Bookblogging: What next for macroeconomics ?

by John Q on November 19, 2009

It’s been slow going, but I’ve finally finished the draft chapter of my book-in-progress that looks forward to a new research program for macroeconomics, an absurdly ambitious task, but one that needs to be tackled. Of course, what I’ve written isn’t fundamentally new – it’s a distillation of points that Old Keynesians, post-Keynesians and some behavioral economists have been putting forward for a while. But I hope I’ve got some positive contribution to make. More than ever, comments are much appreciated.

Update In response to comments, I’ve fairly substantially revised the section on “avoiding stagflation”. While I don’t back away from the points I made previously, I took for granted some things that I’d mentioned in other places in the book. The result made for a fairly unbalanced treatment with an excessive focus on the role of labor militancy. I’ve now tried to put this into proper context. I don’t expect that will satisfy everybody, but this is closer to what I meant to say all along.End update

What next ?

The economics of the textbooks seeks to minimise as much as possible departures from pure economic motivation and from rationality. There is a good reason for doing so – and each of us has spent a good portion of his life writing in this tradition. The economics of Adam Smith is well understood. Explanations in terms of small deviations from Smith’s ideal system are thus clear, because they are posed within a framework that is already very well understood. But that does not mean that these small deviations from Smith’s system describe how the economy actually work.    Our book marks a break with this tradition. In our view, economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations that actually do occur and can be observed. Animal Spirits, Akerlof and Shiller

It was reading this passage in Animal Spirits, and posting about its implications for macroeconomics in the Crooked Timber blog, that led to the writing of this book. A commenter suggest that this, and some earlier posts, would make a good book, Brad DeLong of UC Berkeley picked the idea up and the result is before you. 

Animal Spirits was mostly written before, or in the early stages of, the Global Financial Crisis, but the Crisis has made its central point more important than ever. For many years economists have worked like the anecdotal drunk who searches for his dropped keys under a lamppost because the light is better there. In the future, and particularly in macroeconomics, economists need to start looking where the keys are, and try to build tools that will improve the chances of success.

This does not mean abandoning all the work of the past thirty years and returning to old-style Keynesianism. But it does mean starting from the traditional Keynesian perspective that a general macroeconomic theory must encompass the reality of booms and slumps, and, particularly of sustained periods of high unemployment that cannot be treated as marginal and temporary deviations from general equilibrium. We must model a world where people display multiple and substantial violations of the rationality assumptions of microeconomic theory and where markets depend not only on prices, preferences and profits but on complicated and poorly understood phenomena like trust and perceived fairness. 

First, the program needs more realistic microfoundations. As Akerlof and Shiller observe, we need to look at how people actually behave, and how this behavior contributes to the performance of the economy as a whole. 

Second, we need to reconsider the concept of equilibrium. The whole point of Keynes “General Theory” was that the market-clearing equilibrium analysed by the classical economists, and central to DSGE models, was not the only possible equilibrium. An economy can settle for long periods in a low-output, high-unemployment state that may not meet the neoclassical definition of equilibrium, but does match the original concept, borrowed from physics of a state in which the system tends to remain and to which it tends to return. More importantly, perhaps, we need a theory which encompasses crises, and rapid jumps between one kind of equilibrium and another. Ideally this will combine ‘old Keynesian’ analysis of economic imbalances with a Minsky-style focus on financial instability.

Between these two levels, we need to consider the fact that the economy is not a simple machine for aggregating consumer preferences, and allocating resources accordingly. The economy is embedded in a complex social structure, and there is a continuous interaction between the economic system and society as a whole. Phenomena like ‘trust’ and ‘confidence’ are primarily social, but they affect, and are affected by the performance of the economic system.

Finally, now that Keynesian macroeconomic policy has re-emerged as a practical tool, we need to reconsider the real and perceived failures of the past, and in particular the emergence of stagflation in the 1960s. If the revival of Keynesian policy is to be sustained, it must provide not only an emergency response to the present crisis but a set of tools that can deliver sustained non-inflationary growth.


Better microfoundations ?

It is now generally accepted that people are not, and cannot be, the infinitely foresightful, unbounded rational utility maximizers described by the axioms of dynamic stochastic general equilibrium theory. On the contrary, economic behavior, even that of highly sophisticated actors like the ‘rocket scientists’ who design financial instruments for investment banks, is inevitably driven by a partial view of the world, with heuristics and unconsidered assumptions inevitably playing a crucial role. For finite beings in a world of boundless possibilities, nothing else is possible.

The problem for a new macroeconomics is not so much a failure of economists to understand this point as an embarrassment of riches. Several decades of research in behavioral economics, non-expected utility decision theory and other fields have demonstrated, to anyone willing to look, a wide variety of ways in which real economic behavior differs from the neoclassical ideal. The problem is to focus on behavioral foundations that are most relevant to the problems of macroeconomics.

An obvious place to start is with attitudes to risk and uncertainty. Keynes himself wrote extensively in this topic, and was highly sceptical of the ideas that led to the emergence of the now-dominant expected utility theory (the first formal exposition, von Neumann and Morgenstern’s classic Theory of Games and Economic Behavior was published in 1994 only two years before Keynes’ death. The starting point for expected utility was the idea that people can, and should, reason about uncertainty on the basis of their perceived probability of relevant events such as an increase in interest rates or a slump in exports. 

“By `uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty…The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence…About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” (J.M. Keynes, 1937)

Post-Keynesian economists like Davidson and Shackle argued, that this fundamental uncertainty was central to Keynes’ thought and that it had been ignored as part of the development of the Keynesian-neoclassical synthesis. But, as with so many ‘heterodox’ schools of economic thought, the post-Keynesians were much stronger on critique than on the development of a coherent and usable alternative. Shackle in particular ended up denying that we can know anything about probability, even in such simple cases as the toss of a coin, a nihilistic view that was never likely to convince many. 

Davidson took the critique in more productive directions and did some valuable work on the way in which attitudes to uncertainty affect individuals demand to hold money, which play a crucial role in Keynes theory of the ‘liquidity trap’, a situation where even at interest rates of zero, investors and households would prefer to save rather than invest. 

Mainstream Keynesians, such as James Tobin, had also developed the idea that liquidity preference could be seen as a reflection of risk attitudes. Tobin’s analysis, was developed using the standard financial portfolio analysis based on the idea that the investment involves trading off mean returns against measures of riskiness such as the variance, which depend on the assumption that we can always formulate sensible probabilities for events. Although Tobin himself was always highly critical of the irrational behavior of financial markets, his analysis was easily restated in terms of expected utility theory and  absorbed into models based on the efficient financial markets hypothesis. 

Over the past thirty years, however, a huge body of research has shown that people do not always make choices in line with the requirements of expected utility, and a great many models of choice under uncertainty have been developed over the past thirty years to produce more realistic representation of behavior. Probably the most famous is the prospect theory of Kahneman and Tversky, put forward in 1979, which earned Kahneman a Nobel prize in economics and Tversky a rare posthumous mention. 

My own academic career got its start with a paper published a couple of years later, giving a tweak to the idea of probability weighting by showing that the model worked better if low-probability extreme events (large gains and large losses) were overweighted, while events leading to intermediate outcomes were overweighted. Kahneman and Tversky incorporated this idea in a revised version of their original model, called cumulative prospect theory.

What specific features of a more general and realistic model of choice under uncertainty might contribute usefully to a renewal of Keynesian macroeconomics? There are at least two obvious examples. First, there is the problem of unknown unknowns, which is also, and not coincidentally, a critical problem for the efficient markets hypothesis. An obvious feature of economic crises is that people are forced to consider contingencies they might previously have disregarded, such as the possibility that their employer, or their bank might fail, or that currency might rapidly lose its value. When such a contingency suddenly enters the minds of many people, large macroeconomic shocks may result.

Second, as I’ve already mentioned, although people fail to consider some low-probability extreme contingencies, they tend (perhaps in compensation) to overweight those they do consider. It is this fact that keeps the sellers of lottery tickets and air crash insurance in business. In the macroeconomic context, a ‘normal’ situation in which people disregard or at least do not account for the risk of a serious recession may suddenly be replaced by a far more pessimistic outlook in which the same people place a high weight on the possibility of total economic collapse. Unsurprisingly, such a change in ‘animal spirits’ may represent a self-fulfilling prophecy. If a lot of people expect a recession and try to increase savings and reduce investment, these defensive actions may bring about the recession against which they are designed to guard. 

Of course, awareness of this fact will do nothing to moderate the potential impact; if anything the reverse. People who are suddenly worried about a recession will not, if they are looking to their own well-being, keep spending in the hope that others will do likewise and thereby keep the economy afloat. Rather they will reason that others are likely to think as they do, and that a recession is even more probable than the objective evidence would suggest. 

Keynes talked about such phenomena in terms of ‘animal spirits’. Such notions seemed hopelessly old-fashioned in the light of the development of rigorous models of choice under uncertainty based on the elegant axioms of expected utility theory, the apparent success of the theory in explaining a wide range of economic behavior and the dominance of the efficient markets hypothesis. But as the evidence against these models has mounted, the pendulum has swung. The idea of animal spirits has been revived in by George Akerlof and Robert Shiller in a recent book of the same name.

Akerlof and Shiller consider five deviations from the standard model of rational maximization (confidence/trust, fairness, corruption, money illusion and stories) and argue that some combination of these can be used to explain a range of economic outcomes inconsistent with the standard model. Their discussion makes a compelling case that macroeconomics needs new, and more realistic foundations.

If the prospects for a macroeconomic analysis based on alternatives to expected utility theory are so promising, why has so little work been done along these lines? In part, perhaps, this simply reflects the effects of specialisation. Decision theorists focus on individual choices, and when they seek economic applications, this leads them naturally to look at microeconomic problems (that’s certainly true in my own case).

But there is a more fundamental problem. Individuals who satisfy the conditions of expected utility theory display a property called ‘dynamic consistency’ which, as the name suggests is of fundamental importance in dynamic stochastic general equilibrium models. Dynamically consistent economic agents never change their view of the world in any fundamental way. They respond to new information by changing their subjective probabilities for particular events, but they never change their underlying prior beliefs and preferences about the world. That means, in particular, that they can fully anticipate how they will respond to any possible future situation, and would never wish to change their mind about this, or to ‘lock themselves in’ to a course of action they might be unwilling to carry through when the time comes. 

Such consistency is admirable (at least in the eyes of decision theorists) and makes it much easier to obtain well-defined solutions for dynamic stochastic general equilibrium models. But it is far from realistic. It turns out, however, that the decisions predicted by such models always display dynamic inconsistency under certain circumstances. This problem has been the subject of considerable controversy on the rare occasions when economists have sought to introduce non-expected utility preferences into macroeconomic theory (as with the robust control theory of Hansen and Sargent.

From the neoclassical viewpoint that dominates modern macroeconomics, the absence of a coherent dynamic equilibrium concept seems like a fatal objection. But from a Keynesian perspective, and on the basis of real world experience, this is a positive, indeed necessary, feature of a sensible macroeconomic model. The fundamental macroeconomic problem is precisely that an economy that seems to be enjoying an equilibrium path of steady growth can suddenly crash or veer off into an unsustainable boom.


Aggregate models and equilibrium

If there is one thing that distinguished Keynes’ economic analysis from that of this predecessors it was the rejection of the idea of a unique full employment equilibrium to which a market economy will automatically return when it experiences a shock. Keynes argued that an economy could shift from a full-employment equilibrium to a persistent slump as the result of the interaction between objective macroeconomic variables and the subjective ‘animal spirits’ of investors and other decisionmakers. It is this perspective that has been lost in the absorption of New Keynesian macro into the DSGE framework.

The revival of notions like ‘animal spirits’ by leading economists such as Akerlof and Shiller offers the potential to revive these fundamental Keynesian insights. But this is not simply a matter of modifying the way we model individual behavior  Phenomena like animal spirits, social trust and business confidence can’t be reduced to individual psychology. They arise from economic and social interactions between people. 

It’s precisely for this reason that such social aspects of individual psychology are likely to be associated with multiple equilibria in the real economy. The aggregate level of trust and confidence in an economy cannot be derived by simply adding up individual values in the way in which DSGE models aggregate consumer preferences. 

As long as particular assumptions are implicitly taken for granted in a given social group, such as the business community, few members of that group are likely to consider the possibility that these assumptions might fail. Evidence against those assumptions will be ignored or explained away. So, for example, the spectacular examples of market irrationality and business corruption exhibited during the dotcom boom and bust did almost nothing to shake the faith of business and political leaders in the efficiency and stability of financial markets. This faith remained strong even as the evidence of fundamental problems grew through 2007 and early 2008. Then, in the space of a few months this confidence collapsed to be replaced by a panic in which even the most reputably financial institutions would not lend to each other, and instead threw themselves on the protection of the national governments they had previously dismissed as obsolete relics.

A realistic macroeconomics requires the incorporation of variables like trust and confidence in explanatory models. Fluctuations between ‘irrational exuberance’ and equally irrational ‘panics’ (this old term for a financial crisis is in many ways more useful than the technical language of ‘recessions’) give rise to bubbles and busts, which in turn drive much of the macroeconomic cycle. The insights of behavioral economics provide good reasons to expect such fluctuations, but they do not, at least as yet, admit the kind of rigorous derivation of aggregate values from individual preferences that is referred to in the standard demand for ‘microfoundations’.

Expressed in the language of systems theory, the traditional Keynesian approach treated macroeconomic behavior as an emergent property of the economic system, to be analysed in their own terms rather than being derived from supposedly more ‘fundamental’ microeconomic explanations.  [1]   In a world of boundedly rational economic decisionmakers, and, for that matter, boundedly rational economists, we need to simplify and the simplifications that are appropriate for doing macroeconomics may not be the same as those that are appropriate in microeconomics.

Obviously, it’s much easier to announce a new program for macroeconomics than to actually implement it. To give some more concreteness to the general proposals presented here, it’s worth thinking about some specific problems, such as bubbles and the ‘Minsky moments’ in which they burst.


Bubbles and Minsky moments

Macroeconomists working in the micro-economic foundations framework did not ignore bubbles. Far from it. Dozens of papers were written on the possibility or otherwise of self-sustaining bubbles in asset markets. But, characteristically, the central concern was to determine whether or not bubbles could arise in markets with market participants who were perfectly rational, or nearly so. This focus on microeconomic foundations diverted attention from the real issues.

There was a rather smaller policy oriented literature, concerned with the question of whether central banks should intervene to prevent the emergence of bubbles, or to burst them early, before they became too damaging. Most of this literature followed the lead of Alan Greenspan, who initially showed some sympathy for the idea of intervention, but eventually became the strongest advocate of the view that central banks should not second-guess markets. But even interventionist participants in the discussion took it for granted that an anti-bubble policy had to be implemented within a policy framework of inflation targeting using interest rates as the sole policy instrument.  With these constraints, the conclusion that nothing could or should be done was largely inevitable. 

A realistic theory of bubbles would start with the observation that every bubble has a story to explain why, in the words of …, ‘this time it’s different’. And, for particular assets and markets, sometimes it is different. Those who got in early with shares in Microsoft or Google, or with land in … in … multiplied their money many times over. And although the days of spectacular growth came to an end in each case, there was no bursting of the bubble ending in losses all around.

So a theory of bubbles designed to inform a policy of bubble-pricking must begin with an attempt to understand how ‘this time it’s different’ stories emerge and come to be believed and how to distinguish true, or at least plausible, stories from those that involve a collective abandonment of reality. The story-telling aspect of animal spirits discussed by Akerlof and Shiller is important here.

Given a better understanding of bubbles it may be possible to develop an analysis of the costs and benefits of pricking putative bubbles. Such a policy reduces the damage from spectacular busts such as the one we have just seen, but it would require a willingness on the part of central banks to explicitly over-ride the judgements of capital markets, rather than merely ‘leaning against the wind’ by raising interest rates. 

An uncontrolled bubble must eventually burst, and the bursting of a bubble is a prime example of a ‘Minsky moment’, when euphoria suddenly turns to panic. In Minsky’s model there are three classes of financial enterprises – conservative ‘hedge’ financiers whose operations generate sufficient income to service their capital costs, speculative financiers who  rely on rising asset prices to service debt and who drive the market further upwards, and ‘Ponzi financiers’ cover their costs in either the short term or the long term, but who can conceal their insolvency long enough to reap substantial gains. Ponzi operators fail from time to time, but, in periods of growth, these failures are seen as isolated events of no general significance. However, in the later stages of a bubble, when a large proportion of economic activity has been devoted to speculative finance, the failure of a Ponzi financier can bring about a sudden shift in sentiment, as investors fear that the associated corruption is widespread. The rush to withdraw extended credit brings about more failures, not only of Ponzi financiers but of the speculative finance firms that relied on continued growth.


Avoiding stagflation 

Avoiding stagflation 

The last Keynesian golden age ended in stagflation. The causes of this breakdown are many and complex, but they must be addressed if we are to avoid repeating them. In particular, it is important to avoid relying on easy excuses, such as the 1973 oil shock and to face the fact that the stagflationary breakdown reflected serious failures in the dominant version of Keynesian macro theories, and in the political and industrial strategies of the social democratic, left and labour movements. These failures were amplified by the expansion, from very small beginnings, of a global financial system that broke down the institutional framework of the Bretton Woods agreement. 

The discovery of the Phillips Curve around 1960, and the general success of Keynesian macroeconomic policies in the postwar period produced increasing support for policies of fiscal expansion aimed at reducing already low levels of unemployment even further, and an acceptance of higher rates of inflation and sustained budget deficits as a reasonable price to pay. This intellectual atmosphere fitted in neatly with the political needs of the Johnson Administration in the US, which sought to implement both an expensive (but initially quite successful) set of welfare programs dubbed the War on Poverty and an actual, if undeclared, war in Vietnam, while avoiding the political opprobrium of raising taxes. There were similar developments in other countries as pressure to expand the welfare state ran into the first elements of resistance that would later become the Tax Revolt of the 1970s. 

In the short run at least, expansionary fiscal policies resolved these problems, and an expansionary fiscal stance became accepted as the norm. This contrasted with the older Keynesian approach where expansionary policies used to stimulate the economy out of recessions and depressions were balanced by contractionary policies aimed at controlling overheated booms.

 From the late 1960s onwards, rates of wage and price inflation rose steadily. Throughout society, the combination of (seemingly permanent) full employment and economic growth with inflationary pressure led to the abandonment of attitudes of restraint that had, until then, been engendered by memories of the Great Depression and fears of a new one. Business leaders ceased to be the sober, socially-minded, technocrats described in works like JK Galbraith’s New Industrial State and started on the path that would lead to the lionization of figures like ‘Chainsaw Al’ Dunlap and Jack Welch.

Financial markets shook off the memories of the Great Crash and became, once again, places where vast fortunes could be made from abstruse transactions. Most attention was focused on stock markets, which went through their first real boom since the 1920s. More significant in the long run was the (re)emergence of an uncontrolled global financial market. This began, with the creation of the ‘Eurodollar’ market, in which mostly European banks located outside the regulatory control of the US dealt in dollar-denominated securities, with liquidity provided by the shift of the US balance of payments from a century old pattern of surpluses to an almost equally durable string of deficits. in one of history’s ironies, the most important single player in the early years was Moscow’s Narodny Bank, which faced increasingly pressing needs for access to Western financial markets and an equally pressing imperative to avoid the control of US authorities.

But the most striking manifestation of the inflationary breakout took place in labour markets. There was an explosion of labour militancy, reflected in an upsurge in strikes and in wage demands that could not be met except through continuing inflation. Even without the militant push, low unemployment would have strengthened the bargaining power of unions and put upward pressure on wages. But the revolutionary utopianism of the 1960s, exemplified by the events of May 1968 in Paris, produced an atmosphere where any kind of restraint became impossible. Unions that sought to focus on realistic and sustainable demands were pushed aside by their own members.

By 1973, after the breakdown of the Bretton Woods system and a failed attempt by the Nixon Administration to halt inflation through a wage-price freeze, the era of Keynesian dominance was drawing to a close. The coup de grace came in October of that year when, in response to US support for Israel in the Yom Kippur war, the members of the Organization of Petroleum Exporting Countries first cut off oil supplies to the West, then raised prices fourfold. 

The oil shock was a consequence, not a cause of the inflationary upsurge. Commodity prices were rising sharply across the board well before this event. However, the structure of the oil market, with a small group of oil companies (called the ‘Seven Sisters’) facing an increasingly well-organized OPEC meant that, when the price shift came, it took the form of a single dramatic leap. And, having been caused by stagflation, the oil shock amplified and entrenched it in the economic system, leading to decades of high unemployment and persistent inflation.

The stagflationary outbreak took a heavy toll on the Keynesian social-democratic welfare state and the organizations and ideas associated with it. In particular, the great wage push was disastrous for both for the unions and for the Keynesian/social democratic system. The seemingly-continuous strikes of the 1970s undermined popular support for unions and paved the way for a series of ever-more brutal assaults by governments and employers. Margaret Thatcher’s crushing victory over the National Coal Miners and Ronald Reagan’s equally successful action in firing striking air traffic controllers en masse brought an end to the idea that strikes represented a reliable route to improved wages and conditions, let alone to the collapse of the capitalist system. Particularly in the English-speaking world, union membership dropped rapidly as new laws made it easy for employers to keep unions out.

Keynesian economists were discredited and driven from positions of power by monetarist and new classical rivals. Only by making the massive theoretical and policy concessions involved in New Keynesianism were they able to regain a seat at the table.

Meanwhile, the financial sector, which had precipitated the crisis claimed victory, as did the economists who extolled its merits. Stagflation was seen as a demonstration that attempts to resist the logic of the market must ultimately fail. It took several decades to relearn the Keynesian lesson that an uncontrolled financial system will fail even more disastrously

The inflationary surge that began the late 1960s has some important lessons that must be learned if we are to avoid similar failures in the future. First, it is important to maintain a focus on keeping inflation rates low and stable as well as on maintaining full employment. Once inflation rates get signficantly above 3 per cent per year, the risk of embedding inflationary expectations, and the eventual cost of lowering those expectations, becomes greater. It is therefore important to maintain a commitment to low inflation and to adopting the policies necessary to contain and reduce inflation when some shock to the system produces a significant increase in the price level.

At a theoretical level, this does not involve huge modifications to the standard Keynesian view. The idea of a stable long-run trade-off between unemployment and inflation, represented by the Phillips curve, was a relatively late addition, and quickly abandoned. But the problem of how to deal with inflation remains largely unresolved.

In policy terms, inflation can’t be reduced unless macroeconomic policy acts to constrain excess  demand and liquidity. So Keynesian policies must be used consistently throughout the cycle, to reduce excess demand in boom periods as well as stimulating demand during recessions.

This still leaves the problem of what to do if high inflation becomes established. A number of countries showed, in the 1980s and 1990s, that a co-operative approach could reduce inflation and unemployment simultaneously. In Australia, following a deep recession in the early 1980s, the newly elected Hawke Labor government reached an agreement with the trade unions referred to as ‘The Accord’. Under the Accord, unions agreed to reduce the rate of growth of wages in return for an increase in the social wage, most notably the introduction of a national system of health insurance, called Medicare.

At about the same time, and facing similar problems, unions and employer groups in the Netherlands negotiated the Wassenaar agreement. In this case, the trade-off for wage moderation was a reduction in working hours and the adoption of a range of measures designed to promote employment growth. The Wassenaar approach survived the stresses of the early 1990s and, according to the ILO was “a ground breaking agreement, setting the tone for later social pacts in many European countries.”

The co-operative approach that motivated these policies was ultimately swept away by the ever-growing power of the financial sector. But, if a Keynesian policy framework is to be successful, it must be revived. Hopefully, the memory of past disasters will promote a more cautious and co-operative approach in future.

[1] Unfortunately, discussion of these ideas tends to get bound up in more or less mystical claims and counterclaims about reductionism and holism. But nothing of that kind is intended here. In principle, without doubt, all social phenomena are determined by interactions between individual people, whose behavior is in turned determined by their genes and the environment in which they grew up. Genes are collections of DNA molecules which in turn are made up of atoms made up of subatomic particles behaving according to the laws of quantum physics.  If we were the unboundedly rational individuals posited in the DGSE literature, , such we would presumably be doing quantum physical calculations whenever we made economic decisions.



Hidari 11.19.09 at 9:35 pm

Well I was reading it through and going ‘yes yes yes this is all true’ until I came to these two paragraphs.

‘The last Keynesian golden age ended in stagflation. From the late 1960s onwards, rates of wage and price inflation rose steadily. There was an explosion of labour militancy, reflected in an upsurge in strikes and in wage demands that could not be met except through continuing inflation. Even without the militant push, low unemployment would have strengthened the bargaining power of unions and put upward pressure on wages. But the revolutionary utopianism of the 1960s, exemplified by the events of May 1968 in Paris, produced an atmosphere where any kind of restraint became impossible. Unions that sought to focus on realistic and sustainable demands were pushed aside by their own members.

The great wage push was disastrous for both for the unions and for the Keynesian/social democratic system. The seemingly-continuous strikes of the late 1960s and early 1970s undermined popular support for unions and paved the way for a series of ever-more brutal assaults by governments and employers. Margaret Thatcher’s crushing victory over the National Coal Miners and Ronald Reagan’s equally successful action in firing striking air traffic controllers en masse brought an end to the idea that strikes represented a reliable route to improved wages and conditions, let alone to the collapse of the capitalist system. Particularly in the English-speaking world, union membership dropped rapidly as new laws made it easy for employers to keep unions out.’

Without getting over-political (and because in this blog form it’s impossible to see whether or not you’ve referenced these claims and, if so, who you are referencing), a few questions.

1: Is it in fact true that there was an ‘explosion of labour militancy’ in the late ‘sixties? Where’s the quantitative evidence? (i.e. labour time lost etc.) In what countries? (Assuming May ’68 to be a ‘France only’ thing).

2: Is it in fact true, as you seem to be saying, that ‘union militancy’ and the resulting ‘upward pressure’ on wages led to the collapse of the Keynesian consensus? Specifically, the US was by the ’60s overwhelmingly the most powerful economic force on earth, and yet by the late ‘sixties the US was under economic pressure, not from ‘strong unions’ but from the economic fallout of Vietnam…..and these problems then spread to other countries. The other factor not mentioned of course is the ‘oil shock’ caused by OPEC’s response to Israeli foreign policy. This last in particular had a very strong inflationary effect.

3: Finally, one last point. ‘The seemingly-continuous strikes of the late 1960s and early 1970s undermined popular support for unions and paved the way for a series of ever-more brutal assaults by governments and employers.’

Again, where’s your evidence for this? I’m old enough to remember those days (albeit vaguely) and I can tell you now that popular support for unions only started to erode in the late ‘seventies, not the early ‘seventies (at least in the UK). Moreover it was of course the wave of militancy in the late ‘seventies (not the early ‘seventies) that led, indirectly, to Thatcherism (the ‘winter of discontent’). Union militancy in the early ‘seventies, such as it was, led to a Labour Government.

And one must be very careful to appreciate the role of chance and luck in all this. As everyone points out, if Callaghan hadn’t been stupid about the date he picked for the ’79 election, then Labour might have scraped in and Thatcherism would have been history. Equally, if Galtieri hadn’t been stupid enough to invade the Falklands Islands, the Thatcherism, again, would not have happened, at least in the form we remember it.

These facts, to put it mildly, question the ‘strong unions….therefore….Thatcher’ causal connection you seem to be pushing.


John Quiggin 11.19.09 at 10:55 pm

@Hidai I think you’re right on the dates, at least for the UK, so I’ve just said “late 60s and 70s”. I dug out some UK data
which shows that the peak year for strikes was (not surprisingly once you think about it) 1926. But there is a big upsurge in the 1970s, continuing in the 1980s and then petering out.
Here’s the data for the US. There was a fair bit of strike activity in the 40s and 50s, but (with the arguable exception of the big steel strikes during the Korean war) it didn’t threaten social stability. Then a long period of industrial peace until the late 60s, an upsurge in the early 70s and a collapse, essentially to zero, thereafter
My recollection of the Australian data is similar, though the arrival of the Accord in the early 80s changed things a lot.


John Quiggin 11.19.09 at 10:58 pm

Also, I don’t think there’s any contradiction between “economic fallout from Vietnam” and “stagflationary wage-price spiral”.


Yarrow 11.19.09 at 11:33 pm

the model worked better if low-probability extreme events (large gains and large losses) were overweighted, while events leading to intermediate outcomes were overweighted.

Presumably one occurence of “overweighted” should be underweighted”.


John Quiggin 11.20.09 at 1:33 am

@4 Correct. It’s the second.


Josh 11.20.09 at 2:26 am

Following up on the Stagflation issue, you seem to be implying a causal process whereby union demands were at least partly (or more) to blame for beginning the wage-price spiral. I think Brad Delong has also made that claim in a paper online, citing that wage gains (sort of, maybe, from my reading of the graph) seemed to precede price increases in yearly percentage terms.

Others, however, have disagreed with him. On the left, if I remember correctly, Alan Blinder argues otherwise. On the right, monetarists — though opposed to unions on other grounds — usually say that since inflation is purely a monetary phenomenon, unions can’t really affect it. So, where do you come down on this issue?

It seems to me, given the data you cite above about labor militancy, that militancy was generally a response to already existing inflation, and an attempt by unions to either make up for real wages losses or get ahead of inflation in the future.

Strangely, it seems there’s an odd combination possible whereby one could be very left-leaning in terms of labor and also embrace a monetarist explanation of inflation.

On the other hand, I guess that leaves the question of what one thinks about how monetary policy “really” works to bring inflation down. Does it bring it down in a “direct” way, or does it do so simply by drying up loans and thereby construction, etc. etc., which creates unemployment, a weak job market, and desperate workers? If so, it’s kind of a Phillips Curve explanation by other means.

These are issues I think about as a historian working on economic politics, not as a trained economist. So any clarifications of your views or of the field as a whole would be helpful.


Robert 11.20.09 at 3:39 am

“The economics of Adam Smith is well understood.” That sentence is nonsense. Whatever the formalism of contemporary orthodox macroeconomics is about, one thing is sure. It is not about “the economics of Adam Smith.”

I find it hard to explain Friedman’s, and then Lucas’, popularity by stagflationary pressures in the 1970s in a way that is consistent with economists being honest. My name points to a quote from Joan Robinson. She had an explanation of stagflation by the early 1960s.


John Quiggin 11.20.09 at 5:38 am

@Robert I’m not interested in “what Adam Smith really said” – for that matter, I don’t much care “what Keynes really said”, as opposed to what interesting ideas we can get from reading Keynes.

I read the Joan Robinson passage you cite and I guess, at a stretch, you could read it as an anticipation of the “struggle over income shares” model of stagflation that motivated, for example, the 1972n wage-price freeze in the US. If that had worked, Friedman (and a fortiori Lucas) would never have become so popular.


dsquared 11.20.09 at 8:37 am

I dunno … I probably ought to write my own “whither macro” post, but I don’t think I agree with this one. It’s still very agent-centred rather than institutional. It seems to me almost that what you’re proposing isn’t so much a reform of macroeconomics to have sounder microfoundations as a reform of microeconomics to have sounder macroimplications.

I think the bottom line for me is in the discussion of the financial sector. What we’ve got here are a bunch of institutions which write contracts with each other for fixed nominal values, and then interact with the real economy. I think it makes more sense to treat these as black boxes which do stuff (and then to try and understand the feedback system which operates within them) rather than to start with the psychology of the elves who work inside them – quite apart from anything we know that this psychology is very dependent on institutional context and people might do very different things in a behavioural finance lab and on a trade desk. My practical example of this would be the real estate boom; if I were starting to explain this I would have as my building blocks the rental yield, the competitive equilibrium in the market for loans with competition on price and collateral, the need for certain kinds of institutions to earn a target level of nominal yield in order to maintain regulatory solvency, etc etc etc. I just don’t think that prospect theory had all that much to do with it. Basically as far as I can see, the problem with macroeconomics was too much abstraction and I think your work programme is still pretty abstract.


John Quiggin 11.20.09 at 9:10 am

DD, an obvious implication of your approach is that things should have been very different in, say, the US and UK, not to mention Iceland, since there were very different institutional structures. But, I would argue, the similarities outweighed the differences and the differences could largely be explained in terms of macro variables.

Looking more specifically at the crisis, it seems to me that in any set of institutions of the broad class produced by post-1970s financial deregulation (more precisely, guarantees + permissive regulation), there is a big reward if you can get paid for taking risks while shifting the actual risk on to others. In one form or another, given the right kind of macro environment, people will find ways to do this, and systemic risk will grow until we approach collapse. If it wasn’t subprime loans and derivatives, it would have been something else.

I agree, though, that I’ve underplayed the role of institutions in mediating the relationship between individual and aggregate outcomes and I should probably do more of this.


dsquared 11.20.09 at 12:23 pm

DD, an obvious implication of your approach is that things should have been very different in, say, the US and UK, not to mention Iceland, since there were very different institutional structures.

hmmm I’m not so sure that they’re that different, and conversely if one’s metric for susceptibility to a real estate and financial crisis was based purely on macro variables, you’d have expected things to turn out much worse in Australia and Canada?


Kenny Easwaran 11.20.09 at 2:19 pm

Minor type – von Neumann and Morgenstern didn’t publish in 1994, since that was the year Nash won the Nobel prize, at least partly in honor of the 50th anniversary of the publication, as I’ve heard.

Is your self-citation here to “A theory of anticipated utility”? As a philosopher working on decision theory in infinitary games, I’m very interested in seeing what modifications people have proposed to decisions involving very small probabilities.

And surely one of the instances of “overweighting” in that paragraph must be “underweighting” instead? (Probably the one for events of non-extreme value?) (Oh, I see you addressed this already in an earlier comment.)

Finally, in the footnote, I believe that technically genes aren’t “collections of DNA molecules”, but are rather parts of DNA molecules – they’re collections of nucleotides or something.


Kenny Easwaran 11.20.09 at 2:19 pm

oh, and that should be “minor typo” in my previous comment, not “minor type” – somehow I always make that typo.


JoB 11.20.09 at 2:41 pm


I really liked this one. It brings things together from outside the strict field of economy and might actually show a path hitherto neglected.

The nice thing is that it really starts at the start again: with the preferences of agents or in non-economist speak: with us.

(Before my comments: I think the charge of ‘leading the witness’ is, at least, too soon as you have not concluded anything)


“Of course, awareness of this fact will do nothing to moderate the potential impact; if anything the reverse. (..)”

I don’t think so. It looks a bit like the charge contra Hume that morality could not self-start without some external-to-nature intervention. When social intelligent creatures, over & over again, bump into the same problem they are likely to develop institutions, and that’s where institutions come in: as a solution to a problem, as well as the sense to think it ‘just’ not to follow their instincts (indeed, to make it an instinct to counteract a certain reflex reaction).

On another dimension: given your earlier mentioning of “attraction” points in systems theory, maybe it would be worthwhile to see whether some evolutionary game theory, I think the main name there was Smith as well (Dawkins refers to him profusely) as this just might be modeled like that – multiple equilibria & their ‘attraction zones’ might just emerge naturally from something like this.

T&K is a dynamic theory, hysterisis and all that but lacks, afaik, a formulation that will allow you to track preferences over time (the ‘once bitten twice shy’ of the saying).

“Even without the militant push, low unemployment would have strengthened the bargaining power of unions and put upward pressure on wages.”

A little bit with Hidari on this but also, but I’m shocked you accept what’s conventional wisdom since Thatcher, to wit: unemployment should be high enough for society to be able to bargain for labour. If there is somethng wrong with neoclassical theories, that’d be certainly a prime candidate to be wrong. The evidence is not for it on the long run: I would say rather the contrary. After 150 years of improving labour conditions and less labour hours per labourer there’s nothing to suggest – whatever the scare tactic is being used on greyification of society, on the Chinese closing all our factories, on inflation as in the Weimar-republic, on ….

Maybe what happened in the 70’s was just the result from artificial borders to trade? A strike of the Western employees not against the Western employers but, unwittingly I am sure, against Eastern/Southern employees?

Anyway, whatever, it’s courageous not to fall for the one-sided trap.

PS: on probablity, did Henry Kyburg’s ‘evidential probability’ already make it to those on the economy side?


JoB 11.20.09 at 3:05 pm

Also, I think you could be more powerful if you link into this that part where you have discussed the diversion of risk from the happy few to the supposedly unhappy many. I would look it up myself but haven’t the time.


Hidari 11.20.09 at 4:25 pm

‘The last Keynesian golden age ended in stagflation. From the late 1960s onwards, rates of wage and price inflation rose steadily. There was an explosion of labour militancy, reflected in an upsurge in strikes and in wage demands that could not be met except through continuing inflation. Even without the militant push, low unemployment would have strengthened the bargaining power of unions and put upward pressure on wages. But the revolutionary utopianism of the 1960s, exemplified by the events of May 1968 in Paris, produced an atmosphere where any kind of restraint became impossible. Unions that sought to focus on realistic and sustainable demands were pushed aside by their own members.’

Reading this passage very very closely I now see that it is ambiguous. But looked at as a whole, the general impression it gives is that it was union pressure on wages that ’caused’ the stagflation of the ’70s. Now that may not have been your intention. But that’s how it seems to read. Now in order to prove that you would have to prove that a: All those strikes were all about wages. b: They were all successful. c: It was as a direct result of the new wages getting into worker’s paypackets that inflation started to go up.

For what it’s worth, here’s the wikipedia on the stagflationary recession of ’73-’75. It blames: ‘ The Vietnam War, which turned out to be costly, economically, for the United States of America, the 1973 oil crisis and the fall of the Bretton Woods system. The emergence of newly industrialized countries increased competition in the metal industry, triggering a steel crisis, where industrial core areas in North America and Europe were forced to re-structure.’ (–75_recession). Nothing about ‘militant unions’ there.

If you look at UK inflation figures (, yeah, ok, there was a small rise in the early ’70s. But the high numbers ‘we’ all remember (i.e. double digit inflation) stem from ’74, ’75, and ’76. In other words, clearly because of the oil shock. Not union ‘militancy’.


Alex 11.20.09 at 4:53 pm

Why was it that having a monster housing bubble and associated banking crash was so well correlated with invading Iraq?


John Quiggin 11.20.09 at 7:52 pm

OK, I clearly need a rewrite on the stagflation section. I’ll do some more work and repost it.


bob mcmanus 11.20.09 at 8:33 pm

15,17:AFAIK, the explanations for the 60s-70s stagflation are many and remain controversial among economists, and I would not rely on Wikipedia for the complete story. I remember papers by DeLong & Romer criticizing Fed policy. A sector or exogenous “shock” like oil spikes or demographics does not necessarily have to mean a rise in the general price level. In some ways, understanding the stagflation drove economics for thirty years.

I don’t envy JQ trying to sum it up in a few paragraphs.


bob mcmanus 11.20.09 at 8:35 pm

18 continued.

And a rise in the general price level, even if inevitable, is not the same as persistant or accelerating inflation.


Samir Okasha 11.20.09 at 8:57 pm

“The starting point for expected utility was the idea that people can, and should, reason about uncertainty on the basis of their perceived probability of relevant events such as an increase in interest rates or a slump in exports. ”

What about the standard defence of EU theory, i.e. it’s an ‘as if’ theory? People may not have sharp subjective probabilities for events, but if they obey the Savage axioms, then they end up behaving as if they do.
I realise there’s considerable evidence that people systematically violate those axioms, and that non-EU theories have some empirical support.
But even so, isn’t it odd to critique EU on the grounds that we often “just don’t know”, in Keynes’ words? This doesn’t seem like a good critique, at least of the Savage formulation of EU theory. One might as well argue that people don’t explicitly know what their utility function is.


Walt 11.20.09 at 9:06 pm

If we “just don’t know”, why would we act like we would obey Savage’s axioms? If I don’t know, then I don’t know. I don’t try to form a subjective probability distribution over information I don’t have.


Alex 11.20.09 at 9:44 pm

Oil is one idea; Bretton Woods breakdown is another; a Schumpeter-esque story about a generation of technology going baroque is another. The Hawker-Siddeley Trident, the first airliner with autoland, also had a moving map navigation system using inputs from LORAN and various radio aids and the flight-data system – but the moving map was a paper map mounted on rollers driven by servos controlled by the navigation system.

None of these require stories about how the riffraff just suddenly lost its morals.


Frank the salesforecaster 11.20.09 at 10:05 pm

I wish you good luck with this, let me add that demographic changes shouldn’t be considered an exogenous variable. If you really want to tie macro and micro together in a meaningful way you are going to have to understand what drives household demand.

Having a monster housing bubble is better correlated with having the most populus best-educated generation (the one that invented the 2-income household) hitting the age where the number of existing houses for top 10% households (think McMansions) was wildly insufficent. The housing boom wasn’t a bubble until ’06 and turned into a bubble due to too much capital being created (hedge funds and the yen carry trade, chinese currency peg, baby boom income peak, tax code changes, investment banking rule changes; mix and match as you see fit.)

Game theory shouldn’t really be necassary here. This is an exercise in properly bucketizing your data into relavant behavioraly different subsets while changing the values attributed to an age described bucket due to variation in educational attainment, ethnicity, and household structure of the segment of the population entering that bucket. New households consume capital (college educated 2-income new households even more so,) mature households create capital (except when they are buying that move up McMansion or paying for Jr.’s college etc.) You should find more clues in the marketing department than in the math department.


roublen 11.21.09 at 3:27 am

I think the core of recession economics is in this quote from Tobin’s Nobel speech, quoting Keynes:

. . .Were there a full set of simultaneously cleared markets for all commodities, including commodities for future and contingent delivery, there would be no macro-economic problems, no need for money, and no room for fiscal and monetary policies of stabilization. . .

. . .the departure that sets the stage for macro-economic theory and policy, is one emphasized by Keynes. It is the virtual absence of futures markets and of course contingent markets in any commodities other than money itself. As Keynes said (1936, pp. 210-212),

“An act of individual saving means – so to speak – a decision not to have dinner today. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing today’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, – it is a net diminution of such demand … If saving consisted not merely in abstaining from present consumption but in placing simultaneously a specific order for future consumption, the effect might indeed be different. For in that case the expectation of some future yield from investment would be improved, and the resources released from preparing for present consumption would be turned over to preparing for the future consumption. The trouble arises, therefore, because the act of saving implies, not a substitution for present consumption of some specific additional consumption which requires for its preparation just as much immediate economic activity as would have been required by present consumption equal in value to the sum saved, but a desire for “wealth” as such, that is for a potentiality of consuming an unspecified article at an unspecified time.”

In short, the financial and capital markets, are at their best highly imperfect coordinators of saving and investment, an inadequacy which I suspect cannot be remedied by rational expectations. This failure of coordination is a fundamental source of macro-economic instability and of the opportunity for macroeconomic policies of stabilization.

My understanding is that a recession occurs when 1) people really want to accumulate wealth, and 2) the contractionary methods of accumulating wealth (cutting spending, laying off workers, etc.) are dominating over the expansionary methods of accumulating wealth (making and selling something for profit, etc.)

So to have an economic system less vulnerable to severe recession, ideally you’d want:

1) some way of avoiding sudden and volatile swings in people’s desire to accumulate wealth. One way might be a strong safety net, so people don’t have to fear poverty if they lose their private wealth. Another way might be to discourage borrowing against rapidly appreciating assets. Yet another way might be government programs to ensure full employment, reducing fear of losing a job and not being able to find another.

2) When in a recession, you want to encourage expansionary methods of accumulating wealth, and ,perhaps, discourage contractionary methods. In Ancient Egypt, a government would/should stimulate expansion by doling out cash for pyramids. In Ancient Gaul, cash for mehnirs. In 19th century America, cash for railway tracks. In our day, what should a recession-fighting government announce they’d be willing to dole out cash for?


Cranky Observer 11.21.09 at 3:28 am

> The housing boom wasn’t a bubble until ‘06 and turned into a bubble due to

Uh, no. I was asking my coworkers in Los Angles by 2002 who exactly was going to buy all those 1200 sq ft townhouses being built on desert scrub and former vineyards in the Inland Empire and marketed “from the low 400s”, and pointing out to them that even with the Los Angles area’s traditional growth rates there was no source of population or income growth large enough to support the number of houses being built. Same thing was evident in the far Chicago exurbs where developments “from the low 250s” were creeping past Joliet and headed toward Peoria – even in an area as rich as the Chicago SMSA there just wasn’t enough income for everyone to have a 6-bedroom 1/3 acre McMansion. As indeed it turned out.

And if I was noticing that by 2002 that meant it was going on well before that.



Martin Bento 11.21.09 at 10:51 am

Did the stagflation precede the breakdown of Bretton Woods? I know the inflation did, but the inflation was not a problem for the Keynesian paradigm to explain.

There’s also a problem with this statement that I think is illustrative of a general problem of the field:

“The oil shock was a consequence, not a cause of the inflationary upsurge.”

The official cause of the oil embargo was international support for Israel in the 73 War. Likely, that’s not the whole story, and I wouldn’t doubt economic factors were at work as well, but a *purely* economic explanation would have to be argued and would be a difficult case to make. This is the problem for the field: it is always tempting to treat economic outcomes as determined solely by economic factors because otherwise it is very hard to evaluate the factors. That doesn’t make it true, and this looks like one of the cases where such a view is misleading. Economic history is always part of history.


Barry 11.21.09 at 12:35 pm

In terms of ‘stagflation’, the Oil Crisis seems to me something that economists don’t want to emphasize. The basic commodity on which advanced industrial economies lived on tripled in price, and was both high and highly variable for many years. This caused massive disruptions, and also reduced the ex post value of a quarter century of investment (particularly in the USA). The reduced growth rates were not simply a product of the 70’s. Krugman recently posted figures for growth by decade in the developed world. The 70’s had lower growth than the 60’s (which was lower than in the 70’s), but the 80’s were lower than the 70’s, and the 90’s were lower than the 80’s. At a guess, the 00’s will be lower than the 90’s (at best).

So whatever happened shouldn’t be thought of as a short-term phenomenon. Perhaps things like macroeconomic mismanagement helped, putting us in a bad position when major shocks hit, but they aren’t totally to blame, and might have been a minor coincidence. After all, how many economies *would not* have been hammered by problems on a scale with the Oil Crisis?


dsquared 11.21.09 at 1:40 pm

The housing boom wasn’t a bubble until ‘06

I am on Team Frank Salesforecaster on this. Up until 2006, the housing “boom” was simply a reflection of what had happened to interest rates and reflected a combination of downward-stickiness in rents, combined with quasi-arbitrage between the yield on bonds and the rental yield on property. After 2006, house prices kept rising to levels where the rental yield was well below the bond yield, and this marked the “Minsky moment” at which the boom became a bubble. In early 2007, the rental yield moved below the cost of mortgage financing, and we had the “second Minsky moment” at which the crash was inevitable. (and yes, btw, I did make these predictions at the time, and yes, by the way, I did make money out of them).

the above paragraph, btw, is an example of how I think macroeconomics should be done. We know that rents are sticky in a downward direction, and the reasons why don’t have much to do with agent rationality – they’re a reflection of the way in which contracts are written and in which property investment is financed. We know that there is quasi-arbitrage between bond yields and property yields, and I would also argue that if you’re going to investigate this you are going to get further by getting a load of deep and detailed information about the real estate investment industry than by making stylised models of expectations.


Kenny Easwaran 11.23.09 at 2:29 am

Barry – isn’t there another explanation for continually decreasing growth rates in the developed world? That is, that exponential growth is hard to maintain.


lemuel pitkin 11.23.09 at 3:16 am

Up until 2006, the housing “boom” was simply a reflection of what had happened to interest rates and reflected a combination of downward-stickiness in rents, combined with quasi-arbitrage between the yield on bonds and the rental yield on property. After 2006, house prices kept rising to levels where the rental yield was well below the bond yield, and this marked the “Minsky moment” at which the boom became a bubble.

Wait, are we talking about the United States here? Because in most of the country, prices peaked in summer 2006. In 15 of the metro areas in the Case Shiller index, there was no appreciation after 2006. Or do you think C-S is not a good measure?


lemuel pitkin 11.23.09 at 5:27 am

In 15 of the 20 metro areas, I meant. Case-Shiller 10-metro index peaked in June 2006, 20-metro in July. Prices are now where they were in mid-2003, a good 30% below the 2006 peak. So if there was no bubble until 2006, houses are seriously undervalued right now. Sales-forecasting Frank and Dsquared: Should we be expecting a major increase in house prices in the near future? (And why, if houses are so undervalued, is there still such a big stock of unsold ones?)


lemuel pitkin 11.23.09 at 5:35 am

House price to rent ratios.

How is this picture compatible with the claim that “After 2006, house prices kept rising to levels where the rental yield was well below the bond yield”? The price to rent ratio was rising sharply *until* 2006, but after 2006 it fell sharply.


dsquared 11.23.09 at 12:12 pm

Yes, basically – this is one of the well-known stylised facts about the US housing boom/bubble/kerfuffle; it’s geographically localised. The problem bits were California, Florida, Las Vegas, etc.


lemuel pitkin 11.23.09 at 4:26 pm


I was afraid you would say that — it’s the obvious off-the-cuff response if you haven’t looked at the data. But in fact, the only areas where prices kept rising into 2007 were places where the overall increase was relatively small — Atlanta, Charlotte, Dallas, Portland, Seattle. In all the places with really big increases — the ones you mention, plus DC and NYC — house prices peaked in 2006 (Las Vegas in August, LA in September, Miami in December, etc.). So again, if one takes your statement seriously, you don’t think the US experienced a housing bubble at all.

Of course, since the big decline in bond rates was in 2002-04, your quasi-arbitrage story is still quite plausible. One would have to explain why previous periods of declining bond yields (in the mid 90s or late 80s, say) didn’t see similar bubbles in housing prices — but that’s where the “deep and detailed information about the real estate investment industry” comes in, and of the course the 80s did, to a much lesser extent. (But who exactly is it who’s doing the arbitraging?)

But getting the timing right matters — first, because getting the facts right always matters, and second, because if the fundamentals-driven rise housing prices ended in 2004, a larger part of the overall rise was due to a speculative bubble. I can see why this would be a problem for Frank if he wants housing prices to be mainly a story about demographics, but I don’t see why it should be a problem for you.


Frank the salesforecaster 11.23.09 at 10:54 pm

I don’t want it to be mainly a story about demographics, I just don’t think that demographic changes shouldn’t be considered exogenous if your purpose is to bridge the gap between micro and macro. For example, it seems that declining bond yields would be more likely to create to a housing bubble when the decline in yields is coincidental to an increasing population of households with superior consumer attributes relative to housing.

From a sales forecasting point of view there is no reason to expect a big increase in housing prices for an extended period of time. The baby boom has bought their big move-up houses and the much smaller/more ethnic Gen-X cohort has no lift from an increased education/2 income household standpoint. Downsizing will slow as boomers can’t find enough Gen Xer’s to buy their McMansions. The boomers should still be generating some activity in the vacation/second home space, but I just left’s depression update so I’m not hopeful.


Martin Bento 11.23.09 at 11:29 pm

John, I don’t see what basis there is for insisting on a unicausal model of stagflation. I know you’re not insisting on it in the abstract, but you’re thumping hard for labor intransigence and simply waving aside the oil crisis and the fall of Bretton Woods.

The oil embargo began in October 73. The US entered recession, as later determined retrospectively, in November 73. Inflation continued, and in fact accelerated to about 10%, double the peak of the prior inflation, which was a bit under 5%. That was the stagflation. Before that, there was inflation sans a protracted slowdown, but this is not a problem for Keynesian theory, is it? What forced a theoretical re-evaluation was simultaneous protracted recession and inflation, and that corresponded precisely to the oil crisis, and it’s resurgence later in the decade corresponded precisely to the second one. Not that I think the oil crisis is the sole cause either, but I don’t see how it can be dismissed. The causal mechanism is also pretty transparent: rising oil prices make production and distribution more expensive, forcing prices up and units sold down. Not all businesses can survive in this new environment, and very few do better because of it, especially in the short term.

If Keynesianism worked from the end of WW2 to about 1972, it is worth asking what changed. The most direct suspect would seem to be the breakdown of the Bretton Woods currency system in 1971. The breakdown of Bretton created the international currency market, which gave private interests the ability to “punish” the currencies of countries whose policies that market disfavored. Also, the third world debt crises, usually connected with currency concerns, began in this period. Devaluation of currency is, other things equal, inflationary. Is not where we have seen the most dramatic cases of stagflation where developing economies experience debt and/or currency crises? Argentina earlier this decade: prices through the roof while the economy collapses.

So what caused Bretton to fall? The inflation? Well, the direct cause was the inability of the US to support its gold peg when called on it by the French, so maybe the best course is to work back from the proximate cause. Once the gold peg was dropped, the price of gold almost doubled within a year. Then again, the year after that, and peaking for the decade at over ten times its pegged price in nominal terms, far, far above general inflation. Did general inflation cause this? Cumulative inflation for the decade prior to the drop of the peg was, what, 25%? Something besides inflation was driving the currency down relative to a true market price of gold.

The classic objection to metallic standards is that they force the expansion of the money supply to be determined by the expansion of the metal store. But the gold peg of the Bretton system was more theoretical, and did not strictly require this, as actual exchange was constrained, so the money supply was expanded according to perceived economic need. Eventually, this failed. But is this not at bottom a problem of trying to have a virtual gold standard without respecting the constraints of that standard? Perhaps the problem was having a gold peg all along. Of course, without the gold peg, coordinating controlled exchange rates might have been much harder, but it was probably more US hegemony than the gold peg that made that happen anyway. In any case, what does any of that have to do with labor?

Then there is the question of how the stagflation ended. Volcker engineered two deep recessions to kill the inflation by monetarist means. This worked: the inflation died. Once the inflation died, as I understand things, the economy was supposed to naturally recover as employment ascended to its “natural” rate. But the economy was showing little signs of spontaneously rebounding. Rather it seemed to find a stable state below optimal, as a Keynesian might have suggested. It’s not clear to me why this is a problem for monetarism rather than the NAIRU.

In any case, the great victory of Volcker, which sets him so beyond controversy now, is that he renewed economic expansion without bringing back high inflation. When he let the monetary gates back open, inflation did not significantly resume. But is this true? What we saw in the 80’s, and have mostly seen since, save for the occasional crash, is extremely high inflation in asset prices (coupled with moderate consumer inflation and virtually none in wages). This, however, is not called “inflation”, it is called “creation of wealth”, or was at the time, and it is not measured in the CPI, the GDP deflator, nor most other inflation measures. The Efficient Market Hypothesis is important here for support of the claim that asset prices are always “right”, implying they are never “inflated”. The reasons for this transfer of inflation had a lot to do with government policies like cutting capital gains taxes, and also, yes, with the weakened state of organized labor. But if what I’m suggesting is correct, what we mostly did was replace wage and consumer price inflation, with a complicated distribution of winners and losers, with asset inflation, which causes a direct transfer of wealth to asset holders (effectively an inflation tax whose revenues are extremely concentrated). We still cannot have a high rate of growth without inflation, and the wealthy just found a form of inflation that suited them.

Now all that is not a careful and detailed argument, but it seems to me the beginning of a plausible alternative account of stagflation. It is not clear to me why labor intransigence is of more significance, nor why we should not include asset inflation in our estimates of how inflationary recent history has been.


lemuel pitkin 11.24.09 at 12:09 am

Thanks for the reply, Frank, but it doesn’t really get to the issue. You wrote:

The housing boom wasn’t a bubble until ‘06

But the thing is *all* the appreciation in housing prices — both nationally and in almost all the hot areas — had happened by mid-2006. So what you are saying is that there just was no bubble at all. And if there was no bubble — if prices as of 2006 were based on fundamentals — then there is no reason that prices now should be 30-35% lower than in 2006, as they are. So you should be expecting an increase.

All this stuff about 2-income families and demographic cohorts has nothing to do with the actual dynamics of the housing market. The ratio of housing prices to income exhibited no trend for most of the postwar period. Then it spiked up starting in 2000 or so, and peaked about 50% above its historical level. And then it fell right back again — the ratio today is about where it was 20 years ago.


lemuel pitkin 11.24.09 at 12:35 am

I know you’re not insisting on it in the abstract, but you’re thumping hard for labor intransigence and simply waving aside the oil crisis and the fall of Bretton Woods.

I think John Q. has got this one right…


Martin Bento 11.24.09 at 12:42 am

So why does the stagflation correspond so closely to the oil crises and only very generally to labor disputes, and how did labor intransigence cause the fall of Bretton?


lemuel pitkin 11.24.09 at 1:58 am

1. I wouldn’t focus too much on Bretton Woods — the postwar fixed exchange rates were not viable for all sots of reasons — once comprehensive currency and capital controls were dropped (which was later than you might think) the end of fixed exchange rates followed quickly and inevitably.

2. The labor dispute story fits Europe more straightforwardly than the US. But then, the slowdown in growth was also much greater in Europe than in the US. (Armstrong, Harris and Glyn’s Capitalism Since 1945 remains the definitive work on this.) But it does fit the US too.

3. “Why does the stagflation correspond so closely to the oil crises and only very generally to labor disputes?” I think this is posing the question wrongly. In the US, the 70s were a very good decade for wage-earners and reasonably good decade for growth. The real slowdown happened at the beginning of the 80s, precisely as a result of the policies adopted to reverse the downward redistribution of income that had resulted from sustained full employment in the 1960s. And the faster growth in the 1990s came because the US elite, unlike the European, largely did succeed in stamping out labor militancy and so could risk low unemployment — Alan Greenspan himself said so.

4. The idea that there has been sustained asset-price inflation since 1980 won’t fly — there’s no secular increase in stock prices, house prices, etc., relative to income. What there have been is asset bubbles — i.e. cyclical asset price inflation. but the parallel you’re making doesn’t really work because episodes of asset price inflation have always been followed by episodes of deflation, which has not been true of the general price level since the 19th century.

5. The big secular change we have seen is an upward shift in interest rates — from 1945-1980, long rates were consistently below the rate of nominal GDP growth, since then they’ve generally been above it — and concomitantly a big increase in the share of national income going to interest. (You might call it The Revenge of the Rentiers.) it’s this, not asset-price inflation, that has caused the big redistribution of income toward owners of financial assets.


Martin Bento 11.24.09 at 5:21 am

3) What we’re trying to explain here is stagflation, which is

a phenomenon of the 70’s that bled slightly into, but basically

ended in, the early 80’s. I agree that the Volcker recessions

did serious damage to the standard of living, in part because of

the damage they did to organized labor, but the question at hand

was what caused stagflation, not what caused the decline in

living standards.

4) Here is the daily Dow from 1980 to 2000:

and from 2000 to the present:

It started a bit above 700, peaked above 11,000, and even in this bad economy is hovering around 10,000. Even during the worst of the crash last year, it never went below 7000, about ten times its starting level, and quickly rose back. Cumulative inflation during this period was 261% (CPI) or 229% (GDP deflator) whereas the Dow has risen about 1400%, say 540% in real terms. Yes, there were a series of bubbles and crashes, but except arguably for the one at the very beginning of the 80’s the crashes still left things higher than before the bubble, and the cumulative upside considerably seems to considerably exceed cumulative inflation.

Meanwhile, here’s the picture with median income and housing prices:

This is nominal terms, and you kind of have to estimate the exact figures, but both income and prices are nominal, so it is an apples-to-apples comparison. Looks like income just over doubled, about keeping pace with inflation. In the same period, median existing home prices increased about 9-fold, and that’s including the recent declines.

5) The point about interest rates is well-taken, and I wouldn’t doubt it is also a major factor.


Martin Bento 11.24.09 at 5:24 am

Sorry for the goofy formatting. Pasted from Notepad. Stupid Microsoft software.


john c. halasz 11.24.09 at 7:43 am

I rather agree with Martin Bento’s take here. The supply side shock of oil prices met up with rising popular expectations, conditioned by the prior boom years, but also with widespread indexing in wage contracts and other benefit payments, which passed on and amplified the shock. There were other alternatives possible besides breaking the back of labor/wages to bring down prices, (since inflation always involves an implicit distributional conflict), such as a negotiated national incomes policy. And then there was Abba Lerner’s old proposal of a cap-and-trade mark-up tax policy to allow a robust full employment regime without triggering a wage-price-spiral. The big losers in the 1970’s inflation were the fixed-income investors, who endured a real net capital loss during the decade. But there’s little real evidence that inflation rates above 3% are self-accelerating, nor unmanageable and growth-suppressing, (though tolerances in national traditions/ experiences may vary). And when inflation did subside with the Volckerdaemmerung, the disinflation coincided with a collapse in oil prices, which were at real lows in the 1990’s. But by then, the successive dis-inflationary impulses of “monetarist” policies to prevent excessive wage/employment pressures, combined with global “free trade” policies with mobile finance capital, to take advantage of labor arbitrage opportunities, boosted fixed-income real returns and the accumulation of debt-loads, til: presto!


Martin Bento 11.24.09 at 9:57 pm

Lemuel, one more thing: on Bretton Woods. Did not the currency control mechanisms work for 2 1/2 decades? There may have been some black market stuff and financial strains at the margins, but the currencies were convertible at the official rates, the official rates were fairly stable and reflected sound financials, and none of the participating currencies collapsed. That looks pretty good, especially compared to what followed, doesn’t it? And if it all relied on capital control mechanisms too, well, there are arguments in favor of capital controls as well.


John Quiggin 11.24.09 at 10:26 pm

One reason I’ve put a lot of emphasis on the labour militancy part of the story is that it’s relevant for any positive program for the future, in a way that the details of the breakdown of Bretton Woods are not. I want to point to the possibility of restored full employment, a shift in the balance of power from employers to workers, and a revitalised union movement. Last time we had all that, it ended in stagflation. If, as I argue, mistakes made by the labour movement were a large part of the cause (thought not the only cause by any means), then the problem is how to avoid those mistakes in future. If, on the other hand, that’s just the way capitalism (in all possible variants) works, then such an aim is utopian, and the best thing we can aim for is marginal improvements of the kind offered by, say, Blair and Obama.


dsquared 11.24.09 at 10:56 pm

Lemuel – you might be right; I’m basically assuming that the US housing bubble was like the UK and Irish one, which I did a lot of careful work on.


Martin Bento 11.25.09 at 6:38 am

John, I always think it best to present factual claims uncolored by normative commitments to the extent possible. One of the things that pisses me off about economic discourse is the degree to which it seems to have been corrupted by political agendas.

But even taking the future good of the labor movement in mind, it doesn’t seem to me your emphasis helps. To be sure, if you have concrete ideas how to maintain full, well-compensated employment without generating inflationary pressures, sharing those is all to the good. But letting labor bear the lion’s share of the blame for stagflation and other ills of the 70’s will not strengthen labor’s hand. After all, whatever you propose will be speculative, whereas the blame you are laying will at least seem better founded because it refers to things that have actually happened.

Nor do I think the fall of Bretton is irrelevant. To the extent the gold peg brought it down, it’s hard to see how anyone defends that vulnerability, since goldbuggery is a pass time now regarded as “fringe”. More important, what enabled Bretton to work was a high level of control of currencies and capital. It’s hard for me to see how to the economic strength and relative equality of the Bretton period will be restored without these things. And look at the performance of the Bretton era: by far the greatest rise in the median standard of living in US history, and an even greater one in its allies, most of whom came from desolation to rough parity with the US. Given all that, why would it be an inevitable law of Capitalism that Bretton would fail (unless you believe it inevitable that the rich will always find a way to subvert so good a thing)? Admittedly, seeing how to reconstruct such a thing in the current environment is difficult, but I don’t see any way forward that does not involve something along the lines of Bretton, or at least something that achieves the same distribution of power that it did. As The Economist has crowed for decades, the international financial markets give big private players veto power over the policies of national governments. The fact that it was not always so shows that this is not, in fact, the inevitable order of things.


JoB 11.25.09 at 8:25 am

John@46 – that is a disappointment because you prove dsquared@9 right (that counts as a double fault ;-) ). Human beings do lots of things. One of them is work – sometimes formally employed. To reduce our economic agency to being employed reduces us to, late IX-th century world view. Are we not contributing to the economy on this thread, & I grant unevenly with myself on the lower but hopefully non-negative scale.

Putting it as a false either/or is, by the way, doing yourself an injustice. Surely, there is room for a future which is non-Utopian and which doesn’t require us to get excitedly in a corporatistic movement, fighting for an aspect of the lifes of some citizens in some of the nations.


John Quiggin 11.25.09 at 11:17 am

JoB I certainly don’t want to “reduce our economic agency to being employed”, and I doubt that there is any economist more enthusiastic than I am about the value of amateur activity.

But work and wages aren’t going to go away any time soon, and if you are talking about inflation, they, and not our contributions to networked creativity or social activity, are the aspects of our life that are most relevant.

BTW, while I’m sometimes old-fashioned, I hope you were imputing to me the late XIX century and not what used to be called the Dark Ages.


JoB 11.25.09 at 11:28 am

:-) sure, XIX it should have been.

No, work and wages are not going to go away soon and as far as I am concerned they’re quite allowed to stay. But your ‘amateur activity’ is a misnomer – our consumption is of more weight in the economy than our production – & our consumption is more & more determined by what really can’t be captured in traditional labour employment terms. I do not need to be an economist to see this. Hell, Britney Spears and J-Lo combined are probably dwarving the late XIX Belgian economy (even in real terms).

No, my objection here is principled. Unions are corporatistic. They will conserve that type of employment that is the status quo. We need to find a new analysis that gives us amateurs a non-organized way of making sure we get the time and peace of mind to do what we do. Hell, maybe over time we can even get rid of Britney Spears phenomena.

(this does obviously not mean that it would be good in many parts of the world, & also in the service sector in the West, to get better leverage for unions, and in general to be more tuned to employees than to employers – but mostly because employers want the employees to work more and longer (see increasing retirement age in Europe) whilst a majority of employees wants to work less and shorter)


John Quiggin 11.25.09 at 12:07 pm

I favor less and longer (at least, older at the point of retirement as well as at the point of entry to the workforce). But that’s an argument for another day.


JoB 11.25.09 at 1:01 pm

Looking forward to it.

(I’m not talking about forced early retirement & also I’m only talking about formalized employment)

PS: I think much can be said for earlier entry I think; 1-2 years to make sure there is an independence sufficient to choose according to real talent (& not based on perceptions of parents largely influenced by what happens to be hot on the labour market)


Martin Bento 11.25.09 at 8:24 pm

I think earlier entrance to the workforce, and therefore an earlier sense of independence, is fine. What I think we need is higher education that is drastically cheaper and more accessible to returning students, so people can more easily shift occupations. Academics are in the minority who still usually stick to one lifelong career. All this is pretty off-topic though. I guess John has read the criticisms and is standing pat on the argument in his book. Well, OK, it’s his book.


engels 11.25.09 at 8:36 pm

Of course entering the workforce doesn’t make anyone ‘independent’. For most people it makes them dependent on their employer (rather than their parents, husband, the benefits office, or whatever). For many this is an improvement but it’s crazy to call such a situation ‘independence’…


JoB 11.25.09 at 8:36 pm

54- I’m not too unsympathetic to that argument by the way. Unions did hold on to jobs of the past (coal, to name one) – thereby aggravating something that didn’t need it to be aggravated to be bad enough.

But on the other thing: living in a country where higher education is cheap (but still not cheap enough) it is clear that cheap isn’t good enough. On returning students: hell, yes!


JoB 11.25.09 at 8:39 pm

55, maybe but at least it would be an improvement for many; the state could employ (a bit like the military in its day but then something useful) by the way, but I don’t know if that can be kept manageable.


Martin Bento 11.25.09 at 8:59 pm

Engels, yes, I meant independent of their parents of course. Independent of society no one ever is, so an ideal independence doesn’t exist.


John Quiggin 11.25.09 at 10:11 pm

@54 I did make some fairly substantial changes in response to the first round of criticism, but now I’m standing pat.


Martin Bento 11.25.09 at 10:47 pm

Engels, besides I said earlier “sense of independence”. I do think employed people tend to feel more independent, even though that’s not true in every sense.

John, well, your choice, but I don’t think you’ve made the case.


engels 11.25.09 at 10:58 pm

Is an employed low-wage worker in a country with poor labour protections more independent (or does she feel more independent) than an unemployed worker receiving benefits in a country with a strong welfare state? Does someone who leaves school at 18 to work in a factory feel more indepedent than someone who attends university with money from his parents?


Martin Bento 11.25.09 at 11:22 pm

engels, knock it off, the discussion in which I was engaged was clearly in the context of the developed world, otherwise the entire set of options and considerations are different. And direct comparisons of first and third (I like the older terms; they’re more succinct) people are silly anyway: the choices are completely different, so how is that relevant to the choices either would make? The larger discussion is about stagflation, what caused it, etc., all first world context. I suggested that children employed earlier would have a greater sense of independence than otherwise. As an offhand generalization, that may not be true in every case, but do you dispute it in general?

As for the factory worker versus the dependent student, yes, I think so. I felt more independent when I was working sh*t jobs than when I was a student, and I was only getting minor parental support (considerable state support, though). I *enjoyed* college a lot more, but I did not feel independent. Others may differ I suppose. But you’re trying to pick a huge fight over an offhand comment that I didn’t think earlier entry to the workforce was necessarily a bad thing, in part because of the increased sense of independence it typically brings in a first world context in my opinions. If you disagree with that, fine, but it’s off-topic here, and arguments like “does a sex slave in Mexico feel more independent than someone on welfare in the US” are just silly. It’s an explicit apples-to-oranges comparison. And, in any case, this is all off-topic, which means I’ve been led into expending more time on it than I probably should have anyway.


John Quiggin 11.25.09 at 11:43 pm

Martin @48, I will be making all the points you make, about the success of the postwar period and the need for tight controls on capital. Taken as a whole, I don’t think the book will appear to blame labor for the failure of postwar Keynesianism, or suggest that this failure was inevitable. However, I’ll reconsider whether I need to make more of these points in this section.

My current draft of the book at is not quite up to date, but gives a better view of the book as a whole than this one section.


engels 11.25.09 at 11:47 pm

arguments like “does a sex slave in Mexico feel more independent than someone on welfare in the US” are just silly

Huh? Where did I say anything even resembling that? (Actually I had in mind eg. the US v. Germany.)

I enjoyed college a lot more, but I did not feel independent. Others may differ I suppose.

You suppose right.


john c. halasz 11.26.09 at 6:47 am

I hesitated to press any point about the demise of Bretton Woods, with respect to the 1970’s stagflation, because I’m not sure of the connection and how it played out, but with respect to the current global crisis in general, I definitely would start the history of its genesis and eventuality with the end of Bretton Woods. And in discussing Bretton Woods, it’s not just a matter of its empirical-historical record and efficacy, (which is clear for the first world, but for the third world harder to assess, since much of it was undergoing de-colonization at that time), but also one should go back to Keynes’ original conception, with the Bancor proposal, which would have placed trade-adjustment on the shoulders of creditor/surplus nations, and the 1948 Havana Charter, both of which were nixed by the U.S., ostensibly because of a concern for its “sovereignty”, but more likely because of U.S. hegemonic/imperialist ambitions, (which doesn’t require reading the declassified NSC 68 to grasp). At any rate, Keynes’ aim was to encourage international trade in goods, while discouraging international flows of finance capital, and permitting each nation discretion in pursuing its own domestic fiscal and monetary policies. That does go to the issue of full employment policies. And further, I do believe that the gap between 1st and 3rd world FX rates in nominal and PPP terms has blown out considerably since the end of BW, with heavy debt loads in the 3rd world and “structural adjustment” programs, resulting from financial bubbles followed by collapses that, via such “adjustment” with privatization and “free trade” policies, enabled the capture of domestic economies by “global” MNC and Wall St. financial interests. (Some 40% of international trade is actually direct infra-corporate transfers by MNCs, and indirectly likely much more).

As for restoring the “rights” of labor and more equitable distributions of output/income/opportunity-structures, I would be the last person to decry any increase in unionization. However, there’s no use in being nostalgic, and technological change/automation, as well as, “free trade”, have eroded the rents or quasi-rents that underlay the mass-production/high wage economy, or at least, significantly restructured them and their distributions. It’s likely more public/state-regulated policies would be required to restore an more salutary,- and demand enhancing,- “balance”. (As a slightly irrelevant example, since it is a small homogeneous country, the co-ordinationist policy formation of Finland, by which it emerged from its depression at the beginning of the 1990’s).

It’s bootless to pretend that economics/economy concerns some singular, unified system, independent of its agents, (who are more likely organizations than individuals), such that the sole concerns is “stabilizing” that system, with otherwise self-stabilizing, self-regulating properties. There are a number of functionally equivalent “solutions” to any problem that such systems might confront, in part or as a whole, with no uniquely “correct” solution, but different functional and distributive effects. (For example, reducing household debt burdens, ignoring the legalistic and administrative obstacles presented by “securitization” of debts, would have similar monetary stimulus effects to the Fed’s monetary lollapalooza,- which continues the U.S. $ kiting scheme,- but with different distributional and functional effects). It’s not just that any economy qua system is dynamic and “non-ergodic”, which escape GE analytic frameworks, but that such issues and the way fundamental “choices” are made is more a matter of political-economy than “pure” economics.

But then, to return to the “full employment” problem, economists don’t exactly know what conditions underlying productivity growth, since much depends on the as yet untapped availability of technical possibilities, which they don’t exactly have a handle on. And, er, their distributional effects, since that already effects investment incentives. But clearly, the presence of sensed effective demand, (which moderate inflation signals, since, not only does it motivate renewed investment, but it reduces the credit risk of sunk costs), is tied to the pressure of wage-based demand, as both the factor in sensed demand and as a pressure on investment, to reduce labor-cost. Hence the policy of fighting inflation at all costs results in a reduction of the pressure for investment/innovation. And the over-valorization of existent capital stocks. Especially if re-distributive mechanisms on gains in the surplus-product are “eased”. Which is why “stagflation” is such a canard, since it is really a matter of maintaining the valorization of capital through maintaining its rate-of-profit. In general, I see no way of distinguishing, in neo-classical economics, between increases in profit due to investment in technical improvements in real capital stocks, which thereby increase labor-productivity and lower unit output costs, thus increasing, actually and potentially, the real distributable surplus product, social “wealth”, and increases in the rate-of-profit, due to changes in distribution between wages and profits. But then there is something of a paradox that increases in real social “wealth” might lessen the need to exploit labor, and therefore lessen the exigency of the interests of capital. In other words, the focus on “stagflation” was overdetermined by interests beyond the problem at hand, and the various functional “solutions” to that problem gave rise to the “globalized” over-financialization and the generation of fictitious capital that has broken down in the GFC nowadays. Because of the dogma that the private market will always allocate capital investment efficiently, better than any other possible mechanism, and thereby “guarantee” a social welfare optimum. Which dogma is being refuted “empirically” before our very eyes today. Which is to say, that any salutary exit and recovery from the global crisis might needs involve both a transformation in the current global FX/trade regime, and a much greater role for public investment and regulation, (with expanded social insurance and re-distribution schemes), than mere patches on macro-economic models would allow for.

Finally, the invocation of “utopianism” against any more-than-incremental change is also a befuddled canard. TINA! The kind of incremental liberal progressive meliorism that glides over past pains and struggles, as if collecting the rent, and arbitrarily extrapolates such progress “linearly” into the future-reduced-to-the-present, such that it can’t tell the difference between any “authentic” progress or genuine reform, and social regression and the dismantling of achieved collective gains, because the disruptive “nature” of historical change is most of all to be feared, is, er, passe’. And complicit in current structure of domination. (It tends to result in the sort of slip-shod historical imagining that 1917 and Putin belong to the same historical horizon, apparently constituted by some transcendental Uebermensch,- “leaping tall buildings in a single bound”,- such that the imposition of “shock therapy”, inspite of the absence of any institutional structures to handle it, would be the adequate “resolution” to the Cold War, as opposed to any more gradual process of re-organization and nuclear disarmament, resulting in a chaotic mafia-capitalism, which looted and exported any residual value to painfully accumulated capital stocks, such that the well-nigh inevitable succession of a Chekist-capitalism, to “normalize” the situation, is an outcome to be devoutly condemned!). Nope. The consideration of alternative pathways, multiplely, need to be considered, which the rote condemnation of “utopianism” and “apocalypticism”, as a consideration of the relation between proximate and “ultimate” ends, obfuscates. “History” always contains more possibilities than are actualized in and as history, which is, er what makes it at all history. Constructing some singular unitary systemic theory to “contain” such possibility in the name of its artifactual “necessity” is a fool’s errand. Call it “economics” or what you will. It’s already to lay a claim in the “game” of power.


John Quiggin 11.26.09 at 7:21 am

JCH, I followed the first para and I agree, but I already discussed the breakdown of Bretton Woods in the historical section. Looking forward, the details of BW are only of modest interest. And the second para recapitulates points I’ve already made in my chapter on the efficient markets hypothesis. I got a bit lost after that.


john c. halasz 11.27.09 at 7:07 pm

Perhaps this line of thinking might be more in tune with what’s needed:

Barkley Rosser at “Economists View”:
“I made up the moniker “Bielefeld School” in the Foreword to that book. I labeled it a variety of Post Keynesian approaches, although noting that some of those involved did not like this label as they think of most Post Keynesians as being insufficiently mathematical. In any case, their approach involves explicitly modeling the financial sector along with the production sector and their interrelated nonlinear fluctuations.”


“This is, besides mine, the first mention of Flaschel and Chiarella I have seen in the blogosphere.

is the one I read. I am a fan, without probably understanding a word. Ok, maybe a word.”

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