The Slack Wire – Page 29

How Not to Think about Negative Rates

Last week’s big monetary-policy news was the ECB’s decision to target a negative interest rate, in the form of an 0.25 percent tax on bank reserves. This is the first time a major central bank has announced a negative policy rate, though some smaller ones (like the Bank of Sweden) have done so in the past few years.

Whether a tax on reserves is really equivalent to a negative interest rate, and whether this change should be expected to pass through to interest rates or credit availability for private borrowers, are not easy questions. I’m not going to try to answer them now. I just want to call attention to this rather extraordinary Neil Irwin column, as an example of how unsuited mainstream discussion is to addressing these questions.

Here’s Irwin’s explanation of what a negative interest rate means:

When a bank pays a 1 percent interest rate, it’s clear what happens: If you deposit your money at the bank, it will pay you a penny each year for every dollar you deposited. When the interest rate is negative, the money goes the other direction. … Put bluntly: Normally the banks pay you to keep your money there. Under negative rates, you pay them for the privilege.

Not mentioned here, or anywhere else in the article, is that people pay interest to banks, as well as receiving interest from them. In Irwin’s world, “you” are always a creditor, never a borrower.

Irwin continues:

The theory is that when it becomes more costly for European banks to keep money in the E.C.B., they will have incentive to do something else with it: Lend it out to consumers or businesses, for example.

Here’s the loanable funds theory in all its stupid glory. People put their “money” into a bank, which then either holds it or lends it out. Evidently it is not a requirement to be a finance columnist for the New York Times to know anything about how bank loans actually work.

Irwin:

Banks will most likely pass these negative interest rates on to consumers, or at least try to. They may try to do so not by explicitly charging a negative interest rate, but by paying no interest and charging a fee for account maintenance.

Note that “consumers” here means depositors. The fact that banks also make loans has escaped Irwin’s attention entirely.

Of course, most of us are already in this situation: We don’t receive any interest rate on our transaction balances, and pay are willing to pay various charges and fees for the liquidity benefits of holding them.

The danger of negative rates, per Irwin, is that

It is possible that, assuming banks pass along the negative rates through either fees or explicitly charging negative interest, people will withdraw their money as cash rather than keeping it on deposit at banks. … That is one big reason that the E.C.B. and other central banks are going to be reluctant to make rates highly negative; it could result in people pulling cash out of the banking system.

Again the quantity theory in its most naive and stupid form: there is a fixed quantity of “money” out there, which is either being kept in banks — which function, in Irwin’s world, as glorified safe deposit boxes — or under mattresses.

Evidently he’s never thought about why the majority of us who already face negative rates on our checking accounts continue to hold them. More fundamentally, there’s no explanation of what makes negative rates special. Bank deposits don’t, in general, finance holdings of reserves, they finance bank loans. Any kind of expansionary policy must reduce the yield on bank loans and also — if margins are constant — on deposits and other bank liabilities. Making returns to creditors the acid test of policy, as Irwin does, would seem to be an argument against expansionary monetary policy in general — which of course it is.

What’s amazing to me in this piece is that here we have an article about monetary policy that literally makes no mention of loans or borrowers. In Irwin’s world, “you” are, by definition, an owner of financial assets; no other entities exist. It’s the 180-proof distillation of the bondholder’s view of the world.

Heterodox criticism of the loanable-funds theory of interest and insistence that loans create deposits, can sometimes come across as theological, almost ritual. Articles like this are a reminder of why we can’t let these issues slide, if we want to make any sense of the financial universe in which we live.

Three Ways of Looking at alpha = r k

Piketty’s “first law of capitalism” is the accounting identity

α = r k

where α is the share of capital income in total output, r is the average return on capital, and k is the aggregate capital-output ratio.

As accounting, this is true by definition. As economics, what kind of economic behavior does it describe? There are three ways of looking at it.

In the standard version, the profit share is determined by a production function, which is given by technology. The profit rate r* required by capital owners is fixed by technology in combination with time preferences. In this closure, k is the endogenous, or adjusting, variable. Investment rises or falls whenever the realized profit rate differs from the required rate, thus keeping k at the level that satisfies the equation for r = r*.

In Piketty’s version, r is fixed (somehow; the mechanism is not clear) and k is determined by savings behavior and (exogenous) growth according to his “second law of capitalism”:

k = s/g

That leaves α to passively accommodate r and k. Capitalists get whatever the current capital stock and fixed profit rate entitle them to, and workers get whatever is left over; in effect, workers are the residual claimants in Piketty’s system. (This is the opposite of the classical view, in which wages are fixed and capitalists get the residual.)

In a third interpretation, we could say that α and r are set institutionally — α through some kind of bargaining process, or by the degree of monopoly, r perhaps by the interest rate set in the financial system. The value of the capital stock is then given by capitalizing the flow of profits α Y at the discount rate r. (Y is total output.) This interpretation is the natural one if we think of “capital” as a claim to a share of the surplus as opposed to physical means of production.

This interpretation clearly applies to pure land, or to the market value of a particular firm. What if it applied to capital in general? Since claims on the surplus — including claims exercised through nonproduced assets like land — are not created by reserving output from consumption, aggregate savings would be a meaningless accounting construct in this case. (Or we could adopt a Hicksian view of saving in which it equals the change in net wealth by definition.) Looking at things this way also puts r > g in a different light. Suppose we think of the capital stock as a whole as something like the stock of a firm, which entitles the owners to the flow of profits from that firm. If the profits today are α Y and output is expected to grow at a rate g, what is the value of the stock today? If we discount future profits at r, then it is the sum from t=0 to t=infinity of α Y (1 + g)^t / (1 + r)^t, which works out to α Y / (r – g). So if we can take the rate of return on capital as the discount rate on future profits, then r > g is implied by a finite value of the capital stock.

We shouldn’t ask what capital “really” is. It really is a quantity of money in a process of self-expansion, and it really is a mass of means of production, and it really is authority over the production process. But the particular historical questions Piketty is interested in may be better suited to thinking of capital as a claim on the social surplus than as a physical quantity of means of production. Seth Ackerman has some very interesting thoughts along these lines in his contribution to the Jacobin symposium on the book.

Further Thoughts on Anti-Financialization

I want to amplify the last point from the previous post, about anti-financialization.

If we go back to the beginning of the national accounts in 1929, we find personal consumption accounts for around 75% of GDP. (This is true whether or not we make the C&F adjustments, since in 1929 the imputed and third-party component of consumption were either nonexistent or small.) During the Depression, the consumption share rises to 85% as business investment collapses, during the war it falls to below 50%, and it rises back to around two-thirds after 1945. It’s in the second half of the 1940s, with the growth of pension and health benefits and the spread of homeownership, that we start to see a large wedge between headline consumption and actual cash expenditures by households.

We can think of the ratio of adjusted consumption to GDP as a measure of how marketized the economy is: How much of output is purchased by people for their own use, as opposed to allocated in some other way? In this sense, the steady fall in adjusted consumption as a share of GDP represents a steady retreat of capitalist production in the postwar US. It was squeezed from both sides: from “above” by public provision of health care, education and retirement security, and from “below” by the state-fostered growth of self-provision in housing.

Consumption spending by households bottomed out at 47 percent of GDP in 1981. With the neoliberal turn, the process of de-marketization largely halted — but it did not reverse. Since then, consumption spending by households has hovered around 47-48% of GDP. The phenomena of household financialization, “markets for everything,” etc. are real — but only at the level of ideology. Private life in the US has not become more commodified, marketized or financialized in recent decades; over a longer horizon the opposite. What has happened is that a thickening veneer of fictional market transactions has been overlaid on a reality of social consumption.

In reality, neither collective provision of health care (or of education, public safety, etc.) nor self-provision of housing has been replaced to any noticeable degree by market purchases. What we’ve had, instead, is the statistical illusion of rising private consumption spending — an illusion fostered by the distortion of the national accounts by the dominant economic theory. When health insurance is purchased collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase health coverage individually. When retirement savings are carried out collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase financial assets. When people buy houses for their own use, the national accounts pretend they are profit-maximizing landlords, selling the use of their houses in the rental market. When liquidity constraints force people to hold financial wealth in low-yield forms, the national accounts pretend that financial markets are frictionless and that they are receiving the market yield in some invisible form. Together, these fictional transactions now make up 20 percent of GDP, and fully a third of apparent household consumption.

Of course, that might change. The decline of homeownership and the creation of a rental market for single-family homes may turn the fiction of a housing sector of tenants and profit-seeking landlords into a reality. One result of Obamacare — intended or otherwise — will be to replace collective purchases of health insurance by employers with individual purchases by households. Maybe the Kochs and Mark Zuckerberg will join forces and succeed in privatizing the schools. But none of that has happened yet. What’s striking to me is how many critics of contemporary capitalism — including Cynamon and Fazzari themselves — have accepted the myth of rising household consumption, without realizing there’s no such thing. The post 1980s rise in consumption is a statistical artifact of the ideology of capitalism — a way of pretending that a world of collective production and consumption is a world of private market exchange.

The Nonexistent Rise in Household Consumption

Did you know that about 10 percent of private consumption in the US consists of Medicare and Medicaid? Despite the fact that these are payments by the government to health care providers, they are counted by the BEA both as income and consumption spending for households.

I bet you didn’t know that. I bet plenty of people who work with the national income accounts for a living don’t know that. I know I didn’t know it, until I read this new working paper by Barry Cynamon and Steve Fazzari.

I’ve often thought that the best macroeconomics is just accounting plus history. This paper is an accounting tour de force. What they’ve done is go through the national accounts and separate out the components of household income and expenditure that represent cashflows received and made by households, from everything else.

Most people don’t realize how much of what goes into the headline measures of household income and household consumption does not actually correspond to any flow of money to or from households. In 2011 (the last year covered by the paper), personal consumption expenditure was given as just over $10 trillion. But of that, only about $7.5 trillion was money spent by households on goods and services. Of the rest, as of 2011:

– $1.2 trillion was imputed rents on owner-occupied housing. The national income and product accounts treat housing on the principle that the real output of housing should be the same whether or not the person living in the house happens to be the same person who owns it. So for owner-occupied housing, they impute an “owner equivalent rent” that the resident is implicitly paying to themselves for use of the house. This sounds reasonable, but it conflicts with another principle of the national accounts, which is that only market transactions are recorded. It also creates measurement problems since most owned residences are single-family homes, for which there isn’t a big rental market, so the BEA has to resort to various procedures to estimate what the rent should be. One result of the procedures they use is that a rise in hoe prices, as in the 2000s, shows up as a rise in consumption spending on imputed rents even if no additional dollars change hands.

– $970 billion was Medicare and Medicaid payments; another $600 billion was employer purchases of group health insurance. The official measures of household consumption are constructed as if all spending on health benefits took the form of cash payments, which they then chose to spend on health care. This isn’t entirely crazy as applied to employer health benefits, since presumably workers do have some say in how much of their compensation takes the form of cash vs. health benefits; tho one wouldn’t want to push that assumption that too far. But it’s harder to justify for public health benefits. And, justifiable or not, it means the common habit of referring to personal consumption expenditure as “private” consumption needs a large asterix.

– $250 billion was imputed bank services. The BEA assumes that people accept below-market interest on bank deposits only as a way of purchasing some equivalent service in return. So the difference between interest from bank deposits and what it would be given some benchmark rate is counted as consumption of banking services.

– $400 billion in consumption by nonprofits. Nonprofits are grouped with the household sector in the national accounts. This is not necessarily unreasonable, but it creates confusion when people assume the household sector refers only to what we normally think of households, or when people try to match up the aggregate data with surveys or other individual-level data.

Take these items, plus a bunch of smaller ones, and you have over one-quarter of reported household consumption that does not correspond to what we normally think of as consumption: market purchases of goods and services to be used by the buyer.

The adjustments are even more interesting when you look at trends over time. Medicare and Medicaid don’t just represent close to 10 percent of reported “private” consumption; they represent over three quarters of the increase in consumption over the past 50 years. More broadly, if we limit “consumption” to purchases by households, the long term rise in household consumption — taken for granted by nearly everyone, heterodox or mainstream — disappears.

By the official measure, personal consumption has risen from around 60 percent of GDP in the 1950s, 60s and 70s, to close to 70 percent today. While there are great differences in stories about why this increase has taken place, almost everyone takes for granted that it has. But if you look at Cynamon and Fazzari’s measure, which reflects only market purchases by households themselves, there is no such trend. Consumption declines steadily from 55 percent of GDP in 1950 to around 47 percent today. In the earlier part of this period, impute rents for owner occupied housing are by far the biggest part of the difference; but in more recent years third-party medical expenditures have become more important. Just removing public health care spending from household consumption, as shown in the pal red line in the figure, is enough to change a 9 point rise in the consumption share of GDP into a 2 point rise. In other words, around 80 percent of the long-term rise in household consumption actually consists of public spending on health care.

In our “Fisher dynamics” paper, Arjun Jayadev and I showed that the rise in debt-income ratios for the household sector is not due to any increase in household borrowing, but can be entirely explained by higher interest rates relative to income growth and inflation. For that paper, we wanted to adjust reported income in the way that Fazzari and Cynamon do here, but we didn’t make a serious effort at it. Now with their data, we can see that not only does the rise in household debt have nothing to do with any household decisions, neither does the rise in consumption. What’s actually happened over recent decades is that household consumption as a share of income has remained roughly constant. Meanwhile, on the one hand disinflation and high interest rates have increased debt-income ratios, and on the other hand increased public health care spending and, in the 2000s high home prices, have increased reported household consumption. But these two trends have nothing to do with each other, or with any choices made by households.

There’s a common trope in left and heterodox circles that macroeconomic developments in recent decades have been shaped by “financialization.” In particular, it’s often argued that the development of new financial markets and instruments for consumer credit has allowed households to choose higher levels of consumption relative to income than they otherwise would. This is not true. Rising debt over the past 30 years is entirely a matter of disinflation and higher interest rates; there has been no long run increase in borrowing. Meanwhile, rising consumption really consists of increased non-market activity — direct provision of housing services through owner-occupied housing, and public provision of health services. This is if anything a kind of anti-financialization.

The Fazzari and Cynamon paper has radical implications, despite its moderate tone. It’s the best kind of macroeconomics. No models. No econometrics. Just read the damn tables, and think about what the numbers mean.

Gurley and Shaw on Banking

Gurley and Shaw (1956), “Financial Intermediaries in the Saving-Investment Process”:

As intermediaries, banks buy primary securities and issue, in payment for them, deposits and currency. As the payments mechanism, banks transfer title to means of payment on demand by customers. It has been pointed out before, especially by Henry Simons, that these two banking functions are at least incompatible. As managers of the payments mechanism, the banks cannot afford a shadow of insolvency. As intermediaries in a growing economy, the banks may rightly be tempted to wildcat. They must be solvent or the community will suffer; they must dare insolvency or the community will fail to realize its potentialities for growth.

All too often in American history energetic intermediation by banks has culminated in collapse of the payments mechanism. During some periods, especially cautious regard for solvency has resulted in collapse of bank intermediation. Each occasion that has demonstrated the incompatibility of the two principal banking functions has touched off a flood of financial reform. These reforms on balance have tended to emphasize bank solvency and the viability of the payments mechanism at the expense of bank participation in financial growth. They have by no means gone to the extreme that Simons proposed, of divorcing the two functions altogether, but they have tended in that direction rather than toward endorsement of wildcat banking. This bias in financial reform has improved the opportunities for non-monetary intermediaries. The relative retrogression in American banking seems to have resulted in part from regulatory suppression of the intermediary function.

Turning to another matter, it has seemed to be a distinctive, even magic, characteristic of the monetary system that it can create money, erecting a “multiple expansion”of debt in the form of deposits and currency on a limited base of reserves. Other financial institutions, conventional doctrine tells us, are denied this creative or multiplicative faculty. They are merely middlemen or brokers, not manufacturers of credit. Our own view is different. There is no denying, of course, that the monetary system creates debt in the special form of money: the monetary system can borrow by issue of instruments that are means of payment. There is no denying, either, that non-monetary intermediaries cannot create this same form of debt. …

However, each kind of non-monetary intermediary can borrow, go into debt, issue its own characteristic obligations – in short, it can create credit, though not in monetary form. Moreover, the non-monetaryintermediaries are less inhibited in their own style of credit creation than are the banks in creating money. Credit creation by non-monetary intermediaries is restricted by various qualitative rules. Aside from these, the main factor that limits credit creation is the profit calculus. Credit creation by banks also is subject to the profit condition. But the monetary system is subject not only to this restraint and to a complex of qualitative rules. It is committed to a policy restraint, of avoiding excessive expansion or contraction of credit for the community’s welfare, that is not imposed explicitly on non-monetary intermediaries. It is also held in check by a system of reserve requirements. … The [money multiplier] is a remarkable phenomenon not because of its inflationary implications but because it means that bank expansion is anchored, as other financial expansion is not, to a regulated base. If credit creation by banks is miraculous, creation of credit by other financial institutions is still more a cause for exclamation.

The first paragraph of this long footnote is a succinct statement of a basic tension in bank regulation that remains unresolved. (Recall that Simons’ proposal to eliminate the intermediation function of banks was recently revived by Michel Kumhof at the IMF.) The other two paragraphs are a good clear statement of the argument I’ve been trying to develop on this blog, that there is no fundamental difference between money and other forms of financial claims, and a macroeconomically meaningful “quantity of money” was an artifact of mid-20th century regulatory arrangements.

In a World of Bullshit, This Is Some Egregious Bullshit

Via Scott McLemee and Corey Robin, I learn that Lawrence & Wishart, the publishers of the collected works of Marx and Engels, have issued takedown notice to the Marxist Internet Archive to remove all the material that L & W have copyright on. Which apparently they’re going to do — on May Day, appropriately enough.

As Scott points out, its not clear that this assertion of its property rights is going to earn L & W any money:

Somehow it has not occurred to Lawrence & Wishart that, by enlarging the pool of people aware of and reading the Collected Works, the archive is actually expanding the audience (and potential market) for L & W’s books, including the somewhat pricey MECW volumes themselves, available only in hardback at $25-50 per volume. … If Lawrence & Wishart still considers itself a socialist institution, its treatment of the Archive is uncomradely at best, and arguably much worse; while if the press is now purely a capitalist enterprise, its behavior is merely stupid.

The probability that copyright infringements can increase the income of copyright-holders has been mentioned on this blog before. If you take five minutes to think about who the market is for the collected work of Marx and Engels, it’ll be clear that that the existence of the Marxist Internet Archive is probably not cutting into it.

But beyond the pure stupidity of this, there’s the ideological stupidity.

I’m on an email list about teaching. The issue was raised recently, the list is a space for people to talk about what they do in the classroom, what works, what doesn’t, to vent about what pisses them off. It won’t work if stuff gets shared outside the list. Which, I totally agree! But what struck me, the request not to disseminate things people say on the list elsewhere, it wasn’t phrased in terms of privacy or professional courtesy, it was about respecting people’s intellectual property. That is how ideology happens.

L & W have put up response to being called out on this. We are, they say

not a capitalist organisation engaged in profit-seeking or capital accumulation, but a direct legatee of the Communist/Eurocommunist tradition in the UK, having been at one time the publishing house of the Communist Party of Great Britain. Today it survives on a shoestring, while continuing to develop and support new critical political work by publishing a wide range of books and journals. It makes no profits other than those required to pay a small wage to its very small and overworked staff, investing the vast majority of its returns in radical publishing projects…

In other words, it’s ok for us to use the power of the state to prevent people from reading Marx because we are Good Communists and we are going to do something awesome with whatever rents we can squeeze out of our copyrights. Raskolnikov had nothing on these guys.

Besides, they say, it’s so unfaaaaaair to ask them not to steal every penny they can get their fingers on. If you were real radicals, you’d respect the sacred rights of Property.

In asking L&W to surrender copyrights in this particular edition of the works of Marx & Engels, the Marxist Internet Archives and their supporters are asking that L&W, one of the few remaining independent radical publishers in the UK, should commit institutional suicide.

I guess there’s some dramatic irony in seeing Marx’s publishers engaged in this kind of primitive accumulation. But seriously, this is some egregious bullshit.

Cases like this bring out the black-is-white language of IP piracy. Here we have a group of people engaged in ongoing economic activity — an ongoing sharing of knowledge — and then an outsider arrives and tells them to stop what they’re doing on threat of violence, unless they pay up. Wouldn’t the pirates in this case be that outsiders? Wouldn’t the pirates be the ones using the threat of violence to disrupt an ongoing sharing of in order to appropriate a little booty? — which, as Scott points out, may not even be enough to defray the costs of their pillaging expedition.

“Disgorge the Cash” in The New Inquiry

The New Inquiry, an excellent new online magazine some readers may be familiar, has published an article I wrote based on the various disgorge the cash posts on this blog. Thanks to the superb editing of Mike Konczal and Rob Horning, the article develops the argument more cohesively than I’ve been able to on the blog. Go read it there, and then, if you like, comment here.

UPDATE: Matt Levine at Bloomberg calls me “the world’s leading Marxist analyst of the capital structure of the modern corporation.” That’s very flattering, but not remotely the case. What little I’ve written about this is all based on things I’ve learned from Jim Crotty, Dumenil and Levy, and Doug Henwood. (Including the phrase “disgorge the cash,” which I got from Doug.) Any of them might be contenders for that title (I won’t pick one), but not me. I’m just developing their ideas. And of course the original source of all this stuff is Part 5 of Volume III of Capital, especially chapter 27.

Notes from Capital in the 21st Century Panel

by Suresh Naidu

While I have a long piece on Piketty’s book coming out in Jacobin,
I was lucky enough to be a discussant on a panel with Thomas last Thursday,
where I got a chance to lay out some second-order reactions to the book as well
as talk with him a bit. Here are my notes from that, tidied up a bit and
including some things I didn’t get to say.

Perhaps a useful analogy
is that this is the “Free to Choose” or “Capitalism and Freedom” for
our time, from the left. I can’t think of a book that emerged from economics
for a mass audience with as much reception since then. And what good news this is
for economics! For 50 years Milton Friedman was the public face of partisan
economics, and stamped it with a conservative public face that persisted. Maybe
now Piketty’s book will give my discipline another public face.

But
let me push back against the book a bit. I think there is a
“domesticated” version of the argument that economists and people
that love economists will take away. Then there is a less
domesticated one, one that is more challenging to economics as it is currently
done. I’m curious which one Thomas believes more. I worry that the
impact of the book will be blunted because it becomes a “Bastard Piketty-ism”
and allows macroeconomics to continue in its modelling conventions, which are particularly ill-suited to questions of inequality.

The domesticated version is a story about
technology and the world market making capital and labor more and more
substitutable over time, and this is why r does not fall very much as wealth
accumulates. It is fundamentally a story about market forces, technology and
trade making the demand for capital extremely elastic. We continue to understand
r as the marginal contribution of capital to the production of the economy. I
think this is story that is told to academic economists, and it is plausible,
at least on the surface.

There is another story
about this, one that goes back to Keynes. And the idea here is that the rate of
return on capital is set much more by institutions, norms and
expectations than by supply and demand of the capital market. Keynes writes that “But the most stable, and the least easily shifted, element in
our contemporary economy has been hitherto, and may prove to be in future,
the minimum rate of interest acceptable to the generality of wealth-owners.”
Keynes footnotes it with the 19th century saying that “John Bull can stand many things, but
he cannot stand 2 percent.”

The book doesn’t quite
take a stand on whether it is brute market forces and a production function with a high elasticity of substitution or instead
relatively rigid organization of firms and financial institutions that lies
behind the stability of r.

I think the production
approach is less plausible, partly because housing plays such a large role in
the data, partly because average wages would have increased along with K/Y, partly because the
required elasticity of substitution is too big for net quantities, and partly because of the
differences between book and market capital. The (really great) sections
from the book on corporate governance actually suggest something quite
different, that there is a gap between cash-flow rights and control rights, and
this is why Germany has lower market relative to book values. This political dimension
of capital, the difference between the valuation written down in the balance
sheet and the real power to dispose of the asset, is something that the
institutional view of capital can capture better than the marginal product view. This is, I think, also a fruitful interpretation of what was at stake behind the old capital controversies.

The policy stakes from
this are also potentially large, because if it is just a very high substitutability,
a variety of labor market reforms are taken off the table, as firms just
replace workers with machines if you try to raise the wage.

Second, what is gained by producing long-run data?
Why do economic historians do what we do? And why is it important that the
series go before 1960? Part of the answer is that we discipline the modelling with useful analogies to a past. History gives us a library of options for understanding the present.
So if the wealth or income share looks like 1890 or 1913, maybe our social structure
is also starting to look like 1890 or 1913. And the book uses literature to
make some of those analogies vivid. For example maybe our marriage
patterns will start to look like those in the literature of the period.

But let us look at other
dimensions of that time. The Gilded Age U.S. North was riven with labor
conflict and the South was an apartheid state. U.S. military forces were deployed on U.S. territory more times in the late 19th century than any other period, solely for breaking up strikes and repressing labor conflict.And this points us towards one of the costs of inequality, which is a large
amount of social conflict. But note that this doesn’t have to be actually
observed to be costly. You could have a peaceful high inequality society by
spending a lot on security guards and gated enclaves (or hired economists to tell people it is all efficient and for the best), but that is still costly, in
that social resources are getting unnecessarily spent to repress, persuade, and
manage social conflict. We see the same thing in unequal societies like India,
South Africa or the gulf countries.

There is a place where the analogy breaks down,
however. We live in a world where much more of everyday life occurs on
markets, large swaths of extended family and government services have
disintegrated, and we are procuring much more of everything on markets. And
this is particularly bad in the US. From health care to schooling to
philanthropy to politicians, we have put up everything for sale. Inequality
in this world is potentially much more menacing than inequality in a less commodified
world, simply because money buys so much more. This nasty
complementarity of market society and income inequality maybe means that the
social power of rich people is higher today than in the 1920s, and one response
to increasing inequality of market income is to take more things off the market
and allocate them by other means.

Finally, let me suggest
that if we’re aiming for politically hopeless ideas, open migration is as least
as good as the global wealth tax in the short run, and perhaps complementary.
One weakness of the book is its focus on the large core economies (the data
obviously is better and the wealth is obviously larger). But liberalizing
immigration, while not solving the ultimate problem the book diagnoses,
can go some of the way by raising growth of both income and population. With
political rights and liberties, it is also one thing that could set off a new
set of progressive political energies. These restless and young populations of
the developing world might catalyze a new set of political energies, just as
socialist movements of the Gilded Age were powered by immigrant workers.

Another constituency for
the global wealth tax could also be from this same group, demanding reparations for past slavery and colonialism. If those primordial injustices created the
initial conditions for the accumulation of wealth in the core, perhaps those
legacies can build energy for rectifying them in the future.

A Harrodian Perspective on Secular Stagnation

I’ve mentioned before, I think a useful frame to think about the secular stagnation debate through is what’s become known as Harrod’s growth model. [1] My presentation here is a bit different from his.

Start with the familiar equation:

S – I + T – G = X – M

Private savings minus private investment, plus taxes minus government spending, equal exports minus imports. [2] If the variables refer to the actual, realized values, then this is an accounting identity, always true by definition. Anything that is produced must be purchased by someone, for purposes of consumption, investment, export or provision of public services. (Unsold goods in a warehouse are a form of investment.) If the variables refer to expected or intended values, which is how Harrod used them, then it is not an identity but an equilibrium condition. It describes the condition under which businesses will be “satisfied that they have produced neither more nor less than the right amount.”

The next step is to rearrange the equation as S – (G – T) – (X – M) = I. We will combine the government and external balances into A = (G – T) + (X – M). Now divide through by Y, writing s = S/Y and a = A/Y. This gives us:

s – a = I/Y

Private savings net of government and foreign borrowing, must equal private investment. Next, we decompose investment. Logically, investment must either provide the new capital goods required for a higher level of output, or replace worn-out or obsolete capital goods, or be a shift toward a more capital-intensive production technique. [3] So we write:

s – a = gk + dk + delta-k

where g is the growth rate of the economy, k is the current capital-output ratio, d is the depreciation rate (incorporating obsolescence as well as physical wearing-out) and delta-k is the change in the capital-output ratio.

What happens if this doesn’t hold? Realized net savings and investment are always equal. So if desired savings and desired investment are different, that means that somebody’s expectations were not fulfilled. For a situation to arise in which desired net savings are greater than desired investment, either people must have saved less than they wish they had in retrospect, or businesses must have investment more than they wish they had in retrospect. Either way, expenditure in the next period will fall.

What prevents output from falling to zero, in this case? Remember, some consumption is linked to current income, but some is not. This means that when income falls, consumption falls less than proportionately. Which is equivalent to saying that when income falls, there is also a fall in the fraction of income that is saved. In other words, if the marginal propensity to save out of income is less than one, then s — which, remember, is average saving rate — must be a positive function of the current level of output. So the fall in output resulting from a situation in which s > I/Y will eventually cause s to fall sufficiently to bring desired saving into equality with desired investment. The more sensitive is consumption to current income, the larger the fall in income required; if investment is also sensitive to current income, then a still larger fall in income will be required. (If investment is more sensitive than saving to current income, this adjustment process will not work and the decline in output will continue until investment reaches zero.) This is simply the logic of the Keynesian multiplier.

In addition to current income, saving is also a function of the profit rate. Saving is higher out of profits than out of wages, partly because profit recipients are typically richer than wage-earners, but also because are large fraction of profits remain within the business sector and are not available for consumption. [4] Finally, saving is usually assumed to be a function of the interest rate. The desired capital output ratio may also be a function of the interest rate. All the variables are of course also subject to longer term social, technological and economic influences.

So we write

s(u, i, p) – a = gk + dk + delta-k(i, p)

where u is the utilization rate (i.e. current output relative to some measure of trend or potential), i is some appropriate interest rate, and p is the profit share. s is a positive function of utilization, interest rates and the profit share, and delta-k is a negative function of the interest rate and a positive function of the profit rate. Since the profit share and interest rate are normally positive functions of the current level of output, their effects on savings are stabilizing — they reduce the degree to which output must adjust to maintain equality of desired net savings equal and investment. The effect of interest rates on investment is also stabilizing, while the effect of the profit share on investment (as well as any direct effect of utilization on investment, which we are not considering here) are destabilizing.

How does this help make sense of secular stagnation?

In modern consensus macroeconomics, it is implicitly assumed that savings and/or investment are sufficiently sensitive to interest rates that equilibrium can be normally be maintained entirely by changes in interest rates, with only short-term adjustments of output while interest rates move to the correct level. The secular stagnation idea — in both its current and original 1940s edition, as well as the precursor ideas about underconsumption going back to at least J. A. Hobson — is that at some point interest rate adjustment may no longer be able to play this role. In that case, desired investment will not equal desired saving at full employment, so there will be a persistent output gap.

There are a number of reasons that s – a might rise over time. As countries grow richer, the propensity to consume may fall simply because people’s people’s desires for goods and services are finite. This was what Keynes and Alvin Hansen (who coined the term “secular stagnation”) believed. Desired saving may also rise as a result of an upward redistribution of income, or a shift from wage income to profit income, or an increase in the share of profits retained by firms. [5] Unlike the progressive satiation of consumption demand, these three factors could in principle just as easily evolve in the other direction. Finally, government deficits or net exports might decline — but again, they might also increase.

On the right side of the equation, growth may fall for exogenous reasons, slowing population growth being the most obvious. This factor has been emphasized in recent discussions. Depreciation is hardly mentioned in today’s secular stagnation debate, but it is prominent in the parallel discussion of underconsumption in the Marxist tradition. The important point here is to remember that depreciation refers not only to the physical wearing-out or using-up of capital goods, but also to capital goods displaced by competition or obsolescence. In competitive capitalism, businesses invest not only to increase aggregate capacity, but to win market share from each other. Much of depreciation represents capital that goes out of use not because it has ceased to be physically productive, but because it is attached to businesses that have lost out in the competitive struggle. Under conditions of monopoly, the struggle over market share is suppressed, so effective depreciation rates, and hence desired investment, will be lower. Physical depreciation does also exist, and will change as the production technology changes. If there is a secular tendency toward longer-lived means of production, that will pull down desired investment. As for delta-k, it is clearly the case that the process of industrialization involves a large upward shift in the capital-output ratio. But it’s hard to imagine it continuing to rise indefinitely; there are reasons (like the shift toward services) to think it might reach a peak and then decline.

So for secular, long-term trends tending to raise desired saving relative to desired investment we have: (1) the progressive satiation of consumption demand; (2) slowing population growth; (3) increasing monopoly power; and (4) the end of the industrialization process. Factors that might either raise or lower desired savings relative to investment are: (5) changes in the profit share; (6) changes in the fraction of profits retained in the business sector; (7) changes in the distribution of income; (8) changes in net exports; (9) changes in government deficits; and (10) changes in the physical longevity of capital goods. Finally, there are factors that will tend to raise desired investment relative to desired saving. The include: (11) consumption as status competition (this may offset or even reverse the effect of greater inequality on consumption); (12) social protections (public pensions, etc.) that reduce the need for precautionary and lifecycle saving; (13) easier access to credit, for consumption and/or investment; and (14) major technological changes that render existing capital goods obsolete, increasing the effective depreciation rate. These final four factors will offset any tendency toward secular stagnation.

It’s a long list, but I think it’s close comprehensive. Different versions of the stagnation story emphasize various of these factors, and their relative importance has varied in different times and places. I don’t think there is any a priori basis for saying that any of them are more or less important in general.

One problem with this conversation, from my point of view, is that people have a tendency to pick out a couple items from this list as the story, without considering the whole question systematically. For instance, there’s a very popular story in left Keynesian circles that makes it all about (7), offset for a while by (13) and perhaps (11). I don’t doubt that greater income inequality has increased desired private saving. It may be that this is the main factor at work here. But people should not be confidently asserting it is before clearly posing the question and analyzing the full range of possible answers.

In a future post we will think about how to assess the relative importance of these factors empirically.

[1] While the model itself is simple, the interpretation of it — the question it’s intended to answer — is quite controversial. Harrod himself intended it as a model of economic dynamics — that is, describing the system’s transition from one state to another in historical time. As it entered mainstream economics (via the criticism of Samuelson) and also much of structuralist work, it instead became treated as a model of economic growth — that is, of a long-run equilibrium one of whose variables happens to be the growth rate rather than the level of growth. It seems to me that while Harrod clearly was interested in dynamics, not growth in the current sense, the classic article is in fact ambivalent. In particular, Harrod is simply inconsistent in his definition of g: sometimes it is the change in output from one period to the next, while at other times it is the normal or usual change in output expected by business. Furthermore, as Joan Robinson pointed out, his famous knife-edge results depend on using the average savings rate as a parameter, which only makes sense if we are describing a long-run equilibrium. In the short period, it’s the marginal savings rate that is stable, while the average savings rate varies with output. So while it is true that Harrod thought he was writing about economic dynamics, the model he actually wrote is inconsistent. One way to resolve this inconsistency is to treat it as a model of equilibrium long-run growth, as Samuelson did; the other way, which I take here, is to treat it as a Keynesian short-run model in which the current, usual or expected growth rate appears as a parameter.

[2] Strictly speaking it should be the current account balance rather than the trade balance but there’s no harm in ignoring cross-border income flows here.

[3] I am writing here in terms of a quantifiable capital stock, which I have deep misgivings about. But it makes the exposition much simpler.

[4] This is true even in the “disgorge the cash” era, because much of the higher payouts from corporations go to financial institutions rather to households, and thus stay in the business sector.

[5] On the other hand, in a world where investment is constrained by funding, a higher share of profits retained will raise investment as well as savings, leaving its overall effect ambiguous.

EDIT: I think I’ve been misled by reading too much of the Keynesian classics from the 1930s and 40s. The dynamic I describe in this post is correct for that period, but not quite right for the US economy today. Since 1980, the average private savings rate has moved countercyclically, rather than procyclically as it did formerly and as I suggest here. So the mechanism that prevents booms and downturns from continuing indefinitely is no longer — as Keynes said, and I unthinkingly repeated — the behavior of private savings, but rather of the government and external balances. I can’t remember seeing anything written about this fundamental change in business cycle dynamics, which is a bit surprising, but it’s unambiguous in the data.

Fortunately we are interested here in longer term changes rather than cyclical dynamics, so the main argument of this post and the sequel shouldn’t be too badly undermined.

EDIT 2: Of course this change has been written about, what was I thinking. For example, Andrew Glyn, Capitalism Unleashed:

From Marx to Keynes at least, consumption was viewed as an essentially passive component of the growth process. Capital accumulation, investment spending on machinery and buildings, was the essential driving force on the demand as well as on the supply side. It was the capitalists’ access to finance which allowed capital spending to exceed the previous period’s savings and fuelled the expansion of demand; future profits ensured that such borrowing was repaid with a real return. Deficit spending by the government could, in wartime for example, impart a similar impulse to demand, at least till capital markets took fright at the growing debt interest burden and worries about inflation. However household consumption, some two-thirds of aggregate demand, was seen as playing the role of sustaining the current output level rather than driving it up. Savings ratios often fell during recessions, as consumers attempted to maintain spending in the face of falling incomes. Indeed, Milton Friedman criticized the Keynesians for exaggerating the dependence of consumption on current income and ignoring the extent to which savings could be used to ‘smooth’ out the path of consumption. More recently, rather than acting as a stabilizing influence, sharp falls in the savings ratio have occurred during expansions. By boosting consumption proportionately more than the rise in incomes this has intensified upswings, with the danger of sharp falls in demand if savings rebound sharply when the expansion slackens and pessimism builds up.

A Quick Note on Money

Nick Rowe and David Glasner are having an interesting debate on whether it is possible to speak of excess demand (or excess supply) for money in a world where most money consists of commercial bank deposits.

Nick, naturally, argues for the affirmative. Glasner argues for the negative, drawing on Tobin’s 1967 restatement of the 19th century “law of reflux.”

This is a tricky question to take sides on. The problem, from my point of view, is that to get from the classical “real exchange” economy , to our actual “monetary production” economy (both phrases are Keynes’s), takes not one but two steps. First, you have to see how real activity depends on liquidity conditions. And second, you have to see how liquidity conditions depend on the whole network of actual and potential balance sheet positions — liquidity as a social relation, as Mike Beggs says. A focus on the special role of money is helpful in the first step but an obstacle to the second.

I think Keynes himself contributed to the problem with his discussion money in the General Theory. He was working so hard to get people to take the first step that he pushed the second one out of view. The GT is full of language like:

Unemployment develops, that is to say, because people want the moon; — men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.

This is a story about exogenous money; this kind of language smoothed the the way for what Perry Mehrling calls “Monetary Walrasianism,” as you get from someone like Nick Rowe. Jorg Bibow’s definitive account of Keynesian liquidity preference theory (summarized here) makes it clear that Keynes did this for clear strategic reasons, and the Treatise on Money is better in this respect. But it’s still a problem.

So for me the Tobin article (and Glasner’s summary) has an ambivalent character. They are right to criticize the idea of an exogenous stock of money, and the related idea that transaction demand for money is central to aggregate demand; but I worry that their arguments tend to tip backward toward the classical dichotomy rather than point forward toward a fuller account of liquidity.