Bow down to the Bubble: Larry Summerian Endorses Bubbleonian Madness and Paul Krugman Embraces the Hansenian Stagnation Thesis*

By L. Randall Wray

{*Sorry, I couldn’t resist. As many of NEP’s readers know, Michael Hudson has long advanced the argument that America’s policymakers have purposely created Bubbleonia—NOT to generate growth but rather to enrich the thieves at the top. And many of you are familiar with the work of Geoffrey Ingham—a fellow Chartalist traveler—who has focused on J.M. Keynes’s “Babylonian madness”, the period after Keynes had discovered the writings of A.Mitchell Innes that led him to explore the origins of money in Babylonia. Hudson is also a scholar of that period. Alvin Hansen reintroduced the thesis of secular stagnation, giving it a Keynesian flavor.}

Larry Summers has made a big splash by (finally) recognizing that the US has had a series of financial bubbles. (See here.)  Duh! Who wudduv thought? The Reagan years were just a bubble, driven by thrift excesses. The Clinton years were just a bubble, driven by dot-com excesses. And the most recent real estate boom and bust was just a bubble, driven by Wall Street’s thieving Investment Banks. Bubbles-R-US. It’s all we’ve got going on.

But don’t blame Larry for the bubbles, the last two of which he played a huge role in fueling by playing water-boy for Wall Street’s deregulation movement. Nay, it’s the stagnationary version of TINA: there is no alternative to bubbles because the US is caught in secular stagnation.

Paul Krugman and many others have picked up the “brilliant” argument of “the smartest guy in any room”, Summers. (See Krugman here ; See DeLong here; and See Vinik here.) They’re falling all over themselves to resurrect Larry’s tarnished reputation. He was thought to be a shoe-in at the Fed, until mass revulsion forced Obama to throw smart-guy Larry out of contention. Frankly, I’ve never understood the adulation of Larry. Yes, he had a couple of reasonably good academic papers (over three decades ago), but his career since then has been a series of embarrassing miss-steps, from proposing that developing nations should be turned into toxic waste dumps to proclaiming women unfit for science and on to flushing millions of dollars of Harvard’s endowment down the toilet.

In any event, let’s focus on the message, not the messenger. Here’s Larry’s brilliant message (my paraphrase):

Since the days of Reagan, the “natural” rate of interest that equates saving and investment at the full employment level of output has drifted deep into negative territory. What this means is that given saving propensities, consumption demand is depressed. To fill the demand gap we need a lot of investment (or government spending or net exports—more later). But given depressed demand, firms don’t really want to invest; indeed to get them to invest as much as households want to save at full employment, we would have to pay them interest on their borrowing. As we know from Keynes, ex post saving equals investment, but that is achieved only by having insufficient investment so that many people are unemployed. The unemployed are forced to save less than desired to maintain the equality.

If we could push the real rate well below zero (ie: firms “pay” a negative rate—equivalent to receiving interest on their borrowing) then we could push up investment, raising employment and income, and hence increasing saving so that it would come to equality with investment at full employment.

While we cannot push nominal rates below zero (you can hold cash and get zero), we can raise inflation. More technically, the real interest rate is equal to the nominal rate less expected inflation. So if that Expectations Fairy could get everyone to expect 5% or 10% inflation, the real rate would be far enough below zero, and presto-change-o we’d end stagnation.

But we’ve got a stubborn Fairy. She won’t believe Uncle Ben when he says he’s holding pedal-to-the-metal until he gooses inflation. So the only thing he (and Greenspan before him) can do is to cause serial asset price bubbles.

In the 1980s Washington bubbled up prices of jack-a-lope ranches in the Southwest; in the 1990s it was pet-dot-com firms that marketed kitty litter on-line; and in the 2000s it was sliced-and-diced NINJA mortgages that defaulted when the first payment came due. They all crashed spectacularly, of course.

But, you see, that’s a good thing. Better to have boomed and then busted than never to have boomed at all.

Bow down to the Bubble.

Thanks, Larry, for all you’ve done for the economy. In his “bravura” performance, he even managed to work in his preferences for deregulation—in spite of all the havoc he wrought: if we re-regulated, Wall Street might stop producing asset bubbles, and then we’d really be up the creek without a pot to piss in.

Krugman—as he is wont to do—puts all of this into his liquidity-trapped ISLM model. (See Krugman here for an exposition.) We’re in a permanent liquidity trap, where normal monetary policy won’t work. While fiscal policy would work, we cannot use it. (Full disclosure: Larry and Paul would be willing to use fiscal stimulus, but that is considered by Washington to be out-of-bounds. Indeed, Paul could argue that in a liquidity trap, with a horizontal LM curve, fiscal policy is super-duper effective as you’d shift out the IS curve without crowding-out investment since the interest rate is stuck. But we can’t go there because deficits are a no-no within the beltway.)

Martin Wolf—who ought to know better, since he’s a better Keynesian who has incorporated Wynne Godley’s sectoral balances within his own framework—seems to have bought the argument. Wolf argues:

Mr Summers is not the first to identify the possibility of so-called “secular stagnation”: the fear of emulating Japan’s lost decade has been in the minds of thoughtful analysts since the crisis. But his was a bravura performance.

Why might one believe him? It is possible to point to three relevant features of the western economies.

First, the recovery from the financial crisis of 2007-08 has been decidedly weak. In the third quarter, the US economy was just 5.5 per cent bigger than at its pre-crisis peak, more than five years earlier. US real gross domestic product has continued to decline, relative to the pre-crisis trend. Moreover, such weakness has endured, despite ultra-expansionary monetary policies.

Second, today’s crisis-hit economies experienced rapid rises in leverage, particularly in the financial and household sectors, together with strong jumps in house prices, before the crisis. This was a “bubble economy”. Many governments, notably in the US and UK, also adopted expansionary fiscal policies. Nevertheless, none of the obvious symptoms of excess – particularly above-trend economic growth or inflation – appeared in Britain or America before the crisis hit.

Third, long-term real interest rates remained remarkably low in the years before the crisis, despite strong global economic growth. The yield on UK long-term index-linked gilts fell from close to 4 per cent to about 2 per cent after the Asian financial crisis and then to negative levels after the financial crisis. US Treasury inflation-protected securities (TIPS) followed a similar course, albeit later.

Well, sure, recoveries are weak, and leverage was and remains high. But why would one expect interest rates to rise before the crisis? Remember the Great Moderation? Bernanke helped to convince markets that credit risk was a thing of the past, inflation had been successfully dispatched by competent central bankers, and we’d entered a new era of permanently low spreads. And, besides—as I’ll explain in a minute—the real interest rate notion is pre-Keynesian. But the worst thing about Wolf’s argument is that he adopts the “glut of savings” approach to the crisis—something entirely at odds with Godley’s exposition that Wolf frequently endorses.

Where do they go wrong? Let me count the ways. Then I’ll provide an alternative. (For an insightful critique, see also Yves Smith.)

1. The current fascination with the Wicksellian “natural” real interest rate analysis seems to have begun during the “jobless recovery” of Bush, senior. (See the paper I wrote with Dimitri Papadimitriou back in 1994.) The Fed was thrashing about for an alternative to Friedmanian monetary targeting—because it had failed. As we showed, the Fed proposed, and serially dropped, a wide range of potential targets—from expected inflation targets, to something called “P-star”, and from gold prices to ex ante real interest rate targets. The problem with a real rate target is that it is a compound term—the nominal rate (which the Fed can hit) and expected inflation (which the Fed cannot even determine with accuracy, much less control it). After floating the idea, Greenspan quickly dropped it. For a while, the Fed wandered around the wilderness without focus: Governor Lindsey admitted: “we look at a whole raft of variables—we ignore nothing and we focus on nothing”; Governor LaWare said: “I get a feel for what I think is going on”; and policy formation was likened to “reading tea leaves”, or following “intuition”.

Over the next couple of years, academics developed the “New Monetary Consensus” and the Fed adopted a version based on the Taylor rule such that its nominal rate target would be adjusted taking into account demand gaps and deviation of actual inflation from desired. (See here.)  When inflation, globally, remained low, the Fed and other central bankers were glad to take the credit. By 2004 Chairman Bernanke announced the Great Moderation and we thereupon collapsed into the Great Recession. You all know how that turned out.

2. But that Wicksellian notion came back via the Expecations Fairy. If the Chairman can send out a boatload of Fairies to convince “markets” that inflation will rise, then the Fed can control both the nominal rate and expected inflation. It can make the “real” market rate equal to the Wicksellian “real” natural rate that equates saving and investment in the Loanable Funds market.

Keynes had already dealt with this. He argued that the old Loanable Funds model is wrong, because it has investment demand and saving supply determining the interest rate, but we know that investment equals saving regardless of the interest rate. No, it is adjustment of income that equates saving and investment. He further argued, therefore, that any interest rate is a natural rate in the sense that it is consistent with saving and investment equilibrium.

There is, however, one unique interest rate that is consistent with saving=investment at full employment. This he called the neutral rate.

Now this might all sound like a quibble, a semantic difference from the arguments of Summers and Krugman—they, too, argue that ex post saving always equals ex post investment, so the problem is that rates are currently too high to allow that equality to occur at full employment. True enough. However, their argument is based in “real” terms while Keynes’s was in nominal terms.

Keynes clearly anticipated the problem that the hypothetical neutral rate might need to be negative for the saving=investment equilibrium to be consistent with full employment. Where he parted company with the Hicks-Hansen-Samuelson ISLM Keynesians was over the belief that this is a problem to be resolved with monetary policy.

Keynes argued that the cause of unemployment is not really that the interest rate is too high but that the “marginal efficiency of capital” (the return to investment) is too low. The MEC can easily be negative: looking to the future, if investment is expected to produce losses, the MEC is negative and there is no monetary policy that can induce firms to take those losses. For Keynes, there was no reason to introduce a notion of “real”—the problem is nominal. Yes, the nominal rate cannot fall below zero, but the nominal expected returns can be negative. So, no investment, no matter how loose monetary policy is.

Keynes did perceive some advantage of inflation, which can raise the future expected returns relative to today’s cost of investing. That would raise the MEC relative to the (nominal) interest rate. This is not because some imaginary “real” rate becomes zero but rather because the MEC rises with higher expected returns. However, in a slump with depressed expectations, even Fleets of Fairies will not do the trick. You need some real evidence that things will get better. And it must be personalized: a higher general rate of inflation does not mean that your expected returns will be higher. You want more demand. Even if monetary policy could cause inflation, you need higher expected sales to induce putting in place more capacity. Monetary policy cannot guarantee that.

You need fiscal policy.

As an aside, the worst thing that happened to mainstream macro since the mid-1960s was the introduction of expectations into mechanical-hydraulic Keynesianism. First we got Friedman’s adaptive expectations that presume short-run fooling, then Lucas’s rational expectations with fooling only in the case of random policy, then Real Business Cycle theory with no fooling at all, then New Keynesian fooling due to quasi-rational rigidities, and then finally on to belief in magical mysterious and apparently mercurial Expectations Fairies. But that’s a big and controversial topic for another day.

3. The Summers and Krugman crowd that roots for bubbles to fuel expansion choose to ignore the most insidious aspect of Bubbleonia: it is the most successful instrument ever devised for moving income and wealth from the bottom 99% to the top 1%. And there is a nice, tight, vicious circle: by taking from those who are willing to spend, and giving to those who are far too rich to spend (much of their income), you depress the “real” economy. The only way to counter that is to get the losers of income and wealth to borrow to fuel consumption. As Rick Wolff has powerfully explained, that’s what we’ve been doing since the early 1970s.

Bubble-icious asset price booms not only redistribute to the top, but they also ensure that bubbles are the only way to fuel the economy precisely because all the income and wealth are at the top. Financialization of the economy synergizes these processes, adding layers of finance (ie, debt) on all “real” economic activities. This is why most of the impact of bubbles is in the financial sphere, with relatively little impact on the “real” economy during the bubble phase. The commercial real estate bubble of the Reagan years did create some construction jobs, but the direct economy-wide impact was fairly small. The dot-com bubble had even less impact—it mostly just capitalized future profits of imaginary firms that would never generate a cent of income. The most recent bubble, housing, had a bigger impact because house-building plus furnishing new MacMansions did create jobs and incomes, and rising home values generated wide-spread capital gains that propped up consumption.

But whatever bubbles up must crash. Commercial real estate; dot-coms; houses. Only the last one had nation-wide and disastrous impacts because not only did the prices of the newly built homes underlying the asset price bubble collapse, but this also depressed virtually all house prices everywhere in the country. And in the bubble phase, people had hocked their already owned homes to fuel consumption. So now they are losing them.

Just as Clinton’s dot-com bubble had boosted Federal government tax revenue—which grew at a year-over-year pace above 15 percent, the real estate bubble also boosted growth of Federal government revenue at a pace above 15 percent per year. In the first case, it actually generated the Clinton budget surpluses; in the second, it caused the budget deficit to decline rapidly. Accelerated growth of Federal tax revenue sucked income and wealth out of the private sector. Add on top of that the Fed’s rate hike of 2004 and skyrocketing energy prices, so that American consumers found their finances squeezed to the breaking point.

And so we crashed. The rich made out like bandits both on the way up, and even more so on the way down. As I predicted back in 2005, the real estate bubble and collapse would move all wealth to Bush’s ownership class. (See here.) Well, we should also give Obama credit, as he’s overseen what is almost certainly the biggest transfer of wealth to the one-percenters in the ownership class that the world has ever seen.

No wonder Summers neglects to talk about the downside of the upside of bubbles.

4. Even though loanable funds had a stake driven through its heart by Keynes, it is resurrected in remarkable ways. Here’s an example. Martin Wolf is thoroughly learned in the teachings of Wynne Godley, and yet in his piece cited above, he argues that our chronic stagnation is due to a “glut of savings”:

One of those weaknesses is the “global savings glut”, which can also be labelled an “investment dearth”. Low real interest rates are evidence of such a glut: there were more savings searching for productive investments than there were productive investments to employ it.

Another indication of the savings glut was the “global imbalances” – the huge current account surpluses (net capital exports) of east Asian emerging economies (particularly China), oil exporters, and several high-income economies (notably Germany). These economies became net suppliers of savings to the rest of the world. This was true before the crisis and it remains true today.

Before the financial crisis, the US absorbed much of the global excess savings, but not in productive investments. Despite easy access to cheap credit, fixed investment declined as a share of GDP after 2000. One reason for this fall was that the relative prices of investment goods declined: the share of real investment remained stable, while that of nominal investment shrank. Except in the pre-2000 stock market bubble, business also financed its investment out of its own savings: it did not need finance from elsewhere.

But Wynne taught us that balances balance. If there are external dollar savings in the world, they were created by US current account deficits; they balance dollar for dollar. It makes no sense to talk about an “excess”—foreigners exported to America and they got dollars that are mostly used to buy US Treasuries. It makes no sense to argue that the global exporters are “net suppliers of savings to the rest of the world”—the importers created those savings accumulated by exporters. There are no “extra” savings anywhere—surpluses are the accounting record of deficits, and they match dollar for dollar, yen for yen, and euro for euro.

You cannot have a “savings glut” and “investment dearth”. Nay, as Keynes taught us, investment creates saving. Dollar for dollar. An investment dearth would be matched by a savings dearth—not a glut! There’s no “excess saving” to finance a stock market bubble! Wolf confuses a micro level statement (a firm can finance its investment out of its “saving”—retained earnings) with a macro statement (business finances investment out of saving). The first can be true, the second is a logical error.

Wolf knows all of this, I am sure. In his attempt to lionize Summer’s supposed “bravura” performance he takes leave of his better senses.

5. The Summerian stagnationist theory is seriously deficient in identifying the cause. Again, no wonder. The Washington Keynesians like Summers have played a big role because they’ve never mounted a defense against the anti-government Neoliberals. Both Krugman and Summers give lip service to the need for more fiscal stimulus, but their deficit dovishness prevents them from offering a coherent argument.

Here’s the deal. Stagnation results when government spending grows more slowly than GDP. In other words, if government spending as a share of the economy stops rising, we’re up that creek without a pot.

This is the Domar Problem, analyzed extensively by two Portland professors, Vatter and Walker, over their careers. While virtually all mainstream economists believe in a long-term Say’s Law (supply creates demand, so the ultimate constraint on long term growth comes from the supply side), the real constraint on long-term growth in a developed capitalist economy is always on the demand side. (Note that there’s nothing new in the Summers/Krugman recognition of secular stagnation; David Levy called it a “contained depression” in 1991; Wallace Peterson announced a “silent depression” in 1994; and I demonstrated in 1999 that the problem is chronically constrained demand. At a recent Levy Institute conference in Rio, Paul McCulley laid out what he called a fundamental economic principle: Microeconomics and Macroeconomics are inherently different disciplines. Macro is demand-side; micro is supply-side. For any practical time horizon, demand always drives supply. – See here.)

I know what I’m saying is heretical, even though it is fully backed by all the data. And this stagnation is not due to a liquidity trap, or to a negative “natural” rate of interest. It is in the nature of the productivity of capitalist investment in plant and equipment. To put it in simple terms, the problem is that investment is just too damned productive. The supply side effect of investment (capacity creation) is much larger than the demand side effect (the multiplier), and the outcome is demand-depressing excess capacity. We call that a demand gap.

Let me draw on a paper I wrote in 2007, which was one of the last papers I wrote before the crisis hit. (For an earlier paper on secular stagnation that blames demand constraints, see the one I wrote with Marc-Andre Pigeon.) In this paper I focused on long-term stagnation, following the arguments of Domar and Vatter&Walker. Here’s a quick summary from the paper that lays out the problem.**

In the General Theory, Keynes had addressed the demand-side effects of investment: rising investment generates income that in turn induces consumption spending. Keynes singled out investment as the major “autonomous” component of spending, as it is focused on future sales and expected profits over the life of the plant and equipment. Hence, fluctuations of investment “drive” the economy. Because Keynes was most interested in explaining the determination of aggregate output and employment at a point in time, he tended to hold constant the productive capacity of the economy. Whether the economy was operating at full capacity or with substantial excess capacity could then be attributed to the level of effective demand, itself a function of the quantity of investment.

If the economy were operating below full capacity, then the solution would be to raise effective demand—either by encouraging more investment, or by increasing one of the other components of demand. After WWII, “Keynesian policy” came to be identified with “fine-tuning” of effective demand, accomplished through various investment incentives (tax credits, government-financed research and development, countercyclical management of interest rates) and countercyclical fiscal policy. In practice, policy tended to favor inducements to invest over discretionary use of the federal budget—indeed, “more investment” has been the proposed solution to slow growth, high unemployment, low productivity growth, and other perceived social and economic ills for the entire postwar period.

However, Domar had already recognized the problem with such a policy bias at the very beginning of the post-war period. When we turn to the subject of economic growth, it is not legitimate to ignore capacity effects as investment proceeds. Not only does investment add to aggregate demand, but it also increases potential aggregate supply by adding plant and equipment that increase capacity. To be more precise, a portion of gross investment is used to replace capital that is taken out of service (either because it has physically deteriorated, or because of technological obsolescence), while “net investment” adds to productive capacity. Further, note that while it takes an increase of investment to raise aggregate demand (through the multiplier), a constant level of net investment will continually increase potential aggregate supply. The “Domar problem” results because there is no guarantee that the additional demand created by an increase of investment will absorb the additional capacity created by net investment. Indeed, if net investment is constant, and if this adds to capacity at a constant rate, it is extremely unlikely that aggregate demand will grow fast enough to keep capital fully utilized. This refutes Say’s Law, since the enhanced ability to supply output would not be met by sufficient demand. As such, “more investment” would not be a reliable solution to a situation in which demand were already insufficient to allow full utilization of existing capacity.

Vatter and Walker carried this a step further, showing that after WWII, the output-to-capital ratio was at least one-third higher than it had been before the war. Due to capital-saving technological innovations, it takes less fixed capital per unit of output so that the supply-side effects of investment will persistently outpace the demand-side multiplier effects (for example, as a constant level of net investment adds to capacity at a rising rate). The only way to use the extra capacity generated by net investment is to increase other types of demand. These would consist of household spending (on consumption goods, as well as residential “investment”), government spending (federal, state, and local levels), and foreign spending (net exports).

Vatter and Walker believed that growth of government spending would normally be required to absorb the capacity created by private investment. Indeed, they frequently insisted that government spending would have to grow at a pace that exceeds GDP growth in order to avoid stagnation.

This should not be interpreted as endorsement of Keynesian “pump-priming” to “fine-tune” the economy. Indeed, Hansen had previously demonstrated that pump-priming would fail. If government increases its spending and employment in recession, raising aggregate demand and thus, economic activity, only to withdraw the stimulus when expansion gets underway, will simply take away the jobs that had been created, restoring a situation of excess capacity. The larger the government, the harder it becomes to cut back spending because jobs, consumption, income, and even investment all depend on the government spending. According to Vatter and Walker, in a well-run fiscal system, government spending will rise rapidly when investment is rising (to absorb the created capacity), and then will still rise rapidly when investment falls (to prevent effective demand from collapsing). They call this a “ratchet”—rather than countercyclical swings of government spending, “government as a share of the economy should rise indefinitely”. Adolf Wagner had argued that economic development leads to industrialization and urbanization, which generates an absolute, as well as a relative, increase in the demand for more government services (of course, J.K. Galbraith made a similar point). Hence, for political and socioeconomic reasons, government should grow faster than the economy. If it does not, not only will this leave society with fewer publicly provided services than desired, but it will also generate stagnation through the Domar problem.

These arguments concerning secular trends can be supplemented by the Kalecki/Minsky analysis of the role of government over the cycle. Aggregate profits are equal to investment, plus the government deficit, plus the current account surplus, plus consumption out of profit, and less saving out of wages. When investment falls, profits fall. As Minsky put it, past investment undertaken on the expectation of future profits cannot be validated at the lower level of investment, depressing current investment, and further lowering profits through a process of cumulative causation. In a big government economy with a budget that automatically swings in a counter-cyclical manner, deficits are created that attenuate effects on profits. Capital-saving innovations increase the capacity effects of investment, thus, so long as investment remains above replacement levels, potential aggregate supply rises. To utilize this new capacity, aggregate demand must increase even though investment has fallen to a lower level.

Unless another source of demand fills the gap, the government’s budget must become more stimulative. This is more easily accomplished with a bigger government because of the larger potential swings of its budget balance relative to the size of the economy as a whole. Minsky argued that government must be at least as large as investment, however, government will have to be larger to the extent that investment swings are large and if automatic swings of the budget are relatively small. Further, as discussed below, persistent trade deficits will increase the role of government in maintaining profits and demand.

Compare this explanation of the chronic stagnation with the Summers/Krugman argument that it’s all due to an unobservable “natural” real interest rate that has fallen below zero; and with their argument that to counter the stagnation we need more bubbles.

In my paper I extended the Domar Problem analysis to take account of the headwinds facing the economy of the 2000’s:

it is necessary to update the analysis to take account of major changes that have occurred since the mid 1990s: a) growth of consumption—financed by borrowing—has played a surprisingly large role in fueling growth over the past decade; b) a chronic, and growing, trade deficit has worsened the dynamics of growth; and c) there have been fairly substantial changes to tax policy, especially under the current administration.

I concluded the paper with warnings about the dangers facing the economy.

[T]here are real dangers facing U.S. growth—both in the near term, and over the longer run. Federal government purchases are not growing on trend above the rate of GDP growth. Since 1960 this has been somewhat offset—first by federal transfers to state and local government, and later by growth of transfers to households in the form of “welfare” and old-age pensions. However, welfare spending essentially stagnated after the early 1970s (relative to GDP), and Clinton ended “welfare as we know it” by pushing tight constraints on individuals and on states that will prevent social transfers growth. Further, the supposed “unfunded liabilities” of Social Security and Medicare are used by generational warriors in their attempt to dismantle the safety net for seniors. While successes have so far been limited (to payroll tax hikes and phased increases to the normal retirement age—both pushed through in “reforms” formulated by a commission headed by Alan Greenspan in 1983), they might be more successful in the future. Finally, the federal government has been less supportive of state and local government spending since the mid 1970s. Ironically, this has occurred even as responsibilities have “devolved” to the states—leading to a recurring “fiscal crisis” at the state and local government level.

On the other side of fiscal policy, taxes are overly restrictive. State and local taxes are, on the whole, regressive. Given a presumed inverse relation between the propensity to consume and the level of income, regressive taxes reduce aggregate demand. At the federal level, payroll taxes are regressive, but worse, they penalize employment by taxing both wage earners and wage payers. This raises the cost of domestic employment, favoring employment in nations that do not tax payrolls. Finally, as discussed above, many taxpayers will not correctly anticipate the AMT and will be hit with an “April surprise” in the form of an unexpected tax bill, with possible ramifications for spending next spring and summer.

The third area of concern is the trend rate of growth of private sector debt. To be sure, debt has been growing persistently since 1960, however, recent private sector deficits have accelerated the rate of growth of debt relative to income. Household debt stands at twice disposable income. Willingness to deficit spend helped to fuel the Clinton boom, and fueled the Bush “recovery.” This might have been due, in part, to “democratization” of access to credit—which is not necessarily a bad thing. In addition, the strength and length of the Clinton boom, as well as the stock market bubble and new economy hype, probably raised expectations of American households. When the bubble came to an end, the private sector temporarily retrenched, but borrowing soon was renewed at a rapid clip.

Since 2001, two factors appear to have played the dominant role in generating household deficits. First, the Bush recovery has been weak in terms of jobs created, and, more importantly, in terms of growth of wages. This is the first “expansion” since WWII in which real wages have not risen, indeed, the median hourly wage actually fell by 2% since 2003. Wages and salaries have reached their lowest share of national income since data began to be collected in 1947—just 45% of GDP in the first quarter of 2006, compared with 53.6% in 1970 or 50% as recently as 2001. Even workers at the 90th percentile have seen real pay fall for the past three years. A detailed study of census data found that all of the growth of median income in the United States from 2001 to 2005 was due to growth of incomes of those over age 65; for those under age 65, income fell by an average of $2000. The real income of men was actually lower in 2005 than it had been in 1973. In 2005, the top quintile received more than half of all income, while the share of other quintiles continued to fall. So, to some extent, growth of debt is necessary to maintain rising—or even constant—living standards in an environment of stagnant or falling real income, except at the very top of the income distribution.

That explains some of the “push” into debt, while the real estate and commodity price bubbles provided the “pull.” After the stock market crash (of the early 2000s), investors looked for alternative earning assets, and found them in commodities and real estate. The commodities price boom gained attention because of the impact of rising (and now, falling) crude oil prices on gas prices and U.S. inflation. While it is beyond the scope of this article, much more needs to be written on this topic, including an analysis of the role played by pension funds and hedge funds in fueling the commodities boom, as well as an examination of the possible impacts on the United States and world economies of the coming crash of commodities prices. This could easily reduce GDP growth by a half of a percentage point or more. Here we will consider only the real estate boom, which has added a significant boost to aggregate demand and generated 30% of employment growth during the recovery.

U.S. housing wealth doubled from $10.4 trillion in 1999 to $20.4 trillion in the first quarter of 2006. Households used their homes like ATMs, with “cashout equity” financing consumption, taking out at least $50 billion per year. In addition, mortgages have been increasingly in the form of higher interest rate “non-prime” loans as buyers stretched to afford more expensive homes. Indeed, in 2005, a quarter of all mortgage loans were non-prime, compared with just 11.5% in 2004. For blacks, non-prime loans accounted for a shocking 55% of home purchase loans. Further, about half of the growth of non-prime loans is in the form of “piggy-back lending,” or second lien mortgages to provide a “down payment” when the buyer cannot come up with the usual 20% down payment. Much of the borrowing was at variable interest rates that are now beginning to rise. Indeed, over the next few years, several trillion dollars of ARMs will reset. Goldman Sachs estimates that the expected ARM reset will swallow 10% of the income of a typical household with an ARM, amounting to $6600 per year in additional mortgage payments, or $24 billion per year in the aggregate. To be sure, interest paid by one household is received by another as interest income. However, financial wealth-holders tend to be richer and older than the average household, so the impact on aggregate demand could be significant. Unfortunately, almost all news from the real estate front is now bad, with sales falling, inventories rising, and weak mortgage demand. Rising interest rates and falling house prices would be a recipe for consumer distress. Further, it is not necessary for housing prices to actually fall in order for consumers to be forced to reduce spending, as they have relied on rising prices to collateralize their borrowing and deficit spending. If households merely bring spending back into line with their incomes, the hit to aggregate demand would be around 4% of GDP.

The fourth area of concern is globalization and external pressure on wages and prices. While many analysts emphasize the effects of increased openness on the U.S. trade balance, that is not really the issue at hand. As elementary economics teaches, imports are a benefit and exports are a cost, so net imports represent net benefits. The problem is that elementary analysis presumes full employment. The United States can reap the net benefits of its trade deficit only if it operates at full capacity. Unfortunately, the instinctual response to trade deficits is to reduce domestic demand by imposing fiscal and monetary policy austerity—which only compounds the problems generated by the leakage of demand to imports. This ensures that the potential benefits of a trade deficit will not be enjoyed. The correct response is to find employment for those displaced by a trade deficit, and to ramp-up domestic demand to cover the trade deficit leakage. That, however, is extremely difficult in the current politico-economic environment, in which the trade deficit is attributed to American consumers “living beyond their means,” by relying on “foreign savings.” In truth, the U.S. current account deficit is the source of the dollar assets accumulated by foreigners. While it may be true that American consumers are over-indebted, their debt is in dollars and it makes little difference whether that is owed to domestic wealth holders or to foreigners. What does matter is that foreign competition has been reducing U.S. wages and salaries, and, perhaps, causing American job loss. However, this becomes a problem only if U.S. policy refuses to respond with job creation, as well as protection for decent living standards. Again, this is a medium term or even long run problem, not simply a result of business cycle forces. It is not clear that policy makers understand the nature of the dangers, nor can they mount a proper response because they see exports as a benefit and imports as a cost.

The final longer-term problem is the growth of “neoconservative” ideology. While this may not be easy to define in precise terms, it represents a turn against the “mixed economy” in which “Big Government” has a positive role to play. Essentially, it is a return to Hoover-era laissez faire in which the ideal is a small government, and in which private initiative is supposed to fuel economic growth. That may have been fine in the 19th century, when the economy was relatively undeveloped and productive capacity was limited. In that era, high private investment added to demand and to supply to an approximately equal degree. However, technological advance and innovation increased the capacity effects of investment to the extent that they easily outstripped demand side effects.

Hence, while the neoconservative ideology might be appropriate to some stage of the development of capitalism, it is clearly out of place in the modern economy, where the capacity effects of investment are huge. Further, the neocons would violate Wagner’s Law by reducing the relative size of government as the economy develops. This ignores the social desire and need for increased provision of social services as the economy grows. The argument that J.K. Galbraith made in the early 1960s concerning the relative dearth of public services is only very much stronger today—with unmet needs for universal health care, for universal access to higher education to prepare youth for the “knowledge” economy, and for greater public involvement in finally eliminating the remaining inequalities that result from intransigent racism, sexism, and cultural biases.  All of these are difficult issues and there is no plausible argument or evidence that they can be resolved through “private initiative.” In fact, the neocon ideology has played an important role in reversing progress made since WWII on these and other fronts. Neocon policies reward the privileged and punish the have-nots. The rich get vouchers for well-funded private schools; the poor see funding of their public schools reduced. The rich get tax relief on capital gains and inheritances; the poor get higher local sales taxes and federal payroll taxes. The Katrina victims are evicted from Femaville trailers while the Haliburtons get no-bid contracts to rebuild New Orleans as a playland for well-heeled business conventioneers. Obviously, this reduction of the role played by government moves the U.S. economy in the wrong direction.

As Hyman Minsky used to argue, capitalism was a failed system in 1930. The growth of “Big Government” was singled out by Minsky and by Vatter and Walker as the necessary medicine to build a viable and robust version of capitalism. Minsky always insisted that there are “57 varieties” of capitalism, with different systems appropriate to different historical epochs. Unfortunately, the modern Hooverites are attempting to return to 1929, that is, to a system that was not even appropriate to the pre-war period. The evolutionary or institutional approach taken by Domar, Minsky, and Vatter and Walker, which recognizes the necessity of the “mixed economy,” is the alternative that will help us to formulate policy appropriate to today’s problems.

Well, we know what happened next! We collapsed. We’re still collapsing. We’ll continue to collapse until we understand the positive roles that government must play in the economy.

Bubblemania is not the answer.

**Note: see the paper for citations.

74 Responses to Bow down to the Bubble: Larry Summerian Endorses Bubbleonian Madness and Paul Krugman Embraces the Hansenian Stagnation Thesis*

  1. Very minor.

    When I tried to retweet, it had too many characters. FWIW, here are my humble cuts to a terrific title.

    Bow down to the Bubble: Larry Summerian Endorses Bubbleonian Madness&Krugman Embraces the Hansenian StagnationThesis*

    Please feel free to delete this title.

    • You could use a URL shortener. At this point, even if the post title was changed, the URL would not be modified.

    • L. Randall Wray

      Bow Down to the Bubble seems like a fine title to twit or tweet or whatever it is you do.

    • You should also be able to just click the twitter icon at the end of the post (where you see “Share This”). That’s the quick and dirty way, and you should have no character issues.

  2. These folks are totally out of ideas. For Krugman, the natural rate of interest has become the Philosopher’s Stone.

    • Probably located in the bladder, from which it can be expelled into the creek, since there appears to be not pot.

  3. Thornton Parker

    Randy, how have income concentration and deliberate production of goods (e.g. houses, cars, and pickup trucks) that were more expensive than most of the intended customers could really afford affected demand over time?

  4. “higher general rate of inflation does not mean that your expected returns will be higher. You want more demand.”

    As a serial entrepreneur, I’m here to say that my #1 predictor of future demand is…current demand. When that goes up, my expectations go up.

  5. The best reporter on the Wall Street Thieves is Matt Taibbi of Rolling Stone (who would have thought).

    Coincidentally Matt put himself on the map with a deservedly-famous article called:

    The Great American Bubble Machine (

    The first paragraph contained the now-classic reference to Goldman Sachs as the ‘Vampire Squid’:

    JULY 9, 2009

    The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled dry American empire, reads like a Who’s Who of Goldman Sachs graduates.

  6. “Stagnation results when government spending grows more slowly than GDP. In other words, if government spending as a share of the economy stops rising, we’re up that creek without a pot.”

    (Or perhaps you have no paddle to urinate on.)

    Is that unsustainable, for government’s share of GDP to rise continuously? What happens when government gets to be 100% of GDP? C=zero, I=zero, X-M=zero?

    How has the government’s share of GDP been changing during the time that these bubbles have been occurring?

    • John- The Govt could never be 100% of GDP, because the private sector is the recipient of those spent dollars. Govt spending increases GDP dollar for dollar, therefore its logically impossible for Govt spending to ever be 100%.

      • So, what is the mathematical limit, 50%? And what happens when the limit, whatever it is, is reached and GDP begins to drop because G/GDP is no longer rising, but automatic stabilizers cause G to continue rising? So much for a limit. Is there any equilibrium? Or does the bubble burst, and GDP crashes?

        I’d have to look at the math in greater detail, but it makes no intuitive sense to me that GDP cannot rise unless G/GDP is also rising. Just due to automatic stabilizers, G/GDP tends to behave in the opposite direction to GDP, rising in recessions, and falling in recoveries.

        • Wray is only saying that GDP cannot rise unless G/GDP is also rising given the current value of the output-to-capital ratio. The output-to-capital ratio is not an immutable constant. “Vatter and Walker carried this a step further, showing that after WWII, the output-to-capital ratio was at least one-third higher than it had been before the war. ”

          So, it is possible for the output-to-capital ratio to change again. When this happens the economic prescription that works today will need to be changed accordingly.

          Remember that every economic prescription comes with the implied proviso “given the current circumstances”. Sometimes it is not so obvious what particular current circumstance is the key to making a particular prescription work. Sometimes it takes considerable effort to identify what that circumstance is. In this case it is the output-to-capital ratio. In Keynes’ time it was something else.

          • That makes more sense than the blanket statement. Thank you.

          • From 1947 to 2012, GDP went up in 63 of 65 years. G/GDP went up in 32 years, down in 33 years.

            From 1982 to 2000, G/GDP dropped from 23.4% to 18.5%, dropping in 14 out of 18 years, and GDP increased by 144%.

            The empirical data seem to contradict the thesis. Even if this behavior is due only to fluctuations in the output-to-capital ratio, then with that ratio fluctuating so wildly it is useless anyway.

      • With a trade deficit, some of those government dollars would leave the country, so not all would increase the GDP dollar for dollar.

  7. Wow. The GFC and aftermath should be a wake up call that the old ways of thinking are bunk, and “liberal” economics as is espoused by many is just, well wrong. Perhaps the guys like Krugman do care about people, but the ideas are just wrong. “liberal” guys like Rubin, Summers etc dont even seem to care about people.

    Thanks again Randy and all for an eye opening post.

  8. I don’t understand why inflation might supposedly make investment have apparently higher return. (I know that you don’t recommend this policy, even if it were possible, I am just asking about the logic of it.) Aren’t the creditors also capable in sensing the expected inflation and raising the interest rates accordingly? People act as if only the borrowers saw the expected inflation and creditors were blind and kept the price of credit constant.

    • Think of something like rental housing, where the rent is related to the price of the house. Say you can buy a house now for $100,000 and rent it for $10,000 a year, and the mortgage costs $6,000 a year. You have a return of 4% of capital. (I know, there are other costs, and tax effects, but lets keep it simple for now.)

      If there is inflation, then in some amount of time the house will have a market value of $200,00o and rent for $20,000 a year, and your mortgage is still $6,000. Your rate of return on your original investment is now 14%, not 4%.

      • The scenario you present is a situation when the creditor is getting royally screwed. And this is talking about existing asset, usually the argument is about inducing *new* investment, that counts to GDP. In this case the creditor would have time to raise rates and nullify the effect of inflation.

        • Inflation always benefits debtors at the expense of creditors. Making a long-term, fixed-rate loan is a risk, betting that inflation will not rise above the expectations baked into the interest rate. There is a term premium to induce creditors to choose long over short.

          And it’s the same for building a factory. Today you can sell the product for $1, if there is inflation you can sell later for $2, but your interest cost is constant while the business value of the factory has doubled.

          There are also variable rate loans, which could protect the creditor, but at the cost of a lower interest rate. Creditors would choose one or the other depending on how their expectations differ from the market.

          In any event, inflation benefits the debtor – the one making the investment. It increases his effective return.

  9. “Here’s the deal. Stagnation results when government spending grows more slowly than GDP. In other words, if government spending as a share of the economy stops rising, we’re up that creek without a pot.”

    That implies that eventually government should approach 100% as it attempts to vacuum up an ever expanding supply of excess capacity. I can’t be the only one bothered by that idea. Even the idea that the supply of excess capacity is always expanding seems dubious since technological, organizational, and fashion changes both create and destroy capacity. For instance, such change created automobile production capacity and destroyed horseshoeing capacity or tamagotchi* production replacing pet rock production.

    *Word of the Day.

    • Not mathematically or logically possible for Govt spending to comprise 100% of GDP, see my response to GolferJohn above.

  10. Normally, I’d be inclined to say that a post of this length was too long. In this special case, it was just right – a nearly effortless read from beginning to end. It is a lot for a non-economist to take in, but it’s compelling stuff to ponder. Thank you, L. Randall Wray.

  11. Randall,

    I don’t understand this part:

    “Here’s the deal. Stagnation results when government spending grows more slowly than GDP. In other words, if government spending as a share of the economy stops rising, we’re up that creek without a pot.”

    This seems to suggest that at some point government spending will become 100% of GDP. Is that correct? Could you explain this as it doesn’t make sense to me. Thanks.

  12. Also:

    “You cannot have a “savings glut” and “investment dearth”. You cannot have a “savings glut” and “investment dearth”.”

    I have an example, perhaps you could explain why this is wrong.

    Say for example that I take a loan from a bank, and use the loan to pay for a really expensive haircut or something equally frivolous. The hairdresser receives the income and saves it – so their savings increase. However there is no equivalent increase in investment, as my expenditure was on consumption, not investment. So in this case an increase in debt-financed consumption led to an increase in savings. As such it seems to me that you could at any point in time have a glut of savings and a dearth of investment, however over time this will lead to a reduction in income bringing savings and investment back into balance. Correct?

    • L. Randall Wray

      Phillippe: no net saving in your example: you dissave, hairdresser saves
      Joe: yes, rising govt share will gradually reduce share of economy pursuing “making money”, could be path to Keynes’s “economic possibilities for our grandkids”; skidelsky’s book on “return of keynes, the master” is relevant here

    • actually I guess my debt equals dissaving, which offsets the hairdresser’s saving, so the balance is zero saving overall.

  13. On the question of growth of govt spending exceeding GDP growth, if carried on forever then G=GDP. Right. Readers of the Primer know I don’t accept anything carried on to the infinite horizon. Remember Ramanan’s Girth! Something will happen. I don’t know what. I’m just laying out the logic of today’s capitalism. I think someone before me has claimed capitalism is unsustainable. Might be. Or we might change the dynamics. Minsky said there are 57 varieties. The one we’ve got is headed to hell in a handbasket.

    • I noted that implication too, Randy. But it didn’t bother me, because I viewed it as a gradual approach to democratic socialism, a result I don’t mind at all, having no ideological commitment to either capitalism or socialism, as long as the particular form of either we have produces high living standards for all, not much economic inequality, and strengthens democracy and open society.

      • I’m inclined to support a capitalist system, but I could agree…whatever comes about as long as it produces the results you mentioned that is what really matters. Regardless of what, it’d need to be a moderate system where power and wealth are a bit more spread. I could never support a state dominated socialism really, but maybe a market variety, or some type of “economic democracy”.

        I’m not very familiar with democratic socialism so I just don’t know what that means really, but any of that or a restrained capitalism…long as it affords opportunity while remanining fair, equitable and democratic.

        • “Democratic Socialism” means different things to different people. Examples normally cited are the Scandinavian nations, but I’m not sure they qualify. It depends on what percentage of economic activity is being owned by or generated by the Government. If one’s standard is more than 50% of the economy, I don’t know if any nation qualifies today.

          Of course, the “democratic” part means majority rules, minority rights, civil liberties, civil rights, the usual stuff.

          Also, no reason why democratic socialism can’t be a decentralized form that distributes power and protects liberty. That’s the best kind from my point of view. Anyway I agree that the goals I mentioned at the start are what counts. If we can get there under a more regulated form of capitalism, then fine.

          • Guess that’s why terms are a pain…I thought the Nordics were “social democracy” heh it’s all giving me a headache. Glad to see the sentiment though, wish more people could put ideology aside. Especially with economics

    • Randall,

      “Capital-saving innovations increase the capacity effects of investment, thus, so long as investment remains above replacement levels, potential aggregate supply rises. To utilize this new capacity, aggregate demand must increase even though investment has fallen to a lower level.

      Unless another source of demand fills the gap, the government’s budget must become more stimulative.”

      Could that other source of demand be a reduction in saving and an increase in consumption spending (by savers), and/or a redistribution of wealth?

      • “the government’s budget must become more stimulative.”

        Not the same as an increase in government spending, never mind an increase in the share of GDP consumed by government.

  14. Brilliant piece Randy. I handled the twitter problem this way:

    Bow down to the Bubble: Larry Summerian Endorses Bubbleonian Madness/Paul Krugman Embraces . . . … #MMTbrilliance #MMT

  15. That implies that eventually government should approach 100% as it attempts to vacuum up an ever expanding supply of excess capacity. I can’t be the only one bothered by that idea.

    I’m bothered to the point that I wouldn’t mind getting some clarification, but the implication that government spending should approach 100% of GDP isn’t necessary, at least not mathematically, even if the percentage is ever increasing, so long as it is doing so asymptotically. I’m not sure if that’s the clarification that would be offered, but it could be. I would imagine the productivity of investment can only increase asymptotically, short of violating the laws of thermodynamics.

  16. I follow the Washington Consensus economists (Krugman, Summers, etc) and the MMT economists. All one has to do is compare the Summer’s presentation and the Krugman response to Wray’s explanation here to see who the smartest guy in the room is. These battles cannot not be fought and won in the macroeconomic community. The Washington Consenus economists fame and influence is dictated by their closeness to power. Krugman and Summers have been Washington fixtures for decades. They can ignore people like Wray and Mosler with impunity and get by with it. The press covers these people and that is the source of their power and influence, not their academic credentials. For Wray and others to become recognized for their superior work, these have to become part of the power structure. Some of Warren Mosler’s influence can be traced to his relationship with the Italian government and more recently to other governments around the world. He has still not penetrated the Washington Consensus. People like Wray are educating students that are going out into the world. Instead of all these students becoming professors at UMKC or other universities or working on Wall Street, some should consider working for progressive think tanks or progressive politicians that are on the rise. Only if this body of work gets into future power circles will its wisdom become available to the country. That’s how the supply siders became influential, by building relationships with conservative think tanks and political power groups.

    The tide is turning from neoliberal economics and conservative politics to a more progressive outlook with people like Elizabeth Warren taking center stage. The recent movement to expand Social Security is an example of this. This would have been unthinkable just a few years ago. And even people like Krugman are getting on the bandwagon. It’s time to identify who will be carrying the banner for the progressive movement and supply them with the superior economic understanding needed to advance the progressive cause. If Elizabeth Warren or Bernie Sanders, or the young people who see them as mentors, run for president, what economists will they be listening to? It’s time to start planning for the future, as the conservatives did decades ago to get people like Reagan elected. And this requires not only political talent, but sound economic and governing principles. I hope UMKC and other places that are ahead of the curve are taking the time to see that some of their students are the future leaders of economic policy when the youth of America start governing the country. As we move into the new century the country is becoming more progressive and the economic and financial services that support progressive principles will have to be available to them.

    • You make a great point, and I’d not be opposed. Getting my hands dirty and either going into politics directly, or a think tank. Being near the power…it’s not a pleasant thought but it does need to be done, you are 100% right, as well as trying to get this knowledge out to the mass public, as well as spreading in academia.

      I acutally hope to be a student of this school of thought, (I’m in the process) and do some of these things. I have no idea how academia works in terms of freedom to teach, or if a school sets an agenda, but this economic thought should spread beyond the handful of schools it’s been grown at.

    • Elwood, excellent points! I have been thinking along the same lines too. One caution, I have sent money to support Elizabeth Warren since the beginning, and appreciate her commitment to expanding Social Security, but in reading her campaign literature, I notice that she is still talking about our growing debt burden. Even E.W. will need some serious tutoring to get her up to MMT speed. Then there is Bernie Sanders’ economic advisory committee with several MMT luminaries on board, but an earlier discussion seems to indicate Bernie has not utilized this group either. We need an opening wedge just to get into the room. One suggestion I made earlier is for MMT supporters to offer a free orientation to newly elected Congress people and an ongoing class for Congressional staff. Joe Firestone, who lives in the DC area, said he could offer such a class, and I offered some seed money and a monthly commitment, but I don’t think anyone else did, at least not on this website. If we don’t do it, who will?

      • I am similarly a fan of my Senator, Elizabeth Warren, but I have noticed some of that economic naivety in her pronouncements. I am currently trying to get her to expand her thinking on Social Security to include the work of Modigliani, Muralidhar, et. al. I have put her staff in touch with Arun Muralidhar to see if we can make something happen.

        If you are not familiar with Muralidhar’s work on Social Security, you can read some of it in the article,
        Saving Social Security: A Better Approach –

        I am putting my hopes in being able to work with Elizabeth Warren to get the tone of the conversation in Washington changed significantly. The more of us who say some of these things to her, the more likely she and her staff will sit up and take notice. It was an email I sent through her Senate web page that initiated a call back to me from her staff.

        • Good for you, Steven. I too tried to initiate a discussion with her or her staff about MMT, but had no luck at all. I do think she is a bright light and with the right information she could lead the charge. She’s obviously intelligent and committed. We just need the right people to get her ear.

    • Maybe it was well into the process, but I recall supply side gaining acceptance because of the Laffer Curve. It is so intuitively obvious that supply-siders could not be ignored.

      I think the sectoral balance graph is equally powerful and understandable. MMT just has to get a foot in the door. Warren and Stephanie are great with the media.

      OTOH, like the great social changes of my lifetime, it could well take a generation, until the adherents of the new ethos ascend to power.

  17. Say hello to my little bubble! Kabooooom!

  18. > focused on J.M. Keynes’s “Babylonian madness”,
    Did you say “Bubblonian Madnees?” I think it fits.

  19. Ok Summers wants to push interest rates to negative 15%. Does that mean firms will be literally giving their money away in the hopes they’ll get a return someday? If nobody but Larry knows the answer then I’m ok with that.

  20. It is mathematically impossible for the government spending as a share of GDP to keep growing forever, but it is also impossible for any economy to keep growing forever, if growth involves increased consumption of real resources. At some point in future (if we are not already there) we would have reached the limits of rate of resource consumption. Economies can continue to grow beyond that point but only by commercialising hither to non-commercial activities that do not result in any additional resource consumption. The list of such services is endless, blogging services, commenting services, child care services (taking care of one’s own children), hell, even self care services (taking care of one’s own self). The government can be the buyer of excess capacity for these services i.e, if no one else will pay for these services, the government will.

    • Or education services, or just leisure time to learn on one’s own. The trend is that it takes fewer and fewer hours of human labor to support a human life. What we do in our leisure hours, I suspect, tends to consume fewer real resources than what we do in our productive hours. Some real resources are renewable or recyclable, and some renewable resources are acceptable substitutes for non-renewable resources. It is not certain that we’ll crash in a lack of real resources, surely not as fast as one might think, and by the time we run out of something on earth we may have the technology to import it from somewhere else, or find it in places on earth that are not yet accessible.

      As for the math, someone pointed out that an asymptotic approach to a limit, but never reaching it, is still a monotonic increase. While mathematically true, it is probably economically meaningless. At some point a small increase works just like a zero increase.

    • No it is perfectly possible for government spending as a share of GDP to keep growing forever if it approaches an asymptote. For it to be a monotonically increasing function is a practical, but not a mathematical, impossibility.

  21. In the first part of your message you covered the past thirty some years of neo-liberal bubble making, then you covered the real dangers with the growth in the US. Also, in recent writings you have covered the end of the commodities super cycle. Now, since the early eighties we have been having the growth problem that you described along with dis-inflation. Would you now say that we are on the cusp of deflation both in the US and worldwide?

  22. It would appear that climate change provides plenty of opportunities for government-directed new investment, either in solar panels if we are wise or levees if we remain unwise

  23. It would seem, taking an unbiased an open minded observation, that capitalism left on its own is indeed unstable, prone to increasing bubbles, busts, private debt, consolidation of wealth and inequality.
    I don’t have a problem with inequality per se, depends how it comes about, but right now seems inequality is driven by many taking on debt.
    There is no doubt this “variety” of capitalism is unsustainable, and we’re pretty much at the end I’d think. You say it best Randy, a change in dynamics is needed, maybe a regulated restrained capitalism

    • Inequality, as measured by the GINI index, was falling from the beginning of measurements in 1947 until 1967, when it dramatically reversed its trend, and has been rising ever since. So it seems that falling inequality is also a characteristic of capitalism. One must ask what changed just before 1967.

      Some other economic features seem to have shifted about the same time. From 1947-1967 there were fairly frequent, but mild, recessions and no long and roaring boom times. Since then, recessions have been less frequent and more severe, and the booms more robust, even to the extent that they are called bubbles, up until the current recovery.

      The top income tax bracket dropped from 91% to 70% in 1964, but GINI continued to decline afterwards, and the economy looked pretty much like the 1950’s not like the 1980’s.

      I don’t know that all of this can be attributed to any one factor. The pace of technological change seems to be constantly accelerating, and cultural changes that started in the 1960’s have been dramatic. None of them seem to be related to increasing inequality, though. If anything, the civil rights movement and women’s movement should have reduced inequality. What did we start doing differently in economic policy back then?

      • Good question, Golfer1. One thing that changed about 1965 was the gradual escalation of the Vietnam War and its eclipse of the War on Poverty. By the time Nixon was elected, the War on Poverty, which was a Democratic Party goal anyway, was pretty well spent and allowed to fade away.

        • According to Wikipedia, the Great Society programs continued to expand under Nixon and Ford.

          The War on Poverty only ever worked much for Social Security recipients. Their poverty rate was cut by more than half, but for people 18-64 the poverty rate barely budged, and is essentially the same today as it was just before the War on Poverty began, and during the Johnson administration, and ever since, with only small fluctuations that coincide with the growth and recessions in the general economy. Far from having faded away, today we spend over $14,000 per poor person on poverty programs, over $58,000 for a family of 4 (the poverty level for a family of 4 is about $23,000) , and yet the percentage of the population living in poverty is the same as it was in 1965. (If there is nothing else good to be said about bubbles, they do seem to reduce the poverty rate a little.)

          I don’t mean to say government shouldn’t be helping poor people, just that so-called “poverty” programs seem to be giving a lot more money to non-poor people than to poor people. It’s no wonder that average Americans who believe that the money spent on poverty is coming from their pockets in the form of taxes are unenthusiastic about government programs that fail so miserably to achieve their stated purpose, despite having more than twice the resource required for the job.

          Anyway, the Vietnam War is long over, and the GINI continues to increase. There was no War on Poverty while GINI was going down from 1947 to 1965, so even if War on Poverty spending had dropped in 1969, that could not be the change that caused inequality to end its decline and begin its increase in 1967.

      • All good points. I meant that sincerely, I really dont mind inequality itself…if it’s happening due to forces beyond our control really/technology, more people getting education, women getting into better positions, a shifting economy in general. All of which plays a role, but it seems evident to me that since the 80s (and no not just GOP bashing, it continued through the 90s as well) inequality has been through bubbles, the infamous FIRE economy growing, which is of course helped by the Fed and other gov policies.
        You’re right there is no one answer, but in recent years the FIRE has grown huge, fueled by debt. This rise in inequality is unacceptable and not sustainable.

        I’m not an expert in this stuff, IDK if you’re actually asking but if you have an answer to “what changed?” at 1967 I’m all ears.

        • What changed in 1967 was the chickens coming home to roost from the Vietnam War, guns and butter was the problem then. We couldn’t be wasting all that money in Vietnam and yet try to maintain domestic spending as if the Vietnam War did not exist. This is what started us on the inflation trend that was only exacerbated by the OPEC oil shocks that just made the trend even worse. This then led into the ridiculous Laffer curve. The logic of the Laffer curve is fine, but to think you could know where you were on that curve without making any measurements but could do so by drawing it on a napkin out of pure speculation is the part that is Lafferable.

          • If the logic is fine, then drawing it on a napkin without indexing the x axis is also fine. Empirical evidence from tax cuts in 1964, 1983, 1986, 2001 and the increase in 1994 seem to say the peak is somewhere around 30-40%, not the 70% it was when Laffer drew on the napkin. It remains to be seen what the effect of the 2013 tax hike will be, but it is probably too small a change, given the background noise of other trends, to draw definite conclusions.

            As for inequality, it continued to increase, and continues to increase today 45 years later, even though Vietnam and inflation ended after only a few years.

        • I found a chart at

          The FIRE sector was growing rapidly from 1947 to 1961, and kind of leveled off in the 60’s before resuming its growth. Not a perfect match, but interesting. Perhaps 1967 was when the huge salaries and bonuses started? Which caused FIRE employees to move from the middle of the pack to the “1%”? It would take some more analysis, if the data is even available.

          Another thing, it seems to me FIRE excesses have been rising exponentially, lately, but GINI and the industry growth seem more linear.

          FIRE can’t be helping, but I don’t see a big change occurring near 1967. More of a continuation of what was going on long before.

  24. Something will happen. I don’t know what.

    Heat death?

  25. Thanks for tipping your hat to Vatter and Walker. There seems to be an attribution problem these days in the economics world – glad to see NEP and UMKC economists remain unafraid of standing on the shoulders of giants.

    I had Walker for public finance and economic history. Walker was a great lecturer and handy with a turn of phrase. He used describe secular stagnation by exclaiming, “The problem with the US is that we built too much damned stuff, too damned fast, and we’re still using it!” He would then challenge us to take a trip down the NJ Turnpike and count the number of industrial sites that appear have been built around the turn of the 20th century. And many of them are empty. One can see the problems of excess capacity easily by riding the rails from Chicago to NYC, as I did last spring.

    Unfortunately, Vatter had already passed by the time I entered the economics program at Portland State. But, his legacy remained – carried forward in part by Walker, in part by the memorial lecture in his honor, and the student award in his name. The PSU – UMKC connection owes much to this legacy. You gave the first (and last) lecture that attempted to honor Vatter’s contribution in the area of demand constraints. Two current Ph.D. students at UMKC earned the Vatter Award for academic achievement.

  26. This article was very informative. I have been a Keynesian since I learned about it in college fifty years or so ago. I still learned a lot more from reading this article.

    I have a question. Given the situation during Regan’s term where he supposedly was going to fight inflation with the Lafferable Supply Side Economics, what is the explanation for the inflation at the time given the impact of “more investment” would not be a reliable solution to a situation in which demand were already insufficient to allow full utilization of existing capacity.

    With normal investment, shouldn’t have supply outstripped demand in a way that would have brought inflation down? I might be able to manufacture my own explanation of this, but I would be interested in hearing knowledgeable people’s explanations.

    • Inflation peaked just before Reagan took office. Whatever the cause (guns and butter, oil, or the Fed), it continued in the 80’s mostly, I think, because of automatic or negotiated cost-of-living increases in wages. Whatever the rhetoric on both sides, the compromises between Reagan and O’Neill resulted in fiscal stimulus that raised demand and enabled additional, profitable investment in the growing economy. It was also a time of rapid technology changes, requiring investment just to stay even. The IT industry, where I worked, saw the birth of the PC and the emergence of server and network technologies that now dominate the old mainframe world.

      With so many wages escalating automatically, other employers had to keep up in order to keep employees. Were it not for that, I think inflation would have ended more rapidly, instead of just trending slowly down for 30 years.

  27. Keynes seek explanation for unemployment in enterprenial investment and marginal productivity of capital but in my view he was mistaken. More important is process where households take out housing loans because in there they gain real estate assets that raise their net wealth positions from where it would otherwise be and allow them to “bury” ever increasing amounts of financial liabilities into their balance sheets that of course have counterparts in financial assets elsewhere in the economy.

  28. Maybe in the post-ww2 economic boom aggregate demand was supported by households buildig real estate assets that brought net wealth to the private sector just like goverment budget deficits bring net financial assets to the economy, and supplemented by firms making capital investments in plants and equipment that also increase net wealth.

    That would explain why during the boom government debt fell as share of gdp, this new form of wealth seems to have crowded out goverment issued net financial assets. Trying to keep NFA also high would have just caused unneccesery inflation, so keynesians were happy because aggregate demand remained high and austerians were happy because government could run tight budgets. Nowadays mainstream of the economic profession considers tight budgets of those days as the normal situation even though that era ended in mid 70’s. They just think it has been four decades of fiscal irresponsibility since then.

    (Sectoral financial balances 1952-2012 here: )

    After the post-ww2 boom this process seems to have run into difficulties because once people had houses they didn’t go for double, trible, quadruple apartments. Also population started aging and saving more for their pensions. So now there is clearly need for more net financial assets, only that mainstream of the economic profession seems to have forgotten about them. So we suffer from deficient aggregate demand and bubbleomania.

  29. Suppose the government just gives the money above the GDP growth trend to Goldman Sachs and takes an equity position and lets Goldman invest it ? I hear they are pretty good at that.

  30. Thornton Parker

    As I understand it and to oversimplify, MMT concentrates on federal deficits in relation to private sector consumption and net imports. In this piece, Randy emphasizes the balance between the increasing productivity of capital investment and declining family purchasing power.

    I think another balance to consider is the return from long term productive investments in the Main Street economy and the returns the FIRE sector can get from short term parasitic investments on Wall Street. The competition has induced many companies to concentrate on rapid introduction of products with short life cycles, which gives the appearance of greater productivity of capital.

    If this is generally correct, perhaps we should be looking for ways to discourage parasitic investment or make it less profitable, ways to create jobs and increase employee incomes as investments produce greater output, and ways to do this within the context of environmental constraints.

    • The problem is that there is not enough demand to make a productive investments profitable for the reasons that Wray explains. That is exactly why people turn to parasitic investments to earn their profits. You can tax the parasitic investments to try to take the profit out of it, but what you also need is a way to make productive investments more profitable than parasitic investments.

      This is where the government comes in. Whereas private investors are only concerned with making their part of the economy profitable, the government has to be concerned with making the universe of the country’s economy profitable. In that universe, investments in people, infrastructure, etc. are profitable whereas they are not profitable to the private investor.

      These government investments will spread income to more people, if the rules are set properly, so they can create the demand that makes private investment profitable. But the point that Wray is making is that even when the economy recovers there won’t be enough private demand to continue to make private investment profitable. As long as the output-to-capital ration is high enough, private investment does not create enough private demand to use the capacity that the capital investment creates. Until the ratio decreases, or some other factor changes, there is always a need for the part of demand created by government investment.

      Of curse, to extend Wray’s argument, there could be a day, and perhaps it is already now, when output-to-government-capital ratio is so large that even government investment does not create enough demand.

      • Thornton Parker

        Stephen: there is much to what you say, but consider some alternative investment models.

        Suppose companies obtained long term financing and built bridges to replace faulty ones, leased them to state and local governments, and maintained them until the titles go to the jurisdictions at the end of the leases. And suppose the companies got tax incentives to offset the advantage that the S/Ls have in floating bonds. This could create the jobs of building and maintaining bridges, eliminate the need for the S/Ls to pay Wall Street to obtain the financing, and give the companies guaranteed, long term demands for their products. This would in effect reverse the type of deal in which Chicago sold its parking meters.

        As a second example, several states now authorize public benefit corporations that have specific things the companies will do written into their charters. And suppose that for some, the benefit would include increasing domestic or in-state payrolls as business grows. Investors could receive fixed income like interest for their investments and an equity-like growth kicker from a royalty on the payroll. Instead of investments in them for speculation on future stock prices, they would be for long term earnings streams that retirement plans need. The goals of investors, employees, and managers would be aligned. These companies, which might be called “collaboratives” would increase demand.

        Both of these examples could be particularly good investments for retirement plans that need long term earnings flow and growth but don’t know where to find them.

        Consider a water mill, with a millrace from the dam to the wheel. Water that leaks out of the race without turning the wheel is lost energy. As I see it, we have built a finance system that promotes the leaks. Rather than try to offset the leaks with government spending, I suggest that we do something about reducing leaks and directing the flow to where it can do useful work. If the leaks are reduced, capital might be forced into longer term productive investments that will meet long term demands, and not just grind out ever more disposable trinkets for quick sale.

        • Thornton,

          Your suggestions are good. I am not sure how big a part they can play in the overall recovery. Many companies who received tax benefits for their rate of hiring, find it a better investment to give back the tax breaks an layoff people they have no use for. It stills comes down to the fact that if there aren’t enough customers, it would be hard to give enough incentives to get investments to be made anyway.

          As with all suggestions to fix the economy, you have to be able to estimate how much will the fix cost, and how much will it accomplish. If you can’t figure out if it will cost $100 or $1,000,000 or you can’t figure out if it will make 100 jobs or 1,000,000, then it is only an idea that needs a lot more work.

          I think the estimate must have been in the range of $3 trillion in lost demand, so the estimate was about the same in some kind of spending to replace the lost demand.

          The other thing you have to keep in mind is that a corporation and its investors have to make a profit on any activity, like building infrastructure. The government does not need to make a profit in the same way. Or you could say the government can take a profit in taxes paid by more employed people, taxes paid by more educated people, unemployment payments not made, health care payments not made because people were healthier, prison costs saved by people committing fewer crimes.

          It is hard to see a net saving to the government (tax payers) by letting corporations do the investing and risk taking on things better done by the government.

  31. L. Randall Wray

    Thornton: agreed. What we’ve got is financialization–rent sucking vampires–not finance. As constructed, the biggest part of the financial system (“wall street”) is not focused on finance. (the small part is the 4500 banks, credit unions, and what is left of the thrifts spread around the country–I do not have major complaints about them) We cannot move forward unless we constrain the rent-seeking financialization–which at best barely rises above criminal gangsterism.

  32. Anyone got a connection to Pope Francis?

    “The excluded are still waiting for wealth to “trickle down”

    “In this context, some people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by the facts, expresses a crude and naïve trust in the goodness of those wielding economic power and in the sacralized workings of the prevailing economic system. Meanwhile, the excluded are still waiting. To sustain a lifestyle which excludes others, or to sustain enthusiasm for that selfish ideal, a globalization of indifference has developed. Almost without being aware of it, we end up being incapable of feeling compassion at the outcry of the poor, weeping for other people’s pain, and feeling a need to help them, as though all this were someone else’s responsibility and not our own. The culture of prosperity deadens us; we are thrilled if the market offers us something new to purchase; and in the meantime all those lives stunted for lack of opportunity seem a mere spectacle; they fail to move us.” (54)

    Income inequality is the result of unjust ideologies

    “While the earnings of a minority are growing exponentially, so too is the gap separating the majority from the prosperity enjoyed by those happy few. This imbalance is the result of ideologies which defend the absolute autonomy of the marketplace and financial speculation. Consequently, they reject the right of states, charged with vigilance for the common good, to exercise any form of control. A new tyranny is thus born, invisible and often virtual, which unilaterally and relentlessly imposes its own laws and rules. Debt and the accumulation of interest also make it difficult for countries to realize the potential of their own economies and keep citizens from enjoying their real purchasing power. To all this we can add widespread corruption and self-serving tax evasion, which have taken on worldwide dimensions. The thirst for power and possessions knows no limits. In this system, which tends to devour everything which stands in the way of increased profits, whatever is fragile, like the environment, is defenseless before the interests of a deified market, which become the only rule.” (56)

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