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The subtleties of effective demand

September 25, 2018 1 comment

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

September 24, 2018 3 comments

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!  Read more…

The real problem with free trade

September 23, 2018 5 comments

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.  Read more…

Cheap tricks with economic statistics: the democratic version

September 22, 2018 5 comments

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.  Read more…

real-world economics review – issue no. 85

September 21, 2018 Leave a comment

real-world economics review
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back issues
18 September 2018
issue no. 85
download whole issue

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

September 20, 2018 Leave a comment

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

September 20, 2018 21 comments

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

September 19, 2018 4 comments

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.   Read more…

Minskyan reflections on the ides of September

September 18, 2018 2 comments

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.

Read more…

Tony Lawson vs Uskali Mäki

September 18, 2018 1 comment

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.

title-methodology-image_tcm7-198540Where 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

Read more…

Utopia and climate change

September 17, 2018 3 comments

from David Ruccio

The warnings about the consequences of global warming are becoming increasingly dire. And with good reason.

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Just last month, a report by a multidisciplinary research team published in the Proceedings of the National Academy of Sciences made the case that even fairly modest future carbon dioxide emissions could set off a cascade of catastrophic effects, with melting permafrost releasing methane to ratchet up global temperatures enough to drive much of the Amazon to die off, and so on in a chain reaction around the world that pushes Earth into a terrifying new hothouse state from which there is no return. Civilization as we know it would surely not survive.  Read more…

Simple model explains complex Keynesian concepts

September 16, 2018 5 comments

from Asad Zaman

In the context of the radical Macroeconomics Course I am teaching, I was very unhappy with the material available which tries to explain what Keynes is saying. In attempting to explain it better, I constructed an extremely simple model of a primitive agricultural economy. This model has a lot of pedagogical value in that it can demonstrate many complex phenomenon in very simple terms. In particular, Keynesian, Marxists, Classical and Neo-Classical concepts can be illustrated and compared within our model. We will show the failure of all neoclassical concepts of labor, Supply and Demand, equality of marginal product, value theory —  the whole she-bang — in an intuitive and easy to understand plausible model of a simple economy.  read more

Amazon and Apple: Wall Street’s trillion dollar babies

September 15, 2018 10 comments

from Dean Baker

Last month Amazon joined Apple, becoming the second company in the world to have a $1 trillion market capitalization. Amazon’s accomplishment didn’t cause quite as much celebration as Apple’s – it pays to be number one – nonetheless this was treated as a milestone that all of us should view as good news.

Actually, the celebratory coverage of both events demonstrated the incredibly ill-informed nature of much economic reporting in the United States. A big run-up in share prices is good news for the people who own lots of stock in the company; it is not especially good news for anyone else.

In principle, the value of a stock is supposed to represent the expected future earnings of the company. I said “supposed” because stock prices fluctuate wildly in response to all sorts of things that are not obviously connected to future earnings, but in the textbook definition, it is the discounted value of future earnings that determine stock prices. To be clear, this is not the socialist textbook, this is the capitalist textbook that is taught in business schools.

What does it mean that Amazon and Apple have market valuations of more $1 trillion? Presumably, it means that investors are now more optimistic about the companies’ future profit potential. It’s difficult to see why the rest of us should celebrate this outcome.

Apple obviously makes products that consumers value, and in that sense, it is contributing to the economy and generating wealth. But, suppose instead of one huge company we had 10 little (or littler) Apples that sold iPhones, computers, and the other items that comprise Apple’s product line? Would we be any poorer as a society in that case, even if the market cap of our leading tech company was just $100 billion?  Read more…

Job Guarantee Programs: careful what you wish for

September 15, 2018 8 comments

from Thomas Palley

Some progressive economists are now arguing for the idea of a Job Guarantee Program (JGP), and their advocacy has begun to gain political traction. For instance, in the US, Bernie Sanders and some other leading Democrats have recently signaled a willingness to embrace the idea.

In a recent research paper I have examined the macroeconomics of such a program. Whereas a JGP would deliver real macroeconomic benefits, it also raises some significant troubling economic and political economy concerns. Those concerns should be fully digested before a JGP is politically embraced.

The real benefits of a JGP

The starting point for discussion should be recognition that a JGP delivers multiple benefits. First, it ensures full employment by making available a job to all who want one on the terms specified by the program. Second, it substitutes wages for welfare benefits to workers who accept such jobs and would otherwise be on welfare. Third, it may deliver supply-side benefits to the extent that it helps unemployed workers retain job skills and avoid becoming detached from the labor force during periods of unemployment. Fourth, society benefits from the services produced by workers holding guaranteed employment jobs. Fifth, it has significant desirable counter-cyclical stabilization properties.

That said, a JGP generates some policy conflicts and it also has some drawbacks. Those conflicts and drawbacks concern macroeconomics, microeconomics, and political economy.

Macroeconomic concerns

A first macroeconomic concern is the putative cost of a JGP. This is a complex multifaceted concern. The immediate cost of a JGP will depend on the state of the economy and the state of the aggregate demand (AD) generation process. An economy with a deteriorated AD generation process, marked by a reduced wage share and increased inequality, will be prone to higher unemployment that raises the program’s cost. That speaks to the need to pair a JGP with other conventional structural Keynesian policies that remedy the causes of AD weakness.  Read more…

Ten years after

September 14, 2018 4 comments

from David Ruccio

Everyone, it seems, is writing their version of the lessons to be learned after the crash of 2008. And most of them are getting it wrong.

Here, for the record, are some of the lessons I’ve taken from the crash:

  1. What has changed—and, equally significant, what hasn’t—during the past decade?
  2. Mainstream economists got globalization wrong
  3. The policy consensus on economics has not fundamentally changed
  4. Mainstream economics has fallen in the eyes of the public—and for good reason
  5. Little has changed in terms of the teaching of economics
  6. Mainstream economists reject the new populism, which they helped to create
  7. The normal workings of capitalism created, together and over time, the conditions for the most severe set of crises since the first Great Depression
  8. Mainstream economists, for the most part, haven’t even attempted to make sense of the role inequality played in creating the Second Great Depression

Progressive International Movement

September 13, 2018 33 comments

from Yanis Varoufakis

Our new international movement will fight rising fascism and globalists

Our era will be remembered for the triumphant march of a globally unifying rightwing – a Nationalist International – that sprang out of the cesspool of financialised capitalism. Whether it will also be remembered for a successful humanist challenge to this menace depends on the willingness of progressives in the United States, the European Union, the United Kingdom as well as countries like Mexico, India and South Africa, to forge a coherent Progressive International.

Our task is not unprecedented. Fascists did not come to power in the mid-war period by promising violence, war or concentration camps. They came to power by addressing good people who, following a severe capitalist crisis, had been treated for too long like livestock that had lost its market value. Instead of treating them like “deplorables”, fascists looked at them in the eye and promised to restore their pride, offered their friendship, gave them a sense that they belonged to a larger ideal, allowed them to think of themselves as something more than sovereign consumers.

That injection of self-esteem was accompanied by warnings against the lurking “alien” who threatened their revived hope. The politics of “us versus them” took over, bleached of social class characteristics and defined solely in terms of identities. The fear of losing status turned into tolerance of human rights abuses first against the suspect “others” and then against any and all dissent. Soon, as the establishment’s control over politics waned under the weight of the economic crisis it had caused, the progressives ended up marginalised or in prison. By then it was all over.  read more in The Guardian

The housing bubble and financial crisis was easy to see coming

September 13, 2018 3 comments

from Dean Baker

Ten years ago we saw the culmination of a period of ungodly economic mismanagement with the collapse of Lehman Brothers and a full-fledged financial crisis. The folks who led us into this disaster rushed to do triage and tend to the most important problem: saving the bankrupt banks.

They also had to cover their tracks. They insisted that the financial crisis was some sort of fluke event — a lot of bad things went wrong simultaneously — and who could have predicted or prevented that? They had a lot of assistance in this coverup because almost all the people who did and wrote about economics at the time also missed the housing bubble and the harm that its inevitable collapse would cause.

The coverup continues to the present, largely because the same people who messed up in the years leading up to the crash are still in positions of authority. They are still the ones writing and talking about economics in major news outlets. So we can expect a lot of “who could have known?” drivel in the weeks ahead.

CEPR will be putting out a paper soon showing once again how the bubble was easy to recognize as was the fact that its collapse would be a disaster. Today I will just share one chart that shows much of the story.

The bubble led to an unprecedented run-up in house prices (with no accompanying rise in real rents), which in turn led to residential construction hitting 6.5 percent of GDP, more than two full percentage points above the long-term average. (But hey, who could have noticed that?)  Read more…

Hard-won, self-acquired, self-earned property?!

September 13, 2018 2 comments

from David Ruccio

map

Almost 30 thousand people joined the ranks of the global super-rich last year, as booming global stock markets and corporate profits boosted the fortunes of the already very-rich and bumped them up into the ultra-high-net-worth bracket.

The global population of ultra-high-net-worth people, classed as those with more than $30 million in assets, increased by 12.9 percent last year to a record 255,810 people,  while their combined wealth surged by 16.3 percent to $31.5 trillion, according to a report by research firm Wealth-X.

Read more…

Structural econometrics

September 12, 2018 2 comments

from Lars Syll

In the ongoing discussion on the ’empirical revolution’ in economics, some econometricians criticise — rightfully — the view that quasi-experiments and RCTs are the (only) true solutions to finding causal parameters. But — the alternative they put forward, structural models, have their own monumental problems.

Structural econometrics — essentially going back to the Cowles programme — more or less takes for granted the possibility of a priori postulating relations that describe economic behaviours as invariant within a Walrasian general equilibrium system. In practice, that means the structural model is based on a straightjacket delivered by economic theory. Causal inferences in those models are — by assumption — made possible since the econometrician is supposed to know the true structure of the economy. And, of course, those exact assumptions are the crux of the matter. If the assumptions don’t hold, there is no reason whatsoever to have any faith in the conclusions drawn, since they do not follow from the statistical machinery used!

 LierBy making many strong background assumptions, the deductivist [the conventional logic of structural econometrics] reading of the regression model allows one — in principle — to support a structural reading of the equations and to support many rich causal claims as a result. Here, however, the difficulty is that of finding good evidence for many of the assumptions on which the approach rests. It seems difficult to believe, even in cases where we have good background economic knowledge, that the background information will be sufficient​ to do the job that the deductivist asks of it. As a result, the deductivist approach may be difficult to sustain, at least in economics.

Read more…

Bernanke, Geithner, and Paulson still don’t have a clue about the housing bubble

September 12, 2018 4 comments

from Dean Baker

NYT readers were no doubt disturbed to see a column in which former Fed Reserve Board chair Ben Bernanke, Obama Treasury Secretary Timothy Geithner, and Bush Treasury Secretary Henry Paulson patted themselves on the back for their performance in the financial crisis. First, as they acknowledge in the piece, all three completely failed to see the crisis coming.

During the years when house prices were getting way out of line with both their long-term trend and rents, Bernanke was a Fed governor, then head of the Council of Economic Advisers, and then Fed chair. He openly dismissed the idea that the run-up in house prices could pose any threat to the economy. Henry Paulson was at Goldman Sachs until he became Treasury Secretary in the middle of 2006. As the bank’s CEO, he was personally profiting from the bubble as the bank played a central role in securitizing mortgage-backed securities. Timothy Geithner was president of the New York Fed, where he was paid over $400,000 a year to make sure that the Wall Street banks were not taking on excessive risk.

It is bad enough that these three didn’t see the crisis coming, but they still seem utterly clueless. They tell readers:  Read more…