Even conventional wisdom is starting to worry about insufficient government stimulus

The Institute for New Economic Thinking reports on recent respectable economic opinion encouraging government stimulus (Who's talking about getting fiscal? 06/10/2016)

"A wind of change is howling through the world’s economic institutions,” wrote the Guardian’s Larry Elliot Thursday. “Last week it was the International Monetary Fund saying that austerity could do more harm than good and that neoliberalism was not all it was cracked up to be. This week it is the turn of the Organisation for Economic Cooperation and Development to challenge the orthodoxy.”

He was referring to the latest policy outlook published by the Organization for Economic Cooperation and Development, which argued that the scale of the long-term growth crisis facing the industrialized economies required a strong fiscal response of the type disdained by neoliberal orthodoxy.

“Growth is flat in the advanced economies and has slowed in many of the emerging economies that have been the global locomotive since the crisis,” OECD Secretary-General Angel Gurría told the organization’s annual Ministerial Council meeting in Paris. “Slower productivity growth and rising inequality pose further challenges. Comprehensive policy action is urgently needed to ensure that we get off this disappointing growth path and propel our economies to levels that will safeguard living standards for all”.

Stiglitz on the massive need for Keynesian stimulus policies

"The obstacles the global economy faces are not rooted in economics, but in politics and ideology." - Joseph Stiglitz, 2016

He makes this case in the form of a sensibly Keynesian diagnosis of the state of the world economy in The Great Malaise Continues Project Syndicate 01/03/2015.

The politics in much of the West have been in hock to the gospel of neoliberalism (aka, free-market fundamentalism, Herbert Hoover economics, Angela Merkel economics) for so long now that bonehead textbook Keynesian economics sounds dangerously radical. But however one chooses to position it on the current political spectrum, Keynesian economic analysis address the kinds of problems many economies currently have and offer useful solutions. Not least among them is the need to flush what Stiglitz calls "deficit fetishism." That's why Keynesians like Paul Krugman, who tend to call themselves New Keynesians these days, and Post-Keynesians like Jamie Galbraith and Yanis Varoufakis find a lot to agree on in terms of immediate policy needs right now.

Krugman gives us a hint of what some of the difference would emerge in his post, Presidents and the Economy 12/30/2015:

After I put up my post comparing private-sector jobs under Obama and Bush, a number of people asked me whether I believe that presidents have a large effect on economic performance. My answer is no — but conservatives believe that they do, which is why this kind of comparison is useful.

To expand on my own views, in normal times the economy’s macroeconomic performance mainly depends on monetary policy, which isn’t under White House control. Now, we’ve been in a liquidity trap for the whole Obama administration so far, giving fiscal policy a much more central role — and the initial stimulus did help quite a lot. Since 2010, however, fiscal policy has been paralyzed by GOP obstruction, so we’re back to a situation where the WH has little influence. [my emphasis in bold]

The last book of John Kenneth Galbraith's (1908-2006) published during his lifetime was The Economics of Innocent Fraud (2004). He devotes one of the chapters in this short book to what he calls "our most prestigious form of fraud, our most elegant escape from reality." That, he explains, is that, "Quiet measures enforced by the Federal Reserve are thought to be the best approved, best accepted of economic actions. They are also manifestly ineffective. They do not accomplish what they are presumed to accomplish. ... Here is our most cherished and, on examination, most evident form of fraud."

This is a major difference between New Keynesian and Post-Keynesian economics. The former have faith in the effectiveness of monetary policy, the latter have little or none. I assume that some in the post-Keynesian camp don't go quite as far as Galbraith senior did in dissing monetary policy. However, when it comes to addressing a recession or depression - specifically in economist-speak when the interest rate is at the lower bound, i.e., near zero - New Keynesians and Post-Keynesians alike recognize that monetary policy isn't much use in restoring growth. And not just monetarists, who have declined tremendously in their number of adherents since the 1970s, but the other various forms of conservative/neoliberal economic theories are still devoted to the notion of the Fed's magical monetary powers. As are many investment advisers and people who try to follow the stock market closely on their own with no specialized training.

But getting back to Stiglitz, he's right on the mark here:

Former US Federal Reserve Board Chairman Ben Bernanke once said that the world is suffering from a “savings glut.” That might have been the case had the best use of the world’s savings been investing in shoddy homes in the Nevada desert. But in the real world, there is a shortage of funds; even projects with high social returns often can’t get financing.

The only cure for the world’s malaise is an increase in aggregate demand. Far-reaching redistribution of income would help, as would deep reform of our financial system – not just to prevent it from imposing harm on the rest of us, but also to get banks and other financial institutions to do what they are supposed to do: match long-term savings to long-term investment needs.

... It makes sense for countries like the US and Germany that can borrow at negative real long-term interest rates to borrow to make the investments that are needed. Likewise, in most other countries, rates of return on public investment far exceed the cost of funds. For those countries whose borrowing is constrained, there is a way out, based on the long-established principle of the balanced-budget multiplier: An increase in government spending matched by increased taxes stimulates the economy. Unfortunately, many countries, including France, are engaged in balanced-budget contractions. [emphasis in original]

Russian economic troubles and the EU

Wolfgang Münchau addresses the question of a Russian "bankruptcy," as people are speculating about it, in Auf dem Weg in die Staatspleite Spiegel Online 22.12.2014.

Bankruptcy is actually a legal term applying to the working out of private insolvencies. Governments don't technically go bankrupt. Although the term is often used in practice to refer to sovereign default, which is a threat that investors have to take seriously in the case of Russia.

But Münchau doesn't believe that a Russian default is imminent for 2015. There are certainly grounds for concern. As part of its effort to stop the dizzying plunge of the ruple, Russia has jacked up its interest rates to 17%, which is likely to further depress an economy hard hit by the fall in the price of oil. He notes that Russia has €400 million euros (around $330 million) in foreign reserves that give it breathing room.

But he stresses the seriousness of Russia's economic situation:

Vor der Währungskrise war die russische Wirtschaft ungefähr so groß wie die von Frankreich. Jetzt spielt sie in der Liga der Niederlande. Und sie bewegt sich in Richtung Griechenland.

[Before the currency crisis the Russian economy was about as big as that of France. Now it is playing in the Netherland's league. And it is moving in the direction of Greece.]

He notes that the US and EU sanctions are not an immediate cause of Russia's economic problems

Die Finanzsanktionen des Westens sind für die jetzige Krise nicht direkt verantwortlich, aber sie spielen eine wichtige, indirekte Rolle, die erst in ein oder zwei Jahren offensichtlich werden wird.

[The Western financial sanctions are not directly responsible for the current crisis, but they play an important, indirect role that will first become clear in a year to two.]

But he thinks that some EU leaders are now surprised at the implications of sanctions as the prospect of a major decline in the Russian economy are already facing the EU.

With the eurozone in a protracted depression, they are taking on a lot more risk with sanctions against Russia than they would be taking absent Angela Merkel's draconian austerity policies.

The pro-Western Ukrainian parliament has rescinded Ukraine's position of not joining any military bloc, indicating their intent to proceed to seek NATO membership. Russian Foreign Minister Sergei Lavrov called the action "fully counterproductive," following a statement Monday from Russian Prime Minister Dmitriy Medvedev that the action Ukraine took Tuesday would make Ukraine "a potential military opponent of Russia." (Ende der Blockfreiheit: Lawrow warnt Ukraine vor Eskalation Spiegel Online 23.12.2014)

Spiegel Online also notes that Ukraine formally adopted its neutral status of staying out of military blocs under Russian pressure in 2010.

Tomothy Garton Ash adopts a triumphalist tone in Angela Merkel has faced down the Russian bear in the battle for Europe The Guardian 12/22/2014

The fact that he describes Merkel in the first paragraph as "strongest on economic power" makes me wonder just how much attention he's paying to the actual state of the eurozone under Merkel's austerity policies, though he says he "remain[s] critical of her handling of the eurozone crisis."

But he gushes over her handling of the Ukraine crisis:

At the beginning of this year, German president Joachim Gauck, an east German Protestant, took up the appeal that other Europeans had already made for Germany to assume more leadership responsibility in Europe. In the course of the year, Merkel, an east German Protestant, has answered that appeal. The eastern half of Europe is her world. She has it in her bones. She understands it.

One of the early influences on her was a teacher of Russian. As a schoolgirl, she won East Germany’s Russian-language Olympiad. On her office wall, she has a portrait of Sophie von Anhalt-Zerbst, the Pomeranian princess who became Empress Catherine the Great of Russia. She can speak to Putin in Russian, as he can to her in German. [my emphasis]

The touch about her keeping a potrait of Catherine the Great on her wall adds a bit of reinforcement to my thought that she takes the Soviet management of the Warsaw Pact as her model for managing the European Union.

Ash treats the Ukrainian crisis as though it were a Russian aggression that fell unexpectedly on the virtuous West. In that spirit he quotes Merkel, who has had no compunction about pushing for the ouster of democratically elected governments in Greece and Italy as part of her eurozone crisis management, saying, "Old thinking in terms of spheres of influence, whereby international law is trampled underfoot, must not be allowed to prevail.”

As Charlie Pierce might say: Honky, please.

He even goes on to say, "Everyone knows she is Europe’s real chair." But that doesn't count for him as a sphere of influence.

He also sees in her enthusiasm for sanctions against Russia Churchillian resolve:

As she never tires of repeating, her strategy has three prongs: support for Ukraine, diplomacy with Russia and sanctions to bring Putin to the negotiating table. To see Germany leading the way in economic sanctions against Russia is extraordinary. In the early 1990s, I wrote a history of West Germany’s Ostpolitik, culminating in German unification, and the first commandment of that Ostpolitik was that eastern trade should always go on. Sanctions were called for by the US and resisted by Germany. Today, Germany has more trade with Russia than any other European power. Its energy, machine-tool and other eastward–oriented businesses form a powerful lobby, not least within Merkel’s own Christian Democratic Union. Yet she has taken them down the path of sanctions. [my emphasis]

Ostpolitik was successful in dialing back tensions between East and West and reducing the risk of nuclear war.

Merkel's policy looks to me like a reckless roll of the dice, particularly since she undertook it with no indication she intends to abandon her destructive austerity policies.

Where Garton Ash sees a cautious, determined stateswoman, I'm inclined to see a talented political tactician locked into a dogmatic, unrealistic economic dogma ("ordoliberalism") who gambles big and is constantly riding the tiger.

Garton Ash isn't entirely unaware of that. At the end of his gushing piece he notes:

And then she has been lucky – an essential attribute for any successful stateswoman or statesman. (I can’t bring myself to write statesperson.) Without a spectacular fall in the price of oil, the sanctions, which are still patchy, and not supported by China and other important economic partners of Russia, would not have had this dramatic impact.

The battle of Europe is far from over. In Russia itself, deepening economic crisis will not necessarily translate into more accommodating policy. There is no route map to a post-Putin regime. The cornered bear may lash out. In the bloodied fields of eastern Ukraine, there is still the risk of a series of 1914-style miscalculations leading to an escalation. Russian military planes have flown into the air space of Baltic Nato members.

"The battle of Europe": Western policymakers need to dial back the melodrama and try to stay with a don't-do-stupid-stuff approach to the Ukraine crisis.

Keynes is becoming a better-known name again, finally

Keynes and the contra-cyclical economics associated with his policy recommendations have been getting a lot more attention lately, due to the prolonged stagnation in Japan, the slow recovery in the US and the ongoing depression in the eurozone.

Bloomberg Businessweek recently featured a cover story by Peter Coy, John Maynard Keynes Is the Economist the World Needs Now 10/30/2014:

... even in the past tense, the British economist, investor, and civil servant John Maynard Keynes has more to teach us about how to save the global economy than an army of modern Ph.D.s equipped with models of dynamic stochastic general equilibrium. The symptoms of the Great Depression that he correctly diagnosed are back, though fortunately on a smaller scale: chronic unemployment, deflation, currency wars, and beggar-thy-neighbor economic policies.

An essential and enduring insight of Keynes is that what works for a single family in hard times will not work for the global economy. One family whose breadwinner loses a job can and should cut back on spending to make ends meet. But everyone can’t do it at once when there’s generalized weakness because one person’s spending is another’s income. The more people cut back spending to increase their savings, the more the people they used to pay are forced to cut back their own spending, and so on in a downward spiral known as the Paradox of Thrift. Income shrinks so fast that savings fall instead of rise. The result: mass unemployment.[my emphasis]

Coy also describes the need that more policymakers and advisers are seeing for alternatives to neoliberal orthodoxy, aka, the Washington Consensus:

The big question is whether today’s international financial architecture is up to the challenge of restoring balance to global trade and investment. The IMF, to its credit, has pivoted away from the austere prescriptions of the “Washington Consensus” that it championed through the 1990s and toward a more Keynesian perspective. “His thinking is more relevant at the current juncture than it had been in previous troughs of the global economy,” says Gian Maria Milesi-Ferretti, deputy director of the IMF’s research department.

But the IMF lacks the authority that Keynes’s stillborn international clearing union would have had, and it’s perceived in some quarters to be beholden to U.S. interests. Brazil, China, India, Russia, and South Africa are trying to set up an alternative. Germany isn’t heeding the IMF much either as it presses France and Italy to take the same austerity medicine as Greece, Ireland, Portugal, and Spain. “Flash-in-the-pan, short-term stimulus programs” aren’t the way to boost growth, German Economics Minister Sigmar Gabriel said on Oct. 20 in advance of a joint ministerial meeting in Berlin. At loggerheads, the Germans and French punted a joint proposal to Dec. 1. Eswar Prasad, a Cornell University economist and author of The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance, writes in an e-mail that Keynes’s proposed system “requires good domestic policies and a heavy dose of international cooperation,” both of which are in short supply. [my emphasis]

Coy doesn't mention that Sigmar "Sigi Pop" Gabriel is a Social Democratic Minister in Angela Merkel's Grand Coalition government who is willing backing Merkel's Herber Hoover/Heinrich Brüning economic policies for the eurozone.

Peter Temin and David Vines also write about Keynes in Why Keynes is important today VoxEU 11/14/2014. They discuss how a theory called Ricardian Equivalence came to be a dominant idea among those Paul Krugman calls the Very Serious People:

Ricardian Equivalence is a theory that concludes that any expansion of public spending will be offset by an equal and opposite decline in private spending. The theory is based on a few important assumptions. It assumes forward-looking consumers who adjust their current spending in anticipation of future taxes to pay for the spending. Under these conditions, any increase in current spending leads consumers to anticipate a rise in future taxes and decrease their current spending to save for this.

This theory dominates current macroeconomic discussion. It fits into the form of current macroeconomics that assumes not just forward-looking consumers, but flexible prices as well. And if a Keynesian suggests fiscal policy in current conditions, a modern economist is likely to invoke Ricardian Equivalence.

They also link to a column by Krugman on the concept, A Note on the Ricardian Equivalence Argument Against the Stimulus (Slightly Wonkish) 12/26/2014, in which he explains:

Ricardian equivalence says that what determines consumption is the lifetime present value of after-tax income, and hence that, say, a temporary tax cut won’t stimulate spending, because people will figure that whatever they gain now will be offset by higher taxes later. It is a dubious doctrine even done right; many people are liquidity constrained, and very few people have the knowledge or inclination to estimate the impact of current government budgets on their lifetime tax liability.

But even if you assume that the doctrine is right, it does NOT imply that government spending on, say, infrastructure will be met by offsetting declines in private spending.

Neo-Classical voodoo economics

David Glasner gives an explanation in EconomistSpeak of how neo-classical economics displaced reality-based Keynesian economics in many institutions and in the most prevalent public narratives about economics. From Explaining the Hegemony of New Classical Economics Uneasy Money 09/30/2014:

These early attempts at providing microfoundations were largely exercises in applied price theory, explaining why self-interested behavior by rational workers and employers lacking perfect information about all potential jobs and all potential workers would not result in immediate price adjustments that would enable all workers to find employment at a uniform market-clearing wage. Although these largely search-theoretic models led to a more sophisticated and nuanced understanding of labor-market dynamics than economists had previously had, the models ultimately did not provide a fully satisfactory account of cyclical unemployment. But the goal of microfoundations was to explain a certain set of phenomena in the labor market that had not been seriously investigated, in the hope that price and wage stickiness could be analyzed as an economic phenomenon rather than being arbitrarily introduced into models as an ad hoc, albeit seemingly plausible, assumption.

But instead of pursuing microfoundations as an explanatory strategy, the New Classicals chose to impose it as a methodological prerequisite. A macroeconomic model was inadmissible unless it could be explicitly and formally derived from the optimizing choices of fully rational agents. Instead of trying to enrich and potentially transform the Keynesian model with a deeper analysis and understanding of the incentives and constraints under which workers and employers make decisions, the New Classicals used microfoundations as a methodological tool by which to delegitimize Keynesian models, those models being insufficiently or improperly microfounded. Instead of using microfoundations as a method by which to make macroeconomic models conform more closely to the imperfect and limited informational resources available to actual employers deciding to hire or fire employees, and actual workers deciding to accept or reject employment opportunities, the New Classicals chose to use microfoundations as a methodological justification for the extreme unrealism of the rational-expectations assumption, portraying it as nothing more than the consistent application of the rationality postulate underlying standard neoclassical price theory. [my emphasis]

A brief unpacking: Microeconomics is about transactions at the business level; macroeconomics is about the functioning of economies on the national and international levels.

The famous supply-and-demand charts of microeconomics, featuring things like "marginal pricing," are based on several abstract assumptions, including consumers make rational choices based on full information about the prices and products available in the market.

Now, this is valid up a point. If you're going to make a mathematical model of any process, you have to have some limiting assumptions. Otherwise, you'd have to recreate all of the science of astrophysics to model even the simplest process.

The obvious problem with a model that assumes a world of rational customers, with perfect competition, and all actors have full and perfect knowledge of the markets is that it's plainly not the real world. In such world, the entire fields of marketing and advertising wouldn't exist, to mention just one problem.

But expanding these "microfoundations" to macroeconomics allowed conservative economists to demonstrate with impressive mathematical edifices to show, for instance, that a company's stock valuation always represents its real economic value, that the stock market moves are directly connected to real economic activity, that arbitrage and rent-seeking basically can't exist, and that anything corporations actually do makes perfect economic sense. There are never irrational market panics, or corporate conspiracies against the public interest and - most importantly - economic crises like that of 2008 are impossible.

And if the impossible happens, well, the gubment must be to blame. And black people, of course. (Update: the latter refers in particular to the US Republican version of this ideology.)

Yes, a very large part of respectable economics is just that crude. It comes in various packaging. But its based on the same highly ideological construct. Robert Lucas won the Nobel Prize for Economics in 1995 for a variant called "rational expectations theory," (also known as the rational expectations hypothesis [REH]) which basically argued that no government policies can ever have any substantial effect on an economy's performance, except occasionally to muck things up. The basic concept was developed by John Nash, Jr., continued by John Muth and eventually elaborated into its most famous form by Lucas and Thomas Sargent, as related by Yanis Varoufakis, Joseph Halevi and Nicholas Theocarakis in their textbook Modern Political Economics: Making Sense of the Post-2008 World (2011). As they explain:

If the world behaves like this type of theory suggests, it is impossible for output, employment or any other variable that society cares about to be positively affected by means of government intervention. If agents always entertain the correct expectations plus some random noise), then aggregate output and employment is always going to be as high as it can. Inevitably, meddling governments can only undermine perfection!

Remarkably, the REH literature dominated at a time of historically high unemployment. How did it manage that? To be consistent with their model, they had to claim that if observed unemployment is, say, 8 per cent, then 8 per cent is the level of unemployment that it is 'natural' for the economy to have at that point - the 'natural' rate consistent with agents' rational, i.e. correct, expectations. Suppose, they added, government tried to suppress unemployment to below that 'natural' level by means of 'Keynesian' meddling. The ensuing increase in the quantity of money cannot, in this context, change what people expect (in terms of actual output, employment, etc.) since everyone harbours the correct expectations. Everyone will then know in advance, on the basis of their rational expectations, that the government's effort will leave output and employment unaffected. Immediately they will surmise that prices must rise (since there is now more money in the economy chasing after the same quantity of goods and the same amount of actual labour). [my emphasis in bold]

This is kind of thinking that Glasner accurately calls "extreme unrealism."

Stuff we need more of in American politcs: Keynesian economics

Paul Krugman wrote last year in Mr. Keynes and the Moderns 06/18/2011:

And as it turns out, Keynes-as-equilibrium-theorist ... has a lot to teach us to this day. The struggle to liberate ourselves from Say's Law, to refute the "Treasury view" and all that, may have seemed like ancient history not long ago, but now that we're faced with an economic scene reminiscent of the 1930s, it turns out that we're having to fight those intellectual battles all over again. And the distinction between loanable funds and liquidity preference theories of the rate of interest – or, rather, the ability to see how both can be true at once, and the implications of that insight – seem to have been utterly forgotten by a large fraction of economists and those commenting on economics.

Say's Law was what Ronald Reagan was taught in college in the 1920s, the theory that supply creates its own demand. It was one reason he found the "supply-side economics" scam so persuasive.

Keynesian economics has it's weaknesses. Not least of which is that it prescribes increasing taxes during economic expansions as a way of keeping overproduction restrained. It's sound macroeconomics, but politically it's nearly impossible.

But the Keynesian idea of expanding domestic government spending and running deficits (and borrowing money) if necessary to so is the best prescription for dealing with recessions.

Also from Krugman, The Triumph of Bad Ideas 06/22/2011:

But can we note just how bizarre our situation is? Keynesian economics has actually come through the crisis with flying colors. The only knock on it is the “Obama tried stimulus and it failed, neener neener” thing — but those of us who took our Keynesianism seriously warned literally from the beginning that the stimulus was far too small.

And yet in the political domain Keynesianism is seen as discredited, while various forms of crowding out/austerity is expansionary talk, which have in fact totally failed — look at interest rates! — have become orthodoxy.

And in the EU that's even more so the case than in the US, which is suffering badly enough from Herbert Hoover economics right now.

Tags: keynes, keynesianism, paul krugman

John Maynard Keynes and "Economic Possibilities for our Grandchildren"

Keynes biographer Robert Skidelsky urges us to take a new look at one of Keynes' most famous essays, Economic Possibilities for our Grandchildren (1930).

In Return to capitalism 'red in tooth and claw' spells economic madness Guardian 06/21/2012, he uses Keynes' critical observation in that essay to point to how existing economic arrangements radically restrict the possibilities of our current economic capabilities:

Keynes reckoned that we would hear much more about [technological] unemployment in the future. But its emergence, he thought, was a cause for hope, rather than despair. For it showed that the developed world, at least, was on track to solving the "economic problem" – the problem of scarcity that kept mankind tethered to a burdensome life of toil.

Machines were rapidly replacing human labour, holding out the prospect of vastly increased production at a fraction of the existing human effort. In fact, Keynes thought that by about now (the early 21st century) most people would have to work only 15 hours a week to produce all that they needed for subsistence and comfort.

Developed countries are now about as rich as Keynes thought they would be, but most of us work much longer than 15 hours a week, although we do take longer holidays, and work has become less physically demanding, so we also live longer. But, in broad terms, the prophecy of vastly increased leisure for all has not been fulfilled. Automation has been proceeding apace, but most of us who work still put in an average of 40 hours a week. In fact, working hours have not fallen since the early 1980s.

These are real possibilities in the economy that aren't even on the horizon's of thought for our political and media elites. If the public can change the dominant way of thinking about economic policy away from austerity policies and toward stimulating the economy, more constructive possibilities like this can get back on the radar screen.

Tags: keynes, keynesianism