Avoiding a recession: the Fed conundrum

LevyInstituteThe Levy Economics Institute has published their annual Strategic Analysis paper on the current state of, and prospects for, the US economy, which is always an interesting read. The Institute is non-partisan, but much of its research and output takes its inspiration from two great post-Keynesian economists of the past: Hyman Minsky and Wynne Godley, who both emphasised the importance of aggregate demand to the state of the economy, in the short run and the long run, and the interaction of real and financial factors.

A summary of this short paper can be found here, and the pdf can be downloaded here.

As the paper notes, the US recovery from the pandemic-triggered recession has been swift, with GDP now above its pre-pandemic level, and the employment rate almost there, thanks in large part to the extraordinary scale of the fiscal stimulus enacted by the government. However, it has also been associated with a deteriorating current account deficit and a rise in inflation. Continue reading

Inflation, the supply-demand debate and the policy response

BankofEnglandAs central banks around the world tighten monetary policy by raising interest rates in order to restrict demand, there remains an ongoing debate about whether this is the right response to the current inflation.

A large share of the inflation in many countries has been caused by supply shocks, as much of the world went through and then emerged from pandemic lockdowns, and as a consequence of the war in Ukraine. Taken together, these two have restricted the supply and thus increased the cost of food and energy on global markets. But there have also been impacts from the demand side, as many governments supported their economies with major fiscal stimuli during and after the lockdowns. The scale of these varied across countries, with the economic impact varying as a result. The US stimulus was particularly large and has helped restore its collapsed employment rate to the pre-pandemic level in recent weeks. However it is also arguable that this dramatic boost to demand has helped to fuel inflation. EU countries tended to be less ambitious fiscally, with the supply shocks contributing a greater share of the rise in inflation there than they have done in the US. The current inflation varies between countries, with Japan seeing a much smaller increase given its structurally weak demand and its historic struggles with deflation and weak growth in recent decades.

One of the big questions that has fuelled much debate in the media, not least on Twitter, is whether central banks need to be raising interest rates, which their own models say will only fully affect the rate of inflation a year or two down the line, when the global economy has begun to slow and forecasts of recession are becoming more frequent. If the very purpose of monetary tightening is to reduce demand in the form of investment and consumption and raise unemployment, which economists tend to think of as socially undesirable even if they may sometimes be intentional consequences of policy, the question arises as to whether such moves are necessary. Continue reading

Can tax cuts reduce inflation?

TaxCutsHere in the UK, foreign secretary Liz Truss, leadership candidate for the Conservative Party and potentially our future Prime Minister, has promised immediate tax cuts should she win the contest. She claims that these cuts will boost economic growth and lower inflation. With this approach to policy she will thus somehow solve two of the major current afflictions of the UK economy. Although she has been criticised by a number of party grandees and former ministers, she is claiming Thatcherite precedent for her views. Her rival for the top job, former finance minister Rishi Sunak, has responded by framing her ideas as ‘fantasy’ economics. Indeed her pronouncements do have a whiff of what has been called ‘cakeism’ (ie having your cake and eating it too). This is a key character trait of our ‘caretaker’ Prime Minister Boris Johnson, who is famously unwilling to deliver bad news, preferring instead to rely on ‘boosterism’ to try and please his audience.

So how could tax cuts deliver the economic goodies? The UK economy has performed poorly since the mid-2000s, compared both with its own history and with other comparable countries. Growth in output and productivity has been weak. Raising productivity growth is vital to improving living standards, including the delivery of high quality public goods and services such as health, education and infrastructure, which also support a vibrant private sector. Continue reading

What is really going on? — Real-World Economics Review Blog

by Yanis Varoufakis

. . . what is really going on? My answer: A half-century long power play, led by corporations, Wall Street, governments and central banks, has gone badly wrong. As a result, the West’s authorities now face an impossible choice: Push conglomerates and even states into cascading bankruptcies, or allow inflation to go unchecked. […]

What is really going on? — Real-World Economics Review Blog

Inflation: should we take away the soup bowl? — Real-World Economics Review Blog

The graph below has been constructed by economists of the European Central Bank. It’s based on national accounts data. It shows that present day inflation is profit driven, not wage driven. Money flows to profits, not wages. What does this mean for monetary, fiscal and income policy, taking some other aspects of inflation into consideration? […]

Inflation: should we take away the soup bowl? — Real-World Economics Review Blog

Andrew Smithers on flawed central bank policies

In the spirit of yesterday’s introduction to my new series on the work of Andrew Smithers, here is a fairly recent video in which he criticises the recent policies of central banks. This includes their efforts to keep interest rates low in an attempt to sustain demand in the economy, as well as quantitative easing, which have driven up asset prices to unsustainable levels, the consequence of which is the risk of a new financial crisis and major recession.

Prices and the Market Economy — repost from flassbeck economics international

Inflation continues to be on everyone’s lips. At 7.4 per cent, a rate was reached in April this year that is almost unique in the history of the Federal Republic of Germany. Only in the early summer of 1973, around the turn of the year 1973/1974 and in October 1981 was the rate of increase…

Prices and the Market Economy — flassbeck economics international

Quote of the week: the administrative problems in achieving full employment

Copland-DouglasDouglas Copland was a Australian academic and economist, who advised a number of his country’s governments during his distinguished career. In this week’s quote, I again draw on the edited 1947 volume The New Economics: Keynes’ Influence on Theory and Public Policy. Here Copland discusses some of the practical administrative problems of the Keynesian policy of achieving full employment in a free democratic society. As he makes clear, it is unlikely to be easy. It requires cooperation between the state and the private sector, including certain controls on free enterprise, which the private sector may well resent or resist. Indeed this resistance, which could be overcome in times of national emergency such as war, is likely to be more challenging in peacetime. This proved to be the case as the post-war period progressed, and eventually the Keynesian social democratic consensus collapsed in the 1970s when it seemed to fail in its aim of securing full employment with moderate inflation, and many industrialised economies were beset by stagflation, with unemployment and inflation rising together. In the 1980s politics in the US and the UK in particular shifted to the right, with the rise of an ideology which argued for the retreat of the state and the restoration of greater freedom to the private sector. Continue reading

What’s causing accelerating inflation: pandemic or policy response?

Prominent Modern Monetary Theorist L. Randall Wray and Yeva Nersisyan have written a new working paper published by the Levy Economics Institute. In it they examine the possible causes of the current accelerating inflation in the US. They look at factors on the demand-side, in the form of the fiscal stimulus policy response to the pandemic. They also look at those on the supply-side which are more directly due to the impact of the pandemic itself, such as supply chain disruption, alongside the pricing power of large firms.

In the end, they mainly blame supply-side factors and conclude that a tightening of monetary policy in the form of rising interest rates is likely to be a crude and somewhat ineffective response to higher inflation. If it does work to reduce inflation, it will be accompanied by an economic slowdown or recession, rising unemployment, falling wages, rising debt distress, bankruptcy and even a new financial crisis. In Keynesian fashion the authors see these negative outcomes as hindering the adjustment of the economy. Tipping the economy into recession in order to reduce inflation would also undermine the current benefits of a tighter labour market which by increasing wages for the lowest paid can help to reduce income inequality. Continue reading

Anwar Shaikh on successful macroeconomic stimulus

Anwar-InterviewHere is a link to a short but interesting paper by Anwar Shaikh on the conduct of successful macroeconomic stimulus. Shaikh is the author of the magisterial Capitalism: Competition, Conflict, Crises and works in the tradition of ‘classical’ economics, being greatly inspired by Adam Smith, David Ricardo and Karl Marx, but also by John Maynard Keynes. His book is an attempt to integrate ideas and theories from these four greats into a comprehensive modern analysis of capitalism as an economic system.

The paper notes some historical examples of successful (the US during WWII, Germany in the 1930s) and unsuccessful (many countries during the 1970s, Brazil in the 2000s) application of macroeconomic stimulus intended to accelerate economic growth and reduce unemployment. He comes to the conclusion that if such policies are not to be derailed by rising inflation and/or falling profitability for the economy as a whole, then an incomes policy is necessary to ensure that wages increase in line with productivity; an industrial policy is also needed to sustain rising productivity. Continue reading