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Sarah Quinn: Federal Credit Programs and the Birth of Lemon Socialism

President John F. Kennedy once said that success had many fathers, whereas failure was an orphan.  One wonders what he would have made of today’s Federal credit programs, a vast network whose obscure political origins have finally been laid bare by sociologist Sarah Quinn of the University of Washington. As Professor Quinn, an Institute grantee, points out in the interview below, government-originated credit programs barely existed before the time of the Great Depression until, in 1934, the New Deal chartered the Federal Housing Administration to stimulate mortgage lending. It’s hard to believe that within a generation, the FHA spawned 74 separate programs to bolster credit through guarantees, insurance or outright loans.

But that’s nothing compared to today.

Uncovering securitization’s connection to the vast network of federal credit programs in the postwar era, Quinn’s research seeks to demonstrate how credit programs and securitization together distilled and then exacerbated core tensions running throughout U.S. history, tensions that emerged in the earliest days of the nation and then were crystallized in a fragmented federal government. The point, Quinn says, was nearly always the same:  to camouflage, hide, or understate the extent to which the U.S. government actually intervened in the economy. But the problems went well beyond that. As many of the government’s credit programs were partly privatized (with a view simply to getting them off the government’s balance sheet, if not government care), they were authorized to issue securitized bonds, while encouraged private companies to do the same. The legislation created a system that increasingly encouraged people to take on more risks, and to feel more comfortable holding risks that they did not fully understand. We all saw the rotten fruits of that process in 2008.

For one thing, many of these quasi-public companies, such as Fannie and Freddie, have acted like pure private companies, obscuring the social goals that underlay their inception, whilst using their government heritage to exploit the perception of an implied government guarantee for any loan, no matter how bad. It is a type of securitization that Paul Krugman has called, “lemon socialism”, where profits are private and losses are socialized. Quinn sets all of this out in the interview and provides the historic context to explain how it happened. This is important because if we fail to understand the past, it’s hardly likely that we can construct a future set of policies which avoids these problems going forward.

Teresa Ghilarducci: The Retirement Crisis

The retirement crisis is anything but imaginary.  According to research conducted by Professor Teresa Ghilarducci, head of the Department of Economics at the New School in New York City,  only 44% of workers in the United States have access to a retirement plan at work. Except for workers with defined benefit plans, most middle class U.S. workers will not have adequate retirement income -- 55% of near-retirees will only have Social Security income at age 65.

A labor economist, Ghilarducci’s work focuses on the need to restore the promise of retirement for every American worker. Her research documents the many problems people now face in planning for retirement: decreasing coverage and contributions, increasing investment risk, portability, leakage, high fees, and the drawdown of benefits in retirement. This body of work led her to put forth a bold reform idea - the creation of Guaranteed Retirement Accounts (GRAs) – to provide a secure retirement to an additional 63 million people.  This of course goes against the prevailing trend in our government’s treatment of pensions, particularly public pensions, which governors have persistently raided to avoid the more politically unpalatable option of raising taxes to support the viability of these plans. As she discusses in the interview below, she issues a clarion call for policy makers and political leaders to find a way to save retirement, “a necessary-  if now threatened – feature of civilized societies.”  As Ghilarducci eloquently notes, all people – rich AND poor – deserve a decent retirement income after a long working life.  Are our leaders up to the challenge?

Sir John and Maynard Would Have Rejected the IS-LM Framework for Conducting Macroeconomic Analysis

By Mario Seccareccia and Marc Lavoie

In a recent op-ed dated March 14, “John and Maynard’s Excellent Adventure”, Paul Krugman defends John Hicks’ original 1937 interpretation of Keynes’s General Theory that cast macroeconomics within a general equilibrium framework, but without the current insistence on the micro foundations that so concerns today’s general equilibrium macro theorists. Krugman is absolutely right. One should not be concerned with the so-called micro foundations of macroeconomics, because what is truly macroeconomics cannot be derived from micro analysis, as for example the famous paradox of thrift, whereby micro behavior gives rise to macro paradoxes that cannot be understood from choice-theoretic microeconomic reasoning.

But while we agree with Krugman’s criticism of the hordes of “micro-foundation” revisionists that now dominate economics, we are curious why he did not mention Sir John Hicks recantation of IS-LM analysis (see “IS-LM: An Explanation”, Journal of Post Keynesian Economics, 3 (2) (Winter 1980-81);).  Many of us remain deeply sceptical about the usefulness of the IS-LM framework for interpreting a real world characterized by uncertainty, crises, and institutional transformations that hardly bring the economy towards any equilibrium, never mind “general” equilibrium. But even if we abstract from these complications with the usual excuse of rendering the analysis simple for pedagogic purposes, the original Hicksian IS-LM model and its various textbook extensions (usually constructed with some sort of Phillips curve add-on) are extremely problematic. The difficulties have really little to do with the view that it’s too aggregative by representing only three markets: product, money, and bond markets – which is the criticism to which Krugman seems to be pre-emptively alluding in his article.

The first and obvious problem is that, even in the three-market aggregative model, there can never be such a thing, even at the conceptual level, called general equilibrium. To get that we must presume that there are independent functions of investment and saving and, at the same time, independent demand and supply functions for money. But one of the most basic criticisms that Keynes himself had come to recognize immediately after writing the General Theory is that the supply of money is not some exogenous variable that can be independently pitted against a distinct demand for money function. In a sophisticated monetary economy, the supply of money must be treated as a purely endogenous variable as many modern post-Keynesians and also neo-Wicksellians have come to recognize. Hence, the idea of money market equilibrium is meaningless, since one cannot conceptually ever be out of equilibrium when the two cannot be defined independently of one another.

However, the problem also arises on the product market side. Keynes had long debated the issue of I=S equilibrium, as for instance, also in 1937, with Swedish economists who made use of notions such as ex ante (or planned) investment and ex ante saving . While Keynes said that one can perhaps give some meaning to ex ante investment (in terms of business enterprises planning capital expenditures), at the macroeconomic level one cannot meaningfully describe saving as being anything that can actually differ from investment. Admittedly, this leads to a debate about the meaning and nature of the multiplier as a “disequilibrium” concept. But our point is that if the “supply” of money can never be independent of the “demand” for money and if saving can never be independent of investment, then what use is the IS-LM analysis that presumes exactly that independence? 

Moreover, if one were to postulate an infinitely elastic LM curve (as one can infer from David Romer, “Keynesian Macroeconomics without the LM Curve”, Journal of Economic Perspectives, 2000;) to deal with this lack of independence between the money demand and supply, then the question is what insight does the latter construction provide? It seems that everyone except Paul Krugman believes that short-term interest rates are policy determined, and that they are not set in the way the traditional IS-LM analysis suggests. This means that an increase in investment (entailing a rightward shift of the IS curve) will not lead to an increase in short-term interest rates unless the central bank chooses to raise its central bank rate.  Moreover, if the LM curve is flat at any level of interest rates, then what characterizes a liquidity trap and what is it? It certainly cannot be the traditional “flat” lower portion of an otherwise upward-sloping LM curve. Krugman’s liquidity trap is an LM curve that is flat at the zero rate of interest. But what does the IS-LM model have to say about long-term rates of interest? Krugman leaves us in the dark here. And what can the IS-LM model tell us about how the central bank is able to control and set short-term interest rates and what can it tell us about the consequences of quantitative easing on real output or price inflation? We believe that this model cannot really teach us anything about these issues; one needs an institutional analysis, not a rudimentary and misleading instrument.

Keynes himself was ambivalent about the role of interest rates in determining fixed capital formation (with his contrasting views in chapters 11 and 12 of the General Theory) and few would argue that business investment is strongly sensitive to changes in the rate of interest, as depicted in the traditional textbook loanable funds model. Ironically, nowadays, it is household spending on consumer durables and housing that is much more highly interest elastic and this feature is often muddied in the way this latter spending is represented in the “I” portion of the IS relation.

Heterodox economists have traditionally rejected the IS-LM approach for many such reasons; but, even if one were to hold one’s nose, in an uncertain world in which investment is governed by animal spirits (and therefore I being interest inelastic unless inclusive of household spending) and in a world of endogenous money, at best, the IS curve can be represented by a vertical line (or a more elastic relation when including household spending, an IS’ curve). In much the same way, the LM curve can be represented by a horizontal line at any level of interest rates set by the central bank (as shown in the figure below). What insights can such a tool of analysis really offer economists?  It suggests that an increase in autonomous spending will generate increases in output without any “crowding out” effect arising through higher interest rates. But one hardly needs an IS-LM framework whose truly central feature is the role played by interest rates to infer that! In our humble opinion, Hicksian IS-LM analysis cannot offer us very much and this is why even Sir John Hicks himself eventually abandoned it almost 35 years ago.  And so should Paul Krugman!


The Coming China Crisis

Rapid private-debt growth threw Japan into crisis in 1991 and did the same to the United States and Europe in 2008. China may be next.

Originally posted on Democracy Journal

On the morning of September 8, 2016, the Wenzhou Credit Trust, one of the many trust companies in China, went into default. The firm discontinued all new lending and suspended redemption and interest payments on its trust certificates, the equivalent of deposits made by its customers. Read more

Karl Aiginger: Europe and the Challenge of Re-Starting Growth

The Eurozone is arguably the greatest economic casualty of the 2008 financial crisis.  Whilst both the US and China have managed to exceed 2008 GDP levels, Europe continues to languish and in many cases (notably, Greece, Spain and Portugal) is worse relative to the impact of the Great Depression.   If Europe in its current form is to survive, notes the economist Karl Aiginger, Director of the Austrian Institute for Economic Research (WIFO), then restarting growth is both necessary and (more importantly), feasible. Read more

Get a TAN, Yanis: A Timely Alternative Financing Instrument for Greece

The recent election of an explicitly anti-austerity party in Greece has upset the prevailing policy consensus in the eurozone, and raised a number of issues that have remained ignored or suppressed in policy circles. Expansionary fiscal consolidations have proven largely elusive. The difficulty of achieving GDP growth while reaching primary fiscal surplus targets is very evident in Greece. Avoiding rapidly escalating government debt to GDP ratios has consequently proven very challenging. Even if the arithmetic of avoiding a debt trap can be made to work, the rise of opposition parties in the eurozone suggests there are indeed political limits to fiscal consolidation. Read more

Mission-Oriented Finance for Innovation: new ideas for investment-led growth

“The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.” John M. Keynes, The End of Laissez Faire, 1926 (p. 44)

If there are two words we’re guaranteed to hear a lot of as the economic debate gets heated in the run up to the UK elections it’s “debt” and “deficit”. And even more so in the US elections! Read more

Why Understanding Money Matters in Greece

By Robert W. Parenteau, CFA and Marshall Auerback

As Greece staggers under the weight of a depression exceeding that of the 1930s in the US, it appears difficult to see a way forward from what is becoming increasingly a Ponzi financed, extend and pretend, “bailout” scheme. In fact, there are much more creative and effective ways to solve some of the macrofinancial dilemmas that Greece is facing, and without Greece having to exit the euro. But these solutions challenge many existing economic paradigms, including the concept of “money” itself. Read more

Rana Dasgupta: Can Democracy Survive Aggressive Global Capitalism?

In the naughts, British-born novelist and author Rana Dasgupta was thrilled to call Delhi his home —a city still buzzing with possibility after India’s 1991 entry into the world of market-driven capitalism. Today, he raises concerns that India’s economic rise has come with massive inequality, environmental destruction, and potential social unrest. In Part 2 of an interview with the Institute for New Economic thinking, Dasgupta shares his view of the contradictions and tensions of India’s economic and political scenes. Read more

Drooping Green Shoots

Back in early 2009, commentators starting seeing “green shoots” of economic recovery. More than five years later they may finally be growing into GDP and employment. Read more

Cecilia Nahon: Argentina vs the Vultures

During the 1990s, Argentina had been the poster child for Neoliberal policies—they adopted virtually the whole of the so-called “Washington Consensus” agenda lock-stock-and-barrel. They even adopted a currency board. And unlike Euroland (which also adopted something like a currency board as each member adopted a foreign currency—the euro), Argentina would have consistently met the tight Maastricht criteria on budget deficits and debts over that period. The main purpose of the austere budgets and currency board constraints was to kill high inflation. It worked. But, over that period unemployment grew and GDP growth was moderate. Read more

Michael Shellenberger: Energy and the Economics of Renewables

In this interview we discuss the impact of Schumpeter's concept of creative destruction in economic thinking - and specifically in energy. Most crucially we debate the issues surrounding conservation and the use of new oil and gas technologies in the United States and around the world. The central question is whether moving away from coal and into shale - rather than directly into renewables - is a worthy move from an economic as well as environmental point of view. We also discuss the economics of renewables and what economic policy can do to foster cleaner energy and more sustainable development.

Rana Dasgupta: How India’s Traumatic Capitalism is Reshaping the World

A British national of Bengali origin, novelist Rana Dasgupta recently turned to nonfiction to explore the explosive social and economic changes in Delhi starting in 1991, when India launched a series of profoundly transformative economic reforms. In Capital: The Eruption of Delhi, he describes a city where the epic hopes of globalization have dimmed in the face of a sterner, more elitist world. Read more