Wynne Godley and economics – forecasts, policy and the drivers of prosperity

I have just finished reading Alan Shipman’s fascinating biography of the late economist Wynne Godley, who passed away in 2010. Godley worked in the UK Treasury in the 60s, before moving to Cambridge University and heading the maverick Cambridge Economic Policy Group (CEPG). He became known for his prescient economic forecasts of the UK and later the US, predicting the demise of the ‘Barber Boom’ in the 1970s, the mass unemployment of the 1980s unleashed by Margaret Thatcher’s professed adherence to monetarism, the end of the ‘Lawson Boom’ and return to recession in the late 80s and early 90s, and finally the Global Financial Crisis (GFC) of the 2000s, which followed the build up and subsequent unwinding of unsustainable macroeconomic imbalances in the US, which he had identified as early as 1999.

Through his career, Godley’s approach to economics developed into what are now termed ‘stock-flow consistent’ macroeconomic models. His final book, Monetary Economics, co-authored with Marc Lavoie, develops models of increasing complexity of a hypothetical economy, in which flows of income, expenditure and production interact in a comprehensive and logically consistent way with stocks of assets and liabilities.

One of the key lessons of Godley’s analysis is that incorporating banks or a financial sector into macroeconomic models yields important insights. Thus, the so-called ‘Great Moderation’ period of steady economic growth, moderate unemployment and low inflation which preceded the GFC in economies such as the US and UK, in a way concealed the unsustainable accumulation of private debt, which financed consumption and a boom in asset prices, particularly housing.

The subsequent financial crisis and deep recession were therefore not an ‘exogenous’ shock which arose randomly from outside the system, but were ‘endogenous’, arising from within the economic system itself. Godley, along with economists such as Steve Keen, modeled the dynamics of debt accumulation and predicted an inevitable crisis, as debt accumulation went into reverse, private saving rose, and unemployment rose sharply, even as central banks reduced interest rates towards zero.

Fiscal policy, in the form of tax cuts and public spending increases, made a comeback in many countries, at least until the premature turn towards austerity. Godley and Keen had both predicted that public deficits would soar as governments let the automatic stabilisers operate, and borrowed and spent on top of that, to try and combat the recession. Such was the level of private debt that, as the private sector scrambled to pay it down by curtailing spending, these deficits proved insufficient to prevent recession. In their absence, it would likely have proved even deeper.

Keynesianism and the Golden Age

Godley’s economic models have today spawned an expanding literature applying his stock-flow consistent approach to both the economy as well as the environment. Many of those inspired by his work, as well as the man himself, would be classified as post-Keynesian economists, broadly speaking the heterodox or more radical followers of Keynes. They argue that economic growth, and aggregate supply, are usually constrained by aggregate demand, of which investment is the main driver, as it provides both a source of spending and of capacity on the supply-side. They hold to the vision that sufficiently ambitious public policy can create and sustain full employment, moderate inflation, and widely-shared rising living standards. They tend to take great inspiration from the post-war ‘Golden Age of Capitalism’, which witnessed around 25 years of such outcomes.

The Golden Age ultimately came to an end as a combination of rising unemployment and inflation, or stagflation, apparently discredited the Keynesian consensus, and the Bretton Woods system of fixed but adjustable exchange rates unravelled. The monetarist creed which followed saw policymakers shift their attention to combating inflation with monetary policy and, in theory, fiscal austerity. Unemployment soared in the UK and manufacturing output collapsed.

Left economists of all persuasions, from Keynesian to Marxist, decried these developments. The post-Keynesians argued that their own ideas for economy policy could be used to solve these problems, while some Marxists viewed them as inevitable under capitalism, even if they were hugely damaging to society, as they could encourage a restructuring which would restore business profitability, and create the conditions for a new period of economic growth to take place. Strangely, these latter arguments are in some ways close to conservative ones, although Marxists tend to see socialism as a better answer to the problems created by capitalism, while conservatives would continue with the creative destruction unleashed by capitalist production, often favouring little in the way of the social protections or industrial interventions favoured by those to their political left.

From Keynesianism to industrial policy

Wynne Godley’s economic framework ultimately eschews ‘fine-tuning’ or short-term policy interventions in favour of medium-term strategies which can sustain the goals of most Keynesians, mentioned above. They require management of the public budget, incomes policies to sustain low inflation, and sometimes even import controls such as tariffs or quotas to manage the balance of payments, and prevent a boost to demand at less than full employment ‘leaking’ into foreign demand in the form of imports, rather than encouraging the growth of domestic production and employment.

Also implicit in this framework is the potential for industrial and technology policies to increase the international competitiveness of domestic firms, and thus to encourage a faster growth of net exports given the growth of world demand. The more competitive such firms are internationally, the more of this demand they can capture and serve and the faster the growth of net exports, all else being equal. Another Cambridge post-Keynesian and colleague of Godley’s, Nicholas Kaldor, made arguments along these lines to justify the need for an industrial policy.

Industrial policy can not only create a boost to foreign demand, but it also potentially encourages faster structural change and the adoption of new technologies, which are part of the workings of a successful capitalist economy able to raise productivity and living standards over time. This falls more into the category of microeconomic analysis, but taken together with the ideas of Godley and others, it shows that ‘macro’ and ‘micro’ need to be integrated, rather than kept artificially separate, as is often the case in mainstream analysis, which even drops the case for considering emergent macro properties completely with its arguments for ‘microfoundations’ of macroeconomics.

Marx, Shaikh and competition

For Keynesians of all kinds, aggregate demand, whether domestic or foreign, is seen as a key driver of growth in output and employment, but for modern classical and Marxist economists, Anwar Shaikh being one prominent example, competition between firms and industries drives investment and growth in the search for greater profitability.

Godley was nicknamed the ‘cassandra of the fens’ for his gloomy forecasts for the economy. Although his predictions of recession often turned out to be right, he was perhaps too pessimistic about the prospects for subsequent recoveries in the absence of Keynesian fiscal reflation. Many post-Keynesians, who have historically often prioritised macro over micro analysis, neglect the role of the profit motive and competition in driving economic growth. ‘Accumulate, accumulate, that is Moses and the prophets’, proclaimed Marx, and Shaikh, who has integrated many ideas from classical and Marxist thought as well as some from the post-Keynesian tradition in his own magnum opus Capitalism, makes a strong case for the imperative of profit-making and competition as the central regulating mechanism under capitalism.

For Shaikh, firms and industries compete in the long run by investing in new technologies to increase productivity and cut costs, enabling them to cut prices and expand market share, with the aim of achieving greater profitability. Over the long term, crises or recessions are inevitable from time to time, even if they can be temporarily prevented or postponed with state interventions.

Thus economic growth, despite its often disruptive form in both good times and bad, derives from the intrinsic motives within the capitalist system, and the disruption can only be temporarily ameliorated. Despite this, growth can be seen as being constrained by demand or by supply. It is just that Keynesians tend to see the former as being the dominant tendency and requiring sustained intervention by the state.

As part of an industrial policy, public investment in modern infrastructure and research into and development of new technologies can ‘crowd in’ private investment by opening up new opportunities for firms to take advantage of. The state can therefore ‘create’ new markets for the private sector. This idea is contrary to the conservative view that public investment or borrowing more generally will tend to crowd out private investment. The state can thus expand both demand and supply.

Keynesianism and politics

There is no doubt that Keynesianism offers an attractive political program for the left, with its hope that state intervention can create ‘jobs for all’, poverty reduction and well-funded social policies, not least in the form of a strong welfare state. History seems to suggest that these outcomes cannot be sustained indefinitely, only periodically, under capitalism, while waves of creative destruction and structural change are perhaps more of a constant.

Such changes can prove a threat to sustaining liberal democracy, as the aftermath of the GFC has shown. Keynesianism purports to be able to do so, in the presence of sufficient political will and mass support for progressive parties. But the classical and Marxist canons and their interpretation of economic history show this vision to be at best incomplete, even in the absence of a path to socialism.

Approaching inequality: conservatives, liberals, radicals

StilwellPEofIneqFor anyone looking for a clear, critical and comprehensive guide to inequality in today’s world, I can recommend Frank Stilwell’s The Political Economy of Inequality. It is not technical, so remains suitable for all social scientists, not just economists, as well as the intelligent layperson. It manages to illuminate the key theoretical and practical issues regarding what has become of vital concern to many.

I will not be reviewing or summarising the book here, but I would like to discuss one aspect of it which I found inspiring and enlightening: as the title suggests, this is a book which adopts a political economy approach which, as regular readers of this blog will appreciate, I find offers a richer understanding of particular aspects of the economy and society than pure economics. Continue reading

Joan Robinson on economics and the study of society

Joan Robinson (1973)

Apart from her voluminous academic writings, the Cambridge Keynesian economist Joan Robinson wrote several popular books. Freedom and Necessity – An Introduction to the Study of Society was published in 1970. Although some of it dates somewhat, there is plenty of interest and contemporary relevance that remains. Here are a few such extracts:

(From the preface) “It seems to me that an economic interpretation of history is an indispensable element in the study of society, but it is only one element. In layers below it lie geography, biology and psychology, and in layers above it the investigation of social and political relationships and the history of culture, law and religion.”

Continue reading

Good reasons to become a Keynesian — LARS P. SYLL

Below is a revealing quote by Richard Posner from today’s post on the blog of Lars P. Syll. It sums up some of the economics mainstream’s attitudes towards Keynes’ original work, how neglected it is by those arguing against its importance, and its continuing relevance.

I first read Keynes’ General Theory when in my final year of school, before I went on to university. While finding it difficult, it was also inspiring to me and full of insight. In particular, the notion that unacceptable levels of unemployment are a periodic characteristic of capitalist economies and require government action to remedy, truly hit home. It cemented my Keynesian position for some years.

I have since rowed back from being a confident and dedicated Keynesian, although I remain influenced by leftist and other radical economists. Where appropriate, I find that the interdisciplinarity of political economy can also be helpful, not least in the study of development as a process of economic and social change.

Many of those now known as post-Keynesians, who profess to carry the true mantle of Keynes’ original thinking, also wrote on economic development. This is true in the case of key figures Michal Kalecki, Nicholas Kaldor and Joan Robinson, all of whom strongly influenced the so-called Cambridge School and its radical or heterodox offshoots.

Posner’s full quote can be found at the link below.

Until [2008], when the banking industry came crashing down and depression loomed for the first time in my lifetime, I had never thought to read The General Theory of Employment, Interest, and Money, despite my interest in economics … I had heard that it was a very difficult book and that the book had been […]

via Good reasons to become a Keynesian — LARS P. SYLL

Some (political economy) thoughts on the response to Covid-19 – capitalism, socialism and the role of the state

The big state is back with a vengeance, if it ever went away. The apparent suddenness and rapid escalation of the spread of the coronavirus has called forth an almost equally rapid increase in the scope of state intervention in many nations. Countries that had spurned a move to state capitalism have suddenly found themselves having to embrace it.

Authoritarian state capitalist, though ostensibly communist, China, took a while to respond to the outbreak, but once it did, it acted forcibly and, for now at least, it seems to have stemmed the tide. But democratic Japan, South Korea and Taiwan seem also to have responded relatively effectively to the outbreak, at least compared with many other countries.

The UK government has so far pledged a massive fiscal programme of stimulus, including wage subsidies, bridging loans for firms, and at the time of writing is about to announce support for the self-employed as well. Private sector rail company franchises have been suspended in the wake of collapsing ticket sales. The health service has been promised whatever it needs financially to deal with the virus. Private firms are being asked to switch production to medical supplies as fast as possible. The post-crash decade of austerity was already somewhat at an end, but now it has been dramatically, inevitably put into reverse gear. Continue reading

Keynesian economics – back from the dead?

Here is an interesting recent lecture given by Robert Rowthorn on the “main developments in macroeconomics since the anti-Keynesian counter-revolution 40 years ago.” It can be downloaded for free. Alternatively the video of the lecture can be viewed here.

Rowthorn is Emeritus Professor of Economics at Cambridge University. Back in the 70s and 80s he was very much a Marxist, but has since moved away from that commitment and written on a wide range of topics, from Kaleckian growth and distribution theory to deindustrialisation in the advanced economies and the economics of the family.

For those who are interested in development economics, he supervised the PhD of another prominent Cambridge economist, Ha-Joon Chang, who has written a number of popular books alongside his academic work.

This is the rest of the abstract of Rowthorn’s paper:

It covers both mainstream and heterodox economics. Amongst the topics discussed are: New Keynesian economics, Modern Monetary Theory, expansionary fiscal contraction, unconventional monetary policy, the Phillips curve, hysteresis, and heterodox theories of growth and distribution. The conclusion is that Keynesian economics is alive and well, and that there has been a degree of convergence between heterodox and mainstream economics.

All of these topics are relevant to today’s economic problems, and Rowthorn argues that “many leading economists in the USA and the UK have Keynesian sympathies”.

Thanks to The Case For Concerted Action blog for drawing my attention to this lecture.

Geoff Harcourt on Keynesian theory

In this enlightening video, Professor Geoff Harcourt, who was a distinguished pupil and colleague of Joan Robinson at Cambridge University, discusses a range of issues in Keynesian and post-Keynesian economics.

He covers the need for pluralism in economics; his definition of post-Keynesianism; the work of some of its key protagonists; uncertainty and its impact on business and the economy; the capital theory debates; and finally his vision for analysing a modern capitalist economy, and his most enduring intellectual influences.

Hyman Minsky explains his financial instability hypothesis

In this rare video, Hyman Minsky explains his financial instability hypothesis. The video dates from 1987, but Minsky was prescient in originating a theory that characterises capitalist economies with developed financial systems as inherently unstable and requiring the intervention of ‘Big Government’ (counter-cyclical fiscal policy) and a ‘Big Bank’ (the central bank acting as lender of last resort). His FIH has become much more widely known since the advent of the 2008 financial crisis.

Minsky was influenced by his teacher at Harvard, Joseph Schumpeter, as well as by John Maynard Keynes and Michal Kalecki. His work falls under the post-Keynesian tradition, emphasising the role of finance and the importance of effective demand in the economy, with the former a major cause of instability in the form of booms and busts. His thinking also incorporated ideas on institutions such as households, firms, banks, and governments, and explored how their balance sheets of assets and liabilities evolve over business cycles.

Keynes against capitalism

Crotty Keynes Against CapitalismJohn Maynard Keynes did not wish to merely save capitalism ‘from itself’ but to replace it with ‘Liberal Socialism’. That is the controversial claim made in a new book by the distinguished radical economist James Crotty, whose work ‘attempts to integrate the complementary analytical strengths of the Marxian and Keynesian traditions’.

The book, Keynes Against Capitalism, subtitled His Economic Case for Liberal Socialism, draws heavily on textual evidence found in the collected works of Keynes himself, from the 1920s through to the end of his life in 1946. This is both its strength and its weakness.

Without wishing to get into debate over semantics, one could find oneself agreeing with much of the argument ie that Keynes did in fact wish to replace capitalism with a radically different system called Liberal Socialism, but to say, in some ways, so what? The book is a fine scholarly read, but I found myself questioning whether Keynes’ (Crotty’s?) Liberal Socialism, for all its admirable socially transformative aims, would be both feasible and sustainable. Continue reading

Keynes and the conceptual cul-de-sac of General Equilibrium

Economist John Maynard Keynes

“The reasons for which Keynes’s arguments fail to translate into the orthodox paradigm are not because they are vague, confused or poorly formulated. They fail to translate, instead, because they identify and address crucial flaws in the structure and logic of the dominant paradigm. As Keynes himself put it, what he hoped to do is ‘convince [us] that Walras’ theory, and all others along those lines are little better than nonsense’. He was able to see, like Kornai, that the Walrasian ideal is ultimately ‘a special branch of mathematics’, which employs ‘logical reasoning [but] from arbitrary assumptions’, making it more an ‘intellectual experiment’ than a theory in the mould of the sciences.

The real problem which far too many economists have had with understanding Keynes’s arguments exactly as he expressed them is an intransigent desire to believe that, as once said by Debreu in an interview, ‘the superiority of the liberal economy is incontestable and can be mathematically demonstrated’. The problem with this conviction is that the economy that Debreu had in mind has little connection with reality. It is time, if we want in the future to avoid the terrible waste, not just of the past ten years, but of the many other times that liberal economies have so clearly failed to provide for full employment, that we turn our attention to understanding more accurately not the economic society in which we might wish to live but the one in which we actually live. It is in this regard that Keynes, read without the desire to adhere to the conventional wisdom of the Walrasian General Equilibrium paradigm, provides a truly valuable starting point.”

Mark Pernecky and Paul Wojick