Author Archives: V. Ramanan

Severin Reissl’s Critique Of Steve Keen’s Black Box Economics

Posted on by
Leave a reply

Economics is a strange subject. A lot of times we learn a lot from others’ errors and even if you see the errors, there’s sometimes a lot to learn from others’ critiques of the same because sometimes it is difficult to see all the pitfalls even if one sees a few. Severin Reissl from the University of Glasgow has a fine critique of Steve Keen’s models of aggregate demand and changes in debt.

The paper titled, The return of black box economics – a critique of Keen on effective demand and changes in debt is available here.

From the paper:

The claim investigated in this article, however, has to be clearly distinguished from such arguments. The question at issue is not whether levels of (private) debt or changes therein can have an impact on effective demand and consequently national income, or on macroeconomic stability. On this proposition there appears to be universal agreement in the post-Keynesian literature. Whether such a connection exists in a given context is then an empirical question. For instance, Stockhammer and Wildauer (2015) find a positive effect of household debt on consumption, but a negative one upon investment (including residential investment). Keen’s hypothesis is more fundamental and bold, namely that capitalist economies are always and everywhere credit-driven, that there is an immutable link between changes in aggregate (i.e. all types of) debt and changes in effective demand which can be expressed in a simple relation much like the equation of exchange (M ∗ V = P ∗ Y ).

[emphasis in original]

The article also goes into Keen’s misreading of Minsky and Keynes (which Keen uses to support himself) and the notion that trading in financial assets be included in aggregate demand.

The paper has some non-standard definitions such as expenditure meaning to include other payments than just purchases of goods and services as in the System of National Accounts (SNA). For example equation (7) might better read:

Disposable Income − Expenditure = Change in Financial Assets (net)

with expenditure counting only payments for goods and services.

This of course doesn’t affect the conclusion about issues with Keen’s models. Overall, the paper has a nice discussion on national accounts and literature. Macroeconomics is hard but the best guide is self-consistency. It is as much important as empirical testing. Keen tries to show that his definitions are consistent with data by making various charts in his blog/papers and in articles for newspapers and magazines. These can of course be explained by models which have self-consistency unlike Keen. The paper mentions this point clearly:

Professor Keen displays a tendency to overinterpret the works he utilises as a foundation for his own argument, while these works themselves suffer from terminological imprecisions. These imprecisions can, as demonstrated above, consequently also be found in Keen’s own argument. Keen presents some empirical data to support his argument. Fiebiger (2014) provides an adequate critique of this and all that remains to note is that the evidence cannot resolve the problems raised here, since they are not foremost of an empirical nature.

The U.S. Net International Investment Position At The End Of 2014

Posted on by
Leave a reply

The U.S. Department of Commerce’s Bureau of Economic Analysis today released accounts for the United States’ international investment position. The U.S. is sometimes called the world’s biggest debtor and its net international investment position is now (at the end of 2014) minus $6.9 trillion.

Here’s the chart from the BEA’s website. U.S. Net International Investment Position 2014A few points. The importance of the U.S. balance of payments and international investment position is quite neglected in analysis of the crisis. The United States’ economy went into a crisis (and the rest of the world with it) because a huge rise in private indebtedness led to a fall in private expenditure relative to income when the burden of the debt started pinching. This caused a drop in economic activity and was saved partly due to automatic stabilizers of fiscal policy as tax payments fell due to a drop in economic activity and partly due to a relaxation of fiscal policy itself by the U.S. government and governments abroad. But the huge rise in the U.S. government debt meant that resolving the crisis by fiscal policy alone would have been difficult. This is because a huge fiscal expansion would have meant that the U.S. trade deficit would have risen much faster into an unsustainable path.

See Wynne Godley’s article The United States And Her Creditors: Can The Symbiosis Last? from 2005 here arguing such things.

Back to the international investment position. There are a lot of interesting things about it. Although the U.S. in a huge debtor to the rest of the world, the return on assets held by resident economic units of the United States earn more than paying on liabilities to nonresidents. So according to the BEA release U.S. International transactions 2014, investment income in the full year was about $813 billion while income payments was about $586 billion. (More complication arises from “secondary income”).BEA-2014-U.S.-International-Transactions

In addition, revaluations of assets and liabilities also affect the international investment position and revaluations of direct investment held abroad has acted in the United States’ favour.

Of course this cannot always be the case. Take a simple example: Suppose an economic unit’s assets is $100 and liabilities is $150 and suppose assets earn 8% every year and interest paid on liabilities is 5%. So even though the economic unit has a net indebtedness of $50, it is earning

$100 × 8% − $150 × 5% = $0.5

However, if liabilities rise to $160 and beyond the net return turns negative.

In a similar way, there is a tipping point, beyond which the net primary income of the current account of balance of payments turns negative. Because the United States has a negative current account balance and the deficit adds to the net indebtedness every year, at some point in the future, the international investment position may reach a tipping point.

All this sounds as if domestic demand and output are unrelated. This is of course not the case. Imports depend on domestic demand and exports depend on economic activity abroad. Hence the constraint on output at home because if output were to rise fast, the net indebtedness of the United States will also rise fast.

Of course the concept of a tipping point may itself be misleading. Indebtedness can keep rising even if net primary income turns negative without any trouble in financial markets because it all depends on how the financial markets see the problem. But it may be said that once a tipping point is reached, the debt will start to rise much faster than now. My article here hasn’t gone into any analysis here with numbers but I will leave it for another day.

Disappointing Start, Mr. Bernanke

Posted on by
Leave a reply

Ben Bernanke has a new blog at Brookings.

In his second post, Why are interest rates so low?, Bernanke “explains the rationale behind the Federal Reserve’s continued policies”. We should be thankful to Bernanke for his leadership qualities to have kept interest rates low to help the world economy recover from a crisis. The latest post however ends up just stating the standard neoclassical economics story: a hugely inaccurate way of looking at the world. Keynes himself debunked many such notions.

First he starts off with the notion of the Wicksellian interest rate.

To understand why this is so [“Why are interest rates so low?”], it helps to introduce the concept of the equilibrium real interest rate (sometimes called the Wicksellian interest rate, after the late-nineteenth- and early twentieth-century Swedish economist Knut Wicksell). The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment. Many factors affect the equilibrium rate, which can and does change over time. In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments.

Full employment in the United States? When did this happen? Keynes himself rejected this (see here) (quote h/t Lars Syll).

Keynes said:

In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest—namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s ‘natural rate of interest’, which was, according to him, the rate which would preserve the stability of some, not quite clearly specified, price-level.

I had, however, overlooked the fact that in any given society there is, on this definition, a different natural rate of interest for each hypothetical level of employment. And, similarly, for every rate of interest there is a level of employment for which that rate is the ‘natural’ rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment. Thus it was a mistake to speak of the natural rate of interest or to suggest that the above definition would yield a unique value for the rate of interest irrespective of the level of employment. I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.

I am now no longer of the opinion that the [Wicksellian] concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.

Ben Bernanke then says:

Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment.

This again confuses the direction of causality from saving to investment among other things. Bernanke himself is a witness to the fact that large US government deficits didn’t have such effects. Economists such as Paul Krugman have an explanation for this, claiming this is untrue when the economy is in a “liquidity trap” but think this is the case. A large deficit has the private sector net lending as the mirror image and there’s no reason for interest rates to necessarily rise because of large deficits. Ben Bernanke is simply repeating economists’ favourite “crowding out” argument.

Ben Shalom Bernanke. Huge disappointment.

Respect For Identities

Posted on by
Leave a reply

The accounting identities equating aggregate expenditures to production and of both to incomes at market prices are inescapable, no matter which variety of Keynesian or classical economics you espouse. I tell students that respect for identities is the first piece of wisdom that distinguishes economists from others who expiate on economics. The second? … Identities say nothing about causation.

– James Tobin, 1997, p. 300, ‘Comment’, in B.D. Bernheim and J.B. Shoven (eds), National Saving and Economic Performance, Chicago: University of Chicago Press.

This is such a nice quote by James Tobin. Almost all economists, orthodox or heterodox would agree with it I believe.

In practice, however, economists confuse identities for behaviour and causation no end. They even confuse identities themselves. But it now seems that some think that usage of national accounting identities produces erroneous conclusions.

In a series of posts, (here and few posts before), David Glasner, the author of the blog Uneasy Money — Commentary on monetary policy in the spirit of R. G. Hawtrey, seems to be suggesting that letting identities go is the way forward for macroeconomic modeling.

Glasner says:

There are two reasons why defining savings and investment to be identically equal in all states of the world is not useful in a macroeconomic theory of income. First, if we define savings and investment (or income and expenditure) to be identically equal, we can’t solve, either algebraically or graphically, the system of equations describing the model for a unique equilibrium.

[boldening and emphasis added]

So it seems that using accounting identities in your model would lead to inconsistencies. I and a few other commenters have tried to convince Glasner of his errors in series of posts.

Some people seem to think that identities do not tell anything. The truth is not so straightforward. Identities constrain outcomes. Any macroeconomic model which does not use identities as constraints may produce non-possible states of the world.

Brad deLong confronted Glasner on Twitter with this point:

click to view on Twitter

If you have time, interest and energy, please convince Glasner that accounting identities cause no issues in macroeconomic modeling.

Derailed: Wynne Godley On The Euro Area

Posted on by
Leave a reply

I am in favour of Britain having much closer ties with other European countries, provided that appropriate institutions are created and the whole thing is brought under effective political control. But I have never been able to understand what it is that those who support the Maastricht Treaty think they are going to get out of it. Maastricht supporters are keen on ‘not being left out’. But left out of what exactly?

…

It seems clear that the Maastricht criteria for the establishment of ‘convergence’ were far too narrowly conceived. To fulfil the conditions necessary for a successful currency union it is not nearly enough that member countries agree to follow simple rules on budgetary policy and achieve some minimum period of low inflation and currency stability. They need to reach a degree of structural homogeneity such that shocks to the system as a whole do not normally affect component regions in drastically different ways. Moreover, arrangements should be made which ensure that when substantial changes of a structural kind do turn up the federal authority is equipped to share out any burden which ensues. It would be wrong to suppose that there exist well-defined ‘fault lines’ which can be cured once and for all. Structural changes are always going to be taking place as a consequence of political earthquakes, or for other reasons, and the Community must have some way of dealing with them.

– Wynne Godley, Derailed, 1993

A list of articles by Wynne Godley on the Euro Area:

  1. ‘Commonsense Route To A Common Europe’, Observer,  6 January 1991, page 28 (scan)
  2. ‘Maastricht And All That’, London Review of Books, Vol. 14 No. 19, 8 October 1992, pages 3-4 (link)
  3. ‘Derailed’, London Review of Books, Vol. 15 No. 16, 19 August 1993, page 9 (link, more here)
  4. ‘Curried EMU – The Meal That Fails To Nourish’, Observer, 31 August 1997, page 24 (scan)

Wynne-Godley-July-1981Wynne Godley, July 1981
(picture source)

Anthony Thirlwall’s New Book On Keynesian And Kaldorian Economics

Posted on by
Leave a reply

During the global economic and financial crisis Keynes became popular again but Nicholas Kaldor’s ideas and the mention of the man himself didn’t take off as much. It’s unfortunate, as Kaldor played a huge role in the development of Keynesian economics itself. Kaldor’s own ideas are a subject of its own. Anthony Thirlwall is releasing a new collection of essays on Keynes and Kaldor in a book titled Essays on Keynesian and Kaldorian Economics to be published by Palgrave Macmillan.

Book website here

Anthony Thirlwall - Essays On Keynesian And Kaldorian Economics

Description:

This volume of essays contains sixteen papers that the author has written over the last forty years on various aspects of the life and work of John Maynard Keynes and Nicholas Kaldor. The essays cover both theoretical and applied topics, and highlight the continued relevance of Keynesian and Kaldorian ideas for understanding the functioning of capitalist economies. Kaldor was one of the first economists to be converted to the Keynesian revolution in the mid-1930s, and he never lost the faith, so there was a strong affinity between them. But while Keynes revolutionised employment theory, Kaldor’s major concern in the latter part of his life was with the theory and applied economics of economic growth. The papers on Keynes mainly relate to defending Keynesian economics against his classical and monetarist critics and showing how Keynesian ideas relate to developing economies and the functioning of the world economy in general. The papers on Kaldor give a sketch of his life and role as policy advisor, and outline his vision of the growth and development process within regions; within countries, and also the world economy as a whole.

Table of Contents

Introduction

  1. Keynesian Economics after Fifty Years; N. Kaldor
  2. A ‘Second Edition’ of Keynes’ General Theory (writing as John Maynard Keynes)
  3. Keynesian Employment Theory is Not Defunct
  4. The Renaissance of Keynesian Economics
  5. The Relevance of Keynes Today with Particular Reference to Unemployment in Rich and Poor Countries
  6. Keynes, Economic Development and the Developing Countries
  7. Keynes and Economic Development
  8. A Keynesian View of the Current Financial and Economic Crisis in the World Economy (an interview with John King)
  9. Nicholas Kaldor: A Biography
  10. Kaldor as a Policy Adviser
  11. Kaldor’s Vision of the Growth and Development Process
  12. A Model of Regional Growth Rate Differences on Kaldorian Lines (with R. Dixon)
  13. A General Model of Growth and Development on Kaldorian Lines
  14. A Plain Man’s Guide to Kaldor’s Growth Laws
  15. Testing Kaldor’s Growth Laws across the Countries of Africa (with Heather Wells)
  16. Talking about Kaldor (an interview with John King)

Anthony-P-ThirlwallAnthony Thirlwall

JKH On Paul De Grauwe’s Fiscal Arithmetic

Posted on by
Leave a reply

In a recent article for VOX, Paul De Grauwe and Yuemei Ji write about potential fiscal effects of a possible asset purchase program by the Eurosystem (European Central Bank and the National Central Banks in the Euro Area). In that the authors take an extreme stand suggesting that a default by a Euro Area government on bonds held by the Eurosystem doesn’t even matter.

JKH has written a fantastic critique of the VOX article by De Grauwe and Ji.

JKH says:

De Grauwe goes on to say that because bonds held by the ECB –defaulted or otherwise – are “eliminated” on consolidation, it doesn’t matter what they were valued at on the ECB balance sheet in the first place. They may as well have been valued at zero – because they have effectively been eliminated and replaced by ECB liabilities (assumed by implication to be permanently interest free).

…

Thus, the balance sheet implication of De Grauwe’s treatment is that some portion of future currency issued by the ECB will be “backed” on its own balance sheet by an asset of zero value – the defaulted Italian bond. The problem is that this currency would have been issued in any event according to the demand that will arise naturally from the growth of the European economy over time (notwithstanding current depressed conditions). And so ECB seigniorage will have been reduced from what it would have been had it included the effect of good interest on Italian bonds. That reduction in seigniorage due to default is a real fiscal cost, because it reduces the profit remittance of the ECB from what it would have been in the non-default counterfactual. And the fact that the reduced seigniorage gets distributed to the residual capital holders means that there has been a fiscal transfer to the defaulting sovereign from the remaining capital holders. So De Grauwe is simply wrong on this point.

Another way to look at it is by looking at the international investment position. A default by a nonresident on a claim on held by residents is a reduction in the net international investment position and a reduction in the wealth of the geographic region. (The wealth of a nation is the sum of the value of its non-financial assets plus the net international investment position). International investment position matters as a sounder position implies that there is higher potential to raise output.

De Grauwe has another article for The Economist from today. He writes:

Since Milton Friedman we have all become monetarists. In order to raise inflation it will be necessary to increase the growth rate of the money stock. This requires that the ECB increase the money base. And to achieve the latter there is only one practical instrument, ie, an open-market purchase of government bonds. There is no other way to raise inflation than through an increase in the money base and a bond-buying programme is the time-tested way to achieve this.

It is sad that Monetarism is still alive today, despite being repeatedly been shown to be incorrect. But more importantly for the current discussion about risks, De Grauwe repeats his stand again and states it more explicitly:

This confusion between accounting losses and real losses is unfortunate. It has led to long hesitation to act. It also leads to bad ideas and wrong proposals.

So losses do not even matter!

The problem with a Eurosystem asset purchase program of Euro Area government bonds is that it achieves little. It is not a coordinated Euro Area wide fiscal expansion which is badly needed. The ECB already has the OMT program which has helped government bond yields from rising and leading to a crisis, so a QE will hardly achieve much except having an impact on prices of financial market securities. QE just diverts attention from important challenges for a unified Europe. Challenges such as how to move toward the formation of a central government.

The Devil Is In The Detail

Posted on by
Leave a reply

There are two ways in which the terminology “net lending” is used.

In national accounts, it is the difference between saving and investment for any economic unit or a sector. “S − I”. It is the financial surplus.

Bankers and central bankers use “net lending” a bit differently. Here there is “netting” when redemptions are netted.  For example, suppose a bank lends 100 units in one period and for simplicity assume all 100 are redeemed. Also assume that it makes 110 units of loans in the next period. In this case, net lending is 10 units.

But these two shouldn’t be confused.

Steve Keen should perhaps understand that the devil is in the detail and if he is interested in making accounting models of the economy, he should improve his accounting.

In a recent Forbes piece, he says:

So if the private sector is to finance the government sector’s surplus, and if the economy is growing at the same time, then there has to be a net flow of new money created by the banking sector—part of which expands the non-banking public’s money stock, and part of which finances the government sector’s surplus. Therefore the banking sector has to “run a deficit”: new loans have to exceed loan repayments (plus interest payments on outstanding debt).

Call this net flow of new money NetLend.

[emphasis: mine]

In the scenario assumed, banks have a surplus because presumably their operations are profitable. In the absence of fixed capital formation by banks, their undistributed profits are their financial surplus. Banks are net lenders in the national accounting sense (and hence have a financial surplus not a deficit). They net lenders in bankers’ language because gross new loans exceed redemptions.

While it is not wrong redefine terminologies, Keen is doing a sectoral balance analysis where deficit/surplus has a different meaning.

In short, in a growing economy, if the government is in surplus, it is more likely that non-financial corporations and households together have a deficit or a negative financial balance. Gross new loans by banks exceeding gross redemptions does not imply banks have a deficit (i.e., a negative financial balance). It is of course not impossible for banks to have a deficit in such scenarios: consider for example, banks purchasing a lot of buildings for their offices. In that case, banks’ “S − I”  may be negative.

Keynesian Economics And Thievery

Posted on by
Leave a reply

In a WSJ opinion piece titled An Autopsy for the Keynesians, John H. Cochrane makes the following accusation on Keynesian Economics:

By Keynesian logic, fraud is good; thieves have notoriously high marginal propensities to consume.

Cochrane’s piece reads as assertions after assertions trying to prove that fiscal policy is impotent. Keynesians emphasize the role of effective demand in the determination of national income and expenditure. Hidden in Cochrane’s misprepresentation of Keynesian economics is the assumption that Keynesians think that the supply side does not matter.

No Keynesian would ever say that. In fact Keynesians emphasize that although the principle of effective demand is highly important, output of a nation or a geographic region is finally constrained by the capacity to produce and international competitiveness of its producers. If a nation promotes fraudsters, its capacity to produce will be lower than the case where honesty is promoted. If a nation is full of thieves, Keynes wouldn’t even take off: any attempt by the government to use Keynesian policies will fail to improve real output.

So not just morally, but even from an economic viewpoint, Keynesian economics doesn’t not promote fraud.

Cochrane’s WSJ piece just highlights the sad state of Macroeconomics.

Merry Christmas!