Levy Institute Publications

Nischal Dhungel examines the impact of India’s demonetization experiment—an effort at “forced formalization” of the economy. He urges a more organic approach to formalization, pairing efforts to bring the unbanked population into the banking system with greater funding and accessibility for India’s signature employment guarantee program.

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. 

The year 2023 commemorates the 30th anniversary of the publication of the influential, yet controversial, study The East Asian Miracle report by the World Bank (1993). An important part of the report’s analysis was concerned with the sources of growth in East Asia. This was based on the neoclassical decomposition of growth into productivity and factor accumulation. At about the same time, the publication of Alwyn Young’s (1992, 1995) and J. I. Kim and Lawrence Lau’s (1994) studies, and Paul Krugman’s (1994) popularization of the “zero total factor productivity growth” thesis, led to a very important debate within the profession, on the sources of growth in East Asia. The emerging literature on China’s growth during the 1990s also used the neoclassical growth model to decompose overall growth into total factor productivity growth and factor accumulation. This survey reviews what the profession has learned during the last 30 years about East Asia’s growth, using growth-accounting exercises and estimations of production functions. It demystifies this literature by pointing out the significant methodological problems inherent in the neoclassical growth-accounting approach. We conclude that the analysis of growth within the framework of the neoclassical model should be seriously questioned. Instead, we propose that researchers look at other approaches, for example, the balance-of-payments–constrained growth rate approach of Thirlwall (1979) or the product space of Hidalgo et al. (2007), together with the notion of complexity of Hidalgo and Hausmann (2009).

In recalling John Maynard Keynes’s revolutionary theory of interest, reviewing the doctrines Keynes sought to overthrow, and analyzing the structural transformations of the US economy, James K. Galbraith maintains there is no alternative to a policy of low interest rates. However, such a policy cannot be effective, he argues, without a radical restructuring of the US economy as a whole.

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.

Structural change has long been at the core of economic development debates. However, the gender implications of structural change are still largely unexplored. This paper helps to fill this gap by analyzing the role of structural change in the gender distribution of sectoral employment in sub-Saharan African countries. I employ aggregate and disaggregate measures of gender sectoral segregation in employment on a panel database consisting of 10 sectors and 11 countries during 1960–2010. Fixed effects and instrumental variables’ regression models show a significant, non-linear link between labor productivity and gender segregation. Increasing labor productivity depresses gender segregation at initial phases of structural change. However, further productivity gains beyond a certain threshold of sectoral development increases gender segregation. Country-industry panel data models complement the analysis by considering relative labor productivity as a determinant of sectoral feminization. The estimates suggest that manufacturing, utilities, construction, business, and government services are key to correcting gender biases in employment along the process of structural change.

This paper analyzes the implications of distributional contrast for the monetary theory of distribution. The first step is to try to introduce the banking sector within Pivetti's monetary distribution theory approach. Pivetti in fact does not analyze the links between the central bank and the banking sector. It therefore seems interesting to study what role the banking sector and the financial capitalists play in this framework. Thus, an attempt is made to model the banking sector and its links to the production sector within the framework of Pivetti’s approach. As this integration does not present any particular theoretical problems, the paper discusses then the ability of the aforementioned approach to explain the coexistence of near-zero (if not negative) interest rates and low real wages. The difficulty in explaining this economic phenomenon opens the way to a more general discussion of the dynamics inherent in the contrast between workers and capitalists and between financial and productive capitalists. Thus, the analysis shows that six different distributional configurations are possible (plus two others that are unstable or unrealistic), of which only two can be explained through Pivetti's monetary theory of distribution. The other four can be explained by elaborating more recent approaches that continue, enrich, and develop Marx's approach.

A Financial Post-Keynesian Comparison
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The purpose of public policy, expansionary or contractionary, is to encourage the expansion of income, output, and employment. Theory decides the nature and kind of policy, and the underlying mechanics that result in expansion. Keynes (1964) brings money and a monetary production economy to the forefront of economic analysis, yet in the General Theory, he is skeptical of the efficacy of monetary policy. This paper analyzes how prices of assets, liabilities, and commodities interact in response to unconventional monetary policy and fiscal policy (namely automatic stabilizers) to create conditions that stimulate private investment and economic activity. Modern economics, after accepting the need for intervention, tends to attempt to use monetary policy to steer aggregate demand. “Unconventional” monetary policy such as zero and negative interest rates, and quantitative easing have been instituted in an attempt to fight slumps and stimulate economic activity without increasing government deficits. In this paper, we point out—using Davidson’s (1972) financial post-Keynesian framework—how unconventional monetary policy is not sufficient to create the conditions of backwardation that stimulate production. Finally, we explain how automatic stabilizers, using the Kalecki profits (price) equation, are the best avenue to create the conditions for backwardation that stimulate economic activity. We conclude, like Keynes, that fiscal policy is the reliable path to economic expansion.

Following the recent (June 25, 2023) elections in Greece, Institute President Dimitri B. Papadimitriou and Research Scholar Nikolaos Rodousakis outline the economic and policy challenges facing the Greek government.

A Stock-Flow Consistent Approach to the Currency Hierarchy

Underdevelopment is often conceived as being reproduced domestically. This paper emphasizes the international forces that enable the persistence of underdevelopment. We first explore how the currency hierarchy imposes a dependency relation between developed and underdeveloped economies. We improvise and quantify the currency hierarchy using ratios from the consolidated sovereign balance sheet. Using the improvisation of the currency hierarchy, we identify that a weak currency must compensate its position by resorting to three mechanisms: changes in interest rates, changes in exchange rates, and accumulation of international reserves to improve balance sheet structure. We employ these relationships to formulate two novel, financial post-Keynesian behavioral equations: an international reserves function and a domestic interest rate function. These equations are simulated in a stock-flow consistent model. We simulate the transmission of international shocks and domestic fiscal expansion. The key findings are (1) that the intensity of economic activity in the emerging economy is reliant on the level of economic activity (and policy) i n the developed economy and (2) that any attempts to stimulate—through government spending—the emerging economy benefit primarily the developed economy while harming the emerging economy’s private sector, assuming free capital and goods mobility. This indicates the existence of a balance-of-payment constrained expansion originating from the demand for international reserves as a margin of safety. Simulations show import controls to be a solution. We find government spending complemented by import substitution to be the most appropriate response to a crisis of international origin and suggest the need for international cohesion between emerging economies to create a more conducive international financial and trade system, halting the reproduction of underdevelopment. 

Evidence From an Emerging Country, India

According to the theory of efficient markets, economic agents use all available information to form rational expectations. The rational expectations hypothesis asserts that information is scarce, the economic system generally does not waste information, and that expectations depend specifically on the structure of the entire system. Fiscal marksmanship—the accuracy of budgetary forecasting—can be one important piece of such information that rational agents must consider in forming expectations. Against the backdrop of fiscal rules, our paper explores the budgetary forecast errors of climate change–related public spending in India. The fiscal rules stipulate that fiscal deficit–to–GDP ratio should be maintained at 3 percent. However, in the post-COVID fiscal strategy, a medium-term fiscal consolidation path of 4.5 percent fiscal deficit–to­–GDP is envisioned by 2025–26. Within this fiscal consolidation framework, we analyzed the budget credibility of fiscal commitments for climate change in India. We analyzed the fiscal behavioral variables in terms of bias, variation, and randomness, and captured the systemic variations in budgetary forecast related to climate change for a period 2017–18 to 2020–21 across sectors. We identified the sectors where systematic components of forecasting errors are relatively higher than random components, where minimizing errors through altering the fiscal behavioral models is done by revising the assumptions and by applying better forecasting methods. A state-level decomposition of the public spending revealed that disaggregated fiscal space available for developmental spending constitutes around 60 percent of the total. However, identifying the specifically targeted public spending related to climate change across all states and analyzing its fiscal markmanship can further the subnational inferences.

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.

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.
 

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.
 

The Fed Cannot Engineer a Soft Landing but Risks Stagflation by Trying

Roughly two years into the economic recovery from the COVID-19 crisis, the topic of elevated inflation dominates the economic policy discourse in the United States. And the aggressive use of fiscal policy to support demand and incomes has commonly been singled out as the culprit. Equally as prevalent is the clamor for the Federal Reserve to raise interest rates to relieve inflationary pressures. According to Research Scholar Yeva Nersisyan and Senior Scholar L. Randall Wray, this narrative is flawed in a number of ways. The problem with the US economy is not one of excess of demand in their view, and the Federal Reserve will not be able to engineer a “soft landing” in the way many seem to be expecting. The authors also deliver a warning: excessive tightening, combined with headwinds in 2022, could lead to stagflation. Moreover, while this recovery looks robust in comparison to the jobless recoveries and secular stagnation that have typified the last few decades, in Nersisyan and Wray’s estimation there are few signs of an overheating economy to be found in the macro data. In their view, this inflation is not centrally demand driven; rather dynamics at the micro-level are playing a much more central role in driving the price increases in question, while significant supply chain problems have curtailed productive capacity by disrupting the availability of critical inputs.

The authors suggest there is a better way to conduct policy—one oriented around targeted investments that would increase our real resource space. This will serve not only to address inflationary pressures, according to Nersisyan and Wray, but also the far more pressing climate emergency.

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.

Modern Money Theory (MMT) has been frequently mentioned in recent media—first as “crazy talk” that if followed would bankrupt the nation and then, after the COVID-19 pandemic hit, as a way to finance an emergency response. In recent months, however, Washington seems to have returned to the old view that government spending must be “paid for” with new taxes. This raises the question: Has MMT really made headway with policymakers? This e-pamphlet examines the extraordinary interview given recently by Representative John Yarmuth’s (D, KY-03), Chair of the House Budget Committee, in which he explicitly adopts an MMT approach to budgeting. Chairman Yarmuth also lays out a path for realizing the major elements of President Biden’s proposals. Finally, Wray summarizes a recent presentation he gave to the Congressional Budget Office’s Macroeconomic Analysis section that urged reconsideration of the way that fiscal policy impacts are assessed.

Reexamining the Economic Costs of Debt

On November 20, 2019, Senior Scholar L. Randall Wray testified before the House Committee on the Budget on the topic of reexamining the economic costs of debt:

"In recent months a new approach to national government budgets, deficits, and debts—Modern Money Theory (MMT)—has been the subject of discussion and controversy. [. . .]

In this testimony I do not want to rehash the theoretical foundations of MMT. Instead I will highlight empirical facts with the goal of explaining the causes and consequences of the intransigent federal budget deficits and the growing national government debt. I hope that developing an understanding of the dynamics involved will make the topic of deficits and debt less daunting. I will conclude by summarizing the MMT views on this topic, hoping to set the record straight."

Update 1/7/2020: In an appendix, L. Randall Wray responds to a Question for the Record submitted by Rep. Ilhan Omar

Evidence from sub-Saharan Africa

Gender disparity in the division of responsibilities for unpaid care and domestic work (household production) is a central and pervasive component of inequalities between men and women and boys and girls. Reducing disparity in household production figures as one element of the goal of gender equality enshrined in the United Nations’ Sustainable Development Goals (SDGs) and feminist scholars and political activists have articulated that the redistribution of household production responsibilities from females to males is important for its own sake, as well as for achieving gender equality in labor market outcomes. A cursory examination of available cross-country data indicates that higher per capita GDP—the neoliberal panacea for most societal malaise—provides little bulwark against the gender inequality in household production.
 
Ajit Zacharias, Thomas Masterson, Fernando Rios-Avila, and Abena D. Oduro contribute to the literature on the intrahousehold distribution of household production by placing the question within a framework of analyzing deprivation, applying that framework to better understand the interactions between poverty and the gendered division of labor in four sub-Saharan African nations: Ethiopia, Ghana, South Africa, and Tanzania. Central to their framework is the notion that attaining a minimal standard of living requires command over an adequate basket of commodities and sufficient time to be spent on home production, where meeting those requirements produces benefits for all—including those beyond the household.
 
Their findings motivate questions regarding the feasibility and effectiveness of redistribution of household responsibilities to alleviate time deficits and their impoverishing effects. By developing a framework to assess the mechanics of redistribution among family members and applying it to gender-based redistribution, they derive the maximum extent to which redistribution—either among all family members, between sexes, or between husbands and wives—can lower the incidence of time deficits. The conclude with a discussion of alternative principles of distributing household production responsibilities among family members and examine their impact on the Levy Institute Measure of Time and Income Poverty (LIMTCP) and discuss some policy questions in light of their findings.

A Path to Full Employment

Despite reports of a healthy US labor market, millions of Americans remain unemployed and underemployed, or have simply given up looking for work. It is a problem that plagues our economy in good times and in bad—there are never enough jobs available for all who want to work. L. Randall Wray, Flavia Dantas, Scott Fullwiler, Pavlina R. Tcherneva, and Stephanie A. Kelton examine the impact of a new “job guarantee” proposal that would seek to eliminate involuntary unemployment by directly creating jobs in the communities where they are needed.
 
The authors propose the creation of a Public Service Employment (PSE) program that would offer a job at a living wage to all who are ready and willing to work. Federally funded but with a decentralized administration, the PSE program would pay $15 per hour and offer a basic package of benefits. This report simulates the economic impact over a ten-year period of implementing the PSE program beginning in 2018Q1.
 
Unemployment, hidden and official, with all of its attendant social harms, is a policy choice. The results in this report lend more weight to the argument that it is a policy choice we need no longer tolerate. True full employment is both achievable and sustainable.

Among the more ambitious policies that have been proposed to address the problem of escalating student loan debt are various forms of debt cancellation. In this report, Scott Fullwiler, Research Associate Stephanie Kelton, Catherine Ruetschlin, and Marshall Steinbaum examine the likely macroeconomic impacts of a one-time, federally funded cancellation of all outstanding student debt.

The report analyzes households’ mounting reliance on debt to finance higher education, including the distributive implications of student debt and debt cancellation; describes the financial mechanics required to carry out the cancellation of debt held by the Department of Education (which makes up the vast majority of student loans outstanding) as well as privately owned student debt; and uses two macroeconometric models to provide a plausible range for the likely impacts of student debt cancellation on key economic variables over a 10-year horizon.

The authors find that cancellation would have a meaningful stimulus effect, characterized by greater economic activity as measured by GDP and employment, with only moderate effects on the federal budget deficit, interest rates, and inflation (while state budgets improve). These results suggest that policies like student debt cancellation can be a viable part of a needed reorientation of US higher education policy.
 

A recent article in the New York Times asks whether Modern Money Theory (MMT) can declare victory after its policies were (supposedly) implemented during the response to the COVID-19 pandemic. The article suggests yes, but for the high inflation it sparked. In the view of Yeva Nersisyan and Senior Scholar L. Randall Wray, the federal government’s response largely validated MMT’s claims regarding public debt and deficits and questions of sovereign government solvency—it did not, however, represent MMT policy.

Heterodox Economic Policy for the 21st Century

A Great Leap Forward: Heterodox Economic Policy for the 21st Century investigates economic policy from a heterodox and progressive perspective. Author Randall Wray uses relatively short chapters arranged around several macroeconomic policy themes to present an integrated survey of progressive policy on topics of interest today that are likely to remain topics of interest for many years.

Published by: Elsevier Press