It’s Hard Being a Bear (Part Six)?Good Alternative Theory?

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If the economy does in fact recover from the Global Financial Crisis—without private debt levels once again rising relative to GDP—then my approach to economics will be proven wrong.

But this won't prove conventional neoclassical economic theory right, because, for very different reasons to those that I put forward, modern neoclassical economics argues that the government policy to improve the economy is ineffective. The success of a government rescue would thus contradict neoclassical economics just as much—or maybe even more—than it would contradict my analysis.

The actual reasons for this belief are arcane, but this choice quote from leading neoclassicals Thomas Sargent and Neil Wallace puts the dominant neoclassical case in a nutshell:

In this system, there is no sense in which the authority has the option to conduct countercyclical policy. To exploit the Phillips Curve [a relationship between unemployment and inflation], it must somehow trick the public. But by virtue of the assumption that expectations are rational, there is no feedback rule that the authority can employ and expect to be able systematically to fool the public. This means that the authority cannot expect to exploit the Phillips Curve even for one period. Thus, combining the natural rate hypothesis with the assumption that expectations are rational transforms the former from a curiosity with perhaps remote policy implications into an hypothesis with immediate and drastic implications about the feasibility of pursuing countercyclical policy.’ ("Rational Expectations And The Theory Of Economic Policy", Journal of Monetary Economics, Vol. 2 (1976) pp. 177-78; emphases added)

The neoclassical confidence that the government can’t beneficially affect the economy is thus based on the insane assumption of “rational agents” who live in a world that is permanently in equilibrium, and whose expectations about the future are accurate—something that Ross Gittins’s recent column did a good job of critiquing. The real world is inhabited by real, fallible human beings, who are prone to bouts of irrational exuberance, susceptible to Ponzi Schemes disguised as investment, and who live in a world in permanent disequilibrium and with an uncertain future, in which their expectations are almost always wrong. They are therefore incapable of predicting and therefore neutralizing the impact of government policy, as neoclassical theory assumes that “rational agents” do.

There are other strands in neoclassical theory that argue there is some role for the government in controlling the economy—notably the so-called Taylor Rule which argues that the Central Bank can control the economy by fine tuning the interest rate. Taylor himself is arguing that deviation from his rule—when the Federal Reserve under Greenspan held interest rates at near zero after the burst of the DotCom bubble in 2000 – is what caused the crisis. I disagree, but that’s a topic for a later day.

The general proposition remains that in its overall bias, neoclassical theory argues that the government can’t beneficially influence the economy—and therefore that if there is a genuine, sustainable recovery as a consequence of the government stimulus packages, that contradicts neoclassical economics even more than it would contradict my approach.

That means that if there is a “winning” economic theory out there, then it must be one that argues that government action alone can help an economy recover from a crisis, and indeed maintain output growth at a level that will maintain full employment.

There is one “neoclassical” theory that argues this, which most economists—reflecting their non-existent training in the history of their own discipline—actually think is Keynesian. This is the so-called “IS-LM” model, which argues that the government can manipulate employment via fiscal policy. Neoclassicals are likely to retreat to this model—and declare themselves “Born Again Keynesians” in the process—without realizing that the originator of this model, John Hicks, rejected it on very sound grounds almost 30 years ago.

Hicks realized that his model attempts to represent the economy using just two markets—goods and money—when there is of course another important market: that for labour. He omitted the labour market from his model on the basis of what neoclassical economists call “Walras’ Law”. This is the proposition that, if all but one market in an economy are in equilibrium, then that final market must also be in equilibrium.[1]

Writing in 1979 in the non-orthodox Journal of Post Keynesian Economics, Hicks realized this flaw (and several others) in this logic: it can apply only when the economy is in equilibrium—when both the goods market AND the money market are in balance. That, in terms of the model, is where the two curves cross. But the model is used to simulate what is supposed to happen when one or both markets are not in equilibrium, or when one curve—normally the IS curve—is shifted by deliberate government policy, such as running a deficit during an economic crisis. Therefore it is used to try to describe what happens in disequilibrium.

But in disequilibrium—anywhere on the diagram apart from where the two curves cross—Walras’ Law can’t be used to ignore what’s happening in the labour market. So even working from Hicks’s model, neoclassical economists would need to consider disequilibrium dynamics of 3 or more markets. Hicks damningly concluded that:

the only way in which IS-LM analysis usefully survives - as anything more than a classroom gadget, to be superseded, later on, by something better - is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. (Hicks, J. 1981, 'IS-LM: An Explanation', Journal of Post Keynesian Economics, vol. 3, no. 2, p. 152; my emphasis)

Yet as Gittins pointed out, and as Paul Krugman himself recently confirmed, neoclassical economists are so obsessed with equilibrium methods that they will shy away from thinking in disequilibrium terms. As Krugman put it, right after critiquing neoclassical economics for being braindead, “I, for one, am not going to banish maximization-and-equilibrium from my toolbox”.

I'm sorry Paul, but stick with those tools and you'll never come to grips with Minsky's Financial Instability Hypothesis, let alone the actual dis­e­qui­lib­rium dynam­ics of the real economy.

So there is no coher­ent neo­clas­si­cal the­ory that can take solace from the suc­cess of the gov­ern­ment stim­u­lus pack­ages, should they avert a deep reces­sion and cause a sus­tained recov­ery with­out a rise in the pri­vate debt to GDP ratio.[2] If there is to be a win­ner in this debate, it has to be a non-neoclassical school of thought.

There is such a school of thought which has devel­oped in Post Key­ne­sian lit­er­a­ture recently. Known as Char­tal­ism, it argues that the gov­ern­ment can and should main­tain deficits to ensure full employment.

Char­tal­ism rejects neo­clas­si­cal eco­nom­ics, as I do. How­ever it takes a very dif­fer­ent approach to ana­lyz­ing the mon­e­tary sys­tem, putting the empha­sis upon gov­ern­ment money cre­ation whereas I focus upon pri­vate credit cre­ation. It is there­fore in one sense a rival approach to the “Cir­cuitist” School which I see myself as part of. But it could also be that both groups are right, as in the para­ble of the blind men and the ele­phant: we’ve got hold of the same ani­mal, but since one of us has a leg and the other a trunk, we think we’re hold­ing on to vastly dif­fer­ent creatures.

That said, I do have numer­ous issues with the Char­tal­ist approach, but I haven’t stud­ied its lit­er­a­ture closely enough yet to write a cri­tique. [3] I also could have dis­torted their argu­ments if I had attempted a sum­mary of their views. So what I decided instead to do is to ask a lead­ing Char­tal­ist, Pro­fes­sor Bill Mitchell from the Uni­ver­sity of New­cas­tle, to write a pré­cis of the Char­tal­ist argu­ment (Bill also has a blog on this approach to economics).

This pré­cis fol­lows. I empha­sise in clos­ing my own com­ments that, if there is a gen­uine recov­ery not involv­ing ris­ing pri­vate debt to GDP lev­els, then Char­tal­ism is the only the­ory left stand­ing. Neo­clas­si­cal eco­nom­ics is dead.

The fun­da­men­tal prin­ci­ples of mod­ern mon­e­tary eco­nom­ics, By Bill Mitchell, Pro­fes­sor of Eco­nom­ics, Uni­ver­sity of Newcastle

The fol­low­ing dis­cus­sion out­lines the macro­eco­nomic prin­ci­ples under­pin­ning mod­ern mon­e­tary the­ory (some­times referred to as Chartalism).

The mod­ern mon­e­tary sys­tem is char­ac­terised by a float­ing exchange rate (so mon­e­tary pol­icy is freed from the need to defend for­eign exchange reserves) and the monop­oly pro­vi­sion of fiat cur­rency. The monop­o­list is the national gov­ern­ment. Most coun­tries now oper­ate mon­e­tary sys­tems that have these characteristics.

Under a fiat cur­rency sys­tem, the mon­e­tary unit defined by the gov­ern­ment has no intrin­sic worth. It can­not be legally con­verted by gov­ern­ment, for exam­ple, into gold as it was under the gold stan­dard. The via­bil­ity of the fiat cur­rency is ensured by the fact that it is the only unit which is accept­able for pay­ment of taxes and other finan­cial demands of the government.

The anal­ogy that main­stream macro­eco­nom­ics draws between pri­vate house­hold bud­gets and the national gov­ern­ment bud­get is thus false. House­holds, the users of the cur­rency, must finance their spend­ing prior to the fact. How­ever, gov­ern­ment, as the issuer of the cur­rency, must spend first (credit pri­vate bank accounts) before it can sub­se­quently tax (debit pri­vate accounts). Gov­ern­ment spend­ing is there­fore the source of the funds the pri­vate sec­tor requires to pay its taxes and to net save, and it is not inher­ently rev­enue constrained.

So state­ments such as “the fed­eral gov­ern­ment is spend­ing tax­pay­ers’ funds” are totally inap­plic­a­ble to oper­a­tional real­ity of our mon­e­tary sys­tem. Tax­a­tion acts to with­draw spend­ing power from the pri­vate sec­tor but does not pro­vide any extra finan­cial capac­ity for pub­lic spending.

As a mat­ter of national account­ing, the fed­eral gov­ern­ment deficit (sur­plus) equals the non-government sur­plus (deficit). In aggre­gate, there can be no net sav­ings of finan­cial assets of the non-government sec­tor with­out cumu­la­tive gov­ern­ment deficit spend­ing. The fed­eral gov­ern­ment via net spend­ing (deficits) is the only entity that can pro­vide the non-government sec­tor with net finan­cial assets (net sav­ings) and thereby simul­ta­ne­ously accom­mo­date any net desire to save and hence elim­i­nate unem­ploy­ment. Addi­tion­ally, and con­trary to main­stream eco­nomic rhetoric, the sys­tem­atic pur­suit of gov­ern­ment bud­get sur­pluses is nec­es­sar­ily man­i­fested as sys­tem­atic declines in pri­vate sec­tor savings.

We often read that the appro­pri­ate fis­cal stance is to bal­ance the fed­eral bud­get over the busi­ness cycle. Some econ­o­mists claim the goals should be to run a sur­plus on aver­age over the cycle allow­ing for deficits in extreme down­turns. Both goals would be fis­cally irre­spon­si­ble in Australia’s sit­u­a­tion where our cur­rent account is typ­i­cally in deficit. If the gov­ern­ment bal­anced the bud­get on aver­age and the cur­rent account deficit was in deficit over the busi­ness cycle then the pri­vate domes­tic sec­tor would on aver­age be in deficit (dis-saving) over that cycle. The decreas­ing lev­els of net pri­vate sav­ings financ­ing the gov­ern­ment sur­plus increas­ingly lever­age the pri­vate sec­tor. The dete­ri­o­rat­ing debt to income ratios which result will even­tu­ally see the sys­tem suc­cumb to ongo­ing demand-draining fis­cal drag through a slow-down in real activity.

In other words, adopt­ing a growth strat­egy that relies on increas­ingly lever­ag­ing the pri­vate sec­tor is unsus­tain­able. The only way the pri­vate domes­tic sec­tor can save if there is a cur­rent account deficit is for the gov­ern­ment sec­tor to run deficits up to the desired pri­vate sav­ing. Gov­ern­ment deficits “finance” pri­vate sav­ing by ensur­ing that aggre­gate spend­ing is suf­fi­cient to gen­er­ate the level of out­put and income that will bring forth the pri­vate desired sav­ing levels.

Unem­ploy­ment occurs when net gov­ern­ment spend­ing is too low. As a mat­ter of account­ing, for aggre­gate out­put to be sold, total spend­ing must equal total income (whether actual income gen­er­ated in pro­duc­tion is fully spent or not each period). Invol­un­tary unem­ploy­ment is idle labour unable to find a buyer at the cur­rent money wage. In the absence of gov­ern­ment spend­ing, unem­ploy­ment arises when the pri­vate sec­tor, in aggre­gate, desires to spend less of the mon­e­tary unit of account than it earns. Nom­i­nal (or real) wage cuts per se do not clear the labour mar­ket, unless they some­how elim­i­nate the pri­vate sec­tor desire to net save and increase spend­ing. Thus, unem­ploy­ment occurs when net gov­ern­ment spend­ing is too low to accom­mo­date the need to pay taxes and the desire to net save.

How large should the deficit be? To achieve full employ­ment net gov­ern­ment spend­ing has to be equal to the non-government desire to net save to ensure there is no aggre­gate demand gap. Unlike the main­stream rhetoric, insol­vency is never an issue with deficits. The only dan­ger with fis­cal pol­icy is infla­tion which would arise if the gov­ern­ment pushed nom­i­nal spend­ing growth above the real capac­ity of the econ­omy to absorb it.

If gov­ern­ments are not rev­enue con­strained why do they bor­row? We have to dif­fer­en­ti­ate vol­un­tary con­straints gov­ern­ments impose on them­selves (which reflect ide­o­log­i­cal dis­po­si­tions) from the under­ly­ing mechan­ics of the bank­ing sys­tem in a fiat mon­e­tary system.

In terms of the lat­ter, while the fed­eral gov­ern­ment is not finan­cially con­strained it still might issue debt to con­trol its liq­uid­ity impacts on the pri­vate sec­tor. Gov­ern­ment spend­ing and pur­chases of gov­ern­ment bonds by the cen­tral bank add liq­uid­ity, while tax­a­tion and sales of gov­ern­ment secu­ri­ties drain pri­vate liq­uid­ity. These trans­ac­tions influ­ence the cash posi­tion of the sys­tem on a daily basis and on any one day they can result in a sys­tem sur­plus (deficit) due to the out­flow of funds from the offi­cial sec­tor being above (below) the funds inflow to the offi­cial sec­tor. The sys­tem cash posi­tion has cru­cial impli­ca­tions for the cen­tral bank, which tar­gets the level of short-term inter­est rates as its mon­e­tary pol­icy posi­tion. Bud­get deficits result in system-wide sur­pluses (excess bank reserves).

Com­pe­ti­tion between the com­mer­cial banks to cre­ate bet­ter earn­ing oppor­tu­ni­ties on the sur­plus reserves then puts down­ward pres­sure on the cash rate (as they try to off-load the excess reserves in the overnight inter­bank mar­ket). So bud­get deficits actu­ally put down­ward pres­sure on short-term inter­est rates which is con­trary to all the claims made by main­stream economics.

If the cen­tral bank desires to main­tain the cur­rent pos­i­tive tar­get cash rate then it must drain this sur­plus liq­uid­ity by sell­ing gov­ern­ment debt. In other words, gov­ern­ment debt func­tions as inter­est rate sup­port via the main­te­nance of desired reserve lev­els in the com­mer­cial bank­ing sys­tem and not as a source of funds to finance gov­ern­ment spending.

How­ever, the cen­tral bank could equally just pay the com­mer­cial banks the tar­get rate of inter­est on all overnight reserves which would achieve the same end with­out the need to issue debt. So there is no intrin­sic rea­son for a sov­er­eign gov­ern­ment to bor­row to “finance” its net spending.

The real­ity is, how­ever, that the neo-liberal era has forced the gov­ern­ments to adopt vol­un­tary con­straints on its fis­cal activ­ity which are tan­ta­mount to those that oper­ated dur­ing the gold stan­dard period.

So the fed­eral gov­ern­ment now issues debt to the pri­vate mar­kets via an auc­tion sys­tem $-for-$ with net gov­ern­ment spend­ing (deficits). This allegedly imposes “fis­cal dis­ci­pline” on the gov­ern­ment (it is totally unnec­es­sary from a finan­cial per­spec­tive) because the ris­ing debt becomes a polit­i­cal issue. In con­clu­sion, much of the deficit-debt hys­te­ria that defines the cur­rent macro­eco­nomic debate is based on false premises about the way the mon­e­tary sys­tem oper­ates and the finan­cial con­straints on gov­ern­ment spending.

Mod­ern mon­e­tary the­ory pro­vides a sound basis for under­stand­ing the intrin­sic oppor­tu­ni­ties avail­able to gov­ern­ments in a fiat mon­e­tary sys­tem and exposes most of the con­straints that are imposed on the con­duct of fis­cal pol­icy as being of an ide­o­log­i­cal origin.

[1] I reject this argu­ment, but again that’s a story for another day.

[2] There is one Neo­clas­si­cal School that Krug­man believes is val­i­dated by the suc­cess of the stim­u­lus pack­ages, so called New Key­ne­sian­ism. Yet again I think that’s wrong, and yet again it’s a topic for another day.

[3] This cri­tique by a Span­ish aca­d­e­mic indi­cates that Char­tal­ism is dis­puted within the broad Post Key­ne­sian school of thought; how­ever I should note that some Char­tal­ists regard this cri­tique as a car­i­ca­ture of their views.

PS if you’d like this essay in PDF for­mat, click here.

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414 Responses to It’s Hard Being a Bear (Part Six)?Good Alternative Theory?

  1. scepticus says:

    Fur­ther to my gov bonds in hor­i­zon­tal deriv­a­tive debt instru­ments ques­tion, it seems that if large amount of the national debt are tied up as deriv­a­tives, that if unwound, this hor­i­zon­tal credit trade would require that all these bonds be bought back by the gov­ern­ment, which would inject a huge amount of liq­uid­ity into the system.

    I won­der, is this what elliot­wave was bang­ing on about?

  2. MMitchell says:


    I apol­o­gise in advance but I am going to take issue with your views in a big way here.

    The idea that peo­ple employed by gov­ern­ment are inclined to slack off and take advan­tage of the pub­lic purse is sim­ply not true. If it was all exist­ing gov­ern­ment ser­vices would be hope­lessly inef­fi­cient. This would be true whether you are employed through a JG or not. You believe that only the pri­vate sec­tor can induce peo­ple to work. What is so dif­fer­ent about the pri­vate sec­tor? These days it is prob­a­bly just as dif­fi­cult to get rid of inef­fi­cient work­ers both cases, and I am sure they exist in the pri­vate sector.

    The beliefs of our dom­i­nant insti­tu­tions on what moti­vates peo­ple is in my view one of the most fun­da­men­tal flaws in our society’s per­spec­tives. This idea that peo­ple will only work if they are rewarded for work­ing and/or pun­ished for not work­ing is total­i­tar­ian. It means all our sys­tems are set up to effec­tively coerce peo­ple into doing things (for reward i.e profit or pun­ish­ment i.e sack­ing) rather than accept­ing that peo­ple may do things for intrin­sic rea­sons. It is a com­plete de-humanisation of peo­ple treat­ing them as objects which are only of use when they are serv­ing the “greater good”.

    Com­monly exam­ples such the USSR expe­ri­ence are given as demon­stra­tions why state employ­ment will always fail. I sus­pect they fail because, like our sys­tem, they do not address the intrin­sic moti­va­tions of peo­ple. Peo­ple will work when they are inter­ested in their work, when their work is seen as mean­ing­ful and pur­pose­ful and they gain recog­ni­tion for their role in this pur­pose­ful activ­ity. Not hav­ing choice in what you do will instantly demo­ti­vate peo­ple from work­ing. You may point to exam­ples of peo­ple in our soci­ety who do not par­tic­i­pate and I will argue that this is not nor­mal for peo­ple (it may occur in rare cases) if this is hap­pen­ing on a large enough scale to mat­ter then I believe it is because people’s past expe­ri­ence in our de-humanised sys­tem has turned them off.

    Increas­ingly in our work places we are see­ing the appli­ca­tion of the ideas that peo­ple can­not be trusted to work with­out either: hav­ing a com­mis­sion or bonus based on per­for­mance (extrin­sic rewards) or: being mea­sured and assessed on every aspect of their work and inter­ro­gated (extrin­sic pun­ish­ment) if they do not meet set tar­gets. Requir­ing peo­ple to focus on this assess­ment process rather than the intrin­sic ben­e­fits of their work demo­ti­vates and dis-engages peo­ple. This atti­tude of mea­sure­ment and assess­ment is a can­cer that is increas­ingly spread­ing through our work and edu­ca­tion sys­tems and the effects, I believe, are an increas­ing dis­sil­lu­sion­ment and in fact, lower per­for­mance in many cases. Not only this, but the pri­vate indus­try incen­tive sys­tem you seem to so esteem does not even work. Reward­ing peo­ple for their per­for­mance leads to them act­ing in ways that lead to those rewards, not nec­es­sar­ily doing a bet­ter job — the Bank­ing col­lapse is an exam­ple of that.

    I am sorry but I think you are sub­scrib­ing to a mis­taken belief set that has been, and is been, indoc­tri­nated into the pop­u­la­tion as it serves exist­ing and emerg­ing total­i­tar­ian seg­ments of our com­mu­nity and is which is prob­a­bly a hang-over from the West’s class-based past.

  3. Philip says:


    This atti­tude of mea­sure­ment and assess­ment is a can­cer that is increas­ingly spread­ing through our work and edu­ca­tion sys­tems and the effects, I believe, are an increas­ing dis­sil­lu­sion­ment and in fact, lower per­for­mance in many cases.”

    I agree. Con­sid­er­ing this, you may well be inter­est­ing a three part doc­u­men­tary series that was released in 2007. It was pro­duced by Adam Cur­tis and is called The Trap: What Hap­pened to Our Dream of Free­dom.

    The pri­mary point of the doc­u­men­tary is that the author­i­tar­ian state man­age­ment of soci­ety is being replaced by the author­i­tar­ian cor­po­rate man­age­ment of society.

    A few well-known econ­o­mists are inter­viewed: John Nash, Friedrich von Hayek, James M. Buchanan, Thomas Schelling, and Philip Mirowski.

    Essen­tially we are being taken off the state road to serf­dom and placed on the pri­vate road to serf­dom — von Hayek would be most pleased.

    …and is which is prob­a­bly a hang-over from the West’s class-based past.”

    This is curi­ous. Under pri­vate cap­i­tal­ism, did class only exist in the past?

  4. MMitchell says:


    Thanks for the link. I agree that dif­fer­ent classes still exist, I am say­ing that many of the same myths are being per­pet­u­ated to sup­port them.

  5. Laurence says:

    Let us assume we have already sailed into unchar­tal­isted water, ie, we have left infla­tion, defla­tion and stagfla­tion and now float­ing in the mid­dle of a dol­lar carry trade spec­u­la­tion. What to do? what to do?

  6. Lyonwiss says:


    I agree with most of your obser­va­tions. On Philip’s com­ment and your remark:

    This atti­tude of mea­sure­ment and assess­ment is a can­cer that is increas­ingly spread­ing through our work and edu­ca­tion sys­tems and the effects, I believe, are an increas­ing dis­sil­lu­sion­ment and in fact, lower per­for­mance in many cases.”

    I have to say that it is not quite accu­rate. I must declare that I’m a Drucker fan: “What gets mea­sured gets man­aged.” The prob­lem with bureau­cracy, whether pub­lic or pri­vate, is that mea­sure­ment is not taken seri­ously; it is used as a polti­cal tool, to bully, to intim­i­date and to sub­ju­gate. The result is pscho­pathic work­places full of dis­en­gaged work­ers. The so-called man­age­ment sci­ence is another con or another scam. We need to mea­sure the measurer.

  7. Philip says:


    Fair enough. I read Drucker’s work in my MBA, and I remem­ber that quote.

  8. MMitchell says:

    The whole area of mea­sure­ment needs a seri­ous re-think.
    The trou­ble is that the things of most value to humans are very dif­fi­cult to mea­sure (eg: healthy liv­ing envi­ron­ments — both socially and phys­i­cally). We can­not per­sist with mea­sures that exclude things such as exter­nal­i­ties for exam­ple. I don’t know the answer to this, but a rev­o­lu­tion in mea­sure­ment the­ory seems nec­es­sary, much like the rev­o­lu­tion needed in eco­nomic think­ing. Per­haps the two are linked. My brother is study­ing account­ing. He says given the inabil­ity of accoun­tants to mea­sure the health of organ­i­sa­tions and their assets (eg: Enron and many since), the whole pro­fes­sion is in ques­tion. With such rev­o­lu­tions in thought human­ity could have a glo­ri­ous future, pro­vided it can sur­vive our emerg­ing crises.

  9. Anthony says:


    way back at *340

    If I try and take the Char­tal­ist approach to its log­i­cal extreme, I first assume that gov­ern­ments can pro­duce infi­nite deficits, Then I assume that due to some inex­plic­a­ble event pri­vate sec­tor employ­ment falls to zero, in this case as I under­stand it gov­ern­ment spend­ing would employ every­one, but not in ways that would com­pete with the (now non-existent) pri­vate sec­tor. This sit­u­a­tion seems con­sis­tent with the fear of com­men­ta­tors here who are wor­ried that the Char­tal­ist approach will lead to big gov­ern­ment and an ero­sion of work ethics. How­ever, I am sure the Char­tal­ists would argue that this could not hap­pen (cor­rect me if I am wrong) as deficit spend­ing should only increase as a response to increased sav­ing there­fore low­ered pri­vate eco­nomic activity.”

    The JG is not the only solu­tion for employ­ment. The JG is a safety net, it’s the last resort. Other ways of employ­ment are non-JG pub­lic employ­ment and pri­vate sec­tor employ­ment. It would be unde­sir­able to have the entire work­force employed under the JG.

    In the event of a large down­turn caus­ing sub­stan­tial pri­vate sec­tor job losses, it is the government’s respon­si­bil­ity to increase its net spend­ing to off­set the demand defi­cien­cies. Poli­cies the gov­ern­ment could under­take include pay­roll tax cuts, infra­struc­ture invest­ment, edu­ca­tional invest­ment, invest­ment in health, expand the JG pool, sub­si­dies, one-off stim­u­lus pay­ments, etc. The deci­sions the gov­ern­ment makes that impact on pub­lic and pri­vate employ­ment is a polit­i­cal decision.

    Both left and right wing gov­ern­ments could achieve full employ­ment with price sta­bil­ity by imple­ment­ing com­pletely dif­fer­ent poli­cies. A left wing gov­ern­ment may decide to abol­ish the sales tax, increase spend­ing on pub­lic edu­ca­tion, pub­lic hos­pi­tals, pub­lic trans­port, pub­lic infra­struc­ture, pub­lic hous­ing, etc. A right wing gov­ern­ment (like the left wing gov­ern­ment, would be run­ning bud­get deficits on aver­age) may decide to cut gov­ern­ment spend­ing and rev­enue, abol­ish the pro­gres­sive income tax­a­tion sys­tem, pay sub­si­dies, pri­va­tise pub­lic hos­pi­tals, pub­lic schools, pub­lic trans­port, and almost all other gov­ern­ment assets, etc. The share of pri­vate (pub­lic) employ­ment would be much higher (lower) for the right (left) wing gov­ern­ment. Mod­ern mon­e­tary the­ory is nei­ther left nor right wing.

    What if the unem­ploy­ment is not due to sav­ing but some struc­tural issue in the econ­omy? Will this sit­u­a­tion be treated the same as an increase in sav­ing by Char­tal­ists? How do you dis­tin­guish the two causes, par­tic­u­larly if they occur simultaneously?”

    Ways to deal with struc­tural unem­ploy­ment include the JG, hav­ing a good edu­ca­tion sys­tem and train­ing pro­grams. No mat­ter how low the level of skills some­one might have, there will be a job avail­able for them through the JG. The JG can be used to pro­vide tai­lored train­ing, edu­ca­tion, skills and work expe­ri­ence. There should be ade­quate edu­ca­tion and train­ing places that are of high qual­ity rel­a­tive to demands for spe­cific skills. Struc­tural unem­ploy­ment can be iden­ti­fied by unfilled job vacan­cies. DEEWR has data on skills short­ages.

    Is there a hid­den assump­tion of 100% employ­ment under ideal con­di­tions? If so what are the process by which this equi­lib­rium is reached?”

    Based on his­tor­i­cal data from Australia’s full employ­ment period from the mid 1940’s to the mid 1970’s, fric­tional unem­ploy­ment is esti­mated to be around 2%. There would be an employ­ment tar­get of approx­i­mately 98% at any time. The unem­ploy­ment rate would remain about 2%, but the JG pool would fluc­tu­ate due to changes in the econ­omy. This has been termed ‘loose full employ­ment’ as the JG pro­vides a non infla­tion­ary alter­na­tive to unem­ploy­ment as a way to deal with inflation.

    Here is an excel­lent paper on the dif­fer­ence between using unem­ploy­ment and the JG to bat­tle infla­tion–01.pdf

    Say for exam­ple we have 10% of peo­ple employed under JG and there was a sud­den rise in the costs of imports allow­ing oppor­tu­ni­ties for new employ­ment in local man­u­fac­tur­ing how would the Char­tal­ist econ­omy respond?”

    The JG pool would decrease. If the extra demand cre­ated from the addi­tional pri­vate sec­tor employ­ment is infla­tion­ary (on top of the higher import prices) than the gov­ern­ment should raise taxes and/or reduce spend­ing. There may be a need for gov­ern­ment inter­ven­tion if there are sup­ply side issues relat­ing to the par­tic­u­lar import com­pet­ing domes­tic indus­try that is expanding.

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  11. Chris says:

    Octo­ber 2nd, 2009 at 12:42 pm

    Let us assume we have already sailed into unchar­tal­isted water, ie, we have left infla­tion, defla­tion and stagfla­tion and now float­ing in the mid­dle of a dol­lar carry trade spec­u­la­tion. What to do? what to do?

    Answer: Ignore Keen, read Marx.

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  13. X 2U says:


    I am not an econ­o­mist, but I worked in invest­ment bank for 15 years in trad­ing and cor­po­rate finance. And I have some abstract think­ing abil­ity from the days when I was trained as a physi­cist before my bank­ing career.

    You said: “Reward­ing peo­ple for their per­for­mance leads to them act­ing in ways that lead to those rewards, not nec­es­sar­ily doing a bet­ter job – the Bank­ing col­lapse is an exam­ple of that. ”

    You are totally right! I can­not agree more, with my own expe­ri­ence. The wall street award­ing sys­tem over the years have pro­duced lit­er­ally armies of “mon­sters”, with NOT a shred of decency, hon­esty, shame or sense of value left in them. You are cheered for mak­ing tons of money, not from pro­duc­ing or cre­at­ing goods, ser­vice or value, but sim­ply rip­ping off some less informed, or most of time mis-informed pen­sion­ers or insur­ers or mid-size bank man­agers. You are padded in the back if you talk pro­fan­ity, puff smokes, whor­ing every chance you got. The worst of all, young recruits, with zero real world expe­ri­ence, got sucked into the cul­ture. I remem­ber clearly how a young trader, from the same bank I worked at, cheated my client with the most out­ra­geous scheme, It was out­ra­geous not because it was elab­o­rate, but rather it was so OBVIOUS and it com­pletely stunned me that he had thought he could get away from this. But truth be told, I had no doubt that when he closed that trade, every­one on the trad­ing floor had big high fives with him for the COURAGE he showed of rip­ping someone’s face off.

    You are so right that an incen­tive sys­tem single-mindedly focused on money does NOT work! I for one has ben­e­fited from that sys­tem, but my con­science tells me that it is wrong. This is not the Amer­ica I came for as a teenager. I came because this is the coun­try where peo­ple have val­ues, hon­esty, fair­ness, respect, all the things I could not find in my moth­er­land. I did NOT come to this coun­try because as long as you make big buck, it doesn’t mat­ter if you are the biggest assh*le

    When Gold­man Sach’s CEO said they are doing God’s work, I really don’t know if I should laugh or cry. I had per­son­ally par­tic­i­pated in the rise of the CDO mar­ket so I know even more than the US gov­ern­ment at the time what was really going on. Gold­man made WRONG bet on AIG. As sim­ple as that. Hank Paul­son, in his excuse of sav­ing AIG, was really sav­ing Gold­man Saches, which surely means his entire life time sav­ings. I can­not believe he threat­ened that if AIG was not saved, tanks would be on the street! They are cow­ards!!!!!!! When they rip some­one off, they told the loser “hey take it, you made the wrong bet! That is the way it is!”. But when they made the wrong bet, they had no shame get­ting them­selves off the hook with their con­tacts in high power places. I guess that when some­one makes obscene amount of money, not through cre­at­ing or adding value, but through really steal­ing, he becomes ter­ri­fied for los­ing what he should not get in the first place. They are cow­ards!!!! I guess if your worth goes from 100 mil­lion $ sud­denly to 7 mil­lion$, it is just so ter­ri­fy­ing!!! But this is the incen­tive sys­tem has pro­duced in America’s bank­ing sys­tem. Thieves and Cowards!!!!

    I agree with you that peo­ple, I for one, will choose a job that I believe is mean­ing­ful and serves a pur­pose, even though it is not the best paid options. How­ever, how can a soci­ety make sure that the peo­ple, who are will­ing to take on jobs that actu­ally add value to the com­mu­nity, can sur­vive? From what I can see, many man­u­fac­tures or jobs that actu­ally deliver goods and ser­vices just can­not sur­vive with­out some kind of sub­sidy. Have econ­o­mists done any work to exam­ine this pos­si­ble phe­nom­e­non? I believe that the sur­plus of cap­i­tal that looks to pro­duce pure finan­cial returns rather than pro­duce goods and ser­vice have some roles to blame. THe pure finan­cial cap­i­tals dis­tort, in fact they profit by mak­ing the dis­tor­tion, of the real sup­ply and demand and hence the mar­ket price, caus­ing many real busi­ness can­not sur­vive under the dis­torted mar­ket. I don’t know if any econ­o­mists are pay­ing atten­tion to the dis­tort­ing impacts pure finan­cial cap­i­tals are play­ing now a days in the economy.

  14. Steve Keen says:

    Many thanks for those reflec­tions X 2U,

    They con­firm that the movie “Mar­gin Call” really did cap­ture both the ethos and the dan­gers of that finan­cial culture–in fact it prob­a­bly com­pli­mented the cul­ture, com­pared to what you describe.

    You’re cor­rect in your final sur­mise as well: the growth of the Ponzi econ­omy directly under­mines the prof­itabil­ity of real indus­try (though the col­lapse tends to come all at once, mak­ing it dif­fi­cult to anticipate–whereas work­ers’ incomes decline directly as debt lev­els rise).

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