We expect the unexpected at the Levy Institute. As followers of Keynes, most economists here, including this author, believe that one cannot assign exact probabilities to most important economic outcomes even, say, six months into the future.

On the other hand, thinking about the economic debate on job creation, and the recent release of new jobs data, I have not been very surprised at the gradual pace of progress in reducing the unemployment rate. In fact, we on the macro team have consistently called for more fiscal stimulus rather than less. The reason is that unemployment is a relatively slow-moving variable. As the chart at the top of this post shows, the unemployment rate (shown as a blue line) fell only rather gradually after each of the previous three recessions (shown as shaded areas in the figure). (Here, we count the double-dip recessions of 1980 and 1981–82 as one.) Hence, once the recovery began, we knew that with the unemployment rate at very high levels, it needed to fall unusually fast to be at reasonable levels by this point in the Obama administration.  Hence, since 2007, the team has advocated an easing of fiscal policy. Instead, especially after the 2009 ARRA, little action was taken by the government to stimulate the economy. Partly as a result of inaction on fiscal stimulus, government employment as a percentage of the civilian workforce (red line in the figure above) peters out after 2010.

At this point, we hope for legislation to moderate January’s expected “fiscal cliff”—which will lead to perhaps a $500 billion in reductions in the federal deficit in 2013 unless laws are changed, by CBO estimates.  (In its current form, the cliff would probably have a serious impact on all economic and demographic groups. Lately, I’ve been working on a model that incorporates the larger effects of an additional dollar of income on spending at lower income levels—not a simple task.)

In the figure, both lines are shown in the same units, namely percentages of the civilian labor force age 16 and above, though the two lines use different scales, one on each side of the figure.  For example, a one-unit change in the blue line represents the same number of workers as a move of one unit in the red line. A hypothetical jobs program or another spending measure that gradually increased government employment (red line) by, say, 1 percent of the total US workforce might easily have led to an unemployment rate (blue line) for last month of 1 to 3 percent less than the actual reported amount. But government does not seem to be expanding; in fact, the red line shows that government employment shrank at a time when more hiring from that sector would have been of great help to the economy. (The figures include employees of local and state governments, as well as those of the federal government. The smaller governmental units have seen the biggest cuts in payrolls.) continue reading…

On the surface, the data from Argentina look awfully good—among the top performers in the world over the past decade. And she’s apparently done it without a run-up of either private sector or government sector debt. In other words, Argentineans have bucked the trend among developed countries, that saw (mostly) tepid growth fueled almost entirely by debt.

And that seems to be at least in part due to a policy choice. Argentina had been the poster child for Neoliberal policies all through the 1990s—they adopted virtually the whole Neolib agenda lock-stock-and-barrel. They even adopted a currency board. And unlike Euroland (which also adopted something like a currency board as each member adopted a foreign currency—the euro), Argentina would have consistently met the tight Maastricht criteria on budget deficits and debts over that period. The main purpose of the austere budgets and currency board constraints was to kill high inflation. It worked. But, over that period unemployment grew and GDP growth was moderate. I won’t go further into the problems encountered at the turn of the new decade but the whole thing collapsed into a severe economic, financial, and political crisis. In a last desperation move, the government abandoned the currency board (or, you could say the currency board abandoned the government!), defaulted on its debt, and created a Jobs Guarantee program called Jefes.

(You can read more here and here; or if you want a first-hand account by Daniel Kostzer who played a major role in bringing Argentina out of crisis by helping to create and implement the Jefes program, read this.)

Starting from the depths of a horrible recession, then, Argentina climbed back to recovery—not only making up for ground lost in the downturn, but also in many ways by rectifying problems created by the Neoliberal experiment. continue reading…

Levy Institute scholars James Galbraith and Randall Wray presented at the annual conference held by the Central Bank of Argentina last week. Galbraith’s presentation began with the issue of the flexibility of central bank mandates and then turned to an account of the long-term evolution in the economy that prepared the groundwork for the recent global financial crisis. Randall Wray spoke on the theoretical and policy implications of a government’s ability to issue a sovereign currency.  Video and slides below the fold (full list of speakers here). continue reading…

Kevin Drum has excised another section of the now-famous leaked fundraiser video, and this time the GOP challenger is holding forth on quantitative easing and other subjects. Drum picks on Romney’s specific claim that the government is buying three-quarters of US treasury debt, but there’s something in this quotation that’s more fundamentally off:

We’re living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion? The Chinese aren’t loaning us anymore. The Russians aren’t loaning it to us anymore. So who’s giving us the trillion? And the answer is we’re just making it up. The Federal Reserve is just taking it and saying, “Here, we’re giving it.” It’s just made up money, and this does not augur well for our economic future.

The problem here is that Romney’s “fantasy” world, in which the government “makes up” money, is just a roughly accurate description of fiat money.  And if you’re rooting around in the text of Obama’s American Recovery and Reinvestment Act for the dastardly provision that created this new “feeyat” money thing, don’t waste your time—it’s been around for a long, long time.  If you’re interested in the actual history of money, as opposed to the “we used to have real money before January 2009″ version, this working paper gives a nice rundown of the anthropological and historical material and lays out the economic policy upshot.

Whether it’s buying three-quarters of new treasury debt or a tiny fraction, the Fed is always using “made up money.”  And in theory (which is to say, aside from the various legal obstacles placed in its way), the Fed can buy as much US treasury debt as it wants, because it can never exhaust its ability to “make up” more money.  Don’t believe me?  Ask Alan Greenspan:

To the extent that there’s a real policy limit to this, it’s not that the Fed will somehow run out of money, but that at some point, when the economy is closer to running at full capacity, buying US debt to keep interest rates low could lead to inflation.  But inflation, for now and the near future, just isn’t a significant problem.  (On the contrary, the current challenge is to figure out how to get more of it.)

There are plenty of things to worry about in our current economic situation.  Unemployment would be pretty close to the top of the list.  Fiat money should not be.

Who would have expected extreme thinking from central bankers? That is the theme of some coverage in the financial press over the past few weeks. For example, the Financial Times takes note that “a growing chorus of economists is saying central banks should take more radical steps, including buying assets other than government bonds.”

Some, if not all, of these steps are not so radical from a broad historical perspective. Following the recent bankers’ brainstorming session in Jackson Hole, Wyoming, Fed Chairman Ben Bernanke was said to be pondering various possibilities including (1) QE (quantitative easing) 3, (2) a lowering of the interest rate paid on banks’ reserve accounts at the Fed, (3) an extension until 2015 of the Fed’s low-interest-rate precommitment, and perhaps in the longer term, (4) adopting nominal GDP targeting, as endorsed, for example, by George Soros in a recent opinion piece on the eurozone and Germany in particular.

Today, the Fed announced that it would adopt options (1) and (3), purchasing $40 billion in mortgage-backed debt each month for an indefinite period and predicting that the federal funds rate would remain near zero through mid-2015 (see news article for more details).

Most of the measures being contemplated are portrayed as more radical than they actually are, in my view. For example, most of the actions being pondered by the Fed could not match the impact of the approximately $500 billion “fiscal cliff” due in January, or even the “fiscal clifflet,” the Economist’s phrase for the portion of the cliff that actually winds up going into effect, once the current Congress gets its last chance to pass legislation.  As a blog at that publication’s site puts it,

Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits, imposition of a new 3.8% Medicare investment tax on the wealthy, and the bite to discretionary spending embedded in the Budget Control Act and prior continuing resolutions.

One novel and potentially effective Fed approach would be the monetary “helicopter drop” recently discussed in the full-page FT article and a recent column in the same newspaper. The idea would be for the central bank (the Fed in the US case) to send money to individuals, through direct deposits in Americans’ bank accounts or by distributing currency via the banking system. continue reading…

Whatever the outcome of efforts to resolve severe economic difficulties in Europe and elsewhere, it is becoming increasingly clear that the next big economic crisis may not hinge on interest rates at all. One reason is that the world’s central banks, many of them following something like a Robinsonian “cheap money policy,” have managed to keep interest rates reasonably low in many countries. For example, it seems clear that yields on Spanish and Italian bonds are under control for now, after statements last month by Mario Draghi, the president of the ECB, that he was “ready to do whatever it takes,” to keep interest rates down. As made clear in this interesting and enlightening 2003 book edited by Bell and Nell (Stephanie Bell Kelton and Edward Nell), the theoretical argument for the Eurozone was badly flawed from the beginning.  (Indeed, many in the world of heterodox economics saw these  flaws from the beginning.) But, returning in this post to a key theme in Joan Robinson’s writings on the interest rate, I will offer some of the thoughts of John Maynard Keynes himself, who wrote in 1945 that:

The monetary authorities can have any rate of interest they like.… They can make both the short and long-term [rate] whatever they like, or rather whatever they feel to be right. … Historically the authorities have always determined the rate at their own sweet will and have been influenced almost entirely by balance of trade reasons [Collected Writings*, xxvii, 390–92, quoted from L.–P. Rochon, Credit, Money and Production, page 163 (publisher book link)].

Here in the United States, the Fed has shown its ability as a liquidity provider to keep interest rates on relatively safe investments very low across the maturity spectrum, despite spending much more than it received in tax payments in calendar years 2009–2011, and presumably the current year.  Keynes’s statement, much like the quote from Robinson mentioned above and the one in this earlier post, foretells this outcome.

Hence, recent US experience supports the view that calls for cuts in government spending and/or tax increases cannot be justified by fears that high deficits cause high interest rates at the national or global level.

* Note: The complete set of Keynes’s  works is out of print in hardback and will be reissued as a 30-volume set of paperbacks later this fall, according the Cambridge University Press website. – G.H., September 3

For those who worry that elevated federal deficits and quantitative easing (QE) by the Fed will lead to high inflation, a word about the macroeconomics of the 1970s. The topic came up in the news recently with the passing of economist and former presidential adviser Paul McCracken. In keeping with many orthodox accounts of the era, an obituary in the New York Times cast much of the blame for the stagflation [slow growth combined with high inflation] of the 1970s on “Keynesian” macro policies, in particular large budget deficits:

A wide-ranging thinker, Mr. McCracken was part of a postwar generation of economists who believed that government should play an active role in moderating business cycles, balancing inflation and unemployment, and helping the disadvantaged.

His nearly three years at the White House coincided with a turbulent era marked by rising deficits, rampant inflation, the imposition of wage and price controls, and the breakdown of the system of fixed exchange rates that had governed the world’s currencies since World War II.

As a result, by the early 1980s, Mr. McCracken, like other economists, questioned the Keynesian assumptions that had been dominant since the war. He concluded that high inflation had resulted from “a cumulative paralysis in our will” and called for greater fiscal discipline to limit the growth of government spending — a topic that continues to vex Washington….

Working for Nixon, Mr. McCracken was confronted with an inflation rate that had been rising since 1965, a byproduct of the deficits that the federal government had amassed during the Vietnam War…..

The article paints a picture in which McCracken stood in the middle ground between Keynesian “fine-tuners” of macro policy on the one hand and opponents of “activist” policies, such as Milton Friedman, on the other, who blamed inflation on excessive government spending and erratic growth in the money supply.

The view represented by the Times article is far from the only reasonable account of the causes of the stagflation of the 1970s, in particular the episodes during which the US experienced double-digit inflation (see figure below, in which year-over-year CPI inflation is shown in blue). continue reading…

Randall Wray joined Suzi Weissman for radio KPFK’s Beneath the Surface to discuss monetary policy, financial fraud, and a number of other issues.  The interview kicked off with Wray explaining his skepticism of the effectiveness of monetary policy, and in particular of quantitative easing, under current conditions, touching also on the question of why this long-term bias in favor of monetary over fiscal policy has developed.  The interview turned to LIBOR and the long string of recent financial scandals and outright fraud, with Wray tying it all to a broader (and growing) financialization of the economy.  Elaborating on the dominance of the FIRE sector in our economy, he discussed the increasingly fuzzy boundaries between, say, finance and industry.

Listen to the interview here.

In my last post, I quoted Joan Robinson, the renowned Cambridge University economist, on the determinants of long-term interest rates. The mention of Robinson was made in the context of a comment on the Fed open market committee meeting earlier this week and Chairman Ben Bernanke’s press conference on Wednesday. For those who might be curious, here is the “cheap money” scenario from Robinson that I mentioned in the earlier post; astute readers will notice parallels in recent Fed history:

The first move in the campaign is for the Central Bank to dose the banks with cash, by open market purchases. The amount of advances the banks can make is limited by the demand from good borrowers. The demand is very inelastic (though it shifts violently up and down with the state of trade), so the banks, between whom competition is highly imperfect, see no advantage in cheapening their price. The redundant cash reserve must go into bills. Any rate of return is better than none. The banks with redundant cash find themselves in much the same position as a group of firms with surplus capacity and zero prime costs. If perfect competition prevailed, the bill rate would go to next to nothing and the banks could not cover their costs. They therefore fix up a gentlemen’s agreement which keeps the bill rate steady at a low level. The bill rate is maintained at this low level by the Central Banks giving another dose of cash whenever it threatens to rise.

If the Central Bank is operating in the old orthodox manner, its power ends here, and the authorities must rely on the dealers in credit to bring the long rates down. Nowadays the authorities reinforce the action of the banking system by going into the bond market directly. If necessary, they issue bills in order to buy bonds, the quantity of money being adjusted to whatever level is required to keep the bill rate at its bottom stop. The low interest rates may slow down the velocity of active circulation so that money, as the saying is, stagnates in pools. Long hoards are swollen by the fall in current rates and bear hoards by the fact that expected future rates are not yet revised.

As time goes by, experience of a long rate that is persistently somewhat lower than the expected rate lowers the expected rate and so lowers the actual rate further. The yield on shares falls in sympathy with the bond rate. Thus the whole complex of rates gradually falls through time. If the authorities take it gently and do now try to push the rate down too fast, and if they stick consistently to the policy, once begun, so that the market never has the experience of today’s rate being higher than yesterday’s, it is hard to discern any limit to the possible fall in interest rates (except the mere technical costs of dealing) so long as the full-employment interest rate is below the actual level of rates or is held below it by a budget surplus or other means.

Joan Robinson, in “The Rate of Interest” (1951) from The Generalization of the General Theory and Other Essays, published by St. Martin’s Press, New York, 1979, pages 163–64. (The date of the original article was stated as 1952 in my earlier post; that is the publication date of the first edition of the book, which appeared under the title The Rate of Interest and Other Essays. My apologies for any inconvenience caused by this error.)

As I write, markets are wondering what Fed Chairman Ben Bernanke will say about interest rates in a press conference taking place this afternoon. Many economists, including some on the Federal Reserve’s rate-setting committee, are arguing that the Chairman is courting inflation with his policies of keeping interest rates low. He has been using three main approaches to this task:

(1) keeping short-term interest rates low through open market operations;

(2) buying and holding medium- and long-term bonds in a direct bid to keep longer-term rates low; and

(3) saying that it is likely to keep the federal funds rate near zero for an extended period of time.

Task (1) has been the usual approach of the Fed in modern times (since the early 1950s perhaps); task (2) has been important since the Fed’s response to the financial crisis beginning in 2008 or so. The current version of task (2) consists largely of a “twist” operation in which short-term securities are sold to pay for purchases of long-term securities. Task (3) is a commitment of sorts about short-term rates that helps to keep longer-term rates down. Tasks (2) and (3) are the most directly relevant to mortgage and auto loan rates, which are longer-term rates.

Economists, including critics of the Fed’s expansionary policies, sometimes refer to this three-pronged approach as a “cheap money policy,” but many who oppose “cheap money” have claimed that it would not be possible to maintain such a policy for very long (economic laws, or perhaps the bond markets’ worries about future inflation, would prevent this).

In a 1952 essay, Joan Robinson argued that a modern central bank could achieve a low long-term interest rate, but that it would take a long time to do so, in comparison to the quasi-real-time control the Fed enjoys over the federal funds rate. continue reading…