Monday, February 24, 2014

Work, Unemployment and Aggregate Demand

(I originally posted this as a series of comments on a 2012 post at Steve Randy Waldman's Interfluidity. In that post, Steve suggested that we should think of redistribution under capitalism as "the poor collectively sell[ing] insurance against riot and revolution, which the rich are happy to pay for with modest quantities of efficiently produced goods.")

In Theories of Surplus Value, Marx writes:
Assume that the productivity of industry is so advanced that whereas earlier two-thirds of the population were directly engaged in material production, now it is only one-third. Previously 2/3 produced means of subsistence for 3/3; now 1/3 produce for 3/3. Previously 1/3 was net revenue (as distinct from the revenue of the labourers), now 2/3. Leaving [class] contradictions out of account, the nation would now use 1/3 of its time for direct production, where previously it needed 2/3. Equally distributed, all would have 2/3 more time for unproductive labour and leisure. But in capitalist production everything seems and in fact is contradictory… Those two-thirds of the population consist partly of the owners of profit and rent, partly of unproductive labourers (who also, owing to competition, are badly paid). The latter help the former to consume the revenue and give them in return an equivalent in services—or impose their services on them, like the political unproductive labourers. It can be supposed that—with the exception of the horde of flunkeys, the soldiers, sailors, police, lower officials and so on, mistresses, grooms, clowns and jugglers—these unproductive labourers will on the whole have a higher level of culture than the unproductive workers had previously, and in particular that ill-paid artists, musicians, lawyers, physicians, scholars, schoolmasters, inventors, etc., will also have increased in number.
A large and growing share of employment, in other words, is unnecessary from a technical standpoint. It exists because useless jobs are more conducive to social stability than either mass poverty or a social wage. The payments the majority of the population receives for not rioting or rebelling look better when they are dressed up as payment for our work as mistresses, grooms, jugglers -- or as yoga instructors or economics professors. This way, people are still dependent on a boss. In a differently organized world, we could dispense with most of these jobs and take the benefits of increased productivity in some combination of shorter hours for productive workers and a shift toward more intrinsically fulfilling (craft-like) forms of productive work.

By starting from here we can think more sensibly about employment and unemployment. From a macroeconomic standpoint, all we need is that expenditure on unproductive labor changes in some rough proportion with income.

From my point of view, the essential facts about employment are (1) As long as the most socially accepted form of claim on the social product is wages for work, work will be found for people, along the lines Marx suggests. (This is not true in poor societies, where a large portion of the poor engage in subsistence labor, of either the traditional or garbage-picking variety.) And (2) In the short run, employment will rise and fall as the rich feel a smaller or a greater need for the insurance-value of financial wealth.

As soon as you being to think about employment in terms of an input of labor to a production process, you've taken a wrong turn. We should not try to give supply-based explanations of unemployment, i.e. to show how the allocation of some stock of productive resources by some decision makers could generate unemployment. Unemployment is strictly a phenomenon of aggregate demand.

Unemployment in advanced countries is not characterized by exogenous factor supplies and Leontief-type production functions, where some factors are exhausted leaving an excess supply of their complements.  (The implicit model that lies behind various robots-will-take-all-the-jobs stories.) Unemployment in capitalist economies involves laid-off workers and idle factories; it involves unemployed construction workers and rising homelessness; it involves idle farmworkers and apples rotting on the trees. Unemployment never develops because we need fewer people to make the stuff, but because less stuff is being made. (Again, things are different in poor countries, and in the early stages of industrialization historically.) Unemployment cannot be explained without talking about aggregate demand any more than financial crises can be explained without talking about money and credit. It exists only to the extent that income and expenditure are determined simultaneously.

Unemployment rises when planned money expenditure falls for a given expected money income. Unemployment falls when planned money expenditure rises for a given expected money income. Conditions of production have no (direct) effect one way or the other.

Recognizing that unemployment is an aggregate expenditure phenomenon, not a labor-market phenomenon, helps avoid many errors. For example:

It is natural to think of unemployed people as people not engaged in productive work. This is wrong. The two things have nothing to do with each other. Unemployed people are those whose usual or primary claim on the social product takes the form of a wage, but who are not currently receiving a wage. There are lots of people who do not receive wages but are not unemployed because they have other claims on the social product — children, retirees, students, caregivers, the institutionalized, etc. Almost all of tehse people are capable of productive work, and many are actively engaged in it — caregiving and other forms of household production are essential to society’s continued existence. At the same time, there many people who do receive wages but who are not engaged in productive work; one way to define these is as people whose employment forms part of consumption out of profits or rents.

While there is no relationship between people’s capability for and/or engagement in useful work, on the one hand, and employment, on the other, there is a close link between aggregate expenditure and employment, simply because a very large fraction of expenditure takes the form directly or indirectly of wages, and aggregate wages adjust mainly on the extensive rather than the intensive margin. So when we see people unemployed, we should never ask, why does the production of society’s desired outputs no longer require their labor input? That is a nonsense question that will lead nowhere but confusion. Instead we should ask, why has there been a fall in planned expenditure?


Going beyond the 2012 conversation, two further thoughts:

1. The tendency to talk about unemployment in terms of why some peoples' labor is no longer needed for production, is symptomatic of a larger confusion. This is the confusion of imagining money claims and payments as a more or less transparent representation of physical and social realities, as opposed to a distinct system that rests on but is substantially independent from underlying social and biological existence. Baseball requires human beings who can throw, hit and run; but the rules of baseball are not simply shorthand for people's general activity of throwing, hitting and running. Needless to say, economics education assiduously cultivates the mixing-up of the money game with the substrate upon which it is played.

2. It's natural to think of productive and unproductive labor as two distinct kinds of employment, or at least as opposite poles on a well-defined continuum. Marx usually writes this way. But I don't think this is right, or at least it becomes less valid as the division of labor becomes more extensive and as productive activity becomes more directly social and involves more coordination of activities widely separated in space and time, and more dependent on the accumulation of scientific and technical knowledge.

Today our collective productive and creative activity requires the compliance of a very large number of people, both active and passive. This post will never be read by anyone if I don't keep on typing. It will also never be read if the various tasks aren't performed that are required to operate the servers where this blog is hosted, my internet connection and yours, the various nodes between our computers, the utilities that supply electricity to all the above, and so on. It would not be read if someone hadn't assembled the computers, and transported and sold them to us; and if someone hadn't developed the required technologies, step by step as far back as you want to go. It would not be read, or at least not by anyone except me and a few friends, if various people hadn't linked to this blog over the years, and shared it on social media; and more broadly, if the development of blogs hadn't gotten people into the habit of reading posts like this. Also, the post won't be read if someone breaks into my house before before I finish writing it, and steals my laptop or smashes it with a hammer.

All of these steps are necessary to the production of a blog post. Some of them we recognize as "labor" entitled to wages, like whoever is watching the dials at Ravenswood. Some we definitely don't, like the all-important not-stealing and not-smashing steps. And the status of some, like linking and sharing,  is being renegotiated. Again, a factory only runs if the workers choose to show up rather than stay home in bed; we reserve a share of the factory's output to reward them for making that choice. It also only runs if passersby choose not to throw bricks through the windows; we don't reserve any share of the output for them. But if we were going to write down the physical requirements for production to take place, the two choices would enter equivalently.

In a context where a large part of the conditions of production appear as tangible goods with physically rival uses; where the knowledge required for production was not itself produced for the market; where patterns of consumption are stable; where the division of labor is limited; where most cooperation takes the form of arms-length exchanges of goods rather than active coordination of productive activity; where production does not involve large commitments of fixed capital that are vulnerable to disruption; then the idea that there are distinct identifiable factors of production might not be too big a distortion of reality. In that context, splitting claims on the social product into shares attributable to each "factor" is not too disruptive; if anything, it can be a great catalyst for the development of productive capacities. But as the development of capitalism transforms and extends the division of labor, it becomes more and more difficult to separate out which activities that are contributing to a particular production process. So terms like productivity or productive labor lose touch with social reality.

You can find this argument in chapters 13-14 and 32 of Capital Volume 1. The brief discussion in chapter 32 is especially interesting, since Marx makes it clear that it is precisely this process that will bring capitalism to an end -- not a fall in the rate of profit, which is never mentioned, nor a violent overthrow, which is explicitly rejected. But that thought will have to wait for another time.

Monday, February 17, 2014

A Response to Tom Palley

Tom Palley wrote a strongly worded critique of Modern Monetary Theory last year, which got a lot of attention int he world of heterodox economics. He has just put up a second piece, MMT: The Emperor Still Has No Clothes, reiterating and extending his criticisms.

Palley is a smart guy who I've learned a lot from over the years. But this is not his best work.

By way of preliminaries: MMT consists of three distinct arguments. First is chartalism, the claim that the value of money depends on its acceptability to settle tax obligations. This goes back to G. F. Knapp. Second is functional finance, the claim that government (conceived of as a consolidated budget and monetary authority) seeks to adjust the budget balance to achieve full employment, it can never be prevented from doing so by a financing constraint. This goes back to Abba Lerner and Evsey Domar. And third is the employer of last resort (ELR), a proposal for a specific form of spending to be adjusted under the functional finance rule. This seems to be an original contribution of Warren Mosler goes back to Hyman Minsky.

Personally, I find it useful to set aside the first and third of these arguments and focus on the second, functional finance. My own attempt to restate the functional finance claim in the language of contemporary textbooks is here. In my view, the essential difference between functional finance and orthodoxy is that the assignments of the interest rate and budget instruments are flipped. Instead of setting the interest rate to keep output at potential and setting the budget balance to keep the debt on a sustainable path, we assign the budget balance to keeping output at potential and the interest rate to debt sustainability.

Palley wants to knock down all three planks of MMT. What are his objections to functional finance?

(1) In the absence of economic growth, government deficits will lead to inflation regardless of the output gap. This claim is asserted rather than argued for. [1] It's not clear what the relevance of this point is, since he agrees that deficits are not inherently inflationary when there is positive growth. Perhaps more importantly, this is a rejection not just as of MMT but of almost all policy-oriented macroeconomics, mainstream and heterodox. Whether you're reading David Romer or Wendy Carlin or Lance Taylor, you're going to find a Phillips curve that relates inflation to current output. There are plenty of disagreements about how expected inflation comes in, but nobody is going to include the budget balance as an independent term. In his eagerness to debunk MMT, Palley here finds himself reasserting Milton Friedman-style monetarism.

(2) If we assume an arbitrary floor on spending and an arbitrary ceiling on taxes, then it may be impossible to achieve both full employment/price stability and a sustainable debt path with interest rates fixed at zero. Yes, this is true. But it proves too much: If we impose arbitrary constraints on tax and spending levels then there is no guarantee that we can achieve debt sustainability and price stability with ANY interest rate. At any given interest rate, there is minimum primary balance that must be achieved to keep output at potential. There is also a minimum primary balance that must be achieved to keep the debt-GDP ratio constant. There is no a priori reason to think the first balance is higher than the second. So Palley's argument here could just as well be a proof that there is nothing government can do to prevent public debt from rising without limit. In any case, these arbitrary limits on taxes and spending are not a feature of standard macro models (including Palley's own models elsewhere), so it's hard to justify bringing them in here.

(3) MMT lacks a theory of inflation. On the contrary, MMT has exactly the same theory of inflation as orthodox macro: High or rising inflation is the result of output above potential, disinflation or deflation the result of output below potential. In other words, MMT is consistent with a standard Phillips curve of the same kind Palley (and almost everybody else) uses. To be fair, the Wray and Tymoigne piece Palley is responding to is not as clear as it might be on this point. But Palley is supposed to be writing a critique of MMT, not just of one particular article. And people like Stephanie Kelton state unambiguously that MMT shares the orthodox output-gap story of inflation; see for instance slide 13 here.

(4) MMT doesn't work in open economies because it requires persistent interest rate differentials between countries. Palley claims that the idea that you can hold interest rates in a given country at zero indefinitely is inconsistent with covered interest parity, a "well-established empirical regularity" that "states there is no room for systematic arbitrage of cross-country interest rates." It seems that Palley has confused covered and uncovered interest parity. CIP is indeed well established empirically, but it only says that there is no arbitrage possible between the spot and forward markets for a given exchange rate. It does not rule out interest-rate arbitrage in the form of the carry trade, and so does not have any implications for the viability of MMT. If UIP held, that would indeed rule out a persistent zero interest policy in the absence of an equally persistent currency appreciation. But UIP, unlike CIP, gets no empirical support in the literature. Japan has sustained the near-zero interest rates that Palley says are unsustainable for 15 years now, and in general, persistent interest rate differentials without any offsetting exchange rate movements are ubiquitous. Furthermore, if financial openness rules out a policy of i=0, then it equally rules out the use of interest rates as a tool for demand management. The best thing you can say about Palley here is that he is parroting orthodoxy; otherwise he is thoroughly confused.

There is one thing that Palley is right about, which is that substantially all of MMT can be found in the old Keynesian literature. This isn't news -- in the same Stephanie Kelton slideshow linked above, she goes out of her way to say that there is nothing "modern" about MMT. And so what? There's nothing wrong with updating insights from the past. In my opinion, most useful work in economics is about pouring old wine in new bottles.

I don't write this from a position within MMT. I tend to feel that the genuine insights of Lernerian functional finance are obscured rather than strengthened by basing them in a chartalist theory of money. It's fine if Tom Palley disagrees with our friends at UMKC and the Levy Institute. But he needs to put down the blunderbuss.

[1] In fact it's a bit hard to understand what Palley is claiming here. First he says that "money financed deficits" must lead to inflation in a static economy, even with a zero output gap. He adds in a footnote that money-financed are not inflationary in a growing economy; in that case, for price stability "the high-powered money stock must grow at the rate of growth." Then when he writes down a model, this has become the condition that government budget must be balanced, which is something different again. Also, I must say I can't help wrinkling my nose a little, when I read about the "stock of high-powered money," at the smell of a musty antique.

EDIT: Thanks to Daniele Santolamazza for correcting me on the origins of the ELR proposal.

Tuesday, February 11, 2014

Don't Start from the Coin

Even today, textbooks on Money, Currency, and Banking are more likely than not to begin with an analysis of a state of things in which legal-tender ‘money’ is the only means of paying and lending. The huge system of credits and debits, of claims and debts, by which capitalist society carries on its daily business of production and consumption is then built up step by step by introducing claims to money or credit instruments that act as substitutes for legal tender... Even when there is very little left of [money's] fundamental role in practice, everything that happens in the sphere of currency, credit, and banking is construed from it, just as the case of money itself is construed from barter. 
Historically, this method of building up the analysis of money, currency, and banking is readily understandable… Legal constructions, too, … were geared to a sharp distinction between money as the only genuine and ultimate means of payment and the credit instrument that embodied a claim to money. But logically, it is by no means clear that the most useful method is to start from the coin—even if, making a concession to realism, we add inconvertible government paper—in order to proceed to the credit transactions of reality. It may be more useful to start from these in the first place, to look upon capitalist finance as a clearing system that cancels claims and debts and carries forward the differences—so that ‘money’ payments come in only as a special case without any particularly fundamental importance. In other words: practically and analytically, a credit theory of money is possibly preferable to a monetary theory of credit.
Perry Mehrling quotes this passage at the start of his essay Modern Money: Credit or Fiat. If you're someone who worries about the vexed question of what is money anyway, you will benefit from the sustained intelligence Perry brings to bear on it.

Readers of this blog may not be familiar with Perry's work, so let me suggest a few things. The Credit or Fiat essay is a review of one of Randy Wray's books, but it makes important positive arguments along with the negative criticism of MMT. [1] A good recent statement of Mehrling's own views on the monetary system is The Inherent Hierarchy of Money. Two superb essays on monetary thought in the postwar neoclassical synthesis are The Money Muddle and MIT and Money. [2] The former of these coins the term "monetary Walrasianism." This refers to  the idea that the way to think of a monetary economy is a barter system where, for whatever reason, the nth good serves as unit of account and must be on one side of all trades.  This way of thinking about money is so ingrained that I suspect that many economists would be puzzled by the suggestion that there is any other way of thinking about money. But as Perry shows, this is a specific idea with its own history, to which we can and should imagine alternatives. Finally, The Vision of Hyman Minsky is one of the two best essays I know giving a systematic account of Minsky's, well, vision. (The other is Minsky as Hedgehog by Dymski and Pollin.) Anyone interested in what money is, what "money" means, and what's wrong with economists' answers, could save themselves a lot of trouble and wrong turns by reading those essays. [3]

But let's talk about the Schumpeter quote.  I think it is right. To understand the monetary nature of modern economies, you need to begin with the credit system, that is, the network of money obligations. Where we want to start from is a world of IOUs. Suppose the only means of payment is a promise to pay. Suppose it's not only possible for me to tell the bartender at the end of the night, I'll pay you later, suppose there's nothing else I can tell him -- there's no cash register at the bar, just a box where my tab goes. Money still exists in this system, but it is only a money of account -- concretely we can imagine either an arbitrary unit of value, or some notional commodity that does not circulate, or even exist. (Historical example: non-circulating gold in medieval Europe.) If you give something to me, or do something for me, the only thing I can pay you with now is a promise to pay you later.

This might seem paradoxical -- jam tomorrow but never jam today -- but it's not. Debts in this system are eventually settled. As Schumpeter says, they're settled by netting my IOUs to you from your IOUs to me. An important question then becomes, how big is the universe across which we can cancel out debts? If A owes B, B owes C, and C owes A, it's not hard to settle everyone up. But suppose A owes B who owes C who owes …. who owes M who owes … who owes Z, who owes A. It's not so easy now for the dbets to be transferred back along the chain for settlement. In any case, though, my willingness to accept your IOUs depends on my belief that I will want to make some payment to you in the future, or that I'll want to make some payment to someone who will want to make a payment to someone …. who will eventually want to make a payment to you. The longer the chain, the more important it is for their to be some setting where all the various debts are toted up and canceled out.

The great fairs of medieval Europe were exactly this. During their normal dealings, merchants paid each other with bills of exchange, essentially IOUs that could be transferred to third parties. Merchants would pay suppliers by transferring (with their own endorsement) bills from their customers. Then periodically, merchant houses would send representatives to Champagne or wherever, where the various bills could be presented for payment. Almost all the obligations would end up being offsetting. From Braudel, Capitalism and Civilization Vol. 2:
... the real business of the fairs, economically speaking, was the activity of the great merchant houses. … No fair failed to end with a 'payment session' as at Linz, the great fair in Austria; at Leipzig, from its early days of prosperity, the last week was for settling up, the Zahlwoche. Even at Lanciano, a little town in the Papal States which was regularly submerged by its fair (though the latter was only of modest dimensions), handfuls of bills of exchange converged on the fair. The same was true of Pezenas or Montagnac, whose fairs relayed those of Beaucaire and were of similar quality: a whole series of bills of exchange on Paris or Lyons travelled to them. 
The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun: such were the miracles of scontro, compensation. A hundred thousand or so "ecus d'or en or" - that is real coins - might at the clearing-house of Lyons settle business worth millions; all the more so as a good part of the remaining debts would be settled either by a promise of payment on another exchange (a bill of exchange) or by carrying over payment until the next fair: this was the deposito which was usually paid for at 10% a year (2.5% for three months). 
This was not a pure credit-money system, since coin could be used to settle obligations for which there was no offsetting bill. But note that a "good part" of the net obligations remaining at the end of the fair were simply carried over to the next fair.

I think it would be helpful if we replaced truck-and-barter with something like these medieval fairs, when we imagine the original economic situation. [4] Starting from a credit view of money modifies our intuitions in several, as I see it, helpful ways.

1. Your budget constraint is always a matter of how much people will lend you, or how safe you feel borrowing. Conversely, the consequences of failing to pay your debts is a fundamental parameter. We can't push bankruptcy onto the back burner as a tricky but secondary question to be dealt with later.

2. The extension of credit goes with an extension of the realm of the market. The more things you might be willing to do to settle your debts, the more willing I am to lend to you. And conversely, the further what you owe runs beyond your normal income, the more the question of what you won't do for money comes up for negotiation.

3. Liquidity, money, demand, depend ultimately on people's willingness to trust each other, to accept promises, to have confidence in things working out according to plan. Liquidity exists on the liability side of balance sheets as much as on the asset side.

4. When we speak of more or less liquidity, we don't mean a greater or lesser quantity of some commodity designated "money," but a greater or lesser degree of willingness to extend credit. So at bottom, conventional monetary policy, quantitative easing, lender of last resort operations, bank regulations -- they're all the same thing.

When Minsky says that the fundamental function of banks is "acceptance," this is what he means. The fundamental question faced by the financial system is, whose promises are good?

[1] I don't want to get into Perry criticisms of MMT here. Anyone interested should read the article, it's not long.

[2] MIT and Money also makes it clear that I was wrong to pick Samuelson's famous consumption-loan essay as an illustration of the neoclassical position on interest rates. The point of that essay, he explains, was not to offer a theory of interest rate determination, but rather to challenge economic conservatives by demonstrating that even in a simple, rigorous model of rational optimization, a public pension system could could be an unambiguous welfare improvement over private retirement saving. My argument wasn't wrong, but I should have picked a better example of what I was arguing against.

[3] Perry has also written three books. The only one I've read is The New Lombard Street. I can't recommend it as a starting point for someone new to his work: It's too focused on the specific circumstances of the financial crisis of 2008, and assumes too much familiarity with his larger perspective.

EDIT: I removed some overly belligerent language from the first footnote.