Research Topics

This paper econometrically models the dynamics of Swedish government bond (SGB) yields. It examines whether the short-term interest rate has a decisive influence on long-term SGB yields, after controlling for other macroeconomic and financial variables, such as consumer price inflation, the growth of industrial production, the stock price index, the exchange rate of the Swedish krona, and the balance sheet of Sweden’s central bank, Sveriges Riksbank. It applies an autoregressive distributive lag (ARDL) approach using monthly data to model SGB yields across the Treasury yield curve. The results of the estimated models show that the short-term interest rate has a marked influence on the long-term SGB yield. Such findings reaffirm John Maynard Keynes’s view that the central bank’s monetary policy affects long-term government bond yields through the current short-term interest rate.  It also shows that the interest rate behavior observed in Sweden is in concordance with empirical patterns discerned in previous studies related to government bond yields in both advanced countries and emerging markets.

For more than 25 years, the Social Security Trust Fund was projected to run out of money in 2033 (give or take a few years), potentially causing benefits to be severely reduced in the absence of corrective legislative action. Today (February 2024), projections are made by the Social Security Administration that indicate that future benefits will need to be reduced by roughly 25 percent or taxes will need to be increased by about 33 percent, or some combination to avoid benefit curtailment. While Congress will most probably prevent benefits from being reduced for retirees and those nearing retirement, the longer Congress and the president take to address the shortfall, the more politically unpalatable (and possibly draconian) the solutions will be for all others.
 
Dozens of proposals are being evaluated to address the long-term problem by mainstream benefits experts, economists, think tanks, politicians, and government agencies but, with rare exceptions from a few economists, none address the short-term problem of Trust Fund depletion, provide a workable roadmap for the long-term challenges, or consider fundamental financing differences between the federal government and the private sector.
 
This paper aims to address these issues by suggesting legislative changes that will protect the Social Security system indefinitely, help ensure the adequacy of benefits for retirees and their survivors and dependents, and remove confusing and misleading legislative and administrative complexity. In making recommendations, this paper will demonstrate that the Social Security Trust Funds, while legally distinct, are essentially an artificial accounting contrivance within the US Treasury that have become a tool to force program changes that, for ideological reasons, will likely shift an increasing financial burden onto those who can least bear it.  Finally, while the focus of this paper is on the Social Security system, it would be incomplete without also addressing, albeit in a limited way, the larger political issue of the nation’s debt and deficit along with the implications for inflation.

The post-pandemic surge in inflation was accompanied by a surge in the corporate share of profits. As a result, several economists and policy makers have given to it names such as “profit-led inflation” or “sellers’ inflation.” The present paper discusses the extent to which profit-led inflation, as an explanation for the recent surge in inflation, is compatible with what we know about the price-setting behavior of firms, income distribution, and inflation. We do that in juxtaposition to two recent critiques: that the increase in the profit share is the result of cyclical factors, and that the increase in import prices leads to higher profit shares even under constant markups. We show that there is little evidence that the recent surge in profitability is cyclical in nature. Moreover, after outlining the Structuralist/Kaleckian theories of prices and inflation we argue that profit-led inflation does not require an increase in the markup of the firms and is consistent with these theories. In the face of large import and other price shocks even under constant markups, firms are able to pass the burden of adjustment to real wages. Thus, the term profit-led emphasizes the distributional source and consequences of inflation. We also provide an empirical examination of the markups in the post-pandemic period using data from the Compustat database. We show that, on average, firms were able to increase or maintain their markups, although there is significant heterogeneity across sectors or the position of the firms in the distribution of markups.

Using the model proposed in Krugman and Taylor’s “Contractionary effects of devaluation” (1978), we examine the macroeconomic effects of shocks to foreign prices. We show that these shocks can be contractionary for two reasons: (i) because they imply a loss of income if an economy has a trade deficit or import prices increase proportionally more than export prices; (ii) because there is a redistribution of income from wages to profits and rent, which leads to a decrease in consumption and output (as the wage earner's propensity to consume is higher than those of profit earners and rentiers). An endogenous reaction of nominal wages to the increase in the price level might lead to even higher increases in prices, but mitigates the negative macroeconomic effects of the foreign price shocks because it reduces their negative distributional effects. If the proportional increase in nominal wages is higher than that of domestic prices, the distributional effect becomes positive. The opposite is the case with markups. If they increase in reaction to higher prices, they contribute to further price increases but they also exacerbate the negative distributional effects. The paper also provides an analytical solution for a general case of the model of Krugman and Taylor.

In this Strategic Analysis, Dimitri B. Papadimitriou, Michalis Nikiforos, Giuliano T. Yajima, and Gennaro Zezza discuss how the current state and structural features of the US economy might affect its future trajectory. The recent recovery after the pandemic has been remarkable, when compared to previous cycles, and offers evidence of the efficacy of fiscal policy. Moreover, the inflation rate has been finally decelerating as the problems in global value chains that emerged after the pandemic are resolving and the price of commodities and oil, which spiked after the pandemic and the war in Ukraine, are stabilizing.

Yet despite the recent success of fiscal policy in promoting output and employment growth, the recent debt ceiling deal—culminating in the 2023 Fiscal Responsibility Act—risks putting the US economy on the austerity path of the previous decade. And given the structural weaknesses of the US economy—including its high current account deficits, high level of indebtedness of firms, and overvalued stock and real estate prices—this projected fiscal policy tightening, combined with the impacts of high interest rates, could lead to a significant slowdown of the US economy.

The US economy, the authors contend, is in need of a structural transformation toward modernizing its infrastructure, promoting industrial policy, and investing in the greening of its economy and environmental sustainability. A necessary condition for achieving these goals is an increase in government expenditure; they show that such an increase could also have positive demand effects on output and employment. 

As country after country in the European Union is called to respond to the current challenge of our time—high inflation and declining real wages—governments must engage in a transformative agenda and go beyond emergency energy vouchers and income support cash-transfers. And if the goal is to lead the way to a resilient and sustainable European Union, business as usual will not do. The share of wages to GDP has been declining since the late 1970s, deregulation of labor markets has increased insecurity and precariousness, and, among ordinary working people, a sense of uncertainty, disenfranchisement, and mistrust in governing institutions is prevalent. A thorough re-evaluation of policies is needed. In response to the deterioration of living standards, a guarantee of minimum wages adequate to secure a decent living standard should be a starting point; a permanent policy of automatic adjustment of wages to inflation rates in all member states should be promoted; and strengthening collective bargaining agreements ought to be re-invigorated for a fair sharing of productivity between wages and profits. An EU Job Guarantee should be at the center of this policy transformation. This bold agenda, advocated in this paper, can mobilize people to regain trust that a Social Europe is possible.

This paper econometrically models the dynamics of Indian rupee (INR) swap yields based on key macroeconomic factors using the autoregressive distributive lag (ARDL) approach. It examines whether the short-term interest rate has a decisive influence on long-term INR swap yields after controlling for other factors, such as core inflation, the growth of industrial production, the logarithm of the equity price index, and the logarithm of the INR exchange rate. The estimated models show that the short-term interest rate has an important influence on the swap yields. This implies that the Reserve Bank of India (RBI) can sway borrowing and lending rates not just on Indian government bonds but also INR-denominated private-market financial instruments, such as swaps and swaptions.

This paper econometrically models Japanese yen (JPY)–denominated interest rate swap yields. It examines whether the short-term interest rate exerts an influence on the long-term JPY swap yield after controlling for several key macroeconomic variables, such as core inflation, the growth of industrial production, the percentage change in the equity price index, and the percentage change in the exchange rate. It also tests whether there are structural breaks in the dynamics of Japanese swap yields and related variables. The estimated econometric models show that the short-term interest rate exerts an important influence on the long-term swap yield in some periods but not in other periods in which core inflation exerts a marked influence on the swap yield. The findings from the econometric models reveal a discernable relationship between the call rate and the swap yield of different maturity tenors clearly held prior to April 2014 but did not in the subsequent period. These findings highlight the limits and scope of John Maynard Keynes’s contention that the central bank’s policy rate commands a decisive influence over the long-term market rate through the short-term interest rate. The policy implications of the estimated models’ results are discussed.

While the trigger for the Covid recession was unusual—a collapse of the supply side that produced a drop in demand—the inflation the US economy is now facing is not atypical, according to L. Randall Wray. In this one-pager, he explores the causes of the current inflationary environment, arguing that continuing inflation pressures come mostly from the supply side.

Wray warns that, given federal spending had already been declining substantially before the Fed started raising interest rates, rate hikes make a recession—and potentially stagflation—even more likely. A key part of our fiscal policy response should be focused on well-designed public investment addressing the substantial supply constraints still affecting the US economy—constraints that are not just due to the Covid crisis, but also decades of underinvestment in infrastructure. Such an approach, in Wray's view, would reduce inflationary pressures while supporting growth.
 

In this strategic analysis, Institute President Dimitri B. Papadimitriou, Senior Scholar Gennaro Zezza, and Research Associate Nikolaos Rodousakis discuss the medium-term prospects for the Greek economy in a time of increasing uncertainty—due to the geopolitical turbulence emanating from the Ukraine–Russian conflict, with its impact on the cost of energy, as well as the increase in international prices of some commodities.

Growth projections for the current year are lower than those recorded in 2021, indicating the economy needs to perform much better if it is to continue on the growth path that began in the pre-pandemic period.  Similarly, growth projections for 2023 and 2024 appear much weaker, denoting serious consequences may be in store.

With increasing price levels and the euro depreciating, an economy like Greece’s that is highly dependent on increasingly costly imports will become more fragile as the current account deficit widens. In the authors’ view, the continuous recovery of the Greek economy rests with the government’s ability to utilize the NGEU funds swiftly and efficiently for projects that will increase the country’s productive capacity.
 

Pandemic or Policy Response?

This paper examines the recent increase of the measured inflation rate to assess the degree to which the acceleration is due to problems created (largely on the supply side) by the pandemic versus pressures created on the demand side by pandemic relief. Some have attributed the inflation to excess demand, most notably Larry Summers, who had warned that the pandemic relief spending was too great. As evidence, one could point to the quick recovery of GDP and to reportedly tight labor markets. Others have variously blamed supply chain disruptions, shortages of certain inputs, OPEC’s oil price increases, labor market disruptions because of COVID, and rising profit margins obtained through exercise of pricing power. We conclude that there is little evidence that excess demand is the problem, although we agree that in the absence of the relief checks, recovery would have been sufficiently slow to minimize inflation pressure. We closely examine the main contributors to rising overall prices and conclude that tighter monetary policy would not be an effective way to reduce price pressures. We also cast doubt on the expectations theory of inflation control. We present evidence that suggests there is currently little danger that higher inflation will become entrenched. If anything, rate hikes now will make it harder for the economy to adjust to current realities. The potential for lots of pain with little gain is great. The best course of action is to tackle problems on the supply side.

Modern Money Theory (MMT) has generated considerable scrutiny and discussions over the past decade. While it has gained some acceptance in the financial sector and among some politicians, it has come under strong criticisms from all sides of the academic spectrum and from conservative political circles. MMT has been argued to be both fascist and communist, orthodox and heterodox, dangerous and benign, unworkable and obvious, and unrealistic and clearly nothing new. The contradictory aspects of the range of criticisms suggest that there is at best a superficial understanding of the MMT framework. MMT relies on a well-established theoretical framework and is not inherently about changing the economic system; it is about changing the policymaking praxis to implement a given public purpose. That public purpose can be small or large and can be conservative or progressive; it ought not to be narrowly determined but rather should be set as democratically as possible. While MMT proponents tend to favor a public purpose that deals with what they see as major drawbacks of capitalist economies (persistent nonfrictional unemployment, unfair inequalities, and financial instability), their policy proposals do not lead to a major shift of domestic resources to the public purpose. If a major increase in government spending is implemented, MMT provides some guidance on how to do that in the least disruptive manner by drawing on past economic experiences. The point is to implement the public purpose at a pace that recognizes the potential constraint that comes from domestic resource availability and potential inflationary pressures from bottlenecks, rising import prices, and exchange rate depreciation, among others. In most cases, economies have more flexibility than what is admitted. In all cases, when monetary sovereignty prevails, the fiscal position and the public debt are poor metrics for judging the viability of a public purpose and its pace of implementation.

As such, applying MMT to policymaking does not mean that a government ought to be encouraged to record fiscal deficits or that the relation between the central bank and the treasury ought to be radically changed to allow direct financing. The fiscal balance is not a proper policy goal because it leads to irrelevant or incorrect policymaking and because it is largely outside the control of policymakers. The financial praxis of monetarily sovereign governments already conforms to MMT. Central banks and treasuries routinely coordinate their financial operations. Some governments have allowed direct financing of the treasury by the central bank; others have not but have developed equivalent ways to coordinate their fiscal and monetary operations that work around existing political constraints. Such routine coordination ensures an elastic financing of government operations that at least deals with domestic resources and is not intrinsically inflationary.

The Federal Reserve’s Continuing Experiments with Unobservables

Institute President Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray contend that the prevailing approach to monetary policy and inflation is influenced by a set of concepts that are a poor guide to action. In this policy brief, they examine two previous cases in which the Federal Reserve misread the data and raised rates too soon, as well as the evolution of the Fed’s thought and practice over the past three decades—a period in which the central bank has increasingly turned to unobservable indicators that are supposed to predict inflation. Noting that their criticisms have now been raised by the Fed’s own members and research staff, the authors highlight the ways in which we need to rethink our overall framework for monetary and fiscal policy. The Fed has far less control over inflation than is presumed, they argue, and, at worst, might have the whole inflation-fighting strategy backwards. Managing inflation, they conclude, should not be left entirely in the hands of central banks.

With the US Treasury cutting checks totaling approximately $5 trillion to deal with the COVID-19 crisis, Senior Scholar L. Randall Wray argues that when it comes to the federal government, concerns about affordability and solvency can both be laid to rest. According to Wray, the question is never whether the federal government can spend more, but whether it should. And while there are still strongly held beliefs about the negative impacts of deficits and debt on inflation, interest rates, growth, and exchange rates, with two centuries of experience the evidence for these concerns is mixed at best.

This paper presents multifactor Keynesian models of the long-term interest rate. In recent years there have been a proliferation of empirical studies based on the Keynesian approach to interest rate modeling. However, standard multifactor models of the long-term interest rate in quantitative finance have not been yet incorporated Keynes’s insights about interest rate dynamics. Keynes’s insights about the influence of the current short-term interest rate are introduced in two different multifactor models of the long-term interest rate to illustrate how the long-term interest rate relates to the short-term interest rate, the central bank’s policy rate, inflation expectations, the central bank’s inflation target, volatility in financial markets, and Wiener processes.

The Fed’s Unjustified Rationale

In December 2015, the Federal Reserve Board (FRB) initiated the process of “normalization,” with the objective of gradually raising the federal funds rate back to “normal”—i.e., levels that are “neither expansionary nor contrary” and are consistent with the established 2 percent longer-run goal for the annual Personal Consumption Expenditures index and the estimated natural rate of unemployment. This paper argues that the urgency and rationale behind the rate hikes are not theoretically sound or empirically justified. Despite policymakers’ celebration of “substantial” labor market progress, we are still short some 20 million jobs. Further, there is no reason to believe that the current exceptionally low inflation rates are transitory. Quite the contrary: without significant fiscal efforts to restore the bargaining power of labor, inflation rates are expected to remain below the Federal Open Market Committee’s long-term goal for years to come. Also, there is little empirical evidence or theoretical support for the FRB’s suggestion that higher interest rates are necessary to counter “excessive” risk-taking or provide a more stable financial environment.

Brazil is mired in a joint economic and political crisis, and the way out is unclear. In 2015 the country experienced a steep contraction of output alongside elevated inflation, all while the fallout from a series of corruption scandals left the policymaking apparatus paralyzed. Looking ahead, implementing a policy strategy that has any hope of addressing the Brazilian economy’s multilayered problems would make serious demands on a political system that is most likely unable to bear it.

A Case Study of the Canadian Economy, 1935–75

Historically high levels of private and public debt coupled with already very low short-term interest rates appear to limit the options for stimulative monetary policy in many advanced economies today. One option that has not yet been considered is monetary financing by central banks to boost demand and/or relieve debt burdens. We find little empirical evidence to support the standard objection to such policies: that they will lead to uncontrollable inflation. Theoretical models of inflationary monetary financing rest upon inaccurate conceptions of the modern endogenous money creation process. This paper presents a counter-example in the activities of the Bank of Canada during the period 1935–75, when, working with the government, it engaged in significant direct or indirect monetary financing to support fiscal expansion, economic growth, and industrialization. An institutional case study of the period, complemented by a general-to-specific econometric analysis, finds no support for a relationship between monetary financing and inflation. The findings lend support to recent calls for explicit monetary financing to boost highly indebted economies and a more general rethink of the dominant New Macroeconomic Consensus policy framework that prohibits monetary financing.

For Economic Stimulus, or for Austerity and Volatility?

The implementation of economic reforms under new economic policies in India was associated with a paradigmatic shift in monetary and fiscal policy. While monetary policies were solely aimed at “price stability” in the neoliberal regime, fiscal policies were characterized by the objective of maintaining “sound finance” and “austerity.” Such monetarist principles and measures have also loomed over the global recession. This paper highlights the theoretical fallacies of monetarism and analyzes the consequences of such policy measures in India, particularly during the period of the global recession. Not only did such policies pose constraints on the recovery of output and employment, with adverse impacts on income distribution; but they also failed to achieve their stated goal in terms of price stability. By citing examples from southern Europe and India, this paper concludes that such monetarist policy measures have been responsible for stagnation, with a rise in price volatility and macroeconomic instability in the midst of the global recession.

A Post-Keynesian View

Several explanations of the “great inflation moderation” (1982–2006) have been put forth, the most popular being that inflation was tamed due to good monetary policy, good luck (exogenous shocks such as oil prices), or structural changes such as inventory management techniques. Drawing from Post-Keynesian and structuralist theories of inflation, this paper uses a vector autoregression with a Post-Keynesian identification strategy to show that the decline in the inflation rate and inflation volatility was due primarily to (1) wage declines and (2) falling import prices caused by international competition and exchange rate effects. The paper uses a graphical analysis, impulse response functions, and variance decompositions to support the argument that the decline in inflation has in fact been a “wage and import price moderation,” brought about by declining union membership and international competition. Exchange rate effects have lowered inflation through cheaper import and oil prices, and have indirectly affected wages through strong dollar policy, which has lowered manufacturing wages due to increased competition. A “Taylor rule” differential variable was also used to test the “good policy” hypothesis. The results show that the Taylor rule differential has a smaller effect on inflation, controlling for other factors.

An Augmented Minskyan-Kaleckian Model

This paper augments the basic Post-Keynesian markup model to examine the effects of different fiscal policies on prices and income distribution. This is an approach à la Hyman P. Minsky, who argued that in the modern era, government is both “a blessing and a curse,” since it stabilizes profits and output by imparting an inflationary bias to the economy, but without stabilizing the economy at or near full employment. To build on these insights, the paper considers several distinct functions of government: 1) government as an income provider, 2) as an employer, and 3) as a buyer of goods and services. The inflationary and distributional effects of each of these fiscal policies differ considerably. First, the paper examines the effects of income transfers to individuals and firms (in the form of unemployment insurance and investment subsidies, respectively). Next, it considers government as an employer of workers (direct job creation) and as a buyer of goods and services (indirect job creation). Finally, it modifies the basic theoretical model to incorporate fiscal policy à laMinsky and John Maynard Keynes, where the government ensures full employment through direct job creation of all of the unemployed unable to find private sector work, irrespective of the phase of the business cycle. The paper specifically models Minsky’s proposal for government as the employer of last resort (ELR), but the findings would apply to any universal direct job creation plan of similar design. The paper derives a fundamental price equation for a full-employment economy with government. The model presents a “price rule” for government spending that ensures that the ELR is not a source of inflation. Indeed, the fundamental equation illustrates that in the presence of such a price rule, at full employment inflationary effects are observed from sources other thanthe public sector employment program.

By general agreement, the federal budget is on an “unsustainable path.” Try typing the phrase into Google News: 19 of the first 20 hits refer to the federal debt. But what does this actually mean? One suspects that some who use the phrase are guided by vague fears, or even that they don’t quite know what to be afraid of. Some people fear that there may come a moment when the government’s bond markets would close, forcing a default or “bankruptcy.” But the government controls the legal-tender currency in which its bonds are issued and can always pay its bills with cash. A more plausible worry is inflation—notably, the threat of rising energy prices in an oil-short world—alongside depreciation of the dollar, either of which would reduce the real return on government bonds. But neither oil-price inflation nor dollar devaluation constitutes default, and neither would be intrinsically “unsustainable.”

After a brief discussion of the major worries, Senior Scholar James Galbraith focuses on one, and only one, critical issue: the actual behavior of the public-debt-to-GDP ratio under differing economic assumptions through time. His conclusion? The CBO’s assumption that the United States must offer a real interest rate on the public debt higher than the real growth rate by itself creates an unsustainability that is not otherwise there. Changing that one assumption completely alters the long-term dynamic of the public debt. By the terms of the CBO’s own model, a low interest rate erases the notion that the US debt-to-GDP ratio is on an “unsustainable path.” The prudent policy conclusion? Keep the projected interest rate down. Otherwise, stay cool: don’t change the expected primary deficit abruptly, and allow the economy to recover through time.

A Critique of This Time Is Different, by Reinhart and Rogoff

The worst global downturn since the Great Depression has caused ballooning budget deficits in most nations, as tax revenues collapse and governments bail out financial institutions and attempt countercyclical fiscal policy. With notable exceptions, most economists accept the desirability of expansion of deficits over the short term but fear possible long-term effects. There are a number of theoretical arguments that lead to the conclusion that higher government debt ratios might depress growth. There are other arguments related to more immediate effects of debt on inflation and national solvency. Research conducted by Carmen Reinhart and Kenneth Rogoff is frequently cited to demonstrate the negative impacts of public debt on economic growth and financial stability. In this paper we critically examine their work. We distinguish between a nation that operates with its own floating exchange rate and nonconvertible (sovereign) currency, and a nation that does not. We argue that Reinhart and Rogoff’s results are not relevant to the case of the United States.

To save America—indeed, the global economy as a whole—the private/public sector balance has to shift, and the neoliberal economic model on which the country has been based for the past 25 years has to be modified. In this new working paper, Marshall Auerback details why the role of the state needs to be reemphasized.

The abandonment of a mixed economy and corresponding diminution of the role of government was hailed as the “rebirth of individualism,” yet it caused rising inequality and the decline of median wages, and led to the widespread neglect of public goods vital to its citizens’ welfare. Meanwhile, the country ran through the public investment it had made from the 1930s to the 1970s, with few serious challenges from policymakers or mainstream economists.

The neoliberal model was also aggressively exported: the “optimal” growth strategy for all emerging economies was supposedly one that emphasized limited government, corporate governance, rule of law, and higher levels of state-owned and -influenced enterprise—in spite of significant historical evidence to the contrary. Not even the economic wreckage in Mexico, Argentina, Thailand, Indonesia, and Russia seemed sufficient to challenge, let alone overturn, the prevailing paradigm.

That is, until now: in reaction to the financial crisis, many governments—led by the United States—are enacting massive economic stimulus packages and taking a central role in promoting economic growth strategies. This reemergence of state-driven capitalism constitutes a “back to the future” investment paradigm, one that is consistent with a long and successful pattern of economic development. But once we get beyond the pothole patching and school repairing, what industries can be pushed forward using public seed capital or through Sematech-like consortiums? What must be brought to the fore is the need for a new growth path for the United States, one in which the state has a significant role.  There are already indications that the private sector is beginning to adapt to this new, collaborative paradigm.

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.