The difference a price level makes

The European Central Bank targets the consumer price level, among other reasons because neoclassical macro-economic models often picture a world where this is the only level which matters. Indeed, as there is only one product in quite some models, the only level which even can exist. In reality, money is not only used to purchase vegetables and cars (household consumption) but also to pay for street lights (government consumption)and new houses and machinery (fixed investment). Theoretically, a broader inflation metric like ‘domestic demand inflation’ (household consumption + government consumption + investments) is therefore superior to a consumption price metric as far as targets go.

In a practical sense, this wold not matter too much if all metrics showed the same medium term developments. But they don’t.

Bashing crises predictions

from Lars Syll

Noah Smith has a post up on his blog questioning that people like Dean Baker, Dirk Bezemer, Nouriel Roubini, Barkley Rosser and in particular Steve Keen really – in any essential meaning of the word – “predicted” the latest financial-economic crisis, the one that we are still living through (that mainstream economists didn’t, we know). It makes me come to think of (wonder why …) what James K. Galbraith wrote a couple of years ago in The NEA Higher Education Journal:

Leading active members of today’s economics profession… have formed themselves into a kind of Politburo for correct economic thinking.

Timothy Geithner: modern day Metternich

from Dean Baker

Treasury Secretary Timothy Geithner’s departure from the Obama Administration invites comparisons with Klemens von Metternich. Metternich was the foreign minister of the Austrian Empire who engineered the restoration of the old order and the suppression of democracy across Europe after the defeat of Napoleon. This was an impressive diplomatic feat given the popular contempt for Europe’s monarchical regimes. In the same vein, protecting Wall Street from the financial and economic havoc they brought upon themselves and the country was an enormous accomplishment.

Just to remind everyone, during his tenure as head of the New York Fed and then Treasury Secretary, most, if not all, of the major Wall Street banks would have collapsed if the government had not intervened to save them. This process began with the collapse of Bear Stearns, which was bought up by J.P. Morgan in a deal involving huge subsidies from the Fed. The collapse of Lehman Brothers, a second major investment bank, started a run on the three remaining investment banks that would have led to the collapse of Merrill Lynch, Morgan Stanley, and Goldman Sachs if the Fed, FDIC, and Treasury did not take extraordinary measures to save them.  

It is the worst of times, it is the best of times (USA)

from David Ruccio

Housing bubbles are not funny

from Dean Baker

The United States has more than 20 million people unemployed, underemployed or out of the workforce altogether because of a burst housing bubble. We also have more than 10 million homeowners who are underwater in their mortgages. And, we have tens of millions of people approaching retirement who have seen most of their life’s savings disappear when plunging house prices eliminated most or all of the equity in their home.

This situation could have been prevented if the government had taken steps to stem the growth of the housing bubble before it reached such dangerous levels. It is incredible that the Bush administration’s economics team failed to see the dangers of the bubble. It is even more remarkable that Alan Greenspan, Ben Bernanke and the Fed ignored the growth of the housing bubble. But even more astounding is the fact that no one in a position of authority has learned any lessons from this disaster.

At the moment, there are housing bubbles in the United Kingdom, Canada, and Australia that are arguably larger, relative to the size of their economies, than the one that collapsed and wrecked the U.S. economy. The basis for saying that house prices in these countries are in a bubble is that there has been a sharp increase in the sale prices of homes that has not been matched by a remotely corresponding increase in rents.

The Crisis in 1000 words—or less

from Steve Keen

URPE–The Union for Radical Political Economics–is holding a Summer School for the Occupy movement, and as part of that invited papers that explained the crisis in 1000 words or less (so that they can be printed on one double-sided sheet). Here’s my effort in somewhat less than 1,000 words (though with 2 figures). In the interests of URPE’s objective in this exercise, here’s the PDF of this blog post for general download.  

Both the crisis and the apparent boom before it were caused by the change in private debt. Rising aggregate private debt adds to demand, and falling debt subtracts from it. This point is vehemently denied on conventional theoretical grounds by economists like Paul Krugman, but it is obvious in the empirical data. The crisis itself began in 2008, precisely when the growth of private debt plunged from its peak of almost 30% of GDP p.a. down to its depth of minus 20% in 2010. The recovery, such as it was, began when the rate of decline of debt slowed. Across recession, boom and bust between 1990 and 2012, the correlation between the annual change in private debt and the unemployment rate was -0.92. 

Economics in the crisis

from David Ruccio

It is extraordinary to sit here in the midst of the crisis and read the self-satisfied pronouncements of economists about the state of the discipline.

To be clear, what we’re talking about is the state of the discipline in, not after, the crisis. Whether we’re referring to the situation in the United States or Europe, this is still the deepest and widest set of economic problems since the Great Depression. It is, in short, the Second Great Depression—and there’s no end in sight.

With that sorted out, let’s look at what macroeconomists are writing. First, there’s Simon Wren-Lewis, who explains that “not much” has changed in the teaching macroeconomics since the crash of 2007-08. 

Germany is not New York

Peter Radford

It takes no extraordinary acuity to see that New York is not Germany, and that Germany is not New York. It takes a little more struggle to wish that they were more similar.

For if Germany were New York it would be part of a transfer union where funds flowed easily and anonymously from one local economy to another within the larger whole. Right now that would imply funds rolling out of Germany towards, for example, Spain without a word of debate. It would just happen. And, hey presto, Spain would be bailed out without having to commit to suicidal and, most likely, unsustainable economic policies.

Instead Germany sits in a very rigid and not well designed union where transfers of funds come only after retribution is exacted, penalties assessed, and horrors inflicted so that the creditors can feel morally justified in ‘helping’ out the, presumably morally inferior, debtors.

The Spanish problem is that it had a real estate bubble of sufficient proportion to blow up its banks. In order to save those banks the Spanish government had to borrow a great deal and thus ruined its own creditworthiness. A private sector problem thus became a sovereign debt problem. Lacking an independent monetary policy, and not having its own currency to devalue, the Spanish government was forced to use its only policy weapon, namely fiscal policy. In other words the full brunt of saving the banks was transferred to the unsuspecting taxpayers of Spain. The result is grinding depression, massive unemployment – in excess of 20% across the economy as a whole – and a drop in economic activity that has only made things worse. The drop in activity has made it impossible to hold debt levels down to the levels that Spain’s creditors would like, so interest rates on new debt have risen enough to burden the budget sufficiently that there now looks as if there is no escape. Spain is going down.

1. Germany’s beggar-thy-neighbour wages policy and 2. Shrinking the financial sector to its 1970s pre-bubble size

The above and related issues arise in two papers in the current issue 59 of the Real-World Economics Review. 

Matías Vernengo and Esteban Pérez-Caldentey, “The euro imbalances and financial deregulation: A post-Keynesian interpretation of the European debt crisis” http://paecon.net/PAEReview/issue59/VernengoPerez59.pdf 
and
Robin Pope, “Public debt tipping point studies ignore how exchange rate changes may create a financial meltdown” (co-author Reinhard Selten) http://paecon.net/PAEReview/issue59/PopeSelten59.pdf

 Vernengo, Pérez-Caldentey and Pope all  agree on the need for: 

(i) fiscal stimulus while the private sector deleverages, 

(ii) inter-country fiscal transfers to losers in a global downturn in order to reduce contagious adverse aggregate demand effects, 

(iii) re-regulation of the financial sector to aid in averting future financial bubbles, and 

(iv) an absolute rise in German wages – though for different reasons.
Robin Pope: in order to try to curb the dramatic increase in inequality in Germany between the upper echelon and the average German worker that has occurred over the past decade, an increase that damages democracy and damps internal demand.
Matías Vernengo and Esteban Pérez-Caldentey: in order to reverse the dramatic narrowing of the gap between wages in Germany and non-core countries that occurred over the past decade, a reversal that they believe would eliminate Germany’s dramatically increased export surplus to non-core countries that occurred over this same decade plus.

On where the three disagree, see their extremely interesting exchange below, and do, if inclined, append your comments. 

Wrong lessons from Latvia for the Eurozone

from Mark Weisbrot

Latvia, a Baltic country of 2.2 million that most people could not find on a map, has suddenly gotten more attention from economists involved in the debate over the future of Europe and the global economy. I responded in a column last week to remarks by Christine Lagarde, IMF Managing Director, who on June 5 said that Latvia’s policies in response to the economic crisis had been a “success story.” Paul Krugman has also weighed in several times, and has been joined by Harvard international economist Dani Rodrik, and now by the IMF’s Chief Economist Olivier Blanchard.

The reason it’s important to have an honest and realistic assessment of what happened in Latvia is that for the first time since the country suffered the world’s worst economic losses during the world recession (2008-2009), there are mainstream voices suggesting as Lagarde did, that it “could serve as an inspiration for European leaders grappling with the euro crisis.” Prior to the last week or so, it was only right-wing economists such as Anders Aslund who were willing to even consider this idea.

The Pope, Vernengo and Pérez-Caldentey Discussion

from Robin Pope,  Matías Vernengo and Esteban Pérez-Caldentey

Below is an extremely interesting exchange between the authors of two papers in the current issue of the Real-World Economics Review.

Matías Vernengo and Esteban Pérez-Caldentey, “The euro imbalances and financial deregulation: A post-Keynesian interpretation of the European debt crisis” http://paecon.net/PAEReview/issue59/VernengoPerez59.pdf

and

Robin Pope,  “Public debt tipping point studies ignore how exchange rate changes may create a financial meltdown” (co-author Reinhard Selten) http://paecon.net/PAEReview/issue59/PopeSelten59.pdf 

—————————————————————————————————————–

Here is an exchange on the paper, “The euro imbalances and financial deregulation: A post-Keynesian interpretation of the European debt crisis”

Robin, Matías, Esteban Interchange, collated 9th May 2012
order:
1) Robin comments on Matías and Esteban’s RWER article and relatedly adds a 2nd comment on Trond Andresen’s RWER article
2) Matías responds
3) Robin rejoinders
4) Esteban objects to austerity
5) Robin agrees austerity is the wrong policy
6) Esteban objects to austerity for Spain
7) Robin makes concrete for Spain the non-austerity proposal presented in her joint RWER Tipping Points paper with Reinhard Selten
8) Esteban objects to Robin highlighting a basic similarity in the modeling of him and Matías with that of Ken Rogoff
9) Robin is intransigent
10) Esteban sees the problem as external trade imbalances
11) Robin models with reverse causation to Esteban and Matías and Ken Rogoff – sees the problem as bubble finance causing unhealthy trade imbalance
12) Esteban holds by the current account imbalance as the causal direction
13) Robin grants that there is some two-way causation
14) Esteban sees a deficit balance of payments as a constraint
15) Robin sees no hard constraints
16) Robin beckons RWER readers to her and Reinhard Selten’s verdict in favour the imperfect euro and the dangers of not shifting to an imperfect single world currency
17) Esteban argues for making the euro feasible
18) Robin argues for the euro already being feasible
19) Matías and Esteban’s 4-point Position Summary with Robin’s responses

1 Robin Pope
In their RWER paper on Euro c, Matías Vernengo, Esteban Pérez-Caldentey propose that

Eurozone austerity faces increasing political challenges as economy worsens

from Mark Weisbrot

It has become a ritual: every six months I debate the IMF at their annual meetings, most recently represented by their Deputy Director for Europe. It takes place in the same room of that giant greenhouse-looking World Bank building on 19th Street in Washington, D.C. And the IMF’s defense of its policies in the eurozone is not getting any stronger.

Maybe it’s because most economists at the IMF don’t really believe in what they are doing. The Fund is, after all, the subordinate partner of the so-called “Troika” – with the European Commission and the European Central Bank (ECB) calling the shots. And most Fund economists know their basic national income accounting: fiscal tightening is going to make these economies worse, as it has been doing. Those that have tightened their budgets the most, e.g. Greece and Ireland, have shrunk the most – as would be predicted. The Spanish government, which today announced a 52 percent unemployment rate among its youth, has projected that the planned budget tightening for this year would by itself take 2.6 percentage points off of 2012 growth.

Austerity, democracy, and economics

from David Ruccio

Here’s Amartya Sen, from an interview with Olaf Storbeck and Dorit Heß.

Question: Professor Sen, do you have the impression that economists and economic policy makers are learning the right lessons from the most severe economic and financial crisis since the Great Depression?

Answer: I don’t think that at all. I’m quite disappointed by the nature of economic thinking as well as social thinking that connects economics with politics.

What’s going wrong?

“Given the extraordinary level of incompetence shown by these economists, one may ask. . . .”

from Edward Fullbrook

This post has now started a discussion  Punish Economists For Bad Advice?  at the WEA Ethics Conference.  If you go there, you can take part in the debate.

An article “Stop letting economists off the hook”  by Philip Soos in the Business Spectator should be required reading for economists.  It raises the question: “If other professions can be held accountable for poor job performance, why not economists?”   Here is one section of Soos’s  article.

According to conventional economic theory that the majority of economists advocate

The Debtwatch Manifesto

from Steve Keen

Preamble

Click here for this post in PDF

The fundamental cause of the economic and financial crisis that began in late 2007 was lending by the finance sector that primarily financed speculation rather than investment. The private debt bubble this caused is unprecedented, probably in human history and certainly in the last century (see Figure 1). Its unwinding now is the primary cause of the sustained slump in economic growth. The recent growth in sovereign debt is a symptom of this underlying crisis, not the cause, and the current political obsession with reducing sovereign debt will exacerbate the root problem of private sector deleveraging.

Eurozone crisis enters new phase as ECB fights Europe for austerity

Mark Weisbrot

The house is on fire and the owners are arguing about what kind of safety regulations should be implemented in the future so as to prevent these types of fires.  That is what appears to be going on in the eurozone right now, as European leaders try to reach agreement on a series of measures that would impose “fiscal discipline” on member states in the future.

Inflation Targeting and the Crisis

from Jim Stanford

Many long-held tenets of neoclassical orthodoxy have fallen by the wayside in the past 3 years, but perhaps one of the biggest dominos that is at least teetering precariously (if not fully tipped over) is the consensus that inflation targeting should be the exclusive focus of monetary policy.

The policy was closely associated with the so-called “New Consensus in Macroeconomics” — the premature and presumptuous claim that rational-expectations-augmented analysis had produced the “end of history” in macroeconomics (analogous to Francis Fukuyama’s preposterous claim about global politics).  The idea was that by anchoring inflation expectations at the target, the central bank minimizes the extent to which monetary conditions interfere with the normal efficient operations of the real economy, thus promoting in the long-run stronger real behaviour (including intertemporal behaviour, like savings and investment), which might be affected by fluctuating or inaccurate expectations of future prices.

#OccupyWallStreet: The Real Tea Party

from Dean Baker

Many people have forgotten that the Tea Party movement had its origins in the anti-TARP protests in the fall of 2008. Millions of people across the country were outraged that the government was going to loan hundreds of billions of dollars to the banks that had brought themselves and the country to the brink of ruin through their own greed and incompetence. Just as these people feared, the bailouts saved the banks, leaving their high-flying executives largely unharmed, but did little to get the economy back on its feet.

Eurozone Has A Crisis of Policy Failure, Not Debt

from Mark Weisbrot

Three months ago I wrote about the risks that the European authorities were posing to the U.S. economy and asked what the U.S. government was going to do about it. It was clear at that time that “the Troika” – the European Commission, European Central Bank (ECB), and the International Monetary Fund (IMF) – was once again playing a dangerous game of brinksmanship, at that time with the government of Greece. They were trying to force the Greek parliament to adopt measures that would further shrink the Greek economy and therefore make both their economic situation and their debt problem worse, while inflicting more pain on the Greek electorate.  The threat from the Troika was putting the whole European financial system at risk, since it raised the prospect of a chaotic, unilateral Greek default.

Changing the narrative. Inequality as a cause for the Euro conundrum.

from Merijn Knibbe

If this post is right there is a relation between inequality and the Euro problems. According to the post, high inequality leads to deficits on the current account (an idea vindicated by the ‘plutonomy reports’, see the posts obout these on this blog!) while, especially in former authoritarian countries, tax systems are designed to minimize the tax burden of the rich – which makes it hard for governments to change this ‘structural-deficit-situation’. Is there something to this line of reasoning? Is it a viable alternative to the mistaken view that government deficits (which did not exist, prior to 2008, in Ireland and Spain…) caused the crisis? According to the graph below there is.