SimpleDon
Veteran Member
Income inequality and economic stagnation, competing stories
Based on Inequality, the financial crisis stagnation, competing stories and why they matter, by Tom Palley, available now for subscribers to the Real World Economics Review, here, http://www.paecon.net/PAEReview, subscriptions are free. Will be available to non-subscribers in a month. I will summarize the paper, adding my own take, in italics, usually.
This maybe a link to the paper that might work for non-subscribers. I am a subscriber and it works for me. Of course, I discovered it after I had completely summarized the paper below. The link will download a pdf file.
http://p.feedblitz.com/t3.asp?/9738...www.paecon.net/PAEReview/issue74/Palley74.pdf
In my thread on my poor understanding of basic economics, someone told me that the neoclassical synthesis economics that is the current mainstream orthodoxy of economics is not so much a single economic philosophy as it is a toolbox by which economics can be explained and understood. Implying that many different economic philosophies can be explained and understood with the tools provided by the synthesis toolbox. I agree with that, but only up to a point.
There are some tools missing.[/analogy] There are lines that can't be crossed in the synthesis. Schools of economics that are considered to be heterodoxical schools of economics whose economists can't be published in the mainstream journals. There are subjects that mainstream economists can't get published. There are conclusions that can't be made.
This paper is an example of this. It is being published in an non-mainstream on-line economics journal. It was started by post Keynesians but accepts papers from a broad range of economists.
The first story is from Fault Lines: How hidden fractures still threaten the world economy,, a book by R.G. Rajan. He is an University of Chicago trained economist, currently a professor there and is considered to be every bit of the hard line neoliberal neoclassical that that University stands for. He was the chief economist at the IMF when the crisis occurred and is one of the handful of economists who predicted the financial crisis and the cause of it, the popping of the housing bubble. (No, Ron Paul didn't predict the crisis and the cause of it, more accurately he incorrectly predicted a housing crisis next year for more than twenty years before 2008, and never predicted the proper cause.)
In summary,
This is the response to the problems from the neoclassical/neoliberal right and the preferred explanation for political right. It boils down to the government did it. But this explanation has been repeatedly refuted.
The government interventions had been in place for a long time without causing any problems, the CRA since 1977 and FNMA since 1938. Fannie Mae didn't trade in sub-prime mortgage securities until late in the bubble build up and then only reluctantly under pressure from their stockholders. Stockholders, who would stabilize the previously government owned entity and shield the government from a massive failure, the Republicans insisted when they forced the partial privatization of Fannie Mae.
Finally only one Republican on the House investigating subcommittee voted to submit this explanation as the majority report.
The explanation of the cause of the income inequality is also popular with the right, it says that the inequality was and is unavoidable. Just an unfortunate result of the economy working correctly, unfortunate unless you are wealthy that is. But this explanation runs into a lot of problems, especially for the neoliberals, the supply siders:
The idea that the stagnation is the result of a slow recovery from a recession caused by a financial crisis, as is often seen with these kinds of recessions, has been taken on by a NBER working paper New Evidence on the Impact of Financial Crises in Advanced Countries, by C. and D. Romer, 2015. They found that the recoveries from financial crisis triggered recessions vary all over the place but that they average out to moderate lengths of time.
The theory behind these positions is covered below.
From the neoclassical center we have a second explanation from Inequality, leverage and crises, by Kumhof and Rancière, 2010. This is the synthesis made real, a combination of Keynesian and neoclassical economics.
This is less Keynesian and more neoclassical than it appears.
The economy was at full employment before and and after the financial crisis, so that the inequality doesn't impact employment.
Certainly the erosion of the unions and of the workers' bargaining power that resulted was one of the causes of the inequality, but it wasn't the only reason.
Excessive lending is a financial market failure that increased the fragility of the economy. Underwriting is the obligation of the banks and the financial sector. Denial of market failures is a feature of neoclassical not Keynesian economics.
There is no evidence of a further shock to workers' bargaining power in 2007 or 2008. In fact, wages were increasing.
This model has difficulty explaining the size of the output reduction caused by the financial crisis and the onset of stagnation after the Great Recession. The claim of a 10% reduction in the capital stock is implausible.
The third paper is Debt, deleveraging, and the liquidity trap, by Eggertsson and Krugman, 2012, an explanation from the neoclassical left. Krugman is well known for his largely political New York Times op-ed column and his largely economic theory blog on the same paper's web site.
This article is about the stagnation and only touched on the financial crisis and had nothing about the income inequality. Their attitude about the income inequality was pulled from other blog entries.
Things that are understood by Palley's audience that might need some further explanation here.
Eggertsson and Krugman's arguments,
There are many problems with this explanation of the stagnation and Krugman's stance on the inequality.
Rajan, Kumhof and Rancière, and Krugman are all leading mainstream economists. Their associations are the University of Chicago, the IMF and MIT.
Rajan is identified with the hardcore neoliberalism of the Chicago school which views the economy as approximating textbook perfect competition, presumably in the aggregate, with minimum market failures. Government interference always produces worse outcomes. Government failure is always more costly than market failures.
The others are identified with the softcore neoliberalism of MIT. They believe in the same benchmark competitive model as the hardcore neoliberals but to them, market failures are pervasive and large and that government intervention is an acceptable solution to them. But they all argue that there is nothing wrong with the structure of the economy. Policy is claimed to do a good job remedying their effects.
All of them share a common neoclassical, mainstream theoretical view of the economy. While they differ on the extent of market failures and the effectiveness of government interference, there is one point on which they will all agree on, that the structure of the economy is solid. That the problems from the Great Financial Crisis and Recession will be over in time, no matter what is or what isn't done. That no matter what the disruptions are, that the economy will always return to an equilibrium of full employment and full capacity utilization. Even if it requires them to redefine those two terms from time to time.
This idea of a full employment equilibrium is embodied in the Arrow-Debreu competitive general equilibrium model that remains as the analytic heart of mainstream theoretical economics. The model benchmarks an ideal economy and generates the two famous welfare theorems. The first states that perfectly competitive economies, with no market or informational failures, will be Pareto efficient, that no one can be made better off without making someone else worse off, and that this is independent of the income distribution.
The second welfare theorem says that in an ideal economy there is no way, except for a lump sum tax, to redistribute income without allocative and productive inefficiencies. And a lump sum tax, charging everyone the same amount, is impossible to implement in the real world.
These theorems only apply to an ideal economy, but they bias mainstream economists into thinking incorrectly about inequality in two ways, that inequality doesn't matter for economic efficiency and that it is impossible to redress the inequality without losing efficiency.
Palley is a proponent of what he calls a structural Keynesian approach. I had never heard of Structural Keynesian. As far as I can tell he is the only one who uses the term. Just from reading some of the posts on his web site he is close to being a post-Keynesian, a heterodoxical economics school, in opposition to the orthodoxy, the mainstream, neoclassical synthesis economics. There certainly isn't anything in this paper that would upset most post-Keynesians.
The above argument shows that income distribution does matter. But to show how requires a better macroeconomic story than offered by the ZLB proponents. That is a "structural Keynesian" account of the financial crisis and stagnation. Written long before the stagnation was recognized by mainstream economists like Larry Summers.
Until the late 1970's developed countries, including the US, could be described by a Keynes virtuous circle growth model in which wages were the engine of demand growth.
Within this system, finance was constrained by New Deal type regulation limiting it to a public utility model where its role was to;
After 1980 the virtuous Keynesian (demand side) growth model was replaced by a neoliberal (supply side) growth model. The two key changes in the real economy were;
In addition regulation of the financial sector was eased resulting in the financialization of the economy in which the presence and power of finance in the economy. These changes created a new economic model. Before 1980 increases in wages drove economic growth. After 1980 debt and asset inflation drove economic growth.
This new economic model can be described as a "neoliberal policy box," that fences workers in and pressures them from all sides via;
Also the New Deal financial system public utility model was gutted by deregulation and new financial innovations were largely left unregulated.
The result was a new system characterized by ever growing financial instability, wage stagnation and increased income inequality. These wage and income developments created a growing structural demand shortage. The role assumed by finance was to fill this demand gap, with innovations, speculation and above all increased debt.
Having finance fill the demand gap was an unintended consequence of the neoliberal policies. Neoliberal economic policymakers didn't realize that they were creating a demand gap, but their laissez faire financial ideology unleashed developments that accidentally filled it. This process was inherently unstable and was always destined to implode. There are limits to both private borrowing and to asset price inflation. These processes were of long duration, therefore the collapse was far deeper when it happened.
The structural Keynesian view of the role of inequality in the crisis and the stagnation is,
The above diagnosis makes clear why the middle term outlook is for continued stagnation.
Consequently, despite the Federal Reserve's zero interest rate and quantitative easing policies, the economy is beset by slower growth and overall labor market slack that threatens to become permanent. Further having re-inflated the asset prices the QE experiment will backfire in the form of renewed financial market turmoil.
Which of the above four stories we accept matters enormously because the way that we explain the world affects how we understand it, which in turn has major political and policy consequences.
If Rajan's story is accepted then income inequality is reduced to an issue of political and ethical concern, but not an economic concern. Since labor markets are working as they are suppose to, there is no justification for interventions into the labor market to increase wage share of GDP or to improve workers bargaining power. Rather than focusing on income inequality we should be moving to repeal government interventions in the home mortgage markets and to return to more orthodox monetary policy to prevent asset price bubbles.
If Kumhof and Ranciére story is accepted, the cause of the crisis was financial market failure that allowed workers whose income prospects had diminished to borrow excessively. The policy response should be to tighten financial market regulation prevent a repeat of the lending bubble. Once again, the labor markets were working well and the case for increasing the wage share is again purely ethical and political.
If the Eggertsson-Krugman, ZLB, deleveraging story is accepted income distribution is again reduced to a non-economic issue. Instead the cause of the stagnation is deleveraging which just a process that has to be worked through. However, during this period there is the case for large budget deficits to offset the private savings caused by the deleveraging and avoiding the decreased output and increased unemployment that would result. As above the inequality is a purely ethical and political question, not an economic one.
If the "structural Keynesian" story is accepted, then the income distribution is a central problem and the principle factor explaining the demand shortage that is the cause of the stagnation. The solution is to replace the neoliberal policy framework with a “structural Keynesianism” framework. Metaphorically speaking, policymakers needs to repack the box, take workers out, and put
corporations and financial markets in. That requires replacing corporate globalization with managed globalization; restoring macroeconomic policy commitment to full employment; replacing the anti-government agenda with a social democratic agenda that supports and funds public investment, provision of public services and regulation (including financial markets); and replacing neoliberal labor market flexibility with solidarity based labor markets in which workers have greater bargaining power and receive an increased wage share.
Palley goes on to elaborate the meaning of accepting the structural Keynesian explanation and the political problems with trying to implement it, which are huge, considering that the dominate movement conservatism's policies and those of the Republican party are exactly the neoliberal policy framework, policies that they will defend to the death. Palley's take is interesting and I urge you to read it but it doesn't impact our discussion.
In separate threads recently I have stated the position that the neoclassical synthesis economics' failures are primarily due to its components from Marshall's neoclassical economics like a general, full employment equilibrium, loanable funds, welfare theorems, a non-monetary economy, etc. and especially from its morph into neoliberal economics, which I characterized as rich men's economics because its main purpose seem to be to boost the incomes and wealth of the already rich at the cost of the incomes of everyone else and in spite of its impact on the economy.
I offer this paper as support for the above. The tools provided by neoclassical synthesis economies seem to be capable of being used to develop any analysis except for the most reasonable Keynesian structural one.
Keynes realized that the modern industrial economy is no longer a supply lead economy, as modern neoclassical and neoliberal economics assumes. That the modern economy is now demand lead, that the growth in the economy depends on the amount of demand in the economy.
So which explanation do you believe is closest to the correct one? And why?
Can you provide any additional arguments for or against any of the four explanations?
Based on Inequality, the financial crisis stagnation, competing stories and why they matter, by Tom Palley, available now for subscribers to the Real World Economics Review, here, http://www.paecon.net/PAEReview, subscriptions are free. Will be available to non-subscribers in a month. I will summarize the paper, adding my own take, in italics, usually.
This maybe a link to the paper that might work for non-subscribers. I am a subscriber and it works for me. Of course, I discovered it after I had completely summarized the paper below. The link will download a pdf file.
http://p.feedblitz.com/t3.asp?/9738...www.paecon.net/PAEReview/issue74/Palley74.pdf
In my thread on my poor understanding of basic economics, someone told me that the neoclassical synthesis economics that is the current mainstream orthodoxy of economics is not so much a single economic philosophy as it is a toolbox by which economics can be explained and understood. Implying that many different economic philosophies can be explained and understood with the tools provided by the synthesis toolbox. I agree with that, but only up to a point.
There are some tools missing.[/analogy] There are lines that can't be crossed in the synthesis. Schools of economics that are considered to be heterodoxical schools of economics whose economists can't be published in the mainstream journals. There are subjects that mainstream economists can't get published. There are conclusions that can't be made.
This paper is an example of this. It is being published in an non-mainstream on-line economics journal. It was started by post Keynesians but accepts papers from a broad range of economists.
=============================
1. Rajan's it's the government's fault explanation
1. Rajan's it's the government's fault explanation
The first story is from Fault Lines: How hidden fractures still threaten the world economy,, a book by R.G. Rajan. He is an University of Chicago trained economist, currently a professor there and is considered to be every bit of the hard line neoliberal neoclassical that that University stands for. He was the chief economist at the IMF when the crisis occurred and is one of the handful of economists who predicted the financial crisis and the cause of it, the popping of the housing bubble. (No, Ron Paul didn't predict the crisis and the cause of it, more accurately he incorrectly predicted a housing crisis next year for more than twenty years before 2008, and never predicted the proper cause.)
In summary,
- He believes that the financial crisis was caused by income inequality because of the government's intervention as a reaction to the inequality.
- That income inequity is caused by the economy increasing the rewards for the most skilled and decreasing the rewards for the least skilled.
- He asserts that the labor market was working correctly and that the income and wealth inequality isn't an economic problem.
- That the solution to the inequality is better education and training.
- That the American government, as a sop to the less skilled who were being left behind, promoted cheap credit as a way to get them what they wanted, most notably homeownership.
- That the main evidence was in the Community Redevelopment Act, the CRA, and the behavior of the Federal National Mortgage Association, FNMA or Fannie Mae.
- He didn't address the stagnation in this book but he has more recently attributed it to the long recovery times from recessions caused by financial crises and the remaining high private debt load.
This is the response to the problems from the neoclassical/neoliberal right and the preferred explanation for political right. It boils down to the government did it. But this explanation has been repeatedly refuted.
The government interventions had been in place for a long time without causing any problems, the CRA since 1977 and FNMA since 1938. Fannie Mae didn't trade in sub-prime mortgage securities until late in the bubble build up and then only reluctantly under pressure from their stockholders. Stockholders, who would stabilize the previously government owned entity and shield the government from a massive failure, the Republicans insisted when they forced the partial privatization of Fannie Mae.
Finally only one Republican on the House investigating subcommittee voted to submit this explanation as the majority report.
The explanation of the cause of the income inequality is also popular with the right, it says that the inequality was and is unavoidable. Just an unfortunate result of the economy working correctly, unfortunate unless you are wealthy that is. But this explanation runs into a lot of problems, especially for the neoliberals, the supply siders:
- In 1980 the supply siders were arguing that government policies largely determine the income distribution, now they are denying this.
- The main beneficiaries of the income inequality haven't been the innovators, highly skilled and schooled, it has been the rentiers; the passive investors, the coupon clippers, the bankers and Wall Street.
- Our current economic policies are essentially the same supply side economic policies imposed starting in the 1980's. Even if other factors caused the inequality there is no reason to continue with policies designed specifically to produce inequality.
The idea that the stagnation is the result of a slow recovery from a recession caused by a financial crisis, as is often seen with these kinds of recessions, has been taken on by a NBER working paper New Evidence on the Impact of Financial Crises in Advanced Countries, by C. and D. Romer, 2015. They found that the recoveries from financial crisis triggered recessions vary all over the place but that they average out to moderate lengths of time.
The theory behind these positions is covered below.
=============================
2. Kumhof and Rancière, the reduction in workers' bargaining power and private debt explanation
2. Kumhof and Rancière, the reduction in workers' bargaining power and private debt explanation
From the neoclassical center we have a second explanation from Inequality, leverage and crises, by Kumhof and Rancière, 2010. This is the synthesis made real, a combination of Keynesian and neoclassical economics.
- That the income inequality was caused by the lessening of union bargaining power.
- That the income inequality lead to the financial crisis because of the increase in private debt.
- The inequality led to persistent borrowing from workers as they tried to maintain their standard of living.
- That the private debt load left the economy fragile and vulnerable to another shock to worker's bargaining power that further lowered workers' incomes so that the loans couldn't be paid back triggering the financial crisis.
- That the stagnation is caused by an assumed 10% reduction in the capital stock due to the financial crisis.
This is less Keynesian and more neoclassical than it appears.
The economy was at full employment before and and after the financial crisis, so that the inequality doesn't impact employment.
Certainly the erosion of the unions and of the workers' bargaining power that resulted was one of the causes of the inequality, but it wasn't the only reason.
Excessive lending is a financial market failure that increased the fragility of the economy. Underwriting is the obligation of the banks and the financial sector. Denial of market failures is a feature of neoclassical not Keynesian economics.
There is no evidence of a further shock to workers' bargaining power in 2007 or 2008. In fact, wages were increasing.
This model has difficulty explaining the size of the output reduction caused by the financial crisis and the onset of stagnation after the Great Recession. The claim of a 10% reduction in the capital stock is implausible.
=============================
3. Eggertsson-Krugman's ZLB, liquidity trap, and deleveraging explanation
3. Eggertsson-Krugman's ZLB, liquidity trap, and deleveraging explanation
The third paper is Debt, deleveraging, and the liquidity trap, by Eggertsson and Krugman, 2012, an explanation from the neoclassical left. Krugman is well known for his largely political New York Times op-ed column and his largely economic theory blog on the same paper's web site.
This article is about the stagnation and only touched on the financial crisis and had nothing about the income inequality. Their attitude about the income inequality was pulled from other blog entries.
Things that are understood by Palley's audience that might need some further explanation here.
Eggertsson and Krugman's arguments,
- The income inequality had no part in either the financial crisis or the stagnation.
- The precursor to stagnation is that a financial bubble drove more borrowing and leverage in the economy.
- When the bubble burst in 2007/8 the economy experienced a financial crisis and a deep recession.
- The bubble bursting started a wave of deleveraging in the economy.
- The deleveraging increased savings that the economy was unable to absorb in the economy because of the ZLB.
- That there exists an interest rate that balances full employment savings with full employment investment.
- That the loanable funds market determines the full employment interest rate based on the supply of savings and investment.
- That the deleveraging, paying down debt, causes the upward sloping LM curve to shift to the right, so far that to balance with the full employment savings rate would require a negative real interest rate.
- The lowest the nominal interest rate can go is zero, the interest rate is zero limit bound, ZLB.
- This is the liquidity trap.
- The policy to to recover from the stagnation is two part.
- Run a large budget deficit to soak up the excess private savings.
- Ramp up inflation expectations, the only way to have a effectively negative real inflation rate is to have a higher inflation rate than an interest rate.
- Krugman has persistently contested the significance of the inequality as a cause of the stagnation, citing the declining savings rate after 1980 as proof that inequality doesn't reduce demand.
- To Krugman the main impact of the inequality hasn't been economic but political, as the rich have used their increased wealth to prevent the use of fiscal policies to offset the problems caused by deleveraging, as evidenced by the repeated calls for austerity, for cuts in the safety net and for cuts in the so-called entitlements, Social Security, etc., for example.
There are many problems with this explanation of the stagnation and Krugman's stance on the inequality.
- The originator of the IS-LM diagram, John Hicks, later called it a "classroom gadget" and not a tool for economic investigations.
- The ZLB story rests on a loanable funds theory of interest rates in which the full employment interest rate is determined by the supply of savings and the demand for investment. This theory was discredited by Keynes in The General Theory....
- The ZLB story of stagnation puts too much significance on interest rates as both the source of the problem and as the solution to it.
- Real interest rates were negative in the 1970's and it did nothing to solve the stagnation and employment problems then.
- A negative 3% real interest rate, called for by Krugman et al, would likely trigger a renewed financial bubble that would crash even harder when real interest rates started up.
- The deleveraging story of excess savings and reduced demand is unconvincing, private savings has been increasing since the Great Recession and a significant portion of the deleveraging during the recession was from defaults and debt write offs, which increase aggregate demand and reduces savings.
- The Krugman et al explanation of stagnation assigns no role to income inequality, an obvious omission if you only consider the higher income households greater propensity to save and its identical effects to deleveraging.
- The inequality doesn't increase savings and decrease demand argument ignores the realities of the neoliberal policies, the asset price inflation (increased capital gains, the "good" inflation), a thirty year long credit bubble which increased wealth, collateral, the quantity of credit, and the ease of access to credit all of which masked the neoliberal wage stagnation for the vast majority of Americans.
- The credit bubble ended with the financial crisis, resulting in an increased savings rate to rebound, causing a demand shortage and it was this, not the deleveraging, that caused the stagnation.
- This is shown in Inequality, the Great Recession and Slow Recovery, by Cynamon and Fazzari, 2012.
- While Krugman's political economy argument, that inequality has provided the wealthy with greater political power with which to impose their will, is undoubtedly true, there is also no doubt at this point that Krugman and the other mainstream economists here must still be missing something.
=============================
Why the mainstream economists have missed the effects of income inequality and the causes of the stagnation
Why the mainstream economists have missed the effects of income inequality and the causes of the stagnation
Rajan, Kumhof and Rancière, and Krugman are all leading mainstream economists. Their associations are the University of Chicago, the IMF and MIT.
Rajan is identified with the hardcore neoliberalism of the Chicago school which views the economy as approximating textbook perfect competition, presumably in the aggregate, with minimum market failures. Government interference always produces worse outcomes. Government failure is always more costly than market failures.
The others are identified with the softcore neoliberalism of MIT. They believe in the same benchmark competitive model as the hardcore neoliberals but to them, market failures are pervasive and large and that government intervention is an acceptable solution to them. But they all argue that there is nothing wrong with the structure of the economy. Policy is claimed to do a good job remedying their effects.
All of them share a common neoclassical, mainstream theoretical view of the economy. While they differ on the extent of market failures and the effectiveness of government interference, there is one point on which they will all agree on, that the structure of the economy is solid. That the problems from the Great Financial Crisis and Recession will be over in time, no matter what is or what isn't done. That no matter what the disruptions are, that the economy will always return to an equilibrium of full employment and full capacity utilization. Even if it requires them to redefine those two terms from time to time.
This idea of a full employment equilibrium is embodied in the Arrow-Debreu competitive general equilibrium model that remains as the analytic heart of mainstream theoretical economics. The model benchmarks an ideal economy and generates the two famous welfare theorems. The first states that perfectly competitive economies, with no market or informational failures, will be Pareto efficient, that no one can be made better off without making someone else worse off, and that this is independent of the income distribution.
The second welfare theorem says that in an ideal economy there is no way, except for a lump sum tax, to redistribute income without allocative and productive inefficiencies. And a lump sum tax, charging everyone the same amount, is impossible to implement in the real world.
These theorems only apply to an ideal economy, but they bias mainstream economists into thinking incorrectly about inequality in two ways, that inequality doesn't matter for economic efficiency and that it is impossible to redress the inequality without losing efficiency.
=============================
The Keynesian virtuous circle growth model
The Keynesian virtuous circle growth model
Palley is a proponent of what he calls a structural Keynesian approach. I had never heard of Structural Keynesian. As far as I can tell he is the only one who uses the term. Just from reading some of the posts on his web site he is close to being a post-Keynesian, a heterodoxical economics school, in opposition to the orthodoxy, the mainstream, neoclassical synthesis economics. There certainly isn't anything in this paper that would upset most post-Keynesians.
The above argument shows that income distribution does matter. But to show how requires a better macroeconomic story than offered by the ZLB proponents. That is a "structural Keynesian" account of the financial crisis and stagnation. Written long before the stagnation was recognized by mainstream economists like Larry Summers.
Until the late 1970's developed countries, including the US, could be described by a Keynes virtuous circle growth model in which wages were the engine of demand growth.
- Productivity growth leads to,
- Wage and demand growth which produces,
- Full employment which,
- Provides the incentive to invest which produces,
- Further productivity growth, which takes us back to 1.
Within this system, finance was constrained by New Deal type regulation limiting it to a public utility model where its role was to;
- provide businesses with finance for investment
- provide businesses and households with insurance
- provide households with the means to save
After 1980 the virtuous Keynesian (demand side) growth model was replaced by a neoliberal (supply side) growth model. The two key changes in the real economy were;
- abandonment of the commitment to full employment and replacing it with a commitment to low inflation
- severing the link between wages and productivity growth
In addition regulation of the financial sector was eased resulting in the financialization of the economy in which the presence and power of finance in the economy. These changes created a new economic model. Before 1980 increases in wages drove economic growth. After 1980 debt and asset inflation drove economic growth.
This new economic model can be described as a "neoliberal policy box," that fences workers in and pressures them from all sides via;
- the corporate model of globalization
- the small government agenda that attacks regulation and public sector activity
- the labor market flexibility agenda that attacks unions, worker bargaining power and worker protections
- the replacement of full employment macroeconomic policy with low inflation targeting policies
Also the New Deal financial system public utility model was gutted by deregulation and new financial innovations were largely left unregulated.
The result was a new system characterized by ever growing financial instability, wage stagnation and increased income inequality. These wage and income developments created a growing structural demand shortage. The role assumed by finance was to fill this demand gap, with innovations, speculation and above all increased debt.
Having finance fill the demand gap was an unintended consequence of the neoliberal policies. Neoliberal economic policymakers didn't realize that they were creating a demand gap, but their laissez faire financial ideology unleashed developments that accidentally filled it. This process was inherently unstable and was always destined to implode. There are limits to both private borrowing and to asset price inflation. These processes were of long duration, therefore the collapse was far deeper when it happened.
=============================
4. The structural Keynesian view of income inequality and its role in the financial crisis and the stagnation
4. The structural Keynesian view of income inequality and its role in the financial crisis and the stagnation
The structural Keynesian view of the role of inequality in the crisis and the stagnation is,
- The inequality didn't cause the financial crisis.
- The crisis was caused by the implosion of the asset price and credit bubbles.
- However, once the crisis happened the financial markets ceased filling the demand gap caused by the inequality.
- Bringing the effects of the demand gap to the fore.
- The stagnation resulted, the joint product of the credit bubble, the financial crisis and the income inequality.
- The credit bubble left behind a huge debt overhang, the financial crisis destroyed the credit worthiness of millions and income inequality created a structural demand shortage, removing incentives to produce and to invest.
The above diagnosis makes clear why the middle term outlook is for continued stagnation.
- The US still has a structural "demand gap" caused by a deteriorated income distribution and the income distribution has actually worsened since 2008.
- The credit bubble is over and borrowing can no longer fill the "demand gap," the financial sector reforms have tightened credit.
- The import and investment leakages associated with globalization remain unrepaired, while needed fiscal stimulus has turned into austerity.
Consequently, despite the Federal Reserve's zero interest rate and quantitative easing policies, the economy is beset by slower growth and overall labor market slack that threatens to become permanent. Further having re-inflated the asset prices the QE experiment will backfire in the form of renewed financial market turmoil.
=============================
The story we accept matters
The story we accept matters
Which of the above four stories we accept matters enormously because the way that we explain the world affects how we understand it, which in turn has major political and policy consequences.
If Rajan's story is accepted then income inequality is reduced to an issue of political and ethical concern, but not an economic concern. Since labor markets are working as they are suppose to, there is no justification for interventions into the labor market to increase wage share of GDP or to improve workers bargaining power. Rather than focusing on income inequality we should be moving to repeal government interventions in the home mortgage markets and to return to more orthodox monetary policy to prevent asset price bubbles.
If Kumhof and Ranciére story is accepted, the cause of the crisis was financial market failure that allowed workers whose income prospects had diminished to borrow excessively. The policy response should be to tighten financial market regulation prevent a repeat of the lending bubble. Once again, the labor markets were working well and the case for increasing the wage share is again purely ethical and political.
If the Eggertsson-Krugman, ZLB, deleveraging story is accepted income distribution is again reduced to a non-economic issue. Instead the cause of the stagnation is deleveraging which just a process that has to be worked through. However, during this period there is the case for large budget deficits to offset the private savings caused by the deleveraging and avoiding the decreased output and increased unemployment that would result. As above the inequality is a purely ethical and political question, not an economic one.
If the "structural Keynesian" story is accepted, then the income distribution is a central problem and the principle factor explaining the demand shortage that is the cause of the stagnation. The solution is to replace the neoliberal policy framework with a “structural Keynesianism” framework. Metaphorically speaking, policymakers needs to repack the box, take workers out, and put
corporations and financial markets in. That requires replacing corporate globalization with managed globalization; restoring macroeconomic policy commitment to full employment; replacing the anti-government agenda with a social democratic agenda that supports and funds public investment, provision of public services and regulation (including financial markets); and replacing neoliberal labor market flexibility with solidarity based labor markets in which workers have greater bargaining power and receive an increased wage share.
=============================
End of the summary, the remainder is mine
End of the summary, the remainder is mine
Palley goes on to elaborate the meaning of accepting the structural Keynesian explanation and the political problems with trying to implement it, which are huge, considering that the dominate movement conservatism's policies and those of the Republican party are exactly the neoliberal policy framework, policies that they will defend to the death. Palley's take is interesting and I urge you to read it but it doesn't impact our discussion.
In separate threads recently I have stated the position that the neoclassical synthesis economics' failures are primarily due to its components from Marshall's neoclassical economics like a general, full employment equilibrium, loanable funds, welfare theorems, a non-monetary economy, etc. and especially from its morph into neoliberal economics, which I characterized as rich men's economics because its main purpose seem to be to boost the incomes and wealth of the already rich at the cost of the incomes of everyone else and in spite of its impact on the economy.
I offer this paper as support for the above. The tools provided by neoclassical synthesis economies seem to be capable of being used to develop any analysis except for the most reasonable Keynesian structural one.
Keynes realized that the modern industrial economy is no longer a supply lead economy, as modern neoclassical and neoliberal economics assumes. That the modern economy is now demand lead, that the growth in the economy depends on the amount of demand in the economy.
So which explanation do you believe is closest to the correct one? And why?
Can you provide any additional arguments for or against any of the four explanations?
