant. Their only choice was between the candidates presented. Continue reading →

Tax Cuts, Tax Revenues, and Growth: Reconciling Theory with Evidence

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Yesterday I made a post about how federal tax revenues have not increased as a result of the Bush tax cuts from 2001. Actually much of the post is based upon an analysis of official data that David Cay Johnston did.  In the comments though, William Sullivan asks:

I realize that economic growth, as measured across the last decade, is anemic at best. I think it is abundantly clear that our employment situation is awful. What I don’t understand is how these issues can be attributed to lower taxes. I recognize that ECON 202 is not the end of economic learning but Johnston’s statement seems to be at odds with what we’ve learned.

I thought his question was excellent. It’s the type of question people and principles students should ask in response to an article.  Since I think my response will be useful for future students I decided to answer Mr. Sullivan with a new post (I can find it easier in the future then).

Initially, a quick read of both my post and Johnston’s article does leave the impression that we’re saying “tax cuts don’t stimulate the economy”. Yet we (I) teach in principles of macro classes that “tax cuts are one way of implementing fiscal policy to stimulate the economy”.  So how do we reconcile the theory with the evidence?

Here’s how I do it.  We need to be more precise in both what’s being measured and in what claim or theoretical assertion is being tested.  First let’s look at the linguistics of the three variables of interest here. The controversy or confusion is about the relationship between these 3 variables are:

  • tax rates – the % of income that by law needs to be paid as income (in more sophisticated analyses we should distinquish between marginal rates, the rate paid on additional income vs. average or effective rates, which is tax $ paid divided by income. For now, tax rates are sufficient.
  • tax revenues – the total dollars of taxes collected by the government in a particular year.
  • GDP – the total size of the economy.  Since GDP is roughly equal to gross domestic income, we can basically say this is what the economy earned each year. For our purposes here, we’ll call this “the economy”.

The first issue is lazy semantics that politicians and sometimes economists often use.  They often will use the phrase “tax cuts”. But what does “tax cuts” mean?  We always have to careful about what’s meant when somebody says “tax cuts”.  It could mean “reduction in tax rates” or it could mean “reduced tax revenues”.  We really have to look at context to see what’s meant as I’ll illustrate a little later.

Now the next question is what are the different propositions or assertions that are made about the relationships between these variables.  The first relationship is the purely accounting, definitional relationship and shouldn’t be controversial at all. Namely, in any given year, the average tax rates times GDP = tax revenues.  This is really the idea that taxes are basically income taxes. We earn income as a nation (GDP) and we pay a percentage (tax rates) of it to the government (tax revenues).

Now let’s look at the claims that have been asserted.  Roughly put, there are two separate questions or assertions to be tested here:

  1. Lower tax rates will stimulate the economy (GDP) so much that tax revenues will rise (or at least not fall).  In other words, if tax rates are cut, both GDP and tax revenues will increase.
  2. Lower tax rates will stimulate the economy (GDP) but tax revenues will drop.  In other words, if tax rates are cut, GDP will grow but not grow enough to keep tax revenues from falling.

The difference is important.  If #1 is true, then we don’t have to worry about increasing the federal deficit when deciding to cut taxes. This is what Bush and Republicans asserted to be true in 2001 and most recently in 2010 and 2011. Republicans in Congress have been arguing recently that tax cuts won’t make the deficit worse.  They only way that can be true is if #1 holds true. The essence of the data that David Cay Johnston presented and that I quoted was in response to this assertion.  The data clearly shows that tax rates were cut and tax revenues fell.  They not only fell, they fell by a lot. It’s important to note that tax revenues fell even in the “growth” years before the Great Recession hit in 2008.  One implication of this is that assertion #1 is clearly false. Tax rate cuts do not stimulate the economy enough to keep federal tax revenues from falling.  Therefore, anytime tax cuts are proposed we need to realize they will add to the deficit.  Tax rate cuts make the deficit worse.

Now let’s consider assertion #2 above.  This is really a simplified version of what we teach people in principles classes:  tax cuts can stimulate the economy. This is simple Keynesian theory.  I think, though, that economists have been too lax in how we state this idea  (myself included – I ask for forgiveness!). We don’t clarify what’s meant by “tax cuts” and we don’t clarify the mechanism.  Strictly speaking, the idea is that tax rate cuts will reduce the taxes collected by government (revenues) and if they result in increased spending (aggregate demand) then GDP will increase. The trick here is that tax rate cuts will allow households/corporations to have more after tax income (also called disposable income). Then, if they spend that additional after-tax income, then GDP will rise.  In this sense, when Keynesian economists say “tax cuts” they’re usually meaning lower tax revenues, which most probably happened by tax rate changes.

So, in looking at the data, should we reject or accept the idea of assertion #2.  In this case, I think it’s important to look at a broader historical record than just the Bush tax cuts of 2001. What we see is that tax cuts (as in lower tax revenues) tends to have a stimulating effect on GDP, but the strength of the effect varies widely.  In other words, reducing tax collections (lower tax revenues) will sometimes grow the economy strongly and at other times it will barely have any effect.  If virtually never has a negative effect, unless it was combined with spending cuts.  What makes the difference?  A lot depends on how the taxes are cut and for whom they are cut.  This is because the critical linkage is whether they tax cut will increase spending.  To the extent a tax cut is just saved by the household or used to pay down debt, it doesn’t help the economy grow. This is the difference between the Bush tax cuts and say an earlier, more successful tax cut like the Kennedy-Johnson tax cuts in 1964. The Bush tax cuts were overwhelmingly targeted at top-bracket, high-income individuals and corporations.  Instead of spending the tax savings, these people largely saved the money and converted it into financial assets. Spending in the economy did not get much of a boost.

So in conclusion, I think we can say assertion #2, what we teach in class, is viable, but we really need to be clearer:

tax cuts will stimulate the economy and grow GDP if we implement the tax cuts in a way that they get spend and not saved, but they will worsen the deficit.


 

What we have here is really three different variables that we need to keep track of

 

Krugman Is Still Wrong About MMT – and with it still wrong on deficit

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On Friday Paul Krugman posted the first of what has become 2-3 posts on his blog wherein he claims that MMT is “just wrong”.  As I noted Friday here, I commented on his blog to point out how his post was deceptive and misrepresented MMT.  I was not alone.  Well over 100 people have taken him task in his comments section for not having done his homework on MMT.

For those that want a more detailed refutation of the nonsense Krugman published, here’s a few links that have come up the last few days:

Bill Mitchell at Billyblog My favorite quote here:

Poor scholarship also involves not learning from your errors. You have often rightly accused the main body of our profession of having their heads in the sand (see How Did Economists Get It So Wrong?) and being inflexible in responding to the crisis.

Yet, you seem to keep wheeling the same errors of reasoning out yourself.

Scott Fulwiller writing at NakedCapitalism

The Daily Kos made three posts:

Paul Takes Another Swipe at MMT

Krugman Misleads His Readers – AGAIN!

The lesson, kids, is that even Nobel prize winners need to keep doing their homework.  If you are going to criticize some ideas, it is very important to actually read the stuff first.

 

Krugman on MMT

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Paul Krugman comments today on Modern Monetary Theory (MMT).  Unfortunately, he gets it wrong.  For example, he says:

Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.

I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right.

The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.

I commented and posted this response to him on his blog:

Paul, you either have an incomplete understanding of MMT or have setup a strawman. MMT does NOT hold that “deficits never matter, as long as you have your own currency.” MMT says that deficits do matter but only if (a) there’s no slack of real resources in the economy and (b) the private sector is choosing to net accumulate debt instead of accumulate net financial assets. In the meantime, however, as long the private sector wants to accumulate net financial assets, deficits are necessary to prevent Aggregate demand from falling.

You apparently prefer to use the interest rate on safe assets as the indicator of whether there’s slack real resources available – hence your emphasis on liquidity trap lingo. MMT emphasizes actual unemployment. If there’s significant unemployment, then there’s slack resources available for the government to purchase and put to use producing incomes for people.

A key insight of MMT is how the real world of banking has changed since the 1970′s when gold and fixed rates were abandoned. In our real world today, reserves do not constrain bank lending and money creation. The fears of inflation based on old equation of exchange theories are unfounded. It’s a shortage of real resources that will drive inflation, not deficits per se.

I’m not the expert on MMT. I’m just a teaching economist with both a lot of teaching and practical applied experience. If you really want to know MMT from the experts, try folks like Bill Mitchell and his Billy Blog, or Randy Wray and company at New Economic Perspectives. For that matter, read Wray’s books or Mitchell’s books.