Tag: Harrod

A Harrodian Perspective on Secular Stagnation

I’ve mentioned before, I think a useful frame to think about the secular stagnation debate through is what’s become known as Harrod’s growth model. [1] My presentation here is a bit different from his.

Start with the familiar equation:


S – I + T – G = X – M

Private savings minus private investment, plus taxes minus government spending, equal exports minus imports. [2] If the variables refer to the actual, realized values, then this is an accounting identity, always true by definition. Anything that is produced must be purchased by someone, for purposes of consumption, investment, export or provision of public services. (Unsold goods in a warehouse are a form of investment.) If the variables refer to expected or intended values, which is how Harrod used them, then it is not an identity but an equilibrium condition. It describes the condition under which businesses will be “satisfied that they have produced neither more nor less than the right amount.”

The next step is to rearrange the equation as S – (G – T) – (X – M) = I. We will combine the government and external balances into A = (G – T) + (X – M). Now divide through by Y, writing  s = S/Y and a = A/Y. This gives us:

s – a = I/Y

Private savings net of government and foreign borrowing, must equal private investment. Next, we decompose investment. Logically, investment must either provide the new capital goods required for a higher level of output, or replace worn-out or obsolete capital goods, or be a shift toward a more capital-intensive production technique. [3] So we write:

s – a = gk + dk + delta-k

where g is the growth rate of the economy, k is the current capital-output ratio, d is the depreciation rate (incorporating obsolescence as well as physical wearing-out) and delta-k is the change in the capital-output ratio.

What happens if this doesn’t hold? Realized net savings and investment are always equal. So if desired savings and desired investment are different, that means that somebody’s expectations were not fulfilled. For a situation to arise in which desired net savings are greater than desired investment, either people must have saved less than they wish they had in retrospect, or businesses must have investment more than they wish they had in retrospect. Either way, expenditure in the next period will fall.

What prevents output from falling to zero, in this case? Remember, some consumption is linked to current income, but some is not. This means that when income falls, consumption falls less than proportionately. Which is equivalent to saying that when income falls, there is also a fall in the fraction of income that is saved. In other words, if the marginal propensity to save out of income is less than one, then s — which, remember, is average saving rate — must be a positive function of the current level of output. So the fall in output resulting from a situation in which s > I/Y will eventually cause s to fall sufficiently to bring desired saving into equality with desired investment. The more sensitive is consumption to current income, the larger the fall in income required; if investment is also sensitive to current income, then a still larger fall in income will be required. (If investment is more sensitive than saving to current income, this adjustment process will not work and the decline in output will continue until investment reaches zero.) This is simply the logic of the Keynesian multiplier.

In addition to current income, saving is also a function of the profit rate. Saving is higher out of profits than out of wages, partly because profit recipients are typically richer than wage-earners, but also because are large fraction of profits remain within the business sector and are not available for consumption. [4] Finally, saving is usually assumed to be a function of the interest rate. The desired capital output ratio may also be a function of the interest rate. All the variables are of course also subject to longer term social, technological and economic influences.

So we write

s(u, i, p) – a = gk + dk + delta-k(i, p)

where u is the utilization rate (i.e. current output relative to some measure of trend or potential), i is some appropriate interest rate, and p is the profit share. s is a positive function of utilization, interest rates and the profit share, and delta-k is a negative function of the interest rate and a positive function of the profit rate. Since the profit share and interest rate are normally positive functions of the current level of output, their effects on savings are stabilizing — they reduce the degree to which output must adjust to maintain equality of desired net savings equal and investment. The effect of interest rates on investment is also stabilizing, while the effect of the profit share on investment (as well as any direct effect of utilization on investment, which we are not considering here) are destabilizing.

How does this help make sense of secular stagnation?

In modern consensus macroeconomics, it is implicitly assumed that savings and/or investment are sufficiently sensitive to interest rates that equilibrium can be normally be maintained entirely by changes in interest rates, with only short-term adjustments of output while interest rates move to the correct level. The secular stagnation idea — in both its current and original 1940s edition, as well as the precursor ideas about underconsumption going back to at least J. A. Hobson — is that at some point interest rate adjustment may no longer be able to play this role. In that case, desired investment will not equal desired saving at full employment, so there will be a persistent output gap.

There are a number of reasons that s – a might rise over time. As countries grow richer, the propensity to consume may fall simply because people’s people’s desires for goods and services are finite. This was what Keynes and Alvin Hansen (who coined the term “secular stagnation”) believed. Desired saving may also rise as a result of an upward redistribution of income, or a shift from wage income to profit income, or an increase in the share of profits retained by firms. [5] Unlike the progressive satiation of consumption demand, these three factors could in principle just as easily evolve in the other direction. Finally, government deficits or net exports might decline — but again, they might also increase.

On the right side of the equation, growth may fall for exogenous reasons, slowing population growth being the most obvious. This factor has been emphasized in recent discussions. Depreciation is hardly mentioned in today’s secular stagnation debate, but it is prominent in the parallel discussion of underconsumption in the Marxist tradition. The important point here is to remember that depreciation refers not only to the physical wearing-out or using-up of capital goods, but also to capital goods displaced by competition or obsolescence. In competitive capitalism, businesses invest not only to increase aggregate capacity, but to win market share from each other. Much of depreciation represents capital that goes out of use not because it has ceased to be physically productive, but because it is attached to businesses that have lost out in the competitive struggle. Under conditions of monopoly, the struggle over market share is suppressed, so effective depreciation rates, and hence desired investment, will be lower. Physical depreciation does also exist, and will change as the production technology changes. If there is a secular tendency toward longer-lived means of production, that will pull down desired investment. As for delta-k, it is clearly the case that the process of industrialization involves a large upward shift in the capital-output ratio. But it’s hard to imagine it continuing to rise indefinitely; there are reasons (like the shift toward services) to think it might reach a peak and then decline.

So for secular, long-term trends tending to raise desired saving relative to desired investment we have: (1) the progressive satiation of consumption demand; (2) slowing population growth; (3) increasing monopoly power; and (4) the end of the industrialization process. Factors that might either raise or lower desired savings relative to investment are: (5) changes in the profit share; (6) changes in the fraction of profits retained in the business sector; (7) changes in the distribution of income; (8) changes in net exports; (9) changes in government deficits; and (10) changes in the physical longevity of capital goods. Finally, there are factors that will tend to raise desired investment relative to desired saving. The include: (11) consumption as status competition (this may offset or even reverse the effect of greater inequality on consumption); (12) social protections (public pensions, etc.) that reduce the need for precautionary and lifecycle saving; (13) easier access to credit, for consumption and/or investment; and (14) major technological changes that render existing capital goods obsolete, increasing the effective depreciation rate. These final four factors will offset any tendency toward secular stagnation.

It’s a long list, but I think it’s close comprehensive. Different versions of the stagnation story emphasize various of these factors, and their relative importance has varied in different times and places. I don’t think there is any a priori basis for saying that any of them are more or less important in general.

One problem with this conversation, from my point of view, is that people have a tendency to pick out a couple items from this list as the story, without considering the whole question systematically. For instance, there’s a very popular story in left Keynesian circles that makes it all about (7), offset for a while by (13) and perhaps (11). I don’t doubt that greater income inequality has increased desired private saving. It may be that this is the main factor at work here. But people should not be confidently asserting it is before clearly posing the question and analyzing the full range of possible answers.

In a future post we will think about how to assess the relative importance of these factors empirically.

[1] While the model itself is simple, the interpretation of it — the question it’s intended to answer — is quite controversial. Harrod himself intended it as a model of economic dynamics — that is, describing the system’s transition from one state to another in historical time. As it entered mainstream economics (via the criticism of Samuelson) and also much of structuralist work, it instead became treated as a model of economic growth — that is, of a long-run equilibrium one of whose variables happens to be the growth rate rather than the level of growth. It seems to me that while Harrod clearly was interested in dynamics, not growth in the current sense, the classic article is in fact ambivalent. In particular, Harrod is simply inconsistent in his definition of g: sometimes it is the change in output from one period to the next, while at other times it is the normal or usual change in output expected by business. Furthermore, as Joan Robinson pointed out, his famous knife-edge results depend on using the average savings rate as a parameter, which only makes sense if we are describing a long-run equilibrium. In the short period, it’s the marginal savings rate that is stable, while the average savings rate varies with output. So while it is true that Harrod thought he was writing about economic dynamics, the model he actually wrote is inconsistent. One way to resolve this inconsistency is to treat it as a model of equilibrium long-run growth, as Samuelson did; the other way, which I take here, is to treat it as a Keynesian short-run model in which the current, usual or expected growth rate appears as a parameter.  
[2] Strictly speaking it should be the current account balance rather than the trade balance but there’s no harm in ignoring cross-border income flows here.
[3] I am writing here in terms of a quantifiable capital stock, which I have deep misgivings about. But it makes the exposition much simpler. 
[4] This is true even in the “disgorge the cash” era, because much of the higher payouts from corporations go to financial institutions rather to households, and thus stay in the business sector.
[5] On the other hand, in a world where investment is constrained by funding, a higher share of profits retained will raise investment as well as savings, leaving its overall effect ambiguous.

EDIT: I think I’ve been misled by reading too much of the Keynesian classics from the 1930s and 40s. The dynamic I describe in this post is correct for that period, but not quite right for the US economy today. Since 1980, the average private savings rate has moved countercyclically, rather than procyclically as it did formerly and as I suggest here. So the mechanism that prevents booms and downturns from continuing indefinitely is no longer — as Keynes said, and I unthinkingly repeated — the behavior of private savings, but rather of the government and external balances. I can’t remember seeing anything written about this fundamental change in business cycle dynamics, which is a bit surprising, but it’s unambiguous in the data.

Fortunately we are interested here in longer term changes rather than cyclical dynamics, so the main argument of this post and the sequel shouldn’t be too badly undermined.

EDIT 2: Of course this change has been written about, what was I thinking. For example, Andrew Glyn, Capitalism Unleashed:

From Marx to Keynes at least, consumption was viewed as an essentially passive component of the growth process. Capital accumulation, investment spending on machinery and buildings, was the essential driving force on the demand as well as on the supply side. It was the capitalists’ access to finance which allowed capital spending to exceed the previous period’s savings and fuelled the expansion of demand; future profits ensured that such borrowing was repaid with a real return. Deficit spending by the government could, in wartime for example, impart a similar impulse to demand, at least till capital markets took fright at the growing debt interest burden and worries about inflation. However household consumption, some two-thirds of aggregate demand, was seen as playing the role of sustaining the current output level rather than driving it up. Savings ratios often fell during recessions, as consumers attempted to maintain spending in the face of falling incomes. Indeed, Milton Friedman criticized the Keynesians for exaggerating the dependence of consumption on current income and ignoring the extent to which savings could be used to ‘smooth’ out the path of consumption. More recently, rather than acting as a stabilizing influence, sharp falls in the savings ratio have occurred during expansions. By boosting consumption proportionately more than the rise in incomes this has intensified upswings, with the danger of sharp falls in demand if savings rebound sharply when the expansion slackens and pessimism builds up.

Reviving the Knife-Edge: Aggregate Demand in the Long Run

The second issue of the new Review of Keynesian Economics is out, this one focused on growth. [1] There’s a bunch of interesting contributions, but I especially like the piece by Steve Fazzari, Pietro Ferri, Edward Greenberg and Anna Maria Variato, on growth and aggregate demand.

The starting point is the familiar puzzle that we have a clear short-run story in which changes in output  [2] on the scale of the business cycle are determined by aggregate demand — that is, by changes in desired expenditure relative to income. But we don’t have a story about what role, if any, aggregate demand plays in the longer run.

The dominant answer — unquestioned in the mainstream [3], but also widespread among heterodox writers — is, it doesn’t. Economic growth is supposed to depend on a different set of factors — technological change, population growth and capital accumulation — than those that influence demand in the short run. But it’s not obvious how you get from the short-run to the long — what mechanism, if any, that ensures that the various demand-driven fluctuations will converge to the long-run path dictated by these “fundamentals”?

This is the question posed by Fazzari et al., building on Roy Harrod’s famous 1939 article. As Harrod noted, there are two relations between investment and output: investment influences output as a source of demand in the short run, and in the longer run higher output induces investment in order to maintain a stable capital-output ratio. More investment boosts growth, for the first channel, the multiplier; growth induces investment, through the second, the accelerator. With appropriate assumptions you can figure out what combinations of growth and investment satisfy both conditions. Harrod called the corresponding growth paths the “warranted” rate of growth. The problem is, as Harrod discovered, these combinations are dynamically unstable — if growth strays just a bit above the warranted level, it will accelerate without limit; if falls a little below the warranted rate, it will keep falling til output is zero

This is Harrod’s famous “knife-edge.” It’s been almost entirely displaced from the mainstream by Solow type growth models. Solow argued that the dynamic instability of Harrod’s model was due to the assumption of a fixed target capital-output ratio, and that the instability goes away if capital and labor are smoothly substitutible. In fact, Harrod makes no such assumption — his 1939 article explicitly considers the possibility that capitalists might target different capital-output ratios based on factors like interest rates. More generally, Solow didn’t resolve the problem of how short-run demand dynamics converge to the long-run supply-determined growth path, he just assumed it away.

The old textbook solution was price flexibility. Demand constraints are supposed to only exist because prices are slow to adjust, so given enough time for prices to reach market-clearing levels, aggregate demand should cease to exist. The obvious problem with this, as Keynes already observed, is that while flexible prices may help to restore equilibrium in individual markets, they operate in the wrong direction for output as a whole. A severe demand shortfall tends to produce deflation, which further reduces demand for goods and services; similarly, excessive demand leads to inflation, which tends — though less certainly — to further increase demand. As Leijonhufvud notes, it’s a weird irony that sticky wages and/or prices are held to be the condition of effective demand failures, when the biggest demand failure of them all, the Depression, saw the sharpest falls in both wages and prices on record.

The idea that if it just runs its course, deflation — via the real balance effect or some such — will eventually restore full employment is too much even for most economists to swallow. So the new consensus replaces price level adjustment with central bank following a policy rule. In textbooks, this is glossed as just hastening an adjustment that would have happened on its own via the price level, but that’s obviously backward. When an economy actually does develop high inflation or deflation, central banks consider their jobs more urgent, not less so. It’s worth pausing a moment to think about this. While the central bank policy rule is blandly presented as just another equation in a macroeconomic model, the implications are actually quite radical. Making monetary policy the sole mechanism by which the economy converges to full employment (or the NAIRU) implicitly concedes that on its own, the capitalist economy is fundamentally unstable.

While the question of how, or whether, aggregate demand dynamics converge to a long-run growth path has been ignored or papered over by the mainstream, it gets plenty of attention from heterodox macro. Even in this one issue of ROKE, there are several articles that engage with it in one way or another. The usual answer, among those who do at least ask the question, is that the knife-edge result must be wrong, and indicates some flaw in the way Harrod posed the problem. After all, in real-world capitalist economies, output appears only moderately unstable. Many different adjustments have been proposed to his model to make demand converge to a stable path.

Fazzari et al.’s answer to the puzzle, which I personally find persuasive, is that demand dynamics really are that unstable — that taken on their own the positive feedbacks between income, expenditure and investment would cause output to spiral toward infinity or fall to zero. The reasons this doesn’t happen is because of the ceiling imposed by supply constraints and the the floor set by autonomous expenditure (government spending, long-term investment, exports, etc.). But in general, the level of output is set by expenditure, and there is no reason to expect desired expenditure to converge to exactly full utilization of the economy’s resources. When rising demand hits supply constraints, it can’t settle at full employment, since in general full employment is only reached on the (unfulfillable) expectation of more-than-full employment.

Upward demand instability can drive demand to a level that fully employs labor resources. But the full employment path is not stable. … The system bounces off the ceiling onto an unstable declining growth path.

I won’t go through the math, which in any case isn’t complicated — is trivial, even, by the standards of “real” economics papers. The key assumptions are just a sufficiently strong link between income and consumption, and a target capital output ratio, which investment is set to maintain. These two assumptions together define the multiplier-accelerator model; because Fazzari et al explicitly incorporate short-term expectations, they need a third assumption, that unexpected changes in output growth cause expectations of future growth to adjust in the same direction — in other words, if growth is higher than expected this period, people adjust their estimates of next period’s growth upward. These three assumptions, regardless of specific parameter values, are enough to yield dynamic instability, where any deviation from the unique stable growth path tends to amplify over time.

The formal model here is not new. What’s more unusual is Fazzari et al.’s suggestion that this really is how capitalist economies behave. The great majority of the time, output is governed only by aggregate demand, and demand is either accelerating or decelerating. Only the existence of expenditure not linked to market income prevents output from falling to zero in recessions; supply constraints — the productive capacity of the economy — matters only occasionally, at the peaks of businesses cycles.

Still, one might say that if business-cycle peaks are growing along a supply-determined path, then isn’t the New Consensus right to say that the long run trajectory of the economy is governed only by the supply side, technology and all that? Well, maybe — but even if so,this would still be a useful contribution in giving a more realistic account of how short-term fluctuations add up to long-run path. It’s important here that the vision is not of fluctuations around the full-employment level of output, as in the mainstream, but at levels more or less below it, as in the older Keynesian vision. (DeLong at least has expressed doubts about whether the old Keynsians might not have been right on this point.) Moreover, there’s no guarantee that actual output will spend a fixed proportion of time at potential, or reach it at all. It’s perfectly possible for the inherent instability of the demand process to produce a downturn before supply constraints are ever reached. Financial instability can also lead to a recession before supply constraints are reached (altho more often, I think, the role of financial instability is to amplify a downturn that is triggered by something else.)

So: why do I like this paper so much?

First, most obviously, because I think it’s right. I think the vision of cycles and crises as endogenous to the growth process, indeed constitutive of it, is a better, more productive way to think about the evolution of output than a stable equilibrium growth path occasionally disturbed by exogenous shocks. The idea of accelerating demand growth that sooner or later hits supply constraints in a more or less violent crisis, is just how the macroeconomy looks. Consider the most obvious example, unemployment:

What we don’t see here, is a stable path with normally distributed disturbances around it. Rather, we see  unemployment falling steadily in expansions and then abruptly reversing to large rises in recessions. To monetarists, the fact that short-run output changes are distributed bimodally, with the economy almost always in a clear expansion or clear recession with nothing in between, is a sign that the business cycle must be the Fed’s fault. To me, it’s more natural to think that the nonexistence of “mini-recessions” is telling us something about the dynamics of the economic process itself — that capitalist growth, like love,

is a growing, or full constant light,
And his first minute, after noon, is night.

Second, I like the argument that output is demand-constrained at almost all times. There is no equilibrium between “aggregate supply” and “aggregate demand”; rather, under normal conditions the supply side doesn’t play any role at all. Except for World War II, basically, supply constraints only come into play momentarily at the top of expansions, and not in the form of some kind of equilibration via prices, but as a more or less violent external interruption in the dynamics of aggregate demand. It is more or less always true, that if you ask why is output higher than it was last period, the answer is that someone decided to increase their expenditure.

Third, I like that the article is picking up the conversation from the postwar Keynesians like Harrod, Kaldor and Hicks, and more recent structural-Keynesian approaches. The fundamental units of the argument are the aggregate behavior of firms and households, without the usual crippling insistence on reducing everything to a problem of intertemporal optimization. (The question of microfoundations gets a one-sentence footnote, which is about what it deserves.) Without getting into these methodological debates here, I think this kind of structuralist approach is one of the most productive ways forward for positive macroeconomic theory. Admittedly, almost all the other papers in this issue of ROKE are coming from more or less the same place, but I single out Fazzari for praise here because he’s a legitimate big-name economist — his best known work was coauthored with Glenn Hubbard. (Yes, that Glenn Hubbard.)

Fourth, I like the paper’s notion of economies having different regimes, some of persistently excess demand, some persistent demand shortfalls. When I was talking about this paper with Arjun the other day he asked, very sensibly, what’s the relevance to our current situation. My first response was not much, it’s more theoretical. But it occurs to me now that the mainstream model (often implicit) of fluctuations around a supply-determined growth path is actually quite important to liberal ideas about fiscal policy. The idea that a deep recession now will be balanced by a big boom sometime in the future underwrites the idea that short-run stimulus should be combined with a commitment to long-run austerity. If, on the other hand, you think that the fundamental parameters of an economy can lead to demand either falling persistently behind, or running persistently ahead, of supply constraints, then you are more likely to think that a deep recession is a sign that fiscal policy is secularly too tight (or investment secularly too low, etc.) So the current relevance of the Fazzari paper is that if you prefer their vision to the mainstream’s, you are more likely to see the need for bigger deficits today as evidence of a need for bigger deficits forever.

Finally, on a more meta level, I share the implicit vision of capitalism not as a single system in (or perhaps out of) equilibrium, but involving a number of independent processes which sometimes happen to behave consistently with each other and sometimes don’t. In the Harrod story, it’s demand-driven output and the productive capacity of the economy, and population growth in particular; one could tell the same story about trade flows and financial flows, or about fixed costs and the degree of monopoly (as Bruce Wilder and I were discussing in comments). Or perhaps borrowing and interest rates. In all cases these are two distinct causal systems, which interact in various ways but are not automatically balanced by any kind of price or equivalent mechanism. The different systems may happen to move together in a way that facilitates smooth growth; or they may move inconsistently, which will bring various buffers into play and, when these are exhausted, lead to some kind of crisis whose resolution lies outside the model.

A few points, not so much of criticism, as suggestions for further development.

First, a minor point — the assumption that expectations adjust in the same direction as errors is a bit trickier than they acknowledge. I think it’s entirely reasonable here, but it’s clearly not always valid and the domain over which it applies isn’t obvious. If for instance the evolution of output is believed to follow a process like yt = c + alpha t + et, then unusually high growth in one period would lead to expectations of lower growth in the next period, not higher as Fazzari et al assume. And of course to the extent that such expectations would tend to stabilize the path of output, they would be self-fulfilling. (In other words, widespread belief in the mainstream view of growth will actually make the mainstream view more true — though evidently not true enough.) As I say, I don’t think it’s a problem here, but the existence of both kinds of expectations is important. The classic historical example is the gold standard: Before WWI, when there was a strong expectation that the gold link would be maintained, a fall in a country’s currency would lead to expectations of subsequent appreciation, which produced a capital inflow that in fact led to the appreciation;  whereas after the war, when devaluations seemed more likely, speculative capital flows tended to be destabilizing.

Two more substantive points concern supply constraints. I think it’s a strength, not a weakness of the paper that it doesn’t try to represent supply constraints in any systematic way, but just leaves them exogenous. Models are tools for logical argument, not toy train sets; the goal is to clarify a particular set of causal relationships, not to construct a miniature replica of the whole economy. Still, there are a couple issues around the relationship between rising demand and supply constraints that one would like to develop further.

First, what concretely happens when aggregate expenditure exceeds supply? It’s not enough to just say “it can’t,” in part because expenditure is in dollar terms while supply constraints represent real physical or sociological limits. As Fazzari et al. acknowledge, we need some Marx with our Keynes here — we need to bring in falling profits as a key channel by which supply constraints bind. [4] As potential output is approached, there’s an increase in the share claimed by inelastically-supplied factors, especially labor, and a fall in the share going to capital. This is the classic Marxian cyclical profit squeeze, though in recent cycles it may be the rents claimed by suppliers of oil and “land” in general, as opposed to wages, that is doing much of the squeezing. But in any case, a natural next step for this work would be to give a more concrete account of the mechanisms by which supply constraints bind. This will also help clarify why the transitions from expansion to recession are so much more abrupt than the transitions the other way. (Just as there are no mini-recessions, neither are there anti-crises.) The pure demand story explains why output cannot rise stably on the full employment trajectory, but must either rise faster or else fall; but on its own it’s essentially symmetrical and can’t explain why recessions are so much steeper and shorter than expansions. Minsky-type dynamics, where a fall in output means financial commitments cannot be met, must also play a role here.

Second, how does demand-driven evolution of output affect growth of supply? They write,

while in our simple model the supply-side path is assumed exogenous, it is easy to posit realistic economic channels through which the actual demand-determined performance of the economy away from full employment affects conditions of supply. The quantity and productivity of labor and capital at occasional business-cycle peaks will likely depend on the demand-determined performance of the economy in the normal case in which the system is below full employment.

I think this is right, and a very important point to develop. There is increasing recognition in the mainstream of the importance of hysteresis — the negative effects on economic potential of prolonged unemployment. There’s little or no discussion of anti-hysteresis — the possibility that inflationary booms have long-term positive effects on aggregate supply. But I think it would be easy to defend the argument that a disproportionate share of innovation, new investment and laborforce broadening happens in periods when demand is persistently pushing against potential. In either case, the conventional relationship between demand and supply is reversed — in a world where (anti-)hysteresis is important, “excessive” demand may lead to only temporarily higher inflation but permanently higher employment and output, and conversely.

Finally, obsessive that I am, I’d like to link this argument to Leijonhufvud’s notion of a “corridor of stability” in capitalist economies, which — though Leijonhufvud isn’t cited — this article could be seen as a natural development of. His corridor is different from this one, though — it refers to the relative stability of growth between crises. The key factor in maintaining that stability is the weakness of the link between income and expenditure as long as changes in income remain small. Within some limits, changes in the income of households and firms do not cause them to revise their beliefs about future income (expectations are normally fairly inelastic), and can be buffered by stocks of liquid assets and the credit system. Only when income diverges too far from its prior trajectory do expectations change — often discontinuously — and, if the divergence is downward, do credit constraints being to bind. If it weren’t for these stabilizing factors, capitalist growth would always, and not just occasionally, take the form of explosive bubbles.

Combining Leijonhufvud and Fazzari et al., we could envision the capitalist growth path passing through concentric bands of stability and instability. The innermost band is Leijonhufvud’s corridor, where the income-expenditure link is weak. Outside of that is the band of Harrodian instability, where expectations are adjusting and credit constraints bind. That normal limits of that band are set, at least over most of the postwar era, by active stabilization measures by the state, meaning in recent decades monetary policy. (The signature of this is that recoveries from recessions are very rapid.) Beyond this is the broader zone of instability described by the Fazzari paper — though keeping the 1930s in mind, we might emphasize the zero lower bound on gross investment a bit more, and autonomous spending less, in setting the floor of this band. And beyond that must be a final zone of instability where the system blows itself to pieces.

Bottom line: If heterodox macroeconomic theory is going to move away from pure critique (and it really needs to) and focus on developing a positive alternative to the mainstream, articles like this are a very good start.

[1] It’s unfortunate that no effort has been made to make ROKE content available online. Since neither of the universities I’m affiliated with has a subscription yet, it’s literally impossible for me — and presumably you — to see most of the articles. I imagine this is a common problem for new journals. When I raised this issue with one of the editors, and asked if they’d considered an open-access model, he dismissed the idea and suggested I buy a subscription — hey, it’s only $80 for students. I admit this annoyed me some. Isn’t it self-defeating to go to the effort of starting a new journal and solicit lots of great work for it, and then shrug off responsibility for ensuring that people can actually read it?

[2] It’s not a straightforward question what exactly is growing in economic growth. When I talk about demand dynamics, I prefer to use the generic term “activity,” as proxied by a variety of measures like GDP, employment, capacity utilization, etc. (This is also how NBER business-cycle dating works.) But here I’ll follow Fazzari et al. and talk about output, presumably the stuff measured by GDP.

[3] See for instance this post from David Altig at the Atlanta Fed, from just yesterday:

Forecasters, no matter where they think that potential GDP line might be, all believe actual GDP will eventually move back to it. “Output gaps”—the shaded area representing the cumulative miss of actual GDP relative to its potential—simply won’t last forever. And if that means GDP growth has to accelerate in the future (as it does when GDP today is below its potential)—well, that’s just the way it is.

Here we have the consensus with no hedging. Everyone knows that long-run growth is independent of aggregate demand, so slower growth today means faster growth tomorrow. That’s “nature,” that’s just the way it is.

[4] This fits with the story in Capitalism Since 1945, still perhaps the first book I would recommend to anyone trying to understand the evolution of modern economies. From the book:

The basic idea of overaccumulation is that capitalism sometimes generates a higher rate of accumulation than can be sustained, and thus the rate of accumulation has eventually to fall. Towards the end of the postwar boom, an imbalance between accumulation and the labor supply led to increasingly severe labor shortage. … Real wages were pulled up and older machines rendered unprofitable, allowing a faster transfer of workers to new machines. This could in principle have occurred smoothly: as profitability slid down, accumulation could have declined gently to a sustainable rate. but the capitalist system has no mechanism guaranteeing a smooth transition in such circumstances. In the late sixties the initial effect of overaccumulation was a period of feverish growth with rapidly rising wages and prices and an enthusiasm for get-rich-quick schemes. These temporarily masked, but could not suppress, the deterioration in profitability. Confidence was undermined, investment collapsed and a spectacular crash occurred. Overaccumulation gave rise, not to a mild decline in the profit rate, but to a classic capitalist crisis.

I think the Marxist framework here, with its focus on profit rates, complements rather than contradicts the Keynesian frame of Fazzari et al. and its focus on demand. In particular, the concrete mechanisms by which supply constraints operate are much clearer here.