UNCTAD On Economic Dynamics

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From United Nations’ Conference on Trade and Development (UNCTAD)’s 2015 report, page 44:

… exposure to unregulated and large financial flows alters macroeconomic developments in ways that can lead to a slowdown of GDP growth as well as unstable internal dynamics marked by sudden shifts of income and wealth between the main sectors (private, public and external). A convenient way to map these shifts and their relationship with economic growth is by using the “demand stances” framework (see Godley and Cripps, 1983; Godley and McCarthy, 1998; and Taylor, 2001 and 2006). This framework reasserts the Keynesian principle that sustained growth requires continuously increasing injections (which, in simple macroeconomic terms, include private investment, government expenditure and exports) into the flow of income. These injections, in turn, require a steady growth of leakages (measured by the propensity to save, the tax rate and the import propensity), which over time ensure financial stability, as credit rises along the circular flow of income. Thus GDP growth can be explained as the growth, along stable norms, of injections relative to leakages; these eventually determine financial transfers between the main sectors. Such ratios of injections to leakages are termed stances and provide a measure both of demand drivers and financial balances.

[endnote:

In mathematical terms, the main accounting identity defines GDP as the sum of consumption (C), private investment (I), government expenditure (G) and exports(X) minus imports(M). Simple assumptions allow specifying the tax rate (t) and the savings and import propensities, s and m respectively, as: T = t · GDP; S = s · GDP; M = m · GDP, where T stands for total tax revenue and S for private savings. Arrangements of these equations around the accounting identity yield the expression: GDP = (G + I + X)/(t + s + m), or alternatively: GDP = wt · (G/t) + ws · (I/s) + wm · (X/m) where wt , ws and wm are the weights of each of  the leakages (tax, savings and import propensities, respectively). This equation establishes that growth of GDP depends on the growth of the three variables, G/t, I/s and X/m; defined as fiscal stance, private stance and external sector stance, respectively, amplified by the strength of the respective multipliers, given the mentioned weights, in the macroeconomic context. To avoid complicating the presentation with derivation of the steady state conditions, it is sufficient to note that these stances reflect financial conditions as well, where a larger numerator than the denominator points towards a net borrowing position. Thus, a steady path of sustained growth and financial stability requires that none of these stances grow at a proportionally faster pace than the others for a prolonged period of time.

]

Sergio Cesaratto On TARGET2 Balances

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Sergio Cesaratto has posted a reply on Matias Vernengo’s blog, replying to a paper by Marc Lavoie on economic problems of the Euro Area

For previous discussions, see the citations in that post or see my previous post on this.

Marc’s point is that because TARGET2 allows unlimited and uncollateralized credit/debit facilities between Euro Area NCBs and the ECB, the troubles facing the Euro Area are not balance-of-payments in origin.

As mentioned earlier, this however is not the thing to look at. One should look at counterparts to the intra-ESCB (TARGET2) debts. Intraday overdrafts, marginal lending facility, MRO, LTRO, ELA … none of these can rise without limit. At some point, a crisis occurs and foreigners’ help is needed.

Greece, Portugal, Ireland, Spain, Cyprus all have high negative net international investment positions. No wonder these nations have seen the most troubles.

I echo Sergio’s example (on Calabria) with a similar example of my own. If nations in a monetary union cannot face a balance-of-payments crisis, why not have the whole world join the Euro Area and adopt the Euro as their currency and have the ECB as the central bank of the world and guarantee all government debts without any condition? Surely, that should be the solution to the problems of the world! Not!

Surely austerity has been high and the ECB can help to keep government bond yields in check and allow for expansionary fiscal policies. It had its “OMT”, which has never been used as the annoucement effect itself has kept government bond yields low. But Greece has faced difficulties despite this.

The ECB alone cannot resolve the crisis.  Attempts to boost domestic demand with fiscal policy will bring higher imbalances within the Euro Area. The Euro Area needs a central government with high powers to tax and spend. Regional imbalances will be kept in check via fiscal transfers and regional policies of the government. And the powers of the government won’t be limited with this. There are many other things such as wages which need to be coordinated at the federal level, for example. Euro Area balance-of-payments cannot be neglected.

Free Trade And Tight Fiscal Policy

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Harvard economist Dani Rodrik recently responded to a question/critique on why he doesn’t believe in the faith about free trade between nations while not showing that much dissent for trade within boundaries. Among the various points in his defence are fiscal transfers and regional policies. Rodrik says:

Another thing that happens is that there is an overarching state that will engage in transfer payments and other policies that aid the lagging region. The region will have political representatives in the national government who will push for the interests of those adversely affected.

That’s a nice point. See my blog post on how fiscal transfers help in reducing regional balance-of-payments problems.

Cafe Hayek responded to Rodrik here. An important point in that argument is: why does it matter if the consumer buys from a domestic producer as opposed to a foreign producer. The Cafe Hayek author Don Boudreaux says:

Now to point (1) – the more narrowly economic point.  Sellers in foreign countries sell things to buyers in the home country only because they – the foreign sellers – wish to increase their wealth.  The motives are identical to those of sellers in the domestic economy.  What do foreign sellers do with the revenues they earn from the sale of their exports?  They spend them.  They save them.  They invest them.  Perhaps on occasion they hoard them.  These options are no different from the options confronting domestic sellers.  If the funds spent on imports return to the domestic economy as demand for exports, jobs and economic activity shift from import-competing domestic industries into exporting industries.  No problem.  If these funds instead return as investments in the domestic economy, again there’s no problem: when, for example, Ikea opens a store in New Jersey it employs workers in that store no less than would an American who opened a similar store.

Now to argue straight with the above. FDI flow is just one flow in the capital and financial account of the balance of payments. And in the stock sense, FDI is just one type of liability among many others such as government debt held by foreigners. These just pay interest to foreigners.

Apart from that, foreigners are not likely to import as much as they export. A nation can have a high amount of imports and less exports. So there’s an asymmetry here – differing level of competitiveness.

But even if competitiveness were equal, nationality of buyers and sellers still matters. This is because creditor nations’ governments may not expand fiscal policy to the extent that is needed for the benefit of the world as a whole. If the government of a nation keeps fiscal policy relatively tight, it affects domestic demand, output and incomes of economic units and hence their imports.

So to summarize, difference in competitiveness and a relatively tighter fiscal stance of creditor nations affects trade and balance-of-payments of other nations. This in turn affects output because a nation which could potentially grow fast may find itself with balance-of-payments problems. Free trade doesn’t help poor nations.

This discussion can also be used in the case of the Euro Area where trade was made more free when the Euro Area was formed. Since there is no central government for the Euro Area, free trade works against nations which have been affected by the crisis.

Sergio Cesaratto’s Debate With Marc Lavoie On Whether The Euro Area Crisis Is A Balance-Of-Payments Crisis – II

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This is a continuation of the post from the end of 2014, although reading that isn’t necessary. 

In a new paper, Marc Lavoie continues his debate with Sergio Cesaratto on whether the Euro Area crisis is a balance-of-payments crisis or not. For the sake of completeness, here’s the list of papers, with references copy-pasted from Marc’s latest paper. Not all links are final versions and some may not be available to read in full).

  1. Cesaratto, S. 2013. “The Implications of TARGET2 in the European Balance of payments Crisis and Beyond.” European Journal of Economics and Economic Policy: Intervention 10, no. 3: 359–382. link
  2. Lavoie, M. 2015. “The Eurozone: Similarities to and Differences from Keynes’s Plan.” International Journal of Political Economy 44, no. 1 (Spring): 3–17. link
  3. Cesaratto, S. 2015. “Balance of Payments or Monetary Sovereignty?. In Search of the EMU’s Original Sin–Comments on Marc Lavoie’s The Eurozone: Similarities to and Differences from Keynes’s Plan.” International Journal of Political Economy 44, no. 2: 142–156. link
  4. Lavoie, M. 2015. “The Eurozone Crisis: A Balance-of-Payments Problem or a Crisis Due to a Flawed Monetary Design?” International Journal of Political Economy 44, no. 2: 157-160. (abstract)

As mentioned in my part 1, referred to on top of this post, I agree with Sergio Cesaratto.

sergio-and-marcSergio Cesaratto with Marc Lavoie (picture credit: Matias Vernengo)

Marc Lavoie’s main point in the final paper seems to be that, “Eurozone countries can never run out of TARGET2 balances, which can take unlimited negative values, so that the evolution of the balance of payments cannot be the source of the crisis”.

This is not accurate in my view. Although the rules of the Eurosystem allow unlimited and uncollateralized credit facility between the Euro Area NCBs and the ECB, one has to look at the counterpart to the T2 imbalances. If an economic unit transfers funds across border from country A to country B, this first results in a reduction of balances of banks in country A at their NCB and may result in an intraday overdraft (“daylight overdraft” in U.S. language), usage of the marginal lending facility with the NCB, an MRO, or an LTRO and finally ELA in late stages of a crisis (if capital outflow is large).

Marc himself mentions this point in his latest paper:

If a Eurozone country is running a current account deficit that banks from other Eurozone members decline to finance, or if it is subjected to capital outflows, then all that happens is that the national central bank of that country will be accumulating TARGET2 debit balances at the ECB. There is no legal limit to these debit balances. The national central bank with the debit balances, which pay interest at the target interest rate, has as a counterpart in its assets the advances that it must make to its national commercial banks at that same target interest rate. And the commercial banks can obtain central bank advances as long as they show proper collateral. Why would the size of current account deficits or TARGET2 debit balances worry speculators? There might be a problem with the quality of the loans that have been granted by the banks, or with the size of the government debt, but that as such has nothing directly to do with a balance-of-payments problem.

[italics: mine]

But that is the case! It’s because of balance-of-payments. Nations who had high indebtedness to the rest of the Euro Area saw more capital flight. This is because in times of crisis, there is a home bias and international investors are likely to sell securities abroad and repatriate funds home. Large current account imbalances lead to a large negative net international investment position. (It’s of course also true that revaluations are important, and this is what happened in the case of Ireland). So when non-residents sell securities to domestic investors, banks are likely to get into a bad situation because they have to accommodate these transfer of funds and are losing central bank balances on a large scale.

It is precisely nations which had worse net international investment positions which were affected as charted in my previous post on this.

Now moving on to definitions: what is a balance-of-payments problem? The simplest definition is the problem for residents in obtaining finance from non-residents. Greece precisely has been struggling to obtain funds from non-residents.

So I do not agree with Marc’s view that:

Cesaratto, as others, is adamant that the Eurozone crisis is a balance-of-payments crisis, whereas I believe, as others do, that this is a side issue.

Marc Lavoie also says that the people arguing for this view are implicitly assuming some kind of “excess saving” view on all this:

In discussions with colleagues who support a “current account deficit” view of the Eurozone crisis, I sometimes get the impression that they are also endorsing a kind of “excess saving” view of the economy. They tell me that current accounts deficits are unsustainable within the Eurozone because the core Eurozone countries will refuse to lend to the periphery and will thus prevent these countries from financing economic activity. This seems wrong to me.

I disagree with this. It’s precisely because residents’ liabilities are large compared to their financial assets that they have to rely on non-residents/foreigners. And during the crisis a lot of capital outflow has happened and this precisely shows that non-resident private investors are unwilling to lend again on the same scale as before. This obviously means that to obtain finance, governments of nations affected have to take the help of the official sector abroad, such as from governments, the ECB and the IMF. If TARGET2 alone could do the trick, is the Greek government foolish to go abroad?

It is of course true that the design of the Euro Area was faulty. But that still leaves open the question about why Germany is not facing a crisis as severe as Greece. The design view cannot explain this. Any country (or all countries) in the Euro Area could have faced a crisis. There is a pattern here and that is where balance-of-payments comes in.

This debate is an interesting one. Both Sergio Cesaratto and Marc Lavoie agree on almost everything, except this BIG thing.

Of course this also spills over to policy proposals. Marc Lavoie believes that the European Central Bank can guarantee that all nations can have independent fiscal policies (by promising to buy all government debt which the financial markets isn’t interested in purchasing). Sergio Cesaratto is clear on this (and I agree very much) – in another paper Alternative Interpretation of a Stateless Currency Crisis:

A more resolute role of the ECB as lender of last resort accompanied by fine-tuned expansionary fiscal policies can only be imagined in a different political and institutional framework, quite close to that of a political union.

Let’s consider what happens if there is no federal government and if the ECB is the main supranational authority (ignoring other supranational institutions which have limited powers). Suppose the ECB were to guarantee the debt of governments of all Euro Area nations. There’s nothing to prevent, say, the government of Finland to increase the compensation of its employees every year by a huge percentage and thereby affecting Finnish corporations’ compensation of its employees. This will result in a reduction of competitiveness of Finnish producers and Finnish resident economic units will rely more on goods and services produced abroad. This will raise Finland’s net indebtedness to the rest of the Euro Area and the world. If someone believes that this debt is not a problem, how about the inflationary impact of this rise in demand on the rest of the Euro Area?

So the solution lies in bringing down the balance-of-payments imbalances (both negative and positive ones such as that of Germany). This requires a supranational institution, which is a central government. National governments would have rules on their budgets but the central government — since its goals and objectives are different — wouldn’t be bound by any rules. Wage rises would need to be coordinated. And as I argue in this post, fiscal transfers also plays a role of keeping imbalances in check.

Of course there are many other economists who also argue that the Euro Area problem is a balance-of-payments problem, but with a different motive. Their argument is to blame the nations in crisis instead of taking a humanist approach.

To summarize, the Euro Area problem wouldn’t have been a balance-of-payments problem had the official sector promised to act as a lender of the last resort to national Euro Area governments without any condition. As long as there are conditions, it is a balance-of-payments problem. One cannot pretend that the European Central Bank has or can be given such powers to lend without any condition. And hence the Euro Area crisis is a balance-of-payments problem.

Casual Monetarism

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In an Op-Ed for The New York Times, Japan’s Economy, Crippled by Caution, Paul Krugman is seen using a highly Monetarist language:

As I said, you might think that ending deflation is easy. Can’t you just print money? But the question is what do you do with the newly printed money (or, more usually, the bank reserves you’ve just conjured into existence, but let’s call that money-printing for convenience). And that’s where respectability becomes such a problem.

When central banks like the Federal Reserve or the Bank of Japan print money, they generally use it to buy government debt. In normal times this starts a chain reaction in the financial system: The sellers of that government debt don’t want to sit on idle cash, so they lend it out, stimulating spending and boosting the real economy. And as the economy heats up, wages and prices should eventually start to rise, solving the problem of deflation.

…

… When you print money, don’t use it to buy assets; use it to buy stuff. That is, run budget deficits paid for with the printing press.

Now, there are several things wrong about this. The most important one is the implicit assumption in the “model” that fiscal expansion via increased government expenditure is about neutral and that domestic demand is boosted only because of the way in which the government debt is financed – i.e., central bank purchases of government debt. In other words, Krugman is saying that if there is deflation and if there is an expansion of fiscal policy via a rise in say government expenditures, it will have little effect when the central bank doesn’t purchase government debt. Put it in another way, it is saying that the government expenditure multiplier effect acts mainly because of central bank purchase of government debt and not because of the increase in government expenditure per se.

This is silly intuition and the cause of this is the notion that fiscal policy is more or less neutral except in special circumstances.

In reality, it is the other way round. If the government expenditure rises, and if the central bank purchases government debt, the rise in output is mainly attributable to the former. This can of course be seen in a stock-flow consistent model but can also be seen by simple accounting and flow of funds. A rise in government expenditure on goods and services raises output directly and also via the multiplier effect. The central bank has a huge control over interest rates and the additional debt is simply absorbed by the bond markets easily. There’s no competition with other borrowers as the wealth of the private sector rises. In addition, if the central bank purchases government debt, it is hardly clear if households know if inflation is going to rise and increase their consumption because of “inflation expectations”. Even if they think that if inflation is set to rise, they might reduce consumption as inflation might reduce their real wealth.

Which is not to say that asset purchase programs of the central bank or “quantitative easing” has no effect on demand and output. It works via capital gains in wealth leading to higher consumption and the feedback effects of this. It also works if economic units shift their portfolios to buying non-financial assets. The effect of all this is unclear. In addition, as mentioned earlier, casual Monetarism like the language used by Paul Krugman mixes up correct attributions of government expenditure and central bank government debt purchases on output, misleading everyone.

Simply say “raise government expenditures”. Why all this casual Monetarism with “printing presses”?

Do Keynesians Ought To Love Tax Cuts?

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Cullen Roche – in response to Paul Krugman – says Keynesians should learn to love tax cuts. His argument is that since Keynesians believe in the principle of effective demand and that since tax rate cuts boosts domestic demand and hence output, it is surprising to find Paul Krugman not favouring tax cuts.

Tax cuts raise output by increasing disposable incomes of economic units who will raise their expenditures in response. This via a multiplier effect will raise output. But it’s not as if tax rate cuts is the only tool available to the government.

Let’s see 4 different ways the government can boost domestic demand:

  1. Raise government expenditures,
  2. Decrease tax rates,
  3. Raise government expenditures and decrease tax rates, and,
  4. Increase government expenditures and raise tax rates.

The expansionary nature of the first three ways above is obvious. For the fourth, it depends on the numbers. So if the government raises tax rates from say 25% to 30% and increases government expenditure by 1%, it is likely contractionary. Instead, if the government increases its expenditure by 25%, it is expansionary.

These are not the only ways available for demand management. The government by coordinating with  the central bank can reduce interest rates. It can make lending/borrowing easier by other ways. It can give guarantees to bonds issued by corporations, thus giving an incentive for corporations to increase expenditures. It can raise tariffs on imports. There are several ways but here those things are less relevant for now.

Each of the four ways above has a different effect on output and the distribution of income. Tax cuts usually favour economic units who earn more. Richer economic units such as rich households have a lower propensity to consume and hence this will have a smaller multiplier effect. If Keynesians favour tax cuts, they’d favour it for low earning households than for corporations.

Of course, the multiplier effect is not a complete argument in itself as the opponents might argue “So cut taxes even more according to your logic”. But at any rate, let’s see how it works.

In stock-flow-consistent models, there’s the concept of a fiscal stance toward which GDP converges for a given government expenditure G and a tax rate θ. So we have

GDP = G/θ

With that,

dGDP/GDP = dG/G − dθ/θ

So a percentage rise in government expenditure will have the same multiplier effect as a percentage fall in tax rate.

This of course is the long-run output. For the short run, the expression in the simplest Keynesian model:

GDP = G/(1 − α1·(1 − θ))

α1 < 1

The parameter α1 is the propensity to consume.

In this case, i.e., for the short run,

dGDP/GDP = dG/G − [α1·θ/(1 − α1·(1 − θ))2]·dθ/θ

By taking some values such as 0.6 for α1 and 25% for θ, you can convince yourself that a proportional rise in government expenditure is more effective than a proportional fall in tax rates. Of course, this is not a complete argument but illustrative. If a tax rate cut of x% doesn’t achieve a $1 rise in government expenditure, one can make the case for a higher tax rate cut to achieve a similar result.

Apart from that there are other implicit assumptions of the model: there is no income inequality in the simplest Keynesian models. So rich economic units will have a lower propensity to spend: households working as employees of firms with higher compensation will have lower propensity to consume. Households may have an even lesser propensity to consume out of other incomes such as interest and dividends.

So the multiplier analysis illustrates that a tax cut for richer economic units is not the same as the poorer units because the multiplier in the short run depends on the propensities to spend.

The correct stand hence is about the distributional effects of fiscal policy and the effect on output. So the correct stand is to argue for a rise in government expenditure and fair rates of taxes for economic units. Many economic units will have to pay higher taxes in this view. What’s fair of course is debatable but at least in this line of argument, souls believing in the principle of effective demand needn’t love “tax cuts”.

There is another argument for not promoting lower tax rates. This is because once tax rates are reduced, it is politically difficult to raise it if needed.

The Kaldor-Verdoorn Effect

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Brian Romanchuk has a nice post on how the case for productivity is something which is overstated by economists. There’s less discussion in the econoblogosphere on this. Here I’ll add a few things with a slightly different perspective.

Sometime in the historic past, nations’ economies started diverging. Some nations’ fortunes rose while others lagged behind. Nations which became rich saw high rises in productivity. It’s easy to then conclude that productivity is the raison d’être for the success or failure of nations. In fact this is what Greg Mankiw says in his textbook Principles Of Macroeconomics, 7th Edition, page 13:

The differences in living standards around the world are staggering …

What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries’ productivity—that is the amount of goods and services produced by each unit of labor input. In nations where workers can produce a large quantity of goods and services per hour, more people enjoy a high standard of living; in nations where workers are less productive, most people endure a more meager existence. Similarly, the growth rate of a nation’s productivity determines the growth of its average income.

The fundamental relationship between productivity and living standards is simple, but its implications are far-reaching. If productivity is the primary determinant of living standards, other explanations must be of secondary importance … some commentators have claimed that increased competition from Japan and other countries explained the slow growth in U.S. incomes during the 1970s and 1980s. Yet the real villain was not competition from abroad but flagging productivity growth in the United States.

[bold in original, italics mine]

So although it cannot be denied that rich nations have seen rise in productivity, the above story entirely misses the reverse causality – i.e., from production to productivity. And because of that, it entirely misses the cause of success and failure of nations.

Nicholas Kaldor rediscovered the relation between rise in output and rise in productivity (which can be attributed to Petrus Johannes Verdoorn) in 1966 and interpreted the causality right: from rate of growth of production to the rate of growth of productivity. The main reason given was “learning by doing”.

This still leaves open the question about what determines production itself. Unlike the supply-side models of neoclassical theory, Kaldorians tell a story about a demand-led growth and the balance of payments constraint being the most important determinant of economic growth. Some nations had the fortune of growing fast earlier in history and in this process of cumulative causation became more competitive in the process. This not only increased their fortunes but immiserated other nations. This is because poor nations would get stuck with a balance of payments constraint and this would affect their competitiveness. Competitiveness can either be price-competitiveness or non-price competitiveness. Price competitiveness depends on pricing goods and services in international markets. This in turn depends on productivity. So nations which got an early lead in history saw rise in production and hence productivity via the Kaldor-Verdoorn process and also gained in price-competitiveness.

There is a feedback effect here. Do you see it? That’s circular and cumulative causation. The effect can be better understood by writing a model such as as done by Mark Setterfield in his chapter titled Endogenous Growth: A Kaldorian Approach in the book The Oxford Handbook Of Post-Keynesian Economics, Volume 1, Theory And Origins. 

Usually the story is told with price-competitiveness. I am unaware of any model which also includes non-price competitiveness in the story.

Anyway, to conclude, cheering for productivity is not going to help the world economy. The solution is to increase production: productivity will rise when production rises. The standard story as told in Mankiw’s textbook is erroneous.

Click Bait Monetary Economics

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Some economic commentators, in trying to point out the importance of government deficits and debt, go for the overkill.

Exhibit:

Sorry for picking Steve Roth, who is generally a nice person. But this is counterproductive. If you see the comments below, a commentator who claims to be a trained accountant also agrees with Steve Roth. The bait involves saying that this argument is “technically right”. It can be technically right for several reasons but outright misleading and commentators should stop doing this. So it could be true because the act of bank loan making itself creates an asset and liability equally, so there is no increase in net assets of either households or the private sector as a whole by just one transaction. But this is not just the argument. The argument seems to be that it doesn’t increase household net worth at all even if another transaction is involved, such as a house purchase because a firm sells the house not a household and in national accounts firms are distinct from households. So much click baiting.

In this post, I show how a household’s net worth rises on sale of a house. Let’s assume that I (Household 2) am a sole proprietor of a house building firm (Firm P) and hence the ownership of the firm is not publicly traded in a stock exchange. Suppose I sell a house worth $1mn to you (Household 1). The house is sold from my firm’s inventory of houses and becomes a sale. You buy this after taking a loan from Bank A.

Now, we need some good national accounting. A good way is to just pick up Wynne Godley’s stock-flow consistent models in which he values inventories at current cost of production. See Godley and Lavoie’s book Monetary Economics, Edition 1, page 29.

Let’s suppose the current cost of production is $400,000.

Now we need another concept: own funds at book value from the 2008 SNA, Paragraph 13.71d-e:

d. Book values reported by enterprises with macrolevel adjustments by the statistical compiler. For untraded equity, information on “own funds at book value” can be collected from enterprises, then adjusted with ratios based on suitable price indicators, such as prices of listed shares to book value in the same economy with similar operations. Alternately, assets that enterprises carry at cost (such as land, plant, equipment, and inventories) can be revalued to current period prices using suitable asset price indices.

e. Own funds at book value. This method for valuing equity uses the value of the enterprise recorded in the books of the direct investment enterprise, as the sum of (i) paid-up capital (excluding any shares on issue that the enterprise holds in itself and including share premium accounts); (ii) all types of reserves identified as equity in the enterprise’s balance sheet (including investment grants when accounting guidelines consider them company reserves); (iii) cumulated reinvested earnings; and (iv) holding gains or losses included in own funds in the accounts, whether as revaluation reserves or profits or losses. The more frequent the revaluation of assets and liabilities, the closer the approximation to market values. Data that are not revalued for several years may be a poor reflection of market values.

The accounting entries are simple (I am considering increases/decreases here, so “= +” is understood as an increase in the thing on its left.)

For Household 1:

Assets

Liabilities and Net Worth

House = +$1mn

Bank Loan = +$1mn
Net Worth = +$0

For Bank A:

Assets

Liabilities and Net Worth

Loan to Household 1 = +$1mn

Deposits of Firm P = +$1mn
Net Worth = +$0

For Firm P:

Assets

Liabilities and Net Worth

Deposits = +$1mn
Inventories = −$0.4mn

Own Funds = +$0.6mn
Net Worth = +$0

For Household 2:

Assets

Liabilities and Net Worth

Own Funds at Firm P = +$0.6mn

Net Worth = +$0.6mn

So, my (Household 2’s) net worth has risen by $600,000 by selling you (Household 1) a house.

I have in this example, intentionally chosen a privately owned firm to score a point. If the firm had been publicly owned, the house sale would have increase the firm’s net worth and my (Household 2’s) net worth would increase when the firm’s net worth reflects in the share price (which is not immediate). But I just had to show one example. It’s not just academic – many firms are family owned.

Steve Roth’s claim are similar to claim made by Neochartalists who claim that the private sector can only save if the government runs deficits and so on. All counterproductive.

The case for fiscal expansion can be made quite strongly, but not by these click bait claims.

Economists Can Be So Wrong

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Oh boy! Krugman could not have been more wrong about Macroeconomics than what he said recently in his blog The Conscience Of A Liberal for The New York Times. In a blog post, Competitiveness And Class Warfare, he concludes:

International competition is a mostly bogus notion; …

In a sense it is not surprising. Paul Krugman has done enough to push free trade. With that position, one is forced to take a position that competitiveness doesn’t matter (or that free trade will lead to a convergence between successful and unsuccessful nations).

The notion that balance of payments does not matter is as old as Monetarism. If it is understood that competitiveness does matter and that for a nation it hurts domestic producers and hence one needs some sort of protectionist measures goes against the notion of free trade. For neoclassical economists other than Paul Krugman, competitiveness does matter but in a different sense. They would argue that it there is divergence in performance of nations because of “loose fiscal policy” or “fiscal profligacy” and so on and that once the government balances its budget and behaves the way as per a standard textbook model, there’ll be convergence in performance because market mechanisms will do the trick. But Krugman is different. During the crisis, he has understood that fiscal policy is important and that it is not impotent as claimed by his colleagues.

There are of course other factors at play in the examples Krugman provides. Japanese producers are highly competitive but at the same time, the government of Japan didn’t expand domestic demand by fiscal expansion and so the performance of the economy of Japan has suffered. But that doesn’t mean that the competitiveness of Japanese producers doesn’t matter. Had they been less competitive, Japanese exports would have been lower than otherwise and Japan would have imported more because foreign producers would beat them at their home. Moreover, a weaker current account balance of payments would have led to a bigger government deficit and the Japanese government would have (incorrectly) tightened fiscal policy in response, with the result that both balance of payments and fiscal policy would have reduced domestic demand and hence output.

So while there are other factors affecting economic performance, none of it ever means that competitiveness doesn’t matter.

Cambridge economists were clear on this. Here’s Wynne Godley in a 1993 article Time, Increasing Returns And Institutions In Macroeconomics, in S. Biasco, A. Roncaglia and M. Salvati (eds.), Market and Institutions in Economic Development: Essays in Honour of Paolo Sylos Labini, (New York: St. Martins Press), page 79:

… In the long period it will be the success or failure of  corporations, with or without active help from governments, to compete in world markets which will govern the rise and fall of nations.

In trying to defend the importance of fiscal policy, some economists such as Paul Krugman become forceful in their views about the way the world works and underplay the importance of matters such as international competitiveness. They seem to falsely believe that this strategy would work for them because accepting the importance of competitiveness would give enough chance for their opponents to argue against worldwide fiscal expansion.  It is a sad and counterproductive strategy.