The money multiplier – neat, plausible, and utterly wrong

from Lars Syll

The mainstream textbook concept of money multiplier assumes that banks automatically expand the credit money supply to a multiple of their aggregate reserves.  If the required currency-deposit reserve ratio is 5%, the money supply should be about twenty times larger than the aggregate reserves of banks.  In this way, the money multiplier concept assumes that the central bank controls the money supply by setting the required reserve ratio.

In his Macroeconomics — just to take an example — Greg Mankiw writes:

We can now see that the money supply is proportional to the monetary base. The factor of proportionality … is called the money multiplier … Each dollar of the monetary base produces m dollars of money. Because the monetary base has a multiplied effect on the money supply, the monetary base is called high-powered money.

The money multiplier concept is — as can be seen from the quote above — nothing but one big fallacy. This is not the way credit is created in a monetary economy. It’s nothing but a monetary myth that the monetary base can play such a decisive role in a modern credit-run economy with fiat money.

Externality-downplaying economics

from Duncan Austin

A major first response to our sustainability challenges has been to try and turn profit to more sustainable ends. Alas, even ‘purposeful profit’ seems unable to overcome the deeper momentum of what might be termed ‘externality-denying capitalism’ – ‘externality-denying’ in that billions of daily investment and consumption decisions ignore certain of their social and environmental consequences.

As just one example, the World Bank reports that less than 4 percent of global carbon emissions are currently priced at levels consistent with the Paris Agreement’s temperature goals, endorsed by 194 nations.^[1] Hence, hardly any of today’s market transactions are fully costed, in terms of reflecting their contribution to climate change. The same neglect repeats to varying degrees for certain other environmental and social problems.

We don’t call our predominant socio-economic system ‘externality-denying capitalism’, but possibly we should, to constantly remind ourselves of what we are doing.

Figure 1

Matt Tweed

Caught in this embracing dynamic, first-response market-led sustainability strategies – such as socially responsible investing (SRI), corporate social responsibility (CSR), and an environmental, social and governance (ESG) movement – are showing signs of exhaustion.

Weekend read – The cause of stagflation

from Blair Fix

In my last post, I looked at the relation between economic growth and inflation. As per usual, the evidence didn’t sit well with mainstream economics.

According to standard theory, there is a trade off between low inflation and high economic growth. The idea is that you can have one or the other, but not both. So if you want to keep inflation low, you have to ‘cool off’ the economy by slowing economic growth. (Like many things in economics, this idea comes from the totem of supply and demand.)

The trouble is, the empirical evidence shows that the opposite is true. Rather than being driven by ‘excessive’ economic growth, inflation tends to come during periods of stagnation. So despite what mainstream economists proclaim, there is little evidence for a ‘growth-inflation trade off’. Instead, ‘stagflation’ seems to be the norm.

Now, the question is why?

Soon after I published ‘Is Stagflation the Norm?’ several readers pointed out that I should take a look at causation. The idea is that we want to know what drives what. Does (low) inflation drive (high) economic growth? Or does (low) economic growth drive (high) inflation?

Well, I’ve done the math, and the results may surprise you. But before we get there, let’s take a look at what the theory of capital as power has to say about the causes of inflation.

Stagflation as sabotage

Economic forecasting — why it matters and why it is so often wrong

from Lars Syll

As Oskar Morgenstern noted in his 1928 classic Wirtschaftsprognose: Eine Untersuchung ihrer Voraussetzungen und Möglichkeiten, economic predictions and forecasts amount to little more than intelligent guessing.

Making forecasts and predictions obviously isn’t a trivial or costless activity, so why then go on with it?

The problems that economists encounter when trying to predict the future really underline how important it is for social sciences to incorporate Keynes’s far-reaching and incisive analysis of induction and evidential weight in his seminal A Treatise on Probability (1921).

According to Keynes, we live in a world permeated by unmeasurable uncertainty – not quantifiable stochastic risk – which often forces us to make decisions based on anything but ‘rational expectations.’ Keynes rather thinks that we base our expectations on the confidence or ‘weight’ we put on different events and alternatives. To Keynes, ​expectations are a question of weighing probabilities by ‘degrees of belief,’ beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modelled by ‘modern’ social sciences. And often we “simply do not know.”

Ecological reasoning demands perspectives that economics is designed to obliterate

from Gregory A. Daneke 

Given the numerous disasters exhibited of late involving Mainstream Economics, various heterodox economists have called for much greater consideration of ecological processes (both natural and social, see Fullbrook & Morgan, 2001).  Such processes, in turn, have become increasingly illuminated through the burgeoning science of complex adaptive systems (e.g., Preiser, et al, 2018). What some of these earnest observers fail to fully appreciate, however, is that ecological reasoning demands perspectives that economics as a policy enterprise is specifically designed to obliterate.  Merely invoking alternative perspectives without first exploring the stranglehold that mainstream economists have over specific institutions and the culture at large is mostly a fool’s errand. Economics and ecology stem from the same Greek root “oikos” or eco (meaning home) and referring to the art of life.  Yet, they have become like the twins in the swashbuckling tale by Dumas, The Man in the Iron Mask (with one the vile usurper the other the innocent prisoner). Fairly early on economics abandoned concern for widespread human welfare and focused on what the Greeks called “chrematistics” (or “the art of acquisition”, see Stahel, 2021).

During the middle of the 20^th century, Mainstream Economics became less of a science and more like a primitive cult (for a bit comic relief see Leijonhufvud, 1973). It is now primarily practiced to conceal the contradictions and extoll the virtues of yet another predatory epoch (much like the Guided Age, see Veblen 1899). Mainstream Economics is a pretty much a static system virtually out of touch with the dynamics of “living systems” (popularized by Capra, 1996). It is particularly hostile to anything systemic and symbiotic, especially those theories and methods associated with sustainable socioecological systems. Over the last few decades, the mainstream has morphed to ignore mounting incongruities, moving from Neoclassical to Neoliberal and now Neofeudal representations, further enshrining  inequality and environmental devastation.

An age of crisis

from Oxfam

An age of crisis, causing huge suffering for most of humanity

As billionaires, government leaders and corporate executives jet in to meet atop their mountain in Davos, Switzerland, the world faces a dramatic, dangerous and destructive set of simultaneous crises. These are having a terrible impact on the majority of people, something Oxfam sees in its work across the world.

In 2022, the World Bank announced that we will fail to meet the goal of ending extreme poverty by 2030, and that ‘global progress in reducing extreme poverty has come to a halt,’ amid what it said was likely to be the largest increase in global inequality and the largest setback in addressing global poverty since World War II.

The IMF is forecasting that a third of the global economy will be in recession in 2023. For the first time, the UNDP has found that human development is falling in nine out of 10 countries.

Oxfam analysis shows that at least 1.7 billion workers worldwide will have seen inflation outpace their wages in 2022, a real-terms cut in their ability to buy food or keep the lights on.

Whole nations are facing bankruptcy, with debt payments ballooning out of control. The poorest countries are spending four times more repaying debts – often to predatory, rich, private lenders – than on healthcare. Many are also planning brutal spending cuts. Oxfam has calculated that over the next five years, threequarters of governments are planning to cut spending, with the cuts totalling $7.8 trillion dollars.

An age of crisis, creating huge fortunes for a tiny few

Meanwhile, the scale of wealth being accumulated by those at the top, already at record levels, has accelerated. The global polycrisis has brought huge new wealth to a tiny elite. Over the last 10 years, the richest 1% of humanity has captured more than half of all new global wealth. Since 2020, according to Oxfam analysis of Credit Suisse Data, this wealth grab by the super-rich has accelerated, and the richest 1% have captured almost two-thirds of all new wealth. This is six times more than the bottom 90% of humanity. Since 2020, for every dollar of new global wealth gained by someone in the bottom 90%, one of the world’s billionaires has gained $1.7m.  read more here

Hyman Minsky and the IS-LM obfuscation

from Lars Syll

As a young research stipendiate in the U.S. yours truly had the pleasure and privilege of having Hyman Minsky as a teacher. He was a great inspiration at the time. He still is.

The concepts which it is usual to ignore or deemphasize in interpreting Keynes — the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …

The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …

The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …

The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …

If we are to believe Minsky — and I certainly think we should — then when people like Paul Krugman and other ‘New Keynesian’ critics of MMT and Post-Keynesian economics think of themselves as defending “the whole enterprise of Keynes/Hicks macroeconomic theory,” they are simply wrong since there is no such thing as a Keynes-Hicks macroeconomic theory!

There is nothing in the post-General Theory writings of Keynes that suggests that he considered Hicks’s IS-LM anywhere near a faithful rendering of his thoughts.

Increase in billionaire wealth 1987 to 2022

Debt, deficits, secular stagnation and the which way is up problem in economics

from Dean Baker

The economy can have a problem of too much demand, leading to serious inflationary pressures. It can also have a problem of too little demand, leading to slow growth and unemployment. But can it have both at the same time?

Apparently, the leading lights in economic policy circles seem to think so. As I noted a few days ago, back in the 1990s and 00s economists were almost universally warning of the bad effects of an aging population. The issue was that we would have too many retirees and too few workers to support them.

This meant a problem of excess demand. Since much of the money to support retirees comes from government programs for the elderly, like Social Security and Medicare, this meant we would see this show up as large government budget deficits, unless we had big tax increases to reduce demand.

In recent years, this view had largely been replaced with concerns over secular stagnation. This is a story where an aging population implies a slow-growing or shrinking labor force. This reduces the need for investment spending. The reduction in investment spending, coupled with other factors increasing saving, gives what Larry Summers referred to as a “savings glut.” This is a story of too little demand.

Okay, so it’s January of 2023, the Republicans are threatening to blow up the economy by not raising the debt ceiling, do we have a problem of too much demand or too little demand? Which way is up?

How not to deal with a debt crisis

from Jayati Ghosh

In the 1920s and early 30s, John Maynard Keynes was embroiled in a controversy with the ‘austerians’ of his time, who believed that balancing the government budget, even in a time of economic volatility and decline and financial fragility, was necessary to restore ‘investor confidence’ and therefore provide stability. Keynes was horrified by the idea.

Zachary Carter’s brilliant biography notes that Keynes felt a package of government spending cuts and tax increases would be ‘both futile and disastrous’. It would be an affront to social justice to ask teachers and the unemployed to carry the burden of deflating a doomed currency, in the name of balanced budgets. Even worse would be imposing austerity on debtor countries, as American banks were then demanding of several European nations.

Keynes was concerned with more than just the lack of efficacy and adverse distributional effects of austerity. He worried that such measures would alienate working people, cause them to lose faith in their leaders and make them prey to right-wing demagogy and incitation to violence. His arguments were not heeded and fascism in Europe followed. Deflation in Germany under Heinrich Brüning as chancellor left six million unemployed when Adolf Hitler assumed power in early 1933.

Nearly a century on and after more than a hundred sovereign-debt crises those in charge of global economic governance appear however to have learnt nothing. Those who do not learn from history are condemned to repeat it and, sadly, the worst effects of their decisions are likely to be felt by others, not themselves.

Econometric testing

from Lars Syll

Debating econometrics and its shortcomings yours truly often gets the response from econometricians that “ok, maybe econometrics isn’t perfect, but you have to admit that it is a great technique for empirical testing of economic hypotheses.”

But is econometrics — really — such a great testing instrument?

Econometrics is supposed to be able to test economic theories. But to serve as a testing device you have to make many assumptions, many of which themselves cannot be tested or verified. To make things worse, there are also only rarely strong and reliable ways of telling us which set of assumptions is to be preferred. Trying to test and infer causality from (non-experimental) data you have to rely on assumptions such as disturbance terms being ‘independent and identically distributed’; functions being additive, linear, and with constant coefficients; parameters being’ ‘invariant under intervention; variables being ‘exogenous’, ‘identifiable’, ‘structural and so on. Unfortunately, we are seldom or never informed of where that kind of ‘knowledge’ comes from, beyond referring to the economic theory that one is supposed to test. Performing technical tests is of course needed, but perhaps even more important is to know — as David Colander put it — “how to deal with situations where the assumptions of the tests do not fit the data.”

That leaves us in the awkward position of having to admit that if the assumptions made do not hold, the inferences, conclusions, and testing outcomes econometricians come up with simply do not follow from the data and statistics they use.

The central question is “how do we learn from empirical data?”

Why debate markets vs. government when we let the right rig the market?

from Dean Baker

I was happy to see this segment of Ezra Klein’s show (hosted by Rogé Karma) which featured an interview with Columbia University Law Professor Katharina Pistor. Pistor is the author of The Code of Capital: How the Law Creates Wealth and Inequality.

I’ve not yet read the book, but got the gist from the interview. Pistor is arguing that we have structured the market in ways that generate enormous inequality. In the interview, she presents several ways in which the law has been written that facilitate the accumulation of wealth by a small group of people. These include rules on property in land, intellectual property, and the creation of corporations as distinct entities with an existence independent of their owners.

Pistor’s point is that the way these rules are structured is not set in stone. They can be written differently so that they don’t lead to so much inequality.[1] Having written several books and endless blogposts in this vein, Pistor’s interview almost made my day. (There is also the video version.) 

Victoria Chick (1936-2023) – RWER 2018 paper “Industrial policy, then and now”

Abstract

After 40 years of neoliberalism, even governments believe that they are inefficient when compared to the private sector. And economics, in its swing to the right, reinforces this view. The philosophy behind public expenditure for social purposes and the criteria for judging such projects has not been a subject for public debate until recently. In particular, industrial policy was very simple: leave it to the private sector to allocate resources as the market prompts. In Keynes’s time this was not the case. This article reviews some of the issues concerning industrial policy that were aired in the interwar period. The debate needs to be revived, revisited and, where appropriate, revised to suit the present day, but on basic principles there is much to learn from the interwar discussions. The contrast between the recent (2018) UK government’s White Paper on Industrial Strategy and the Liberal Industrial Inquiry’s Britain’s Industrial Future (1928) is quite instructive.

read more

Share of new wealth gained by richest 1% between 2020-21

Source: Oxfam calculation based on Credit Suisse Global Wealth Report.

Inflation in an unequal world economy: How the Fed’s policies are doubly perverse for the Global South

from C. P. Chandrasekhar and Jayati Ghosh 

Tight monetary policies in rich countries obviously affect people in the countries where they are applied, but they also cause ripple effects across the world. We were already in a very unequal world before the most recent global price increases. Most developing countries were not able neutralize the damage inflicted by the pandemic, largely because they had much weaker fiscal stimuli. Of nearly $14 trillion in additional fiscal spending by the end of 2021, more than 80 percent was from just ten advanced economies, and more than half was from the U.S.

This fiscal inequality worsened after the start of the Ukraine War. Governments of low- and middle-income countries were constrained by declining revenues and externally or self-imposed austerity, because of concerns about high levels of sovereign debt, or IMF conditions imposed on borrowing, or simply the fear of potential credit rating downgrades and capital flight.

So advanced economies experienced faster and stronger recovery from the pandemic. And the highly mobile capital that moved into “emerging” markets in search of higher yields during the years after the global financial crisis, when the global financial system was awash with cheap liquidity, began flowing back to the advanced economies.

All this has been devastating for many economies, especially those with high levels of import dependence.

Economic modeling — a constructive critique

from Lars Syll

If we have independent reasons to believe that the phenomena under investigation are mechanical in Mill’s sense, well and good: mathematical modeling will prove an apt mode of representation … But if we have independent reasons to believe that there is more going on in the phenomena under investigation than a mathematical model can suggest – that is, that the phenomena in question are not in fact mechanical in the required sense – then mathematical modeling will prove misleading … Moreover, as will be discussed, the empirical assessment of such models using econometric methods will not be sufficient to reveal that mismatch.

These problems cannot themselves be addressed through reforms to mathematical methods. That would simply be to produce a more refined version of the wrong tool for the job, like sharpening one’s knife when what is needed is a spoon. Rather than striving to improve the quality of mathematical models given the assumption that the subject matter under investigation is mechanical in Mill’s sense and therefore susceptible of mathematical analysis, we need to ask a prior question, which is whether there is sufficient reason to feel confident that the subject matter under investigation is mechanical in the first place. That means scrutinizing the subject matter in the first instance in non-mathematical ways … We as scientists must remain sensitive to information about the phenomena in which we are interested that lies outside our models’ conceptual maps. In the case of economics, what this requires is a new field dedicated to qualitative empirical methods that would play a similar role to that played by econometrics in the matter of quantitative empirical methods.

Highly recommended reading!

Using formal mathematical modeling, mainstream economists sure can guarantee that the conclusions hold given the assumptions. However, the validity we get in abstract model worlds does not warrantly transfer to real-world economies.

Social protection for the self-employed

from C. P. Chandrasekhar and Jayati Ghosh

The Covid-19 pandemic highlighted the urgent need for a universal social protection floor—something that has been talked about and even internationally accepted for more than a decade now, but has still received relatively little serious attention from policy makers in most countries. The challenge is to ensure basic levels of food, health, income and livelihood security, not only in periods of crisis like the pandemic or economic shocks but also in the “normal” course of economies and societies.

This has become a major concern because of the dramatically increased economic inequality and greater vulnerability of people to adverse events and processes, as well as the heightened fragility of material life. It has been compounded by the large (and growing) share of informal workers in almost all economies, which means that, even among those in some form of paid employment, there are few forms of legal protection or social security that they can automatically access in periods of difficulty.

While the problems of providing social protection for informal workers are obviously significant and varied, they are even more acute in the case of workers who are described as “self-employed”.  For such workers, there are no declared employers who could be seen as even partly responsible for providing either legal or social protection

It is true that there is widespread prevalence of outsourcing of both goods and services, and an increasing tendency to label small producers of goods and services as “independent contractors”, even when they are effectively dependent on a particular company. This means that though  there is some sort of employment relationship, this is effectively concealed, certainly for legal and policy purposes. Therefore even those who are tied to particular companies as suppliers do not have legal recourse and end up being responsible for their own remuneration, safety and other conditions at work, and social security.

This is a much more extensive concern than is often realised. Figure 1 shows the proportion of self-employed workers to total (recognised) employment, disaggregated by per capita income group of countries.

Contrary to what the NYT tells you, the problem in an aging society is distribution

from Dean Baker

The New York Times had a major article reporting on how many people in South Korea, Hong Kong, and Japan are being forced to work well into their seventies because they lack sufficient income to retire. The piece presents this as a problem of aging societies, which will soon hit the United States and other rich countries with declining birth rates and limited immigration.

While the plight of the older workers discussed in the article is a real problem, the cause is not the aging of the population. The reason these people don’t have adequate income to retire is a political decision about the distribution of income.

If the issue was simply that too few people were working in these aging societies, we should expect to see slower per capita growth than in countries where aging is less of a problem. That is not the case. The figure below shows real per capita income in these three countries from 2014, along with projections to 2027, as well as France, which has maintained a relatively high birth rate.

My philosophy of economics

from Lars Syll

A critique yours truly sometimes encounters is that as long as I cannot come up with some own alternative to the failing mainstream theory, I shouldn’t expect people to pay attention.

This is however to misunderstand the role of philosophy and methodology of economics!

As John Locke wrote in An Essay Concerning Human Understanding:

The Commonwealth of Learning is not at this time without Master-Builders, whose mighty Designs, in advancing the Sciences, will leave lasting Monuments to the Admiration of Posterity; But every one must not hope to be a Boyle, or a Sydenham; and in an Age that produces such Masters, as the Great-Huygenius, and the incomparable Mr. Newton, with some other of that Strain; ’tis Ambition enough to be employed as an Under-Labourer in clearing Ground a little, and removing some of the Rubbish, that lies in the way to Knowledge.

That’s what philosophy and methodology can contribute to economics — clear obstacles to science.

Fed will cause unnecessary harm to the US and world economy this year

from Mark Weisbrot

Here are eight predictions for the coming year, in accordance with a hallowed tradition that I have previously not honored. If some of the supporting facts below seem unfamiliar, it could be because they have not received the attention they deserve. But they are real, and links to sources are provided. First, some good news about the US economy:

1. Inflation will likely continue to fall until it becomes obvious that it is no longer a serious concern. Inflation (as measured by the Consumer Price Index) has already fallen precipitously over the past five months: annualized inflation has been 2.5 percent (July through November), as compared with 11.8 percent for the preceding five months (February through June). If this looks surprising, it’s because the number most reported in the media is for November 2021-November 2022, which is 7.1 percent. This is true, but not as informative about what’s been happening more recently.
2. The Fed will continue to harm the economy by raising interest rates unnecessarily: That’s the bad news. The economy will slow, and unemployment will rise; the latest survey of economists finds a 70 percent probability of a recession. But, whether it’s technically a recession or “just” a slowdown, the pain will be real for many employees and job-seekers. Sadly, the Fed has actually caused most of the US recessions since World War II by raising interest rates.