September 2023 – J. W. Mason

Remembering Jim Crotty

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

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

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

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

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

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

by Arjun Jayadev and J. W. Mason

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

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

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

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

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

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.)