by Lekha Chakraborty and Amandeep Kaur[1]

The macroeconomic uncertainty during the Covid-19 pandemic is hard to measure. Economists and policymakers use the “output gap” variable to capture “slack.” It is a deviation between potential output and actual output, which is a standard representation of a “cycle.” The potential output is an unobserved variable. There is an increasing concern about the way we measure potential output—decomposing the output into trends and cycles. This is because the business cycle is not always a “cycle.” Sometimes, the “cycle is the trend.”[2]

When macroeconomic crises and recessions tend to “permanently” push down the level of a country’s GDP, it is inappropriate to assume that output will bounce back to previous levels. The notion of the output gap is ill-conceived and ill-measured. Scholars have highlighted the significance of “hysteresis” (the dependence of economic path on history) in analyzing the output dynamics in crisis.[3] Against the backdrop of the Covid-19 pandemic crisis, there is a renewed interest in hysteresis and business cycles. The state of the economy and the level of GDP are history dependent (hysteresis). The concept of hysteresis has urgent relevance for designing apt fiscal and monetary policies to tackle low demand during recessions. continue reading…

In the last 24 hours, two big news stories regarding the economic impact of the Covid-19 pandemic have broken. The first is news that the Senate has passed a $2 trillion stimulus package that legislators claim is intended to alleviate the economic damage caused by the responses to the unfolding pandemic: closures of schools and businesses as well as the social isolation of much of the population. The second–a reported 3 million new unemployment claims in the last week alone–is a direct result of the aforementioned responses, as businesses close, events and travel plans are canceled and those who can remain isolated in their homes wondering which will run its course first: the supply of binge-able content on Netflix or the pandemic.

continue reading…

by Felipe Rezende

This is the second in a series of blog posts on financing infrastructure assets.

From 1990 to 2012, the stock of global financial assets increased from $56 trillion to $225 trillion. In 2012, it included a $50 trillion stock market, $47 trillion public debt securities market, $42 trillion in financial institution bonds outstanding, $11 trillion in non-financial corporate bonds, and $62 trillion in non-securitized loans and $13 trillion in securitized loans outstanding (Figure 1).

Figure 1. Stock of Global Financial Assets (USD trillion)

Source: Lund et al. 2013, p. 2

From 2007 to 2012, government debt securities increased by 47 percent (Figure 1) while financial depth rose to 355 percent of global GDP in 2007 from 120 percent in 1980 (Lund et al. 2013: 2). In spite of a massive increase in the stock of global financial assets—equivalent to 302 percent between 1990 and 2012—“[m]ost of the increase in financial depth prior to the crisis was due to financial system leverage and equity valuations” (Lund et al. 2013: 2). Yet the world needs more and better infrastructure, and redirecting finance towards sustainable infrastructure will require a major shift in policy coordination with various stakeholders. For instance, Standard & Poor’s estimated that “institutional investors could provide as much as $200 billion per year—or $3.2 trillion by ­­­2030—for infrastructure financing” (Standard & Poor’s 2014: 2). But “if the right levers are pulled, there is potential to increase investment from private institutional investors by ~$1.2 trillion per year” (Bielenberg et al. 2016: 28). Thus, the problem is not necessarily one of funding but how to direct the finance created by the financial system towards productivity-enhancing investments. continue reading…

Pavlina Tcherneva — who, along with L. Randall Wray, Flavia Dantas, Scott Fullwiler, and Stephanie Kelton, authored this report estimating the economic impact of a job guarantee proposal (the Public Service Employment program) — was interviewed by Bloomberg’s Joe Weisenthal and Julia Chatterley about the purposes and costs of the plan.

This recently released policy note by L. Randall Wray also takes on some of the criticisms raised by the interviewers, in addition to seeking a consensus among the job guarantee proposals emanating from progressive think-tanks.

by Felipe Rezende

This is the first in a series of blog posts on financing infrastructure assets

Insufficient or inadequate infrastructure in both developing and developed economies has sparked a debate about whether financing is sufficient to sustain infrastructure investment to at least keep pace with projected global GDP growth. The task of keeping the minimum investment required to maintain current levels and fostering incremental spending to close the infrastructure gap has revived the debate over the role played by each actor in closing the gap and how to finance this process (see for instance G-20 2013; OECD 2013; World Bank 2015).

One of the major post-crisis challenges is that in spite of an ultra-low interest rate environment or even negative nominal and real rates, investment has been anemic in developed and developing economies (IMF 2015). This is particularly important because, since the crisis, investment has collapsed across all sectors (public, business, and household sectors) in Europe (McKinsey 2016, 2). And in the United States, “the trajectory of net fixed capital formation, which decreased from 12 percent of GDP in 1950 to 8 percent in 2007, then fell to only 4 percent in 2014. Average depreciation rates accelerated by about 20 percent during the 1980s as companies invested in shorter-lived assets such as ICT equipment but did not compensate in terms of higher gross investment rates. This amplified the decline in net investment” (2). To make matters worse, most governments in developed and developing nations (with the exception of a few cases) are cutting back on infrastructure spending due to fiscal consolidation (Figure 1), generating a public-funding shortfall in infrastructure investment.

Figure 1

Source: Mckinsey 2016, p.11

Moreover, insufficient private investment and declining real public investment have contributed to reduce the stock of public capital as a share of output over the past three decades (Figure 2). continue reading…

The Economist‘s analysis of Germany’s job market miracle of the past ten years offered in “What the German economic model can teach Emmanuel Macron” is more balanced than the usual accounts one hears in Germany itself. Germans are in love with the idea that structural reform of their labor market and persistent budgetary austerity were solely responsible for the German economy’s superior performance in recent years. The Economist highlights that Germany was fortunate enough to embark on its route for national salvation – the decisive lowering of its labor costs relative to its European partners – at a time when the world economy and global trade were booming, when China was craving German capital goods, and German companies were restoring their special relationship with a region reemerging from behind the iron curtain. No doubt France and its struggling euro partners are facing a far less benign regional and global environment today.

The Economist would have done well to remind us that despite enjoying a more favorable economic context, Germany became known at the time as “the sick man of Europe/the euro.” Between 1996 and 2006, Germany managed to almost persistently suffocate domestic demand to such an extent that the economy was growing, if barely, on exports alone: the background to Germany’s 8.5 percent-of-GDP current account surplus today. As for France, the bar is much higher today, not only because of stagnant export markets, but also for the fact that France is a far more closed economy than Germany. In other words, there is more to suffocate in terms of domestic demand, but less to gain in terms of exports. In short, the chances of France getting seriously sick by mimicking Germany are very high indeed.

Also, if Europe’s second-largest economy were to embark on the deflationary path earlier trodden by Germany, bear in mind here that the European Central Bank is already in a quagmire. After overcoming many obstacles, legal and intellectual, the bank is applying its full weaponry today in trying to move Eurozone inflation back closer to its 2 percent price stability norm – while facing the prospect of soon running out of ammunition in terms of the fast-shrinking German public debt available for purchase on the market.

And this directs the attention to the true challenge that France and Europe are facing today: German public debt is shrinking fast because Germany runs a sizeable budget surplus. Quite obviously – as the vast imbalance between private saving and investment reveals, which is closely related to the surge in inequality in Germany –this is only made possible by the fact that Germany runs a massive external surplus: the counterparts to which are current account deficits and rising debts of other countries. The upshot of all this is that France and Europe have a zero chance to rebalance for as long as Europe’s largest economy refuses to rebalance too; which means that Germany’s evangelized, but greatly distorted, narrative of its own success will need some fine-tuning too.

For the sake of Europe, let us hope that Angela Merkel’s newfound wisdom that “we Europeans must really take our destiny into our own hands” means that Germany is finally getting ready for a decisive course change to its own economic affairs. Failure to do so, leaving France out in the cold under Emmanuel Macron, would bring Marine Le Pen back into the limelight much sooner than in five years’ time.

A little while back, Pavlina Tcherneva appeared with Bloomberg’s Joe Weisenthal to talk about the potential infrastructure policy of president-elect Donald Trump. She noted that, contrary to initial assumptions, the upcoming administration may not end up pushing public-debt-financed infrastructure spending, and that if the program simply amounts to tax incentives and public-private partnerships, it won’t be nearly as effective. But Tcherneva added another important dimension to this debate. (You can watch the interview here):

Tcherneva’s point is that infrastructure investment should be determined primarily by the state of dilapidation or obsolescence of our roads, bridges, etc., and not so much by the moment we occupy in the business cycle.

There are some who would argue that the time for a large fiscal stimulus has passed, with unemployment at 4.6 percent and growth continuing apace. There’s a good argument to be made that we’re not at “full employment” even at this moment, and that there’s no need to back off on stimulus (though there’s still the question as to whether the Federal Reserve would attempt to depress economic activity by raising interest rates in response to any substantial fiscal expansion — and, additionally, whether the Fed would succeed in those circumstances). But the point is, where you stand on this debate regarding the business cycle and the meaning of full employment shouldn’t be the driving factor behind infrastructure policy — we shouldn’t necessarily pursue or avoid infrastructure repairs and improvements for those reasons.

Moreover, if you’re looking for a job creation program, which Tcherneva would argue ought to be the point of “stimulus,” there are more effective options. In particular, she advocates a job guarantee that would provide paid employment at a minimally decent wage to all who are willing and able to work. Among other reasons, Tcherneva notes that such a program, which automatically expands during economic downturns and contracts in better times, is more effective as a countercyclical stabilizer, as compared to spending on infrastructure projects (read the tweet-storm version of the argument here).

And given that infrastructure seems to have become the go-to spending-side stimulus policy, we might also want to think about the distributive implications. continue reading…

by Felipe Rezende

Part IV

This last part of the series (see Part I, II, and III here, here, and here) will focus on the Brazilian response to the crisis.

1. What Should Brazil Do?

The current Brazilian crisis fits with Minsky’s theory of instability (see here, here, and here). The traditional response to a Minsky crisis involves government deficits to allow the non-government sector to net save. That is, if the private sector desire to net save increases, then fiscal deficits increase to allow it to accumulate net financial assets. The sharp increase in budget deficits in 2015 comes as no surprise. Rezende (2015a) simulated

a scenario in which we have rising government deficits to offset current account deficits, to allow the domestic private sector balance to generate financial surpluses. In this case, in the presence of current account deficits equal to 4% of GDP, to allow the private sector to net save 2% of GDP, it would require government deficits equal to 6% of GDP.  If the private sector is going to save 5% of GDP (equal to the 2002-2007 average pre-crisis) and a current account deficit equal to 4% of GDP then we must have an overall government budget in deficit equal to 9% of GDP. Given the current state of affairs, government deficits of this magnitude might be politically unfeasible right now. (Rezende 2015a)

In 2015, Brazil’s budget deficit increased from 2% of GDP in 2008 to 10.38% of GDP in 2015. Though government deficits support incomes (cash flow and portfolio effects) and stabilizes profits, the bad composition of the government budget, that is, virtually the entire deficit is due to interest payments, did little to sustain employment. Brazil’s primary budget balance swung from a surplus of 3% of GDP over a decade to a deficit. As this happened, credit rating agencies’ decision to downgrade Brazil’s sovereign debt to junk status put Ms. Rousseff under growing pressure to cut public spending. In this regard, with the implementation of austerity policies in 2015 automatic stabilizers were switched off, that is, the real growth (deflated by IPCA) of expenses by the central government sharply declined (figure 1) aggravating the recession. continue reading…

by Felipe Rezende

Part III

This part of the series (see Parts I and II, here and here) will focus on macroeconomic and microeconomic aspects of financial fragility and the provision of liquidity. Minsky’s framework not only sheds light on how to detect unsustainable financial practices, but the position adopted in this paper is that the current Brazilian crisis does fit with Minsky’s instability theory. This is a Minsky crisis in which during economic expansions market participants show greater tolerance for risk and forget the lessons of past crises so economic units gradually move from safe financial positions to riskier positions and declining cushions of safety. continue reading…

by Felipe Rezende

This series will discuss at length the underlying forces behind Brazil’s current crisis. (See Part I here)

Part II

Building on Keynes’s investment theory of the cycle, Minsky’s work suggests that the structure of the economy becomes more fragile over a period of tranquility and prosperity. That is, endogenous processes breed financial and economic instability. While Minsky adopted Keynes’s “investment theory of the cycle,” he added a financial theory of investment, with a detailed exposition of the theory in his book John Maynard Keynes (1975), which put at the forefront the interrelation between investment decisions and the financial structure designed to allow economic units to take positions in assets by issuing debt. In this regard, debt accumulation is at the core of Minsky’s instability theory. His financial theory of investment incorporated Kalecki’s approach in which aggregate profits are created, mostly, by the autonomous components of demand (Minsky 1986, 1989). One can add to this analysis Godley’s three balances approach, which explores the interlinkages between the government sector, the private sector, and the external sector. This means that a surplus must be matched by an equal deficit and flows accumulate to stocks.

In this regard, Godley’s framework sheds light on the identification of financial fragility at the macro level, in which, to accumulate financial wealth, the private sector (firms and households) needs to spend less than its income. This can be accomplished through a combination of government budget deficits and current account surpluses. This framework is then incorporated into Minsky’s theory of the business cycle to analyze Brazil’s current crisis. In particular, Minsky’s framework not only sheds light on how to detect unsustainable financial practices, but the position adopted in this paper is that the current Brazilian crisis does fit with Minsky’s instability theory.

This article attempts to demonstrate the existence of endogenously generated instability in the Brazilian economy, which has created frequent and systemic financial crises. Brazil’s current crisis is not due to unsustainable policies; the country’s problem is systemic. continue reading…