Macro Reading List

I recommend Kevin Hoover’s The New Classical Macroeconomics: A Sceptical Inquiry. It was the organizing prinicple for my discussions of 1970s theory when I taught Ph.D. Macro I in the 90s.

this was a great article. But I found it interesting that Groshen-Potter discussed the difference between the most recent recovery and previous recoveries without once saying a word about productivity. From 1961 to 1973 productivity growth averaged 68% of real GDP growth. During the weak productivity era of 1974 to 1994 productivity growth fell to only 55% of real GDP growth. But since 1955 productivity growth has been 88% of real GDP growth. So this cycle a 1% increase in real GDP only generates a 0.1% employment gain versus 0.32% and 0.45% in earlier eras.

In any calculations between the current recovery and previous recoveries virtually all analysts
— both right and left– credit/blame improved productivity for the weak employment growth this cycle. Moreover, there is a massive litature on the causes behind the productivity gains this cycle.

The structural work in this article is very good, and probably explains why the drop in labor participations was so large.

But since the structural changes and improved productivity account for so much of the unusual nature of the job recovery, I wonder why they spent so much space writing about unions,and other factors that seems so insignificant in the overall picture.

Why don’t you just try and explain to your students the greatest problem facing America today.

We have excess, and uneconomic, manufacturing capacity in the US similar to the 1920’s. Excess capacity had been created prior to 1918 to supply World War I. Today, the addition of China and eastern Europe to our marketplace has made much domestic capacity surplus.

When investments are rendered uneconomic, capital is destroyed. Destroying capital is deflationary. Creating excess credit cannot offset the reduction in capital, even though very confused Monetarist economists claim that it can.

In the 1920’s, excess credit creation found no economic outlet in productive investment due to gross excess capacity. As a result the excess credit creation flowed almost entirely into financial bubbles.

Excess domestic credit creation finds few productive investments today, so credit creation has again flowed almost entirely into financial bubbles.

Investment in innovation rarely fails due to a lack of credit, thus over-supplying credit is extremely unlikely to result in more innovation. This is true in all eras.

In the larger picture, excess credit creation is creating price inflation of labor and other inputs in China and eastern Europe. Indeed, goods from these locations are frequently sold to us at a loss, being subsidized by excess credit flowing into those nations which will never be repaid.

Monetarist theories break down and create catastrophic results when applied during conditions like today or the 1920’s.

Yet Monetarists like Milton Friedman insist the economic depression of the 1930’s would not have happened if only credit creation had been even more profligate. Thus its no surprise that he has the same advice on offer today.

We live in a Monetarist economic system where credit demand is fulfilled, regardless of supply.

As the over-lending system supplies additional credit, well past the point of available supply, interest rates decline.

This is a paradoxical application of supply and demand where a large pool of artificial supply is poured onto the market. Since most Because of the underlying deflationary forces in the economy, the grossly excessive credit creation is resulting in speculative bubbles rather than inflation of manufactured goods. Economist Charles Rist observed this is the 1930’s.

“A policy aimed at monetary stability will secure a relative stability of prices, but the economic history of the 1920’s teaches us that a policy whose goal is stabilization of prices may result in inflation of money and credit, and very unsound speculation.

Charles Rist

As long as we continue to pursue wrong-headed Monetarist policies, interest rates will continue to decline further. One of the principle defects of the Monetarist economic system is that it makes financial bubbles self-sustaining.

Consider this comparison with our situation today.

During WW-I producers of commodities and manufactured goods used debt to expanded their production to meet the demands of the war. Post 1918, prices declined revealing a large destruction of capital and ushering in a deflationary environment.

This loss of capital and over-capacity caused a deflationary environment. During the 1920s central banks sought to stabilize prices through money and debt creation – which caused a problem. Money creation in a deflationary environment can stabilize prices – but at the expense of asset inflation and the creation of financial bubbles.

Again:

“A policy aimed at monetary stability will secure a relative stability of prices, but the economic history of the 1920’s teaches us that a policy whose goal is stabilization of prices may result in inflation of money and credit, and very unsound speculation.”

Charles Rist

Or as Joseph Schumpeter, another “hard money” economist, said,

“Policy does not allow a choice between depression and no depression, but between depression now and a worse depression later.

Inflation pushed far enough would undoubtedly turn depression into the sham prosperity so familiar from European postwar (WW-I) experience, and would, in the end, lead to a collapse worse than the one it was called in to remedy.

For recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another worse crisis ahead.”

Or as many have recently cited Alan Greenspan saying earlier in his career, “during the 1920s central banks made the mistake of putting a penny in the fuse-box.” How ironic that he has done the same.
*****

I believe we are in an environment where much capital has been, and is being, destroyed – producing a deflationary environment.

The factors causing the “over-capacity” and destruction of capital are: the addition of former communist nations to our marketplace and their “absolute advantage”, as you cite; demographics; the removal of tariffs through the WTO; our insane voluntary transfer of intellectual capital to nations like China and India, which you also cite: our constant “wars on” terror, drugs, etc, which you also cite; and the list goes on, generally related to our approach to “globalization”.

This destruction of capital: means a decline in living standards; and creates a deflationary environment similar to the post WW-I period.

Foolishly, central banks have repeated the mistakes of the 1920s. They have used money creation to stabilize prices in a deflationary period stemming from the effects of capital destruction. Once again, this has simultaneously inflated asset prices leading to financial bubbles and a hollow “sham prosperity” just like the 1920s.

Now that we have created huge financial bubbles, through the creation of money and credit, to “mitigate” the ill-effects of the destruction of capital, we have a problem. To paraphrase Schumpeter, if you don’t want the economic depression don’t have the bubble.