Author: JW Mason

Heterodoxy and the Fly-Bottle

(I have a review in the new Review of Keynesian Economics of a collection of essays on pluralist, or non-mainstream, economics teaching. You can the full review here. Since I doubt most readers of this blog are interested in the book, I’ve posted a shorter version of the review below – just the parts on the broader issues rather than my assessment of these particular essays.)

 

Wittgenstein famously described his aim in philosophy as “showing the fly the way out of the fly bottle.” The goal, he said, was not to resolve the questions posed by philosophers, but to escape them. As long as the fly is inside the bottle, understanding its contours is essential to getting it wherever it wants to go; but once the fly is outside, the shape of the bottle doesn’t matter at all.

Non-mainstream economists have a similar relationship to dominant theory. Because we’ve been inculcated for years that the best way to think about the economy is in terms of the exchange of goods by rational agents, criticisms of that framework are a necessary step on the way to thinking in other terms. But the logical and empirical shortcomings of thinking about economic life in terms of a perfectly rational representative agent optimizing utility over infinite future time don’t, in themselves, tell us how we should think instead.

The essentially negative character of economic heterodoxy is a special challenge for undergraduate teaching. You can’t teach criticisms of economic orthodoxy without first teaching the ideas to be criticized. Finding our way out of orthodoxy was, for many of us, central to our intellectual development. Naturally we want to reproduce that experience for our students. This leads to a style of teaching that amounts to putting the flies into the bottle so we can show them the way out. But how useful is it to our students to understand the defects of a logical system it would never have occurred to them to adopt in the first place? Having spent so much time looking for a way out, it sometimes seems we don’t know what do in the open air.

This dilemma is on full display in The Handbook of Pluralist Economics Education. In order to present a realistic model of the economy, Steve Keen writes in one of his two chapters, “an essential first is to demonstrate to students that the ostensibly well-developed and coherent traditional model is in fact an empty shell”. Many of the volume’s other contributors make similar claims. This is the spirit of Joan Robinson’s famous quip that the only reason to study economics is to avoid being fooled by economists. But if that is all we can offer, better to send our students to the departments of history, anthropology, engineering, or some other field that offers positive knowledge about social reality.

What then are we to do? Pluralism as such is not a useful guide; carried to an extreme it would, as Sheila Dow says here, amount to “anything goes,” which is not a viable basis for teaching a class (or for any other intellectual endeavor). This is a problem with pluralism as a positive value (and not only in economics teaching): Pluralism implies a number of distinct perspectives, but to be distinct they must be internally coherent, that is, unitary. Carried to an extreme, pluralism is self-undermining. To challenge the mainstream, at some point you must argue not just for the value of diversity in the abstract, but in favor of a particular alternative.

In practice, even economists who completely reject mainstream approaches in their own work often give them a large share of time in the classroom, in part because they feel obligated to prepare students for future academic work and in part, as Keen says, simply because of “the pressure to teach something”. Teaching is hard enough work even when you aren’t reconstructing the curriculum from the ground up. It’s much easier to teach a standard course and then add some critical material.

But pluralism in economics teaching doesn’t have to mean simply presenting orthodoxy and adding some criticisms of it. It could also mean approaching the material from a different angle that avoids — rather than attacks — the dominant formalisms in economics and gives students a useful set of tools for engaging with economic reality. For me, this means a focus on the definition and measurement of macroeconomic aggregates, and on the causal relationships between those aggregates. Concretely, it means reliance on flowcharts where the nodes are some observable variable, as opposed to the normal emphasis on diagrams representing functional relationships — ISLM, AS-AD, etc. — that can’t be directly observed.

A more specific problem in heterodox teaching — and heterodox economics in general — is the weight put on the financial crisis as an argument for alternatives to the mainstream. Many of the authors in this collection present the crisis of 2008 and its aftermath as a decisive refutation of economic orthodoxy. Edward Fullbrook declares that ‘no discipline has ever experienced systemic failure on the scale that economics has today.” David Wheat, less hyperbolically, argues that “the failure to foresee the financial epidemic in 2008” demonstrates a need to shift the focus of economics teaching away from long-run equilibrium. One might push back against this line of argument. It is true that several large financial institutions went bankrupt in 2008, and some financial assets fell steeply in value, to the dismay of their owners; but with the perspective of close to a decade, it’s less clear how much of a base these events offer for critique of either the economics profession or economic institutions. Singleminded focus on “the crisis” risks implying that the problem with our economic system is the rare occasions on which it fails to work well for owners of financial assets, while ignoring the ongoing problems of inequality, hierarchy and privilege; tedious and demeaning work; environmental degradation; and the fundamental disconnect between ever-increasing money wealth and unmet human needs – none of which has much to do with the failure of Lehman Brothers. As people used to say: capitalism is the crisis.

It is true, of course, that the economics profession failed to foresee or explain the 2008 crisis, but that’s nothing special. To make a list of phenomena unexplained by orthodox economics, just open the business pages of a newspaper. In any case, while it might have been reasonable at the time to expect some degree of self-criticism in the economics profession, and some increase in openness to alternatives, seven years later it is clear that there has not been. With a handful of exceptions – Naryana Kocherlakota is probably the most prominent in the US – mainstream economists have not revised their views in the light of the crisis; even those who were initially inclined to soul-searching have mostly decided that they were right all along. The case for heterodoxy must be made on other grounds.

Varieties of Sabotage

Today’s New York Times: DNAInfo and Gothamist Are Shut Down after Vote to Unionize

Thorstein Veblen, The Engineers and the Price System:

“Sabotage” is a derivative of “sabot,” which is French for a wooden shoe. It means going slow, with a dragging, clumsy movement, such as that manner of footgear may be expected to bring on. So it has come to describe any manoeuvre of slowing-down, inefficiency, bungling, obstruction. … Manoeuvres of restriction, delay, and hindrance have a large share in the ordinary conduct of business; but it is only lately that this ordinary line of business strategy has come to be recognized as being substantially of the same nature as the ordinary tactics of the syndicalists. …But all this strategy of delay, restriction, hindrance, and defeat is manifestly of the same character, and should conveniently be called by the same name, whether it is carried on by business men or by workmen; so that it is no longer unusual now to find workmen speaking of “capitalistic sabotage” as freely as the employers and the newspapers speak of syndicalist sabotage. As the word is now used, and as it is properly used, it describes a certain system of industrial strategy or management, whether it is employed by one or another. What it describes is a resort to peaceable or surreptitious restriction, delay, withdrawal, or obstruction.

Sabotage commonly works within the law, although it may often be within the letter rather than the spirit of the law. It is used to secure some special advantage or preference, usually of a businesslike sort. It commonly has to do with something in the nature of a vested right, which one or another of the parties in the case aims to secure or defend, or to defeat or diminish; some preferential right or special advantage in respect of income or privilege, something in the way of a vested interest. Workmen have resorted to such measures to secure improved conditions of work, or increased wages, or shorter hours, or to maintain their habitual standards, to all of which they have claimed to have some sort of a vested right. Any strike is of the nature of sabotage, of course. Indeed, a strike is a typical species of sabotage. … So also, of course, a lockout is another typical species of sabotage. That the lockout is employed by the employers against the employees does not change the fact that it is a means of defending a vested right by delay, withdrawal, defeat, and obstruction of the work to be done. …

By virtue of his ownership the owner-employer has a vested right to do as he will with his own property, to deal or not to deal with any person that offers, to withhold or withdraw any part or all of his industrial equipment and natural resources from active use for the time being, to run on half time or to shut down his plant and to lock out all those persons for whom he has no present use on his own premises. There is no question that the lockout is altogether a legitimate manoeuvre. It may even be meritorious, and it is frequently considered to be meritorious when its use helps to maintain sound conditions in business—that is to say profitable conditions—as frequently happens. … It should not be difficult to show that the common welfare in any community which is organized on the price system cannot be maintained without a salutary use of sabotage — that it to say, such habitual recourse to delay and obstruction of industry…

All this is matter of course, and notorious. But it is not a topic on which one prefers to dwell. Writers and speakers who dilate on the meritorious exploits of the nation’s business men will not commonly allude to this voluminous running administration of sabotage, this conscientious withdrawal of efficiency, that goes into their ordinary day’s work. One prefers to dwell on those exceptional, sporadic, and spectacular episodes in business where business men have now and again successfully gone out of the safe and sane highway of conservative business enterprise … by increasing the productive capacity of the industrial system …

It is for these business men to manage the country’s industry, of course, and therefore to regulate the rate and volume of output; and also of course any regulation of the output by them will be made with a view to the needs of business; that is to say, with a view to the largest obtainable net profit, not with a view to the physical needs of these peoples who have come through the war and have made the world safe for the business of the vested interests. Should the business men in charge, by any chance aberration, stray from this straight and narrow path of business integrity, and allow the community’s needs unduly to influence their management of the community’s industry, they would presently find themselves discredited and would probably face insolvency. Their only salvation is a conscientious withdrawal of efficiency.

 

Some Interviews

One new one, and two older ones I should have posted here a while ago.

The new one is with Seth Ackerman at Jacobin. Its starting point is a new article (co-authored with Arjun Jayadev and Enno Schroeder) I have coming out in Development and Change. But it’s also a continuation of the argument I made in my earlier Jacobin piece on the socialization of finance [*], and in my talk at this year’s Left Forum. (I still hope to get a transcript of that one at some point.)

The older two are both in response to my “What Recovery?” report for the Roosevelt Institute. This one, with David Beckworth at the Mercatus Institute, was a wide-ranging conversation that touched on a lot of topics beside the immediate question of whether we should regard the US economy as having reached full employment or potential output. This one, with Joe Weisenthal and his colleagues at “What Did You Miss” on Bloomberg, was much briefer but still managed to cover a lot of ground.

Supposedly there’s also an interview with me coming out in Der Standard, an Austrian newspaper, but I’m not sure when it will appear.

If you’re reading this blog, you’ll probably find these interviews interesting.

[*] Incidentally, my preferred title was that: The Socialization of Finance. I understand why the editors changed it to the catchier imperative form, but what I liked about my original was that it could refer both to something done to finance, and something done by finance.

Review of Mark Wilson’s Destructive Creation

The new issue of Dissent has a review by me of Mark Wilson’s Destructive Creation: American Business and the Winning of World War II. (At the Dissent site the review is still paywalled.)

World War II is a weirdly neglected topic in US economic history. Lots written about the Depression, of course, and then we seem to skip straight to the postwar period. But there’s a lot to learn from the wartime experience, including some important lessons for today’s debates around potential output and the responsiveness of labor force participation and productivity to demand conditions. Wilson’s book is not helpful on those particular questions, but it has a lot of interesting material on its own topic of how relations between private business and government shifted during the war. Anyway, you can read the review here.

 

 

Five, Ten or Even Thirty Years

Neel Kashkari is clearly a very smart guy. He’s been an invaluable voice for sanity at the Fed these past few years. Doesn’t he see that something has gone very wrong here?

Kashkari:

When people borrow money to buy a house, or businesses take out a loan to build a new factory, they don’t really care about overnight interest rates. They care about what interest rates will be for the term of their loan: 5, 10 or even 30 years. [*] Similarly, when banks make loans to households and businesses, they also try to assess where interest rates will be over the length of the loan when they set the terms. Hence, expectations about future interest rates are enormously important to the economy. When the Fed wants to stimulate more economic activity, we do that by trying to lower the expected future path of interest rates. When we want to tap the brakes, we try to raise the expected future path of interest rates.

Here’s the problem: recession don’t last 5, 10 or even 30 years. Per the NBER, they last a year to 18 months.

Mainstream theory says we have a long run dictated by supply side — technology, demographics, etc. On average the output gap is zero, or at least, it’s at a stable level. On top of this are demand disturbances or shocks — changes in desired spending — which produce the businesses cycle, alternating periods of high unemployment and normal growth or rising inflation. The job of monetary policy is to smooth out these short-term fluctuations in demand; it absolves itself of responsibility for the longer-run growth path.

If policy responding to demand shortfalls lasting a year or two, how is that supposed to work if policy shifts have to be maintained for 5, 10 or even 30 years to be effective?

If the Fed is faced with rising inflation in 2005, is it supposed to respond by committing itself to keeping rates high even in 2010, when the economy is sliding into depression? Does anyone think that would have been a good idea? (I seriously doubt Kashkari thinks so.) And if it had made such a commitment in 2005, would anyone have worried about breaking it in 2010? But if the Fed can’t or shouldn’t make such a commitment, how is this vision of monetary policy supposed to work?

If monetary policy is only effective when sustained for 5, 10 or even 30 years, then monetary policy is not a suitable tool for managing the business cycle. Milton Friedman pointed this out long ago: It is impossible for countercyclical monetary policy to work unless the lags with which it takes effect are decidedly shorter than the frequency of the shocks it is supposed to respond to. The best you can do, in his view, is maintain a stable money supply growth that will ensure stable inflation over the long run.

Meanwhile, conventional monetary policy rules like the Taylor rule are defined based on current macroeconomic conditions — today’s inflation rate, today’s output gap, today’s unemployment rate. There’s no term in there for commitments the Fed made at some point in the past. The Taylor rule seems to describe the past two or three decades of monetary policy pretty well. Now, Kashkari says the Fed can influence real activity only insofar as it is setting policy over the next 5, 10 or even 30 year’s based on today’s conditions. But what the Fed actually will do, if the Taylor rule continues to be a reasonable guide, is to set monetary policy based on conditions over the next 5, 10 or even 30 years. So if Kashkari takes his argument seriously, he must believe that monetary policy as it is currently practiced is not effective at all.

In the abstract, we can imagine some kind of rule that sets policy today as some kind of weighted average of commitments made over the past 5, 10 or even 30 years. Of course neither economic theory nor official statements describe policy this way. Still, in the abstract, we can imagine it. But in practice? FOMC members come and go; Kashkari is there now, he’ll be gone next year. The chair and most members are appointed by presidents, who also come and go, sometimes in unpredictable ways. Whatever Kashkari thinks is the appropriate policy for 2022, 2027 or 2047, it’s highly unlikely he’ll be there to carry it out. Suppose that in 2019 Fed chair Kevin Warsh  looks at the state of the economy and says, “I think the most appropriate policy rate today is 4 percent”. Is it remotely plausible that that sentence continues “… but my predecessor made a commitment to keep rates low so I will vote for 2 percent instead”? If that’s the reed the Fed’s power over real activity rests on it, it’s an exceedingly thin one. Even leaving aside changes of personnel, the Fed has no institutional capacity to make commitments about future policy. Future FOMC members will make their choices based on their own preferred models of the economy plus the data on the state of the economy at the time. If monetary policy only works through expectations of policy 5, 10 or even 30 years from now, then monetary policy just doesn’t work.

There are a few ways you can respond to this.

One is to accept Kashkari’s premise — monetary policy is only effective if sustained over many years — and follow it to its logical conclusion: monetary policy is not useful for stabilizing demand over the business cycle. Two possible next steps: Friedman’s, which concludes that stabilizing demand at business cycle frequencies is not a realistic goal for policy, and the central bank should focus on the long-term price level; and Abba Lerner’s, which concludes that business cycles should be dealt with by fiscal policy instead.

The second response is to start from the fact — actual or assumed — that monetary policy is effective at smoothing out the business cycle, in which case Kashkari’s premise must be wrong. Evidently the effect of monetary policy on activity today does not depend on beliefs about what policy will be 5, 10 or even 30 years from now. This is not a hard case to make. We just have to remember that there is not “an” interest rate, but lots of different credit markets, with rationing as well as prices, with different institutions making different loans to different borrowers. Policy is effective because it targets some particular financial bottleneck. Perhaps stocks or inventories are typically financed short-term and changes in their financing conditions are also disproportionately likely to affect real activity; perhaps mortgage rates, for institutional reasons, are more closely linked to the policy rate than you would expect from “rational” lenders; perhaps banks become more careful in their lending standards as the policy rate rises. One way or another, these stories depend on widespread liquidity constraints and the lack of arbitrage between key markets. Generations of central bankers have told stories like these to explain the effectiveness of monetary policy. Remember Ben Bernanke? His article Inside the Black Box is a classic of this genre, and its starting point is precisely the inadequacy of Kashkari’s interest rate story to explain how monetary policy actually works. Somehow or other policy has to affect the volume of lending on a short timeframe than it can be expected to move long rates. Going back a bit further, the Fed’s leading economist of the 1950s, Richard Roosa, was vey clear that neither the direct effect of Fed policy shifts on longer rates, nor of interest rates on real activity, could be relied on. What mattered rather was the Fed’s ability to change the willingness of banks to make loans. This was the “availability doctrine” that guided monetary policy in the postwar years. [2] If you think monetary policy is generally an effective tool to moderate business cycles, you have to believe something like this.

Response three is to accept Kashkari’s premise, yet also to believe that monetary works. This means you need to adjust your view of what policy is supposed to be doing. Policy that has to be sustained for 5, 10 or even 30 years to be effective, is no good for responding to demand shortfalls that last only a year or two at most. It looks better if you think that demand may be lacking for longer periods, or indefinitely. If shifts in demand are permanent, it’s not such a problem that to be effective policy shifts must also be permanent, or close to it. And the inability to make commitments is less of a problem in this case; now if demand is weak today, theres a good chance it will be weak in 5, 10 or even 30 years too; so policy will be persistent even if it’s only based on current conditions. Obviously this is inconsistent with an idea that aggregate demand inevitably gravitates toward aggregate supply, but that’s ok. It might indeed be the case that demand deficiencies an persist indefinitely, requiring an indefinite maintenance of lower rates. There’s a good case that something like this response was Keynes’ view. [3] But while this idea isn’t crazy, it’s certainly not how central banks normally describe what they’re doing. And Kashkari’s post doesn’t present itself as a radical reformulation of monetary policy’s goals, or mention secular stagnation or anything like that.

I don’t know which if any of these responses Kashkari would agree with. I suppose it’s possible he sincerely believes that policy is only effective when sustained for 5, 10 or even 30 years, and simply hasn’t noticed that this is inconsistent with a mission of stabilizing demand over business cycles that turn much more quickly. Given what I’ve read of his I feel this is unlikely. It also seems unlikely that he really thinks you can understand monetary policy while abstracting from banks, finance, credit and, well, money — that you can think of it purely in terms of an intertemporal “interest rate,” goods today vs goods tomorrow, which the central bank can somehow set despite controlling neither preferences nor production possibilities. My guess: When he goes to make concrete policy, it’s on the basis of some version of my response two, an awareness that policy operates through the concrete financial structures that theory abstracts from. And my guess is he wrote this post the way he did because he thought the audience he’s writing for would be more comfortable with a discussion of the expectations of abstract agents, than with a discussion of the concrete financial structures through which monetary policy is transmitted. It doesn’t hurt that the former is much simpler.

Who knows, I’m not a mind reader. But it doesn’t really matter. Whether the most progressive member of the FOMC has forgotten everything his predecessors knew about the transmission of monetary policy, or whether he merely assumes his audience has, the implications are about the same. “The Fed sets the interest rate” is not the right starting point for thinking about monetary policy manages aggregate demand.

 

[1] This is a weird statement, and seems clearly wrong. My wife and I just bought a house, and I can assure you we were not thinking at all about what interest rates would be many years from now. Why would we? — our monthly payments are fixed in the contract, regardless of what happens to rates down the road. Allowing the buyer to not care about future interest rates is pretty much the whole point of the 30-year fixed rate mortgage. Now it is true that we did care, a little, about interest rates next year (not in 5 years). But this was in the opposite way that Kashkari suggests — today’s low rates are more of an inducement to buy precisely if they will not be sustained, i.e. if they are not informative about future rates.

I think what may be going on here is a slippage between long rates — which the borrower does care about — and expected short rates over the length of the loan. In any case we can let it go because Kashkari’s argument does work in principle for lenders.

[2] Thanks to Nathan Tankus for pointing this article out to me.

[3] Leijonhufvud as usual puts it best:

Keynes looked forward to an indefinite period of, at best, unrelenting deflationary pressure and painted it in colors not many shades brighter than the gloomy hues of the stagnationist picture. But these stagnationist fears were based on propositions that must be stated in terms of time-derivatives. Modern economies, he believed, were such that, at a full employment rate of investment, the marginal efficiency of capital would always tend to fall more rapidly than the long rate of interest. … When he states that the long rate “may fluctuate for decades about a level which is chronically too high” one should … see this in the historical context of the “obstinate maintenance of misguided monetary policies” of which he steadily complained.

Readings: A Couple New Papers on Fiscal Policy

From the NBER working paper series — essential reading if you want to follow what the mainstream of the profession is up to — here are a couple interesting recent papers on fiscal policy. They offer some genuinely valuable insights, while also demonstrating the limits of orthodoxy.

Geographic Cross-Sectional Fiscal Spending Multipliers: What Have We Learned?
Gabriel Chodorow-Reich
NBER Working Paper No. 23577

Gabriel Chodorow-Reich has a useful new entry in the burgeoning literature on the empirics of fiscal multipliers — a review of the now-substantial work on state-level multipliers. Most of these papers are based on spending under the 2009 stimulus (the ARRA) — since many components of its spending were set by formulas not responsive to local economic conditions, cross-state variation can reasonably be considered exogenous. (Another reason the ARRA features so heavily in these papers is, of course, that the revival of mainstream interest in fiscal multipliers is mostly a post-crisis phenomenon.) Other studies estimate local multipliers based on  other public spending with plausibly exogenous regional variation, such as that involved in a military buildup or response to a natural disaster.

How do these local multipliers translate into the national multiplier we are usually more interested in? There are two main differences, pointing in opposite directions. On the one hand, states are more open than the US as a whole (or than other large countries, though perhaps not more than small European countries). This means more spillover of demand across borders, meaning a smaller multiplier. On the other hand, since states don’t conduct their own monetary policy (and since the US banking system is no longer partitioned by state) the usual channels of crowding out don’t operate at the state level. This implies a bigger multiplier. It’s hard to say which of these effects is bigger in general, but when interest rates are constrained, by the zero lower bound for example, crowding out doesn’t happen by that channel at the national level either. So at the zero lower bound, Chodorow-Reich argues, the national multiplier should be unambiguously greater than the average state multiplier.

Based on the various studies he discusses (including a couple of his own), he estimates a state-level multiplier of 1.8.  He subtracts an arbitrary tenth of a point to allow for financial crowding out even at the ZLB, giving a value of 1.7 as a lower bound for the national multiplier. This is toward the high end of existing estimates. For whatever reason, Chodorow-Reich makes no effort to even guess at the impact of the greater openness of state-level economies. But if we suppose that the typical import share at the state level is double the national import share, then a back-of-the-envelope calculation suggests that a state-level multiplier of 1.7 implies a national multiplier somewhere above 2.0. [1]

It’s a helpful paper, offering some more empirical support for the new view of fiscal policy that seems to be gradually displacing the balanced-budget orthodoxy of the past generation. But it must be said that it is one of those papers that presents some very interesting empirical results and is evidently attempting to deal with a concrete, policy-relevant question about economic reality — but that seems to devote a disproportionate amount of energy to making its results intelligible within mainstream theory. We’ll really have made progress when this kind of work can be published without a lot of apologies for the use of “non-Ricardian agents.”

The Dire Effects of the Lack of Monetary and Fiscal Coordination
Francesco Bianchi, Leonardo Melosi
NBER Working Paper No. 23605

The subordination of real-world insight to theoretical toy-train sets is much worse in this paper. But there is a genuine insight in it — that when you have a fiscal authority targeting the debt-GDP ratio and a monetary authority targeting inflation (or equivalently, unemployment or the output gap), then when they are independent their actions can create destabilizing feedback loops. In the simple case, suppose the monetary authority responds to higher inflation by raising interest rates. This raises debt service costs, forcing the fiscal authority to reduce spending or raise taxes to meet its debt target. The contractionary effect of this fiscal shift will have to be offset by the central bank lowering rates. This process may converge toward the unique combination of fiscal balance and interest rate at which both inflation and debt ratio are at their desired levels. But as Arjun Jayadev and I have shown, it can also diverge, with the interactions the actions of each authority provoking more and more violent responses from the other.

I’m glad to see some mainstream people recognizing this problem. As the authors note, the basic point was made by Michael Woodford. (Unsurprisingly, they don’t cite this recent paper by Peter Skott and Soon Ryoo, which carefully works through the possible dynamics between the two policy rules. [2]) The implications, as the NBER authors correctly state, are, first, that fiscal policy and monetary policy have to be seen as jointly affecting both the output gap and the public debt; and that if preventing a rising debt ratio is an important goal of policy, holding down interest rates and/or allowing a higher inflation rate are useful tools for achieving it. Unfortunately, the paper doesn’t really develop these ideas — the meat of it is a mathematical exercise showing how these results can occur in the world of a representative agent maximizing its utility over infinite time, if you set up the frictions just right.

 

[1] For the simplest case, suppose the multiplier is equal to (1-m)[1/(1-mpc)], where m is the marginal propensity to import and mpc is the marginal propensity to consume. Then if the state level import propensity is 0.4 and the state level multiplier is 1.7, that implies an mpc of 0.65. Combine that with a national import propensity of 0.2 and you get a national multiplier of 2.3.

[2] The paper was published in Metroeconomica in 2016, but I’m linking to the unpaywalled 2015 working paper version.

 

New Article on Financialization

I have a new article forthcoming in Development and Change, on the political economy of financialization, coauthored with Arjun Jayadev and Enno Schroeder. Abstract:

We discuss the political economy of financialization in three settings: The US, the euro area, and India. The quantitative growth and increased social prominence of financial institutions and markets, we suggest, can be usefully seen in terms of the constraints or “discipline” they impose on other private and public decision makers. The role of finance in allocating real resources may be less important than its role in supporting the claims and authority of wealth-owners vis-a-vis other social actors. In the US, this is most visible in the pressure nonfinancial corporations face to increase payouts to shareholders. In Europe, the financial constraints on national governments are more salient. Tightening these constraints is openly acknowledged as the major benefit of financial integration. On the other hand, the constraints financialization imposes on policy may also limit the extent to which finance can in fact be liberalized. This countervailing pressure is visible in the great expansion of central bank’s balance sheets and management of financial markets over the past decade. It is even more clearly visible in India, where the conflict between financialization and concrete policy goals has sharply limited the extent of liberalization, despite consistent rhetorical support.

Full article here.

Reading Notes: Demand and Productivity

Here are two interesting articles on demand and productivity that people have recently brought to my attention.

The economic historian Gavin Wright — author of the classic account of the economic logic of the plantation — just sent me a piece he wrote a few years ago on the productivity boom of the 1990s. As he said in his email, his account of the ‘90s is very consistent with the suggestions I make in my Roosevelt paper about how strong demand might stimulate productivity growth.

In this article, Wright traces the idea that high wage regions will experience faster productivity growth back to H. J. Habbakuk’s 1962 American and British Technology in the Nineteenth Century. Then he assembles a number of lines of evidence that rapid wage growth drove the late-1990s productivity acceleration, rather than vice versa.

He points out that the widely-noted “productivity explosion” of the 1920s — from 1.5 percent a year to over 5 percent — was immediately preceded by a period of exceptionally strong wage growth: “The real price of labor in the 1920s … was between 50 and 70 percent higher than a decade earlier.” [1] The pressure of high wages, he suggests, encouraged the use of electricity and other general-purpose technologies, which had been available for decades but only widely adopted in manufacturing in the 1920s. Conversely, we can see the productivity slowdown of the 1970s as, at least in part, a result of the deceleration of wage growth, which — Wright argues — was the result of institutional changes including the decline of unions, the erosion of the minimum wage and other labor regulations, and more broadly the shift back toward “‘flexible labor markets,’ reversing fifty years of labor market policy.”

Turning to the 1990s, the starting point is the sharp acceleration of productivity in the second half of the decade. This acceleration was very widely shared, including sectors like retail where historically productivity growth had been limited. The timing of this acceleration has been viewed as a puzzle, with no “smoking gun” for simultaneous productivity boosting innovations across this range of industries over a short period. But “if you look at the labor market, you can find a smoking gun in the mid-1990s. … real hourly wages finally began to rise at precisely that time, after more than two decades of decline. … Unemployment rates fell below 4 percent — levels reached only briefly in the 1960s… Should it be surprising that employers turned to labor-saving technologies at this time?” This acceleration in real wages, Wright argues, was not the result of higher productivity or other supply-side factors; rather “it is most plausibly attributed to macroeconomic conditions, when an accommodating Federal Reserve allowed employment to press against labor supply for the first time in a generation.”

The productivity gains of the 1990s did, of course, involve new use of information technology. But the technology itself was not necessarily new. “James Cortada [2004] lists eleven key IT applications in the retail industry circa 1995-2000, including electronic shelf levels, scanning, electronic fund transfer, sales-based ordering and internet sales … with the exception of e-business, the list could have come from the 1970s and 1980s.”

Wright, who is after all a historian, is careful not to argue that there is a general law linking higher wages to higher productivity in all historical settings. As he notes, “such a claim is refuted by the experience of the 1970s, when upward pressures on wages led mainly to higher inflation…” In his story, both sides are needed — the technological possibilities must exist, and there must be sufficient wage pressure to channel them into productivity-boosting applications. I don’t think anyone would say he’s made a decisive case , but if you’re inclined to a view like this the article certainly gives you more material to support it.

*

A rather different approach to these questions is this 2012 paper by Servaas Storm and C. W. M. Naastepad. Wright is focusing on a few concrete episodes in the history of a particular country, which he explores using a variety of material — survey and narrative as well as conventional economic data. Storm and Naastepad are proposing a set of general rules that they support with a few stylized facts and then explore via of the properties of a formal model. There are things to be learned from both approaches.

In this case the model is simple: output is demand-determined. Demand is either positive or negative function of the wage share (i.e. the economy is either wage-led or profit-led). And labor productivity is a function of both output and the wage, reflecting two kinds of channels by which demand can influence productivity. And an accounting identity says that employment growth is qual to output growth less labor productivity growth. The productivity equation is the distinctive feature here. Storm and Naastepad adopt as “stylized facts” — derived from econometric studies but not discussed in any detail — that both parameters are on the order of 0.4: An additional one percent growth in output, or in wages, will lead to an 0.4 percent growth in labor productivity.

This is a very simple structure but it allows them to draw some interesting conclusions:

– Low wages may boost employment not through increased growth or competitiveness, but through lower labor productivity. (They suggest that this is the right way to think about the Dutch “employment miracle of the 1990s.)

– Conversely, even where demand is wage-led (i.e. a shift to labor tends to raise total spending) faster wage growth is not an effective strategy for boosting employment, because productivity will rise as well. (Shorter hours or other forms of job-sharing, they suggest, may be more successful.)

– Where demand is strongly wage-led (as in the Scandinavian countries, they suggest), profits will not be affected much by wage growth. The direct effect of higher wages in this case could be mostly or entirely offset by the combination of higher demand and higher productivity. If true, this has obvious implications for the feasibility of the social democratic bargain there.

– Where demand is more weakly wage-led or profit-led (as with most structuralists, they see the US as the main example of the latter), distributional conflicts will be more intense. On the other hand, in this case the demand and productivity effects work together to make wage restraint a more effective strategy for boosting employment.

It’s worth spelling out the implications a bit more. A profit-led economy is one in which investment decisions are very sensitive to profitability. But investment is itself a major influence on profit, as a source of demand and — emphasized here — as a source of productivity gains that are captured by capital. So wage gains are more threatening to profits in a setting in which investment decisions are based largely on profitability. In an environment in which investment decisions are motivated by demand or exogenous animal spirits (“only a little more than an expedition to the South Pole, based on a calculation of benefits to come”), capitalists have less to fear from rising wages. More bluntly: one of the main dangers to capitalists of a rise in wages, is their effects on the investment decisions of other capitalists.

What Recovery: Reading Notes

My Roosevelt Institute paper on potential output came out last week. (Summary here.) The paper has gotten some more press since Neil Irwin’s Times piece, including Ryan Cooper in The Week and Felix Salmon in Slate. My favorite headline is from Boing Boing: American Wages Are So Low, the Robots Don’t Want Your Jobs.

In the paper I tried to give a fairly comprehensive overview of the evidence and arguments that the US economy is not in any meaningful sense at potential output or full employment. But of course it was just one small piece of a larger conversation. Here are a few things I’ve found interesting recently on the same set of issues. .

Perhaps the most important new academic contribution to this debate is this paper by Olivier Coibion, Yuriy Gorodnichenko, and Mauricio Ulate, on estimates of potential output, which came out too late for me to mention in the Roosevelt report. Their paper rigorously demonstrates that, despite their production-function veneer, the construction of potential output estimates ensures that any persistent change in growth rates will appear as a change in potential. It follows that there is “little value added in estimates of potential GDP relative to simple measures of statistical trends.” (Matthew Klein puts it more bluntly in an Alphaville post discussing the paper: “‘Potential’ output forecasts are actually worthless.”) The paper proposes an alternative measure of potential output, which they suggest can distinguish between transitory demand shocks and permanent shifts in the economy’s productive capacity. This alternative measure gives a very similar estimate for the output gap as simply looking at the pre-2008 forecasts or extrapolating from the pre-2008 trend.  “Our estimates imply that U.S. output remains almost 10 percentage points below potential output, leaving ample room for policymakers to close the gap through demand-side policies if they so chose to.” Personally, I ‘m a little less convinced by their positive conclusions than by their negative ones. But this paper should definitely put to the rest the idea (as in last year’s notorious CEA-chair letter) that it is obviously wrong — absurd and unserious — that a sufficient stimulus could deliver several years of 4 percent real growth, until GDP returned to its pre-recession trend. It may or may not be true, but it isn’t crazy.

Many of the arguments in my paper were also made in this valuable EPI report by Josh Bivens, reviving the old idea of a “high pressure economy”. Like me, Bivens argues that slow productivity growth is largely  attributable to low investment, which in turn is due to weak demand and slow wage growth, which blunts the incentive for business to invest in labor-saving technology. One important point that Bivens makes that I didn’t, is that much past variation in productivity growth has been transitory; forecasts of future productivity growth based on the past couple of years have consistently performed worse than forecasts based on longer previous periods. So historical evidence gives us no reason see the most recent productivity slowdown as permanent. My one quibble is that he only discusses faster productivity growth and higher inflation as possible outcomes of a demand-driven acceleration in wages. This ignores the third possible effect, redistribution from from profits to wages — in fact a rise in the labor share is impossible without a period of “overfull” employment.

Minneapolis Fed president Neel Kashkari wrote a long post last fall on “diagnosing and treating the slow recovery.” Perhaps the most interesting thing here is that he poses the question at all. There’s a widespread view that once you correct for demographics, the exceptional performance of the late 1990s, etc., there’s nothing particularly slow about this recovery — no problem to diagnose or treat.

Another more recent post by Kashkari focuses on the dangers of forcing the Fed to mechanically follow a Taylor rule for setting interest rates. By his estimate, this would have led to an additional 2.5 million unemployed people this year. It’s a good illustration of the dangers of taking the headline measures of economic performance too literally. I also like its frank acknowledgement that the Fed — like all real world forecasters — rejects rational expectations in the models it uses for policymaking.

Kashkari’s predecessor Narayan Kocherlakota — who seems to agree more with the arguments in my paper — has a couple short but useful posts on his personal blog. The first, from a year ago, is probably the best short summary of the economic debate here that I’ve seen. Perhaps the key analytic point is that following a period of depressed investment, the economy may reach full employment given the existing capital stock while it is still well short of potential. So a period of rapid wage growth would not necessarily mean that the limits of expansionary policy have ben reached, even if those wage gains were fully passed through to higher prices. His emphasis:

Because fiscal policy has been too tight, we have too little public capital. … At the same time, physical investment has been too low… Conditional on these state variables, we might well be close to full employment.  … But, even though we’re close to full employment, there’s a lot of room for super-normal growth. Both capital and TFP are well below their [long run level].  The full-employment growth rate is going to be well above its long-run level for several years.  We can’t conclude the economy is overheating just because it is growing quickly.

His second post focuses on the straightforward but often overlooked point that policy should take into account not just our best estimates but our uncertainty about them, and the relative risks of erring on each side. And if there is even a modest chance that more expansionary policy could permanently raise productivity, then the risks are much greater on the over-contractionary side. [1] In particular, if we are talking about fiscal stimulus, it’s not clear that there are any costs at all. “Crowding out” is normally understood to involve a rise in interest rates and a shift from private investment to public spending. In the current setting, there’s a strong case that higher interest rates  at full employment would be a good thing (at least as long as we still rely on as the main tool of countercyclical policy). And it’s not obvious, to say the least, that the marginal dollar of private investment is more socially useful than many plausible forms of public spending. [2] Kashkari has a post making a similar argument in defense of his minority vote not to raise rates at the most recent FOMC meeting. (Incidentally, FOMC members blogging about their decisions is a trend to be encouraged.)

In a post from March which I missed at the time, Ryan Avent tries to square the circle of job-destroying automation and slow productivity growth. One half of the argument seems clearly right to me: Abundant labor and low wages discourage investment in productivity-raising technologies. As Avent notes, early British and even more American industrialization owe a lot to scarce labor and high wages. The second half of the argument is that labor is abundant today precisely because so much has been displaced by technology. His claim is that “robots taking the jobs” is consistent with low measured productivity growth if the people whose jobs are taken end up in a part of the economy with a much lower output per worker. I’m not sure if this works; this seems like the rare case in economics where an eloquent story would benefit from being re-presented with math.

Along somewhat similar lines, Simon Wren-Lewis points out that unemployment may fall because workers “price themselves into jobs” by accepting lower-wage (and presumably lower-productivity) jobs. But this doesn’t mean that the aggregate demand problem has been solved — instead, we’ve simply replaced open unemployment with what Joan Robinson called “disguised unemployment,” as some of people’s capacity for work continues to go to waste even while they are formally employed. “But there is a danger that central bankers would look at unemployment, … and conclude that we no longer have inadequate aggregate demand…. If demand deficiency is still a problem, this would be a huge and very costly mistake.”

Karl Smith at the Niskanen Center links this debate to the older one over the neutrality of money. Central bank interventions — and aggregate demand in general — are understood to be changes in the flow of money spending in the economy. But a lon-standing tradition in economic theory says that money should be neutral in the long run. As we are look at longer periods, changes in output and employment should depend more and more on real resources and technological capacities, and less and less on spending decisions — in the limit not at all. If you want to know why GDP fell in one quarter but rose in the next (this is something I always tell my undergraduates) you need to ask who chose to reduce their spending in the first period and who chose to increase it in the first. But if you want to know why we are materially richer than our grandparents, it would be silly to say it’s because we choose to spend more money. This is the reason why I’m a bit impatient with people who respond to the fact that, relative to the pre-2008 trend, output today has not recovered from the bottom of the recession, by saying “the trend doesn’t matter, deviations in output are always persistent.” This might be true but it’s a radical claim. It means you either take the real business cycle view that there’s no such thing as aggregate demand, even recessions are due to declines in the economy’s productive potential; or you must accept that in some substantial sense we really are richer than our grandparents because we spend more money. You can’t assert that GDP is not trend-stationary to argue against an output gap today unless you’re ready to accept these larger implications.

The invaluable Tom Walker has a fascinating post going back to even older debates, among 19th century anti-union and pro-union pamphleters, about whether there was a fixed quantity of labor to be performed and whether, in that case, machines were replacing human workers. The back and forth (more forth than back: there seem to be a lot more anti-labor voices in the archives) is fun to read, but what’s the payoff for todays’ debates?

The contemporary relevance of this excursion into the archives is that economic policy and economic thought walks on two legs. Conservative economists hypocritically but strategically embrace both the crowding out arguments for austerity and the projected lump-of-labor fallacy claims against pensions and shorter working time. They are for a “fixed amount” assumption when it suits their objectives and against it when it doesn’t. There is ideological method to their methodological madness. That consistency resolves itself into the “self-evidence” that nothing can be done.

That’s exactly right. When we ask why labor’s share has fallen so much over the past generation, we’re told it’s because of supply and demand — an increased supply of labor from China and elsewhere, and a decreased demand thanks to technology. But if it someone says that it might be a good idea then to limit the supply of labor (by lowering the retirement age, let’s say) and to discourage capital-intensive production, the response is “are you crazy? that will only make everyone poorer, including workers.” Somehow distribution is endogenous when it’s a question of shifts in favor of capital, but becomes exogenously fixed when it’s a question of reversing them.

A number of heterdox writers have identified the claim that productivity growth depends on demand as Verdoorn’s law (or the Kaldor-Verdoorn Law). For example, the Post Keynesian blogger Ramanan mentions it here and here. I admit I’m a bit dissatisfied with this “law”. It’s regularly asserted by heterodox people but you’ll scour our literature in vain looking for either a systematic account of how it is supposed to operate or quantitative evidence of how and how much (or whether) it does.

Adam Ozimek argues that the recent rise in employment should be seen as an argument for continued expansionary policy, not a shift away from it. After all, a few years ago many policymakers believed such a rise was impossible, since the decline in employment was supposed to be almost entirely structural.

Finally, Reihan Salam wants to enlist me for the socialist flank of a genuinely populist Trumpism. This is the flipside of criticism I’ve sometimes gotten for making this argument — doesn’t it just provide intellectual ammunition for the Bannon wing of the administration and its calls for vast infrastructure spending,  which is also supposed to boost demand and generate much faster growth? Personally I think you need to make the arguments for what you think is true regardless of their political valence. But I might worry about this more if I believed there was even a slight chance that Trump might try to deliver for his working-class supporters.

 

[1] Kocherlakota talks about total factor productivity. I prefer to focus on labor productivity because it is based on directly observable quantities, whereas TFP depends on estimates not only of the capital stock but of various unobservable parameters. The logic of the argument is the same either way.

[2] I made similar arguments here.

 

EDIT: My comments on the heterodox literature on the Kaldor-Verdoorn Law were too harsh. I do feel this set of ideas is underdeveloped, but there is more there than my original post implied. I will try to do a proper post on this work at some point.