Transcript General Theory - Associação Keynesiana Brasileira

THE GENERAL THEORY after
EIGHTY YEARS: REVISITING
ENDOGENOUS MONEY AND THE
FISCAL MULTIPLIER
Louis-Philippe Rochon
Full Professor, Laurentian University
Founding co-editor, Review of Keynesian Economics
Co-editor, New Directions in Post-Keynesian Economics
Associação Keynesiana Brasileira
São Paulo, Brazil
September 3, 2016
Outline of presentation
Brief discussion of endogenous money and the General
Theory;
Revisiting Keynes’s concept of the fiscal multiplier;
Conclusion: It is inconsistent with endogenous money: you
cannot have a theory of the fiscal multiplier (or any output
multiplier) outside the confines of endogenous money;
Challenge for post-Keynesians: we need to do research on
integrating bank lending and finance into the theory of the
multiplier. Richer theory of fiscal multiplier.
Money and the General Theory
Two views regarding the endogeneity of money in the
General Theory:
1st view: Keynes assumed as exogenous money
supply in the General Theory (Asimakopulos, Moore,
Rochon)
2nd view: Keynes had endogenous money, but
assumed the money supply ‘given’ (Chick, Dow).
***
Money and the General Theory
1st view:
Asimakopulos (1991, pp. 86-7): “Keynes assumed in The
General Theory that the money supply is exogenously
determined by the monetary authority, even though he had
observed in the Treatise … that the amount of bank money was
very much influenced by the decisions of individuals in the
economy.” This view is also defended by Moore (1988).
2nd view:
While Keynes admittedly did classify in The General Theory
the money supply as one of his ‘exogenous variables’, we should
not conclude that this means he considered the money supply
as exogenous. Rather, Dow claims, the money supply should be
interpreted as ‘given’ by Keynes. Indeed, according to the
author: ‘Thus the passage should be interpreted as taking the
money supply to be given, not exogenous’ (Dow, 1997, p. 63).
Money and the General Theory
The controversy surrounds this passage:
“Thus we can sometimes regard our ultimate
independent variables as consisting of (i) the three
fundamental psychological factors, namely, the
psychological propensity to consume, the psychological
attitude to liquidity and the psychological expectation of
future yield from capital-assets, (2) the wage-unit as
determined by the bargains reached between employers
and employed, and (3) the quantity of money as
determined by the action of the central bank” (p. 247)
Money and the General Theory
But Dow’s argument was that Keynes kept the money supply “given”, not
fixed or exogenous.
But, in Chapter 18, Keynes specifically identifies 3 types of variables: those
variables that ‘we usually take as given, which are the independent variables of
our system and which are the dependent variables’ (Keynes, CW, vol. VII, p.
245).
Keynes therefore separates those variables considered ‘given’ from those he
considers ‘independent’.
With respect to ‘given’ variables, he writes, ‘does not mean that we assume
these factors to be constant; but merely that, in this place and context, we are
not considering or taking into account the effects and consequences of
changes in them’ (Ibid). This would be Dow’s definition as well.
Among the list of those variables Keynes considers given, he does not
mention the money supply. Rather the money supply appears in the list of
variables that he specifically considers the ‘ultimate independent variables’:
‘the quantity of money as determined by the action of the central bank’ (Ibid
p. 247).
Money and the General Theory
The problem of course is that within the context of endogenous
money, how can you have changes in output while keeping the
money supply fixed (or ‘given’ for that matter)? A theory of
endogenous money, as described earlier, suggests that when output
is changing, so must be the quantity of money since production
and output must be financed by bank credit.
If not, it is no longer a ‘monetary theory of production’?
In the Preface, Keynes states:
“This book, on the other hand, has evolved into what is
primarily a study of the forces which determine changes in
the scale of output and employment as a whole; and, whilst
it is found that money enters into the economic scheme in
an essential and peculiar manner, technical monetary
detail falls into the background.”
Money and the General Theory
So we cannot have a theory of endogenous
money where output is changing and the money
supply is ‘given’.
Indeed, as Foster (1986, p. 953) argues,
Keynes’s analysis in The General Theory
requires the money supply to be endogenous
***
Money and the General Theory
This raises the issue of why Keynes chose to have the money supply as
exogenous
Was it because, as is commonly argued, he wanted to place effective demand
at the heart of his analysis without any further distractions, as is suggested by
Robinson (1970)?
In other words, this oversight was ‘strategic’ and ‘tactical’ (Dow and Dow,
1989, p. 149).
Or is it because Keynes did not quite understand the workings of a central
bank?
Irrespective of the reason, his decision to eclipse discussion over the role of
the central bank, and keep, as he tells us in the preface to The General Theory,
the ‘technical monetary details … into the background’ (Keynes, CW, vol. VII,
p. vii), has certainly complicated the analysis.
Money and the General Theory
So while this does not mean that Keynes was a fervent defender of
the notion of an exogenous money supply, it does suggest that we
need to dig deeper in his analysis to see what he believed;
On that note, I am in full agreement with Dow (1997, p. 61) when
she writes that ‘an exploration of Keynes’s other writing reveals an
understanding of the process of money creation through bank
lending, and of the limitations on the scope for control by the
monetary authorities’ (see finance motive articles);
I agree with Kaldor’s (1982) assessment that Keynes’s views in the
General Theory are “a modification of the quantity theory of
money, not its abandonment.”
Production and debt
For me the exogeneity of the money supply was necessary to make Keynes’s
simple story of the multiplier.
If you leave “monetary details in the background”, you also leave other issues
that accompany it: the process of production, which requires the creation and
destruction of debt, which then have implications for fiscal policy multipliers;
Parguez and Seccareccia (2001, p. 416):
“Money is the by-product of a balance sheet operation of a third agent,
who in modern parlance, can be dubbed a bank. In particular, money
always emerges as a debt (or liability) issued by this third agent on itself,
which has as a counterpart a credit simultaneously granted to buyers of
of goods and services of an economy.”
Deleplace and Nell (1996, p. 11): “In a modern economy, the creation of
money takes place in a credit relation between the banking system and firms
… finally: credit must be reimbursed by the firms to the banks, and money is
destroyed.”
Production and debt
Endogenous money carries very important implications for the
theory of the fiscal multiplier (see Rochon, 2008)
In particular, debt formation, debt repayment and the banking
system play integral part in this story;
Inspired by the work of the monetary circuit, especially the work
of Alain Parguez and Augusto Graziani.
At the heart of this analysis of the circuit is the dual principle of
money creation and money destruction, or the flux and reflux
principles: major implications for multiplier analysis
“the multiplier does not fully account for the nature of a creditmoney economy and should therefore be upgraded” (Gechert,
2011)
Fiscal Multipliers
Post-Keynesians have a strenuous relationship with
multipliers (Asimakopoulos, Moore; Cottrel);
Keynesian multiplier is “fundamentally flawed”
(Moore, 1988, p. 312).
Moore (2008), “The Demise of the Keynesian
Multiplier” (in a book I edited on ‘The Keynesian
Multiplier, 2008)’
Fiscal multipliers
In the first round, government expenditures increase,
which in turn generates revenues in the private sector.
Yet, in the second rounds, these revenues will now
generate consumption and savings, and subsequent
multiple rounds of consumption and savings, all
subject to a marginal propensity to consume;
In the end, the initial injection will contribute to
increased output and “converging series of ever
diminishing waves of expenditures” (Meade 1975: 84)
∆Y = 1/(1-c) ∆G
THE TRADITIONAL MULTIPLIER STORY
INITIAL INJECTION
$1,000
RECIPIENT OF FUNDS
$1,000
PAYMENT OF WAGES
$1,000
Consumption
Savings
$900
$100
Consumption
Savings
$810
$90
Consumption
Savings
$729
$81
Consumption
Savings
$590
$66
But …..
What is wrong with this story?
There is consumption, payment of wages, production even …. But
where is the process of production?
The process of production requires a bank, bank loans, therefore debt,
and money’s endogeneity: and bank debt must be reimbursed ….
“Without a rise in overall debt, private or public, the growth process
would essentially come to a halt in a monetary economy. Indeed,
whether it is business enterprises, households, or governments, in a
dynamic growth process someone must first borrow in excess of any ‘preexisting’ amount of financial resources.” (Seccareccia, 2011, pp. 12-3)
In other words, Keynes’s simple theory of the multiplier ignores the
financing of production through debt creation and is incompatible
with the theory of endogenous money
But …..
There is an increasing and voluminous NK literature
on regime-dependent multiplier analysis since the crisis
and attempts to measure the value of the fiscal
multiplier: De Cos, P. and E. Moral-Benito (2013);
Christiano, Eichenbaum and Rebelo (2011); Auerbach,
A, and Y. Gorodnichenko (2012); Thomakos (2012);
Baul, Poplawski-Ribeiro, and Weber (2012), RieraCrichton, Vegh, and Vuletin (2014);
… and so much more;
Fiscal multipliers
Values range from 0.5 to 1.5 and more (according to RieraCrichton, Vegh and Vuletin (2014), multiplier can be as
high as 2,3. and 3.1 in ‘extreme recessions’)
This literature argues that the value of multiplier changes
through the cycle
Been given more importance since the crisis and the
importance of fiscal expenditures;
Typically, multiplier is large in a recession, and weaker
during an expansion: gives credence to an expansionary
fiscal policy now (endogenous multipliers)
Fiscal multipliers
de Long and Summers (2012, p. 233fn) argue that in a recession, “the
Keynesian multiplier is likely to be substantially greater than the
relatively small value it is thought to have in normal times.”
Dufrénot, et. al (2016): “Keynesian effects appear essentially during
downturns, while anti-Keynesian effects are observed during
expansions. Transfer payments contributes to a higher private
consumption when they are given to consumers in bad times.
Reducing taxes boosts consumption in good times. Investment
responds positively to lower taxes during downturns, but negatively in
the upturn regime. Our results thus suggest that Keynesian effects
have been associated to expansionary policies during recessions, while
anti-Keynesian effects were observed during expansions illustrating
situations of expansionary fiscal consolidation. The effectiveness of
fiscal positive impulses increases in downturns relative to upturns. A
corollary is therefore that austerity measures during recessions would
have detrimental effects on the GDP and its components.”
Post-Keynesians and Fiscal multipliers
There is now also an emerging and growing heterodox
literature on this question:
Mittnik and Semmler (2014); Qazizada and
Stockhammer (2014); Charles, Dallery, Marie (2014);
Charles (2016);
See ROKE 2017: Stockhammer; Semmler; Setterfield
(and Rochon)
All echo the mainstream analysis by arguing that the
multiplier is large during recessions
Post-Keynesians and fiscal multipliers
Mittnik and Semmler (2012): “[W]e show that the
fiscal multiplier varies with the state of the business
cycle and the particular specifics of the measure taken.
For the U.S. we find, for example, the fiscal expansion
multiplier is much higher in a regime of a low
economic activity than in a regime of high activity. As
we also show it is size dependent.”
Hence, “proper timing of government expenditure
programs could increase their effectiveness” (p. 22)
Post-Keynesians and fiscal multipliers
Charles (2016, p. 188): “a nonnegligible part of the
increase in the multiplier during recessions could be
also due to strong variations in the propensity to
import. Thus our approach could potentially explain
between 10 percent and 30 percent of the variation in
multipliers.”
Post-Keynesians and fiscal multipliers
I had actually said something similar already in 2008!!
I had not given it much thought at the time. It was
only a sentence at the end of the paper:
“this suggests that not only that the multiplier depends
on the banking system, but that it will vary through the
cycle. In periods of optimism, when banks are more ‘cooperative’, that is when credit is easier to obtain, there
will be a greater multiplier.”
In an important way, that paper foreshadowed the idea
that the multiplier changes values through the cycle
Post-Keynesians and fiscal multipliers
So there was there a hint in 2008 of what is now
known as ‘regime-dependent’ multiplier analysis
But in my analysis, I reach conclusions contrary to
what most of this literature says: the multiplier is small
in recessions, large during an expansion.
Seems contrary to the PK and NK literature: it is,
although we all end us arguing that we need more fiscal
policy in a recession: for me, the multiplier is not only
regime-dependent but also policy-dependent!
Post-Keynesians and fiscal multipliers
Nell (2014) reminds us:
“Keynes’s views on the likelihood that the multiplier might
vary in value with the state of the economy seems to be an
early version of the argument that James Duesenberry
presented in the 1950s and 60s. He proposed that the
multiplier / accelerator mechanism in the upswing of the
cycle would be different from that in the downswing, and
every cycle would very likely differ in some ways from every
other. Duesenberry asserts this but doesn’t demonstrate it,
nor does he present much evidence. But he makes a plausible
case for looking into it.”
Post-Keynesians and fiscal multipliers
While all these articles are interesting and valuable in
understanding fiscal policy dynamics, they all lack an
endogenous money approach;
In other words, none of these papers incorporate bank
lending and bank debt;
Some have come close: “an expansionary fiscal policy always
raises the rate of growth, but that the magnitude of this
effect depends on both the precise form of the central
bank’s interest rate rule, and the relationship between real
activity and inflation” (Setterfield (2009, p. 642)
Post-Keynesians and fiscal multipliers
My conclusion is rather straightforward:
Failure to include banks and bank debt will have important
policy implications, as I will briefly discuss at the end. This
does not diminish the important contribution of Keynes,
nor does it reject the principle of the multiplier. It does,
however, suggest that there are, according to Trevithick’s
(1994), “monetary prerequisites” to the multiplier analysis
that must be taken into consideration.
In other words, as I will argue the multiplier is not
automatic, as in Keynes’s simple story.
The monetary circuit
I won’t spend too much time summarizing what the monetary circuit is,
although see Rochon (JEI, 1999); Graziani (2004).
Relationship between debt to finance production and the creation of money
(consistent with PK)
But debt must be reimbursed; destruction of money
Reflux mechanism (initial and final finance)
As Keynes (1930, VI, p. 197) reminds us, "Credit is the pavement along which
production travels, and the bankers if they knew their duty, would provide the
transport facilities to just the extent that is required in order that the
productive powers of the community can be employed at their full capacity.”
Money must be introduced “on the very ground floor of our analytical
structure” (Schumpeter, 1954): real vs monetary analysis
The monetary circuit
The important element in this analysis is the role played by banks
Demand and credit: banks are never constrained by deposits but
by creditworthy borrowers;
Banks and ‘bursts of optimism and pessimism’ (Keynes); See
Rochon (2006) in Festchrift for Basil Moore;
Creditworthy criteria change through the cycle; banks will curtail
lending in recession: bet against future levels of aggregate demand:
macro-uncertainty vs micro-uncertainty.
Bank lending and the multiplier
How does this affect the multiplier?
In the monetary circuit, firms reimburse outstanding
debt from revenues;
There is no difference from the point of vue of the
firm between revenues from the sale of goods to
consumers or from the State (fiscal policy)
Bank lending and the multiplier
Assume fiscal expenditures; firms receive these funds
and use them to reimburse banks;
For the multiplier process to take root, firms must be
able to spend these funds again, and this can only
happen if they can borrow anew in order to generate a
second round of production, and pay wages.
If banks do not agree to extend a new round of
spending, there is no multiplier effect beyond the
initial injection of State expenditures;
The multiplier is truncated: not automatic
INITIAL
INJECTION OF
FUNDS
∆G
Bank loans for
production =
debt incurred by
private sector
Bank must agree
to lend anew: but
will depend on
existing economic
climate
If banks refuse to lend again,
the multiplier process is
interrupted.
Private sector
recipient of fiscal
revenues
New round of
production must
secure new loan
and new debt
Multiplier is small in
recessions
In recession, banks are
pessimistic and loan supply
is restricted (credit
constraints)
Bank lending and the multiplier
Kahn’s original 1931 paper on the multiplier, where
the multiplier depends on “the intelligent co-operation
of the banking system” (1931, p. 174), otherwise all
efforts “maybe rendered nugatory” (p. 175).
“If the increased circulation of notes and the increased
demand for working capital that may result form increased
employment are made the occasion for a restriction of credit,
then any attempts to increase employment – whether it is by
way of road-building or by any other means, or indeed, by
awaiting the return of world prosperity – may be rendered
nugatory.”
Bank lending and the multiplier
Trevithik (1994, p. 78) developed this idea even more,
by arguing that “a policy of monetary accommodation
is, in general, a prerequisite for the multiplier process
to become airborne.”
“In the absence of such a policy [of monetary
accommodation], a programme of public works to raise
the levels of output and employment will be put in
unnecessary jeopardy”
Bank lending and the multiplier
Also in Graziani. According to Bellofiore and Passarella
(2016, ROKE):
“In Graziani’s theoretical scheme, the effectiveness of
government spending (and taxation) is affected crucially by
the reaction of the firms. Should firms not wish to modify
their production plans following a change in the fiscal (or
monetary) policy stance, then no effect on the level of real
income and distribution would materialize.
This is very close to what I say: but production plans
depends on banks.
Bank lending and the multiplier
“Any exogenous increase in a component of nominal
GDP (such as nominal government expenditure g)
cannot affect total nominal GDP, if credit creation for
GDP transactions (ΔCR) remains unaltered. … This
could explain why record fiscal stimulation in Japan in
the 1990s failed to trigger a significant or lasting
recovery, while interest rates continued to decline.”
(Werner, 2010, p. 12).
Bank lending and the multiplier
So in a recession, when banks are pessimistic, the natural
value of the multiplier is low. This means that there is a
great need for additional fiscal expenditures; the multiplier
is regime-dependent;
But, by spending, the State increases the creditworthiness of
firms by reducing the micro-uncertainty of firms; State
expenditures also reduce macro-uncertainty by increasing
aggregate demand; banks become more optimistic and lend
more: this increases the value of the multiplier;
The multiplier itself is also policy-dependent.
Post-Keynesian reconciliation
How is this different that other PK research on the
topic?
In the end, may be saying similar things: in recession, if
government spends, it helps to increase aggregate
demand and the macro-environment, thereby
contributing to more bank lending and further
expansion of output.
In the end, this increases the multiplier effect: same
conclusion as other PK research !
Post-Keynesian reconciliation
But the inclusion of the banking system is important to
show the precariousness nature of the multiplier;
The ‘higher’ value of the multiplier during recessions
would depend on:
1) the co-operation of the banking system
2) important fiscal stimulus: if fiscal response is too
small, the ‘policy-dependent’ nature of the multiplier
won’t materialize;
So fiscal response must be ‘large’ or will be inefficient
Post-Keynesian reconciliation
Let’s recall Mittnik and Semmler (2012): “[W]e show
that the fiscal multiplier varies with the state of the
business cycle and the particular specifics of the
measures taken. For the U.S. we find, for example, the
fiscal expansion multiplier is much higher in a regime
of a low economic activity than in a regime of high
activity. As we also show it is size dependent.”
In a “regime [where] firms may face both output and
credit constraints”, multiplier is larger when these
constraints are reduced (“particular specifics”).
Conclusions
Role of fiscal policy during a downturn
Policy should be a full assault rather than gradual;
Policies toward ensuring the health of banks is wellplaced, although this may be achieved through
different policies:
In the US, direct subsidies to home owners would have
been preferable to bail out of banks
Is there a need for public banks?