Summers on the crisis

James Devine jdevine at
Thu Sep 3 20:24:28 PDT 1998

Brad writes that: >So U.S. administration economic policy is reduced to (i) fiscal discipline (to try to get investment and productivity growth up), and (ii) begging the Federal Reserve to behave (which it has... mostly... so far...)<

(i) is pre-Keynesian economics: "fiscal discipline" (which I interpret as balancing the budget) hurts fixed investment via the accelerator effect. The usually-perceived benefit of balancing the budget -- lower interest rates -- has little effect on fixed investment in plant and equipment, according to most empirical studies. So the net effect should be to depress fixed investment and, if sustained, hurt long-term productivity growth. (Somewhere I read an interesting empirical paper about the big impact of investment in equipment on productivity growth. Who wrote it? hmm... my addled brain.)

(Why has investment done okay recently _despite_ fiscal discipline? because of high profit rates, which are partly a result of low real wages and the shift in the income distribution toward capital (along with the rise in the output/fixed capital ratio). Maybe Clinton can take credit for that, though Greenspan deserves it more.)

Low interest rates encourage housing investment, which has little or no positive impact on productivity growth. A budget-balancing-induced recession can easily hurt housing investment.

Budget balancing also hurts government investment -- in research, education, and infrastructure -- because US accounting conventions treat these the same as spending on price supports for tobacco farmers.

(ii) The Fed doesn't care about what the President or his advisors think. They care about what the banks and Wall Street think. Last time a Fed Head cared about the President's wishes instead, he (G. William Miller --- remember him?) was summarily booted out and replaced by Paul Volcker. (Gerry Epstein has written about this.)

Why has the Fed "behaved"? Because the reserve army of labor has been large enough to prevent inflation (when helped by falling oil prices and the high dollar).

In another missive, Carrol Cox wrote: >>>Someplace in Vol. 3 of *Capital* Marx declares that there is no law of interest rates, for interest rates are driven by the kind of contingent events that bourgeois economists claim drives prices, and that therefore they are utterly unpredictable....<<<

Doug answers: >>You thinking of this? "Where, as here [with interest rate determination], it is competition as such that decides, the determination is inherently accidental, purely empirical, and only pedantry or fantasy can seek to present this accident as something necessary."...<<<

Brad asks: >No necessary connection between the real interest rate and the rate of profit? Or the nominal interest rate and the rate of inflation? My my...<

My remembrance of Marx's discussion is that interest rates are determined by the supply and demand for loanable funds. They are unpredictable because unlike the price of physical commodities, there is no "natural" price or "price of production" for them to gyrate around. (Marx's price of production is a more scientific term for what Smith called "natural prices." There is nothing "natural" about the economy.) Marx denies the existence of a "natural rate of interest" (which does not mean Wicksell's later concept, but a hypothetical long-term equilibrium cost-determined price).

Marx does talk about the limits to the fluctuations of the real interest rate. The upper limit is the profit rate (what Keynes might call the "average efficiency of capital"), except during financial crises, which are typically temporary. The lower limit is zero (or close to it). That doesn't fit with the experience of the 1970s, when we saw negative real interest rates for awhile, so I would interpret Marx's limits (both of them) as applying only over long periods. He also talked about the institutional balance (power balance) between banking capital and industrial capital as playing a role in determining the interest rate's relation to the profit rate (over the long haul).

Anyone who's read CAPITAL recently, please correct me. BTW, I think that the stock market is _more_ unpredictable than interest rates, as indicated by the fact that stocks are riskier than bonds.

As for the connection between inflation rates and nominal interest rates, the experience of the 1970s indicates that it takes some time for inflation to be reflected in nominal rates, as expectations and loan agreements take time to adjust. That's why we had the negative real rates. (which helps explain why the financiers declared war on the economy.) Also, even with full adjustment of expectations and contracts, the nominal rate may not reflect the inflation rate -- because the economy is in recession. (Unlike others who used the loanable funds framework (and shockingly, many modern macroeconomists!), Marx did not assume continual full employment. However, Keynes added a lot of clarity here.)

Jim Devine jdevine at &

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