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.

A new year, a new look at the US economy:


These are the sectoral balances for the US, which can be accessed through FRED here:

private sector

government sector

ROTW (rest of the world = current account)

To get an updated version of the graph above you can click here to go to the FRED2 website.

It looks like the private sector is starting to save more and/or invest less. The government deficit has stabilized, and so has the current account deficit. Given that the dollar is expensive and global growth weak, demand from the rest of the world will be relatively weak. In order to grow, demand must come from domestic sources then. The private sector, as I just wrote, does not seem to go on a spending binge (and into debt) right now, so it seems like expansionary fiscal policy is the way forward. Let’s see what 2017 brings.

The FT writes about Laffer endorsing Trump’s policy of tax cuts for the rich:

Although tax rates in most countries rose throughout the 20th century, which was by far the best century in economic history, Mr Laffer is unbowed. “When [taxes] went up [countries] did very poorly and when they went down, they did very well,” he says.

I would like to back up the criticism of the FT at the start of the first sentence with a chart taken from FRED2:


The blue line shows you tax receipts on corporate income divided by GDP. The red line is real GDP growth. Now Mr Laffer claims that cutting taxes leads to higher GDP and hence more tax income, so that the tax intake of the government will not decline even though rates have been cut. Wikipedia, though not authoritative on the subject of economics, gets it reasonably right when it says: “Generally, economists have found little support for the claim that tax cuts from current rates increase tax revenues or that most taxes are on the side of the Laffer curve where additional cuts could increase government revenue.”

If Mr Laffer would have been right, then one should have expected that with lower marginal tax rates from the 1980s onwards, when Reagan cut them being advised by Laffer, the tax intake would not go down (much) since higher GDP growth would lead to higher tax intake. However, the figure shows that the blue line falls and stays down. The (red) economic growth rates also do not go up to reach the levels of the 1950s-1970s. Remember that the US was not destroyed after WWII, like so many other countries, so no claim can be made that economic growth is more difficult to achieve after the post-war boom had fizzled out.

Laffer’s trickle-down economics did not do well empirically. Whether a cut in taxes stimulates the economy is a different question, and also any changes in tax rates might be overcompensated by changes in government spending taking place simultaneously. This, I believe, was part of the bait-and-switch under Ronald Reagan (tax cuts for the rich, but huge increase in government spending on defence) and will be part of the Trump policy, too. Nothing new here.

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.

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