In a new policy brief, developed with support from the United Nations Development Programme, Rania Antonopoulos considers how women’s economic empowerment can be advanced in the context of this evolution in social protection policy.  She zeroes in on the ways in which social protection policies, while addressing income gaps, also shape women’s opportunities through the manner in which these programs “see” or “position” women (whether intentionally or not).  To explain how this “positioning” works, she points to three different policies for addressing food insecurity (all targeted at women): cash transfers, free delivery of food staples, and access to land plus subsidized seed and fertilizer.  While all these interventions are aimed at reducing food insecurity, Antonopoulos observes that “there are stark differences between them in terms of the process through which deprivation is addressed, and from a gender perspective, differences in the (implicitly) assigned positioning of the beneficiary”:

The first addresses income poverty by enabling women to participate in the economy as consumers, which they otherwise cannot do on their own. The second, in the case of free rationed food, allocates food directly to those deserving of support because of their destitute status and inability to cope. The third approach addresses the income gap through means that enable the beneficiary to engage in the economy as a producer.While all three reduce an identified deprivation, the last one acknowledges it as an outcome of social relations of exclusion in production (i.e., women farmers do not have access to necessary agricultural inputs and support systems) that often underpin people’s experiences of chronic poverty and vulnerability.

While Antonopoulos stresses that there is no one-size-fits-all approach that follows from these observations, these “positioning” dynamics should inform program design:  social protection instruments can reinforce gender inequalities, or leave them untouched, but they also offer the potential to help promote women’s roles as active participants in economic life.

Antonopoulos devotes a fair amount of the brief to discussing a pair of policies currently in use in the developing world — conditional cash transfers (CCTs) and employment guarantee programs (EGPs) — and sketches out the areas in which gender equality can be advanced through program redesign.  CCTs, increasingly popular in Latin America, offer a cash stipend to primary caretakers on condition that, for instance, said caretakers offer proof that their children are attending school and receiving regular medical checkups. EGPs are relatively new (examples can be found in both South Africa’s Expanded Public Works Programme and India’s Mahatma Gandhi National Rural Employment Guarantee Act).  They offer a paying job in a public project for a specified period of time to low-skilled workers who cannot otherwise find employment.  Antonopoulos looks at the ways in which EGPs can be designed so as to not only cover income gaps but also tackle some of the disparities women face in the labor market:  everything from recognizing and even alleviating women’s unpaid work burdens to avoiding reinforcing women’s exclusion from certain occupational categories.

Antonopoulos also takes on arguments surrounding the question of whether low-income countries can afford to devote an expanding percentage of GDP to social protection spending — pointing out that these arguments often ignore the large costs of not investing in effective social protection policies.

The policy brief, which can be downloaded here, is also accompanied by a background working paper.

I thought you might enjoy my powerpoint presentation, given at the Levy-Ford annual Minsky conference in NYC in mid-April. It summarizes some of the main arguments of the book. However, you really need the book – it is brilliant, and a good antidote to all the silly arguments made by economists that we “need” to keep tens of millions of Americans unemployed.

As Keynes put it:

“The Conservative belief that there is some law of nature which prevents men from being employed, that it is ‘rash’ to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years….” (J. M. Keynes)

Here’s the powerpoint.

the eurozone was to involve the inclusion of independent states, with highly diverse economic systems and cultural settings, that were required to give up national currency sovereignty in exchange for a “foreign” currency without the backing of a treasury or a central bank ready to act as lender of last resort in the event of a financial crisis.

And with the eurozone mired in recession (the latest numbers from Eurostat are here) and a deep depression in Greece, it might look like a failed experiment.  But it only looks this way, Polychroniou suggests, if you think of economic growth and the wellbeing of the average worker as among the primary goals of the project.  The setup of the EMU is not the result of some set of technical errors or oversights.  It is consistent with a long-developing attempt, culminating in the Maastricht Treaty, at transforming a social market economy into a laissez-faire market economy:  “it stemmed,” Polychroniou writes, “from the very premises of the fundamentally neoliberal economic thinking that had begun to take hold of the mindset of European policymakers in the 1980s.”  If anything, he argues, the struggles in the eurozone, particularly on the periphery, are being seized on as an opportunity to accelerate this transformation, with Germany playing the role of “neocolonialist” in the process:

Germany has adopted toward the indebted eurozone member-states the same policy it carried out with regard to East Germany after unification: the destruction of its industrial base and the conversion of the former communist nation into a satellite of Berlin. The bank rescues masquerade as the rescue of nations, and are followed by the enforcement of unbearable austerity measures to ensure repayment of the “rescue” loans. Then comes the implementation of strategic economic policies aimed at reducing the standard of living for the working population and the shrinking of the welfare state, complete labor flexibility, and the sale of public assets, including state-controlled energy companies and ports. This constitutes the German strategy for pillaging the debt-laden economies of the Mediterranean region.

Read it here.

One problem with this analysis is that it assumes the voting public would even recognize/concede the existence of a budget surplus.  If you’ve been paying any attention to US public affairs, you’ll have observed that the realm of empirical fact is a fiercely contested battlefield (see warming, global).  And on budget matters, as Dimitri Papadimitriou has pointed out, the battlefield is tilted in one direction:  “The deficit has arguably gained the distinction of being the single most widely misunderstood public policy issue in America. Just 6% (6!) of respondents in a recent poll correctly stated that it had been shrinking, which has in fact been the case for several years, while 10 times more, 62%, wrongly believed that it’s been getting bigger.”

Now, it ought to be mentioned that no one should get any credit for a budget surplus in 2015 (or for a deficit as low as 2.1% of GDP, as the CBO predicts).  Under current economic conditions, this would represent the continuation of an inexcusable fiscal policy error — and the reason it would be an error points to another problem with Salam and Pethokoukis’s political concerns.

Growth has to come from somewhere.  Given the depressed economies around the world, there’s unlikely to be much of a boost from exports, and if the public sector will continue to withdraw purchasing power and jobs from the economy, that leaves the private sector.  But as the Levy Institute’s macroeconomic research team has been pointing out, the only way to reconcile the CBO’s budget forecasts with their growth numbers (given the IMF’s projections for GDP growth among US trading partners) is for private sector borrowing to explode (see Figure 5 of this Strategic Analysis).  If that doesn’t happen, we’re likely to see much lower growth than the CBO suggests.  But even the CBO’s growth numbers wouldn’t be high enough to shrink the unemployment rate down to a non-abysmal level by 2015; particularly since we’ve been experiencing a weakening link between output and job growth for over 30 years now (we need much higher growth to produce the rises in employment we saw in the past).

“Sure, the unemployment rate is still terrible, but look, no budget deficit!” isn’t a winning message outside of the constituency of op-ed writers (and maybe not even there).  In this sense, Salam’s political party has nothing to fear from a budget surplus.  Heading into a presidential election with an unemployment rate that still hasn’t recovered to pre-crisis levels after nine years gives the non-incumbent party a pretty solid talking point.

The budget surplus/high unemployment scenario would also set up the Republican party quite nicely in terms of a policy agenda — Salam’s second concern.  After all, the last several years have demonstrated that while the Republican party is rhetorically committed to austerity, its revealed preferences point to a much higher priority:  high-end tax cuts.  Demands for tax cuts can sound somewhat awkward when paired with deficit-reduction rhetoric, but with a budget surplus, it would be 2000 all over again.

We can see this by looking at two types of deposits that correspond to the dual functions of banks:  deposits of currency and coin, and deposits created when loans are made.  If a bank makes bad loans — and as Kregel points out, “it is the failure of the holder of the second type of deposit [loan-created deposits] to redeem its liability that is the major cause of bank failure” — the first type of depositor (of currency and coin) should not bear the brunt of these bad decisions.  The role of deposit insurance, one might argue, is to provide such protection.

But since deposit insurance has to be extended to all of a banks’ deposits (up to a certain level), including those created by loans, moral hazard is inevitable.  Ideally, deposit insurance would be structured in such a way as to distinguish between deposits based on currency and coin and deposits generated through loans, as well as between deposits created by good and bad loans (loans that default).  But if you examine how the banking system functions, says Kregel, this isn’t operationally possible:

Unfortunately, it is impossible in practice to make these distinctions between reserve deposits, defaulted-loan-created deposits, and deposits created by loans that are current. It is for this reason that there are limits on the size of insured deposits based on the presumption that the first type of deposits will be relatively small household deposits created by the transfer of reserves and used as means of payment or store of value. It thus limits coverage of the other types of deposits. However, this is clearly inequitable for the deposits held by borrowers who are still current on their loans.

As he explains, with some help from Minsky, it is the means of payment function that makes these distinctions practically impossible (for more on why this is, read the note here).  Kregel concludes that “It would thus seem impossible to design a truly fair deposit insurance scheme that eliminates the inherent moral hazard and the necessity of a contingent guarantee of the central bank.”

“Kocherlakota Says Low Fed Rates Create Financial Instability,” one publication announced.  In fact, what Kocherlakota said (see the full speech below) was far more nuanced (and to be fair, most of the media reports grasped the key points.  I’m told it’s fairly common for reporters not to write their own headlines).  He argued that low-rate policy can create phenomena that are commonly taken to be signs of financial instability:  “unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity. All of these financial market outcomes are often interpreted as signifying financial market instability.”

If low interest rates created financial crises of the sort that tanked the global economy in 2007/2008, this would be a pretty good argument for siding with the hawks.  But Kocherlakota’s actual, stated views are perfectly consistent with a zero-interest-rate policy creating only signs of instability.  The cost-benefit analysis facing the central banker therefore looks more like this, according to Kocherlakota (his emphasis):  “On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”

Unfortunately, euro weakness as the supposed solution to the euro crisis is a thoroughly misguided piece of advice. The idea about the euro being expensive for some but cheap for others at its current level is nothing else but the external mirror image to the fact that competitiveness positions inside Europe’s currency union are utterly unbalanced – which led to corresponding intra-area current account imbalances and debt overhangs. While this is a correct diagnosis of intra-euro imbalances, implying a need for rebalancing, it must be stressed that there was absolutely nothing inevitable about this outcome. It was just that, contrary to the requirements of a currency union, Euroland simply failed to keep unit-labor cost trends within the union aligned with the commonly agreed two-percent inflation norm. In particular, as Germany stabilized its nominal unit labor cost trend at zero under the euro, the country turned űber-competitive in due course as a result. This resulted in the buildup of excessive current account surpluses – with corresponding German exposure to debts issued by its euro partner countries and exuberantly gobbled up by German banks and investors.

Perversely rewarded by the markets, Germany is imposing competitive austerity on its uncompetitive partners as the cure-all that is supposed to restore stability as well as growth. Quite predictably, the result of allegedly “growth-friendly” continent-wide austerity is catastrophic. Domestic demand in the eurozone has been shrinking for over a year now, at an annual rate of around 2 percent. The decline in GDP has been contained to less than one percent only due to a very sizable positive growth contribution from net exports.

How much more stimulus from abroad does Euroland deserve for its rescue, one may then ask? Do Messrs Feldstein, Darvas, and Keohane suggest that Euroland has some natural right to enjoy an export-led recovery? The German authorities may well think so. And if the euro were to weaken and hence propel Germany’s exorbitant external imbalance of currently around 7 percent of GDP toward and beyond 10 percent, they might sing Germany’s competitiveness anthem (“envy of the world”) even prouder.

Beware handing out open invitations for pursuing beggar-thy-neighbor policies, policies that risk triggering currency wars, trade wars, and more. Euroland is already sucking the air out of the global recovery in a big way. Both the U.S. and China, the two key engines that have done most of the heavy-lifting since 2009, seem to be losing steam by the day. It is highly doubtful that the global economy can withstand even more collateral damages resulting from Europe’s ongoing economic suicide. Arguably, the euro should rise sufficiently so as to concentrate the damages locally where they are inflicted, instead of burdening the world community with the consequences of – never-ending? – euro folly. This is not a matter of reasonable international burden-sharing but a matter of enticing the euro authorities to “get their own house in order.”

Here’s Krugman’s argument. To briefly summarize, historical experience has demonstrated that the “growth through austerity” argument is false. Further, the monetarists have also got it wrong: monetary policy won’t get us out of this recession trap; what we really need is a good dose of fiscal policy. Given that we are in a “liquidity trap,” we can safely expand government spending without worrying about the usual downside to deficits. And in a liquidity trap, there is really no difference between Modern Money Theory and the conventional ISLM analysis. It is only once we return to a more “normal” situation that budget deficits would “matter” in the sense that they’d cause problems.

DeLong amplifies the argument here. Once we’re out of the liquidity trap, then sustained budget deficits will push up interest rates and crowd out private spending (especially investment). This is basic ISLM stuff. For those who have not taken intermediate macro, it is enough to know that in current conditions increasing budget deficits will not raise interest rates because the private sector welcomes all the liquid and safe government debt it can get. Further, flooding the economy through Quantitative Easing will not cause inflation because, again, everyone wants liquidity and would rather hold it than spend it. In more normal times, budget deficits and money helicopters would cause inflation and rising interest rates. And that would be bad.

Note, both of them raise additional good arguments against the R&R results and against austerity more generally. I am focusing in on the one point about the liquidity trap for the purposes of this blog simply because it seems to be the sticking point that prevents them from fully embracing MMT. From the perspective of Krugman and DeLong, MMT is fine for the liquidity trap, but wrong for the normal situation—when deficits will matter.

While many economists think the ISLM liquidity trap derives from J.M. Keynes that is actually not true. Here’s what he said (Ch 15 of the General Theory):

Nevertheless, there are two reasons for expecting that, in any given state of expectation, a fall in r will be associated with an increase in M2. In the first place, if the general view as to what is a safe level of r is unchanged, every fall in r reduces the market rate relatively to the ‘safe’ rate and therefore increases the risk of illiquidity; and, in the second place, every fall in r reduces the current earnings from illiquidity, which are available as a sort of insurance premium to offset the risk of loss on capital account, by an amount equal to the difference between the squares of the old rate of interest and the new. For example, if the rate of interest on a long-term debt is 4 per cent, it is preferable to sacrifice liquidity unless on a balance of probabilities it is feared that the long-term rate of interest may rise faster than by 4 per cent of itself per annum, i.e. by an amount greater than 0.16 per cent per annum. If, however, the rate of interest is already as low as 2 per cent, the running yield will only offset a rise in it of as little as 0.04 per cent per annum. This, indeed, is perhaps the chief obstacle to a fall in the rate of interest to a very low level. Unless reasons are believed to exist why future experience will be very different from past experience, a long-term rate of interest of (say) 2 per cent leaves more to fear than to hope, and offers, at the same time, a running yield which is only sufficient to offset a very small measure of fear.

Sorry for that. Let me translate: while the Fed can push the short term rate to a really low level (think ZIRP), there’s a limit to how low it can push the longer rates. The problem is that we “know” we will not have ZIRP forever, and when short term rates rise, there will be capital losses on longer maturity debt (that is stuck with today’s low rate). So in this environment, no matter how much QE we get, we cannot push long rates lower. It is a “liquidity trap”—banks will hold the excess reserves and earn, say, 25 basis points rather than plunging into 30 year bonds that pay, say, 2 percent, due to fear of capital losses.

Keynes’s liquidity trap argument is not relevant to the ISLM result that when the LM curve is NOT horizontal, deficits raise rates. And it is that ISLM result that is contestable.

(I won’t go into the problems with ISLM analysis; even the creator of the model, John Hicks, later rejected it. We’ve known since the 1970s that it is an incoherent mess. It really is not taken very seriously anymore and I cannot explain why Krugman clings to it. Even in its updated form—a three equation “new consensus” model—it is still a mess with real rates and Taylor rules and imagined trade-offs.)

As MMT teaches, the operational function of selling Treasuries is to offer a higher interest earning alternative to low earning reserves (recall that until the GFC reserves paid zero; now they pay a positive rate chosen by the Fed). How much higher? Well that depends on the maturity and the state of liquidity preference. As Keynes implies, when you’ve got ZIRP you’ll have to pay about 200 basis points to get banks or others to give up liquidity to hold longer maturities. When short term rates are higher and are expected to fall, the premium required on long term maturities is lower (you can even invert the yield curve structure, with short rates above long rates).

The great fear is that if the government continues to run sustained budget deficits even after recovery, it could get into a debt trap. Trying to finance those deficits supposedly pushes up interest rates paid by government, which increases debt service costs, which accelerates the growth of budget deficits and raises interest rates more. You get the picture: a vicious cycle that increases the debt-to-GDP ratio. Eventually the bond vigilantes foreclose on the US government and we’re forced to grovel like Greeks.

But that argument misses the point. Short term rates are determined by monetary policy. The Fed can pay what it wants on reserves and charge what it wants on lending at the discount window. It targets the fed funds rate and keeps it within the bounds more-or-less set by the other two rates. When the economy begins to expand, the Fed will most likely raise rates. (And while it might raise rates in response to budget deficits, that is clearly a policy decision, not something that markets do to us.)

Deficits increase bank reserves and sustained deficits will result in excess reserve positions unless countervailing action is taken. Excess reserves put downward pressure on the fed funds rate. The Fed can sell government bonds (open market sale) to relieve that pressure, or the Treasury can sell new bonds. In either case, the operational impact is to substitute Treasuries for excess reserves (it is the opposite of QE). And note that if no such action is taken, budget deficits PUSH INTEREST RATES DOWN, not up.

What interest rate will Treasury need to pay to sell those Treasuries? Well, it depends on the maturity of the issues and the state of liquidity preference at the time. The Treasury could choose to sell short term obligations (bills) at a rate that tracks the Fed’s target rate; or it can sell longer maturities. We call that “debt management.” But note that it is a policy choice. Not a bond vigilante choice. Vigilantes cannot force the Treasury to sell long maturities.

Could the Fed try to make us grovel like Greeks? Yes. It could do a Volcker—push rates above 20%. That could get the US government into a vicious interest rate-growing debt cycle. It would of course do the same to the private sector—whose debt ratio is already a lot higher than that of the federal government. Place your bets now on which crashes first: federal government that has the magic porridge pot, or the private sector that doesn’t.

You cannot completely rule out bad policy. That’s the bad part about democracy. And every other form of government. The good thing about democracy is you can throw the buggers out every now and then.

The problem is that most people think Fed independence is natural, desirable, immutable.

That’s an upcoming topic I’ll address later. The Fed is a branch of government and a creature of Congress. So the question comes down to this: Can the Fed go all vigilante on us, without Congress putting it back into its proper place?

Bad apples, after all, can be replaced.  But what if the ignorance is real; if managers really don’t know what’s going on in the units below them due to the sheer complexity of the financial institutions they’re running?  This might be thought of as a convenient excuse; a universal “get out of jail free” card.  But if true, it has more far-reaching, radical implications than most Bankers Behaving Badly scenarios, because it points to a problem that touches on the very structure of the financial system and its key institutions.

This, says Jan Kregel, is part of the the deeper lesson of JP Morgan Chase’s “London whale” fiasco.  In a new policy brief, Kregel reviews the recent Senate Permanent Subcommittee on Investigations report on JP Morgan Chase’s difficulties and draws out the lessons for financial reform:

The most probable explanation of the misinformation concerning the “London whale” affair is a massive failure of managerial direction and control that was not the result of deliberate deception, but rather the natural response of individuals who were being paid handsomely to take responsibility but simply did not know what was going on because the size and complexity of the organization made that impossible—again, evidence of an institution that was too big to manage effectively and, a fortiori, too big to regulate.

And as Kregel emphasizes, although it’s not size per se that is problem, but rather the complexity of the institution, there’s often an intimate connection between them:  “While complexity is clearly a bigger threat to financial stability than large size, it is usually, but not only, large size that induces complexity.”

Although a lot of the information in the Senate report is not new (and can be found, says Kregel, in JP Morgan Chase’s internal report), it does reveal some of the internal communications between management, the Chief Investment Office (CIO), and its Synthetic Credit Portfolio (SCP) unit where most of the trouble emerged.  According to Kregel, the report confirms that there was some misrepresentation on the part of management, but more importantly, it also reveals the degree to which management had little idea or understanding of what was going on at the SCP.

Kregel digs into the activities of the CIO and its SCP unit, and explains how and when things started to go wrong with what he calls its “macro-hedging” operations (“The activities mandated to the CIO,” Kregel writes, “may be seen as the private sector equivalent of regulators’ recent fascination with ‘macroprudential regulation’.”)  One criticism often levied against the London whale trades is that they were “disguised proprietary trading” of the type that should be prohibited under the proposed Volcker rule.  Kregel has a somewhat different take on this.  “Such hedging activities are by definition proprietary,” Kregel writes, “and the extent of hedging and basis risks will make it impossible to judge when such hedging is adequate to cover perceived risks or is excessive and thus concealed speculative trading.”  And, he continues, “[i]t should be clear that it is not the proprietary trading as such that caused the bank’s difficulties.  The problem is the failure to accept that such activity comes at a cost and therefore cannot be a profit center, nor can it be funded from either customer deposits or an internal shadow bank.”

If this is the case, then Dodd-Frank’s Volcker rule, even if it emerges from the rule-making process in a robust form (which is looking less and less likely), won’t be getting to the heart of the matter.  According to Kregel, the deeper problem is that we have a financial system that creates the necessity for “macro hedging” via derivatives in the first place.  The upshot of the London whale affair is not simply that we need a change in personnel, or even a more robust implementation of Dodd-Frank, but rather a repeal of the Financial Services Modernization Act (otherwise known as Gramm-Leach-Bliley).

Kregel also takes issue with the Senate report’s criticism of the CIO’s remuneration policy.  The problem, says Kregel, is not that the compensation was well above the average for normal traders, but that — for a unit engaged in hedging — the compensation was tied to profitability:

A hedging unit is expected to incur losses most of the time if the bank’s operating strategy and credit assessments are well run; it will only generate profits in periods of crisis. It was thus totally inappropriate to remunerate CIO operations on the basis of profitability.

Kregel’s policy brief can be downloaded here.

In light of the euro crisis both nations are bound to reassess the euro’s viability. No doubt France has seen all its hopes for the euro disappointed. France is facing the prospect of a lost generation today, a prospect shared with other debtor nations in the union, and a prospect that undermines the Franco-German axis and may soon turn it into the ultimate euro battleground.

…  Continue reading in English / Spanish

(see this working paper for more background)