Posted by: Dirk | December 6, 2016

The US government needs to spend more

Sometimes it is interesting to look at the long run in order to see policy changes that somehow slip through under the radar. One of these instances, I think, is the way that real government consumption expenditures and gross investment have decreased since the Great Financial Crisis of 2008/09 (h/t to Nersisyan and Wray). Don’t get me wrong: there is lots of talk about upgrading infrastructure, sure. However, most people seem to believe that this is the result of a neglect for public infrastructure over some decades. While I think that this is right, probably most people would not have thought that this problem got a lot worse since 2010:
us-govspendtaxThe expenditures of government stopped following the upward trend after the recession, whereas transfers and taxes resumed the historical upward-sloping path. Only in the last few years did government expenditures grow again, but just slightly, not surpassing the historical maximum from 2009. This means that government could do and probably should do more in order to get the economy out of a situation of low growth and low participation in labor markets. The Civilian employment to population ratio has still not recovered and seems to stagnate now (data).

So, if there are people who would like to rejoin the labor market, why not return to normal and lift US government spending up to where it was before the crisis? That surely would create unemployment and since the US government cannot go broke anyway it would not do any harm to future generations either.

Posted by: Dirk | November 18, 2016

Eurozone: The Stability and Growth Pact is dead.

As Reuters reported two days ago, the EU has decided not to punish the government of Spain and Portugal respectively for running deficits that were higher than the EU demanded:

The European Commission said on Wednesday it will not suspend EU funds for Spain and Portugal next year following their breach of EU budget rules, as it also called for looser fiscal policy across the euro zone.

The European Union’s executive Commission has the power to impose fines and to suspend EU funds for countries that run deficits above 3 percent of their gross domestic product and do not take measures to correct their excessive gaps.

Spain and Portugal were found in breach of EU fiscal rules last year, but the Commission has concluded there is no need to sanction them as they have taken sufficient measures to correct their imbalances, Commission vice president Valdis Dombrovskis told a news conference.

So, it should not come as a surprise that European politics is, well, political. Greece is now the only country where the rules are applied harshly (and unfairly, I think), whereas the others seem to be free to increase government spending. Any future punishments can now be attacked by referring to what happened (or rather not happened) to Spain and Portugal.

Finally, Keynesian thought has replaced neoclassical thought at Brussels! Austerity in times of crisis is, was and always will be a bad idea, if you have no outside option to export lots of stuff to other trade partners. However, not everybody thinks like this. Daniel Gros,Director of the Brussels-based Center for European Policy Studies, at Project Syndicate had noticed the death of the Stability and Growth Pact a few weeks ago, writing:

But the decline in support for European fiscal rules carries serious risks. If the most concrete elements of the eurozone’s governance framework are not applied rigorously, what will compel member states to undertake reforms and stabilize their debt levels? Vague exhortations will not work. It seems that the crisis, and the untenably large risk premia for highly indebted governments that followed, has already been forgotten.

Officially, the Commission is still working to realize the blueprint for a “genuine” Economic and Monetary Union. But in the wake of the Commission’s decision not to enforce the SGP, this effort has become meaningless. It is now clearer than ever that EU member states prioritize domestic political imperatives over common rules – and Europe’s common good.

I do not agree with these statements at all. Stabilizing public debt levels is not a feasible economic policy at all, because in the pursuit of one number – public debt to GDP – you lose sight of the real world. In Spain, an old lady died this week after a candle started a fire at her place and she fell down when trying to run away. Why was she using a candle? Because the electricity company had cut her off for not paying her bills. So, in Western Europe we have households now that have no electricity. That is ridiculous! Are we so poor that we cannot afford to provide electricity to the elderly? No, we are not. This is a political choice, and the decision that caused this was to cut government spending because of this sad ideology of expansionary austerity.

“Untenably large risk premia for highly indebted governments”? That was a mistake, and it has been corrected. Now the ECB will make sure that bond yields will not rise if “the market” starts to doubt a government. It was wrong to give so much power to financial markets and to let them punish governments. In the end, they would have punished all governments and driven them into bankruptcy if during the crisis we would not have interfered with the market by changing the governance of the eurozone.

EU member states, as I see, prioritize meaningful domestic political imperatives like fighting unemployment over meaningless common rules like the Stability and Growth Pact, which only have been put in place to increase the power of the financial sector.

The death of the Stability and Growth Pact is a good thing. However, it is only the first step in the right direction. More will have to follow before the next recession hits the eurozone and destroys the single currency.

Posted by: Dirk | November 15, 2016

Stock-flow consistent (SFC) model for beginners

A while ago I created the SIM(mple) model as a graphical tool on InsightMaker, which is a really great software that runs on the web for free and allows users to play around with the models and also copy them. Today I received an email informing me that the model has had 100 views – wow! It is originally from the book by Godley and Lavoie (not anymore) available here. The good thing about Insightmaker is that you can try out the model with different parameter choices and hence experience it without having to use some mathematical software. I hope that more people will get to know this really easy way of understanding the mechanisms behind the very simple SFC model.

Posted by: Dirk | November 9, 2016

Was FDR a populist? (Was New Labour populist?)

At the 2017 EAEPE conference in Manchester last week the British “New Labour” politician Lord Peter Mandelson offered the participants to gather in a room and discuss the question of “becoming an economist in times of populism”. Lord Mandelson was very nice and we had a very good exchange of ideas, open enough that different positions were voiced and respected. It was not so clearcut what populism is in term of policy, and also in terms of politicians. Coincidentally, I had the last question to Lord Mandelson and I asked whether he thought that Franklin Delano Roosevelt (FDR), Democrat presidential candidate in 1932, was a populist? To get some idea of his policies, here is an excerpt form his first inaugural address:

Yet our distress comes from no failure of substance. We are stricken by no plague of locusts. Compared with the perils which our forefathers conquered because they believed and were not afraid, we have still much to be thankful for. Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because the rulers of the exchange of mankind’s goods have failed, through their own stubbornness and their own incompetence, have admitted their failure, and abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men.

True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.

The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit.

Happiness lies not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort. The joy and moral stimulation of work no longer must be forgotten in the mad chase of evanescent profits. These dark days will be worth all they cost us if they teach us that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.

Recognition of the falsity of material wealth as the standard of success goes hand in hand with the abandonment of the false belief that public office and high political position are to be valued only by the standards of pride of place and personal profit; and there must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and selfish wrongdoing. Small wonder that confidence languishes, for it thrives only on honesty, on honor, on the sacredness of obligations, on faithful protection, on unselfish performance; without them it cannot live.

That, I think, was not a surprise speech that shocked voters, but rather a confirmation that FDR was serious about the economy and the unemployment problems. So, was FDR a populist? Lord Mandelson said no, because FDR listened to the right people when it mattered. I am not exactly happy with that answer. Instead of making my point by writing up my own ideas, let me just show you an excerpt of a 2001 speech by Tony Blair (New Labour):

But globalisation is a fact and, by and large, it is driven by people.

Not just in finance, but in communication, in technology, increasingly in culture, in recreation. In the world of the internet, information technology and TV, there will be globalisation. And in trade, the problem is not there’s too much of it; on the contrary there’s too little of it.

The issue is not how to stop globalisation.

The issue is how we use the power of community to combine it with justice. If globalisation works only for the benefit of the few, then it will fail and will deserve to fail.

But if we follow the principles that have served us so well at home – that power, wealth and opportunity must be in the hands of the many, not the few – if we make that our guiding light for the global economy, then it will be a force for good and an international movement that we should take pride in leading.

So, is this populism, then? Globalisation is a fact? It can’t be stopped? There is no alternative? But if it can’t be channeled into more benefits for everybody, it will fail? (And then…?)

I believe that the problem we face today is that we need to think very hard about who is populist and who isn’t. We also need to think about whether change will come from the populists or the non-populists. Obviously, Germans elected a populist madman in 1933, but that was much clearer with hindsight than back then. If FDR is judged to have been a populist, then he was no a madman and probably a good choice. What we need now is more public debate about policies and parties, not only in the US, but also in Europe and elsewhere.

(This is not geared toward the US elections so that I’ve scheduled this article to appear on Wednesday, Nov 9, noon European time.)

The so-called elephant chart (see here) has been discussed a lot recently. It shows that change in real income was very nice for those people on this planet who were neither really poor nor belonged to Western middle class during the period of 1988-2008. The chart was first made popular by Branko Milanovic.

The question that comes to mind automatically is: if we had positive rates of economic growth in the western world from 1988-2008 (and we had!), then were did all that income go? And the answer, at least for the US, you find in another chart, taken from page 62 of the Financial Crisis Inquiry Commission’s report:

compensation Any more questions?

The above quote is attributed to Albert Einstein, and it is a typical one following Einstein’s motto “as simple as you can, but not simpler!” So, how could we describe the economy? Would we need to take into account the line by Einstein and be careful about descriptions that are technically correct but lose the essence somewhere along the way, or can we just start and describe physical things and the transformations of inputs into outputs without having to stop for some reflection?

I strongly believe the latter is the case. The economy is something in which goods are produced and then exchanged, but there is a lot more to it than this description would make you think. What about social justice in a system where workers specialise in certain tasks and this receive a money wage? What about the uncertainty for the entrepreneur who first pays workers and then gets his production process started? What is the role of money and banking in this process? Who has the power and why? What about individual rights and duties? Who protects the weak, and who is watching the watchmen?

Having just attended a conference which celebrated an economic journal, I believe that with the problems that we face today we need to rethink economics as the academic discipline. Nine years after the start of the sub-prime crisis, there were still presentations about DSGE models (nothing about SFC models), about government spending that would pay for itself (whereas the government cannot go bankrupt if it issues debt in its own currency), about a Cobb-Douglas production function that assumed that you can give a price to capital (here the alternatives are harder to imagine, but classical economists like Smith and Marx would come to mind). Where is the new economic thinking?

Let me slightly rephrase the quote by Einstein:

“It would be possible to describe absolutely everything scientifically, but it would make no sense. It would be without meaning, as if you described a capitalist process of development as an accumulation of capital and labour.”

Just as with Beethoven, the single parts and the whole have to be seen from completely different angles. Whereas there are many ways to listen to Beethoven, there is still only one academically correct way of “doing economics”, which is neoclassical economics. This is wrong and this needs to be corrected. One of the publications that celebrated its birthday today will shortly publish an article on the need for a Pluralist economics. Just as the last 100 years, the next will surely be intellectually stimulating!

The consolidated version of the treaty on the functioning of the European Union reads:

TITLE IX

EMPLOYMENT

Article 145 (ex Article 125 TEC)

Member States and the Union shall, in accordance with this Title, work towards developing a coordinated strategy for employment and particularly for promoting a skilled, trained and adaptable workforce and labour markets responsive to economic change with a view to achieving the objectives defined in Article 3 of the Treaty on European Union.

Article 146 (ex Article 126 TEC)

1. Member States, through their employment policies, shall contribute to the achievement of the objectives referred to in Article 145 in a way consistent with the broad guidelines of the economic policies of the Member States and of the Union adopted pursuant to Article 121(2).

2. Member States, having regard to national practices related to the responsibilities of management and labour, shall regard promoting employment as a matter of common concern and shall coordinate their action in this respect within the Council, in accordance with the provisions of Article 148.

Article 147 (ex Article 127 TEC)

1. The Union shall contribute to a high level of employment by encouraging cooperation between Member States and by supporting and, if necessary, complementing their action. In doing so, the competences of the Member States shall be respected.

2. The objective of a high level of employment shall be taken into consideration in the formulation and implementation of Union policies and activities.

I am not a specialist in European law, but it seems to me that Article 147 (1) says that “[t]he Union shall contribute to a high level of employment by encouraging cooperation between Member States and by supporting and, if necessary, complementing their action. In doing so, the competences of the Member States shall be respected.”

How you could impose austerity policies in a policy framework like this is unclear to me. The failure of Europe is a political failure and maybe also a failure of legal institutions. It is an economic failure only in so much as the advise of many, many economists was ignored and a euro was set up that was almost designed to fail (the so-called Krönungstheorie says that this was deliberate) and when it did the economists were proved right but politicians were scared and panicked.

Posted by: Dirk | October 10, 2016

Money is a store of value … really?

The way that economists discuss low interest rates and the problems of savers seems to imply that they think we are saving by holding deposits at the central bank or, more realistically, at our commercial bank of choice. This idea was dispelled long ago by Keynes (1937), who wrote in his article in the Quarterly Journal of Economics:

Money, it is well known, serves two principal purposes. By acting as a money of account it facilitates exchanges without its being necessary that it should ever itself come into the picture as a substantive object. In this respect it is a convenience which is devoid of significance or real influence. In the second place, it is a store of wealth. So we are told, without a smile on the face. But in the world of the classical economy, what an insane use to which to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. Why should anyone outside a lunatic asylum wish to use money as a store of wealth?

Good point. Sadly, modern economics has returned to a state in which knowledge lost long ago becomes practically relevant. People have invested their savings in real estate, stocks, bonds, etc. The returns of these assets diverge quite significantly from interest rates set by the central bank (for instance, Chinese real estate performs quite well this year). So, neoclassical models with only one interest rate fall way short to make sense of our complex world.

Olivier Blanchard has distilled two assumptions that either make DSGE the prominent tool for macroeconomic research or they don’t. However, before this paragraph he writes that there are three propositions with wide agreement:

  1. Macroeconomics is about general equilibrium.
  2. Different types of general equilibrium models are needed for different purposes. For exploration and pedagogy, the criterion should be transparency and simplicity, and for that, toy models are the right vehicles. For forecasting, the criterion should be forecasting accuracy, and purely statistical models may, for the time being, be best. For conditional forecasting, i.e. to look for example at the effects of changes in policy, more structural models are needed, but they must fit the data closely and do not need to be religious about micro foundations.
  3. Partial equilibrium modelling and estimation are essential to understanding the particular mechanisms of relevance to macroeconomics. Only when they are well understood does it become essential to understand their general equilibrium effects. Not every macroeconomist should be working on general equilibrium models (there is such a thing as division of labor).

I do not agree with these positions, and many others don’t. Macroeconomics is about examining the causes for unemployment first. As secondary objectives, it is about economic growth and distribution, both of which already play a role when examining unemployment. Macroeconomics is not about general equilibrium. Blanchard confuses the method with field. When it comes to method, I would argue for a balance sheet approach. Equilibrium means that balance sheets have to be balanced, not necessarily at full employment. I have a book chapter for publication in 2017 sitting on my desk of which a first draft already exists (ResearchGate). Anybody interested in it is invited to comment on that draft.

I think that DSGE has shown itself to be useless when you need the macroeconomist – in times of macroeconomic crisis. Even worse, it can be used to give bad policy advice and analysis (see here) that is hard to falsify because the models do not lend themselves to empirical tests. It is a bit like trying to prove that dragons do not exist. Common sense is more helpful than a mathematical model that shows that a dragon is possible. The DSGE model shows that a very particular world is possible where wishes to save always trigger investment so that the economy is self-regulating. However, we can clearly see in the real world that it’s not. DSGE should be allowed to die.

Posted by: Dirk | September 29, 2016

Bank Of Japan: mark it zero, dude!

cnbcAccording to a recent video feed by CNBC, the Bank of Japan has negative interest rates, scrapped monetary base targets and controls the yield curve. Actually, it communicated that 10y bonds will have a zero interest rate. As a look at recent data shows, the BoJ is clearly achieving what it has announced. Somehow, all of these things used to be in the territory of monetary cranks when monetarism ruled for a blip during the 1980s:

  • negative interest rates
  • no monetary supply targets
  • controlling the yield curve (long-term interest rates)

Now, they are all reality, in one of the biggest industrial powers of this planet. Sometimes, things change rather quickly. It is now monetary theory that has to adjust to the new world we live in.

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