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Given one parameter restriction, an output-stabilization rule for the provision of public services turns a Kaldor–Kalecki–Steindl growth model with unstable, catastrophe-prone dynamics into one with a stable limit cycle. In contrast, using a budget-balancing rule produces a saddle point, along with closed orbits near the boundaries of the state space. Adding Kaleckian mark-up dynamics destabilizes the equilibrium, with a spiraling path followed by a spin-out found in simulation. A final exercise establishes the possibility of adding a variable workforce and a public unemployment insurance system. Throughout, an identity governs the dynamics of the stocks of public financial liabilities.

The process of constructing impulse-response functions (IRFs) and forecast-error variance decompositions (FEVDs) for a structural vector autoregression (SVAR) usually involves a factorization of an estimate of the error-term variance-covariance matrix V. Examining residuals from a monetary VAR, this paper finds evidence suggesting that all of the variances in V are infinite. Specifically, this study estimates alpha-stable distributions for the reduced-form error terms. The ML estimates of the residuals' characteristic exponents "alpha" range from 1.5504 to 1.7734, with the Gaussian case lying outside 95 percent asymptotic confidence intervals for all six equations of the VAR. Variance-stabilized P-P plots show that the estimated distributions fit the residuals well. Results for subsamples are varied, while GARCH(1,1) filtering yields standardized shocks that are also all likely to be non-Gaussian alpha stable. When one or more error terms have infinite variance, V cannot be factored. Moreover, by Proposition 1, the reduced-form DGP cannot be transformed, using the required nonsingular matrix, into an appropriate system of structural equations with orthogonal, or even finite-variance, shocks. This result holds with arbitrary sets of identifying restrictions, including even the null set. Hence, with one or more infinite-variance error terms, structural interpretation of the reduced-form VAR within the standard SVAR model is impossible.

A revisionist view of economic history now holds that New Deal legislation that, in particular, enabled unionization in the early 1930s seriously prolonged the Great Depression. The freshwater econ...

The advent of representative agent, microfounded macroeconomics brought with it new techniques for analyzing the welfare effects of macroeconomic policy. The agent's utility function becomes a measuring rod for the costs and benefits of policies that alter the path of consumption over time. Robert E. Lucas used this method in his Presidential Address to the AEA, when he claimed that the welfare costs of the business cycle in the United States equaled .05% of consumption. Applying Amartya Sen's chooser-dependent preferences to this class of welfare measurements, I will suggest that in carrying out public duties, policymakers must use different sorts of reasoning than optimizing consumers, and that people have different attitudes toward risk that is imposed than risk that is voluntarily taken on. Hence, different objective functions are appropriate in each case. These conceptual arguments lead to new expressions for the welfare effects of macroeconomic policies for use when preferences are chooser-dependent and not of the expected value, discounted utility form and to caveats for the estimation and calibration of utility functions used in such welfare analysis.

In this latest Strategic Analysis, the Institute's Macro Modeling Team examines the current, anemic recovery of the US economy. The authors identify three structural obstacles--the weak performance of net exports, a prevailing fiscal conservatism, and high income inequality--that, in combination with continued household sector deleveraging, explain the recovery's slow pace. Their baseline macro scenario shows that the Congressional Budget Office's latest GDP growth projections require a rise in private sector spending in excess of income--the same unsustainable path that preceded both the 2001 recession and the Great Recession of 2007-9. To better understand the risks to the US economy, the authors also examine three alternative scenarios for the period 2015-18: a 1 percent reduction in the real GDP growth rate of US trading partners, a 25 percent appreciation of the dollar over the next four years, and the combined impact of both changes. All three scenarios show that further dollar appreciation and/or a growth slowdown in the trading partner economies will lead to an increase in the foreign deficit and a decrease in the projected growth rate, while heightening the need for private (and government) borrowing and adding to the economy’s fragility.

We hope to model financial fragility and money in a way that captures much of what is crucial in Hyman Minsky's financial fragility hypothesis. This approach to modeling Minsky may be unique in the formal Minskyan literature. Namely, we adopt a model in which a psychological variable we call financial prudence (P) declines over time following a financial crash, driving a cyclical buildup of leverage in household balance sheets. High leverage or a low safe-asset ratio in turn induces high financial fragility (FF). In turn, the pathways of FF and capacity utilization (u) determine the probabilistic risk of a crash in any time interval. When they occur, these crashes entail discrete downward jumps in stock prices and financial sector assets and liabilities. To the endogenous government liabilities in Hannsgen (2014), we add common stock and bank loans and deposits. In two alternative versions of the wage-price module in the model (wage-Phillips curve and chartalist, respectively), the rate of wage inflation depends on either unemployment or the wage-setting policies of the government sector. At any given time t, goods prices also depend on endogenous markup and labor productivity variables. Goods inflation affects aggregate demand through its impact on the value of assets and debts. Bank rates depend on an endogenous markup of their own. Furthermore, in light of the limited carbon budget of humankind over a 50-year horizon, goods production in this model consumes fossil fuels and generates greenhouse gases. The government produces at a rate given by a reaction function that pulls government activity toward levels prescribed by a fiscal policy rule. Subcategories of government spending affect the pace of technical progress and prudence in lending practices. The intended ultimate purpose of the model is to examine the effects of fiscal policy reaction functions, including one with dual unemployment rate and public production targets, testing their effects on numerically computed solution pathways. Analytical results in the penultimate section show that (1) the model has no equilibrium (steady state) for reasons related to Minsky's argument that modern capitalist economies possess a property that he called "the instability of stability," and (2) solution pathways exist and are unique, given vectors of initial conditions and parameter values and realizations of the Poisson model of financial crises.

If the Congressional Budget Office's recent projections of government revenues and outlays come to pass, the United States will not grow fast enough to bring down the unemployment rate between now and 2016. The public sector deficit will decline from present levels, endangering the sustainability of the recovery. But as this new Strategic Analysis shows, a public sector stimulus of a little over 1 percent of GDP per year focused on export-oriented R and D investment would increase US competitiveness through export-price effects, resulting in a rise of net exports, and slowly lower unemployment to less than 5 percent by 2016. The improvement in net export demand would allow the US economy to enter a period of aggregate-demand rehabilitation—with very encouraging consequences at home.

Should shocks be part of our macro-modeling tool kit—for example, as a way of modeling discontinuities in fiscal policy or big moves in the financial markets? What are shocks, and how can we best put them to use? In heterodox macroeconomics, shocks tend to come in two broad types, with some exceptions for hybrid cases. What I call Type 1 shocks are one-time exogenous changes in parameters or variables. They are used, for example, to set computer simulations in motion or to pose an analytical question about dynamic behavior outside of equilibrium. On the other hand, Type 2 shocks, by construction, occur at regular time intervals, and are usually drawn at random from a probability distribution of some kind. This paper is an appreciation and a survey of shocks and their admittedly scattered uses in the heterodox macro literature, along with some proposals and thoughts about using shocks to improve models. Since shocks of both types might appear at times to be ad hoc when used in macro models, this paper examines possible justifications for using them.

As this report goes to press, the official unemployment rate remains tragically elevated, compared even to rates at similar points in previous recoveries. The US economy seems once again to be in a "jobless recovery," though the unemployment rate has been steadily declining for years. At the same time, fiscal austerity has arrived, with the implementation of the sequester cuts, following tax increases and the ending of emergency extended unemployment benefits just two months ago. Our new report provides medium-term projections of employment and economic growth under four different scenarios. The baseline scenario starts by assuming the same growth rates and government deficits as the Congressional Budget Office's (CBO) baseline projection from earlier this year. The result is a new surge of the unemployment rate to nearly 8 percent in the third quarter of this year, followed by a very gradual new recovery. Scenarios 1 and 2 seek to reach unemployment-rate goals of 6.5 percent and 5.5 percent, respectively, by the end of next year, using new fiscal stimulus. We find in these simulations that reaching the goals requires large amounts of fiscal stimulus, compared to the CBO baseline. For example, in order to reach 5.5 percent unemployment in 2014, scenario 2 assumes 11 percent growth in inflation-adjusted government spending and transfers, along with lower taxes. As an alternative, scenario 3 adds an extra increase to growth abroad and to private borrowing, along with the same amount of fiscal stimulus as in scenario 1. In this last scenario of the report, the unemployment rate finally pierces the 5.5 percent threshold from the previous scenario in the third quarter of 2015. We conclude with some thoughts about how such an increase in demand from all three sectors—government, private, and external—might be realistically obtained.

Should we allow the fiscal cliff, with its across-the-board spending cuts and big tax increases that will affect almost every American, to take effect? Economists have been weighing in on such fiscal policy questions in what seems to be the most intense election-year debate in many years. To help our readers keep track of this debate, we offer a list of some of the specious arguments against fiscal stimulus and for austerity, together with our responses.

The United States must make a fundamental choice in its economic policy in the next few months, a choice that will shape the US economy for years to come. Pundits and policymakers are divided over how to address what is widely referred to as the "fiscal cliff," a combination of tax increases and spending cuts that will further weaken the domestic economy. Will the United States continue its current, misguided, policy of implementing European-style austerity measures, and the economic contraction that is the inevitable consequence of such policies? Or will it turn aside from the fiscal cliff, using a combination of its sovereign currency system and Keynesian fiscal policy to strengthen aggregate demand? Our analysis presents a model of what we call the "fiscal trap"—a self-imposed spiral of economic contraction resulting from a fundamental misunderstanding of the role and function of fiscal policy in times of economic weakness. Within this framework, we begin our analysis with the disastrous results of austerity policies in the European Union (EU) and the UK. Our account of these policies and their results is meant as a cautionary tale for the United States, not as a model.

Though the economy appears to be gradually gaining momentum, broad measures indicate that 14.5 percent of the US labor force is unemployed or underemployed, not much below the 16.2 percent rate reached a full year ago. In this new report in our Strategic Analysis series, we first discuss several slow-moving factors that make it difficult to achieve a full and sustainable economic recovery: the gradual redistribution of income toward the wealthiest 1 percent of households; a failure to fully stabilize and reregulate finance; serious fiscal troubles for state and local governments; and detritus from the financial crisis that remains on household and corporate balance sheets. These factors contribute to a situation in which employment has not risen fast enough since the (supposed) end of the recession to significantly increase the employment-population ratio. Meanwhile, public investment at all levels of government fell from roughly 3.7 percent of GDP in 2008 to 3.2 percent in the fourth quarter of 2011, helping to explain the weak economic picture. For this report, we use the Levy Institute macro model to simulate the economy under the following three scenarios: (1) a private borrowing scenario, in which we find the appropriate amount of private sector net borrowing/lending to achieve the path of employment growth projected under current policies by the Congressional Budget Office (CBO), in a report characterized by excessive optimism and a bias toward deficit reduction; (2) a more plausible scenario, in which we assume that the federal government extends certain key tax cuts and that household borrowing increases at a more reasonable rate than in the previous scenario; and (3) a fiscal stimulus scenario, in which we simulate the effects of a fully "paid for" 1 percent increase in government investment. The results show the importance of debt accumulation as a consideration in macro policymaking. The first scenario reproduces the CBO's relatively optimistic employment projections, but our results indicate that this private-sector-led growth scenario quickly brings household and business debt to new all-time highs as percentages of GDP. We note that the CBO makes its projections using an orthodox model with several common, but fundamental, flaws. This makes possible the agency's result that current policies will reduce the unemployment rate without a run-up in the private sector’s debt—"business as usual," in the words of our report's title. The policies weighed in the second scenario do not perform much better, despite a looser fiscal stance. Finally, our third scenario illustrates that a small, tax-financed increase in government investment could lower the unemployment rate significantly—by about one-half of 1 percent. A stimulus package of this size might be within the realm of political possibility at this juncture. However, our results lead us to surmise that it would take a much more substantial fiscal stimulus to reduce unemployment to a level that most policymakers would regard as acceptable.

Recently, some have wondered whether a fiscal stimulus plan could reduce the government's budget deficit. Many also worry that fiscal austerity plans will only bring higher deficits. Issues of this kind involve endogenous changes in tax revenues that occur when output, real wages, and other variables are affected by changes in policy. Few would disagree that various paradoxes of austerity or stimulus might be relevant, but such issues can be clarified a great deal with the help of a complete heterodox model. In light of recent world events, this paper seeks to improve our understanding of the dynamics of fiscal policy and financial crises within the context of two-dimensional (2D) and five-dimensional heterodox models. The nonlinear version of the 2D model incorporates curvilinear functions for investment and consumption out of unearned income. To bring in fiscal policy, I make use of a rule with either (1) dual targets of capacity utilization and public production, or (2) a balanced-budget target. Next, I add discrete jumps and policy-regime switches to the model in order to tell a story of a financial crisis followed by a move to fiscal austerity. Then, I return to the earlier model and add three more variables and equations: (1) I model the size of the private- and public-sector labor forces using a constant growth rate and account for their social reproduction by introducing an unemployment-insurance scheme; and (2) I make the markup endogenous, allowing its rate of change to depend, in a possibly nonlinear way, on capacity utilization, the real wage relative to a fixed norm, the employment rate, profitability, and the business sector’s desired capital-stock growth rate. In the conclusion, I comment on the implications of my results for various policy issues.

Fiscal austerity is now a worldwide phenomenon, and the global growth slowdown is highly unfavorable for policymakers at the national level. According to our Macro Modeling Team's baseline forecast, fears of prolonged stagnation and a moribund employment market are well justified. Assuming no change in the value of the dollar or interest rates, and deficit levels consistent with the Congressional Budget Office's most recent "no-change" scenario, growth will remain very weak through 2016 and unemployment will exceed 9 percent. In an alternate scenario, the authors simulate the effect of new austerity measures that are commensurate with the implementation of large federal budget cuts. Here, growth falls to 0.06 percent in the second quarter of 2014 before leveling off at approximately 1 percent and unemployment rises to 10.7 percent by the end of 2016. In their fiscal stimulus scenario, real GDP growth increases very quickly, unemployment declines to 7.2 percent, and the US current account balance reaches 1.9 percent by the end of 2016—with a debt-to-GDP ratio that, at 97.4 percent, is only slightly higher than in the baseline scenario. An export-led growth strategy may accomplish little more than drawing a small number of scarce customers away from other exporting nations, and the authors expect no net contribution to aggregate demand growth from the financial sector. A further fiscal stimulus is clearly in order, they say, but an ill-timed round of fiscal austerity could result in a perilous situation for Washington.

Research Scholar Greg Hannsgen and President Dimitri B. Papadimitriou disprove claims made by Social Security skeptics that the program is nothing more than a "Ponzi scheme."

President Dimitri B. Papadimitriou and Research Scholar Greg Hannsgen make the case that the recession has turned into a prolonged and very unusual slump in growth, preventing a labor-market recovery—and the government lags far behind in creating the new jobs needed to deal with this disaster.

With quantitative easing winding down and the latest payroll tax-cut measures set to expire at the end of this year, pressing questions loom about the current state of the US economic recovery and its ability to sustain itself in the absence of support from monetary and fiscal policy.

The slow recovery of the job market after the recessions of 2001 and 2007–09 has fostered concerns that the link between output growth and job creation has been severed. Between 2000 and 2010, the employment rate for males plunged from 71.9 to 63.7 percent—a decline that can be accounted for almost entirely by a fall in the employment rate for the disabled members of this group. Research Scholar Greg Hannsgen examines whether the Great Recession disproportionately affected the job prospects of disabled workers, and whether the long-run fall in employment among the disabled can be blamed largely on the design of Social Security disability insurance. His findings? At least since 2008, the ongoing fall in the probability of being employed has strongly affected the job prospects of both the disabled and the nondisabled, and the accelerated declines since 2007 hint at an important, and negative, role for the recent recession. Hence, a government jobs initiative such as an employer-of-last-resort program, and not just long-term improvements in entitlement programs, is still very much apropos.

This public policy brief analyzes the current economic climate in light of recent data and commentary. The authors’ approach rests upon a Keynesian framework in which departures from full employment can persist even in the long run. Moreover, monetary policy matters in our view, but fiscal policy and finance are more central to the problem of stabilizing a modern economy. In keeping with Wynne Godley’s stock-flow consistent approach to macroeconomics, levels of debt and financial imbalances play a central role in our analysis through good times and bad. Problems with private-sector debt are a subtle and important matter, which we interpret through the lens of Hyman P. Minsky’s financial fragility hypothesis. In this public policy brief, we find that as of early spring 2011, the economic recovery is still alive, but numerous dangers lie both ahead and behind: ill-conceived calls for fiscal austerity in Washington and other capitals; concerns about monetary laxity that unfortunately persist in the face of low long-term interest rates and inflation in almost every major economy; undercapitalized banks that have yet to deal with the many low-quality assets that remain on their books; a dysfunctional public-finance system in the European Union; commodity prices that are in many cases rising at double-digit annual rates; and high rates of short- and long-term unemployment. Fortunately, in spite of these nagging issues, consumer spending and the export sector have been showing some signs of improved health. Nevertheless, our analysis suggests that the current situation requires increased fiscal deficits and additional long-maturity asset purchases by the Federal Reserve.

The US economy grew reasonably fast during the last quarter of 2010, and the general expectation is that satisfactory growth will continue in 2011-12. The expansion may, indeed, continue into 2013. But with large deficits in both the government and foreign sectors, satisfactory growth in the medium term cannot be achieved without a major, sustained increase in net export demand. This, of course, cannot happen without either a cut in the domestic absorption of US goods and services or a revaluation of the currencies of the major US trading partners. Our policy message is fairly simple, and one that events over the years have tended to vindicate. Most observers have argued for reductions in government borrowing, but few have pointed out the potential instabilities that could arise from a growth strategy based largely on private borrowing-as the recent financial crisis has shown. With the economy operating at far less than full employment, we think Americans will ultimately have to grit their teeth for some hair-raising deficit figures, but they should take heart in recent data showing record-low "core" CPI inflation—and the potential for export-led growth to begin reducing unemployment.

Fiscal austerity is now a worldwide phenomenon, and the global growth slowdown is highly unfavorable for policymakers at the national level. According to our Macro Modeling Team's baseline forecast, fears of prolonged stagnation and a moribund employment market are well justified. Assuming no change in the value of the dollar or interest rates, and deficit levels consistent with the Congressional Budget Office's most recent "no-change" scenario, growth will remain very weak through 2016 and unemployment will exceed 9 percent. In an alternate scenario, the authors simulate the effect of new austerity measures that are commensurate with the implementation of large federal budget cuts. Here, growth falls to 0.06 percent in the second quarter of 2014 before leveling off at approximately 1 percent and unemployment rises to 10.7 percent by the end of 2016. In their fiscal stimulus scenario, real GDP growth increases very quickly, unemployment declines to 7.2 percent, and the US current account balance reaches 1.9 percent by the end of 2016—with a debt-to-GDP ratio that, at 97.4 percent, is only slightly higher than in the baseline scenario. An export-led growth strategy may accomplish little more than drawing a small number of scarce customers away from other exporting nations, and the authors expect no net contribution to aggregate demand growth from the financial sector. A further fiscal stimulus is clearly in order, they say, but an ill-timed round of fiscal austerity could result in a perilous situation for Washington.

This paper adumbrates a theory of what might be going wrong in the monetary SVAR literature and provides supporting empirical evidence. The theory is that macroeconomists may be attempting to identify structural forms that do not exist, given the true distribution of the innovations in the reduced-form VAR. The paper shows that this problem occurs whenever (1) some innovation in the VAR has an infinite-variance distribution and (2) the matrix of coefficients on the contemporaneous terms in the VAR’s structural form is nonsingular. Since (2) is almost always required for SVAR analysis, it is germane to test hypothesis (1). Hence, in this paper, we fit a -stable distributions to VAR residuals and, using a parametric-bootstrap method, test the hypotheses that each of the error terms has finite variance.

The US economy grew reasonably fast during the last quarter of 2010, and the general expectation is that satisfactory growth will continue in 2011-12. The expansion may, indeed, continue into 2013. But with large deficits in both the government and foreign sectors, satisfactory growth in the medium term cannot be achieved without a major, sustained increase in net export demand. This, of course, cannot happen without either a cut in the domestic absorption of US goods and services or a revaluation of the currencies of the major US trading partners. Our policy message is fairly simple, and one that events over the years have tended to vindicate. Most observers have argued for reductions in government borrowing, but few have pointed out the potential instabilities that could arise from a growth strategy based largely on private borrowing-as the recent financial crisis has shown. With the economy operating at far less than full employment, we think Americans will ultimately have to grit their teeth for some hair-raising deficit figures, but they should take heart in recent data showing record-low "core" CPI inflation—and the potential for export-led growth to begin reducing unemployment.

In recent years, the US public debt has grown rapidly, with last fiscal year’s deficit reaching nearly $1.3 trillion. Meanwhile, many of the euro nations with large amounts of public debt have come close to bankruptcy and loss of capital market access. The same may soon be true of many US states and localities, with the governor of California, for example, publicly regretting that he has been forced to cut bone, and not just fat, from the state’s budget. Chartalist economists have long attributed the seemingly limitless borrowing ability of the US government to a particular kind of monetary system, one in which money is a "creature of the state" and the government can create as much currency and bank reserves as it needs to pay its bills (this is not to say that it lacks the power to impose taxes). In this paper, we examine this situation in light of recent discussions of possible limits to the federal government’s use of debt and the Federal Reserve’s "printing press." We examine and compare the fiscal situations in the United States and the eurozone, and suggest that the US system works well, but that some changes must be made to macro policy if the United States and the world as a whole are to avoid another deep recession.

There is no justification for the belief that cutting spending or raising taxes by any amount will reduce the federal deficit, let alone permit solid growth. The worst fears about recent stimulative policies and rapid money-supply growth are proving to be incorrect once again. We must find the will to reinvigorate government and to maintain Keynesian macro stimulus in the face of ideological opposition and widespread mistrust of government.

In this new policy brief, President Dimitri B. Papadimitriou and Research Scholar Greg Hannsgen evaluate the current path of fiscal deficits in the United States in the context of government debt and further spending, economic recovery, and unemployment. They are adamant that there is no justification for the belief that cutting spending or raising taxes by any amount will reduce the federal deficit, let alone permit solid growth. The worst fears about recent stimulative policies and rapid money-supply growth are proving to be incorrect once again. In the authors’ view, we must find the will to reinvigorate government and to maintain Keynesian macro stimulus in the face of ideological opposition and widespread mistrust of government.

Though recent market activity and housing reports give some warrant for optimism, United States economic growth was only 2.8 percent in the third quarter, and the unemployment rate is still very high. In their new Strategic Analysis, the Levy Institute's Macro-Modeling Team project that high unemployment will continue to be a problem if fiscal stimulus policies expire and deficit reduction efforts become the policy focus. The authors--President Dimitri B. Papadimitriou and Research Scholars Greg Hannsgen and Gennaro Zezza--argue that continued fiscal stimulus is necessary to reduce unemployment. The resulting federal deficits would be sustainable, they say, as long as they were accompanied by a coordinated and gradual devaluation of the dollar, especially against undervalued Asian currencies--a step necessary to prevent an increase in the current account deficit and ward off the risk of a currency crash.

Since the current recession began in December 2007, New Deal legislation and its effectiveness have been at the center of a lively debate in Washington. This paper emphasizes some key facts about two kinds of policy that were important during the Great Depression and have since become the focus of criticism by new New Deal critics: (1) regulatory and labor relations legislation, and (2) government spending and taxation. We argue that initiatives in these policy areas probably did not slow economic growth or worsen the unemployment problem from 1933 to 1939, as claimed by a number of economists in academic papers, in the popular press, and elsewhere. To substantiate our case, we cite some important economic benefits of New Deal–era laws in the two controversial policy areas noted above. In fact, we suggest that the New Deal provided effective medicine for the Depression, though fiscal policy was not sufficiently countercyclical to conquer mass unemployment and prevent the recession of 1937–38; 1933’s National Industrial Recovery Act was badly flawed and poorly administered, and the help provided by the National Labor Relations Act of 1935 came too late to have a big effect on the recovery.

As the nation watches the impact of the recent stimulus bill on job creation and economic growth, a group of academics continues to dispute the notion that the fiscal and job creation programs of the New Deal helped end the Depression. The work of these revisionist scholars has led to a public discourse that has obvious implications for the controversy surrounding fiscal stimulus bills. Since we support a new stimulus package—one that emphasizes jobs for the 9.8 percent of the workforce currently unemployed—we have been concerned about this debate. With Congress, the White House, pundits, and the press riveted on the all-important health care debate, we worry that they are also distracted by skirmishes over economic theory and history, while millions wait for a new chance to do meaningful work and effective, if imperfect, policy tools are readily at hand. (See also, Public Policy Brief No. 104.)

A wave of revisionist work claims that "anti-competitive" New Deal legislation such as the National Industrial Recovery Act (NIRA) and the National Labor Relations Act (NLRA) greatly slowed the recovery from the Depression; in this new public policy brief, President Dimitri B. Papadimitriou and Research Scholar Greg Hannsgen review these claims in light of current policy debates and cast into doubt the argument that NIRA and NLRA significantly prolonged or worsened the Depression. Moreover, Social Security, federal deposit insurance, and other New Deal programs helped usher in an era of relative prosperity following World War II. When it comes to combating the current recession and employment slump, it is the successful experience with relief and public works, and not the repercussions of pro-union and regulatory legislation, that offer the most relevant and helpful lessons.

Federal government and Federal Reserve (Fed) liabilities rose sharply in 2008. Who holds these new liabilities, and what effects will they have on the economy? Some economists and politicians warn of impending inflation. In this new Strategic Analysis, the Levy Institute's Macro-Modeling Team focuses on one positive effect--a badly needed improvement of private sector balance sheets--and suggest some of the reasons why it is unlikely that the surge in Fed and federal government liabilities will cause excessive inflation.

Though recent market activity and housing reports give some warrant for optimism, United States economic growth was only 2.2 percent in the third quarter, and the unemployment rate is still very high. In this new Strategic Analysis, we project that high unemployment will continue to be a problem if fiscal stimulus policies expire and deficit reduction efforts become the policy focus. We argue that continued fiscal stimulus is necessary to reduce unemployment. The resulting federal deficits would be sustainable as long as they were accompanied by low interest rates and a coordinated and gradual devaluation of the dollar, especially against undervalued Asian currencies - a step necessary to prevent an increase in the current account deficit and ward off the risk of a currency crash.

As shown in recent Federal Reserve flow-of-funds data, federal government liabilities rose sharply in 2008 . Who holds these new liabilities, and what effects will they have on the economy? Some economists and politicians warn of impending inflation. Below we focus on one positive effect - a badly needed improvement of private sector balance sheets - and suggest some of the reasons why it is unlikely that the surge in Fed and federal government liabilities will cause excessive inflation.

This paper considers a plan proposed by Warren Buffett, in which importers would be required to obtain certificates proportional to the amount of non-oil goods (and possibly also services) they brought into the country. These certificates would be granted to firms that exported goods. Exporting firms could then sell certificates to importing firms on an organized market. In this paper, starting from a relatively neutral projection of all major variables for the U.S. economy, we estimate that the plan would raise the price of imports by approximately 9 percent, quickly reducing the current account deficit to about 2 percent of GDP. We discuss several problems that might arise with the implementation of the Buffett plan, including possible instability in the price of certificates and retaliation by U.S. trade partners. We also consider an alternative version of the Buffett plan, in which certificates would be sold at a government auction, rather than granted to exporters. The revenues from certificate sales would then be used to finance a reduction in FICA payroll taxes. We report the results of simulations of the alternative plan's effects on macroeconomic balances and GDP growth. Notably, the alternative plan would lessen the severity of the growth recession expected in our base projection.

This paper attempts to explain one version of an empirical puzzle noted by Mankiw (2003): a Baumol-Tobin inventory-theoretic money demand equation predicts that the average U.S. adult should have held approximately $551.05 in currency and coin in 1995, while data show an average of $100. The models in this paper help explain this discrepancy using two assumptions: (1) the probabilities of being robbed or pickpocketed, or having a purse snatched, depend on the amount of cash held; and (2) there are costs of being robbed other than loss of cash, such as injury, medical bills, lost time at work, and trauma. Two models are presented: a dynamic, stochastic model with both instantaneous and decaying noncash costs of robbery, and a revised version of the inventory-theoretic model that includes one-period noncash costs. The former model yields an easily interpreted first-order condition for money demand involving various marginal costs and benefits of holding cash. The latter model gives quantitative solutions for money demand that come much closer to matching the 1995 data - $75.98 for one plausible set of parameters. This figure implies that consumers held approximately $96 billion less cash in May 1995 than they would have in a world without crime. The modified Baumol-Tobin model predicts a large increase in household money demand in 2005, mostly due to reduced crime rates.

This paper considers a plan proposed by Warren Buffett, in which importers would be required to obtain certificates proportional to the amount of non-oil goods (and possibly also services) they brought into the country. These certificates would be granted to firms that exported goods. Exporting firms could then sell certificates to importing firms on an organized market. In this paper, starting from a relatively neutral projection of all major variables for the U.S. economy, we estimate that the plan would raise the price of imports by approximately 9 percent, quickly reducing the current account deficit to about 2 percent of GDP. We discuss several problems that might arise with the implementation of the Buffett plan, including possible instability in the price of certificates and retaliation by U.S. trade partners. We also consider an alternative version of the Buffett plan, in which certificates would be sold at a government auction, rather than granted to exporters. The revenues from certificate sales would then be used to finance a reduction in FICA payroll taxes. We report the results of simulations of the alternative plan's effects on macroeconomic balances and GDP growth. Notably, the alternative plan would lessen the severity of the growth recession expected in our base projection.

Since Christopher Sims's "Macroeconomics and Reality" (1980), macroeconomists have used structural VARs, or vector autoregressions, for policy analysis. Constructing the impulse-response functions and variance decompositions that are central to this literature requires factoring the variance-covariance matrix of innovations from the VAR. This paper presents evidence consistent with the hypothesis that at least some elements of this matrix are infinite for one monetary VAR, as the innovations have stable, non-Gaussian distributions, with characteristic exponents ranging from 1.5504 to 1.7734 according to ML estimates. Hence, Cholesky and other factorizations that would normally be used to identify structural residuals from the VAR are impossible.

Levy Institute Strategic Analyses have always stressed the relevance of the linkages between conditions in financial markets and the real economy. In our last Strategic Analysis, we reported a simulation showing a high probability for a recession and an increase in unemployment in 2008, conditional on the assumption that turmoil in financial markets would slow the pace of household borrowing to more moderate levels. We projected that there would be serious consequences for aggregate demand, output, and employment. At the time of that analysis, in November 2007, most commentators still focused on financial markets, doubting that the financial upheaval that began last summer would have effects on the real economy. Subsequently, the assumed drop in household borrowing that underlay our conditional projection was borne out in actual data, and a U.S. recession is now thought by almost everyone to be a serious possibility.

This Strategic Analysis provides a retrospective view of U.S. growth in the last 10 years, showing that the authors’ previous work, grounded in the linkages between growth and the financial balances of the private, public, and foreign sectors of the economy, has proven a useful contribution to the public discussion. The analysis reviews recent events in the U.S. housing and financial markets to obtain a likely scenario for the evolution of household spending. It argues that a significant drop in borrowing is likely to take place in the coming quarters, with severe consequences for growth and unemployment, unless (1) the U.S. dollar is allowed to continue its fall and thus complete the recovery in the U.S. external imbalance, and (2) fiscal policy shifts its course—as it did in the 2001 recession.

Longstanding speculation about the likelihood of a housing market collapse has given way in the past few months to consideration of just how far the housing market will fall and how much damage the debacle will inflict on the economy. In this paper, we discuss recent developments related to the housing market; econometrically assess the magnitude of the impact of housing price decreases on real private expenditure; assess the importance of new types of mortgages and mortgage-related securities; and briefly analyze possible policy responses.

With economic growth having cooled to 0.7 percent in the first quarter of 2007, the economy can ill afford a slump in consumption by the American household. But it now appears that the household sector could finally give in to the pressures of rising gasoline prices, a weakening home market, and a large debt burden. The signals are still mixed; for example, while April’s retail sales numbers caused concern, May’s were much improved, and so was the ISM manufacturing index for June. Consumption growth indicates a slowdown. This Public Policy Brief examines the American household and its economic fortunes, concentrating on how falling home prices might hamper economic growth, generate social dislocations, and possibly lead to a full-blown financial crisis.

In his presidential address to the American Economic Association, Robert Lucas claimed that the welfare costs of the business cycle in the United States equaled .05 percent of consumption. His calculation compared the utility of a representative consumer receiving actual per-capita consumption each year with that of a similar consumer receiving the expectation of consumption. To a risk-averse person, the latter path of consumption confers more utility, because it is less volatile. Applying Amartya Sen's chooser-dependent preferences to a nonÐexpected utility case, I will counter Lucas's claim by arguing that people have different attitudes toward risk that is imposed and risk that is voluntarily taken on, and that policymakers, in carrying out public duties, must use sorts of reasoning different from those used by the optimizing consumers of neoclassical economic theory.

Recently, many economists have credited the late-1990s economic boom in the United States for the easy money policies of the Federal Reserve. On the other hand, observers have noted that very low interest rates have had very little positive effect on the chronically weak Japanese economy. Therefore, some theory of how money affects the economy when it is endogenous would be useful. This paper pursues several such explanations, including the effects of interest rate changes on (1) investment; (2) consumer spending; (3) the exchange rate; and (4) financial markets. The theories of such authors as Kalecki, Keynes, Minsky, and J. K. Galbraith are discussed and evaluated, with an emphasis on the role of cash flow. Some of these theories turn out to be stronger than others when subjected to tests of logic and empirical evidence.

In his presidential address to the American Economic Association, Robert Lucas claimed that the welfare costs of the business cycle in the United States equaled .05 percent of consumption. His calculation compared the utility of a representative consumer receiving actual per-capita consumption each year with that of a similar consumer receiving the expectation of consumption. To a risk-averse person, the latter path of consumption confers more utility, because it is less volatile. Applying Amartya Sen’s chooser-dependent preferences to a non–expected utility case, I will counter Lucas’s claim by arguing that people have different attitudes toward risk that is imposed and risk that is voluntarily taken on, and that policymakers, in carrying out public duties, must use sorts of reasoning different from those used by the optimizing consumers of neoclassical economic theory. Keywords: costs of the business cycle, non–expected utility preferences, chooser-dependent preferences, Amartya Sen

This Strategic Analysis provides a retrospective view of U.S. growth in the last 10 years, showing that the authors’ previous work, grounded in the linkages between growth and the financial balances of the private, public, and foreign sectors of the economy, has proven a useful contribution to the public discussion. The analysis reviews recent events in the U.S. housing and financial markets to obtain a likely scenario for the evolution of household spending. It argues that a significant drop in borrowing is likely to take place in the coming quarters, with severe consequences for growth and unemployment, unless (1) the U.S. dollar is allowed to continue its fall and thus complete the recovery in the U.S. external imbalance, and (2) fiscal policy shifts its course—as it did in the 2001 recession.

Longstanding speculation about the likelihood of a housing market collapse has given way in the past few months to consideration of just how far the housing market will fall and how much damage the debacle will inflict on the economy. In this paper, we discuss recent developments related to the housing market; econometrically assess the magnitude of the impact of housing price decreases on real private expenditure; assess the importance of new types of mortgages and mortgage-related securities; and briefly analyze possible policy responses.

In this new Strategic Analysis, we review what we believe is the most important economic policy issue facing policymakers in the United States and abroad: the prospect of a growth recession in the United States, linked to the imbalances in the U.S. current account, government, and private sector deficits. The current account balance, which is a negative addition to U.S. aggregate demand, is now likely to be above 6.5 percent of GDP and has been rising steadily for some time. The government balance has improved, again giving no stimulus to demand, which has therefore relied entirely on a large and growing private sector deficit. A rapidly cooling housing market is one of the signs showing that this growth path is likely to break down. We focus first on the current account deficit. Our analysis suggests that a necessary and sufficient condition to address this problem, without dire consequences for unemployment and growth, is that net export demand grow by a sufficient amount. For this to happen, three conditions need to be satisfied: foreign saving has to fall, especially in Europe and East Asia; U.S. saving has to rise; and some mechanism, such as a change in relative prices, should be put in place to help the previous two phenomena translate into an improvement in the U.S. balance of trade.

The Gibson paradox, long observed by economists and named by John Maynard Keynes (1936), is a positive relationship between the interest rate and the price level. This paper explains the relationship by means of interest-rate, cost-push inflation. In the model, spending is driven in part by changes in the rate of interest, and the central bank sets the interest rate using a policy rule based on the levels of output and inflation. The model shows that the cost-push effect of inflation, long known as Gibson's paradox, intensifies destabilizing forces and can be involved in the generation of cycles.

The development of the permanent income/life cycle consumption hypothesis was a key blow to Keynesian and Kaleckian economics, and, according to George Akerlof, it ‘set the agenda’ for modern neoclassical macroeconomics. This paper focuses on the relationship of housing wealth to neoclassical consumption theory and, in particular, the degree to which homes can be treated collectively with other forms of ‘permanent income.’ The neoclassical analysis will be evaluated as a partly normative and partly positive one, in recognition of the dual function of the neoclassical theory of rationality. The paper rests its critique primarily on the distinctive role of homes in social life; theories that fail to recognize this role jeopardize the social and economic goods at stake. Since many families do not own large amounts of assets other than their places of residence, these issues have important ramifications for the relevance of consumption theory as a whole.

In dealing with the problematic relationship of morality to rational choice theory, neoclassical economists since Lionel Robbins have often argued that they can incorporate moral values into consumer theory by putting those values into the utility function. This paper tests the viability of such an approach in the context of international finance. The moral value at stake is autonomy, which may be lost when borrowers must submit to the edicts of international financial institutions. When such a value is inserted into the utility function of a small economy, the growth rate of consumption and the level of investment change. Furthermore, potential borrowers may lose their ability to credibly commit to paying back loans, resulting in a complete absence of borrowing where it might otherwise take place. The author argues that while this model illustrates the possibility of analyzing a noneconomic value (sovereignty) through rational choice theory, it also shows that standard methods of empirical inference, policy evaluation, and welfare analysis may fail in such a situation. To answer questions that mix morality and economics, economists must seek tools other than conventional rational choice theory.