Classical economics and recession in many countries (wonkish)

Sharp tests of economic theories are rare and hard to find, particularly in macroeconomics. Any examination of particular episodes in economic history necessarily involves counterfactuals, and these provide room for endless dispute. As an obvious example, assessing the impact of the Obama Administration’s 2009 stimulus requires an estimate of how things would have gone without the stimulus, and that is obviously hard to do.

Similarly, arguments about unemployment in the US get bogged down in disputes over whether it is structural or demand-driven and the extent to which policies such as the extension of unemployment benefits to 99 weeks have contributed. 

There is, though, one way in which the current Great Recession/Lesser Depression provides a sharp test of a critical proposition in economics. All forms of classical economics involve, in one form or another, the claim that the causes of unemployment are to be found in labour markets, and not in  macroeconomic variables such as the level of aggregate demand. That’s equally true of the Say’s Law version of classical economics criticized by Keynes, the New Classical macroeconomics of Robert Lucas and the attempts by Real Business Cycle theorists like Kydland and Prescott to explain cyclical fluctuations in terms of labor market shocks.

The crucial problem for all these theories is that labor markets and the associated institutions operate mainly at the national level. Even within the EU, different countries have very different labor markets. So, it is essentially impossible for labor markets in many different countries to move together, except as the result of macroeconomic influences operating at an international level[1]. That means that the occurrence of a sharp and sustained increase in unemployment, taking place in many countries at once, is inconsistent with classical economics.

This point seems trivially obvious, but as far as I can tell hasn’t been made, or at least not clearly. Once it’s conceded, it seems impossible to avoid a view of the world that is basically Keynesian in its analysis of the macroeconomy.  It is possible to hold such a view and reject Keynesian policies on pragmatic grounds, as in Friedman’s critique of ‘fine-tuning’. But the longer and deeper the recession the harder it is to sustain this view.

This seems like a good time to plug the fact that a paperback edition of Zombie Economics will be out soon (May 6) with a brand-new chapter on Austerity, bits of which have been seen here. On 9 May, I’ll be launching an Australian edition, where the added material is a chapter on Economic Rationalism. And a week or two ago, I received some copies of the Italian edition










fn1. Of course, you can cheat and label these macro influences “technology shocks”, then assume them to be internationally correlated. But in the ordinary meaning of technology, there is no plausible way in which economies as disparate as, say, the US and Greece can experience a common technology shock.

Posted via email from John’s posterous

95 thoughts on “Classical economics and recession in many countries (wonkish)

  1. See Lee Ohanian for The Economic Crisis from a Neoclassical Perspective. He finds that
    • the great recession differs substantially from other post-war U.S. recessions, and also from the 2008-2009 recession in other countries

    • lower labor input accounts for virtually all of the decline in income and output in the U.S while lower productivity accounts for much of other U.S. recessions and the 2007-2009 recession in other countries.

    • The existing classes of models, including financial market imperfections models, do not explain the U.S. recession. This is because the 2007-2009 recession is almost exclusively related to what appear to be labor market distortions, a topic about which current classes of financial imperfection models are largely silent.

    • Alternative hypotheses for the recession are considered, including the view of John Taylor and others that economic policies intended to help manage the crisis, actually deepened the recession by increasing uncertainty and distorting incentives.

    See also Fiscal Sentiment and the Weak Recovery from the Great Recession: A Quantitative Exploration by Finn E. Kydland and Carlos E. J. M. Zarazaga
    • The U.S. economy isn’t recovering from the deep Great Recession of 2008-2009 with the anticipated strength. A widespread conjecture is that this weakness can be traced to perceptions of an imminent switch to a higher taxes regime.

    • The main finding is that the fiscal sentiment hypothesis can account for a significant fraction of the decline in investment and labor input in the aftermath of the Great Recession.

    • These results require a qualification: The perceived higher taxes must fall almost exclusively on capital income.

    • As agents realize that their capital income will be taxed more heavily in the future, they reduce their holdings of the capital stock by not completely replenishing the part of it that depreciates every period and by changing the composition of output in favour of consumption.

  2. I beg to differ on the crucial problem with the classical economic theory regarding labour markets. In a sense, it is the ‘labour market’ that is part of the uneven unemployment problem all over the world. But, to the best of my knowledge, classical economic theory cannot deal with this ‘labour market problem’ because it treats ‘labour’ as essentially a homogenous ‘input’ (and ‘the economy’ has ‘one market’). To be a little more specific, the actual ‘labour market’ includes innovators of physical products as well as financial securities and it includes hierarchies of decision makers within organisations that are, in one way or another institutionally determined. The ‘labour market’ also includes the decision makers on macro-economic variables. The way I see it, the ‘labour’ in one or several segments of ‘the labour market’ have caused ‘a shock’ to ‘labour’ in other segments of ‘the labour market’.

    As for Keynes, the relevant sentence which comes to mind regarding the current unemployment problem is, from memory, ‘the wrong people have the money’.

    So I agree classical economic theory is irrelevant for the currently severe unemployment problem but I fail to see how macro-economic demand management (via government expenditure financed through debt or printing money) per se is a solution.

    Maybe I misunderstood the argument.

  3. It’s stunning to me that this is a serious point of debate between internationally respected economists. If this was physics, the equivalent debate would be about the shape of the earth. It makes me think that at least one side is composed entirely of intellectual impostors and/or fraudsters. Economics as a discipline ought to feel ashamed of this state of affairs.

  4. <blockquote….it seems impossible to avoid a view of the world that is basically Keynesian in its analysis of the macroeconomy.

    This is pretty much how the world runs today. Surely the use of deliberate injections (stimulus) into the circular flow is a key Keynesian novelty. The usage of IS-LM (at least in teaching) also is Keynesian.

    If you combine injections with fiddling with interest rates to change then money supply, then to this extent Keynesianism causes the wrong people to have the money (Ernestine’s point). Fiddling with interest rates gives money to bond traders and banks, not consumers.

    The solution is probably too radical for Keynesians to countenance but if either a circular flow was established that did not require stimulus (ie market socialism) or, alternatively, if stimulus was applied through paying wages and creating jobs (ie regulated capitalism) unemployment may fall.

    In a sense unemployment and stimulus are essentially the same thing. Society has a choice, do we maintain profits by cutting wage-costs, (the unemployment angle) or do we increase demand to enable fresh capacity to realise profits (the stimulus angle).

    Western capitalism has been using the latter, but it appears this capability has now reached a limit, so unemployment in affected states (eg Spain) now skyrockets.

    If ‘the wrong people have the money’ – this is a core outcome of Keynesian stimulus in a IS-LM (or similar) framework. Consequently we must look outside the Keynesian fence.

  5. Neoclassical (or any exchange) theory is useless in analysing monetary events. Is it any wonder Ohanian gets it badly wrong?

  6. @Chris Warren

    IS-LM is not Keynesian. It is a neoclassical synthesis of Keynes. Its creator, Hicks, later admitted in a paper that it completely misrepresented Keynes’ view of how the economy operates.

    The stimulus capability you refer has only reached its limit in terms of private debt financing ponzi schemes. To the extent where stimulus came from 1. Fiscal policy to reduce the private debt burden, and 2. Debt finance for productive investments – there is no

  7. Accidentally posted too early. Below is the whole post.

    @Chris Warren

    IS-LM is not Keynesian. It is a neoclassical synthesis of Keynes. Its creator, Hicks, later admitted in a paper that it completely misrepresented Keynes’ view of how the economy operates.
    The stimulus capability you refer has only reached its limit in terms of private debt financing ponzi schemes. To the extent where stimulus came from 1. Fiscal policy to reduce the private debt burden already sunk in ponzi schemes and 2. Debt finance strictly for productive investments – there is no reason to suggest that any limit has been reached.

    This is in line with Post-Keynesian theory which is the true representation and extension of Keynes.

    @Ernestine Gross

    I think JQ suggests demand side management is the solution to unemployment because unemployment occurs not necessarily because of labour market imperfections, but because of a structural inability to generate effective demand as a characteristic of capitalism. Flexible prices will not cure unemployment because falling wages drives down demand for goods and services which drives down demand for labour, and the cycle continues in a positive feedback loop.

    Recognising this inherent instability of capitalism (as opposed to market imperfections) logically leads to the notion that demand side management is the solution. Past experience actually confirms this as well.

  8. Vast sections of the modern economic profession apparently ignore Marx and Keynes. The general equivalent in the physics profession would be to have physicists ignoring Newton and Einstein. By this very general analogy I simply mean that the two greatest thinkers in economics have been apparently ignored or forgotten by the modern public discourse mainstream of classical and neo-classical economics.

    If anything Keynes is perhaps like Newton. He gives us the laws that work in a bounded case; the general theory of employment, interest and money as they work within the political economy of capitalism. Marx is a bit like Einstein in that he shows us the two-way relativism between economy and politics and thus Marx develops a more complete overall theory of political economy.

  9. Ernestine states, “I fail to see how macro-economic demand management (via government expenditure financed through debt or printing money) per se is a solution.” Ernestine is referring to unemployment as the problem needing solution.

    The logical corollary of Ernestine’s statement is that Ernestine does not accept the validity or efficacy of Keynesian counter-cyclical spending ie. deficit spending in a recession or depression. Is that what you meant to say Ernestine?

  10. @Adit

    Yes, IS-LM came from Hicks, it is however infuses our Keynesian world which labels itself neoclassical. I am trying to stay away form these sort of academic one-upmanship arguments, as one can easily be diverted into arguing about what neoclassical economics means once you strip out the mathematics. Who really believes you can build any theory on identities (essentially Says Law) – as did Walras.

    Keynes probably was of the same mind except he proposed that the labour market would not necessarily be in equilibrium if other markets were in equilibrium. His fault is that he never perceived the role of capitalist form of profit in producing this outcome. So all through the 1950’s to today, useless stimulus and population growth is generated in the real economy and we all end up with a GFC and looming 25% unemployment: a ‘General Employment Crisis?’.

    The problem is capitalism, particularly as you cannot have a identity (or a system of identities) if you have capitalist profit. You can have windfall profits and profits during adjustments but not at equilibrium.

    It is worse if you have maximising capitalist profit because this implies it is entirely opportunistic and uncontrolled. This then must feed back into any supposedly equilibrium and create chaos.

    Despite a direct conflict with a Nobel Prize winner, presumably there is no long-term efficacy in ‘counter-cyclical’ spending – this just provides a short-run placebo to be paid for by future generations. When future generations look at the Bill, (which they are now doing) they see they owe, globally, around 100 trillion dollars (2 billion man-years @ $50,000).

    To the extent Walras and Keynes appear to base themselves on identities, they merely replicate Classical theory. You therefore resolve neoclassical mathematical presentations by looking at these classical foundations.

    Probably it is the IS-LM model that is false, irrespective of who produced it under what banner and in what form we use it today. So how do you teach macroeconomics without the circular flow identities or IS-LM?

  11. Chris Warren says “Despite a direct conflict with a Nobel Prize winner, presumably there is no long-term efficacy in ‘counter-cyclical’ spending – this just provides a short-run placebo to be paid for by future generations.”

    Before addressing that statement, let me say where I agree with your Chris. Yes, I do agree that capitalism is ultimately the problem. Unregulated capitalism ends in egregious exploitation of workers and gross human rights abuses of all kinds. Look at the Marianas / Saipan experiment (Tom DeLay and Jack Abromoff) as a recent example. BTW, strongly pro-capitalist politicians are almost always crooks IMO.

    Regulated capitalism can work “for a while” Remember that a couple of centuries is only “a while” in historical terms. Properly regulated capitalism can even be benign for most people when it occurs within a democratic capitalist polity. Note that democracy and capitalism are very different things and capitalism per se is actually anti-democratic.

    Within regulated capitalism which works “for a while” and where the government runs a fiat currency it is simply not true to say “there is no long-term efficacy in ‘counter-cyclical’ spending – this just provides a short-run placebo to be paid for by future generations.”

    For a start, this counter-cyclical spending could be “Hard Keynesianism” where the budget is still eventually balanced over the cycles. Therefore there is no long term debt in that case. Secondly, a fiat currency issuing government does not have to go into debt to issue currency. It can simply issue it ie. print it or electronically credit it. The creation of Government “debt” is an accounting figleaf with some utility in managing interest rates. If this money printing is excessive of course hyper-inflation will result. If however, this money printing does not exceed the capacity of the economy to respond to stimulus by utilising previously idle capacity then an economic upswing can (and does) occur without signficant attendant inflation. Why classical, neo-classical and many other orthodox economists persist in being incapable of seeing this relatively simple point (which has also been proven empirically over and over) is quite beyond me. It can only be an ideologically conditioned blind spot which leads to such a denial of simple logical deduction and the empirical evidence.

  12. Sam and Ikonoclast,
    the majority of macroeconomists are still New Keynesians. Not surprisingly, they have trouble understanding economic crises because they attribute them to the demand-side.

    New Keynesians have a great deal of trouble understanding the prolongation of recessions because all that have to hang their hat is sticky wages and prices.

    In Great Depressions of the Twentieth Century, Kehoe and Prescott (2007), together with 22 other economists conclude that bad government policies are responsible for causing great depressions. While different sorts of shocks can lead to ordinary business cycle downturns, overreaction by governments can prolong and deepen the downturn, turning it into a depression.

    Two polar models of bank crises and what government lender-of-last-resort and deposit insurance do to arrest them or promote them were used to understand the GFC. They are polar models because:
    • in the Diamond-Dybvig and Bryant model, deposit insurance and other bailouts are purely a good thing because they stop panic induced bank runs; and
    • In the Kareken and Wallace model, deposit insurance and lender-of-last-resorts are purely bad because moral hazard encourages the initial risk taking unless there is regulation or there is proper surveillance and pricing of the insurance.

    In the Diamond-Dybvig and Bryant model, is that if you put in government-supplied deposit insurance, people don not initiate bank runs because they trust their deposits to be safe. There is no cost to the government for offering the deposit insurance!

    Tom Sargent considers the Bryant-Diamond-Dybvig model has been very influential generally, and in particular that it was very influential in 2008 among policymakers.

    Governments saw Bryant-Diamond-Dybvig bank runs everywhere in 2008. The logic of the Bryant-Diamond-Dybvig panic model of bank runs persuaded many governments that if they could arrest the actual or potential runs by convincing creditors that their loans were insured, that could be done at little or no eventual cost to the taxpayers.

    As for central banks, as Greg Mankiw noted:
    • Autobiographies and other hands-on sources show that recent developments in business cycle theory by new classical and new Keynesians have had close to zero impact on practical policymaking.
    • Central banker’s analysis of economic fluctuations and monetary policy are intelligent and nuanced, but it shows no traces of modern macroeconomic theory, and would seem almost completely familiar to someone who was schooled in the neoclassical-Keynesian synthesis that prevailed around 1970 and has ignored the scholarly literature ever since.

    p.s. see Franklin Allen and Douglas Gale’s 2007 book Understanding Financial Crises for a good read. The introduction is online.

  13. Jim, if you are saying what I think you are saying then you are 100% wrong. What I think you are saying is that supply side economics explains economic crises. If we rule out external real world shocks (long droughts, widespread floods, super-volcano eruptions or mass resource shortages etc) then there are two broad possibilities to explain economic downturns. These supply side problems or demand side problems. Where are or what are the supply side problems which caused the 2008 Great Recession? Was there a Labour shortage? Was there a private capital shortage? No. Labour was under-utilised and the world was awash with capital created by the debt money created by banks.

    The precepitating factor for the 2008 Recession was the fact that growth had been fuelled by debt growth for decades whilst the wage share of the economy remained stagnant. Thus when no more borrowing (at such a rate and scale) could occur because returns on capital no longer justified it and borrowers business and domestic needed to de-lever. This took demand out of the economy and precipiated the crisis and collapses in the banking sector etc. Only if the government now steps in with deficit spending can the demand be ramped up to employ current un-utilised capacity in the economy.

  14. So I think it is reasonable to say that most people here (all of you?) that the first-round effects of Keynesian stimulus can be beneficial. The key question might well be: what happens next? Or, what are the second- and subsequent-round consequences/corollaries of Keynesian stimulus?

    Chris said: “presumably there is no long-term efficacy in ‘counter-cyclical’ spending – this just provides a short-run placebo to be paid for by future generations.” This is incorrect as if there is idle productive/consumptive capacity that stimulus brings online, that both productive and consumptive capacity. In short, it increases the velocity of money.

    As someone who’s an agnostic leaning towards pessimism as goes the overall capitalist growth model (albeit coming from an ecological, rather than Marxian, perspective), even if Keynesianism works on its own terms – which I am convinced it does – I suspect that’s not a good thing in the long term, and I think it would be sensible to recalibrate our economies so 0% rather than 3%p.a. growth is the aim (leaving us with tricky questions of distribution – but we have those regardless). Note that even in such a scenario Keynesian strategies could still be used to increase velocity where and when necessary.

  15. Jim, you are quoting these guys as if they are authorities. If “Kehoe and Prescott (2007), together with 22 other economists” were at all accurate in their understanding, they would have concluded “and, looking at current policies, we expect/fear another crisis in the near future”. Did they?

  16. @John Quiggin

    Absolutely JQ. I feel very comfortable that Marx and Keynes and Mitchell and Keen (the latter 2 contemporary Australian empirical economists) and Prof JQ (orthodox? but approximately Keynesian and certainly democratic socialist) are all basically on my side of the analysis; or rather I am basically on their side.

    On the basis that the world giants (Marx and Keynes) and the best contemporary Australian economists support my views or rather I their.. I can say I am vey confident (99%+) than I doggone right.

  17. Dan, not all here are Keynesians though I am (within the parameters of mixed economy capitalism). You asked “What are the second- and subsequent-round consequences/corollaries of Keynesian stimulus. Well the consquence of well timed-Keynesian stimulus is that the recessionary economy recovers unless very adverse exogenous features exist (like war, plague endless drought etc.) The corollary is that the full emplyment can be created in this way.

    Subsequent rounds of Keynesian stimulus are no problem provided the economy needs it (i.e. is recessionary again) and provided idle capacity remains available to be put to work and provided there are not exogenous limits to the economy (e.g. a resource shortage).

    People who think government debt in itself is an issue (while the above provisos hold) simply do not understand the (floating) fiat currency system and/or are in thrall to false beliefs about currency or spurious notions about the GBC (Government Budgetary Constraints). The only practical constraints on fiat currency use by the government (other than ideology and politics) are real resource constraints (limits on real goods and material that government can purchase) and the prospect of currency debasement (hyper-inflation). That said, fiat currency issuing governments in recessions and depressions (in the absence of economically limiting exogenous factors) should deficit spend until unemployment reaches the frictional rate (about 2%) or until the currency shows serious signs of an inflationary break-out (over perhaps 5% to 7.5%).

    This is called or ought to be called, letting the real world economic system and financial system tell you what to do. It is the emipircal approach pure and simple but many modern economists are too full of ideology and bunkum non-empirical modelling to realise this plain fact.

  18. Well, yes.

    Please note: I think you can agree that a first-round stimulus effect exists without signing on to Keynesianism per se (heck, I know Austrian school guys who are like: well, of course in the immediate term people become employed), which is why I phrased the way I did at #13.

  19. @Dan

    And why (I wonder) do “Austrians” think there will be second order issues. I suppose they subscribe to the “crowding out” fallacy, the “free market is always efficient” and the “there’s no such thing as market failure” fallacy.

  20. @Ikonoclast

    It may appear that:

    If however, this money printing does not exceed the capacity of the economy to respond to stimulus by utilising previously idle capacity then an economic upswing can (and does) occur without signficant attendant inflation.

    but this relationship between idle capacity and money cannot be measured under capitalism because capitalists always add-on additional opportunistic profit.

    However if new stimulus money was used only to employ the unemployed and if (n.b.) all of the money was used in their, new workers, final consumption expenditures, then I agree, with a few other provisos (stable population, closed economy.

    But any other stimulus – giving capitalist banks more funds to lend – will not work in the longrun – they will always capitalise it.

  21. on iconoclastic economics, arguments from authority, and your remark about my “quoting these guys as if they are authorities”, both you and the real business cycle theorists want to tear down the temple albeit to build rather different replacements.

    That requires an environment were critical discussion is prized. Critics of all persuasions do us a great favour by doing what we must otherwise do for ourselves, which is test the logical and empirical limits of our arguments.

    The conclusions of the gang of 24 were that overreactions by governments can prolong and deepen the downturn, turning it into a depression. This is not a controversial proposition. Nor is their proposition that different sorts of shocks can lead to ordinary downturns.

    To be more specific, massive public interventions to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a great depression.
    • Those who justify Keynesian policies often quote Keynes’ dictum that “The long run is a misleading guide to current affairs. In the long run we are all dead.”
    • The Prescott and Kehoe book studying great depressions turns this dictum on its head: “If we do not consider the consequences of policy for productivity, in the long run we could all be in a great depression”.

    As to your question, ‘looking at current policies, we expect/fear another crisis in the near future’, I would heisted a guess at yes. Ed Prescott advocates narrow banking, as did Friedman. Sounds rather concerned for nipping further crises in the bud?

    Friedman tipped that the Euro-zone would not last past the first major recession. What was your tip back then?

    One of the gang of 24, Finn Kydland considers the reason that most economies have not recovered since 2008 is continuing errors in government positions on public finance:
    • Kydland considers fiscal policy is at the heart of current problems.
    • He predicted that instead of restructuring and investing more prudently, Western countries faced with budget shortfalls would seek first to increase taxes in some regard. people are therefore getting more concerned about the government debt and worried about axes going up and cut back in investing.

    Perhaps Kydland has crossed over to the dark side with his stress on the power of fiscal policy and that a wave of pessimism is stifling investment demand in the USA and EU?

    When a list was drawn up of the ten economic papers that the incoming Reagan administration should read, Kareken and Wallace’s 1978 paper on banking crises was at the top. The idea that deposit insurance leads to more financial crisis even troubled FDR before he signed the 1934 U.S. bill.

    V. V. Chari and Patrick J. Kehoe have written a nice paper Bailouts, Time Inconsistency and Optimal Regulation that says that because of time-inconsistency, the government cannot commit itself to not bailing out firms so a pragmatic approach to policy dictates ex post, ex ante regulation of firms is desirable.

    Kareken and Wallace called for much higher capital reserves for banks and more regulation of their portfolios to avoid future crises. It might have been Peltzman in the 1960s who found that 1930s U.S. banks halved their capital ratios after the introduction of deposit insurance.

  22. The neoclassicals continue to ignore or at best misunderstand the dynamics of a monetary economy where money is an endogenous variable. Ohanian is a serial offender in belittling the role thet banking crisis played in the Great Depression, I guess the decline in the money supply was just a figment of everyone’s imagination. As for the argument that the industrial decline preceding the banking panics is somehow “evidence” finance played a secondary role in the severity of the depression is absurd.

    He also argues that there was “remarkably little distortion in capital markets during 2007-09”. That comment alone suggests his “analysis” can be pretty swiftly dismissed. He of course ignores the similarities between the early 30s and the present situation, that being a huge credit boom and a near collapse of the banking system. Just coincidence apparently.

    Have not read the Kehoe Prescott piece but the absence of finance and monetary time series from their data set suggests there analysis is no different.

  23. @Dan

    I think you are making much the same point as Ikonoclast.

    Stimulus may work under market socialism, but not under capitalism if capitalists eventually get the stimulus. Capitalists must then capitalise their new earnings without themselves having necessarily increased productive capacity.

    However, arguably, under capitalism stimulus may work if it is given only to sectors that are not capitalist and as a short-term bandaid. But capitalists eventually get the new money and the old problems re-emerge in an aggravated form.

    Stimulus does not address the cause of the need for stimulus. It responds to idle capacity which is a symptom. Capacity is idle because it cannot earn a capitalist profit after so much previous profit has been fed back (and then seeking the previous rate of return or more). Extra money eventually in the hands of capitalists (with the same population and constant work intensity) only makes the next need for stimulus worse.

    Various other countervailing tendencies complicate this picture.

    However there is a trivial case – if stimulus was used to pay the unemployed to destroy existing homes, farms, factories and shops, then rebuilding will provide incomes for all for some time.

    Stimulus probably works everywhere except under capitalism.

  24. @Chris Warren

    Oh absolutely, I agree. The stimulus must go to directly to workers/consumers/pensioners/unemployed and to ensuring full employment. Stimulus money must not go directly to capitalists which equals free money for the rich and which is what actually happens now with most neo-classical stimulus going to the rich.

    In a roundabout way the stimulus money going as we advocate still gets to capitalists via boosted consumer spending. This is not so deleterious as it least only the most competitive businesses with the lower prices will get the money. Combined with strong labour laws ensuring workers’ rights and that a considerably higher proportion of national income goes to wage earners and less to capitalist profits combined with higher taxes on the wealthy, the overall effect would be highly beneficial to the total mixed economy (GDP would go up) and most beneficial to the 95% if not the 99%.

    I still think we need to transition away from oligarchic or plutocratic capitalism but that is another post.

  25. sdfc, Finn Kydland together with Scott Freeman and others have written on the endogenous money and the business cycle for a long time:
    • William T. Gavin & Finn E. Kydland, 1999. “Endogenous Money Supply and the Business Cycle,” Review of Economic Dynamics
    • Scott Freeman & Finn E. Kydland, 2000. “Monetary Aggregates and Output,” American Economic Review,
    • Robert D. Dittmar & William T. Gavin & Finn E. Kydland, 2005. “Inflation Persistence And Flexible Prices,” International Economic Review,
    • Gavin, William T. & Kydland, Finn E. & Pakko, Michael R., 2007. “Monetary policy, taxes, and the business cycle,” Journal of Monetary Economics,

    Lee Ohanian has been investigating the abnormally slow recovery in the labor market during the Great Recession. why did labor hours and employment levels drop so precipitously in the U.S. Great Recession compared with earlier U.S. recessions and the parallel recessions elsewhere?

    • The financial explanation argues that declining values of asset-backed securities and the near-failure of banks accelerated the recession through reduced borrowing and lending and spikes in interest rate spreads.

    • the most challenging issue for the financial explanation is why economic weakness has continued for so long after the worst of the financial crisis passed in 2008 or so?

    The 1930s U.S. depression was “Great” before any of the monetary contractions or banking crises occurred. Industrial hours per capita worked dropped by 29 per cent in the U.S before the first big bank crisis in late 1930 and before the nation’s money stock fell. the first banking episodes did not have important macroeconomic effects.

    a factor other than monetary contraction or bank runs was central in initiating the Great Depression. Hours worked in agriculture, which had roughly the same employment share as industry at that time, were roughly unchanged during the early 1930s, which indicates that the initiating factor behind the Depression was sector-specific.

  26. A reference to a paper debunking the monetary drivers of the depression and the GFC (or great recession) would be appreciated.

    Lee Ohanian has been investigating the abnormally slow recovery in the labor market during the Great Recession. why did labor hours and employment levels drop so precipitously in the U.S. Great Recession compared with earlier U.S. recessions and the parallel recessions elsewhere?

    Earlier post-war US recessions were not accompanied by financial crisis as deep as the current one simply because the previous credit booms were nowhere near as steep. The flexibility of the US labour market likely accounts for the precipitous decline in employment. Legislated employment protection is low in the US. US recessions with the exception of the depression and the GFC follow a similar pattern in that they are instigated by the Fed raising rates and ended by the Fed lowering rates. The two episodes which buck this trend are both characterized by high levels of private sector debt. Central bank action works through the credit transmission mechanism, when the demand for credit is low central bank policy becomes relatively ineffective.

    The persistence of the economic weakness is a feature of the high levels of private sector debt. Growth prior to the crisis was driven by sharp increases in credit. That credit high level of credit growth has now ended and the economy is left with a debt overhang.

    Of course banking crises have important economic effects. Once income falls to levels where financial obligations are no longer able to be serviced this feeds into banking sector stress. Once the banking sector is under stress then so is the money supply. The money supply being essentially liablities of the banks. The resulting deflation drives the economy further away from equilibrium.

  27. sdfc, on financial crises and real business cycles, see:

    • Harold L. Cole & Lee E. Ohanian, 2001. “Re-Examining the Contributions of Money and Banking Shocks to the U.S. Great Depression,” In NBER Macroeconomics Annual 2000
    • Harold L. Cole & Lee E. Ohanian, 2004. “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis,” Journal of Political Economy
    • Ohanian, Lee E., 2009. “What – or who – started the great depression?,” Journal of Economic Theory

    See too Real Business Cycle Theory and the Great Depression: The Abandonment of the Abstentionist Viewpoint by De Vroey and Pensieroso at versus the great depressions book at

    over to the night shift.

  28. Jim, it’s well known that the recessions following financial crises are typically long and deep. I made this point in my 2006 paper with Stephen Bell, Asset Price Instability and Policy Responses:
    The Legacy of Liberalization, citing Reserve Bank Governor Ian MacFarlane.

    The question of why this is so may be a “challenge” for economists committed to a micro-based macro, but it’s not a challenge to financial explanations of the current crisis – it has developed in a way very typical of financial crises where the policy response is inadequate or counterproductive, as it has been in the US, UK and Europe.

    And, as regards the timing of the Depression, your quote from Ohanian manages to omit the Great Crash of the stockmarket in 1929.

  29. @John Quiggin

    Precisely. And we ought not forget that following the over-run of private debt it has been the consequent enforced de-leveraging that has sucked the demand out of the economy. If the government does not step in and run deficits there is no immediate way to replace the lost demand.

    Financial deregulation, easy debt money, asset bubbles and the poor wages share of national income have been the culprits of the GFC or Great Recession. in the USA we could add under-taxation of the rich. In Australia, we could add things like First Home Owners Grant and negative geraing and other subsidies for the already well off playing a role in asset bubbles.

  30. Yep. It’s a fascinating paradox that surplus liquidity sloshing around precipitated a liquidity crisis. I guess when it’s pointed out that that liquidity was being used to gamble rather than going into the modest wallets of Joe and Jane Ordinary (who instead were issued with credit cards) the picture sharpens up a bit.

  31. The other thing is that speculative finance is a game whose high risks are forced on the players. Even Varoufakis (who I admire greatly) seems to say that the reason bankers went for increasingly risky assets is because they were greedily, capriciously, seeking higher returns. In fact if you don’t seek higher returns (that is to say, take on more risk), the board gets asked very hard questions about the performance of the company relative to other companies. Your share price goes down. So, in a sense it’s forced greed, forced appetite for risk. In that context separating retail and investment banking is doing everyone – including the bankers – a huge favour.

  32. All depressions and recessions can be reduced to one basic, simple question and while Marx gave his famous answer, what do our Keynesiansneoclassicalologists say about this very simple issue:

    If everything else stays the same, and products have cost $100 to produce and transport, how can I sell them for $105?

    What do our Friedmanites and Hayekians have to say? What is the view from the temple?

    Do Keynesians just require “injections” and “stimulus” to balance the extra $5?

    How does supply of 100% of spending produce incomes equal to 105% of spending?

    [Marx’s answer was 5% was created by setting up a political regime so workers only got approx 95% and a upper class received the “surplus”. Marx implied that this worked under fuedalist forms of profit, but not when you add in specifically capitalist form of profits based on labouring for a wage ]

    And so our economists of all sorts take refuge in ignoring the long-run and pretend they are doing great things with the short run.

    All that our Keynesians (eg Paul Krugman) say is:

    the attempt to shift the discussion away from the short run is not, as often portrayed, an act of vision of courage. On the contrary, it’s an act of cowardice, an attempt to evade responsibility for a disastrous state of affairs that we could fix, but choose not to.

    Keynes had it right:

    But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

    [see: ]

    The introduction of “cowardice” by Krugman is unfortunate as this epithet can be hurled back at Keynesians with much greater momentum.

    Do Keynesians really believe that their stimulus will produce this ‘flat ocean’ and fair weather? Or do they need more exports, foreign earnings, and population growth?

  33. thanks John, the crash of 1929 was in October 1929. The collapse in industrial hours and output started several months earlier than that crash. See

    • Friedman showed the Fed’s deliberate tightening of monetary policy began in the spring of 1928 and continued until the stock market crash of October 1929

    • The Bank of France’s drain on world gold reserves started in 1928 as shown by James Hamilton and others

    • According to Friedman, during the two months from the cyclical peak in August 1929 to the october stock market crash, production, wholesale prices, and personal income fell at annual rates of 20 per cent, 7-1/2 per cent, and 5 per cent, respectively.

    Of course as Ohanian notes, “any monetary explanation of the Great Depression requires a theory of very large and very protracted monetary non-neutrality. Such a theory has been elusive because the Depression is so much larger than any other downturn, and because explaining the persistence of such a large non-neutrality requires in turn a theory for why the normal economic forces that ultimately undo monetary non-neutrality were grossly absent in this episode.”

    In their draft paper ‘Cartelization Policies and the International Great
    Depression’, Cole and Ohanian analyze how much cartelisation policies depressed economic activity in 18 countries other than the U.S. in the 1930s.

    • Cartelization policies account for much of the change in labor, particularly after 1933 when these policies become more severe in several countries.

    • Monetary shocks are somewhat important in accounting for real variables early in the 1930s, as deflation accelerates in this period, but money accounts for very little of the change in real variables after 1933.

  34. @Chris Warren

    Are you trying to suggest in #10 that there was some significant link between stimulus spending/population growth and the GFC and unemployment? This sounds bizarre to me, interested to hear you elaborate on this link.

    It’s important to call things by their right name; it’s not about one upmanship, more about clarity.

    Trying to link the pursuit of profit with the problems of capitalism (financial crises) is a shallow argument. Post-Keynesians acknowledge that capitalism by definition is unstable and that there are two main sources of instability. Creative instability and financial instability. Capitalism encourages creative instability in a way no other economic system so far has – the experience of accelerated technical progress can be seen as a function of this (and vice versa, working in a feedback loop). It is important to note that this is built on the activities of entrepreneurs as distinct from bankers – another reason why the term “capitalist” or “owners of the means of production” has little clarity. Their activities is what should define them.

    So financial instability is the cause of problems, because bankers pursuit of profit is a function of an increase in the private debt burden of society. This is the source of financial instability and it has been shown empirically by Minsky’s analysis, amongst countless others after him. It’s also been shown that when you have rising private debt, rising financialisation, this is when you get wealth becoming more and more centralised. When entrepreneurs reigned in the post war era, we saw ‘real’ wealth being created and distributed much more evenly, and people saw unambiguous increases in their quality of life.

    So your analysis of profit seems a little shallow. It is less insightful to view capitalism as the problem. This is not to say that capitalism should be the ultimate system of organizing society and economies. Capitalism is dynamic and hence evolutionary. The problem moreso stems from a shallow understanding of its dynamics that ends up informing policy. So demand management is not the problem unless it helps reinflate bubbles/props up financialisation.

    Also your comment “short run placebo to be paid by future generations”. There is nothing inherently wrong with debt. Anthropologists argue credit and debt has been around for thousands of years and has always formed the basis of social interaction since the days of “ceremonial exchange” and is integral to the idea of technical progress/development – David Graeber talks about this in Debt: The first 5000 years. Issues arise historically only when we block mechanisms of debt jubilees/supporting creditors over debtors and when considering what that debt is financing (ponzi schemes bad for e.g.). This brings us back to Keynes’ line of thinking – “we can afford what we can create”. IS-LM has fundamental supply side constraints, there is no concept of dynamics, debt, or classes (all of which Keynes viewed fundamental to understanding capitalism). So its analysis of demand side management is extremely shallow.

    In terms of the direction for macroeconomics, I think Post-Keynesians are headed in the right direction trying to build dynamic class based monetary models of the economy. So circular flow identities are a part of it but they must be modeled dynamically by definition, which neoclassicals/new Keynesians do not do.

  35. @Chris Warren

    A little research (very little admittedly) that I have done indicates the following in California in the bakery industry. Capitalist run bakeries, which take their capitalist profits of course, pay their workers about $22,000 to $33,000 per annum dependng on grade.

    In worker/owner fully cooperative bakeries each and every worker/owner takes income of about $66,000 per annum after running, maintenance and even expansion costs. These co-op bakeries are very successful and turn out high quality price-competitive products. Thus if workers can free themselves from capitalist domination, exploitation and servitude it seems the gains for workers are of the order of double to treble the income. Not to mention full worker/owner management and democratic decision making.

    Truly, the workers have nothing to lose but their chains in getting rid of oligarchic, plutocratic capitalism.

  36. John, what would be a policy response that is productive in the US, UK and Europe?

  37. @Adit

    Are you trying to suggest in #10 that there was some significant link between stimulus spending/population growth and the GFC and unemployment? This sounds bizarre to me, interested to hear you elaborate on this link.

    There are certainly significant links between stimulus and GFC. There are also links between GFC and unemployment. And there are also complementary links between stimulus and population increase. This are best considered assumimg population growth is zero as this is a countervailing tendency and has its own additional problems. Any system that requires population growth cannot survive.

    Stimulus is linked to a GFC because it is required due to a GFC.

    Unemployment is linked to a GFC because higher unemployment is caused by cuts emanating from a GFC.

    Stimulus is linked to population because the viability of stimulus depends on having future workers to pay the interest or pay off the debt. Population is linked to unemployment because population determines the labour force.

    I don’t think there is an issue here?

    No-one is:

    Trying to link the pursuit of profit with the problems of capitalism (financial crises)

    If you reread my post you will see that there is a clear distinction between profit and capitalist profit.

    The problems of capitalism are 100% identified with capitalist profit and there is no escape from this.

    This is odd:

    Their activities is what should define them.

    Bankers and owners of means of production are both capitalists to the extent they both have the same activity – putting money into circulation only on the condition they receive a surplus at the end of the accounting period. A non-profit bank would be very different to a capitalist bank, even though their overt activities are identical.

    Whether this occurs in this or that occupation is beside the point. Entrepreneurs can work for a wage but usually they employ others and try to expropriate as much as they can through fees and intellectual property.

    So the activity is not relevant, its the political and economic relationships that encapsulate that activity. Presumably you can have banks and entrepreneurs and owners of means of production under market socialism.

    So clearly – capitalism is the problem. The specific activities are mundane and should cause no problem in themselves.

    I don’t follow:

    So financial instability is the cause of problems, because bankers pursuit of profit is a function of an increase in the private debt burden of society.

    What is causing what???? Is financial instability caused by bankers profits which is caused by private debt?

    Maybe you meant that financial instability and the increase in private debt are in part caused by bankers pursuing profit.

    Of course then you need to explain why bankers pursue profits or note that only capitalist bankers need to pursue profits – others do not eg credit unions, cooperatives.

    Human life is evolutionary and dynamic. Capitalist dynamics and evolution creates wealth at one pole and poverty at the other. I suppose anyone can accuse anyone of being shallow – but such accusations as shallow as they see others.

    But if there is some other “non-shallow” understanding of capitalism that shows it is not the problem then lets see it. How would financial instability occur without wage labour, without increasing per capita debt, or with cooperative banks? If wages received the full value of their productivity or otherwise ensured it was not capitalised, how would a structural financial instability arise?

    Clearly capitalist profit causes financial instability. This is the key insight based on understanding its specific dynamics.

    Debt as stimulus of capitalism is always bad in the medium to long-run. Debt to build the Snowy Mountains Scheme or the Harbour Bridge is not.

    Capitalist debt has not been around for thousands of years. Feudal, usurers and merchantile forms may well have.

    Keynes’s – “we can afford what we create” in theory means in capitalist practice, that capitalists afford more than they create and workers afford less than they create. The latter provides the basis for the former.

    This then leads to a GFC.

    I am not sure that modelling dynamically has any real insight as presumably any dynamic model must balance at every point in time – as a static system. But this depends on the details, particular how capitalist profit is modelled. Sraffa tried this but he committed the cardinal sin of setting wages as “consisting of the necessary subsistence of the workers” [Sraffa Prod.of Commod. by means of Commod. pg 9] He then only allowed workers a share of the surplus or “a share of the annual product” paid post factum [Sraffa p10].

  38. @Chris Warren

    Chris, we are both anti-capitalist and thus simpatico on that score. I worry about a couple of your perceptions though.

    You say, “Stimulus is linked to population because the viability of stimulus depends on having future workers to pay the interest or pay off the debt.”

    However, stimulus monies paid by deficit funding by a fiat currency issuing government do not ever have to “paid off”, at least not in total. Part can be “paid off” by taxes. “Offset” would be better terminology as it is the real consumption of goods and services by a deficit spending government (and/or recipients of its payments) that is offset by withdrawing (taxing) real spending power from the well-off and wealthy.

    However, yes a system (capitalism) which requires endless exponential growth in population, production and consumption on a finite planet is…. well doomed.

    You also say, “I am not sure that modelling dynamically has any real insight as presumably any dynamic model must balance at every point in time – as a static system.” I am sure this wrong, quite wrong. Any engineer (my son is an engineering student) will tell you that statics and dynamics are two very different disciplines each with their own mathematical and modelling rules developed from theoretical and empirical research. A dynamic system is not static over any measureable duration of time though some its components, forces and potential energy may be static for an instant during transitions. A swinging pendulum is a simple dynamic, oscillating system. There are also dynamic systems that do not exhibit oscillations or at least not such obvious regular oscillations. All this can be deduced if one stops and thinks about it.

    I am sure that dynamic modelling of the economy as per the work of Steve Keen for example is very important and he shows that the capitalist economy is a dynamic, unstable system. He models with complex differential equations as would an engineer modelling a complex dynamic system.

  39. @Ikonoclast

    It is possible to fine tune.

    The dynamic metaphor should only be applied to the extent it is relevant to monetary flows.

    Where are Keen’s supposed equations? I would have expected to see them in ch14 of Debunking Economics Revised – but no.

    I don’t think modelling economics makes any real sense. In reality economics is driven by games and politics, which cannot be modelled except in hindsight.

  40. Chris – see Keen’s paper The Incoherent Emperor, a major thrust of which is to show that an economic equilibrium at the macro level is indeterminate.

    Noah Smith has also argued similarly (though I don’t know if he’s done formal work – it could be an informal theoretical objection to the idea of dynamic equilibrium. I think he has the chops though, having a background in theoretical physics…)

  41. @Chris Warren

    I think the book provides links to online material. His equations and mathematical models are online I believe. Sorry, I dont have the link. I could not understand all of his equations just as I could not understand all of Einstein’s equations. That does not mean I cannot make an informed decision in each case on the validity of the work by checking that predictions match known empirical outcomes and checking whether prdictions and conclusions are consonant with other areas of my and others’ knowledge. On these grounds, I think Keen’s work shows very distinct promise.

    I do think modelling economics (mathematically) does make sense. After all, Marx does provide various equations in his work. (He also models the political economic world with language based socio-political-philosophical analysis.) I will have to explain in what sense I mean modelling mathematically makes sense. Clearly, economics is driven by games (gaming the system) and politics as you said. That is why the subject is properly called Political Economy. However, a given socio-political-financial order at a particular time (provided it is not in rapid change or transition) provides a set of “standard” conditions. Standard for that time and place. Within that given ambit or framework, the behaviour of various parts of the system can be mathematically modelled and patterns of behaviour, statistical correlations and possibly even some causes and effects can be detected and attributed.

  42. As JQ is probably happy to confirm, the problem of indeterminacy is not new in models where the distinction between micro- and macro-economics is meaningless (poar 1950s general equilibrium models). See for example Darrell Duffie, Chapter 3, Vol I, Handbook of Monetary Economics, North Holland, 1990.

  43. @Dan

    Keen’s paper does not really “show” this – it “argues” it rather speculatively.

    The two equations for utility and production are standard and the Lagrange functions are mundane – for example see Michael Hoy, Mathematics for Economists 2nd ed pg 596.

    Unfortunately Lagrange functions can always be set up when ever a number of functions touch using the fact that tangents have the same slope at this point. It was not clear why Keen went through all this?

    This seems the wrong tack to take. When any function is maximised or constrained, for all intents and purposes – this point is a static point.

    Maybe these techniques can show instability and indeterminacy in Keens terms ( without identifying capitalist profit) but I doubt it.

    Keens essentially is a capitalist who is seeking “the development of a dominant economic theory which actually has some relevance to the dynamics of a modern capitalist economy” with a partiality to the post-Keynesian approach which cannot perceive whether capitalism is worse than any other. So it appears he is prepared to fix up capitalism and, like Minsky, just oppose some forms of debt (Ponzi).

    Keen does not realise that capitalism itself is the problem and coming up with some new model may not have any relevance.

    We need most of existing theory to establish an alternative to capitalism. No one is comfortable with great speculative excursions into confusion.

  44. Hi Jim

    That production declined prior to the financial crisis is neither here nor there in analysing the depth of the slump from 1929 to 1933. The banking crisis turned what was a severe recession into depression. The resulting deflation fully accounts for the severity of the depression because as we know falling nominal income drives up the real value of outstanding debt. The debt-deflation theory of depression.

    The recovery between 1934 and 1937 was quite robust with real GDP reaching its 1929 peak in 1936. Unemployment remained high through the period because real GDP remained below its pre-recession trend which is no surprise given the severity of the initial slump. Of course with nominal income remaining well below its previous peak, balance sheets remained under stress.

    I have done a little investigating into farm employment and the publication “Historical Statistics of the United States 1789-1945” shows that hired workers on farms declined by ~20% between 1929 and 1934. Hired workers however made up only 26% of total farm employment in 1929. The number of family workers increased 2.2% over the same period. I assume this was the result of family members returning to the farm due to the scarcity of jobs in urban areas.

  45. thanks sdfc, the main banking crisis in the USA was in 1933. there was one bank failure in France and none in canada. the one bank failure in Oz was in NSW, as I recall?

    many countries were recovering with single digit unemployment rates by the mid-1930s except the USA, in the latter case, thanks to the anti-competitive policies in the new deal.

    under the Premiers’ plan of austerity, Australia (and NZ with a similar fiscal policy) shifted from 25%+ unemployment rates in 1931 to single digit unemployment rates in 1936. the USA had a depression within a great depression in 1937.

    most of the increase in U.S. per-capita output that occurred after 1933 was due to higher productivity – not higher labor input. There is little recovery in labor, as hours were about 27 percent down in 1933 relative to 1929, and remain about 21 percent down on trend in 1939.

    Increasing aggregate demand is supposed to increase output by increasing labor, not by increasing productivity, which is considered to be outside the scope of short-run policies.

    the slow recovery from the U.S. Depression has been known for decades, including work by Armen Alchian, Milton Friedman and Anna Schwartz, and Robert Lucas, all of whom point to New Deal policies that depressed competition in labor and product markets.

    the key point is that GDP growth during the New Deal was due primarily to higher productivity – not higher labor input, which is the focus of stimulus policies. Field showed that the 1930s was one of the highest productivity decades on record due to innovation.

    HT: Lee Ohanian

  46. Jim Rose, writes:

    (a) “many countries were recovering with single digit unemployment rates by the mid-1930s except the USA, in the latter case, thanks to the anti-competitive policies in the new deal.”

    I say, maybe, maybe not. The statement is too vague regarding ‘many countries’, even when setting aside the colonial period, to allow me to form a probability assessment of the credibility of the content of the statment in (a) on the basis of my prior knowledge.

    (b) “under the Premiers’ plan of austerity, Australia (and NZ with a similar fiscal policy) shifted from 25%+ unemployment rates in 1931 to single digit unemployment rates in 1936. the USA had a depression within a great depression in 1937.”

    I say: I don’t believe it because:

    1) A quick search of data on Australia’s unemployment rate resulted in finding Jeff Borland and Steven Kennedy’s paper “Dimension, Structure and History of Australian Unemployment, University of Melbourne. This paper contains a diagram, sourced from Goodridge et al (1995). It is linked to below

    This data contradicts the assertion in (b).

    2. Has WWII been forgotten?

    3. Has it been forgotten that Friedman’s reworked quantity theory of money does not include a financial sector? One cannot find evidence of something if one does not allow for its existence in the model used to analyse empirical data. (This is my gripe with macro-models.)

    4. The term ‘austerity’ does not imply a unique policy prescription other than reducing budget deficits. For example, the German promotion of ‘austerity’ features in contemporary discussions. When one looks for what the German people mean by that, one finds that over 70% of the people surveyed want a reintroduction of the wealth tax for very high wealth agents. Source: Sueddeutsche Zeitung 29 April 2012.

  47. John,
    The Lucas version of business cycles is a price surprise in the context of a continuously clearing labour market, coupled with asymmetric information requirements. An unexpected decrease in P, shifts the supply of labour to the left, leads to an increase real wages, and a decrease in employment. Now a negative price shock can surely be transmitted internationally. Indeed, you could start off the world event with a negative real shock in say the US, which decreases its demand for imports, causing a negative price shock in the exporting countries, and hence transmitting the negative shock internationally.

    Does that make sense?

  48. @Chris Warren

    I know they’re relating but it looked like you were suggesting that stimulus caused GFC. And stimulus caused unemployment. I must have been wrong in my inference.
    On the idea that there’s a link, sure no disagreement.

    Bankers don’t own the means of production. At least they don’t have to for capitalism to function. They simply create credit for capitalists to finance their operations I.e. Finance their ownership of the means of production. Banks’ income comes from interest. Firms receive profit. These are nontrivial differences in the activity they engage in; the consequences of this are important.

    Banks pursue profits but this is simply a function of the rate of interest on their creation of credit. So they will always dream up ways of extending as much credit as possible – without proper regulation this inevitably means bubbles from rising private debt – yes that is the source of financial instability. Every recession/depression can be traced back to private debt dynamics, not ‘capitalist profit’. There is no reason why commercial banks should operate as free profit enterprises, rather than public utilities – I suppose this part is in line with your thinking. Although I think with appropriate regulation, glass-stegal, appropriate LVRs etc, they could operate as private enterprises where it becomes accepted that they only make normal profits and they can stop thinking of themselves as “masters of the universe”.

    How would you calculate wages receiving the full value of their productivity? This sounds very much like marginalist/neoclassical analysis which is full of internal contradictions. Such things cannot be calculated for an entire system. Wages are set according to conventions/institutional arrangements – we need to bring back the presence of unions to counter the power of monopolies.

    Capitalist profit causes creative instability, not financial. The opportunity for profit is where many new creations come from. They also come from publicly funded R&D – corollary, creative instability is really a function of technology, which the profit motive can accelerate. (new firms entering, old firms dying off etc etc).

    If you take this analysis of capitalism it follows necessarily the kind of regulatory requirements/safety nets you must have. And we have/had them, post-war era saw many of these introduced in what Minsky and L.RWray call “managerial welfare state capitalism”. This was preceded by commercial capitalism and financial capitalism. This is the evolutionary process I referred to. So I suppose you’re right in a sense – I didn’t meant to suggest that capitalism by definition is evolutionary, but rather that the way humans interact within capitalism is evolutionary and hence always changing with our understanding of it. The capitalist system actually allows it and is one of its strengths. Demand management is then a corollary to this. The to make for the last 30 years is that our view of the way capitalism functions changed and we had financial capitalism creep back in and destroy the gains made in the post war era.

    Again, debt has been around for thousands of years. It has always been the basis of social interaction – it is not unique to capitalism. The way debt has changed under capitalism is the extent to which debts have become tradable – e.g. Money as IOUs. This isn’t an inherently bad thing – in fact it is why capitalism is an infinitely more complex system of social organization.

    Snowy scheme/harbour bridge IS stimulus. Or can be. That’s the point – stimulus does not need to mean simply monetary stimulus e.g. Quantitative easing. Understanding capitalism would actually show why quantitative easing will not work in an environment where you have private sector Deleveraging. Keynes himself suggested fiscal policy as the best tool for stimulus using the pushing on a string analogy for the problems of monetary easing. So using fiscal policy for stimulus you’re actually injecting money into the system for circulation to fund some productive use/investment. So I agree this is the best kind of stimulus and demand side management. Have govt inject money to fund initiatives society needs! Better functioning capitalism as a result!

    No Keynes’ we can afford what we can create is more a universal truth. It will be true whether society operates under capitalism or any other system. Even from your reasoning it follows that society can afford what it creates. That is the point. Demand side management can mean (and in Keynes’ writings DID mean) funding activities according to societies needs/demands. Capitalist/fiat currency system gives us a great platform to engage in this.

    Also re your last point in #43. Existing theory definitely gives us alternatives to the current form that capitalism takes. E.g. The post-Keynesian approach envisions a significant departure from the current capitalism where banks and corporate power rule the people.

  49. Also,

    Re your thought on the “So the activity is not relevant, its the political and economic relationships that encapsulate that activity. Presumably you can have banks and entrepreneurs and owners of means of production under market socialism.”

    The political relationships are important to the extent where the political system is captured from the people by the banks and corporate power I alluded to in the last post. There is no reason why this cannot occur in market socialism. This is an outcome that transcends capitalism.

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