Links for May 25, 2016

Deliberately. The IMF has released its new Debt Sustainability Analysis for Greece. Frances Coppola has the details, and they are something. Per the IMF,

Demographic projections suggest that working age population will decline by about 10 percentage points by 2060. At the same time, Greece will continue to struggle with high unemployment rates for decades to come. Its current unemployment rate is around 25 percent, the highest in the OECD, and after seven years of recession, its structural component is estimated at around 20 percent. Consequently, it will take significant time for unemployment to come down. Staff expects it to reach 18 percent by 2022, 12 percent by 2040, and 6 percent only by 2060.

Frances adds:

For Greece’s young people currently out of work, that is all of their working life. A whole generation will have been consigned to the scrapheap. …

The truth is that seven years of recession has wrecked the Greek economy. It is no longer capable of generating enough jobs to employ its population. The IMF estimates that even in good times, 20 percent of adults would remain unemployed. To generate the jobs that are needed there will have to be large numbers of new businesses, perhaps even whole new industries. Developing such extensive new productive capacity takes time and requires substantial investment – and Greece is not the most attractive of investment prospects. Absent something akin to a Marshall Plan, it will take many, many years to repair the damage deliberately inflicted on Greece by European authorities and the IMF in order to bail out the European banking system.

For some reason, that reminds me of this. Good times.

Also, here’s the Economist, back in 2006:

The core countries of Europe are not ready to make the economic reforms they so desperately need—and that will change, alas, only after a diabolic economic crisis. … The sad truth is that voters are not yet ready to swallow the nasty medicine of change. Reform is always painful. And there are too many cosseted insiders—those with secure jobs, those in the public sector—who see little to gain and much to lose. … One reason for believing that reform can happen … is that other European countries have shown the way. Britain faced economic and social meltdown in 1979; there followed a decade of Thatcherite reform. … The real problem, not just for Italy and France but also for Germany, is that, so far, life has continued to be too good for too many people.

I bet they’re pretty pleased right now.



Polanyism. At Dissent, Mike Konczal and Patrick Iber have a very nice introduction to Karl Polanyi. One thing I like about this piece is that they present Polanyi as a sort of theoretical back-formation for the Sanders campaign.

The vast majority of Sanders’s supporters … are, probably without knowing it, secret followers of Karl Polanyi. …

One of the divides within the Democratic primary between Bernie Sanders and Hillary Clinton has been between a social-democratic and a “progressive” but market-friendly vision of addressing social problems. Take, for example, health care. Sanders proposes a single-payer system in which the government pays and health care directly, and he frames it explicitly in the language of rights: “healthcare is a human right and should be guaranteed to all Americans regardless of wealth or income.” … Sanders offers a straightforward defense of decommodification—the idea that some things do not belong in the marketplace—that is at odds with the kind of politics that the leadership of the Democratic Party has offered … Polanyi’s particular definition of socialism sounds like one Sanders would share.


Obamacare and the insurers. On the subject of health care and decommodification, I liked James Kwak’s piece on Obamacare.

The dirty not-so-secret of Obamacare … is that sometimes the things we don’t like about market outcomes aren’t market failures—they are exactly what markets are supposed to do. …  at the end of the day, Obamacare is based on the idea that competition is good, but tries to prevent insurers from competing on all significant dimensions except the one that the government is better at anyway. We shouldn’t be surprised when insurance policies get worse and health care costs continue to rise.

It’s too bad so many intra-Democratic policy debates are conducted in terms of the radical-incremental binary, it’s not really meaningful. You can do more or less of anything. Would be better to focus on this non-market vs market question.

In this context, I wish there’d been some discussion in the campaign of New York’s new universal pre-kindergarten, which is a great example incremental decommodification in practice. Admittedly I’m a bit biased — I live in New York, and my son will be starting pre-K next year. Still: Here’s an example of a social need being addressed not through vouchers, or tax credits, or with means tests, but through a universal public services, provided — not entirely, but mainly and increasingly — by public employees. Why isn’t this a model?


The prehistory of the economics profession. I really liked this long piece by Marshall Steinbaum and Bernard Weisberger on the early history of the American Economics Association. The takeaway is that the AEA’s early history was surprisingly radical, both intellectually and in its self-conception as part of larger political project. (Another good discussion of this is in Michael Perelman’s Railroading Economics.) This is history more people should know, and Steinbaum and Weisberger tell it well. I also agree with their conclusion:

That [the economics profession] abandoned “advocacy” under the banner of “objectivity” only raises the question of what that distinction really means in practice. Perhaps actual objectivity does not require that the scholar noisily disclaim advocacy. It may, in fact, require the opposite.

The more I struggle with this stuff, the more I think this is right. A field or discipline needs its internal standards to distinguish valid or well-supported claims from invalid or poorly supported ones. But evaluation of relevance, importance, correspondence to the relevant features of reality can never be made on the basis of internal criteria. They require the standpoint of some outside commitment, some engagement with the concrete reality you are studying distinct from your formal representations of it. Of course that engagement doesn’t have to be political. Hyman Minsky’s work for the Mark Twain Bank in Missouri, for example, played an equivalent role; and as Perry Mehrling observes in his wonderful essay on Minsky, “It is significant that the fullest statement of his business cycle theory was published by the Joint Economic Committee of the U.S. Congress.” But it has to be something. In economics, I think, even more than in other fields, the best scholarship is not going to come from people who are only scholars.


Negative rates, so what. Here’s a sensible look at the modest real-world impact of negative rates from Brian Romanchuk. It’s always interesting to see how these things look from the point of view of market participants. The importance of a negative policy rate has nothing to do with the terms on which present consumption trades off against future consumption, it’s about one component of the return on some assets relative to others.


I’m number 55. Someone made a list of the top 100 economics blogs, and put me on it. That was nice.

At Jacobin: The Fed Doesn’t Work for You

I have a new piece up at Jacobin on December’s rate hike. In my experience, the editing at Jacobin is excellent. But for better or worse, they don’t go for footnotes. So I’m reposting this here with the original notes. And also for comments, which Jacobin (perhaps wisely) doesn’t allow.

I conveyed some of the same views on “What’d You Miss?” on Bloomberg TV a couple weeks ago. (I come on around 13:30.)


To the surprise of no one, the Federal Reserve recently raised the federal funds rate — the interest rate under its direct control — from 0–0.25 percent to 0.25–0.5 percent, ending seven years of a federal funds rate of zero.

But while widely anticipated, the decision still clashes with the Fed’s supposed mandate to maintain full employment and price stability. Inflation remains well shy of the Fed’s 2 percent benchmark (its interpretation of its legal mandate to promote “price stability”) — 1.4 percent in 2015, according to the Fed’s preferred personal consumption expenditure measure, and a mere 0.4 percent using the consumer price index — and shows no sign of rising.

US GDP remains roughly 10 percent below the pre-2008 trend, so it’s hard to argue that the economy is approaching any kind of supply constraints. Set aside the fundamental incoherence of the notion of “price stability” (let alone of a single metric to measure it) — according to the Fed’s professed rulebook, the case for a rate increase is no stronger today than a year or two ago. Even the business press, for the most part, fails to see the logic for raising rates now.

Yet from another perspective, the decision to raise the federal funds rate makes perfect sense. The consensus view considers the main job of central banks to be maintaining price stability by adjusting the short-term interest rate. (Lower interest rates are supposed to raise private spending when inflation falls short of the central bank’s target, and higher interest rates are supposed to restrain spending when inflation rises above the target.) But this has never been the whole story.

More importantly, the central bank helps paper over the gap between ideals and reality — the distance between the ideological vision of the economy as a system of market exchanges of real goods, and the concrete reality of production in pursuit of money profits.

Central banks are thus, in contemporary societies, one of the main sites at which capitalism’s “Polanyi problem” is managed: a society that truly subjected itself to the logic of market exchange would tear itself to pieces. But the conscious planning that confines market outcomes within tolerable bounds has to be hidden from view because if the role of planning was acknowledged, it would undermine the idea of markets as natural and spontaneous and demonstrate the possibility of conscious planning toward other ends.

The Fed is a central planner that dare not speak its name. [1]

One particular problem for central bank planners is managing the pace of growth for the system as a whole. Fast growth doesn’t just lead to rising prices — left to their own devices, individual capitalists are liable to bid up the price of labor and drain the reserve army of the unemployed during boom times. [2] Making concessions to workers when demand is strong is rational for individual business owners, but undermines their position as a class.

Solving this coordination problem is one of modern central bankers’ central duties. They pay close attention to what is somewhat misleadingly called the labor market, and use low unemployment as a signal to raise interest rates.

So in this respect it isn’t surprising to see the Fed raising rates, given that unemployment rates have now fallen below 5 percent for the first time since the financial crisis.

Indeed, inflation targeting has always been coupled with a strong commitment to restraining the claims of workers. Paul Volcker is now widely admired as the hero who slew the inflation dragon, but as Fed chair in the 1980s, he considered rolling back the power of organized labor — in terms of both working conditions and wages — to be his number one problem. [3] Volcker described Reagan’s breaking of the air-traffic controllers union as “the single most important action of the administration in helping the anti-inflation fight.”

As one of Volcker’s colleagues argued, the fundamental goal of high rates was that

labor begins to get the point that if they get too much in wages they won’t have a business to work for. I think that really is beginning to happen now and that’s why I’m more optimistic. . . . When Pan Am workers are willing to take 10 percent wage cuts because the airlines are in trouble, I think those are signs that we’re at the point where something can really start to happen.

Volcker’s successors at the Fed approached the inflation problem similarly. Alan Greenspan saw the fight against rising prices as, at its essence, a project of promoting weakness and insecurity among workers; he famously claimed that “traumatized workers” were the reason strong growth with low inflation was possible in the 1990s, unlike in previous decades.

Testifying before Congress in 1997, Greenspan attributed the “extraordinary’” and “exceptional” performance of the nineties economy to “a heightened sense of job insecurity” among workers “and, as a consequence, subdued wages.”

As Greenspan’s colleague at the Fed in the 1990s, Janet Yellen took the same view. In a 1996 Federal Open Market Committee meeting, she said her biggest worry was that “firms eventually will be forced to bid up wages to retain workers.” But, she continued, she was not too concerned at the moment because

while the labor market is tight, job insecurity also seems alive and well. Real wage aspirations appear modest, and the bargaining power of workers is surprisingly low . . . senior workers and particularly those who have earned wage premia in the past, whether it is due to the power of their unions or the generous compensation policies of their employers, seem to be struggling to defend their jobs . . . auto workers are focused on securing their own benefits during their lifetimes but appear reconciled to accepting two-tier wage structures . . .

And when a few high-profile union victories, like the Teamsters’ successful 1997 strike at UPS, seemed to indicate organized labor might be reviving, Greenspan made no effort to hide his displeasure:

I suspect we will find that the [UPS] strike has done a good deal of damage in the past couple of weeks. The settlement may go a long way toward undermining the wage flexibility that we started to get in labor markets with the air traffic controllers’ strike back in the early 1980s. Even before this strike, it appeared that the secular decline in real wages was over.

The Fed’s commitment to keeping unemployment high enough to limit wage gains is hardly a secret — it’s right there in the transcripts of FOMC meetings, and familiar to anyone who has read left critics of the Fed like William Greider and Doug Henwood. The bluntness with which Fed officials take sides in the class war is still striking, though.

Of course, Fed officials deny they’re taking sides. They justify policies that keep workers too weak, disorganized, and traumatized to demand higher wages by focusing on the purported dangers of low unemployment. Lower unemployment, they say, leads to higher money wages, and higher money wages are passed on as higher prices, ultimately leaving workers’ real pay unchanged while eroding their savings.

So while it might look like naked class warfare to deliberately raise unemployment to keep wage demands “subdued”, the Fed assures us that it’s really in the best interests of everyone, including workers.

Keeping Wages in Check

The low-unemployment-equals-high-prices story has always been problematic. But for years its naysayers were silenced by the supposed empirical fact of the Phillips curve, which links low unemployment to higher inflation.

The shaky empirical basis of the Phillips curve was the source of major macroeconomic debates in the 1970s, when monetarists claimed that any departure from unemployment’s “natural” rate would lead inflation to rise, or fall, without limit. This “vertical Phillips curve” was used to deny the possibility of any tradeoff between unemployment and inflation — a tradeoff that, in the postwar era, was supposed to be managed by a technocratic state balancing the interests of wage earners against the interest of money owners.

In the monetarist view, there were no conflicting interests to balance, since there was just one possible rate of unemployment compatible with a stable price system (the “Non Accelerating Inflation Rate of Unemployment”). This is still the view one finds in most textbooks today.

In retrospect, the 1970s debates are usually taken as a decisive blow against the “bastard Keynesian” orthodoxy of the 1960s and 1970s. They were also an important factor in the victory of monetarism and rational expectations in the economics profession, and in the defeat of fiscal policy in the policy realm.

But today there’s a different breakdown in the relationship between unemployment and inflation that threatens to dislodge orthodoxy once again. Rather than a vertical curve, we now seem to face a “horizontal” Phillips curve in which changes in unemployment have no consequences for inflation one way or another.

Despite breathless claims about the end of work, there hasn’t been any change in the link between output and employment; and low unemployment is still associated with faster wage growth. But the link between wage growth and inflation has all but disappeared.

Annual wage growth for nonsupervisory workers (X) and CPI inflation (Y), 1965–1995.
Annual wage growth for nonsupervisory workers (X) and CPI inflation (Y), 1965–1995.


Annual wage growth for nonsupervisory workers (X) and CPI inflation (Y), 1995–2015.
Annual wage growth for nonsupervisory workers (X) and CPI inflation (Y), 1995–2015.

This gap in the output-unemployment-wages-inflation causal chain creates a significant problem for central bank ideology.

When Volcker eagerly waited for news on the latest Teamsters negotiations, it was ostensibly because of the future implications for inflation. Now, if there is no longer any visible link between wage growth and inflation, then central bankers might stop worrying so much about labor market outcomes. Put differently, if the Fed’s goal was truly price stability, then the degree to which workers are traumatized would no longer matter so much.

But that’s not the only possibility. Central bankers might want to maintain their focus on unemployment and wages as immediate targets of policy for other reasons. In that case they’d need to change their story.

The current tightening suggests that this is exactly what’s happening. Targeting “wage inflation” seems to be becoming a policy goal in itself, regardless of whether it spurs price increases.

recent piece by Justin Wolfers in the New York Times is a nice example of where conventional wisdom is heading: “It is only when nominal wage growth exceeds the sum of inflation (about 2 percent) and productivity growth (about 1.5 percent) that the Fed needs to be concerned. . .”

This sounds like technical jargon, but if taken seriously it suggests a fundamental shift in the objectives of monetary policy.

By definition, the change in the wage share of output is equal to the rise in money wages minus the sum of the inflation rate and the increase in labor productivity. To say “nominal wage growth is greater than the sum of inflation and productivity growth” is just a roundabout way of saying “the wage share is rising.” So in plain English, Wolfers is saying that the Fed should raise rates if and only if the share of GDP going to workers threatens to increase.

Think for a moment about this logic. In the textbook story, wage growth is a problem insofar as it’s associated with rising inflation. But in the new version, wage growth is more likely to be a problem when inflation stays low.

Wolfers is the farthest thing from a conservative ideologue. His declaration that the Fed needs to guard against a rise in the wage share is simply an expression of conventional elite wisdom that comes straight from the Fed. A recent post by several economists at the New York Fed uses an identical definition of “overheating” as wage growth in excess of productivity growth plus inflation.

Focusing on wage growth itself, rather than the unemployment-inflation nexus, represents a subtle but far-reaching shift in the aim of policy. According to official rhetoric, an inflation-targeting central bank should only be interested in the part of wage changes that co-varies with inflation. Otherwise changes in the wage share presumably reflect social or technological factors rather than demand conditions that are not the responsibility of the central bank.

To be fair, linking demand conditions to changes in the distribution between profits and wages, rather than to inflation, is a more realistic than the old orthodoxy that greater bargaining power for workers cannot increase their share of the product. [4]

But it sits awkwardly with the central bank story that higher unemployment is necessary to keep down prices. And it undermines the broader commitment in orthodox economics to a sharp distinction — both theoretically and policy-wise — between a monetary, demand-determined short run and a technology and “real”-resources-determined long run, with distributional questions firmly located in the latter.

There’s a funny disconnect in these conversations. A rising wage share supposedly indicates an overheating economy — a macroeconomic problem that requires a central bank response. But a falling wage share is the result of deep structural forces — unrelated to aggregate demand and certainly not something with which the central bank should be concerned. An increasing wage share is viewed by elites as a sign that policy is too loose, but no one ever blames a declining wage share on policy that is too tight. Instead we’re told it’s the result of technological change, Chinese competition, etc.

Logically, central bankers shouldn’t be able to have it both ways. In practice they can and do.

The European Central Bank (ECB) — not surprisingly, given its more overtly political role — has gone further down this road than the Fed. Their standard for macroeconomic balance appears to be shifting from the NAIRU (Non-Accelerating Inflation Rate of Unemployment) to the NAWRU (Non-Accelerating Wage Rate of Unemployment).

If the goal all along has been lower wage growth, then this is not surprising: when the link between wages and inflation weakens, the response is not to find other tools for controlling inflation, but other arguments for controlling wages.

Indeed finding fresh arguments for keeping wages in check may be the real content of much of the “competitiveness” discourse. Replacing price stability with elevating competitiveness as the paramount policy goal creates a convenient justification for pushing down wages even when inflation is already extremely low.

It’s interesting in this context to look back at the ransom note the ECB sent to the Spanish government during the 2011 sovereign debt crisis. (Similar letters were sent to the governments of other crisis-hit countries.) One of the top demands the ECB made as a condition of stabilizing the market for government debt was the abolition of cost-of-living (COLA) clauses in employment contracts — even if adopted voluntarily by private employers.

Needless to say this is far beyond the mandate of a central bank as normally understood. [5] But the most interesting thing is the rationale for ending COLA clauses. The ECB declared that cost-of-living clauses are “a structural obstacle to the adjustment of labour costs” and “contribute to hampering competitiveness.”

This is worth unpacking. For a central bank concerned with price stability, the obvious problem with indexing wages to prices (as COLA clauses do) is that it can lead to inflationary spirals, a situation in which wages and prices rise together and real wages remain the same.

But this kind of textbook concern is not the ECB’s focus; instead, the emphasis on labor costs shows an abiding interest in tamping down real wages. In the old central bank story, wage indexing was supposedly bad because it didn’t affect (i.e., raise) real wages and only led to higher inflation. In the new dispensation, wage indexing is bad precisely because it does affect real wages. The ECB’s language only makes sense if the goal is to allow inflation to erode real wages.

The Republic of the Central Banker

Does the official story matter? Perhaps not.

The period before the 2008 crisis was characterized by a series of fulsome tributes to the wisdom of central banking maestros, whose smug and uncritical tone must be causing some embarrassment in hindsight.

Liberals in particular seemed happy to declare themselves citizens of the republic of the central bankers. Cristina Romer — soon to head President Obama’s Council of Economic Advisers — described the defeat of postwar Keynesian macroeconomics as a “glorious counterrevolution” and explained that

better policy, particularly on the part of the Federal Reserve, is directly responsible for the low inflation and the virtual disappearance of the business cycle . . . The story of stabilization policy of the last quarter century is one of amazing success. We have seen the triumph of sensible ideas and have reaped the rewards in terms of macroeconomic performance. The costly wrong turn in ideas and macropolicy of the 1960s and 1970s has been righted and the future of stabilization looks bright.

The date on which the “disappearance of the business cycle” was announced? September 2007, two months before the start of the deepest recession in fifty years.

Romer’s predecessor on Clinton’s Council of Economic Advisers (and later Fed vice-chair) Alan Blinder was so impressed by the philosopher-kings at the central bank that he proposed extending the same model to a range of decisions currently made by elected legislatures.

We have drawn the line in the wrong place, leaving too many policy decisions in the realm of politics and too few in the realm of technocracy. . . . [T]he argument for the Fed’s independence applies just as forcefully to many other areas of government policy. Many policy decisions require complex technical judgments and have consequences that stretch into the distant future. . . . Yet in such cases, elected politicians make the key decisions. Why should monetary policy be different? . . . The justification for central bank independence is valid. Perhaps the model should be extended . . . The tax system would surely be simpler, fairer, and more efficient if . . . left to an independent technical body like the Federal Reserve rather than to congressional committees.

The misguided consensus a decade ago about central banks’ ability to preserve growth may be just as wrong about central banks’ ability to derail it today. (Or at least, to do so with the conventional tools of monetary policy, as opposed to the more aggressive iatrogenic techniques of the ECB.)

The business press may obsess over every movement of the Fed’s steering wheel, but we should allow ourselves some doubts that the steering wheel is even connected to the wheels.

The last time the Fed tightened was ten years ago; between June 2004 and July 2006, the federal funds rate rose from 1 percent to 5 percent. Yet longer-term interest rates — which matter much more for economic activity — did not rise at all. The Baa corporate bond rate and thirty-year mortgage, for instance, were both lower in late 2006 than they had been before the Fed started tightening.

And among heterodox macroeconomists, there is a strong argumentthat conventional monetary policy no longer plays an important role in the financial markets where longer-term interest rates are set. Which means it has at best limited sway over the level of private spending. And the largest impacts of the rate increase may not be in the US at all, but in the “emerging markets” that may be faced with a reversal of capital flows back toward the United States.

Yet whatever the concrete effects of the Fed’s decision to tighten, it still offers some useful insight into the minds of our rulers.

We sometimes assume that the capitalist class wants growth at any cost, and that the capitalist state acts to promote it. But while individual capitalists are driven by competition to accumulate endlessly, that pressure doesn’t apply to the class as a whole.

A regime of sustained zero growth, by conventional measures, might be difficult to manage. But in the absence of acute threats to social stability or external competition (as from the USSR during the postwar “Golden Age”), slow growth may well be preferable to fast growth, which after all empowers workers and destabilizes existing hierarchies. In China, 10 percent annual growth may be essential to the social contract, but slow growth does not — yet — seem to threaten the legitimacy of the state in Europe, North America, or Japan.

As Sam Gindin and Leo Panitch persuasively argue, even periodic crises are useful in maintaining the rule of money. They serve as reminders that the confidence of capital owners cannot be taken for granted. As Kalecki famously noted, the threat of a crisis when “business confidence” is shaken is a “powerful controlling device” for capitalists vis-à-vis the state. Too much success controlling crises is dangerous — it makes this threat less threatening.

So perhaps the most important thing about the Fed’s recent rate hike is that it’s a reminder that price stability and inflation management are always a pretext, or at best just one reason among others, for the managers of the capitalist state to control rapid growth and the potential gains for workers that follow. As the shifting justifications for restraining wage growth suggest, the republic of the central banker has always been run in the interests of money owners.

Some critics of the rate hike see it as a ploy to raise the profits of banks. In my opinion, this theory isn’t convincing. A better conspiracy theory is that it’s part of the larger project of keeping us all insecure and dependent on the goodwill of the owning class.


[1] The role of central banks in disguising the moment of conscious planning under capitalism and preserving the ideological fiction of spontaneous order is clearly visible in the way monetary policy is discussed by economists. From the concrete to the abstract. First, the “independent” status of central banks is supposed to place them outside the collective deliberation of democratic politics. Second, there is a constant attraction to the idea of a monetary policy “rule” that could be adopted once and for all, removing any element of deliberate choice even from the central bankers themselves. (Milton Friedman is only the best-known exponent of this idea, which is a central theme of discussion of central banks from the 18th century down to the present.) Third, in modern models, the “reaction function” of the central bank is typically taken as one of the basic equations of the model — the central bank’s reaction to a deviation of inflation from its chosen path has the same status as, say, the reaction of households to a change in prices. As Peter Dorman points out, there’s something very odd about putting policy inside the model this way. But it has the clear ideological advantage of treating the central bank as if it were simply part of the natural order of optimization by individual agents.

[2] The best analysis of the crisis of the 1970s in these terms remains Capitalism Since 1945, by Armstrong, Glyn and Harrison.

[3] The linked post by Peter Frase does an excellent job puncturing the bipartisan mythmaking around the Volcker and bringing out the centrality of his anti-labor politics. But it contains one important error. Frase describes the late-1970s crisis to which Volcker was responding as “capital refusing to invest, and labor refusing to take no for an answer.” The latter might be true but the former certainly is not: The late 1970s saw the greatest boom in business investment in modern US history; 1981 had the highest investment-GDP ratio since the records begin in 1929. High demand and negative real interest rates — which made machines and buildings more attractive than wealth in financial form — outweighed low profits, and investment boomed. (An oil boom in the southwest and generous tax subsidies also helped.) The problem Volcker was solving was not,as Frase imagines, that the process of accumulation was threatened by the refusal of unhappy money owners to participate. It was, in some ways, an even more threatening one — that real accumulation was proceeding fine despite the unhappiness of money owners. In the often-brilliant Buying Time, Wolfgang Streeck  makes a similar mistake.

[4] More precisely, it’s a return to what Anwar Shaikh calls the classical Phillips curve found in the Marxist literature, for instance in the form of Goodwin cycles. (The Shaikh article is very helpful in systematically thinking through alternative relationships between nominal wages, the wage share and inflation.)

[5] It’s worth noting that in these cases the ECB got what it wanted, or enough of it, and did aggressively intervene to stabilize government debt markets and the banking systems in almost all the crisis countries. As a result, the governments of Spain, Italy and Portugal now borrow more cheaply than ever in history. As I periodically point out, the direct cause of the crisis in Greece was the refusal of the ECB to extend it the same treatment. A common liberal criticism of the euro system is that it is too rigid, that it automatically applies a single policy to all its members even when their current needs might be different. But the reality is the opposite. The system, in the form of the ECB, has enormous discretion, and the crisis in Greece was the result of the ECB’s choice to apply a different set of policies there than elsewhere.

Mark Blyth on the Creditor’s Paradise

There’s a lot to like in this talk by Mark Blyth, reposted in Jacobin. I will certainly be quoting him in the future on the euro system as a “creditor’s paradise.” But I can’t help noting that the piece repeats exactly the two bits of conventional wisdom that I’ve been criticizing in my recent posts here on Europe. [1]

First, the uncritical adoption of the orthodox view that if Greece defaults on its debts to the euro system, it will have to leave the single currency.  Admittedly it’s just a line in passing. But I really wish that Blyth would not write “default or ‘Grexit’,” as if they were synonyms. Given that the assumption that they have to go together is one of the strongest weapons on the side of orthodoxy, opponents of austerity should at least pause a moment and ask if they necessarily do.

Second, this:

Austerity as economic policy simply doesn’t work. … European reforms … simply ask everyone to become “more competitive” — and who could be against that? Until one remembers that being competitive against each other’s main trading partners in the same currency union generates a “moving average” problem of continental proportions. 

It is statistically absurd to all become more competitive. It’s like everyone trying to be above average. It sounds like a good idea until we think about the intelligence of the children in a classroom. By definition, someone has to be the “not bright” one, even in a class of geniuses.

In comments to my last post, a couple people doubted if critics of austerity really say it’s impossible for all the countries in the euro to become more competitive. If you were one of the doubters, here you go: Mark Blyth says exactly that. Notice the slippage in the referent of “everyone,” from all countries in the euro system, to all countries in the world. Contra Blyth, since the eurozone is not a closed trading system, it is not inherently absurd to suggest that everyone in it can become more competitive. If competitiveness is measured by the trade balance, it’s not only not absurd, it’s an accomplished fact.

Obviously — but I guess it isn’t obvious — I don’t personally think that the shift toward trade surpluses throughout the eurozone represents any kind of improvement in the human condition. But it does directly falsify the claim Blyth is making here. And this is a problem if the stance we are trying to criticize austerity from is a neutral technocratic one, in which disagreements are about means rather than ends.

Austerity is part of the program of reinforcing and extending the logic of the market in political and social life. Personally I find that program repugnant. But on its own terms, austerity can work just fine.

[1] One of my posts was also cross-posted at Jacobin. Everybody should read Jacobin.


The Syriza victory as a Rorschach test for U.S. politicians:

Mayor De Blasio and President Obama both called Tsipras this morning to congratulate him. According to the press release from the Mayor’s office,

Mayor Bill de Blasio called Greek Prime Minister Alexis Tsipras Thursday morning to congratulate him on his victory, and to commend him for forcefully raising the issue of inequality during his campaign. The Mayor expressed New York City’s solidarity with Greece in the joint struggle against inequality, and commented on how the Prime Minister’s victory sends a powerful message to progressives across the world. The Prime Minister expressed his admiration for New York City, and called it one of the most extraordinary cities in the world. The Prime Minister invited the Mayor to visit Greece, and the Mayor expressed interest in visiting in the future.

And here’s the one from the White House:

The President spoke with Prime Minister Tsipras today to congratulate him on his recent election victory. The President noted that the United States, as a longstanding friend and ally, looks forward to working closely with the new Greek government to help Greece return to a path of long-term prosperity.  The two leaders also reviewed close cooperation between Greece and the United States on issues of European security and counterterrorism

In this context, there’s something sinister about the words “long-term.”

Strange Defeat

Following up on the previous post, below the fold is an article Arjun and I wrote last year for the Indian publication Economic and Political Weekly, on how liberal New Keynesian economists planted the seeds of their own defeat in the policy arena. 

I should add that Krugman is very far from the worst in this respect. If I criticize my soon-to-be colleague so much, it’s only because of his visibility, and because the clarity of his writing and his genuinely admirable political commitments make it easier to see the constraints imposed by his theoretical commitments. You might say that his distinct virtues bring the common vices into sharper focus.

Strange Defeat: How Austerity Economics Lost All the Intellectual Battles but Won the War
J. W. Mason[1] and Arjun Jayadev[2]
In 2010, policy makers in the advanced industrialized world pivoted sharply away from the Keynesian policies they had briefly espoused in the wake of the financial crisis of 2008-2009. A confluence of economic and political events meant that the fragile consensus in favor of expanding government expenditure broke apart.  Contributing factors included the sharp rise in public debt in much of Europe, largely due to government assumption of the liabilities of failing banks; the rise of “Tea Party” conservatives in the US following the November 2010 congressional elections; and the lack of a convincing political narrative about government expenditure. The Keynesian position was replaced, at least among elite policy makers, with a commitment towards fiscal consolidation and ‘austerity’.
With the hindsight of three years it is clear that this historical recapitulation of the Keynesian versus “Treasury view” debate, 80 years after the original, and the consequent implementation of orthodox policies, was both tragic and farcical. Tragic, because fiscal retrenchment and rectitude prolonged depression conditions in the advanced economies and sentenced millions to the misery of unemployment. Farcical, because the empirical and theoretical foundations of wholesale austerity policies were almost comically weak. A few implausible and empirically questionable papers were used to provide the intellectual cover for the pivot, despite the fact that each in turn was quickly discredited both on their own terms and by real life events. As Mark Blyth (Blyth 2013) put it “Austerity didn’t just fail – it helped blow up the world.”
In the first part of this paper, we review some of the most influential academic arguments for austerity, and describe how they collapsed under scrutiny. In the second, we broaden the focus, and consider the “new consensus” in macroeconomics, shared by most pro-stimulus economists as well as the “austerians.” We argue that this consensus – with its methodological commitment to optimization by rational agents, its uncritical faith in central banks, and its support for the norms of “sound finance” – has offered a favorable environment for arguments for austerity. Even the resounding defeat of particular arguments for austerity is unlikely to have much lasting effect, as long as the economics profession remains committed to a view of the world in which in which lower government debt is always desirable, booms and downturns are just temporary deviations from a stable long-term growth path, and in which – in “normal times” at least — central banks can and do correct all short-run deviations from that optimal path. Many liberal, New Keynesian, and “saltwater” economists have tenaciously opposed austerity in the intellectual and policy arenas.[3] But they are fighting a monster of their own creation.
In April 2013, an influential paper (“Growth in a Time of Debt”) by Carmen Reinhart and Kenneth Rogoff (Reinhart and Rogoff 2010) that purported to show hard limits to government debt before causing sharp decreases in growth was the subject of an enormous amount of attention for the second time.  Whereas in its first airing, the paper became a touchstone paper for the austerity movement across the advanced industrialized world, this time it was for less august reasons. Papers by Herndon, Ash and Pollin (2013) and by Dube (2013) showed the paper to have had serious mistakes in both construction and interpretation. This was not the first time that the academic case for austerity had been shown to be invalid or overstated. Two years earlier the major source of intellectual, support for immediate fiscal retrenchment was provided by another paper (“Large Changes in Fiscal Policy: Taxes Versus Spending”), again by two Harvard economists-Alberto Alesina and Silvia Ardagna (Alesina and Ardagna 2009). This too was shown almost immediately to be deeply flawed, misapplying lessons from boom periods to periods of recession, wrongly attributing fiscal consolidation to countries undergoing fiscal expansion, wrongly applying the special conditions of small open economies to the world at large, and other egregious errors (IMF, 2010, Jayadev and Konczal 2010).
Below, we examine the claims of these key papers and their logical and empirical failings. But the weakness of these papers invites a broader question: How could the wholesale shift to austerity have been built on such shaky foundations? While some of the blame must go to opportunism by policy makers and confirmation bias by politically motivated researchers, a large share of the blame rests with what is often called the “new consensus” in macroeconomic theory, a consensus shared as much by austerity’s ostensible opponents as by its declared supporters. It is a matter of some amazement that the most effective theoretical counterpoint to the austerity position is provided not by cutting edge scholarship, but by a straightforward application of models that college students learn in their second year. Paul Krugman, for instance, most often makes his claims that “economic theory” has well-established answers to the problem of deep recessions, by referring t the IS-LM model. This was first written down by John Hicks in 1936, and has not appeared in graduate economics textbooks in 50years .That it is being trotted out now as the public face of a professional economics to which it bears no resemblance, is remarkable. But it’s perhaps less of a surprise when one recalls that the essential insights of Keynesian economics have long been  banished from mainstream economics, to linger on only in “the Hades of undergraduate instruction.” (Leijonhufvud, 1981)
Modern macroeconomic theory is organized around inter-temporal optimization and rational expectations, while policy discussions are dominated by a commitment to the doctrines of “sound finance” and a preference for ‘technocratic’ monetary policy conducted by ‘independent’ central banks. The historical processes that led to these commitments are complex.  For present purposes, what is important to note is that they severely limit the scope of economic debate.The need for “structural reform” and for long-term budget balance is agreed across the admissible political spectrum, from pro-austerity European conservatives to American liberals who savor the memory of Clinton era debt reduction. Even someone like Paul Krugman, who has been the foremost critic of austerity policies, treats the idea that governments do not face financing constraints, and that macroeconomic policy cannot be fully trusted to central banks, as special features of the current period of “depression economics,” which must sooner or later come to an end. Mainstream Keynesians then become modern day Augustines: “Give me chastity and continence, but not yet”.
In 2010 Alberto Alesina from Harvard University was celebrated by Business Week for his series of papers on fiscal consolidation. This was ‘his hour,’ the article proclaimed (Coy, 2010). His surprising argument that the best way forward for  countries facing high unemplyment was to undertake “Large, credible and decisive spending cuts” was, for a while, on everyone’s lips. Such cuts, he reasoned, would change the expectations of market participants and bring forward investment that was held back by the uncertainty surrounding policy in the recession. Specifically, Alesina and Ardagna purported to show that across a large sample of countries, governments had successfully cut deficits, reduced debts and seen higher growth as a result. The mechanism by which this occurs  enhancing the confidence of investors in countries with “credible” governments, thereby raising investment —  has been derisively labeled ‘the confidence fairy’ by Paul Krugman.
This idea of ‘expansionary austerity’– the notion that cutting spending would increase growth–is both an attack on traditional notions of demand management, and also extraordinarily convenient for conservative macroeconomic policy makers. Not only would reducing the deficit and debt burdens of countries advancetheir  long term goal of reducing  the size of the state, it would riase spending even in the short term, since the confidence effects of fiscal surpluses on private expenditure would more than offset any drag from the public sector contraction. Even better, consolidation was better according to Alesina and Ardagna (2009) if it was weighted towards spending cuts, rather than tax increases. As Coy (2010) notes “The bottom line: Alesina has provided the theoretical ammunition fiscal conservatives want..”
As Blyth (2013) documents, this idea obtained immediate traction among policy-making elites and by mid 2010 the idea of deficit reduction in a period of weak demand (which might otherwise have been deemed nonsensical), was receiving support from high-level policy makers who spoke knowingly about the immediate need to restore ‘confidence’ in the markets.  Thus, for example Jean Claude Trichet, the president of the European Central Bank, observed that
“It is an error to think that fiscal austerity is a threat to growth and job creation. At present, a major problem is the lack of confidence on the part of households, firms, savers and investors who feel that fiscal policies are not sound and sustainable”.[4]
As Blyth notes, while the argument for expansionary austerity was enthusiastically endorsed by policymakers (especially but not only in Europe), the intellectual case collapsed almost immediately. The paper was .. “dissected, augmented, tested, refuted and generally hauled over the coals” (Blyth 2013). First, Jayadev and Konczal (2010) noted that none of the alleged cases of expansionary austerity occurred during recessions. They also noted that in some cases Alesina -Ardagna had misclassified periods of fiscal expansion as periods of fiscal consolidation. Immediately following this, the IMF  (IMF, 2010) noted that the way in which Alesina -Ardagna had classified fiscal policy as being expansionary or contractionary seemed to have very little connection with actual fiscal policy changes. In terms of both effects and causes, the empirical work turned out to be valueless for policy.
Faced with mounting challenges to his work, Alesina appeared undeterred and defended his ideas while prognosticating on the future of Europe: “In addition, what is unfolding currently in Europe directly contradicts Jayadev and Konczal. Several European countries have started drastic plans of fiscal adjustment in the middle of a fragile recovery. At the time of this writing, it appears that European speed of recovery is sustained, faster than that of the U.S., and the ECB has recently significantly raised growth forecasts for the Euro area.” (Alesina 2010).
Three years on, this confident prognostication is an embarassment. The Washington Post,  taking stock of the argument, concluded “No advanced economy has proved Alesina correct in the wake of the Great Recession” (Tankersley, 2013). Not only did austerity not deliver higher growth: in the countries that tried it, output contracted more or less exactly in line with the degree of austerity they managed to impose. (Degrauwe and Ji 2013)
But just as the case for short-term fiscal consolidation was disintegrating in the eyes of all but a few diehard believers, a new set of arguments became the intellectual bulwark of the austerity movement. As the Greek debt crisis spun out of control and interest rates on sovereign debt rose   elsewhere in the European periphery, concern with public debt rose even in countries like the US, where  bond markets were untroubled and yields on government debt remained at record lows. For respectable opinion, the question was when, and not if, government debt needed to be cut, if we do’t want to “turn into Greece.”[5]
It was at this point that the paper by Reinhart and Rogoff struck its mark. Using a panel of data on growth and government debt over many decades, Reinhart and Rogoff came up with a magic number – a 90% government debt to GDP ratio — beyond which economies faced a sharp drop-off in growth rates.
As with expansionary austerity, this argument caught on very quickly with policy makers it was cited by David Cameron, Olli Rehn and Paul Ryan, among others,  to justify a push for deep, immediate debt reduction. Unlike the Alesina-Ardagna paper, this one was not easily refuted.  For one thing, the construction of the paper made it difficult for other researchers to try to replicate the results. But despite some early warnings about interpretations of the data (Bivens and Irons 2010. Ferguson and Johnson 2010), this difficulty was generally  interpreted as a reason to defer to its findings rather than as a basis for skepticism. Second, and more insidiously, there is a widespread agreement among mainstream economists that high government debt must eventually reduce growth, and so Reinhart and Rogoff’s work was received without much critical scrutiny. The 90% threshold seemed to simply confirm a widely accepted principle.
It is not surprising therefore that the errors in Reinhart and Rogoff’s work was discovered by researchers decidedly out of the mainstream. Thomas Herndon, Michael Ash and Robert Pollin, all from the University of Massachusetts Amherst—a department that has been called the ‘single most important heterodox department in the country’ — published a paper in April 2013 which showed that the Reinhart-Rogoff results were the consequence of coding errors and omissions and nonstandard weighting of data. The 90% drop-off in growth disappeared when these errors were corrected.
Even more devastatingly, Arindrajit Dube (also from the University of Massachusetts) showed that if at all there was a correlation between debt and growth, it was more likely that episodes of low growth led to higher levels of debt rather than the other way around. ( Dube, 2013) Again, this counter argument had been made by opponents of austerity, and could easily have been verified by supporters of austerity or Reinhart and Rogoff themselves, but simply hadn’t been taken seriously.
With the key intellectual arguments for the austerity consensus falling apart before their eyes, the commentariat went into overdrive, speculating on the reasons why such policies could be adopted with such little vetting.
The media proposed various  relatively benign reasons: confirmation bias, opportunism by politicians, etc.. But while these were surely factors, they surely do not explain the catastrophic failure of the economics profession to offer a rational basis for policy discussion.
James Crotty has provided a larger political economy framing of the austerity wars (Crotty, 2012). He suggests  that austerian policies should  be seen as class conflict—protecting the interests of the wealthy and attacking those of the poor, and that these battles should be seen as the latest skirmish in a longer war of ideas and priorities. Austerity, fro this viewpoint, is less an intellectual failure than a deliberate choice reflecting the political dominance of finance capital and capital in general[6].
Our purpose in this paper is to more deeply explore the battle of ideas and the extent to which the “macroeconomic consensus”, shared by mainstream economists across the political spectrum, must take a large part of the blame. Many liberal “New Keynesian” economists have done yeoman work in making the political case for stimulus and against austerity. But they have not yet come to terms with the role their own theoretical and policy frameworks played in the turn to austerity – and continue to impede realistic discussion of the crisis and effective responses to it.
While there is much to admire in the doggedness of the UMass-Amherst team (and the alacrity with which a network of left-leaning bloggers and media figures publicized their results) the truth is that knocking down Alesina and Ardagna and Reinhart and Rogoff’s results wasn’t difficult. The real question is, how was such crude work so successful in the first place?
The easy answer is that it was telling policymakers what they wanted to hear. But that lets the economics profession off too easily. For the past thirty years the dominant macroeconomic models that have been in used by central banks and by leading macroeconomists have had very little time and space for discussions of fiscal policy. In particular, the spectrum of models really ranged only from what have been termed real business cycle theory approaches on the one end to New Keynesian approaches on the other: perspectives that are considerably closer in flavor and methodological commitments to each other than to the ‘old Keynesian’ approaches embodied in such models as the IS-LM framework of undergraduate economics. In particular, while demand matters in the short run in New Keynesian models, it can have no effect in the long run; no matter what, the economy always eventually returns to its full-employment growth path.
And while conventional economic theory saw the economy as self-equilibrating, , economic policy discussion was dominated by faith in the stabilizing powers of central banks and in the conventional wisdom of “sound finance.” Perhaps the major reason Reinhart and Rogoff’s work went unscrutinized for so long is that it was only putting numbers on the prevailing consensus.
This is clearly seen when one observes that some of the same economists who today are leading the charge against austerity, were arguing just as forcefully a few years ago that the most important macroeconomic challenge was reducing the size of public debt. More broadly, work like Alesina -Ardagna and Reinhart – Rogoff has been so influential because the new Keynesians in the economics profession do not provide a compelling argument in favor of stimulus. New Keynesians follow Keynes in name only; they’ve certainly given better policy advice than the austerians in recent years, but such advice does not always flow naturally from their models.
There are two distinct failures here, one in economic theory and the other in discussions of economic policy.
The limited support for fiscal expansion in ‘frontier’ theory
On a theoretical level, professional economists today are committed to thinking of the economy in terms of intertemporal optimization by rational agents. In effect, the first question to ask about any economic outcome is, why does this leave people better off than any alternative? In such framework, agents know their endowments and tastes (and everyone else’s,) and the available production technology in all future periods. So they know all possible mixes of consumption and leisure available to them over the entire future and the utility each provides. Based on this knowledge they pick, for all periods simultaneously (“on the 8th day of creation”) the optimal path of labor, output and consumption (Leijonhufvud 1981)).
Given a framework in which explanation in terms of optimization is always the default, it’s natural to think that unemployment is just workers making an optimal choice to take their leisure now, in the knowledge that they will be more productive in the future. In this view — mockingly termed the ‘Great Vacation’ theory of recessions – stimulus is not only ineffective but unneeded, since the “problem” of high unemployment is actually what’s best for everyone. Most economists wouldn’t accept this claim in its bald form. Yet they continue to teach their graduate students that the best way to explain changes in investment and employment is in terms of the optimal allocation of consumption and leisure over time. . New Keynesians have spent a generation trying to show why the economy can move (temporarily) off the optimal path. The solution to these deviations is almost always found in monetary policy and only in very special circumstances can fiscal policy play a (limited)  role.
Degrauwe (2010) distinguishes ‘Old Keynesian’, ‘New Keynesian’ and Real Business cycle (Ricardian) models. He notes that the latter two ‘state of the art’ frameworks are similar in their framing and methodological commitments. As he puts it:

In the (Old) Keynesian model there is no automatic return to the long run output equilibrium. As a result, policy can have a permanent effect on output. The New Keynesian model, like the Ricardian model, contains a very different view of the economy. In this model fiscal policy shocks lead to adjustments in interest rate, prices and wages that tend to crowd out private investment and consumption. As a result, output is brought back to its initial level. In the Ricardian model this occurs very rapidly; in the New Keynesian models this adjustment takes time because of rigidities in wages and prices. But fundamentally, the structure of these two models is the same.

Moreover, in most cases, the ‘rigidities in wages and prices’ in New Keynesian models are best handled by monetary policy.  While these class of models are extremely large and varied, for the most part, in the New Keynesian approach, the key problem arises because periodically the interest rate generated by imperfect competition and pricing rigidities lead to a ‘wrong’ real interest rate.  As Simon Wren-Lewis (2012) argues:

Once we have the ‘wrong’ real interest rate, then (using imperfect competition as a justification) New Keynesian analysis determines output and perhaps employment only from the demand side, and the determination of effective demand becomes critical to the model. Perhaps a better way of saying this is that if real interest rates are at their natural level, we do not need to think about demand when calculating output. In most cases, it is the job of monetary policy to try and get the economy back to this natural real interest rate. This gives you the key insight into why, ZLB problems apart, it is monetary rather than fiscal policy that is the primary stabilizing policy.

Indeed, the New Keynesian models that provide any support for fiscal policy only do so at the zero lower bound, where monetary policy has stopped being effective. And even here, the models can provide some tremendously counterintuitive predictions that militate against common-sense. For example, in the canonical model of policy at the ZLB, a payroll tax cuts are contractionary, by the same logic that  government expenditure is expansionary. Since nobody actually believes this odd result – liberal economists universally supported payroll tax cuts as part of the Obama stimulus package in 2009, and bemoaned the demand-reducing effects of the cuts’ expiration at the beginning of this year – it appears that even New Keynesians don’t really believe their own models are useful guides to questions of stimulus and austerity.
Even if one does believe them, the truth is that New Keynesian models provide very little support for stimulus. With Ricardian equivalence built in, this is always going to be case-but as Cogan et al (2010) show, the majority of these models provide very little empirical support for fiscal policy. Instead, the estimates of effectiveness of fiscal expansion coming from the wide array of these models were very small indeed.
Taken as a whole then, neither the New Classical nor New Keynesian theoretical approaches—those that dominate modern macroeconomics– afford a robust case for fiscal expansion. It is not surprising therefore that Keynesians seeking support for stimulus have ‘retreated’ to older Keynesian frameworks like IS-LM. But this embrace of IS-LM is only for purposes of advocacy; in the journals and the graduate classrooms, New Keynesian models are as dominant as ever.[7]
On the specific question of government finances and the sustainability of debt, the analysis in any modern macroeconomics textbook is in terms of the intertemporal budget constraint. The core idea is that the present value of government spending across all future time must be less than or equal to the present value of taxation across all future time, minus the current value of government debt. This assumes that government must balance budget eventually: After infinite time (this is how economists think), debt must go to zero. And it assumes that interest rates and growth rates are can’t be changed by policy, and that inflation makes no difference — any change in inflation is fully anticipated by financial markets and passed through one for one to interest rates. At the same time, the budget constraint assumes that governments face no limit on borrowing in any given period. This is the starting point for all discussions of government budgets in economics teaching and research. In many graduate macroeconomics courses, the entire discussion of government budgets is just the working-out of that one equation.
But this kind of budget constraint has nothing to do with the kind of financial constraint the austerity debates are about.  The textbook constraint is based on the idea that government is setting tax and spending levels for all periods once and for all. There’s no difference between past and future — the equation is unchanged if you reverse the direction of time and simultaneously reverse the sign of the interest rate. This approach isn’t specific to government budgetconstraints, it’s the way most matters are approached in contemporary macroeconomics. The starting point for most macro textbooks is a model of a “representative agent” allocating known production and consumption possibilities across an infinite time horizon.[8] Economic growth simply means that the parameters are such that the household, or planner, chooses a path of output with higher values in later periods than in earlier ones. Financial markets and aggregate demand aren’t completely ignored, of course, but they are treated as details to be added later, not part of the main structure.
One important feature of these models is that the interest rate is not the cost of credit or finance; rather, it’s the rate of substitution, set by tastes and technology, of spending or taxing between different periods. The idea that interest is the cost of money, not the cost of substitution between the future and the present, was arguably the most important single innovation in Keynes’ General Theory. But it has disappeared from contemporary textbooks, and without it there isn’t even the possibility of bond markets limiting government budget options. As soon as we begin talking about the state of confidence in the bond market, we are talking about a financial constraint, not a budget constraint. But the whole logic of contemporary macroeconomics excludes the possibility of government financial constraints. At no point in either of the two most widely-used macro textbook in the US — Paul Romer’s Advanced Macroeconomics and Blanchard and Fischer’s Lectures on Macroeconomics — are they seriously discussed.
This framework at once overstates and understates the limits on government finances. On the one hand, it ignores the positive possibilities of financial repression to hold down interest rate, and of growing or inflating out of debt,[9] and also the possibility — in fact certainty — that government debt can be held by the public permanently rather than being eventually paid off. But on the other hand, it also ignores reasons why governments might not be able to borrow unlimited amounts in any given period. (This goes for private budget constraints too.) The theory simply doesn’t have any place for the questions about government borrowing
A faulty excel spreadsheet was able to carry the field on stimulus and austerity because the economics profession had already limited itself to conceiving of the main problems of fluctuations as either desirable or easily solved by monetary policy. But the limits of modern macroeconomic theory are only half the problem. The other half is the policy implications promoted by consensus macroeconomics — specifically, the consensus that all the hard policy questions can be delegated to the central bank.
The preference for technical monetary policy
In the view of consensus macroeconomics, Keynes was right that markets alone can’t ensure the full use of society’s resources. But that’s only because a single wrong price, the interest rate. Let a wise planner set that correctly, and everything else will fall into place. Historically, this view owes more to Wicksell than to Keynes. [See Axel Leijonhufvud, “The Wicksellian Heritage.” 1987] But Wicksell was deeply worried by the idea that the market rate of interest, determined by the financial system, could depart from the “natural” rate of interest required to balance demands for present versus future goods. For him, this was a grave source of instability in any fully developed system of credit money. For modern economists, there’s no need to worry; the problem is solved by the central bank, which ensures that the rate of interest is always at the natural rate. Lost in this updating of Wicksell is his focus on the specific features of the banking system that allow the market rate to diverge from the natural rate in the first place. But without any discussion of the specific failures that can cause the banking system to set the interest rate at the “wrong” level, it’s not clear why we should have faith that the central bank can overcome those failures.
Nonetheless, faith in monetary-policy ‘Maestros’, became nearly universal in the 1990s as the cult of Greenspan reached full flower in the US, the European Central Bank came into being as the commanding institution of the European Union, and central banks replaced government ministries as the main locus of economic policy in many countries.  Respectable mainstream economists flirted with fatuity in their paeans to the wisdom of central bankers. In a somewhat ill-timed issue of the Journal of Economic Perspectives, Goodfriend (2007) argued that

The worldwide progress in monetary policy is a great achievement that, especially when viewed from the perspective of 30 years ago, is a remarkable success story. Today, academics, central bank economists, and policymakers around the world work together on monetary policy as never before … The worldwide working consensus provides a foundation for future work because it was forged out of hard practical lessons from diverse national experiences over decades, and because it provides common ground upon which academics and central bankers can work to improve monetary policy in the future.

Christina Romer, a leading American New Keynesian who was soon to lead Barack Obama’s Council of Economic Advisors, was even more obsequious in her praise for the wisdom of central bankers:

The most striking fact about macropolicy is that we have progressed amazingly. … The Federal Reserve is directly responsible for the low inflation and the virtual disappearance of the business cycle in the last 25 years. … The story of stabilization policy of the last quarter century is one of amazing success. We have seen the triumph of sensible ideas and have reaped the rewards… Real short-run macroeconomic performance has been splendid. … We have seen a glorious counterrevolution in the ideas and conduct of short-run stabilization policy. (Romer 2007)

This was, to put it mildly, an overstatement.
As far as the capabilities of central banks go, there’s reason to doubt that they have the decisive influence on real economic outcomes that the conventional wisdom of the 2000s attributed to them. Short-term interest rates appear to have ceased having much effect on longer rates and on economic activity well before they reached zero.  And if central banks could always guarantee full employment assuming positive interest rates, there would undoubtedly be ways to work around the problem of zero — committing to more expansionary policy in the future, intervening at longer maturities through quantitative easing, and so on. But while the Fed and other central banks – such as the Bank of Japan — have tried many of these unconventional approaches, they have had little impact. This failure should raise serious questions about whether the effectiveness of conventional policy was also exaggerated. The relative stability of output and employment prior to 2008 may not have been, as widely believed, due to the skillful hand of central bankers on the economy’s tiller, but to favorable conditions that were largely outside their control. And in any case, that stability is easy to exaggerate. In the US and Europe, the so-called “Great Moderation” featured asset bubbles and long “jobless recoveries,” while in much of the developing world it witnessed a series of devastating financial crises and repeated collapses in employment and output.
For economists who received their training under the monetarist consensus that has dominated policy discussions since the 1980s, the terms “effective demand failure” and “monetary policy error” were practically synonyms.  This notion that the central bank can achieve any level of money expenditure that it wishes, has always been a matter of faith rather than reason or evidence. But it was a very convenient faith, since it allowed the consensus to remove the most contentious questions of macroeconomic policy from the democratic process, and vest them in a committee of “apolitical” experts.
And that is the other problem with the cult of the central bankers: They have never really been apolitical. Mainstream economists have made the disinterestedness of central banks into an axiom — in standard macro models, the  “reaction function” of monetary policy has the same status as an objective fact about the world as, say, the relationship between unemployment and inflation. It’s taken for granted that while elected officials may be corrupt or captured by particular interests, central bankers are disinterested technicians who only want what’s best for everyone, or at least always follow their stated rules. For prominent liberal economists like Alan Blinder (who served on the Fed board under President Clinton), the performance of “apolitical” central banks is so exemplary that it becomes an argument against political democracy in general:

We have drawn the line in the wrong place, leaving too many policy decisions in the realm of politics and too few in the realm of technocracy. … the argument for the Fed’s independence applies just as forcefully to many other areas of government policy. Many policy decisions require complex technical judgments and have consequences that stretch into the distant future. … Yet in such cases, elected politicians make the key decisions. Why should monetary policy be different? … The justification for central bank independence is valid. Perhaps the model should be extended to other arenas. … The tax system would surely be simpler, fairer, and more efficient if … left to an independent technical body like the Federal Reserve rather than to congressional committees. (Blinder 1987)

The idea of leaving hard questions to “independent technical bodies” is seductive. But in practice, “independent” often means independent from democratic accountability, not from the interests of finance. Private banks have always had an outsize influence on monetary policy. In the early 1930s, according to to economic historians Gerald Epstein and Thomas Ferguson, expansionary monetary policy was blocked by pressure from private banks, whose interests the Fed put ahead of stabilizing the economy as a whole (Epstein and Ferguson, 1984). More recently, in the 1970s and ’80s, for the Fed of this era, holding down wages was job number one, and they were quite aware that this meant taking the of side of business against labor in acute political conflicts. And when a few high-profile union victories, like 1997’s successful strike of UPS drivers, briefly made it appear that organized labor might be reviving, Fed officials made no effort to hide their displeasure:

I suspect we will find that the [UPS] strike has done a good deal of damage in the past couple of weeks. The settlement may go a long way toward undermining the wage flexibility that we started to get in labor markets with the air traffic controllers’ strike back in the early 1980s. Even before this strike, it appeared that the secular decline in real wages was over.” (Quoted in “Not Yet Dead at the Fed: Unions, Worker Bargaining, and Economy-Wide Wage Determination” (2005) by  Daniel J.B. Mitchell and Christopher L. Erickson.)

Europe today offers the clearest case of “independent” central banks taking on an overtly political role. The ECB has repeatedly refused to support the markets for European sovereign debt, not because such intervention might fail, but precisely because it might work. As Deutsches Bundesbank president Jens Weidman put it last year, “Relieving stress in the sovereign bond markets eases imminent funding pain but blurs the signal to sovereigns about the precarious state of public finances and the urgent need to act.” (“Monetary policy is no panacea for Europe,” Financial Times, May 7 2012.) In a letter to the Financial Times, one European bank executive made the same point even more bluntly: “In addition to price stability, [the ECB] has a mandate to impose structural reform. To this extent, cyclical pain is part of its agenda.” In other words, it is the job of the ECB not simply to maintain price stability or keep Europe’s financial system from collapsing, but to inflict “pain” on democratically elected governments in order to compel them to adopt “reforms” of its own choosing.
What the ECB means by “reforms” was made very clear in a 2011 memo to the Italian government, setting out the conditions under which it would support the market in Italian debt.  The ECB’s demands included “full liberalisation of local public services…. particularly… the provision of local services through large scale privatizations”; “reform [of] the collective wage bargaining system … to tailor wages and working conditions to firms’ specific needs…”;  “thorough review of the rules regulating the hiring and dismissal of employees”; and cuts to private as well as public pensions, “making more stringent the eligibility criteria for seniority pensions” and raising the retirement age of women in the private sector. (Quoted in: “Trichet e Draghi: un’azione pressante per ristabilire la fiducia degli investitori,” Corriere della Serra, September 29, 2011.[10]) Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions. This goes well beyond the textbook remit of a central bank. But it makes perfect sense if one thinks that central banks are not the disinterested experts but representatives of a specific political interest, one that stands to gain from privatization of public goods and weakened protections for workers.
Certainly many economists don’t support the kind of slash-and-burn “reform” being promoted by the ECB. But for the most part, consensus macroeconomics endorsed the delegation of all macroeconomic policymaking to central banks, insisted that monetary policy was a matter for technical expertise and not democratic accountability, and downplayed the real conflicting interests involved. This opened the way to a power grab by the central banks, on behalf of the owners of financial wealth who are their natural constituents.
The theoretical commitment to an economy where markets optimally arrange work, consumption and investment across all time, and the practical commitment to central banks as sole custodians of macroeconomic policy: These were undoubtedly the two most important ways in which the New Keynesian mainstream of economics prepared the way for the success of the austerian Right. A third contribution, less fundamental but more direct, was the commitment of economists to the tenets of “sound finance.”

Commitment to ‘Sound Finance’
The term “sound finance” was adopted in the 1940s by the pioneering American Keynesian Abba Lerner, to describe the view that governments are subject to the same kind of budget constraints as businesses and households, and should therefore guide their fiscal choices by the dangers of excessive debt. He contrasted this view with his own preferred approach, “functional finance,” which held that government budget decisions should be taken with an eye only on the state of the macroeconomy. High unemployment means higher spending and lower taxes are needed, high inflation the opposite; the government’s financial position is irrelevant.
Consensus macroeconomics has a strong commitment to the idea of sound finance. But this commitment is more reflexive, emotional or psychological than based on any coherent vision of the economy. As a result, liberal, “saltwater” economists waver between incompatible views depending on the rhetorical needs of the moment. . On the one hand, when stimulus is  required, they dismiss the idea of financial constraints, and reject the idea of some threshold above which the costs of pubic debt rise precipitously. This was the heart of the Reinhart and Rogoff dispute, and the 90% threshold was the (disproven) cliff. But on the other hand, they invoke the very same cliffs when arguing for surpluses in good times, that they dismiss when arguing for stimulus in bad ones.
This idea that the inflationary constraint to government spending is logically the primary constraint to government spending is rarely promoted. Instead appeals to unobservable ‘cliffs’, nonlinearities and future collapses in confidence dominate the conversation about government spending. Then ECB President Jean-Claude Trichet was roundly attacked by the pro-stimulus economists for arguing, in 2010, in the depths of Europe’s recession, that it was time to cut deficits and raise interest rates, on the grounds that:

The economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors. My understanding is that an overwhelming majority of industrial countries are now in those uncharted waters, where confidence is potentially at stake. Consolidation is a must in such circumstances. (Trichet:”Stimulate no more: Now is the time for all to tighten.” Financial Times, July 22, 2010.)

As the critics rightly pointed out, there is no evidence or systematic argument for these “nonlinear responses.” The Reinhart – Rogoff paper was intended to provide exactly such evidence; its usefulness to conservative policymakers like Trichet was undoubtedly part of the reason for its success. The problem is, the collapse of Reinhart-Rogoff has hardly touched the larger vision of even the richest countries governments as perpetually teetering on the edge of a financial cliff. And one reason for the persistence of this vision is that it is shared by many of Reinhart-Rogoff’s liberal critics.

Here again is Christina Romer — one of the country’s leading “Keynesian” economists—arguing in 2007 that the biggest macroeconomic problem facing the country is that policymakers are not sufficiently worried about holding down government debt. True, she admits, there is no direct evidence high public debt has caused any problems so far. But:

It is possible that the effects of persistent deficits are highly nonlinear. Perhaps over a wide range, deficits and the cumulative public debt really do have little impact on the economy. But, at some point, the debt burden reaches a level that threatens the confidence of investors. Such a meltdown and a sudden stop of lending would unquestionably have enormous real consequences.  (Romer 2007)

Soon after giving this speech, Romer would be one of the leading advocates within the Obama administration for a larger stimulus bill. Lined up against her were economists such as Larry Summers and Peter Orszag. The conservatives’ arguments in that debate recapitulated the language Romer herself had been using less than two years before. Summers, in a contemporary account, “believed that filling the output gap through deficit spending was important, but that a package that was too large could potentially shift fears from the current crisis to the long-term budget deficit, which would have an unwelcome effect on the bond market.”  (Lizza 2009)
Mainstream New Keynesian economists want to argue that lack of fiscal space is never a constraint on stimulus in bad times, but that gaining fiscal space is a reason to run surpluses in good times. Logically, these two views are contradictory. After all, “With low debt, fiscal policy is less costly” and “With high debt, fiscal policy is more costly” are just two ways of saying the same thing. But the mainstream of economists has so far failed to face up to this contradiction. Liberal American economists seem unable to accept that if they give up the idea of a threshold past which the costs of public debt rise steeply, they must also give up the main macroeconomic argument in favor of the Clinton surpluses of the 1990s. Most critics of austerity are reluctant to admit that if high debt is not a constraint on stimulus in bad times, then it is not sensible to talk about “paying for” stimulus with surpluses in good times. Instead, they remain committed to the idea that government surpluses are definitely, absolutely needed – not now, but at some point in the future, they say. But that only cedes the moral high ground to the principled austerians who insist that surpluses are needed today.
In the stimulus vs. austerity wars of the past four years, the New Keynesians who make up the left wing of the mainstream consensus have undoubtedly been on the right side of many big policy questions. Case by case, they certainly have the better arguments. But they have no  vision. And so their victories  overAlesina -Ardagna or  Reinhart- Rogoff, count for much less than you might expect, since in the end, the vision of the economy, of the economics profession, and of economic policy hardly differs between the two camps. Alternative views of the macroeconomy exist, but they are simply ignored.
In this light, it’s interesting to compare Krugman’s 2009 New York Times magazine piece with his recent New York Review of Books piece. In the earlier article, while he has plenty of criticism for politicians, he makes it clear that the  insidious problem is in economics profession. Even the best economists, he writes, prefer mathematical elegance to historical realism, make a fetish of optimization and rational expectations, and ignore the main sources of instability in real economies. In 2009, Krugman was scathing about “the profession’s blindness to the very possibility of catastrophic failures in a market economy,” and made it clear that better policy would require better economics. He was unsparing — and insightful — about his own school as well as his opponents. The New Keynesian models used by “saltwater” economists like himself, he wrote, still “assume that people are perfectly rational and financial markets are perfectly efficient.” He was scornful of the all-purpose excuse that “no one could have predicted,” insisting that the world faced “disasters that could have been predicted, should have been predicted.”[11]
In the 2013 piece,  this self-critical tone is gone. Now, the economics profession as a whole is almost completely exonerated. Their “failure to anticipate the crisis,” he writes, “was a relatively minor sin. Economies are complicated, ever-changing entities; it was understandable that few economists realized” the fragility of the system before the crisis. Instead, his fire is all aimed at politicians, who “turned their back on practically everything economists had learned.”[12]the economists who have given intellectual support for austerity are reduced in this telling to a few outliers, a marginal clique. As a whole, he now says, the profession understands the problem properly; the lack of a proper solution is a sign of “just how little good comes from understanding.” Building a better economics seemed both urgent and promising in 2009; four years later, that project has been abandoned.
It is too easy to dismiss the idea of the pivot to austerity as being the failure of flawed papers or as political opportunism alone. Such an analysis misses the fact that, for the majority of the economics profession, , the ideas of stimulus and especially fiscal policy have always been intellectually uncomfortable, while the arguments for austerity and sound finance come naturally. A conception of macroeconomic dynamics in which the economy was by its nature unstable, and central banks could not be relied on to stabilize it, was difficult even to describe in the language of the mainstream. This state of affairs is what Gramsci would identify as hegemony.
The 2008 financial crisis and the multiple subsequent crises it engendered did seem to shake that hegemony. For a brief period, it became obvious that writers such as Keynes, Bagehot, Minsky and even Marx had much more to provide in terms of explanation and solutions than were available from the kind of macroeconomic taught in graduate classes and published in the top journals. But as time has gone on and memories of the crisis have faded, the consensus has reasserted itself. Nowhere, perhaps, has this been more evident, and more consequential, than in the austerity wars.
If Krugman got it right the first time and macroeconomists have no answers today’s urgent questions, and not just that politicians won’t listen to them – the question, then, is what is to be done? There are those who argue that there is nothing intrinsically wrong with the ways in which macroeconomics is studied, that it is just a matter of adding a few more frictions. But this is simply the traditional cherished belief of intellectual endeavors that the discipline always improves on itself. As any historian of ideas might suggest, this narrative of continuously closer approximation to the truth is often a myth, and intellectual “progress” is often down a blind alley or wrong turn.
In Axel Leijonhufvud’s eloquent essay on the value of studying the history of economic thought (Leijonhufvud 2002), he offers the metaphor of a traveller who finds himself at a dead end in the road. If he is very bold, he might try to scale the walls (or bushwhack through the forest) blocking the path. But often, it’s better to backtrack, to see if there was a turnoff somewhere earlier on the road that looked less promising at the time but in retrospect might have been a better choice. This, he suggests, is the situation of economics today. In this case, further progress means, first of all, looking back to earlier points in the discipline’s evolution to see what of value might have been overlooked.
How far back we need to go — how long ago did economics take the wrong turn that led us to the current impasse? Was it 40 years ago, when the rational expectations revolution overturned Gordon’s  “Economics of 1978,” which had less faith in central banks and was perhaps better suited to describing economies as systems evolving in time? Or was it 75 years ago, when Keynes’ radical insights abut fundamental uncertainty and the inherent instability of the capitalist investment process were domesticated by writers like Hicks and Samuelson in the neoclassical synthesis? Or was it 150 years ago, when the classical tradition of Ricardo and Marx – with its attention to dynamics, and central concern with distributional conflict  — was displaced by the marginalist approach that made economics primarily about the static problem of efficient allocation? We do not here suggest that there is nothing worth keeping in the current macroeconomic canon, but we think these earlier traditions suggest important routes forward that have been abandoned. Indeed, those economists who worked in alternative traditions (Minskyan, Post-Keynesian, Marxist, and even Austrian) had a much more robust vocabulary for making sense of the crisis and the responses to it.
The industrialized world has gone through a prolonged period of stagnation and misery and may have worse ahead of it. Probably no policy can completely tame the booms and busts that capitalist economies are subject to. And even those steps that can be taken, will not be taken without the pressure of strong popular movements challenging governments from the outside. The ability of economists to shape the world, for good or for ill, is strictly circumscribed. Still, it is undeniable that the case for austerity – so weak on purely intellectual grounds – would never have conquered the commanding heights of policy so easily, if the way had not been prepared for it by the past thirty years of consensus macroeconomics.  Where the possibility and political will for stimulus did exist, modern economics – the stuff of current scholarship and graduate education –  tended to hinder rather than help. While when the turn to austerity came, even shoddy work could have an outsize impact, because it had the whole weight of conventional opinion behind it. For this the mainstream of the economics profession – the liberals as much as the conservatives — must take some share of the blame.
Alesina, Alberto (2010) ‘Fiscal Adjustments:  What do We Know and What are We doing?’ Mercatus Center Working Paper September 2010
Alesina, Alberto and Ardagna, Silvia (2009) ‘Large Changes in Fiscal Policy: Taxes Versus Spending’, National Bureau of Economic Research (NBER), Working Paper No. 15438.
Ball, Laurence, Davide Furceri, Daniel Leigh, and  Prakash Loungani
(2013) The Distributional Effects of Fiscal  Consolidation. IMF working paper

Bivens, Josh and John Irons (2010)’ Government Debt and Economic Growth’
Blinder, Alan S (1987) Is Government Too Political? Foreign Affairs Vol. 76, No. 6 (Nov. – Dec., 1997), pp. 115-126
De Grauwe Paul  (2010) Fiscal policies in “normal” and “abnormal” recessions. VoxEU, 30th March 2010
De Grauwe Paul and Yuemei Ji (2013) Panic-driven austerity in the Eurozone and its implications.  VoxEu 21st Feb 2013.
Kotlikoff, Laurence (2011).America’s debt woe is worse than Greece’s
Leijonhufvud, Axel (1981) Information and Coordination : Essays in Macroeconomic Theory by Axel Leijonhufvud (1981, Paperback)
Lizza, Ryan (2009)  “Inside the Crisis:Larry Summers and the White House economic team”, New Yorker October 2009.
Tankersley, James (2013).Sequester, to some economists, is no sweat, Washington Post, April 2013
Taylor, Lance (2004) Reconstructing Macroeconomics: Structuralist Proposals and Critiques of the Mainstream. Harvard University Pres.

  Economic Policy Institute, #271
Blyth, Mark (2013). Austerity: The History of a Dangerous Idea, OUP USA,
Cogan, John F. & Cwik, Tobias & Taylor, John B. & Wieland, Volker, 2010. “New Keynesian versus old Keynesian government spending multipliers,” Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 281-295, March
Coy, Peter (2010) ‘Keynes vs Alesina. Alesina Who?’ Bloomberg Business Week, June 3, 2010
Crotty, James (2012) The great austerity war: what caused the US deficit crisis and who should pay to fix it?Camb. J. Econ. (2012) 36 (1): 79-10
Dube, Arindrajit (2013) ‘Growth in a Time Before Debt: A Note Assessing Causal Interpretations of Reinhart and Rogoff (2010)’. Mimeo
Eggertsson, Gauti B., What Fiscal Policy is Effective at Zero Interest Rates? (November 1, 2009). FRB of New York Staff Report No. 402. Available at SSRN: or
Epstein, Gerald, and Thomas Ferguson (1984). “Monetary Policy,Loan Liquidation, and Industrial Conflict: The Federal Reserve and the Open Market Operations of 1932’ Journalof Economic History (December 1984), pp. 957-83.
Ferguson, Thomas and Robert Johnson (2010) “A World Upside Down? Deficit Fantasies in the Great Recession”. Roosevelt Institute
Goodfriend, Marvin. 2007. “How the World Achieved Consensus on Monetary Policy.” Journal of Economic Perspectives, 21(4): 47-68.
Gordon, Robert (2009). “Is Modern Macro or 1978‐era Macro More Relevant to the Understanding of the Current Economic Crisis?”. Mimeo
Herndon, Thomas Michael Ash and Robert Pollin, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Political Economy Research Institute,  Working Paper 322. April 2013;
IMF (2010). “From stimulus to consolidation: revenue and expenditure policies in advanced and emerging economies” Mimeo
Jayadev, Arjun and Michael Konczal (2010) ‘The Boom Not the Slump: The Right Time For Austerity’, August 23, Roosevelt Institute
Leijonhufvud, Axel, (1997), The Wicksellian Heritage, No 9705, Department of Economics Working Papers, Department of Economics, University of Trento, Italia.
Leijonhufvud, Axel, (2002), The Uses of History. Department of Economics, University of Trento, Italia.
Reinhart, Carmen M and Kenneth S. Rogoff (2010), “Growth in a Time of Debt,” American Economic Review: Papers & Proceedings 100 (May 2010): 573–578

Romer, Christina (2007), “Macroeconomic  Policy in the 1960s: The Causes and Consequences of a Misguided Revolution” Speech delivered at the Economic History Association Annual Meeting
Wren-Lewis, Simon (2012).  What is New Keynesian economics really about?
[1]          University of Massachusetts Amherst and Roosevelt University
[2]          University of Massachusetts Boston and Azim Premji University
            We would like to thank, without implicating, Suresh Naidu, Jim Crotty, Mark Blyth, Peter Spiegler and an anonymous referee for very helpful comments.
[3]   There is a challenge of terminology here, since economists, perhaps even more than most academics, are committed to the idea of a professional consensus. For the purposes of this article, “liberal”  refers to the left side of mainstream U.S. politics, as opposed to conservative. “New Keynesian” refers to a particular methodology in macroeconomics, which combines the Walrasian general-equilibrium framework of neoclassical economics with a specific set of “frictions” that allow for superficially Keynesian results in the short run, including some form of aggregate demand. (This is opposed by “New Classical” economists, who believe that the long-run models they and the New Keynesians share should be used for the short run as well.) “Saltwater” refers to one side of a sociological divide within the economics profession, with saltwater economists more eclectic, more willing to modify their models as needed to describe particular events or support particular policies, while “freshwater” economists are more committed to logically consistent reasoning from first principles. While these three divisions are distinct in principle, in practice there is much overlap between them. The important point for our purposes is that a strong set of assumptions is shared across all these divides, especially with respect to methodology but also with respect to policy. There is a much wider field of economic beyond this consensus, from the postwar economics of Samuelson, Solow and Tobin; to the radical (or “heterodox”) Keynesian economics kept alive at places like UMass-Amherst, The New School, and the University of Missouri-Kansas City; to the various traditions of Marxism. But since these schools currently have little or no influence on policy in the US or in Europe, they are outside the scope of this article.
[4]          See European Central Bank, Interview with Jean-Claude Trichet, President of the ECB, and Liberation, July 8 2010
[5]          For example, Laurence Kotlikoff (2011) – a respected financial economist —  argued  “The financial sharks are circling Greece because Greece is small and defenseless, but they’ll soon be swimming our way.”
[6]          It is interesting in this regard that a recent paper by the IMF addresses the distributional effects of austerity (Ball et al. 2013) . The abstract alone confirms the Crotty viewpoint: “This paper examines the distributional effects of fiscal consolidation. Using episodes of fiscal consolidation for a sample of 17 OECD countries over the period 1978–2009, we find that fiscal consolidation has typically had significant distributional effects by raising inequality, decreasing wage income shares and increasing long-term unemployment. The evidence also suggests that spending-based adjustments have had, on average, larger distributional effects than tax-based adjustments
[7]   For a sense of what a serious academic development of “IS-LM-style” models could look like, the best starting point is probably the work of Lance Taylor, particularly Reconstructing Macroeconomics. Taylor (2004)
[8]   It is somewhat ironic that the specific growth model that is most often used is the version developed by Robert Solow, since Solow himself is quite critical of the turn toward intertemporal optimization as the core methodology of macroeconomics.
[9]          This is also ironic because Carmen Reinhart and Kenneth Rogoff have both argued (albeit unenthusiastically) for financial repression or inflation.
[10]        See also the discussion on the Triple Crisis blog:
[11]        “How Did Economists Get It So Wrong,” New York Times Magazine, September 2, 2009.
[12] “How the Case for Austerity Has Crumbled,” New York Review of Books, June 6, 2013.

“Recession Is a Time of Harvest”

Noah and Seth say pretty much everything that needs to be said about this latest #Slatepitch provocation from Matt Yglesias.  [1] So, traa dy lioaur, I am going to say something that does not need to be said, but is possibly interesting.

Yglesias claims that “the left” is wrong to focus on efforts to increase workers’ money incomes, because higher wages just mean higher prices. Real improvements in workers’ living standards — he says — come from the same source as improvements for rich people, namely technological innovation. What matters is rising productivity, and a rise in productivity necessarily means a fall in (someone’s) nominal income. So we need to forget about raising the incomes of particular people and trust the technological tide to lift all boats.

As Noah and Seth say, the logic here is broken in several places. Rising productivity in a particular sector can raise incomes in that sector as easily as reduce them. Changes in wages aren’t always passed through to prices, they can also reflect changes in the distribution between wages and other income.

I agree, it’s definitely wrong as a matter of principle to say that there’s no link, or a negative link, between changes in nominal wages and changes in the real standard of living. But what kind of link is there, actually? What did our forebears think?

Keynes notoriously took the Yglesias line in the General Theory, arguing that real and nominal wages normally moved in opposite directions. He later retracted this view, the only major error he conceded in the GT (which makes it a bit unfortunate that it’s also the book’s first substantive claim.) Schumpeter made a similar argument in Business Cycles, suggesting that the most rapid “progress in the standard of life of the working classes” came in periods of deflation, like 1873-1897. Marx on the other hand generally assumed that the wage was set in real terms, so as a first approximation we should expect higher productivity in wage-good industries to lead to lower money wages, and leave workers’ real standard of living unchanged. Productivity in this framework (and in post-GT Keynes) does set a ceiling on wages, but actual wages are almost well below this, with their level set by social norms and the relative power of workers and employers.

But back to Schumpeter and the earlier Keynes. It’s worth taking a moment to think through why they thought there would be a negative relationship between nominal and real wages, to get a better understanding of when we might expect such a relationship.

For Keynes, the logic is simple. Wages are equal to marginal product. Output is produced in conditions of declining marginal returns. (Both of assumptions are wrong, as he conceded in the 1939 article.) So when employment is high, the real wage must be low. Nominal wages and prices generally move proportionately, however, rising in booms and falling in slumps. (This part is right.) So we should expect a move toward higher employment to be associated with rising nominal wages, even though real wages must fall. You still hear this exact argument from people like David Glasner.

Schumpeter’s argument is more interesting. His starting point is that new investment is not generally financed out of savings, but by purchasing power newly created by banks. Innovations are almost never carried out by incumbent producers simply adopting the new process in place of the existing one, but rather by some new entrant — the famous entrepreneur– operating with borrowed funds. This means that the entrepreneur must bid away labor and other inputs from their current uses (importantly, Schumpeter assumes full employment) pushing up costs and prices. Furthermore, there will be some extended period of demand from the new entrants for labor and intermediate goods while the incumbents have not yet reduced theirs — the initial period of investment in the new process (and various ancillary processes — Schumpeter is thinking especially of major innovations like railroads, which will increase demand in a whole range of related industries), and later periods where the new entrants are producing but don’t yet have a decisive cost advantage, and a further period where the incumbents are operating at a loss before they finally exit. So major innovations tend to involve extended periods of rising prices. It’s only once the new producers have thoroughly displaced the old ones that demand and prices fall back to their old level. But it’s also only then that the gains from the innovation are fully realized. As he puts it (page 148):

Times of innovation are times of effort and sacrifice, of work for the future, while the harvest comes after… ; and that the harvest is gathered under recessive symptoms and with more anxiety than rejoicing … does not alter the principle. Recession [is] a time of harvesting the results of preceding innovation…

I don’t think Schumpeter was wrong when he wrote. There is probably some truth to idea that falling prices and real wages went together in 19th century. (Maybe by 1939, he was wrong.)

I’m interested in Schumpeter’s story, though, as more than just intellectual history, fascinating tho that is. Todays consensus says that technology determines the long-term path of the economy, aggregate demand determines cyclical deviations from that path, and never the twain shall meet. But that’s not the only possibility. We talked the other day about demand dynamics not as — as in conventional theory — deviations from the growth path in response to exogenous shocks, but as an endogenous process that may, or may not, occasionally converge to a long-term growth trajectory, which it also affects.

In those Harrod-type models, investment is simply required for higher output — there’s no innovation or autonomous investment booms. Those are where Schumpeter comes in. What I like about his vision is it makes it clear that periods of major innovation, major shifts from one production process to another, are associated with higher demand — the major new plant and equipment they require, the reorganization of the spatial and social organization of production they entail (“new plant, new firms, new men,” as he says) make large additional claims on society’s resources. This is the opposite of the “great recalculation” claim we were hearing a couple years ago, about how high unemployment was a necessary accompaniment to major geographic or sectoral shifts in output; and also of the more sophisticated version of the recalculation argument that Joe Stiglitz has been developing. [2] Schumpeter is right, I think, when he explicitly says that if we really were dealing with “recalculation” by a socialist planner, then yes, we might see labor and resources withdrawn from the old industries first, and only then deployed to the new ones. But under capitalism things don’t work like that  (page 110-111):

Since the central authority of the socialist state controls all existing means of production, all it has to do in case it decides to set up new production functions is simply to issue orders to those in charge of the productive functions to withdraw part of them from the employments in which they are engaged, and to apply the quantities so withdrawn to the new purposes envisaged. We may think of a kind of Gosplan as an illustration. In capitalist society the means of production required must also be … [redirected] but, being privately owned, they must be bought in their respective markets. The issue to the entrepreneurs of new means of payments created ad hoc [by banks] is … what corresponds in capitalist society to the order issued by the central bureau in the socialist state. 

In both cases, the carrying into effect of an innovation involves, not primarily an increase in existing factors of production, but the shifting of existing factors from old to new uses. There is, however, this difference between the two methods of shifting the factors : in the case of the socialist community the new order to those in charge of the factors cancels the old one. If innovation were financed by savings, the capitalist method would be analogous… But if innovation is financed by credit creation, the shifting of the factors is effected not by the withdrawal of funds—”canceling the old order”—from the old firms, but by … newly created funds put at the disposal of entrepreneurs : the new “order to the factors” comes, as it were, on top of the old one, which is not thereby canceled.

This vision of banks as capitalist Gosplan, but with the limitation that they can only give orders for new production on top of existing production, seems right to me. It might have been written precisely as a rebuttal to the “recalculation” arguments, which explicitly imagined capitalist investment as being guided by a central planner. It’s also a corrective to the story implied in the Slate piece, where one day there are people driving taxis and the next day there’s a fleet of automated cars. [3] Before that can happen, there’s a long period of research, investment, development — engineers are getting paid, the technology is getting designed and tested and marketed, plants are being built and equipment installed — before the first taxi driver loses a dollar of income. And even once the driverless cars come on line, many of the new companies will fail, and many of the old drivers will hold on for as long as their credit lasts. Both sets of loss-making enterprises have high expenditure relative to their income, which by definition boosts aggregate demand. In short, a period of major innovations must be a period of rising nominal incomes — as we most recently saw, on a moderate scale, in the late 1990s.

Now for Schumpeter, this was symmetrical: High demand and rising prices in the boom were balanced by falling prices in the recession — the “harvest” of the fruits of innovation. And it was in the recession that real wages rose. This was related to his assumption that the excess demand from the entrepreneurs mainly bid up the price of the fixed stock of factors of production, rather than activating un- or underused factors. Today, of course, deflation is extremely rare (and catastrophic), and output and employment vary more over the cycle than wages and prices do. And there is a basic asymmetry between the boom and the bust. New capital can be added very rapidly in growing enterprises, in principle; but gross investment in the declining incumbents cannot fall below zero. So aggregate investment will always be highest when there are large shifts taking place between sectors or processes. Add to this that new industries will take time to develop the corespective market structure that protects firms in capital-intensive industries from cutthroat competition, so they are more likely to see “excess” investment. And in a Keynesian world, the incomes from innovation-driven investment will also boost consumption, and investment in other sectors. So major innovations are likely to be associated with booms, with rising prices and real wages.

So, but: Why do we care what Schumpeter thought 75 years ago, especially if we think half of it no longer holds? Well, it’s always interesting to see how much today’s debates rehash the classics. More importantly, Schumpeter is one of the few economists to have focused on the relation of innovation, finance and aggregate demand (even if, like a good Wicksellian, he thought the latter was important only for the price level); so working through his arguments is a useful exercise if we want to think more systematically about this stuff ourselves. I realize that as a response to Matt Y.’s silly piece, this post is both too much and poorly aimed. But as I say, Seth and Noah have done what’s needed there. I’m more interested in what relationship we think does hold, between innovation and growth, the price level, and wages.

As an economist, my objection to the Yglesias column (and to stuff like the Stiglitz paper, which it’s a kind of bowdlerization of) is that the intuition that connects rising real incomes to falling nominal incomes is just wrong, for the reasons sketched out above. But shouldn’t we also say something on behalf of “the left” about the substantive issue? OK, then: It’s about distribution. You might say that the functional distribution is more or less stable in practice. But if that’s true at all, it’s only over the very long run, it certainly isn’t in the short or medium run — as Seth points out, the share of wages in the US is distinctly lower than it was 25 years ago. And even to the extent it is true, it’s only because workers (and, yes, the left) insist that nominal wages rise. Yglesias here sounds a bit like the anti-environmentalists who argue that the fact that rivers are cleaner now than when the Clean Water Act was passed, shows it was never needed. More fundamentally, as a leftist, I don’t agree with Yglesias that the only important thing about income is the basket of stuff it procures. There’s overwhelming reason — both first-principle and empirical — to believe that in advanced countries, relative income, and the power, status and security it conveys, is vastly more important than absolute income. “Don’t worry about conflicting interests or who wins or loses, just let the experts make things better for everyone”: It’s an uncharitable reading of the spirit behind this post, but is it an entirely wrong one?

UPDATE: On the other hand. In his essay on machine-breaking, Eric Hobsbawm observes that in 18th century England,

miners’ riots were still directed against high food prices, and the profiteers believed to be responsible for them.

And of course more generally, there have been plenty of working-class protests and left political programs aimed at reducing the cost of living, as well as raising wages. Food riots are a major form of popular protest historically, subsidies for food and other necessities are a staple policy of newly independent states in the third world (and, I suspect, also disapproved by the gentlemen of Slate), and food prices are a preoccupation of plenty of smart people on the left. (Not to mention people like this guy.) So Yglesias’s notion that “the left” ignores this stuff is stupid. But if we get past the polemics, there is an interesting question here, which is why mass politics based around people’s common interests as workers is so much more widespread and effective than this kind of politics around the cost of living. Or, maybe better, why one kind of conflict is salient in some times and places and the other kind of conflict in others; and of course in some, both.

[1] Seth’s piece in particular is a really masterful bit of polemic. He apologizes for responding to trollery, which, yeah, the Yglesias post arguably is. But if you must feed trolls, this is how it’s done. I’m not sure if the metaphor requires filet mignon and black caviar, or dogshit garnished with cigarette butts, or fresh human babies, but whatever it is you should ideally feed a troll, Seth serves it up.

[2] It appears that Stiglitz’s coauthor Bruce Greenwald came up with this first, and it was adopted by right-wing libertarians like Arnold Kling afterwards.

[3] I admit I’m rather skeptical about the prospects for driverless cars. Partly it’s that the point is they can operate with much smaller error tolerances than existing cars — “bumper to bumper at highway speeds” is the line you always hear — but no matter how inherently reliable the technology, these things are going to be owned maintained by millions of individual nonprofessionals. Imagine a train where the passengers in each car were responsible for making sure it was securely coupled to the next one. Yeah, no. But I think there’s an even more profound reason, connected to the kinds of risk we will and will not tolerate. I was talking to my friend E. about this a while back, and she said something interesting: “People will never accept it, because no one is responsible for an accident. Right now, if  there’s a bad accident you can deal with it by figuring out who’s at fault. But if there were no one you could blame, no one you could punish, if it were just something that happened — no one would put up with that.” I think that’s right. I think that’s one reason we’re much more tolerant of car accidents than plane accidents, there’s a sense that in a car accident at least one of the people involved must be morally responsible. Totally unrelated to this post, but it’s a topic I’d like to return to at some point — that what moral agency really means, is a social convention that we treat causal chains as being broken at certain points — that in some contexts we treat people’s actions as absolutely indeterminate. That there are some kinds of in principle predictable actions by other people that we act — that we are morally obliged to act — as if we cannot predict.

Bring Back Butlerism

From Eric Foner’s A Short History of Reconstruction:

Even more outrageous than Tweed … was Massachusetts Congressman Benjamin F. Butler, who flamboyantly supported causes that appalled reformers such as the eight-hour day, inflation, and payment of the national debt in greenbacks. He further horrified respectable opinion by embracing women’s suffrage, Irish nationalism, and the Paris Commune.

Or, as a horrified Nation put it, Butlerism was

the embodiment in political organization of a desire for the transfer of power to the ignorant and poor, and the use of government to carry out the poor and ignorant man’s view of the nature of society.

Labor law, inflation, women’s rights, anti-imperialism, and small-c communism, not to mention government by the poor? We could use a little more of that 1870s spirit today. People on the left who want to central banks to do more, in particular, could talk more about loose money’s radical pedigree.

So who was this guy? The internet is mainly interested in his Civil War career. Made a general on the basis of his pro-union, anti-slavery politics, he was, not surprisingly, pretty crap at it; but it does appear that he was the first Union officer to refuse to return fugitive slaves to their masters, and the first to successfully enlist black troops in the South. That was enough for Jefferson Davis to order that if he were captured, he should be executed on the spot. So he didn’t know how to lead a cavalry charge; sounds like a war hero to me.

In the current Jacobin (which everyone should be reading), Seth Ackerman offers emancipation and Reconstruction as a usable past for the Occupy left, unfavorably contrasting “the heavily prefigurative and antipolitical style of activism practiced by William Lloyd Garrison” with the pragmatic abolitionists who

saw that a strategic approach to abolition was required, one in which the “cause of the slave” would be harnessed to a wider set of appeals. At each stage of their project, from the Liberty Party to the Free Soil Party and finally the Republican Party, progressively broader coalitions were formed around an emerging ideology of free labor that merged antislavery principles with the economic interests of ordinary northern whites.

Today’s left, he suggests, could learn from this marriage of radical commitments and practical politics. Absolutely right.

There is, though, a problem: Reconstruction wasn’t just defeated in the South, it was abandoned by the North, largely by these same practical politicians, whose liberalism was transposed in just a few years from the key of anti-slavery to the key of “free trade, the law of supply and demand, the gold standard and limited government” (that’s Foner again), and who turned out to be less frightened by the restoration of white supremacy in the South than by “schemes for interference with property.”

If we must, as we must, “conjure up the spirits of the past …, borrowing from them names, battle slogans, and costumes in order to present this new scene in world history in time-honored disguise and borrowed language,” then certainly, we could do worse than the Civil-War era Republicans who successfully yoked liberalism to the cause of emancipation (though I’m not sure why Seth name-checks Salmon P. Chase, an early opponent of Reconstruction). But personally, I’d prefer to dress up as a populist who continued to support the rights of working people even after liberalism had decisively gone its own way, and who ended up representing “all that the liberals considered unwholesome in American politics.” Anybody for a revival of Butlerism?


Keith Richards wrote a book. A month ago, at least, you could find it on the front shelf of the Barnes & Noble, next to the Glenn Beck.

I haven’t read the book, but I did read David Remnick’s review in The New Yorker. I was struck by this bit:

In the teen-aged imagination, the virtue of being a member of the band is that you end the day in the sack with the partner, or partners, of your choice. Not so, Richards says: “You might be having a swim or screwing the old lady, but somewhere in the back of the mind, you’re thinking about this chord sequence or something related to a song. No matter what the hell’s going on.”

One could preach a whole sermon on that text. To begin with, that’s what it is to be an artist, isn’t it? It’s work, hard work, and you’re always working. Or as the man says:

Labour time cannot remain the abstract antithesis to free time in which it appears from the perspective of bourgeois economy. … Labour becomes the individual’s self-realization, [but this] in no way means that it becomes mere fun, mere amusement, as Fourier with grisette-like naivete, conceives it. Really free working, e.g. composing, is at the same time precisely the most damned serious, the most intense exertion.

And there’s nothing more satisfying than that exertion. That’s what Keith Richards says, anyway. All the varieties of consumption the world can offer — and it offers them all to the rock star — can’t compete with the need to produce, in this case to produce music. The development of capitalism has certainly increased the number of of people who can get some of the satisfactions of consuming like Keith Richards, but has it increased the number who get the satisfaction of producing like him, freely and creatively?

This need to be doing productive work, and to do one’s work well, what Michelet called “the professional conscience” is, it seems to me, one of the most fundamental but one of the most neglected human drives. You can hear it from Richards. You can hear it from people like the stonemason interviewed in Studs Terkel’s Working:

There’s not a house in this country that I built that I don’t look at every time I go by. I can set here now and actually in my mind see so many you wouldn’t believe. If there’s one stone in there crooked, I know where it’s at and I never forget it. Maybe 30 years, I’ll know a place where I should have took that stone out and redone it but I didn’t. I still notice it. The people who live there might not notice it, but I notice it. I never pass that house that I don’t think of it …. My work, I can see what I did the first day I started. All my work is set right out there in the open and I can look at it as I go by. It’s something I can see the rest of my life. Forty years ago, the first blocks I ever laid in my life, when I was 17 years old. I never go through Eureka that I don’t look thataway. It’s always there. Immortality as far as we’re concerned

Or you can hear it from the sailor Stanislav in B. Traven’s The Death Ship, explaining why he took a grueling, barely-paid job as a stoker on the titular vessel when he was living comfortably as a petty criminal on land:

You get awfully tired and bored of that kind of business. There is something which is not true about the whole thing. And you feel it, see? … You want to do something. You wish to be useful. I do not mean that silly stuff about man’s duty. That’s bunk. There is in yourself that which is driving you on to do something worth while. Not all the time hanging on like a bum… It is that you want to create something, to help things going.

This is what liberals, who think that human wellbeing consists in the consumption of goods and services, cannot understand. Capitalism piles up consumer goods but deprives more and more of us of the satisfaction of genuine work. A good trade, when it’s a question of meeting basic needs. But once they are met — and they are met; they are finite, tho liberals, from Mill to DeLong, deny it — all the bacchanals in the world are no substitute for the knowledge that one has produced something worthwhile by one’s own free efforts. Or as that other guy said, It’s not that which goes into the mouth, but that which comes out of it, that defiles people. Or that exalts them.

EDIT: Thanks to (I think) Chris Mealy, this has quickly become the most-read ever post on Slackwire. If you like it, you might also appreciate this one and this one.

Keyes Is Right

Alan Keyes says, “If citizenship is not a birthright then it must be a grant of the government. And if it is a grant of the government, it could curtail that grant in all the ways that fascists and totalitarians always want to.”

In other words, the rights vis-a-vis the state we call citizenship, are prior to the legal acts that formalize them.

Joshua Micah Marshall thinks that’s “dramatically crazier than any of the opinions on offer,” since Keyes attributes the priority of citizenship, in part, to God.

But as a historical matter, Keyes is certainly right. The founding documents of political liberalism — the Declaration of the Rights of Man and Citizen, the Declaration of Independence — explicitly state that the rights of the citizen are prior to their recognition by governments. If a government fails to recognize them, it’s that government’s legitimacy that is diminished, not the rights of the citizen.

In the specific 14th Amendment context, the point is that the right of the freedmen to citizenship wasn’t created by the 14th Amendment, but already existed by virtue of their living in this country and being subject to its laws. Did Congress have the power or the authority to deny them citizenship? Seems to me the Civil War answered that question clearly in the negative. The law binds most of the time, but ultimately it derives its authority from a set of norms that are prior to it.

This is certainly how the founders of liberal political orders, here and elsewhere, understood the relationship between the rights of the citizen and the law. That’s why they were ready to overthrow existing governments by force. Of course today it’s the Constitution and the law that regulate citizenship. But it’s important to remember that the fact that we — or almost anyone else — are citizens at all is not the result of legal or constitutional acts.

EDIT: It’s funny that reference to the founding documents of political liberalism is these days almost a monopoly of conservatives. Of course it’s not so strange, since conservatism is backward-looking by nature, while progressives naturally believe in progress. But the DNA of liberalism hasn’t changed that much, and Jefferson, Madison, and Hamilton, Lafayette and Saint-Just, and other Enlightenment political figures expressed it pretty robustly.

Unlike their forebears, modern liberals tend to insist on the absolute autonomy of the law in general, and the Constitution in particular. They’re unwilling, for obvious reasons, to accept a political order grounded on divine revelation, but they don’t have any alternative ground to put it on, so it ends up floating in the air. (Carl Schmitt is very good on this.) There’s what’s useful, and there’s what’s legal, under the law as it exists; but there’s no category of political legitimacy behind the law. Given the remarkable political stability of the United States since the Civil War, and just as important, as Herbert Croly emphasized, the continuously rising standard of living here, we’ve mostly gotten along fine without one. But one suspects that it wouldn’t take that much political strain for “government by lawyers” (Croly’s phrase) to experience its Wile E. Coyote moment, when it turns out that the authority of the law wasn’t underpinned by anything but a lack of good reasons to question it. Not unlike, perhaps, what happened in the financial crisis of 2008, when it turned out that not only did the traditional tools of monetary policy not work, they’d stopped working some time before.