Archive for March, 2012

Money and Self-Justifying Economic Models

Michael Stephens | March 13, 2012

Philip Pilkington shares a discussion he had with Dean Baker about, among other things, the Post-Keynesian take on the limitations of some conventional economic models (of the “LM” part of IS-LM, in particular.  And if that just looks like an arbitrary string of letters to you, Pilkington has an accessible explanation at the beginning of his post).  His description of the “self-justifying” dynamics of the IS-LM view of money and central banking is worth quoting:

By assuming an upward-sloping LM-curve – that is, a fixed supply of funds – there is an implicit assumption that actions on the part of the central bank are somehow neutral. ISLM enthusiasts implicitly assume that the central bank is simply responding to some otherwise ‘equilibrating’ market conditions and adjusting its rates in line with this. …

… [The standard ISLM model] buries the fact that the central bank is actually taking a specific stance on policy and then tries to pass off this stance as a sort of quasi-market response (i.e. as if there were a market for a fixed supply of funds). But the central bank’s policy stance is nothing of the sort. Instead it is a sort of a simulation of what a market response is thought to be. Thought to be by whom? By economists that adhere to models similar to the ISLM, of course!

In a related vein, Greg Hannsgen points me to the latest volume of essays published in honor of Wynne Godley, “Contributions to Stock-Flow Modeling,” in which Marc Lavoie highlights this Godley quotation on the fixed stock of funds assumption in IS-LM:

Godley was always puzzled by the standard neoclassical assumption, found in both the IS/LM model and among monetarists, of an exogenous or fixed stock of money, the worse example of which is Friedman’s money helicopter drop. As Godley says, ‘governments can no more control stocks of either bank money or cash than a gardener can control the direction of a hosepipe by grabbing at the water jet’.


Healthcare and the Budget Forecast: Don’t Think of the Children

Michael Stephens | March 9, 2012

Medicare cost growth has been slowing down, and according to research published in the New England Journal of Medicine there may be more going on here than just a temporary reaction to the recession.  This is just one analysis of course, but if it pans out, if it marks the beginning of a sustained trend, the implications for the budget debates would be huge.

If Medicare cost growth tapers off, this would address the most pressing issue for those who are concerned (in good faith at least) about the long-term US budget picture.  “Deficit doves,” who are careful to state that we need to increase deficits in the short-term to deal with the recession’s aftermath, will tell you that in the long run the problem is not spending in general, or entitlements (the long-term gap in Social Security funding is estimated to be about 0.6 percent of GDP), or even demographics (the aging of the population will inevitably mean more spending on programs for the elderly, but this trend levels off after a certain period; it’s predictable and manageable).  The very core of their case for long-term debt anxiety is the belief that healthcare costs (and by extension Medicare costs) will rise much faster than GDP for the foreseeable future.

But this means that a large part of the debate has been driven by what we think will happen to healthcare costs decades and decades into the future.  That’s not to say that we should simply wave away problems if they’re based on long-term projections, but we do need to keep it all in perspective.  In this vein, Karl Smith picks up the story on Medicare costs and delivers a bracing inoculation against the “think of the children!” disease that afflicts so many policymakers: continue reading…


“What Manner of Union Is This?”

Michael Stephens | March 8, 2012

The title of C. J. Polychroniou’s latest policy note, “Neo-Hooverian Policies Threaten to Turn Europe into an Economic Wasteland,” gives you a pretty good idea of where he’s coming from:

There can be no denying that, despite the experiences provided by the Great Depression and the numerous financial crises that have taken place since 1973, policymakers have been dismally wrong in their assessment of the 2007–08 global crisis and governments dreadfully incompetent in developing a clear strategy for addressing it appropriately. The reason for this lies with an economic ideology, a conceptual framework with which government officials and bankers deal with economic reality, that is fundamentally flawed.

As a way of addressing some of the flaws of the eurozone policy architecture, and of counteracting the ideology of austerity that is embedded in that architecture (the “fiscal compact” currently being debated, which would place more automatic penalties on governments that deviate from severe limits on budget deficits, goes even further in embedding this ideology in the setup of the European Monetary Union), Polychroniou is looking to a “United States of Europe” model, with an expansion of EU-level fiscal policy powers.

As he observes, however, the European project is moving in the opposite direction:

Indeed, in an indication of where Europe may be headed politically, the EU’s budget was slashed by four billion euros in 2010, with some governments arguing that the EU budget, in the words of British Prime Minister David Cameron, should be progressively “reduced rather than increased”—and this appears to be the definite trend in Euroland.

What manner of union is this?

Read the policy note here.


Wray on the Burden of Social Security

Michael Stephens | March 7, 2012

Randall Wray has been engaged in a back-and-forth with John Carney of CNBC.  Their latest exchange touched on the question of the “real” economic burdens of Social Security (distinct from issues of affordability).  Wray responds:

“John Carney agrees with me that supporting our elderly is not an ‘affordability’ problem, but he claims that I fail to see the ‘real’ burden—the dependency ratios and all that. Actually I’ve been writing about that since the early 1990s. The ‘real’ burden is the only thing that matters.

Here’s just a short list of easily accessible things I’ve written at

The Case Against Intergenerational Accounting: The Accounting Campaign Against Social Security and Medicare [2009]

Global Demographic Trends and Provisioning for the Future [2006]

The Burden of Aging [2006]

Social Security’s 70th Anniversary [2005]

Killing Social Security Softly with Faux Kindness [2001]

More Pain, No Gain [1999]

Does Social Security Need Saving? [1999]

… There are two important issues here. continue reading…


“I Happen to Have Mr. McLuhan Right Here,” Wonk Edition

Michael Stephens |

It won’t be quite as satisfying as having Marshall McLuhan stashed in a corner to back up your argument, but for the next time you find yourself in a real-time wonkfight, FRED (the go-to database of the St. Louis Fed) is now available as a mobile app.


Minsky Explains Bank Management Motivation

Michael Stephens | March 2, 2012

Your Minsky quotation of the day:

The rise in bank share prices that follows a growth in profitability is particularly important in a world of professionally managed institutionalized banks.  The typical professional bank president is not a rich man when he starts his career.  As a bank president he is a hired hand trying to achieve a personal fortune.  But given the tax structure, it is difficult to accumulate a fortune by saving out of income; the most efficient route for a business executive is by way of stock options and the capital gains that accrue as the stock market price per share rises.  As holders of stock options, bank management is interested in the price, on the exchanges, of their bank’s shares.

The price of any stock is related to the earnings per share, the capitalization rate on earnings of the bank’s perceived risk class, and the expected rate of growth of such earnings.  If bank management can accelerate the growth rate of earnings by increasing leverage without a decrease in the perceived security and safety of the bank’s earnings, then the price of shares will rise because both earnings and the capitalization rate on earnings that reflects growth expectations rise.  In a capitalist society with institutionalized organizations and tax laws such as ours, fortune-seeking by the mangers of institutionalized enterprises leads to an emphasis upon growth, which in turn leads to efforts to increase leverage.  But increased leverage by banks and ordinary firms decreases the margins of safety and thus increases the potential for instability of the economy.

From Minsky’s “Stabilizing an Unstable Economy,” p. 266 (first published in 1986, though I’m told largely finished by 1982).


EU Anorexia

Michael Stephens | March 1, 2012

C. J. Polychroniou surveys the distressing results, in terms of unemployment (and particularly youth unemployment), of the “neo-Hooverism” and obsession with price stability that permeate European Union policymaking and explains that a fundamental change in approach is needed:

Europe is in dire need of an economic and political revolution. It needs an immediate return to Keynesian measures and a new institutional architecture for the eurozone. It needs to move toward a United States of Europe. If such steps are not taken, Europe’s economies and societies could very well end up in a situation similar to that of the United States in the 1930s.

Read Polychroniou’s one-pager here.