From the pen of Interfluidity

by on April 9, 2012 at 7:13 am in Economics | Permalink

Post-Keynesians did predict a crisis, on broadly the terms that we actually experienced. They argue that there are adverse side effects to using monetary policy to manage aggregate demand. Although in theory this might be avoidable, post-Keynesians point out that in practice monetary stabilization, even above the zero-bound, seems to engender increasing indebtedness and financial fragility, and to distort activity towards overspecialization in finance and real estate. They pay much more attention to the details of financing arrangements than the other schools, and emphasize that vertiginous collapses of aggregate demand are nearly always accompanied by malfunctions in these arrangements. Aggregate demand, post-Keynesians argue, cannot be managed without concrete attention to the operation of financial institutions and the conditions that lead to their fragility. Post-Keynesians make the deep and underappreciated point that fiscal policy, even if it is conventionally tax-financed, can deleverage the private sector and reduce financial fragility in a way that monetary operations cannot. Monetary operations, if you follow the cash flows, amount to debt finance of the private sector by the public sector. The central bank advances funds today, in exchange for diverting precommitted streams of future cash from the private sector entities to the central bank. Fiscal expansion is more like equity finance of the private sector by the public sector. Public funds are advanced, and captured by parties with weak balance sheets as well as strong. But taxes are not withdrawn on a fixed schedule. They are recouped “countercyclically”, in good times, when private sector agents are most capable of paying them without financial distress. Further, the private sector’s tax liability is distributed according to ex post cash flows realized by individuals and firms, while debt obligations are distributed according to ex ante hopes, expectations, and errors. So tax-financed fiscal policy acts as a kind of balance-sheet insurance. Both by virtue of timing and distribution, taxation is less likely than monetary-policy induced debt service to provoke disruptive insolvency in the private sector. Plus, during a depression, fiscal expansions may never need to be offset by increased taxation…Never-to-be-taxed-back fiscal expenditures, if they are not inflationary, shore up weak private-sector balance sheets without putting even a dent into the financial position of the strong. They represent a free lunch both in real and financial terms.

Here is more, and it is insightful throughout.  I would add two points, both in the skeptical direction:

1. I so rarely hear the post Keynesians utter the word “Congress” in discussions such as this.

2. Fiscal policy does best when it is obvious what should be produced, and there is a political consensus to make that stick, as was the case in 1940-45 for instance.

NAME REDACTED April 9, 2012 at 7:20 am

“2. Fiscal policy does best when it is obvious what should be produced, and there is a political consensus to make that stick, as was the case in 1940-45 for instance.”

Barro *demolished* the ww2 as stimulus theory.

Nathan Tankus April 9, 2012 at 7:30 am

sometimes i feel as if neoclassical economists don’t know the difference between a consumption basket and a balance sheet.

NAME REDACTED April 9, 2012 at 7:49 am

The same is true of the Keynesians it seems.

Nathan Tankus April 9, 2012 at 7:58 am

That’s a joke right? Post-keynesians can be accused of a lot of things, lacking balance sheet analysis is not one of them.

NAME REDACTED April 9, 2012 at 8:17 am

I was accusing them of doing the same thing. However for the PK’s the direction is reversed they use balance sheets when they should be using consumption baskets.

Becky Hargrove April 9, 2012 at 10:26 am

By looking at the entire shape the consumption basket takes, and the degree of obligation of economic actors one to the other(circles of sustainability), more sustainable flows overall help the balance sheet. It’s like knowing your checkbook has a better chance of balancing if one’s obligations are actually lie within reach.

jonm April 9, 2012 at 12:56 pm

It’s a bit more nuanced than that. Here’s Barro, from his January 22, 2009 op-ed, “Government Spending Is No Free Lunch “:

“I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. ”

http://online.wsj.com/article/SB123258618204604599.html

TallDave April 9, 2012 at 4:49 pm

Well, that does help explain all the rationing.

TallDave April 9, 2012 at 4:54 pm

http://www.ameshistoricalsociety.org/exhibits/events/rationing.htm

It’s really very odd that 70 years later this period is held up as a model of economic good times.

NAME REDACTED April 9, 2012 at 5:46 pm

I think its beyond odd. I think it reaches the point of dishonest.

Nathan Tankus April 9, 2012 at 7:31 am

This is quite a fair post by the way Tyler.

Andrew' April 9, 2012 at 8:15 am

That and the Roman Empire, right?

NAME REDACTED April 9, 2012 at 8:21 am

“Never-to-be-taxed-back fiscal expenditures, if they are not inflationary, shore up weak private-sector balance sheets without putting even a dent into the financial position of the strong. They represent a free lunch both in real and financial terms.”

If by “inflationary” you mean ‘do not cause a larger CPI’, then this statement is just wrong. Monetary expansion or contraction is never a free lunch, there are winners and losers to every such movement.

NAME REDACTED April 9, 2012 at 8:22 am

Furthermore there can be many situations where CPI doesn’t budge but dangerous bubbles are formed instead from the excess money.

sc April 9, 2012 at 12:34 pm

Yep, isn’t that the essence of the problem with the desire to “shore up weak private-sector balance sheets”. When incentives and moral hazard are included as costs TANSAFL surely still holds.

NAME REDACTED April 9, 2012 at 5:47 pm

Very true! Plus the most important things in economics are success and failure. If you screw with that, you destroy the evolutionary nature of the market.

PD April 9, 2012 at 12:23 pm

This discussion goes a long way to distilling the salient points from the pedantic minutiae. It seems wise to coordinate fiscal and monetary policy with the logical consequence that fiscal policy becomes less political. The benefits described appear sensible but I’m bothered by key decisions becoming technocratic without a fair process for evaluating the uncertainties of unintended consequences created. In other words, how do you avoid a process that’s overly technocratic? It seems to me you need some elements of a political process (and all the problems that come with it) to hold technocratic uncertainty in check.

Floccina April 9, 2012 at 2:09 pm

Every time I read the post Keynesian’s views I think free banking would do some of the things that they want to accomplish through government action. I of course may not be correctly envisioning where free bank would have taken us had we allowed it from the beginning of the USA.

UnlearningEcon April 10, 2012 at 4:28 am

Free banking doesn’t deal with the LP theory of interest which most PKs endorse. I think PKS also advocate the CB as a lender of last resort.

To April 9, 2012 at 2:22 pm

1. I so rarely hear the post Keynesians utter the word “Congress” in discussions such as this.

There is no substitute for a functioning democracy ?…

2. Fiscal policy does best when it is obvious what should be produced, and there is a political consensus to make that stick, as was the case in 1940-45 for instance.

Note many P-K’s advocate fiscal stabilization to be performed by a job guarantee program. It supposes government can find remotely useful things to be done by unemployed workers, though. It could be done by subsidizing private hiring instead. Imagine drawing lists of unemployed people, and letting potential employers bid a subsidy amount to hire someone at their previous salary. The lowest bids win. In good times, this would clear at a near-zero value.

Of course people will object to being auctioned off, but that’s a job for the PR department.

Barkley Rosser April 9, 2012 at 3:17 pm

This generally reasonable post by Interfluidity (and Tyler) raises the point of divisions within the PKs (no hyphen, that is strictly a British thing). Most particularly, the MMT sub-group that has gotten lots of publicity recently and has strong bases at UMKC and the Levy Institute would strongly disagree with portions of this post, particularly the argument about monetary policy possibly leading to greater fragility. Many of them do not see that as a problem.

However, I would say that the PKs who did forecast things most closely to how they turned out, and I would say that particular sub-group probably did better at it than any other clearly identifiable sub-group of economists (think people like Dean Baker, Nouriel Roubini, Steve Keen, and some others who will remain unnamed here now, hack cough, :-)) are not so clearly tied to MMT (although Keen has exhibited some sympathy for it in the recent debates with Krugman). I do not keep track of exactly how often these people talk about Congress or not (Dean Baker certainly says plenty about them; Keen is in Australia), but certainly in the US Congress is where one must go to do fiscal policy of any sort obviously.

BTW, the people most strongly tied to the full employment guarantee policy are also MMTers, although some of the others are at least somewhat sympathetic to such ideas, if not necessarily in the same form as pushed by the CFEPS at UMKC..

(On the matter of hyphenating versus non-hyphenating PK econ, the US PKs identify doing so with Paul Samuelson’s labeling of his own position and that of other what we would now call “Old Keynesians” or “neo-Keynesians” as “eclectic post-Keynesianism,” something that does not bother the non-US-based PKs as much.)

TallDave April 9, 2012 at 4:47 pm

2. Fiscal policy does best when it is obvious what should be produced, and there is a political consensus to make that stick, as was the case in 1940-45 for instance.

People often seem to conveniently forget there was a lot of rationing and, ahem, austerity in 1940-45, not to mention tens of millions of deaths. Just because GDP goes up does not necessarily mean life is getting better, especially for the people you’re dropping bombs on.

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