europe – J. W. Mason

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Revisiting the Euro Crisis

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

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

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

The four common stories are:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In The American Prospect: The Collapse of Austerity Economics

(This review is coauthored with Arjun Jayadev, and appears in the Fall 2019 issue of the The American Prospect. The version below includes a few passages that were cut from the published version for space reasons.)

Review of Albert Alesina, Carlo Faverro and Francesco Giavazzi, Austerity: When It Works and When It Doesn’t
With Arjun Jayadev

A decade ago, Alberto Alesina was one of the most influential economists in the world. His theory of ‘expansionary austerity’ – the paradoxical notion that reducing public expenditure would lead to an increase in economic activity — was one of the hottest ideas in macroeconomics. He claimed to have shown that government surpluses could actually boost growth, but only if they were achieved via spending cuts rather than tax increases. At a moment when many governments were seeking Keynesian remedies to a global recession, his work (along with fellow Harvard economist Silvia Ardagna) reassured conservatives that there was no conflict between keeping up demand in a crisis, and the longer-term goal of reining in the public sector.

Not surprisingly, his ideas were taken up by right-wing politicians both in Europe and in the US, where he was widely cited by the Republicans who took control of the House in 2010. Along with the work of Reinhart and Rogoff on the supposed dangers of excessive government debt, Alesina’s work provided one of the key intellectual props for the shift among elite policymakers towards fiscal consolidation and austerity.

Right from the outset, other economists pointed to serious flaws in the case for expansionary austerity, and challenged virtually aspect of the statistical exercises underlying it. A partial list of criticisms includes: using inappropriate measures of fiscal balance; misapplying lessons from boom times to periods of crisis; misclassifying episodes of fiscal expansion as austerity; and generalizing from the special conditions of small open economies, where exchange rate moves could cushion the effects of austerity. Even the most cherished result— that expenditure based austerity worked better than tax-based austerity — has been convincingly challenged.

In 2009, Alesina suggested that Europe was likely to see faster growth because it was cutting public spending in response to the crisis, while the US had embraced conventional Keynesian stimulus. He was right about the difference in responses to the crisis; about economic growth, not so much. The US recovery was weak by historical standards, but in Europe there was hardly a recovery at all. In the countries that cut public spending the most, such as Spain, Portugal, and Ireland, GDP remained below its 2008 peak four, five, even six years after the crisis. By 2013 the financial journalist Jim Tankersley could offer an unequivocal verdict: “No advanced economy has proved Alesina correct in the wake of the Great Recession.”

Macroeconomic debates have moved on since then. A large new empirical literature on fiscal policy has emerged over the past decade, the great majority of it confirming the old Keynesian wisdom that in a depressed economy, increased public spending can raise output by perhaps $1.50 for each dollar spent. New questions have been raised about central banks’ ability to stabilize the economy, whether with conventional monetary policy or with new tools like forward guidance and quantitative easing. The seemingly permanent reality of low interest rates has changed the debate over the sustainability of government finances, with prominent mainstream economists suggesting that public debt no longer poses the dangers it was once thought to. The revived idea of secular stagnation has suggested that economic stimulus may not be a problem for occasional downturns, but an ongoing necessity. And the urgency of climate change has created big new tasks for the public sector.

It’s a very different conversation from a decade ago. Can Alesina’s ideas adapt to this new environment?

That’s the challenge for his new book, Austerity: When It Works and When It Doesn’t, which offers a summing-up of work on government budgets that goes back now almost three decades. Through the years, Alesina has had a rotating case of co-authors, often from Bocconi University in Italy; this book is co-authored with Carlo Ferro and Francisco Giavazzi, both professors there. Given the way that the book has been advertised and promoted (“towering”, a “counterblast”), one might expect a thorough response to the new arguments that have developed over the past decade about aggregate demand management and the appropriate size of the public sector.

Disappointingly, this is not the case. There has been no marking of beliefs to market. For the most part, the book restates the same arguments that were made a decade ago: countries with high public debt must adopt austerity, and this will not hurt growth if it takes the form spending cuts rather than tax increases. Alesina and his coauthors do make some effort to respond to specific methodological criticisms of the earlier work. But they don’t engage with – or even acknowledge – the larger shifts in the landscape. Tellingly, all the book’s formal analysis and almost all of its text (as well as the online data appendix) stop in 2014. For what is supposed to be a definitive statement, it’s an odd choice. Why ignore everything we might learn about austerity and government budgets from the experiences of the past five years?

The book also operates at an odd mix of registers, which makes it hard to understand who the audience is. Exoteric chapters seemingly intended for a broad readership are interspersed with math-heavy esoteric chapters that will be read only by professional economists. You get the feeling this is mostly material that sat in a drawer for a long time before being fished out and stapled together into a book.

To be fair, there are some advances from the previous iterations. Alesina’s earlier work had been criticized for ignoring problems of causality – when high growth and government surpluses are found together, how do we know which is causing which? Now, instead of relying on purely statistical measures of association, there is more extensive attention given to what has been called the “narrative” approach, with periods of austerity defined by the stated intentions of policy makers rather than simply by changes in the budget position. This approach– pioneered by Romer and Romer to understand US policy actions and expanded by economists at the IMF — does have advantages over the naive statistical approach. By including only tax increases and spending cuts made for reasons other than current economic conditions, it avoids, in principle at least, the problem of fiscal adjustments resulting from changes in economic activity, rather than causing them. But it is still no substitute for a real historical analysis that considers the whole complex of factors influencing both budget positions and growth. Gesturing towards the need for more substantive narrative, the later chapters include several case studies on various OECD countries which undertook austerity measures. These are rather thin and have a Wikipedia air about them; in any case the great bulk of the argument is still based on statistical exercises.

Those who are not convinced by the econometrics in Alesina’s earlier work will not be convinced here either. Even people who share the authors’ commitment to rolling back the public sector may suspect that they are in the presence of what is politely called motivated reasoning.

To those who don’t share that commitment, it is clear from the opening pages that we are dealing with ideological fiction, not objective analysis. Per Alesina and co, most austerity episodes reflect countries persistently spending beyond their means, with debt rising until a tipping point is reached. But in Europe – surely ground zero in any discussion of contemporary austerity – this story lacks even superficial plausibility. On the eve of their crises, Ireland, Spain and even Portugal had debt-GDP ratios below that of unscathed France; Spain and Ireland were well below Germany. (The fact that Germany consistently ran large deficits in the decade before the crisis is not mentioned here.) Indeed, until 2011 Ireland, now an austerity poster child, had the lowest debt ratio of any major Western European country.

The book asserts that episodes of austerity triggered by outside pressures – as opposed to a government’s own mismanagement of its finances – are rare exceptions. But in Europe they were the rule. The crisis came first, then the turn to austerity; the rising debt ratios came last, driven mainly by falling GDP; budget deficits were an effect, not a cause. Even Greece, perhaps the one country where public finances were a genuine problem before the crisis, is a case in point: From 2010 to 2015, deep cutbacks in public services successfully reduced public debt by about $15 billion euros, or 5 percent — but the debt-GDP ratio still rose by 30 points, thanks to a collapse in GDP.

It would be easy to debate the book point by point. But it’s more useful to take a step back, and think about the larger argument. While the book shifts erratically in tone and subject, underlying all of its arguments – and the larger pro-austerity case – is a rigid logical skeleton. First, a government’s fiscal balance (surplus or deficit) over time determines its debt-GDP ratio. If a country has a high debt to GDP, that is “almost always … the result of overspending relative to tax revenues.” (2) Second, the debt ratio leads markets to be confident in the government’s debt – private investors do not want to buy the debt of a country that has already issued too much. Third, the state of market confidence determines the interest rate the government faces, or whether it can borrow at all. Fourth, there is a clear line where high debt and high interest rates make debt unsustainable; austerity is the unavoidable requirement once that line is passed. And finally, when austerity restores debt sustainability that contributes – via lower interest rates and “confidence” more broadly – to economic growth, especially if the austerity involves spending cuts.

Individually, these claims are in keeping with the conventional wisdom of the business press and the maxims of “sound finance.” Together, they make a causal story that’s a one-way track with no side branches: Any problems that a government encounters with debt are the result of its fiscal choices in the past. And any solution must involve a different set of fiscal choices – higher taxes or, better, less public spending.

If you accept the premises, the conclusions follow logically. Even better, they offer the satisfying spectacle of public-sector hubris meeting its nemesis.

But real-world debt dynamics don’t run along such well-oiled tracks. At every step, there are forks, sidings and roundabouts, that leave the link from fiscal misconduct to well-deserved austerity much less direct than the book suggests.

First of all, as a historical matter, differences in growth, inflation and interest rates are at least as important as the fiscal position in determining the evolution of the debt ratio over time. Where debt is already high, moderately slower growth or higher interest rates can easily raise the debt ratio faster than even very large surpluses can reduce it – as many countries subject to austerity have discovered.

Conversely, rapid economic growth and low interest rates can lead to very large reductions in the debt ratio without the government ever running surpluses, as in the US and UK after World War II. More recently, Ireland reduced its debt-GDP ratio by 20 points in just five years in the mid-1990s while continuing to run substantial deficits, thanks to very fast growth of the “Celtic tiger” period. In situations like the European crisis, extraordinary actions like public assumptions of private debt or writedowns by creditors (as in Cyprus and Greece) can also produce large changes in the stock of debt, without any changes in spending or taxes. Ireland again is an example: The decision to assume the liabilities of private banks catapulted its debt-GDP ratio from 27 percent to over 100 percent practically overnight. Cases like this make a mockery of the book’s central claim that a country’s debt burden reliably reflects its past fiscal choices.

At the second step, market demand for government clearly is not an “objective” assessment of the fiscal position, but reflects crowd psychology, self-confirming conventional expectations, and all the other pathologies of speculative markets. The claim that the interest rates facing a country are directly and reliably linked to the state of its public finances is critical to the book’s argument; rising interest rates are the channel by which high debt creates pressure for austerity, while falling interest rates are the channel by which austerity supports renewed growth. But the claim that interest rates reflect the soundness or otherwise of public budgets runs up against a glaring problem: The financial markets that recoil from a country’s bonds one day were usually buying them eagerly the day before. The same markets that sent interest rates on Spanish, Portuguese and Greek bonds soaring in 2010 were the ones snapping up their public and private debt at rock-bottom rates in the mid-2000s. And they’re the same markets that are setting interest rates for those countries at historical low levels today (Greece now pays less to borrow than the US!), even as their debt ratios, in many cases, remain extremely high.

The authors get hopelessly tangled on this point. They want to insist both that post-crisis interest rates reflect the true state of public finances, and that the low rates before the crisis were the result of a speculative bubble. But they can’t have it both ways: If low rates in 2005 were not a sign that the state of public finances was sound, then high rates in 2010 can’t be a sign that they were unsound.

If the analysis had extended beyond 2014, this problem would only have gotten worse. What’s really striking about interest rates in Europe in recent years is how uniformly they have declined. Ireland, which has managed to reduce its debt ratio by 50 points since 2010, today borrows at less than 1 percent. But so does Spain, whose debt ratio increased by 40 points over the same period. The claim that interest rates are mainly a function of a country’s fiscal position just doesn’t fit the historical experience. It’s hard to exaggerate how critical this is for the whole argument. Rising interest rates are the only cost Alesina and his coauthors ever mention for high debt, and hence the only reason for austerity; and reducing interest costs is the only intelligible mechanism they offer for the supposed growth-boosting effects of austerity – vague invocations of “confidence” don’t count.

And this brings us to the third step. One of the clearest macroeconomic lessons of the past decade is that market confidence doesn’t matter: A determined central bank can set interest rates on public borrowing at whatever level it chooses. In the years before 2007, there were endless warnings that if the US did not get its fiscal house in order, it would be faced with rising interest rates, a flight from the dollar and eventually the prospect of default. (In 2005, Nouriel Roubini and Brad Setser were bold enough to predict that unsustainable deficits would lead to a collapse in the dollar within the next two years.) Today, with the debt much higher than even the pessimistic forecasts of that period, the federal government borrows more cheaply than ever in history. And there hasn’t been even a hint of the Fed losing control of interest rates.

Similar stories apply around the world. Perhaps the clearest illustration of central banks’ power over financial markets came in 2011-2012, when a series of interventions by the European Central bank – culminating in Mario Draghi’s famous “whatever it takes” — stopped the sharp spike in southern European interest rates in its tracks. With an implicit guarantee from their central banks – which other developed countries like the US and UK also enjoy – governments simply don’t need to worry about losing access to credit. To the extent that governments like Greece remained locked out of the markets after Draghi’s announcement, this was a policy choice by the ECB, not a market outcome.

If countries can face financial crises even when their debt ratio is low, and can enjoy ultra-low interest rates even when they are high, then it’s hard to see why the debt ratio should be a major object of policy. Alesina and colleagues’ central question – whether expenditure-based or tax-based austerity is better for growth – is irrelevant, since there’s no good reason for austerity at all.

In a world of chronically low interest rates and active central banks, government debt just isn’t a problem. At one point, this was a fringe position but today it’s been accepted by economists with as impeccable mainstream credentials as Olivier Blanchard, Lawrence Summers and Jason Furman – the former chief economist of the IMF, Treasury Secretary and chair of the Council of Economic Advisors, respectively. But not by Alesina, who just goes on singing the same old songs.

The pro-austerity arguments in this book will therefore face more of a headwind than they did when Alesina made them a decade ago. “Sound finance” is no longer the pillar of elite opinion it once was. As we write this, Christine Lagarde, the new head of the European Central Bank, is calling for European governments to spend more during downturns – something hard to imagine when Alesina’s ideas were in vogue. In the US, meanwhile, concerns about the federal debt seem almost passe.

This is progress, from our point of view. The intellectual case for austerity has collapsed, and this book will do little to rebuild it. But that has not yet led to an expansion of public spending – let alone one large enough to restore genuine full employment and meet the challenge of climate change and other urgent social needs. The austerity machinery of the euro system and IMF still churns away, grinding out misery and unemployment across southern Europe and elsewhere, even if it no longer commands the general assent that it once did. At the level of ideas, Keynesian economists can point to real gains in the decade since the crisis. At the level of concrete policy, the work has barely begun.

Populism, or Its Opposite?

[I am an occasional contributor to the roundtables in the magazine The International Economy. This month’s topic was “Why is populism on the rise?” My answer is below. While the format of the roundtables doesn’t really allow for citations, I should say here that Corey Robin has made the same point about Trump.]

As a political category, populism is uniquely slippery. Far from describing any consistent doctrine, program or form of organization, it is applied to Die Linke and Alternative for Germany, Geert Wilders and Elizabeth Warren, Podemos and Le Pen, Bernie Sanders and Jair Bolsonaro – to people and organizations whose substantive programs and bases of support are diametrically opposed on every point.

A cynic might say the word simply refers to democratic outcomes of which the speaker doesn’t approve. Even more cynically, but more precisely, one might see it as an attempt to discredit the left by linking it with the far right, via a portmanteau political category that somehow includes both outright fascists and anyone to the left of today’s established social-democratic parties.

A more charitable reading would be that populism describes the elevation of popular support over other criteria of legitimacy, such as law or business support or professional expertise. This is a reasonably clear definition that fits most common uses of the term. But does it fit developments in the real world?

It seems to me that if populism means something like illiberal democracy, then the central feature of today’s political moment is not populism but its opposite.

In the US, Trump is widely seen as populist. Certainly in his public persona he rejects established norms and expert opinion. But it’s important to remember that he lost the popular vote by a wide margin, and became president only thanks to the electoral college – one of a number of anti-democratic features of the US constitution that exist precisely to limit the power of popular majorities. To the extent Trump has advanced a policy agenda, it has been essentially the same as an establishment Republican would have. And it has been enacted into law only thanks to the non-majoritarian character of the Senate. His most lasting impact may well come through his Supreme Court appointments — which have been made in strict accordance with law and will be consequential precisely because of the Court’s power to overrule popular majorities.

In Brazil, Bolsonaro did win the popular vote — but only after the previous president was removed from office in what was effectively a soft coup, and the country’s most popular politician was banned from running by the courts. This judicial preemption of democracy is the opposite of what is usually meant by populism.

In Europe, the rise of anti-establishment parties, mainly on the right, would seem to give a stronger basis for fears of populism. It is certainly true that many countries have seen a rise in new parties, thanks to the discrediting of the established ones by a decade of economic crisis. But consider Italy. Yes, the governing League and Five Star Movement show up on many lists of populist political parties. But the real novelty in Italian politics today isn’t the election of politicians claiming a mandate from the people — which don’t? — but the fact that their proposed budget was overruled by the European Commission. The right to approve budgets has been the fundamental right of legislatures since the origin of the modern state, so its surrender is a political watershed. The projected deficits that justified the Commission’s intervention are not even exceptional by European standards; France, for instance, has had larger deficits every year for the past decade. So it’s hard to see this as anything but a shift in the center of political authority. And the new authority, framed in terms of a mathematical formula, is based on exactly the anti-populist grounds of expertise and impersonal rules.

The recent history of the EU is a series of such victories of liberalism over democracy. The takeover of Greece by the “troika” of the European Commission, the ECB and the IMF was the most dramatic example, but it was simply a continuation of the ECB’s strategy of using financial crises on the periphery to push through an agenda of deregulation, privatization and liberalization that democratically-accountable governments could not enact on their own. When the ECB intervened to stabilize the market for Spanish bonds in 2011, it was only after imposing a long list of conditions, including labor market reforms far outside the normal remit of a central bank, and even a demand that the government take “exceptional action” to hold down private sector wage growth. Other governments under bond-market pressure were subject to similar demands. What’s striking in this context is not the occasional victory of anti-European political parties, but how consistently — so far at least — they have backed down in confrontations with the European authorities.

All this may change. But for the moment concerns about “populism” seem like an evasion of the actual political realities — perhaps a sign of bad conscience by an elite whose authority, more than in many years, lacks a basis in popular consent.

V for Varoufakis

I have a long review up at Boston Review of three books by Yanis Varoufakis: The Global Minotaur, And the Weak Suffer What They Must?, and Adults in the Room. Here’s the start:

In the spring of 2015, a series of debt negotiations briefly claimed a share of the world’s attention that normally goes only to events where celebrities give each other prizes. Syriza, a scrappy left-wing party, had stormed into office in Greece on a promise to challenge the consortium of international creditors that had effectively ruled the country since its debt crisis broke out in 2010. For years, austerity, deregulation, the rolling back of labor rights and public services, the rule of money over society, had been facts of life. Now suddenly they were live political questions. It was riveting.

Syriza was represented in these negotiations by its finance minister, Yanis Varoufakis. With his shaved head, leather jacket, and motorcycle, he was not just a visual contrast to the gray-suited Eurocrats across the table. His radical but rigorous proposals for a different kind of Europe—one based on meeting human needs rather than rigid financial criteria—offered a daily rebuke to the old refrain “there is no alternative.”

The drama was clear, but the stakes were a little obscure. Why did it matter if Greece stayed in the euro? Orthodox economic theory, after all, gives little role for money or finance. What matters are real wants and real resources, for which money is just a convenient yardstick. University of Chicago economist John Cochrane probably spoke for much of the profession when he asked why it made any more sense to talk about Greece leaving the euro than about Greece leaving the metric system.

But money does indeed matter—especially in economic relations between countries, as Varoufakis himself has convincingly shown. In his three books—The Global Minotaur (2011), And the Weak Suffer What They Must (2016), and Adults in the Room (2017)—Varoufakis offers a fascinating lens on the euro system and its masters. While the first two books chart the history of the international monetary system from World War II up to the debt crisis, his last and most recent book is a reflection on his five months as Greek finance minister. Taken together, they read as if Varoufakis is the protagonist in some postmodern fable, in which he is transformed from a critic of the play to one of the main characters in it. …

Read the rest there, and then comment here if you are so inclined.

What It’s About

Shortly after Syriza’s victory in January 2015, Yanis Varoufakis is traveling around Europe for his first official meetings with various and economics ministers. Here’s an interesting conversation with one of them:

Pier Carlo Padoan, Italy’s finance minister and formerly the OECD’s chief economist, is in many ways a typical European social democrat: sympathetic to the Left but not prepared to rock the boat… Our discussion was friendly and efficient. I explained my proposals, and he signalled that he understood what I was getting at, expressing not an iota of criticism but no support. To his credit, he explained why: when he had been appointed finance minister a few months earlier, Wolfgang Schäuble had made a point of having a go at him at every available opportunity…

I enquired how he had managed to curb Schäuble’s hostility. Pier Carlo said that he had asked Schäuble to tell him the one thing he could do to win his confidence. That turned out to be “labour market reform” – code for weakening workers’ rights, allowing companies to fire them more easily with little or no compensation and to hire people on lower pay with fewer protections. Once Pier Carlo had passed appropriate legislation through Italy’s parliament, at significant political cost to the Renzi government, the German finance minister went easy on him. “Why don’t you try something similar?” he suggested.

“I’ll think about it,” is Varoufakis’ diplomatic reply.

A couple days later, he has a meeting with the German finance minister himself, perhaps the most important single figure in the Euroepan establishment. Schauble brushes off Varoufakis’ suggestions for strengthening the Greek tax authorities, insisting instead on

his theory that the “overgenerous” European social model was no longer sustainable and had to be ditched. Comparing the costs to Europe of maintaining welfare states with the situation in places like India and China, where no social safety net exists at all, he argued that Europe was losing competitiveness and would stagnate unless social benefits were curtailed en masse. It was as if he was telling me that a start had to be made somewhere and that that somewhere might as well be Greece.

I’m supposed to be writing a review of Adults in the Room.That right there is the story, I think. Debates over fiscal arrangements were a pretext, the real agenda has always been restoring the rule of market over society, over labor in particular. And Greece was just a convenient place to start, or to make an example of. Despite the constant framing of Eruope’s divisions in national terms, I think it’s clear that for German conservatives like Schauble, the real target has always been their own working class.

Links for July 17, 2017

The action is on the asset side. Arjun Jayadev, Amanda Page-Hoongrajok and I have a new version of our state-local balance sheets paper up at Washington Center for Equitable Growth. It’s moderately improved from the version posted here a few months ago. I’ll have a blogpost up in the next day or two laying out the arguments in more detail. In the meantime, here’s the abstract:

This paper … makes two related arguments about the historical evolution of state-local debt ratios over the past 60 years. First, there is no consistent relationship between state and local budget deficits and changes in state and local government debt ratios. In particular, the 1980s saw a shift in state and local budgets toward surplus but nonetheless saw rising debt ratios. This rise in debt is fully explained by a faster pace of asset accumulation as a result of increased pressure to prefund future expenses… Second, budget imbalances at the state level are almost entirely accommodated on the asset side – both in the aggregate and cross-sectionally, larger state-local deficits are mainly associated with reduced net asset accumulation rather than with greater credit-market borrowing. …

What recovery? One of the central questions of U.S. macroeconomic policy right now is whether the slow growth of output and employment over the past decade are the result of supply-side factors like demographics and an exhaustion of new technologies, or whether — despite low measured unemployment — we are still well short of potential output. Later this month, I’ll have a paper out from the Roosevelt Institute making the case for the latter — that there is still substantial space for more expansionary policy. Some of my argument is anticipated by this post from Simon Wren-Lewis, which briefly lays out several ways in which a demand shortfall can have lasting effects on the economy’s productive capacity — discouraged workers leaving the labor force; reduced investment by business; and slower technical progress, because a slack economy is less favorable for innovation. He concludes: “There is no absence of ideas about how a great recession and a slow recovery could have lasting effects. If there is a problem, it is more that this simple conceptualization” — textbook model in which demand has only short-run effects — “has too great a grip on the way many people think.”

Along the same lines, here is a nice post from Adam Ozimek on the “mystery” of low wage growth. The mystery is that despite low unemployment, annual wage growth (as measured by the Employment Costs Index) has remained relatively low – 2 to 2.5 percent, rather than the 3 to 3.5 percent we’d expect based on historical patterns. (Ozimek doesn’t mention it, but total compensation growth — including benefits — is even lower, less than one percent for the year ending March 2017.) But, he points out, this historical relationship is based on measured unemployment; if we use the employment-population ratio instead, then recent wage gains are exactly where you’d expect historically. So the behavior of wages is another piece of evidence that the official unemployment rate is underestimating the degree of labor market slack, and that the fall in the employment-population ratio reflects — at least in part — weak demand rather than the inevitable result of worse demographics (or better video games).

The bondholders’ view of the world. Matthew Klein has a very enjoyable post at FT Alphaville taking apart the claim (from three prominent academics) that “The French Revolution began with the bankruptcy of the ancient regime.” This is, of course, supposed to illustrate the broader dangers of allowing sovereigns to stiff bondholders. But in fact, as Klein points out, the old regime did not default on in its loans — Louis XVI went to great lengths to avoid bankruptcy, precisely because he was afraid of the reaction of creditors. Further: It was the monarchy’s efforts to avoid default — highly unpopular taxes and spending cuts, then the calling of the Estates General to legitimate them — that set in motion the events that led to the Revolution. So the actual history — in which a government was overthrown after choosing austerity over bankruptcy — has been reversed 180 degrees to fit the prevailing myth of our times: that good and bad political outcomes all depend on the grace of the bond markets. As Klein says, this might seem like a small mistake, but it is deeply revealing about how ideology operates: “ Whoever introduced it must have been working off what he thought was common knowledge that didn’t need to be checked. There is no citation.”

Klein’s piece is also, in passing, a nice response to that silly Jacob Levy post which argues that democracy and popular sovereignty are myths and that modern states have always been ruled by the bondholders. Levy offers zero evidence for this claim; his post is of interest only as a signpost for where elite discourse may be heading.

Don’t blame Germany. Here is a very useful paper from Enno Schroeder and Oliver Piceck estimating the effects of an increase in German demand on other European economies. They use an input-output model to estimate the effect of an increase in spending in Germany on output and employment in each of the other 10 largest euro-area countries. One of the things I really like about this is that it does not depend on either econometrics or on any kind of optimization; rather, it is simply based on the observable data of the distribution of consumption spending and of intermediate inputs by various industries over different industries and countries, along with the fraction of household income consumed in various countries. This lets them answer the question: If spending in Germany increased by a certain amount and the composition of spending otherwise remained unchanged, what would the effect be on total spending in various European countries? Yes, they ignore possible price changes; but I don’t think it’s any less reasonable than the conventional approach, which goes to the opposite extreme and assumes prices are everything. And even if you want to add a price story, this approach gives you a useful baseline to build on.

Methodology aside, their results are interesting and a bit surprising: They find that the spillovers from Germany to other European countries are surprisingly small.

Our main finding suggests that if Germany’s final demand were to exogenously increase by one percent of GDP, then France, Italy, Spain, and Portugal’s GDP would grow by around a 0.1 percent, their unemployment rates would be reduced by a bit over 0.1 points, and their trade balances would improve by approximately 0.04 points. The spillover effects on Greece are significantly smaller.

Given how much larger Germany is than most of these countries, and how tightly integrated European economies are understood to be, these are surprisingly small numbers. It seems that a large proportion of German demand still falls on domestic goods, while imports come largely from the euro area — particularly, in the case of intermediate goods, from the former Warsaw Pact countries. As a result, even

if a German demand boom were to materialize, France, Greece, Italy, Spain, and Portugal would not benefit much in terms of growth and external adjustment. The real beneficiaries would be small neighbors (e.g. Austria and Luxembourg) and emerging economies in Eastern Europe that are well integrated into German supply chains (e.g. Czech Republic and Poland).

Of course, this doesn’t mean that more expansionary policy in Germany isn’t desirable for other reasons. (For one thing, German workers badly need raises.) But for the balance of payments problems in Southern Europe, other solutions are needed.

Today’s conventional is yesterday’s unconventional, and vice versa. Here is a useful NBER paper from Mark Carlson and Burcu Duygan-Bump on the conduct of monetary policy in the 1920s. As they point out, much of today’s “unconventional” policy apparatus was standard at that point, including large purchases of a range of securities — quantitative easing avant le lettre. As I’ve written on this blog before (here and here and here) discussion of monetary policy is made needlessly confusing by economists’ habit of treating the policy instrument as having a direct, immediate link to macroeconomic outcomes, which can be derived from first principles. Whereas anyone who reads even a little history of central banking finds that the ultimate goal of control over the pace of credit expansion has been pursued by a wide range of instruments and intermediate targets in different settings.

Also on the mechanics of monetary policy, I liked these two posts from the New York Fed’s Liberty Street Economics blog. They do something which should be standard but isn’t — walk through step by step the balance sheet changes associated with various central bank policy shifts. In my experience, teaching monetary policy in terms of balance sheet changes is much more straightforward than with the supply-and-demand diagrams that are the basic analytic tool in most textbooks. The curves at best are metaphors; the balance sheets tell you what actually happens.

Posts in Three Lines

I haven’t been blogging much lately. I’ve been doing real work, some of which will be appearing soon. But if I were blogging, here are some of the posts I might write.

Lessons from the 1990s. I have a new paper coming out from the Roosevelt Institute, arguing that we’re not as close to potential as people at the Fed and elsewhere seem to believe, and as I’ve been talking with people about it, it’s become clear that your priors depend a lot on how you think of the rapid growth of the 1990s. If you think it was a technological one-off, with no value as precedent — a kind of macroeconomic Bush v. Gore — then you’re likely to see today’s low unemployment as reflecting an economy working at full capacity, despite the low employment-population ratio and very weak productivity growth. But if you think the mid-90s is a possible analogue to the situation facing policymakers today, then it seems relevant that the last sustained episode of 4 percent unemployment led not to inflation but to employers actively recruiting new entrants to the laborforce among students, poor people, even prisoners.

Inflation nutters. The Fed, of course, doesn’t agree: Undeterred by the complete disappearance of the statistical relationship between unemployment and inflation, they continue to see low unemployment as a threatening sign of incipient inflation (or something) that must be nipped in the bud. Whatever other effects rate increases may have, the historical evidence suggests that one definite consequence will be rising private and public debt ratios. Economists focus disproportionately on the behavioral effects of interest rate changes and ignore their effects on the existing debt stock because “thinking like an economist” means, among other things, thinking in terms of a world in which decisions are made once and for all, in response to “fundamentals” rather than to conditions inherited from the past.

An army with only a signal corps. What are those other effects, though? Arguments for doubting central bankers’ control over macroeconomic outcomes have only gotten stronger than they were in the 2000s, when they were already strong; at the same time, when the ECB says, “let the government of Spain borrow at 2 percent,” it carries only a little less force than the God of genesis. I think we exaggerate power of central banks over real economy, but underestimate their power over financial markets (with the corollary that economists — heterodox as much as mainstream — see finance and real activity as much more tightly linked than they are).

It’s easy to be happy if you’re heterodox. This spring I was at a conference up at the University of Massachusetts, the headwaters of American heterodox economics, where I did my Phd. Seeing all my old friends reminded me what good prospects we in the heterodox world have – literally everyone I know from grad school has a good job. If you are wondering whether your prospects would be better at a nowhere-ranked heterodox economics program like UMass or a top-ranked program in some other social science, let me assure you, it’s the former by a mile — and you’ll probably have better drinking buddies as well.

The euro is not the gold standard. One of the topics I was talking about at the UMass conference was the euro which, I’ve argued, was intended to create something like a new gold standard, a hard financial constraint on governments. But that that was the intention doesn’t mean its the reality — in practice the TARGET2 system means that national central banks don’t face any binding constraint , unlike under the gold standard the central bank is “outside” the national monetary membrane. In this sense the euro is structurally more like Keynes’ proposals at Bretton Woods, it’s just not Keynes running it.

Can jobs be guaranteed? In principle I’m very sympathetic to the widespread (at least among my friends on social media) calls for a job guarantee. It makes sense as a direction of travel, implying a commitment to a much lower unemployment rate, expanded public employment, organizing work to fit people’s capabilities rather than vice versa, and increasing the power of workers vis-a-vis employers. But I have a nagging doubt: A job is contingent by its nature – without the threat of unemployment, can there even be employment as we know it?

The wit and wisdom of Haavelmo. I was talking a while back about Merijn Knibbe’s articles on the disconnect between economic theory and the national accounts with my friend Enno, and he mentioned Trygve Haavelmo’s 1944 article on The Probability Approach in Econometrics, which I’ve finally gotten around to reading. One of the big points of this brilliant article is that economic variables, and the models they enter into, are meaningful only via the concrete practices through which the variables are measured. A bigger point is that we study economics in order to “become master of the happenings of real life”: You can contribute to economics in the course of advancing a political project, or making money in financial markets, or administering a government agency (Keynes did all three), but you will not contribute if you pursue economics as an end in itself.

Coney Island. Laura and I took the boy down to Coney Island a couple days ago, a lovely day, his first roller coaster ride, rambling on the beach, a Cyclones game. One of the wonderful things about Coney Island is how little it’s changed from a century ago — I was rereading Delmore Schwartz’s In Dreams Begin Responsibilities the other day, and the title story’s description of a young immigrant couple walking the boardwalk in 1909 could easily be set today — so it’s disconcerting to think that the boy will never take his grandchildren there. It will all be under water.

Links for May 5, 2017

Some economics content, for this rainy Friday afternoon:

Turbulence. Over at INET, Arjun Jayadev has posted the next in our series of “rebel masters” interviews with dissenting economists. This one is with Anwar Shaikh, who is, I’m sure, familiar to readers of this blog. Shaikh’s work resists summary, but the

broad thesis revolves around the idea that there is an alternative tradition-embedded in the classical approach of Smith, Ricardo and Marx which insists on understanding the world on its own terms rather than from an idealized economy from which the real world deviates. This approach focuses on what is termed “real competition” wherein competition between firms, each seeking to get the highest price they can, leads to a “turbulent gravitation” of prices around values. As such, there is never an equilibrium, but a dancing around some key deeper parameters.

As with all these interviews, there’s also some discussion of his own political and intellectual development, as well as of the content of his work.

I haven’t made a serious effort to read Shaikh’s big new book Capitalism. Given its heft, I suspect it will function more as a reference work, with people going to specific sections rather than reading it from front to back. (I know one person who is using it as an undergraduate textbook, which seems ambitious.) But if you want an admiring but not uncritical overview of the book as a whole, this review in New Left Review by John Grahl could be a good place to start. It’s written for people interested in the broad political economy tradition; it’s focused on the broad sweep of the argument, not on Shaikh’s position within current debates in heterodox economics.

The rich are different from you and me. [1] At Washington Center for Economic Growth, Nick Bunker calls attention to some new research on income inequality over the past 15 years. The key finding is that since the end of the 1990s, the rise in income inequality is almost all due to income from S-corporations (pass-through companies, partnerships, etc.) at the very top of the distribution. As a result, rising inequality shows up in tax data, but not in Social Security data, which captures only labor income. What do we take from this? First, the point I’ve made periodically on this blog: Incomes at the top are mainly capital income, not labor income. But there’s also a methodological point — the importance of constantly walking back and forth between your theoretical construct, the concrete social reality it hopes to explain, and the data (collected by somebody, according to some particular procedures) that stands between them.

What are foreign investors for? At FT Alphaville, Matthew Klein has a very interesting post on capital controls. As he notes, during the first decade of the euro, Spain was the recipient of one of “the greatest capital flows of all time,” with owners of financial assets all over Europe rushing to trade them for claims on Spanish banks. This created immense pressure on Spanish banks to increase lending, which in the event financed a runup in real estate prices and an immense quantity of never-to-be-occupied houses and hotels. (It’s worth noting in passing that this real estate bubble developed without any of the securitization that so mesmerized observers of the American bubble.) Surely, Klein says,

if you accept the arguments for regulating cross-border financial movements in any situation, you have to do the same for Spain. The country raised bank capital requirements and ran large fiscal surpluses, but none of that was enough. Plus, it didn’t have the luxury of a floating currency. Both the boom and bust would clearly have been smaller if foreigners had been prevented from buying so many Spanish financial assets, or even just persuaded to buy fewer bonds and more stocks and direct equity.

This seems right. But we could go a step farther. What’s the point of capital mobility? If you don’t in fact want bank balance sheets expanding and shrinking based on the choices of foreign investors, what benefit are those investors providing to your economy? They provide foreign exchange (allowing you to run current account deficit), they provide financing (allowing credit to expand more), they substitute their judgement of future for domestic actors’. These are exactly the problems in the Spanish case. What is the benefit, even in principle, that Spain got from allowing these inflows?

There’s always a first time. Also from Matthew Klein, here is a paper from the Peterson Institute looking at historical fiscal balances and making the rather obvious point that there is little historical precedent for the surpluses the Greek government is expected in order to pay its ~~conquerors~~ creditors. It is not quite true that no country has ever sustained a primary surplus of 3.5 percent for a decade a more, as Greece is expected to do; but such episodes are exceedingly rare.

My one criticism of Klein’s piece is that it is a little too uncritical of the idea that “market rates” are just a fact about the world. The Peterson paper also seems to regard interest rates as set by markets in response to more or less objective macroeconomic variables. Klein notes in passing that the interest rate Greece pays on its borrowing will depend on official choices like whether Greek debt is included in the ECB’s bond-buying programs. But I think it’s broader than this — I think the interest rate on Greek bonds is entirely a policy choice of the ECB. Suppose the ECB announced that they were fixing the interest rate on Greek bonds at 1 percent, and that they’d buy them as long as the yield was above this. Then private lenders would be happy to hold them at 1 percent and the ECB would not have to make any substantial purchases. This is how open market operations work – when a central bank announces a policy rate, they can move market rates while buying or selling only trivial amounts. If the ECB wished to, it could put Greece on a stable debt path and open up space for a less sociocidal budget, without the need for any commitment of public funds. But of course it doesn’t wish to.

Capital with Chinese characteristics. This new paper on wealth and inequality in China from Piketty, Zucman and Li Yang is an event; it’s a safe bet it’s going to be widely cited in the coming years. The biggest contribution is the construction of long-run series on aggregate wealth and the distribution of wealth and income for China. Much of the paper is devoted, appropriately, to explaining how these series were produced. But they also draw several broad conclusions about the evolution of the Chinese economy over the apst generation.

First, while the publicly-owned share of national wealth has declined, it is still very high relative to other industrialized countries:

China has ceased to be communist, but is not entirely capitalist; it should rather be viewed as a “mixed economy” with a strong public ownership component. … the share of public property in China today is somewhat larger than – though not incomparable to – what it was in the West during the “mixed economy” regime of the post-World War 2 decades (30% in China today vs. 15-25% in the West in the 1950s-1970s). … Private wealth was relatively small in 1978 (about 100% of national income), and now represents over 450% of national income. Public wealth [has been] roughly stable around 250% of national income.

It’s worth noting that the largest component of this increase in private wealth is housing, which largely passed from public to private hands, The public sector, by Piketty and coauthors’ measures, continues to own about half of China’s non-housing wealth, including the majority of corporate equity, and this fraction seems to have increased somewhat over the past decade.

Second, income distribution has become much more unequal in China over the past generation, but seems to still be more equal than in the United States:

In the late 1970s China’s inequality… [was] close to the levels observed in the most egalitarian Nordic countries — while it is now approaching U.S. levels. It should be noted, however, that … inequality levels in China are still significantly lower than in the United States…. The bottom 50% earns about 15% of total income in China (19% in rural China, 23% in urban China), vs. 12% in the U.S. and 22% in France. For the time being, China’s development model appears to be more egalitarian than that of the United States, and less than Europe’s. Chinese inequality levels seem to have stabilized in recent years (the biggest increase in inequality took place between the mid-1980s and the mid-2000s)

The third story — much less prominent in the article, and of less important, but of particular interest to me — is what explains the observed rise in the ratio of wealth to national income. Piketty et al. suggest that 50-70 percent of the rise can be explained, in accounting terms, by the observed rates of saving and investment and their estimate of depreciation, while the remaining 30-50 percent is due to valuation changes. But in a footnote they add that this includes a large negative valuation change for China’s net foreign wealth, presumably attributable to the appreciation of the renminbi relative to the dollar. So a larger share of the rise in domestic wealth relative to income must be accounted for by valuation changes. (The data to put an exact number on this should be available in their online appendices, which are comprehensive as always, but I haven’t done it yet.)

This means that a story that conflates wealth with physical capital, and sees its growth basically in terms of net investment, will not do a good job explaining the actual growth of Chinese capital. (The same goes for the growth in capital relative to income in the advanced countries.) The paper explains the valuation increase in terms of a runup in the value of private housing plus

changes in the legal system reinforcing private property rights for asset owners (e.g., lifting of rent control, changes in the relative power of landlords and tenants, changes in the relative power of shareholder and workers).

This seems plausible to me. But I wish Piketty and his coauthors — and even more, his admirers — would take this side of the story more seriously. If we want to talk about the “capital” we actually see in public and private accounts, a theory that sees it growing through net investment is not even roughly correct. We really do have to think of capital as a social relation, not a physical substance.

On other blogs, other wonders.

Here’s a video of me chatting with James Parrott about robots.

Who’d have thought that Breitbart is the place to find federal government employment practices held up as an ideal?

At PERI, Anders Fremstad and Mark Paul have a nice paper on the distributional impact of different forms of carbon taxes.

Also at PERI, another whack at the Reinhart-Rogoff piñata.

I’ll be speaking at this Dissent thing on May 22.

[1] This phrase has an interesting backstory. The received version has it that it’s F. Scott Fitzgerald’s line, to which Ernest Hemingway replied: “Yes. They have more money.” But in fact, Hemingway was the one who said the rich were different, at a lunch with Maxwell Perkins and the critic Mary Colum, and it was Colum who delivered the putdown. (The story is in that biography of Perkins.) In “Hills like White Elephants,” Hemingway, for reasons that are easy to imagine, put the “rich are different” line in the mouth of his frenemy Fitzgerald, and there it’s stayed.

Links and Thoughts for March 15, 2017

Do you guys know The Death Ship? B. Traven’s first novel, the only one not set in Mexico? It begins with an American sailor who goes ashore in the Netherlands, gets distracted as you do, his ship leaves. The Dutch don’t want him, they send him across the border to Germany. The Germans don’t want him, send him to Belgium, the Belgians send him to France. The French send him back to the Netherlands, where he ends up on the eponymous ship. It’s a good book. I was just thinking of it the other day, for some reason.

Against the sonderweg. Here is a fascinating article on the pre-history of Swedish social democracy. Contrary to claims of Swedish “sonderweg”, or special path, toward egalitarianism, Erik Bengtsson convincingly shows that until the 1930s, Sweden was not especially egalitarian relative to other West European countries or the US. Both economically and politically, it was at the unequal end of the European continuum, and considerably less equal than the US. “In 1900, it was one of the countries in Western Europe with the most restricted suffrage, and wealth was more unequally distributed than in the United States. …The more likely explanation of Swedish twentieth-century equality, rather than any deep roots, is the extraordinary degree of popular organization in the labour movement and other popular movements” in the 210th century. Income and wealth distribution were similar to France or Britain, while the franchise was more restricted than in any other major West European country. Up through World War One, Swedish politic was dominated by the same kind of “iron and rye” alliance of feudal landowners with big industrialists as Bismarkian Germany. “The exceptional equality of Swedish economy and society c. 1920-1990 did not arrive as the logical conclusion of a long historical continuity”; rather, it was the result of an exceptionally effective mass mobilization against what was previously an unusually inegalitarian state.

More speculatively, Bengtsson suggests that it was precisely the exceptionally strong and persistent domination by a small elite that created the conditions for Swedish social democracy: “the late democratization of Sweden” may have “fostered a liberal-socialist democratizing alliance … [between] petit bourgeois liberals and working-class socialists … unlike Germany, where the greater inclusion of lower-middle class men meant that middle class liberals and haute bourgeois market liberals could unite around a program of economic liberalism.” It’s a neat inversion of Werner Sombart’s famous argument that “the free gift of the ballot” prior to the appearance of an organized working class was the reason no powerful socialist party ever developed in the United States. Bengttson’s convincing claim that Swedish egalitarianism was not the result of a deep-rooted history but of a deliberate political project to transform a previously inegalitarian society, has obvious relevance for today.

High productivity in France. While we are debunking myths about social democracy, here is Thomas Piketty on French productivity. “If we calculate the average labour productivity by dividing the GDP … by the total number of hours worked … we then find that France is at practically the same level as the United States and Germany, … more than 25% higher than the United Kingdom or Italy.” And here’s a 2014 post from Merijn Knibbe making the same point.

Against Hamilton. In The Baffler, Matt Stoller argues that Hamilton is overrated. Richard Kreitner makes a similar case in The Nation, with an interestingly off-center focus on Paterson, New Jersey. Christian Parenti (my soon-to-be colleague at John Jay College) made the case for Hamilton not long ago in the Jacobin; he’s writing an introduction to a new edition of Hamilton’s Report on Manufactures. This is not a new debate. Twenty years ago, as the books editor of In These Times, I published a piece by Dan Lazare making a similar pro-Hamilton case; it was one of the things that Jimmy Weinstein fired me for.

My sense of these arguments is that one side says that Hamilton was a predecessor of today’s Koch brothers-neocon right, an anti-democratic militarist who believed the country should be governed by and for the top 1 percent; his opponent Jefferson must therefore have been a democrat and anti-imperialist. The other side says that Jefferson was a predecessor of today’s Tea Party right, an all-in racist and defender of slavery who opposed cities, industry and progress; his opponent Hamilton must therefore have been an abolitionist, an open-minded cosmopolitan and a liberal. I am far from an expert on early American politics. But in both cases, I think, the first half of the argument is right, but the second half is much more doubtful. There are political heroes in circa-1800 America, but to find them we are going to have look beyond the universe of people represented on dollar bills.

Against malinvestment. Brad Delong has, I think, the decisive criticism of malinvestment theories of the Great Recession and subsequent slow recovery. In terms of the volume of investment based on what turned out to be false expectations, and the subsequent loss of asset value, the dot-com bubble of the late 1990s was much bigger than the housing bubble. So why were the macroeconomic consequences so much milder?

Selective memory in Germany. Another valuable piece of political pre-history, this one of German anti-Keynesianism by Jörg Bibow. Among a number of valuable points, he describes how German economic debate has been shaped by a strangely selective history of the 20th century, from which depression and mass unemployment – the actual context for the rise of Nazism — have been erased. Failures of economic policy can only be imagined as runaway inflation.

The once and future bull market in bonds. Here is an interesting conversation between Srinivas Thiruvadanthai of the Levy Center and Tracy Alloway and Joe Weisenthal of Bloomberg, on the future of the bond market. Thiruvadanthai’s forecast: interest rates can fall quite a bit more in the coming decades. He makes several interesting and, to me, convincing points. First, that in an environment of large balance sheets, we can’t analyze the effects of things like interest rate changes just in terms of the real sector. The main effect of higher rates today wouldn’t be to discourage borrowing, but to raise the burden of existing debt. He also makes the converse argument, which I’m less sure about — that after another round or two of fiscal expansion and unconventional monetary policy, public sector debt could make up a large share of private balance sheets, with proportionately less private debt. Under those conditions, an increase in interest rates would be much less contractionary, or even expansionary, creating the possibility for much larger rate hikes if central banks continue to use conventional policy to stabilize demand.

More generally, he points out that, historically, the peacetime inflation of the 1970s is a unique event over the hundreds of years in which bond markets have existed, so it’s a little problematic to build a whole body of macroeconomic theory around that one episode, as we’ve done. And, he says, capitalism doesn’t normally face binding supply constraints — the vast majority of firms, the vast majority of the time, would be happy to sell more at their current prices. And he expresses some — much-needed, IMO — skepticism about whether central banks can in general hit an inflation target, reliably or at all.

Positive money? Here is a vigorous critique of 100 percent reserve backed, or positive, money. (An idea which is a staple of monetary reformers going back at least to David Hume, and perhaps most famous as the Chicago Plan.) I don’t have a settled view on this idea. I do think it’s interesting that the reforms the positive money people are calling for, are intended to produce essentially the tight link between public liabilities and private assets which MMT people claim already exists. And which Thiruvadanthai thinks we might inadvertently move toward in the future.

Captial flows: still unstable. Here’s a useful piece in VoxEU on the volatility of capital flows. Barry Eichengrreen and his coauthors confirm the conventional wisdom among heterodox critics of the Washington Consensus: free movement of finance is the enemy of macroeconomic stability. FDI flows — which are linked to the coordination of real productive activity across borders — are reasonably stable; but portfolio flows remain as prone to sudden stops and reversals as they’ve always been.

Killing conscience. Over at Evonomics, Lynn Stout makes the important point that any kind of productive activity depends on trust, norms, and the disinterested desire to do one’s job well – what Michelet called “the professional conscience.” These are undermined by the creation of formal incentives, especially monetary incentives. Incentives obstruct, discourage, even punish, the spontaneous “prosocial” behavior that actually makes organizations work, while encouraging the incentivized people to game the system in perverse ways. under socialism, to speak of someone’s interests will be considered an insult; to give someone incentives will be considered an act of violence.

It’s a good piece; the one thing I would add is that one reason incentives are used so widely despite their drawbacks is that they are are about control, as well as (or rather than) efficiency. Workers’ consciences are very powerful tools at eliciting effort; but the boss who depends on them is implicitly acknowledging a moral claim by those workers, and faces the prospect that conscience may at some point require something other than following orders.

The deficit is not the problem. Jared Bernstein makes the same argument about trade that I made in my Roosevelt Institute piece a few months ago. The macroeconomic-policy question posed by US trade deficits should not be, how do we move our trade towards balance? It should be: how do we ensure that the financial inflows that are the counterpart of the deficit, are invested productively?

We simply do not know. Nick Rowe has always been one of my favorite economics bloggers – a model for making rigorous arguments in a clear, accessible way. I don’t read him as consistently as I used to, or comment there any more — vita breve and all that — but he still is writing good stuff. Here he makes the common-sensical point that someone considering investment in long-lived capital goods does not face symmetric risks. “A recession means that capital services are wasted at the margin, because the extra output cannot be sold. But booms are not good, because a bigger queue of customers does nothing for profitability if you cannot produce more to meet the extra demand.” So uncertainty about future economic outcomes — or, what is not quite the same thing, greater expected variance — will depress the level of desired investment. I don’t know if Nick was thinking of Keynes — consciously or unconsciously when he wrote the post, but it’s very much in a Keynesian spirit. I’m thinking especially of the 1937 article “The General Theory of Employment,” where Keynes observes that to carry out investment according to the normal dictates of economic rationality, we must “assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto.”

The health policy tightrope. The Republican plan health care plan, the CBO says, would increase the number of uninsured Americans by 24 million. I don’t know any reason to question this number. By some estimates, this will result in 40,000 additional deaths a year. By the same estimate, the Democratic status quo leaves 28 million people uninsured, implying a similar body count. Paul Ryan’s idea that health care should be a commodity to be bought in the market is cruel and absurd but the Democrats’ idea that heath insurance should be a commodity bought in the market is not obviously less so. Personally, I’m struggling to find the right balance between these two sets of facts. I suppose the first should get more weight right now, but I can’t let go of the second. Adam Gaffney does an admirable job managing this tightrope act in his assessment of the Obama health care legacy in Jacobin. (But I think he’s absolutely right, strategically, to focus on the Republicans for the Guardian’s different readership .)

On other blogs, other wonders.

I’m looking forward to reading Ann Pettifor’s new book on money. In the meantime, here’s an interview with her in Vogue.

Towards the Garfield left.

The end of austerity is perfectly feasible in Spain.

“Underfunded” doesn’t mean what it sounds like. Based on the excellent Sgouros piece I linked to earlier.

Uber is doomed.

The decline of blue-collar jobs. I admit I was surprised to see what a large share of employment manufacturing accounted for a generation ago.

Perry Anderson: Why the system will win. Very worth reading, like everything Anderson writes. But too sympathetic to anti-immigrant politics.

The ECB should give money directly to European citizens.

Manchester by the Sea is a good movie. But Margaret is a great movie.