“Re-Breaking Bones” is the opposite of what should be done

A guest post by Mark Sadowski

(Mark put up this long comment in my “On breaking bones” post. It clearly should be post on its own.)

Edward Lambert:
“As it is, Christina Romer is telling us not to fear an economic correction as long as its recovery is done correctly. It is like re-breaking a bone to set it straight. If the re-breaking of a bone is not done, the bone won’t work correctly in the future. It is proper medicine. You will be better off going through the moment of extra pain…My prescription is to re-break the economic bone which has not set correctly, and this time let’s be aggressive in setting straight better wages and labor share from the start. The idea of re-breaking the economy may sound crazy to you, but the methods of medicine have a greater wisdom than what I see currently among economists.”

If you listen to Christina Romer’s speech (Edward has a fondness for posting videos rather than papers, precisely because I believe he hopes no one will take the time to view them) she says in her list of strategies:

“Avoid crises if possible.”

“End crises quickly if they do happen.”

“Use monetary and fiscal policy aggressively.”

and

“Avoid self-inflicted wounds.”

This is exactly counter to Edward Lambert’s perscription of re-breaking the economy.

One key to understanding Edward Lambert’s views is that he considers himself to be a follower of “Institutional Economics”. Paul Krugman had this to say about Institutional Economics recently:

 “…Before I turn to Syll’s critique, let me summarize my understanding of one of the great turning points in the practice of economics – the turn away from institutional economics in the 1940s and 1950s. Until that time, institutional economics – generally taking the form of long, discursive books rich in historical detail – had been a strong presence in U.S. thought. But then came Samuelson and associates, and models took over.

Why did this happen? It wasn’t, as some might imagine, about free-market ideology: Samuelson started with Keynesian macro (or “Keynesian” macro, if you feel the urge to claim that the master meant something different), and in fact faced a fierce campaign by right-wingers to keep his work out of the schools. No, what happened was the Great Depression.

Think about it. Here we had an utter catastrophe, and people wanted answers: how could this happen, what can we do? Institutional economics replied, in effect, by saying “Clearly what is happening is a complex process with deep historical roots. We need to address those complexities. It would be foolish to expect easy answers.” Meanwhile, American Keynesians said, “We have inadequate demand. Increase government spending!”…”

So you see, indifference to adequate aggregate demand stimulus has apparently always been a key feature of Institutional Economics.

Some other keys to understanding Edward Lambert’s economic views:

1) His model of “Effective Demand” misappropriates its name chiefly from Keynes, but also from Michal Kalecki. In Lambert’s model, labor share of income acts as a constraint on employment and capacity utilization which he terms the “effective demand limit”. But if you actually read Keynes’ General Theory (Chapter 3) you’ll find that “effective demand” is simply the intersection point between the aggregate demand and aggregate supply curves. Keynes argues that effective demand can be increased through monetary stimulus and public works projects. Similarly, Kalecki argues that effective demand can be increased through aggregate demand stimulus. This of course runs completely counter to Lambert’s claim that effective demand is a limit to employment and capacity utilization against which aggregate demand stimulus is totally ineffective.

2) Edward Lamberts’ model of “Effective Demand” is originally derived from the work of Boddy and Crotty (1975), Boddy (2007) and Goldstein (1986, 1996). Rather than link all three I’ll simply link the most recent paper.

Boddy shows through careful examination of the research evidence that labor share of income can be described as a function of employment and industrial capacity utilization. Once again Lambert perverts this, this time by inverting cause and effect. In his model, employment and capacity utilization are functions of the labor share of income. The fact that this runs counter to his own sources and a large body of research evidence seems to be of no concern to him, since he is not interested in the truth, only in advancing his own model of “Effective Demand”.

3) If you examine his blog posts, you’ll find that Edward Lambert’s main public policy perscription is the reduction of aggregate demand stimulus, specifically by ending QE and raising interest rates. Given what we know from the research evidence, this is exactly the opposite of what should be done if one’s goal were to raise labor share of income, as Lambert repeatedly claims.

I have a hard time reconciling all of this with the idea that Lambert’s intentions are good and that it is his thinking that is simply muddled. How can one so blatantly misapprehend Keynes and Kalecki, or Boddy, Crotty and Goldstein? There is something seriously amiss here.

11 thoughts on ““Re-Breaking Bones” is the opposite of what should be done

    • I see no problem with calling for higher labor share of income. But I have a problem with people saying just about anything and everything if they think it will achieve it.

      Edward Lambert:
      1) Routinely cites people as evidence for his views, when on closer inspection their views are almost always the opposite of his own.
      2) Has misappropriated terminology implying his views are the same as the people from whom he took the terms.
      3) Cited empirical research and yet constructed a model with assumptions that totally contradict that research.

      The alternative is he has problems with reading comprehension. That thought has crossed my mind many times. See for example this conversation with Lambert on the definition of “effective demand”:

      http://angrybearblog.com/2013/12/potential-insights.html

      Or see this conversation with him on Boddy’s model of labor share of income:

      http://economistsview.typepad.com/economistsview/2013/04/gdp-report-has-good-news-and-bad-news.html#comment-6a00d83451b33869e2017d4327a4cf970c

      In the first case Lambert seemed genuinely surprised that he had misinterpreted Keynes. And it does seem to me that since than conversation (mid-December 2013) that he has ceased claiming his ideas on “effective demand” come from Keynes.

      In the second conversation he asks me to show him where it says that labor share of income is a function of employment. I point to the very research that he cited in our earlier conversations. He responds by eliding into the claim that his research is about constraints and not causality. But causality matters a great deal when talking about constraints. because if, as the empirical research shows, labor share is caused by employment and capacity utilization, then demand is a constraint on labor share, not labor share a constraint on demand.This calls for a very different policy response than the one Lambert has been hammering on for the last couple of years, which is essentially to decrease the amount of aggregate demand stimulus.

      But there is more to this than simply not understanding what he is reading. There seems to be a willful blindness when it comes to the facts. Each and every one of these conversations where I draw his attention to something I know he will find unpleasant, the conversation ends at that point.

      Lambert’s latest call for “re-breaking” the economy is, quite frankly, way over the top. Frankly I’m a little shocked at how you and others seem so willing to defend Lambert no matter what he does.

      • It seems clear from all Edward’s writings that his underlying goal is to improve the lot of everyone, and that he believes that can be achieved through increasing labor share. I agree with him on that 100%. (And I think the only way to achieve that is through increased redistribution — given political realities, probably via labor-based programs like the EITC, or wage subsidies, or… Higher minimum wage will help some…)

        But I think you’re saying that he’s making this current argument more to defend his model (a common human failing) — and that his bone-breaking prescription, ironically, would achieve the opposite of his larger goals. Those two things may be true.

        But in any case I’m delighted to see you engaging with him, because he at least states his model’s terms rigorously and formulaically. Notably, he has a clearly stated formulaic definition of effective demand – an economic measure that can be calculated from numbers published in the national accounts. I haven’t found such a definition/measure in other economists’ work. Is that measure/definition “right”? That’s not even a useful question. It provides a coherent analytical method for describing how economies work. There’s a whole lot of discussion to be done about whether it does so successfully and usefully.

      • “But in any case I’m delighted to see you engaging with him, because he at least states his model’s terms rigorously and formulaically.”

        You might also note that I’ve given up trying to engage him, and rarely even take the time to comment on his posts. That is precisely because he is not responsive to constructive criticism.

        “Notably, he has a clearly stated formulaic definition of effective demand – an economic measure that can be calculated from numbers published in the national accounts. I haven’t found such a definition/measure in other economists’ work. Is that measure/definition “right”? That’s not even a useful question.”

        If he were to call it something other than “effective demand” that at least would be a modest improvement. The term “effective demand” is a long established economic term with well known meaning and implications. It is really not ethically appropriate to take a professional term that is already in use and then use it to promote your own model. (I’m shocked that I even have to explicitly state this.)

        “It provides a coherent analytical method for describing how economies work. There’s a whole lot of discussion to be done about whether it does so successfully and usefully.”

        It is definitely not coherent to knowingly ignore the large body of empirical research on labor share that contradicts the assumptions of one’s model. And then for Lambert to ignore my criticisms pointing this out indicates to me that the discussion has long since passed the stage of whether his model does so successfully or usefully.

        Lambert’s model of “effective demand” is a Potemkin’s Village of economic analysis, comforting only to those who are so attracted to its conclusions they are unwilling to peer behind its facade.

      • “The term “effective demand” is a long established economic term with well known meaning and implications.”

        Has anyone defined it forumulaically so it can be calculated from measures in the national accounts? I’ve searched and haven’t found such.

        Absent that kind of definition, I question how well “known” its meanings and implications are.

      • “Has anyone defined it forumulaically so it can be calculated from measures in the national accounts? I’ve searched and haven’t found such.”

        Effective demand is the intersection point between the AD and AS curves in the AD-AS Model. It is the level of real output and the price level corresponding to that point. If you’re asking if me have formulas for determining real output and the price level the answer is yes.

        For example, the canonical New Keynesian macroeconomic model has three equations:
        1. An expectations-augmented Phillips Curve.
        2. An Euler-equation IS curve.
        3. A Taylor Rule reaction function for monetary policy.

        The Phillips Curve is for all intents and purposes a dynamic (rate of change) AS curve. The Taylor Rule and the IS curve together determine the behavior of a dynamic AD curve. This is because the AD curve is not so much an economic relationship as it is a model of central bank behavior. And the immediate implication of that is that real output and the price level are the result of policy decisions, not something that just happens.

        Are these the only formulas for determining effective demand? No, there are lots of variations on this theme. So please don’t tell me you couldn’t find any.

      • There’s no need to use any equations. We already have the numbers.

        Effective demand was ($15,942.3 billion, 107.197) in 2013Q4, where real GDP is measured in 2009 dollars, and the price index is 2009=100.

      • Effective demand is a coordinate pair of numbers representing real GDP and the price level (in that order).

  1. There really are a lot of ways these days to call for a rate hike… ineffective policy, effective demand, new monetarism, bubble phobia, looming hyperinflation, too low risk premie….you name it!
    Mr Sadowski, thnx for another amazing effort you truly are economist’s angel 😀

    Greets!
    P.

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