The state of macroeconomics: it all went wrong in 1958

Third, Friedman used his critique of fine-tuning that macro policy should be confined to a rules-based monetary policy, with no role for fiscal policy.

Typo: “to argue” after “fine-tuning”?

I read around the post-war inflation literature when I was doing my dissertation, and I was surprised to find just how different it was from what I had been led to expect about ‘Keynesian’ inflation theory – i.e., that it was all about the Phillips curve. As you say, Phillips’ paper itself wasn’t published until 1958, and it wasn’t until Lipsey and Samuelson & Solow in 1960 that it was put as a theory rather than an empirical regularity. And it wasn’t until still later in the decade that it became ubiquitous. If you look at the long survey paper on inflation theory by Bronfenbrenner and Holzman in the American Economic Review in 1963, the Phillips curve takes up maybe 3-4 out of 70 pages. That means the Phillips curve was hardly established before it started being ‘expectations-augmented’ Friedman/Phelps style from 1968.

Prior to the PC, and coexisting with it, were a number of other approaches to inflation. There were plenty of ways of talking about a tension between full employment and price stability without taking the PC step of a menu – it was one of the great themes of 1950s macro, especially in practical policy-making circles. There was much scepticism about the idea of a stable trade-off – from Phillips himself, as you say, and I think in Samuelson & Solow (1960) itself – they explicitly warn about its instability. (When Phillips came to Australia soon after the publication of his 1958 paper, he did a new curve based on Australian data, and was met with a lot of scepticism from Australian economists, who pointed out the importance of the arbitration court in setting wages and the major impact of large fluctuations in international commodities prices on Australian incomes.)

One thing that strikes me about the 1950s literature is that it was still common to conceptualise it in terms of shifts in the equilibrium price level rather than an equilibrium rate of inflation – which is one of the things that made PC models novel. There was plenty of discussion about the possibility of inflationary momentum and acceleration before Friedman, even in the 1950s, though this was often blamed on wage and price setting catching up with past inflation rather than anticipating future inflation. It wasn’t that economists pre-1968 ignored the possibility, but that econometric estimations in fact found little influence of past inflation on present inflation (via expectations or otherwise), so it could be dropped from the model in favour of the typical PC relationship between present unemployment and present inflation. Expectations-augmentation alone doesn’t explain why inflation took off in the 1970s – within the NAIRU/natural-rate paradigm, it seems that the NAIRU itself must have shifted substantially in countries like the UK or Australia, where around-2-percent unemployment had been for many years consistent with very modest inflation.

Finally, it is interesting that the idea of a Phillips-curve-style trade-off had a different political colouring in different countries. In the US it was associated with liberalism, with Samuelson & Solow as Presidential advisers, because US unemployment was relatively high and the PC was deployed to suggest it could come down. Whereas in the UK and Australia, with low unemployment, it was associated with conservatism and the idea that full employment was unsustainable.

I like this post very much.

I especially like the nod to financial repression. I suspect this is a major direction realistic policy-oriented macroeconomics is going to go in — that if you want central banks to be responsible for stabilization policy, it’s not enough for them to set the short-term risk-free rate, they need to also control interest rate spreads and the composition of lending, implying. a much more comprehensive set of controls on credit markets.

Under the current regime, the interest rate corresponding to full employment may well be too low for financial stability. (“John Bull can stand many things, but he cannot stand two percent.”) Of course the other way to resolve this contradiction is simply to give up on full employment, and conclude that the only problem with rule by central banks — I also like how clear the OP is that this is the content of the pre -2007 liberal consensus — is that they have been too lenient, keep interests rates “far too low for far too long.” This is the conclusion of e.g. Claudio Borio’s recent BIS working paper. I sketch out some criticisms of this view here, but fundamentally whether it is accepted probably depends on whether chronically higher unemployment is politically sustainable. If it’s not — if we have two, three, many Occupies — then I think a policy turn toward financial repression is almost inevitable.

@ponce:

I suspect I may be riding into a well-laid trap, but…

If interest rates are negative, I’d sit on my money and not lend it to anyone. Not even you.

“@ponce:

I suspect I may be riding into a well-laid trap, but…”

Well, laid…

Hehe, I think we see why their are no famous Australian comedians.

Isn’t anyone who places cash in a bank safe deposit box getting a negative interest rate?

John, three questions:

1) Why are we expected to endorse that the Great Moderation, even sans the subsequent fall, was a consummation devoutly to be wished? It featured lower average GDP and especially real wage growth than the preceding 30-year period. If you have to choose between higher but less stable growth and lower growth with smaller fluctuations, how is it rational to prefer the latter, at least within the parameters we are talking about? The benefits of growth are cumulative, whereas those of “steadiness” are not, at least not directly. The faster growing society will eventually be wealthier even in its troughs than the other is at its peaks. Further, isn’t higher growth what conservative economic actually promised, and lack of fluctuation a goalpost move that occurred after the ball had landed? Perhaps, I’m wrong on this, but I haven’t seen anyone, including you in your book, actually state this or point to articles circa 1980 advocating neoclassical policy as a way to slower but more stable growth and claim that this is desirable. Further, Schumpeter fans would seem to dislike this tradeoff as an encouragement of innovation.

2) Why is the appreciation of asset prices, at least in P/E terms, not inflation like other prices? If we simply stipulate strong EMH – that these prices must accurately reflect discounted future value, as least as well as anything can – I suppose we could say that the apparent inflation measured by current P/E ratios is an illusion, but if that were true, how could there be asset bubbles? If we don’t stipulate that, should not asset inflation be part of what we measure when we measure inflation? In fact, given the liquidity of stock in particular, should not what I am purchasing be considered a claim on short-term earnings, rather than some long run to which I am not committing anyway?

3) If asset inflation is inflation, how much was inflation actually tamed in the 80s and 90s, and how much simply redirected from consumer goods to assets?

problem with most economists is they’re always looking backwards and have yet to get into the current century..

I loved the post, it clarified some things, others I knew, and I agree, sounds consistent with everything I think.

But I wonder if you are using the Keynesian classification in the broadest sense, including the likes of Hicks, Samuelson, and even on perhaps to Krugman, or in the extremely narrow sense of Keynes’ own works, and is the distinction interesting?

Some claim it makes a big difference, that the true Keynesian theory–which I always thought was more of a basic framework and orientation, not a modeling method, but I should really crack the actual book one day–does not lend itself to the kinds of modeling used by Keynes’ followers, including all kinds of equilibrium modeling. Or at least, only a few have figured out ways to do so, and the Hicks IS-LM and perhaps the DSGE being two of them, but both of those being fundamentally flawed. But the larger point being that the assumptions made to permit equilibrium modeling are so outrageous that it’s not surprising their results have little empirical support…and equilibrium modeling itself is fundamentally the wrong approach to study an evolving thing like an economy, true dynamic modeling being the correct approach, and true dynamic modeling is also consistent with Keynes, even more than equilibrium modeling actually. Or at least that’s how I understand the argument or several of them.

Ponce, seems to me if you charge banks for holding excess reserves at the Fed, they’ll hold them somewhere else – but if nothing’s appealing that could be a cash stockpile. I don’t see where that either accomplishes much or says much about economic theory. The Fed could generate negative real interest, of course, by generating more inflation and not letting its interest rate on reserves rise. That should kick out the extra reserves.

An excellent post. But isn’t “expectations” part of DSGE? There is no need to defend Samuelson and Solow by pointing out that “their journal articles included lots of qualifications about expectations”.

What is necessary is to discredit Friedman 1968 — in other words, to provide a better explanation than “expectations” for why the Phillips Curve shifted away from the origin and how we ended up with higher inflation and higher unemployment, both.

One appealing alternative is to return to the view that cost-push forces can and do drive inflation. Appealing, because it is a view from the time before DSGE. Let me try to open a door.

Ponce, I thought we were talking about reserves held at the Fed. I was responding specifically to comment 14. Those are not FDIC insured, but, of course, the Fed is responsible for them, which is even better because the Fed can print money and the FDIC cannot. However, I think commercial banks are capable of better physical security than I am in my closet, not that we are mostly talking about material currency here.

In any case, the fact that it may be possible and desirable to take a minor loss on your money to make its possession more secure doesn’t seem to me to get at the policy issue – if interest rates are close to zero, can you stimulate the economy by lowering them? Is your plan is to get banks to lend rather than hoard money by hiring hoards of Bonnies and Clydes to reduce the physical security for banks of hoarding money, and therefore make them willing to pay to store it securely?

@ Michael Harris

If interest rates can be negative, so can the value of Ponce’s financial wealth. I did warn you about that trap.

Michael, even Switzerland can only get away with charging 0.2% over a year. I think you’ve been undercut!

(Yes yes, I know bond yields and interest rates aren’t the same )

In 1958, almost all wages were paid with cash (officially issued paper and metal currency) but by 1978, almost all was paid by the transfer of credit with privately-owned banks. At some stage in between, bank credit usurped official currency as the predominant medium of exchange. Since then everything has gone pear-shaped as banks first created too much money and then too little. Somehow, we should get back to the scenario of 1958 so that governments can issue just the appropriate quantity of new money and, thereby, enjoy the benefit of seigniorage so that they no longer need to borrow. That will not be with paper and metal currency but with digital cash. The UK nearly got there with the development of the National Giro in the 1970’s but, alas, ………..

3) If asset inflation is inflation, how much was inflation actually tamed in the 80s and 90s, and how much simply redirected from consumer goods to assets?

Right, this is exactly what the Borio piece I linked above argues.

The thing is, unemployment was not especially low in the past three decades and wage growth was almost nonexistent. So if you say that asset bubbles show that policy was too loose on average, you are arguing that unemployment should have been even higher and wages should have fallen.

Rather than trying to construct a single measure of inflation, it would seem better to recognize that the interest rate consistent with asset price stability will not in general be the same as the interest rate consistent with full employment and a stable wage share. What we’ve actually gotten is interest rates too low for the former, but too high for the latter. The only solution is to give up on the idea that macroeconomic stabilization can be limited to administering a single price (the overnight interest rate), as the current New Keynesian consensus believes.

JW, glad someone thinks I’m on the right track with this. There seem policy alternatives, though. Things like higher capital gains or Tobin taxes might discourage asset bubbles without requiring higher interest rates. I’ll look over that paper when I get a chance, though, thanks.

JW Mason @ 30

I think the discussion of macroeconomics suffers mightily from being stuck in analytic a priori modeling, when we should be building operational models in our heads. Too often, U.S. macroeconomists talk about targeting interest rates, in the abstract, when, concretely, in most of the post-WWII period in the U.S. that has meant targeting housing (and autos).

We re-write history to feature Friedman lecturing on the natural rate of unemployment and inflationary bias, when Nixon, oil, hitting the global resource ceiling in 1973, and floating exchange rates might have had something to do with it. I look at the instability of the 1970s, and I see an impasse on income distribution, which is resolved, as we know, decisively, in favor of capital.

It seems to me that a policy of asset inflation had a lot to do, initially, with the decision to import oil and to pay for it with financial paper, instead of manufactured goods, creating a need to recycle petrodollars, and a knock-on requirement — if we were not going to simply sell the whole country to oil sultans — to inflate U.S. asset prices.

The misplaced abstraction, which “explains” macro as disembodied interest rate targeting has a correspondence in the fetish for explaining international trade and exchange rates with “price level” (as if there even could be such a thing!). (I admired Josh’s post on his own blog taking Krugman to task for endorsing the idea that the European peripheral countries were being put under deflationary pressure to adjust trade goods prices toward “balance”.)

The U.S. has been “supplying” a money (not money, “a money” — nominally zero-risk debt securities) to finance the development of China. We talk about the “housing bubble” as if it were some psychological curiosity, like Tulip Mania, with no apparent understanding of how it related to the need of China for U.S. treasuries, a need that was supplied by mortgage-backed securities. (And, the loop back from investment in manufacturing in China that left the Great Lakes a Rust Bowl, while Manhatten glistened?)

It may be that it is politically impossible to speak plainly about policy in a country that still has at least the form of democratic governance, and to do policy of the sort pushed by the neoliberals. That alone would seem to be reason enough to try to speak plainly and concretely.

In the 1960s, Davidson, Kaldor, Kalecki, Robinson, and Weintraub were all mainstream macroeconomists. Economics went bad when economists at, say, MIT and Yale starting ignoring these economists and taking seriously economists following on Friedman and Lucas. (Robinson did help forwarding her brand of economics at Cambridge by feuding with Kaldor.)

These are sociological observations. Why economics took this turn might have something to do with Bruce Wilder’s observations in 33.

bloggers in general, and perhaps at CT, often like to complain that the mainstream media will cherry pick among opinons and experts, often showcasing inflammatory views that represent a tiny minority of experts

Re JW:

“Rather than trying to construct a single measure of inflation, it would seem better to recognize that the interest rate consistent with asset price stability will not in general be the same as the interest rate consistent with full employment and a stable wage share. ”

ISTM, a single measure of inflation is a good idea, insofar as inflation intended to measure changes in the value of money. And that measure should include assets, as they are a non-trivial portion of what money is spent to purchase. Cost of living is a somewhat different matter. What you’re saying about the interest rate, though, holds I think only if you believe the interest rate is the philosopher’s stone that can transform all substances, which has been the prevailing notion. I think that is your actual point – not that there is a problem with the concept of inflation, but that juicing the interest rate is insufficient for management. Even there, though, we should note that the transfer of inflation to assets seemed to have something to do with such things as capital gains tax cuts and financial deregulation – policy changes that are not concerned with the interest rate per se.

@39:

Inflation should not include investment assets because investment is only used as a tool to push back ultimate consumption. Long-dated, durable assets are “consumed” only as they are depreciated and as they need to be repaired. Using an asset price as a proxy for this consumption makes little sense since that unnecessarily brings real interest rates and possible bubbles into the picture.

And keeping the purchasing power of money at somewhat constant path is very beneficial to investors. Real interest rates may go up or go down overtime, but if investors and borrowers know the expected inflation ahead of time, neither will suddenly have more real wealth transferred from them.

It is also false to say that inflation can’t be zero because of the zero-lower-bound. The reason has nothing to do with interest rates at all. NGDP is the real cause of the ills normally attributed to low inflation. Firms do not lay off people because prices are not increasing, but because revenues are not increasing. A lower price but higher revenues per worker keeps lay offs from happening as much as higher prices causing higher revenues per worker.

Finally, as far as “asset inflation” in general, assets do become inflated as real interest rates go down. If inflation and NGDP to up at constant rates, and capital earns a constant percentage of NGDP, lower inflation rates will increase the price of equities and of previously issued fixed-rate bonds. But new buyers of equities or debt actually earn smaller refurns once they sell those equities or the fixed-rate bonds hit maturity. I don’t get the idea that the rentier class does better when real interest rates to down. It’s exactly the opposite over the long-term.

As a policy goal, constant real interest rates seem extremely appealing, especially to those already rich. But that’s incompatible with a goal of NGDP rising fast enough to prevent unemployment. The real interest rate required to achieve that will go up or down based on the appetite for saving. The possibility that it will go down is something that buyers of equities or variable-rate bonds will need to take into account.

Nor does asset inflation = bubbles. Asset inflation from a decrease in interest rates is completely different than appreciation to prices with a negative NPV. That’s on asset buyers to not buy assets with negative NPV, while regulation can help make some markets more efficient than they would be without regulation.

May I suggest that you and Gordon are both correct? Two good analyses, imho. Seems like things slowly went awry with the misuse of the Phillips curve, and the reaction by the late-1970s was (being polite here) less-than-optimal. The latter, made possible by the former, was a greater disaster for the academic field, policymakers, and people.

@52

A lot of workers get fired for reasons that have nothing to do with whether the company they work for is profitable or not.

@52,

The issue is that some workers do become more productive and some workers become less productive. If revenue growth is 5%, then these workers could get raises of 7% and 3%. If it’s zero, the firm still has to give the productive worker a 2% raise to keep them from going to other firms. To keep from having a loss, either the unproductive workers see their wages cut 2% or 2% of them get laid off.

BTW, I’m not sure of the decline in NGDP from peak to trough, but it wasn’t just flat from 2008 to 2009. It was fairly flat 2001 to 2003 which was why that was such a slow recovery, but it actually declined dramatically from 2008 to 2009. You had to either become much more productive or you had a chance of getting laid off.

Why do workers, particularly in developed countries where they can lead a dignified life, have to earn more year after year?

I’m not sure the guy without legs who sells M&M’s on my street corner is what you would call leading a dignified life (in the sense you mean).

Look around you. Much of America 2nd world at best.

” Neither do I understand the argument that Americans had to go into debt because they always have to consume more even when wages are not going up.”

Well of course the simple answer is that Americans did not “have to” go into debt. But this returns us to the various points I made in the last thread, about things that could not happen again. The epic transformation in people’s lives occurred between 1850 and 1950 (or if you want to stretch it. between about 1750 and 1985). It was in this period that the TV, the radio, the washing machine, the home computer, the vacuum cleaner, the car, etc etc etc the average house in 1985 is more or less identical to the average house now (the only exception being the increased prevalence of mobile phones and the fact that the home computer now is likely to be networked).

But, once invented these things could not be reinvented Good for consumers…not so good for capitalists. So what was to be done? Two options presented themselves: 1; the deliberate spreading of the ideology of conspicuous consumption via advertising and 2; planned obselescence of consumer problems.

One further problem presented itself. The “golden age of capitalism” (roughly 1945-1967) had been “funded” so to speak, via strong trade unions, leading to rapidly increased consumption power, and the rest of the social democratic-Keynesian framework. But this had led to workers being “uppity” and demanding more gruel….an inevitable consequence of growth given that workers were no longer frightened by unemployment. Therefore the power of organised labour and the social democratic-Keynesian framework would have to be destroyed, high unemployment reintroduced etc. etc. etc. This of course was “Thatcherism”.

But then you have a problem. With declining real wages how are you to sell your products? This had not been a problem in the period 1800-1945 because the products that capitalists were selling really were products people needed (washing machines etc.) and also because overall capitalist economies grew. And it had been assumed that this would always be the case.

But it seems that possibly this is wrong. It seems (and this could be wrong) that capitalist economies grow and grow and grow….and then they stop growing, at least at the same rate. Certainly the only high growth countries at the moment are relatively poor countries that are playing “catch up” to the West. For the last 20 years low or no growth has been the norm for the most advanced Western capitalist economies. And since the internet in the mid 1990s there have been few new products that consumers really need. So consumers can’t afford to pay for new products which in any case they don’t really need. Planned obselescence and the ideology of consumption can take care of the “need” part of the equation but households still can’t afford to buy the products.

The only possible solution: Debt and lots of it. Get consumers into debt and you can now persuade them to buy your products. Also you now have control of them…what we have seen in recent years is a form of neo-Feudalism in which people live their entire lives in debt. essentially controlled by the financial centre of the economy.

The problem is when consumers “max out” on their credit cards and the economy stagnates and that is where we are now.

https://en.wikipedia.org/wiki/Conspicuous_consumption

https://en.wikipedia.org/wiki/Keeping_up_with_the_Joneses

https://en.wikipedia.org/wiki/Planned_obsolescence

Hidari,

Yes! – and worth reading twice ;-)

@62 Yes. A better way of putting it would be “make credit (debt) available and consumers can now delude themselves that they can afford to buy the products they don’t really need.”

Remember George Carlin?

“Buying things you don’t need with money you don’t have.
Buying things you don’t need with money you don’t have.
That’s the American dream…so called ‘cos when you wake up you realise it’s not real. “

Matt, assets are not limited to durable assets. Stock and residential real estate seem the largest asset classes and neither has a fixed value that simply depreciates. Indeed, since real estate is fundamentally land (and affixed material) and the largest component of its value is location, and stock does not get worn out, neither of these can be said fundamentally to be consumed by depreciation.

What is inflation intended to measure? The cost of living? Does that definition make sense in the context of monetary policy? After all, technological change can change the cost of living, but is not directly a function of monetary policy. When we say that expanding the money supply causes inflation, we mean that it causes the value of money to fall. What value? Its value relative to the various things for which it is exchanged. But of course the relative values of these various things to one another also change constantly. So it has to mean some average of all of them. Assets are one of the things for which money is exchanged, so they belong in the basket of things used to determine the purchasing power of money. Deliberately excluding bubbles is perverse. Bubbles are rapid increases in price, and how is a definition of inflation that excludes them not ignoring precisely what it is supposed to measure? True, a bubble in some asset does not imply that all other prices are going up, but no change in any price implies that all prices are going up – that is why you need a comprehensive or at least well-distributed sample of the various things money can buy to determine inflation.

Your next paragraph leaps without transition into prescriptions, rather suggesting that your normative positions are mixed into your analysis.

I’ve heard of a liberal being defined as a man who doesn’t take his own side in a knife fight, but a radical leftist who doesn’t take their own side in the class struggle?

Matt Waters@55

the firm still has to give the productive worker a 2% raise to keep them from going to other firms. To keep from having a loss, either the unproductive workers see their wages cut 2% or 2% of them get laid off.

There are very few workers whose productivity can be measured with such preciseness. What exactly would you measure to determine that a doctor, a teacher, or a programer’s productivity went up or down by exactly 2%? How does this fit in with women, ugly, fat, and darker skinned people earning less for the same work? The impact of family and networking? How do workers know that another firm is paying 2% more and that there is an opening? What if it is farther away and people are not as nice?

Firms do not need to grow in order to not lay off workers. They can easily stay the same size.

Alex@66

Productivity growth is a thing. Having noted that, the conclusion that follows is that the alternative to workers getting the benefits of it is capital getting the benefits.

How can the workers in a bakery become more productive? Will someone discover that it is not necessary to knead the dough as long? Will it rise faster? Will it take less time to bake? Once a business determines an efficient way to produce a good given quantity and quality of the product, we cannot assume that it will be made more efficient by 2% the next year. And another 2% the next. And then again. Forever.

Then there are millions of civil servants. When one or a group of them become more productive and do not get a wage increase, no capitalist will receive any benefit from it.

Wages do not need to grow year after year after year.

SusanC@68

I’ve heard it said (particularly in the high tech industry) that a shareholder demand for unachievable levels of growth can be a real problem.

Indeed. Then there was a time when firms that had existed for decades productively fulfilling a need had to grow in order to avoid a hostile takeover. Now, the US has to grow in order to cover ballooning interest payments without decreasing its standard of living too much or cutting military spending. But where will this growth come from? Will agriculture that already relies on a workforce of semi-literate, foreign peasants return to slavery? Will Americans eat more? Will university football coaches earn more? Will algebra teachers get their students to crack more polynomials? What are the growth options for prosperous nations with mature economies and little or no population growth other than bubbles and dodgy statistics?

I think the real question is, can capitalism survive without growth?

@69

“Now, the US has to grow in order to cover ballooning interest payments”

The US needs to keep interest rates near zero to avoid ballooning interest payments.

Interest payments are quite manageable now:
http://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

Which interest rates are going to be kept near zero?

Contrary to the imaginings of our macroeconomists, there is more than one interest rate. And, some people make a business out of borrowing at one rate and lending at another rate.

And, for how long will some interest rates be kept near zero?

And, with what effects on the dynamics of the economy?

@73

As far as debt payments go, the important interest rate to keep as low as possible is the rate the U.S. government has to offer on its debt to sell it.

lupita

I think the real question is, can capitalism survive without growth?

Precisely. However few economists see the issues in these terms.

A capitalist system without growth would need to obtain capitalist profit internally ie by expropriating workers (of standard of living and leisure) and expropriating smaller capitalists in a blatantly Marxist scenario.

A capitalist system with growth destroys the environment, overpopulates urban and rural centres, and obtains profits through passing problems onto future generations.

Under socialism, normal profits are obtainable internally without expropriating and without needing continually expanding markets and resources. Under socialism growth is represented by higher quality, not more quantity, and some of the quality can appear as more leisure.

A thought that occurs to me reading this thread as a non-economist… formulations of Say’s Law tend to ignore the time-shifting aspect of money: that we sometimes sell goods or services now in order to buy them later, using money as the means of storage. A general glut in the present can be matched by a shortage in the future (or people’s expectation of the future): if everyone wants to exchange things they’re producing now for things they want to consume later, the flows don’t balance and you can’t sell the current production.

And, possibly related: if the total production capacity is declining, and you can’t have negative interest rates because people can just stuff banknotes under the mattress, then inflation seems inevitable: in the future, the same amount of money will be chasing fewer goods. (Unless the government deploys other ways to destroy money, such as burning the money it receives in taxes).

Bruce Wilder

The stable core of capitalism is that ceteris paribus capital gets a profit at the same (or increasing) rate year after year.

Not too difficult?

Maybe not difficult to type; difficult to understand or confirm, though. What work is ceteris paribus doing? Where and when in the 300-year history of the modern capitalist economy and industrial revolution has capital reliably gotten an ever-increasing “profit”?

Conventional neoclassical economic theory asserts that, as a market economy approaches equilibrium, economic profit approaches zero. The sunk cost nature of most capital investment in dedicated organization and equipment means that returns to capital are always risky and subject to competitive erosion. So, at least according to its own ideology, profit should, in the long-run, be declining in a “capitalist” system.

So, I remain confused by claims to the contrary, and regarding an alleged essential nature of the beast, to be distinguished for other beasts, such as reified “socialism”.

SusanC @ 79

Exactly right.

Money, as currency and in its various extended forms as financial instruments, would seem to be a key explanator for why the macro-economy is not self-stabilizing, without institutions to stabilize it, including institutions to competently manage (a fiat) money.

Why, exactly, economists feel compelled to keep abstracting away from money in analysis of the macro-economy’s functioning is a great puzzlement. Moving on from this simple, basic and seemingly long understood point, though, appears extremely difficult for those tasked to do the moving on.

And, to reinforce your second insight, yes, some rate of positive inflation will characterize any competently managed system of money. It is absolutely necessary to maintain pressure in the system of flows.

Chris Warren:

You need a rigorous definition of capitalism to properly understand it

A capitalist system . . . overpopulates urban and rural centres

The stable core of capitalism is that ceteris paribus capital gets a profit at the same (or increasing) rate year after year.

A capitalist system . . . obtains profits through passing problems onto future generations.

You are not making points in a clear fashion. (This is clearly not a productive exchange, and I will stop now.)

@84

“Startup ventures being funded by kickstarters are not necessarily capitalists.”

Or maybe modern capitalists are more interested in funding something cool than funding something profitable.

Martin @ 15 wrote:

“If you have to choose between higher but less stable growth and lower growth with smaller fluctuations, how is it rational to prefer the latter, at least within the parameters we are talking about? The benefits of growth are cumulative, whereas those of “steadiness” are not, at least not directly. The faster growing society will eventually be wealthier even in its troughs than the other is at its peaks.”

It is rational because we care about individuals, not just about aggregates. In practice, the down side of fluctuations see some individuals lose their jobs and possibly have their entire lives blighted. It is known that the state of the economy the year someone enters the job market, say after college graduation, can have very long-lasting effects on their careers. In other words, the losses to those caught on the down side are cumulative. The added benefits to the lucky do not make up for the ill effects on the unlucky.

Even if in some sense they did, reduction of uncertainty has a positive value. People value a certain amount of loss avoidance more than they do a corresponding gain. Tversky and Kahneman established this a long time ago.

@69,

The numbers were just to show a point. The math has to work, one way or another, for firms with flat revenues. Can the firm just freeze all salaries and hiring? Of course, but more likely for a larger company is some divisions are doing well and others are doing poorly.

This is especially true if you extrapolate the example out to the whole economy. If total income, or NGDP, is kept flat, then a sector doing well and increasing revenue must have a sector with decreasing revenue. If the attrition of the sector is less than the decline in revenue, there must be lay-offs assuming wages are sticky.

Martin, you might find this chart useful:
http://3.bp.blogspot.com/-frc0NNmMPGA/UObdEiRgG6I/AAAAAAAAXRs/rIHTNbKGOdo/s1600/EmployRecDec2012.jpg

Agree with Charles Peterson @19. Equilibrium analysis is always a definite error in economics.

In reply to my comment @91 Martin @ 92 wrote:

“f we’re going to talk about stability in the life of the average person, we have to acknowledge that the Great Moderation was a period where…” followed by a list of things that disrupted peoples’ lives during that period.

“The notion that the period from the 80s to the present feature greater economic stability is the life of the average person than the late 40s, 50s, and 60s is absurd.”

I did not make such a claim. My comment was simply about aggregate stability vs higher growth ceteris paribus. While not perhaps mathematically inevitable, I do think that in fact higher aggregate instability will usually result in greater average instability in the lives of individuals. The list of factors other than aggregate instability that could and did disrupt people’s lives is largely correct but irrelevant.

In other words, gross aggregate fluctuations during the actual Great Moderation would have made the disruptions in the lives of ordinary people even worse than the noted factors actually did make them.

Accidentally posted before finished. Continuing:

2) Broader participation in equities through 401K and such vehicles replacing defined-benefit pensions.
3) Less progressive taxation and lower capital gains taxes increasing returns to capitla.
4) Financial deregulation.

Among others. Not is the least coincidentally, these are also many of the same policies that caused so much disruption in the lives of individuals. So “ceteris parabis” comparisons are absurd, as the putative stability you endorse has the same causes as the instability you seek to rule out of the discussion. Further, the Great Moderation is a claim about recessions as measured by GDP growth. You leaped straight from that to the pain of unemployment. But the Great Moderation did not provide greater stability measured by that variable, as the chart Ponce linked illustrated.

P.S. A corrolory of JVB’s law is that given accounting identities (as identified for instance by MMT advocates) – is that in the presence of persistant trade deficits, it is necessary for governments to run deficits in order to protect private sector balance sheets (although it would be better to avoid persistant trade deficits).

“The error this time around wasn’t a lack of stimulus but interest rates which stayed non-negative, because no government let banks go under and depositors to lose their money.”

?????

This time was not worse. And a probability of losing your money, is not the same thing as a certainty of losing your money. In the depression the failure of banks encouraged depositors to withdraw their money – which is a beggar thy neighbour strategy because it ensures others WILL lose their money. It didn’t encourage those with money under their mattress to spend it – in fact the reverse.

Why should I not regard you as a crank?