The Real Economy

The inevitable stop-go

Hector McNeill¹
SEEL

One of issues that arose during the post-war years was that the ability of the management of the economy to remain in the hands of government "leading from the front" was always a fool's errand. The policy-induced instability known as "stop-go" caused many to realise things were not that simple. Michal Kalecki did warn us about this.

The post 1970s emergence of monetarism and the figment of the imagination, called "price stability", was yet another fool's errand that ended in the current finanical crisis.

Let's take things one fool's errand at a time. This aricle reproduces notes from the Real Incomes tutorial of 2012 which refer to stop-go.

Is there a problem?

From Part 2 of the 2012 Online Real Incomes Tutorial

A Real Incomes approach (RIA) to economics is a way of analysing the economy which provides useful insights as to feasible social, political and economic objectives and useful tools for securing those objectives through policy. Of fundamental importance is that RIA provides a basis for fashioning macroeconomic policy which achieves a functional coherence between macroeconomic and microeconomic operational objectives.

The policy objectives of RIA are to:

to support sustainable economic growth based upon microeconomic principles through the:

support of normal management decisions to secure higher real incomes

Policy in the making....!

In reproducing this tutorial it occurred to me that an objective was missing from the original tutorial. This has been inserted in the bullet list on the left in blue.

achieve an acceptable level of distribution of real incomes

to affect a significant movement to weaken the financialization of economic transactions by:
- reducing and eliminating the disruptive monopoly market interventions by government (state) such as the practices of demand management and/or fixing of money rental (interest) rates.
- reducing and eliminating the disruptive market manipulations by large commercial organizations who abuse their public macroeconomic policy "agency" role for private and corporate gain, such as private banks and other types of financial intermediaries.
- to reduce the reliance of economic activities on finance
- to eliminate extra-constitutional "regulatory regimes" that protect those responsible for economic and financial prejudice from the rule of law
- to support the constitutional approach of the "Minority Principle" as opposed to the "Majority Priciple" in all government and corporate decision-making so as to safeguard the freedom an interests of the economic and social constituencies

Current approaches to macroeconomic analysis and policy-making have not moved very far from a perspective which gained acceptance in post-1945 Britain. As this section will show this has exposed and continues to expose the British economy to possible future instabilities arising from the combination of so-called freer markets and an intensification of globalization. This is not a stand against free markets or globalization but rather a call for macroeconomic management which is more relevant and attuned to the needs of the population of a participatory democracy where the defence of individual freedom is paramount in the face of changing international circumstances.

So, if there is a problem, what is it? In order to identify the problem it is necessary to spell out some recent history and the role of economic policy. The most important period for this discussion is 1945 to the present date. I make no apology for this somewhat drawn out story but the purpose is to make clear an analysis of events which have occurred over the last 63 years and with which most economists are familiar having lived through some parts of the period concerned. The story is a mix of events, policy actions and outcomes of various types all subject to varying interpretations from the standpoint of economic analysis.

Policy-induced instability, the stop-go syndrome

Post-1945 the basis of macroeconomic management, that is of the whole economy, was largely based on a Keynesian model aimed at sustaining full employment. This had become a vital macroeconomic objective after the experience of the Great Depression of the 1920s and massive unemployment after the New York Stock Exchange Crash of 1929 and, indeed, experience with government-directed munitions manufacture and the economic management of the “war effort” during hostilities. John Maynard Keynes’ book on this topic was his well known, "The General Theory of Employment, Interest and Money" published in 1936. This advocated a government-sponsored policy of full employment. Experience with managing armaments manufacturing during the Second World War gave politicians some confidence that Keynesianism might well provide a practical basis for management of the economy. The economic instruments applied were principally designed to control overall demand levels in the economy through the crude policy variables of taxation and government expenditure through such things as public works. Interest rates were also used as a basis for encouraging the policy targets of higher investment and raising levels of credit and therefore consumer demand through a reduction in interest rates or a reduction in investment and or consumer credit by raising interest rates.

All such policy instruments involved the use of variables with different effects within the economy some "differential" and all "lagged". In other words once different effects went into action it has always been difficult to reverse them within a short period. One of my economics professors at Stanford, Lorie Tarshis, who had been one of Keynes' students at Cambridge, used to express this dilemma as the ability to apply the policy strings to pull the economy forward but you then face the problem that you can't push on a string! As a result there were policy-induced destabilizing cycles of "overheating" economies marked by inflation and the need to introduce mini-depressions by reducing demand, often leading to “overcooling”. Thus the origin of the common syndrome known as stop-go and the attendant policy-induced economic cycles.

Michal Kalecki's contribution

These economic policy-induced effects of instability were associated with company failures and some loss of employment and this frustrated British politicians who did not welcome the negative impact this had upon the image of the government's competence at managing the economy or upon the workings of a centralised welfare state ² . However, I think it is only right to acknowledge that these types of problems had been precisely predicted to be a potential problem with Keynesianism by the Polish economist Michal Kalecki (1899-1970). I came across some translations of Kalecki's work whilst at Stanford only to discover that he had been publishing most of his works in Polish and French and that he had predated Keynes in many concepts considered to have been developed by Keynes. For example, he produced highly sophisticated and transparent mathematical treatments of the business cycles and investment lags in several papers which were finally published in English between 1935 and 1954 ³ . My own feeling is that Kaleki's contributions deserve a wider acknowledgement than they were given at the time.

A dangerous unresponsiveness of the economy

Unfortunately Keynesianism conditioned politicians to develop a paternalistic "lead from the font" approach applying broad brush instruments to economic management. The perverse impacts of policy decisions such as corporate failures, unemployment and house repossessions were, as it were, considered to be collateral damage resulting from the "right"ťpolicy decisios. This habit of lack of political concern for those prejudiced by the outcomes considered to be of benefit "to the majority" has contributed to the removal of a requisite level of sensitivity to the very specific conditions facing all individual economic units.

Shadow boxing policies

Although policies in the post-war years, especially post 1965 spiralled into stop-go absurdity the so-called "Golden Age" of Keynesianism" between 1945 and 1965 when we had constant growth and relative stability - and no stop-go - had nothing to do with policy. In fact, it would seem that this was achieved in spite of policy (See: In spite of policy - a note).

What was important for policy was the "general condition"ť or the "average"ť and such an unrefined basis for setting the governor of the economic engine was particularly crude. This went hand in hand with the increasing political party commitment to centralized planning largely as a basis for levering their political party power. As a result, during the period 1945 through 1975 we in Britain had become used to government being the predominant force in managing the economy. The idea of the economic units making up the economy managing their affairs in such a way as to not require government intervention was considered to be an impossibility or was confused with the specific political philosophy of laissez faire which in the light of steady as you go welfare-statism was considered to be a sort of anarchistic irresponsibility. Flexibility and therefore adaptability of the economy took second place. As a result what passed for an acceptable basis for economic management in fact was undermining the potential responsiveness of the economy to yet-to-be experienced exogenous economic impacts.

Slumpflation as a counter-intuitive shock

A first major demonstration of this significant lack of flexibility in the economy was the slumpflation crisis which was intensified by three major international petroleum price hikes which occurred in 1973, 1979 and 1980. These were all exogenous or externally-generated impacts. Slumpflation ⁴ - also known as stagflation - was characterised by a combination of simultaneous rises in unemployment and inflation. This for Keynesians was completely counter-intuitive since conventional demand management policy for the economy did not normally have inflation rising with unemployment on the one hand or with demand and output falling on the other. Accordingly the Keynesian bag of policy tools was unable to come up with an instrument able to address this issue, at first, even on theoretical grounds. To address unemployment by higher government expenditure would have made the inflation worse and to reduce demand to lower inflation would have increased unemployment.

¹ Hector McNeill is the director of SEEL - Systems Engineering Economics Lab.

² The British welfare state, we should recall, found its roots in the pioneering work of William Beveridge working with the Liberals as far back as 1909.

³ In mentioning his contributions in the US academic environment of the late 1960s, the fact that he was classed as a Marxist economist seemed to cause many to discount his contributions. On the other hand, Kaleki's work on class, income distribution and imperfect competition seems to have influenced a whole generation of economists including UK-based Cambridge Keynesians such as Goodwin, Harrod, Kaldor, Robinson and Shackle some of whom advised different Labour governments.

⁴ I use the term slumpflation because it is more descriptive and ties in with Keynes' own use of the word slump. Slump was the common English word used by those who experienced the unemployment of the Great Depression and who, for example, participated in the Jarrow March from Jarrow down to London in 1936; slump meant high unemployment and no production. Thus, stagflation, the combination of no demand, reduced output, high unemployment and high inflation.