Remembering Jim Crotty

Last weekend I went up to Amherst, for an event — half conference, half memorial — in honor of Jim Crotty.

Jim was a very important presence for me when I was at a graduate student at the University of Massachusetts, as he was for many people who passed through the economics program there in the 1980s, 1990s and 2000s. His approach to economics, drawing on the traditions of Marx and Keynes, was for us almost the definition of heterodox macroeconomics. He was also a model for us as a human being. He never wavered from his political commitments, and he was — as many speakers at the event testified — a wonderful person, down to earth, warm and outgoing.

Some years ago, Arjun Jayadev and I recorded a long interview with Jim. INET has put video of the interview online. (The videos are somewhat abridged; you can read the full transcript here. ) I think the interview managed to capture Jim’s broader outlook as well as his economics interests. (Well, some of them — his interests were very broad!) He also has some very interesting things to say about the origins of radical economics as a distinct body of thought in the 1970s. I think the videos are well worth watching, if you want to get a sense (or a reminder) of what Jim Crotty was all about.

I wrote a piece on his work in 2016, to go along with the interviews. That piece focuses on his argument for taking Keynes seriously as a socialist, the argument which later became his last published work, Keynes against Capitalism. (There is an earlier draft that circulated within the UMass economics department, which I think makes the argument more clearly than the published book does.)

For this event, Arjun and I wrote an article on Jim, talking more about what his teaching meant for us and how one might carry his vision forward. It will be published in an upcoming special issue of the Review of Radical Political Economics, along with a number of other pieces on Jim’ thought and work. Here are some excerpts from our contribution. You can read the whole thing here, if you’re interested.

 

 

“If Keynes were Alive Today…”: Reflections on Jim Crotty

by Arjun Jayadev and J. W. Mason

Jim Crotty’s ECO 710 was for us, as for hundreds of UMass grad students over the past 40 years, the starting point for systematic thought about the economy as a whole. In this he was, like all the great teachers, presenting not so much any particular technique or ideas as himself as a model – a touchstone to go back to when you hit a dead end, and a living example of how to be a serious economist-in-the-world. The content of the class varied over the years, but it usually involved a close reading of The General Theory, with a focus on its three great advances— fundamental uncertainty, liquidity preference and effective demand.

Perhaps the most distinctive aspect of Jim’s pedagogy and scholarship, almost alone among economists we have known, was his ability to synthesise these two thinkers in ways that gave equal weight to both, that placed them in conversation rather than in tension. Crotty’s Marx anticipates Minsky, while his Keynes is a political radical – a socialist – in ways that few others have recognized.

Perhaps his most profound contribution to both traditions was the brilliant 1985 article “The Centrality of Money, Credit, and Financial Intermediation in Marx’s Crisis Theory” (Crotty 1985). There, he developed the idea that the Marxian vision of capitalist crises could only be understood in terms of the development of the credit and the financial system – that it was only via financial commitments that a fall in the profit rate could lead to an abrupt crisis rather than just a slower pace of accumulation. His reconstruction of a vision of the credit system that may either dampen or amplify disruptions to the underlying process of production suggests that Marx anticipated the ideas about financial fragility later developed in the Post Keynesian tradition. With a critical difference: While Minsky has finance calling the tune, in the Marx-Crotty version the ultimate source of instability is in the real world of labor and capital.

For us, Jim’s most important work came in four areas. The first was the interplay of real and financial instability in capitalist crises, as in the 1985 article and his work after 2008. Second was the shifting relationship between shareholders and managers in the governance of corporations. Third was his insistence on the importance of fundamental uncertainty for macroeconomic theory – if we imagine one phrase in Jim’s voice, it is “we simply do not know.” Last, chronologically, but certainly not least, was his rehabilitation of Keynes’ socialist politics – a socialist Keynes to go with his Minskyan Marx.

Most of Crotty’s published work fits within the broad post-Keynesian tradition. But his earlier and stronger commitment was to Marx. In a series of papers in the 1970s with Raford Boddy he put class conflict and imperialism front and centre in the analysis of contemporary capitalism, exploring Marxian crisis theory and what it could illuminate about contemporary macroeconomic problems. From the mid-1980s onward, his published work no longer used an explicitly Marxist framework, and the name Keynes appears much more often than that of Marx. But this was a matter of shifting focus and circumstances rather than any more fundamental re-evaluation. In a conversation with us in 2016, he described Marx as: “clearly the more brilliant social scientist and thinker and philosopher” of the two, “with a much more ambitious project, with clearer and deeper political roots.” And yet, he added: “I am writing a book about Keynes.”

Keynes on Newton and the Methods of Science

I’ve just been reading Keynes’ short sketches of Isaac Newton in Essays in Biography. (Is there any topic he wasn’t interesting on?) His thesis is that Newton was not so much the first modern scientist as “the last of the magicians” — “a magician who believed that by intense concentration of mind on traditional hermetics and revealed books he could discover the secrets of nature and the course of future events, just as by the pure play of mind on a few facts of observation he had unveiled the secrets of the heavens.”

The two pieces are fascinating in their own right, but they also crystallized something I’ve been thinking about for a while about the relationship between the methods and the subject matter of the physical sciences.

It’s no secret that Newton had an interest in the occult, astrology and alchemy and so on. Keynes’ argument is that this was not a sideline to his “scientific” work, but was his project, of which his investigations into mathematics and the physical world formed just a part. In Keynes’ words,

He looked on the whole universe and all that is in it as a riddle, as a secret which could be read by applying pure thought to … mystic clues which God had laid about the world to allow a sort of philosopher’s treasure hunt to the esoteric brotherhood. He believed that these clues were to be found partly in the evidence of the heavens and in the constitution of elements… but also partly in certain papers and traditions … back to the original cryptic revelation in Babylonia. …

In Keynes’ view — supported by the vast collection of unpublished papers Newton left after his death, which Keynes made it his mission to recover for Cambridge — Newton looked for a mathematical pattern in the movements of the planets in exactly the same way as one would look for the pattern in a coded message or a secret meaning in a ancient text. Indeed, Keynes says, Newton did look in the same way for secret messages in ancient texts, with the same approach and during the same period in which he was developing calculus and his laws of motion.

There was extreme method in his madness. All his unpublished works on esoteric and theological matters are marked by careful learning, accurate method and extreme sobriety of statement. They are just as sane as the Principia, if their whole matter and purpose were not magical. They were nearly all composed during the same twenty-five years of his mathematical studies. 

Even in his alchemical research, which superficially resembled modern chemistry, he was looking for secret messages. He was, says Keynes, “almost entirely concerned, not in serious experiment, but in trying to read the riddle of tradition, to find meaning in cryptic verses, to imitate the alleged but largely imaginary experiments of the initiates of past centuries.”

There’s an interesting parallel here to Foucault’s discussion in The Order of Things of 16th century comparative anatomy. When someone like Pierre Belon carefully compares the structures of a bird’s skeleton to a human one, it superficially resembles modern biology, but really “belongs to the same analogical cosmography as the comparison between apoplexy and tempests,” reflecting the idea that man “stands in proportion to the heavens just as he does to animals and plants.”

Newton’s “scientific” work was, similarly, an integral part of his search for ancient secrets and, perhaps, for him, not the most important part. Keynes approvingly quotes the words that George Bernard Shaw (drawing on some of the same material) puts in Newton’s mouth:

There are so many more important things to be worked at: the transmutations of matter, the elixir of life, the magic of light and color, above all the secret meaning of the Scriptures. And when I should be concentrating my mind on these I find myself wandering off into idle games of speculation about numbers in infinite series, and dividing curves into indivisibly short triangle bases. How silly!

None of this, Keynes insists, is to diminish Newton’s greatness as a thinker or the value of his achievements. His scientific accomplishments flowed from this same conviction that the world was a puzzle that would reveal some simple, logical, in retrospect obvious solution if one stared at it long enough. His greatest strength was his power of concentration, his ability to

hold a problem in his mind for hours and days and weeks until it surrendered to him its secret. Then being a supreme mathematical technician he could dress it up… for purposes of exposition, but it was his intuition which was pre-eminent … The proofs … were not the instrument of discovery. 

There is the story of how he informed Halley of one of his most fundamental discoveries of planetary motion. ‘Yes,’ replied Halley, ‘but how do you know that? Have you proved it?’ Newton was taken aback—’Why, I’ve known it for years,’ he replied. ‘ If you’ll give me a few days, I’ll certainly find you a proof of it’—as in due course he did. 

This is a style of thinking that we are probably all familiar with — the conviction that a difficult problem must have an answer, and that once we see it in a flash of insight we’ll know that it’s right. (In movies and tv shows, intellectual work is almost never presented in any other way.) Some problems really do have answers like this. Many, of course, do not. But you can’t necessarily know in advance which is which. 

Which brings me to the larger point I want to draw out of these essays. Newton was not wrong to think that if the motion of the planets could be explained by a simple, universal law expressible in precise mathematical terms, other, more directly consequential questions might be explained the same way. As Keynes puts it,

He did read the riddle of the heavens. And he believed that by the same powers of his introspective imagination he would read the riddle of the Godhead, the riddle of past and future events divinely fore-ordained, the riddle of the elements…, the riddle of health and of immortality. 

It’s a cliché that economists suffer from physics envy. There is definitely some truth to this (though how much the object of envy resembles actual physics I couldn’t say.)  The positive content of this envy might be summarized as follows: The techniques of physical sciences have yielded good results where they have been applied, in physics, chemistry, etc. So we should expect similar good results if we apply the same techniques to human society. If we don’t have a hard science of human society, it’s simply because no one has yet done the work to develop one. (Economists, it’s worth noting, are not alone in believing this.)

In Robert Solow’s critical but hardly uniformed judgement,

the best and the brightest in the profession proceed as if economics is the physics of society. There is a single universal model of the world. It only needs to be applied. You could drop a modern economist from a time machine … at any time in any place, along with his or her personal computer; he or she could set up in business without even bothering to ask what time and which place. In a little while, the up-to-date economist will have maximized a familiar-looking present-value integral, made a few familiar log-linear approximations, and run the obligatory familiar regression. 

It’s not hard to find examples of this sort of time-machine economics. David Romer’s widely-used macroeconomics textbook, for example, offers pre-contact population density in Australia and Tasmania (helpfully illustrated with a figure going back to one million BC) as an illustration of endogenous growth theory. Whether you’re asking about GDP growth next year, the industrial revolution or the human population in the Pleistocene, it’s all the same equilibrium condition.

Romer’s own reflections on economics methodology (in an interview with Snowdon and Vane) are a perfect example of what I am talking about. 

As a formal or mathematical science, economics is still very young. You might say it is still in early adolescence. Remember, at the same time that Einstein was working out the theory of general relativity in physics, economists were still talking to each other using ambiguous words and crude diagrams. 

In other words, people who studied physical reality embraced precise mathematical formalism early, and had success. The people who studied society stuck with “ambiguous words and crude diagrams” and did not. Of course, Romer says, that is now being corrected. But it’s not surprising that with its late start, economics hasn’t yet produced as definite and useful knowledge as the physical science have.  

This is where Newton comes in. His occult interests are a perfect illustration of why the Romer view gets it backward. The same techniques of mathematical formalization, the same effort to build up from an axiomatic foundation, the same search for precisely expressible universal laws, have been applied to the whole range of domains right from the beginning — often, as in Newton’s case, by the same people. We have not, it seems to me, gained useful knowledge of orbits and atoms because that’s where the techniques of physical science happen to have been applied. Those techniques have been consistently applied there precisely because that’s where they turned out to yield useful knowledge.

In the interview quoted above, Romer defends the aggregate production function (that “drove Robinson to distraction”) and Real Business Cycle theory as the sort of radical abstraction science requires. You have “to strip things down to their bare essentials” and thoroughly grasp those before building back up to a more realistic picture.

There’s something reminiscent of Newton the mystic-scientist in this conviction that things like business cycles or production in a capitalist economy have an essential nature which can be grasped and precisely formalized without all the messy details of observable reality. It’s tempting to think that there must be one true signal hiding in all that noise. But I think it’s safe to say that there isn’t. As applied to certain physical phenomena, the idea that apparently disparate phenomena are united by a single beautiful mathematical or geometric structure has been enormously productive. As applied to business cycles or industrial production, or human health and longevity, or Bible exegesis, it yields nonsense and crankery. 

In his second sketch, Keynes quotes a late statement of Newton’s reflecting on his own work:

I do not know what I may appear to the world; but to myself I seem to have been only like a boy, playing on the sea-shore, and diverting myself in now and then finding a smoother pebble or a prettier shell than ordinary, whilst the great ocean of truth lay all undiscovered before me. 

I’m sure this quote is familiar to anyone who’s read anything about Newton, but it was new and striking to me. One way of reading it as support for the view that Newton’s scientific work was, in his mind, a sideshow to the really important inquiries which he had set aside. But another way is as a statement of what I think is arguably the essence of a scientific mindset – the willingness to a accept ignorance and uncertainty. My friend Peter Dorman once made an observation about science that has always stuck with me – that what distinguishes scientific thought is the disproportionate priority put on avoiding Type I errors (accepting a false claim) over avoiding Type II errors (rejecting a true claim). Until an extraordinary degree of confidence can be reached, one simply says “I don’t know”.

It seems to me that if social scientists are going to borrow something from the practices of Newton and his successors,  it shouldn’t be an aversion to “ambiguous words,” the use calculus or geometric proofs, or the formulation of universal mathematical laws. It should be his recognition of the vast ocean of our ignorance. We need to accept that on most important questions we don’t know the answers and probably cannot know them. Then maybe we can recognize the small pebbles of knowledge that are accessible to us.

Video: Monetary Policy since the Crisis

On May 30, I did a “webinar” with INET’s Young Scholar’s Intiative. The subject was central banking since the financial crisis of a decade ago, and how it forces us to rethink some long-held ideas about money and the real economy — the dstinction between a demand-determined short run and a supply-determined long run; the neutrality of money in the long run; the absence of tradeoffs between unemployment, inflation and other macroeconomic goals; the reduction of monetary policy choices to setting a single overnight interest rate based on a fixed rule.My argument is that the crisis — or more precisely, central banks’ response to it — creates deep problems for all these ideas.

The full video (about an hour and 15 minus, including Q&A) is on YouTube, and embedded below. It’s part of an ongoing series of YSI webinars on endogenous money, including ones by Daniela Gabor, Jo Mitchella nd Sheila Dow. I encourage you, if you’re interested, to sign up with YSI — anyone can join — and check them out.

I didn’t use slides, but you can read my notes for the talk, if you want to.

Rogoff on the Zero Lower Bound

I was at the ASSAs in Chicago this past weekend. [1] One of the most interesting panels I went to was this one, on Advances in Open Economy Macroeconomics. Among other big names, Ken Rogoff was there, as the discussant for a rather strange paper by Pierre-Olivier Gourinchas and Helene Rey.

The Gourinchas and Rey paper, like much of mainstream macro these days, made a big deal of how different everything is at the zero lower bound. Rogoff wasn’t having it. Here’s a rough transcript of what he said:

The obsession with the zero lower bound is encouraging all kinds of wacko ideas. People are saying that at the ZLB, productivity increases are bad (Eggertsson/Krugman/Summers), protectionism is good (Eichngreen), price flexibility is bad, and so on.

But there is an emerging literature that says economists are taking the zero lower bound too literally. In fact, getting negative rates is not that hard. So before you take seriously these, let’s say, very creative ideas, it would be simpler to think about getting rid of the zero bound.

There are lots of ways to do it. I talk about some in my book, but people already understood this back in the 1930s. There was Robert Eisler’s proposal to have banks accept cash deposits at a discount, for instance, which would have effectively created negative rates. If Keynes had read Eisler, he might have gone in a different direction. [2] It’s a very old idea — Kublai Khan did something similar. There will be pushback from the financial sector, of course, who think negative rates will be costly for them, but fundamentally it is not hard to do.

These rather striking comments crystallized something in my mind. What is the big deal about the ZLB? For mainstream macroeconomists, including Gourinchas and Rey in this paper, the reason the ZLB matters is that it prevents the central bank form setting an interest rate low enough to keep output at potential. [3] It’s precisely this that makes inapplicable the conventional analysis of a nonmonetary problem of allocating scarce resources between alternative ends, and requires thinking about other entry points. If the central bank can’t solve the problem of aggregate demand then you have to take it seriously, with all the wacko and/or creative stuff that follows.

In the dominant paradigm, this is a specific technical problem of getting interest rates below zero. Solve that, and we are back in the comfortable Walrasian world. But for those of us on the heterodox side, it is never the case that the central bank can reliably keep output at potential — maybe because market interest rates don’t respond to the policy rate, or because output doesn’t respond to interest rates, or because the central bank is pursuing other objectives, or because there is no well-defined level of “potential” to begin with. (Or, in reality, all four.) So what people like Gourinchas and Rey, or Paul Krugman, present as a special, temporary state of the economy, we see as the general case.

One way of looking at this is that the ZLB is a device to allow economists like Krugman and Gourinchas and Rey — who whatever their scholarly training, are aware of the concrete reality around them — to make Keynesian arguments without forfeiting their academic respectability. You can understand why someone like Rogoff sees that as cheating. We’ve spent decades teaching that the fundamental constraint on the economy is the real endowment of resources and technology; that saving boosts growth; that trade is always win-win; that money and finance matter only in the short run (and the short run is tolerably short). The practical problem of negative policy rates doesn’t let you forget all of that.

Which, if you turn it around, perhaps reflects well on the ZLB crowd. Maybe they want to forget all that? Maybe, you could say, they take the zero lower bound seriously because they don’t take it literally. That is, they treat it as a hard constraint precisely because they are aware that it is only a stand-in for a deeper reality.

 

[1] The big annual economics conference. It stands for Allied Social Sciences Association — the disciplinary imperialism is right there in the name.

[2] This was an odd thing for Rogoff to say, since of course while Keynes didn’t discuss Eisler as far as I know, he talks at length about the similar proposals for depreciating cash of Silvio Gesell and Major Douglas. Notoriously he says these “brave cranks and heretics” have more to offer than Marx.

[3] Gourinchas and Rey are reality-based enough to say “the policy rate,” not “the interest rate.”

 

EDIT: Added the seriously-but-not-literally phrasing as suggested by Steve Roth on Twitter.

At Jacobin: Socializing Finance

(Cross-posted from Jacobin. A shorter version appears in the Fall 2016 print issue.)

 

At its most basic level, finance is simply bookkeeping — a record of money obligations and commitments. But finance is also a form of planning – a set of institutions for allocating claims on the social product.

The fusion of these two logically distinct functions – bookkeeping and planning – is as old as capitalism, and has troubled the bourgeois conscience for almost as long. The creation of purchasing power through bank loans is hard to square with the central ideological claim about capitalism, that market prices offer a neutral measure of some preexisting material reality. The manifest failure of capitalism to conform to ideas of how this natural system should behave, is blamed on the ability of banks (abetted by the state) to drive market prices away from their true values. Somehow separating these two functions of the banking system –  bookkeeping and planning –  is the central thread running through 250 years of monetary reform proposals by bourgeois economists, populists and cranks. We can trace it from David Hume, who believed a “perfect circulation” was one where gold alone were used for payments, and who doubted whether bank loans should be permitted at all; to the 19th century advocates of a strict gold standard or the real bills doctrine, two competing rules that were supposed to restore automaticity to the creation of bank credit; to Proudhon’s proposals for giving money an objective basis in labor time; to Wicksell’s prescient fears of the instability of an unregulated system of bank money; to the oft-revived proposals for 100%-reserve banking; to Milton Friedman’s proposals for a strict money-supply growth rule; to today’s orthodoxy that dreams of a central bank following an inviolable “policy rule” that reproduces the “natural interest rate.” What these all have in common is that they seek to restore objectivity to the money system, to legislate into existence the real values that are supposed to lie behind money prices. They seek to compel money to actually be what it is imagined to be in ideology: an objective measure of value that reflects the real value of commodities, free of the human judgements of bankers and politicians.

*

Socialists reject this fantasy. We know that the development of capitalism has from the beginning been a process of “financialization” – of extension of money claims on human activity, and of representation of the social world in terms of money payments and commitments. We know that there was no precapitalist world of production and exchange on which money and then credit were later superimposed: Networks of money claims are the substrate on which commodity production has grown and been organized.  And we know that the social surplus under capitalism is not allocated by “markets,” despite the fairy tales of economists.  It is allocated by banks and other financial institutions, whose activities are not ultimately coordinated by markets either, but by planners of one sort or another.

However decentralized in theory, market production is in fact organized through a highly centralized financial system. And where something like competitive markets do exist, it is usually thanks to extensive state management, from anti-trust laws to all the elaborate machinery set up by the ACA to prop up a rickety market for private health insurance. As both Marx and Keynes recognized, the tendency of capitalism is to develop more social, collective forms of production, enlarging the domain of conscious planning and diminishing the zone of the market. (A point also understood by some smarter, more historically minded liberal economists today.) The preservation of the form of markets becomes an increasingly utopian project, requiring more and more active intervention by government. Think of the enormous public financing, investment, regulation required for our “private” provision of housing, education, transportation, etc.

In  world where production is guided by conscious planning — public or private — it makes no sense to think of  money values as reflecting the objective outcome of markets, or of financial claims as simply a record of “real’’ flows of income and expenditure. But the “illusion of the real,” as Perry Mehrling somewhere calls it, is very hard to resist. We must constantly remind ourselves that market values have never been, and can never be, an objective measure of human needs and possibilities. We must remember that values measured in money – prices and quantities, production and consumption – have no existence independent of the market transactions that give them quantitative form. We must recognize the truth that Keynes – unlike so many bourgeois economists – clearly stated: a quantitative comparison between disparate use-values is possible only when they actually come into market exchange, and only on the terms given by the concrete form of that exchange. It is meaningless to compare  economic quantities over widely separated periods of time, or in countries at very different levels of development. On such questions only qualitative, more or less subjective judgements can be made.

It follows that socialism cannot be described in terms of the quantity of commodities produced, or the distribution of them. Socialism is liberation from the commodity form. It is defined not by the disposition of things but by the condition of human beings. It is the progressive extension of the domain of human freedom, of that part of our lives governed by love and reason.

There are many critics of finance who see it as the enemy of a more humane or authentic capitalism. They may be managerial reformers (Veblen’s “Soviet of engineers”) who oppose finance as a parasite on productive enterprises; populists who hate finance as the destroyer of their own small capitals; or sincere believers in market competition who see finance as a collector of illegitimate rents. On a practical level there is much common ground between these positions and a socialist program. But we can’t accept the idea of finance as a distortion of some true market values that are natural, objective, or fair.

Finance should be seen as a moment in the capitalist process, integral to it but with two contradictory faces. On the one hand, it is finance (as a concrete institution) that generates and enforces the money claims against social persons of all kinds — human beings, firms, nations — that extend and maintain the logic of commodity production. (Student loans reinforce the discipline of wage labor, sovereign debt upholds the international division of labor.)

Yet on the other hand, the financial system is also where conscious planning takes its most fully developed form under capitalism. Banks are, in Schumpeter’s phrase, the private equivalent of Gosplan, the Soviet planning agency. Their lending decisions determine what new projects will get a share of society’s resources, and suspend — or enforce — the “judgement of the market” on money-losing enterprises. A socialist program must respond to both these faces of finance.  We oppose the power of finance if we want to progressively reduce the extent to which human life is organized around the accumulation of money. We embrace the planning already inherent in finance because we want to expand the domain of conscious choice, and reduce the domain of blind necessity. “It is a work of culture — not unlike the draining of the Zuider Zee.”

*

The development of finance reveals the progressive displacement of market coordination by planning. Capitalism means production for profit; but in concrete reality profit criteria are always subordinate to financial criteria. The judgement of the market has force only insofar as it is executed by finance. The world is full of businesses whose revenues exceed their costs, but are forced to scale back or shut down because of the financial claims against them. The world is full of businesses that operate for years, or indefinitely, with costs in excess of their revenues, thanks to their access to finance. And the institutions that make these financing decisions do so based on their own subjective judgement, constrained ultimately not by some objective criteria of value, but by the terms set by the central bank.

There is a basic contradiction between the principles of competition and finance. Competition is imagined as a form of natural selection: Firms that make profits reinvest them and thus grow, while firms that make losses can’t invest and must shrink and eventually disappear. This is supposed to be a great advantage of markets.

But the whole point of finance is to break this link between profits yesterday and investment today. The surplus paid out as dividends and interest is available for investment anywhere in the economy, not just where it was generated. Conversely, entrepreneurs can undertake new projects that have never been profitable in the past, if they can convince someone to bankroll them. Competition looks backward: The resources you have today depend on how you’ve performed in the past. Finance looks forward: The resources you have today depend on how you’re expect (by someone!) to perform in the future. So, contrary to the idea of firms rising and falling through natural selection, finance’s darlings — from Amazon to Uber and the whole unicorn herd — can invest and grow indefinitely without ever showing a profit. This is also supposed to be a great advantage of markets.

In the frictionless world imagined by economists, the supercession of markets by finance is already carried to its limit. Firms do not control or depend on their own surplus. All surplus is allocated centrally, by financial markets. All funds for investment comes from financial markets and all profits immediately return in money form to these markets. This has two contradictory implications. On the one hand, it eliminates  any awareness of the firm as a social organism, of the activity the firm carries out to reproduce itself, of its pursuit of ends other than maximum profit for its “owners”. The firm, in effect, is born new each day by the grace of those financing it.

But by the same token, the logic of profit maximization loses its objective basis. The quasi-evolutionary process of competition – in which successful firms grow and unsuccessful ones decline and die  – ceases to operate if the firm’s own profits are no longer its source of investment finance, but both instead flow into a common pool. In this world, which firms grow and which shrink depends on the decisions of the financial planners who allocate capital between them. Needless to say it makes no difference if we move competition “one level up” – money managers also borrow and issue shares.

The contradiction between market production and socialized finance becomes more acute as the pools of finance themselves combine or become more homogenous. This was a key point for turn-of-the-last-century Marxists like Hilferding (and Lenin), but it’s also behind the recent fuss in the business press over the rise of index funds. These funds hold all shares of all corporations listed on a given stock index; unlike actively managed funds they make no effort to pick winners, but hold shares in multiple competing firms. Per one recent study, “The probability that two randomly selected firms in the same industry from the S&P 1500 have a common shareholder with at least 5% stakes in both firms increased from less than 20% in 1999 to around 90% in 2014.”

The problem is obvious: If corporations work for their shareholders, then why would they compete against each other if their shares are held by the same funds? Naturally, one proposed solution is more state intervention to preserve the form of markets, by limiting or disfavoring stock ownership via broad funds. Another, and perhaps more logical, response is: If we are already trusting corporate managers to be faithful agents of the rentier class as a whole, why not take the next step and make them agents of society in general?

And in any case the terms on which the financial system directs capital are ultimately set by the central bank. Its decisions — monetary policy in the narrow sense, but also the terms on which financial institutions are regulated, and rescued in crises – determine not only the overall pace of credit expansion but the criteria of profitability itself. This is acutely evident in crises, but it’s implicit in routine monetary policy as well. Unless lower interest rates turn some previously unprofitable projects into profitable ones, how are they supposed to work?

At the same time, the legitimacy of the capitalist system — the ideological justification of its obvious injustice and waste —  comes from the idea that economic outcomes are determined by “the market,” not by anyone’s choice. So the planning has to be kept out of site. Central bankers themselves are quite aware of this aspect of their role. In the early 1980s, when the Fed was changing the main instrument it used for monetary policy, officials there were concerned that their choice preserve the fiction that interest rates were being set by the markets. As Fed Governor Wayne Angell put it, it was essential to choose a technique that would “have the camouflage of market forces at work.”

Mainstream economics textbooks explicitly describe the long-term trajectory of capitalist economies in terms of an ideal planner, who is setting output and prices for all eternity in order to maximize the general wellbeing. The contradiction between this macro vision and the ideology of market competition is papered over by the assumption that over the long run this path is the same as the “natural” one that would obtain in a perfect competitive market system without money or banks. Outside of the academy, it’s harder to sustain faith that the planners at the central bank are infallibly picking the outcomes the market should have arrived at on its own. Central banks’ critics on the right — and many on the left — understand clearly that central banks are engaged in active planning, but see it as inherently illegitimate. Their belief in “natural” market outcomes goes with fantasies of a return to some monetary standard independent of human judgement – gold or bitcoin.

Socialists, who see through central bankers’ facade of neutral expertise and recognize their close association with private finance, may be tempted by similar ideas. But the path toward socialism runs the other way. We don’t seek to organize human life on an objective grid of market values, free of the distorting influence of finance and central banks. We seek rather to bring this already-existing conscious planning into the light, to make it into a terrain of politics, and to direct it toward meeting human needs rather than reinforcing relations of domination. In short: the socialization of finance.

*

in the U.S. context, this analysis suggests a transitional program perhaps along the following lines.

Decommodify money. While there is no way to separate money and markets from finance, that does not mean that the routine functions of the monetary system must be a source of private profit. Shifting responsibility for the basic monetary plumbing of the system to public or quasi-public bodies is a non-reformist reform – it addresses some of the directly visible abuse and instability of the existing monetary system while pointing the way toward more profound transformations. In particular, this could involve:

 1. A public payments system. In the not too distant past, if I wanted to give you some money and you wanted to give me a good or service, we didn’t have to pay a third party for permission to make the trade. But as electronic payments have replaced cash, routine payments have become a source of profit. Interchanges and the rest of the routine plumbing of the payments system should be a public monopoly, just as currency is.

 2. Postal banking. Banking services should similarly be provided through post offices, as in many other countries. Routine transactions accounts (check and saving) are a service that can be straightforwardly provided by the state.

 3. Public credit ratings, both for bonds and for individuals. As information that, to perform its function, must be widely available, credit ratings are a natural object for public provision even within the overarching logic of capitalism. This is also a challenge to the coercive, disciplinary function increasingly performed by private credit ratings in the US.

 4. Public housing finance. Mortgages for owner-occupied housing are another area where a patina of market transactions is laid over a system that is already substantively public. The 30-year mortgage market is entirely a creation of regulation, it is maintained by public market-makers, and public bodies are largely and increasingly the ultimate lenders. Socialists have no interest in the cultivation of a hothouse petty bourgeoisie through home ownership; but as long as the state does so, we demand that it be openly and directly rather than disguised as private transactions.

 5. Public retirement insurance. Providing for old age is the other area, along with housing, where the state does the most to foster what Gerald Davis calls the “capital fiction” – the conception of one’s relationship to society in terms of asset ownership. But here, unlike home ownership, social provision in the guise of financial claims has failed even on its own narrow terms. Many working-class households in the US and other rich countries do own their own houses, but only a tiny fraction can meet their subsistence needs in old age out of private saving. At the same time, public retirement systems are much more fully developed than public provision of housing. This suggests a program of eliminating existing programs to encourage private retirement saving, and greatly expanding Social Security and similar social insurance systems.

Repress finance. It’s not the job of socialists to keep the big casino running smoothly. But as long as private financial institutions exist, we cannot avoid the question of how to regulate them. Historically financial regulation has sometimes taken the form of “financial repression,” in which the types of assets held by financial institutions are substantially dictated by the state. This allows credit to be directed more effectively to socially useful investment. It also allows policymakers to hold market interest rates down, which — especially in the context of higher inflation — diminishes both the burden of debt and the power of creditors. The exiting deregulated financial system already has very articulate critics; there’s no need to duplicate their work with a detailed reform proposal. But we can lay out some broad principles:

1. If it isn’t permitted, it’s forbidden. Effective regulation has always depended on enumerating specific functions for specific institutions, and prohibiting anything else. Otherwise it’s too easy to bypass with something that is formally different but substantively equivalent. And whether or not central banks are going to continue with their role as the main managers of aggregate demand —  increasingly questioned by those inside the citadel as well as by outsiders — they also need this kind of regulation to effectively control the flow of credit.

2. Protect functions, not institutions. The political power of finance comes from ability to threaten routine social bookkeeping, and the security of small property owners. (“If we don’t bail out the banks, the ATMs will shut down! What about your 401(k)?”) As long as private financial institutions perform socially necessary functions, policy should focus on preserving those functions themselves, and not the institutions that perform them. This means that interventions should be as close as possible to the nonfinancial end-user, and not on the games banks play among themselves. For example: deposit insurance.

3. Require large holdings of public debt. The threat of the “bond vigilantes” against the US federal government has  been wildly exaggerated, as was demonstrated for instance by the debt-ceiling farce and downgrade of 2012. But for smaller governments – including state and local governments in the US – bond markets are not so easily ignored. And large holdings of pubic debt also reduce the frequency and severity of the periodic financial crises which are, perversely, one of the main ways in which finance’s social power is maintained.

4. Control overall debt levels with lower interest rates and higher inflation. Household leverage in the US has risen dramatically over the past 30 years; some believe that this is because debt was needed to raise living standards of living in the face of stagnant or declining real incomes. But this isn’t the case; slower income growth has simply meant slower growth in consumption. Rather, the main cause of rising household debt over the past 30 years has been the combination of low inflation and continuing high interest rates for households. Conversely, the most effective way to reduce the burden of debt – for households, and also for governments – is to hold interest rates down while allowing inflation to rise.

As a corollary to financial repression, we can reject any moral claims on behalf of interest income as such. There is no right to exercise a claim on the labor of others  through ownership of financial assets. To the extent that the private provision of socially necessary services like insurance and pensions is undermined by low interest rates, that is an argument for moving these services to the public sector, not for increasing the claims of rentiers.

Democratize central banks. Central banks have always been central planners. Choices about interest rates, and the terms on which financial institutions will be regulated and rescued, inevitably condition the profitability and the direction as well as level of productive activity. This role has been concealed behind an ideology that imagines the central bank behaving automatically, according to a rule that somehow reproduces the “natural” behavior of markets.

Central banks’ own actions since 2008 have left this ideology in tatters. The immediate response to the crisis have forced central banks to intervene more directly in credit markets, buying a wider range of assets and even replacing private financial institutions to lend directly to nonfinancial businesses. Since then, the failure of conventional monetary policy has forced central banks to inch unwillingly toward a broader range of interventions, directly channeling credit to selected borrowers. This turn to “credit policy” represents an admission – grudging, but forced by events – that the anarchy of competition is unable to coordinate production. Central banks cannot, as the textbooks imagine, stabilize the capitalists system by turning a single knob labeled “money supply” or “interest rate.” They must substitute their own judgement for market outcomes in a broad and growing range of asset and credit markets.

The challenge now is to politicize central banks — to make them the object of public debate and popular pressure.  In Europe, the national central banks – which still perform their old functions, despite the common misperception that the ECB is now the central bank of Europe – will be a central terrain of struggle for the next left government that seeks to break with austerity and liberalism. In the US, we can dispense for good with the idea that monetary policy is a domain of technocratic expertise, and bring into the open its program of keeping unemployment high in order to restrain wage growth and workers’ power. As a positive program, we might demand that the Fed aggressively using its existing legal authority to purchase municipal debt, depriving rentiers of their power over financially constrained local governments as in Detroit and Puerto Rico, and more broadly blunting the power of “the bond markets” as a constraint on popular politics at the state and local level. More broadly, central banks should be held responsible for actively directing credit to socially useful ends.

Disempower shareholders. Really existing capitalism consists of narrow streams of market transactions flowing between vast regions of non-market coordination. A core function of finance is to act as the weapon in the hands of the capitalist class to enforce the logic of value on these non-market structures. The claims of shareholders over nonfinancial businesses, and bondholders over national governments, ensure that all these domains of human activity remain subordinate to the logic of accumulation. We want to see stronger defenses against these claims – not because we have any faith in productive capitalists or national bourgeoisies, but because they occupy the space in which politics is possible.

Specifically we should stand with corporations against shareholders. The corporation, as Marx long ago noted, is “the abolition of the capitalist mode of production within the capitalist mode of production itself.” Within the corporation, activity is coordinated through plans, not markets; and the orientation of this activity is toward the production of a particular use-value rather than money as such. “The tendency of big enterprise,” Keynes wrote, “is to socialize itself.” The fundamental political function of finance is to keep this tendency in check. Without the threat of takeovers and the pressure of shareholder activists, the corporation becomes a space where workers and other stakeholders can contest control over production and the surplus it generates – a possibility that capitalist never lose sight of.

Needless to say, this does not imply any attachment to the particular individuals at the top of the corporate hierarchy, who today are most often actual or aspiring rentiers  without any organic connection to the production process. Rather, it’s a recognition of the value of the corporation as a social organism; as a space structured by relationships of trust and loyalty, and by intrinsic motivation and “professional conscience”; and as the site of consciously planned production of use-values.

The role of finance with respect to the modern corporation is not to provide it with resources for investment, but to ensure that its conditional orientation toward production as an end in itself is ultimately subordinate to the accumulation of money. Resisting this pressure is no substitute for other struggles, over the labor process and the division of resources and authority within the corporation. (History gives many examples of production of use values as an end in itself, which is carried out under conditions as coercive and alienated as under production for profit.) But resisting the pressure of finance creates more space for those struggles, and for the evolution of socialism within the corporate form.

Close borders to money (and open them to people). Just as shareholder power enforces the logic of accumulation on corporations, capital mobility does the same to states. In the universities, we hear about the supposed efficiency  of unrestrained capital flows, but in the political realm we hear more their power to “discipline” national governments. The threat of capital flight and balance of payments crises protects the logic of accumulation against incursions by national governments.

States can be vehicles for conscious control of the economy only insofar as financial claims across borders are limited. In a world where capital flows are large and unrestricted, the concrete activity of production and reproduction must constantly adjust itself to the changing whims of foreign investors. This is incompatible with any strategy for  development of the forces of production at the national level; every successful case of late industrialization has depended on the conscious direction of credit through the national banking system. More than that, the requirement that real activity accommodate cross-border financial flows is  incompatible even with the stable reproduction of capitalism in the periphery. We have learned this lesson many times in Latin America and elsewhere in the South, and are now learning it again in Europe.

So a socialist program on finance should include support for efforts of national governments to delink from the global economy, and to maintain or regain control over their financial systems. Today, such efforts are often connected to a politics of racism, nativism and xenophobia which we must uncompromisingly reject. But it is possible to move toward a world in which national borders pose no barrier to people and ideas, but limit the movement of goods and are impassible barriers to private financial claims.

In the US and other rich countries, it’s also important to oppose any use of the authority – legal or otherwise – of our own states to enforce financial claims against weaker states. Argentina and Greece, to take two recent examples, were not forced to accept the terms of their creditors by the actions of dispersed private individuals through financial markets, but respectively by the actions of Judge Griesa of the US Second Circuit and Trichet and Draghi of the ECB. For peripheral states to foster development and serve as vehicle for popular politics, they must insulate themselves from international financial markets. But the power of those markets comes ultimately from the gunboats — figurative or literal — by which private financial claims are enforced.

With respect to the strong states themselves, the markets have no hold except over the imagination. As we’ve seen repeatedly in recent years — most dramatically in the debt-limit vaudeville of 2011-2013 — there are no “bond vigilantes”; the terms on which governments borrow are fully determined by their own monetary authority. All that’s needed to break the bond market’s power here is to recognize that it’s already powerless.

In short, we should reject the idea of finance as an intrusion on a preexisting market order. We should resist the power of finance as an enforcer of the logic of accumulation. And we should reclaim as a site of democratic politics the social planning already carried out through finance.

New-Old Paper on the Balance of Payments

Four or five years ago, I wrote a paper arguing that the US current account deficit, far from being a cause of the crisis of 2008, was a stabilizing force in the world economy. I presented it at a conference and then set it aside. I recently reread it and I think the arguments hold up well. If anything the case that the US, as the center of the world financial system, ought to run large current account deficits indefinitely looks even stronger now, given the contrasting example of Germany’s behavior in the European system.

I’ve put the paper up as a working paper at John Jay economics department site. Here’s the abstract:

Persistent current account imbalances need not contribute to macroe- conomic instability, despite widespread claims to the contrary by both mainstream and Post Keynesian economists. On the contrary, in a world of large capital inflows, a high and stable level of world output is most likely when the countries with the least capacity to generate capital inflows normally run current account surpluses, while the countries with the greatest capacity to generate capital inflows (the US in particular) normally run current account deficits. An emphasis on varying balance of payments constraints is consistent with the larger Post Keynesian vision, which emphasizes money flows and claims are not simply passive reflections of “real” economic developments, but exercise an important influence in their own right. It is also consistent with Keynes’ own views. This perspective helps explain why the crisis of 2008 did not take the form of a fall in the dollar, and why reserve accumulation in East Asia successfully protected those countries from a repeat of the crisis of 1997. Given the weakness of the “automatic” mechanisms that are supposed to balance trade, income and financial flows, a reduction of the US current account deficit is likely to exacerbate, rather than ameliorate, global macroeconomic instability.

You can read the whole thing here.

A Quick Point on Models

According to Keynes the purpose of economics is “to provide ourselves with an organised and orderly method of thinking out particular problems”; it is “a way of thinking … in terms of models joined to the art of choosing models which are relevant to the contemporary world.” (Quoted here.)

I want to amplify on that just a bit. The test of a good model is not whether it corresponds to the true underlying structure of the world, but whether it usefully captures some of the regularities in the concrete phenomena we observe. There are lots of different regularities, more or less bounded in time, space and other dimensions, so we are going to need lots of different models, depending on the questions we are asking and the setting we are asking them in. Thus the need for the “art of choosing”.

I don’t think this point is controversial in the abstract. But people often lose sight of it. Obvious case: Piketty and “capital”. A lot of the debate between Piketty and his critics on the left has focused on whether there really is, in some sense, a physical quantity of capital, or not. I don’t think we need to have this argument.

We observe “capital” as a set of money claims, whose aggregate value varies in relation to other observable monetary aggregates (like income) over time and across space. There is a component of that variation that corresponds to the behavior of a physical stock — increasing based on identifiable inflows (investment) and decreasing based on identifiable outflows (depreciation). Insofar as we are interested in that component of the observed variation, we can describe it using models of capital as a physical stock. The remaining components (the “residual” from the point of view of a model of physical K) will require a different set of models or stories. So the question is not, is there such a thing as a physical capital stock? It’s not even, is it in general useful to think about capital as a physical stock? The question is, how much of the particular variation we are interested is accounted for by the component corresponding to the evolution of a physical stock? And the answer will depend on which variation we are interested in.

For example, Piketty could say “It’s true that my model, which treats K as a physical stock, does not explain much of the historical variation in capital-output ratios at decadal frequencies, like the fall and rise over the course of the 20th century. But I believe it does explain very long-frequency variation, and in particular captures important long-run possibilities for the future.” (I think he has in fact said something like this, though I can’t find the quote at the moment.) You don’t have to agree with him — you could dispute that his model is a good fit for even the longest-frequency historical variation, or you could argue that the shorter frequency variation is more interesting (and is what his book often seems to be about). But it would be pointless to criticize him on the grounds that there isn’t “really” such a thing as a physical capital stock, or that there is no consistent way in principle to measure it. That, to me, would show a basic misunderstanding of what models are.

An example of good scientific practice along these lines is biologists’ habit of giving genes names for what happens when gross mutations are induced in them experimentally. Names like eyeless or shaggy or buttonhead: the fly lacks eyes, grows extra hair, or has a head without segments if the gene is removed. It might seem weird to describe genes in terms of what goes wrong when they are removed, as opposed to what they do normally, but I think this practice shows good judgement about what we do and don’t know. In particular, it avoids any claim about what the gene is “for.” There are many many relationships between a given locus in the genome and the phenotype, and no sense in which any of them is more or less important in an absolute sense. Calling it the “eye gene” would obscure that, make it sound like this is the relationship that exists out in the world, when for all we know the variation in eye development in wild populations is driven by variation in entirely other locuses. Calling it eyeless makes it clear that it’s referring to what you observe in a particular experimental context.

EDIT: I hate discussions of methodology. I should not have written this post. (I only did because I liked the gene-naming analogy.)  That said, if you, unlike me, enjoy this sort of thing, Tom Hickey wrote a long and thoughtful response to it. He mentions among others, Tony Lawson, who I would certainly want to read more of if I were going to write about this stuff.

Minsky on the Non-Neutrality of Money

I try not to spend too much time criticizing orthodox economics. I think that heterodox people who spend all their energy pointing out the shortcomings and contradictions of the mainstream are, in a sense, making the same mistake as the ones who spend all their energy trying to make their ideas acceptable to the mainstream. We should focus on building up our positive knowledge of social reality, and let the profession fend for itself.

That said, like almost everyone in the world of heterodoxy I do end up writing a lot, and often obstreperously, about what is wrong with the economics profession. To which you can fairly respond: OK, but where is the alternative economics you’re proposing instead?

The honest answer is, it doesn’t exist. There are many heterodox economics, including a large contingent of Post Keynesians, but Post Keynesianism is not a coherent alternative research program. [1] Still, there are lots of promising pieces, which might someday be assembled into a coherent program. One of these is labeled “Minsky”. [2] Unfortunately, while Minsky is certainly known to a broader audience than most economists associated with heterodoxy, it’s mainly only for the financial fragility hypothesis, which I would argue is not central to his contribution.

I recently read a short piece he wrote in 1993, towards the end of his career, that gives an excellent overview of his approach. It’s what I’d recommend — along with the overview of his work by Perry Mehrling that I mentioned in the earlier post, and also the overview by Pollin and Dymski — as a starting point for anyone interested in his work.

* * *

“The Non-Neutrality of Money” covers the whole field of Minsky’s interests and can be read as a kind of summing-up of his mature thought. So it’s interesting that he gave it that title. Admittedly it partly reflects the particular context it was written in, but it also, I think, reflects how critical the neutrality or otherwise of money is in defining alternative visions of what an economy is.

Minsky starts out with a description of what he takes to be the conceptual framework of orthodox economics, represented here by Ben Bernanke’s “Credit in the Macroeconomy“:

The dominant paradigm is an equilibrium construct in which initial endowments of agents, preference systems and production relations, along with maximizing behavior, determine relative prices, outputs and allocation… Money and financial interrelations are not relevant to the determination of these equilibrium values … “real” factors determine “real” variables.

Some people take this construct literally. This leads to Real Business Cycles and claims that monetary policy has never had any effects. Minsky sees no point in even criticizing that approach. The alternative, which he does criticize, is to postulate some additional “frictions” that prevent the long-run equilibrium from being realized, at least right away. Often, as in the Bernanke piece, the frictions take the form of information asymmetries that prevent some mutually beneficial transactions — loans to borrowers without collateral, say — from taking place. But, Minsky says, there is a contradiction here.

On the one hand, perfect foresight is assumed … to demonstrate the existence of equilibrium, and on the other hand, imperfect foresight is assumed … to generate the existence of an underemployment equilibrium and the possibility of policy effectiveness.

Once we have admitted that money and money contracts are necessary to economic activity, and not just an arbitrary numeraire, it no longer makes sense to make simulating a world without money as the goal of policy. If money is useful, isn’t it better to have more of it, and worse to have less, or none? [3] The information-asymmetry version of this problem is actually just the latest iteration of a very old puzzle that goes back to Adam Smith, or even earlier. Smith and the other Classical economists were unanimous that the best monetary system was one that guaranteed a “perfect” circulation, by which they meant, the quantity of money that would circulate if metallic currency were used exclusively. But this posed two obvious questions: First, how could you know how much metallic currency would circulate in that counterfactual world, and exactly which forms of “money” in the real world should you compare to that hypothetical amount? And second, if the ideal monetary system was one in which the quantity of money came closest to what it would be if only metal coins were used, why did people — in the most prosperous countries especially — go to such lengths to develop forms of payment other than metallic coins? Hume, in the 18th century, could still hew to the logic of theory and and conclude that, actually, paper money, bills of exchange, banks that functioned as anything but safety-deposit boxes [4] and all the rest of the modern financial system was a big mistake. For later writers, for obvious reasons, this wasn’t a credible position, and so the problem tended to be evaded rather than addressed head on.

Or to come back to the specific way Minsky presents the problem. Suppose I have some productive project available to me but lack sufficient claim on society’s resources to carry it out. In principle, I could get them by pledging a fraction of the results of my project. But that might not work, perhaps because the results are too far in the future, or too uncertain, or — information asymmetry — I have no way of sharing the knowledge that the project is viable or credibly committing to share its fruits. In that case “welfare” will be lower than it the hypothetical perfect-information alternative, and, given some additional assumptions, we will see something that looks like unemployment. Now, perhaps the monetary authority can in some way arrange for deferred or uncertain claims to be accepted more readily. That may result in resources becoming available for my project, potentially solving the unemployment problem. But, given the assumptions that created the need for policy in the first place, there is no reason to think that the projects funded as a result of this intervention wil be exactly the same as in the perfect-information case. And there is no reason to think there are not lots of other unrealized projects whose non-undertaking happens not to show up as unemployment. [5]

Returning to Minsky: A system of markets

is not the only way that economic interrelations can be modeled. Every capitalist economy can be described in terms of interrelated balance sheets … The entries on balance sheets can be read as payment commitments (liabilities) and expected payment receipts (assets), both denominated in a common unit.

We don’t have to see an endowments of goods, tastes for consumption, and a given technology for converting the endowments to consumption goods as the atomic units of the economy. We can instead start with a set of money flows between units, and the capitalized expectations of future money flows captured on balance sheets. In the former perspective, money payments and commitments are a secondary complication that we may want to introduce for specific problems. In the latter, Minskyan perspective, exchanges of goods are just one of the various forms of money flows between economic units.

Minsky continues:

In this structure, the real and the financial dimensions of the economy are not separated. There is no “real economy” whose behavior can be studied by abstracting from financial considerations. … In this model, money is never neutral.

The point here, again, is that real economies require people to make commitments today on the basis of expectations extending far into an uncertain future. Money and credit are tools to allow these commitments to be made. The more available are money and credit, the further into the future can be deferred the results that will justify today’s activity. If we can define a level of activity that we call full employment or price stability — and I think Keynes was much too sanguine on this point — then a good monetary authority may be able to regulate the flow of money or credit (depending on the policy instrument) to keep actual activity near that level. But there is no connection, logical or practical, between that state of the economy and a hypothetical economy without money or credit at all.

For Minsky, this fundamental point is captured in Keynes’ two-price model. The price level of current output and capital assets are determined by two independent logics and vary independently. This is another way of saying that the classical dichotomy between relative prices and the overall price level, does not apply in a modern economy with a financial system and long-lived capital goods. Changes in the “supply of money,” whatever that means in practice, always affect the prices of assets relative to current output.

The price level of assets is determined by the relative value that units place on income in the future and liquidity now. …  

The price level of current output is determined by the labor costs and the markup per unit of output. … The aggregate markup for consumption goods is determined by the ratio of the wage bill in investment goods, the government deficit… , and the international trade balance, to the wage bill in the production of consumption goods. In this construct the competition of interest is between firms for profits.

Here we see Minsky’s Kaleckian side, which doesn’t get talked about much. Minsky was convinced that investment always determined profits, never the other way round. Specifically, he followed Kalecki in treating the accounting identity that “the capitalists get what they spend” as causal. That is, total profits are determined as total investment spending plus consumption by capitalists (plus the government deficit and trade surplus.)

Coming back to the question at hand, the critical point is that liquidity (or “money”) will affect these two prices differently. Think of it this way: If money is scarce, it will be costly to hold a large stock of it. So you will want to avoid committing yourself to fixed money payments in the future, you will prefer assets that can be easily converted into money as needed, and you will place a lower value on money income that is variable or uncertain. For all these reasons, long-lived capital goods will have a lower relative price in a liquidity-scare world than in a liquidity-abundant one. Or as Minsky puts it:

The non-neutrality of money … is due to the difference in the way money enters into the determination of the price level of capital assets and of current output. … the non-neutrality theorem reflects essential aspects of capitalism in that it recognizes that … assets exist and that they not only yield income streams but can also be sold or pledged.

Finally, we get to Minsky’s famous threefold classification of financial positions as hedge, speculative or Ponzi. In context, it’s clear that this was a secondary not a central concern. Minsky was not interested in finance for its own sake, but rather in understanding modern capitalist economies through the lens of finance. And it was certainly not Minsky’s intention for these terms to imply a judgement about more and less responsible financing practices. As he writes, “speculative” financing does not necessarily involve anything we would normally call speculation:

Speculative financing covers all financing that involves refinancing at market terms … Banks are always involved in speculative financing. The floating debt of companies and governments are speculative financing.

As for Ponzi finance, he admits this memorable label was a bad choice:

I would have been better served if I had labeled the situation “the capitalization of interest.” … Note that construction finance is almost always a prearranged Ponzi financing scheme. [6]

For me, the fundamental points here are (1) That our overarching vision of capitalist economies needs to be a system of “units” (including firms, governments, etc.) linked by current money payments and commitments to future money payments, not a set of agents exchanging goods; and (2) that the critical influence of liquidity comes in the terms on which long-lived commitments to particular forms of production trade off against current income.

[1] Marxism does, arguably, offer a coherent alternative — the only one at this point, I think. Anwar Shaikh recently wrote a nice piece, which I can’t locate at the moment, contrasting the Marxist-classical and Post Keynesian  strands of heterodoxy.

[2] In fact, as Perry Mehrling demonstrates in The Money Interest and the Public Interest, Minsky represents an older and largely forgotten tradition of American monetary economics, which owes relatively little to Keynes.

[3] Walras, Wicksell and many others dismiss the idea that more money can be beneficial by focusing on its function as a unit of account. You can’t consistently arrive earlier, they point out, by adjusting your watch, even if you might trick yourself the first few times. You can’t get taller by redefining the inch. Etc. But this overlooks the fact that people do actually hold money, and pay real costs to acquire  it.

[4] “The dearness of every thing, from plenty of money, is a disadvantage … This has made me entertain a doubt concerning the benefit of banks and paper-credit, which are so generally esteemed advantageous … to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities… And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce.” Political Discourses, 1752.

[5] This leads into Verdoorn’s law and anti-hysteresis, a topic I hope to return to.

[6] Daniel Davies should appreciate this.

What to Read on Liquidity

In comments, someone asks for references behind “the point is liquidity, the point is liquidity, the point is liquidity.” So, here are my recommended readings on liquidity.

Mike Beggs: “Liquidity as a Social Relation.” This is the best single discussion I know of the Keynesian view of liquidity. Beside laying out the fundamental conceptual issues, and sketching the historical development of the concept, this piece also has a good discussion of how the definition of liquidity used in monetary policy has been transformed over the past couple decades. This is the first thing I’d recommend to anyone who wants to understand what exactly those of us in the left-Keynsian tradition mean by “liquidity.”

John Hicks: “Liquidity.” A lucid and intelligent summary of where the discussion of liquidity stood 20 years after Keynes’ death.

Jorg Bibow: “Liquidity preference theory revisited: to ditch or to build on it?” A rigorous analysis of the role of liquidity in the Keynesian theory of interest rates, with particular attention to the dynamics of conventional expectations. If you want to know how Keynes’ ideas about liquidity fit into contemporary debates about monetary policy, Bibow is your man. Also worth reading: “On Keynesian Theories of Liquidity Preference,” and Bibow’s book.

J. M. Keynes: chapters 12, 13, 15, 17 and 23 of the General Theory. Also: “The General Theory of Employment”; “The Ex-Ante Theory of Interest. The original source. I think  the presentation in the articles is clearer than in the book. Beggs and Hicks and Bibow are even clearer.

Jean Tirole, “Illiquidity and All Its Friends.” Within the mainstream, Tirole has by far the best discussion of liquidity that I’m aware of. I have profoundly mixed feelings about his approach but I’ve certainly learned from him — for example, the distinction between funding liquidity and market liquidity is genuinely useful. If you’re tempted to criticize “mainstream” economics’ treatment of liquidity, you need to seriously engage with Tirole first — he incorporates a surprisingly large part of the Keynesian vision of liquidity into an orthodox framework.

Jim Crotty, “The Centrality of Money, Credit and Intermediation in Marx’s Crisis Theory”. Addresses liquidity in a somewhat different context than most of the above — he asks how the specifically monetary character of capitalist production shapes the dynamics of accumulation as described by Marx and his followers. It’s a bit askew to the other pieces here, but the underlying questions are, I think, the same. And it is one of the most brilliant scholarly essays I have read.

Perry Mehrling, “The Vision of Hyman Minsky.” I think this lays out the logic of Minsky’s work better than anything by Minsky himself. Also see Mehrling’s book, The Money Interest and the Public Interest. Everything we need to know about liquidity is in there, though you may have to read between the lines to find it. His “Inherent Hierarchy of Money” is also useful, making the point that any system of payments is inherently hierarchical, with the same instrument appearing as credit at one level and as money at the level below.

EDIT: Should also include Joan Robinson, “The Rate of Interest,” which has a useful taxonomy distinguishing illiquidity in the strict sense from capital uncertainty, income uncertainty and lender’s risk.

By the way, the phrasing the post starts with is taken from Tree of Smoke, Denis Johnson’s Vietnam war novel. (I know that’s not what you were asking.) It’s the best novel I read this year, I recommend it almost unreservedly. There of course the point is Vietnam.

Alvin Hansen on Monetary Policy

The more you read in the history of macroeconomics and monetary theory, the more you find that current debates are reprises of arguments from 50, 100 or 200 years ago.

I’ve just been reading Perry Mehrling’s The Money Interest and the Public Interest, which  is one of the two best books I know of on this subject. (The other is Arie Arnon’s Monetary Theory and Policy Since David Hume and Adam Smith.) About a third of the book is devoted to Alvin Hansen, and it inspired me to look up some of Hansen’s writings from the 1940s and 50s. I was especially struck by this 1955 article on monetary policy. It not only anticipates much of current discussions of monetary policy — quantitative easing, the maturity structure of public debt, the need for coordination between the fiscal and monetary policy, and more broadly, the limits of a single interest rate instrument as a tool of macroeconomic management — but mostly takes them for granted as starting points for its analysis. It’s hard not to feel that macro policy debates have regressed over the past 60 years.

The context of the argument is the Treasury-Federal Reserve Accord of 1951, following which the Fed was no longer committed to maintaining fixed rates on treasury bonds of various maturities. [1] The freeing of the Fed from the overriding responsibility of stabilizing the market for government debt, led to scholarly and political debates about the new role for monetary policy. In this article, Hansen is responding to several years of legislative debate on this question, most recently the 1954 Senate hearings which included testimony from the Treasury department, the Fed Board’s Open Market Committee, and the New York Fed.

Hansen begins by expressing relief that none of the testimony raised

the phony question whether or not the government securities market is “free.” A central bank cannot perform its functions without powerfully affecting the prices of government securities.

He then expresses what he sees as the consensus view that it is the quantity of credit that is the main object of monetary policy, as opposed to either the quantity of money (a non-issue) or the price of credit (a real but secondary issue), that is, the interest rate.

Perhaps we could all agree that (however important other issues may be) control of the credit base is the gist of monetary management. Wise management, as I see it, should ensure adequate liquidity in the usual case, and moderate monetary restraint (employed in conjunction with other more powerful measures) when needed to check inflation. No doubt others, who see no danger in rather violent fluctuations in interest rates (entailing also violent fluctuations in capital values), would put it differently. But at any rate there is agreement, I take it, that the central bank should create a generous dose of liquidity when resources are not fully employed. From this standpoint the volume of reserves is of primary importance.

Given that the interest rate is alsoan object of policy, the question becomes, which interest rate?

The question has to be raised: where should the central bank enter the market -short-term only, or all along the gamut of maturities?

I don’t believe this is a question that economists asked much in the decades before the Great Recession. In most macro models I’m familiar with, there is simply “the interest rate,” with the implicit assumption that the whole rate structure moves together so it doesn’t matter which specific rate the monetary authority targets. For Hansen, by contrast, the structure of interest rates — the term and “risk” premiums — is just as natural an object for policy as the overall level of rates. And since there is no assumption that the whole structure moves together, it makes a difference which particular rate(s) the central bank targets. What’s even more striking is that Hansen not only believes that it matters which rate the central bank targets, he is taking part in a conversation where this belief is shared on all sides.

Obviously it would make little difference what maturities were purchased or sold if any change in the volume of reserve money influenced merely the level of interest rates, leaving the internal structure of rates unaffected. … In the controversy here under discussion, the Board leans toward the view that … new impulses in the short market transmit themselves rapidly to the longer maturities. The New York Reserve Bank officials, on the contrary, lean toward the view that the lags are important. If there were no lags whatever, it would make no difference what maturities were dealt in. But of course the Board does not hold that there are no lags.

Not even the most conservative pole of the 1950s debate goes as far as today’s New Keynesian orthodoxy that monetary policy can be safely reduced to the setting of a single overnight interest rate.

The direct targeting of long rates is the essential innovation of so-called quantitative easing. [2] But to Hansen, the idea that interest rate policy should directly target long as well as short rates was obvious. More than that: As Hansen points out, the same point was made by Keynes 20 years earlier.

If the central bank limits itself to the short market, and if the lags are serious, the mere creation of large reserves may not lower the long-term rate. Keynes had this in mind when he wrote: “Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement that can be made in the technique of monetary management. . . . The monetary authority often tends in practice to concentrate upon short-term debts and to leave the price of long-term debts to be influenced by belated and imperfect re- actions from the price of short-term debts.” ‘ Keynes, it should be added, wanted the central bank to deal not only in debts of all maturities, but also “to deal in debts of varying degrees of risk,” i.e., high grade private securities and perhaps state and local issues.

That’s a quote from The General Theory, with Hansen’s gloss.

Fast-forward to 2014. Today we find Benjamin Friedman — one of the smartest and most interesting orthodox economists on these issues — arguing that the one great change in central bank practices in the wake of the Great Recession is intervention in a range of securities beyond the shortest-term government debt. As far as I can tell, he has no idea that this “profound” innovation in the practice of monetary policy was already proposed by Keynes in 1936. But then, as Friedman rightly notes, “Macroeconomics is a field in which theory lags behind experience and practice, not the other way around.”

Even more interesting, the importance of the rate structure as a tool of macroeconomic policy was recognized not only by the Federal Reserve, but by the Treasury in its management of debt issues. Hansen continues:

Monetary policy can operate on two planes: (1) controlling the credit base – the volume of reserve balances- and (2) changing the interest rate structure. The Federal Reserve has now backed away from the second. The Treasury emphasized in these hearings that this is its special bailiwick. It supports, so it asserts, the System’s lead, by issuing short- terms or long-terms, as the case may be, according to whether the Federal Reserve is trying to expand or contract credit … it appears that we now have (whether by accident or design) a division of monetary management between the two agencies- a sort of informal cartel arrangement. The Federal Reserve limits itself to control of the volume of credit by operating exclusively in the short end of the market. The Treasury shifts from short-term to long-term issues when monetary restraint is called for, and back to short-term issues when expansion is desired.

This is amazing. It’s not that Keynesians like Hansen  propose that Treasury should issue longer or shorter debt based on macroeconomic conditions. Rather, it is taken for granted that it does choose maturities this way. And this is the conservative side in the debate, opposed to the side that says the central bank should manage the term structure directly.

Many Slackwire readers will have recently encountered the idea that the maturities of new debt should be evaluated as a kind of monetary policy. It’s on offer as the latest evidence for the genius of Larry Summers. Proposing that Treasury should issue short or long term debt based on goals for the overall term structure of interest rates, and not just on minimizing federal borrowing costs, is the main point of Summers’ new Brookings paper, which has attracted its fair share of attention in the business press. No reader of that paper would guess that its big new idea was a commonplace of policy debates in the 1950s. [3]

Hansen goes on to raise some highly prescient concerns about the exaggerated claims being made for narrow monetary policy.

The Reserve authorities are far too eager to claim undue credit for the stability of prices which we have enjoyed since 1951. The position taken by the Board is not without danger, since Congress might well draw the conclusion that if monetary policy is indeed as powerful as indicated, nonmonetary measures [i.e. fiscal policy and price controls] are either unnecessary or may be drawn upon lightly.

This is indeed the conclusion that was drawn, more comprehensively than Hansen feared. The idea that setting an overnight interest rate is always sufficient to hold demand at the desired level has conquered the economics profession “as completely as the Holy Inquisition conquered Spain,” to coin a phrase. If you talk to a smart young macroeconomist today, you’ll find that the terms “aggregate demand was too low” and “the central bank set the interest rate too high” are used interchangeably. And if you ask, which interest rate?, they react the way a physicist might if you asked, the mass of which electron?

Faced with the argument that the inflation of the late 1940s, and price stability of the early 1950s, was due to bad and good interest rate policy respectively, Hansen offers an alternative view:

I am especially unhappy about the impli- cation that the price stability which we have enjoyed since February-March 1951 (and which everyone is justifiably happy about) could quite easily have been purchased for the entire postwar period (1945 to the present) had we only adopted the famous accord earlier …  The postwar cut in individual taxes and the removal of price, wage, and other controls in 1946 … did away once and for all with any really effective restraint on consumers. Under these circumstances the prevention of price inflation … [meant] restraint on investment. … Is it really credible that a drastic curtailment of investment would have been tolerated any more than the continuation of wartime taxation and controls? … In the final analysis, of course,  the then prevailing excess of demand was confronted with a limited supply of productive resources.

Inflation always comes down to this mismatch between “demand,” i.e. desired expenditure, and productive capacity.

Now we might say in response to such mismatches: Well, attempts to purchase more than we can produce will encourage increased capacity, and inflation is just a temporary transitional cost. Alternatively, we might seek to limit spending in various ways. In this second case, there is no difference of principle between an engineered rise in the interest rate, and direct controls on prices or spending. It is just a question of which particular categories of spending you want to hold down.

The point: Eighty years ago, Keynes suggested that what today is called quantitative easing should be a routine tool of monetary policy. Sixty years ago, Alvin Hansen believed that this insight had been accepted by all sides in macroeconomic debates, and that the importance of the term structure for macroeconomic activity guided the debt-issuance policies of Treasury as well as the market interventions of the Federal Reserve. Today, these seem like new discoveries. As the man says, the history of macroeconomics is mostly a great forgetting.

[1] I was surprised by how minimal the Wikipedia entry is. One of these days, I am going to start having students improve economics Wikipedia pages as a class assignment.

[2] What is “quantitative about this policy is that the Fed buys a a quantity of bonds, evidently in the hopes of forcing their price up, but does not announce an explicit target for the price. On the face of it, this is a strangely inefficient way to go about things. If the Fed announced a target for, say, 10-year Treasury bonds, it would have to buy far fewer of them — maybe none — since market expectations would do more of the work of moving the price. Why the Fed has hobbled itself in this way is a topic for another post.

[3] I am not the world’s biggest Larry Summers fan, to say the least. But I worry I’m giving him too hard a time in this case. Even if the argument of the paper is less original than its made out to be, it’s still correct, it’s still important, and it’s still missing from today’s policy debates. He and his coauthors have made a real contribution here. I also appreciate the Hansenian spirit in which Summers derides his opponents as “central bank independence freaks.”