What is Wrong with Macroeconomics

Macro Mess

     People complain that macroeconomics is a confused mess. It is said that macroeconomists disagree among themselves, that the government is pursuing the wrong policies, that the opposition is not mounting an effective opposition. 

     Diane Coyle in 2012 put the case in a well argued lecture (1), and again in a shorter, less formal, way in a passionate blog (2). Jonathan Portes, in his rebuttal blog (3), summarizes Coyle’s case succinctly as:  

a) "although macroeconomists will insist that there are known scientific facts, they do not appear to agree on what these are”,

b)" the discussion among macroeconomists is so shouty”,

c) "all economists need to do far, far better at explaining their work to the general public”.  

Portes partly rebutted each charge, but in doing so seems to concede each, in large part. 

     That was in 2012; but the argument persists. Last month ‘Unlearning Economics’ (4) weighed in against macroeconomists, and last week Simon Wren-Lewis rushed to his own defence in Mainly Macro (5). But now the argument brings in the extra dimension of politics. Both these bloggers assume ‘progressive’ means ‘distributing downwards the benefits of labour’, and is ‘good’, while ‘regressive’ means ‘reinforcing the power of capital’ and  is ‘bad’. 

     It seems rather pompous of me to join this learned debate, but I have a point or two of my own that I want to make. In my own field of expertise I have seen intellectual tribalism, and well understand a reluctance to grapple properly with alternative ways of rationalising the data. “Intellectuals”, my illustrious colleague often said, “seldom  concede; but they do eventually die”. Natural scientists can usually (in time) be shamed into testing their theories against data; arguments can only persist if both theories are able to rationalise the facts. Does this hard filter operate adequately in macroeconomics?

     However, much of the argument is occurring at levels less rational than the purely academic; between politicians, business men, media commentators, bloggers and the average voter. There are hidden agendas, and consequent confusion, not only about the means, but about the objectives of government policy. Are we trying to increase GDP, or actually trying to reduce taxes, trying to decrease unemployment, or secretly trying to increase it (to bring down costs)? Are we seriously trying to bring down the cost of housing when we ourselves have houses and are getting rather rich thereby, or are we trying to increase profit margins in the industry? Are we simply trying to win an election?  Even phrases like ‘fair taxation’ sow confusion, for some will think it means making the relative burden equal across the spectrum of wealth, while others may think it means we all pay the same absolute amount, like the 'poll tax'. 

     

     It alarms the laymen when they see professors of economics disagreeing (6) and calling each other idiots (7).  It is fair to say that the subject matter of the discipline is complex. But most cutting-edge academic work is complex, and effectively closed to the layman. Macroeconomics, however, is additionally hampered by a traditionally cryptic exposition. Keynes was obviously very clever, which enabled him to conceive the most convoluted and arcane pronouncements (8). Imagine the thrill of finding that your academic competitors do not see the relevance of IS-LM. You will need to explain it! (9), but not clearly enough to be understood; you do not mention what I,S,L and M signify, do not explain that the graph is rotated 90º and uses jumbled axes. (c.f. wikipedia, and https://www.youtube.com/watch?v=mTr2PVbbpxg). 

     Yet there is a simplicity in macroeconomics, as in most things, if you have a mind simple enough to see it. Suppose government wants businesses to produce more goods and employ more men, so that more people have more money and buy more goods. It urges the Bank to lowers interest rates. The people with money buy, those without money borrow and buy. The businesses borrow and build, take on workers, who in turn can now buy goods. Success! But what if interest rates are already near zero? And still people are not buying. (There is clearly no requirement for cash, no point in building factories, no confidence in the near future.) What does 'Marcoeconomics’ suggest? "Fiscal loosening”, says Krugman; but does he mean increasing government spending, or lowering taxes to leave more money in the people’s pockets, both of which increase public debt? (See Chick and Pettifor, 10). 

Now here comes the real problem. What does government do but cut Government spending, and flood the banks with ‘quantitative easing’. (Hadn’t we just established that it was not money we were short of but ‘demand’, and confidence?) The rich get richer, and the poor get poorer, and there is barely a flicker of a recovery. The bosses can invest in new plant! — but there is no point, as there are no customers, no demand.

It is not so much that ‘Macro got it wrong’ as ‘Macro got ignored’. But Macro did get it wrong, twice. It failed to get its point across to those who would have heeded. And in my opinion cutting taxes is not remotely as effective as increasing taxes and increasing government spending; it is merely easier. (See my “Tax and Spend”, 11).  There was no need to scare the public by increasing public debt; and therefore no point in advocating it. Crikey! 

References:

(1) https://www.bnc.ox.ac.uk/downloads/news/tanner_lecture_2012_text.pdf

(2) http://www.enlightenmenteconomics.com/blog/index.php/2012/06/a-macroeconomist-tells-me-off/

(3) http://www.niesr.ac.uk/blog/macroeconomics-what-it-good-response-diane-coyle#.WNkH0GU0mdE

(4) https://medium.com/@UnlearningEcon/no-criticising-economics-is-not-regressive-43e114777429#.iwfjl01sl

(5) https://mainlymacro.blogspot.co.uk/2017/03/on-criticising-existence-of-mainstream.html

(6) https://krugman.blogs.nytimes.com/2016/12/24/dont-blame-macroeconomics-wonkish-and-petty/?_r=0

(7) https://www.forbes.com/sites/timworstall/2016/12/25/paul-krugman-gets-his-recessionary-macroeconomics-wrong-again/#5cc30754701e

(8) http://occidentis.blogspot.co.uk/2014/06/keynes1.html

(9) https://krugman.blogs.nytimes.com/2011/10/09/is-lmentary/

(10) http://www.debtonation.org/wp-content/uploads/2010/06/Fiscal-Consolidation1.pdf

(11) http://occidentis.blogspot.co.uk/2016/07/tax-and-spend.html

George and Dragon (1)

George and Dragon (1)

     Sitting by the fire in the George and Dragon with my new ‘mates’, one mentioned a regular they called ‘Prozac’. I was amused, and wondered aloud at the mood-altering effects of the absent ‘Prozac’. 

     “Yes,” they said, “quite different in temperament from ‘Viagra’. And they call him that to his face. I once heard someone call out to him, as he was leaving, ‘Bye, Viagra’, not realising the effect that would have on diners at the adjacent table, where a lady dropped her fork.”

     "Then there is 'Basher', of course." 

     "I wonder," I mused "if I have seen Basher". "Oh, you would know him if you saw him,  ― but he has been banned from most pubs now." 

     John and Andy go back a bit; both retired, but both graduates of Chelsea College, one in geology, the other in physics. 

     A minute later, when someone mentioned ‘Posh Pete’, I laughed out loud and wondered what they called me behind my back. No hint from Andy, just the wisp of a smile.  I would not object to 'Prof', which I occasionally heard in Thrussington, and regularly heard in The Forge at Ulgham.

Exchange Rates and Balance of Payments

Translation and Comment on:
BALANCE OF PAYMENTS AND THE EXCHANGE RATE

“Summary and conclusion (as posted by FRANK SHOSTAK  on Cobden Centre 13 MARCH2017)

"Contrary to a popular belief, the state of the balance of payments has nothing to do with the determination of exchange rates. The key factor behind the rate of exchange determination is the relative purchasing power of various monies. The trade balance statistics could be however useful in ascertaining the diversion of foreigners’ real wealth from the rest of the world to the US given that the US dollar is the most popular money created out of thin air by the US central bank and the US banking system. As long as the floating exchange rate regime is allowed to function the more severe damage is inflicted onto the process of real wealth generation. One way out of this mess is the introduction of a gold standard.”

Let me try to understand what is being said in the above quotation.  I shall simplify by dropping the first 5 words, as they declare themselves to be irrelevant.  I shall next suggest that the “state of the balance” is “the balance”.  Perhaps “the determination of exchange rates” can be understood to mean “determining exchange rates”. For “monies” I shall write “currencies”.  For his “... rate of exchange determination” perhaps we could try “The key factor determining the exchange rate between two currencies is their relative purchasing power.”   So it seems that Shostak is suggesting:

The balance of payments has nothing to do with determining exchange rates. The key factor determining the exchange rate between two currencies is their relative purchasing power.

I disagree with both statements. I think the Trade Balance is a major factor determining exchange rates (ER), while not the only factor. And I think the link between exchange rates and relative purchasing power is so close as to make it hard to decide which "causes" which. (Does sunset cause the onset of night or vice versa?)

I believe the exchange rate US$:Yen is determined by a number of factors all round the world among which I would include: the desire of the Japanese to acquire dollars, and their desire to sell goods to the USA, and reciprocally the need in the USA for yen, and their need to sell goods to Japan; plus a host of smaller influences like tourism and trade flows with third countries. But there are two other big influence that need to be recognized: capital flows, and reserves. If Japan has a positive trade-balance with the States they will have dollars to: [1] sell, or [2] to invest, or [3] to keep in reserve. If Japan sells their dollars for Yen the exchange rate will be affected (the dollar will devalue). But Japan may be content to keep the dollars as “quasi-gold”, or they may invest in the USA to gain interest.  (Of course, the States may reciprocally hold Yen or invest in Japan.)

The Balance of Trade used to be the main ‘determiner’ of the exchange rate, but now there is (apparently) far more money shooting round the world looking for ‘interest’, than looking for ‘goods’. Many countries maintain a trade imbalance for many years, because capital flows and interest rates are not taken into account.

Suppose a basket of mixed goods costs 550 Yen in Japan and 5 US$ in the United States. However, the current ‘exchange rate’ in the money markets is 111 Yen:US$. The “real exchange rate”  (RER) is calculated by correcting the ratio of the basket-prices by the ratio of the currency-prices to produce a dimentionless number. In theory, with perfect markets and large baskets, the “real exchange rate” is 1.0 ; in our example 550/5 x 1/111 = 0.991. It can be imagined that if the basket contained tuna the ratio of the prices (Japan:USA) might be 650/5, and our view of the “real exchange rate” would be distorted by the Japanese love of tuna. We need a large basket.

RER(Japan:USA)= 650/5 x 1/111 = 1.171.

Likewise, if interest rates were higher in the USA than in Japan the desire to hold US$ could distort the “real exchange rate” the other way. In time, and with perfect markets, the RER should relax towards 1.0

RER(Japan:USA)= 550/5 x 1/121 = 0.909

In short: I think Shostak underrates the role of trade-balance in determining exchange-rates; it remains funtamental, though it is by no means the only factor. For me, the value of his article is that it has forced me to go elsewhere to understand the matter.  I suspect it has only won a place on the Cobden Centre website because of the miraculously irrelevant mention of gold. 

Leader of the Parliamentary Labour Party

Leader of the PLP

Dear Christine Shawcroft,

     I heard you on the radio this morning, and I looked up your website. I approve all your attitudes, and applaud your massive efforts in support of those attitudes. But I come to a different conclusion. 

     You were advocating lowering the requirement for MP endorsement for the selection of a future Leader of the Labour Party (LLP). It seems to be a matter of observable fact that the Parliamentary Labour Party (PLP) will not follow Jeremy Corbyn. And that the Membership will not follow anyone else. So, we are at an impasse.

     Why not scrap completely the requirement for MP endorsement? Let Congress/NEC/Membership/Affiliated unions select a Chairman/President/Leader.  You may see no reason why 229 MPs should frustrate the democratic wishes of the 515,000 Party members, merely on the grounds that they have won a parliamentary election?  

     But the team in Parliament needs to be a team. I would like the PLP to get their act together, and to put their best parliamentarians forward to advocate effective opposition. They need to create the semblance of a Government in Waiting. Let the PLP select their own leader, unanimously — a shadow Prime Minister, if you like.

     If you question the democratic authority of the PLP, bear in mind that 229 MPs represent 229 x  75,000 = 17.2 million constituents; and are therefore voted for by 229 x 37,500 voters; i.e. approximately 8.6 million voters. That makes the Party Membership seem almost irrelevant. 

Yours sincerely, Cawstein

Future of the Labour Party

The Future of the Labour Party

Introduction

     ‘Power’ in British politics requires commanding the ‘interest' of 51% of the population. The movement called 'New Labour' in the nineteen nineties grasped the truth that our ‘first past the post’ voting system leaves no room for parties that  appeal to minorities: to Trade Union members, Manual Workers, Recyclers, Climate Changers, or Liberals. To campaign honourably and passionately on behalf of the weakest sectors of society may inspire 30%; but not 51%. Climate change may worry 30% of the country. But unless these interest groups combine, and combine with others, till their consortium comprises a majority of the population, they will never have the power to form a government and change the law.

     It may be that 'New Labour’ grasped the even more depressing truth that the biggest umbrella to cover the biggest interest group is money. If you can convincingly claim to have policies that will make 51 percent of the population richer, you will gain power. If you offer to raise disability allowance you may gain some respect, but will gain a mere handful of votes for your cause.

     What New Labour did not grasp, however, is the importance of proportional representation. Had they introduced proportional representation when they had the power to do so, the forming of these alliances would have become a much simpler task. Parliament would have become more representative and more powerful (relative to Government). Our present electoral system is a system for generating disgruntled voters. With three or more parties we have the triumph of some 30% and the eventual despair of the 70%.  The system disenfranchises the majority of voters and throws their votes away. Voting turnout falls. (In ‘Safe Seats’ voting is always pointless for supporters of the 2^nd 3^rd and 4^th parties.) It is perfectly possible to devise a system where at least some account is taken of the 70% of votes that are lost in the present system. The first step would be simply to publicise the figures.

     Labour surely arose as a class-based party. Its success doubtless stemmed from the  fact that there were many more manual workers than owners. If the many little people combined and unified, they could take on the big guns. But automation has progressively eroded the manual work-force, and we have seen an enormous growth in the numbers of white-collar workers. Today the Labour Party probably attracts some traditional workers, and some others who are the loyal sons and daughters of former Labour voters. Labour’s support for the underprivileged, and the unemployed may appeal to another bunch of voters, and this altruism may attract further voters with ethical issues. But this is inevitably a weak alliance. Without the power to make law, it is hard to convince the electorate that Labour would reduce CO2 levels better than Green Party.

     There is an enormously important factor in deciding the outcome of constituency elections which is barely touched on in the media, and that is the intellectual and moral quality of the candidates. Unless a party can field good quality candidates they will not win elections. And failure to win elections feeds back on the ability to attract good candidates. Unfortunately the hysteresis in this feedback loop is vey long — maybe extending to a generation. After a by-election, there is much discussion of the issues, and voter responses to those issues, but scarcely a mention of the candidate. However, in a general election it is possible to detect candidate-specific results as ‘results that buck the trend’. Though these seldom attract the attention of the press unless that candidate wins. However, it is quite clear that there are good candidates and weak candidates; and that voters can tell the difference.

     In a two-party system the ‘official opposition’ can be seen as a government in waiting.  The quality of the party in opposition will be judged very largely by its performance in the House of Commons. It may wish to oppose at every opportunity, or it may wish to appear judicious. But need we have a two-party system and an ‘official opposition’? We should think outside that box.

     Any two-party system is divisive; it causes, exploits, and perpetuates a split in opinion. The original Right/Left nomenclature comes from the French Revolution when those wanting little change sat on the right side of the legislative chamber and the new radicals who wanted to change everything sat on the left. It was not in essence a Rich/Poor divide, but of course there is a tendency for those who are already well off to resist change, while the dissatisfied will seek it. In nineteenth century Britain the split was not based on wealth but on source of wealth; land versus commerce. Both sides of the house were wealthy, and all MPs were gentlemen. The issues included: free-trade, empire, education and the franchise.  In the twentieth century the Labour party brought to parliament the clash between capital and labour, which had already existed for a hundred years on the shop-floor. Success was its undoing. Leap-frogging wage-claims forced Britain out of world markets, and annoyed the country, with Thatcherism as the result. New-Labour was hardly a Labour party. It adopted many capitalist concepts (and faults), among them the idea that money is the only motivator, and that every issue should be judged by 'the market'; but it won three elections. Since 2010, the Tories have run with the same baton, though surely the banking fiasco should have put paid to this discredited system. Unfortunately, economics is a complex intellectual puzzle and academic economists are as split as the politicians. The current Labour party, with a tenth of the expertise of the Tories, was just beginning to focus on economic fairness when a second divisive issue arose in the field of foreign policy. It gradually became clear to thinking people that our military adventures in the middle east were both immoral and damaging. Jeremy Corbyn rode into the ring on this latter issue, supported by a wave of disgust at militarism, elitism, and a feeling of grass-roots-powerlessness. But his appeal is not currently sufficient to win 51% of the country. The moral high ground, alone, is not enough.

     The country was split more or less 50/50 in the nineteenth century on the issues of free trade and imperialism. The Labour/Capital debate of the twentieth century produced an unstable equilibrium (and needs further thought — see below). The present split of Self/Others will of course always be won by ‘Self’ interest, though there are now the issues of Europe, immigration, and ‘populism’ to divide us further.

The Future

     Pending proportional representation there should be as much deliberate and courteous pre-election discussion as possible between opposition parties; like the Primaries in the United States;  Labour waving a popular LibDem candidate through in one constituency should be matched by an uncluttered two-candidate fight in another where a Labour candidate has a good chance of winning. Scores can be kept, and there should be an explicit agreement to support PR at all times.

     Quality candidates must be sought and cultivated.  It is infuriating for the grass-roots to see resignations and firings of able front-benchers. The method of choosing ‘the party leader’ must be re-examined. Indeed the very concepts of 'party leader' may need re-thinking. I suggest that the Parliamentary Labour Party must be a team and have a unity of purpose; the 'official opposition' must be seen as ready to take office. Party Leader in the House must be agreed unanimously by the MPs, probably for his qualities as a chairman. He may not have the qualities of a cross-examining barrister required at Prime Minister’s Question time, but need these questions come from the Party Leader in the House?

     The Party membership, and the trade unions can certainly choose a leader; a president perhaps, or Chairman of Congress, but clearly cannot foist their choice on the MPs.

    

     The economy must be thoroughly and visibly understood by any party of government. A beginning was made in 2015 when John McDonnell, as Corbyn’s shadow chancellor, formed an economic advisory committee, but that has broken up and vanished. Why? Was it from faulty chairmanship, or perhaps from lack of funding?  The Danish Labour Movement formed their "Economic Council of the Labour Movement" (ECLM) in 1936. Where is ours?

     Post-war Germany developed a unique political philosophy they call Ordoliberalismus, believing that the state must actively protect and regulate the operation of the ‘free market’. “Ordoliberal ideals drove the creation of the post-war German social market economy”. We talk about the German Economic Miracle, but do little to understand and imitate; we suspect that it involves hard work and leave it at that. Why?       (Word count = 1,452)

Letter to a Sanguine 'Leaver'

Dear Max,

You have a very clear head. What you say sounds perfectly straight-forward and, once it is said, it sounds obvious. Brexit terms ‘should’ end up as 'zero tariffs both ways, free movement on reciprocal bases, co-operation on police, security and intelligence'. But:-

[1]  It is largely true (is it not) that the big “Leave” voices have disappeared or gone quiet (Gove, Farage, Leadsom, Boris). We are left with Remainers trying to implement (gestate) the other camp’s baby (May, Hammond, the Civil Service). And why is that??

[2]  It is unfortunate but true; the terms of Brexit will be at least partly determined by the 27 and not by us. So it is reasonable to fear that the Junckery-type people (who were our bogeymen in the first place) will see their job as 'preventing exit from being beneficial’ (in case Europe unravels). (It is a pity we did not have the foresight, force of character, or interest, to curb these people when we had the chance. Whyever is the head of the European Civil service called a President? )

[3]  We look back with pride and astonishment at the first two years of WWII — alone against the fascists. We remember a Commonwealth extending round the world. (People born in New Zealand still referring to Britain as “home”, selling us butter and lamb and buying our cars). But some of this will not come back, because the world has moved on. Some of our capital is spent, some of our coal and oil burnt. India, Brazil, China and the Far East,  have developed. But we also ‘remember’ the long hot summers and the crisp snows of our youth, even though the meteorological tables accuse us of misremembering. 

[4]  Europe took it into its head to include the ex-communist states of eastern Europe and the ‘sunny’ states of southern Europe. We were perhaps doubtful, but saw them as possible markets and went along. The time to object to the extension of Europe to the east was back then, but we missed our chance. They are of course a burden and a problem to which the remaining core states of Europe are bound and with which they are lumbered. We now opt out of Europe and its burdens. But the 27 will (probably) not let us compete using both hands when they have one tied behind their backs. There is (I suppose) an honourable side to trying to weld a cultural entity at considerable personal cost, but the practical English do not see it that way; they see only the costs. And I suppose we on our island never did have to rub shoulders with the Balkans in the way that Austria, Germany, Italy and Poland have been doing for 2 millennia. 

Though I voted 'Remain', I was not over-enthusiastic about remaining in Europe and hope not to lose friends over Brexit. I expect there will be some compensations to counter the loss of influence, status, and wealth that will result from opting from a trading bloc of 360 million to one of 60 million with a GDP resembling the assets of a middle sized commercial company. There is a whiff of excitement, as on beginning any new relationship. But I do not expect the 'long hot summers' and the 'sunny uplands' that some leavers have been dreaming of.