demandside

At one time, the New Economics of Keynesianism was almost universally accepted.  No longer.

Today, we have copy from Joseph Stiglitz on the spring of the zombies and John Irons on offshore tax havens.  No Idiot of the Week, but an extended history note.  First, some news.

From Calculated Risk.

Nouriel Roubini appeared on CNBC looking plump and pleased.  It is an ill wind that blows nobody good.  Roubini’s correct predictions have made Doctor Doom’s house calls quite lucrative.

Capacity utilization means no private sector investment in traditional industries for years to come.  It also means that demand pull inflation is not in the cards anytime soon.

Unemployment continues upward, but a lot of cheer was taken from the break in initial claims for unemployment.

Since the recession will not be resolved by a return of consumer spending, Demand Side expects this is a very dim light at the end of the tunnel.  Certainly we are not backing off our prediction of many months ago that ten percent unemployment is baked in.  We likely will see twenty percent or very near it in the broad U-6 measure.

Now, today, on the difficulty of sorting through the mish mash of economic schemes.  Every analyst, economist, or commentator has a different scheme.  It was not always the case.

Thus, The history note:

In the mid - 1960’s, it is no exaggeration to say, and Lord Eric Roll in his definitive History of Economic Thought did say, “… the New Economics enjoyed an acclaim unprecedented in its speed and intensity.”

Economics and economists had penetrated the policy-making framework as never before.  in the Depression, the New Deal Brain Trust around FDR drew some economists in, but by the 1950s and 1960s there was a systemic and institutional presence of economists in countries around the globe.

And as Lord Roll puts it …

“for at least over thirty years after the appearance of Keynes’ General Theory, the status of economics, largely with the kind associated with his name and general approach, increased steadily until it reached a position of authority, both as a branch of social science and as a perceived tool for the better ordering of human affairs, unparalleled in its history and unequalled by any of the other of the non-physical sciences.”

This is not the situation today.  A recent edition of Business Week lampooned economists as people who could not agree on what had happened, on what to do, on what would happen, and would be wrong anyway.

In a moment we will look at what happened to change the situation from a condition in which economics and economists were held in high regard to one in which they are … not.  But first, let me emphasize that the high standing and respect accorded to economists int he postwar years prior to 1970 is not my invention.  The clear perception among politicians and the public was that Keynesian economics, demand side economics, had been refined and perfected and was responsible for that period of growth, prosperity, low unemployment and modest inflation.

What happened?

Two things:  The stagflation of the 1970s and early 1980s and a counter-revolution.

Much could be said about the stagflation.  It occasioned Richard Nixon’s wage-price freezes, initially well-received, and later experienced as disruptive and counter-productive.  Still ill-appreciated is the role of oil prices, energy prices, not just as demand shocks, but as directly eroding wages and incomes.  Whatever might be said, the stagflation exploded the illusion of precision which economists had gathered around themselves, and offered the opening for a politically led counter revolution that unseated the orthodoxy of the New Economics.

I choose the words “politically led” very carefully.  The Monetarist laissez faire supply side scheme that replaced the Keynesian conventional wisdom was by no means generally accepted among economists or among nations, though it has achieved sway among bankers.  The revolution against Keynesianism was decidedly not a revolution led by economists.  At most there was a civil war during which time the elections of Thatcher and Reagan put the new dogma into the seats of power in some influential countries.

Supply Side has never really been a branch of economics.  More a parasitic vine.  No serious academic lineage has followed it.  Its advocates are not housed primarily in universities, but are centered in corporate-sponsored Right Wing think tanks like the American Enterprise Institute and the Heritage Foundation.

Monetarism, laissez fair, New Classical math-based, and Rational Expectations schools have enjoyed far less consensus among economists than the Demand Side schools that preceded them, although they too have been the beneficiaries of significant corporate sponsorship, in the form of endowed chairs and business school boosterism.  However that may be, none of these schools carries any pretense of precision into the second year of this current recession.

The hybrid Monetarism and laissez faire philosophy that controls the Fed and Treasury can claim no precision now after so many years of false promises and predictions.  To have the financial potentates still at the helm after so many protests that they had not seen it coming is one of the great ironies of the current year.  The Rational Expectations and the mathematical strains of the New Classical school are clearly wrong or irrelevant.  Libertarian bias sometimes masquerades as a market efficiency theme, but both are as completely out of place looking forward as they were in describing the corporate oligarchy that rose up behind the smokescreen of Reaganism.

The current crisis and its depth are impossibilities from the points of views espoused by these folks only a couple of years ago.

That said, until this recession, the collapse of this housing market and this financial sector, and for the twenty years prior, for an economists to be Keynesian or Demand Side in approach was to be hopelessly naive and stuck in the past, and to look for employment at the Post Office.

Keynesianism may have been defeated by a motley coalition of political opportunists, corporate connivers and academic hacks, but it WAS defeated.

I took my degree from a large state university in 1995.  The name Keynes appeared about twice — literally during my undergraduate education.  It was not until after graduation I even learned how to pronounce the name of the greatest economist of the Twentieth Century.  Only subsequent to the 2007 housing collapse and financial debacle did KEENES become Keynes again to the policy maker and the media talking head.

Paul Krugman’s blog the other day said something about this period.  Where is it?

The IS-LM model was an invention of John Hicks, later Sir John Hicks.  He won the Nobel Prize for it, which did not prevent him from later recanting, or more accurately, ascribing its relevance only to a narrow part of reality.  But it was mathematical, and Keynesian.  I’m not sure by this whether Krugman, DeLong or any others actually advocate this scheme.  A paper Krugman wrote at that time makes this note:

Hicks and the IS-LM were searching for precision and found it in irrelevance.  But the formulation remained the central Macro formulation, event absent Keynes’ name.  It is best ignored for the present.

The Keynesian policies in play today are the federal infrastructure spending, the aid to states and local governments and assistance to health and education systems.  You might also add the New Deal programs of social security and unemployment insurance as base supports of demand, but which are not strictly Keynesian.  I combine the two in the definition of Demand Side.

These are the measures of which JMK would have approved.

Compare the “Timely Targeted and Temporary” tax cuts of early 2008, which was plainly a bust from the beginning from a Demand Side perspective.  If you’ve been with us, you heard us among the voices discounting the efficacy of these checks to individuals, no matter their political popularity.  The primary sponsor of Timely Targeted and Temporary was, of course, Larry Summers.  As we predicted from before the beginning here on the podcast, that triple T stimulus was a non-starter in the real economy.  Republicans and Conservative economists who continue to insist on tax cuts as being effective are ignoring this evidence.

Those who expect big things from loan guarantees and making nice with the banks so they will lend are destined for disappointment from the same cause.  The consumer is not going to be the engine it once was.  The why’s go beyond the fact that his/her net worth is going negative fast and his/her income is dropping on average, but we won’t go into them here.

Getting back to Timely Targeted and Temporary.  Didn’t work any better than tax cuts for the rich.

The entire Monetarist scheme to refloat the banks is from the Demand Side perspective a Monetarist scheme to refloat the banks.  To us there is no clear reason why it should work as a remedy for the economy, since there is no clear motivation to invest or borrow or lend absent demand strength.  It’s great to have a good ferry, but if nobody wants to go across the river, nobody will benefit, even the ferry.

The idea that the financing function of the economy will be saved by salvaging the companies that screwed it up is dubious on its face.  Or that ratifying their bad decisions by having the government cover them with taxpayer money?  It does not stand the test of common sense, let alone the Demand Side theory.  In fact, it’s hard to see whose theory it does test out in.  Perhaps the theory that those who control the government set the policy.

But this IS the history note.  And the note is simply the contrast.  First between the economic consultants of the New Deal and the economic establishment that grew out of Keynesianism to such prominence in the third quarter of the Twentieth Century, and second the contrast between that and the current Tower of Babel.  The rise of Keyneisanism and Demand Side, its successful revolution against classical laissez fair and broad acceptance, to the unseating of that consensus by a commercial-political-economic gang that had no coherent or widely accepted replacement philosophy, sharing only the common trait of being contrary.

Anyway, that’s the abbreviation of the Cliff Notes version of the Keynesian Revolution, the establishment of the first coherent policy framework, and the subsequent fall into intellectual chaos.

Before we leave, we’d like to put a period on the following sentence:  Rational Expectations theory has collapsed under the weight of reality.  One of the seminal works of Rational Expectations was the article in a 1974 issue of the Journal of Political Economy entitled “Are Government Bonds Net Wealth?” by Robert Barro.  In the article, Professor Barro argued that there is no difference between taxation and borrowing in financing government expenditure.  Economic agents will regard borrowing as only postponing taxation and will increase their savings to meet that future taxation, thus compensating for government deficits.  They will not view government bonds as part of their wealth.

Again weak from common sense angles, history and evidence of savings patterns during periods of high deficits — until the present — disprove the position.  The practice of government in stimulating the economy dismisses the concern.  The current stimulus is not yet into results, so we do not point to that.  But most damaging is the obvious “flight to quality” which has depressed returns on U.S. bonds — the U.S. being the greatest deficit nation.  This undeniable phenomenon blows the idea that economic agents do not see government bonds as part of their wealth into many smithereens it cannot be possible to but the nonsense back together again.

So, now into more recent history

Shrinking loopholes By John Irons 05-07-09 http://www.epi.org/analysis_and_opinion/entry/shrinking_loopholes/#When:17:44:39Z

Earlier this week, the Obama Administration announced several important proposals to close loopholes that allow multinational corporations to avoid paying taxes, and to crack down on illegal tax evasion by individuals.  These proposed changes are certainly a move in the right direction.

It is now well documented that corporations have been exceptionally successful at using every legal means to game the system to reduce their tax obligations. For example, the GAO has noted that 83 of the 100 largest U.S. corporations have subsidiaries in tax havens; and in 2004 U.S. multinational corporations paid taxes amounting, on average, to just 2.3 percent of their $700 billion in foreign income. Not only do current tax rules allow corporations to dodge their responsibility, but they also create perverse incentives to keep capital investments abroad,  thus encouraging companies to create jobs offshore rather than here at home.

The measures outlined by the administration would also crack down on individuals’ use of tax havens and secretive banks abroad.  By requiring certain banks to share information with the U.S. and by devoting more resources to international tax enforcement, the IRS would have a fighting chance of catching these law-breakers.

The revenue raised by these changes would be used to extend the Research and Experimentation tax credit that was intended to encourage R&D here in the U.S. The tax credit is typically extended piecemeal in one- or two-year increments by Congress. While the current tax credit can and should be improved, adding a measure of certainty is important to allow businesses to properly plan for future expenditures. By paying for the extension, the administration is showing a commitment to fiscal responsibility.

While there are still many tax policy challenges ahead, these common-sense changes are a good first step toward modernizing the tax code so that multinational corporations and wealthy individuals cannot dodge their obligations.

05.08.09

The Spring of the Zombies , by Joseph Stiglitz, Commentary, Project Syndicate: http://economistsview.typepad.com/economistsview/2009/05/stiglitz-the-spring-of-the-zombies.html

As spring comes to America, optimists are seeing “green sprouts” of recovery… The good news is that we may be at the end of a free fall. The rate of economic decline has slowed. The bottom may be near - perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon. Hitting bottom is no reason to abandon the strong measures that have been taken to revive the global economy.

This downturn is complex: an economic crisis combined with a financial crisis. Before its onset, America’s debt-ridden consumers were the engine of global growth. That model has broken down, and will not be replaced soon. … The collapse of credit made matters worse; and firms, facing high borrowing costs and declining markets, responded quickly, cutting back inventories. Orders dropped abruptly …

We are likely to see a recovery in some of these areas… But examine the fundamentals:… real estate prices continue to fall, millions of homes are underwater…, and unemployment is increasing… States are being forced to lay off workers as tax revenues plummet.

The banking system has just been tested to see if it is adequately capitalized - a “stress” test that involved no stress - and some couldn’t pass muster. But, rather than welcoming the opportunity to recapitalize, perhaps with government help, the banks seem to prefer a Japanese-style response: we will muddle through.

“Zombie” banks - dead but still walking among the living - are, in Ed Kane’s immortal words, “gambling on resurrection.” Repeating the Savings & Loan debacle of the 1980’s. the banks are using bad accounting… Worse still, they are being allowed to borrow cheaply from the United States Federal Reserve, on the basis of poor collateral, and simultaneously to take risky positions. …

The American government, too, is betting on muddling through: the Fed’s measures and government guarantees mean that banks have access to low-cost funds, and lending rates are high. If nothing nasty happens - losses on mortgages, commercial real estate, business loans, and credit cards - the banks might just be able to make it through… In a few years time, the banks will be recapitalized, and the economy will return to normal. This is the rosy scenario.

But experiences around the world suggest that this is a risky outlook. Even were banks healthy, the deleveraging process and the associated loss of wealth means that, more likely than not, the economy will be weak. And a weak economy means, more likely than not, more bank losses. …

Fixing the financial system is necessary, but not sufficient, for recovery. America’s strategy for fixing its financial system is costly and unfair, for it is rewarding the people who caused the economic mess. But there is an alternative…: a debt-for-equity swap.

With such a swap, confidence could be restored to the banking system, and lending could be reignited with little or no cost to the taxpayer. It’s neither particularly complicated nor novel. Bondholders obviously don’t like it - they would rather get a gift from the government. But there are far better uses of the public’s money, including another round of stimulus. …

In spite of some spring sprouts, we should prepare for another dark winter: it’s time for Plan B in bank restructuring and another dose of Keynesian medicine.

That from Joseph Stiglitz

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