The Slack Wire

Quasi-Monetarism: A Second Opinion

(Anush Kapadia, who knows this stuff much better than me, writes in with some comments on the last few posts. I accept this as a friendly amendment, and don’t disagree with any of it. I agree with particular enthusiasm with the points that we should be talking about liquidity, not money; that the the link between any quantifiable money stock and real activity had broken down by the early 1980s if not before (my point was only that it wasn’t entirely obvious until the great financial crisis); that to make sense of this stuff you need a concrete, institutionally grounded account of the financial system; and that for that, a very good place to start is Perry Mehrling’s work.)

Some cavils:

The meaningfulness of monetary aggregates depends on the configuration of the credit system. In a world of tight banking regulations, the monetarist assumption that “there’s a stable relationship between outside money and inside money” worked fine precisely because regulations made it so. Once those regulations break down, the relationship between outside and and inside money transforms. As the mainstream understands, “the rapid pace of financial innovation in the United States has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables” (Bernanke, “Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective,” FRB 2006).

Thus your claim that “Between 1990 and 2008, this [monetarist] story isn’t glaringly incompatible with the evidence” is not entirely true. Post-deregulation, money demand (“velocity”) became quite unmeasurable, breaking the link between the two sides of the quantity equation. “Behavior” had already changed significantly by the late 1960s, i.e. just as the monetarists were gaining the upper hand in the battle of ideas. (Note that the Fed eventually stopped measuring M3; but not everyone did: http://www.shadowstats.com/charts/monetary-base-money-supply).

Eventually, in response to this breakdown, the Fed quits its ill-conceived monetarist experiment and targets price rather quantity, specifically the Fed Funds rate. Thus “changing the stock of base money” has not been “the instrument of central banks, at least in theory, since the early 20th century.” Since the empirical and theoretical tractability of “the money supply” gave way, monetary control moved to the price of central-bank refinance, i.e. “the price of liquidity.” [1]

Price-based control works by acting on the leverage capacity of the balance sheets “downstream,” most immediately those in the primary dealer system. (Mehrling, New Lombard Street). Modulation of this capacity is effected through changes in the price of refinance—the bailout price—for these dealers, thereby changing their bid-ask spread. So changes in the prices of the assets in which they make markets are a key transmission mechanism to changes in interest rates.

The effect interest rates have on investment and/or consumer demand itself depends on the configuration of the credit system, i.e. how investment and consumption are financed. The price of credit might not be as important as its quantity for investment, but the former might be very important for consumption and thus aggregate demand.

So you can get a recession thanks to insufficient aggregate demand if you have a credit system that ties consumption to finance. The reason is the same as that which enables what Mehrling calls “monetary policy without sticky prices,” i.e. the leverage capacity of (in this case, consuming) balance sheets. If people are stuffed with debt, their “excess demand for money” basically represents a demand for liquidity to pay down their debts. Extra income will go first and foremost towards deleveraging rather than consumption; this of course is Richard Koo’s Minsky-flavored lesson from Japan.

Given the current configuration of the system, a coordination problem of the kind referred to would mean that those with spare lending capacity can’t find those with spare borrowing capacity. Yet in sectoral terms, its only households that are truly overleveraged: government is only political so and business are relatively okay. The problem is to get the big balance sheet with the spare capacity online again; of course, that is a political problem.[2] Boosting liquidity qua “the money supply” will simply pass through to paying down debts before it starts to affect consumption and thereby investment. In short, we might be some time, especially if we abstract away from the institutional configuration of the credit system.

[1] This signaled a return to pre-WWI “banking school” methods employed by the Bank of England, modulo differences in the respective credit systems: commercial paper for the trade-credit-based English system and government paper for the postwar US system. The Fed in our own period seems to be feeling its way to dealing in paper other than the government’s (QE I), something that is appropriate given the importance of non-government debt in the present system.

[2] Incidentally, Morris Copeland’s analogy of the credit system as an electric grid works much better than Fisher’s “currency school” vision of money as a liquid. See http://www.nber.org/books/cope52-1.

What’s the Matter with (Quasi-)Monetarism?

Let’s start from the top.

What is monetarism? As I see it, it’s a set of three claims. (1) There is a stable relationship between base money and the economically-relevant stock of money. [1] That is, there’s a stable relationship between outside money and inside money. (2) There is a stable velocity of money, so we can interpret the equation of exchange MV = PY (or MV = PT) as a behavioral relationship and not just an accounting identity. Since the first claim says that M is set exogenously by the monetary authority, causality in the equation runs from left to right. And (3), the LM aggregate supply curve is shaped like a backward L, so that changes in PY show up entire in Y when the economy is below capacity, and entirely in changes in P when it is at capacity.

In other words, (1) the central bank can control the supply of money; (2) the supply of money determines the level of nominal output; and (3) there is a single strictly optimal level of nominal output, without any tradeoffs. The implication is that monetary policy should be guided by a simple rule, that the money supply should grow at a fixed rate equal to (what we think is) the growth rate of potential output. Which is indeed, exactly what Friedman and other monetarists said.

You can relax (3) if you want — most monetarists would probably agree that in practice, disinflation is going to involve a period of depressed output. (Altho on the other hand, I’m pretty sure that when monetarism was officially adopted as the doctrine of the bank of England under Thatcher, it was claimed that slowing the growth of the money supply would control inflation without affecting growth at all. And the hedge-monetarism you run into today, that insists the huge growth in base money over the past few years could show up as hyperinflation without warning, seems to be implicitly assuming a backward-L shaped LM AS curve as well.) But basically, that’s the monetarist package.

So what’s wrong with this story? Here’s what:

The red line is base money, the blue line is broad money (M2), and the green line is nominal GDP. The monetarist story is that red moves blue, and blue moves green. Between 1990 and 2008, this story isn’t glaringly incompatible with the evidence. But since then? It’s clear that the money multiplier, as we normally talk about it, no longer has any economic reality. There might still be tools out there to control the money supply. But changing the stock of base money — the instrument of central banks, at least in theory, since the early 20th century — is no longer one of them. Monetary policy as we knew it is dead. The divergence between the blue and green lines is less dramatic in this graph, but if anything it’s even more damning. While output and prices lurched downward in the great Recession, the money supply just kept chugging along. Milton Friedman’s idea that stable growth of the money supply is a sufficient condition for stable growth of nominal GDP looks pretty definitively refuted.

So that’s monetarism, and what’s the matter with it. How about quasi-monetarism? What’s the difference from the unprefixed kind?

Some people would say, There is no difference. Quasi-monetarist is just what we call a New Keynesian who’s taken off his Keynes mask and admitted he was a Friedmanite all along. And let’s be honest, that’s sort of true. But it’s like one of those episodes in religious history where at some point the disciples have to acknowledge that, ok, the prophecies don’t seem to have exactly worked out. Which means we have to figure out what they really meant.

In this case, the core commitment is the idea that if PY is too low (we’re experiencing a recession and/or deflation) that means M is too low; if PY is too high (we’re experiencing inflation) that means M is too high. In other words, when we talk about insufficient aggregate demand, what we’re really talking about is just excess demand for money. And therefore, when we talk about policies to boost demand, we’re really just talking about policies to boost the money stock. (Nick Rowe, as usual, is admirably straightforward on this point.) But how to reconcile this with the graph above? You just have to replace some material entities with spiritual ones: The true M, or V, or both, is not visible to mortal eyes. Let’s say that velocity is exogenous but not stable. Then there is still a unique path of M that would guarantee both full employment and stable prices, but it can’t be characterized as a simple growth rate as Friedman hoped. Alternatively, maybe the problem is that the monetary authority can only control M clumsily, and can’t directly observe how far off it is. (This is the DeLong version of quasi-monetarism. The assets that count as M are always changing.) Then, there may still be the One True Growth Rate of M just as Friedman promised, but the monetary authority can’t reliably implement it. Or sublunary M and V could both depart from their platonic ideals. In any case, the answer is clear: Since it’s hard to get MV right, your rule should be to target a steady growth rate of PY (nominal GDP). Which is, indeed, exactly what the quasi-monetarists say. [2]

So what’s the alternative? I’ve been arguing that one alternative is to think of recessions as coordination failures, which could happen even in an economy without money. I’m honestly not sure if that’s going to turn out to be a productive direction to go in, or not. But in terms of the monetarist framework, the alternative is clear. Say that V is not only unstable, but endogenous. Specifically, say that it varies inversely with M. In this case, it remains true — as it must; it’s an accounting identity — that MV = PY. But nonetheless there is nothing you can do to M, that will affect P or Y. (This situation, by the way, is what Keynes meant by a liquidity trap. It wasn’t about the zero lower bound.)

This, I think, is what we actually observe, not just right now, but in general. “The” interest rate is the price of liquidity, that is, the price of money. [3] And what kinds of activity are sensitive to interest rates? Well, uh … none of them. None, anyway, except for housing. When an economic unit is deciding on the division of its income between currently-produced goods and services vs. money, the price at which they exchange just doesn’t seem to be much of a consideration. (Again, except — and it’s an important exception — when the decision takes the form of purchasing housing services from either an existing home, or a new one.) Which means that changes in M don’t have any good channel to produce changes in P or Y. In general, increases or decreases in M will just result in pro rata decreases or increases in V. Yes, it may be formally true that insufficient demand for goods equals excess demand for money; but it doesn’t matter if there’s no well-defined money demand function. A traditional Keynesian expenditure function (Z = A + cY) cannot be usefully simplified, as the quasi-monetarists would like, by thinking of it as a problem of maximizing the flow of consumption subject to some real balance constraint.

So, monetarism made some strong predictions. Quasi-monetarism admits that those predictions don’t hold up, but argues that the monetarist model is still the right one, we just can’t observe the variables in it as directly as early monetarists hoped. On some level, they may be right! But at some point, when the model gets too loosely coupled with reality, you’ll want to stop using it. Even if, in some sense, it isn’t wrong.

Which is all to say that, even if I can’t find a way to disprove it analytically, I just can’t accept the idea that the question of aggregate demand can be usefully reduced to the question of the supply of money.

[1] The simplest form of the first claim would be that the money multiplier is equal to one: Outside money is all the money there is. Something like this was supposed to be true under the gold standard, tho as the great Robert Triffin points out, it wasn’t really. Over at Windyanabasis, rsj claims that Krugman, a closet quasi-monetarist, implicitly makes this assumption.

[2] In practice, despite the tone of this post, I’m not entirely sure they’re wrong. More generally, Nick Rowe’s clear and thorough posts on this set of questions are essential reading.

[3] I’ve learned from  Bob Pollin never to write that phrase without the quotes. There are lots of interest rates, and it matters.

Are Recessions All About Money: Quasi-Monetarists and Babysitting Co-ops

Today Paul Krugman takes up the question of the post below, are recessions all about (excess demand for) money? The post is in response to an interesting criticism by Henry Kaspar of what Kaspar calls “quasi-monetarists,” a useful term. Let me rephrase Kaspar’s summary of the quasi-monetarist position [1]:

1. Logically, insufficient demand for goods implies excess demand for money, and vice versa.
2. Causally, excess demand for money (i.e. an increase in liquidity preference or a fall in the money supply) is what leads to insufficient demand for goods.
3. The solution is for the monetary authority to increase the supply of money.

Quasi-monetarists say that 2 is true and 3 follows from it. Kaspar says that 2 doesn’t imply 3, and anyway both are false. And Krugman says that 3 is false because of the zero lower bound, and it doesn’t matter if 2 is true, since asking for “the” cause of the crisis is a fool’s errand. But everyone agrees on 1.

Me, though, I have doubts.

Krugman:

An overall shortfall of demand, in which people just don’t want to buy enough goods to maintain full employment, can only happen in a monetary economy; it’s correct to say that what’s happening in such a situation is that people are trying to hoard money instead (which is the moral of the story of the baby-sitting coop). And this problem can ordinarily be solved by simply providing more money.

For those who don’t know it, Krugman’s baby-sitting co-op story is about a group that let members “sell” baby-sitting services to each other in return for tokens, which they could redeem later when they needed baby-sitting themselves. The problem was, too many people wanted to save up tokens, meaning nobody would use them to buy baby-sitting and the system was falling apart. Then someone realizes the answer is to increase the number of tokens, and the whole system runs smoothly again. It’s a great story, one of the rare cases where Keynesian conclusions can be drawn by analogizing the macroeconomy to everyday experience. But I’m not convinced that the fact that demand constraints can arise from money-hoarding, means that they always necessarily do.

Let’s think of the baby-sitting co-op again, but now as a barter economy. Every baby-sitting contract involves two households [2] committing to baby-sit for each other (on different nights, obviously). Unlike in Krugman’s case, there’s no scrip; the only way to consume baby-sitting services is to simultaneously agree to produce them at a given date. Can there be a problem of aggregate demand in this barter economy. Krugman says no; there are plenty of passages where Keynes seems to say no too. But I say, sure, why not?

Let’s assume that participants in the co-op decide each period whether or not to submit an offer, consisting of the nights they’d like to go out and the nights they’re available to baby-sit. Whether or not a transaction takes place depends, of course, on whether some other participant has submitted an offer with corresponding nights to baby-sit and go out. Let’s call the expected probability of an offer succeeding p. However, there’s a cost to submitting an offer: because it takes time, because it’s inconvenient, or just because, as Janet Malcolm says, it isn’t pleasant for a grown man or woman to ask for something when there’s a possibility of being refused. Call the cost c. And, the net benefit from fulfilling a contract — that is, the enjoyment of going out baby-free less the annoyance of a night babysitting — we’ll call U.

So someone will make an offer only when U > c/p. (If say, there is a fifty-fifty chance that an offer will result in a deal, then the benefit from a contract must be at least twice the cost of an offer, since on average you will make two offers for eve contract.) But the problem is, p depends on the behavior of other participants. The more people who are making offers, the greater the chance that any given offer will encounter a matching one and a deal will take place.

It’s easy to show that this system can have multiple, demand-determined equilibria, even though it is a pure barter economy. Let’s call p* the true probability of an offer succeeding; p* isn’t known to the participants, who instead form p by some kind of backward-looking expectations looking at the proportion of their own offers that have succeeded or failed recently. Let’s assume for simplicity that p* is simply equal to the proportion of participants who make offers in any given week. Let’s set c = 2. And let’s say that every week, participants are interested in a sitter one night. In half those weeks, they really want it (U = 6) and in the other half, they’d kind of like it (U = 3). If everybody makes offers only when they really need a sitter, then p = 0.5, meaning half the contracts are fulfilled, giving an expected utility per offer of 2. Since the expected utility from making an offer on a night you only kind of want a sitter is – 1, nobody tries to make offers for those nights, and the equilibrium is stable. On the other hand, if people make offers on both the must-go-out and could-go-out nights, then p = 1, so all the offers have positive expected utility. That equilibrium is stable too. In the first equilibrium, total output is 1 util per participant per week, in the second it’s 2.5.

Now suppose you are stuck in the low equilibrium. How can you get to the high one? Not by increasing the supply of money — there’s no money in the system. And not by changing prices — the price of a night of baby-sitting, in units of nights of baby-sitting, can’t be anything but one. But suppose half the population decided they really wanted to go out every week. Now p* rises to 3/4, and over time, as people observe more of their offers succeeding, p rises toward 3/4 as well. And once p crosses 2/3, offers on the kind-of-want-to-go-out nights have positive expected utility, so people start making offers for those nights as well, so p* rises further, toward one. At that point, even if the underlying demand functions go back to their original form, with a must-go-out night only every other week, the new high-output equilibrium will be stable.

As with any model, of course, the formal properties are less interesting in themselves than for what they illuminate in the real world. Is the Krugman token-shortage model or my pure coordination failure model a better heuristic for understanding recessions in the real world? That’s a hard question!

Hopefully I’ll offer some arguments on that question soon. But I do want to make one logical point first, the same as in the last post but perhaps clearer now. The statement “if there is insufficient demand for currently produced goods, there must excess be demand for money” may look quite similar to the statement “if current output is limited by demand, there must be excess demand for money.” But they’re really quite different; and while the first must be true in some sense, the second, as my hypothetical babysitting co-op shows, is not true at all. As Bruce Wilder suggests in comments, the first version is relevant to acute crises, while the second may be more relevant to prolonged periods of depressed output. But I don’t think either Krugman, Kaspar or the quasi-monetarists make the distinction clearly.

EDIT: Thanks to anonymous commenter for a couple typo corrections, one of them important. Crowd-sourced editing is the best.

Also, you could think of my babysitting example as similar to a Keynesian Cross, which we normally think of as the accounting identity that expenditure equals output, Z = Y, plus the behavioral equation for expenditure, Z = A + cY, except here with A = 0 and c = 1. In that case any level of output is an equilibrium. This is quasi-monetarist Nick Rowe’s idea, but he seems to be OK with my interpretation of it.

FURTHER EDIT: Nick Rowe has a very thoughtful response here. And my new favorite econ blogger, the mysterious rsj, has a very good discussion of these same questions here. Hopefully there’ll be some responses here to both, soonish.

[1] Something about typing this sentence reminds me unavoidably of Lucky Jim. This what neglected topic? This strangely what topic? Summary of the quasi-what?

[2] Can’t help being bugged a little by the way Krugman always refers to the participants as “couples,” even if they mostly were. There are all kinds of families!

Are Recessions All About Money?

There is a view that seems to be hegemonic among liberal economists, that recessions are fundamentally about money or finance. Not just causally, not just in general, but always, by definition. In this view, the only sense in which one can speak about aggregate demand as a constraint on output, is if we can identify excess demand for some non-produced financial asset.

In the simplest case, people want to hold a stock of money in some proportion to their total income. Money is produced only by the government. Now suppose people’s demand for money rises, and the government fails to increase supply accordingly. You might expect the price of money to rise — that is, deflation. But deflation doesn’t restore equilibrium, either because prices are sticky (i.e., deflation can’t happen, or not fast enough), or because deflation itself further raises the demand for money. It might do this by raising precautionary demand, since falling prices make it likely that businesses and households won’t be able to meet obligations fixed in money terms and will face bankruptcy (Irving Fisher’s debt-deflation cycle). Or deflation might increase demand for money by because it redistributes income from net borrowers to net savers, and the latter have a higher marginal demand for money holdings. Or there could be other reasons. In any case, the price of money doesn’t adjust, so government has to keep its quantity growing at the appropriate rate instead. From this perspective,  if we ever see an economy operating bellow full capacity, it is true by definition that there is excess demand for some money-like asset.

This sounds like Milton Friedman. It is Milton Friedman! But it also seems to be most of the liberal macroeconomists who are usually called Keynesians. Here’s DeLong:

there was indeed a “general glut” of newly-produced commodities for sale and of workers to hire. But it was also the case that the excess supply of goods, services, and labor was balanced by an excess demand elsewhere in the economy. The excess demand was an excess demand not for any newly-produced commodity, but instead an excess demand for financial assets, for “money”…

How, exactly, should economists characterize the excess demand in financial markets? Where was it, exactly? That became a subject of running dispute, and the dispute has been running for more than 150 years, with different economists placing the cause of the “general glut” that was excess supply of newly-produced goods and of labor at the door of different parts of the financial system.

The contestants are:

Fisher-Friedman: monetarism: a depression is the result of an excess demand for money–for those liquid assets generally accepted as means of payment that people hold in their portfolios to grease their market transactions. You fix a depression by having the central bank boost the money stock…

Wicksell-Keynes (Keynes of the Treatise on Money, that is): a depression happens when there is an excess demand for bonds… You fix a depression by either reducing the market rate of interest (via expansionary monetary policy) or raising the natural rate of interest (via expansionary fiscal policy) in order to bring them back into equality….

Bagehot-Minsky-Kindleberger: a depression happens because of a panic and a flight to quality, as everybody tries to sell their risky assets and cuts back on their spending in order to try to shift their portfolio in the direction of safe, high-quality assets… You fix a depression by restoring market confidence and so shrinking demand for AAA assets and by increasing the supply of AAA assets….

From the perspective of this Malthus-Say-Mill framework Keynes’s General Theory is a not entirely consistent mixture of (1), (2), and (3)…Note that these financial market excess demands can have any of a wide variety of causes: episodes of irrational panic, the restoration of realistic expectations after a period of irrational exuberance, bad news about future profits and technology, bad news about the solvency of government or of private corporations, bad government policy that inappropriately shrinks asset stocks, et cetera. Nevertheless, in this Malthus-Say-Mill framework it seems as if there is always or almost always something that the government can do to affect asset supplies and demands that promises a welfare improvement

That’s an admirably clear statement. But is it right? I mean, first, is it right that demand constraints can always and only be usefully characterized as excess demand for some financial asset? And second, is that really what the General Theory says?

The first answer is No. Or rather, it’s true but misleading. It is hard to talk sensibly about a “general glut” of currently produced goods except in terms of an excess demand for some money-like financial asset. But recessions and depressions are not mainly characterized by a glut of currently produced goods. They are characterized by an excess of productive capacity. Markets for all currently-produced goods may clear. But there is still a demand constraint, in the sense that if desired expenditure were higher, aggregate output would be higher. The simple Keynesian cross we teach in the second week of undergrad macro is a model of just such an economy, which makes sense without money or any other financial asset. (And is probably more useful than most of what gets taught in graduate courses.) Arguably, this is the normal state of modern capitalist economies.

I’ll come back to this in a future post, hopefully. But it’s important to stress that the notion of aggregate demand limiting output, does not imply that any currently-produced good is in excess supply. [1]

Meanwhile, how about the second question — in the General Theory, did Keynes see demand constraints as being fundamentally about excess demand for money or some other financial asset, with the solution being to change the relative price of currently produced goods, and that asset? Again, the answer is No.

In his explanation of the instability of capitalist economies, Keynes always emphasizes the fluctuations in investment demand (or in his terms, the marginal efficiency of capital schedule). Investment demand is based on the expected returns of new capital goods over their lifetime. But the distribution of future states of the world relevant to those returns is not just stochastic but fundamentally unknown, so expectations about profits on long-lived fixed capital are essentially conventional and unanchored. It is these fluctuations in expectations, and not the demand for financial assets as expressed in liquidity preference, that drives booms and slumps. Keynes:

The fact that a collapse in the marginal efficiency of capital tends to be associated with a rise in the rate of interest may seriously aggravate the decline in investment. But the essence of the situation is to be found, nevertheless, in the collapse of the marginal efficiency of capital… Liquidity preference, except those manifestations which are associated with increasing trade and speculation, does not increase until after the collapse in the marginal efficiency of capital.  

It is this, indeed, which renders the slump so intractable. Later on, a decline in the rate of interest will be a great aid to recovery and probably a necessary condition of it. But for the moment, the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough [to offset it]. If the reduction in the rate of interest was capable of proving an effective remedy by itself, it might be possible to achieve a recovery without the elapse of any considerable interval of time and by means more or less directly under the control of the monetary authority. But in fact, this is not usually the case.

In this sense, Keynes agrees with the Real Business Cycle theorists that the cause of a decline in output is not fundamentally located in the financial system, but a fall in the expected profitability of new investment. The difference is that RBC thinks a decline in expected profitability must be due to genuine new information about the true value of future profits. Keynes on the other hand thinks there is no true expected value in that sense, and that our belief about the future are basically irrational. (“Enterprise only pretends to itself to be actuated by the statements in its prospectus … only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come.”) This is an important difference. But the key point here is the bolded sentences. Keynes considers DeLong’s view that the fundamental cause of a downturn is an autonomous increase in demand for safe or liquid assets, and explicitly rejects it.

The other thing to recognize is that Keynes never mentions the zero lower bound. He describes the liquidity trap as theoretical floor of the interest rate, which is above zero, but nothing in his argument depends on it. Rather, he says,

The most stable, and least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in the future, the minimum rate of interest acceptable to the generality of wealthowners. (Cf. the nineteenth-century saying quoted by Bagehot, that “John Bull can stand many things, but he cannot stand 2 percent.”) If a tolerable level of employment requires a rate of interest much below the average rates which ruled in the nineteenth century, it is most doubtful whether it can be achieved merely by manipulating the quantity of money.

This is an important part of the argument, but it tends to get ignored by mainstream Keynesians, who assume that monetary authority can reliably set “the” interest rate. But as we see clearly today, this is not a good assumption to make. Well before the policy rate reached zero, it had become effectively disconnected from the rates facing business borrowers. And of course the hurdle rate from the point of view of the decisionmakers at a firm considering new investment isn’t just the market interest rate, but that rate plus some additional premium reflecting what Keynes (and later Minsky) calls borrower’s risk.

So, Keynes thought that investment demand was subject to wide, unpredictable fluctuations, and probably also a secular downward trend. He doubted that very large movements in the interest rate could be achieved by monetary policy. And he didn’t think that the moderate movements that could be achieved, would have much effect on investment. [2] Where did that leave him? “Somewhat skeptical of the success of a merely monetary policy directed toward influencing the rate of interest” at stabilizing output and employment; instead, the government must “take an ever greater responsibility for directly organizing investment.”

Of course, DeLong could be misrepresenting Keynes and still be right about economic reality. But we need to at least recognize that aggregate demand is logically separate from the idea of a general glut; that the former, unlike the latter, does not necessarily involve excess demand for any financial asset; and that in practice supply and demand conditions in financial markets are not always the most important or reliable influences on aggregate demand. Keynes, at least, didn’t think so. And he was a smart guy.

[1] The other point, to anticipate a possible objection, is that the investment decision does not involve allocation of a fixed stock of savings between capital goods and financial assets.

[2] The undoubted effectiveness of monetary policy in the postwar decades might seem to argue against this point. But it’s important to recognize — though Keynes himself didn’t anticipate this — that in practice monetary policy has operated largely though its effect on the housing market, not on investment.

Don’t Let Nobody Walk All Over You

Here’s a heartening story from the old neighborhood:

An 82-year-old great-grandmother cried tears of joy Friday as nearly 200 neighbors rallied in her support on the day she was to be evicted. Mary Lee Ward was granted a reprieve when the owner of the Brooklyn house where she lives agreed to continue meeting with her lawyers next week. “You have to stick with it when you know your right,” Ward told the cheering crowd. “Don’t let nobody walk all over you.” 

Ward, who fell victim in 1995 to a predatory subprime mortgage lender that went under in 2007, has been battling to stay in the Tompkins Avenue home for more than a decade. A city marshal was supposed to boot Ward from the one-family frame house Friday, but didn’t show as her lawyers sat down with an assemblywoman and the home’s owner. … “I hope they realize that they can never really win,” Ward said. “I will not compromise.”

Why don’t we see more of this kind of thing? There are millions of families with homes in foreclosure, and millions more heading that way. Being forcibly evicted from your home has got to be one of the most wrenching experiences there is. And yet as long as you’re in the house, you have some real power. And the moral and emotional claims of someone like Ward to her home are clear, regardless of who holds the title. Someone just has to organize it. Here, I think, is where we are really suffering from the loss of ACORN — these situations are tailor-made for them.

Still, there is some good work going on. I was at a meeting recently of No One Leaves, a bank tenant organization in Springfield, MA. Modeled on Boston’s City Life/Vida Urbana, this is a project to mobilize people whose homes have been foreclosed but are still living in them. Homeowners who still have title have a lot to lose and are understandably anxious to meet whatever conditions the lender or servicer sets. But once the foreclosure has happened, the homeowner, paradoxically, is in a stronger negotiating position; if they’re going to have to leave anyway, they have nothing to lose by dragging the process out, while for the bank, delay and bad publicity can be costly. So the idea is to help people in this situation organize to put pressure — both in court and through protest or civil disobedience — on the banks to agree to let them stay on as tenants more or less permanently, at a market rent. In the longer run, this will discourage foreclosures too.

It’s a great campaign, exactly what we need more of.

But there’s another important thing about No One Leaves: They’re angry. The focus isn’t just on the legal rights of people facing foreclosure, or their real chance to stay in their homes if they organize and stick together, it’s on fighting the banks. There’s a very clear sense that this is not just a problem to be solved, but that the banks are the enemy. I was especially struck by one middle-aged guy who’d lost the home he’d lived in for some 20 years to foreclosure. “At this point, I don’t even care if I get to stay,” he said. “Look, I know I’m probably going to have to leave eventually. I just want to make this as slow, and expensive, and painful, for Bank of America as I can.” Everyone in the room cheered.

Liberals hate this sort of thing. But it seems to be central to successful organizing. Back when I was at the Working Families Party, one of the things the professional organizers always talked about was the importance of polarizing — getting people to articulate who was responsible for their problems, who’s the other side. It was a central step in any house visit, any meeting. And from what I could tell, it worked. I mean, it’s foolish of someone like Mary Lee Ward to say, “I will not compromise,” isn’t it? Objectively, compromise is how most problems get solved. But if she didn’t have a clear sense of being on the side of right against wrong, how would she have the energy to keep up what, objectively, was very likely to be a losing fight, or convince her neighbors to join her? Somebody or other said there are always three questions in politics. You have to know what is to be done — the favorite topic of intellectuals. But that’s not enough. You also have to know which side you are on, but that’s not enough either. Before you devote your time and energy to a political cause, you have to know who is to blame.

A while back I had a conversation with a friend who’s worked for the labor movement for many years, one campaign after another. If you know anyone like that, or have been part of an organizing drive yourself, you know that in the period before a union representation vote, an American workplace is a little totalitarian state. (Well, even more than usual.) Spies reporting on private conversations, mandatory mass meetings, veiled and open threats, punishment on the mere suspicion of holding the wrong views, no due process. And yet people do still vote for unions and support unionization campaigns, even when being fired would be a a personal catastrophe. Why, I asked my friend. I mean, union jobs do have better pay, benefits, job security —  but are they that much better, that people think they’re worth the risk? “Oh, it’s not about that,” he said. “It’s about the one chance to say Fuck You to your boss.”

Hardt and Negri have a line somewhere in Empire about how, until we can overcome our fear of death, it will be “carried like a weapon against the hope of liberation.” When I first read the book, I thought that was pretty strange. But now I think there’s something important there. Self interest, even enlightened, only takes you so far, because when you’re weak, your self-interest is very often going to be in accomodation to power. I’m not sure I’d go as far as Hardt and Negri, that we have to lose our fear of death to be free moral agents. But it is true that we can’t organize collectively to assert our rights in our homes and our jobs as long as we’re dominated individually by our fear of losing them. Some other motivation — dignity,  pride, anger or even hatred — is needed to say, instead, that nobody is going to walk all over you.

A History of Debt/GDP

“Probably more uninformed statements have been made on public-sector debt and deficits,” says Willem Buiter, “than on any other subject in macroeconomics. Proof by repeated assertion has frequently appeared to be an acceptable substitute for proof by deduction or proof by induction.”

It’s hard to disagree. 
But at least we know where an informed discussion starts. It starts from the least controversial equation of macroeconomics, the law of motion of public debt:
b is the ratio of public debt to GDP, d is the ratio of primary deficit to GDP, i is the nominal interest rate, g is the real growth rate of GDP, and pi is inflation. In principle this is true by definition. (In practice things aren’t alway so simple.) The first thing you realize, looking at this equation, is that contrary to the slack-jawed bleating of conventional opinion, there’s no necessary connection between the evolution of public debt and government spending and taxes. Interest rates, growth rates and inflation are, in principle, just as important as the primary balance. Which naturally invites the question, which have been more important in practice?
There have been various efforts to answer this question for different countries in different periods, but until recently there wasn’t any systematic effort to answer it for a broad sample of countries over a long period. I was thinking of trying to do such an exercise myself. But it looks like that’s not necessary. As Tom M. points out in comments,  the IMF has just undertaken such an exercise. Using the new Historical Public Debt Database, they’ve decomposed the debt-GDP ratios of 174 countries, from 1880 to the present, into the four components of the law of motion. (Plus a fifth, discussed below.) It’s an impressive project. Ands far as one can tell from this brief presentation, they did it right. Admittedly it’s a laconic 25-page powerpoint, but there’s not even the hint of a suggestion that microfoundations or welfare analysis would contribute anything. The question is just, how much has each of the components contributed to shifts in debt-GDP ratios historically?
As I’ve noted here before, the critical issue is the relationship between g and i, or (g + pi) and i as I’ve written it here. On this point, the IMF study gives ammunition to both sides.
From roughly 1895 to 1920, and from 1935 to 1980, nominal growth rates (g + pi) generally exceeded nominal interest rates. From 1880 to 1895, from 1920 to 1935, and from 1980 to the present, interest mostly exceeded growth. It’s impossible, looking at this picture, to say one relationship or the other is normal. Lernerian-Keynesians will say, why can’t the conditions of the postwar decades be reproduced by any government that chooses to; while the orthodox (Marxists and neoclassicals equally) will say the postwar decades were anomalous for various reasons — financial repression, limited international mobility of capital, exceptionally strong growth. The historical evidence doesn’t clearly resolve the question either way.

Given the unstable relationship between g and i, it’s not surprising there’s no consistent pattern in episodes of long-term reduction in debt-GDP ratios. I had hoped such episodes would turn out to be always, or almost always, the result of faster growth, lower interest rates, and higher inflation. This is basically true for the postwar decades, when the biggest debt reductions happened. Since 1980, though, it seems that countries that have reduced their debt-GDP ratios have done it the hard way, by taxing more than they spent. Over the whole period since 1880, periods of major (at least 10 percent of GDP) debt reduction has involved primary surpluses and g > r in about equal measure.

Another interesting point is how much the law of motion turns out to have exceptions. The IMF’s version of the equation above includes an additional term on the right side: SFA, or stock-flow adjustment, meaning the discrepancy between the flow of debt implied by the other terms of the equation and the stock of debt actually observed. This discrepancy turns out to be often quite large. This could reflect a lot of factors; but for recent episodes of rising debt-GDP ratios (in which SFA seems to play a central role) the obvious interpretation is that it reflects the assumption by the government of the banking system’s debts, which is often not reflected in official deficit statistics but may be large relative to the stock of debt. The extreme case is Ireland, where the government guarantee of the financial system resulted in the government assuming bank liabilities equal to 45 percent of GDP. To the extent this is an important factor in rising public debt generally — and again, the IMF study supports it — it suggests another reason why concern with balancing the long-term budget by “reforming” Medicare, etc., is misplaced. One financial crisis can cancel out decades of fiscal rectitude; so if you’re concerned about what the debt-GDP ratio will be in 2075, you should spend less time thinking about public spending and taxes, and much more time thinking about effective regulation of the financial sector.
The bottom line is, the dynamics of public debt are complicated. But as always, intractable theoretical controversies become more manageable, or at least more meaningful, when they’re posed as concrete historical questions. Good on the IMF for doing this.

A History of Catastrophes

Schumpeter says:

Even if he confines himself to the most regular of commodity bills and looks with aversion on any paper that displays a suspiciously round figure,the banker must not only know what the transaction is which he is asked to finance and how it is likely to turn out, but he must also know the customer, his business, and even his private habits, and get, by frequently “talking things over with him,” a clear picture of his situation. … However, this is not only highly skilled work, proficiency in which cannot be acquired in any school except that of experience, but also work which requires intellectual and moral qualities not present in all people who take to the banking profession. 

… In the case of bankers, however, failure to be up to what is a very high mark interferes with the working of the system as a whole. Moreover, bankers may, at some times and in some countries, fail to be up to the mark corporatively: that is to say, tradition and standards may be absent to such a degree that practically anyone, however lacking in aptitude and training, can drift into the banking business, find customers, and deal with them according to his own ideas. In such countries or times, wildcat banking develops. This in itself is sufficient to turn the history of capitalist evolution into a history of catastrophes.

From Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process.

What a magnificent book! Leaving my heavily-annotated copy on the NYC subway is one of my great regrets in life, bookwise. It doesn’t seem to be in print now. Does anybody still read it?

We Are All Austerians Now

Mark Thoma:

we must cut spending and raise taxes to get the debt under control

I’m sorry, but This. Is. Not. True.

If you look at future debt-GDP ratios and think they are too high, how can you reduce them?

1. You can improve the primary balance by raising taxes and/or reducing spending.

2. You can raise the growth rate.

3. You can lower the real interest rate on government debt.

4. You can raise inflation. (This may also help with 3, depending what we think of Fisher’s law.)

EDIT: 5. You can default. (Thanks, Bruce Wilder.)

One is not the only choice. We can, of course, debate which of these choices offers the best tradeoff between feasibility and desirability. But it is not true that reducing the long-run debt-GDP ratio necessarily involves reducing spending or raising taxes. And anyone who want a rational discussion of fiscal issues, needs to stop lying to people that it is.

How bad things are, can be seen by the fact that someone as smart as Barkely Rosser has been convinced that a reluctance to raise taxes is the problem for aggregate demand. When the debate comes down or whether we should raise taxes or cut spending, the real question has been answered, and answered wrong. At that point it’s just a question of what flavor of austerity we want. Thank god at least there’s still Daniel Davis.

If we wanted to move this debate forward, the next step would be to look at periods when the long term debt-GDP ratio was reduced in rich countries. How much was due to the primary balance that Thoma takes for granted is the only solution, how much was due to faster growth, how much to lower interst rates and how much to higher inflation?

How the Other Side Thinks

At least someone is happy about the debt-ceiling deal:

Low government debt yields may reflect concern about the health of the economy and the drag spending cuts would have on gross domestic product.

Reductions are “going to be good for Treasuries, ironically, because it’s bad for the economy,” Tad Rivelle, the head of fixed-income investment at Los Angeles-based TCW Group Inc., which manages about $115 billion, said in an interview last week. “It ought to further restrain economic growth by in effect withdrawing a good deal of fiscal stimulus.” 

By “good for Treasuries,” he means good for people who own Treasuries.

This brings out a point I’ve been thinking about for a while. Marxist  and mainstream economists don’t agree on much, but one view they do generally share is that under capitalism, growth is the central objective pursued by the state. Maybe we should not take that for granted.

For individual capitals, growth, endless accumulation, is a necessity imposed by the pressure of competition. And when the individual capitalist tries to influence the state they are generally looking for measures to help them grow faster. They have to, it’s a condition of their survival. But insofar as the capitalist class as a whole (or some substantial fraction of it) exercises political agency, they’re not subject to competition. An individual capital needs to grow as fast as possible so as not to be overtaken by its rivals; but for capital as a whole, there is no equivalent pressure. What capital as a whole needs from the state is to maintain its basic conditions of existence and secure its political dominance. And that may well be as well achieved through slower growth, as through faster. Directly, because the labor supply is liable to be dangerously depleted by rapid growth. More broadly, because growth is inherently chaotic, unpredictable and destabilizing. This isn’t in the textbooks but you can learn it from Schumpeter just as well as from Marx. Or from just from looking around.

There’s a long line of arguments, going back to Marx’s reserve army of the unemployed, via Kalecki’s “Political Aspects of Full Employment,” formalized in the postwar period as Goodwin cycles or Crotty and Boddy’s political business cycles, and most fully developed in Glyn et al.’s Capitalism Since 1945, that periods of low unemployment can’t be sustained under capitalism, because they put upward pressure on wages and more broadly leave workers overly confident and politically empowered. Greenspan, bless his shriveled soul, was onto something important when he insisted in the late 1990s that the Fed could tolerate low unemployment without raising interest rates only because workers were intimidated by downsizing and the loss of job security.

Now, these are cyclical arguments. And the US hasn’t had a cycle of this kind since the 1980s. The last couple of downturns haven’t been about wages, at least overtly, but about asset bubbles and oil prices. But even if this recession wasn’t caused by the Fed raising interest rates to choke off wage growth (and clearly it wasn’t) capital and its political representatives could take advantage of it opportunistically to force down the wage share. One wouldn’t deliberately provoke a deep recession just to reduce wages, because of the political risks; but if one stumbles into it and the politics turn out to be manageable, why let a good crisis go to waste?

More broadly, if high growth rates are risky for capital, and if they were only politically necessary thanks to competition with the Soviet Union (this is an important argument that’s not quite spelled out in the Glyn book), then we shouldn’t be shocked if the post-Cold War state ends up preferring growth-reducing policies. Brad DeLong has been complaining lately about the failure, as he sees it, of the state to live up to its role as the committee to manage the collective affairs of the bourgeoisie. But maybe he just hasn’t been invited to the meetings.

UPDATE: Yglesias makes a similar argument in a less provocative way. Before the 1980s, we had episodes of high inflation, and no episodes of sustained high unemployment. Since the 1980s, we’ve had no episodes of high inflation, but we’ve had repeated episodes of sustained high unemployment. The obvious interpretation, which I share with Ygelsias, is that the Phillips Curve is not vertical even over the long run — there is a secular tradeoff between employment and price stability, and since Volcker the Fed’s preferences have shifted toward the price-stability side. Why this is the case is a different question, but it seems safe to say it has to do with the diverging interests of workers and owners and their respective political strength.