Krugman vs. Keen

from John Balder and the current issue of the RWER

To explore the origins of the global financial crisis, the first step is to specify the relationship between banking, money and credit. According to the mainstream view, a bank serves as an intermediary between a borrower and a lender. As a pure intermediary, a bank has no impact on real economic activity. This view – taught in most Economics 101 textbooks – implicitly assumes that money is available in finite quantities that are regulated by the central bank.

Several years ago, Paul Krugman and Steve Keen engaged in an enlightening back-and-forth about banking, money and credit. The discussion examined whether banks lend existing money (implying money is neutral) or newly create the money they lend (money is not neutral).

Economist	Category	Result
Krugman (2012)	Money is neutral	Banks lend already existing money
Keen (2011, 2017)	Money is not neutral	Banks newly create the money they lend

In support of neutral money (mainstream view), Krugman (2012) casually asserts:

“Think of it this way: when debt is rising, it’s not the economy, as a whole borrowing more money. It is rather, a case of less patient people – people who, for whatever reason want to spend sooner rather than later – borrowing from more patient people.”  

Capital and class

from David Ruccio and Jamie Morgan and the current issue of the RWER

The premise and promise of capitalism, going back to Adam Smith, have been that global wealth would increase and serve as a benefit to all of humanity.[1] However, the experience of recent decades has challenged those claims: while global wealth has indeed grown, most of the increase has been captured by a small group at the top. This has continued into the “recovery” in the United States and globally. The result is that an obscenely unequal distribution of the world’s wealth has become even more unequal. Those in the small group at the top have long been able to put distance between themselves and everyone else precisely because they’ve been able to capture the surplus and then convert their share of the surplus into ownership of wealth. And the returns on their wealth allow them to capture even more of the surplus produced within global capitalism. This is accompanied by growing income inequality.

However, although people are aware of inequality, they are typically unaware of its real extent, and mainstream economics and the popular press contribute to this situation, which in turn leads to the reproduction of the system that produces ever-more-grotesque levels of inequality.

Both class and ideology underpin this worsening situation. The tiny group at the top, both nationally and globally, have both an interest and the means to maintain the economic and social rules and institutions that allow them to capture the surplus, and thus create more distance between themselves and everyone else. Meantime, mainstream economic and political discourses, inside and outside the academy, tend to ignore the class conditions and consequences of inequality – and to undermine the possibility of a real debate about the kinds of changes that are necessary to give the majority of people a say in how the surplus is utilized.

Global wealth inequality  

Regression analysis — a constructive critique

from Lars Syll

As a descriptive exercise, all is well. One can compare the average salary of men and women, holding constant potential confounders. The result is a summary of how salaries differ on the average by gender, conditional on the values of one or more covariates. Why the salaries may on the average differ is not represented explicitly in the regression model …

Moving to causal inference is an enormous step that needs to be thoroughly considered. To begin, one must ponder … whether the causal variable of interest can be usefully conceptualized as an intervention within a response schedule framework [a formal structure in which to consider what the value of the response y would be if an input x were set to some vaue]. Once again consider gender. Imagine a particular faculty member. Now imagine intervening so that the faculty member’s gender could be set to ‘male.’ One would do this while altering nothing else about this person …

Clearly, the fit between the requisite response schedule and the academic world in which salaries are determined fails for at least two reasons: The idea of setting gender to male or female is an enormous stretch, and even, if gender could be manipulated, it is hard to accept that only gender would be changed. In short, the causal story is in deep trouble even before the matter of holding constant surfaces … 

Globalization checkmated?

from Thomas Palley and current issue of the RWER

1. Economic failings and the rise of politics

It has been ten years since the financial crisis. Since then, the global economy has recovered and attention has increasingly shifted to political risks as the trigger for the next economic crisis. That shift of attention has been driven by political events like the UK’s Brexit referendum, the election of President Trump, and the rise of anti-euro populist political parties in Italy. Such events have the potential to cause financial disruptions that trigger broader economic dislocation, which in turn could further aggravate political conditions. In effect, we have moved to a world in which politics has become an important potential economic detonator.

The rise of politics is no accident. Instead, it reflects the popularly perceived failings of the neoliberal economic paradigm which has dominated economic policymaking for the past forty years. Since globalization is the most prominent feature of the neoliberal program and has also had some of the most visible negative effects, it has been placed in the forefront of the backlash. That backlash suggests globalization is unlikely to deepen further, and may even unravel a bit.

2. Globalization as economists’ version of the “end of history” fallacy

The challenge to globalization has taken economists by surprise. In many ways, there are parallels between economists’ faith in globalization and Francis Fukuyama’s (1989) “end of history” hypothesis. After the demise of the Soviet Union, Fukuyama prophesied that free market liberal democracy had become the “final form of human government, to which all countries would now converge (Fukuyama, 1989, 3)”.

Trump’s tariffs on Chinese imports are actually a tax on the US middle class

from Dean Baker

In his escalating trade war with China, Donald Trump is acting increasingly like Captain Queeg in the Caine Mutiny. He has imposed a 10 percent tariff on $200 billion in US imports from China, a rate he proposes to increase to 25 percent at the start of the next year. He also is threatening tariffs on the rest of our imports from China, an additional $300 billion in goods and services.

The straight arithmetic tells us that 10 percent of $200 billion is $20 billion on an annual basis. If this rises to 25 percent next year, the tariffs would be $50 billion. If we add in 10 percent tariffs on another $300 billion, that comes to $30 billion, bringing the total to $80 billion.

While Trump talks as though he thinks his tariffs are taxing China, they aren’t. Most immediately, they are a tax on US households. The full $80 billion would come to a bit less than $600 per household.

It is true that the tariffs will not be passed on dollar for dollar. Some companies will decide it’s better to see their profit market squeezed than pass on the full price increase. This means that Apple and Nike may not raise the price for the iPhone and running shoes by the full amount of the tariff.

In that case, a portion of the tax will be borne by US companies manufacturing items in China. This is fine, since corporate profits are near record highs as a share of GDP. But, this is still not taxing China.

There will be some spillovers where either Chinese companies importing items to the US end up with less money or Chinese suppliers selling to US companies are forced to accept less money, but there is little doubt that the bulk of the tariff will be borne by the US. Trump is effectively proposing one of the largest tax increases on the middle class in memory. 

QE and inflation (not), Swiss edition. Two graphs.

 

 

Graph 1. Printing Francs to satisfy external demand for Francs led to a fast increase of the amount of money in Switzerland. Did this lead to inflation?

After 2008 rich people from all over the globe started to  buy Swiss Francs. This, of course led to appreciation of the Swiss Franc. The Swiss national bank didn’t like this: bad for exports. And, related to this but much worse, structural lower demand for export products of a small country like Switzerland will erode the manufacturing base of this country. Highly productive fixed capital, specialized knowledge hubs, production ecosystems – these all will flounder. Not good. What to do?

Switzerland is a monetary sovereign country. In 2011 the national bank decided to print money and sell it at a fixed Euro-price to foreign rich people. This policy was highly succesful: the exchange rate of the Swiss Franc (in Euro) stabilized. The ‘cost’ of this policy was of course that Switzerland assembled an awful amount of foreign currencies. The Swiss did lose their nerve at the end of 2014 and tried to stop this policy. Once the understood that this led to a fast and humongous appreciation of the France, with depressing consequences for the Swiss economy, they re-installed it and again with success. Quite some rich foreigners parked their Franc at normal deposits Swiss bank which led to a doubling of the ‘M3’ amount of exchange money. An interesting question: did this increase in the stock of money lead to inflation? The answer is clear: no, it didn’t. While the revaluation at the end of 2014 did lead to deflation. The money was not used in the exchange economy. It was just stacked away.

Graph 2. Despite the fast increase in the amount of money, the Swiss price level declined (mainly because the Franc became more expensive relative to other currencies)

Models and Reality

from Asad Zaman

When should we believe the unconfoundedness assumption?

from Lars Syll

Economics may be an informative tool for research. But if its practitioners do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfil its task. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics — like yours truly — will continue to consider its ultimate arguments as a mixture of rather unhelpful metaphors and metaphysics.

In mainstream economics, there is an excessive focus on formal modelling and statistics. The models and the statistical (econometric) machinery build on — often hidden and non-argued for — assumptions that are unsupported by data and whose veracity is highly uncertain.

Econometrics fails miserably over and over again. One reason is that the unconfoundedness assumption does not hold. Another important reason why it does is that the error term in the regression models used is thought of as representing the effect of the variables that were omitted from the models. The error term is somehow thought to be a ‘cover-all’ term representing omitted content in the model and necessary to include to ‘save’ the assumed deterministic relation between the other random variables included in the model. Error terms are usually assumed to be orthogonal (uncorrelated) to the explanatory variables. But since they are unobservable, they are also impossible to empirically test. And without justification of the orthogonality assumption, there is, as a rule, nothing to ensure identifiability:

With enough math, an author can be confident that most readers will never figure out where a FWUTV (facts with unknown truth value) is buried. A discussant or referee cannot say that an identification assumption is not credible if they cannot figure out what it is and are too embarrassed to ask.

Distributional assumptions about error terms are a good place to bury things because hardly anyone pays attention to them. Moreover, if a critic does see that this is the identifying assumption, how can she win an argument about the true expected value the level of aether? If the author can make up an imaginary variable, “because I say so” seems like a pretty convincing answer to any question about its properties.

Paul Romer

Socialism, economics, and the Left

from David Ruccio

Last month, Alexander Beunder, the editor of Socialist Economist, asked a handful of “expert economists from around the world”—including Johanna Bockman, Prabhat Patnaik, Andrew Kliman, and myself—two key questions concerning the problems and prospects for socialism, economics, and the Left in the world today. Beunder requested that we keep our answers to two hundred words.

Our answers are now posted on-line, which can be read by clicking on the links below. Here are mine:

What economic obstacles is the Left facing in the 21st Century? 

The spectacular failures of capitalism in the United States have provided fertile ground for a renewed interest in socialism. These include the punishments meted out by the Second Great Depression, the lopsided nature of the current recovery, and a decades-old trend of obscene and still-rising inequality. In addition, the increasing indebtedness associated with higher education, the high cost and limited access to healthcare, and the growing precariousness of the workplace have left working-class Americans, especially young workers, with gnawing financial insecurity — and growing support for socialism. However, the U.S. Left currently faces two main economic obstacles: the decline in labor unions and an attempt to regulate capitalism. During the postwar Golden Age, union representation peaked at almost 35%. Now, it is down to 11.1% — and only 6.6% in the private sector. At least in part as a result, the Left has shifted its focus more to regulating capitalism, often by invoking a nostalgia for manufacturing and using the theoretical lens of Keynesian economics, and moving away from criticizing capitalism, especially its class dimensions (particularly the way the surplus is appropriated and distributed, as Marxists and other socialists understand them).

Getting serious about debt and deficits: the deficit hawks did enormous harm to our kids

from Dean Baker

Debt and Deficits, Again

With the possibility that the Democrats will retake Congress and press demands for increased spending in areas like health care, education, and child care, the deficit hawks (DH) are getting prepared to awaken from their dormant state. We can expect major news outlets to be filled with stories on how the United States is on its way to becoming the next Greece or Zimbabwe. For this reason, it is worth taking a few moments to reorient ourselves on the topic.

First, we need some basic context. The DH will inevitable point to the fact that deficits are at historically high levels for an economy that is near full employment. They will also point to a rapidly rising debt to GDP ratio. Both complaints are correct, the question is whether there is a reason for anyone to care.

Just to remind everyone, the classic story of deficits being bad is that they crowd out investment and net exports, which makes us poorer in the future than we would otherwise be. The reason is that less investment means less productivity growth, which means that people will have lower income five or ten years in the future than if we had smaller budget deficits. Lower net exports mean that foreigners are accumulated U.S. assets, which will give them a claim on our future income.

Debt is bad because it means a larger portion of future income will go to people who own the debt. This means that the government has to use up a larger share of the money it raises in taxes to pay interest on the debt rather than for services like health care and education. Or, to put it in a more Keynesian context, there will be more demand coming from people who own the debt, which means the government would need higher taxes, to support the same level of spending, than would otherwise be the case. 

The subtleties of effective demand

from Asad Zaman

As I read more and more about effective demand, I got more and more confused — how can I explain this concept to my poor students, if I don’t understand it myself? There are a huge number of articles with different and conflicting views and interpretations of this concept, which Keynes describes as being central to his theory. Let me proceed to clarify the insights that have resulted from struggling with this material, and going through many iterations of revisions in terms of how to make sense of this theory.

Keynes and followers — both the Hicks-Hansen-Samuelson variety, as well as true blue post Keynesians — argue that it is deficiencies in the Aggregate Demand which lead to the unemployment equilibrium which is central to Keynesian economics. Stated in very simple terms, the argument can be phrased like this. The process of production generates factor incomes. These incomes are exactly the source of the demand for the product. If all the income generated is always spent on purchase of products, then the aggregate demand will exactly equal the aggregate supply — this is Say’s Law. In this case, there is no concept of shortfall in aggregate demand which could lead to unemployment.

However, Keynes and his followers deny the equality. They argue that some portion of the factor income could go into savings, thereby lowering the aggregate demand. Now the aggregate demand could be greater or lesser than the aggregate supply. An equilibrium would occur when the two are the same, but there is no guarantee that this equilibrium would occur at full employment. The standard diagram used to illustrate this idea is given below:  read more

Re-examining economic laws

from Lars Syll

In mainstream economics, there is a lot of talk about ‘economic laws.’ The crux of these laws that allegedly do exist in economics, is that they only hold ceteris paribus. That fundamentally means that these laws only hold when the right conditions are at hand for giving rise to them. Unfortunately, from an empirical point of view, those conditions are only at hand in artificially closed nomological models purposely designed to give rise to the kind of regular associations that economists want to explain. But — since these laws do not exist outside these socio-economic machines, what is the point in constructing thought experimental models showing these non-existent laws? When the almost endless list of narrow and specific assumptions necessary to allow the ‘rigorous’ deductions are known to be at odds with reality, what good do these models do?

Deducing laws in theoretical models is of no avail if you cannot show that the models — and the assumptions they build on — are realistic representations of what goes on in real life.

Conclusion? Instead of restricting our methodological endeavours at building ever more rigorous and precise deducible models, we ought to spend much more time improving our methods for choosing models! 

The real problem with free trade

from Jayati Ghosh

Even if free trade is ultimately broadly beneficial, the fact remains that as trade has become freer, inequality has worsened. One major reason for this is that current global trade rules have enabled a few large firms to capture an ever-larger share of value-added, at a massive cost to economies, workers, and the environment.

For most critics of globalization, trade is the villain, responsible for deepening inequality and rising economic insecurity among workers. This is the logic driving support for US President Donald Trump’s escalating tariffs. Why, then, does the message resonate far beyond the United States, and even the advanced economies, to include workers in many of the developing countries that are typically portrayed as globalization’s main beneficiaries?

Free trade is hardly the only – or even primary – source of inequality and insecurity worldwide. Surprisingly, one enduring problem that provokes far less popular backlash is that finance continues to dominate the world economy, generating substantial instability and mounting risks like those that led to the 2008 global financial crisis.

Moreover, some countries continue to pursue fiscal austerity, instead of consolidating their budgets by, say, addressing large-scale tax avoidance and evasion by major companies and wealthy individuals. And labor-saving innovations continue to be developed and deployed, producing “technological unemployment” among some groups.

Some argue that free trade is being demonized simply because people do not understand what is in their own best interest. But that is both patronizing and simplistic. Even if free trade is ultimately broadly beneficial, the fact remains that as trade has become freer, inequality has worsened. 

Cheap tricks with economic statistics: the democratic version

from Dean Baker

We all know Donald Trump’s tendency to make up numbers to tell everyone what a great job he is doing as president. People are rightly appalled, both that Trump is not doing a great job, but also that he is lying to imply otherwise.

While Trump is clearly over the top in just inventing data to back his argument, Democrats are also often not very straightforward in assessing the data. We got a dose of that last week when there were complaints that the rate of income growth had slowed down in 2017 compared with 2016 and 2015.

Workers should be unhappy about the pace of income growth. They have much ground to make up following the losses of the Great Recession and the weak growth even prior to the downturn, but the main reason that income growth was slower in 2017 than in 2016 and 2015 is that oil, and energy prices more generally, rose in 2017 after falling the prior two years.

As a result of the reversal in oil prices, inflation was 2.1 percent in 2017, compared to 1.3 percent in 2016, and just 0.1 percent in 2015. This means that even though there was a very modest acceleration in nominal wage growth, and comparable gains in employment in all three years, the growth in income adjusted for inflation was far lower in 2017 than in the prior two years.

Workers have to pay for gas and heating oil, so the rise in energy prices does affect their living standards. In that sense, the weaker income growth in 2017 is very real, but this hardly represents some new failure of the political system. The speeding of income growth in 2015 and 2016, and its slowing in 2017, are just the story of fluctuating world oil prices, which any honest analyst should acknowledge. 

real-world economics review – issue no. 85

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18 September 2018
issue no. 85
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Globalization checkmated?
Thomas Palley          download pdf

Post-crisis, next crisis

Capital and class: Inequality after the crash
David Ruccio and Jamie Morgan          download pdf

Post-crisis perspective: sorting out money and credit and why they matter!
John M. Balder           download pdf 

With their back to the future, will past earnings trigger the next crisis?
Shimshon Bichler and Jonathan Nitzan           download pdf              

Changing economics

Radical paradigm shifts
Asad Zaman           download pdf   

How to transform economics and systems of power?
Deniz Kellecioglu            download pdf      

Economics and normativity in four sections
Jamie Morgan           download pdf       

From Pareto economics, to Pareto politics, to fascism
Jorge Buzaglo             download pdf                  

Trump politics towards Mexico:
Alicia Puyana           download pdf                       

Note: The structure of “crowding out” is reappearing
Leon Podkaminer          download pdf

Board of Editors, past contributors, submissions, etc.       

The best way to remove corruption in medicine: take the money out

from Dean Baker

Former New England Journal of Medicine editor Marcia Angell had an op-ed in the NYT explaining how efforts to increase transparency had not ended the corrupting influence of money on medical research. Her piece describes various ways in which the researchers who get money from drug companies bend research to favor their benefactors.

While Dr. Angell suggests some reforms, there is an obvious one that is overlooked: take the money out. Drug companies have incentives to bend research findings because patent monopolies allow them to sell their drugs at prices that are several thousand percent above the free market price.

As every good economist knows, when the government puts in an artificial barrier that raises prices above the free market price it is creating an incentive for corruption. However, they are usually thinking about gaps like those created by Trump’s 10 or 25 percent tariffs that are supposed to punish our trading partners.

They usually don’t think about the corruption from patent monopolies that allow drug companies to sell drugs for tens of thousands of dollars that would sell for a few hundred dollars as a generic. But the same principle applies, with the incentives for corruption being proportionately larger.

The economist’s remedy would be the same in both cases: get rid of the artificial barrier. We could do this by paying for drug research upfront and make all findings fully public and place all patents in the public domain (discussed here and in Rigged Chapter 5). This would allow all new drugs to be sold at generic prices. There would then be no more incentive to make payoffs to doctors to help promote drugs.

Kant’s blunder

from Asad Zaman

What is a model? How does it relate to reality? This question has been discussed thoroughly in previous post on  Models and Reality , and briefly in previous lectures. Western understanding of models was derailed by a complex set of historical accidents. This is a tangled tale with bewildering twists and turns, some aspects of which are discussed in “Deification of Science and Its Disastrous Consequence“, and some others in Logical Positivism and Islamic Economics . The reason we need to tell this story is because without understanding it, it is impossible to understand why Friedman could say, without being laughed out of court, that “Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions.” Similarly, how could Lucas and Sargent make assumptions that are certifiably crazy, and receive Nobel Prizes and accolades? To understand why completely crazy understanding of models currently dominates the economics profession, it is necessary to understand some aspects of this story. Nonetheless, it is too long and difficult a task, so we will vastly oversimplify, and pin all the blame on poor stodgy German philosopher Kant — not that he does not deserve a lot of blame, but he also had a lot of accomplices, both before and after. A more nuanced account must be left for a much longer treatment by someone much more knowledgeable about Western philosophy and intellectual history. For students of economics, a brief explanation can be provided by looking at a key turning point, called a “Copernican Revolution” by Kant himself.  read more

The bank bailout of 2008 was unnecessary

from Dean Baker

Last week marked 10 years since the harrowing descent into the financial crisis — when the huge investment bank Lehman Bros. went into bankruptcy, with the country’s largest insurer, AIG, about to follow. No one was sure which financial institution might be next to fall.

The banking system started to freeze up. Banks typically extend short-term credit to one another for a few hundredths of a percentage point more than the cost of borrowing from the federal government. This gap exploded to 4 or 5 percentage points after Lehman collapsed. Federal Reserve Chair Ben Bernanke — along with Treasury Secretary Henry Paulson and Federal Reserve Bank of New York President Timothy Geithner — rushed to Congress to get $700 billion to bail out the banks. “If we don’t do this today we won’t have an economy on Monday,” is the line famously attributed to Bernanke.

The trio argued to lawmakers that without the bailout, the United States faced a catastrophic collapse of the financial system and a second Great Depression.

Neither part of that story was true.

Still, news reports on the crisis raised the prospect of empty ATMs and checks uncashed. There were stories in major media outlets about the bank runs of 1929.  

Minskyan reflections on the ides of September

from Jan Kregel  source

The 10th anniversary of the September collapse of the US financial system has led to a number of commentaries on the causes of the Lehman bankruptcy and cures for its aftermath. Most tend to focus on identifying the proximate causes of the crisis in an attempt to assess the adequacy of the regulations put in place after the crisis to prevent a repetition. It is interesting that while Hyman Minsky’s work became a touchstone of attempts to analyze the crisis as it was occurring last September, his work is notably absent in the current discussions.

While it is impossible to discern how Minsky might have answered these questions, his work does provide an indication of his likely response. Those familiar with Minsky’s work would recall his emphasis on the endogenous generation of fragility in the financial system, a process building up over time as borrowers and lenders use positive outcomes to increase their confidence in expectations of future success. The result is a slow erosion of the buffers available to cushion disappointment in those overconfident expectations. And disappointed these expectations must be, for, as Minsky argued, the confirmation of expectations of future results depends on decisions that will only be taken in the future. Since these decisions cannot be known with certainty, today’s expectations are extremely unlikely to be fully validated by future events. In a capitalist economy financial commitments are financed by incurring debt, so the disappointment of expectations will produce a failure to validate debt, leading to the inexorable transformation of financial positions from what Minsky called “hedge” to “speculative” to “Ponzi” financing structures. These structures refer to the ability of current cash flows to meet these commitments.

Tony Lawson vs Uskali Mäki

from Lars Syll

We are all realists and we all — Mäki, Cartwright, and I — self-consciously present ourselves as such. The most obvious research-guiding commonality, perhaps, is that we do all look at the ontological presuppositions of economics or economists.

Where we part company, I believe, is that I want to go much further. I guess I would see their work as primarily analytical and my own as more critically constructive or dialectical. My goal is less the clarification of what economists are doing and presupposing as seeking to change the orientation of modern economics … Specifically, I have been much more prepared than the other two to criticise the ontological presuppositions of economists—at least publically. I think Mäki is probably the most guarded. I think too he is the least critical, at least of the state of modern economics …

One feature of Mäki’s work that I am not overly convinced by, but which he seems to value, is his method of theoretical isolation (Mäki 1992). If he is advocating it as a method for social scientific research, I doubt it will be found to have much relevance—for reasons I discuss in Economics and reality (Lawson 1997). But if he is just saying that the most charitable way of interpreting mainstream economists is that they are acting on this method, then fine. Sometimes, though, he seems to imply more …

I cannot get enthused by Mäki’s concern to see what can be justified in contemporary formalistic modelling endeavours. The insights, where they exist, seem so obvious, circumscribed, and tagged on anyway …

As I view things, anyway, a real difference between Mäki and me is that he is far less, or less openly, critical of the state and practices of modern economics … Mäki seems more inclined to accept mainstream economic contributions as largely successful, or anyway uncritically. I certainly do not think we can accept mainstream contributions as successful, and so I proceed somewhat differently …

So if there is a difference here it is that Mäki more often starts out from mainstream academic economic analyses accepted rather uncritically, whilst I prefer to start from those everyday practices widely regarded as successful.

Tony Lawson