Tuesday, September 16, 2014

Lars P. Syll on how wrong Krugman & Mankiw are on loanable funds

By Lars P. Syll
Earlier this autumn yours truly was invited to participate in the New York Rethinking Economics conference. A busy schedule didn’t allow me to “go over there.” Fortunately some of the debates and presentations have been made available on the web, as for example here. Listening a couple of minutes into that video one can hear Paul Krugman strongly defending the loanable funds theory. Unfortunately this is not an exception among “New Keynesian” economists. Neglecting anything resembling a real-world finance system, Greg Mankiw — in the 8th edition of his intermediate textbook Macroeconomics — has appended a new chapter to the other nineteen chapters where finance more or less is equated to the neoclassical thought-construction of a “market for loanable funds."
Read rest here.

Monday, September 15, 2014

Ben Fine on the Material Culture of Financialisation

A FESSUD Working paper by Ben Fine.

From the abstract:
The purpose of this paper is threefold. First is to comment upon the nature of financialisation. Second is to frame how this leads financialisation to be understood whether consciously or otherwise. And, third, is to draw out implications for surveying households as their experiences and understandings of, and reactions to, financialisation without specifically designing a questionnaire itself for this purpose. As should already be apparent, underpinning this contribution is the presumption that financialisation is a characteristic of contemporary capitalism (and that the term is also an appropriate category for representing this characteristic). The material culture of financialisation is addressed by drawing upon the 10 Cs approach that was developed for the study of consumption, highlighting how it is Constructed, Construed, Commodified, Conforming, Contextual, Contradictory, Closed, Contested, Collective, and Chaotic.
Read rest here.

Sunday, September 14, 2014

On the blogs

New ILO Book: "Transforming Economies - Making industrial policy work for growth, jobs and development"

From the introduction
Building on a description and assessment of the contributions of different economic traditions (neoclassical, structural, institutional and evolutionary) to the analysis of policies in support of structural transformation and the generation of productive jobs, this book argues that industrial policy goes beyond targeting preferred economic activities, sectors and technologies. It also includes the challenge of accelerating learning and the creation of productive capabilities. This perspective encourages a broad and integrated approach to industrial policy. Only a coherent set of investment, trade, technology, education and training policies supported by macroeconomic, financial and labour market policies can adequately respond to the myriad challenges of learning and structural transformation faced by countries aiming at achieving development objectives. The book contains analyses of national and sectoral experiences in Costa Rica, the Republic of Korea, India, Brazil, China, South Africa, sub-Saharan Africa and the United States. Practical lessons and fundamental principles for industrial policy design and implementation are distilled from the country case studies. Given the fact that many countries today engage in industrial policy, this collection of contributions on theory and practice can be helpful to policy-makers and practitioners in making industrial policy work for growth, jobs and development.
Be sure to see the chapter by Robert Hunter Wade - "The mystery of US industrial policy: the developmental state in disguise" - on page 379.

The book is available as a pdf for free download here.

Saturday, September 13, 2014

How Keynesianism became a dirty word: not Hayek, the New Deal is the real cause

Noah Smith, now writing regularly for Bloomberg, had a piece on this subject. There are a few good points on how New Keynesians are really followers of Friedman, something Mankiw admitted long ago, and how everybody including conservative economists (meaning GOP economists like John Taylor and Ben Bernanke) are New Keynesians (these would be the potty trained GOP economists, not your supply-side fringe economists like Arthur Laffer). Note that this is essentially correct as pointed out here before, since New Keynesians accept fully Friedman's notion of a natural rate of unemployment, while Keynes explicitly said he wanted to reject the twin concept of a natural rate of interest.

Noah also suggests that Keynes only wanted stabilization policies, and no redistributive policies, which is more open to debate. Keynes was certainly a moderate reformer trying to save capitalism from itself, and was no fan of the Soviet experiment. On the other hand, he was an Asquith liberal, meaning concerned with the expansion of the welfare system, and knew that laissez-faire, if it had advantages in the past, was essentially dead.

In the General Theory (GT) he famously starts chapter 24, on his social philosophy, with the idea that: "the outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes." That is, income distribution is squarely in the middle of his preoccupations, and the socialization of investment at the center of his solution (let alone the euthanasia of the rentier). Using public investment, and one would imagine taxes, to deal with employment and income distribution, plus compressing the remuneration of rentiers, and keeping low rates of interest to expand the safety net, are not simply stabilization policies.

On the main topic of his piece, however, Noah is simply wrong. He argues that the reason why: "people think Keynesianism is socialism-lite [is] the fault of Keynes’s main intellectual opponent, Friedrich Hayek." First, while it's true that Keynes and Hayek had a few debates in the 1930s (but the key Keynesian author in these debates was actually Sraffa, not Keynes), prompted by Lionel Robbins plan to make the London School of Economics (LSE) an alternative to Cambridge, it is preposterous to say that Hayek was the main intellectual opponent of Keynes. In the GT, it was his own teacher Pigou, and the Marshallian tradition in Cambridge that Keynes was battling. In his personal debates Robertson was certainly more relevant than almost any other conventional (Marshallian) economist. Hayek was irrelevant.

Second, Hayek basically vanished, literally, after the 1940s only to reaper in the 1970s as a result of his dubious "Nobel"/Bank of Sweden's prize (see Sissela Bok's, Myrdal's daughter, story on that topic). By that time Keynes and Keynesianism were already dirty words. Early on Keynesian ideas were associated, fairly or not, with Roosevelt and the New Deal in the US, and then to the war coalition government in the UK, the Beveridge Report and the post-war Labour reforms. Keynesian economists were in many cases persecuted, like Lauchlin Currie, the first economist to work inside the White House, and one of the early Keynesians. But by the 1950s and 1960s (particularly after the Kennedy administration) one kind of Keynesianism was dominant anyway (the Kennedy tax cut and the economists working for his administration are the symbol of the dominance of Keynesian ideas).

So you ask why indeed did Keynesianism become a dirty word? Simply because even if Keynes had differences with Roosevelt (FDR was actually a sound finance guy) and with Labour, his ideas did provide the intellectual basis for New Deal policies, particularly after the 1937-38 recession, and for the expansion of the Welfare State in general. The economists that where against these policies by the 1940s were in the minority. Mont Pelerin is, if anything, prove of their sheer irrelevance. Friedman years later would complain about how ostracized he was (but less than Hayek, since he accepted the ISLM/Phillips curve apparatus of the Neoclassical Synthesis Keynesians; and that's why New Keynesians, who are really followers of Friedman, can say they are Keynesian, by the way). Liberalism, in the US sense of the word, was at its height. But the rise of conservatism (Goldwater was a joke back then) eventually transformed liberalism into a dirty word (that's why we use progressive now rather than liberal).

Hayek was resuscitated very much like conservative ideas. By the big bucks of business leaders and their think tanks that were against the New Deal. The rise of Hayek or of his renewed respectability results from the same forces that explain why Keynesianism and the New Deal kind of welfare policies fell in disrepute, to the point that Niall Ferguson could say that Keynesianism was flawed because Keynes was childless and gay. Oh well.

PS: In fact, the title of this blog is related to the view that Keynesianism is a dirty word, and that some people (Galbraith) unashamedly teach naked Keynesianism to innocent college kids. For more see here.

Friday, September 12, 2014

Krugman is actually right on ISLM and Minsky

I tend to disagree a lot with Krugman, at least on theoretical issues. His brand of Keynesianism supposes that the system doesn't work because of imperfections. For him, the current slow recovery is due to the fact that the natural rate of interest is basically negative and you cannot use monetary policy to stimulate the economy (see critique of this here). However, on his recent debate with Lars Syll (and here; Brad De Long also posted here), a post-Keynesian, with whom I probably share a more radical interpretation of Keynes and its relevance for economic theory, Krugman seems to get things right.

The main points in Lars initial post, based on Minsky's book John Maynard Keynes is that traditional representations of Keynes do not emphasize the cyclical component of Keynes' theory and that true or fundamental (non-probabilistic) uncertainty is often ignored. Lars adds a little bit more on his response to Krugman and De Long, but essentially is the same argument. Keynes didn't like the ISLM (which is from a historical point of view difficult to defend, after all the only stuff he wrote on this, to Hicks, was quite positive, even if it is of little relevance), that it is static (not paying attention to cyclical or dynamic phenomena), and perhaps more interestingly that the interaction of real and monetary variables in the model is simplistic.

Krugman points out that the General Theory (GT) is NOT about cyclical fluctuations per se. It is about the determination of the long run level of output and employment, around which the economy fluctuates, and he correctly notes that cycles only appear as an afterthought in chapter 22 of the GT. And that is precisely correct. The GT is revolutionary because it suggests that with price flexibility (not price rigidity as in the old Neoclassical Synthesis or the New Keynesian stories) the system gets stuck in a situation of unemployment equilibrium. Emphasis on equilibrium. Yes, unemployment at less than full employment and output below its potential level are both together in an equilibrium situation.

Patinkin suggested that Keynes meant unemployment disequilibrium, since within the neoclassical framework, unless there is a rigidity of some sort, and the system should go to its long run equilibrium position with full employment. Minsky (1975, p. 268), in the book cited above, says that Keynesian economics should be seen as the: "economics of permanent disequilibrium." That has no basis on the GT. Actually, the GT would be a less radical book if it only said that with instability the system might be always in a disequilibrium position. Keynes was very radical since he argued that the very notion of a natural rate should be abandoned (on this Paul and Brad have a lot to learn). Some Post Keynesians tend to dislike the idea of equilibrium (echoes of Joan Robinson's late critique of the idea), which ends up making them closer in many respects to the modern mainstream authors with their dislike for long term equilibrium positions.

So the GT is not about cycles (Keynes' Treatise on Money, a very conventional and Wicksellian book was about cyclical disequilibrium caused by differences between the natural and banking rates of interest, which, interestingly enough is closer to Krugman's way of thinking than the GT, or than to Lars, who is aware of the limitations of the natural rate concept). But that's not all that Krugman got right this time.

He quotes the famous passage in which Keynes says that the system is not violently unstable (GT, p. 249). And while Post Keynesians are correct to note the relevance of fundamental uncertainty, it is important also to consider the stabilizing role of conventions and institutions, to which Keynes alludes. Expectations play a role, but investment is not completely volatile, and it was a problem for Keynes only when "the capital development of a country becomes the by product of the activities of a casino" (GT, p. 159). In fact, given the relevance of the accelerator in determining investment, the central role of expectations is about the level of demand. For example, in the US investment has been subdued since demand is not growing fast and there are not reasonable expectations that it will any time soon.

Where New Keynesians go wrong, and in this case is actually Brad, not Paul (but he would certainly agree) is on the relevance of the marginal efficiency of capital, criticized by Minsky (even though it's far from clear that Minsky abandoned it). Brad thinks that Minsky critique of it is myopic and basically a PR problem. He says that it is: 
"Short-sighted, in that it is not Hicks who would be Minsky’s long-run intellectual adversary but rather Freidman [sic], Lucas, and Hayek, and so building bridges to the Hicksians ought to be a very high priority."
Probably true, but from a policy point of view. From a theoretical point of view, Hicks use of the marginalist notion of an investment function inversely related to the rate of interest (something Keynes also used) implies that there would be a rate of interest low enough that would produce full employment, that is a natural rate, which would preclude Keynes' claim about unemployment equilibrium (and the absence of a natural rate). In other words, with the marginal productivity of capital you have that unemployment must be a disequilibrium situation caused by some imperfection that inhibits the system from reaching the natural rate.

And yes the capital debates are relevant since they show that the inverse relation is only possible in a one commodity world. No natural rate, and no need to think about imperfections. And that's why the comment by Lars on the connection between real and monetary variables being simplistic within the ISLM is right on the mark. The idea that the central bank controls a monetary rate, that may get out of whack with the natural, and that by manipulating it can affect real variables is limited at best.

PS: For my previous defense of a modified ISLM go here and here

Thursday, September 11, 2014

Structuralist (Keynesian) Response to Piketty's Capital in the Twenty-First Century

A series of papers that provide more than a review a collective response to Piketty's book can be found here. It was part of a mini-symposium organized by Lance Taylor, co-sponsored by the New School and INET.

Wednesday, September 10, 2014

New Book: "The Euro, The Dollar and the Global Financial Crisis" By Miguel Otero-Iglesias

Editorial Reviews:
Many scholars have contributed to ongoing debates about the competition between the dollar and the euro for global monetary dominance. Few have added as much value as Miguel Otero-Iglesias with his systematic and original survey of the views of financial elites in major emerging market economies. Where conventional interpretations emphasize material "reality," Otero-Iglesias's ideational analysis clearly demonstrates how important it is to consider as well how "reality" is perceived and framed by key actors. The euro may be structurally weak, limiting its "hard" power. But at the cognitive level of "soft" power, Otero-Iglesias suggests, Europe's money poses a significant challenge to America's greenback. This is an argument to be taken seriously.
Benjamin J. Cohen, Louis G. Lancaster Professor of International Political Economy University of California, Santa Barbara, USA.
This is a book I’ve been waiting for: a detailed analysis of what financial elites in the large reserve-holding countries are thinking about the future of the international monetary system. Drawing on extensive research, Miguel Otero-Iglesias argues persuasively that the views of authorities in China, Brazil, and the Gulf states matter enormously for the future of the global roles of dollar and the euro. An engaging and innovative book that makes a major contribution to our understanding of the world’s money."
Eric Helleiner, Faculty of Arts Chair in International Political Economy and Professor in the Department of Political Science of the University of Waterloo
In this original, well written and carefully researched book, Otero-Iglesias suspends motion in this fast moving story of currency rivalry to give the reader a view into the deeper logic of global monetary change. The author has synthesized skilfully across a wide spectrum of perspectives, from various systemically important emerging countries, and for which he has accessed key financial elites, and policy shapers, in China and Brazil, as well as the Gulf States. This book is truly a must read for scholars of the politics of the international monetary system, especially those with an eye to systemic change.
Gregory T. Chin, Associate Professor, York University, Canada and Co-Editor, Review of International Political Economy'

About the Author:
Miguel Otero-Iglesias is Senior Analyst on the European Economy and the Emerging Markets at the Elcano Royal Institute in Spain and Research Fellow in International Political Economy at the EU-Asia Institute at ESSCA School of Management in France.

For more info go here.

***My RIPE paper with Matias Vernengo, "Hegemonic Currencies During The Crisis, The Dollar Versus The Euro In a Cartalist Perspective" (see here), is cited.

Tuesday, September 9, 2014

Keynes (1930) on Economic Possibilities for Our Grandchildren

Below is an excerpt from Keynes' "Essays In Persuasion" (1930), in which he provides his invaluable insights on human potentialities concerning human freedom during the Great Depression.  Notice that the overall message is quite relevant to the turbulence of today. (h/t to Nate Cline for noticing that in the first part of the essay Keynes, in fact, is very un-Keynesian in the sense that he accepts the 'natural rate' theory of capital & unemployment).
We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down – at any rate in Great Britain; that a decline in prosperity is more likely than an improvement in the decade which lies ahead of us. I believe that this is a wildly mistaken interpretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another. The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium requires. And even so, the waste and confusion which ensue relate to not more than 7½ per cent of the national income; we are muddling away one and sixpence in the £, and have only 18s. 6d., when we might, if we were more sensible, have £1; yet, nevertheless, the 18s. 6d. mounts up to as much as the £1 would have been five or six years ago. We forget that in 1929 the physical output of the industry of Great Britain was greater than ever before, and that the net surplus of our foreign balance available for new foreign investment, after paying for all our imports, was greater last year than that of any other country, being indeed 50 per cent greater than the corresponding surplus of the United States. Or again-if it is to be a matter of comparisons – suppose that we were to reduce our wages by a half, repudiate four fifths of the national debt, and hoard our surplus wealth in barren gold instead of lending it at 6 per cent or more, we should resemble the now much-envied France. But would it be an improvement? The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface to the true interpretation. of the trend of things. For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time – the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments. My purpose in this essay, however, is not to examine the present or the near future, but to disembarrass myself of short views and take wings into the future. What can we reasonably expect the level of our economic life to be a hundred years hence? What are the economic possibilities for our grandchildren? 
Read rest here.

Don't Cry For Me Scotland? Bill Black on Failed Banks and Scottish Independence

By Bill Black
I do not know whether the Scots should vote for independence.  I assume that the odds are they will vote against it.  I do know that the reasons advanced for voting against independence by business interest are false.  Indeed, the opposite of what they claim is far more likely to be true.  What I find a joy to behold, however, is the suggestion by the banksters that the Scots should get their economic advice about independence from a group of failed and often fraudulent parasites and that they should avoid any action that creates “uncertainty” or would cause them to act as a Nation rather than a U.K. province.  There is a serious effort to make independence from the Brits sound like the path of economic madness. Each of these asserted business bases for cowering from independence is an insult to the people of Scotland.  In an irony that, if the polls are accurate, is increasingly sensed by Scots, the business arguments against independence, unintentionally, have made a compelling case for independence.  The thrust of the Brit’s strategy is to promise that they will try to cripple Scotland economically should it vote to restore its independence and sovereignty.  Thus we see the English, and their EU allies, claiming that they would prevent Scotland from joining the EU or extort it to adopt the euro (a terrible idea) as a condition of entry into the EU, block its ability to continuing to use the pound as its currency, and even major businesses in Scotland threatening to flee the Nation should it vote in favor of independence.  Labor leader Ed Miliband went so far as to threaten to place armed border guards on the border with Scotland should the Scots vote to restore their sovereignty.
Read rest here.

Decent work is all you need

The International Labor Organization (ILO) argues that beyond the Millennium Development Goals (MDGs), the international community should also address the structural underpinnings behind poverty, inequality and sustainability, the lack of decent jobs.

Sunday, September 7, 2014

William K. Tabb on the Criminality of Wall Street

By William K. Tabb
The current stage of capitalism is characterized by the increased power of finance capital. How to understand the economics of this shift and its political implications is now central for both the left and the larger society. There can be little doubt that a signature development of our time is the growth of finance and monopoly power. In 1980 the nominal value of global financial assets almost equaled global GDP. In 2005 they were more than three times global GDP. The nominal value of foreign exchange trading increased from eleven times the value of global trade in 1980 to seventy-three times in 2009. Of course it is not certain what this increase means, since such nominal values can fluctuate widely, as we saw in the Great Financial Crisis. They cannot be compared directly and without all sorts of qualifications to the value added in the real economy. But they do give an impressionistic sense of the enormous magnitude by which finance grew and came to dominate the economy. Between 1980 and 2007, derivative contracts of all kinds expanded from $1 trillion globally to $600 trillion. Hedge funds and private equity groups, special investment vehicles, and mega-bank holding companies changed the face of Western capitalism. They also brought on the collapse from which we still suffer. Ordinary people may not be acquainted with the numbers (and even those best informed are not sure of their significance), but people generally understand in different and often deep ways what has been happening: namely, an ongoing process of financialization that has come to dwarf production.
Read rest here.

Saturday, September 6, 2014

Institutions, what institutions?

There are many explanations for why some nations are rich while others are poor. The dominant view, in mainstream (neoclassical) economic circles is that institutions are the central cause of the divide between developed (center) and underdeveloped (periphery). I discussed before (here and here) the role of institutions vis-à-vis geography and culture. I have also noted how the New Institutionalist argument concentrates on the institutions (fundamentally property rights) that act on the supply side of the economy. That is growth arises because property rights provide incentives for productive investment. I also noted (here) that the historical evidence for patents, copyright and other forms of property protection for explaining growth is limited at best. Note that mainstream authors and heterodox authors, at least the majority, tend to agree that institutions rather than geography or culture are central for development.
Also, the table above suggests that cultural and geographical explanations tend to put an emphasis on the supply side, but that is not necessarily the case, and it would be difficult to speculate about what Jared Diamond, for example, thinks about the relative role of supply and demand. Also, it’s worth noticing that while in his early work economic historian David Landes favored a demand-led view (which I tentatively put in the institutional box) he clearly moved to a cultural supply-side interpretation in his later work.

So if you believe most heterodox economists institutions are relevant, but not primarily those associated to the supply side; the ones linked to the demand side, in Keynesian fashion are more important than the mainstream admits. Poor countries that arrive late to the process of capitalist development cannot expand demand without limits since the imports of intermediary and capital goods cause recurrent balance of payments crises. The institutions that allow for the expansion of demand, including those that allow for higher wages to expand consumption and to avoid the external constraints, are and have been central to growth and development. The role of the State in creating and promoting the expansion of domestic markets, in the funding of research and development, and in reducing the barriers to balance of payments constraints, both by guarantying access to external markets (sometimes militarily, like in the Opium Wars) and reducing foreign access to domestic ones was crucial in the process of capitalist development.

In this view, for example, what China did not have that England did, was not lack of secure property rights and the rule of law, but a rising bourgeoisie (capitalists) that had to compete to provide for a growing domestic market that had acquired a new taste (and hence explained expanding demand) for a set of new goods, like cotton goods from India, or china (porcelain) from… well China, as emphasized by economic historian Maxine Berg among others (for the role of consumption in the Industrial Revolution go here). Or simply put, China did not have a capitalist mode of production (for the concept of mode of production and capitalism go here). Again, I argued that Robert Allen’s view according to which high wages and cheap energy forced British producers to innovate to save labor, leading to technological innovation and growth, and the absence of those conditions in China led to stagnation is limited since it presupposes that firms adopt more productive technologies even without growing demand.

The same is true of Latin American economies, which several authors like Engerman Sokoloff suggest fell behind as a result of absence of secure property rights. Latin American economies entered the world economy to produce silver (mining-economy/Amerindian population), sugar (plantation-economy/African-American population) and other commodities, for external markets. They were exploitation colonies, less reliant on the development of domestic markets, typical of settlement colonies in the Northeast United States or of the central countries in Western Europe.

The economies that depend on the production of commodities for world markets and import everything else are more vulnerable to the fluctuations of the price of commodities. Booms in commodity prices lead to growth, albeit very concentrated in the hands of the owners of capital, but they leave very little in terms of infrastructure for future growth. Further, since the economy must import everything to satisfy domestic demand, the economy is dependent on external sources of production, and when the export of commodities does not allow for enough imports, then either demand must be curtailed or the economy must become indebted to be able to continue to consume. A thriving domestic market is central for economic development, and the ability to diversify production to provide for the market is the key to catching up.

Finally, since the economy was based on the mono-production of commodities (and the size of the domestic markets is relatively limited) there were little if any incentives for technological innovation and higher productivity. Note also, that once a country falls behind, and almost all countries were essentially at the same level of income per capita around 1800 (or at least differences were considerably smaller than now), it is very hard to catch up, since the distance to the technological frontier is increasingly steep. It is not the same to copy a textile mill that uses a steam engine than to emulate the development of the Silicon Valley. In this sense, the institutions associated to the colonization period are central, rather than property rights, to explain underdevelopment in Latin America. Capitalism and its institutions both caused growth in the center, and stagnation in the periphery.*

* I discussed here how the industrialization of Britain meant the deindustrialization of India and China.

Friday, September 5, 2014

Employment growth still slow

For those still in doubt on whether the Fed should or should not raise interest rates, the news today send a clear message. Only 142K jobs created in August, and unemployment steady at 6.1%. BLS report here. Graph below shows monthly change in non-farm employment.
Employment, as noted before, is above the pre-recession level, but not by much, and given the growth of population, it's not surprising that the labor market is not doing particularly well. So inflation hawks have clearly misplaced expectations.

Thursday, September 4, 2014

The US Net International Investment Position (IIP)

The graph below shows the Net International Investment Position (IIP) as a share of GDP for the US, since 1976. The last report by the Bureau of Economic Analysis (BEA) is available here. Note that by the first quarter of the year the IIP corresponded to US$ 5.5 trillion, or slightly more than 30% of GDP.
The IIP position has been negative since the late 1980s, which is the reason why economists argue that the US is a debtor country. The negative position follows as a result of the persistent current account (CA) deficits, which imply that foreigners accumulate dollars and dollar denominated assets. A negative IIP means that foreigners have more financial claims on residents than vice versa, and is seen often as a problem for most countries.

The conventional view also suggests that CA deficits are not dangerous if they finance domestic investment, which leads to growth, and presumably higher exports, even though this is often not explained by mainstream authors that tend to forget that most countries borrow in foreign currency. In this case, in which the CA deficits allow for higher exports in the future, a negative IIP is seen as sustainable. On the other hand, if the CA is used to finance consumption, then the negative IIP would be unsustainable. Many analysts think that the US IIP is not sustainable and from time to time someone suggests that a run of the dollar is possible. For example, Paul Krugman famously predicted that a run on the dollar would eventually occur, what he termed a 'Wile E. Coyote moment,' in which agents holding dollars would finally get that the floor was gone, and the dollar would depreciate sharply (this was before the Lehman's collapse and the run for dollar denominated assets, and the appreciation of the dollar; subsequently the gradual depreciation of the dollar returned, but so far no Wile E. Coyote moment).

Some mainstream authors are also puzzled by the fact the US, in spite of having persistent CA deficits and a large and negative IIP, has consistently had a positive net investment income position. In other words, interest and profits resulting from holding foreign assets has exceeded the payments of income to owners of US assets. Hausmann and Sturzenegger argued creatively (let's call it that) that the reason for this 'paradox' is that the CA does not measure well the net international investment position, since insurance and liquidity services go unaccounted. Their adjusted measure to add those invisible services, which they refer to as 'dark matter'* would explain the paradox, and why the US IIP is sustainable after all.

Note, however, that once one takes into account that the US holds the reserve/vehicle currency much of the discussion about the dangers of the CA deficits, the sustainability of IIP and the paradox of the positive net investment income position sort of vanishes. US debts are in dollars, which implies that there is no possibility of default in a fiat system. Chartalism holds in the open economy too.

The US does not need to export to obtain dollars, and how it uses the accumulation of financial claims on the US by foreigners is not crucial for sustainability. Holding the key currency does NOT come without consequences, but those are not the ones often suggested by the mainstream. Certainly given US policy choices there has been a loss of industrial jobs in the Rust Belt, yet as noted in another post, not with a significant loss in terms of technological advantage for US corporations. The consequence, thus, of the hegemonic position of the dollar, together with other policy choices (e.g. financial deregulation, lower taxes for the wealthy, deregulation of labor markets, etc.) has been one that affected the balance between labor and capital domestically.

Also, there is no need for dark matter, or other neologisms, to understand why the US has positive net investment income flows. By definition, the key currency is the risk free asset, and hence investments denominated in other currencies must pay a risk premium. Yes, sure BOP accounts are imperfect, like NIPA or any other measure of the economy. But there is no need to revamp the BOP accounts to get that the US CA deficit and the negative IIP are not really unsustainable.

* Hausmann has a flair for coining terms for ideas or problems that were well known by heterodox authors, and to incorporate them inconspicuously in the mainstream discourse. He refers to the notion that developing countries cannot borrow long term in their own currency as "the original sin." Note that the original sin is exactly the notion suggested by Prebisch, Kaldor, Thirlwall and others, that argue that since these countries cannot borrow internationally, and must pay with exports in the long run, then the CA becomes a constraint for economic growth.

Tuesday, September 2, 2014

How well has Brazil done during the Workers' Party administration?

First, let me be absolutely clear. I do in general favor the current administration in Brazil, as much as other left of center governments in South America. But I do understand some of the critiques from the left (not the right wing conservatives that are against social spending and more redistribution of income). A good example of the limits to the current experience in the region are provided by the Brazilian case.

Recently a post (in Portuguese; full disclosure one of the authors is a friend) went viral in Brazil. It showed how much Brazil has grown during Lula/Dilma, from the Workers' Party (PT, in Portuguese) compared to the rest of the world, and advanced economies, and the same exercise done for the Fernando Henrique Cardoso (FHC), from the Brazilian Social Democratic Party (PSDB in Portuguese) period.

Clearly, the FHC period (1995-2002) is worse than the Lula/Dilma period (2003-2014), in which the last year is an estimate (all data, as in the viral post, from the IMF's World Economic Outlook). In the Workers' Party period Brazil was growing faster and keeping pace with the rest of the world, and catching up, growing faster than advanced economies.

However, as noted in this blog several times (Dean Baker has been one of the few others that noted this in the US; part of debunking the BRICS myth) Brazil has not grown really that fast. Instead of comparing with advanced economies and the rest of the world, the picture changes a bit if one does it with developing countries, as shown below.
Note that while it is true, as it should be, that Brazil catches up with the advanced economies during the Lula/Dilma period and not so during the FHC one, it is also the case that the Brazilian performance when compared to developing countries is far from stellar. In that sense, there is a certain frustration about the lost possibilities. Mind you, conservative views that Brazil needs to return to more rigid fiscal surpluses, and tighter inflation targeting (presumably with an independent central bank, and higher rates of interest) are NOT the solution. But that is the topic of another post, I guess.

PS: I should note that there is also a frustration on part of the left in the US with Obama, and the notion that an opportunity was lost. In that respect, there is a similarity between left of center critics of the Workers' Party and the US counterparts.

Sunday, August 31, 2014

Riccardo Bellofiore on why Italy’s stagnation could be future for Euro Zone

From The Guardian
This summer Italy fell into a triple-dip recession. After the 2008/09 collapse, the economy stagnated, heading back into recession during 2011 and never really recovering. The philosophy of Giulio Tremonti, who was the economic minister at the time, was to wait and see, until speculation killed Berlusconi’s government. Prime ministers Mario Monti and Enrico Letta followed Brussels’ self-defeating diktat for fiscal rigour, but even with moderate deficits the public debt/GDP ratio soared. The situation remained under control only thanks to the zero rate of interest and rhetoric by the European central bank president, Mario Draghi. Then came along Matteo Renzi, and Italian economic policy was all talk, talk, talk. While turning the screw of authoritarian parliamentary and electoral reforms, future lower taxes and liberalisations are promised to compensate for public cuts and to attract foreign investments. The €80 monthly tax break to lower-paid workers did not raise household consumption, and was instead spent on tariffs and local taxes. Yet in the past few weeks the outlook has changed, with 2014 second-quarter data showing France flat and Germany experiencing negative growth. Greece, Spain and Portugal registered rosier figures only because they were recovering from severe austerity. The eurozone cannot but be driven by the three biggest economies alone. This is a continental crisis within an anaemic global economy. However, an old Gramscian truth about Italy must be remembered: the “backwardness” of its capitalism is paradigmatic. Europe’s exit from the crisis needs the same policies that Italy needs, and without them Italy’s stagnation is the future for the entire continent.
Read rest here.

Saturday, August 30, 2014

Mundell-Fleming, Independent Central Banks, Inflation and Openness

Bucknell's Academic West (Bertrand Library in the background)

Teaching international finance this semester, after a long while. At Utah I taught mostly intermediate macro and Latin American Development for undergrads (and macro and history of thought for graduate students), and the eventual elective. But here the course was up for grabs, so to speak. Decided to use Peter Montiel's International Macroeconomics, since his books always provide competent presentations of the mainstream views, plus having worked at the IMF and World Bank, he always tries to cover real problems with plenty of developing country examples.

The limitation of the book is, as it should be expected, that the mainstream analytical view is, as Montiel's (p. x) says: "a generalized and modernized [sic] version of the original Mundell-Fleming model." The book does present in the last chapter the 'modern' intertemporal approach to the current account. In a later post I'll discuss the limitations of the Mundell-Fleming model, but for those interested check this paper by Serrano and Summa. In other words, Montiel's book can present the mainstream views, but lacks any critical perspective, which is not uncommon, but certainly problematic given the poor state of the mainstream understanding of how the economy works.

It is illustrative of the lack of alternatives in the book, the presentation of the relation between openness and inflation. Montiel's follows the evidence on an inverse relation between openness (that can be measured in many ways: import share, imports plus exports over GDP, etc.) and inflation presented in David Romer's well-known paper (see here). Montiel argues that in closed economies governments might tend to run fiscal deficits, that if monetized, would lead to inflation. In a more open economy, the higher deficits and inflation would lead to higher rates of interest, since international creditors faced with a risky government would demand a higher premium. In this context, "the higher interest rates that the government has to pay would tend to discourage excessively expansionary fiscal policies, thus reducing pressures on central banks to expand the money supply." If the central bank is more autonomous or independent from the Treasury then you should expect also less inflation (that would be Bernanke's explanation for the Great Moderation; here).

Many problems, as you can see. Yes, for Montiel inflation is caused by excess demand (fiscal deficits) and by increasing money supply, which seems to be what the central bank controls (let alone that all central banks control really the rate of interest). Worse, in a sense, is the notion that fiscal deficits in domestic currency (presumably, since nothing is said), may cause foreign investors to punish the government. Note that what should have investors concerned would be the current account surplus (which provides foreign reserves) and the amount of foreign reserves held by the central bank. The evidence on interest rates and fiscal deficits, by the way, is less than forthcoming for Montiel's story (see here).

A simple alternative suggests that inflation more often than not is caused by cost pressures, rather than excess demand, and that two of the main sources of cost pressures are the prices of imported goods and wage pressures. In a more open economy, in which firms are faced with competition from foreign firms, and workers might be afraid of losing their jobs, then wage resistance might be subdued. Note that over the last few decades unionization rates have declined and that also constrains the ability of workers to demand higher wages (see here). In this case, lower inflation in the globalized economy has been predicated on a weaker labor force that faces more international competition, and is more willing to accept stagnant wages. Inequality and stagnant wages, rather then well-behaved governments and independent central banks are behind the Great Moderation in this story.

Two ex-graduate students of mine (yes, someone was paying attention after all) teamed up and provided some empirical evidence in favor of the alternative story (go here). If you want to see alternative views on inflation, implicit in this discussion, go to the linked posts and papers here.