A working site for research and writing on the thinkers who developed the system that works.

Sunday, October 25, 2009

A Demand Side Lineage - Draft

Demand Side economics may at first blush be seen as a counter to Supply Side economics, a Reagan era fad that served as pretext for trickle down policies.  But Demand Side has a longer and more noble lineage.  Arising from the theoretical work of John Maynard Keynes, the greatest economic mind of the past century, and from the pragmatic policies of the New Deal, Demand Side is a system that works and explains.

John Maynard Keynes and the Great Depression

The Great Depression, whatever its causes, was a contradiction to the free market capitalism as practiced in the United States and to its Classical apologists. The causes have been extensively debated, but the contradiction lies not in the advent, but in its lingering and worsening year after year. In Classical theory, a condition such as the Depression could not persist for any meaningful length of time. When the Depression did persist, the response by economists had to be either learning and adaptation or denial. There was no shortage of the latter in academia, but political reality propelled the former to the fore in the arena of public policy.

Keynes identified a paucity of effective demand as the cause of the prolonged slump. Economic activity was not returning to adequate levels because there was no impulse to draw it there. In classical theory, production itself always provided the means to purchase. This was codified in Say's Law, and adherence to it determined whether you were a legitimate economist or a crackpot. Keynes addressed his most stinging critiques to Say's Law and its totemistic Classical followers. There is no automatic stabilizing mechanism to the a market economy, he said.  This is the nut of Demand Side economics: It is the strength and direction of demand which organizes and energizes a society's economy. (This means effective demand, of course, not simply an intense desire or even need, but a demand with real money behind it.)

Leon Keyserling, the New Deal and the Postwar Prosperity

Deficit spending recommended itself as well to activist economists in Franklin Roosevelt's New Deal, but from concern for the unemployed, aged, disabled and impoverished. Programs to help these groups in the absence of an ability by the government to raise sufficient revenue created the deficit spending Keynes prescribed. During the dark years of the 1930s, however, the efforts of the Deal never reached a scale sufficient to banish all doubts or completely invigorate the economy. That scale was found in World War II.

The massive government action and mobilization of the economy required by the War washed the Depression away virtually overnight. Domestic living standards actually rose even as the society's treasure poured into munitions, war machinery, massive operations across the globe - in other words, into products and services that were entirely destructive or would eventually be destroyed. In spite of nonproductive, non-consumer goods being produced on a tremendous scale, the economy also produced more consumer goods for the people on the home front.

This ratified Keynesianism, and until the middle of the 1970s, public policy was guided by a Demand Side understanding. At the same time the United States was in a favored position industrially by virtue of the destruction of the competing industry of Europe and Japan. The two converged in a broad prosperity that had never before been seen.

One of the draftsmen of the New Deal and one of the architects of the full employment that followed the war was little-known economist Leon Keyserling.

John Kenneth Galbraith and the rise of the corporate state

As was Keynes, American economist John Kenneth Galbraith was active in public service and at the same time accomplished in theory and teaching. Canadian born, but raised at Harvard, Galbraith moved into the federal government at the outset of World War II, where he directed the Office of Price Administration and was literally controller of prices in the United States. This was the second most powerful civilian post in the management of the wartime economy. Effective programs for price control were essential to keep wartime shortages from turning into crippling inflation or spawning debilitating black markets. After the war, Galbraith led the post-mortem survey and analysis of the European Theater. Under John F. Kennedy he served as ambassador to India. Often described as a maverick, Galbraith simply examined the affluence and institutional changes that were forming without the self-congratulation for the good times that followed the war. The conceit of Americans was by no means confined to economists, but the prosperity that occasioned it was based less on the imagined American virtues than on the advantage of having an infrastructure intact and an industrial capacity left undamaged by the war.

Galbraith described the rise of the corporation to dominance, the rise of government as a primary component of and actor in the economy, and the immense explosion of material prosperity that followed the War. Galbraith's writings explored a need for institutional counterweights to the Corporate Oligarchy - unions, governmental oversight, regulations, and social insurance. His foundational New Industrial State defined the part of the economy dominated by the large corporations as the Industrial System. This was the chief trait of the new industrial state. While previously corporations had rule industries where scale of operations required bigness, Galbraith saw that they had moved into other parts of the economy as well. This pervasiveness is even more apparent today than when Galbraith wrote in 1967. The New Industrial State dissected the Corporate Oligarchy, the technical reasons for its arising, the group think which he called the Technostructure, its goals, how it determined prices and controlled markets, and its ever more involved relationship with the state.

The direct look Galbraith took at the American scene contrasted starkly with the approach taken by the Conservative economic schools (Monetarist, Neoclassical, Neoliberal, Supply Side schools). These began and ended with neat and simple theory and assumed away inconvenient reality, ignoring the power and even the presence of the Corporate Oligarchy. The resulting world did not exist, but at least it was marked by healthy free competition. The popularity of these schools derived from their political convenience, to their appeal to a resurgent conservative bloc (particularly after the Vietnam War) and to eager sponsorship from the very corporations whose power they failed to acknowledge.

Hyman Minsky and the Rise of Economic Instability

Joseph Stiglitz and Globalization

Not only did the poor get poorer in the United States (in inflation-adjusted, or "real," terms) beginning in the late 1970s, but also around the globe, particularly in Africa and Latin America. Some Asian economies did begin to develop, but others struggled. Remarkable successes have been scored by China, Japan, South Korea, and others. Tragedies have occurred in Africa and Latin America. It was no coincidence that the economic troubles of these countries followed their adoption of the charts of the free marketeers. The conservative thinking that had failed so well within the United States failed even better in these countries. Those under the sponsorship of the dominant corporations fell extremely hard. This international situation has been the context for the work of Joseph E. Stiglitz on Globalization.

Stiglitz was awarded the Nobel Prize in Economics in 2001 for work which demonstrated the shortcomings of the hypothesis of free market efficiency in the absence of perfect information. Like Keynes and Galbraith, Stiglitz contributed significantly in public life. He served as chief economist in the administration of Bill Clinton and later as senior vice president and chief economist to the World Bank. Two of his books Globalization and Its Discontents and Making Globalization Work describe the causes and conditions of a world economy in stress and unable to meet the desperate need of billions of its people.

James K. Galbraith and the Predator State

George Soros and the New Paradigm for Markets

The work of these giants of the theory and practice of economics - Keynes, Keyserling, Galbraith the elder,  Minsky, Stiglitz, Galbraith the younger and Soros - informs the Demand Side economics that worked before and can work again.  Unlike Neoclassical and other schools, Demand Side has developed with the society it seeks to explain.  Each of these men, Minsky aside, held highly responsible positions in government or the private sector, and each contributed substantially to the advancement of understanding in the discipline of economics.

Thursday, July 9, 2009

George Soros in the series of those who got it right 10.19.09

Today we look at George Soros, the billionaire investor and philanthropist, who has a view of ever expanding bubbles.  Soros is notable for being rich, yet advocating normalization and structure to financial markets.

I am sometimes -- not so much recently -- asked, "If you're so smart, why aren't you rich."  I point to -- or pointed to -- Soros, replying, "He's rich, why don't you listen to him?"

Soros is famous for purportedly breaking the British Pound for his own enrichment, which earned him opprobrium from both sides along the lines of, "If you're so concerned with social welfare, Mr. Soros, Why did you do such a thing?"  Converted to an assertive statement, it might be, "It's all right to profit if you're greedy, but not if you have concern for others."

Let's begin from Soros most recent book, The New Paradigm for Financial Markets:  The Credit Crisis of 2008 and What It Means."


"... The central idea in my conceptual framework [is] that social events have a different structure from natural phenomena.  In natural phenomena there is a causal chain that links one set of facts directly with the next.  In human affairs the course of events is more complicated.  Not only facts are involved, but also the participants views and the interplay between them enter into the causal chain.  There is a two-way connection between the facts and opinions prevailing at any moment in time:  on the one hand participants seek to understand the situation (which includes both facts and opinions); on the other, they seek to influence the situation (which again includes both facts and opinions).  The interplay between the cognitive and manipulative functions intrudes into the causal chain so that the chain does not lead directly from one set of facts to the next, but reflects and affects the participants' views.  Since those views do not correspond to the facts, they introduce an element of uncertainty into the course of events that is absent from natural phenomena.  That element of uncertainty affects both the facts and the participants' views.  Natural phenomena are not necessarily determined by scientific laws of universal validity, but social events are liable to be less so."

It certainly is necessary to address this question of the difference between economics and a natural science.

Robert Skidelsky, Keynes most famous biographer, pointed out that if economics were a natural science it likely would have responded to the mathematical tools employed so enthusiastically on its behalf to produce some significant progress.  Unlike physics or biology, it has not.  Skidelsky notes we are having the same arguments today as were had in the 1930s.  The exact same, down to the level of vitriol between the parties.  He refers to Krugman v. the Chicago School.  Look for that Skidelsky interview on Bloomberg on the Economy with Tom Keene last week.

Here in Soros we see one explanation for the resistance (near complete resistance in the Demand Side view) of economics to the mechanical tools valid for the natural sciences.  Soros calls it reflexivity.

"I explain the element of uncertainty inherent in social events by relying on the correspondence theory of truth and the concept of reflexivity....

Knowledge is represented by true statements.  A statement is true if and only if it corresponds to the facts.  That is what the correspondence theory of truth  tells us.  To establish a correspondence, the facts and the statements which refer to them must be independent of each other.  It is this requirement that cannot be fulfilled when we are part of the world we seek to understand."


Demand Side has repeatedly referred to no independent variables within the mathematics, no closed system, hence no fulcrum from which to lever the hypothetical world.  If all variables in the model are dependent upon each other, and indeed can morph into each other, there is no causal chain that mathematics can produce.  It becomes radically dependent on its assumptions.

Soros is talking in a different sphere, although he describes a similar recognition he had in his early years at the London School of Economics, where assumptions were allowed in economic theory to:

"produce universally valid generalizations that were comparable to those of Isaac Newton in physics."

As economics was forced to abandon one assumption, it replaced with others until,

"The assumptions became increasingly convoluted and gave rise to an imaginary world that reflected only some aspects of reality, but not others.  That was the world of mathematical models describing a putative market equilibrium.  I was more interested in the real world than in mathematical models, and that is what led me to develop the concept of reflexivity."


"I contend that rational expectations theory totally misinterprets how financial markets operate.  Although rational expectations theory is no longer taken seriously outside academic circles, the idea that financial markets are self-correcting and tend toward equilibrium remains the prevailing paradigm on which the various synthetic instruments and valuation models which have come to play such a dominant role in financial markets are based.  I contend that the prevailing paradigm is false and urgently needs to be replaced.

"The fact is that participants cannot base their decisions on knowledge.  The two-way, reflexive connection between the cognitive and manipulative functions introduces an element of uncertainty or indeterminacy into both functions.  That applies both to market participants and to the financial authorities who are in charge of macroeconomic policy and are supposed to supervise and regulate markets.  The members of both groups act on the basis of an imperfect understanding of the situation in which they participate.  The element of uncertainty inherent in the two-way reflexive connection ... cannot e eliminated, but our understanding, and our ability to cope with the situation, would be greatly improved if we recognized this fact."

Soros by his own admission desperately wants to be taken seriously as a philosopher.  He should be.  His conceptual framework brings forward the problem of understanding the world in which we exist by way of concepts that are necessarily symbols or shortcuts to reducing the mass of phenomena to a manipulable scale.  I would say that the exercise leaves us relating to something that is really our own projection.

Graduating from LSE with grades too poor to gain him entry into Academia, he finally hooked on as an arbitrage trader.  Soros interest in reflexivity and fallibility equipped him to handle the states of nonequilibrium, boom and bust, well enough to make one fortune after another.

And indeed, markets proved to be the perfect application of reflexivity, as market players create boom and bust by their participation, not their comprehension.  Perception created reality, a reality that folded back on non-market participants in often harmful ways.

Thinking about thinking and conceptual frameworks which try to define concepts are inherently subject to contradiction.  So when Soros assumes an objective aspect of reality, it may become more useful, but less accurate, just as his theory predicts.  Everyday events are predictable and reflexive processes are not, he says.  But it would seem that reflexivity can provide momentum in stability as well as instability. 

We'll leave Soros here, well short of full development, with the note that his assessments of markets and economic dynamics when he is making his calls is often simple and often intuitive, but what he does show in his practical looks adheres broadly to demand side functionalities.

We also note for the benefit of those who have complete confidence in their economic schemes, but view forecasts as a crap shoot, that Soros passes on the observation from Popper,

"Predictions and explanations are symmetrical and reversible."

Monday, June 29, 2009

James K. Galbraith - Links

U Texas faculty site
Toward a New Pragmatism
Minsky Conference speech 3/09
James K. Galbraith website
Interview with Bill Moyers (and transcript)
in the New York Times
Harper's 2008 Six Questions
Google books citations
Complete Links

James K. Galbraith in the series of those who got it right

In our series looking for the perspective of those who got it right, we turn to James K. Galbraith, son of the great economist John Kenneth Galbraith and apparently invisible to those who say nobody saw it coming.

We've promoted Galbraith's book the Predator State ad nauseum here on the podcast. Let's review a few of the anti-orthodox principles that organize that book.

One, and quoting:

Because markets cannot and do not think ahead, the United States needs a capacity to plan. To build such a capacity, we must, first of all, overcome our taboo against planning. Planning is inherently imperfect, but in the absence of planning, disaster is certain.

Two, and continuing to quote:

The setting of wages and control of the distribution of pay and incomes is a social, and not a market, decision. It is not the case that technology dictates what people are worth and should be paid. Rather, society decides what the distribution of pay should be, and the technology adjusts to that configuration. Standards -- for pay but also for product and occupational safety and for the environment -- are a device whereby society fashions technology to its needs. And more egalitarian standards -- those that lead to a more just society -- also promote the most rapid and effective forms of technological change, so that there is no trade-off, in a properly designed economic policy, between efficiency and fairness.

And three, with a final quote:

At this juncture in history, the United States needs to come to grips with its position in the global economy and prepare for the day when the unlimited privilege of issuing never-to-be-paid chits to the rest of the world may come to an end. We should not hasten that day. In fact, if possible, we should delay it. We should take reasonable steps to try to keep the current system intact. But given the rot in the system, we should also be prepared for a crisis that could come up very fast. The fate of the country, and indeed the security and prosperity of the entire world, could depend on whether we are able to deal with such a crisis once it starts.

Galbraith traces the fall of conservativism from the Reagan Revolution into the more or less overt plundering of the society by the politically well-positioned oligarchs of Big Oil, Big Pharma, Insurance, Finance, Agriculture and Media.

Galbraith in 1981 as a young director of the Congressional Goint Economic Committee organized what he called "a largely futile frontline resistance to Reaganomics." The vapid combination of Supply Side pap and Milton Friedman Monetarism resulted in immediate large deficits and the beginning of hte deindustrialization of America. (Whatever might be contested about the causes of the events, the timing is not debatable.) Earlier Galbraith drafted the Humphrey-Hawkins bill, which generated the dual mandate for the Fed, and other mechanisms that focused on full employment.

The bill was created by Representative Augustus Hawkins and Senator Hubert Humphrey and signed into law in 1978. Its full title is the Full Employment and Balanced Growth Act. As written it was a worthy successor to the most important piece of economics legislation, the Full Employment Act of 1946. As implemented, it has been a way to get the Fed Chairman before Congress a couple of times a year, but otherwise has been limited to creative footnotes. Lip service is a strong description.

In particular, the Act requires the President to set numerical goals for the economy of the next fiscal year in the Economic Report of the President and to suggest policies that will achieve these goals and requires the Chairman of the Federal Reserve to connect the monetary policy with the Presidential economic policy.

The Act sets specific numerical goals for the President to attain. By 1983, unemployment rates should be not more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over, and inflation rates should not be over 4%. The Act allows Congress to revise these goals as time progresses. If private enterprise is lacking in power to achieve these goals, the Act expressly allows the government to create a "reservoir of public employment." These jobs are required to be in the lower ranges of skill and pay so as to not draw the workforce away from the private sector.

Coordination between fiscal policy and economic policy has not occurred, of course, and it was actually one of the accomplishments of the Reagan Revolution to drive them as far apart as they have become. Unemployment rates of 3 and 4 percent are now considered the stuff of fantasy. A public employment program?

The Reagan Revolution, whatever its tenets, resulted not in principled conservativism, but in a corporate takeover of the state, as Galbraith has described in his book. By the way, this digression on Galbraith's early work is not from the book, but our contribution with an assist from Wikipedia.

The American economic model in Galbraith's view, is not the free rein to the markets and public be damned approach of Reagan and Bush, but is the structure created by the New Deal. The institutions, Galbraith writes, "are neither purely private nor wholly public. They are not like the socialist welfare institutions of Europe, but neither are they private enterprise."

Some are supported by state spending -- entitlements, but also bank credit, credit guaranetees, and implicit guarantees, and -- Galbraith is writing prior to the massive bailouts when he says -- quote --- the expectation of rescue in the event of trouble. Mortgages, health, agriculture, and the military are some of the other areas receiving massive public subsidies.

And Galbraith is also adamant about the need for standards, which rises from the delusion that markets will produce a competitive market price. Quoting

"As economic theorists know, the real world is necessarily devoid of any such thing [as a competitive market price]. If there is one administered, or controlled, or monopolistic price in the system -- an oil price or an interest rate -- then even if all the other markets are perfectly competitive, all of them will be "distorted" by the presence of that one monopolistic price ...


The fact is that monopoly and market power are not only pervasive, they are at the center of economic life. The very purpose of a new technology is, of course, to create a monopoly where none previously existed.



That being so, prices and wages would serve a quite different function in the real world than the market model assigns to them. Instead of being set so as to maximize efficiency in production, they are set essentially by social relations between groups of workers and by the pattern of prices that are explicitly controlled. They express, in other words, the preixisting matrix ...

... Seen in this light, deregulation of wages and prices ... is nothing more than a rearrangement of social power relations. And the consequences have little or nothing to do with the efficiency whereby a good or service is produced...

p. 179-180

Tuesday, June 9, 2009

James K. Galbraith - What! Respect among political differences? Bruce Bartlett and James K. Galbraith 10.19.09

Here James K. Galbraith welcomes Bruce Bartlett into the fold.  This may be overstating the situation.  But it's nice that progressives (and nobody is more progressive than James K.) and conservatives (and nobody is more principled in conservativism than Bruce) can talk without throwing bricks.  Here, from Bartlett's blog.
Galbraith on Bartlett
Last night James K. Galbraith hosted a forum on the firedoglake website about my new book. Jamie is now a professor of economics at the University of Texas at Austin, but back in the early 1980s he and I alternated as executive directors of the Joint Economic Committee of Congress. Following is Jamie's introduction to the forum. BB

In January 1981, Bruce Bartlett and I took over direction of the staff of the Joint Economic Committee -- he on the Republican and I on the Democratic side.  Our situation was unique: a bicameral committee, evenly divided between Democrats and Republicans, no majority either way.  This, at the start of the Reagan revolution, which he favored and I opposed.

Bruce was a resolute supply-sider, having drafted the Kemp-Roth tax cuts. I was a resolute Keynesian, who had helped draft the Humphrey-Hawkins Full Employment Act. His specialty was taxation, mine was monetary policy. We were both twenty-nine years old.

Stalemate would have been possible but we took a different path, creating flexible subcommittees and turning the JEC into an open forum on every economic issue. The result was an exceptionally productive two years, and an enduring friendship - though we agreed on nothing then and not all that much even now.

Bruce's views are, in my view, romantic: he is (or was, until this book) a small-government conservative and a fiscal hawk. But he thinks deeply and writes honestly -- something that is not easy to do without tenure.  For his apostasy in the matter of George W. Bush, some years back, Bruce paid with his job.

It would appear however that apostasy is an acquired taste. In The New American Economy Bruce ladles it out with gusto, and with a message that should cause an entire generation of the American Right true heartburn. The message?  That John Maynard Keynes was really one of their own.

John Maynard Keynes?  The John Maynard Keynes?   How can this possibly be?

Bruce's dark secret, here exposed, is that he is primarily a historian. He has a keen interest in the musty words of thinkers from a past day, and he actually goes off to read them. A good part of The New American Economy concerns itself with the old American economy -- the economy that collapsed in the Depression and that was revived-or, more accurately, rebuilt-in the New Deal.

Though English, Keynes was central to the ferment of New Deal ideas. Bruce here admirably introduces him as, among other things, the greatest enemy communism had in those years.   Why?  Because Keynes understood that if capitalism were not saved, revolution would result -- and because he felt that revolution would be worse.  Drastic measures were therefore justified, whatever the business leaders of the day thought. As Bruce notes, this assessment agrees with one made decades back by my father [John Kenneth Galbraith], who characterized FDR's motives in similar terms.

Bruce takes up JKG on another point, his 1965 testimony to the Joint Economic Committee on the tax cut bill of the previous year, which my father had opposed.  "There was a danger," he said, "that conservatives, once introduced to the delights of tax reduction, would like it too much.  Tax reduction would then become a substitute for increased outlays on urgent social needs.  We would then have a new and reactionary form of Keynesianism with which to contend."

And so it happened.  The Reagan period takes up much of this book.  It  is interesting in large part because of the wars that broke out between conservatives once the postwar American Keynesian liberals had been swept out of the way.  Much of this is highly arcane, and to understand it, it helps to have been there, as monetarists, supply-siders, fiscal conservatives, free-marketeers and pro-business corporatists battled it out.

Bruce is a first-hand witness, and quite a good one -- though not disinterested. In particular he makes a persuasive case (to me) that the leading supply-siders were not charlatans. They were, rather, for the most part idealists, who took their cues from what was then reputable thought in mainstream economics.  (This, of course, raises a question as to whether the mainstream economists were charlatans, but let's leave that one alone here.)

Still, there was an interesting practical convergence between supply-side and Keynesian perspectives. In public the supply-siders reviled the "discredited Keynesians," and insisted that their tax cuts were all about "incentives to work save and invest."  But in private even Reagan's own top economic adviser, Murray Weidenbaum, admitted in 1981 that the tax cuts would provide a powerful economic stimulus, Keynes-style, once the recession was past and the president was gearing up for re-election.

Given that the (Galbraithian) alternative of public investment and a stronger welfare state was not a political possibility, the choice then was between a tax cut-fueled boom and prolonged stagnation. One can argue -- I do argue -- that by reconciling Keynes with the interests of the rich, the supply-siders made the country more prosperous than it would otherwise have been.  They also kept the Republican Party in business. It is true therefore that Reagan's tax cuts replicated Kennedy's success in 1964.

When Bruce turns his eye to the present crisis, he confronts a Republican Party in a near-vegetative state, able at best to blink and mutter "tax cut" in the face of any and all problems. He suggests, sensibly, that the lesson of the debacle of Bush's Social Security privatization scheme be accepted: the welfare state is here to stay. He argues (again as my father once did) in favor of a Value-Added Tax to provide a stable, admittedly regressive, pro-saving funding source. Thus Bruce Bartlett becomes an advocate of the European-style tax-and-welfare state!

Here, we again part company on the merits.  For Bruce, our key economic problem going forward is an insufficiency of saving and the supposed burden of public debt.  For me, it's a lack of investment, and of jobs, brought on by the debacle of private debt and a disastrously deregulated and corrupted financial sector.  I'm not a fan of the European solution -- among other things it leaves savings idle, unemployment high and education (in particular) underfunded.  I like the progressive income tax and even more the estate tax, which spur philanthropy and fuel our vast non-profit sector. I think Social Security is the best part of the American welfare state -- and one of the most successful public pension programs in the world.

Back to the trenches, Bruce?

Note: I wouldn't say that I have become an advocate of a European-style welfare state; I've simply resigned myself to its inevitability. If we are going to have one then I think it should be properly financed. BB

Saturday, May 30, 2009

Saturday, May 9, 2009

Joseph Stiglitz on the question of incentives 10.21.09

In this piece, Stiglitz contrasts the career of Norman Borlaug to that of the nameless Wall Street bankers, and wonders whether some noble people are corrupted by the immense money to be made in finance. The question goes beyond this, as must be plain by now. The incentives themselves were corrupting, not only of the people, but they suborned criminal and near criminal unconsciousness of the public's welfare. You don't get rich by doing the right thing on Wall Street. Of course, many have clothed themselves in the invisible hand, a myth to which even Stiglitz gives too much credit.. It is less than a fig leaf. Here is Stiglitz.
Borlaug and the Bankers
Joseph E. Stiglitz
Project Syndicate
October 20, 2009

NEW YORK – The recent death of Norman Borlaug provides an opportune moment to reflect on basic values and on our economic system. Borlaug received the Nobel Peace Prize for his work in bringing about the “green revolution,” which saved hundreds of millions from hunger and changed the global economic landscape.

Before Borlaug, the world faced the threat of a Malthusian nightmare: growing populations in the developing world and insufficient food supplies. Consider the trauma a country like India might have suffered if its population of a half-billion had remained barely fed as it doubled. Before the green revolution, Nobel Prize-winning economist Gunnar Myrdal predicted a bleak future for an Asia mired in poverty. Instead, Asia has become an economic powerhouse.

Likewise, Africa’s welcome new determination to fight the war on hunger should serve as a living testament to Borlaug. The fact that the green revolution never came to the world’s poorest continent, where agricultural productivity is just one-third the level in Asia, suggests that there is ample room for improvement.

The green revolution may, of course, prove to be only a temporary respite. Soaring food prices before the global financial crisis provided a warning, as does the slowing rate of growth of agricultural productivity. India’s agriculture sector, for example, has fallen behind the rest of its dynamic economy, living on borrowed time, as levels of ground water, on which much of the country depends, fall precipitously.

But Borlaug’s death at 95 also is a reminder of how skewed our system of values has become. When Borlaug received news of the award, at four in the morning, he was already toiling in the Mexican fields, in his never-ending quest to improve agricultural productivity. He did it not for some huge financial compensation, but out of conviction and a passion for his work.

What a contrast between Borlaug and the Wall Street financial wizards that brought the world to the brink of ruin. They argued that they had to be richly compensated in order to be motivated. Without any other compass, the incentive structures they adopted did motivate them – not to introduce new products to improve ordinary people’ lives or to help them manage the risks they faced, but to put the global economy at risk by engaging in short-sighted and greedy behavior. Their innovations focused on circumventing accounting and financial regulations designed to ensure transparency, efficiency, and stability, and to prevent the exploitation of the less informed.

There is also a deeper point in this contrast: our societies tolerate inequalities because they are viewed to be socially useful; it is the price we pay for having incentives that motivate people to act in ways that promote societal well-being. Neoclassical economic theory, which has dominated in the West for a century, holds that each individual’s compensation reflects his marginal social contribution – what he adds to society. By doing well, it is argued, people do good.

But Borlaug and our bankers refute that theory. If neoclassical theory were correct, Borlaug would have been among the wealthiest men in the world, while our bankers would have been lining up at soup kitchens.

Of course, there is a grain of truth in neoclassical theory; if there weren’t, it probably wouldn’t have survived as long as it has (though bad ideas often survive in economics remarkably well). Nevertheless, the simplistic economics of the eighteenth and nineteenth centuries, when neoclassical theories arose, are wholly unsuited to twenty-first-century economies. In large corporations, it is often difficult to ascertain the contribution of any individual. Such corporations are rife with “agency” problems: while decision-makers (CEO’s) are supposed to act on behalf of their shareholders, they have enormous discretion to advance their own interests – and they often do.

Bank officers may have walked away with hundreds of millions of dollars, but everyone else in our society – shareholders, bondholders, taxpayers, homeowners, workers – suffered. Their investors are too often pension funds, which also face an agency problem, because their executives make decisions on behalf of others. In such a world, private and social interests often diverge, as we have seen so dramatically in this crisis.

Does anyone really believe that America’s bank officers suddenly became so much more productive, relative to everyone else in society, that they deserve the huge compensation increases they have received in recent years? Does anyone really believe that America’s CEO’s are that much more productive than those in other countries, where compensation is more modest?

Worse, in America stock options became a preferred form of compensation – often worth more than an executive’s base pay. Stock options reward executives generously even when shares rise because of a price bubble – and even when comparable firms’ shares are performing better. Not surprisingly, stock options create strong incentives for short-sighted and excessively risky behavior, as well as for “creative accounting,” which executives throughout the economy perfected with off-balance-sheet shenanigans.

The skewed incentives distorted our economy and our society. We confused means with ends. Our bloated financial sector grew to the point that in the United States it accounted for more than 40% of corporate profits.

But the worst effects were on our human capital, our most precious resource. Absurdly generous compensation in the financial sector induced some of our best minds to go into banking. Who knows how many Borlaugs there might have been among those enticed by the riches of Wall Street and the City of London? If we lost even one, our world was made immeasurably poorer.

Joseph Stiglitz - Thanks to the Deficit, the Buck Stops Here - 08.29.09

Stiglitz: Thanks to the Deficit, the Buck Stops Here

Joseph Stiglitz repeats a warning that he and others have made in the past that, like it or not, the dollar's days as a reserve currency are numbered. Thus, instead of resisting this change -- as we have -- "it's better for us to participate in the construction of a new system than have it happen without us":
Thanks to the Deficit, the Buck Stops Here, by Joseph E. Stiglitz, Commentary, Washington Post: Beware of deficit fetishism. Last week we learned that the national debt is likely to grow by more than $9 billion. That's not great news -- no one likes a big deficit -- but President Obama inherited an economic mess from the Bush administration, and the cleanup comes with an inevitably high price tag. We're paying it now. ...
There are ... consequences, however, that we're missing in the debate over all this red ink. Our budget deficit, as well as the Federal Reserve's ballooning lending programs and other financial obligations, will accelerate a process already well underway -- a changing role for the U.S. dollar in the global economy.
The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback's role as a reliable store of value around the world. ...
Anxieties about future inflation can lead to a weaker dollar today. So, are these anxieties justifiable? ... The worries are justified, even though Fed Chairman Ben Bernanke ... assures us that he will deftly manage monetary policy... This is a tough balancing act... Anyone looking at the Fed's record in recent years will be skeptical of its forecasting skills and its ability to get the balance right.
In addition, international markets understand that the United States may face strong incentives to reduce the real value of its debts through inflation...
Like it or not, out of the ashes of this debacle a new and more stable global reserve system is likely to emerge, and for the world as a whole, as well as for the United States, this would be a good thing. It would lead to a more stable worldwide financial system and stronger global economic growth. ... Discussions on the design of the new system are already underway. ...
The United States has resisted these changes, but they will come regardless, and it's better for us to participate in the construction of a new system than have it happen without us. The United States has seen great advantages with the dollar as the world's reserve currency..., particularly the ability to borrow at low interest rates seemingly without limit. But we haven't seen the costs as clearly: the inevitable trade deficits, the instability, the weaker global economy. The benefits to us are likely to shrink, and rapidly so, as countries shift their holdings away from the dollar. ...
America should show leadership in helping shape this new structure and managing the transition, rather than burying its head in the sand. We may have preferred to keep the old system, in which the dollar reigned supreme, but that's no longer an option.

Joseph Stiglitz - Stimulate or Die - 08.15.09

 Stimulate or Die
Joseph E. Stiglitz

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NEW YORK – As the green shoots of economic recovery that many people spied this spring have turned brown, questions are being raised as to whether the policy of jump-starting the economy through a massive fiscal stimulus has failed. Has Keynesian economics been proven wrong now that it has been put to the test?

That question, however, would make sense only if Keynesian economics had really been tried. Indeed, what is needed now is another dose of fiscal stimulus. If that does not happen, we can look forward to an even longer period in which the economy operates below capacity, with high unemployment.

The Obama administration seems surprised and disappointed with high and rising joblessness. It should not be. All of this was predictable. The true measure of the success of the stimulus is not the actual level of unemployment, but what unemployment would have been without the stimulus. The Obama administration was always clear that it would create some three million jobs more than what would otherwise be the case. The problem is that the shock to the economy from the financial crisis was so bad that even Obama’s seemingly huge fiscal stimulus has not been enough.

But there is another problem: In the United States, only about a quarter of the almost $800 billion stimulus was designed to be spent this year, and getting it spent even on “shovel ready” projects has been slow going. Meanwhile, US states have been faced with massive revenue shortfalls, exceeding $200 billion. Most face constitutional requirements to run balanced budgets, which means that such states are now either raising taxes or cutting expenditures –a negative stimulus that offsets at least some of the Federal government’s positive stimulus.

At the same time, almost one-third of the stimulus was devoted to tax cuts, which Keynesian economics correctly predicted would be relatively ineffective. Households, burdened with debt while their retirement savings wither and job prospects remain dim, have spent only a fraction of the tax cuts.

In the US and elsewhere, much attention was focused on fixing the banking system. This may be necessary to restore robust growth, but it is not sufficient. Banks will not lend if the economy is in the doldrums, and American households will be particularly reluctant to borrow – at least in the profligate ways they borrowed prior to the crisis. The almighty American consumer was the engine of global growth, but it will most likely continue to sputter even after the banks are repaired. In the interim, some form of government stimulus will be required.

Some worry about America’s increasing national debt. But if a new stimulus is well designed, with much of the money spent on assets, the fiscal position and future growth can actually be made stronger.

It is a mistake to look only at a country’s liabilities, and ignore its assets. Of course, that is an argument against badly designed bank bailouts, like the one in America, which has cost US taxpayer hundreds of billions of dollars, much of it never to be recovered. The national debt has increased, with no offsetting asset placed on the government’s balance sheet. But one should not confuse corporate welfare with a Keynesian stimulus.

A few (not many) worry that this bout of government spending will result in inflation. But the more immediate problem remains deflation, given high unemployment and excess capacity. If the economy recovers more robustly than I anticipate, spending can be canceled. Better yet, if much of the next round of stimulus is devoted to automatic stabilizers – such as compensating for the shortfall in state revenues – then if the economy does recover, the spending will not occur. There is little downside risk.

Nevertheless, there is some concern that growing inflationary expectations might result in rising long-term interest rates, offsetting the benefits of the stimulus. Here, monetary authorities must be vigilant, and continue their “non-standard” interventions – managing both short-term and long-term interest rates.

All policies entail risk. Not preparing for a second stimulus now risks a weaker economy – and the money not being there when it is needed. Stimulating an economy takes time, as the Obama administration’s difficulties in spending what it has allocated show; the full effect of these efforts may take a half-year or more to be felt.

A weaker economy means more bankruptcies and home foreclosures and higher unemployment. Even putting aside the human suffering, this means, in turn, more problems for the financial system. And, as we have seen, a weaker financial system means a weaker economy, and possibly the need for more emergency money to save it from another catastrophe. If we try to save money now, we risk spending much more later.

The Obama administration erred in asking for too small a stimulus, especially after making political compromises that caused it to be less effective than it could have been.  It made another mistake in designing a bank bailout that gave too much money with too few restrictions on too favorable terms to those who caused the economic mess in the first place – a policy that has dampened taxpayers’ appetite for more spending.

But that is politics. The economics is clear: the world needs all the advanced industrial countries to commit to another big round of real stimulus spending. This should be one of the central themes of the next G-20 meeting in Pittsburgh.

Thursday, April 30, 2009

Thursday, April 9, 2009

Hyman Minsky 03.20

And we go back to the algebra derived from Michal Kelecki's most simple assumption -- that workers consume all their income -- and see how Minsky develops it.  Of course the assumption is not completely true, but it is not fatal to the analysis when it deviates the way, for example, the assumption of Neoclassical economics that all firms are price takers or the assumptions of rational expectations that market participants, indeed all economic actors, are imbued with economic omniscience.

Kalecki showed that when his assumption was allowed and in an economy with small government and little trade, investment equals profits, or profits equal investment.

By nothing more controversial than simple algebra, Minsky then demonstrated first that price is positively related to the wage rate and to the ratio of investment goods to consumption goods production, and negatively related to labor productivity.  We went over that a couple of weeks ago, when we then digressed on the inappropriately prominent place the quantity theory of money has in the primitive orthodoxy that rules economics today.

But let's consider what Minsky's relationships mean.  It's a no-brainer that prices vary in the opposite direction as productivity, because, productivity simply means producing more with the same labor.  We at Demand Side recently demonstrated that productivity also goes up when the unemployment rate goes down.  (I was so excited.)  And since wages and unemployment also vary inversely, there is some amelioration of the labor cost impact on price, that is, on inflation.  Put simply, prices do not rise in proportion to wages in periods of falling unemployment.  This is, of course, opposite to the information derived from the famous Phillips Curve.

But the second part of this finding is very instructive.  The algebra shows what we might also derive from common sense.  As investment goods are emphasized over consumer goods, the price of consumer goods tends to rise, because, basically, workers in both sectors are bidding for the output of the consumer goods sector.  So when the ratio favors investment goods more, demand for consumer goods is higher and output is lower.

But the implications are not all so common-sensical.  The Kalecki demonstration that profits equal investment combines with this revelation that as new investment goes up, so do prices, to produce a condition in which higher prices, higher investment and higher profits coexist.  Since investment also connects positively with output and income, we can expect these two -- output and income -- to be in the same virtuous soup.

This indeed was a somewhat surprising empirical finding of our research on economic performance by president.  We found that in the postwar period employment is higher, unemployment lower, investment higher, corporate profits higher and GDP growth better when a Democrat is in the White House.  It surprised us somewhat that with all the effort by Republicans to push companies into profitability, some would say at the expense of others, that  is, the whole supply side idea, that they were not able to accomplish profits better than Democrats.  The Kalecki-Minsky analysis demonstrates why it has to be.  You can find it on pages 140 and following in Stabilizing an Unstable Economy

Prices, Minsky says, carry profits, the raison d'etre for investment.  In my micro courses we had fixed costs and variable costs and average costs.  Prices were determined by marginal costs and where the marginal cost curve intersected the demand curve.  This may be true, Minsky says, for price takers.  But a whole great swath of the economy, by far its major part, is composed of firms which more or less set prices and vary output according to demand.

These firms operate on the basis of a set of nesting average cost curves, the highest of which includes capital asset validation cost, or profits in the normal use of the word.  Such firms keep prices at the requisite level when demand falls by their market power, pricing power.  Without this ability to constrain price movements, they may not be able to employ expensive and highly specialized capital assets and large-scale debt financing, Minsky observes.

We include that mention here not because we expect you to get it, the nesting average cost curves and so on, but just to let you know it is there in Minsky, as it is in the real world, and it informs what follows.

Returning to the propositions derived from the insights of Kelecki.  Minsky expanded these by introducing big government and trade and workers who save.  Elegant and simple algebra yields some remarkable insights.

Note here and we'll explain more in a minute that Minsky's profit is not the same profit with which we are familiar, nor that which we measured in our comparisons of economic performance by president. 

Nevertheless, when government and taxes and deficits are introduced, something remarkable appears.  It can be shown that after-tax profits equal investment plus the government deficit.  When there is no investment, profits equal the deficit.  See the details on page 148.

What are the implications of this?  One implication is certainly that the big business types who encouraged the tax cuts to promote business should not now be bellyaching about the deficits.  They are supporting profits.  Now let's look at exactly what profits they are supporting.

Minsky's profits he also terms the "surplus," and it is not only the return on capital we normally think of as profit, but all the returns which are not technologically determined costs of production.  These include advertising and professional services, executive salaries and overhead costs, costs of financing and the aforementioned costs to validate capital assets.

Two things jump out at me.  One is that the profit or surplus feeds the white collars and presumably the big salaries as opposed to the blue collars on the production side.  The other is that price-taking firms are disciplined into being more lean and less top heavy.  It appeals to me as justification for taxing incomes progressively.

But let's go back to the price takers versus the price makers.  What happens when demand falls?  In the case of price takers, demand is reflected by a price that runs back along the marginal cost curve.  In the case of price makers, who set the price and prevent its falling by market power, something else happens.

If output drops below the first critical average cost curve, capital asset prices are no longer validated and investment in new capital assets stops -- with implications across the economy for incomes and output.  If output drops below the second critical curve, fixed debt payments can no longer be supported, and the various financing instruments come under pressure.  Of course, the overhead and executive costs are compressed to some extent, but these may be resistant.  For example, firms may increase advertising in attempts to gin up demand.

And when overall demand affects many firms, the same kinds of financial instruments come under pressure and we walk into the kind of crisis we have today.

See that the deflation is resisted by such firms on their products, because they have individual pricing power, but that the drop in output affects incomes and investments and financial arrangements dramatically -- without affecting price.

So my take here is that we ought not to be too ecstatic that deflation is not spiraling.  The cost-cutting and absence of investment and the pressure on the financial sector, all too evident in the current stagnation and apparent in declining payrolls may likely mean more bad jujus.

AND of course, business cash flow is being supported mightily by government deficits.

Hyman Minsky on Speculative Finance and Instability 08.11.09

Hyman Minsky writing in 1985

p. 5

... Fundamental institutional changes similar in scope to the basic reforms of the first six years of the Roosevelt presidency are necessary if we are to recapture such relative tranquility.

For a new era of serious reform to enjoy more than transitory success it should be based on the understanding of why a decentralized market mechanism -- the free market of the conservatives -- is an efficient way of handling the many details of economic life, and how the financial institutions of capitalism, especially in the context of production processes that use capital-intensive techniques, are inherently disruptive. Thus, while admiring the properties of free markets we must accept that the domain of effective and desirable free markets is restricted. We must develop economic institutions that constrain and control liability structures, particularly of financial institutions and of production processes that require massive capital investments. Paradoxically, capitalism is flawed precisely because it cannot readily assimilate production processes that use large-scale capital assets.


p. 6

oscillation between imminent collapse and rampant speculation


The financial fragility that led to the instability so evident since the 1960s was ignored. The deregulation drive and successful effort to bring the inflation rate down by large-scale and protracted monetary constraint and unemployment exacerbated the financial instability that was so evident in 1967, 1970, 1974-75 and 1979-80. Lender-of-last-resort interventions, which had papered over the problems of the fragile financial structure in the intermittent crises of the late 1960s and 1970s, became virtually everyday events in the 1980s.


The protracted unemployment and bankruptcies and near bankruptcies of firms and banks radically transformed the labor force from being income-oriented to being job-security oriented. Job security is no longer being guaranteed by federal macroeconomic policy; the only guarantee that labor now enjoys seems to be the right to make concessionary wage settlements.

These concessions by workers mean that the cost push part of the business cycle is attenuated -- but it also means that consumer demand due to increasing wage income will be less buoyant during an expansion. If anything, the Reagan reforms made prospects for instability worse -- but like many things in the economy and politics the full effects of the reforms will not be felt for some time. Even as a deficit-aided strong recovery leads to an apparent success for Reaganomics, the foundations for another round of inflation, crises, and serious recession are being laid.

p. 7

The major contours of our present institutional setup were put in place during the Roosevelt reform era, particularly in the second New Deal, which was completed by 1936. This structure was a response to the failures of the emergency legislation of 1933 to foster a quick recovery and to the spate of Supreme Court rulings invalidating various portions of the first New Deal that had been enacted during the one hundred days of 1933.

p. 8

footnote: There is a policy ineffectiveness theorem in contemporary economics. (See Thomas J. Sargent and Neil Wallace, "Rational expectations and the Theory of economic Policy," Journal of Monetary Economics, 1976, pp. 169-83.) Such theorems can be maintained only as the in fact institutional structure is ignored.

... when the difficulties encountered by giant corporations ad financial institutions are central to the instability that plagues the economy, the very largest concentrations of private power should, in the interest of efficiency as well as stability, be reduced to more manageable dimensions.

p. 9

The major flaw of our type of economy is that it is unstable. This instability is not due to external stocks (sic) or to the incompetence or ignorance of policy makers. Instability is due to the internal processes of our type of economy. The dynamics of a capitalist economy which has complex, sophisticated, and evolving financial structures leads to the development of conditions conducive to incoherence -- to runaway inflations or to deep depressions. But incoherence need not be fully realized because institutions and policy can contain the thrust to instability. We can, so to speak, stabilize instability.

Minsky's point so far is that the stability of the economy after 1966 was due to two things. First the presence of Big Government whose purchases and programs tended to be counter-cyclical, but whose debt being secure tended to act as ballast to the portfolios of private actors. Second, the Fed acted as backstop to the speculative financing that grew up during the good times. As lender of last resort, it became the de facto alternative financing when the first line of financing faced trouble. Only the Fed was big enough and had the money to stand up when the demand for backstop financing became enormous.

Here, from Chapter 2:

Chapter 2

p. 13

In the first quarter of 1975 (and again in midyear 1982), it seemed as if the American and the world economy was rushing toward a depression that might approach the severity of the Great Depression of the 1930s. Not only was income declining rapidly and the unemployment rate exploding, but virtually each day saw another bank, financial organization, municipality, business corporation, or country admit to financial difficulties.

p. 14-15

What, then, prevented a deep depression in 1975 and 1982? The answer centers on two aspects of the economy. The first is that Big Government stabilizes not only employment and income, but also business cash flows (profits) and as a result asset values. [FN: This is a proposition derived from the work of Kalecki. See Michael (sic) Kalecki, Selected Essays on the Dynamics of the Capitalist Economy (1933-1970) ...] The second aspect is that the Federal Reserve System, in cooperation with other government agencies and private financial institutions, acts as a lender of last resort. It will be argued that the combined behavior of the government and of the central bank, in the face of financial disarray and declining income, not only prevents deep depressions but also sets the stage for a serious and accelerating inflation to follow. The institutions and usages that currently rule have not prevented disequilibrating forces from operating. What has happened is that the shape of the business cycle has been changed; inflation has replaced the deep and wide trough of depressions.

You may say there have been no long periods of inflation since Minsky wrote in 1985. Here I would substitute "bubble" for inflation. Bubble is essentially an inflated asset price. These may not appear in CPI, but they are inflations. This would then lead into some of Soros work.

I do want to clarify here that "speculative financing" is simply that financing which is not a straightforward loan arrangement. I will buy a machine and borrow the money from you and pay you back with the cash flow generated by the machine. Much or most of modern corporate finance entails interim financing arrangements, where some borrowing is done to pay off the capital investment loan. This is speculative and has to have a backup if it is not going to be completely unstable.

Minsky Rises from Obscurity, per Stephen Mihm

Hyman Minsky saw it happening. To say "he saw it coming" is not correct, because what was happening washappening right under his nose. Everybody's nose, for that matter. But Minsky's glass saw into the workings. Like seeing a tree coming out of the ground and predicting fruit one day, it's not really a matter of foresight, it's a matter of recognition.

Here from the Boston Globe is an account. composed more of the conclusions than the description of the activity, it is nonetheless instructive. How appropriate and ironic that the non-Nobelists Minsky, Joan Robinson, John Kenneth Galbraith, should be right on the mark, while Nobelists Milton Friedman, Robert Lucas and too many others have been a monumental waste of time. The latter are like the pilots looking for the Northwest Passage before the ice melted, except that they led convoys of ships with the productive capacity of the world. Now forced to retreat, or more often, resisting that and insisting on continuing in futility, these are more self-important sirens than any sort of guide.

Why capitalism fails
The man who saw the meltdown coming had another troubling insight: it will happen again

By Stephen Mihm
Boston Globe
September 13, 2009

Since the global financial system started unraveling in dramatic fashion two years ago, distinguished economists have suffered a crisis of their own. Ivy League professors who had trumpeted the dawn of a new era of stability have scrambled to explain how, exactly, the worst financial crisis since the Great Depression had ambushed their entire profession.

Amid the hand-wringing and the self-flagellation, a few more cerebral commentators started to speak about the arrival of a “Minsky moment,” and a growing number of insiders began to warn of a coming “Minsky meltdown.”

“Minsky” was shorthand for Hyman Minsky, a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck, and he remains a shadowy figure in the profession. But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through. A contrarian amid the conformity of postwar America, an expert in the then-unfashionable subfields of finance and crisis, Minsky was one economist who saw what was coming. He predicted, decades ago, almost exactly the kind of meltdown that recently hammered the global economy.

In recent months Minsky’s star has only risen. Nobel Prize-winning economists talk about incorporating his insights, and copies of his books are back in print and selling well. He’s gone from being a nearly forgotten figure to a key player in the debate over how to fix the financial system.

But if Minsky was as right as he seems to have been, the news is not exactly encouraging. He believed in capitalism, but also believed it had almost a genetic weakness. Modern finance, he argued, was far from the stabilizing force that mainstream economics portrayed: rather, it was a system that created the illusion of stability while simultaneously creating the conditions for an inevitable and dramatic collapse.

In other words, the one person who foresaw the crisis also believed that our whole financial system contains the seeds of its own destruction. “Instability,” he wrote, “is an inherent and inescapable flaw of capitalism.”

Minsky’s vision might have been dark, but he was not a fatalist; he believed it was possible to craft policies that could blunt the collateral damage caused by financial crises. But with a growing number of economists eager to declare the recession over, and the crisis itself apparently behind us, these policies may prove as discomforting as the theories that prompted them in the first place. Indeed, as economists re-embrace Minsky’s prophetic insights, it is far from clear that they’re ready to reckon with the full implications of what he saw.

In an ideal world, a profession dedicated to the study of capitalism would be as freewheeling and innovative as its ostensible subject. But economics has often been subject to powerful orthodoxies, and never more so than when Minsky arrived on the scene.
That orthodoxy, born in the years after World War II, was known as the neoclassical synthesis. The older belief in a self-regulating, self-stabilizing free market had selectively absorbed a few insights from John Maynard Keynes, the great economist of the 1930s who wrote extensively of the ways that capitalism might fail to maintain full employment. Most economists still believed that free-market capitalism was a fundamentally stable basis for an economy, though thanks to Keynes, some now acknowledged that government might under certain circumstances play a role in keeping the economy - and employment - on an even keel.

Economists like Paul Samuelson became the public face of the new establishment; he and others at a handful of top universities became deeply influential in Washington. In theory, Minsky could have been an academic star in this new establishment: Like Samuelson, he earned his doctorate in economics at Harvard University, where he studied with legendary Austrian economist Joseph Schumpeter, as well as future Nobel laureate Wassily Leontief.

But Minsky was cut from different cloth than many of the other big names. The descendent of immigrants from Minsk, in modern-day Belarus, Minsky was a red-diaper baby, the son of Menshevik socialists. While most economists spent the 1950s and 1960s toiling over mathematical models, Minsky pursued research on poverty, hardly the hottest subfield of economics. With long, wild, white hair, Minsky was closer to the counterculture than to mainstream economics. He was, recalls the economist L. Randall Wray, a former student, a “character.”

So while his colleagues from graduate school went on to win Nobel prizes and rise to the top of academia, Minsky languished. He drifted from Brown to Berkeley and eventually to Washington University. Indeed, many economists weren’t even aware of his work. One assessment of Minsky published in 1997 simply noted that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.”

Yet he was busy. In addition to poverty, Minsky began to delve into the field of finance, which despite its seeming importance had no place in the theories formulated by Samuelson and others. He also began to ask a simple, if disturbing question: “Can ‘it’ happen again?” - where “it” was, like Harry Potter’s nemesis Voldemort, the thing that could not be named: the Great Depression.

In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century. But where most economists drew a single, simplistic lesson from Keynes - that government could step in and micromanage the economy, smooth out the business cycle, and keep things on an even keel - Minsky had no interest in what he and a handful of other dissident economists came to call “bastard Keynesianism.”

Instead, Minsky drew his own, far darker, lessons from Keynes’s landmark writings, which dealt not only with the problem of unemployment, but with money and banking. Although Keynes had never stated this explicitly, Minsky argued that Keynes’s collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff.

This insight bore the stamp of his advisor Joseph Schumpeter, the noted Austrian economist now famous for documenting capitalism’s ceaseless process of “creative destruction.” But Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises.

Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers - what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit. Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment - what was later dubbed the “Minsky moment” - would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

From the 1960s onward, Minsky elaborated on this hypothesis. At the time he believed that this shift was already underway: postwar stability, financial innovation, and the receding memory of the Great Depression were gradually setting the stage for a crisis of epic proportions. Most of what he had to say fell on deaf ears. The 1960s were an era of solid growth, and although the economic stagnation of the 1970s was a blow to mainstream neo-Keynesian economics, it did not send policymakers scurrying to Minsky. Instead, a new free market fundamentalism took root: government was the problem, not the solution.

Moreover, the new dogma coincided with a remarkable era of stability. The period from the late 1980s onward has been dubbed the “Great Moderation,” a time of shallow recessions and great resilience among most major industrial economies. Things had never been more stable. The likelihood that “it” could happen again now seemed laughable.

Yet throughout this period, the financial system - not the economy, but finance as an industry - was growing by leaps and bounds. Minsky spent the last years of his life, in the early 1990s, warning of the dangers of securitization and other forms of financial innovation, but few economists listened. Nor did they pay attention to consumers’ and companies’ growing dependence on debt, and the growing use of leverage within the financial system.

By the end of the 20th century, the financial system that Minsky had warned about had materialized, complete with speculative borrowers, Ponzi borrowers, and precious few of the conservative borrowers who were the bedrock of a truly stable economy. Over decades, we really had forgotten the meaning of risk. When storied financial firms started to fall, sending shockwaves through the “real” economy, his predictions started to look a lot like a road map.

“This wasn’t a Minsky moment,” explains Randall Wray. “It was a Minsky half-century.”

Minsky is now all the rage. A year ago, an influential Financial Times columnist confided to readers that rereading Minsky’s 1986 “masterpiece” - “Stabilizing an Unstable Economy” - “helped clear my mind on this crisis.” Others joined the chorus. Earlier this year, two economic heavyweights - Paul Krugman and Brad DeLong - both tipped their hats to him in public forums. Indeed, the Nobel Prize-winning Krugman titled one of the Robbins lectures at the London School of Economics “The Night They Re-read Minsky.”

Today most economists, it’s safe to say, are probably reading Minsky for the first time, trying to fit his unconventional insights into the theoretical scaffolding of their profession. If Minsky were alive today, he would no doubt applaud this belated acknowledgment, even if it has come at a terrible cost. As he once wryly observed, “There is nothing wrong with macroeconomics that another depression [won’t] cure.”

But does Minsky’s work offer us any practical help? If capitalism is inherently self-destructive and unstable - never mind that it produces inequality and unemployment, as Keynes had observed - now what?

After spending his life warning of the perils of the complacency that comes with stability - and having it fall on deaf ears - Minsky was understandably pessimistic about the ability to short-circuit the tragic cycle of boom and bust. But he did believe that much could be done to ameliorate the damage.

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve - what he liked to call the “Big Bank” - step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke - like Minsky, a scholar of the Depression - it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

Minsky’s other solution, however, was considerably more radical and less palatable politically. The preferred mainstream tactic for pulling the economy out of a crisis was - and is - based on the Keynesian notion of “priming the pump” by sending money that will employ lots of high-skilled, unionized labor - by building a new high-speed train line, for example.

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

While economists may be acknowledging some of Minsky’s points on financial instability, it’s safe to say that even liberal policymakers are still a long way from thinking about such an expanded role for the American government. If nothing else, an expensive full-employment program would veer far too close to socialism for the comfort of politicians. For his part, Wray thinks that the critics are apt to misunderstand Minsky. “He saw these ideas as perfectly consistent with capitalism,” says Wray. “They would make capitalism better.”

But not perfect. Indeed, if there’s anything to be drawn from Minsky’s collected work, it’s that perfection, like stability and equilibrium, are mirages. Minsky did not share his profession’s quaint belief that everything could be reduced to a tidy model, or a pat theory. His was a kind of existential economics: capitalism, like life itself, is difficult, even tragic. “There is no simple answer to the problems of our capitalism,” wrote Minsky. “There is no solution that can be transformed into a catchy phrase and carried on banners.”

It’s a sentiment that may limit the extent to which Minsky becomes part of any new orthodoxy. But that’s probably how he would have preferred it, believes liberal economist James Galbraith. “I think he would resist being domesticated,” says Galbraith. “He spent his career in professional isolation.”

Stephen Mihm is a history professor at the University of Georgia and author of “A Nation of Counterfeiters” (Harvard, 2007).

Saturday, February 28, 2009

Leon Keyserling, the New Deal and the Postwar Prosperity

A manifesto


Employment and the "New Economics"

Leon H. Keyserling Council of Economic Advisers
The main focus of national economic and related social policies should be upon federally guaranteed full em ployment and a federally initiated nationwide system of guar anteed income for those who cannot be brought within the employment stream. Progress toward these objectives will add more to personal development and national achievement than a further proliferation of marginal programs called "new." Full-time unemployment should be reduced to about 2 per cent of the civilian labor force, and the true level of unemployment to about 3 to 3.5 per cent. Full employment, optimum eco nomic growth, and optimum allocation of resources, in line with the great social priorities of national needs, are inseparable objectives and do not involve much programmatic differentia tion. The prevalent view that these objectives involve exces sive or even enlarged inflationary pressures is not justified by empirical observation. The drive against "inflation" thus far has inflated the fat and starved the lean. The aggregate and structural approaches to full employment need a new synthesis. We need, particularly under the aegis of the Employment Act of 1946, a ten-year budget of our needs and resources. All na tional public policies importantly affecting resource-allocation, including the federal budget, should be made an integral part of this long-range budget. The core problem for the years ahead is to maintain that one increasing purpose in our national life which is essential if we are to realize the promise of America.

The ANNALS of the American Academy of Political and Social Science, Vol. 373, No. 1, 102-119 (1967)
DOI: 10.1177/000271626737300105

Monday, February 9, 2009

Leon Keyserling on the Fed - 08.12.09


Throughout the recorded history of mankind, there have been periods when certain institutions or other citidels of power became what might be called "sacred cows." Although the damage they did far exceeded the benefits, their strongly positioned defenders prevented effective challenge to their misdeeds, or at least reduced the challenge to an ineffectual whisper. Very few people, unlike the child in the wellknown fable, dared to raise their voices and point out that "the king has no clothes on."

The outstanding example of this in the United States has become the Federal Reserve Board and System ... created in 1913 during the first Administration of Woodrow Wilson. It would be interesting and instructive to trace in detail the many times since 1913 when the Fed has instituted policies so erroneous and impervious to real needs that great hurt has been done to the economy and to the American people. Before and during the Great Depression, the smaller depression of 1920-1922, and the economic stagnations and recessions since 1953, the Fed has been a main contributor to the oncoming of economic and related social disaster or lesser calamity and to their aggravation and protraction.


The opening of Leon Keyserling's "Money, Credit and Interest Rates: Their Gross Mismanagement by the Federal Reserve System," 1980, published by the Conference on Economic Progress.


Treatment of ... technicalities is not necessary to describe and appraise the practical consequences of the two basic things which the Fed is doing or attempting to do, which are to determine or predominantly influence the availability of money and credit and rates of interest. Indeed, the excessive focus upon ... technicalities involves recognition that the general public cannot really be well-informed about them, and all too frequently is based upon awareness that this excessive focus maintains the unchallenged authority of the "sacred cow." This leads the trusting public to believe that it must let those in authority do as they please, because only they and other experts or so-called experts can possibly understand what it is all about.

Leon Keyserling - Bio Sketch from W. Robert Brazelton

                                    W. ROBERT BRAZELTON, PHD.
                                                            Preliminary: Not for general distribution.

            Leon H. Keyserling had a primary goal in terms of economic policy—constant, full employment/output growth.  This appeared in his writings, his critiques before numerous Congressional Committees from the 1930’s , the 1940’s until his death in 1987;   and as Chairman of the  Council of Economic Advisors  to President Truman, 1949-53.  Before Keyserling had been responsible for the New Deal/Fair Deal Legislation as a principle author of several important  Congressional  Bills/Acts, such as: the Public  Works Act of Senator  Robert Wagner (D, NY) with whom Keyserling was closely connected; The National Industrial Recovery Act, 1935; The National Labor Relations Act( The Wagner Act), 1935; U.S. Housing Acts—an important part of Keyserling’s   policies for full employment, countercyclical policy, and decent housing, 1937 and afterwards; The Employment Act of 1946: General Housing Act of 1949, Full Employment and Balanced Growth Act ( The Humphrey-Hawkins Act), 1977 and others (Brazelton, 2001, p. 160).

            Keyserling received his primary economics at Columbia University of New York City under the Institutionalist, Rexford Guy Tugwell both as an  undergraduate and, after his Law Degree for  Harvard University( 1931), as a doctoral student having returned to Columbia.  Having been taken to Washington , D.C. by Tugwell and Senator Wagner after the inauguration of President Franklin Roosevelt (1933), he did not finish his doctoral dissertation, but considered the Congressional Acts mentioned above primarily or partly written by him to be of, at least, an equivalent.  As a student of Tugwell, he was a liberal with both influences from the Institutionalists and  Keynes and, as Lynn Turgeon  writes (Turgeon, 1987) was pragmatic in is views, but, to me, within a largely Institutional/Keynesian framework (Brazelton, 2001,2005, 2006).  Also, as a member of the Council of Economic Advisors, 1946-49, and its Chair, 1949-52, he developed what was to referred to later as the “Full Employment Budget” under Walter Heller in the Kennedy-Johnson Administrations (Brazelton, 2003; Pechman and Simler, especially the chapter by Walter Heller therein). As such,  his constant concentration was upon full employment and full output secularly and cyclically—even during  periods of inflation (Brazelton, 1997, 2001, 2005).  As I have covered these points elsewhere, I will herein concentrate upon his full employment beliefs to indicate his early stress upon the concept of economic (f9scal) policy and its relevance for us today---still a man for our times!

            Full employment meant to Keyserling a constant goal for both secular and cyclical  economic policy.  Secular referred to his constant growth policies for constant,  full employment growth such as  in the Full Employment Budget Concept; and  his cyclical policy meant that even in an inflation, he would not first stress restricting demand but, rather increasing supply as the cause of inflation was to him primarily inadequate demand, not excess demand!  Thus, increase supply in the economy where needed via selective economic policies aimed at the lagging sectors—micro and macro.  This related to his concept of “economic balance” where supply growth must equal demand growth, both micro and macro.  To increase supply in an inflation, one needed selective incentives.  But to decrease demand in an inflation would,  to him,  not end inflation, but create more due to administered pricing, high interest rates, and in cutting  output forcing  companies to operate to the left of minimum average costs—all inflationary.  Indeed administered pricing, was a major result of inflationary pressures and of imperfect market structures which Keyserling accepted as reality (Brazelton, 1997, 2001, 2005), as can be seen in his publications of the Conference on Economic Progress (see Appendix); and the early development of the “Full Employment Budget Concept”—his “Freedom Budget” or “Nation’s Economic Budget”, etc.   (Brazelton, 2001,2003).  To Keyserling, full employment growth meant a constant emphasis upon full employment/output.  This can be seen from a selection of pertinent  quotes; and from a sixteen point program for constant growth and employment (Keyserling, 1975).  To quote:

“Maximum employment means full-time jobs for all willing and able to work, allowing for minimum or “frictional “ unemployment, with growth in the number seeking employment not inhibited by scarce job opportunity.  It means programs to qualify for employment those now handicapped by inadequate education or training, or debilitated by bad housing and inadequate health care.  It means  also that those on the job should not be underutilized, and should have a chance to upgrade their skills  and earning power.  By definition, maximum employment is incompatible with unemployment—or inferior employment or pay—based upon  discrimination due to color, race, or sex” (Keyserling, 1964, pp. 87f).


“Under the Employment Act, full employment means more than jobs.  It means full employment of our natural resources, our technology and science, our farms and factories, our business brains, and our labor skills…Full employment means maximum opportunity under the American system of responsible freedom…and a concept which must grow as our capabilities grow” (Keyserling, 1975,p. 7).

It should be noted that in the above Keyserling stresses economic balance (“…a concept which must grow as our capabilities grow”); and the growth of jobs and income as, to him, the relations between jobs and adequate  income are crucial.  The growth of output must be offset by the growth of demand (micro/macro). Thus, to Keyserling if C=f(Y),  and Y=f(wages), then Y=f(wages) so that to take goods off the growing market (supply—micro/macro,  then wages and other forms of demand must grow as well—micro/macro. 

That is the essence of long term growth, stability and social justice (Keyserling 1975: Brazelton, 1997, 2001,2003, 2005).  Thus, the sixteen points. 

            In his Conference on Economic Progress Report “Full Employment Without Inflation, 1975 (pp. 34-44), Keyserling argues for a sixteen point program shich I will indicate below and elucidate upon when I consider relevant to the problem of employment introduces by the preceding analysis by Professor Henry.  In this paper I will deal with those points which specifically deal with the problem of “employment”, a subject raised by this session.  I will number to points as they are numbered by Keyserling and comment upon them  in analytic terms. 

1.      The need for consistent long-term goals

a.       Keyserling’s point here was that too much time is spent on short-term analysis and forecasting, not enough on long-term constant full employment/output growth.

2.      Growth analysis is an essential, constant goal, but needs as awareness of high
Priorities such as housing, education, health, environment and other shortages.
3.      Goals to overcome shortages: The Key Role of Housing

Housing increased the quality of life, but also gave employment to many skilled and unskilled; and increased output/employment in related industries such as furnishings, utilities, roads, etc.---a multiplier effect.

4.      Public employment—a permanent public service employment for “eligibles               not employed elsewhere” which would serve about one million people (his      estimate) and similar to propositions such as the Center for Full                                     Employment  and Price Stability (C-FEPS) at the University of Missouri-                 Kansas City, Department of Economics.

5.      A new monetary policy to lower interest rates for investment, housing; and   to reduce (or end) the independence of the Federal Reserve (yes,            controversial) to make monetary policy  “…in accord with the real       economic  growth needs required to restore maximum employment and             production…” (Keyserling, 1975, p.34).  The same must be true for fiscal         expenditures via the multiplier effect.

8.      Balance the Federal Budget, but, first, get out of recessionary conditions and           lance only after  “…restoration of a fully-rised economy (Keyserling,            1975. p. 38;  Brazelton, 2005;  Pechman and Simler, 1987).

10.  Income supports would be to restore full  employment equilibrium and in     terms  of needed “social insurance” such as unemployment compensation,    etc.

11. In terms of the above (10) substitute the “…ragbag or costly and grossly     inadequate  ‘welfare’ programs …” with “..limited universal income supports…” (Keyserling, 1975, p.40).

13.  A manpower to train and retrain workers in regard to the needs of full         employment and national priorities and shortages.

The above selected, employment related sections of Keyserling’s  sixteen
Points are all basically for the purpose of establishing a full employment/output growth economy constantly.  This is obvious in terms of its income/employment suggestions (aggregate demand)  and its output stress (aggregate supply) where on both the micro and the macro level, the growth of both must be equal for full employment, price stable growth in the long-run.  Also,  in Keyserling’s stress against administered pricing, we see a stress upon output in real terms, not merely monetary terms—the former increasing output, the latter limiting real output in favor of price increases and inflation via said administered pricing.  These are, of course, still the needs of our times as they were the needs of  Keyserling’s times---the fulfillment of national priorities and shortages;  maximum output/employment; the control of inflation including administered pricing;  the training  of an adequate labor force; and environmental, health, income support and energy needs met and reformed.  Thus, Keyserling is “Still a Man For Our Times”—or, perhaps, for the future as we have never reached the goals set forth by Keyserling decades ago.  That is our failure, not his!


Brazelton, W. Robert (1997), “Retrospectives: The Economics of  Leon H. Keyserling”,
            Journal of Economic Issues, 11 (4), pp. 189-97.
Brazetlon, W. Robert, (2001), Designing US Economic Policy: An Analytical Biography            or Leon H. Keyserling, London, Palgrave Press.
Brazelton, W. Robert, (2003),  “The Council of Economic Advisors and the ‘Full          Employment Budget Concept’ : Keyserling Before Heller”.  Journal of    Economics , xxix (2), pp. 87-102.
Brazelton, W.Robert, (2005), “Oral Interview with Leon H. Keyserling”, Research Paper          Report, Vol . 2, pp. 377-445.  On deposit at the Truman Memorial (Presidential )           Library, Independence, Missouri, USA; and the University of Missouri-Kansas      City Library and Archives.
Keyserling, Leon H.  (1964), Progress and Poverty, Conferences on Economic Progress,          Washington, D.C. , pp. 87f (see, also, appendix hereto).
Keyserling, Leon H. (1975), Full Employment Without Inflation, Conference on             Economic  Progress, Washington, D.C.( see appendix hereto).
Pechman, Joseph and Simler, N.J. ,(1982), Economics in the Public Service: Papers in Honor of Walter Heller( especially chapter by Walter Heller), Norton Press,  New             York.
Turgeon, Lynn (1987), Leon H. Keyserling, The New Palgrave Dictionary in Economics,          John  Eatwell, Murray Milgate, Peter Newman, (eds),  Vol. III, Macmillan Press,
            New York. 


            The following are pamphlets edited by Leo H. Keyserling and his wife, Mary Dublin Keyserling, an economist in her own right, via the Conference on  Economic Progress, 1954-83.  They are deposited at the Truman Memorial (Presidential) Library, Independence, Missouri, USA and are crucial in terms of research in this area and era of economic policy and analysis. 


Toward Full Employment and Full  Production, 1954
National Prosperity Program for 1955, 1955
Full Prosperity for Agriculture, 1955
The Gaps in Our Prosperity, 1956
Consumption—Key to Full Employment, 1957
Wages and the Public Interest, 1958
The “Recession”—Cause and Cure, 1958
Toward A New Farm Program, 1958
Inflation—Cause and Cure, 1959
The Federal Budget and “The General Welfare”, 1959
Tight Money and Rising Interest Rate, 1960
Food and Freedom.1960
Jobs and Growth, 1961
Poverty and Deprivation in the U.S.,1962
Key Policies for Full Employment, 1962
Taxes and the Public Interest, 1963
The Top-Priority Programs to Reduce Unemployment, 1963
The Toll of  Rising Interest Rates, 1964
Agriculture and the Public Interest, 1965
The Role of Wages in a Great Society, 1966
A “Freedom Budget” for all Americans, 1966
Goals for Teachers’ Salaries in our Public Schools, 1967
Achieving Nationwide Educational Excellence, 1968
Taxation of Whom and for What, 1969
Growth with Less Inflation or More Inflation Without Growth, 1971
The Scarcity School of Economics, 1973
Full Employment Without Inflation, 1975
Towards Full Employment Within Three Years, 1976
The Humphrey-Hawkins Bill  “Full Employment and Balanced
            Growth Act of 1977, 1978

Goals for Employment and How to Achieve Them Under the “Full Employment
            And Balanced  Growth Act of 1977, 1978
“Liberal” and “Conservative” National Economic Policies
            And Their Consequences, 1919-1979,  1979
Money, Credit and Interest Rates: Their Gross Mismanagement by the Federal
            Reserve System, 1980.
How to Cut  Unemployment to Four Percent and End Inflation
            And Deficits by 1987, 1983