Different Answers Given by the Post-Keynesian School - Macroeconomics from the Perspective of China

Different Answers Given by the Post-Keynesian School - Panden's Notes on Macroeconomics

The Challenge of the Subprime Mortgage Crisis to Neo-Neoclassical Synthesis

In the 20th century, we have seen the Great Depression and stagflation give macroeconomics two revolutions - the Keynesian revolution and the rational expectations revolution. The occurrence of these two revolutions stemmed from the emergence of major economic phenomena that could not be explained by the old theoretical system, and both brought about fundamental changes in the research paradigm of macroeconomics.

The neo-neoclassical comprehensive macro system of thought is a rigorous framework, full of theoretical beauty, and also gives many insightful conclusions about the economic operation of the real world. Just like the Great Depression and stagflation, the subprime mortgage crisis that occurred in 2008 also challenged the macro theory system. In at least three aspects, the economic operation after the subprime mortgage crisis cannot be explained by the neo-neoclassical comprehensive system.

1. The absence of a financial system in the neo-neoclassical synthesis is difficult for it to explain the subprime mortgage crisis, let alone prevent the subprime crisis. Finance is only in a relatively marginal position in the neo-neoclassical synthesis. Especially in the New Keynesian model widely used by macro policymakers such as central bankers, the entire financial system is only summarized by a nominal interest rate.
2. The neo-neoclassical synthesis cannot provide a satisfactory explanation for the operation of the global economy and the application of macroeconomic policies in the post-crisis era. The neo-neoclassical synthesis believes that the market will allow resources to be in the state of the most efficient allocation in the long run, and the deviation from the efficient state only exists in the short term. Correspondingly, macroeconomic policies can only be effective in the short term and should only be implemented in the short term. However, in the post-crisis era, the global economy has clearly deviated from the track before the crisis. The long-term market adjustment mechanism believed by the neo-neoclassical synthesis has not worked, and the global economy has been in a long-term downturn. In order to support economic growth, all countries have generally adopted extremely loose macro policies, and the application of policies has already broken through the short-term boundaries. The central banks of the United States, Europe and Japan have adopted unconventional and extremely loose monetary policies, not only reducing the interest rate level to zero, but also expanding the balance sheet of the central bank on a large scale, injecting a huge amount of liquidity into the financial system. These policies have broken through the scope of policy application considered by neo-neoclassical synthesis;
3. The neo-neoclassical synthesis lacks explanatory power for the main characteristics of the world economy before and after the crisis—global imbalance, and the subsequent results, so it is naturally unable to prescribe effective medicines; to a large extent, the US real estate bubble that gave birth to the subprime mortgage crisis from the global savings glut. In the post-crisis era, the global savings glut has turned into a global aggregate demand deficit, which has led to a long-term slump in economic growth. In the integrated neo-neoclassical framework, there is no room for excess saving and insufficient demand due to the belief that the market has an efficient adjustment force on resources.

In addition to monetary policy, the decline in China's economic growth cannot be explained by neo-neoclassical synthesis

No matter from the perspective of changes in real world economic reality or from the perspective of the development of macro theory itself, it seems that we should all be in a period of macroeconomic "revolution". However, unlike after the Great Depression and stagflation, this time we do not see a new macroeconomic analysis paradigm being conceived, and we do not see the possibility of another revolution.

• On the plus side, this suggests that the neo-neoclassical synthesis, unlike the systems it superseded before, has proven to be valid and valuable in quite a few ways, and has merit.
• On the bad side, this shows that from the current point of view, we still can't find a way out to break through the current thinking barrier, and we can't find a substitute to overthrow the neo-neoclassical synthesis.

Before the revolution comes, macroeconomics is not idle. The outbreak of the subprime mortgage crisis has promoted the development of macroeconomics in two ways

1. The integrated neo-neoclassical framework itself complements itself in response to the challenges posed by the subprime mortgage crisis. At the heart of this framework is a mixture of long-term efficient markets (RBC theory) and short-term friction. That is, when we find that the market in the real world is not as perfect as the RBC theory imagined, we can better approach reality by adding more imperfect factors into the model. As long as we add enough "sand" (friction) to the RBC theory, it will eventually make the whole model work as badly as a market economy in the real world.
2. Other scholars have set their sights beyond the neo-neoclassical comprehensive framework, trying to find a new paradigm for macroeconomics outside this framework. They do not accept the basic assumptions of the neo-neoclassical synthesis of rationality, market clearing, rice field conditions, etc., and create a completely different set of macro models from scratch. Its ideas originated before the rational expectations revolution, and these models are naive, because they also lack the conciseness and self-consistency of the neo-neoclassical comprehensive model. According to the classification of the history of economics, these theories are inherited from the " heterodox school " of neo-neoclassical synthesis .

Historical Origins of Unorthodox Macroeconomic Theory

Just as the neo-neoclassical synthesis has a clear historical development, unorthodox macroeconomic theory has a long historical heritage. Some of the core ideas can be traced back to such great economists as Malthus, Marx, and Keynes. Retrospecting the historical clues in this regard can help us understand the relevant ideas more deeply.

Unlike the neo-neoclassical synthesis, heterodox macroeconomic theory is not a unified system. In fact, it is a loose collection of many different genres. The main thing they all have in common is that none of them embraces the framework of the neo-neoclassical synthesis (and its classical predecessors). But there is not much consensus among heterodox macro theories about which parts of the neo-neoclassical synthesis framework to specifically object to, and how to replace them with better assumptions and analyses. If I had to sum up the various schools of unorthodox macroeconomic theory in one sentence, it would be that they all have doubts about the efficiency of the market.

Classical vs. Keynesian Controversy

The deepest core of classical and neoclassical macroeconomics is the "Say's Law" that asserts that supply creates demand . It reflects a high degree of trust (or even belief) in efficient markets. The ideas of unorthodox macroeconomic theory, which is quite different from the neoclassical tradition, can be traced back to the refutation of Say's law. Let us review the logic of Say's Law again. Say believed that any productive activity would generate income. These incomes are immediately spent by the recipients of the income. Because someone would never start productive activities if they didn't have the need to spend. If it is assumed that flexible interest rates can clear the lending market, the introduction of savings will not change the above conclusions.

The refutation of Say's Law focuses on the link from income to expenditure. Many economists believe that having income does not necessarily lead to a willingness to spend. If the willingness to spend is insufficient, demand will become the bottleneck of economic operation, and supply may not create the same amount of demand. Malthus was the first master of economics to put forward this logic. Many modern people's understanding of Malthus is limited to the "Malthus trap", but in fact Malthus's creation of effective demand theory is equally impressive. In a mail to David. In Ricardo's letter, Malthus wrote the following

有效需求由两个成分构成，即购买力和购买愿望．..．
我认为购买力并不一定包含成比例的购买愿望，我也不同意．.．
谈到某个国家，供给总不能超过需求。一国必然拥有购买它所生产的全部产品的购买力，但我很容易地设想它不拥有购买这些产品的愿望

At first glance, the lack of demand may seem hard to imagine. Even in modern times, where the material standard of living is quite rich, it is far from being able to say that people's desires have been fully satisfied. It is human nature to always want more and better. So economics always assumes that people's preferences are insatiable. Since human desires are infinite, how can it be said that the needs derived from human desires will be insufficient?

• Human desires are endless, but only desires with purchasing power are the needs we care about. How human desires manifest as needs in the economy depends on how income is distributed in the economy. Let us imagine such an economy consisting of workers and capitalists. Among them, the income of the workers only comes from their wages, and the wages are extremely low, barely sufficient for their food and clothing. So, workers spend all their wage income on consumer goods. The capitalist's income comes from the profits of the business (return on capital). The capitalist invests the greater part of his income in the production of consumer goods. Assuming that the increase in wages of workers cannot keep up with the rate of capital expansion, workers' purchasing power of consumer goods will not keep up with the expansion of consumer goods production capacity, thereby reducing the profits of capitalists and inhibiting capitalists' investment behavior. As a result, economic growth will slow down under the constraint of insufficient demand. Here, income has not been effectively combined with people's desires, so demand rather than supply has become the bottle lock for long-term growth .

Looking at the above story with a neoclassical theoretical system, many doubts can be raised. For example, if the production technology of the whole society is described by a neoclassical production function with constant returns to scale, then the proportion of total wages to total income will be a constant, which means that the growth rate of wages will be proportional to the growth rate of total output flat. From the perspective of consumer intertemporal substitution optimization, if there is too much capital, the decline in the rate of return on capital will make people consume more and save less, and resources will automatically shift from investment to consumption. However, what unorthodox macroeconomic theory opposes is the neoclassical production function and the neoclassical assumption that the market allocates resources efficiently . When the neoclassical belief in markets is abandoned, the misallocation of resources in the economy creates a situation of insufficient demand. Therefore, whether to believe that there is insufficient demand depends on whether or not to believe in the power of the market. This is where the crucial difference between Malthus and Say lies.

Marx's critique of the classics

• In Marx's view, in order to save wage costs, capitalists will increasingly use capital to replace labor. But this would lead to a growing ranks of poor unemployed (Marx called them the "reserve army of the unemployed"), reducing demand for consumer goods across society. As a result, the shortage of demand for consumer goods reduces the profit rate earned by capitalists, which eventually leads to a crisis. Marx believed that the more developed capitalism is, the more prominent the contradiction between huge supply and insufficient demand will be, which will eventually lead to the demise of capitalism. From a modern perspective, there are some things that can be improved in Marx's theory, but Marx did grasp some shortcomings in the operation of the market, and his theory has a certain explanatory power for the crisis of capitalism. This is why, after the subprime mortgage crisis, attention to Marx's theory has risen again.

Keynes's critique of the classics

• The most powerful rebuttal to classical economics and Say's Law came from Keynes. Keynes did not entirely deny that the market adjusted spontaneously, but he believed that this adjustment would be rather slow. In Keynes's view, it was too late when this adjustment force was finally exerted in the long run. So Keynes would say: "In the long run, we are all dead." (In the long run, we are all dead.) Keynes believed that the situation of insufficient demand and excess capacity will continue to exist for a long time. Keynes believed that in a situation of excess capacity, demand can create more demand (the so-called multiplier effect).
• When discussing demand, Keynes divided the subject of demand into two categories. Residents (workers) are one category, capitalists and the government are another category. For residents, their expenditure is determined by their income (mainly wages). The reverse is true for capitalists and governments, whose revenues are partly determined by their spending. Here again we see the difference between micro thinking and macro thinking. At the micro level, a micro agent's spending should always be determined by its income. But at the macro level, there are situations where the expenditures of some macro departments will become their own needs and then their own income. The difference between macro and micro is that there is a feedback effect between the income and expenditure of some departments at the macro level, but there is no such mechanism at the micro level.

Kaldor and Keynes have something in common

• Kaldor (1956) once famously said: "Capitalists earn what they spend, workers spend what they earn." This sentence sums up the preceding distinction very well. Keynes once used the story of the "Widow's Altar" in the Bible as a metaphor for this feedback effect between income and expenditure in certain macro-departments. In the book "On Money" published in 1930 (Keynes, 1930), Keynes said: "No matter how much the entrepreneur spends on consumption, the incremental wealth belonging to the entrepreneur is still the same as before. Profits, as entrepreneurial capital A source of increment, no matter how much is spent in a life of revelry, is never exhausted, like the widow's altar."

Post-Keynesian

We know that the neo-neoclassical synthesis already contains part of Keynes's thoughts. But some economists think so. The absorption of Keynesian thought by neo-neoclassical synthesis is one-sided, and the core thought of Keynes is missing. In the new Keynesian model, the market failure caused by nominal rigidity only exists in the short term, and will soon be replaced by the efficient market assumed by the RBC theory. This is obviously a far cry from what Keynes meant by "in the long run we are all dead". Therefore, in addition to the inclusion of Keynesian theory by neo-neoclassical synthesis, some economists try to construct other theoretical models to better reflect Keynes' thought. Among them, the Cambridge school and its evolved " post-Keynesian " school have a greater influence. Roy Harrod, Nicholas Kaldor, Joan Robinson, and Michal Kalecki are some of the representatives.

The post-Keynesian school is not a logically rigorous theoretical system like the neo-neoclassical synthesis, but a loose combination of many ideas and models. There are also several obvious branches that can be separated. But the scholars of post-Keynesian school put the attention on effective demand at the center of their research. In terms of methodology, the post-Keynesian school adheres to the method of realism, and believes that the macro model should be similar to the real world it describes. This is obviously different from the neoclassical school which adheres to instrumentalism. The latter holds that a model does not matter if its assumptions are true as long as its conclusions are useful. The post-Keynesian school believes that it is precisely because of adhering to the methodology of instrumentalism that the neoclassical school is increasingly obsessed with its imaginary world, and the gap between it and reality is getting wider and wider.

The Cambridge Model for Describing Insufficient Needs

This model does not start from the optimization problem of micro-subjects, but directly assumes some relationships between macro-variables. This model will be attacked by Lucas' criticism. From a classical perspective, this model contains arbitrary assumptions and belongs to the "ad hoc model". In the vocabulary of mainstream macroeconomics, ad hoc is absolutely is a pejorative term; but in order to jump out of the neo-neoclassical synthesis, we must have an ad hoc model;

The nominal total output of a closed economy includes wages, corporate profits, and government taxes from the income approach; and consumption, investment, and fiscal expenditure from the expenditure approach; Y t = W t + Π t +
$$Y_t=W_t+{Pi}_t+T_t=C_t+I_t+G_t$$
Define the government fiscal deficit $D_t=G_t-T_t$, then the above formula can be written as
$$W_t+{Pi}_t=C_t+I_t+D_t$$
In decomposing worker consumption $C_{w,t}$Consumption with capitalist $C_{c,t}$
$$W_t+{Pi}_t=C_{w,t}+C_{c,t}+I_t+D_t$$

The following two important assumptions are made for the model

1. Workers only receive wage income and use their wage income entirely for consumption
   $$W_t=C_{w,t}$$
2. Savings rate of capitalists is constant, $S>0$
   $$(1-s)P_t=C_{c,t}$$
   The reason for making such an assumption here is to capture the fact that workers' expenditures in the real world are largely determined by their income. It follows that the income of capitalists is largely determined by their expenditures. This assumption is reflected in Kaldor's statement that "workers spend what they earn";

基于假设一：
$$\begin{gathered} W_t+{Pi}_t=C_{w,t}+C_{c,t}+I_t+D_t \\ \Rightarrow {Pi}_t=C_{c,t}+I_t+D_t \end{gathered}$$
This shows that the capitalist's profit is equal to the capitalist's own consumption and investment plus the government's fiscal deficit. Thus, the more the capitalist spends, the higher his own profit. This is the embodiment of Kaldor's saying that "capitalists earn what they spend";

Based on hypothesis two:
$${Pi}_t=\frac{I_t+D_t}{s}$$
This is the famous "Cambridge Profit Equation" in the post-Keynesian theory. He showed that the capitalist's profit is proportional to the growth rate of capital.

Divide the left and right sides of the above formula by ttNominal capital stock at the beginning of period$t$$K_{t-1}$, and define $r_t\triangleq \frac{{Pi}_t}{K_{t-1}}$is the return on capital, $g_t\triangleq \frac{I_t}{K_{t-1}}$is the growth rate of capital stock in period t, $d_t\triangleq \frac{D_t}{K_{t-1}}$As the ratio of government fiscal deficit to capital stock, the above Cambridge profit equation can be transformed into
$$r_t=\frac{(g_t+d_t)}{s}\left(1\right)$$
The above formula is called "Cambridge Equation", which embodies the logical relationship that the rate of return on capital is determined by the growth rate of capital and the fiscal deficit;

The growth of capital comes from investment, so the growth rate of capital is determined by the willingness of capitalists to invest. When capitalists decide how much to invest, the most important consideration should be the expectation of the future rate of return on capital. Therefore, the capital growth rate at the capitalist's will can be expressed as the following function
$$g_t^d=f(r_t^e)(2)$$
$g_t^d$is the capitalist's willingness to grow capital, $r_t^e$At the beginning of period t, the capitalist expects the rate of return on capital at the end of period t. Function $f(\cdot )$ is a concave function ($f^{\prime }(\cdot )>0,f^{\prime \prime }(\cdot )<0$ ), indicating that the higher the capitalist's expectation of the future rate of return on capital, the higher the desired capital growth rate. However, there is a characteristic of diminishing marginal benefit in the increase of expected return on capital on investment willingness. We assume that capitalists use static expectations to form expectations. That is to say, at the beginning of each period, capitalists expect that the rate of return on capital at the end of this period will be the same as that of the previous period, that is,
$$r_t^e=r_{t-1}$$

Similar to the steady state, combining (1) and (2), the return on capital is expected $r$ and capital growth rate$g$ has the relationship as shown in the figure below

• Point L is called the "low-level steady state point". When the capitalist's expectation on the rate of return on capital is lower than point L, both the rate of return on capital and the growth rate will diverge downward.
• Point H is called the "high-level steady state point". When the capitalist's expectation on the rate of return on capital is higher than point L, both the rate of return on capital and the growth rate will diverge downward.

Application to the model

The underlying assumption of the model is that the economy is in a state of excess capacity, so it can produce as much as it needs. Instead of the mechanism of market regulation that the neo-neoclassical synthesis believes in, we see a self-reinforcing mechanism on the demand side . In the case of relatively optimistic initial expectations, capitalists are more enthusiastic about investing. Higher investment in turn leads to higher return on capital, confirming the previous optimistic expectations. On the contrary, if the initial expectations are relatively pessimistic, then the depressed investment brought about by the pessimistic expectations will in turn further strengthen the pessimistic expectations, thus putting the economy in a downturn.

Looking at the figure below, we can find that fiscal policy has a supporting effect on the economy

• When the initial capitalist's expectation is $r_1$, according to the Cambridge model, the economy will enter a contraction channel, and the growth rate and return on capital will continue to decline;
• At this time, if the government can expand expenditure, let the Cambridge equation line ((1)) drop to d-dig, and let the intersection point move to $L_2$, In this way, the economy can enter a good track and eventually converge to a high level. Therefore, the fiscal policy here not only has a short-term effect, but also has a significant long-term effect;

The Enlightenment of Post-Keynesian Economics to China's Economy

economic facts

Still use price volume analysis to judge whether the market bottleneck is on the supply side or the demand side

• GDP growth rate is positively correlated with inflation, indicating that the bottleneck is on the demand side

• According to the sum of investment and current account surplus is savings, if savings are given, then investment and current account surplus should satisfy a negative correlation; but the situation in China is not the case, the more investment, the more savings, and the growth of savings is greater than investment ;

The state of China's economy is strong enough to affect the world

Discussion of the Chinese economy

With the help of the model introduced above, we analyze the Chinese economy. We should know that the set of market adjustment mechanism assumed by the neoclassical has not been fully reflected in the reality of the Chinese economy. In the post-crisis era, many evidences also show that China's economy is in a state of excess production capacity and insufficient demand. This shows that the previous macro model describing insufficient demand is applicable to the Chinese economy.

In the past few decades, the polarization tendency of China's economic operation has been very obvious. The economy, which has always been good, quickly becomes overheated and must be cooled by macro policy tightening. Once the economy deteriorates, it will quickly slide into overcooling, and it will be difficult to maintain stability even with the support of macro policies. The " circle of life and chaos " is very obvious. Song Guoqing once compared the Chinese economy to table tennis. Macro policies are like two beats, constantly hitting the Chinese economy from the two extremes back to the middle area. Over the past 30 years, attempts to stabilize the Chinese economy in the middle have failed. It can be said that the stable operation of China's economy depends on the long-term uninterrupted regulation of macro policies. This is quite different from the economic operation in the neo-neoclassical comprehensive worldview, and is closer to the state of economic growth described by the Cambridge model;

The policy inspiration for us is: it is necessary to create demand and stabilize economic growth through expansionary aggregate macro policies

• Letting the decline in economic growth lead to a (overproduction) economic crisis - as in the years 1998-2002

Top, Middle and Bottom Ways of China's Economy

• The best policy: make major reforms in income distribution that are beneficial to the resident sector, and effectively promote consumption transformation (not something that can be solved at the economic level)
• Medium policy: before the reform of income distribution fails, continue to stimulate aggregate demand through expansionary aggregate macro policies and stabilize growth (policy bottom line)
• Bad policy: If income distribution reform is not carried out, and aggregate macroeconomic policies do not stimulate aggregate demand, China will drag the world into an economic crisis—China is already a big country and has obvious spillover effects on the global economy

The Enlightenment of Post-Keynesian School and Neo-Neoclassical Synthesis

• We live in the world, but also in the world view - how we see the world, how the world presents to us
• The neo-neoclassical synthesis is a world view of the economy - one that both helps us see some things and blinds us to many
  • The world view is like a pair of colored glasses, which can only let us see a few colors in the real world
  • The colors seen through the glasses, in turn, reinforce our belief in the glasses
• Beyond the neo-neoclassical synthesis, there are different worldviews
  • The neo-neoclassical synthesis is not the truth
  • we have no choice
• Seek truth from facts, start from the problem - the world view is just a tool, you must become the master of the tool, not the slave of the tool

Charlie Munger said, "If you have a hammer, everything looks like a nail." After the subprime mortgage crisis, a large part of the chaos and analysis of China’s economy was based on the new-neoclassical comprehensive world view, but in fact this world view does not conform to China’s actual situation. If this world view is used blindly, It will inevitably lead to abnormal development; therefore, the thoughts in our minds determine our world. If we want to care about China's economy, we must jump out of the inherent framework and combine China's actual situation in order to make the best choice for the economy;