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Policy Notes No.8
01 August 2001
The War Economy
AbstractThere is no chance that events will right themselves in a few weeks, or that we will be saved by such underlying factors as technology and productivity growth or by lower interest rates or the provisions of the recent tax act. Rather, we are in for a crisis; the sooner this is recognized and acted upon, the better.
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Strategic Analysis
01 August 2001
As the Implosion Begins . . . ?
AbstractDistinguished Scholar Wynne Godley and Research Scholar Alex Izurieta respond to Jan Hatzius’s rebuttal of their July 2001 Strategic Analysis, in which they stated that the American economy was probably already in recession, and that a prolonged period of subnormal growth and rising unemployment was likely unless there were another round of policy changes. Hatzius, a senior economist with Goldman Sachs, vigorously disagreed.
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Working Paper No.337
01 August 2001
Can Countries under a Common Currency Conduct Their Own Fiscal Policies?
AbstractThe debate about balance of payment problems is generally linked with adjustments in the fiscal sector, especially since the views of Bretton Woods institutions became predominant. For the majority of theoretical models that currently inform policy, it is becoming common thought that in a world of free trade and free movement of capital, a floating rate of exchange may clear the market for financial assets. In these models, the persistence of balance of payment problems can be attributed to rigidities either in the fiscal sector (that is, the inability of the public sector to run a balanced budget), or the labor market (that is, trade union pressures and welfare protective measures leading to uncompetitive salaries). This approach, which makes the fiscal stance the culprit of macroeconomic imbalances in countries with floating exchange rates, is, however, also applied to countries that have adopted other, more rigid forms of exchange rate policy, such as currency boards, dollarization, and common currency agreements. It seems to be overlooked that systems of common currency pose problems of an entirely different kind because two major mechanisms of macroeconomic adjustment—exchange rate flexibility and money issuing—are obviously removed. Thus, theoretical and policy-oriented propositions need to take into account this new set of restrictions.
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Working Paper No.336
01 August 2001
The Role of Institutions and Policies in Creating High European Unemployment
AbstractThe conventional wisdom is that high European unemployment is the result of job markets that are rigid and inflexible. This paper presents new empirical evidence that challenges this received wisdom. A major contribution of the paper is that it fully accounts for both micro- and macroeconomic factors, as well as taking account of cross-country economic spillovers. The evidence shows that macroeconomic factors dominate in explaining unemployment. These factors are robust to changes in empirical specification. Labor market institutions do matter for unemployment, but not in the way conventionally spoken about. Unemployment benefits and union density have no effect. The level of wage bargaining coordination and the extent of union wage coverage both matter, but if properly paired they can actually reduce unemployment. Lower tax burdens can also reduce unemployment, but a far more cost-effective fiscal approach is to increase spending on active labor market policies. The bottom line is that high unemployment in western Europe has been the result of self-inflicted dysfunctional macroeconomic policy. European policymakers adopted a course of disinflation, high real interest rates, and slower growth that raised unemployment. Moreover, they all did so at the same time, thereby generating a wave of trade-based spillovers that generated a continentwide macroeconomic funk and further raised unemployment.
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Working Paper No.334
01 July 2001
Reflections on the Current Fashion for Central Bank Independence
AbstractThis paper challenges the time-inconsistency case for central bank independence. It argues that the time-inconsistency literature not only seriously confuses the substance of the rules versus discretion debate, but also posits an implausible view of monetary policy. Most worrisome, the inflationary bias featured prominently in the time-inconsistency literature has encouraged the development of a dangerously one-sided approach to central bank independence that entirely ignores the potential risks involved in maximizing central bankers’ latitude for discretion. The analysis shows that a more balanced and symmetric approach to central bank independence is urgently warranted. The views of John Maynard Keynes and Milton Friedman are shown to shed some illuminating and disconcerting light on a fashionable free-lunch promise that is based on rather shallow theoretical foundations.
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Policy Notes No.7
01 July 2001
The New Old Economy
AbstractConsensus opinion sees the United States’ economy growing by around 3 percent per year over the next few years, a high enough rate to keep unemployment low and outpace Europe. One problem with the consensus view is that it pays little heed to the very unusual nature of the American expansion. A minor downturn prompted by a bit of inflation and higher interest rates is one thing, and easily fixed by conventional means. But America’s boom was unique and so, alas, will be its bust.
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Strategic Analysis
01 July 2001
As the Implosion Begins . . . ?
AbstractThe American economy is probably now in recession, and a prolonged period of subnormal growth and rising unemployment is likely unless there is another round of policy changes. A further relaxation of fiscal policy will probably be needed, but if a satisfactory rate of growth is to be sustained, this will have to be complemented by measures that raise exports relative to imports.
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Working Paper No.332
01 June 2001
Contradictions Coming Home to Roost?
AbstractIt is widely believed that the current economic slowdown will be mild and temporary in nature, the result of a momentary wobble in the stock market. This paper argues that the slowdown stands to be more deep-seated, owing to contradictions in the existing process of aggregate demand generation. These contradictions are the result of deterioration in income distribution. They have been held at bay for almost two decades by a range of different demand compensation mechanisms: steadily rising consumer debt, a stock market boom, and rising profit rates. However, these mechanisms are now exhausted, confronting the US economy with a serious aggregate demand generation problem. Fiscal policy adjustments may be the only way out of this impasse, but such adjustments should be accompanied by measures to rectify the structural imbalances at the root of the current impasse. Absent this, the problem of deficient demand will reassert itself, and the next time around public sector finances may not be in such a favorable position to deal with it.
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Public Policy Brief No.64
01 June 2001
Campaign Contributions, Policy Decisions, and Election Outcomes
AbstractProposals for campaign finance reform are essentially based on the belief that political influence can be bought with financial donations to a candidate’s campaign. But do contributions really influence the decisions of legislators once they are in office? In this brief, Christopher Magee examines the link between campaign donations and legislators’ actions. His results suggest that political action committees donate campaign funds to challengers in order to affect the outcome of the election by increasing the challenger’s chances of winning. These contributions have a large effect on the election outcome but do not seem to affect challengers’ policy stances. In contrast, campaign contributions to incumbents do not raise their chances of being reelected and seem to be given with the hope of gaining influence.
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Policy Notes No.6
01 June 2001
Killing Social Security Softly with Faux Kindness
AbstractThe President’s commission claims that the Social Security program is “unsustainable” and requires a complete “overhaul.” It also claims that the program is a bad deal for women and minorities. However, any honest accounting of all Social Security benefits finds that the program is a good deal for disadvantaged groups. Social Security will become a worse deal only if tomorrow’s politicians slash benefits—as the commission presumes they will—or increase the taxation of the disadvantaged. A suspicious person might conclude that the reason the report uses such scare tactics is because its authors fear that future Congresses will indeed keep their promises to maintain Social Security. Hence, the urgent need to privatize today.
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Working Paper No.331
01 May 2001
Skills, Computerization, and Earnings in the Postwar US Economy
AbstractUsing both time-series and pooled cross-section, time-series data for 44 industries in the United States over the period 1947–97, the authors find no evidence to support the idea that the growth of skills or educational attainment had any statistically significant effect on growth of earnings. However, earnings growth is found to be positively related to overall productivity growth and equipment investment, while computerization and international trade both had a retardant effect on earnings.
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Working Paper No.330
01 May 2001
Is Wealth Becoming More Polarized in the United States?
AbstractRecent work has documented a rising degree of wealth inequality in the United States between 1983 and 1998. In this paper we look at another dimension of the distribution: polarization. Using techniques developed by Esteban and Ray (1994) and extended by D’Ambrosia (2001), we examine whether a similar pattern exists with regard to trends in wealth polarization over this period. The approach followed provides a decomposition method, based on counterfactual distributions, that allows one to monitor which factors modified the entire distribution and precisely where on the distribution these factors had an effect. An index of polarization is provided, as are summary statistics of the observed movements and of distance and divergence among the estimated and the counterfactual distributions. The decomposition method is applied to US data on the distribution of wealth between 1983 and 1998. We find that polarization between homeowners and tenants and among different educational groups continuously increased from 1983 to 1998, while polarization by income class continuously decreased. In contrast, polarization by racial group increased from 1983 to 1989 and then declined from 1989 to 1998, while polarization by age group followed the opposite pattern. We also find that most of the observed variation in the overall wealth density over the 1983-98 period can be attributed to changes in the within-group wealth densities rather than changes in household characteristics.
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Working Paper No.328
01 May 2001
On the “Burden” of German Unification
AbstractThis paper investigates the causes of western Germany’s remarkably poor performance since 1992. The paper challenges the view that the poor record of the nineties, particularly the marked deterioration in public finances since unification, might be largely attributable to unification. Instead, the analysis highlights the role of ill-timed and overly ambitious fiscal consolidation in conjunction with tight monetary policies of an exceptional length and degree. The issue of fiscal sustainability and Germany’s fiscal and monetary policies are assessed both in the light of economic theory and in comparison to the best practices of other more successful countries. The analysis concludes that Germany’s dismal record of the nineties must not be seen as a direct and apparently inevitable result of unification. Rather, the record arose as a perfectly unnecessary consequence of unsound macro demand policies conducted under the Bundesbank’s dictate in response to it, policies that caused the severe and protracted de-stabilization of western Germany in the first place.
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Policy Notes No.5
01 May 2001
The Backward Art of Tax Cutting
AbstractThis policy note examines the case for large tax cuts, focusing on the issues surrounding the purpose and overall size of the needed cut. Although Congress has passed a significant package of tax relief, many have worried that the budget surplus on which it was based will never appear. Thus, some have advocated “triggers” to reduce the size of the tax cuts should tax revenues begin to decline. This note argues that such a proposal represents “backward thinking.”
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Policy Notes No.4
01 April 2001
Put Your Chips on 35
AbstractAccording to Federal Reserve Chairman Alan Greenspan, we live in a time “profoundly different from the typical postwar business cycle.” Our experiences have “defied conventional wisdom” and mark ”veritable shifts in the tectonic plates of technology.” Evidently, the law of supply and demand has been repealed. This is the theme of “Put your chips on 35”—where 35 refers to the standard industrial classification code for machinery, of which 357, computers and office equipment, is the ground zero of the technological earthquake.
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Public Policy Brief No.63
01 March 2001
The Future of the Euro
AbstractThis brief provides a detailed description of the Stability and Growth Pact, an agreement entered into by the member states of the European Union that has far-reaching implications for the long-run value of the euro, and therefore, on the real economy in terms of output growth and employment. Yet despite the fact that the pact underpins the adoption of the single currency and has fundamentally redefined the scope and nature of economic policymaking in the member states, public discussion about it is relatively scant, especially on our side of the Atlantic, even though the economic health of the European Union does matter to the economic and strategic position of the United States. The authors provide propose a critique of the pact that focuses on the shortcomings induced by the its regime of mandatory fiscal austerity, the separation between fiscal and monetary policy, the undemocratic structure and lack of accountability of the European Central Bank, and the paramount importance attached to price stability at the expense of other policy objectives. According to the authors, these shortcomings will have serious negative effects on the current and future economic performance of the member states and the material well-being of its citizens.
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Working Paper No.327
01 March 2001
Part-year Operation in 19th Century American Manufacturing
AbstractUsing unpublished data contained in samples from the manuscripts of the 1870 and 1880 censuses of manufactures—the earliest comprehensive estimates available—this study examines the extent and correlates of part-year manufacturing during the late 19th century. While the typical manufacturing plant operated full-time, part-year operation was not uncommon; its likelihood of this varied across industries and locations and with plant characteristics. Workers in such plants received somewhat higher monthly wages than those in firms that operated year round, compensating them somewhat for their losses and possible inconvenience.
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Working Paper No.326
01 March 2001
Making EMU Work
AbstractThis paper investigates the lessons learned from Europe’s convergence process of the 1990s. The paper challenges the conventional focus on labour market institutions and “structural rigidities” as the root cause of Europe’s poor employment record. Instead, it is argued that macroeconomic demand management, particularly monetary policy, played the key role. Concentrating on Germany, the analysis shows that fiscal consolidation was accompanied by monetary tightness of an extraordinary degree and duration. This finding is of interest for the past as well as the future, for the Maastricht regime much resembles the one that produced the unsound policy mix of the 1990s: a constrained fiscal authority paired with an independent monetary authority free to impose its will on the overall outcome. The analysis thus highlights a key asymmetry in the Maastricht regime that is not unlikely to continue to inflict a deflationary bias on the system. It is argued that this policy bias may be overcome only if the ECB deliberately assumes its real role of generating domestic demand-led growth, thereby resolving Euroland’s key structural problem: asymmetric monetary policy. Concerning the conventional structuralist theme, the analysis debunks the “Dutch myth” of supply-led growth through structural reform. Depicting a popular fallacy of composition, we stress that the peculiar Dutch strategy of demand-led growth does not present itself as an option for Euroland.
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Policy Notes No.3
01 March 2001
Financing Health Care
AbstractThe problem is that the payers of health care—government and employers alike—are in open revolt against costs they never anticipated would become so high. Payers succeeded for a time in limiting increases to rises in the general price level. But it is one thing to remedy the most glaring inefficiencies in the system—to pick, as it were, the low-hanging fruit—and quite another to maintain quality when all of that has been harvested.
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Working Paper No.325
01 March 2001
Endogenous Money in a Coherent Stock-flow Framework
AbstractA method advocated by Wynne Godley to model monetary macroeconomics, is presented. The method, based on a transactions matrix, essentially makes sure that every flow goes somewhere and comes from somewhere, so that there are no black holes. The method is put to use for several purposes: to illustrate the monetary circuit of credit money; to demonstrate that there can be a separate portfolio (stock) demand for money, but not one independent from the rest of the model; to show that there cannot be an excess supply of credit; to handle the cases of credit for speculation purposes and high liquidity preference; to underline that endogenous money at fixed interest rates is still compatible with any government deficit; and to show that even when banks have liquidity norms, larger amounts of loans do not necessarily induce higher interest rates. Briefly stated, the paper shows that many of the claims made by Horizontalist authors are confirmed when a fully coherent accounting framework is put in place to assess their claims.
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Working Paper No.324
01 March 2001
The Causes of Euro Instability
AbstractThis paper examines the causes of the general decline in the value of the euro. First, it assesses the various explanations proffered in existing literature, and then it offers a more satisfactory one. The argument prevalent in the literature that the decline in value of the euro is due to “US strength” rather than to any inherent difficulties with its imposition is viewed as somewhat undeveloped. We suggest that US strength is an important but only partial factor in the euro’s decline; the other side of US strength is Eurozone weakness. We review the (poor) performance of the ECB and assess the level of macroeconomic convergence of Eurozone countries. We conclude that a combination of Eurozone weakness, endogenous to the inception of the euro, and US strength is the most plausible explanation for the euro’s decline in value. We find that although the future value of the euro is uncertain, the prospects for the eurozone will remain bleak as long as the current institutions underpinning the euro, with their inherent tendencies to promote deflation, are in place.
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Working Paper No.323
01 March 2001
Easy Money through the Back Door
AbstractThis paper assesses the performance of the European Central Bank (ECB) over the first two years of Europe’s new policy regime. The verdict is that the ECB was not actually in charge, as the markets took over and imposed easy money on the euro zone. It is argued that the causes for the ECB’s loss of effective control over the currency and monetary stance lie partly in the low-growth legacies of unsound macro policies inflicted upon Europe over the 1990s. The ECB made matters worse, though, first by failing to communicate effectively and coherently with financial market participants and, second, by playing against the markets’ dominant theme: growth. This resulted in a time-inconsistency problem: attempts to prop up the euro through narrowing the current interest rate spread vis-a-vis the US dollar were perceived as risking the euro zone’s growth prospects and hence the sustainability of tighter money in the future. Under such conditions, interest rate hikes might then weaken rather than strengthen the currency. A more balanced and proactive attitude toward growth, and medium-term orientation as regards inflation, might have both reduced inflation in the short run and improved growth in the longer run. The recent short run of impressive GDP and employment growth spurred by easy money embarrasses the structural myth, and underlines that the ECB was not actually in charge.
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Working Paper No.322
01 March 2001
Will the Euro Bring Economic Crisis to Europe?
AbstractIt has been argued that the eurozone will face considerable economic difficulties. These will take a number of forms, two of which could qualify as “crises.” First, the euro was launched at a time when unemployment levels were high (10 percent of the workforce) and disparities in the experience of unemployment and standards of living were particularly severe. These high levels of unemployment are likely to continue in the foreseeable future, and the policy arrangements that surround the operation of the euro, notably the objectives of the European Central Bank and the workings of the Stability and Growth Pact, will have a deflationary bias. These levels of and disparities in unemployment could be termed a crisis. Second, the introduction of the euro and the associated institutional setting could well serve to exacerbate tendencies toward financial crisis, including the volatility and subsequent collapse of asset prices and runs on the banking system. Some additional forces of instability may arise from the current trade imbalances and the relationship between the dollar and the euro as two major global currencies. Further, the operating arrangements of the European System of Central Banks can be seen as inadequate to cope with such financial crises.
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Book Series
01 February 2001
Corporate Governance and Sustainable Prosperity
AbstractHow can we explain the persistent worsening of the income distribution in the United States in the 1980s and 1990s? What are the prospects for the reemergence of sustainable prosperity in the American economy over the next generation? In addressing these issues, this book focuses on the microeconomics of corporate investment behavior, especially as reflected in investments in integrated skill bases, and the macroeconomics of household saving behavior, especially as reflected in the growing problem of intergenerational dependence of retirees on employees. Specifically, the book analyzes how the combines pressures of excessive corporate growth, international competition, and intergenerational dependence have influenced corporate investment behavior over the past two decades. Part One sets out a perspective on how corporate investment in skill bases can support sustainable prosperity. Part Two presents studies of investments in skill bases in the machine tool, aircraft engine, and medical equipment industries. Part Three provides a comparative and historical analysis of corporate governance and sustainable prosperity in the United States, Japan, and Germany. By integrating a theory of innovative enterprise with in-depth empirical analyses of industrial development and international competition, Corporate Governance and Sustainable Prosperity explores the relation between changes in corporate resource allocation and the persistence of income inequality in the United States in the 1980s and 1990s. Contributors to the volume include Beth Almeida, Robert Forrant, Michael Handel, William Lazonick, Philip Moss, Mary O’Sullivan, and Chris Tully. Editors Lazonick and O’Sullivan are Levy Institute research associates, as is contributor Handel.