Sometimes everything comes together in unintended ways. That has happened to me this week. I…
Welcome to 2010. Today, in the overcast summer that we are enduring here, in between other things I am finishing off, I was in my office reading about how mainstream economics actually saved us from a major depression over the last 2 years. Far from having to hang their heads in shame, the article indicated we had all embraced Keynes and glory be the day. I also read a counter to that which outlined what further needed to be done. I concluded neither writer really had grasped what has been going on and both would benefit from exposure to modern monetary theory. Not a lot has changed overnight. Happy new year!
Financial Times economics writer Martin Wolf is back from holidays. I think he would have been better staying on vacation more or less permanently. In his article (December 29, 2009) – The challenges of managing our post-crisis world, Wolf outlines some key areas where the world has to avoid complacency and instigate fundamental reforms.
After some personal remininsces, Wolf concludes that “… civilisation is as fragile as glass. Moreover, when chaos comes, the worst of human nature will almost always emerge …” He goes on to say that:
At an emotional level, these views shaped how I have responded to the financial catastrophe of the past few years. I was convinced that, without the policy responses we saw, the world would have experienced a still greater depression. Policymakers could not stand idly by while such calamities unfolded. We could not, in such times, even take the survival of civilisation itself for granted. Never before had I felt more strongly the force of John Maynard Keynes’s toast “to the economists – who are the trustees, not of civilisation, but of the possibility of civilisation”.
The point of all of this is that we allegedly are confronting “huge challenges at a time of great global transformations” and “(s)omehow, we must manage to sustain a dynamic global economy, promote development, deliver environmental sustainability and ensure peaceful and co-operative international relations”.
While us practictioners of the dismal science have limited scope, as Wolf points out, to stop ” nuclear weapons from falling into the hands of terrorists or terrorist regimes” (hasn’t America already got them? – see recent Chomsky news) among other catastrophes that might undermine “civilisation”.
But Wolf suggests us economists have some use – to help the world economy “return to health” … “That is, as Keynes would surely have said, the contribution economists ought to be able to make. What else can they be good for?”
The full quote (which Wolf lifts from) is provided in Roy Harrod’s 1951 book The Life of John Maynard Keynes (published by Harcourt Brace and Co., New York). On pages 193-194 you read:
I give you the toast of the Royal Economic Society, of economics and economists, who are trustees not of civilization, but of the possibility of civilization.
Harrod, who was a friend of Keynes said that the quote was in fact a toast he made after his farewell speech in 1945 at the Council of the Royal Economic Society. Keynes was retiring after 33 years of service as the editor of the Economic Journal, the Society’s major publication.
There was an on-going and vigourous debate about the concept of civilisation in the 1920s and into the 1930s. This followed World War 1 when the British intelligentsia were fond of discussing how civilisation was to be protected from the barbarism of the Germans.
Keynes was at Cambridge at the same time as the art critic and writer Clive Bell who in 1928 published Civilization: an Essay (published by Harcourt Brace and Co., New York). They were friends and part of the London Bloomsbury group. Bell mostly wrote about aesthetics and the value of art. As an aside, Bell was married to the sister of Virginia Woolf to whom Civilization is dedicated.
In Civilisation (it is worth reading at some point in your life), Bell argues (not that successfully) that civilised societies have to maintain an elite group in their leisure (they wouldn’t work!) to safeguard and promote higher values. Remember it was written following World War 1 when the British intelligentsia were on about protecting their values from those of the Hun!. To my German friends, that was the language actually used – BMW – doesn’t that stand for Bob Marley and the Wailers.
Some interesting points from the book are that Bell considered utilitarianism, the then catchcry of neo-classical economics to be rather contemptuous (page 169). He earlier says that civilised societies always “sacrifice style to comfort … [as] … an inevitable consequence of the sense of values” (page 71).
In that regard he noted (page 62) that the concept of “productive efficiency” is dubious because it usually promotes ambitions that are “more obvious and immediate” at the expense of values which are “more subtle and remote” but closer to what a civilised society is.
In this sense he juxtaposes (page 260) the higher values of civilisation with the “the creed of the producers. Those who hold it have no will to civilization. But they have power.”
The members of this elite must be free of the need to work but will at times be called upon in the public debate to define what good is – “the disseminators of culture are a group of men and women of whom most create no tangible work and leave no eximious monument …” (page 121).
However, it is this passage in Civilisation, which has been pinpointed, as being the source of Keyne’s link between civilisation and the economist – the link he made in his famous Royal Economic Society toast. It appears on page 250:
Those who use authority, like those who create wealth, can be civilized but not completely civilized. They must be of the second order. The mere exercise of power, the coercing of others, will tinge a man with barbarism. My praetorians, my policemen, my administrators and magistrates, and I myself if I am to be an efficient ruler, which, however, I decline to be – must be content to be the imperfectly civilized guardians of civility. Fortunately there are in the world a number of people who appear not only to enjoy ruling (an all too common taste), but to enjoy ruling well … and if in fact they generally fail that is not the result of malevolence but of stupidity. It should not be impossible for a civilized elite by bringing intelligence and education into fashion partially to remedy this …
Compare the toast made by Keynes where he talks about the “trustees” of civilisation whereas Bell uses the term “guardians” of civility. It was clear at the time that Keynes considered economists to be among this elite group who would bring their “intelligence and education” to keep the masses on track.
However, in the historical context, Bell would never have agreed that economists were of such a quality as to be in his leisured elite. It would be worrying if we were to believe the proposition that if we didn’t take the advice of economists without question then we will undermine our civilisation.
But Keynes clearly thought economists had something to offer although in some modest way. The profession certainly took the first idea to heart (something to offer) but didn’t stay humble for very long.
Indeed, we have worked steadily at undermining civilisation by taking heed of the advice of mainstream economists. To a large extent that is why we are in this mess.
Anyway, if you are interested you can find a lot of literature about his old debate.
However, Wolf’s just seems to think it is worth quoting Keynes without context, and he quickly moves from “civilisation” as if we are to take Keynes’ proposition at face value.
He then says:
In an article published in the FT this week, Arvind Subramanian of the Peterson Institute for International Economics, argues that economics has redeemed itself by rescuing the world economy from the crisis. I agree, but only up to a point. Many economists argued that the measures were unnecessary, or even harmful. Moreover, these extraordinary interventions have not returned the patient to health. They have merely prevented him from dying. We now must heal five chronic conditions, instead of survive last year’s brutal heart attack.
The Subramanian article that Wolf mentions – The Triumph of Ecoomics – was reprinted HERE on December 29, 2009.
Subramanian argues that the “greatest Depression that could so easily have happened in 2009 but did not is the tribute that the world owes to economics”. My question is which ones? He says that:
In 2008, as the global financial crisis unfolded, the reputation of economics as a discipline and economists as useful policy practitioners seemed to be irredeemably sunk. Queen Elizabeth captured the mood when she asked pointedly why no one (in particular economists) had spotted the crisis coming. And there is no doubt that, notwithstanding the few Cassandras who had correctly prophesied gloom and doom, the profession had failed colossally.
He notes that mainstream economics had promoted “a belief system that elevated markets beyond criticism” and policy makers had deregulated financial markets to the point that they couldn’t see the crisis coming.
That is one of the major issues to emerge from this crisis. The policy makers did not even have the data available to them to see the extent of the risk that was building up. From a modern monetary theory (MMT) perspective there were clear signs brewing in the late 1990s as governments persisted in deregulating financial markets and raising the fetish of budget surpluses to “academy award” status.
But the day to day (real-time) data that was needed to understand the web of failures that was inevitable was not considered important by the neo-liberal policy makers to collect or monitor. Never mind we were told – markets self-regulate.
As I noted in an earlier blog – Being shamed and disgraced is not enough – former US Federal Reserve boss Alan Greenspan actually thought markets would even deal with liars, crooks and frauds efficiently. However, the only way this could happen would be for massive bankruptcies to follow the corporate failure with huge losses and lots of innocent people suffering collateral damage. And in all likelihood, the fraudsters escape with the booty.
Further, as I have noted often the old teaching structure in economics is not suited to educating students to understand anything about what has happened in the world economies the last few years. Quite the contrary in fact. The textbooks represent a denial of crisis and a eulogisation of equilibrium and market-created wealth. Chapters on government regulation are typically negatively constructed.
So if all of this is what Subramanian is referring to then I agree with his point.
Subramanian then suggests that crisis are inevitable:
But crises will always happen, and … will elude prognostication. Most crises, notably the big ones, almost always creep upon us from unsuspected quarters; that is perhaps the very definition of a crisis … So, if the value of economics in preventing crises will always be limited (hopefully not non-existent), perhaps a fairer and more realistic yardstick should be its value as a guide in responding to crises. And here, one year on, we can say that economics stands vindicated.
This comment interested me because it is one of those statements that are made from the straitjacket of mainstream economics. By that I mean, that crisis would be very limited and short-lived if the way we thought about the balance between public and private activities in the economy changed.
When you set up a system which promotes a decline in public employment capacity a decline in public scrutiny of key markets, then it is true, crises – either of a financial or real origin – will occur with regularity and cause damage to the well-being of individuals.
But if there is considerably more scope for public activity as a built-in part of the wealth generating process then while private sentiment swings will drive variations in private spending, the consequences of these swings need not be severe. For a start with an in-built Job Guarantee, the swings would have less severe employment consequences that without such a capacity.
We were caught out this time because as noted above our government didn’t see it coming (because they had closed their eyes) and they had fallen so much into the obsession that monetary policy was the answer to counter-stabilisation issues that they took some time to get their head around the obvious palliative intervention – to revive their fiscal policy capacity, which had been undermined by years of ideological attacks by mainstream economists.
Subramanian then outlines why economists rescued us. He says that the:
… recession of the late 1920s in the US became the Great Depression, owing to a combination of three factors: Overly tight monetary policy; overly cautious fiscal policy (especially under Franklin D Roosevelt in 1936 when tighter fiscal policy led to another sharp downturn in the US economy), and dramatic recourse to beggar-thy-neighbour policies, including competitive devaluations (as countries went off the gold standard in the 1930s) and increases in trade barriers worldwide. The impact of this global financial crisis has been significantly limited because on each of these scores, the policy mistakes of the past were strenuously and knowingly avoided.
First, it is true that monetary policy was eased (interest rates were cut fairly quickly). But the hangover remained. There was an on-going mis-trust of fiscal policy and an obsession that monetary policy was the main policy tool in town.
The hangover emanated from the ridiculous claim that “inflation targetting” had been a success (see this blog for more on that).
As a consequence, policy makers thought monetary policy could do more “salvage work” if unconventional means were used.
They also thought they had understood the Japanese recovery in the late 1990s as being due to “quantitative easing” even though the Japanese policy makers, themselves knew, that it was fiscal policy that restored some semblance of growth to their economy.
Notables such as Bernanke and Krugman and others have all made incorrect statements in the last 18 months about Japan as they did in the 1990s.
But, in this regard, and consistent with the fact that mainstream economics totally misunderstand the way banking operations work – the early policy emphasis was focused on “quantitative easing” with the result that trillions of different currency units around the world were substituted for other privately-held financial assets to “give the banks some money to enhance their lending capacity”.
This just created a massive build up of reserves (the so-called expansion of central bank balance sheets) and little gains were observed. Further, it led to arcane and falsely-constructed debates about whether these reserves would be inflationary and the fear campaigns mounted. Economists were involved in perpetuating these false statements which reflected their total ignorance of monetary operations.
The fact that banks don’t lend out reserves anyway seems to have escaped them. This operation had some benefits (may have reduced longer-maturity investment rates) but patently failed to stimulate lending. Why? Because the lack of lending had nothing to do with a lack of liquidity. Banks have been cautious in their lending because risk has risen and further there has been a dearth of credit-worthy customers (in their assessment) coming through their doors.
So the early reliance on massive monetary policy shifts – both conventional and “unconventional” – has not in my view been a glowing reference for the economics profession. See the blogs – Quantitative easing 101 – Building bank reserves will not expand credit – Building bank reserves is not inflationary – for more discussion on this point.
Second, it is clear that fiscal interventions then occured in significant proportions reversing the previous disdain for net spending as as vehicle for salvaging an aggregate demand failure. Much of the swings into deficit, however, reflected the automatic stabilisers built into fiscal settings and so no credit can be given to economists who may have been advising policy makers.
In fact, as the deficits rose a growing “squawk squad” of mainstream economists, started advocating for fiscal rules to be urgently installed that would have negated even the beneficial moderation provided by these automatic stabilisers. They also increasingly demanded “exit strategies” in total denial of the fact that with private demand so weak and fragile any move to withdraw the discretionary (and automatic) stimulus would have not only plunged the world into a double-dip recession but would have increased the deficits even more.
This “squawk squad” has largely intimidated governments everywhere into modifying their fiscal interventions to the point that they are not sufficient to fill the spending gap left by the private withdrawal. So we have seen a drawn out and unnecessarily damaging recession and now the signs of a very slow and tepid recovery.
All that could have been avoided with properly scaled fiscal interventions. So the economists in general haven’t anything in this regard to be proud of.
Yes, there was a lot of talk about John Maynard Keynes and he was quoted more in the last two years by commentators than in the previous 30 years. During the last 30 years any mention of “Keynesian” strategies would have been laughed out of town by the mainstream economists. I have now 30 years of personal professional experience as a testament to that!
Further while Subramanian correctly notes that governments provided “massive public demand for goods and services where private demand had collapsed under the weight of indebtedness and non-functioning credit markets”, he doesn’t seem to realise that the current debate among economists still fails to understand why that private debt grew so substantially.
There is very little recognition that the private sector was squeezed of liquidity by the moves to fiscal austerity by governments around the world. The only way the economies could continue growing (with the exception of those who enjoyed large net export surpluses) with government increasing their fiscal drag on spending was for the private sector to go increasingly into debt.
In that sense, all the claims now that governments need to get back into surplus as soon as they can denies the underlying accounting dynamics that link the government and non-government sectors. It is this ignorance by economists that will set the scene for the next crisis.
Subramanian also notes there has not been a wide-scale move to “beggar-thy-neighbour policies” although he also indicates that the “exception to this rule was the large-scale assistance to the financial and automobiles sectors especially in the US”.
He then notes that these monetary and fiscal responses were “were crafted across the globe … in emerging market economies and developing countries as much as in the industrial world”. In saying that he conveniently ignores the fact that in the vast majority of cases the IMF agreements imposed on low income countries during the recession were pro-cyclical and their made things worse. Please read my blog – IMF agreements pro-cyclical in low income countries – for more discussion on this point.
I agree generally that the large fiscal responses have stopped the world economy from collapsing into a decade-long Great Depression II. But the conduct of economists has been begrudging at best. The worst of them have just denied that the fiscal intervention was required. Many, like John B. Taylor in the US have argued it has made matters worse!
And the majority of the rest have begrudgingly become “Keynesians” for the time being because any other position would have made them look more ridiculous than they already were looking given their denial leading up to the crisis that anything was wrong. But they are all poised, on a daily basis, waiting for the time they can say these deficits are dangerous and need to be cut. Then they will swing back into text-book mode and they will deny deficits have an on-going role to play in allowing the economy to grow with private saving desires being achieved.
Then you will hear the mantra “budgets have to be balanced across the cycle” or “higher surpluses are need to pay back the debt more quickly”. Then you will appreciate the expression that the leopard cannot change its spots!
So now back to the chief economist of the Financial Times, Martin Wolf, who to repeat, said this in reaction to Subramanian positive judgement in favour of economists:
Moreover, these extraordinary interventions have not returned the patient to health. They have merely prevented him from dying. We now must heal five chronic conditions, instead of survive last year’s brutal heart attack..
I agree with Wolf’s assessment that “the patient has not returned to health”. That is very clear – there has not been a death but a hospital full of very sick patients remains.
So what is the way ahead? Wolf has five suggestions.
First, we have the ongoing force of the balance-sheet recession in the US, UK and a number of other significant high-income countries. It is overwhelmingly likely that the highly indebted parts of the private sectors of these countries will seek to lower their indebtedness and raise savings over an extended period.
I agree but probably not with the inference. There is no doubt that the private sectors in most countries are going to have to reduce their debt levels and that means they are going to have to learn to save again – which they clearly are (as a sector) if the latest national accounts being published by various nations is anything to go by.
But the important point which we will come to next is that this imposes a responsibility on the government sectors in these countries – and that folks – is to run continuous deficits of a sufficient magnitude to ensure that aggregate spending matches that required to maintain high levels of income and employment so that the private sector can save. Only where net exports are so strong will this rule be altered.
So this leads us to Wolf’s second areas that need healing:
Second, we have, quite rightly, substituted public sector borrowing for private sector borrowing, on an unprecedented scale, for peacetime. This can continue for some time, but not forever, as the US and UK come to look like Italy, but without Italy’s healthier private sector finances.
Now we are heading into confusion. You will first note that his first area of healing (reducing private debt) requires that governments run deficits and provide the income growth necessary to allow the private sector to save.
You will also understand that governments around the world unnecessarily burdon themselves with the constraint that they have to borrow (usually) $-for-$ from the private markets when they net spend. This practice is a hang-over from the gold standard days that are long gone.
There is no financial necessity for governments to do this at all. There are advantages to the non-government sector in doing so however. They get an interest-bearing and risk-free financial asset – a guaranteed annuity, which they can hold or use for other purposes (such as pricing more risky derivative assets). But the government gets nothing from the “borrowing”.
Indeed as I have already demonstrated several times – the government just “borrows” back the funds it injected into the economy via its net spending. As they say – its a wash. Please read my blog – On voluntary constraints that undermine public purpose – for more discussion on this point.
But, given they behave in this way, it follows that debt levels will always rise when net spending rises. But there is never any solvency risk in this which makes Wolf’s claim that “this can continue for some time, but not forever” just inapplicable. The fact is that the private sector could increase debt forever, service it at very low interest rates as long as there was a need to generate that much net spending.
The other fact is that the net spending growth should stop once the economy reaches full employment and the spending gap is closed. That is when the rise in deficits will reasonably stop. The reality is that they will be artificially pulled back by governments under pressure from the “squawk squad” of economists who give them advice or give advice to others, who politically pressure the governments, well before full employment is reached.
The other interesting point that tells me that Wolf doesn’t really understand the way the national accounts operate lies in his statement that the UK and US will “come to look like Italy, but without Italy’s healthier private sector finances”.
The higher deficits in Italy have allowed the private sector to have healthier finances by providing spending stimulus over time to generate income growth (and private saving). The fact he doesn’t tie the two together is very telling.
It also disqualifies him from quoting Keynes in some positive manner because one of the essential insights that Keynes provided was that saving was a function of income and income was a function of spending. And when private spending was deficient, public spending had to grow and fill the gap.
As an aside, I also think the US and UK would be better off “looking like” Italy, which is arguably, in the context of our earlier discussion, eminently more civilised than they are. After all, Italy is the home of Campagnolo! And yes, okay, there is more than beautiful bicycle components – there is the art and the literature and the joie de vive.
Wolf’s third healing suggestion is:
Third, despite modest – and, quite possibly, temporary – reductions, the US, UK, Spain and other erstwhile bubble economies continue to have large structural current account deficits, with substantial offsetting surpluses in China, Germany, Japan, the oil exporters and several other countries. Yet, so long as these external deficits continue, the countries concerned must be running ongoing financial deficits in either the public sector, or the private sector, or both. In other words, the domestic balance-sheet problem is likely to become not better, but worse, without global rebalancing.
Well the national accounting is correct. If the country is running a current account deficit then the sum of the private domestic balance and the government budget balance has to be in deficit.
The further point is that if you then want the private balance (net saving) to be in surplus then the government has to be deficit. If not the income adjustments will make sure this holds. The causality of how these balances are generated in not mechanical, however.
Presumably current account deficits reflect the voluntary decisions of mostly private agents (firms and households) which we would consider to refect their assessment of their best interest. Further, a current account deficit is a good thing for a country in material terms as I have noted previously – see this blog among others.
So then if you want the private sector to participate in a growing economy, enjoying the fact that some foreign economies want to accumulate financial assets in your own currency and are willing to net ship real goods and services to you to achieve that desire, and – you want the private sector not to accumulate large levels of indebtedness – then, quod erat demonstrandum – you have to be prepared for continuous government deficits.
To consider this situation to be a deterioration, as Wolf obviously does, is to fundamentally misunderstand the relationships between the sectors. A rising budget deficit does not – as a matter of definition – indicate a worsening situation.
In some cases, it might reflect a fall in private spending and a failure of governments to act so that the automatic stabilisers push the deficit up. That would not be a nice situation.
But in other situations where the government is pro-actively managing fiscal policy to maintain high levels of employment given the flux in private spending a rising deficit would indicate the exemplar of responsible and prudent fiscal management.
The real costs that we have to worry about are real losses in output and employment. We should never worry about the size of the budget deficit in isolation of those real concerns.
The case for global rebalancing is a different issue and I will write a separate blog on this another day. It is largely a beat-up. But that will address Wolf’s fourth point about China and its “addiction” to trade surpluses. Eventually the Chinese people will deal with that I suspect although it is sometime to go before they will have the capacity to do.
Wolf’s fifth area of healing is:
Finally, the financial system remains damaged. Not only does it still own vast quantities of the “toxic assets” its “talented” employees created, but the world is not addressing the structural causes of the crisis. In some ways, the oligopolistic banking system that has emerged from the crisis is riskier than the one that went into it.
I agree with this point. The US bailouts, in particular, have not provided the necessary leadership in financial reform. The evidence is that the US Governemtn on Wall Street is back to their old tricks when they should have been fundamentally forced to restructure.
But moreover, there is no sign (and none I have seen in Wolf’s writings) that there is a serious intent on actually changing the concept of a bank away from the speculative units they have become under lax neo-liberal period and back to being institutions which only exist to serve public purpose.
Please read the following blogs (among others) – https://billmitchell.org/blog/?p=5098″>Operational design arising from modern monetary theory – Asset bubbles and the conduct of banks – Breaking up the banks – where I deal with the reforms that would be necessary to restructure the financial system so that it only serves public purpose and promotes or engages in no other activity.
Wolf certainly has shown no leadership in his columns in this regard. As an aside, I have seen E-mail exchanges between Wolf and a financial markets professional (who understands MMT) and Wolf’s position is simply untenable.
Finally, let me provide my own quote from Keynes. In Chapter 24, in his concluding notes to his grand tome The General Theory of Employment, Interest and Money, he said:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back … Sooner or later, it is ideas, not vested interests, which are dangerous for good or evil.
This is why we have to keep advancing modern monetary understandings. For this body of literature consistently predicted the crisis and also provides you with an understanding of why we are recovering.
Saturday Quiz tomorrow
Yes, it has survived the advent of the New Year and the 2010 edition of the Quiz will be lethal! Modern monetary theory has to advance.
PS: Cultural note – Dear Americans, if you are uncertain about some of my jibes then assume I am mostly joking! best wishes, bill