{"id":6705,"date":"2019-10-08T15:45:55","date_gmt":"2019-10-08T14:45:55","guid":{"rendered":"https:\/\/progressiveeconomyforum.com\/development\/?p=6705"},"modified":"2019-10-08T15:45:58","modified_gmt":"2019-10-08T14:45:58","slug":"market-economies-require-policy-management-what-keynes-taught-us","status":"publish","type":"post","link":"https:\/\/progressiveeconomyforum.com\/development\/blog\/market-economies-require-policy-management-what-keynes-taught-us\/","title":{"rendered":"Market economies require policy management: What Keynes taught us"},"content":{"rendered":"\n<p>Many including the\nUnited Nations Conference on Trade and Development predict an imminent global\nrecession (<a href=\"https:\/\/www.theguardian.com\/business\/2019\/sep\/25\/global-recession-a-serious-danger-in-2020-says-un\">Larry\nElliot<\/a> and the <a href=\"https:\/\/unctad.org\/en\/pages\/newsdetails.aspx?OriginalVersionID=2194\">report<\/a>\nitself). What causes such instability to sweep the major capitalist economies? To\nunderstand why we suffer severe global economic barely ten years after the\nGreat Financial Crisis of the late 2000s, we must look back at the immediate\npost-WWII policy consensus and its demise.<\/p>\n\n\n\n<p>Over five decades the\nprinciple that capitalist economies required active, continuous management by\nnational governments established itself as policy orthodoxy, then the consensus\nabruptly ended. The first governments to practice active policy management\ncould hardly have been less alike, the Nazi regime in Germany that took power in\nJanuary 1933 and the presidency of Franklin Delano Roosevelt inaugurated in\nMarch of the same year. The abrupt end came in 1979-1980 with the election of\nMargaret Thatcher in May 1979 and Ronald Reagan in the United States (inaugurated January\n1981).<\/p>\n\n\n\n<p>That the\nresponsibility for economic prosperity falls to governments drew its analytical\njustification from the work of John Maynard Keynes, and its political urgency\nfrom two great catastrophes that threatened to destroy the liberal capitalist\norder, the Great Depression of the 1930s and the Second World War. As Kurt\nRothschild argued in his famous <a href=\"https:\/\/www.roterboersenkrach.at\/wp-content\/uploads\/2011\/12\/rothschild-1947-price-theory-and-oligopoly.pdf\">1947\n<em>Economic Journal<\/em> article<\/a>, the depression,\nfascism and the subsequent world war resulted from the inherent dysfunction of\nunmanaged capitalism.<\/p>\n\n\n\n<p>Fiscal policy, monetary policy and exchange rate policy provided the three instruments for national governments to achieve effective macroeconomic management. The International Monetary Fund, established by the Bretton Woods Conference in 1944, served as the vehicle for international exchange rate management for 25 years. It collapsed in 1971 when the US government ended its guaranteed dollar price of gold. After brief and ineffective attempts to establish alternative international monetary \u201canchors\u201d to replace the US guarantee, governments of major capitalist countries reverted to the various forms of partially managed exchange rate floats we have now. <\/p>\n\n\n\n<p>Financial speculation and loss of the exchange rate as a policy tool followed as the long term effects of the end of the Bretton Woods system. The <em>de facto<\/em> control of exchange policy by financial interests prepared the ground for the same interests to take control of monetary policy a decade later. As part of a broader argument against democratic accountability in economic policy, the new financial orthodoxy advocated central bank \u201cindependence\u201d from governments. This new orthodoxy asserted the necessity to exclude political considerations from monetary decisions, because of the<a href=\"https:\/\/thomaspalley.com\/\">\u00a0technical nature and precision of central bank decisions<\/a> made these decisions the territory of experts.<\/p>\n\n\n\n<p>Arguments to de-commission fiscal policy represented an extension of the ideology of market-determined exchange rates and independent central banks. The vulgar arguments for a neutral, non-interventionist fiscal policy took and continue to take the form of the allegedly self-evident necessity for governments to \u201clive within their means\u201d (see Chapter 1 of my forthcoming book <em><a href=\"http:\/\/politybooks.com\/bookdetail\/?isbn=9781509532933\">The Debt Delusion: Living within our means and other myths<\/a><\/em>). Superficially more sophisticated, the new anti-policy orthodoxy argued that failure to balance budgets would provoke speculative attacks on currencies and stimulate inflation. <\/p>\n\n\n\n<p>The neoliberal \u201cneutral policy\u201d orthodoxy made an integrated package. Governments have no alternative to floating exchange rates (so-called market-determined). Because this exchange rate policy facilitates speculation, governments must constrain their monetary and fiscal policies to adhere to the expectations of speculators (aka \u201cinvestors\u201d). Macroeconomic stability requires a passive approach to exchange rates, inflation targeting and balanced budgets (deflationary monetary policy and pro-cyclical fiscal policy).<\/p>\n\n\n\n<p>This brave new\nneoliberal macroeconomic policy world embodies a fundamental flaw. It derives\nfrom the belief that market economies are inherently stable. Neoclassical\neconomics provides the theory underpinning the policy world of neoliberalism. If\nstability cannot be established theoretically and empirically, the neoclassical\nneutral policy framework collapses, and with it the justification for balanced\nbudgets, independent central banks and floating exchange rates.<\/p>\n\n\n\n<p>Neoclassical automatic stabilizing adjustment occurs according to the principles of <a href=\"https:\/\/www.investopedia.com\/terms\/g\/general-equilibrium-theory.asp\">Walrasian general equilibrium<\/a> (WGE). However, this theory does not address the practical problems of market instability. Explaining WGE to the non-specialist proves extremely difficult not because of its complexity but its inherent implausibility. Fortunately, it is not necessary to do so, because neoclassical economics invokes WGE to solve an imaginary problem, which proves to be theoretically unsolvable. <\/p>\n\n\n\n<p>The neoclassical stability problem can be stated as follows. In a system of production and distribution without central coordination, what is the process by which markets stabilize? To put the problem simply, with so many products and markets what prevents instability-generating surpluses and shortages that would cause extreme price fluctuations? Neoclassical economists claim that WGE provides the answer to that question. <\/p>\n\n\n\n<p>Quite the opposite is\nthe case: WGE demonstrates the impossibility of stability in an unregulated\nmarket system. WGE achieves market instability through central coordination. That\ncoordination is achieved by the <a href=\"https:\/\/www.thoughtco.com\/overview-of-walrasian-auctioneers-1147333\">intervention\nof an &#8220;auctioneer&#8221;<\/a>, who has the power to prevent any exchange in any\nmarket that does not occur at a price that leaves that market (and by\nimplication all others) with neither a surplus nor a shortage. The Walrasian\nauctioneer is a purely imaginary or hypothetical creation &#8211; no such auctioneer with\nthese powers exists in any market. <\/p>\n\n\n\n<p><a href=\"https:\/\/www.goodreads.com\/en\/book\/show\/18060112-economics-of-the-1\">As I\nhave explained<\/a> in non-technical language, neoclassical economics offers no\noperative solution to the problem it poses (the technical version <a href=\"https:\/\/www.routledge.com\/The-Irreconcilable-Inconsistencies-of-Neoclassical-Macroeconomics-A-False\/Weeks\/p\/book\/9781138799158\">here,\npages 44-45<\/a>). Market stability results because instability is excluded by\nassumption (the imaginary auctioneer prohibits it).<\/p>\n\n\n\n<p>The actual solution to\nthe neoclassical problem proves quite mundane. Market economies are\ncoordinated, by private producers. In practice, corporations set prices and\nsell what they can at that price. The problem of price and quantity stability\nin an uncoordinated market system of many buyers and sellers exists only in the\narcane world of neoclassical economics. Corporations minimize the effects of\nsurpluses and shortages of goods through inventory change. &nbsp;Surpluses and shortage of services are managed\nby decreasing or increasing employment.<\/p>\n\n\n\n<p>Yet capitalist\neconomies do suffer periodically from extreme instability, the most recent\nexample being the Great Financial Crisis of the late 2000s. These moments of\nextreme instability, recessions and depressions, result not from lack of\ncoordination across markets. They result from private demand\n&#8220;failures&#8221;; specifically, the volatility of private investment and to\na lesser extent of export demand. For example, decline in export demand is the\nsource of the <a href=\"https:\/\/www.socialeurope.eu\/german-rebalancing-out-of-exit-options\">imminent\nGerman recession<\/a>.<\/p>\n\n\n\n<p>We can easily verify\nthe instability caused by private demand. The components of aggregate demand\nconsist of private consumption, private investment, exports and public\nexpenditure. The first of the four, private consumption, is a function of GDP\nitself, so aggregate demand reduces to private investment plus exports plus\npublic expenditure.<\/p>\n\n\n\n<p>Figure 1 shows the\nvariability of UK GDP and its two private components, measured by the\ncoefficient of variation (standard deviation divided by the mean). Over the\nlast 17 years, growth of gross domestic product had a variation approximately\nequal to its average. In contrast, the variation in the growth rate of private\ninvestment was more than three times its average and export growth in between\nthe two at about 1.5 times is average. Moderate fluctuations in aggregate\nproduction result from extreme fluctuations in private demand, especially investment.\n<\/p>\n\n\n\n<p>We find the same pattern\nin the United States, with GDP growth showing a lower coefficient of variation\nof approximately .3. The variability measures for private investment and\nexports are three times larger. The measures refer to constant prices,\neliminating any variability due to inflation.<\/p>\n\n\n\n<p><strong>Figure 1: UK Variability of Growth Rates of GDP, GFCF and Exports, 2002-2018 (constant prices, coefficient of variation).<\/strong><\/p>\n\n\n\n<div class=\"wp-block-image\"><figure class=\"aligncenter is-resized\"><img fetchpriority=\"high\" decoding=\"async\" src=\"https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/UKcoefficient.png\" alt=\"\" class=\"wp-image-6707\" width=\"362\" height=\"320\" srcset=\"https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/UKcoefficient.png 533w, https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/UKcoefficient-300x266.png 300w\" sizes=\"(max-width: 362px) 100vw, 362px\" \/><figcaption> Notes: Coefficient of variation is the standard deviation divided by the mean. GFCF is private gross fixed capital formation.  Source: <a href=\"https:\/\/www.ons.gov.uk\/file?uri=\/economy\/grossdomesticproductgdp\/compendium\/unitedkingdomnationalaccountsthebluebook\/2018\/supplementarytables\/bbchapter01nationalaccountsataglancev5.xls\">ONS<\/a>. <\/figcaption><\/figure><\/div>\n\n\n\n<p><strong>Figure 2 USA: of Growth Rates of GDP, GFCF and Exports, 2002-2018<\/strong> <strong>(constant prices, coefficient of variation)<\/strong><\/p>\n\n\n\n<div class=\"wp-block-image\"><figure class=\"aligncenter is-resized\"><img decoding=\"async\" data-src=\"https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/US-coefficient.png\" alt=\"\" class=\"wp-image-6708 lazyload\" width=\"354\" height=\"314\" data-srcset=\"https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/US-coefficient.png 518w, https:\/\/progressiveeconomyforum.com\/development\/wp-content\/uploads\/2019\/10\/US-coefficient-300x265.png 300w\" data-sizes=\"(max-width: 354px) 100vw, 354px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 354px; --smush-placeholder-aspect-ratio: 354\/314;\" \/><figcaption> Notes: Coefficient of variation is the standard deviation divided by the mean.<br> GFCF is private gross fixed capital formation.<br> Source: <a href=\"https:\/\/www.govinfo.gov\/app\/collection\/erp\/2019\">Economic Report of the President 2018<\/a>, Tables 3, 5, &amp; 15. <\/figcaption><\/figure><\/div>\n\n\n\n<p>In the simplest case,\nwe would expect that the variation in the total (GDP) would equal the sum of\nthe different elements weighted by their chares in GDP. For the UK the weighted\nsum of the variation of the private components, private investment and exports\ncalculates as .89, slightly less than the 1.0 for GDP. The difference might be\nexplained by the variation in public expenditure resulting from the fiscal\nausterity cuts after 2009. For the United States, private variation sums to .32.<\/p>\n\n\n\n<p>The message from the statistics is clear &#8212; private demand causes aggregate economic instability. Keynes knew this, policymakers after WWII knew it, and they sought to counter the systemic instability caused by private producers. Private demand tends to instability, especially for investment. The instability results because investments are made in anticipation of future economic conditions, which are uncertain.<\/p>\n\n\n\n<p>Public expenditure serves\nto compensate for the inherent instability of private demand. This is the\nessence of &#8220;counter-cyclical&#8221; fiscal policy, that the central\ngovernment increases its spending when private demand declines, and raises taxes\nwhen private expenditures create excessive inflationary pressures. During\n1950-1970 that was the policy consensus, and it coincided with the &#8220;<a href=\"https:\/\/www.oxfordscholarship.com\/view\/10.1093\/acprof:oso\/9780198287414.001.0001\/acprof-9780198287414\">golden\nage of capitalism<\/a>&#8220;. <\/p>\n\n\n\n<p>Those who argue that there is no return to that policy era fail to understand the fundamental contribution Keynes and his analysis made to economic policy. The guiding principle is simple and applies to all market economies &#8212; private sector instability requires public sector stabilization policies. That principle does not provide the solution to the ills of market economies, but it represents the basis upon which market economies flourish.<\/p>\n\n\n\n<p><em>Photo credit: <a href=\"https:\/\/www.flickr.com\/photos\/rogbu\/3063609309\/in\/photolist-5EHNja-PzphM-7ieLSz-543wYS-RTRyYQ-dNQbQU-piT8ss-W1ZBeC-5nduiR-FVpTf3-292yQx8-rU7Gm-TkSiiy-NXTrX8-25ZgLtr-bQDcbZ-6DiZjG-4MxKA2-kkbQ3v-24xmMR5-4UoUNp-2WXCys-6Ssfaa-pnJuSC-pzWnQ-8KynUY-7uqCTm-hg2ow-7Q5Kz4-nVRVqN-67jNfr-SjYpff-PSGqi-bEf6fA-6SKJam-24ad4J7-s2T93f-pCPGFs-chpAay-8dk1Fr-49NiMH-5KPFQ-5nhJo7-kkbRpi-b7NTPc-rBpGL-kkdwFV-9FKwGQ-5t6WCr-cFanME\">Flickr\/Rog b<\/a><\/em>.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>&#8216;Over five decades the principle that capitalist economies required active, continuous management by national governments established itself as policy orthodoxy, then the consensus abruptly ended.&#8217; PEF Council Coordinator John Weeks reminds us what Keynes taught us about managing capitalism.<\/p>\n","protected":false},"author":11,"featured_media":6711,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"nf_dc_page":"","_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"site-sidebar-layout":"default","site-content-layout":"default","ast-site-content-layout":"default","site-content-style":"default","site-sidebar-style":"default","ast-global-header-display":"","ast-banner-title-visibility":"","ast-main-header-display":"","ast-hfb-above-header-display":"","ast-hfb-below-header-display":"","ast-hfb-mobile-header-display":"","site-post-title":"","ast-breadcrumbs-content":"","ast-featured-img":"","footer-sml-layout":"","ast-disable-related-posts":"","theme-transparent-header-meta":"default","adv-header-id-meta":"","stick-header-meta":"","header-above-stick-meta":"","header-main-stick-meta":"","header-below-stick-meta":"","astra-migrate-meta-layouts":"default","ast-page-background-enabled":"default","ast-page-background-meta":{"desktop":{"background-color":"","background-image":"","background-repeat":"repeat","background-position":"center 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Weeks"}],"_links":{"self":[{"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/posts\/6705","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/users\/11"}],"replies":[{"embeddable":true,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/comments?post=6705"}],"version-history":[{"count":3,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/posts\/6705\/revisions"}],"predecessor-version":[{"id":6712,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/posts\/6705\/revisions\/6712"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/media\/6711"}],"wp:attachment":[{"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/media?parent=6705"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/categories?post=6705"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/progressiveeconomyforum.com\/development\/wp-json\/wp\/v2\/tags?post=6705"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}