Macroeconomic Policy Mix, Employment and Inflation in a Post-Keynesian Alternative to the New Consensus Model

Abstract

New Consensus Models (NCMs) have been criticised by Post-Keynesians for a variety of reasons, and amendments or alternatives have been presented. The present paper attempts to provide a Post-Keynesian alternative model to the NCM. The model consists of three classes: rentiers, firms and workers. It has a short-run inflation barrier derived from distribution conflict between these classes, which is endogenous in the medium run. Distribution conflict affects not only inflation but also income shares. On the demand side, the income classes have different saving propensities. We apply a Kaleckian investment function with expected sales and internal funds as major determinants. The paper analyses short-run stability and includes medium-run endogeneity channels for the Non-Accelerating-Inflation-Rate-of-Unemployment, or NAIRU: persistence mechanisms in the labour market, adaptive wage and profit aspirations, investment in capital stock and cost effects of interest rate changes. From the model, Post-Keynesian policy rules are derived. We argue that improved employment without increasing inflation will be possible if macroeconomic policies are coordinated along the following lines: the central bank targets distribution, wage bargaining parties target inflation and fiscal policies are applied for short- and medium-run real stabilisation purposes.

Acknowledgments

For helpful comments we would like to thank Philip Arestis, Juergen Kromphardt, Jan-Oliver Menz, Alfonso Palacio-Vera and the participants in conferences in Cambridge (UK), Dijon, and Roskilde, and in research seminars at the Department of Economics, Vienna University of Economics and Business, Austria, and at the Macroeconomic Policy Institute (IMK) at Hans Boeckler Foundation, Duesseldorf, Germany, in 2007 and 2008. We would also like to thank two anonymous referees for their comments and suggestions. The major part of the paper was written while Eckhard Hein was a visiting professor at Vienna University of Economics & Business (WU). The hospitality of the WU is gratefully acknowledged.

Notes

¹On NCMs, see Carlin & Soskice (2006), Clarida et al. (1999), Meyer (2001), and Romer (2000) for NCMs.

²The literature is vast and much of it will be cited below. For a general sense of the Post-Keynesian assessments of the NCM and its main elements, the NAIRU and an inflation targeting central bank, see, for example: Arestis (2009), Arestis & Sawyer (2004a), Davidson (2006), Fontana (2009), Fontana & Palacio-Vera (2002, 2006), Gnos & Rochon (2007), Hein (2006a), Kriesler & Lavoie (2007), Lavoie (2004, 2006), Palley (2006, 2007), Rochon & Rossi (2006), Sawyer (2002), Seccareccia (1998), Setterfield (2006, 2009), Smithin (2007), Stockhammer (2008) and Wray (2007).

³The distinction between short-term finance for production purposes (initial finance) and long-term finance for investment purposes (final finance), not dealt with in the present paper, can be found in the monetary circuit literature; see Graziani (1989), Lavoie (1992, pp. 151–169) or Seccareccia (1996).

⁴For a similar procedure with respect to the introduction of monetary variables into PK models of distribution and growth see Dutt (1989), Hein (2006a, 2006b, 2008), Lavoie (1992, 1993, 1995) and Taylor (2004).

⁵Repayment of debt is not considered explicitly.

⁶This means that we will not treat the long-run dynamics of the debt/capital ratio triggered by changes in the interest rate, capital accumulation or distribution. For such an analysis on the basis of the income generation part of the present model, albeit without (unexpected) inflation, see Hein (2006b, 2008).

⁷This part is developed on the basis of Stockhammer (2008) and extends the model presented there. For PK conflicting claims models of inflation see also Arestis & Sawyer (2004a, 2005), Hein (2006a, 2008), Lavoie (1992, 2002), Rowthorn (1977), and Sawyer (2001, 2002).

⁸Of course, there may also be exogenous shocks generating unexpected inflation.

⁹See Tarling & Wilkinson (1985) for a simple model with lagged responses of firms to changes in wage costs. Hein et al. (2006) present empirical observations for Germany and the European Monetary Union.

¹⁰The ‘income generation process’ in this paper is based on Hein (2006a, 2006b, 2008) and extends the models developed there. Rochon & Setterfield (2007b), Setterfield (2009) and Stockhammer (2008) have also introduced a more elaborated income generation process than the one in the NCMs. However, they do not fully take into account the distribution effects of unexpected inflation and of changes in the interest rate on effective demand when deriving the goods market equilibrium.

¹¹Whereas expected sales are closely related to profit expectations and therefore affect investment decisions, retained earnings are required for long-term investment finance. They also affect the access to external funds on imperfect capital markets and therefore investment finance, according to Kalecki’s (1937) ‘principle of increasing risk’.

¹²See Hein (2006b, 2008) and Lavoie (1995) for discussions of ‘puzzling’ and ‘normal’ cases in Kaleckian distribution and growth models.

¹³We may also have converging oscillations, which are not shown graphically.

¹⁴For an indication of the related dynamics associated with a persistent change in the real interest rate in a somewhat simpler model, see Hein (2006a, 2008).

¹⁵Whether the change in the NAIRU associated with labour market persistence mechanisms is temporary or permanent depends on the precise model. Nickell (1998) shows in a standard NAIRU model that labour market-related persistence mechanisms will only have a permanent effect on the NAIRU if the long-term unemployed have no effect on wages.

¹⁶For recent empirical work on the effects of capital stock on unemployment see Alexiou & Pitelis (2003), Arestis et al. (2006, 2007), Arestis & Biefang-Frisancho Mariscal (2000), Palacio-Vera et al. (2006), Stockhammer (2004b), and Stockhammer & Klär (2008).

¹⁷Note that W ₀ + h ₀ < 1.

¹⁸The idea that lasting variations in interest rates may affect functional income distribution and hence the share of wages and gross profits in total income goes back to Sraffa (1960, p. 33; see also, for example, Pivetti, 1991). In the Post-Keynesian literature, we find it also in the work of (Kaldor, 1982, p. 63), Pasinetti (1974, pp. 139–141) and Lavoie (1995). This idea is also compatible with Kalecki’s (1954, p. 18) notion that the degree of monopoly and hence the mark-up ‘may, but need not necessarily, increase’ when overheads and hence interest costs increase.

¹⁹Wray (2007) proposes a zero nominal interest rate in order to get rid of the rentier class. However, this seems to imply overcoming the main characteristics of a monetary production economy, the advancement of credit in order to get production started. Obviously, with a zero nominal interest rate in a single interest rate model there is no incentive for banks or rentiers to grant credit to finance production and capital accumulation.

²⁰Finally, wage moderation and redistribution at the expense of labour will not only negatively affect effective demand and employment in the short run, as well as the inflation barrier in the long run through the channels mentioned above, it will also be associated with weak real wage induced productivity growth which will further add to the weakening of long-run growth. See Bhaduri (2006) on the theoretical arguments, and Hein & Tarassow (2009), Naastepad (2006) and Naastepad & Storm (2007) for empirical analysis.

²¹See Hein (2006a, 2008) and Kriesler & Lavoie (2007) for the implementation of coordinated wage bargaining into PK models and Hein (2002, 2004) for reviews of the related literature.

²²Setterfield (2007, p. 417, emphasis in original) shows that even within the NCM framework there is good reason to conclude that ‘fiscal policy is at least as, if not, more potent as an instrument of stabilization policy than is monetary policy …’. See also Fontana (2009) and Hein & Truger (2009).

²³We therefore disagree with Lavoie (1996a) who recommends that the central bank should apply credit rationing or credit controls in order to stop demand inflation. We hold that fiscal policies are far more straightforward in achieving this goal.

²⁴The functional finance view, pioneered by Lerner (1943), recommends government deficits to mop up the excess of private sector planned saving over planned investment, plus the difference between imports and exports, at the full employment level of economic activity. Applying government deficit spending in this way assures that there is always enough saving to fund government deficits. Crowding out will not occur, provided that the central bank does not raise the interest rate.