Neoliberalism, Keynesian Economics, and responding to today’s inflation

Joseph E. Stiglitz

Godley-Tobin Lecture

February 24, 2023

Neoliberalism as the predominant ideology of past forty years

• Based on interests and simplistic models
• Small government, with limited regulation, limited redistribution
• Irony: Keynes saved capitalism from capitalists, but they opposed Keynesian ideas.
• Why? Because he provided rationale for government
• Neoliberal policies often disjoint with neoliberal models and both disjoint from realities
• Models said debt didn’t matter; policies often focused on debt
• Some models (RBC) denied existence of unemployment
• Others blamed the victim (NK)—problem was wage rigidities
• Variants with price rigidities (menu costs) ad hoc, lacked plausibility
• All sought explanation for fluctuations in external shocks
• 2008 and most other downturns endogenous

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Not surprising that neoliberalism didn’t “deliver”

• Lower growth
• What growth that did occur went to those at the top
• Trade liberalization enhanced divides
• Financial liberalization led to deepest downturn in three quarters of a century
• All of this had strong political consequences

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Pandemic showed key role of government

• In innovation
• In addressing public health externalities
• In sustaining economy
• Keynesian policies worked—everyone became a Keynesian
• 2008 Great Recession had shown that fiscal multipliers could be large
• Fiscal more important than monetary—as in 2008

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Aspects of Keynesian Economics (as developed further by Godley and Tobin) proved relevant

Monetary policy was about more than lowering interest rates

• In fact, the interest rate and even QE proved largely irrelevant—as argued more generally by Greenwald and Stiglitz
• Issue is not just zero lower bound
• Access to credit (credit rationing) critical—now, even Bernanke agrees
• But Fed and US government did a poor job in thinking deeply about the allocation of credit—both who should get it and how it should be done
• Banks did a particularly poor job, and were unjustly rewarded

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Sectoral issues

• These were sectoral shocks
• But so were shocks leading to Great Depression and Great Recession (Delli Gatti et al 2012)
• With large changes in relative prices
• Can’t use simple aggregative model

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The first service-sector recession?

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Sector shocks require sectoral responses

• Importance of macroeconomic externalities (the macroeconomic manifestations of the pecuniary externalities in the presence of market imperfections explored by Greenwald and Stiglitz (1986))
• As in the Great Depression
• Weaknesses in service sector would have been translated to weaknesses in other sectors

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Distributional issues

Covid-19 exposed and exacerbated inequalities in society

• Large differences in impacts
• Large differences in impacts of assistance—rich saved; poor spent (large differences in MPC)
• Models that ignore this are leaving out something important
• Targeting money on poor not only protecting the most vulnerable, but also most macro-economically effective
• Should/could have done a better job (politics aside)(but if Trump had had his way, we would have done a much poorer job at targeting)
• But the failure to target did not have adverse effects claimed by some (such as Summers)

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Economic Impacts of the Pandemic

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Stimulus Checks April 15^th RD

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High aggregate savings

• Not a surprise—given the level of uncertainty: precautionary savings among those who could sustain themselves (higher- income individuals)
• Needed to take that into account in deciding size of fiscal stimulus required to sustain economy
• US did a better job than most others
• High savings rate explains why high fiscal spending did not have inflationary effects

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Large increase in “excess savings” which have been spent down only gradually

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Excess savings was also caused by reduction in outlays—precautionary savings

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And much of the draw-down was to pay taxes (high level of non-withholding)

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Covid-19 enabled clean tests of other hypotheses

How important are labor supply effects (disincentives of UI)?

• Large variation in benefits across states provide clear inference
• Contrary to right-wing rhetoric, incentive effects were very low

But there were worries that large separations of individuals from firms might have longer-run adverse consequences

• Worries proved correct—has taken long time for labor force participation to return to more normal levels
• Europe, New Zealand, others did a much better job in keeping workers attached to firms (keeping unemployment rate low)
• Further benefits in administration
• Because so many rely on employer-provided health insurance, it was even more important to keep workers attached to firms in US

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Pandemic and post-pandemic inflation shows we have to go beyond simplistic macroeconomics

• There were unprecedented shocks
• Can’t use stationary stochastic processes—distinction between risk and uncertainty
• Uncertainty key—not intertemporal substitution
• With large precautionary savings

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Responding to unprecedented shocks

• Even though unprecedented, we do know something
• If there is high unemployment, fiscal policy likely to work
• Automatic stabilizers can be very effective
• Challenge to identify idiosyncratic aspects of shock, transitory vs. permanent effects, if transitory, how long the effects will last
• Key failure of central banks was not acting too slowly, but not realizing that this inflation was not due to excess aggregate demand
• May have made matters worse

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Explaining why standard macro models were not helpful

• Sectoral shock, not a simple aggregate shock
• With large distributional consequences—representative agent model misguided
• With large change in savings (precautionary)—intertemporal substitution effects second order
• With liquidity effects (credit rationing) critical for many households and firms (and would have been critical to states and localities in absence of broader fiscal support)
• There has been some downward movement in real wages (even nominal wages in some cases)—and this has almost surely weakened aggregate demand
• Wage and price rigidities were not the central problem, and making wages and prices more flexible is not an important part of the solution

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Key failures of policy economists

• “Team transitory”
• Failed to recognize less transitory than thought
• Failed to recognize lack of resilience of market
• Other side
• Thought problem was excess aggregate demand
• Didn’t realize sectoral nature
• Didn’t realize that increasing interest rates could make matters worse
• Didn’t realize role of market power
• Thought changes in underlying macro relations (Phillips curve, Beveridge curve) were permanent

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Beyond “neoliberal” response to inflation

1. Understanding the underlying drivers—the disturbances to the economy—that are causing increased inflation and worsening inequality
2. Right question: How do we respond to these disturbances and their consequences?
3. Focus on monetary policy wrong. It will worsen inequality and do little to tame inflation, unless push to unacceptable levels, with long-run consequences
4. Host of better ways that (i) do a better job at taming inflation; (ii) reduce inequality; and (iii) regardless of model of inflation and estimate of its inertia, have positive effect on economy

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Basic perspective

• Unprecedented disturbance
• Hard to predict short-term and long-term consequences
• Underlying hypothesis: Economy will largely return to prior behavior
• But don’t know how long it will take
• Policies and analysis must be predicated on recognizing deep uncertainty
• Debate in US—transitory, with inflation will largely be tamed on own vs. need long painful transition to return to lower inflation rates

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Underlying drivers

• Not excess demand, or even excess consumption caused by excess pandemic support
• But rather supply side problems and demand shifts induced by pandemic, exacerbated by Russia’s invasion

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Excess consumption was not the problem

Total Real Aggregate demand below trend

Real Government Expenditure Below Trend

Real Aggregate Demand below CBO estimate of potential output

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Figure 1.10

Investment in plants and equipment is below trend

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Large inventory accumulation sign of weak aggregate demand

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Increase in US inflation only slightly higher than other advanced countries

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Figure 4.1

[1] 

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Multiple differences in policies

• Much higher pandemic spending
• Much worse pandemic labor policies (higher unemployment rate)
• Much worse working conditions and job protections
• Much poorer health policies

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Source of inflation

• Pandemic-induced supply side shortages
• Interruptions in global supply chains
• Chip shortages—particularly large effect in auto sector, which played big role in early price surges
• Demand shifts, partly induced by pandemic, partly induced by large changes in relative prices, partly induced by supply shortages in other sectors
• Asymmetric price responses—with shortages leading to greater price increases than excess demands leading to price decreases
• Exemplified by rental market
• Unexpected lack of resilience of markets to shocks—consequence of short-sightedness
• Exercise of market power—with prices going up more in sectors and with firms with more market power
• Phelps/Winter/Greenwald/Stiglitz model predicts greater uncertainty leading to higher mark-ups
• Contributing to lack of resilience—baby formula
• All exacerbated by war
• Some inflation was “imported”—caused by increases in prices of imported goods (US demand may have played some role)
• Market is responding—and inflation is falling
• Inflation for last six months has been at an annual rate of just over 2%

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Price increases centered on certain sectors and timing not related to gap between aggregate demand and potential output

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Including imported goods other than fuel

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Large increase in mark-ups�

Increase in Corporate Profits

The labor market and a wage price spiral?

• Wage adjustments initially focused on sectors with very low wages—a “normalization”; this now seems over
• Key issue: How transitory vs. how permanent is shift in Phillips curve and Beveridge curve?
• Large transitory effects in US: high levels of separation; individuals in new jobs have higher quit rates
• We’ve already returned large way towards pre-pandemic patterns
• Wages not keeping up with prices—not a sign of tight labor market; in any case, no evidence of out-of-control wage price spiral
• Limited bargaining power of workers
• Wages can and should increase at pace faster than is in long run sustainable
• To increase real wages
• Mark-ups can and should decrease

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Short-run correction in low wages in some sectors�

Salaries of Private Workers

Picture today

• Inflation is being tamed, as pandemic and its effects weaken
• Bottlenecks being resolved
• Disinflationary forces at play (oil, cars, etc.) as sectoral prices normalize
• Inflationary expectations remain tame
• Though models where inflationary expectations play central role are not very persuasive for economies where inflation rates are as low as they have been in US and Europe (highly ad hoc)
• Inflation has seeped into core, there is some price-price inflation, and overall disinflationary process may be slow
• 2% target totally arbitrary, time to get to target even more arbitrary
• And cost of getting there quickly may be very high

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Why monetary policy is not the right instrument

• Problem not caused by excess of aggregate demand
• Monetary policy doesn’t address underlying source of problem—won’t resolve supply bottlenecks
• Would need sectoral credit allocation policies
• May make matters worse
• Will discourage investment required to resolve them
• In “customer markets” (Phelps/Winter/Greenwald/Stiglitz) increases in interest rates induce firms to raise prices
• Some evidence that higher interest rates get passed on in rents

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Monetary policy increases inequality

• Increased unemployment
• Hitting hardest at marginalized groups
• Significant hysteresis effects
• Globally even more adverse
• New form of “beggar-thy-neighbor policy”
• Recessions in Europe, elsewhere will be worse
• Global debt crisis
• Increased value of dollar
• Higher interest rates
• Slower global growth

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There are alternative policies

• Real supply side policies
• Increasing green energy
• Increasing food production
• Increasing labor supply
• Better childcare, family leave policies
• Increased wages
• Immigration reform
• Stronger and better enforced anti-trust policies
• Better protective policies, partially financed by windfall profits tax
• Can be designed to discourage price increases
• These policies have long-term benefits, even if inflation turns out to be more transitory that seems to be the case now

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Big Lesson of Covid-19 and its aftermath

• Insights of basic Keynesian models, as amplified in subsequent decades by economists like Wynne Godley and James Tobin, provide far more insights into what is going on and how to sustain the economy at near full employment than do the models that have become more standard in macroeconomics (whether of the RBC, new classical, DSGE, NKDSGE) models
• And this is especially so of those models that emphasize the role of distribution, sectoral shocks and impediments to intersectoral mobility, precautionary savings, credit rationing, market power, disequilibrium, and macroeconomic externalities

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Some references

• D. Delli Gatti, M. Gallegati, B. Greenwald, A. Russo and J. E. Stiglitz, “Mobility Constraints, Productivity Trends, and Extended Crises,” Journal of Economic Behavior & Organization, 83(3): 375– 393
• B. Greenwald and J. E. Stiglitz, “Externalities in Economies with Imperfect Information and Incomplete Markets,” Quarterly Journal of Economics, Vol. 101, No. 2, May 1986, pp. 229-264.
• M. Guzman and J. E. Stiglitz, "Towards a dynamic disequilibrium theory with randomness." Oxford Review of Economic Policy 36, no. 3 (2020): 621-674.
• Guzman, Martin, and Joseph E. Stiglitz. “The Pandemic Economic Crisis, Precautionary Behavior, and Mobility Constraints: An Application of the Dynamic Disequilibrium Model with Randomness,” Industrial and Corporate Change, Vol. 30, Issue 2, pp. 467–497, April 2021.
• Peter R. Orszag, Robert E. Rubin, and J. E. Stiglitz. “Fiscal Resiliency in a Deeply Uncertain World: The Role of Semiautonomous Discretion,” Peterson Institute for International Economics Policy Brief 21-2, January, 2021. Accessible at: https://www.piie.com/publications/policy-briefs/fiscal-resiliency-deeply-uncertain-world-role-semiautonomous-discretion
• J. E. Stiglitz and Bruce Greenwald, Towards a New Paradigm in Monetary Economics, Cambridge: Cambridge University Press, 2003.
• J. E. Stiglitz and Ira Regmi, “The Causes of and Responses to Today’s Inflation”, Roosevelt Institute Working Paper, 2023

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