Defunct but still dominant and dangerous

I am reserving Friday’s for no blog, short blog or normal blog depending on whether I can do other things and keep my weekend’s free of blog activity. In general I will use Friday’s to put a Quiz up for Saturday and prepare the Answers and Discussion for Sunday. If I have some “blog” time left and there is something interesting to write about then I will post it – like today. There was an interesting article in the UK Guardian (July 21, 2010) by Robert Skidelsky who was the biographer of John Maynard Keynes. The article – What do deficit slashers wear under their hair shirts? – probes the “assumptions made by the economists who demand rapid ‘fiscal consolidation'”. I thought that was interesting given that most of the published justifications for austerity rather vaguely invoke failed economic theories like Ricardian Equivalence and Rational Expectations. Skidelsky’s point is that these defunct macroeconomic doctrines which got us into this mess are now resurfacing as the dominant narrative. That spells disaster.

Skidelsky begins:

All intellectual systems rely on assumptions that do not need to be spelled out because all members of that particular intellectual community accept them. These “deep” axioms are implicit in economics as well but, if left unscrutinised, they can steer policymakers into a blind alley. That is what is happening in today’s effort, in country after country, to slash spending and bring down budget deficits.

I think this is an essential point for people to understand. The mainstream economists hide behind lies. Most of the time they claim their policy recommendations are derived from economic theory. The reality is that they are not and economists lie and obsfucate.

There are many situations where strident policy suggestions – like the austerity packages – cannot be based on the economic theory that they are associated with – on the theories that economists use to give an air of authority and legitimacy to what are otherwise demands based on their blind ideology.

Unfortunately, the public is not in a position to judge and get swamped by the arrogance of economists. They never realise that the policy statements being made are rarely traceable in any legitimate way to the theories being held out as the authority for the statements. They never realise that most of the theories fail to have any traction if the underlying assumptions do not hold in their entirety.

Given they rarely (if ever) do, then there is no theoretical authority.

In 1956 two economists (Richard Lipsey and Kelvin Lancaster) came up with a very powerful new insight which was called the Theory of the Second Best. You won’t hear much about the theory any more because like all the refutations of mainstream theory it got swept under the dirty (filthy) neoclassical carpet and economics lecturers using homogenised, ideologically-treated textbooks continue blithely as if nothing happened.

The Theory of Second Best basically says that if all the assumptions of the mainstream theory do not hold then trying to apply the results of the theory is likely to make things worse not better. So “if one optimality condition in an economic model cannot be satisfied, it is possible that the next-best solution involves changing other variables away from the ones that are usually assumed to be optimal” (Source).

Take the model of perfect competition which requires several assumptions to be valid (for example, perfect information, perfect flexibility of prices, perfect foresight, no market power being wielded by firms, workers or anyone etc) for the main theoretical insights (results) to have validity.

Economists often say that governments should try to dismantle real world “rigidities” (as they call them) so that they can move the economy closer (but not to) perfect competition – because in their fantasy comic book texts this is the ideal state.

The Theory of Second Best tells us that if you do not have that “ideal state” and you dismantle one “rigidity” but leave others then you can make things worse off. The other point is that often it is “better” for governments to introduce new “rigidities” to confront existing departures from perfect competition.

It is all in the “counting angels on the top of a pinhead” territory that us economists spend most of our tawdry careers engaged in as if it matters but the point is that the theory really destroys the capacity of the mainstream economists to use “perfect competition” models as an authority in the policy debate. The text book models have no legitimacy in the policy domain. You might like to read Paul Krugman’s take on Lancaster’s work.

Another example of the way theory is misused in the policy debate is in the application of Ricardian Equivalence. It is one of the theories being used at present to legitimise the austerity push The modern version was developed by Robert Barro at Harvard.

First, start with the mainstream view that: (a) In the short-run, budget deficits are likely to stimulate aggregate demand as long as the central bank accomodates the deficits with loose monetary policy; and; (b) in the long-run, the public debt build-up crowds out investment because it competes for scarce savings.

I have written countless words to show how farcical this view of the monetary system is. First, deficits put downward pressure on the interest rate and central banks issue debt to stop that downward pressure from arresting control from them of their target interest rate. Second, there is no finite pool of saving except at full employment. Income growth generates its own saving (investment brings forth its own saving) and governments just borrow back the funds (drain bank reserves) $-for-$ that the deficits inject anyway.

But lets just start with the mainstream view. Barro then said that the government does “our work” for us. It spends on our behalf and raises money (taxes) to pay for the spending. When the budget is in deficit (government spending exceeds taxation) it has to “finance” the gap, which Barro claims is really an implicit commitment to raise taxes in the future to repay the debt (principal and interest).

Under these conditions, Barro then proposes that current taxation has equivalent impacts on consumers’ sense of wealth as expected future taxes.

For example, if each individual assesses that the government is spending $500 this year per head and collects $500 per head “to pay for it” then the individual will cut consumption by $500 because they are worse off.

Alternatively, if the individual perceives that the government has spent $500 this year but proposes to tax him/her next year at such a rate that the debt will be cleared then the person will still be poorer over their lifetime and will probably cut back consumption now to save the money to pay the higher taxes.

So the government spending has no real effect on output and employment irrespective of whether it is “tax-financed” or “debt-financed”. That is the Barro version of Ricardian Equivalence.

The models suggest that individuals assess the total stream of income and taxes over their lifetime in making consumption decisions in each period.

On tax cuts, Barro wrote (in ‘Are Government Bonds Net Wealth?’, Journal of Political Economy, 1974, 1095-1117):

This just means that lower taxes today and higher taxes in the future when the government needs to pay the interest on the debt; I’ll just save today in order to build up savings account that will be needed to meet those future taxes.

So what are the assumptions that Barro makes which have to hold in entirety for the logical conclusion he makes to follow? Note this is not to say that any of his reasoning is a sensible depiction of the basic operations of a modern monetary system. It just says that if we suspend belief and go along with him for the ride then the only way he can derive the conclusions from his model that he does requires the following assumptions to hold forever.

Should any of these assumptions not hold (at any point in time), then his model cannot generate his conclusions and any assertions one might make based on this work are groundless – meagre ideological raving.

First, capital markets have to be “perfect” (remember those Chicago assumptions) which means that any household can borrow or save as much as they require at all times at a fixed rate which is the same for all households/individuals at any particular date. So totally equal access to finance for all.

Clearly this assumption does not hold across all individuals and time periods. Households have liquidity constraints and cannot borrow or invest whatever and whenever they desire. People who play around with these models show that if there are liquidity constraints then people are likely to spend more when there are tax cuts even if they know taxes will be higher in the future (assumed).

Second, the future time path of government spending is known and fixed. Households/individuals know this with perfect foresight. This assumption is clearly without any real-world correspondence. We do not have perfect foresight and we do not know what the government in 10 years time is going to spend to the last dollar (even if we knew what political flavour that government might be).

Third, there is infinite concern for the future generations. This point is crucial because even in the mainstream model the tax rises might come at some very distant time (even next century). There is no optimal prediction that can be derived from their models that tells us when the debt will be repaid. They introduce various stylised – read: arbitrary – time periods when debt is repaid in full but these are not derived in any way from the internal logic of the model nor are they ground in any empirical reality. Just ad hoc impositions.

So the tax increases in the future (remember I am just playing along with their claim that taxes will rise to pay back debt) may be paid back by someone 5 or 6 generations ahead of me. Is it realistic to assume I won’t just enjoy the increased consumption that the tax cuts now will bring (or increased government spending) and leave it to those hundreds or even thousands of years ahead to “pay for”.

Certainly our conduct towards the natural environment is not suggestive of a particular concern for the future generations other than our children and their children.

Barro’s theorem led to a torrent of empirical work, particularly after the US Congress gave out large tax cuts in August 1981, which was the first real world experiment possible (that is, if you consider the US as they do to be the real-world!).

The tax cuts were legislated to be given over 1982-84 to stimulate aggregate demand. Barro’s adherents all predicted there would be no change in consumption and saving should have risen to “pay for the future tax burden” which was implied by the rise in public debt at the time.

But, if you examine the US data you will see categorically that the personal saving rate fell between 1982-84 (from 7.5 per cent in 1981 to an average of 5.7 per cent in 1982-84).

Once again this was an example of a mathematical model built on un-real assumptions generating conclusions that were appealing to the dominant anti-deficit ideology but which fundamentally failed to deliver predictions that corresponded even remotely with what actually happened.

Barro’s RE theorem is a dismal failure and cannot be used as an authority for the type of statements I noted earlier. Please read my blogs – Deficits should be cut in a recessionWe are sorrySpending multipliers and Pushing the fantasy barrow – for more discussion on the poverty of the Ricardian Equivalence notion.

Skidelsky continued:

The chief task that John Maynard Keynes set himself in writing his General Theory of Employment, Interest, and Money was to uncover the deep axioms underlying the economic orthodoxy of his day, which assumed away the possibility of persistent mass unemployment. The question he asked of his opponents was: “What must they believe in order to claim that persistent mass unemployment is impossible, so that government ‘stimulus’ to raise the employment level could do no good?” In answering this question, Keynes reconstructed the orthodox theory – and then proceeded to demolish it.

Today, despite the Keynesian revolution, the same question demands an answer. What do people who demand rapid “fiscal consolidation” amid heavy unemployment need to believe about the economy to make their policy coherent?

This is very important because the bullies (G20, the IMF and the OECD and the market economists and academic commentators) are all pushing the line that pro-cyclical budgets at a time when private spending growth is weak or non-existent “is the only way back to prosperity”.

At the very least this defies the logic that firms are not investing because they cannot sell enough goods and services at present and consumers are not spending because they fear rising unemployment and they are trying to reduce their debt levels.

All the empirical evidence points to this being an large-scale aggregate demand failure. That means a spending failure. If the non-government sector has cut its spending and is reluctant to restore its growth then there is only one sector left!

The mainstream austerity proponents seem to think that in this environment if the government joins the wowser brigade and cuts back too the private sector will start to feel good despite unemployment rising and sales falling and start spending. They apparently will start to relish the prospect of lower taxes in the future because the deficit will be lower.

And at that point I always conclude these proponents have not studied history properly and do not have a clue about the way budgets work and the way way they interact with the monetary system.

Skidelsky notes that:

When I ask this question, I never get a coherent answer; so let me retrace Keynes’s steps.

Mainstream macroeconomists are deft at avoiding discussion outside the narrow box they operate in. I have had a career of this sort of non-engagement. I have met so many walls of arrogant denial that I became used to it very early.

Skidelsky provides his readers with a refresher on the so-called “Keynes and the Classics” debate which pitted the UK Treasury view in the 1930s with the emerging views that became identified with Keynes but were also developed by several others (Kalecki, Marx etc).

A major flaw in the mainstream reasoning in the 1930s (and still today) surrounds the so-called “Say’s law” which claims that “supply creates its own demand”. Say’s law denies there can ever be over-production and unemployment. If consumers decide to save more then the firms react to this and produce more investment goods to absorb the saving. There is total fluidity of resources between sectors and workers are simply shifted from making iPods to making investment goods.

Keynes showed that when people save – they do not spend. They give no signal to firms about when they will spend in the future and what they will buy then. So there is a market failure. Firms react to the rising inventories and cut back output – unable to deal with the uncertainty.

The break with neoclassical thinking came with the failure of markets to resolve the persistently high unemployment during the 1930s. The debate in the ensuing years were largely about the existence of involuntary unemployment. The 1930s experience suggested that Say’s Law, which was the macroeconomic component and closure of the neoclassical system based on the optimising behaviour of individuals, did not hold.

The neoclassical economists continued to assert that unemployment was voluntary and optimal but that some factors not previously included in the model prevented Say’s Law from working. Keynes, following Marx and Kalecki, adopted the distinctly anti-orthodox approach and refuted the basis of Say’s Law entirely.

The theoretical push to reassert Say’s Law by neoclassical economists was severely dented by the work of Clower (1965) and Axel Leijonhufvud (1968). They demonstrated, in different ways, how neoclassical models of optimising behaviour were flawed when applied to macroeconomic issues like mass unemployment.

Clower (1965) showed that an excess supply in the labour market (unemployment) was not usually accompanied by an excess demand elsewhere in the economy, especially in the product market. Excess demands are expressed in money terms. How could an unemployed worker (who had notional or latent product demands) signal to an employer (a seller in the product market) their demand intentions?

Leijonhufvud (1968) added the idea that in disequlibrium price adjustment is sluggish relative to quantity adjustment. Leijonhufvud interpreted Keynes’s concept of equilibrium as being actually better considered to be a persistent disequilibrium. Accordingly, involuntary unemployment arises because the labour market is not in equilibrium and there is no way that the unemployed workers can signal that they would buy more goods and services if they were employed.

Any particular firm cannot assume their revenue will rise if they put a worker on even though revenue in general will clearly rise (because there will be higher incomes and higher demand). The market signalling process thus breaks down and the economy stagnates.

Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

Skidelsky notes that:

Say’s law is alive and well among new classical macroeconomists such as John Cochrane and Eugene Fama. It amounts to claiming that the factors of production will always be fully employed, and that, in Cochrane’s words, “if the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment.”

So a theory that was categorically reduced to having zero validity in a previous time has remained alive in the conservative economics departments and is once again being used to justify the ideological policy positions. How many government officials who are designing these austerity programs are familiar with the “Keynes and Classics” debate and the subsequent contributions of Robert Clower (1965) and Axel Leijonhufvud (1968), for example? Not many!

Skidelsky says that the other contribution of Keynes is being ignored:

The second classical postulate Keynes identified was that the “real wage is equal to the marginal disutility of labour”. This means that, in a competitive labour market, real wages will always be instantly adjusted to changes in conditions of demand. In other words, there can never be involuntary, or unwanted, unemployment.

Keynes denied that real wages are set in the labour market. Workers bargain for money wages, and a reduction in their money incomes might leave total demand too low to employ all those willing to work. Yet today most economists model unemployment as “voluntary” – a rational preference for leisure rather than work. This reinforces the idea that “stimulus” cannot do any good, since workers have as much employment as they want.

The mainstream position on unemployment is based on a fallacy of composition. Macroeconomics emerged out of the failure of mainstream economics to conceptualise economy-wide problems – in particular, the problem of mass unemployment. Please read my blog – What causes mass unemployment? – for more discussion on this point.

Marx had already worked this out and you might like to read Theories of Surplus value where he discusses the problem of realisation when there is unemployment.

In my view, Marx was the first to really understand the notion of effective demand – in his distinction between a notional demand for a good (a desire) and an effective demand (one that is backed with cash).

This distinction, of-course, was the basis of Keynes’ work and later debates in the 1960s where Clower and Axel Leijonhufvud demolished mainstream attempts to undermine the contribution of Keynes by advancing a sophisticated monetary understanding of the General Theory.

The point is that prior to this the mainstream failed to understand that what might happen at an individual level will not happen if all individuals do the same thing. In terms of their solutions to unemployment, they believed that one firm might be able to cut costs by lowering wages for their workforce and because their demand will not be affected they might increase their hiring.

However, they failed to see that if all firms did the same thing, total spending would fall dramatically and employment would also drop. Again, trying to reason the system-wide level on the basis of individual experience generally fails.

Wages are both a cost and an income. The mainstream ignored the income side of the wage deal. The technical issue comes down to the flawed assumption that aggregate supply and aggregate demand relationships are independent. This is a standard assumption of mainstream economics and it is clearly false.

Mass unemployment occurs when there are not enough jobs and hours of work being generated by the economy to fully employ the willing labour force. And the reason lies in there being insufficient aggregate spending of which the net spending by government is one source.

The erronous mainstream response to the persistent unemployment that has beleaguered most economies for the last three decades is to invoke supply-side measures – wage cutting, stricter activity tests for welfare entitlements, relentless training programs. But this policy approach, which has dominated over the neo-liberal period, and reflects their emphasis on the individual falls foul of the fallacy of composition problem.

They mistake a systemic failure for an individual failure. You cannot search for jobs that are not there. The main reason that the supply-side approach is flawed is because it fails to recognise that unemployment arises when there are not enough jobs created to match the preferences of the willing labour supply.

The research evidence is clear – churning people through training programs divorced from the context of the paid-work environment is a waste of time and resources and demoralises the victims of the process – the unemployed.

Skidelsky’s final point is worth noting:

The classical view of the economy, which Keynes set out to demolish, is not only alive, but in recent years has been dominant, feeding the belief that competitive markets can be left to regulate themselves, will always provide as much employment as is wanted, and are immune to large-scale collapse. This also fuels opposition to government intervention, and to “stimulus” policies, which are supposedly redundant, if not harmful, since the events that require them cannot happen (but do).

Yes, and the application of these ideological beliefs to real policy will not only undermine short-term prosperity but will set the conditions for a further major crisis in the coming years and ultimately, ugly social unrest.

Conclusion

I heard an idiot from the right-wing Centre of Independent Studies last night being interviewed on the ABC’s new 24-hour news channel. I cannot find the transcript but it would have been a good way to finish the week – comic relief. He was talking about the Australian election campaign which is now in full swing. Both sides of politics are trying to win votes by preaching the virtues of austerity when we still have 12.2 per cent (minimum) of our willing labour resources not working! Go figure that!

His mantra was “the Government has run out of money. The government has no more money left. Whoever wins will have to cut back”. My eyes rolled at that stage and it is lucky I am not prone to temper tantrums or I would have replaced many TV sets.

The important point is that the ABC has the audacity to put this galoot in front of our nation in the first hour of launching their new channel. It was an appalling interview and shows that charlatans exist everywhere. It reminded me of something that Fox would show in America not something that our publicly-funded national broadcaster should be showing here. It just shows how far things have slipped.

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    25 Responses to Defunct but still dominant and dangerous

    1. Senexx says:

      You’re not referring to someone from the IPA are you? Easy to get that and the CIS confused.

    2. bill says:

      Dear Senexx

      No names but he was from the CIS.

      best wishes
      bill

    3. This is off topic. Bill’s last item on full reserve banking (a few weeks ago) said MMT was indifferent to full reserve. I just discovered that the governor of the Bank of England is in favour of full reserve and clamping down on maturity transformation. Also the The Basel Committee on Banking Supervision is thinking along similar lines. See respectively:

      http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article7005471.ece

      http://www.zerohedge.com/article/remarks-bill-dudley-australia-dodecatuple-secret-banker-meeting-where-we-have-been-where-we- (word search for “Basel committee”)

      So things may be moving in this area. I suggest Bill blogs some more on this, if he is to keep up.

    4. Stephan says:

      Apropos assumptions. Yesterday I read some of the statements of economists made to the US House Committee on Science and Technology on “Building a Science of Economics for the Real World”. Basically Solow and Colander told the politicians that dominant macro models fantasy land. Solow: “I do not think that the currently popular DSGE models pass the smell test.” And Colander advocates that the NSF starts to include a wider range of peers including heterothox economists and people with real world experience to overcome the current state of inbreeding in economics. You can read more here:

      http://science.house.gov/publications/hearings_markups_details.aspx?NewsID=2876

      I’m pretty sure the impact of these statements and recommendations on mainstream macro-economists will be: Hear. Hear. And then they will continue tinkering with their DSGE models and pontificating their model-derived propaganda to the public.

    5. john says:

      Stephan,
      There has been a noticeable uptick in the financial press in references to the “sectorial approach” while “economists” with their sunk personal capital invested in cant and dogma will go back to their fetishes. Because MMT makes testable hypothesis’ and tends to correlate with obvious macro data people who work in the markets, once properly introduced to MMT seem to appreciate its insights: they can be acted upon.

      The dogmatic inertia consequent from the lock on “prestige”, and more importantly funding, neo-classical economics has achieved is to my mind the single best argument global warming is a hoax: the GW denialists base their denial on the premise that climate scientists are paid to see global warming so they find it everywhere and should not be trusted; economists are paid to see the short term interests of the financial institutions that pay them and thus see inflation everywhere and should not be trusted. Still my money is on the climate scientists.

      I say forget economists, their sunk capital will sink them. Sell these ideas directly to the markets and there are enough smart people there that MMT will take root. As an entrepreneur and employer, an executive, I don’t quite share Bill’s disdain for that class. There are plenty of us out there who understand that our profits and ability to employ people are demand driven. To anyone in that position who thinks about it, the current demand deficiency is obvious but the “mainstream” opinion is oblivious. Mainstream has no credibility.

      I logged into this site six months ago essentially a defacto neo-classicist but puzzled by two years of systematic predictive failure on the part of the entire American political economy. Two years ago we were “winning in Iraq”, “a surge would bring victory in Afghanistan”, “the Fed had stabilized the markets”, “TARP would fix the financial industry”, “the recession (if it wasn’t just a bunch of liberal carping) would be a sharp V” and Obama had no chance against the Clinton machine.

      Bill is fighting the urge to smash TVs in his penultimate paragraph because he made the mistake of looking for information there. If it is on TV, it’s entertainment: if your tastes run toward rage, watch FOX; if you prefer to laugh, watch Jon Stewart. As yet the new media paradigm failed to congeal on the information side only individual bloggers thus far can prove themselves trust worthy as filters by their honesty in addressing their own errors.

      The mainstream has discredited itself to a degree not seen since stagflation and the Viet Nam War conspired to destroy the credibility of the New Deal. The supply side era that followed has a lot less to recommend it than the New Deal had but has succeeded in changing the laws to legalize graft and propaganda. At least in the US.

      Unfortunately it looks like the UK is about to run a double blind (Cameron and Clegg) experiment in macro-economics. The stupidity of subjecting 60,000,000 citizens to this Neo-Liberal Great Leap Forward combined with Asia’s resounding success managing stimulus should clear the air at the macro altitude, at least for those of us who’s lives are not devastated by the folly.

    6. Stephan says:

      @John: Well said!

    7. Fed Up says:

      “A major flaw in the mainstream reasoning in the 1930s (and still today) surrounds the so-called “Say’s law” which claims that “supply creates its own demand”. Say’s law denies there can ever be over-production and unemployment. If consumers decide to save more then the firms react to this and produce more investment goods to absorb the saving. There is total fluidity of resources between sectors and workers are simply shifted from making iPods to making investment goods.

      Keynes showed that when people save – they do not spend. They give no signal to firms about when they will spend in the future and what they will buy then. So there is a market failure. Firms react to the rising inventories and cut back output – unable to deal with the uncertainty.”

      I’ll try to keep this simple. Can debt cause say’s law to be violated?

      The rich people and the rich corporations save and then “convince” the lower and middle class into debt giving the appearance of supply and demand being in balance IN THE PRESENT BUT NOT NECESSARILY IN THE FUTURE.

      iPods and Apple is a good example. How much medium of exchange is Apple sitting on? Maybe 40 billion?

    8. Fed Up says:

      “Third, there is infinite concern for the future generations. This point is crucial because even in the mainstream model the tax rises might come at some very distant time (even next century). There is no optimal prediction that can be derived from their models that tells us when the debt will be repaid. They introduce various stylised – read: arbitrary – time periods when debt is repaid in full but these are not derived in any way from the internal logic of the model nor are they ground in any empirical reality. Just ad hoc impositions.”

      I see this not knowing when the debt will be repaid as a BIG problem. Why shouldn’t gov’t debt have “interest payments” that include both interest and principle being paid back so that there is NO rollover risk?

    9. Keith Newman says:

      A galoot??

    10. bill says:

      Dear Keith

      http://en.wikipedia.org/wiki/Galoot

      “a person with an ungainly, cumbersome, and clumsy personality”.

      It can also be somewhat more perjorative than this if you want it be.

      best wishes
      bill

    11. Alan Dunn says:

      Fed Up,

      Generally speaking the adjustment in the short-term is assumed to be of a non-price nature. For Say’s Law to hold unintended inventories must be equal to zero.

      Finding examples of when Say’s Law is violated is very easy. The hard part is finding a situation when it holds. Even some hardcore Austrians don’t expect Say’s Law to hold in anything other than its identity form.

      The work Bill mentioned earlier by Leijonhufvud is pretty much acknowledged as sound even amoung our good friends the Austrians. My former PhD supervisor who was an Austrian economist even gave me a copy of Leijonhufvud’s book when I asked her of the Austrian position with respect to Say’s Law.

    12. pebird says:

      One problem I have had with Say’s Law is that it is counter to micro behaviors.

      If I am a firm and all inventories clear – I don’t know how much I under-produced. Optimally, there should be one remaining unit that does not clear – that would identify demand.

      So, there is an incentive to market participants to over-produce, there are low incremental costs and high information value knowing when the market is glutted.

    13. Min says:

      Fed Up: “I see this not knowing when the debt will be repaid as a BIG problem.”

      Unless we change how we create our money, the answer is easy: We will never repay the national debt. Andrew Jackson did it, and ushered in the depression of 1837. Every time we have significantly paid down the debt since then, the result has been a recession or depression. As long as it is debt for dollars, we cannot afford to pay off the debt, because we need the money.

    14. Blissex says:

      «In 1956 two economists (Richard Lipsey and Kelvin Lancaster) came up with a very powerful new insight which was called the Theory of the Second Best. You won’t hear much about the theory any more because like all the refutations of mainstream theory it got swept under the dirty (filthy) neoclassical carpet and economics lecturers using homogenised, ideologically-treated textbooks continue blithely as if nothing happened.»

      I have always wondered about this, and I learned about it in my undergrad days, and I have been mentioning it as demolishing the relevance of the pernicious Arrow-Debreu-Lucas model for quite a few years in my comments on various blogs. Perhaps people have read those comments as it seems to have become mentioned a lot more often since (for example in Yves Smith’s book). Sure people like you (and Steve Keen, but his book did not give it enough prominence) have always known, but it is nice that it is being dragged out the carpet.

      If the Second Best theorem had not been conveniently forgotten a lot of interesting research could have happened. But then Arrow-Debreu-Lucas is the core tool for proving the central verity of Economics, which is that the distribution of income depends solely on merit, and high incomes are always justified by higher productivity (see Jim Cayne, Stephen Fuld, …) and thus must be upheld at any cost.

    15. Blissex says:

      «The mainstream has discredited itself to a degree not seen since stagflation and the Viet Nam War conspired to destroy the credibility of the New Deal.»

      Those may have wounded the credibility of “fine tuning” keynesianism, to usher in Greenspan’s “fine tuning” monetarism, which proved as credible (or less).

      The credibility of the New Deal was destroyed by the black riots, that terrified the white working class, and by the increasing rise into the middle class of that same white working class composed largely of irish, jewish and italian descent workers, who became property and stock owners, and this petty landlords and bourgeoisie. and whose children went to uni and also got into the property owning middle classes.

      As Grover Norquist described so well:

      The growth of the investor class–those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result — is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.

      http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=11699

      The 1930s rhetoric was bash business — only a handful of bankers thought that meant them. Now if you say we’re going to smash the big corporations, 60-plus percent of voters say “That’s my retirement you’re messing with. I don’t appreciate that”. And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, “We’re sorry about the seals and everything but we really got to get the stock market up.

    16. Agog says:

      Regarding Say and his law, Dirk Bezemer in his No-one saw it coming paper (that I linked to not long ago) contends that he has been widely misconstrued, and that he in fact was an antecedent of those making use of accounting identities in modern economic analysis.

      “If the Physiocrats were économistes, then Say’s was an accountant’s approach to the
      national economy. The point he made in the Law that bears his name (‘production creates its own
      demand’) was not about a tendency to equilibrium. Say’s Law was not that in a free market,
      demand and supply will automatically equilibriate though the price mechanism leading to full
      employment – an interpretation of it that Keynes attacked during the Great Depression.
      Say’s Law is an accountant’s logical equality: all sold output will be bought. “Inherent in supply is the
      wherewithal for its own consumption”, is the literal translation from the French. The purchasing
      power embodied in the funds acquired by producers to produce goods, passes via wages and profit
      to become the funds that embody the demand for those goods. Though this is an axiom, it is not
      therefore a tautology without analytical use. As demonstrated above, it is the very logical
      completeness of accounting models that allows for their distinctive forecasting ability, e.g. on how
      sustainable debt-driven growth is. For instance, it implies that if the funds acquired by producers to
      produce goods are drained to the FIRE sector in debt servicing, this will interrupt the productive
      flow of fund and so disrupt economic growth.”

    17. Greg says:

      Bill

      I would like some clarification.

      You said “Keynes showed that when people save – they do not spend”

      Is it not true that most “saving” today is in fact spending? When I “save” by “buying” a stock or bond (on the secondary market) I am spending on a financial product am I not? I am adding to GDP and supporting jobs in the financial sector. When I decide to pay down debt, that money is simply extinguishing a liability and not adding to GDP correct? So isnt the only “saving” in Keynes’ definition debt repayment? The other “saving” is simply buying something I hope to sell later but it is still something which adds to GDP. Right?

      Thanks

    18. ParadigmShift says:

      Greg

      Good question, and I am not really the best person to answer it, but I’ll have a stab anyway.

      I’m pretty sure that buying a bond on the secondary market doesn’t add to GDP, since it’s just an exchange of claims. Otherwise, GDP could be inflated simply by paper shuffling.

      I think it is the non-spending on consumption goods or services, out of income, that is considered “saving”. It doesn’t mean “not spending” in general.

      I could be wrong and if so, hopefully someone more in the know will correct me.

    19. Sergei says:

      Greg, one can only save in cash or government bonds. Everything else counts as (your) spending with your money being transferred to the seller and the question is then what the seller does with this money. As ParadigmShift said that is just an exchange of claims. It is exactly in this sense why existing home sales are irrelevant for GDP but new home sales are critical: the former is exchange and the latter is spending.

      And at the end of the chain this money stays in cash or goes government securities.

    20. Greg says:

      Thanks paradigm shift and sergei

      I am under the impression that GDP is national income. Anything which ends up going to someones income (not capital gains) is counted in GDP. If I’m correct than reselling houses and stocks/bonds generates incomes for brokers of real estate and stock, generates incomes for mortgage lenders and the like and generates incomes for those insuring these things. I realize that not all the $300,000 I pay for someone elses house is counted in GDP but a rather significant portion is, is it not?

      My main point is that investment as Bill uses the term is that which generates NEW sources of income (I’m paraphrasing so correct me if I’m wrong Bill) and that some of what we term savings does in fact do that. However to look at what we purchase with our savings and calll that investment is incorrect. The savings we have result from someone elses investment, right?

    21. Sergei says:

      Greg, no transaction happens for free and there are always leakages to third parties who can obviously save from their income. But as Tom said in comments to another post, a blog post carries a simplified message and not a full and comprehensive story.

      The way I look at saving/investment problem is the following.

      Firstly I try to keep in my mind that savings from macro perspective can not be directly measured in contrast to any other macro component of national accounts. So I consider savings as a matching category which equates everything else. I do not think I am terribly wrong here and it helps to keep my mind clear.

      Secondly, I try to think in terms of two-period economy. The reason for this is that income in the first period defines spending in the second. At the same time spending in the first period defines investment in the second.

      Now, when we get to the second period spending and investment decisions are already fixed and are being executed upon. If you look now at supply and demand stories of GDP then the original spending plans represent current consumption. Now we need to add original investment plans as part of GDP on the demand side and they become savings on the supply side because savings are required to balance everything out. Obviously it is not about any particular serial number of the dollar bill which becomes savings but rather about macro flow as to how savings are created in the context of GDP production.

      I know it is a confusing explanation and maybe somehow could handle it better :)

    22. Min says:

      Sergei: “I know it is a confusing explanation and maybe somehow could handle it better”

      It is puzzling to find

      S = I

      in one place and

      (S – I)

      as a term in another!

    23. Sergei says:

      Min, good point.

      S = I is accounting for any given period and S is picked to match I

      (S – I) defines the change during the period. Any change requires two time points: beginning of the period and end. So if your initial savings were lower than investments made then you financial balance got worse. And of course somebody’s spending is another person’s income and savings

    24. Min says:

      Sergei: “S = I is accounting for any given period and S is picked to match I

      “(S – I) defines the change during the period. Any change requires two time points: beginning of the period and end. So if your initial savings were lower than investments made then you financial balance got worse.”

      So (S – I) might (more clearly) be written (S(0) – I(1))? (I don’t do subscripts. ;))

    25. Sergei says:

      Min, that is my understanding. Will appreciate anyone to do it better :)

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