Another Eccles at the Fed?

Greg Hannsgen | July 30, 2014

From time to time, I call attention to solid coverage of the Federal Reserve in the popular press, for example this post, which links to an interesting William Greider profile of Ben Bernanke. Nicholas Lemann profiles the new Fed chair in the July 21 issue of The New Yorker. One of the key themes of the newer article is that Yellen is “the most liberal [Fed chair] since Marriner Eccles,” and an “unrepentant Keynesian.”

The article usefully contrasts Yellen’s policy views with those of orthodox macroeconomics. Yellen identifies as an adherent of the philosophy that government is capable of greatly improving on the outcomes of a modern capitalist system. (For many, this is the essence of what is known as the liberal view in the US political realm. Yellen’s liberalism will matter (1) in financial regulation, and (2) in macro policy, where the Fed is influential.)

Of course,  there are many varieties of liberalism. Here is a perhaps-characteristic Yellen quote from the article, explaining economics as a personal career choice: “What I really liked about economics was that it provided a rigorous, analytical way of thinking about issues that have great impact on people’s lives.  Economics is a subject that really relates to core aspects of human well-being, and there’s a methodology for thinking about these things. This was a very appealing combination to me.”

The quote continues, “Market economies are capable of massive breakdowns that can result in long, devastating periods of high unemployment. And I felt that economists had really learned something about how to address that.”

On the other hand, the article expresses sympathy with the view expressed by Bernanke and others that Keynesian economics  itself (as practiced by most academic economics departments) did not foresee the financial crisis that began about 2008. As readers of this blog know, of course, economists affiliated with the Levy Institute and its Minskyan tradition were among the few who did anticipate a crisis. The article notes that Yellen herself “began to be concerned that there was a dangerous bubble in housing markets” in 2005 and 2006, but quotes her as conceding that she “absolutely did not see it as something that could take the financial system down.”

What about the role of bank money and nominal wages, topics on my own mind with the approach of the International Post Keynesian Conference, which the Levy Institute is partially sponsoring? Yellen notes the labor economics insight that companies do not easily or often cut wages, despite the fact that many unemployed workers seek openings. As Yellen helped to show years ago, there are good reasons based on simple mathematical models why this might be so. As a result, it is far more common for firms to leave wages unchanged in a given month than to cut wages by one penny.

Is this the fundamental reason why unemployment can remain elevated for years at a time? Not at all. As Keynes emphasized in chapter 19 of the General Theory of Employment, Interest and Money, reductions in average wages rarely alleviate an unemployment problem in any event. Indeed, pay cuts might push the economy off a “ledge” of some sort in a well-specified nonlinear model, or at least intensify problems arising from a lack of consumer demand. So despite the validity of the empirical observation that wages are somewhat “sticky,” rightly mentioned in connection with Yellen’s approach, the unemployment problem remains to be solved even if wages are free to fall. In this sense, slow or nonexistent wage adjustment is not the root cause of recession or unemployment. In fact, overall deflation can bring economic havoc of many kinds, as witnessed in Japan in most of the period since the 1990s.

This Keynesian insight—emphasized in the US mostly by the Post Keynesian school, Yellen’s mentor Tobin, and a handful of others—is a good reason—along with the macroeconomic importance of debt repayment commitments—to be attempting to bring money, finance, and banking into a macro model at this point. The many thorny and interesting policy problems and debates faced by Yellen in the coming years as the Fed carries out its long-anticipated withdrawal of monetary-policy stimulus are of course another, as pointed out by Lemann in his fine article.

My project for  the upcoming conference mentioned above: to add private money and credit to a model of growth, distribution, and fiscal policy, along with greenhouse-gas emissions and accumulation.  The distinguished heterodox economist Duncan Foley gives his cutting-edge take on forms of Keynesian economics in this essay written for a conference that I had the pleasure of attending in New York earlier this year. And one must not forget blogger and recent American Economic Journal coauthor J. W. Mason.


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