The Slack Wire

Inflation Came Down, and Team Transitory Was Right

Line goes down, and up. Last week, I wrote out a post arguing that the inflation problem is largely over, and the Fed had little to do with it. Yesterday, the new CPI numbers were released and they showed a sharp rise in inflation — a 4 percent rate over the past three months, compared with 2 percent when I wrote the piece.

Obviously, I’m not thrilled about this. It would be easier to make the arguments I would like to make if inflation were still coming down. But it doesn’t really change the story. Given that the spike last month is entirely energy, with growth in other prices continuing to slow, almost everyone seems to agree that it has nothing to do with demand conditions in the US, or anything the Fed has been doing or ought to do.

Here is an updated version of the main figure from the piece. You can see the spike at the far right – that’s the numbers released yesterday. You can also see that it is all energy costs (the pink bar). Everything else is still coming down.

Here is a table presenting the same data, but now comparing the high inflation of June 2021-June2022 with the lower inflation of the past yer. The last column shows how much each category has contributed to the change in inflation between the two periods. As you can see, the fall in inflation is all about goods, especially energy and cars. Services, which is where you’d expect to see any effects of a softening labor market, have not so far contributed to disinflation.

One thing the figure brings out is that we have not simply had a rise and then fall in inflation over the past couple of years. We’ve had several distinct episodes of rising prices. The first, in the second half of 2020, was clearly driven by reopening and pandemic-related shifts in spending. (One point Arjun and I make in our supply-constraints article is that big shifts in the composition of spending lead to higher prices on average.) The next episode, in the second half of 2021, was all about motor vehicles. The third episode, in the first half of 2022, was energy and food prices, presumably connected to the war in Ukraine. Finally, in later 2022 and early this year, measured inflation was all driven by rising housing costs.

Even though they may all show up as increases in the CPI, these are really four distinct phenomena. And none of them looks like the kind of inflation the Fed claims to be fighting. Energy prices may continue to rise, or they may not — I really have no idea.  But either way, that’s not a sign of an overheated economy.

It’s the supply side. Of course I am not the only one making this point. Andrew Elrod had a nice piece in Jacobin recently, making many of the same arguments. I especially like his conclusion, which emphasizes that this is not just a debate about inflation and monetary policy. If you accept the premise that spending in the economy has been too high, and workers have too much bargaining power, that rules out vast swathes of the progressive political program. This is something I also have written about.

Mike Konczal makes a similar argument in a new issue brief, “Inflation is Down. It’s a Supply-Side Story.” He looks at two pieces of evidence on this: different regression estimates of the Phillips curve relationship between unemployment and inflation, and second, expenditure and price changes across various categories of spending. I admit I don’t find the regression analysis very compelling. What it says is that a model that used past inflation to predict future inflation fit the data pretty well for 2020-2022, but over predicted inflation this year. I’m not sure this tells us much except that inflation was rising in the first period and falling in the second.

The more interesting part, to me, is the figure below. This shows quantities and prices for a bunch of different categories of spending. What’s striking about this is the negative relationship for goods (which, remember, is where the disinflation has come from.)

It is literally economics 101 that when prices and quantities move together, that implies a shift in demand; when they move in opposite directions, that implies a shift in supply. To put it more simply, if auto prices are falling even while people are buying more automobiles, as they have been, then reduced demand cannot be the reason for the price fall.

Larry Summers, in a different time, called this an “elementary signal identification point”: the sign the price increases are driven by demand is that “output and inflation together are above” their trend or previous levels. (My emphasis.) Summers’ point in that 2012 article (coauthored with Brad DeLong) was that lower output could not, in itself, be taken as a sign of a fall in potential. But the exact same logic says that a rise in prices cannot, by itself, be attributed to faster demand growth. The demand story requires that rising prices be accompanied by rising spending. As Mike shows, the opposite is the case.

In principle, one might think that the effect of monetary policy on inflation would come through the exchange rate. In this story, higher interest rates make a country’s assets more attractive to foreign investors, who bid up the price of its currency. A stronger currency makes import prices cheaper in terms of the domestic currency, and this will lower measured inflation. This is not a crazy story in principle, and it does fit a pattern of disinflation concentrated in traded goods rather than services. As Rémi Darfeuil points out in comments, some people have been crediting the Fed with US disinflation via this channel. The problem for this story is that the dollar is up only about 4 percent since the Fed started hiking — hardly enough to explain the scale of disinflation. The deceleration in import prices is clearly a matter of global supply conditions — it is also seen in countries whose currencies have gotten weaker (as the linked figure itself shows).

Roaring out of recession. I’ve given a couple video presentations on these questions recently. One, last Friday, was for Senate staffers. Amusingly —to me anyway — the person they had to speak on this topic  last year was Jason Furman. Who I imagine had a rather different take. The on Monday I was on a panel organized by the Groundwork Collaborative, comparing the economic response to the pandemic to the response to the financial crisis a decade ago. That one is available on zoom, if you are interested. The first part is a presenation by Heather Boushey of the Council of Economic Advisors (and an old acquaintance of mine from grad school). The panel itself begins about half an hour in, though Heather’s presentation is of course also worth listening to.

 

[Thanks to Caleb Crain for pointing out a mistake in an earlier version of this post.]

At Barron’s: Inflation Is Falling. Don’t Thank the Fed

(I write a monthly opinion piece for Barron’s. This one was published there in September. My previous pieces are here.)

You wouldn’t necessarily guess it from the headlines, but we may soon be talking about inflation in the past tense. After peaking at close to 10% in the summer of 2022, inflation has fallen even faster than it rose. Over the past three months inflation, as measured by the CPI, has been slightly below the Federal Reserve’s 2% target. Nearly every other measure tells a similar story.

Predicting the future is always risky. But right now, it seems like the conversation about how to fix the inflation problem is nearing its end. Soon, we’ll be having a new debate: Who, or what, should get credit for solving it?

The Fed is the most obvious candidate. Plenty of commentators are already giving it at least tentative credit for delivering that elusive soft landing. And why not? Inflation goes up. The central bank raises interest rates. Inflation goes back down. Isn’t that how it’s supposed to work? 

The problem is, monetary policy does not work through magic. The Fed doesn’t simply tell private businesses how much to charge. Higher interest rates lead to lower prices only by reducing demand. And so far, that doesn’t seem to have happened – certainly not on a scale that could explain how much inflation has come down.  

In the textbook story, interest rates affect prices via labor costs. The idea is that businesses normally set prices as a markup over production costs, which consist primarily of wages. When the Fed raises rates, it discourages investment spending — home construction and business spending on plant and equipment — which is normally financed with credit. Less investment means less demand for labor, which means higher unemployment and more labor market slack generally. As unemployment rises, workers, with less bargaining power vis-a-vis employers, must accept lower wages. And those lower wages get passed on to prices.

Of course this is not the only possible story. Another point of view is that tighter credit affects prices through the demand side. In this story, rather than businesses producing as much as they can sell at given costs, there is a maximum amount they can produce, often described as potential output. When demand rises above this ceiling, that’s when prices rise. 

Either way, the key point — which should be obvious, but somehow gets lost in macro debates — is that prices are determined by real conditions in individual markets. The only way for higher rates to slow down rising prices, is if they curtail someone’s spending, and thereby production and employment. No business — whether it’s selling semiconductors or hamburgers — says “interest rates are going up, so I guess I’ll charge less.” If interest rates change their pricing decisions, it has to be through some combination of fall in demand for their product, or in the wages they pay.

Over the past 18 months, the Fed has overseen one of the fast increases in short-term interest rates on record. We might expect that to lead to much weaker demand and labor markets, which would explain the fall in inflation. But has it?

The Fed’s rate increases have likely had some effect. In a world where the Federal Funds rate was still at zero, employment and output might well be somewhat higher than they are in reality. Believers in monetary-policy orthodoxy can certainly find signs of a gently slowing economy to credit the Fed with. The moderately weaker employment and wage growth of recent months is, from this point of view, evidence that the Fed is succeeding.

One problem with pointing to weaker labor markets as a success story, is that workers’ bargaining power matters for more than wages and prices. As I’ve noted before, when workers have relatively more freedom to pick and choose between jobs, that affects everything from employment discrimination to productivity growth. The same tight labor markets that have delivered rapid wage growth, have also, for example, encouraged employers to offer flexible hours and other accommodations to working parents — which has in turn contributed to women’s rapid post-pandemic return to the workplace. 

A more basic problem is that, whether or not you think a weaker labor market would be a good thing on balance, the labor market has not, in fact, gotten much weaker.

At 3.8%, the unemployment rate is essentially unchanged from where it was when at the peak of the inflation in June 2022. It’s well below where it was when inflation started to rise in late 2020. It’s true that quits and job vacancy rates, which many people look to as alternative measures of labor-market conditions, have come down a bit over the past year. But they still are extremely high by historical standards. The prime-age employment-population ratio, another popular measure of labor-market conditions, has continued to rise over the past year, and is now at its highest level in more than 20 years. 

Overall, if the labor market looks a bit softer compared with a year ago, it remains extremely tight by any other comparison. Certainly there is nothing in these indicators to explain why prices were rising at an annual rate of over 10% in mid-2022, compared with just 2% today.

On the demand side, the case is, if anything, even weaker. As Employ America notes in its excellent overview, real gross domestic product growth has accelerated during the same period that inflation has come down. The Bureau of Economic Analysis’s measure of the output gap similarly shows that spending has risen relative to potential output over the past year. For the demand story to work, it should have fallen. It’s hard to see how rate hikes could be responsible for lower inflation during a period in which people’s spending has actually picked up. 

It is true that higher rates do seem to have discouraged new housing construction. But even here, the pace of new housing starts today remains higher than at any time between 2007 and the pandemic. 

Business investment, meanwhile, is surging. Growth in nonresidential investment has accelerated steadily over the past year and a half, even as inflation has fallen. The U.S. is currently seeing a historic factory boom — spending on new manufacturing construction has nearly doubled over the past year, with electric vehicles, solar panels and semiconductors leading the way. That this is happening while interest rates are rising sharply should raise doubts, again, about how important rates really are for business investment. In any case, no story about interest rates that depends on their effects on investment spending can explain the recent fall in inflation. 

A more disaggregated look at inflation confirms this impression. If we look at price increases over the past three months compared with the period of high inflation in 2021-2022, we see that inflation has slowed across most of the economy, but much more so in some areas than others.

Of the seven-point fall in inflation, nearly half is accounted for by energy, which makes up less than a tenth of the consumption basket. Most of the rest of the fall is from manufactured goods. Non-energy services, meanwhile, saw only a very modest slowing of prices; while they account for about 60% of the consumption basket, they contributed only about a tenth of the fall in inflation. Housing costs are notoriously tricky; but as measured by the shelter component of the Bureau of Labor Statistics, they are rising as fast now as when inflation was at its peak.

Most services are not traded, and are relatively labor-intensive; those should be the prices most sensitive to conditions in U.S. product and labor markets. Manufactured goods and especially energy, on the other hand, trade in very internationalized markets and have been subject to well-publicized supply disruptions. These are exactly the prices we might expect to fall for reasons having nothing to do with the Fed. The distribution of price changes, in other words, suggests that slowing inflation has little to do with macroeconomic conditions within the US, whether due to Fed action or otherwise.

If the Fed didn’t bring down inflation, what did? The biggest factor may be the fall in energy prices. It’s presumably not a coincidence that global oil prices peaked simultaneously with U.S. inflation. Durable-goods prices have also fallen, probably reflecting the gradual healing of pandemic-disrupted supply chains. A harder question is whether the supply-side measures of the past few years played a role. The IRA and CHIPS Act have certainly contributed to the boom in manufacturing investment, which will raise productive capacity in the future. It’s less clear, at least to me, how much policy contributed to the recovery in supply that has brought inflation down.

But that’s a topic for another time. For now it’s enough to say: Don’t thank the Fed.


(Note: Barron’s, like most publications I’ve worked with, prefers to use graphics produced by their own team. For this post, I’ve swapped out theirs for my original versions.)

At Barron’s: Who Is Winning the Inflation Debate?

(I write a monthly opinion piece for Barron’s. This one was published there in July. My previous pieces are here.)

Is inflation fundamentally a macroeconomic problem – a sign of an overheated economy, an excess of aggregate demand over supply? Or is it – at least sometimes – better understood in microeconomic terms, as the result of producers in various markets setting higher prices for their own reasons? 

Not long ago, almost all economists would have picked door No. 1. But in the postpandemic world the choice isn’t so clear.

The answer matters for policy. If the problem is too much spending, then the solution is to bring spending down — and it doesn’t matter which spending. This is what interest rate hikes are intended to do. And since wages are both the largest source of demand and the biggest single component of costs, bringing down spending entails higher unemployment and slower wage growth. Larry Summers – perhaps the most prominent spokesman for macroeconomic orthodoxy – predicted that it would take five years of above-5% unemployment to get inflation under control. He was widely criticized for it. But he was just giving the textbook view.

If inflation is driven by dynamics in particular markets, on the other hand, then an across-the-board reduction in demand isn’t necessary, and may not even be helpful. Better to address the specific factors driving price increases in those markets – ideally through relieving supply constraints, otherwise through targeted subsidies or administrative limits on price increases. The last option, though much maligned as “price controls,” can make sense in cases where supply or demand are particularly inelastic. If producers simply cannot increase output (think, automakers facing a critical chip shortage) then prices have little value as a signal, so there’s not much cost to controlling them.

The debate between these perspectives has been simmering for some time. But it’s reached a boil around Isabella Weber, a leading exponent of the microeconomic perspective. Her recent work explores the disproportionate importance of a few strategic sectors for inflation. Weber has probably done more than any other economist to bring price controls into the inflation-policy conversation.

A recent profile of Weber in the New Yorker describes how she has become a lightning rod for arguments about unconventional inflation policy, with some of her critics going well beyond the norms of scholarly debate.  

This backlash probably owes something to the fact that Weber is, biographically, a sort of anti-Summers. While he is a former Treasury secretary and Harvard president who comes from academic royalty (two of his uncles won economics Nobels), she is young, female, and teaches at the University of Massachusetts, Amherst, a department best-known for harboring heterodox, even radical, thinkers. (Full disclosure: I got my own economics doctorate there, though well before Weber was hired.) Some prominent economists embarrassed themselves in their rather obvious professional jealousy, as the New Yorker recounts.

But even more than jealousy, what may explain the ferocity of the response is the not unjustified sense that the heterodox side is winning.

Yes, central banks around the world are hiking interest rates – the textbook response to rising prices. But the debate about inflation policy is much broader than it used to be, in both the U.S. and Europe.

Weber herself served on the committee in Germany that devised the country’s “price brake” for natural gas, which is intended to shield consumers and the broader economy from rising energy prices while preserving incentives to reduce consumption. In the wake of the New Yorker piece, there was a furious but inconclusive debate about whether a “brake” is the same as a “control.” But this misses the point. The key thing is that policy is targeted at prices in a particular market rather than at demand in general.

Such targeted anti-inflation measures have been adopted throughout Europe. In France, after President Emmanuel Macron pledged to do “whatever it takes” to bring down inflation, the country effectively froze the energy prices facing households and businesses through a mix of direct controls and subsidies. Admittedly, such an approach is easier in France because a very large share of the energy sector is publicly owned. In effect, the French measures shifted the burden of higher energy costs from households and businesses to the government. The critical point, though, is that measures like this don’t make sense as inflation control unless you see rising prices as coming specifically from a specific sector (energy in this case), as opposed to an economy-wide excess of demand over supply. 

Even economists at the International Monetary Fund – historically the world’s biggest cheerleader for high rates and austerity in response to inflation – acknowledge that these unconventional policies appear to have significantly reduced inflation in Europe. This is so even though they have boosted fiscal deficits and GDP, which by orthodox logic should have had the opposite effect.

The poster child for the “whatever it takes” approach to inflation is probably Spain, which over the past two years has adopted a whole raft of unconventional measures to limit price increases. Since June 2022, there has been a hard cap on prices in the  wholesale electricity market; this “Iberian exception” effectively decouples electricity prices in Spain from the international gas market. Spain has also adopted limits on energy price increases to retail customers, increased electricity subsidies for low-income households, reduced the value-added tax for energy, and instituted a windfall profits tax on energy producers. While the focus has been on energy prices (not surprisingly, given the central role of energy in European inflation) they have also sought to protect households from broader price increases with measures like rent control and reduced transit fares. Free rail tickets aren’t the first thing that comes to mind when you think of anti-inflation policy, but it makes sense if the goal is to shift demand away from scarce fossil fuels.

This everything-plus-the-kitchen-sink approach to inflation is a vivid illustration of why it’s so unhelpful to frame the debate in terms of conventional policy versus price controls. While some of the Spanish measures clearly fit that description, many others do not. A more accurate, if clunkier, term might be “targeted price policy,” covering all kinds of measures that seek to influence prices in particular markets rather than the economy-wide balance of supply and demand.

More important than what we call it is the fact that it seems to be working. Through most of the postpandemic recovery, inflation in Spain was running somewhat above the euro-area average. But since summer 2022 – when the most stringent energy-price measures went into effect – it has been significantly below it. Last month, Spain saw inflation fall below 2%, the first major European country to do so.

Here in the U.S., direct limits on price rises are less common. But it’s not hard to find examples of targeted price policy. The more active use of the Strategic Petroleum Reserve, for example, is a step toward managing energy prices more directly, rather than via economy-wide spending. The Russian sanctions regime — though adopted, obviously, for other reasons — also has a significant element of price regulation. 

The Inflation Reduction Act is often lampooned as having nothing to do with its name, but that’s not quite right. Instead, it reflects a very different vision of inflation control than what you’d get from the textbooks. Rather than seeking to reduce aggregate demand through fiscal contraction, it envisions massive new public outlays to address problems on the supply side. It’s a sign of the times that a closely divided Congress could pass a vast expansion in federal spending as an anti-inflation measure. 

Meanwhile, there’s growing skepticism about how much rate hikes have actually achieved. Inflation has declined steeply without Summers’ prescribed three years of over-5% unemployment, or indeed any noticeable rise in unemployment at all. By connventional measures, demand is no weaker than it was a year ago. If it’s interest rates that brought down inflation, how exactly did they do so?

To be sure, hardly anyone in either camp correctly predicted the 2021 surge in inflation, or its equally dramatic decline over the past year. So it’s too soon to declare victory yet. But for the moment, it’s Team Weber and not Team Summers that seems to be gaining ground.

 

Revisiting the Euro Crisis

The euro crisis of the 2010s is well in the past now, but it remains one of the central macroeconomic events of our time.  But the nature of the crisis remains widely misunderstood, not only by the mainstream but also — and more importantly from my point of view — by economists in the heterodox Keynesian tradition. In this post, I want to lay out what I think is the right way of thinking about the crisis. I am not offering much in the way of supporting evidence. For the moment, I just want to state my views as clearly as possible. You can accept them or not, as you choose. 

During the first 15 years of the euro, a group of peripheral European countries experienced an economic boom followed by a crash, with GDP, employment and asset prices rising and then falling even more rapidly. As far as I can tell, there are four broad sets of explanations on offer for the crises in Greece, Ireland, Italy, Portugal and Spain starting in 2008. 

(While the timing is the same as the US housing bubble and crash, that doesn’t mean they are directly linked — however different they are in other respects, most of the common explanations for the European crisis I’m aware of locate its causes primarily within Europe.s)

The four common stories are:

1. External imbalances. The fixed exchange rate created by the euro, plus some mix of slow productivity growth in periphery and weak demand growth in core led to large trade imbalances within Europe. The financial expansion in the periphery was the flip side of a causally prior current account deficit.

2. Monetary policy. Both financial instability and external imbalances were result of Europe being far from an optimal currency area. Trying to carry out monetary policy for the whole euro area inevitably produced a mix of stagnation in the core and unsustainable credit expansion in the periphery, since a monetary stance that was too expansionary for Greece, Spain etc. was too tight for Germany.

3. Fiscal irresponsibility. The root of the crisis in peripheral countries was the excessive debt incurred by their own governments. The euro was a contributing factor since it led to an excessive convergence of interest rates across Europe, as markets incorrectly believed that peripheral debt was now as safe as debt of core countries.

4. Banking crises. The booms and busts in peripheral Europe were driven by rapid expansions and then contractions of credit from the domestic banking systems, with dynamics similar to that in credit booms in other times and places. The specific features of the euro system did not play any significant role in the development of the crisis, though they did importantly shape its resolution. 

In my view, the fourth story is correct, and the other three are wrong. In particular, trade imbalances within Europe played no role in the crisis. In this post, I am going to focus on why I think the external balances story is wrong, since that’s the one that people who are on my side intellectually seem most inclined toward.

As I see it, there were two distinct causal chains at work, both starting with a credit boom in the peripheral countries.

easy credit —> increased aggregate spending —> increased output and income —> increased imports —> growing trade deficit —> net financial inflows

easy credit —> rising asset prices —> bubble and/or fraud —> asset price crash —> insolvent banks —> financial crisis

That the two outcomes — external imbalances and banking crisis — went together is not a coincidence. But there is no causal link from the first to the second. Both rather are results of the same underlying cause. 

Yes, in the specific conditions of the late-2000s euro area, a credit boom led to an external deficit. But in principle it is perfectly possible to have a a credit-financed asset bubble and ensuing crisis in a country with a current account surplus, or one with current account balance, or in a closed economy. What was specific to the euro system was not the crisis itself, but the response to it. The reason the euro made the crisis worse because it prevented national governments from taking appropriate action to rescue their banking systems and stabilize demand. 

This understanding is, I think, natural if we take a “money view” of the crisis, thinking in terms of balance sheets and the relationship between income and expenditure. Here is the story I would like to tell.

Following the introduction of the euro in 1998, there were large credit expansions in a number of European countries. In Spain, for example, bank credit to the non-financial economy increased from 80 percent of GDP in 1997 to 220 percent of GDP in 2010. Banks were more willing to make loans, at lower rates, on more favorable terms, with less stringent collateral requirements and other lending standards. Borrowers were more willing to incur debt. The proximate causes of this credit boom may well have been connected to the euro in various ways. European integration offered a plausible story for why assets in Spain might be valued more highly. The ECB might have followed a less restrictive policy than independent central banks would have (or not — this is just speculation). But the euro was in no way essential to the credit boom. Similar booms have happened in many other times and places in the absence of currency unions — including, of course, in the US at roughly the same time.

In most of these countries, the bulk of the new credit went toward speculative real estate development. (In Greece there was also a big increase in public-sector borrowing, but not elsewhere.) The specifics of this lending don’t matter too much. 

Now for the key point. What happens when a a Spanish bank makes a loan? In the first step the bank creates two new assets – a deposit for the borrower, and the loan for itself. Notice that this does not require any prior “saving” by a third party. Expansion of bank credit in Spain does not require any inflow of “capital” from Germany or anywhere else.

Failure to grasp is an important source of confusion. Many people with a Keynesian background talk about endogenous money, but fail to apply it consistently. Most of us still have a commodity money or loanable-funds intuition lodged in the back of our brains, especially in international contexts. Terms like “capital flows” and “capital flight” are, in this respect, unhelpful relics of a gold standard world, and should probably be retired.

Back to the story. After the deposits are created, they are spent, i.e. transferred to someone else in return, in return for title to an asset or possession of a commodity or use of a factor of production. If the other party to this transaction is also Spanish, as would usually be the case, the deposits remain in the Spanish banking system. At the aggregate level, we see an increase in bank credit, plus an increase in asset prices and/or output, depending on what the loan finances, amplified by any ensuing wealth effect or multiplier.

To the extent that the loans finance production – of beach houses in Galicia say — they generate incomes. Some fraction of new income is spent on imported consumption goods. Probably more important, production requires imported intermediate and capital goods. By both these channels, an increase in Spanish output results in higher imports. If the credit boom leads Spain to grow faster relative to its trade partners — which it will, unless they are experiencing similar booms — then its trade balance will move toward deficit.

(That changes in trade flows are primarily a function of income growth, and not of relative prices, is an important item in the Keynesian catechism.)

Now let’s turn to the financial counterpart of this deficit. A purchase of a German good by a Spanish firm requires a bank deposit to be transferred from the Spanish firm to the German firm. Since the German firm presumably doesn’t hold deposits in a Spanish bank, we’ll see a reduction in deposits in the Spanish banking system and an equal increase in deposits in the German banking system. The Spanish banks must now replace those deposits with some other funding, which they will seek in the interbank market. So in the aggregate the trade deficit will generate an equal financial inflow — or, better said, a new external liability for the Spanish banking system. 

The critical thing to notice here is that these new financial positions are generated mechanically by the imports themselves. It is simply replacing the deposit funding the Spanish banks lost via payment for the imports. The financial inflow must take place for the purchase to happen — otherwise, literally, the importer’s check won’t clear. 

But what if there is an autonomous inflow – what if German wealth owners really want to hold more assets in Spain? Certainly that can happen. These kinds of cross-border flows may well have contributed to the credit boom in the periphery. But they have nothing to do with the trade balance. By definition, autonomous financial flows involve offsetting financial transactions, with no implications for the current account. 

Suppose you are a German pension fund that would like to lend money to a Spanish firm, to take advantage of the higher interest rates in Spain. Then you purchase, let’s say, a bond issued by Spanish construction company. That shows up as a new liability for Spain in the international investment position. But the Spanish firm now holds a deposit in a German bank, and that is an equal new asset for Spain. (If the Spanish firm transfers the deposit to a Spanish bank in return for a deposit there, as I suppose it probably would, then we get an asset for Spain in the interbank market instead.) The overall financial balance has not changed, so there is no reason for the current account to change either. Or as this recent BIS paper puts it, “the high correlations between gross capital inflows and outflows are overwhelmingly the result of double-entry bookkeeping”. (The importance of gross rather than net financial positions for crises is a pint the bIS has emphasized for many years.)

It may well happen that the effect of these offsetting financial transactions is to raise incomes in Spain (the contractor got better terms than it would at home) and/or banking-system liquidity (thanks to the fact that the Spanish banking system gets the deposits without the illiquid loan). This may well contribute to a rise in incomes in Spain and thus to a rise in the trade deficit. But this seems to me to be a second-order factor. And in any case we need to be clear about the direction of causality here — even if the financial inflows did indirectly cause the higher deficit, they did not in any sense finance it. The trade balances of Germany and Spain in no way affect the ability of German institutions to buy Spanish debt, any more than a New Yorker’s ability to buy a house in California depends on the trade balance between those states.

At this point it’s important to bring in the TARGET2 system. 

Under normal conditions, when someone wants to take a cross-border position within the euro systems the other side will be passively accommodated somewhere in the banking system. But if a net position develops for whatever reason, central banks can accommodate it via TARGET2 balances. Concretely, let’s say soon in Spain wants to make a payment to someone in Germany, as above. This normally involves the reduction of a Spanish bank’s liability to the Spanish entity and the increase in a German bank’s liability to the German entity. To balance this, the Spanish bank needs to issue some other liability (or give up an asset) while the German bank needs to acquire some asset. Normally, this happens by the Spanish bank issuing some new interbank liability (commercial paper or whatever) which ends up, perhaps via various intermediaries, as an asset for a German bank. But if foreign banks are unwilling to hold the liabilities of Spanish banks (as happened during the crisis) the Spanish bank can instead borrow from its own central bank, which in turn can create two offsetting positions through TARGET2 — a liability to the euro system, and a reserve asset (a deposit at the ECB). Conceptually, rather than the transfer of the despot being offset by a liability fro the Spanish to the German bank the interbank market, it’s now offset by a debt owed by the Spanish bank to its own national central bank, a debt between the central banks in the TARGET2 system, and a claim by the German bank against its own national central bank.

In this sense, within the euro system TARGET2 balances stand at the top of the hierarchy of money. Just as non financial actors settle their accounts by transfers of deposits at commercial banks, and banks settle their balances by transfers of deposits at the central bank, central banks settle any outstanding balances via TARGET2. It plays the same role as gold in the old gold standard system. Indeed, I sometimes think it would be better to describe the euro system as the “TARGET2 system.” 

There is however a critical difference between these balances and gold. Gold is an asset for central bank; TARGET2 balances are a liability. When a payment is made from country X to country Y in the euro area, with no offsetting private payment, the effect on central bank balance sheets is NOT a decrease in the assets of the central bank of X (and increase in the assets of the central bank of Y) but an increase in the liabilities of the central bank of X. This distinction is critical because assets are finite and can be exhausted, but new liabilities can be issued indefinitely. The automatic financing of payments imbalances through the TARGET2 system seems like an obscure technical detail but it transforms the functioning of the system. Every national central bank in the euro area is in effect in the situation of the Fed. It can never be financially constrained because all its obligations can be satisfied with its own liabilities. 

People are sometimes uncomfortable with this aspect of the euro system and suggest that there must be some limit on TARGET2 balances. But to me, this fundamentally misunderstands the nature of a single currency. What makes “the euro” a single currency is not that it has the same name, or that the bills look the same in the various countries, or even that it trades at a fixed ratio of one for one. What makes it a single currency is that a bank deposit in any euro-area country will settle a debt in any other euro-area country, at par. TARGET2 balances have to be unlimited to guarantee the this will be the case — in other words, for there to be a single currency at all.

(In this sense, we should not have been so fixed on the question of being “in” versus “out” of the euro. The relevant question is the terms on which payments can be made from one bank account another, for settlement of which obligations.)

The view of the euro crisis in which trade imbalances finance or somehow enable credit expansion is dependent on a loanable-funds perspective in which incomes are fixed, money is exogenous and saving is a binding constraint. It’s implicitly based on a model of the gold standard in which increased lending impossible without inflow of reserves — something that was not really true in practice even in the high gold standard era and isn’t true even in principle today. What’s strange is that many people who accept this view would reject those premises – if they realized they were applying them.

Meanwhile, on the domestic side, abundant credit was bidding up asset prices and encouraging investment that was, ex post, unwise (and in some case fraudulent, though I have no idea how important this was quantitatively). When asset prices collapsed and the failure of investment projects to generate the expected returns became clear, many banks faced insolvency. There was a collapse in activity in the real-estate development and construction activity that had driven the boom and, as banks tightened credit standards across the board, in other credit-dependent activity; falling asset values further reduced private spending; all these effects were amplified by the usual multiplier. The result was a steep fall in output and employment.

I don’t believe there’s any sense in which a sudden stop of cross-border lending precipitated the crisis. Rather, the “nationalization” of finance came after. Banks tried to limit their cross-border positions came only once the crisis was underway, as it became clear that there would be no systematic euro-wide response to insolvent banks, so that any rescues or bailouts would be by national governments for their own banks.

Credit-fueled asset booms and crashes have happened in many times and places. There was nothing specific to the euro system about the property booms of the 2000s. What was specific to the euro system was what happened next. Thanks to the euro, the affected governments could not respond as developed country governments have always responded to financial crises since World War II — by recapitalizing insolvent banks and shifting public budgets toward deficit until private demand recovers. 

The constraints on euro area governments were not an inevitable feature of system, in this view. Rather, they were deliberately imposed through discretionary choices by the authorities in order to use the crisis to advance a substantive political agenda.

 

Industrial Policy: Further Thoughts

(Cross-posted from my Substack. If you like this blog, why not subscribe to that too?)

I just returned from Bangalore, where Arjun and I spent an intense 10 days working on our book, and on another project which I’ll be posting about in due time. I’d never been to India before, and it was … a lot. It took me a while to put my finger on the overarching impression: not chaos, or disorder, but incongruity — buildings and activities right on top of each other that, in an American context, you’d expect to be widely separated in space or time. That, and the constant buzz of activity, and crowds of people everywhere. In vibes, if not in specifics, it felt like a city of back-to-back Times Squares. I imagine that someone who grew up there would find an American city, even New York, rather dull.

It’s a city that’s gone from one million people barely a generation ago to 8 million today, and is still growing. There’s a modern subway, clean, reliable and packed, with the open-gangway cars New York is supposed to switch to eventually. It opened 15 years ago and now has over 60 stations — I wish we could build like that here. But the traffic is awesome and terrifying. Every imaginable vehicle — handpainted trucks, overloaded and dangling with tassels and streamers; modern cars; vans carrying sheep and goats; the ubiquitous three-wheeled, open-sided taxis; the even more ubiquitous motorbikes, sometimes carrying whole families; and of course the wandering cows — with no stoplights or other traffic control to speak of, and outside the old central city, no sidewalks either. Crossing the street is an adventure.

I realize that I am very far from the first person to have this reaction to an Indian city. Some years ago Jim Crotty was here for some kind of event, and the institution he was visiting provided him with a driver. Afterwards, he said that despite all the dodging and weaving through the packed roads he never felt anything but safe and comfortable. But, he added, “I would never get into a car with that guy in the United States. He’d be so bored, he’d probably fall asleep.”

Varieties of industrial policy. The panel I moderated on industrial policy is up on YouTube, though due to some video glitch it is missing my introductory comments. Jain Family Institute also produced a transcript of the event, which is here.

It was a very productive and conversation; I thought people really engaged with each other, and everyone had something interesting to contribute. But it left me a bit puzzled: How could people who share broad political principles, and don’t seem to disagree factually about the IRA, nonetheless arrive at such different judgements of it?

I wrote a rather long blog post trying to answer this question.

The conclusion I came to was that the reason Daniela Gabor (and other critics, though I was mostly thinking of Daniela when I wrote it) takes such a negative view of the IRA is that she focuses on the form of interface between the state and production it embodies: subsidies and incentives to private businesses. This approach accepts, indeed reinforces, the premise that the main vehicle for decarbonization is private investment. Which means that making this investment attractive to private business owners, for which profitability is a necessary but not sufficient condition. If you don’t think the question “how do we solve this urgent social problem” should be immediately translated into “how do we ensure that business can make money solving the problem,” then the IRA deserves criticism not just on the details but for its fundamental approach.

I am quite sympathetic to this argument. I don’t think anyone on the panel would disagree with it, either normatively as a matter of principle or descriptively as applied to the IRA. And yet the rest of us, to varying degrees, nonetheless take a more positive view of the IRA than Daniela does.

The argument of the post was that this is because we focus more on two other dimensions. First, the IRA’s subsidies are directed to capital expenditure itself, rather than financing; this already distinguishes it from what I had thought of as derisking. And second the IRA’s subsidies are directed toward narrowly specified activities (e.g. battery production) rather than to some generic category of green or sustainable investment, as a carbon tax would be. I called this last dimension “broad versus fine-grained targeting,” which is not the most elegant phrasing. Perhaps I would have done better to call it indicative versus imperative targeting, tho I suppose people might have objected to applying the latter term to a subsidy. In any case, if you think the central problem is the lack of coordination among private investment decisions, rather than private ownership s such, this dimension will look more important.

Extending the matrix. The post got a nice response; it seems like other people have been thinking along similar lines. Adam Tooze restated the argument more gracefully than I did:

Mason’s taxonomy focuses attention on two axes: how far is industrial policy driven by direct state engagement v. how far does it operate at arms-length through incentives? On the other hand, how far is green industrial policy broad-brush offering general financial incentives for green investment, as opposed to more fine-grained focus on key sectors and technologies?

Skeptics like Daniel Gabor, Mason suggests, can be seen as placing the focus on the form of policy action, prioritizing the question of direct versus indirect state action. Insofar as the IRA operates by way of tax incentives it remains within the existing, hands-off paradigm. A big green state would be far more directly involved. Those who see more promise in the IRA would not disagree with this judgment as to form but would insist that what makes the IRA different is that it engages in relatively fine-grained targeting of investment in key sectors.

My only quibble with this is that I don’t think it’s just two dimensions — to me, broad versus narrow and capital expenditure versus financing are two independent aspects of targeting.

I should stress that I wrote the post and the table to clarify the lines of disagreement on the panel, and in some similar discussions that I’ve been part of. They aren’t intended as a general classification of industrial policy, which — if it can be done at all — would require much more detailed knowledge of the range of IP experiences than I possess.

Tooze offers his own additional dimensions:

  • The relationship of economic policy to the underlying balance of class forces.
  • The mediation of those forces through the electoral system …
  • The agenda, expertise & de facto autonomy of state institutions…

These are certainly interesting and important questions. But it seems to me that they are perhaps questions for a historian rather than for a participant. They will offer a very useful framework for explaining, after the fact, why the debate over industrial policy turned out the way that it did. But if one is engaged in politics, one can’t treat the outcome one is aiming at as a fact to be explained. Advocacy in a political context presumes some degree of freedom at whatever decision point it is trying to influence. One wouldn’t want to take this too far: It’s silly to talk about what policies “should” be if there is no one capable of adopting them. But it seems to me that by participating in a political debate within a given community, you are accepting the premise, on some level, that the outcome depends on reason and not the balance of forces.

That said, Tooze’s third point, about state institutions, I think does work in an advocacy context, and adds something important to my schema. Though it’s not entirely obvious which way it cuts. Certainly a lack of state capacity — both administrative and fiscal — was an important motivation for the original derisking approach, and for neoliberalism more broadly. But as Beth Popp Berman reminds us, simple prohibitions and mandates are often easier to administer than incentives. And if the idea is to build up state capacity, rather than taking it as a fact, then that seems like an argument for public ownership.

I’ve thought for years that this was a badly neglected question in progressive economics. We have plenty of arguments for public goods — why the government should ensure that things are provided in different amounts or on different terms than a hypothetical market would. We don’t have so many arguments for why, and which, things should be provided by the public. The same goes for public ownership versus public provisions, with the latter entailing non-market criteria and intrinsic motivation, with the civil service protections that foster it.

The case for public provisioning. One group of people who are thinking about these questions seriously are Paul Williams and his team at  the Center for Public Enterprise. (Full disclosure: I sit on CPE’s board.) Paul wrote a blog post a couple weeks ago in response to some underinformed criticisms of public housing, on why public ownership is an important part of the housing picture. Looking at the problem from the point of view of the local government that are actually responsible for housing in the US, the problem looks a bit different than the perspective of national governments that I implicitly adopted in my post.

The first argument he makes for public ownership is that it economizes on what is often in practice the binding constraint on affordable housing, the fixed pot of federal subsidies. A public developer doesn’t need the substantial profit margin a private developer would expect; recovering its costs is enough. Public ownership also allows for, in my terms, more fine-grained targeting. A general program of subsidies or inclusionary zoning (like New York’s 421a tax credits) will be too lax in some cases, leaving affordable units on the table, and too stringent in others, deterring construction. A public developer can assess on a case by case basis the proportion and depth of affordable units that a given project can support. A third argument, not emphasized here but which Paul has made elsewhere, is that developing and operating public housing builds up the expertise within the public sector that is needed for any kind of transformative housing policy.

It’s telling but not surprising to see the but-this-one-goes-to-11 response to Paul’s post that all we need for more housing is land-use deregulation. Personally, I am quite sympathetic to the YIMBY position, and I know Paul is too. But it doesn’t help to oversell it. The problems of “not enough housing” and “not enough affordable housing” do overlap, but they are two distinct problems.

A somewhat different perspective on these questions comes from this report by Josh Wallack at Roosevelt, on universal childcare as industrial policy. Childcare doesn’t have some of the specific problems that industrial policy is often presented as the solution to – it doesn’t require specialized long-lived capital goods, or coordination across multiple industries. But, Wallack argues, it shares the essential element: We don’t think that demand on its own will call forth sufficient capacity, even with subsidies, so government has to intervene directly on the supply side, building up the new capacity itself. I’ve always thought that NYC’s universal pre-K was a great success story (both my kids benefited from it) that should be looked to as a model of how to expand the scope of the public sector. So I’m very glad to see this piece, which draws general lessons from the NYC experience. Wallack himself oversaw implementation of the program, so the report has a lot more detail on the specifics of implementation than you normally get. Very worth reading, if you’re at all interested in this topic.

One area where Wallack thinks the program could have done better is democratic participation in the planning process. This could be another dimension for thinking about industrial policy. A more political practice-oriented version of Tooze’s bullets would be to ask to what extent a particular program broadens or narrows the space for popular movements to shape policy. Of course the extent to which this is feasible, or even desirable, depends on the kind of production we’re talking about. In Catalyst, Matt Huber and Fred Stafford argue, persuasively in my view, that there is a tension between the need for larger-scale electricity transmission implied by the transition away from carbon, and the preference of some environmentalists for a more decentralized, locally-controlled energy system. I am less persuaded by their argument that the need for increased transmission and energy storage rule out a wholesale shift toward renewables; here as elsewhere, it seems to me, which obstacles you regard as insurmountable depend on where you want to end up.

The general point I would make is that politics is not about a final destination, but about a direction of travel. Whether or not we could have 100 percent renewable electricity — or 100 percent public ownership of housing, or whatever — is not so important. What matters is whether we could have substantially more than we have now.

On other topics.

Showing the inconsistencies between conservative free-market economics and actual conservative politics is, in my experience, much harder in practice than it seems like it ought to be, at least if you want to persuade people who actually hold one or both. So it’s fun to see Brian Callaci’s (excellent) arguments against non-compete agreements in ProMarket, the journal of the ur-Chicago Stigler Center.

Garbriel Zucman observes that the past few years have seen very large increases in the share of income at the very top, which now seems to have passed its gilded age peak.  Does this mean that I and others have been wrong to stress the gains for low-wage workers from tight post-pandemic labor markets? I don’t think so — both seem to be true. According to Realtime Inequality, the biggest income gains of the past two years have indeed gone to the top 1 percent and especially its top fractiles. But the next biggest gains have gone to the bottom half, which has outpaced the top 10 percent and comfortably outpaced the middle 40 percent. Their income numbers don’t further break out the bottom half, but given that the biggest wage gains have come a the very bottom, I suspect this picture would get even stronger if we looked further down the distribution.

This may well be a general pattern. The incomes that rise fastest in an economic boom are those that come from profits, on the one hand, and flexible wages that are strongly dependent on labor-market conditions on the other. People whose income comes from less commodified labor, with more socially embedded wage-setting, will be relatively insulated from swings in demand, downward but also upward. This may have something to do with the negative feeling about the economy among upper-middle class households that Emily Stewart writes about in Vox.

I’m still hoping to write something more at length about the debates around “greedflation” and price controls. But in the meantime, this from Servaas Storm is very good.

What I’ve been reading. On the plane to Bangalore, I finished Enzo Traverso’s Fire and Blood. I suppose it’s pretty common now to talk about the period from 1914 to 1945 as a unit, a second Thirty Years War. Traverso does this, but with the variation of approaching it as a European civil war — a war within a society along lines of class and ideology, rather than a war between states. A corollary of this, and arguably the animating spirit of the book, is the rehabilitation of anti-fascism as a positive political program. It’s a bit different from the kind of narrative history I usually read; the organization is thematic rather than chronological, and the focus is on culture — there are no tables and hardly any numbers, but plenty of reproductions of paintings. It reads more like a series of linked essays than a coherent whole, but what it lacks in overarching structure in makes up with endless fascinating particulars. I liked it very much.

 

Varieties of Industrial Policy

I was on a virtual panel last week on industrial policy as derisking, in response to an important new paper by Daniela Gabor. For me, the conversation helped clarify why people who have broadly similar politics and analysis can have very different feelings about the Inflation Reduction Act and similar measures elsewhere. 

There are substantive disagreements, to be sure. But I think the more fundamental issue is that while we, inevitably, discuss the relationship between the state, the organization of production and private businesses in terms of alternative ideal types, the actual policy alternatives are often somewhere in the fuzzy middle ground. When we deal with a case that resembles one of our ideal types in some ways, but another in other ways, our evaluation of it isn’t going to depend so much on our assessment of each of these features, but on which of them we consider most salient.

I think this is part of what’s going on with current discussions of price controls. There has been a lot of heated debate following Zach Carter’s New Yorker profile of Isabella Weber on whether the energy price regulation adopted by Germany can be described as a form of price controls. Much of this criticism is clearly in bad faith. But the broad space between orthodox inflation-control policy, on the one hand, and comprehensive World War II style price ceilings, on the other, means that there is room for legitimate disagreement about how we describe policies somewhere in the middle. If you think that the defining feature of price regulation is that government is deciding how much people should pay for particular commodities, you will probably include the German policy. If you’re focused on other dimensions of it, you might not.

I am not going to say more about this topic now, though I hope to return to it in the future. But I think there is something parallel going on in the derisking debate.

People who talk about industrial policy mean some deliberate government action to shift the sectoral composition of output — to pick winners and losers, whether at the industry or firm level. But of course, there are lots of ways to do this. (Indeed, as people sometimes point out, governments are always doing this in some way — what distinguishes “industrial policy” is that it is visible effort to pick different winners.) Given the range of ways governments can conduct industrial policy, and their different implications for larger political-economy questions, it makes sense to try to distinguish different models. Daniela Gabor’s paper was a very helpful contribution to this.

The problem, again, is that models are ideal types — they identify discrete poles in a continuous landscape. We need abstractions like this — there’s no other way to talk about all the possible variation on the multiple dimensions on which we can describe real-world situations. If the classification is a good one, it will pick out ways in which variation on one dimension is linked to variation on another. But in the real world things never match up exactly; which pole a particular point is closer to will depend on which dimension we are looking at.

In our current discussions of industrial policy, four dimensions seem most important — four questions we might ask about how a government is seeking to direct investment to new areas. Here I’ll sketch them out quickly; I’ll explore them in a bit more detail below.

First is ownership — what kind of property rights are exercised over production? This is not a simple binary. We can draw a slope from for-profit private enterprises, to non-profits, to publicly-owned enterprises, to direct public provision.

Second is the form of control the government exercises over investment (assuming it is not being carried out directly by the public sector). Here the alternatives are hard rules or incentives, the latter of which can be positive (carrots) or negative (sticks).

The third question is whether the target of the intervention is investment in the sense of creation of new means of production, or investment in the sense of financing. 

The last question is how detailed or fine-grained the intervention is — how narrowly specified are the activities that we are trying to shift investment into and out of?

“Derisking” in its original sense had specific meaning, found in the upper right of the table. The idea was that in lower-income countries, the binding constraint on investment was financing. Because of limited fiscal capacity (and state capacity more generally), the public sector should not try to fill this gap directly, but rather to make projects more attractive to private finance. Offering guarantees to foreign investors would make efficient use of scarce public resources, while trusting profit motive to guide capital to socially useful projects.

In terms of my four dimensions, this combines private ownership and positive incentives with broad financial target.

The opposite case is what Daniela calls the big green state. There we have public ownership and control of production, with the state making specific decisions about production on social rather than monetary criteria. 

For the four of us on the panel, and for most people on the left, the second of these is clearly preferable to the first. In general, movement from the upper right toward the lower left is going to look like progress.

But there are lots of cases that are off the diagonal. In general, variation on each of these dimensions is independent of variation on the others. We can imagine real world cases that fall almost anywhere within the grid.

Say we want more wind and solar power and less dirty power.

We could have government build and operate new power plants and transmission lines, while buying out and shutting down old ones.

We could have a public fund or bank that would lend to green producers, along with rules that would penalize banks for holding assets linked to dirty ones.

We could have regulations that would require private producers to reduce carbon emissions, either setting broad portfolio standards or mandating the adoption of specific technologies.

Or we could have tax credits or similar incentives to encourage voluntary reductions, which again could be framed in a broad, rules-based way or incorporate specific decisions about technologies, geography, timelines, etc.

As we evaluate concrete initiatives, the hard question may not be where we place them in this grid nor on where we would like to be, but how much weight we give to each dimension. 

The neoliberal consensus was in favor of private ownership and broad, rules-based incentives, for climate policy as in other areas. A carbon price is the canonical example. For those of us on the panel, again, the consensus is  that the lower left corner is first best. But at the risk of flattening out complex views, I think the difference between let’s say Daniela on one side and Skanda Amarnath (or me) on the other is the which dimensions we prioritize. Broadly speaking, she cares more about movement in horizontal axis, as I’ve drawn the table, with a particular emphasis on staying off of the right side. While we care more about vertical axis, with a particular preference for the bottom row. 

Some people might say it doesn’t matter how you manage investment, as long as you get the clean power. But here I am completely on (what I understand to be) Daniela’s side. We can’t look at policy in isolation, but have to see it as part of a broader political economy, as part of the relationship between private capital and the state. How we achieve our goals here matters for more than the immediate outcome, it shifts the terrain on which next battle will be fought. 

But even if we agree that the test for industrial policy is whether it moves us toward a broader socialization of production, it’s not always easy to evaluate particular instances.

Let’s compare two hypothetical cases. In one, government imposes strict standards for carbon emissions, so many tons per megawatt. How producers get there is up to them, but if they don’t, there will be stiff fines for the companies and criminal penalties for their executives. In the second case, we have a set of generous tax credits. Participation is voluntary, but if the companies want the credits they have to adopt particular technologies on a specified schedule, source inputs in a specified way, etc. 

Which case is moving us more in the direction of the big green state? The second one shifts more expertise and decision making into the public sector, it expands the domain of the political not just to carbon emissions in general but to the organization of production. But unlike the first, it does not challenge the assumption that private profitability is the first requirement of any change in the organization of production. It respects capital-owners’ veto, while the first does not. 

(Neoliberals, it goes without saying, would hate both — the first damages the business climate and discourages investment, while the second distorts market more.) 

Or what about if we have a strict rule limiting the share of “dirty” assets in the portfolios of financial institutions? This is the path Europe seems to have been on, pre IRA. In our discussion, Daniela suggested that this might have been better, since it had more of an element of discipline — it involved sticks rather than just subsidy carrots. To Skanda or me, it looks weak compared with the US approach, both because it focuses on financing rather than real investment, and because it is based on a broad classification of assets rather than trying to identify key areas to push investment towards. (It was this debate that crystallized the idea in this post for me.)

Or again, suppose we have a sovereign wealth fund that takes equity stakes in green energy producers, as Labour seems to be proposing in the UK. How close is this to direct public provision of power?

In the table, under public ownership, I’ve distinguished public provision from public enterprise. The distinction I have in mind is between a service that is provided by government, by public employees, paid for out of the general budget, on the one hand; and entities that are owned by the government but are set up formally as independent enterprises, more or less self-financing, with their own governance, on the other. Nationalizing an industry, in the sense of taking ownership of the existing businesses, is not the same as providing something as a public service. To some people, the question of who owns a project is decisive. To others, a business where the government is the majority stakeholder, but which operates for profit, is not necessarily more public in a substantive sense than a business  that isprivately owned but tightly regulated.

Moving to the right, government can change the decisions of private businesses by drawing sharp lines with regulation — “you must”; “you must not” — or in a smoother way with taxes and subsidies. A preference for the latter is an important part of the neoliberal program, effectively shifting the trading -off of different social goals to the private sector; there’s a good discussion of this in Beth Popp Berman’s Thinking Like an Economist. On the other side, hard rules are easier to enforce and better for democratic accountability — everybody knows what the minimum wage is. Of course there is a gray area in between: a regulation with weak penalties can function like a tax, while a sufficiently punitive tax is effectively a regulation.

Finally, incentives can be positive or negative, subsidies or taxes. This is another point where Daniela perhaps puts more stress than I might. Carrots and sticks, after all, are ways of getting the mule to move; either way, it’s the farmer deciding which way it goes. That said, the distinction certainly matters if fiscal capacity is limited; and of course it matters to business, who will always want the carrot.

On the vertical axis, the big distinction is whether what is being targeted is investment in the sense of the creation of new means of production, or investment in the sense of financing. Let’s step back a bit and think about why this matters.

There’s a model of business decision-making that you learn in school, which is perhaps implicitly held by people with more radical politics. Investment normally has to be financed; it involves the creation of real asset and a liability, which is held somewhere in financial system. You build a $10 million wind turbine, you issue a $10 million bond. Which real investment is worth doing, then, will depend on the terms on which business can issue liabilities. The higher the interest rate on the bond, the higher must be the income from the project it finances, to make it worth issuing.

Business, in this story, will invest in anything whose expected return exceeds their cost of capital; that cost of capital in turn is set in financial markets. From this point of view, a subsidy or incentive to holders of financial assets is equivalent to one to the underlying activity. Telling the power producer “I’ll give you 10 percent of the cost of the turbine you built” and telling the bank “I’ll give you 10 percent of the value of the bond you bought” are substantively the same thing. 

As I said, this is the orthodox view. But it also implicitly underlies an analysis that talks about private capital without distinguishing between “capital” as a quantity of money in financial form, and “capital” as the concrete means of production of some private enterprise. If you don’t think that the question “what factory should I build” is essentially the same as the question “which factory’s debt should I hold?”, then it doesn’t make sense to use the same word for both.

Alternatively, we might argue that the relevant hurdle rate for private investment is well above borrowing costs and not very sensitive to them. Investment projects must pass several independent criteria and financing is often not the binding constraint. The required return is not set in financial markets; it is well above the prevailing interest rate and largely insensitive to it. If you look at survey evidence of corporate investment decisions, financing conditions seem to have very little to do with it.  If this is true, a subsidy to an activity is very different from a subsidy to financial claims against that activity. (A long-standing theme of this blog is the pervasive illusion by which a claim on an income from something is equated with the thing itself.)

Daniela defines derisking as, among other things, “the production of inevitability”, which I think is exactly right as a description of the (genuine and important) trend toward endlessly broadening the range of claims that can be held in financial portfolios. But I am not convinced it is a good description of efforts to encourage functioning businesses to expand in certain directions. Even though we use the word “invest” for both.

Conversely, when financing is a constraint, as it often is for smaller businesses and households, it takes the form of being unable to access credit at all, or a hard limit on the quantity of financing available (due to limited collateral, etc.), rather than the price of it. One lesson of the Great Recession is that credit conditions matter much more for small businesses than for large ones. So to the extent that we want to work through financing, we need to be targeting our interventions at the sites where credit constraints actually bind. (The lower part of the top row, in terms of my table.) A general preference for green assets, as in Europe, will not achieve much; a program to lend specifically for, say, home retrofits might. 

This leads to the final dimension, what I am calling fine-grained versus broad or rules-based interventions. (Perhaps one could come up with better labels.) While for some people the critical question is ownership, for others — including me — the critical question is market coordination versus public coordination. It is whether we, as the government, are consciously choosing to shift production in specific ways, or whether we are setting out broad priorities and letting prices and the profit motive determine what specific form they will take. This — and this may be the central point of this post — cuts across the other criteria. Privately-owned firms can have their investment choices substantively shaped by the public. Publicly-owned firms can respond to the market. 

Or again, yes, one way of distinguishing incentives is whether they are positive or negative. But another is how precise they are — in how much detail they specify the behavior that is to be punished or rewarded. A fine-grained incentive effectively moves discretion about specific choices and tradeoffs to the entity offering the incentive. A broad incentive leaves it to the receiver. An incentive conditioned on X shifts more discretion to the public sector than an incentive conditioned on any of X, Y or Z, regardless of whether the incentive is a positive or negative. 

Let me end with a few concrete examples.

In her paper, Daniela draws a sharp distinction between the IRA and CHIPS Act, with the former as a clear example of derisking and the latter a more positive model. The basis for this is that CHIPS includes penalties and explicit mandates, while the IRA is overwhelmingly about subsidies.1. This is reflected in the table by CHIPS’ position to the left of the IRA. (Both are areas rather than points, given the range of provisions they include.) From another point of view, this is a less salient distinction; what matters is that they are both fairly fine-grained measures to redirect the investment decisions of private businesses. If you focus on the vertical axis they don’t look that different.

Similarly, Daniela points to things like the ECB’s climate action plan, which creates climate disclosure requirements for bank bond holdings and limits the use of carbon-linked bonds as collateral, as a possible alternative to the subsidy approach. It is true that these measures impose limits and penalties on the private sector, as opposed to the bottomless mimosas of the IRA. But the effectiveness of these measures would require a strong direct link from banks’ desired bond holdings, to the real investment decisions of productive businesses. I am very skeptical of such a link; I doubt measures like this will have any effect on real investment decisions at all. To me, that seems more salient.

The key point here is that Daniela and I agree 100% both that private profit should not be the condition of addressing public needs, and that the public sector does need to redirect investment toward particular ends. Where we differ, I think, is on which of those considerations is more relevant in this particular case.

If the EPA succeeds in imposing its tough new standards for greenhouse gas emissions from power plants, that will be an example of a rules-based rather than incentive-based policy. This is not exactly industrial policy — it leaves broad discretion to producers about how to meet the standards. But it is still more targeted than a carbon tax or permit, since it limits emissions at each individual plant rather than allowing producers to trade off lower emissions one place for higher emissions somewhere else.

Finally, consider the UK Labour Party’s proposal for a climate-focused National Wealth Fund, or similar proposals for green banks elsewhere. The team at Common Wealth has a very good discussion of how this could be a tool for actively redirecting credit as part of a broader green industrial policy. But other supporters of the idea stress ownership stakes as an end in itself. This is similar to the language one hears from advocates of social wealth funds: The goal is to replace private shareholders with the government, without necessarily changing anything about the companies that the shares are a claim on. 2 From this point of view, there’s a critical difference between whether the fund or bank has an equity stake in the businesses it supports or only makes loans.

To me, that doesn’t matter. The important question is does it acts as an investment fund, buying the liabilities (bonds or shares or whatever) of established business for which there’s already a market? Or does it function as more of a bank, lending directly to smaller businesses and households that otherwise might not have access to credit? This would require a form of fine-grained targeting, as opposed to buying a broad set of assets that fit some general criteria.3 Climate advocate showing to shape the NWF need to think carefully about whether it’s more important for it to get ownership stakes or for it to target its lending to credit-constrained businesses.

My goal in all this is not to say that I am right and others are wrong (though obviously I have a point of view). My goal is to try to clarify where the disagreements are. The better we understand the contours of the landscape, the easier it will be to find a route toward where we want to go. 

At Barron’s: With the Debt Ceiling Deal, the Administration Takes a Step Backward

(I write a monthly-ish opinion piece for Barron’s. This is my most recent one. You can find earlier ones here.)  

Since the onset of the pandemic, policy makers in the U.S. and elsewhere have embraced a more active role for government in the economy. The extraordinary scale and success of pandemic relief, the administration’s embrace of the expansive Build Back Better program, and the revived industrial policy of the Inflation Reduction Act and the Chips and Science Act all stand in sharp contrast with the limited-government orthodoxy of the past generation. 

The debt ceiling deal announced this weekend looks like a step back from this new path – albeit a smaller one than many had feared. Supporters of industrial policy and more robust social insurance have reason to be disappointed – especially since the administration, arguably, had more room for maneuver than it was willing to use. 

To be fair, the agreement in part merely anticipates the likely outcome of budget negotiations. Regardless of the debt ceiling, the administration was always going to have to compromise with the House leadership to pass a budget. The difference is that in a normal negotiation, most government spending continues as usual until a deal is reached. Raising the stakes of failure to reach a deal shifts the balance in favor of the side more willing to court disaster. Allowing budget negotiations to get wrapped up with the debt ceiling may have forced the administration to give up more ground than it otherwise would. 

The Biden team’s major nonbudget concession was to accept additional work requirements for some federal benefits. The primary effect of work requirements, with their often onerous administrative burdens, will be to push people off these programs. This might be welcome, if you would prefer that they not exist in their current form at all. But it’s a surprising concession from an administration that, not long ago, was pushing in the other direction

In a bigger sense this change directly repudiates one of the main social-policy lessons of recent years. Pandemic income-support programs were an extraordinary demonstration of the value of simple, universal social insurance programs, compared with narrowly targeted ones. The expiration of pandemic unemployment benefits gave us the cleanest test we are ever likely to see of the effect of social insurance and employment. States that ended pandemic benefits early did not see any faster job growth than ones that kept it longer – despite the fact that these programs gave their recipients far stronger incentives against work than those targeted in the budget deal. 

These compromises are all the more disappointing since there were routes around the debt ceiling that the administration, for whatever reason, chose not to explore. The platinum coin got a healthy share of attention. But there were plenty of others. 

The Treasury Department, for example, could have looked into selling debt at a premium. The debt ceiling binds the face value, or principal, of federal debt. There is no reason that this has to be equal to the amount the debt sells for – this is simply how auctions are currently structured. For much of U.S. history, government debt was sold at a discount or premium to its face value. Fixing an above-market interest rate and selling debt at more than face value would allow more funds to be raised without exceeding the debt ceiling. 

The administration might also have asked the Federal Reserve to prepay future remittances. In most years, the Fed makes a profit, which it remits to the Treasury. But it can also report a loss, as it has since September. When that happens, the Fed simply creates new reserves to make up the shortfall, offsetting these with a “deferred asset” representing future remittances. (Currently, the Fed is carrying a deferred asset of $62 billion.) The same device could be used to finance public spending without issuing debt. In a report a decade ago, Fed staff suggested that deferred assets could be used in this way to give the Treasury department “more breathing room under the debt ceiling.” (To be clear, they were not saying that this was a good idea, just noting the possibility.) 

Another route around the debt ceiling might come from the fact that about one-fifth of the federal debt – some $6 trillion – is held by federal trust funds like Social Security, rather than by the public. (Another $5 trillion is held by the Federal Reserve.) This debt has no economic function. It is a bookkeeping device reflecting the fact that trust fund contributions to date have been higher than payments. Retiring these bonds, or replacing them with other instruments that wouldn’t count against the ceiling, would have no effect on either the government’s commitment to pay scheduled benefits or its ability to do so. But it would reduce the notional value of debt outstanding. 

None of these options would be costless, risk-free, or even guaranteed to work. But there is little evidence they were seriously considered. This is a bit disheartening for supporters of the administration’s program. It’s hard to understand why you would go into negotiations with one hand tied behind your backs, and not have a plan B in case negotiations break down.

Tellingly, the one alternative the Biden team did consider was invoking the 14th Amendment to justify issuing new debt in defiance of the ceiling. The amendment refers specifically to the federal government’s debt obligations. But of course, hitting the debt ceiling would not only endanger the government’s debt service. It would threaten all kinds of payments that are legally mandated and economically vital. The openness to the 14th Amendment route, consistent with other public statements, suggests that decision-makers in the administration saw the overriding goal as protecting the financial system from the consequences of a debt default – as opposed to protecting the whole range of public payments. 

What looks like a myopic focus on the dangers to banks recalls one of the worst failures of the Obama administration. 

In the wake of the collapse of the housing market, Congress in 2009 authorized $46 billion in assistance for homeowners facing foreclosure through the Home Affordable Modification Program. But the Obama administration spent just a small fraction of this money (less than 3%) in the program’s first two years, helping only a small fraction of the number of homeowners originally promised. 

The failure to help homeowners was not due to callousness or incompetence. Rather, it was due to the overriding priority put on the stability of the banking system. As Obama’s Treasury Secretary Timothy Geithner later explained, they saw the primary purpose of HAMP not as assisting homeowners, but as a way to “foam the runway” for a financial system facing ongoing mortgage losses.

Geithner and company weren’t wrong to see shoring up the banks as important. The problem was that this was allowed to take absolute priority over all other goals — with the result that millions of families lost their homes, an important factor in the slow growth of much of the 2010s.

One wouldn’t want to push this analogy too far. The debt ceiling deal is not nearly as consequential – or as clear a reflection of administration priorities – as the abandonment of underwater homeowners was. But it does suggest similar blinders: too much attention to the danger of financial crisis on one side, not enough to equally grave threats from other directions.

It’s clear that Treasury Secretary Janet Yellen and the rest of the Biden administration are very attuned to the dangers of a default. But have they given enough thought to the other dangers of failing to reach a debt-ceiling deal — or of reaching a bad one? Financial crises are not the only crises. There are many ways that an economy can break down.

 

At Substack: The End of Laissez Faire

(I wrote this post about two weeks ago, but then took a while getting the Substack actually launched. Going forward, hopefully the content will be more timely. All substack content is free; you can subscribe to the newsletter version here. Hopefully the content will be more timely in the future!)

Sometimes I think being a normal economist must be like one of those classic office jobs. You drive to work, park in the garage, take the elevator up to your office. You take some papers from your inbox and put them in your outbox. There’s the research frontier; ok, we’ve advanced it a little bit. Then the bell rings, quitting time. Whereas here in the heterodox world, it’s like you’ve let yourself in through a gap in the fence and you’re wondering, is this place a construction site, or is something being demolished, or is it an archaeological dig? I think this is my desk, but it could be some weird art object, or possibly part of the ventilation system. This person in the hallway — are they the boss, or a customer, or maybe someone in need of emergency medical assistance? Am I sure I have a job? Am I even supposed to be in here?

Well then. Back to work!

The question of the moment is industrial policy. Not so long ago, the consensus on climate policy, at the high table at least, was that carbon pricing was it. Government provides the public interest with an abstract monetary representation, and then private businesses (or “markets”) will translate that representation into whatever concrete changes to production are called for. In recent years, though, the debate seems to have been shifting rather rapidly towards what I have called an investment-focused approach. The passage of the Inflation Reduction Act (along with other similar measures) seems to mark a decisive turn toward industrial policy, in the US at least. This is not only about climate — the disruptions to global supply chains during the pandemic and, more worryingly, a renewed sense of rivalry with China, have strengthened the case for support for key sectors of the economy.

(Full disclosure: When someone mentioned to me early in the Biden administration that there was interest in dealing with the chip shortage by fostering a US industry, I thought it was a silly idea that would go nowhere. This was, it seemed to me, about the worst case for policy — a problem that was at once both extraordinarily hard for government to solve, and likely to take care of itself on its own before long. Shows you how much I know! — or perhaps, how much things have changed.)

The case for industrial policy, obviously, involves a reevaluation of the capacity of government and the problems it is expected to solve — what Keynes, in an essay whose title can be repurposed today, called the line between agenda and non-agenda. But it also, a bit less obviously, involves a shift in how we think about the economy. An economy where industrial policy makes sense is not one that can be usefully described in terms of a unique, stable equilibrium toward which decentralized decisionmakers will converge. Industrial policy only makes sense in a world where increasing returns and learning by doing create significant path dependence — what we are good at today depends on what we were doing yesterday — and where an uncertain future and the need for large, irreversible investments, and the prevalence of complementarity rather than substitution, creates coordination problems that markets are unable to solve. I don’t know that the drafters of the IRA were conscious of it, but they were implicitly endorsing a very different model of the economy than the one that one finds in textbooks.

Supply constraints. My big recent publication, coauthored as usual with Arjun Jayadev, is an article in the Review of Keynesian Economics called “Rethinking Supply Constraints.” It addresses exactly this issue. The one-sentence summary is that it makes more sense to think of the productive capacity of the economy in terms of a speed limit — a limit on the rate at which output and employment can grow — rather than an absolute ceiling, as in conventional measures of potential output. This, we argue, fits better with a wide range of empirical phenomena. Equally important, it fits better with a vision of the economy as an open-ended collective transformation of the world, as opposed to the allocation of an existing basket of stuff.

There’s a summary in this blogpost, and video of my presentation of it at the University of Massachusetts is here. (I start around 47 minutes in.)  I will try to write more about it in this newsletter soon.

Low rates and bubbles. My latest Barron’s piece (I write one more or less monthly) was on whether the post-2007 decade of low interest rates can be blamed for Sam Bankman-Fried and financial bubbles and frauds more generally. As always, when the headline is a question, the answer is no.

I don’t think I quite stuck the landing with this one. The big point I should have hammered on is that if abundant credit ends up supporting projects that are socially and privately worthless, that’s a problem. But it is a problem with the institutions whose job it is to allocate credit, not with low interest rates or abundant credit as such. If banks and bank-like institutions can borrow at lower rates, it’s easy to see why they’d lend to projects with lower returns. It’s harder to see why they’d lend to projects with negative returns. The idea, evidently, is that for some reason when interest rates are too low financial-market participants will make choices that are not only socially costly but costly to themselves as well. The low rates-cause-bubbles arguments almost amount to a kind of financial terrorism — give us the risk-free returns we were counting on, or we’ll blow up our portfolios, and some chunk of the economy along with it.

The connection to industrial policy? If we don’t trust financial markets to make investment decisions, that strengthens the case for a bigger public role.

Biden, Brenner, and Benanav. Robert Brenner’s frequent collaborator Dylan Riley wrote a piece in the NLR blog Sidecar, drawing on Brenner’s work to argue that industrial policy  is hopeless because of global overcapacity; you’ve got to seize the commanding heights or stay home. I don’t agree. I think there are ways that the socialist project can be advanced via Biden administration initiatives like the IRA, and wrote a piece for Jacobin explaining why.

Some people liked it — Adam Tooze gave it a nice mention in one of his newsletters. Others did not. Aaron Benanav wrote a long and rather irritated rebuttal in New Left Review. I disagree with a lot of what he wrote, which is fine; he, as he made very clear, disagreed with what I wrote. As the protagonist of James Salter’s great Korean War novel The Hunters says, “You shoot at them, they shoot at you. What could be fairer?” But I am a little annoyed that my jaunty Hamilton reference, intended to warn against the danger of imagining that you are in a position of power, got turned into evidence that I myself dream of being in the “room where it happens.” That seems unsporting.

I talked about my piece and the larger debate with Doug Henwood on his excellent Behind the News podcast. I will also be writing a piece for NLR that will be in part a response to Benanav but mostly, I hope, an intervention to move the debate in a more positive direction.

Speaking of Korea. I was on an English-language Korean news show recently, talking about the IRA. The video is here; a twitter thread summarized the points I was trying to make is here. An implicit background point, also very relevant to my objections to the Brenner-Riley-Benanav position, is that trade flows respond mostly to income, not relative prices. How much the US imports from Korea is to a first approximation a function of US GDP growth; subsidies (and exchange rates) are distinctly secondary.

What I am reading. I just finished the novel Variations on Night and Day, by Abdelrahman Munif. It’s the third novel in the Cities of Salt trilogy, though the first chronologically. The first novel, also called Cities of Salt, is about people in a fictional Middle Eastern Country (more or less Saudi Arabia) in the early days of the oil boom. It’s an extraordinary book in many ways, including its use of mostly collective protagonists — large parts of the narration are from the point of view of “the villagers”, “the workers” and so on. The second book, The Trench, moves up the social scale, focusing on the various schemers, strivers, climbers and entrepreneurs – business and political – who accrete around the monarchy’s capital. It’s got an ensemble, rather than collective cast, with one central character and an endless number of minor ones – it would make a great tv show. (Think a gulf-monarchy version of Hillary Mantel’s Cromwell novels.) The third book — Variations on Night and Day — moves up the social scale again, and back in time, to the earlier life of the sultan whose death occurs at the very beginning of The Trench. It’s a great book, gripping as narrative and morally serious. It provides what science fiction and fantasy promise but very seldom deliver, an immersive experience of a world very different from our own. Still I have to say, I somewhat preferred the first two books. At the end of the day, sultans are just not that interesting.

ETA: As it happens, I went to graduate school with Munif’s son Yasser. He was in the sociology department while I was in economics and we used to hang out quite a bit, tho I haven’t seen him in some years.

At Substack: Hello World

I barley keep up this blog any more; do I really need a new format for (not) writing online? The problem, from my point of view, is that, these days, the only way people see blogs (or most other things one writes) is via twitter. And relying on twitter does not, at this point, see like a great idea. I’m moderately hopeful that an email newsletter can offer an alternative way.

In any case, my new substack is here. It’s pretty no-frills at the moment. I’ve pasted the first post below. For the moment I plan on cross-posting everything, but depending on how the substack goes I may revisit that.


What is this? This is an email newsletter, delivered through Substack. You probably get some others like it already. This one is from me, Joshua William Mason, or J. W. Mason as I usually write it. It’s called Money and Things. This specific email or post is the first one.

Why am I getting this? Either you signed up for it, or I added you. I subscribed a few people who I thought might be interested in hearing from me now and then. I hope you don’t mind! If you do, there’s an unsubscribe button somewhere. I promise I won’t add you again.

Thanks for reading Money and Things! Subscribe for free to receive new posts and support my work.

What’s the point of it? My main goal with this is to share things I’ve said or written in other settings, along with some interesting things I have read. I write a fair amount in a fair number of venues, and am in the news now and then. So it seems worth having one place to share it all with people who might like to see it. And then, despite the firehouse of content constantly aimed at each of our heads, it still can be nice to have someone point out something worth reading that you might not have run across otherwise.

The other goal is to have a structure for comments on things that are happening in the world. There are always things going on that I don’t have the time or energy or confidence to write about at length, but might have something interesting to say about in a more informal setting. Will a substack be any better for this than the blog I’ve been keeping for the past dozen years? I don’t know, but it seems worth a try.

So, a lot like a twitter feed, then? Yes, very much. I want to use the newsletter to share material that right now I use twitter for. Not everyone is on twitter, after all. And while I can’t see myself getting off twitter entirely – there are still too many interesting people there – I would like to spend less time on it, for all the familiar reasons.

How often will you be sending these? I’m vaguely hoping for once a week. I’m sure it won’t be more often than that; it could be much less. I will at least try to send one out whenever I publish something.

Why is the newsletter called Money and Things? Well, that captures the range of my interests. I write a lot about money, finance, central banks, credit and debt, inflation and other money-related and money-adjacent topics. But I also write about other things.

Also, Money and Things is the working title of the book that Arjun Jayadev and I are working on. This book has been in progress for longer than I care to think about, but it’s now mostly written and should be coming out from the University of Chicago Press  sometime in the next year. So I also want to use this email to share material from the book, and, down the road, to encourage people to read it.

What is the book about? Oof, I hoped you wouldn’t ask that. Well, it’s about money … and things.

Can you be more specific? The book is an effort to pull together some different strands of thinking around money that Arjun and I have been grappling with since we were students at the University of Massachusetts 20 years ago. One place to start is the tendency — both in economics and everyday common sense — to think of money either as just one useful object among others, or as a faithful reflection of a material world outside itself. Whereas to us it seems clear we should think of it as constituting its own self-contained world, a game or a logic, that in some ways responds to external material and social reality, but also evolves autonomously, and reshapes that external world in its turn. Economists like to think that when we measure things in terms of money, that is capturing some pre-existing “real” value or quantity. (Like, when you see a figure like GDP, you assume in some sense it reflects a quantity of stuff that was produced.) But in fact — our argument goes — while money is a yardstick that allows all sorts of things to be numerically compared, it doesn’t reflect any underlying quantity except money itself.

Keynesians have been criticizing the idea that money is neutral, just a veil, for decades. But we think there’s still space to spell out what the positive alternative looks like, and why it matters. You might say it’s an attempt to elevate the argument of our “Fisher dynamics” papers — where we argued that movements in debt-income ratios have more to do with interest rates and inflation than change in borrowing behavior — into a worldview or paradigm.

What we’re mainly interested in is the interface or boundary between money-world and the concrete world outside of it. (One jokey summary is that we’re starting from Keynes’ General Theory of Money, Interest and Employment, and writing about the “and”.) The idea is that by focusing there, we can connect some long-standing theoretical questions around the nature of money with contemporary debates about policy and politics, and with historical developments like the shareholder revolution or the euro crisis. We’re aiming for a spot in intellectual space somewhere between Jim Crotty, Perry Mehrling, Doug Henwood and David Graeber, if that makes sense.

Will you have a better answer to this question by the time the book comes out? I hope so!

Getting back to the newsletter — will there be free and paid versions? No, there will not. If someone wanted to give me money for it, I wouldn’t say no. If I got a little, I’d buy my kids ice cream. If I got a significant amount, which seems unlikely, then I might put more time into writing it. If I get none at all, that’s perfectly fine.

My personal view – which I know not everyone shares – is that if you are a tenure-track academic, it’s a bit unethical to charge money for a newsletter or similar product. The job of an academic is not just teaching; we are being paid to think about the world and share what we learn. So to me – again, I know many people feel differently – when you turn your work as a scholar into a kind of private business venture, that’s almost a form of embezzlement. Perhaps you saw Inside Job, that movie about economists and the financial crisis. Remember how eagerly someone like Frederic Mishkin turned his stature as a big-name monetary economist into big checks for himself? I don’t want to be that guy. Of course I’m not under any illusion that my integrity carries anything like the market price of a Mishkin’s. But it’s still worth something to me.

To be clear, this doesn’t apply to people who make a living as journalists or writers. If you are a professional writer your readers need to be paying you one way or another, and subscriber-only newsletter content is a legitimate way to make that happen. But as an academic, I’m already being compensated for this kind of work.

Does this mean your book will also be distributed for free? Well, no. The publishers will charge whatever they normally do for a book like this, and Arjun and I will get whatever (presumably small) royalties we’re entitled to out of that.

So how is that different? I don’t know. I feel like it’s different? Of course producing a physical book is costly, and the publisher has their own employees, whose services are valuable, and other costs that have to be paid. On the other hand, it would be technically feasible to just put the book up online as a pdf, and let anyone download it. So making people pay is in some sense a choice we are making. Still, if Inside Job had merely caught Mishkin admitting he’d published a book about financial crises, I don’t think that would have been much of a gotcha. Although then again, on the other hand, the textbook-writing business does seem a bit morally compromised. (Personally I try not to assign anything I can’t distribute a free pdf of.) I do hope our book will be used in the classroom. But I wish students could get excerpts of it in xeroxed course packets, they way I did when I was in college.

Anyway. Money and Things, the newsletter, will always be entirely free. Money and Things, the book, will not be.

You seem to have strong feelings on this topic. Do you have anything else to say about it? Yes, I do. I’ve always found it infuriating that so much scholarly work is hidden behind paywalls. It goes against the whole idea of scholarship, especially if you think of your academic work as part of some political project or as otherwise useful. During the six-seven years between my two stints in graduate school, I was intermittently engaged in online economics discussions, and I found it deeply frustrating that there were so many interesting articles that, without an academic affiliation, I was not permitted to read. I hope someday we recognize IP as applied to academic work for what it is, a comprehensive regime of censorship. (And Alexandra Elbakyan, the creator of sci-hub, as one of humanity’s heroes.)

A bit more recently, but still some years ago, I joined the steering committee of the Union for Radical Political Economics in large part to see if I could convince them to convert URPE’s journal, the Review of Radical Political Economics, to open access. Here you are, I thought, doing work that’s supposed to be part of a larger transformative project, that is relevant not just for other academics but for workers and activists. So why are you enlisting the power of the state to stop people from reading it?

As is often the case, what seemed unanswerable in principle turned out to be less straightforward in practice. The leadership of URPE the organization is largely separate from that of the journal; there’s a multi-year contract with the publisher; and even if open access were allowed, URPE’s share of the subscription revenue is basically the organization’s entire budget. If we went open-access, how would we pay the editor, or award fellowships to students in heterodox programs, or fly people out for the steering committee meetings? Maybe, I suggested, allowing people to read the journal is more important than flying people to meetings. Easy for you to say, someone replied, you live in New York; for others, if they can’t come out and meet in person, they won’t be part of this community at all. Besides, are there really so many non-academics who want to read RRPE?

Maybe if I’d pushed harder I could have got somewhere. But the obstacles were real, and no one seemed to agree with me, so I gave up, and eventually left the steering committee. (Life is too short to be on too many committees.) But I still think I was right.

Anything else? No, I think that’s it for now. But don’t worry – there will be another post coming shortly after this one.

At Barron’s: Are Low Rates to Blame for Bubbles?

(I write a monthly opinion piece for Barron’s. These sometimes run in the print edition, which I appreciate — it’s a vote of confidence from the editors, and means more readers. It does impose a tighter word count limit, though. The text below is the longer version I originally submitted. The version that was published is here. All of my previous Barron’s pieces are here.)

The past year has seen a parade of financial failures and asset crashes. Silicon Valley bank was the first bank failure since 2020, and the biggest since 2008. Before that came the collapse of FTX, and of much of the larger crypto ecosystem. Corporate bankruptcies are coming faster than at any time since 2011.  Even luxury watches are in freefall. 

The proximate cause of much of this turmoil is the rise in interest rates. So it’s natural to ask if the converse is true. Is the overvaluing of so many worthless assets  – whether through bubbles or fraud – the fault of a decade-plus of low rates? For those who believe this, the long period of low rates following the global financial crisis fueled an “everything bubble”, just as the earlier period of low rates fueled the housing boom of the 2000s. The rise of fragile or fraudulent institutions, which float up on easy credit before inevitably crashing back to earth, is a sign that monetary policy should never have been so loose. As journalist Rana Foorohar put it in a much-discussed article, “Keeping rates too low for too long encourages speculation and debt bubbles.”

You can find versions of this argument being made by  prominent Keynesians, as well as by economists of a more conservative bent. At the Bank for International Settlements “too low for too long” is practically a mantra. But, does the story make sense?

Yes, low interest rates are associated mean high asset prices. But that’s not the same as a bubble.To the extent an asset represents a stream of future payments, a low discount rate should raise its value. 

On the other hand, asset prices are not just about discounted future income streams; they also incorporate a bet on the future price of the asset itself. If a fall in interest rates leads to a rise in asset prices, market participants may mistakenly expect that rise to continue. That could lead to assets being overvalued even relative to the current low rates.

Another argument one sometimes hears for why low rates lead to bubbles is that when income from safe assets is low, investors will “reach for yield” by taking on more risk, bidding up the price of more speculative assets. Investors’ own liabilities also matter. When it’s cheap and easy to borrow, an asset may be attractive that wouldn’t be if financing were harder to come by.

But if low interest rates make acquiring risky assets more attractive, is that a problem? After all, that’s how monetary policy is supposed to work. The goal of rate cuts is precisely to encourage investment spending that wouldn’t happen if rates were higher.  As I argued recently, it’s not clear that most business investment is very responsive to interest rates. But whether the effect on the economy is strong or weak,  “low interest rates cause people to buy assets they otherwise wouldn’t” is just monetary policy working as intended.

Still, intended results may have unintended consequences. When people are reaching for yield, the argument goes, they are more likely to buy into projects that turn out to be driven by fraud, hype or fantasy.

Arguments for the dangers of low rates tend to take this last step for granted. But it’s not obvious why an environment of low yields should be more favorable to frauds. Projects with modest expected returns are, after all, much more common than projects with very high ones; when risk-free returns are very low, there should be more legitimate higher-yielding alternatives, and less need for risky long shots. Conversely, it is the projects that promise very high returns that are most likely to be frauds  — and that are viable at very high rates.

Certainly this was Adam Smith’s view. For him, the danger of speculation and fraud was not an argument for high interest rates, but the opposite. If legal interest rates were “so high as 8 or 10 percent,” he believed, then “the greater part of the money which was to be lent would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people … would not venture into the competition.” 

The FTX saga is an excellent example. At one point, Sam Bankman-Fried—a projector and prodigal if ever there was one—offered as much as 20% on new loans to his hedge fund, Alameda, according to The Wall Street Journal. It wouldn’t take low rates to make that attractive — if he was good for it. But, of course, he was not. And that is the crux of the problem. Someone like Bankman-Fried is not offering a product with low but positive returns, that would be attractive only when rates are low but not when they were high. He was offering a product with an expected return that, in retrospect, was in the vicinity of -100 percent. Giving  him your money to him would be a bad idea at any interest rate. 

We can debate what it would take to prevent fraud-fueled bubbles in assets like cryptocurrency. Perhaps it calls for tighter restrictions on the kinds of products that can be offered for sale, or more stringent rules on the choices of retail investors. Or perhaps, given crypto’s isolation from the broader financial system, this is a case where it’s ok to just let the buyer beware. In any case, the problem was not that crypto offered higher returns than the alternative. The problem was that people believed the returns in crypto were much higher than they actually were. Is this a problem that interest rates can solve?

Let’s suppose for the sake of argument that it is. Suppose that without the option of risk-free returns of 3 or 4 or 5 percent, people will throw their money away on crazy longshots and obvious frauds. If you take this idea seriously, it has some funny implications. Normally, when we ask why asset owners are entitled to their income in the first place, the answer is that it’s an incentive to pick out the projects with the highest returns. (Hopefully these are also the most socially useful ones.) The “too low for too long” argument turns this logic on its head. It says that asset owners need to be guaranteed high returns because they can’t tell a good project from a bad one.

That said, there is one convincing version of this story. For all the reasons above, it does not make sense to think of ordinary investors being driven toward dangerous speculation by low interest rates. Institutions like insurance and pension funds are a different matter. They have long-term liabilities that are more or less fixed and, critically, independent of interest rates. Their long investment horizons mean their loss of income from lower rates will normally outweigh their capital gains when they fall. (This is one thing the BIS surely gets right.) When the alternative is insolvency, it can make sense to choose a project where the expected return is negative, if it offers a chance of getting out of the hole. That’s a common explanation for the seemingly irresponsible loans made by many Savings & Loans in the 1980s—faced with bankruptcy, they “gambled for resurrection.” One can imagine other institutions making a similar choice.

What broke the S&Ls in was high rates, not low ones. But there is a common thread. A structure set up when interest rates are in a certain range may not work when they move outside of it. A balance sheet set up on the basis of interest rates in some range will have problems if they move outside it. 

Modern economies depend on a vast web of payment expectations and commitments stretching far into the future. Changes in interest rates modify many change of those future payments; whether upward or downward, this means disappointed expectations and broken commitments. 

If the recent period of low rates was financially destabilizing,  then, the problem wasn’t the not low rates in themselves. It was that they weren’t what was planned on. If the Fed is going to draw general lessons from the bubbles that are now popping, it should not be about the dangers of low rates, but that of drastic and unexpected moves in either direction.