Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 1 February 2015

Saying the obvious

Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity. And they would be right, as I set out in this recent VoxEU piece. There I present some back of the envelope calculations, but they are confirmed by model simulations: not just those I quoted in the text, but also others that I did not have space to mention.

When writing that piece, I kept having doubts. Not about the analysis, but just that this was all so obvious. It uses basic models (DSGE or more eclectic) that we teach undergraduates and postgraduates. It is supported by the clear majority of empirical evidence. I felt like I was telling people the macroeconomic equivalent of a rise in the demand for apples will mean an increase in their price.

The reason I put those doubts aside are also familiar. The fact that at least half the world’s politicians and mediamacro continue to ignore the obvious. The fact that too many economists continue to look for other reasons to explain this malaise (or pretend there is no malaise), because somehow they think acknowledging that fiscal policy can influence demand is old fashioned, or left wing, or something. These facts and that I was in good company.

While there are too many academic economists who want to deny that fiscal policy is largely responsible for the weak recovery from the Great Recession, I also suspect there is a majority that know it is true. This is why I wrote a post about the lessons to draw for the future. Although we teach students all about time inconsistency and say at the same time what advantages independent central banks can have, I suspect we also know that the case for independent central banks is broader than issues to do with commitment.

Economics is always in danger of being corrupted by politics and ideology, and macroeconomics seems particularly vulnerable in this respect. (I have still not entirely convinced myself if and why macroeconomics is special in this respect. Sometimes things that are actually micro, like financial regulation or labour supply responses to tax changes, seem just to get labelled macro when they become controversial or have macro consequences!) Some say that this corruption is inevitable and that we should embrace it, rather than attempt to avoid it through delegation to institutions like independent central banks. I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates. And of course there would be a few economists with their models saying it was a good idea, even though the vast majority thought otherwise.

The reaction to my earlier post, both from comments and elsewhere, was that this weak recovery caused by fiscal austerity was not just bad luck caused by a misreading of the Eurozone crisis, but the result of a more fundamental political economy problem. We therefore need to rethink how stabilisation policy is done at the Zero Lower Bound (ZLB). Of course we also need to think about whether we should try and minimise these ZLB episodes, by either raising the inflation target, or by reformulating how monetary policy is done, or some other means. However the risk of large negative demand shocks will remain, so it would be prudent to complete the delegation of macroeconomic stabilisation policy that was begun by making the operation of interest rate policy independent of political control. Doing that would also be a good opportunity to revisit the arrangements that can ensure independence is compatible with accountability and some degree of democratic oversight.   


49 comments:

  1. Hi Simon,

    I believe I have designed a monetary system that would end demand fluctuations without central bank or government stimulus. It's radical in terms of changes required. But I think this tiresome and endless stimulus debate is just one of the many reasons we need to think about more drastic solutions. I've posted some frequently asked questions on my blog-- www.onemonthmoney.com . But the full proposal is in my book!

    I am looking for people like you to tear it apart.

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  2. Hi Simon

    What you say does make a lot of sense; Richard Koo has some very good material on Youtube applying this principle to Japan.

    My own concerns about this is that it is pitched as a cyclical issue with perhaps an implication that it will somehow be reversed down the line. However with the secular forces of technological innovation, demographics and continuing globalisation how realistic is this?

    All of these tend to transfer from labour to capital (technological advance) or to lower spending cohorts (the demographic effect) which may leave us with a pemanent demand deficiency and to my mind the word "permanent" in this context means structural or secular. So my disquiet about your assertion is that it may be true within the cycle but are we actually in the cycle or something more fundamental?

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  3. I wasn't going to bother to rely as the post and obvious replies to it are are so repetitive.

    However, the Sunday Politics has just been on, and there was a moment that supports S-W-L

    Q: To the nearest 100bn what is the size of the UK debt ?

    Clegg: "5%"

    I still think that the claims that

    (i) Monetary and fiscal policy are or could be 'technical' and independent of normative considerations

    and

    (ii) The sacrifice of democratic control to rule by 'experts' is a price worth paying

    is utterly laughable, indeed only the kind of thing one of the 'experts' could put forward with a straight face, but the Deputy PM just undermined me.

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    Replies
    1. So you oppose "experts" at the BoE MPC determining interest rate changes, QE, etc?

      Delete
    2. Ralph, we have been through this.

      Yes, I do. These are political decisions, That they are made by unelected people is a complete disgrace. There was good sense in the view of all governments before 1997 in refusing to give this power to unelected 'exprerts'.

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    3. S Hugo
      I think SWL has lost the plot. He used to pay a respectful nod to tight monetary policy at the ZLB as a problem too. That seems to have been forgotten now as the election campaign gears up and balance and truth gets thrown out of the window and intolerant, and surprsingly undemocratic, ranting takes over. Anyone who disagrees with him is either stupid or has seriously hidden motives to achieve ...?

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    4. I don't think that is fair. His views on taking fiscal policy out of the hands of the pols are of longstanding.

      If he were an expert on, say, energy provision , he would feel the same I expect.

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    5. Ralph,

      If, as you usually do, you claim that monetary policy is a science without need for democratic accountability, I refer you to the ECB's decision to raise rates in 2011.

      Remind me, who do we get to vote against for that one?

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    6. "There was good sense in the view of all governments before 1997 in refusing to give this power to unelected 'exprerts'.|"

      This was not the only stupid economic decision taken over the period 1978-2008. And not the only one mainstream economists and their models were behind.

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    7. Spinning H,

      The idea that monetary policy might be a “science” is completely absurd (if by that you mean it has the precision of physics). I’ve never suggested that, and I know no one who has.

      As for the idea that “democratic accountability” would make it more scientific, are you seriously suggesting that a bunch of MPs, 95% of whom haven’t got a GCSE in economics, would improve on the decisions made by a committee of people with economics degrees and ten years teaching the subject or ten years experience in banking? The latter people are of course are not omniscient (as they themselves would be the first to admit), but MPs are complete ignoramuses by comparison.

      Re your claim that there is something wrong with us not being able to vote against those responsible for ECB decisions, are you aware that we are not in the EZ? And given that Fed and ECB decisions have a similar impact on the UK, do I take it you’d argue that UK citizens ought to be able to vote on who is the next chairman of the Fed, or whether Republicans or Democrats dominate Congress? That would, after all, be very "democratic."

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    8. @Spinning Hugo -- somehow I doubt that voters would feel any more empowered to influence monetary policy if it was decided by politicians instead of central banks. Nor would voters have any way of making a judgement about what good monetary policy would be, except by consulting experts -- the same ones you think shouldn't make the decision because it's undemocratic.

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    9. SpinningH. OK SWL is not "surpisingly undemocratic". Just undemocratic, then. Great.

      Not sure how many people would like to participate in his experiments on the economy. Would he leave power if proved wrong or just dig a bigger hole, like Chavez, Putin or North Korea? (I would have chose a right wing dictator but there aren't many around these days, only left wing ones.) The anger and intolerance on display on this blog to political enemies makes me very wary.

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    10. I agree. The similarities between this blog and North Korea are uncanny. Great contribution.

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    11. Ralph,

      "The idea that monetary policy might be a “science” is completely absurd ... I’ve never suggested that, and I know no one who has"

      http://mainlymacro.blogspot.co.uk/2014/05/how-to-avoid-austerity-mistake-next-time.html

      " do we have politicians design nuclear power stations and tell heart surgeons how to do heart surgery?"
      -Ralph Musgrave

      Must be a different Musgrave I suppose.

      (i) Of course the elected representative must act under professional advice.

      (ii) The logic of your argument would seem to be that the argument for democracy is weak because other people in other countries make decisions that impact on our lives and we have no democratic control of them.

      The logical conclusion of that piece of sophistry I leave to you.

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    12. Now you'e just trolling, Hugo. At least let your quotes match your arguments if you want to be taken seriously.

      Delete
  4. Robert Shiller's 'What Good Are Economists?' at Project Syndicate JAN 15, 2015, as well as defending his profession, compares the lack of criticism economists received after the interwar Great Recession to the extensive criticism they have taken since 2006-8.

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  5. Simon,

    I don't see that the debate, ultimately, is about Austerity vs. Stimulus. If we want to speak in these terms, then I would frame the debate as a question: "How much Stimulus?".

    I fully agree with you that stimulus now would create growth now. The problem -- for us who find ourselves in "There is such a thing as too much stimulus" camp -- is that (credit-financed) stimulus translates to "borrowing future growth through intertemporal effects" (to use William White's expression). If you and I could agree on this, then the question would be: "How much stimulus, or borrowing from future, is sustainable so that we don't just create a bigger hole in the road ahead?".

    What we disagree on is the *amount of' stimulus. We agree on the fact that stimulus usually translates to growth here and now. What we are missing is common understanding on how credit -- always intertemporal -- really works in the economy. Until we have it, you and I cannot agree on how much we are borrowing from the future, or even how exactly we are borrowing from the future.

    I'm in the "We have been borrowing too much from the future camp", with Mr White and BIS economists. We are not stupid. You are not stupid either. Our views on credit just differ substantially, because there is no sound credit theory. (Exhibit 1: Modern Monetary Theory, though it gets many technical facts right, is far from sound enough to convince you, or me.)

    I'm very far in my work on a sound (and simple) credit theory which, in my view, will change this situation totally and free us to do real science again. I'm sharing my thoughts (not the exact theory, yet) here: http://clumsystatements.blogspot.com/ .

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    1. There no need whatever to any sacrifices whatever in the future to pay for current stimulus. If you look at the ACTUAL NUMBERS for national debt you'll find that basically it is never repaid. Bar the occasional surplus year, it has grown constantly for the last 50 years, 100 years or whatever period you want to take.

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    2. Ralph,

      First, which country are we talking about? I'm not from the US or the UK, so when thinking more theoretically I try to have a sample of countries (always incl. the US) in the back of my head. And I can't see that the national debt has been only increasing the last 100 years, not in the US and not in many other countries either.

      Second, I don't think we are talking about the same thing here. As I wrote:

      "What we are missing is common understanding on how credit -- always intertemporal -- really works in the economy. Until we have it, you and I cannot agree on how much we are borrowing from the future, or even how exactly we are borrowing from the future."

      Don't take this too personally now -- it's the same with many of the best economists. But you sound like a snake oil salesman when you say:

      "There no need whatever to any sacrifices whatever in the future to pay for current stimulus."

      "Whatever", twice? I don't think you are selling snake oil, but you end up sounding like one who does because there is no sound theory that you could back your arguments with.

      Debt, what is owed, is not the real problem. The real problem is the asset you create.

      If you say that public debt is a more benevolent form of debt, I probably agree with you. What I'm saying is that with so much private debt, it is a big mistake to try to boost growth with public debt. No matter what Krugman and others say, this is no Depression -- yet. I'm 100 % for public spending to fight debt deflation and 15-25 % unemployment.

      I'm against public spending aimed at keeping the GDP growth rate positive in the face of an enormous debt overhang and continuing credit-fueled spending around the world. We should keep our powder dry.

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    3. Ralph, it seems we agree on many things. I found this on your blog:

      "I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics."

      I think the same. But I'm afraid we disagree with MMT mostly for different reasons. I have opened up my thinking (a little bit) on this topic here (it is also directly related to our discussion here):

      http://clumsystatements.blogspot.com/2015/01/mmt-is-most-flawed-monetary-theory.html

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    4. Peter,

      I’ll take your points in turn. I had the US and UK in mind. National debt for both will certainly be bigger in dollar / pound terms than say in 1960.

      “There is no sound theory that you could back your arguments with.” I set out some relevant arguments here:

      http://ralphanomics.blogspot.co.uk/2013/03/the-national-debt-and-deficit-are-total.html

      Re “snake oil salesman”, don’t worry: I’m regularly on the receiving end of far worse insults than that!

      Re debt, it is a huge mistake to regard public debt as being a debt in anything like the normal sense of the word “debt”. In particular at low rates of interest, public debt is little different to plan simple money, as Martin Wolf pointed out recently in the Financial Times. (See right hand column on my blog) So public debt is less of a problem than you claim. As to private debt, that is artificially high because of the subsidies we pay to banks, and I spend a lot of time arguing against those subsidies.

      Re the link you gave, I left a short comment there.

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    5. Ralph,

      "National debt for both will certainly be bigger in dollar / pound terms than say in 1960."

      Talking in nominal terms here supports your argument, but you know it has nothing to do with economics. The economy can function really well with a stable, let's say 2-3 %, inflation and this will make it futile to think in nominal terms when the timeframe is a decade or more.

      I don't make the "huge mistake" of regarding public debt as any other debt. In my model of the world, public debt is public debt -- different from private debt, but in no way "neutral", not even close.

      As I replied to you in the comments on my blog, for me, inflation (CPI) under control, at target, alone is no sign that credit creation is not excessive. Now, it would be too obvious to point only at *asset* price inflation as a problem, like many do. We should keep asset prices in mind too, but I would like to make a broader point. We need to look at the total amount of credit in the economy and decide whether the amount is sustainable or not.

      And this is where we cannot find agreement. In my comment to Simon Wren-Lewis above, I have explained what in my opinion is the cause for this seemingly unsolvable disagreement (same disagreement which we can see between BIS and most of the academic economists).

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  6. Might I humbly suggest:

    Economics is about human behavior. This is obvious in all the embedded assumptions about inflation expectations, Ricardo equivalence, etc. Viewed, then, rather than , one would then as "why has dominant theory been unable to account for observed behavior?"

    Might I suggest that the reason is that, when viewed from a long-term stability perspective, people are much less confident of the eventual promise (in terms of balance sheets, debt to GDP, etc) of early fiscal stimulus? Nothing nefarious is needed to justify this, simply the recognition that it relies on a difficult downstream decision - the withdrawal of stimulus in "better" times.

    Given two paths, one of which requires a long sequence of "correct" decisions, I might well (and reasonably) choose the path with a lower expected outcome (but attendant lower long-term risk).


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  7. "I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates. And of course there would be a few economists with their models saying it was a good idea, even though the vast majority thought otherwise."

    I could not disagree more. These were essentially the arguments, I might add for the classical Gold Standard - a technical operation independent of the democratic process.

    People don't trust economists. For very good reasons. Economics is not a science. The theory is built on highly contestable ontological and epistemological grounds.

    2008 was when enough was enough. Chris Sims said that economic theory and its autistic models failed because this was an "exceptional event." How stupid! The whole idea is to avoid these "exceptional events".

    We cannot let central banks and economists and their models run loose. They have to be accountable to the democratic process. We make bigger decisions than monetary policy. We make decisions to go to war. We do not rely on foreign policy rational expectations computer models that apparently are too difficult for people other than foreign policy and military strategy specialists to understand!!

    You do not like democracy. That is clear. But it is the best defence we have against far more dangerous technocratic rule.

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  8. Seems relatively simple: Unemployment Insurance. It's a fiscal policy that automatically kicks in during downturns. Have enough programmes that work like that, and you don't need the legislature to be working properly when recessions come. You'll note of course, that the Tories are opposed to such programmes, so they don't actually get around the Conservative Intransigence problem. Indeed, the only way to beat conservative intransigence is to win elections against them.

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  9. Simon ends by saying “Doing that would also be a good opportunity to revisit the arrangements that can ensure independence is compatible with accountability and some degree of democratic oversight.” I suggest that’s all been thought out by Positive Money, Richard Werner and the New Economics Foundation in their submission to the Vickers Commission. See:

    http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

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  10. Simon W. L. How about getting radical. As the "zero lower bound" has become some sort of religious artefact, why not embrace it 100%?

    Sovereign fiat currency issuing States', should mandate their Central Banks to: (1) Set their base policy interest rates at ZERO %. (2) Stop Government issuing any, so called "debt" assets (Gilts / Bonds etc.). That is, all government fiat spending remains as "reserves", at the central bank, until removed by government tax / charges collection. (3) Re design the tax system to have economic sector specific taxes, that will act as the brake pedal on specific sectors, that tend to bubble; like housing.

    Without Gilt issuance, where the government pretends it has to "borrow" its own previously issued "money", in-order to pay the nurses etc, there will be far more "reserves" than will be required for interbank settlement. This will keep LIBOR at zero percent. The central bank can always pay interest on "reserves", should it need to, for an economy wide, interest rate control mechanism. If the fiscal system taxes are designed and work properly, there will be no need for any monetary mechanism at all. Central banks can go back to running the payment; clearance and settlement system for national and international trade.

    All the bast Acorn. (MMT will rule OK).

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    1. Agreed. Far as I can see the only excuse for pure monetary policy (i.e. interest rate adjustments and QE) is if lags are shorter than with fiscal policy and/or if monetary policy is easier to reverse. I might be wrong, but far as I can see, monetary policy is not far better than fiscal policy in either of those respects.

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    2. Thanks Ralph. Fiscal policy in the form of government spending gets to the problem, lack of demand; quicker than tax cuts, a portion of which tend to get saved. Both of those are far, far more effective than monetary policy.

      The latter only has an affect if it induces demand side spending. The evidence so far, is that pension and insurance funds are not rushing to give up their "risk free" 3% yielding government bonds, for a risky 10% on some teenager, who reckons he has invented the next Google! All they have done is push up FTSE share prices, making those companies potential borrowing rates cheaper; which, to be fair, was the original idea of the Central Banks. But; non of those companies are going to borrow, to invest, if hordes of customers are not beating down the factory gates to buy products.

      Western style governments, have to insulate themselves from the possibility of being blamed for anything that goes wrong. Hence, they arrange to have at least one, if not two, Quangos to take the blame, when a probable vote losing policy cock-up / blame event occurs.

      Central Banks were invented to fulfil this requirement as far as the economy goes. No neo-liberal government, can be seen to be increasing the dreaded "deficit" and "national debt"; so the Central Bank has to event tricks to fool the voters and protect the politicians from voter anger.

      This governments "Funding for Lending" scheme, was a text book example of how Treasury fiscal stimulus was disguised as BoE monetary stimulus (to protect government politicians from "increased deficit" attack, by opposition politicians) . It should be taught in all economic classes. BoE Quarterly Bulletin 2012 Q4. The Funding for Lending Scheme Appendix A.
      The operation of the FLS. (Yours in MMT, Acorn)

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  11. "When writing that piece, I kept having doubts. Not about the analysis, but just that this was all so obvious. It uses basic models (DSGE or more eclectic) that we teach undergraduates and postgraduates. It is supported by the clear majority of empirical evidence."

    One has to wonder what kind of information this model actually delivers. Can it determine the optimal inflation target? Can it tell us what the neutral rate of interest is? (Apparently much lower than the old rate...)

    Did it predict a 7-year slump? Can it show us how long the slump will last? Can it assure us we will actually get out of the slump without falling back into recession after attempting to raise interest rates?

    Does it tell us why we returned to boom-to-bust business cycles? (First the dot com bubble, followed by the housing/derivatives bubble: aka, "The Great Moderation.") Does it inform us these were just flukes and there's no way that's going to happen again (whenever the next business cycle begins)?

    Perhaps it can tell us the storm has passed, but only if we look out the window and see that the ocean is flat...

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  12. There is always a lot of hulaballo raised by economic-free politicians about increased deficits by automatic stabilisers in time of downturn.
    1) I suggest that to remove the politicizing such essential policy from the hands of idiots, deficits from automatic stabilizers should go on FED's tab. It can finance it by new money or new debt, it doesn't matter. But this should be in CB rulebook not to risk such essential policy to the whims of idiotic politicians.

    2) Interest target rate should not be bellow 4%. Since monetary policy is working trough housing loans (by admition of CB governers) and banks do not offer loans bellow 4% rate why go lower then 3% if banks will not follow with their rates to borrowers? Do you know any bank that offers housing loan bellow 4%? Danger of low inflation is same as deflation.
    Why? Inflation on fixed term loans eats away the burden of loans in 15-20 years allowing for more borrowing.

    3) In the case of reaching 8% loan default rate, CB should take over the refinacing of most critical and burdensome loans at much lower rate of 2-3%. If allowed market to continue defaulting, the cost of refinancing is much lower then crashing banks by defaults and then spending on their recoveries or resolution. This way people will also benefit by saving banks if money goes to people first and then to banks. By helping only banks, as they did, economy was left in ruins.

    4) Reverse the rules of credit scores. Those with money get lowest rates while poor get highest rates for loans. This is the biggest source of growing inequality and the true reason for r>g of Piketty. Credit scores as they are now, punish those that are in trouble allready.

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  13. "I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates."

    Nobel Laureate Joseph Stiglitz disagrees in his book Freefall. He says there's a conflict of interest in "demand management" between bondholders and workers.

    Whatever the neoclassical hypotheses, the fact is the central banks rein in inflation by carpet bombing the economy: jacking up interest rates, causing recession and layoffs and lowering the employment rate. (The unemployment rate is an unreliable measure because people drop out of the workforce involuntarily.)

    If central bankers err on the side of bondholders, it will hurt workers and borrowers. If they err on the side of workers it will cause rising inflation and hurt savers.

    Since the central bankers ran the ship aground -- stuck at the zero bound for 7 years (and counting) -- clearly they did not do a good job of striking the right balance. That's because they held the interest of bondholders above that of workers.

    As Winston Churchill said, democracy is the best of all worse alternatives. And that includes pretend technocracies with a hidden agenda.

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  14. This post is all about the economist and his identity - exclusion, inclusion and the justification of one's place in the world. Imagine if post-graduate economists just took one less unit on DSGE and were forced to read just one book, but really read it - no models, no nonsense - by the likes of Adorno, Habermas or Derrida, especially the likes of Sargent, Yates and Prescott - imagine the difference it would make!

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    1. Far better to read an economics book! And to remember Joan Robinson:

      "The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists."

      That will get you much further than the higher silliness you recommend

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  15. America is in a Goldilocks economy of tame inflation and modest economic growth. The evidence points to fed policy, despite numerous criticisms, as being a success. Fed and fiscal policy should maximize the creation of wealth, technology and economic flourishing and policy since 2008 has been a success in that regard..

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  16. A good synopsis of post 2008 policy choices by Brad DeLong...did you read it already?
    http://www.project-syndicate.org/commentary/2008-financial-crisis-lessons-by-j--bradford-delong-2015-01

    Similarly, though in more detail, Nouriel Roubini spells out the failures of a purely Monetarist approach to the financial crisis...a piece you won't find in the Mail or Telegraph (but was in the Guardian)!
    http://www.project-syndicate.org/commentary/unconventional-monetary-policies-and-fiscal-stimulus-by-nouriel-roubini-2015-02
    Thoughts?

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  17. HI Simon, in a previous post you posted a graph with the output gaps as estimated by the oecd: could you quote the source exactly? Thanks! J.

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  18. Simon
    Martin wolf is giving a good recipe for better monetary policy. 3% inflation target is the lowest at which monetary policy would have "little room for maneuver when the water got choppy". Monetary policy is barely effective bellow 3% but not effective at all bellow 2% interest rate.

    Brad DeLong did not give the reasons why it is so.
    I will attempt to do it. By CB governors admision, monetary policy primary chanell is housing loans. And loans do not get offered bellow 4% interest. They reach that level only when official interest rates reach 2,5%.

    But there is little known corelation, causality and intercausality. It is in feedback loop of causality. Interest rates follow inflation and inflation follows interest rates. Interest rates are in feedback loop of inflation.
    But neo-keynesians think that affecting inflation on it's own, which is a signal from the market, will help get out of crisis. but, thats wrong. Inflation is a signal from market, it will not change market outcomes if it's forced to change by other direct means.
    Inflation that can help get out of the crisis is inflation that comes only from wage increase, not from asset price inflation as it succeded doing it. Raising interest rates will rise inflation, due to fiscal income from interest payments, but will not rise incomes of those with propensity to spend, but incomes of those that will put it back into finacial assets or back to Treasuries, where it came from.

    We all know why moderate inflation is good, right? Because inflation with fixed mortgage terms eat away the burden of debt. In 10-20 years those on fixed mortgage will grow incomes and burden of debt will be small and allow for more debt. Interest tax deduction is another debt easing program. Negative real interest of debt is what allows for economic growth. And what allowed for USA expansion even at stagnating wages for 40 years.
    40 year of falling interest rate trend is what allowed for faster debt reduction- higher negative real rate for borroving.

    Moderate inflation coupled with fixed debt rate and interest tax deduction with acces to personal bankrupcy is what makes debt forgivness on the large scale. That is in normal times. Times are not normal anymore since we are in positive real interest debts. no more debt forgivness.

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  19. If you want a good historical case study (which is always better than a model) on why you need democratic macro-economic policy making, the Eurozone is a good one. The Gold Standard is another.

    It is also a largely non-technical operation. I like the way Kocherlakota puts it in his recent speech "Rules vs Discretion". Basically he said that monetary policy is not a technical operation, decisions involve a lot of unquantifiable information, and it "cannot be run from a computer".

    Polanyi is a good starting point to discuss the link between democracy and macro-policy.

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  20. When you say, "Economics is always in danger of being corrupted by politics and ideology, and macroeconomics seems particularly vulnerable in this respect."

    I wonder whether things might actually be improved if the politics of it was instead embraced as being part and parcel of what is needed to understand the system. If there were two macroeconomists and one was able to predict what consequence a policy would have over ten years by taking into account political feedbacks etc whilst the other macroeconomist studiously ignored such effects and couldn't -then what is the glory of not being political and not being able to predict?

    To me the economy simply needs to be understood as it is and we can't pretend that that isn't inextricably wrapped up in politics.

    A great example of looking at how politics and macro mesh IMO is

    http://mrzine.monthlyreview.org/2010/kalecki220510.html

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    1. The way mainstream economists talk about the link between politics and macro policy reflects the fact they have not studied the link systematically - Polanyi.

      Divorcing economics from politics has been a long term ambition of monetarists, and this was an aim that Lucas was even explicit about (together with questions of equity). Economics has developed its own language which acts as barrier to engagement for people outside. This is about identity and inclusion and exclusion. Very simple issues have become technical and unnecessarily complex. This is not good for democracy, and in the end, good economics and good policy making.

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  21. Simon
    Also the Roubini gives excellent reasoning about supply glut and demand shortages, but international implications are wrong.

    "The inability of unconventional monetary policies to prevent outright deflation partly reflects the fact that such policies seek to weaken the currency, thereby improving net exports and increasing inflation. This, however, is a zero-sum game that merely exports deflation and recession to other economies."

    Why is this a zero-sum game? Main problem is that USA cut world demand by 25% in 2008, not today. It was a one time cut of world demand for world countries that refuse to increase their internal demand for decades. They relied on USA as hegemon to keep demand and employment in their countries up.
    Some of it is IMF and World Bank's fault whose policies is to force austerity onto countries it is supposed to "save" from default. They are instruments of USAs hegemony. Now USA cut their demand export by 25%, according to Yanis Varoufakis from his Global Minotaur book and refuses to rise it.
    It happened in 2008 and it stayed low.

    But the reson QE did not work is not by exporting deflation as Roubini claims, deflation that was exported happened in 2008, not anymore.
    The real reason that QE did not work is because of false Loanable funds theory. QE relies on that theory to work, but it is false.

    Loanable funds theory relies on the thinking that banks loan out their reserves, and QE was supposed work trough that chanell.
    But banks do not lend out their reserves. Ben Bernanke and Alan Greenspan admited that and Carney and a lot of CB governors
    http://www.positivemoney.org/2013/08/repeat-after-me-banks-can-not-and-do-not-lend-out-reserves-sp-report/

    Thinking about QE goes that buying financial assets from banks will increase their reserve which will they lend out trough fractional reserve banking. They will lower interest rates on loans to private elements just as banks do to lower rates for public debt.

    But, BANKS DO NOT OFFER LESS THEN 4% rates to private clients. So there was no new, additional borrowing which would grow spending and then the economy. Rates were allready at 4%.
    And banks were never reserve constraind for lending. There is no fractional reserve lending. Banks were always constraind only by capital ratio, and that was solved long time ago by changing mark to market rule to mark to model rule.

    QE did not work because banks did not lower their loan terms to private borrowers as they do to public borrowing.

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  22. “Economics is always in danger of being corrupted by politics.. “
    It’s worth remembering that the discipline started with Smith and Ricardo as, “An inquiry into the Principles of Political Economy.” Whilst economics might concern itself with production, politics concerns itself with distribution, perhaps more accurately, redistribution. Politics is in the DNA.
    Part of the problem is that despite its best efforts, “do as much math as you can,” Economics has never quite attained the status of the “hard sciences.” The discipline appears to proceed by building a body of conjectures rather than by building a body of knowledge in the way that Hawking proceeds from Einstein proceeding from Newton proceeding from Copernicus. If there is a body of established knowledge a large part of the discipline has, in any case, chosen to ignore it as frequently lamented by Pr. Krugman. In what other discipline can the same data series’ be used to “prove” opposing views; the recent return of growth in UK GDP, the long-running German “success” story.
    That, I think, is the failure that lies behind Keyne’s famous quip about dentistry. Demand management may be a “technical” issue but it also involves choices, trade-offs and moral judgments. It’s no coincidence that the German word for debt also means guilt or fault. Keynes provided the technician’s tools but he could not provide the moral compass.

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    1. Very informative comment.

      I might add that economics is inherently biased because people take a position along the left-right economic spectrum according to their feelings of how society should be structured.

      Left-wing people free society should be egalitarian. Right-wing people feel society should be strongly hierarchical to the point where there is no society. Centrists believe in moderate levels of inequality.

      (Although it should be noted that the political economic spectrum and the actual economic spectrum are two different things. Today's "centrist liberal" is significantly right-of-center. Yesterday's Republican like Dwight Eisenhower, who raised taxes on the rich to 91% to fund an interstate highway system, might be considered "socialist" by today's standards. But he was in the economic center.)

      Therefore economics is not a science built on definite knowledge that makes progress because economists are unwilling to let go of their biases. And knowledge built up on top of biases gets passed down as culture to economic students who mistake it for truth. All this makes economics politics.

      But I believe that economics can become a science. It has a concrete goal: to create a system that: a) allocates resources to their most productive use; b) yields the most real prosperity; and c) is stable and sustainable.

      This means a certain position along the left-right spectrum can be shown to be the optimal position from a scientific or engineering perspective.

      Given we have two centuries of experimental data from countries and time periods across the left-right spectrum, economic science is doable. But it will require real scientists using the scientific method to comb through the records. (Trained economists used to manipulating data to get the result they want would not be well suited to the task.)

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    2. "Keynes provided the technician’s tools but he could not provide the moral compass."

      He did. Unlike the likes of Sargent, Lucas and even Samuelson who did a good job of undoing it. Keynes warned about "pretty and polite techniques". Unfortunately applied mathematicians (and often bad ones) who make up the bulk of the discipline like the technical tools, but not the moral compass.

      So their autistic approach come up with daft ideas. Rational expecations was one. The latest is that high interest rates cause inflation.

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  23. When we are at the question on how to improve monetary policy, why not question on how economist could improve their theories?

    It should be a duty of every economist to check out the real world.
    Two areas of needed improvement for economists is the question of bank credit creation; how it happens and where the funds come from.
    Another question is about ever increasing nominal public debt, how is that possible? Anyone who looks at charts of nominal public debts will notice that public debt increases for 50 years, 100 years almost continously with occasional one or two years of lowering it just before recession.
    Why is the everincreasing public debt possible? Looking into this question by looking at banking credit system, the real world, will definitely improve economic theories.

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  24. Re SWL's VoxEU piece. An excellent comment today by Scott Sumner takes the CBO forecast in 2012 for the impact of the US austerity in 2013 and shows that economic growth was superior to even that. So, taking the CBO as a good guide to the impact of austerity seems flawed as their own predictions spectacularly failed - using models similar to SWK.
    http://econlog.econlib.org/archives/2015/01/the_cbos_foreca.html

    Where are MainlyMacro's predictions for 2015? US or UK? "Back of the envelope" calculations are fine for historic counter-factuals, but what about some forecasts?

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  25. Well there is a certain tautology that if Y = C + G + I + x than increasing anyone of the terms on the right increases Y.

    However, the critics have a point that it isn't necessarily the correct thing to do to increase G.

    After all, if C and I are too low (thus making Y to low), while it is true that increasing G would make Y larger, surely the critics have a point when they say increasing G is a distraction, the thing to do is to increase C and I, and oh by the way, the critics say, we have just the tool to do so: monetary policy. Furthermore, they note, increasing G in such a situation exacerbates the problem as doing so makes Y larger, but puts further pressure on C and I which are precisely the things needing to be made larger.

    Now, as far as I know, no one has a compelling argument or analysis that answers the question what the relative sizes of C G and I should be. No doubt there is some level of G which does pressure C and I, and no doubt there is some level of G which does increase C and I. what when where how and why?

    What level of G maximizes Y, C and I? has that been answered?


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  26. Public sector austerity in the UK has been negligible in the UK compared to the overall de-levaerage that the private sector has executed. So the slow recovery is almost entirely to do with private sector austerity, which monetary policy has been unable to stop. And I guess (sorry no model) is that this private sector de-leverage would have been more acute if the government had not talk up and implemented their austerity-lite programme.

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