Posted by: Dirk | April 18, 2017

Keynes: rules or discretion?

I’m reading the Tract on Monetary Reform and it is quite interesting. The big question that could come up in the future for many small, open economies in what today is the Eurozone is: what to do after the euro is gone? Target an exchange rate, or the inflation rate, use discretion or follow rules – these are all very interesting questions that Europeans might be forced to answer in the coming years. Here is an excerpt from Keynes’ writings (last chapter):

If the Bank of England, the Treasury, and the Big Five were to adopt this policy, to what criteria should they look respectively in regulating bank-rate, Government borrowing, and trade-advances? The first question is whether the criterion should be a precise, arithmetical formula or whether it should be sought in a general judgement of the situation based on all the available data. The pioneer of price-stability as against exchange-stability, Professor Irving Fisher, advocated the former in the shape of his “compensated dollar,” which was to be automatically adjusted by reference to an index number of prices without any play of judgement or discretion. He may have been influenced, however, by the advantage of propounding a method which could be grafted as easily as possible on to the pre-war system of gold reserves and gold ratios. In any case, I doubt the wisdom and the practicability of a system so cut and dried. If we wait until a price movement is actually afoot before applying remedial measures, we may be too late. “It is not the past rise in prices but the future rise that has to be counteracted.”[1] It is characteristic of the impetuosity of the credit cycle that price movements tend to be cumulative, each movement promoting, up to a certain point, a further movement in the same direction. Professor Fisher’s method may be adapted to deal with long-period trends in the value of gold but not with the, often more injurious, short-period oscillations of the credit cycle. Nevertheless, whilst it would not be advisable to postpone action until it was called for by an actual movement of prices, it would promote confidence, and furnish an objective standard of value, if, an official index number having been compiled of such a character as to register the price of a standard composite commodity, the authorities were to adopt this composite commodity as their standard of value in the sense that they would employ all their resources to prevent a movement of its price by more than a certain percentage in either direction away from the normal, just as before the war they employed all their resources to prevent a movement in the price of gold by more than a certain percentage. The precise composition of the standard composite commodity could be modified from time to time in accordance with changes in the relative economic importance of its various components.

Posted by: Dirk | April 12, 2017

… and austerity for all! (Martin Schulz reloaded)

Many of my European friends ask me about Martin Schulz and the success of social-democrats at the polls. Since they are progressive, they hope for reforms in the eurozone to curb mass unemployment, stellar youth unemployment and social problems that exist in many crisis countries. I always had my doubts if Martin Schulz was the right person to end austerity and bring the Eurozone back on its path to prosperity and full-employment. Now these doubts have been confirmed by the FT:

Martin Schulz signalled he would not soften Germany’s pro-austerity stance if elected chancellor this year, a message that will disappoint those in the EU hoping the Social Democrat leader might usher in a change in Berlin’s policy on the eurozone. In his first encounter with the foreign press since being elected SPD leader last month, Mr Schulz projected a message of continuity, suggesting there would be no big shift in Germany’s insistence on debt reduction and structural reform if he replaces Angela Merkel as chancellor. He said Germany had a “great interest” in ensuring all EU member states achieved stable growth, “but to get there, certain reforms are needed in these countries”.

This means that for the Eurozone as a whole, the deflationary bias – all crises lead to cuts in wages and spending, which lower the rate of inflation – will continue. This will have an effect on the distribution of income and on employment as well as the financial crisis, since lower nominal incomes and more unemployment mean that it will be harder to repay debt.

I expect the Schulz effect to fizzle out before September. German social-democrats are on the same trajectory as their European comrades. They become a splinter party, trying to be progressive with a neoliberal mind set. The Netherlands, France, Greece, and (probably) soon Spain, depending on which leadership the party choses, show that the progressive left will reorganize along new lines.

Posted by: Dirk | April 3, 2017

Structuralist Macroeconomics

I have recently ordered a copy of “Structuralist Macroeconomics – Applicable Models for the Third World” by Lance Taylor. However, I did not read very far into the book. Let me explain why. On p. 12, chapter 2 – titled “Adjustment Mechanisms – the Real Side” – starts with the sentence:

“MACROECONOMICS begins with the notion that the value of saving generated by all participants in the economy must by one means or another come into equality with the value of investment in the short run.”

While most economists will probably nod their heads, I don’t. Informed by a book chapter written by Basil Moore (download) and my own research, let me point out the fundamental problems with this statement. The first is trivial, the second not so.

First, macroeconomics – for most economists, I assume – does not begin with saving. It should start with employment. Why do we care about macroeconomics? Because we care about unemployment. If we would not care about unemployment, why then do we have central banks that decrease interest rates to spur investment in times of economic recession or depression? Why do governments engage in deficit spending? It is obvious that any social science must first define a problem that it wants to analyze and then, hopefully, fix.

The second fundamental problem is connected to the definition of saving. Moore’s chapter title, which goes back to Warren Mosler, connects saving to investment, with the latter causing the former. Moore writes: “Saving is always identical to investment, irrespective of the time unit or the time period over which they are measured, or how investment is defined” (p. 8). If Mosler via Moore is correct that saving is the accounting record of investment, than the fundamental methodology of structuralist macroeconomics must be wrong.

Moore writes that in the world economy, not distinguishing government or private sector, there are only two types of goods: consumption goods and investment goods. World GDP equals consumption + investment, or – in letters – Y = C + I. From the expenditure side, people of the world can decide to spend their money on consumption goods or … not. So, in other words, world GDP equals consumption plus what is not consumed. If we define what is not consumed as savings, then we get Y = C + S.

Subtracting one equation from the other gives us either 0 = I – S or 0 = S – I. Both can be transformed into S = I. So, there we are! This savings to investment relationship is one of an identity, hence a definition: what we do not consume we call investment from the “real” perspective of use of goods and services and “savings” from the financial perspective. Moore says that “in reality there is no underlying ‘real’ economy that somehow lies below and exists independently of the nominal economy” (p. 20). So, investment equals savings all of the time everywhere, and only problems of accounting give us problems with the data that sometimes seem to show that savings do not match investment.

In summer 2014, I taught a course at Free University Berlin and told my students that ultimately savings depend on investment – except for the case where not spending creates an increase in inventory, which is marked as investment – and it was a popular sport over the term to come up with examples that would imply that savings rise without a corresponding rise in investment or vice versa. We did not find a single valid example.

I know from many conversations I had with students that the investment-savings inequality is very difficult to grasp and had my own problems in the context of planned investment / planned saving, but by now I am very certain. Students of macroeconomics have to understand this identity from the very beginning to save them the trouble of falling for the loanable funds fallacy and other concepts based on misperceptions about he working of a modern monetary system. I’m sure that “Structuralist Macroeconomics” has a lot of knowledge that can be used to improve things, but the way that the models are drawn up will make it difficult to extract the good stuff (on institutions and distributions, as I see it). Perhaps the good stuff can be explained using balance sheets and aggregation at the sectoral level? That might be a worthwhile initiative.

Posted by: Dirk | March 21, 2017

J. S. Mill (1848) on tax-driven money

Via Matt Forstater (link), I have found some paragraphs by J. S. Mill on tax-driven money (see below). It is quite amazing that this knowledge got lost in the 21st century, with all that technology available. Perhaps information technology must be imagined like a race between weapons and armor. There are more sources available, but the creation of “filter bubbles” has also increased quite a lot. It was probably easier to spread good ideas and theories in the 19th or 20th century than it is now in the 21st. Perhaps it took longer and access to publishing books was more restrictive. Anyway, here is the excerpt from J. S. Mill’s Principles of Political Economy:

Book III, Chapter XIII

Of an Inconvertible Paper Currency


§1. After experience had shown that pieces of paper, of no intrinsic value, by merely bearing upon them the written profession of being equivalent to a certain number of francs, dollars, or pounds, could be made to circulate as such, and to produce all the benefit to the issuers which could have been produced by the coins which they purported to represent; governments began to think that it would be a happy device if they could appropriate to themselves this benefit, free from the condition to which individuals issuing such paper substitutes for money were subject, of giving, when required, for the sign, the thing signified. They determined to try whether they could not emancipate themselves from this unpleasant obligation, and make a piece of paper issued by them pass for a pound, by merely calling it a pound, and consenting to receive it in payment of the taxes. And such is the influence of almost all established governments, that they have generally succeeded in attaining this object: I believe I might say they have always succeeded for a time, and the power has only been lost to them after they had compromised it by the most flagrant abuse.


In the case supposed, the functions of money are performed by a thing which derives its power for performing them solely from convention; but convention is quite sufficient to confer the power; since nothing more is needful to make a person accept anything as money, and even at any arbitrary value, than the persuasion that it will be taken from him on the same terms by others. The only question is, what determines the value of such a currency; since it cannot be, as in the case of gold and silver (or paper exchangeable for them at pleasure), the cost of production.


We have seen, however, that even in the case of a metallic currency, the immediate agency in determining its value is its quantity. If the quantity, instead of depending on the ordinary mercantile motives of profit and loss, could be arbitrarily fixed by authority, the value would depend on the fiat of that authority, not on cost of production. The quantity of a paper currency not convertible into the metals at the option of the holder, can be arbitrarily fixed; especially if the issuer is the sovereign power of the state. The value, therefore, of such a currency is entirely arbitrary.


Posted by: Dirk | February 15, 2017

Spanish central bank involved in Bankia investigation

During the crisis, some Spanish banks were joined together and put into the market as “Bankia”, which turned out – surprise! – to be a “bad” bank: lots of non-performing loans, investors lost a lot of money. Now the criminal investigations have started and some people belonging to the leadership of the Spanish central bank, Banco de España, have been indicted, according to the NY Times from Monday:

The case could be the first instance in which the apex of Spain’s financial regulatory system is held directly accountable for its failure to prevent the Bankia scandal, in particular the initial public offering, in which shareholders were wiped out.


This again opens up the discussion of EU banking rules, after the “bail-in” basically failed on its first test some two months ago when Italy decided to bail-out Banco Monte dei Pasci di Siena. Apparently, the rules did not work before the crisis and thus were changed during the crisis. However, it seems now that the new rules don’t work either. The European Union seems to be unable to deal with its financial and economic crises, and this is dangerous for the integrity of the European project.

According to the Eurobarometer 86 (link), the biggest issues the member states face are unemployment, immigration and the economic situation in general. If the EU cannot get its act together in these areas we will see further dissolution of the project, however well-meant it is. The banking troubles are the cause of the economic troubles of the eurozone, made worse by austerity policies, enforced rules that don’t work (“bail-in”) and non-enforced rules that would (macroeconomic imbalances procedure). For all the talk in Germany about the importance “Ordnungspolitik” (basically institutions framing the way that markets work), the situation in Europe in 2017 is worse than ever before. It seems that nothing has been learned from the crisis yet.

Posted by: Dirk | February 6, 2017

Hyman Minsky on the aim of policy

I am currently writing up an article on what Minsky added to Keynes an onwards to whether this is an up to date theoretical framework ready for use in the 21st century. In a nutshell, Keynes explained that output, inflation and unemployment are driven by changes in investment, which is itself driven by changes in interest rates and expected yields. Minsky adds a financial structure – the liability side – to this part of Keynes’s theory.

Both have in common the idea that economics is not a discipline free of value judgments that are mostly prior to theorizing. Keynes thought unemployment a “bad”, and especially mass unemployment. His idea was to add social stability to society by keeping everybody willing to work employed. The modern welfare state developed, financed and run by big government and with the support of a big central bank that ensured the government does not run out of money. Then came neoliberalism and all of this was declared to be bonkers and the cause for inflation, unemployment and low economic growth. After enduring three decades and a half of neoliberal policies one has to conclude that we now have even lower economic growth rates, problems of deflation and not inflation, and a skewed labour market with lots of unemployment, low-paid and part-time jobs and historically high levels of inequality.

In order to return to the decades of social peace that Western societies enjoyed in the 1950s up until the 70s, it is useful to reread some of that periods thinker. Among the greatest in economics is Hyman Minsky. This excerpt is from the last paper published by Hyman Minsky (link):

The aim of policy is to assure that the economic prerequisites for sustaining the civil and civilized standards of an open liberal society exists. If amplified, uncertainty and extremes in income maldistribution and social inequality attenuate the economic underpinnings of democracy, then the market behavior that creates these conditions have to be constrained. If it is necessary to give up a bit on market efficiency or aggregate income, in order to contain democracy threatening uncertainty, then, so be it. In particular, there is a need to supplement private incomes with socially provided incomes, so that civility and civic responsibility are promoted.

If we want to go forward, then we have to change course. Both in the real world, where policy makers, press and the lay public have to understand the recent history as one of decline and not progress. Of course it is up to some to persuade the others that we have to reinterpret our recent past, and that will take time. However, letting things continue without implementing change on a larger scale will not lead to any improvement in economic or social terms.

One issue where what Minsky wrote in the paragraph applies is the euro zone. How can people expect Greeks or Spanish or Irish or other people to behave decently if they have sky-high unemployment, low-paid jobs (after having had much better-paid ones), a lack of power in their relation to employers, etc.? The euro zone is socially unstable, and it needs to be fixed. Whether it is still possible to do so the future might show.

For those of you who are interested in my book (published with Routledge in 2016) but want to have a look first before buying the hardcover version or the ebook I provide this link to Google Books which shows quite a lot of the pages for free:

The book is an introduction into the creation of central bank money by the European Central Bank, the creation of deposits by banks and fiscal activities of the state. In a way, these are the microeconomic fundamentals that need to be understood before one continues to aggregate the data and do macroeconomics. In the second part of the book this aggregation is done through the construction of sectoral balances and an application of the theory to the eurozone.

I have seen a lot of ways to arrive at the sectoral balances identity, which states that the sum of the change in net financial assets of the private, the public and the external sector sums up to zero. I prefer to show my students six equations – hence five steps – to make them understand the nature of the identity. We start with two definitions (in bold), which are those of GDP (Y) and private saving (Sp). From there, we arrive at the sectoral balances through rearranging the private saving equation, then subtracting the GDP identity from it and rearranging again:

(1) Y = C + I + G + EX IM

(2) Sp= Y C T

(3) Y = Sp+ C + T

(4) 0 = Sp+ T – I – G – EX + IM                      [eq. (3) – eq. (1)]

(5) Sp – I + T – G + IM – EX = 0

(6) (Sp – I) + (T – G) + (IM – EX) = 0

This is not rocket science, but in terms of macro state-of-the-art. As I am currently building a textbook around this identity, keep on coming back to my blog to see some more stuff related to this way of theorizing macroeconomics that was pioneered by Wynne Godley and others before him.

Posted by: Dirk | January 11, 2017

President Obama and the gains from trade

Going through my inbox, I found this quote from President Obama from November 2016:

That’s why I firmly believe that one of our greatest challenges in the years ahead — across our nations and within them — will be to make sure that the benefits of the global economy are shared by more people and that the negative impacts, such as economic inequalities, are addressed by all nations.  When it comes to trade, I believe that the answer is not to pull back or try to erect barriers to trade.  Given our integrated economies and global supply chains, that would hurt us all.  But rather the answer is to do trade right, making sure that it has strong labor standards, strong environmental standards, that it addresses ways in which workers and ordinary people can benefit rather than be harmed by global trade.  All of this is the central work of APEC.

Looking back at the elections of 2016, I think it shows a lot of what went wrong.

According to standard international trade theory, the Heckscher-Ohlin model, there are winners and losers from trade. The model suggests that the gains from trade are higher than the losses, so that the winners can compensate the losers so that everybody wins. That, obviously, is the world we want to live in. Economists help politicians to make the world a better place – for everybody!

However, even the textbook “International Economics” by Krugman/Melitz/Obstfeld contains some insights in why things did not work out that well. They have a graph showing that the computer industry declined in terms of jobs badly between 2000 and 2009, even worse than the industrial sector as a whole. The graph looked something like this (but only for 2000-2009), which I got from the World Bank:

Employment in industry (% of total employment)

employmentThere has been a fall in industry jobs, and that means that there have been losers from trade. It has been very obvious that the jobs went elsewhere as the US started to import manufactured products from abroad, with much of the increase coming from Asia, where China was used as a platform to export Asian products to the rest of the world.

According to the Heckscher-Ohlin model, the winners from trade are the owners of capital. Capital is abundant in the US, and scarce in China. Obviously, the model does not allow US firms to move their machines to China, even though this is what happened to some extent. The losers are the workers, which see their jobs leave to never return. The sensible policy that an economist using the Heckscher-Ohlin model should give to the US government is to increase taxes on capital and cut taxes on labor. In reality, the opposite happened. George W Bush cut taxes for the rich, and the relatively poor and the middle class was left to itself.

Incoming President Trump does not seem to keen to rely on economic advisors, as a recent Bloomberg article makes clear:

Economists aren’t shying away from joining Donald Trump’s administration and would be willing to pitch in if asked, according to former economic policy makers now in academia. […] Alan Krueger, who led the CEA in the White House of President Barack Obama from 2011 to 2013 before passing the torch to incumbent Jason Furman, suggested that it might be more of a matter of Trump not wanting many economists in his administration, rather than the other way around.

With the record of advice of the recent past, it will be difficult for economists to resume their role at the table of the powerful. Of course, US policy was not completely driven by economists, but then I can’t recall any dissatisfaction of economists from the early 2000s with the tax and trade policies of George W Bush. Yes, it was pointed out that the rich stood to benefit, but where was the connection to international trade?

Here is what I found on Greg Mankiw’s blog, written by Bob Frank who debates him (link):

While serving as chairman of the Council of Economic Advisers, Greg actively supported the Bush tax cuts targeted at top earners by arguing that the cuts would spur them to work harder. Greg would have been astonished to observe such a response from his colleagues at Harvard. Does he have a behavioral model that leads him to expect different behavior from high achievers in other occupations? Or does he have one that explains why any such differences consistently fail to reveal themselves in the data? In the absence of a plausible behavioral model backed by persuasive empirical evidence to the contrary, I stand by my conclusion that trickle-down theory is supported neither by economic theory nor by empirical evidence.

That to me seems like the typical economist of the early 2000s.

UPDATE JAN 11, 2017: Since Obama mentioned his job record in his farewell speech, I’d like to add another statistic which includes the latest data and comes from the BLS. Here is the number of employees in US manufacturing (in thousands):


As you can see, there was an upward movement from 2010-2015, but that has fizzled out and the sector is on decline again. Again, this is not a good record for the average American. If the new jobs were not created in manufacturing, they must come from the service sector. But these jobs normally don’t pay so well. This is one of the crucial issues that the new administration might address – or paper over, using economists to confuse and mislead the public over what determines the size of the manufacturing sector and the rate of unemployment. We’ll have to wait and see.

I’ve been watching one of the “Free to Chose” programs hosted by Milton Friedman, which are very odd to watch in terms of clothing and the absence of any ethnic minorities. What I find interesting about this programme is a sentence by the then former Chairman of the Fed, William McChesney Martin:

When I’ve talked for a long time about the independence of the Federal Reserve, that’s independence within the government not independence of the government.

The way that central bank independence is discussed nowadays seems to imply that central banks are independent from government. A recent article on reads:

Over the past 30 years, most central banks across the advanced economies have been given the ability to conduct monetary policy independently from interference by fiscal and political authorities (Crowe and Meade 2007). Today, almost all central banks in OECD countries are operationally instrument-independent, counting on their own tools to set or target several interest rates, even if none of them is goal-independent, since political bodies give them their mandate.

I reject the notion that it is possible to run central bank “independently from interference by fiscal and political authorities”. An increase in government spending, for instance, increases the amount of reserves in the system when it happens. Perhaps before, the government borrowed from banks, which themselves borrowed from the central bank. This is going on everywhere all of the time, and for me it is plain wrong to say that a central bank can be independent from the Treasury. This is recognized by most modern literature, including the Fed (see this paper).

What Milton Friedman and his insistence on monetary policy did to monetary theory was not advancing monetary thought, but rather a regression to older neoclassical times in which the monetary neutrality was an axiom. Keynes got rid of it, making money explicit, and then Friedman and his followers closed the curtain on Keynes. In the last few years, the picture changed again and Keynes has been revived in a modern form. Fiscal policy made a comeback, and 2017 will see more advancement towards Keynesian positions that stress the role of the state in fighting unemployment that results from leaving it to the market alone to determined the level of jobs available.

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