Working Paper Roundup 6/4/2014

Michael Stephens | June 4, 2014

Monetary Mechanics: A Financial View
Éric Tymoigne
“This paper presents an alternative framework that can be used to analyze monetary systems by drawing on the work of Smith, MacLeod, Knapp, Innes, Hawtrey, Keynes, Murad, Olivecrona, Wray, and Ingham, among others. The analysis asks what “money” is instead of what “money” does. Monetary instruments are not defined by what they do, or by what a researcher thinks they do, but by specific financial characteristics. By defining explicitly what “money” is, this framework provides some insights into past monetary systems and into monetary mechanisms.”

Autonomy-enhancing Paternalism
Martin Binder and Leonhard K. Lades
“Behavioral economics has shown that individuals sometimes make decisions that are not in their best interests. This insight has prompted calls for behaviorally informed policy interventions popularized under the notion of “libertarian paternalism.” This type of “soft” paternalism aims at helping individuals without reducing their freedom of choice. We highlight three problems of libertarian paternalism: the difficulty of detecting what is in the best interest of an individual, the focus on freedom of choice at the expense of a focus on autonomy, and the neglect of the dynamic effects of libertarian-paternalistic policy interventions. We present a form of soft paternalism called “autonomy-enhancing paternalism” that seeks to constructively remedy these problems.”

The Political Economy of Shadow Banking: Debt, Finance, and Distributive Politics under a Kalecki-Goodwin-Minsky SFC Framework
Eloy Fisher and Javier López Bernardo
“[T]he financial operation of the shadow financial system is not a mere mechanical outgrowth of advances in securitization and risk management, but the natural result of tensions in the political economy of democratic capitalism …
[T]he dynamics of shadow banking rest on the distributive tension between workers and firms. Politics wedge the operation of the shadow financial system as government policy internalizes, guides, and participates in dealings mediated by financial intermediaries. We propose a broad theoretical overview to formalize a stock-flow consistent (SFC) political economy model of shadow banking (stylized around the operation of money market mutual funds, or MMMFs). Preliminary simulations suggest that distributive dynamics indeed drive and provide a nest for the dynamics of shadow banking.”

Shadow Banking: Policy Challenges for Central Banks
Thorvald Grung Moe
“I discuss the expanding role of the shadow banking sector and the key drivers behind its growing importance. There are close parallels between the growth of shadow banking before the recent financial crisis and earlier financial crises, with rapid growth in near monies as a common feature. This ebb and flow of shadow-banking-type liabilities are indeed an ingrained part of our advanced financial system. We need to reflect and consider whether official sector liquidity should be mobilized to stem a future breakdown in private shadow banking markets. Central banks should be especially concerned about providing liquidity support to financial markets without any form of structural reform. It would indeed be ironic if central banks were to declare victory in the fight against too-big-to-fail institutions, just to end up bankrolling too-big-to-fail financial markets.”

What Do We Know About the Labor Share and Profit Share?
Olivier Giovannoni
Part 1: Theories
“This series of working papers explores a theme enjoying a tremendous resurgence: the functional distribution of income—the division of aggregate income by factor share. This first installment surveys some landmark theories of income distribution. Some provide a technology-based account of the relative shares while others provide a demand-driven explanation (Keynes, Kalecki, Kaldor, Goodwin). Two questions lead to a better understanding of the literature: is income distribution assumed constant?, and is income distribution endogenous or exogenous? However, and despite their insights, these theories alone fail to fully explain the current deterioration of income distribution.”
Part 2: Empirical Studies
“In this second part of our study we survey the rapidly expanding empirical literature on the determinants of the functional distribution of income. Three major strands emerge: technological change, international trade, and financialization.”
Part 3: Measures and Structural Factors
“Economic theory frequently assumes constant factor shares and often treats the topic as secondary. We will show that this is a mistake by deriving the first high-frequency measure of the US labor share for the whole economy. We find that the labor share has held remarkably steady indeed, but that the quasi-stability masks a sizable composition effect that is detrimental to labor. The wage component is falling fast and the stability is achieved by an increasing share of benefits and top incomes. Using NIPA and Piketty-Saez top-income data, we estimate that the US bottom 99 percent labor share has fallen 15 points since 1980. This amounts to a transfer of $1.8 trillion from labor to capital in 2012 alone and brings the US labor share to its 1920s level.”

The Great Recession and Unpaid Work Time in the United States: Does Poverty Matter?
Tamar Khitarishvili and Kijong Kim
“In times of economic crises, household production, and the unpaid work time associated with it, can serve as a coping mechanism for absorbing the impact of shocks. Evidence from the Great Recession has been supportive of this possibility, and has revealed the presence of gender asymmetries stemming from men having experienced disproportionately high job losses. In this paper, we further examine the presence of poverty-based asymmetries in the unpaid work time changes of men and women given that the role of household production as a coping mechanism may vary by poverty status. … Our findings reveal that the changes in men’s and women’s unpaid work time indeed varied by poverty status.”

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Taxes and the Public Purpose

L. Randall Wray | May 30, 2014

In previous installments we have established that “taxes drive money.” What we mean by that is that sovereign government chooses a money of account (Dollar in the USA), imposes obligations in that unit (taxes, fees, fines, tithes, tolls, or tribute), and issues the currency that can be used to “redeem” oneself in payments to the government. Currency is like the “Get Out of Jail Free” card in the game of Monopoly.

Taxes create a demand for “that which is necessary to pay taxes” (and other obligations to the state), which allows the government to purchase resources to pursue the public purpose by spending the currency.

Warren Mosler puts it this way: the purpose of the tax is to create unemployment. That might sound a bit strange, but if we define unemployment as a situation in which job seekers want to work for money wages, then government can hire them by offering its currency. The tax frees resources from private use so that government can employ them in public use.

To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed.

By putting the subjects or citizens into debt, real resources could be moved to serve the public purpose. Taxes drive money.

So, money was created to give government command over socially created resources.

As Warren puts it, taxes function first to create sellers of real goods and services, and have further consequences as well, including what falls under “social engineering,” which are political decisions—something we’ll discuss a bit more below.

This is why money is linked to sovereign power—the power to command resources. That power is rarely absolute. It is contested, with other sovereigns but often more important is the contest with domestic creditors. Too much debt to private creditors reduces sovereign power—it destroys the balance of power needed to govern. continue reading…

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Bubbles and Piketty: An Interview with L. Randall Wray

Michael Stephens | May 29, 2014

L. Randall Wray appeared on Thom Hartmann’s radio show yesterday for a lengthy and wide-ranging interview:

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Is the Eurozone Crisis Really Over?

C. J. Polychroniou | May 23, 2014

Economic pundits who predicted the collapse of the euro at the start of the eurozone crisis have been proven wrong. But those who say the crisis is over are equally wrong.

Four years after the start of the euro crisis, the bailed-out countries of the eurozone (Greece, Ireland, Portugal, and Spain) are still facing serious problems, as the austerity policies imposed on them by the European Union (EU) authorities and the International Monetary Fund (IMF) not only failed to stabilize their economies, but actually made matters worse; in fact, much worse: the debt load increased substantially, national output was seriously undermined, unemployment reached potentially explosive levels, a credit crunch ensued, and emigration levels rose to historic heights. Because of these highly adverse effects, the citizens in the bailed-out countries have grown indignant and mistrustful toward parliamentary democracy itself, euroskepticism has taken firm roots, and a cleavage has reemerged between north and south.

Take unemployment, for example. The current unemployment rates in the four bailed-out eurozone countries are: 27 percent for Greece; 25 percent for Spain; 15 percent for Portugal; and 12 percent for Ireland, the nation with the highest emigration rate in all of Europe, and whose government was actually asking the unemployed recently to leave and take jobs in other European countries.

A similarly dramatic picture emerges when one looks at current government debt. In Greece, it ballooned from slightly less than 130 percent in 2009 to 175 percent at the end of 2013 and it still growing. Ireland’s public debt, which stood at 25 percent of GDP in 2008, grew to nearly 65 percent by 2010 and climbed to over 125 percent by the end of 2013. Portugal’s public debt, which was slightly less than 70 percent in 2008, jumped to over 100 percent by 2011 and then to over 130 percent by 2013. And Spain’s public debt has surged to nearly 95 percent of GDP, standing at close to 1 trillion euros—three times as much as it was at the start of the crisis in 2008—and is projected to go over 100 percent by the end of 2014.

In short, the rest of the bailed-out eurozone countries are looking more and more like Greece when it comes to public debt—the result of the “voodoo” economics that the witch doctors of the EU and the IMF cooked up in order to formulate the so-called “rescue” plans.

The prospects for real growth in the periphery of the eurozone are grim as the EU’s current economic mindset, a set of economic dogmas that include (1) relegating unemployment to the status of a natural and inevitable (and perhaps even desirable) outcome of fiscal adjustment, (2) relying on austerity as a confidence builder, (3) treating structural reform as a panacea and (4) valuing exports as the primary engine of growth trump serve to impede recovery.

Each one of these ideas, as I spell out in detail in a public policy brief that was just released by the Levy Economics Institute, are highly flawed and, when combined, they can be deadly dangerous. They constitute tenets of an ideological “worldview” rather than empirically proven statements. continue reading…

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An Employment Safety Net for Youth

Michael Stephens | May 22, 2014

Pavlina Tcherneva participated in a conference on youth unemployment at Middlebury College and shared her ideas for a youth employment safety net (beginning at 38:45):

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Is Inequality Holding Back the Recovery?

Michael Stephens | May 21, 2014

“The biggest obstacle to a sustainable recovery,” according to the Levy Institute’s newest strategic analysis of the US economy, “is the inequality in the distribution of income.”

In their latest, Dimitri Papadimitriou, Michalis Nikiforos, Gennaro Zezza, and Greg Hannsgen begin with a familiar point: the Congressional Budget Office has been predicting fairly rosy economic growth rates for the coming years (rising to 3.4 percent in 2015 and ‘16)—rosy, that is, given the CBO’s expectation that government budgets will remain tight, and get even tighter, over this period (with the federal budget deficit shrinking to 2.6 percent of GDP by 2015).

As Papadimitriou et al. point out, the only way to make these growth and budget forecasts both come true, assuming there are no significant changes in net exports (a safe assumption), is if the private sector substantially increases its indebtedness. There really isn’t any other option. If we don’t see a return to ballooning private debt-to-income ratios, then either government budgets will have to be loosened or we won’t get the growth rates the CBO is telling us to expect.

Now, there are reasons to think that the reappearance of accelerated growth in private debt is unlikely (a theme the authors dealt with in their last US strategic analysis), but if it does happen, rising private debt ratios—which played the starring role in the financial crisis from which we’re still recovering—might destabilize the financial system. This is one sense in which maintaining tight government budgets over the next several years should not be portrayed, as it all-too-often is, as the “prudent” course of action.

And the widening of income inequality over the last few decades makes these dynamics even more problematic. As the authors point out, the trend of rising inequality has gone hand-in-hand with mounting indebtedness among households in the bottom 90 percent of the income distribution:

[O]ver the last 30 years not only was there a sharp increase in the level of household debt but a disproportionate share of this debt was incurred by the middle class and the poorest American households. Moreover, there seems to be a strong correlation between the two variables: as the disposable income of the top 10 percent of the population increased relative to the disposable income of the bottom 90 percent, the gross debt of the latter rose relative to the debt of the former.

Fig 10_Ratios of Disposable Income and Gross Debt_Levy Institute Strategic Analysis

Going forward, the current stance of public policy (including, but not limited to, tight fiscal policy) de facto requires a rise in household debt—borne entirely by the bottom 90 percent of households—as the only path to modest economic growth rates (in the range of CBO’s 3.1–3.4 percent). If, on the other hand, the bottom 90 percent of US households continue to “deleverage,” lowering their debt loads, then the authors show that we’re more likely to see economic growth fall to a piddling 1.7 percent by 2017, with unemployment rising to 7.6 percent.

In other words, absent a change in policy aimed at loosening the government budget or increasing net exports (perhaps through targeted R&D investment), the US economy is facing one of two outcomes: “a prolonged period of low growth—secular stagnation—or a bubble-fueled expansion that will end with a serious financial and economic crisis.”

“The only way out of this dilemma,” they conclude, “is a reversal of the trend toward greater income inequality. A change in the income distribution is a necessary condition for sustainable growth in the future.”

Read the report: Is Rising Inequality a Hindrance to the US Economic Recovery?

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What Are Taxes For? The MMT Approach

L. Randall Wray | May 16, 2014

Previously we have argued that “taxes drive money” in the sense that imposition of a tax that is payable in the national government’s own currency will create demand for that currency. Sovereign government does not really need revenue in its own currency in order to spend.

This sounds shocking because we are so accustomed to thinking that “taxes pay for government spending.” This is true for local governments, provinces, and states that do not issue the currency. It is also not too far from the truth for nations that adopt a foreign currency or peg their own to gold or foreign currencies. When a nation pegs, it really does need the gold or foreign currency to which it promises to convert its currency on demand. Taxing removes its currency from circulation making it harder for anyone to present it for redemption in gold or foreign currency. Hence, a prudent practice would be to constrain spending to tax revenue.

But in the case of a government that issues its own sovereign currency without a promise to convert at a fixed value to gold or foreign currency (that is, the government “floats” its currency), we need to think about the role of taxes in an entirely different way. Taxes are not needed to “pay for” government spending. Further, the logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.

Some who hear this for the first time jump to the question: “Well, why not just eliminate taxes altogether?” There are several reasons. First—as we said last time–it is the tax that “drives” the currency. If we eliminated the tax, people probably would not immediately abandon use of the currency, but the main driver for its use would be gone.

Further, the second reason to have taxes is to reduce aggregate demand. If we look at the United States today, the federal government spending is somewhat over 20% of GDP, while tax revenue is somewhat less—say 17%. The net injection coming from the federal government is thus about 3% of GDP. If we eliminated taxes (and held all else constant) the net injection might rise toward 20% of GDP. That is a huge increase of aggregate demand, and could cause inflation.

Ideally, it is best if tax revenue moves countercyclically—increasing in expansion and falling in recession. That helps to make the government’s net contribution to the economy countercyclical, which helps to stabilize aggregate demand. continue reading…

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Phillips Curve Still Alive for Compensation?

Greg Hannsgen | May 13, 2014

wage_phillips_curve

On reading a recent post by Ed Dolan at Economonitor with some evidence of the lack of a strong Phillips relationship for consumer-price inflation in US data, it occurred to me to try a measure of total compensation per hour with recent data. The wage relationship estimated over all available quarters, using averaged monthly observations for the civilian unemployment rate, is shown above, with a scatter plot and an estimated regression line. Like the relationship estimated by Dolan, the regression line above suffers from a rather loose fit (constant: 6.87; slope coefficient: -.29; R-squared = .02). A complete explanation of inflation is complicated and of course also involves other costs, including raw materials such as fuel. The latter costs are subject of course to “cost-push”-type inflation at times, as are wages. Exchange rates of course affect these costs.

A time series graph below displays both series over the entire sample period, 1948q1 to 2014q1. As some have observed, the exceedingly high unemployment rates of the post-financial-crisis era (blue line) have resulted in very weak or negative compensation growth rates (red line). The latter are not adjusted for inflation in the figures, since we are focusing on nominal data in this post.  The downward trend in nominal wage growth in the right side of the figure (red line) helps to explain recent declines in the so-called wage share, which measures the fraction of national income going to labor costs. (However, see this New York Times article for some evidence that falling unemployment is beginning to bring some inflation-adjusted wage growth to parts of the US.)

wage-Phillips time series

By the way, if inflation were to become a large problem (and it seems well-contained now), non-recessionary methods exist to try to alleviate it. Even where the Phillips-curve relationship is strong, the human costs of using it to combat inflation are usually very high, given the existence of alternative policies that could perhaps be given a try in the US.

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Greece Has Returned to the Bond Markets—Mission Accomplished?

Michael Stephens | May 5, 2014

C. J. Polychroniou interviewed Levy Institute President Dimitri Papadimitriou for the Sunday edition of Greece’s Eleftherotypia. What follows is an excerpt from the English version of that interview (part one of the Greek version is here):

C. J. Polychroniou: After four years as the pariah of the financial markets, in the course of which 330 billion euros was granted/guaranteed in international bailouts in order to avoid an official bankruptcy, Greece has made a successful return to the international bond markets. Why did Greece return to the bond markets now when the country’s debt-to-GDP ratio is much bigger than it was back in 2010?

Dimitri B. Papadimitriou: The return to the bond markets was an act of pure symbolism. The government purposely made the success of the austerity program dependent on achieving a primary surplus as opposed to the return to growth in output and employment. Recall that the idea of expansionary austerity embraced by the country’s international lenders was spectacularly discredited. Thus, the Troika (IMF, EU and European Central Bank ) and Greece’s compliant government needed to invent a new metric of success, and it was associated with achieving a primary surplus as large as it could be so that financial markets can be impressed. However, no one else is impressed, especially the international lenders, for three main reasons: (1) The primary surplus was achieved by a one-off (non-recurring) excess revenue from the gains of Greek bonds in the portfolios of Eurozone’s central banks and the European Central Bank’s (ECB) holding that were returned to Greece; (2) collections of old tax revenue; and (3) non-recurring spending cuts and delayed payment of the government’s debt to the private sector, whether VAT refunds or non-payments to private sector vendors.

Finally, the return to the markets was costly to the country — the apparent low interest rate of 4.95% notwithstanding — since the interest rate of the funds borrowed from the European Stability Mechanism (ESM) is at a very much lower interest rate. To be sure, the hedge funds and the private sector [parties] buying the new bonds knew that there was an implicit guarantee from the ECB that would accept these bonds under its Outright Monetary Transactions (OMT) program. So the bonds were not backed by the progress of the Greek economy — it would be ludicrous to assume so, for an economy in continuing recession and increasing debt to GDP ratio, especially if its credit rating is still below investment grade. So, all in all, it was an act of desperation and a strategy to give the government extra help in the soon-to-be-held local and European Parliament elections.

[...]

CJP: Radical structural reforms, which include labor and product markets and blanket privatizations, constitute the second component of the conditions behind Greece’s bailout plans. First, is there in economic literature a direct connection between labor market flexibility, productivity growth and national economic performance?

DBP: The economic literature, as economists know, can produce conflicting results. It will not be surprising to find cases when statistics will prove that there is a positive outcome in terms of increasing productivity with flexible labor conditions, but this is always dependent on the level of technology diffusion. To be sure, German workers have the highest productivity in Europe along with those in the Netherlands, but it is not because they are paid less than other Eurozone workers but because of the high level of effective technology used. So they are about 70% more productive as compared to Greeks, Portuguese or Spaniards despite the fact that the latter work substantially many more hours during the week. Clearly, Germany’s and other North European economies enjoy better economic performance, but this is not due to so-called labor flexibility only. Germany is successful because it is lucky, having an extraordinary number of idle and low-wage workers from East Germany when the unification took place. Unification gave Germany the ability to hold West German wages down. But this should not be used as an example of a successful application of a labor flexibility policy. The literature also abounds in studies showing that labor productivity is not dependent on labor flexibility. Indeed, the theory and policy of “efficiency” wages, promoted by none other than Nobel Laureate George Akerlof and current Fed Chair Janet Yellen, is part of the economic research which shows there are productivity gains and other positive outcomes to firms which pay higher than market wages. All in all, then, the argument of flexible wages does not, I am afraid, hold water.

Read the rest of the interview at Truthout.

Related: “Prospects and Policies for the Greek Economy

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The Reality of the Present and the Challenge of the Future: Fagg Foster for the 21st Century

L. Randall Wray | April 23, 2014

(Here is a presentation I gave at the University of Denver at the annual J. Fagg Foster honors ceremony. Most of you will not know of Foster, but you should. While he did not publish much, he was the professor of a number of prominent institutionalists who attended DU in the early postwar period. I was lucky to have studied with his student, Marc Tool, and was introduced to Foster’s work at the very beginning of my studies of economics. My presentation below is based on two of Foster’s articles: J. Fagg Foster (1981) “Understandings and Misunderstandings of Keynesian Economics,” JEI, vol XV, No 4, p. 949-957.; and (1981) “The Reality of the Present and the Challenge of the Future”, JEI vol XV, No 4, p. 963-968. Both are from 1966, republished in a special issue of the Journal of Economic Issues, 1981. You should read them.)

Is this the age of Keynes? That’s the question raised by Fagg Foster in 1966.

In the 1960s the answer seemed obvious. Keynes dominated economics—or, at least, macroeconomics—and Keynesianism dominated policy. And it worked! Or, so most thought.

Foster wasn’t sure. While he agreed that “[t]here probably has been no instance in history in which a pattern of ideas has had so much effect on the everyday life of everyone in so short a time,” he thought most of Keynes’s followers misunderstood his theory.

Further, Foster wasn’t convinced the theory provided a firm basis for policy.

Finally, he lamented that “among all post-Keynesian economists, the institutionalists seem to have been least affected by Keynes’s theory…. The institutionalists have not even contemplated the possibility of any generic relationships between the Keynesian theory and their own.”

A decade later, so-called Keynesian economics was in disarray, a casualty of the apparent failure of policy to fine-tune the economy. Stagflation at the end of the 1970s delivered the final blow, and fueled the rise of increasingly preposterous approaches such as Rational Expectations, Real Business Cycle theory, the Efficient Markets Hypothesis and hence on to DSGE with a single representative agent standing in for the whole economy.

In truth, even in the heyday of Keynesianism, policy was directed to stimulate the sentiments of business undertakers—precisely what Keynes recommended against—with supply-side tax cuts and a cornucopia of subsidies to the captains of industry.

While a parallel approach developed calling itself New Keynesian, the only thing new was the adoption of the craziest “new” orthodox ideas (witness rational expectations). And the only thing “Keynesian” was the presumption that sticky wages and prices prevent instantaneous market clearing—which was actually the old Neoclassical explanation of unemployment that Keynes had dispatched.

With friends like these, Keynes doesn’t need enemies.

In retrospect, Foster might have been a bit hard on the institutionalists. continue reading…

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