Frontiers of Heterodox Macroeconomics

Philip Arestis, Malcolm Sawyer, Philip Arestis, Malcolm Sawyer

• Publisher: Palgrave Macmillan
• Year: 2019
• Print ISBN: 9783030239282
• eBook ISBN: 9783030239299
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

In the past few decades, and intensified since the global financial crisis of August 2007, heterodox macroeconomics has developed apace and its scope has broadened in a number of directions. The purpose of this volume is to review the 'state of the art' in heterodox macroeconomics, its strengths and weaknesses and future directions. Heterodox macroeconomics has broadened its scope through gender macroeconomics, ecological macroeconomics and further incorporated income distribution and inequality into macroeconomics analysis. New macroeconomic models, particularly stock-flow consistent modelling has become a widely used mode of analysis. Money and finance, monetary policy and fiscal policy as well as other policies have been discussed widely. The focus of this edited collection is on all of these issues, with chapters focusing on inflation, ecological sustainability and regulatory policy.

© The Author(s) 2019

P. Arestis, M. Sawyer (eds.)Frontiers of Heterodox MacroeconomicsInternational Papers in Political Economyhttps://doi.org/10.1007/978-3-030-23929-9_1

Begin Abstract

1. Critique of the New Consensus Macroeconomics and a Proposal for a More Keynesian Macroeconomic Model

Philip Arestis¹

(1)

Department of Land Economy, University of Cambridge, Cambridge, UK

Philip Arestis

Email: [email protected]

Keywords

New Consensus MacroeconomicsProblems with the New Consensus MacroeconomicsA more Keynesian macroeconomic modelEconomic policies

JEL Classification

E10E12E13E50Q60

End Abstract

1 Introduction

This contribution begins with the New Consensus Macroeconomics (NCM) in the case of an open economy (see also, Arestis 2007a, b, 2009b, 2011; Arestis and González Martinez 2015), which is critically discussed. We should note that the ‘Global Financial Crisis’ (GFC) and the ‘Great Recession’ (GR) have forced the profession to begin to reexamine the theoretical and policy propositions of the NCM. Blanchard (2011), for example, argues that the crisis “forces us to do a wholesale reexamination of those principles” (p. 1). It is true that following the GR some aspects of the NCM have been questioned and relevant changes undertaken. Still problems remain. We propose a new theoretical framework that goes well beyond the NCM and its main inflation targeting policy (see also, Arestis 2007b, 2009b, 2010). We discuss our theoretical framework along with its economic policies, and suggest that in addition to fiscal and monetary policies, which should be properly coordinated, two ‘new’ policy dimensions, which had been ignored prior to the GFC, are proposed. These policies are distributional effects and financial stability, both of which are necessary to avoid crises similar to the GFC, and the subsequent GR.

We proceed in Sect. 2 with the open economy theoretical framework of the NCM and its policy implications; we critically appraise the NCM and its policy implications. Section 3 deals with our proposal of a different theoretical framework, along with its economic policy implications, emphasising distributional, and financial stability policies. Section 4 summarises and concludes.

2 New Consensus Macroeconomics and Policy Implications

We discuss in this section the open economy NCM model, along with its policy implications.

2.1 The Open Economy NCM Model

We employ the following six-equation model for the open economy NCM model.¹

(1)

(2)

(3)

(4)

(5)

(6)

The symbols have the following meaning: a_0, d_0, and e₀ are constants; Y^g is the domestic output gap (the difference between actual and trend output; the latter is the output that prevails when prices are perfectly flexible, and as such it is a long-run variable, determined by the supply-side of the economy);

is world output gap, R is nominal rate of interest, R_w the world nominal interest rate, p is the rate of domestic inflation, p_w the world inflation rate, and p^T is the target inflation rate to be achieved by the independent Central Bank. RR* is the ‘equilibrium’ real rate of interest, that is the rate of interest consistent with zero output gap, which implies from Eq. (2) a constant rate of inflation; (rer) stands for the real exchange rate, and (er) for the nominal exchange rate, defined as in Eq. (6) and expressed as foreign currency units per domestic currency unit. CA is the current account of the balance of payments, s_i (with i = 1, 2, 3, 4, 5) represents stochastic shocks, and E_t refers to expectations held at time t. P_w and P (both in logarithms) are world and domestic price levels, respectively. The change in the nominal exchange rate can be derived from Eq. (6) as in

.

Equation (1) is the aggregate demand equation with the current output gap determined by past and expected future output gap, the real rate of interest and the real exchange rate (through effects on the demand for exports and imports). Equation (1) emanates from intertemporal optimisation of expected lifetime utility of the representative agent who never defaults on debts, and under the assumption of short-run wage and price rigidities or frictions of the Calvo (1983) type. This optimisation reflects optimal consumption smoothing subject to a budget constraint, and based on the transversality condition that all debts are ultimately paid in full. The latter condition means that all economic agents with their rational expectations are perfectly credit worthy, and agents would never default. There is, thus, no need for a specific monetary asset. Under such circumstances, no individual economic agent or firm is liquidity constrained, which implies that there is no need for financial intermediaries (commercial/investment banks or other non-bank financial intermediaries) and money (see also, Goodhart 2004, 2007, 2009).

The non-appearance of money in the model is justified on the assumption that the Central Bank allows the money stock to be a residual to achieve the desired real rate of interest (Woodford 2008). Thereby money plays no role other than being a unit of account (Galí and Gertler 2007). Furthermore, there is the question of the role for investment, introduced in terms of the expansion of the capital stock that is required to underpin the growth of income. There is then by assumption, no independent investment function that arises from firms’ decisions (Woodford 2003, Chapter 4).

Equation (2) is a Phillips curve, derived from the intertemporal-optimising representative firm in a model of staggered price setting as, for example, in Calvo (1983). Inflation in Eq. (2) is based on the current output gap, past and future inflation, expected changes in the nominal exchange rate, and expected world prices; the latter accounts for imported inflation. The model allows for sticky prices in the short run, the lagged price level in this relationship, and full price flexibility in the long run. It is assumed that b₂ + b₃ + b₄ = 1, thereby implying a vertical Phillips curve in the long run at the point of the Non-Accelerating Inflation Rate of Unemployment (NAIRU). The term E_t(p_t+1) captures the forward-looking aspect of inflation determination. It implies that the Central Bank’s success to achieve its inflation target not only does it depend on its current policy stance but also on what economic agents perceive that stance to be in the future. The assumption of rational expectations is important in this respect. Agents are in a position to know the consequences of current policy actions on the future inflation rate. Consequently, the term E_t(p_t+1) is viewed to reflect Central Bank credibility. If the Central Bank can achieve its inflation target, then expectations of inflation are contained. Expected changes in import prices and in the nominal exchange rate are another two important determinants of inflation as shown in Eq. (2).

Equation (3) is a monetary policy rule of the Taylor (1993, 1999, 2001) type. It is derived from the optimisation of the monetary authorities’ loss function subject to the model utilised. The nominal interest rate, thereby derived, is related to the equilibrium rate of interest (RR*), defined as the “equilibrium real rate of return when prices are fully flexible” (Woodford 2003, p. 248), expected inflation, output gap, deviation of inflation from target, and with the lagged interest rate representing the monetary authorities’ interest rate ‘smoothing’. The exchange rate is assumed to play no role in the setting of interest rates (except in s...

Table of contents

• Cover
• Front Matter
• 1. Critique of the New Consensus Macroeconomics and a Proposal for a More Keynesian Macroeconomic Model
• 2. Approaching Budget Deficits, Debts and Money in a Socially Responsible Manner
• 3. Advances in the Post-Keynesian Analysis of Money and Finance
• 4. Why the Subprime Financial Crash Should Have Been Prevented and Implications for Current Macroeconomic and Regulatory Policy
• 5. Inflation: Failures of Inflation Targeting—A European Perspective
• 6. Stock-Flow Consistent Dynamic Models: Features, Limitations and Developments
• 7. Fiscal Policy and Ecological Sustainability: A Post-Keynesian Perspective
• 8. Secular Stagnation and Income Class Structure in Europe: Policy and Institutional Implications
• Back Matter