The reform of the central bank charter was necessary for growth and stability

By Sergio Cesaratto, Marc Lavoie and John Weeks

“Give me a one-handed economist! All my economists say: on the one hand… on the other…” once famously said the U.S. President Truman. In his interview to La Nación professor Lance Taylor provides the perfect example of a two-handed economist: he supports growth, but he warns of the dangers of inflation; he approves of a central bank that cooperates with fiscal authorities, but he warns of excessive public spending; he gives his support to import controls, but he warns of their possible “micro-inefficiencies”. Professor Taylor thus plays the two-handed game of criticizing whatever the Argentineans could possibly do, even if we are not completely convinced that he actually said in the interview that he is in favor of an Independent Central Bank, as the headline would make you believe.

Of course we share, and we are sure that the Argentinean government shares, some of these preoccupations – although we are less concerned with the idea that import controls only protect domestic inefficient sectors. To begin with, comparing Argentina with Europe, where the inability of the Central Bank to cooperate with the national treasuries has created the crisis, Argentina looks pretty good, with a central bank that is mandated to cooperate with the democratically-elected government to pursue growth and employment rates that are consistent with the lowest possible inflation rate. In Europe, a non-cooperative European Central Bank has let interest rates on sovereign debt jump to unsustainable levels. In that respect the Argentinean central bank acts more like the North American Federal Reserve.

In addition, European central bankers and political leaders have advocated austerity measures that are causing a serious recession and that exacerbate the public budget problems caused by the financial crisis, very much like Argentina did during the Convertibility period, in which the former Central Bank Charter was imposed. By contrast, in Argentina now, there is a pro-growth central bank that carefully uses its foreign exchange reserves to reduce the needs of the government to borrow on international financial markets, and that wishes to sustain domestic investment through a public investment bank. This can only be good news.

Nobody would deny the importance of a competitive real exchange rate to sustain exports and favor the development of a competitive manufacturing sector. We believe that the reliance of exports on the vagaries of soya prices and harvests is a preoccupation of the Argentinean authorities too. Many Argentinean economists are however skeptical about the positive effects of currency depreciation on manufacturing exports; instead they are more concerned about the inflationary effects that exchange depreciation might have in a country like Argentina, with its strong tradition of labour militancy in defending real wages. They also warn that a policy of real wage compression through a depreciating exchange rate, if successful, would depress domestic consumption, growth and unemployment, with little compensation from an unlikely export-led boom. So, in any case, the objective of a competitive exchange rate should not be accompanied by restrictive fiscal and monetary policies, but rather should be accompanied by income policies that would preserve real wages.

Finally, the government with the support of many economists, in its attempt to diversify the export sector and reduce the import dependence, is relying on a pro-active industrial and trade policy, rather than relying on the real-exchange-rate-depreciation cum fiscal-contraction model proposed by critics. One cannot forget that Brazil has public control of long-term finance through BNDES, and that given Argentina’s higher GDP growth rate, the Argentinean government might have legitimate reasons to impose imports controls. As to the inefficiencies allegedly brought about by import substitution policies and import controls, the de-industrialization outcomes of decades of neo-liberalism are a much worse heritage. We do favor, in general, a more depreciated exchange rate to reduce the external constraint, but because devaluation is inflationary, on the cost side, and there often is wage resistance, one must be moderate. Exchange rates are only one price, and the notion that there is a perfect level that would solve everything, leading to growth, stability and sustainable current account by itself, might be a chimera.

Originally published in Página/12 (in Spanish).

Useless European austerity

By Sergio Cesaratto*

The European financial crisis is not over, it has just begun. In the long run, the Greek tragedy will appear just as one minor episode. It is not difficult for the Argentineans to understand the origin of this crisis, as I shall shortly explain, although they will still be surprised as to why one of the richest regions in the world and a world reference for growth with social fairness is committing suicide by adopting austerity measures that aggravate, rather than solve, the crisis.

The European Monetary Union (EMU) was born out of a French political design of linking for good the post-unification German destiny to Western Europe. The greater Germany would have otherwise looked East - as the facto it has anyway later done by becoming the manufacturing hub of Central and Eastern Europe where it has decentralized her low-value added productions. By participating in the EMU, Italy and the other Southern countries aimed to import the German fiscal, monetary and labor discipline.

The American economists alerted the Europeans that the EMU was not an “optimal currency area”, too heterogeneous, economically, culturally and linguistically. The European elites cried about an U.S. plot to avoid the birth of a new international currency along the dollar. Be as it may, what happened during the EMU from 1999 and 2008 is a story that the Argentinean public, mutatis mutandis, can well understand. Financial liberalization and exchange rates fixed for good led to huge financial flows from the European “core” (Germany, The Netherlands, Austria, Finland) to the “periphery” (mainly to Spain, Greece, Ireland). France and Italy do not strictly belong to either group - the Italian manufacturing sector is second only to Germany and this marks the main difference between Italy and Spain. The capital flows generated a construction boom in Spain and Ireland and encouraged government profligacy in Greece. This led to an ephemeral growth in these countries accompanied by a relatively high inflation and consequent lose of competitiveness. Their foreign accounts became negative and they accumulated a huge foreign debt mainly with Germany.

Asymmetrically, from the late 19990s under the social-democrat Chancellor Schroeder, Germany adopted a mercantilist policy of wage and fiscal moderation and of labour flexibility. So Germany was, on the one hand, compressing domestic demand and inflation and, on the other hand, financing aggregate demand in the periphery. This became the débouché for the German export-led model. The only problem is that the periphery accumulated a huge foreign debt without being able to get eventually out from the imbalances by devaluating the national currency, as Argentina did in 2001 or Italy did in a similar situation in 1992, after the imbalances created by the European Monetary System in the 1980s.

In late 2009, after the explosion of the American financial crisis and the discovery that the Greek centre-right government (a good friend and client of Angela Merkel) had concealed the true level of the public debt, the financial market begun to have doubts about the solvency of the peripheral economies. The crisis affected Greece, Ireland, the Portugal in 2010, and the fourth and third largest EMU economies, Spain and Italy (and marginally Belgium and even France), in 2011. As a consequence of the fall in the fiscal revenues and of the public bail out of the banking sector in countries like Ireland and Spain, the private debt problem became also a public debt problem. (The huge Italian public debt was much older and sustainable, but for a country used to defend her manufacturing competitiveness by devaluing the lira, the EMU was a clear disaster, so markets begun to doubt also about the Italian solvency).

The European reaction has always been characterized by being systematically “too little, too late”. European emergency funds have been created to avoid the default of the peripheral governments. There is a problem, however: a conspicuous part of the cash comes from the same countries that need support, a vicious circle. Against the German will, the European Central Bank (ECB) has timidly intervened to sustain the periphery sovereign debts, but just in order to avoid a sudden collapse of the EMU and not to keep at sustainable levels the interest rates on those debts (both the two German members of the top board of the ECB resigned in protest during 2011). The Germans oppose that the ECB acts as the lender of last resort for States and banks, the main reason why central banks have been created. The idea of a central bank that democratically cooperates with fiscal policy has, for instance, informed the recent Argentinean reform of the central bank.

Indeed German’s leaders, both the ruling Christian Democrats and the opposition Social-democrats, consciously or not, share a wrong diagnosis of the European crisis. In the name of a non-existing inflation fear they oppose a firm action of the ECB to calm down the markets acting as the ultimate guarantor/warrantor of the peripheral sovereign debts. Moreover Germany has imposed fiscal austerity measures on the periphery with the wrong argument that fiscal profligacy was responsible of the crisis. The result is that the economic situation is getting worse, while the social situation is deteriorating.

Germany likely hopes to outlive in spite of the fall of the European periphery markets, by looking at the emerging economies’ markets. The only effective action has been taken in December 2011 by the President of the ECB Mario Draghi, again with the German opposition, by lending European banks 1 trillion Euros at an interest rate of 1% for three years expecting that part of this money to be used to sustain government bonds. The operation brought some short-term relief, but now peripheral banks are even more plenty of domestic treasury bonds, a not very reassuring situation given that the underlying imbalances that generated the crisis are still there and the confidence on sovereign solvency is, as the result of the austerity measures, getting worse, as shown by Greece, Portugal and Spain.

European countries are in Kafkian situation: damned if they stay, damned if they leave. On the one hand, a Euro-break would likely leave the global financial system devastated, given that any indebted country will in practice default at the same time, Italy included. On the other hand Germany opposes the most reasonable solution: let the ECB to sustain the European sovereign debt; support domestic demand in Germany by letting wages and fiscal spending to grow; implement a great European Marshall plan for the periphery financed by issuing Eurobonds.

As I said at the beginning, this is the sad final of a beautiful European story of building a reasonably fair and efficient society. Perhaps once things get worse, including in Germany, the failure of the austerity policies might lead to more progressive actions. This would not compensate, however, the useless suffering that the present policies are imposing on millions of Europeans. Pressure by the U.S. and by the emerging countries on Germany to assume regional and global leadership and not to behave like small Switzerland would clearly be helpful.

*Published originally in Spanish in Página12 (Thanks to Sergio Cesaratto for providing the English version).

Sraffian economics vs. Post Keynesian methodology

A very nice debate on the nature of heterodox economics took place yesterday in a heterodox conference in Buenos Aires. Sergio Cesaratto and Marc Lavoie (depicted above during the interval) presented alternative views which, in spite of some important differences, agreed that Sraffian economics is part of the broadly defined heterodox Keynesian camp (or Post Keynesian if one prefers the term). The question of the relation of Sraffians, and more broadly all of those that believe in the importance of the old classical political economy school (from Petty to Marx, including Quesnay, Smith and Ricardo), with non neoclassical Keynesians, that is, those that believe that unemployment does not result from some rigidity or imperfection (be that of the price, wage or interest rate), has been difficult to say the least.

Marc presented first. A version of the paper is here. Taking aside obvious confusions, and sloppy scholarship of the type that suggests that Sraffians accept Say’s Law, because in the determination of normal prices quantities are taken as given (the fact that those quantities are determined by demand in accumulation theory is, apparently, not understood by these critics), the main line of critique of Sraffians comes from what Marc refers to as Post Keynesian methodologists. For him, “the influence of methodologists ... felt through the study group around Tony Lawson at Cambridge ... that [argues that] proper economics should be based on critical or transcendental realism and ‘open’ systems” and that has led to an “‘open systems’ criterion to judge whether a model can be given a post-Keynesian stamp of approval” (Lavoie, pp. 6-7).

Marc correctly dismisses this supposition that from a methodological point of view the Sraffian approach is limited to closed models. As he clearly notes the Sraffian price equations require that one distributive variable (real wages or rate of profits) are determined exogenously outside of the system by historical and institutional circumstances, which by definition makes it an open system, that is, one in which there is an exchange with its environment. Marc, in fact, suggests that the strong case for a Sraffian-Keynesian interaction is based on the fact that the determination of the rate of profit by the exogenous short term rate of interest set by the central bank provides an obvious link to Post Keynesian endogenous money literature (Pivetti and Panico’s work in that area, among others, shows that Sraffians do have a lot to say about money too, by the way).

Marc notes that the main reason, however, why Post Keynesians reject the Sraffian approach is there is “little enthusiasm for any notion of long-period ‘prices of production’ as centers of gravity towards which short-period or market prices are supposed to tend” (p. 14). However, as Marc suggests there is little difference between prices of production and full cost pricing. Full cost pricing, in my view, should be connected to the Oxford Economists Research Group (particularly P.W.S. Andrews, a tradition that through Andrews’s disciple Wynne Godley influenced Cambridge Keynesians). In other words, I see full cost pricing as compatible with the normal prices in Sraffa, both being determined by a mark up, which represents the social conflicts that allow one class to subtract surplus from another, over costs, which are determined by the technical conditions of production.

My main disagreement with Marc’s exposition, then, is related to his argument that “if one wishes to connect Sraffian economics with the other strands of post-Keynesian economics, one needs to examine production prices in a different light, not as long-run or long-period centers of gravity to which market prices tend” (p. 15). This is also complicated by the incorrect notion that gravitation requires the use of marginalist principles in order to obtain that market prices converge to normal long term prices, which is not the case [I’ll leave the details of that for another post though]. It seems to me that Marc believes somehow that full cost prices are somehow not fully adjusted prices, and that firms do not use their normal costs rather than their short run costs when computing prices.

Sergio counter presentation (not available, but you can check some of his extensive publications here), was narrower in scope, and dealt with the difference between certain Post Keynesian growth models (in particular the so-called Neo Kaleckian school) and Sraffians (he also distinguished among certain Sraffian groups). I should note that Cesaratto agreed with Marc in his rejection of the critique of the so-called Post Keynesian methodologists, and suggested that their lack of understanding of the capital debates and its consequences, reduces the significance of their views. He correctly points out that the capital debates produced the only occasion that forced neoclassical economics to openly recognize its flaws, and, I would add, led to a significant change in the way they do economics, forcing the change in the notion of equilibrium and the development of disaggregated intertemporal short term models (i.e. without a uniform rate of profit, something first noted by Piero Garegnani).

Sergio notes that when dealing with models of accumulation there are three features that most heterodox groups would want to incorporate in their models, namely: (A) the Classical (or in general exogenously given) income distribution, (B) the Keynesian Hypothesis of an investment rate independent from an exogenously given rate of savings, and (C) normal accumulation paths, with the traditional corollary of a long run normal degree of capacity utilisation. Between these three features one obtains what Sergio refers to as the Magical Accumulation triangle.

Neo Kaleckian (NK) models (some of Marc’s models, particularly in his Foundations of Post Keynesian Economic Analysis are of this type, but not the ones in his book with Wynne Godley) tend to assume A and B, but not C. The absence of the notion of normal (or fully adjusted) positions, as we saw above with regards to prices, is the main difference between the NKs and what Sergio calls the supermultiplier Sraffians (which have A, B and C). The supermultiplier models (which are in a sense Kaldorian, on Kaldor and Sraffa see this paper) implies that long term capacity output (not optimal in the sense of full employment) is determined by the exogenous components of demand, and investment is derived demand (as noted by Sergio the key contribution here is Franklin Serrano’s PhD thesis).

Here it is important to note why long term normal positions are important. It has little to do with a belief that economic systems are stable and tend to optimal levels, since the normal positions are tendencies, and are, generally, below full capacity, and crisis are the norm. Normal positions are important because they show that the regular functioning of capitalist economies does not produce efficient allocation of resources. Without suggesting that those that deny the relevance of long term positions are imperfectionists in the same sense that neoclassical authors that believe that an accumulation path below full employment is due to price, wage or interest rate rigidities, the argument still relies on an inability of capacity to adjust fully to the exogenous growth of the autonomous components of demand. The question then is why would a business not invest enough to keep its capacity growing in line with the growth of its demand? Here, I believe, lies the fundamental difference between classical-Keynesians (or supermultiplier Sraffians) and Neo Kaleckians.

By the way, as I noted before in the blog, the use of the term Kaleckians for the NKs is a bit of a misnomer, since the models derive really from Joan Robinson (and as noted by Sergio, Harrod and Steindl too). In part, I think, for her role in the rejection of normal positions and her views on history versus equilibrium, Sergio suggested that Robinson played a negative role in these debates.

There are several other things to discuss about this topic (the role of Joan Robinson among the important ones), brought about by the interesting, controversial, but very friendly debate between Marc Lavoie and Sergio Cesaratto which I’ll leave for other posts.

Cesaratto on 'Monetary Mercantilism'

Sergio Cesaratto on what one might term national views on the European crisis, in particular on orthodox German views. Very instructive. He says:

It obviously makes little sense to blame Germany or any other country for the European crisis. Each dominant class joined the European Monetary Union (EMU) in its own interest or pretending to do so for its respective country. If the collective design of the EMU has failed, the responsibility is not of one single country: each national elite has made its own calculations and they should all have known that Europe was not an optimal currency area. We cannot know, of course, what would have happened to Europe or to single members of the Eurozone (EZ) without the EMU. Less excusable is, especially for major countries, not to appreciate and change national policies that are particularly inconsistent with the EMU. Unfortunately this is far from happening.

Read the rest here.