Bookblogging: a snippet

A little bit I plan to include in the chapter on the Great Moderation, linking on to a critique of post-70s macroeconomics. As always, comments and criticism gratefully (and, mostly, I hope, gracefully) accepted

The failure of the Great Moderation calls for a rethinking of the macroeconomic experience of the 20th century, and, in particular, the crisis of the 1970s. Considered as a whole, the performance of developed economics in the era of market liberalism looks considerably less impressive than that of the postwar period of Keynesian social democracy.

Yet the Keynesian era ended in the chaos and failure of the 1970s. Until the current crisis, that failure was widely taken as conclusive. Whatever its merits, it seemed, Keynesian economic management had proved unsustainable in the end, while the methods of market liberalism seemed to promise the continuing stability of the Great Moderation.

That view can no longer be sustained. The Great Moderation has ended in a failure at least as bad as that of the postwar boom. And, if there is a recovery, it will be due to the very measures that market liberalism was supposed to have rendered obsolete. How then, should we think about the Keynesian era and its failure?

One possible interpretation, a pessimistic one, is that business cycles are so deeply embedded in the logic of market economics (and, perhaps of all modern economies) that they cannot be tamed. Success breeds hubris, and hubris leads us to ignore the lessons of the past: that resources are always constrained, that budgets must ultimately balance, that wages and other incomes cannot, for long, exceed the value of production and so on. It the 1960s, this hubris manifested itself in the wage-price spiral. In the 1990s and 2000s, it was seen in the speculative frenzy unleashed by the self-styled Masters of the Universe in the financial sector.

But this is not the only possible interpretation. Perhaps the failures of the 1970s were the result of mistakes that could have been avoided with a better understanding of the economy and stronger social institutions. If so, the current crisis may mark a return to successful Keynesian policies that take account of the errors of the past.

The end of the Great Moderation has forced policymakers to relearn the basic lessons of Keynesian economics. Economies can collapse to a point where only large scale monetary expansion and fiscal stimulus can revive them. But having revived the economy, can Keynesian policies restore and sustain full employment in a system that is inherently prone to crisis. To answer this question, we requires radical new directions in macronomics. As we will argue in the following chapter, that means the abandonment of yet more dead or obsolete ideas.

46 thoughts on “Bookblogging: a snippet

  1. JQ – Im not so sure the wage price spiral of the 1970s can be attributed at source to the hubris of the 1960s….the inflation was an international phenomenon but there is evidence that it started to boil in the US in rises in manufacturing wages which some have attributed to labour shortages and the US intervention in Vietnam….others particularly conservatives have put the inflation of the 1970s (particularly here in Australia) to union activity but this is a too convenient and localised reason when the inflation was international in character…its unlikely that militant union activity happened to break out in all those countries around the same time (early 1970s).

    It seems likely that it originated in the US as so many cyclical aberrations do but was it really hubris or was it tightness of labour and why did it manifest in manufacturing wages initially? Which commodity was it that first caused the inflation in manufacturing wages in the US – from about 1962/3 I seem to recall.. and caused it to be transferred to many other countries later?(and yes we know about the commodity oil but that came a decade later…).

    Was it labour shortages due to Vietnam or some other commodity in the US in the 1960s…?some metal if it hit manufacturing wages first…. Interestingly, and as an aside, it was in 1962 that the US started using agent orange which came in metal containers. Also the US commenced sustained continuous air raids of North Vietnam in 1965 which went on for three years in operation rolling thunder. That would have cost a pretty penny and used a lot of manufacturing labour (and metal).

    Or was it hubris in the US in the latter half of 1960s after the injection of Vietnam? And were wages chasing inflation or inflation chasing wages in Australia in the 1970s? I suspect the former…

  2. OK, that’s your comment. Nothing more until after noon tomorrow, please.

    I don’t think any reply is needed, so I request that we get back to the actual topic of the thread.

  3. hope I didn’t sound too impatient at #2! I recall reading an article that you wrote a long time ago that described the unraveling of Bretton Woods in terms of the “Impossible Trinity” or fixed exchange-rates, capital mobility and independent monetary policy. It’s an interesting line of explanation and certainly better than the hand-waiving typical of books like Yergin and Stanislaw’s “Commanding Heights”.

    One thing I think is very important is the US dollar’s position as an international reserve currency, especially with regard to its role in the petroleum and financial industries. It really is a defining aspect of the post-Bretton Woods, “post-Keynesian” world system. I am guessing that the US dollar’s textbook-defying status as a super-currency is in large part what allowed the bizarre disparity of savings and debt between the East and the West which inflated this mother-of-all-bubbles. A reconsideration of dollar hegemony will be key to any post-post Bretton Woods system, and may force the US economy into some pretty severe adjustments down the track once it can no longer keep on adding zeros to its mega-debt without any consequences. The proposals coming from China about using the IMF special drawing rights as an international reserve currency, which have been in the news for the last couple of days, are really interesting in this regard. What ever new system emerges out of this debacle will not be a return to the post-war order but something new and unfamiliar.

  4. Pr Q says September 10th, 2009 at 06:08 #16

    And you should get your insults up to date. Postmodern relativism is a distinctly rightwing phenomenon these days. Libertarians in particular are keen to reject the results of mainstream science (on climate change, for example) and inevitably resort to postmodernist/relativist/social constructionist arguments to support this.

    This is true as far as it goes but it does not go nearly far enough in one way and goes too far in another way. The New Right’s brand of post-modern liberalism is based on a rejection of the mainstream in both elite science and populist common sense.

    Basically post-modern liberals turn ever policy into a marketing campaign. Success is measured by the degree to which the public is hoodwinked. The only critiques are of the efficacy and “sensitivity” of the campaign.

    What is striking about the libertarian New Right is how radically at odds its post-modern philosophy is with the more authoritarian Old Right. Much to the favour of the latter.

    You can see this in the militarist New Right’s post-modern contempt for foreign policy realism ie the “reality-based community”. (In at least one sense the invasion of Iraq was a species of liberal internationalism gone mad.

    By contrast the Old Right was steeped in realism with a strong tendency towards isolationism.

    Next there is the financial New Right’s post-modern liberalism, as expressed in the riot of financial speculation based on totally intangible derivatives. Which “melted to air” at first contact with the realism of servicing debt.

    By contrast the Old Right had a strong suspicion of financial wheeler-dealing, “money changers” and usury. Unfortunately laced with anti-semitism, but thats how most people were in those days.

    Then there is the globalist New Right who tend to be hard-core boosters of Open Borders. This fabulous idea is based on the post-modern ideology of the Blank Slate: all ethnic differences are supposed to be sociologically constructed, not biologically conserved. (Mainstream science supports the hereditarian view but is effectively censored by politically correct thought police.) How politically realistic this philosophy is can be asessed by the emergence of crypto-fascist parties in Europe.

    And finally there is the industrialist New Right, which apparently thinks that Nature is just one big Free Lunch. Most vigorously expressed by Julian Simon. This is only true when ecological costs are not counted on balance sheets, a dubious method of accounting.

    Again, the constrast with the environmentalist Old Right – think Malthus’s “dismal science” and Hardin’s “Tragedy of the Commons” could hardly be more striking. Not so long ago the strongest environmentalists were on the Old Right, think Teddy Rooseveldt.

    Right-libertarians have drunk the post-modern Kool Aid as their Left-libertarian cousins. They completely fail to even acknowledge, let alone act on, the relationship between ecological nature and sociological structure. And they never bother to re-visit their arguments to see if their theory is tracking or tricking the evidence.

    A consignment to the Dustbin of History is indicated.

  5. Pr Q says:

    Perhaps the failures of the 1970s were the result of mistakes that could have been avoided with a better understanding of the economy and stronger social institutions. If so, the current crisis may mark a return to successful Keynesian policies that take account of the errors of the past.

    The failure of Keynsian demand management in the seventies occurred mainly because the economic stumbling blocks were located on the supply side: in the escalating costs of factor inputs markets for labour and raw materials, passed onto goods output markets. In that sense, the failure of Keynsianism was caused by heightened Class War, broadly understood as conflict between resource owners over the distribution of income. Industrial agitation peaked during the late sixties and seventies.

    Merely pump-priming the demand for goods failed to alleviate unemployment of factors. It raised the price, rather than the quantity utilisation, of labour. The problem was the oligopolistic nature of factor markets. The absence of competition allowed unionists and oil well owners to factor price inflation into their cost-based indexed contracts.

    The Keynsian log-jam was broken by the breaking of supply side factor cartels, basically the trade union movement and the OPEC oil cartel. Not to mention the emergence of high-IQ low-cost Asian Miracle economies throughout East Asia, which reduced the price of manufactured goods.

  6. @Jack Strocchi
    Jack – Id rather the old right to the new right and I think the crisis of the 1970s greatly (hugely) overemphasised the role of union cartels. As the inflation happened in many countries at the same time…and union militancy did not…its more than a bit of a red herring…manufacturing costs clearly increased along with wages, yes but go back to the Vietnam war Jack…cklassic shortages and high demand for manufacturing resources inputs and outputs…the union bit I dont buy.

  7. I very much doubt that business cycles can be suppressed in a capitalism-based economy. The moniker “business cycle” conveys the idea – however inadvertently – of a regular pattern, one which could presumably be anticipated and controlled. Short of placing a large source of friction upon financial transactions – a punitive tax – it is difficult to see how to smooth the fluctuations that construct the business oscillation. Humans just innovate around such things anyway, often to the point of constructing an ad hoc black market to avoid punitive taxes. Since a black market is the dark matter in the economic universe, even if a measure of economic growth, say rate of increase of GDP, isn’t showing signs of oscillation, the dark matter is not necessarily being measured except by some indirect effects upon the legal economy. If the legal and illegal economy could be aggregated, chances are that a business oscillation signal would appear in our measure of economic growth. It is a bit like the American expression of wack-a-mole: knock down one source of business oscillation, only to have another appear elsewhere in the economy.

    Perhaps business oscillation is an intrinsic phenomenon of capitalist-based market economies. Certainly it is a robust phenomenon; even the more extreme boom-bust oscillation seems robust. Kindleberger’s book “Manias, Panics and Crashes” certainly covers a wide enough range of economies to demonstrate robustness of the boom-bust oscillation.

    One mechanism that pops up a bit is the loosening of credit standards as a marketplace goes from trend growth to boom conditions. The cheap money invigorates the boom to reach bubble proportions, and eventually some deal somewhere comes undone and an audible pop heralds the collapse. Variants of this abound, as do entirely different arcane theories that I don’t understand 🙂

    The Howard-Costello years kept consumption going through a range of policy measures: first home owner’s grant, negative gearing changes, selling of government held assets to pay down debt, middle class welfare, withdrawal of many government services and privatisation of them, shifting of risk from government to the individual, etc. The resource boom did its bit in keeping government in surplus, and gave some support to the boom in property and stocks. These policy measures had the effect of pushing the boom-bust oscillation farther out in time.

    If China and India had flatlined rather than boomed, the Howard-Costello economic period may have ended badly due to the household debt levels, and the number of households with investment mortgages supported by negative gearing. How it ends now, given that the Rudd-Gilliard government has spent big to catch our fall, is going to be dependent to a degree on timing, and on just how serious the US situation is ultimately.

  8. I think a review of post-70’s macroeconomics would be highly advantageous. It could include a discussion of underlying causes from WWII as depicted the chapter 3 (viz “Policy successes and failures since the early 1970’s”) of:

    “Economic Forecasting and Policy: The International Dimension”, Llewellyn, J., Potter S., Samuelson, L.

  9. Here is a snippet on 1970s inflation source. Brimmer (71) claims it had its mainspring in the Vietnam war when the US economy was already close to full employment, making the US federal government the source of inflation. The inflation emerged post 1965 with two fifths of the increase of GNP in current dollars (65-68) reflecting only higher prices with the GDP deflatir rising at an annual rate of 3.3%, but from 1968 through 1969 (4 quarters) the general price level rose such that the increase in current dollar GNP was three quarters inflation. Net exports declined at an average annual rate of 4.4 billion but domestic demand increased imports. Demand for missiles, electronics, aircraft,ordnance, and other prime military constributed to rapidly growing manufacturing payrolls with wages jumping from a 4% average increase before 1965 to an average of around 9% pa 65 t0 68 ( end date of study). There was a substantial increase in income shares of the two lowest deciles, yet there was no increase in factory workers “real” purchasing power …over this period.
    So wages chasing inflation, caused by inappropriate timing of a war intervention. So it seems more and more unlikely to me the big bogey man that caused the 1970s inflation was militant unions. More likely it was the higher price of US manufacturing exports (production inputs elsewhere) that got transferred to other countries like a bad virus. A bad war virus.

  10. It seems to me that the recent financial crisis and the stagflation of the 1970’s can both be attributed to expectations created by governments. In the first case governments encouraged people to expect that they would maintain full employment despite rising inflation. In the latter case governments encouraged people to expect that they would not allow a big bank to fail, no matter what risk the bank might take.

    Call it hubris if you like. Hayek would have called it conceit.

  11. Winton I think you are partly right the crises of the 1970s and this decade were caused by poor decision making by private agents under loose monetary conditions. The high inflation of the 1970s was likely exacerbated by the price controls early in the decade.

  12. Prof Quiggin/Jack Strocchi,

    I have yet to come across any postmodern relitivist arguments against climate change by right wingers. Could you provide references please, preferably in the form of web links?

    I was under the impression that the climate change skeptics believed that climate change was objectively wrong.

  13. @Winton Bates
    I’m going to use my one daily comment to say “hear hear”. Although if you want to avoid getting your comments rationed to one a day, you might want to stick to “socially useful” remarks and avoid mentioning Hayek by name, and instead refer to him as the “Evil Overlord of Brutopia”.

  14. @Winton Bates
    Ill grant you this Winton on the 1970s inflation – at least governments thought they could maintain full employment and enter a major war…without it having any effect at undoing stable full employment…much like Greenspan thought he could run on forever with low interest rates blowing up into a housing debt fuelled boom which escaped his and Beranke’s attention entirely…
    what is it with governments AND central banks…they get drunk on the good times and cant make sober decisions about how to miantain it???

  15. @sdfc
    sdfc – thats an interesting comment that you made about price controls exacerbating the inflation of the 1970s. In the 1950s wool boom episode of inflation – it would appear the wool price collapsed with the imposition of price controls (and the inflationary episode was brief). How much of the end of the inflation in Australia was due to strong fiscal and monetary contractions and how much was due to US imposition of price controls is an interesting question. It is a fact that the golden year of a pound a pound for wool crashed the same quarter of the same year…the US put in price controls. Maybe in the 1970s they were trying to use the same method…?

  16. Inflation in the late 60s was due to Vietnam and attempts to exploit a supposed static Phillips curve.

    Inflation in the 70s was due to overly opyimistuc estimates of potential output growth, and the belief by governments and central banks that inflation was cost push and couldn’t be fixed by restricting demand. These factors lead to negative real interest rates, which caused the inflation.

  17. @Tim Peterson The belief that mainstream science is wrong about global warming requires either
    (a) an absurd conspiracy theory; or
    (b) even more absurd intellectual hubris (drama critics who think they know more about science than actual scientists);or
    (b) a view of truth as inherently ideological.

    In my experience, AGW delusionists fluctuate between the lunacy of (a) and (b) and the postmodern relativism of (c).

  18. I haven’t seen much climate skepticism appart from a TV show on the ABC, and that looked more like (b).

    Option (c) is pretty loopy; as if people who live on the waterfront and disbelieve in climate change will be high and dry in 100 tears time, while their neighbours who believe in it will be deluged.

    Plato showed that relitivism is logically incoherent over 2,000 years ago; essentially, relativism itself cannot be a relative truth. It is either true for everyone or not true at all – one of the neatest knock-down refutations in the history of philosophy.

  19. I should add that if relativism is true for everyone, then it is false. So relativism is false either way.

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