Archive for June 2014


Keynes understood, why can’t New Keynesians?

I’ve often argued that prices and output are the wrong variables for macroeconomic analysis. Instead we should use nominal GDP as the nominal variable, and employment as the real variable. When sticky wages are added, I call this the musical chairs model. I’ve suggested that there is no “fact of the matter” as to the actual rate of inflation, it’s merely a matter of (bureaucratic) opinion.  Indeed economists have never adequately defined the term ‘inflation’.  Is it the increase in nominal consumption needed to maintain constant utility?  In that case in a world where utility is mostly about “keeping up with the Jones’s,” wage inflation is closer to the truth than price inflation.  And goods are always changing in quality, with new goods appearing all the time.  Since we cannot measure inflation, real output data is also misleading. Only NGDP is the “real thing.”  At best, inflation indices can be used as a very crude tool for estimating economic growth in the long run.  That’s all.

Merijn Knibbe wrote a wonderful post that makes the following observation:

Market monetarists like Scott Sumner totally focus on nominal GDP. And employment. Keynes, of course, totally did the same thing.  .  .  .  much of what Scott Sumner wrote sounds a lot like chapter 4 of the General Theory (sometimes even the style):

(I wish my style was even 10% as good as Keynes’s)

Then he quotes from Keynes:

The three perplexities which most impeded my progress in writing this book, so that I could not express myself conveniently until I had found some solution for them, are: firstly, the choice of the units of quantity appropriate to the problems of the economic system as a whole; secondly, the part played by expectation in economic analysis; and, thirdly, the definition of income.


That the units, in terms of which economists commonly work, are unsatisfactory can be illustrated by the concepts of the National Dividend, the stock of real capital and the general price-level:””

(i) The National Dividend, as defined by Marshall and Professor Pigou, measures the volume of current output or real income and not the value of output or money-income. Furthermore, it depends, in some sense, on net output; “” on the net addition, that is to say, to the resources of the community available for consumption or for retention as capital stock, due to the economic activities and sacrifices of the current period, after allowing for the wastage of the stock of real capital existing at the commencement of the period. On this basis an attempt is made to erect a quantitative science. But it is a grave objection to this definition for such a purpose that the community’s output of goods and services is a non-homogeneous complex which cannot be measured, strictly speaking, except in certain special cases, as for example when all the items of one output are included in the same proportions in another output.

(ii) The difficulty is even greater when, in order to calculate net output, we try to measure the net addition to capital equipment; for we have to find some basis for a quantitative comparison between the new items of equipment produced during the period and the old items which have perished by wastage. In order to arrive at the net National Dividend, Professor Pigou deducts such obsolescence, etc., “as may fairly be called ‘normal’; and the practical test of normality is that the depletion is sufficiently regular to be foreseen, if not in detail, at least in the large.” But, since this deduction is not a deduction in terms of money, he is involved in assuming that there can be a change in physical quantity, although there has been no physical change; i.e. he is covertly introducing changes in value. Moreover, he is unable to devise any satisfactory formula to evaluate new equipment against old when, owing to changes in technique, the two are not identical. I believe that the concept at which Professor Pigou is aiming is the right and appropriate concept for economic analysis. But, until a satisfactory system of units has been adopted, its precise definition is an impossible task. The problem of comparing one real output with another and of then calculating net output by setting off new items of equipment against the wastage of old items presents conundrums which permit, one can confidently say, of no solution.

(iii) Thirdly, the well-known, but unavoidable, element of vagueness which admittedly attends the concept of the general price-level makes this term very unsatisfactory for the purposes of a causal analysis, which ought to be exact.

Nevertheless these difficulties are rightly regarded as “conundrums.” They are “purely theoretical” in the sense that they never perplex, or indeed enter in any way into, business decisions and have no relevance to the causal sequence of economic events, which are clear-cut and determinate in spite of the quantitative indeterminacy of these concepts. It is natural, therefore, to conclude that they not only lack precision but are unnecessary. Obviously our quantitative analysis must be expressed without using any quantitatively vague expressions. And, indeed, as soon as one makes the attempt, it becomes clear, as I hope to show, that one can get on much better without them.

The fact that two incommensurable collections of miscellaneous objects cannot in themselves provide the material for a quantitative analysis need not, of course, prevent us from making approximate statistical comparisons, depending on some broad element of judgment rather than of strict calculation, which may possess significance and validity within certain limits. But the proper place for such things as net real output and the general level of prices lies within the field of historical and statistical description, and their purpose should be to satisfy historical or social curiosity, a purpose for which perfect precision “” such as our causal analysis requires, whether or not our knowledge of the actual values of the relevant quantities is complete or exact “” is neither usual nor necessary. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth “” a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of a quantitative analysis.


On every particular occasion, let it be remembered, an entrepreneur is concerned with decisions as to the scale on which to work a given capital equipment; and when we say that the expectation of an increased demand, i.e. a raising of the aggregate demand function, will lead to an increase in aggregate output, we really mean that the firms, which own the capital equipment, will be induced to associate with it a greater aggregate employment of labour. In the case of an individual firm or industry producing a homogeneous product we can speak legitimately, if we wish, of increases or decreases of output. But when we are aggregating the activities of all firms, we cannot speak accurately except in terms of quantities of employment applied to a given equipment. The concepts of output as a whole and its price-level are not required in this context, since we have no need of an absolute measure of current aggregate output, such as would enable us to compare its amount with the amount which would result from the association of a different capital equipment with a different quantity of employment. When, for purposes of description or rough comparison, we wish to speak of an increase of output, we must rely on the general presumption that the amount of employment associated with a given capital equipment will be a satisfactory index of the amount of resultant output; “” the two being presumed to increase and decrease together, though not in a definite numerical proportion.

In dealing with the theory of employment I propose, therefore, to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment

It is my belief that much unnecessary perplexity can be avoided if we limit ourselves strictly to the two units, money and labour, when we are dealing with the behaviour of the economic system as a whole; reserving the use of units of particular outputs and equipments to the occasions when we are analysing the output of individual firms or industries in isolation; and the use of vague concepts, such as the quantity of output as a whole, the quantity of capital equipment as a whole and the general level of prices, to the occasions when we are attempting some historical comparison which is within certain (perhaps fairly wide) limits avowedly unprecise and approximate.

New Keynesians are certainly not Keynesians.  Neither are old Keynesians, post Keynesians, MMTers, nor anyone else of that ilk.  Market monetarists are the true heirs to Keynes.  Fluctuations in the “money-value” of GDP cause changes in the quantity of employment. Period, end of story.  🙂

PS.  British employment as a share of the population is approaching record levels. What do you think Keynes would make of the modern “Keynesians” who claim Britain is in a deep demand-side depression because measured productivity growth has been poor?  Yup, that’s also my reaction to modern Keynesians.  They don’t seem to know that AD is NGDP, not RGDP.  Never reason from a quantity change.

PPS.  Love the sentence about the 2 queens, and the next one.  Have you ever seen a better description of the foolishness of modern macroeconomics?

The American system is rigged to favor the rich

All across America there are millions of people who live in the underground economy, fearful of the government.  Thousands of them are people who are unable to pay legal bills, and face jail time if caught:

More than a third of all states now allow borrowers who don’t pay their bills to be jailed, even when debtor’s prisons have been explicitly banned by state constitutions. A report by the American Civil Liberties Union found that people were imprisoned even when the cost of doing so exceeded the amount of debt they owed.

Sean Matthews, a homeless New Orleans construction worker, was incarcerated for five months for $498 of legal debt, while his jail time cost the city six times that much. Some debtors are even forced to pay for their jail time themselves, adding to their financial troubles.

In contrast, when wealthy people like Donald Trump go bankrupt, they are allowed to keep many of their assets and obviously don’t go to jail.  Here are some other ways that the system in America is rigged to favor the rich:

1.  The poor are often jailed for drug crimes, while people like Rush Limbaugh get off scot-free.  Or go into “rehab.”

2.  The government allows big banks to borrow money (via deposits) at T-bond interest rates, due to government promises to repay the debt if the bank fails.  The poor borrow from loan sharks.

3.  The government shovels vast sums of money into healthcare, as they pick up the tab for Medicare, Medicaid, the VA, and even much of the cost of “private” health insurance.  But they don’t regulate costs, allowing medical suppliers like doctors and big pharma to earn large incomes (by international standards.)

4.  In addition to the medical subsidies, they severely restrict entry in medicine, allowing American doctors to earn far more than doctors in other countries.

5.  They also restrict entry in law, and as if that isn’t enough, they set up tort laws in such a way that lawyers can skim massive profits from routine class action lawsuits.  Meanwhile, there are no barriers to entry into picking peaches in the hot Georgia sun.  That’s a “free market” in labor.  The American dream.

6.  In my field (higher education) they heavily subsidize spending, allowing me to earn a higher salary and lower teaching load than in a free market.

7.  They have patent laws that give monopolies to the inventor of a product.  But not just major new products with social externalities like the internet, or semi-major ideas like social media, but slight tweaking of existing platforms such as social media.  This allows vast profits to be earned in knowledge-oriented industries that are winner-take-all and near-zero marginal cost of production. These rules also funnel vast sums into the finance industries that funds high tech companies, and the investors who pick the winners.

8.  People who own auto dealerships are protected from competition from direct sales from auto companies.

I’m sure there are many other ways the rich are favored, these are just a few off the top of my head. And note that while I oppose many of these government policies (although not the one that let Limbaugh off scot-free) the question of whether the policies are justified has no bearing on whether the system is rigged to favor the rich.  The system may be rigged for justified reasons or unjustified reasons.  Maybe we need strong patent laws.  But it is most definitely rigged to favor the rich.

Many on the left favor superficial palliatives like higher minimum wages and taxes on capital, which would do little to solve the problem and indeed would do more harm than good.  The term “radical” originally meant getting to the root of the problem.  That’s what I favor, but clearly both Democratic and Republican politicians don’t agree with me.  They both protect the rich.

Over at Econlog I did a post arguing that the rich really were highly productive.  This was in response to Piketty’s claim that their wealth was mostly unmerited, as (he claimed) people like CEOs earn far more than they contribute to a company’s bottom line.  I think this productivity claim is wrong; CEOs are very productive if we measure productivity in terms of a company’s bottom line.  On the other hand the social productivity of many of the rich is far less than their private productivity.  He may be right about “merit,” but for the wrong reason.

Oddly, this means that my critique of modern American capitalism is far more radical than Piketty’s.

Update:  Tyler Cowen linked to an article on how the Dems are switching their views on the Ex-Im bank.  And this is the party that supposedly worries about “inequality.”

And Krugman too?

The sickening plunge in corporate profits

Here is the evolution of labor compensation and corporate after-tax profits over the past 9 quarters:

Total labor compensation:  $8315.3b.  —->  $9049.5b.  Up 8.8%

After-tax corporate profits:  $1184.6b.  —->  $1099.5b.  Down 7.2%

So why have workers been doing so much better than corporations in recent years?  And why did corporate after-tax profits plunge from $1.3 trillion in 2013 Q4 to $1.1 trillion in 2014 Q1?

I know what you are thinking.  “I don’t believe those numbers.  Where did you get them?”  I got them from the BEA.  And I don’t believe them either.  And that’s why I don’t believe that nominal GDI fell 1.4% rate in Q1.  Because if you look at components of gross domestic income, you get the following:

Compensation plus depreciation (reliable data):  Up at a 3.7% rate in Q1.

That’s more than 2/3rds of national income.  So basically the unusual (1.4%) plunge in NGDI was a story of plunging corporate profits.  I know of no other data confirming that plunge. Stock prices are soaring.  Corporations have been reporting very strong earnings.  If someone can find non-government data supporting the claim that workers are far outperforming corporations in recent years, I’d love to see the evidence.

PS.  The new revisions put Mark Sadowski even further ahead of the pack, as even he underestimated the final plunge in GDP.  Q2 is just a month away.

PPS.  This erratic GDP data does slightly weaken the argument for NGDP targeting, but only very slightly:

1.  The idea is to target a forecast of NGDP one or two years ahead, figures that are much less affected by quarter-to-quarter data quirks.

2.  This does slightly strengthen the argument for targeting total nominal labor compensation, rather than NGDP, as it seems to be much closer to what’s going on in the labor market (which was OK in Q1.)

Watch for the endgame

I just returned from the UK where I gave several talks and interviews.  The main purpose of my trip was to give the Adam Smith Lecture at the Adam Smith Institute.  I was very impressed with the people there, especially Ben Southwood and Sam Bowman.  Here is a link with a video of the lecture.  I also spoke at the Cambridge Union, and to some bankers and Treasury people.  I did a BBC radio interview, and an interview on BBC’s “Newsnight” TV show, which should be broadcast soon.

Almost from the beginning, I’ve been more popular in the UK than the US.  That’s probably because the US has a sharper left/right split.  Over here my views are too right wing for the left (which is rapidly moving ever further leftward), whereas the right sees me as a redistributive Keynesian inflationist.

I noticed that in the UK all the talk is of raising interest rates later this year, as their economy is growing fast and the employment population ratio is nearing the previous all time peaks of 1971 and 2006 (what a contrast with the US!)  You may recall that a few years ago I said that the exit from policies can be very revealing.  It can help us to understand the effects of policy (as when tapering had a market reaction in the US) and also the underlying dynamics of the monetary fiscal interaction.

First a bit of background information.  Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument (although I have doubts due to monetary offset), but the implication is that if the recovery ever becomes so strong that you need to raise rates, then clearly the first place to tighten is fiscal policy, and policymakers should only raise rates when the budget deficit has returned to the optimal level based on the classical principles of public finance.  Britain is obviously far from that point.

A few years back I was very skeptical of the notion that fiscal stimulus in the US was being done because of a lack of effectiveness of monetary stimulus.  I predicted that when the time came for tightening Keynesians would prefer monetary tightening to fiscal austerity, even though their own model says that fiscal austerity should be done first, as it reduces the (still too high) budget deficit.

In my admittedly unscientific survey of the UK press it seems to me that there is more enthusiasm for monetary tightening than accelerated fiscal austerity, just as I expected.  Here is an editorial in The Independent, which doesn’t even mention of the option of fiscal tightening.  (And here’s the Times.)

Just to be clear, I am not criticizing the BoE, which has done a good job under Mark Carney. NGDP is rising at a brisk rate.  Given the refusal of fiscal policymakers to speed up the austerity process, the BoE may need to raise rates in 6 months to a year.  That’s monetary offset, and it is quite appropriate.  The real problem in Britain is government spending, which is still too high.  (Or if you are a left-winger, the real problem is that taxes are too low.)

PS.  Obviously I’m pleased that there is a single-minded focus on the BoE as the institution that should and does steer the nominal economy.  It’s a pity that single-minded focus wasn’t there in 2008 and 2009.

HT:  Travis, W. Peden

Sumner demolishes Piketty

Just back from the UK and just finished Piketty’s new book.  I’ll have lots to say when I get caught up, but I thought I’d begin with a little puzzle.

Explain the title of this post.  Hint.