I wasn’t too excited about “agent-based models” before this, but I saw this paperWhat Drives Markups? Evolutionary Pricing In An Agent-Based Stock-Flow Consistent Macroeconomic Model by Marc Lavoie (co-authored with Pascal Seppecher and Isabelle Salle) and it got me a bit interested.
From the paper:
ABMs are conceived to analyze out-of-equilibrium dynamics and adaptation processes from heterogeneous and interacting entities … On a more specific note, we use a stock-flow consistent (hereafter, SFC) framework … there has been a multiplicity of macroeconomic models that combine two important features: the principle of decentralization/disaggregation which is found in ABM and the principle of stock-flow consistency … In an ABM, macroeconomic variables are the result of a simple process of aggregation of individual data, as in the real word [sic] …, so that the accounting accuracy provided by the SFC ensures the relevance of the aggregation process …, as well as the interconnected nature of the balance sheets of all agents. Symmetrically, AB principles could provide micro-foundations to SFC macroeconomics, that is, a way to logically articulate and rigorously organize the interactions between the micro and the macro levels.
Recently, The Economist‘s cover story declared that the government of Germany ought to expand domestic demand and its refusal to do so is a threat to the world economy. It also said, “Germany’s surpluses are themselves a threat to free trade’s legitimacy.”
Post-Keynesians have long recognized this problem with the world economy. Keynes himself said in 1941:
It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments. … The contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors. Nor is this all. … The social strain of an adjustment downwards is much greater than that of an adjustment upwards. … The process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannotfall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion
– in Collected Works, Vol. XXV, pages 27-28.
Few things:
Keynes is building a narrative to argue that creditor nations have responsibilities, although at that time (and also at present), they have no obligation. This was the motivation for his plan for Bretton-Woods, where he proposed to impose fines on creditor/surplus nations and set out some responsibilities for them.
Also, although the above was written keeping in mind a new world order (at 1941), it’s still valid for the post-Bretton-Woods era. This is because, although floating exchange rates help making adjustments, their power is completely exaggerated.
It’s also important to keep in mind, that the world is more complicated now. Creditor/suprlus nations have achieved their status by making adjustments, i.e., by keeping wages and domestic demand low. So it’s not exactly or literally like what Keynes presented. It’s not the best of worlds in Germany or China.
Still, what Keynes said was highly insightful.
It’s also interesting that for The Economist, Germany’s behaviour is a “threat to free trade’s legitimacy.” Nicholas Kaldor also said the same in 1980:
In the absence of … measures all countries may suffer a slower rate of growth and a lower level of output and employment, and not only the group of countries whose economic activity is ‘balance-of-payments constrained’. This is because the ‘surplus’ countries’ own exports will be lower with the shrinkage of world trade, and they may not offset this (or not adequately) by domestic reflationary measures so that their imports will also be lower.
For The Economist, Germany’s behaviour is a threat to free trade. For Post-Keynesians, Germany’s behaviour is expected (and ought to be different) and is a good reason to reject free trade.
But it’s not a bad thing that The Economist recognizes Keynes’ insights.
This is a continuation of a recent post at this blog, Public Debt And Current Account Deficits, in which I argued that the current account balance of payments affects the public debt.
A usual objection to the connection is that the two deficits—current account deficit and the budget deficit—although connected by an identity, don’t move together and in fact move in the opposite direction frequently. This point was raised by the blog Econbrower, yesterday.
The identity in question is:
NL = DEF + CAB
where, NL is the private sector net lending, DEF is the government’s deficit and CAB is the current account balance of payments (and is to a zeroth order approximation, exports less imports).
This is not a behavioural hypothesis but still a useful tool to build a narrative. Also, the causality connecting the identities is domestic demand and output at home and abroad.
Imagine, initially that NL is a small positive relative to GDP (for example, NL/GDP = 2%), Also remember that,
NL = Private Income − Private Expenditure
Now assume that private expenditure rises relative to private income. This will lead to higher GDP, a higher national income and a rise in imports because of income effects and hence a lower CAB. It will also lead to higher taxes because of higher income and hence will reduce the budget deficit, DEF, ceteris paribus.
So if the current account balance is in deficit, it would mean that the budget deficit and the current account deficit move in opposite directions.
That’s the theoretical basis for the empirical relationship. But that in itself isn’t the whole story. This is because the other balance—net lending, NL—has a life of its own. As is the case in the United States and several western countries, it turned negative once or twice in the 1990s the 2000s, and when the private sector’s debt rose, it made a sharp U-turn into the positive territory. The blue line in this graph:
Click the graph to see it on FRED.
So, if net lending reverts to its mean of staying positive, one can then conclude that the cumulative budget deficit, or the public debt is affected by cumulative current account deficits.
At any rate, the public debt shouldn’t be the main object of study. What’s more important is the international investment position. And it’s an identity that:
NIIP = cumulative CAB + Revaluations
where, NIIP, is the net international investment position.
A nation which runs current account deficits can become indebted to the rest of the world. IIP is the position of assets and liabilities of resident sectors of a nation. So, the net debt (the negative of NIIP) is the nation’s debt.
The above linked Econbrowser post brings in the complication of revaluations to deny the relationship between CAB and NIIP. But revaluations can’t save you for long.
In short, both public debt and NIIP depend on current account deficits.
Finally a weak analogy: if you play in the rain, you might enjoy it as well. But then if you get sick, you can’t say, “I felt so good playing in rains, so playing in the rain didn’t make me sick”. Saying the two deficits (current account and budget) move in opposite directions is an argument like that.
Recently, a U.S. politician Rick Perry cited Say’s Law:
Here’s a little economics lesson: supply and demand. You put the supply out there and the demand will follow.
Just saying that implicitly rejects the Keynesian principle of effective demand.
But it’s interesting to see that according to Nicholas Kaldor, the principle of effective demand is not a rejection of Say’s Law.
What is Say’s Law. Usually this paragraph—from Jean Baptiste Say’s book, A Treatise On Political Economy; Or The Production, Distribution, And Consumption Of Wealth, published in 1821,page 38—is referred:
It is worth while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent foi other products.
In Keynesian Economics After Fifty Years, in the book, Keynes And The Modern World, ed. George David Norman Worswick and James Anthony Trevithick, Cambridge University Press, 1983, page 5, Kaldor says:
The Principle Of Effective Demand
The core of Keynes’s theory is the principle of effective demand which is best analysed as a development or refinement of Say’s law, rather than a complete rejection of the ideas behind that law.
Further, on page 6:
The originality in Keynes’s conception of effective demand lies in the division of demand into two components, an endogenous component and an exogenous component. It is the endogenous component which reflects (i.e., is automatically generated by) production, for much the same reasons as those given by Ricardo, Mill or Say — the difference is only that in a money economy (i.e. in an economy where things are not directly exchanged, but only through the intermediation of money) aggregate demand can be a function of aggregate supply (both measured in money terms) without being equal to it — the one can be some fraction of the other. To make the two equal requires the addition of the exogenous component (which could be one of a number of things, of which capital expenditure – ‘investment’ – is only one) the value of which is extraneously determined. Given the relationship between aggregate output and the endogenous demand generated by it (where the latter can be assumed to be a monotonic function of the former), there is only one level of output at which output (or employment) is in ‘equilibrium’ – that particular level at which the amount of exogenous demand is just equal to the difference between the value of output and the value of the endogenous demand generated by it. If the relationship between output and endogenous demand (which Keynes called ‘the propensity to consume’) is taken as given, it is the value of exogenous demand which determines what total production and employment will be. A rise in exogenous demand, for whatever reasons, will cause an increase in production which will be some multiple of the former, since the increase in production thus caused will cause a consequential increase in endogenous demand, by a ‘multiplier’ process.
A capitalist economy (for reasons explained below) is not ‘self-adjusting’ in the sense that an increase in potential output will automatically induce a correspond¬ing growth of actual output. This will only be the case if exogenous demand expands at the same time to the required degree: and as this cannot be taken for granted, the maintenance of full employment in a growing economy requires a deliberate policy of demand management … the mere existence of competition between sellers (‘firms’) will not in itself ensure the full utilization of resources unless all firms expand in concert. Any one firm, acting in isolation, may find that the market for its own products is limited, and will therefore refrain from expanding its production even when its marginal costs are well below the ruling price. Under these conditions involuntary unemployment could only be avoided if something – the growth of some extraneous component of demand – drives the economy forward.
So Say’s law is not wrong, it’s incomplete. Nonetheless, it’s not surprising that politicians like Rick Perry are going to use it, mislead and reject the Keynesian principle of effective demand.
tl;dr
Say’s law: supply creates demand.
Principle of effective demand: demand also creates its own supply. supply creating demand doesn’t mean the economy is running at full capacity.
The Economist‘s latest cover is about the German balance of payments. The subheading of its editorial says, that it “[t]he country saves too much and spends too little”.
That’s welcome, although the article claims that the German government’s policy is not mercantilist, while at the same time saying that wages have been held down to achieve more competitiveness in exports.
🤦🏻♂️
Anyway, it’s good that it has recognized that this is a problem for the world economy. Funnily, the editorial is still defending free trade, without realizing that the ideology is based on the assumption that market forces will resolve imbalances. If the magic of the price mechanism works, why do you need active policy?
It’s important to remember that John Maynard Keynes recognized that active policy measures are needed to resolve global imbalances. He proposed to impose a penalty on creditor nations in his plan for Bretton-Woods and also require them to take measures such as:
(a) Measures for the expansion of domestic credit and domestic demand. (b) The appreciation of its local currency in terms of bancor, or, alternatively, the encouragement of an increase in money rates of earnings; (c) The reduction of tariffs and other discouragements against imports. (d) International development loans.
– page 24 of The Keynes Plan
A lot of times, people argue that the moral stand that Germany reduce its surpluses is vacuous. Germany is independent and responsible for its own decision. Who are others asking German politicians to raise domestic demand?
The answer to that is Germany makes huge gains out of its success in international trade. What if deficit nations form a union and impose high tariffs and quotas on their imports? International trade runs under a set of rules (the “rules of the game”) and other nations have a right to demand this from Germany and ask for fairer rules.
Anyway, The Economist has finally accepted what Keynes was saying 80 years ago!
Yesterday, there was an article at Vox which takes issue with a statement from Donald Trump which connects the US public debt with current account deficits.
Trump ran his campaign on dividing people, is out to destroy health care and wants a regressive system of taxation and so should be resisted. At the same time, a blanket opposition is counterproductive, especially when it is an important matter.
Vox quotes Trump:
For many, many years the United States has suffered through massive trade deficits; that’s why we have $20 trillion in debt.
In response, Vox claims:
The US trade deficit refers to the fact that the US imports more from the world than it exports. The national debt is the result of the fact that the US government spends more revenue than it collects. There’s no direct relationship between the two.
The whole article is written to claim that there is no connection. But anyone who knows the sectoral balances identity will recognize that there is a connection.
So the sectoral balances identity is:
NL = DEF + CAB
where, NL is the private sector net lending, DEF is the government’s deficit and CAB is the current account balance of payments (and is to a zeroth order approximation, exports less imports).
Of course, this is an identity and shouldn’t be confused for any behavioural hypothesis but it’s still useful in creating a narrative around a model (such as an SFC model) with behaviour for households, firms, the financial system, the government and the rest of the world.
On an average the private sector net lending is a small positive number relative to GDP (such as 2%), although it can fluctuate a lot. So for the U.S. economy, we saw that it was negative a lot in the 2000s and then reverted to a large positive just before and during the crisis.
One should of course keep in mind the correct causality connecting the three terms. What connects them is demand and output at home and abroad.
So the government’s deficit is affected by exports and imports. If there’s a large current account deficit, there’s a fall in demand and hence output and hence income and hence taxes leading to a higher government deficit than otherwise. Deficits in turn affects the public debt.
In other words, the U.S. public debt would have been lower, ceteris paribus, had the problem of the U.S. trade imbalance would have been addressed. This would have happened because of higher national income and higher taxes.
People don’t see the connection because they are comparing different nations. So for example, Japan has been successful in international trade and yet has a high public debt. In the other extreme, Australia has had large current account deficits over the years and public debt much lower than Japan (relative to GDP). But one should do a ceteris paribus comparison.
Excellent Jayati Ghosh interview with The Real News Network, from earlier this week, titled Jayati Ghosh On Imperialism In The 21st Century.
click to watch on YouTube.
Excerpts:
… [I]mperialism is fundamentally about the struggle over economic territory. It’s not just about state control or colonial control or any specific kind of control. It’s really the struggle of large capital over different kinds of economic territory. And these could be territories defined in terms of markets, in terms of workers and labor, in terms of natural resources, in terms of new kinds of markets that are developed.
…
… [I]mperialism has gone through many different forms in the course of its evolution. There was the time when it was explicit colonial control, when it was the control by the state over other physical territories which they could then change to their own desires.
…
… [I]mperialism has had to move towards new ways of control. They are not purely military. They are not purely political. They are much more, I would call them, legal and institutional forms of control … So, the WTO, of course, several of the rules of the IMF, but much more significantly, the new trade and investment treaties that are being signed, plurilateral, bilateral, all of these mega regionals. All of these are really oriented towards limiting the power of nation states to control capital, which in turn means that imperialism is able to take new forms.
Also a good explanation of what neoliberalism is:
Neoliberalism is fundamentally the view that the role of the state is not necessarily to reduce its power but to exercise its power directly in favor of capital … People talk about it as a retreat of the state. It’s not a retreat of the state. It’s a shift of the state away from protecting the interests of society at large and particularly, therefore, the working class towards protecting the interests of capital. Because we will see that states are no less powerful. In fact, some of the most neoliberal states are often the most authoritarian. And they’re becoming more and more authoritarian.
There’s a nice interview of Noam Chomsky and Ha-Joon Chang by C.J. Polychroniou of Truthout on the myths of globalization. Of course, as Chomsky and Ha-Joon Chang point out, the debate is not against globalization per se, but globalization under the current rules of the game.
Ha-Joon Chang is direct about his views:
The assumption that globalization benefits everyone is based on mainstream economic theories that assume that workers can be costlessly re-deployed, if international trade or cross-border investments make certain industries unviable.
In this view, if the US signs NAFTA with Mexico, some auto workers in the US may lose their jobs, but they will not lose out, as they can retrain themselves and get jobs in industries that are expanding, thanks to NAFTA, such as software or investment banking.
You will immediately see the absurdity of the argument — how many US auto workers do you know who have retrained themselves as software engineers or investment bankers in the last couple of decades? Typically, ex-auto-workers fired from their jobs have ended up working as night-shift janitors in a warehouse or stacking shelves in supermarkets, drawing much lower wages than before.
He also talks of winners and losers and compensation. Of course, I wish he went further and argued that globalization—under the current rules of the game—-produces not just individual winners and losers and also leads to polarization between nations.
Emmett Rensin has a fantastic essayThe Blathering Superego At The End of History on liberalism for the Los Angeles Review Of Books. Rensin says:
The most significant development in the past 30 years of liberal self-conception was the replacement of politics understood as an ideological conflict with politics understood as a struggle against idiots unwilling to recognize liberalism’s monopoly on empirical reason. The trouble with liberalism’s enemies was no longer that they were evil, although they might be that too. The problem, reinforced by Daily Kos essays in your Facebook feed and retweeted Daily Show clips, was that liberalism’s enemies were factually wrong about the world. Just take a look at this chart …
And Vox and The New Yorker and so on. A good example of this is Paul Krugman’s Ricardo’s Difficult Idea. We are told how silly it is to reject free trade. Heterodox economists can see all this because we know the real history: Keynesian economics overthrown by Friedmanism and neoliberalism.
I also loved the line:
The Clinton campaign believed that it would win because it predicted that it would win, and because the capacity to predict and manage was precisely the competence Clinton’s team was selling. But then Clinton lost. The car crashed in the desert instead.
The article is written keeping in mind the UK referendum on the EU membership (“Brexit”), Clinton’s loss/Trump’s win and Jeremy Corbyn’s rise and liberals’ reaction to it and how what Rensin calls the “intellectual authority” is suddenly ripping away.
Morris Copeland was the discoverer (or inventor?) of the flow of funds approach. The U.S. Federal Reserve publishes the statistics every quarter but is largely ignored. Copeland was of the view that it is essential to get rid of myths in economics. He said:
The subject of money, credit and moneyflows is a highly technical one, but it is also one that has a wide popular appeal. For centuries it has attracted quacks as well as serious students, and there has too often been difficulty in distinguishing a widely held popular belief from a completely formulated and tested scientific hypothesis. I have said that the subject of money and moneyflows lends itself to a social accounting approach. Let me go one step farther. I am convinced that only with such an approach will economists be able to rid this subject of the quackery and misconceptions that have hitherto been prevalent in it.
– in Social Accounting For Moneyflows, in Flow-of-Funds Analysis: A Handbook for Practitioners (1996) [article originally published in 1949]
In an article titled, Some Illustrative Analytical Uses Of Flow-of-Funds Data, in the book, The Flow-of Funds Approach To Social Accounting, published in 1962, he has several interesting things to say about the myths prevalent even among most economists.
Page 196:
The FOF accounts help to dispel various misconceptions in regard to the role of money and of other forms of credit in the income and money circuit. Among these misconceptions are such ideas as that: (1) it is safe to assume that private nonbank cash balances are mostly consumer cash balances; (2) the banking sector is more than a mere financial intermediary, that by itself it can “create” a substantial amount of “money” that can be used to finance a substantial increase in aggregate demand; (3) a government deficit in a particular year or other period can be considered inflationary without stopping to consider whether it represents a fiscal change from the preceding period that tends to increase aggregate demand or whether it occurs at a time when the economy is operating at or near or far below full capacity; and (4) when the government seeks to raise a large amount of money through financial channels to finance a war, one can ignore the fact that an excess of nonfinancial uses over nonfinancial sources of funds for the government means an equal excess of nonfinancial sources over nonfinancial uses of funds for the rest of the economy and a consequent equal amount of money that the rest of the economy will necessarily advance to the government through financial channels.
Note: in (2) above, Copeland is talking of finance of government deficit via sale to banks as compared to sale to the general public and these two have different effects on the money stock. Same below.
Page 197:
It is not easy for us today to imagine what it must have been like to try to understand the workings of our economy in the absence of social accounting information. The workings of those aspects that involve financial transactions seem to have been particularly difficult to understand. Indeed, I think we can say that in the absence of financial transaction social accounting information various misunderstandings were permitted to develop. Let me mention three:
One of these relates to the role of trade credit in the business cycle. This is a subject that probably received somewhat less attention than it deserved fifty-odd years ago, but it seems to have greatly intrigued H. J. Davenport, and he came up with this curious conclusion about the contraction of credit during a commercial crisis— “Side by side with the diminution of bank credit there is taking place an enforced and inevitable expansion of credit relations between producers and consumers, producers and middle-men, and between middle-men and consumers.”
During World War I Secretary of the Treasury W. G. McAdoo, among others, was greatly concerned about the possibility that the huge wartime increase in the demand for funds would drive interest rates sharply up. As a matter of fact, interest rates did rise but by no means as sharply as McAdoo had anticipated. Railroad bond yields rose from 4.12 per cent in April 1917 to 4.42 per cent in November 1918. During World War II the yields on long-term United States bonds actually declined.
There is a view still entertained by quite a number of economists that an increment in the currency and deposit liabilities of the banking and monetary system creates a net addition to the total sources of funds available to finance purchases of GNP and so, a net addition to aggregate demand.
Page 207:
There is still another type of misconception that I hesitated to mention in my opening remarks because it is of a rather subtle nature. I would like to comment on it briefly at this point. Let me indicate its nature by quoting from George Leland Bach’s Economics. An Introduction to Analysis and Policy:
When private spending on consumption and investment falls short of high production and employment levels, the government can increase total expenditures by spending more than it currently collects in taxes. At the extreme, it can finance this net addition by creating new money so as to assure a net addition to private spending. Or it can borrow existing funds from the public, hoping to draw on funds that would not otherwise be spent …
Conversely, when total private spending is too high, with resulting inflation, the government can withdraw funds from the income stream by taxing away more than it spends. At the extreme, it may simply hold or destroy this net surplus. Or it may use the surplus to pay off government debt, hoping that the bondholders will not rush out and spend the funds they receive.
This policy statement seems to imply three propositions that a good many economists have accepted, propositions the validity of which I want to question. The three propositions are:
A federal government nonfinancial deficit makes for an increase (or surplus makes for a decrease) in aggregate demand.
A federal government nonfinancial deficit financed by an increase (or a federal nonfinancial surplus resulting in a decrease) in currency outside banks plus demand deposits adjusted makes for a larger increase (or for a larger decrease) in aggregate demand than a deficit financed by the sale to the public of (or a surplus that is used to retire publicly held) interest-bearing federal obligations.
In considering the effect of a federal deficit (or surplus) on aggregate demand we can afford to neglect the difference between a deficit brought about by an increase in government expenditures and one brought about by a decrease in government receipts (or between a surplus brought about by a decrease in government expenditures and one brought about by an increase in government receipts).
So you see Morris Copeland was the clearest monetary economist at his time.
