Research Topics

In this report, Institute President Dimitri B. Papadimitriou, Research Scholar Giuliano T. Yajima, and Senior Scholar Gennaro Zezza discuss the rapid recovery of the US economy in the post-pandemic period. They find that robust consumption and investment and a relaxation of fiscal policy were the key drivers of accelerated GDP growth—however, the signs that the same rapid rate of growth will continue are not encouraging. In the authors’ assessment, projections relying on significant increases in private sector expenditures, including residential investment, are doubtful unless the relaxation of fiscal policy continues; both the household and corporate sectors will be deleveraging instead of increasing spending; the trade balance will continue along its same path in a deficit position; and the run up in the stock market carries significant downside risks.

In this Strategic Analysis, Dimitri B. Papadimitriou, Michalis Nikiforos, Giuliano T. Yajima, and Gennaro Zezza discuss how the current state and structural features of the US economy might affect its future trajectory. The recent recovery after the pandemic has been remarkable, when compared to previous cycles, and offers evidence of the efficacy of fiscal policy. Moreover, the inflation rate has been finally decelerating as the problems in global value chains that emerged after the pandemic are resolving and the price of commodities and oil, which spiked after the pandemic and the war in Ukraine, are stabilizing.

Yet despite the recent success of fiscal policy in promoting output and employment growth, the recent debt ceiling deal—culminating in the 2023 Fiscal Responsibility Act—risks putting the US economy on the austerity path of the previous decade. And given the structural weaknesses of the US economy—including its high current account deficits, high level of indebtedness of firms, and overvalued stock and real estate prices—this projected fiscal policy tightening, combined with the impacts of high interest rates, could lead to a significant slowdown of the US economy.

The US economy, the authors contend, is in need of a structural transformation toward modernizing its infrastructure, promoting industrial policy, and investing in the greening of its economy and environmental sustainability. A necessary condition for achieving these goals is an increase in government expenditure; they show that such an increase could also have positive demand effects on output and employment. 

Greece’s fragile economic recovery was halted by the COVID-19 pandemic: GDP, employment, exports, and investment are expected to record significantly negative trends. While some projections for GDP growth show a quick V-shaped recovery beginning in 2021, this is rather improbable given the Greek economy’s structural inefficiencies.
 
This strategic analysis explores the consequences of various assumptions about the fall in the different sources of aggregate demand in order to produce a baseline projection for the Greek economy. A more optimistic scenario is also analyzed, in which the European Commission’s recently announced Recovery Fund materializes, allowing the government to increase public consumption as well as investment through EU grants and loans. The authors recommend additional measures to alleviate the impact of the shock and help put Greece’s economy back on track when the epidemic has died out.

If the Trump administration is to fulfill its campaign promises to this age’s “forgotten” men and women, Director of Research Jan Kregel argues, it should embrace the broader lesson of the 1930s: that government regulation and fiscal policy are crucial in addressing changes in the economic and financial structure that have exacerbated the problems faced by struggling communities.

In this policy note, Kregel explains how overcoming the economic and financial challenges we face today, just as in the 1930s, requires avoiding what Walter Lippmann identified as an “obvious error”: the blind belief that reducing regulation and the role of government will somehow restore a laissez-faire market liberalism that never existed and is inappropriate to the changing structure of production of both the US and the global economy.
 

From a macroeconomic point of view, 2016 was an ordinary year in the post–Great Recession period. As in prior years, the conventional forecasts predicted that this would be the year the economy would finally escape from the “new normal” of secular stagnation. But just as in every previous year, the forecasts were confounded by the actual result: lower-than-expected growth—just 1.6 percent.
 
The radical policy changes promoted by the new Trump administration dominated economic conditions in the closing quarter of the year and the first quarter of 2017. Markets have responded with exuberance since the November elections, on the expectation that the proposed policy measures would increase profitability by boosting growth and cutting personal and corporate taxes. However, an evaluation of the US economy’s structural characteristics reveals three key impediments to a robust, sustainable recovery: income inequality, fiscal conservatism, and weak net export demand. The new administration’s often conflicting policy proposals are unlikely to solve any of these fundamental problems—if anything, the situation will worsen.
 
Our latest Strategic Analysis provides two medium-term scenarios for the US economy. The “business as usual” baseline scenario (built on CBO estimates) shows household debt and GDP growth roughly maintaining their moribund postcrisis trends. The second scenario assumes a sharp correction in the stock market beginning in 2017Q3, combined with another round of private sector deleveraging. The results: negative growth and a government deficit of 8.3 percent by 2020—essentially a repeat of the crisis of 2007–9. 

Flavia Dantas and L. Randall Wray argue that the emerging conventional wisdom—that the US economy has reached full employment—is flawed. The unemployment rate is not providing an accurate picture of the health of the labor market, and the common narrative attributing shrinking labor force engagement to aging demographics is overstated. Instead, falling prime-age participation rates are the symptom of a structural inadequacy of aggregate demand—a problem of insufficient job creation and stagnant incomes that conventional public policy remedies have been unable to address. The solution to our long-running secular stagnation requires targeted, direct job creation for those at the bottom of the income scale.

The Greek government has agreed to a new round of fiscal austerity measures consisting of a sharp increase in taxes on income and property and further reductions in pension and other welfare-related expenditures. Based on our model of the Greek economy, policies aimed at reducing the government deficit will cause a recession, unless other components of aggregate demand increase enough to more than offset the negative impact of fiscal austerity on output and employment.

In this report we argue that the troika strategy of increasing net exports to restart the economy has failed, partly because of the low impact of falling wages on prices, partly because of the low trade elasticities with respect to prices, and partly because of other events that caused a sharp reduction in transport services, which used to be Greece’s largest export sector.

A policy initiative to boost aggregate demand is urgently needed, now more than ever. We propose a fiscal policy alternative based on innovative financing mechanisms, which could trigger a boost in confidence that would encourage renewed private investment.

To the extent that policymakers have learned anything at all from the Great Depression and the policy responses of the 1930s, the lessons appear to have been the wrong ones. In this public policy brief, Director of Research Jan Kregel explains why there is still a great deal we have to learn from the New Deal. He illuminates one of the New Deal’s principal objectives—quelling the fear and uncertainty of mass unemployment—and the pragmatic, experimental process through which the tool for achieving this objective—directed government expenditure—came to be embraced.

In the search for a blueprint from the 1930s, Kregel suggests that too much attention has been paid to the measures deployed to shore up the banking system, and that the approaches underlying the emergency financial policy measures of the recent period and those of the 1930s were actually quite similar. The more meaningful divergence between the 1930s and the post-2008 policy response, he argues, can be uncovered by comparing the actions that were taken (or not taken, as the case may be) to address the real sector of the economy following the resolution of the respective financial crises. 

Our latest strategic analysis reveals that the US economy remains fragile because of three persistent structural issues: weak demand for US exports, fiscal conservatism, and a four-decade trend in rising income inequality. It also faces risks from stagnation in the economies of the United States’ trading partners, appreciation of the dollar, and a contraction in asset prices. The authors provide a baseline and three alternative medium-term scenarios using the Levy Institute’s stock-flow consistent macro model: a dollar appreciation and reduced growth in US trading partners scenario; a stock market correction scenario; and a third scenario combining scenarios 1 and 2. The baseline scenario shows that future growth will depend on an increase in private sector indebtedness, while the remaining scenarios underscore the linkages between a fragile US recovery and instability in the global economy. 

Even under optimistic assumptions, the policy status quo being enforced in Greece cannot be relied upon to help recover lost incomes and employment within any reasonable time frame. And while a widely discussed public investment program funded by European institutions would help, a more innovative, better-targeted solution is required to address Greece’s protracted unemployment crisis: an “employer of last resort” (ELR) plan offering paid work in public projects, financed by issuing a nonconvertible “fiscal currency”—the Geuro.

The Greek economy has not succeeded in restoring growth, nor has it managed to restore a climate of reduced uncertainty, which is crucial for stabilizing the business climate and promoting investment. On the contrary, the new round of austerity measures that has been agreed upon implies another year of recession in 2016.

After reviewing some recent indicators for the Greek economy, we project the trajectory of key macroeconomic indicators over the next three years. Our model shows that a slow recovery can be expected beginning in 2017, at a pace that is well below what is needed to alleviate poverty and reduce unemployment. We then analyze the impact of a public investment program financed by European institutions, of a size that is feasible given the current political and economic conditions, and find that, while such a plan would help stimulate the economy, it would not be sufficient to speed up the recovery. Finally, we revise our earlier proposal for a fiscal stimulus financed through the emission of a complementary currency targeted to job creation. Our model shows that such a plan, calibrated in a way that avoids inflationary pressures, would be more effective—without disrupting the targets the government has agreed upon in terms of its primary surplus, and without reversing the improvement in the current account. 

The Euro Treasury Plan

The euro crisis remains unresolved and the euro currency union incomplete and extraordinarily vulnerable. The euro regime’s essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union. We propose a “Euro Treasury” scheme to properly fix the regime and resolve the euro crisis. This scheme would establish a rudimentary fiscal union that is not a transfer union. The core idea is to create a Euro Treasury as a vehicle to pool future eurozone public investment spending and to have it funded by proper eurozone treasury securities. The Euro Treasury could fulfill a number of additional purposes while operating mainly on the basis of a strict rule. The plan would also provide a much-needed fiscal boost to recovery and foster a more benign intra-area rebalancing.

The Greek economy has the potential to recover, and in this report we argue that access to alternative financing sources such as zero-coupon bonds (“Geuros”) and fiscal credit certificates could provide the impetus and liquidity needed to grow the economy and create jobs. But there are preconditions: the existing government debt must be rolled over and austerity policies put aside, restoring trust in the country’s economic future and setting the stage for sustainable income growth, which will eventually enable Greece to repay its debt.

In this latest Strategic Analysis, the Institute’s Macro Modeling Team examines the current, anemic recovery of the US economy. The authors identify three structural obstacles—the weak performance of net exports, a prevailing fiscal conservatism, and high income inequality—that, in combination with continued household sector deleveraging, explain the recovery’s slow pace. Their baseline macro scenario shows that the Congressional Budget Office’s latest GDP growth projections require a rise in private sector spending in excess of income—the same unsustainable path that preceded both the 2001 recession and the Great Recession of 2007–9. To better understand the risks to the US economy, the authors also examine three alternative scenarios for the period 2015–18: a 1 percent reduction in the real GDP growth rate of US trading partners, a 25 percent appreciation of the dollar over the next four years, and the combined impact of both changes. All three scenarios show that further dollar appreciation and/or a growth slowdown in the trading partner economies will lead to an increase in the foreign deficit and a decrease in the projected growth rate, while heightening the need for private (and government) borrowing and adding to the economy’s fragility. 

From Bad to Worse

In a recent policy note (A Decade of Flat Wages?) we examined wage trends since 1994, and found that while wages grew between 1994 and 2002, average real wages stagnated or declined after 2002–03. Our latest study provides a more detailed analysis of wage trends for wage-level, age, and education groups, with emphasis on the periods following the 2001 and 2007–09 recessions.   There was a more or less cohesive evolution of wages among different groups until 2002–03. However, after controlling for structural changes in the labor force, wages diverged sharply in the years that followed for different age, education, and wage groups, with the majority of workers experiencing real declines in their wages. This was not a short-term decline among a few numerically insignificant groups. Nearly two-thirds of all full-time wage earners have less than a four-year college degree and saw their wages decline compared to peak wages in 2002. Workers aged 44 and younger, representing slightly more than 38 million full-time wage earners or 71.4 percent of all full-time wage earners in the United States, also experienced a large reduction in cumulative wage growth after 2002. In terms of wage groups, the bottom 75 percent of full-time workers saw a decline in real wages, while those at the top of the wage distribution saw their wages rise—clear evidence of increasing wage inequality.   Given the downward trend in real wages for the majority of full-time wage earners since 2009, it should come as no surprise that recovery from the Great Recession has been weak. In the absence of an employer-of-last-resort policy, federal and state policy must focus its efforts on increasing wages through measures such as progressive tax policy, raising the minimum wage, ensuring overtime pay laws are enforced, and creating opportunities for the most vulnerable workers.  

Criticisms of the Federal Reserve’s “unconventional” monetary policy response to the Great Recession have been of two types. On the one hand, the tripling in the size of the Fed’s balance sheet has led to forecasts of rampant inflation in the belief that the massive increase in excess reserves might be spent on goods and services. And even worse, this would represent an attempt by government to inflate away its high levels of debt created to support the solvency of financial institutions after the September 2008 collapse of asset prices. On the other hand, it is argued that the near-zero short-term interest rate policy and measures to flatten the yield curve (quantitative easing plus "Operation Twist") distort the allocation and pricing in the credit and capital markets and will underwrite another asset price bubble, even as deflation prevails in product markets.   Both lines of criticism have led to calls for a return to a more conventional policy stance, and yet there is widespread agreement that this would have a negative impact on the economy, at least in the short-term. However, since the analyses behind both lines of criticism are mistaken, it is probable that the analyses of the impact of the risks of return to more normal policies are also in error.  

The Fed’s zero interest policy rate (ZIRP) and quantitative easing (QE) policies failed to restore growth to the US economy as expected (i.e., increased investment spending à la John Maynard Keynes or from an expanded money supply à la Ben Bernanke / Milton Friedman). Senior Scholar Jan Kregel analyzes some of the arguments as to why these policies failed to deliver economic recovery. He notes a common misunderstanding of Keynes’s liquidity preference theory in the debate, whereby it is incorrectly linked to the recent implementation of ZIRP. Kregel also argues that Keynes’s would have implemented QE policies quite differently, by setting the bid and ask rate and letting the market determine the volume of transactions. This policy note both clarifies Keynes’s theoretical insights regarding unconventional monetary policies and provides a substantive analysis of some of the reasons why central bank policies have failed to achieve their stated goals.

In the postwar period, income growth has become more inequitably distributed with virtually every subsequent economic expansion. From 2009 to 2012, while the economy was recovering from one of the biggest economic downturns in recent memory, the top 1 percent took home 95 percent of the income gains. To reverse this pattern, Research Associate Pavlina R. Tcherneva recommends policy strategies to promote growth from the bottom up—to change the income distribution directly by funding employment opportunities in the public, nonprofit, or social entrepreneurial sector. 

What are the prospects for economic recovery if Greece continues to follow the troika strategy of fiscal austerity and internal devaluation, with the aim of increasing competitiveness and thus net exports? Our latest strategic analysis indicates that the unprecedented decline in real and nominal wages may take a long time to exert its effects on trade—if at all—while the impact of lower prices on tourism will not generate sufficient revenue from abroad to meet the targets for a surplus in the current account that outweighs fiscal austerity. The bottom line: a shift in the fiscal policy stance, toward lower taxation and job creation, is urgently needed. 

Contrary to German chancellor Angela Merkel’s recent claim, the euro crisis is not nearly over but remains unresolved, leaving the eurozone extraordinarily vulnerable to renewed stresses. In fact, as the reforms agreed to so far have failed to turn the flawed and dysfunctional euro regime into a viable one, the current calm in financial markets is deceiving, and unlikely to last.   The euro regime’s essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union. In this public policy brief, Research Associate Jörg Bibow proposes a Euro Treasury scheme to properly fix the regime and resolve the euro crisis. The Euro Treasury would establish the treasury–central bank axis of power that exists at the center of control in sovereign states. Since the eurozone is not actually a sovereign state, the proposed treasury is specifically designed not to be a transfer union; no mutualization of existing national public debts is involved either. The Euro Treasury would be the means to pool future eurozone public investment spending, funded by proper eurozone treasury securities, and benefits and contributions would be shared across the currency union based on members’ GDP shares. The Euro Treasury would not only heal the euro’s potentially fatal birth defects but also provide the needed stimulus to end the crisis in the eurozone.

The US economy has been expanding moderately since the official end of the Great Recession in 2009. The budget deficit has been steadily decreasing, inflation has remained in check, and the unemployment rate has fallen to 6.7 percent. The restrictive fiscal policy stance of the past three years has exerted a negative influence on aggregate demand and growth, which has been offset by rising domestic private demand; net exports have had only a negligible (positive) effect on growth.   As Wynne Godley noted in 1999, in the Strategic Analysis Seven Unsustainable Processes, if an economy faces sluggish net export demand and fiscal policy is restrictive, economic growth becomes dependent on the private sector’s continuing to spend in excess of its income. However, this continuous excess is not sustainable in the medium and long run. Therefore, if spending were to stop rising relative to income, without either fiscal relaxation or a sharp recovery in net exports, the impetus driving the expansion would evaporate and output could not grow fast enough to stop unemployment from rising. Moreover, because growth is so dependent on “rising private borrowing,” the real economy “is at the mercy of the stock market to an unusual extent.” As proved by the crisis of 2001 and the Great Recession of 2007–09, Godley’s analysis turned out to be correct.   Fifteen years later, the US economy appears to be going down the same road again. Postrecession, foreign demand is still weak and the government is maintaining its tight fiscal stance. Once again, the recovery predicted in the latest Congressional Budget Office report relies on excessive private sector borrowing, and once again, the recovery is at the mercy of the stock market. Given that the income distribution has worsened since the crisis—continuing a 35-year trend—the burden of indebtedness will again fall disproportionally on the middle class and the poor. In order for the CBO projections to materialize, households in the bottom 90 percent of the distribution would have to start accumulating debt again in line with the prerecession trend while the stock of debt of the top 10 percent remained at its present level. Clearly, this process is unsustainable. The United States now faces a choice between two undesirable outcomes: a prolonged period of low growth—secular stagnation—or a bubble-fueled expansion that will end with a serious financial and economic crisis. The only way out of this dilemma is a reversal of the trend toward greater income inequality.  

If the Congressional Budget Office’s recent projections of government revenues and outlays come to pass, the United States will not grow fast enough to bring down the unemployment rate between now and 2016. The public sector deficit will decline from present levels, endangering the sustainability of the recovery. But as this new Strategic Analysis shows, a public sector stimulus of a little over 1 percent of GDP per year focused on export-oriented R & D investment would increase US competitiveness through export-price effects, resulting in a rise of net exports, and slowly lower unemployment to less than 5 percent by 2016. The improvement in net export demand would allow the US economy to enter a period of aggregate-demand rehabilitation—with very encouraging consequences at home. 

Monetary policy is running out of gas. Six years ago, in the heat of crisis, the Federal Reserve’s response was awesome. The Fed created trillions of dollars and flooded the system with easy money—enough to stabilize financial markets and rescue wounded banks. It brought short-term interest rates down to near zero and long-term mortgage rates to bargain-basement levels. It provided a huge backstop for the dysfunctional housing sector, buying $1.25 trillion in mortgage-backed securities, nearly one-fourth of the market.

Flooding Wall Street with money saved the banks, but it didn’t work for the real economy, where most Americans live and toil. And official Washington now appears to have opted for an unspoken policy of complacency.

The Fed knows, even if politicians do not, the danger of sliding into a liquidity trap, which would utterly disarm its monetary tools. So the Fed wants Congress and the White House to borrow and spend more because, when the private sector is stalled and afraid to act, only the federal government can step in and provide the needed jump start. The country needs a stronger Fed—a central bank not afraid to use its awesome powers to help the real economy more directly. One of the ways it can do this is by revisiting—and extending—its bold ideas on debt relief. By harnessing the power of money creation, the Fed can help clear away the overhang of mortgage and student debt holding back the economic recovery.   This policy note draws from articles originally published in The Nation. Portions are republished with permission. 

Should we allow the fiscal cliff, with its across-the-board spending cuts and big tax increases that will affect almost every American, to take effect? Economists have been weighing in on such fiscal policy questions in what seems to be the most intense election-year debate in many years. To help our readers keep track of this debate, we offer a list of some of the specious arguments against fiscal stimulus and for austerity, together with our responses.

Interim Report

In this interim report, we discuss the evolution of major macroeconomic variables for the Greek economy, focusing in particular on the sources of growth before and after the euro era, the causes and consequences of the continuing recession, and the likely results of the policies currently being implemented. Some preliminary suggestions for alternative policies are included. These alternatives will be tested in a more robust econometric framework in a subsequent report.

Though the economy appears to be gradually gaining momentum, broad measures indicate that 14.5 percent of the US labor force is unemployed or underemployed, not much below the 16.2 percent rate reached a full year ago. In this new report in our Strategic Analysis series, we first discuss several slow-moving factors that make it difficult to achieve a full and sustainable economic recovery: the gradual redistribution of income toward the wealthiest 1 percent of households; a failure to fully stabilize and reregulate finance; serious fiscal troubles for state and local governments; and detritus from the financial crisis that remains on household and corporate balance sheets. These factors contribute to a situation in which employment has not risen fast enough since the (supposed) end of the recession to significantly increase the employment-population ratio. Meanwhile, public investment at all levels of government fell from roughly 3.7 percent of GDP in 2008 to 3.2 percent in the fourth quarter of 2011, helping to explain the weak economic picture.

For this report, we use the Levy Institute macro model to simulate the economy under the following three scenarios: (1) a private borrowing scenario, in which we find the appropriate amount of private sector net borrowing/lending to achieve the path of employment growth projected under current policies by the Congressional Budget Office (CBO), in a report characterized by excessive optimism and a bias toward deficit reduction; (2) a more plausible scenario, in which we assume that the federal government extends certain key tax cuts and that household borrowing increases at a more reasonable rate than in the previous scenario; and (3) a fiscal stimulus scenario, in which we simulate the effects of a fully “paid for” 1 percent increase in government investment.

The results show the importance of debt accumulation as a consideration in macro policymaking. The first scenario reproduces the CBO’s relatively optimistic employment projections, but our results indicate that this private-sector-led growth scenario quickly brings household and business debt to new all-time highs as percentages of GDP. We note that the CBO makes its projections using an orthodox model with several common, but fundamental, flaws. This makes possible the agency’s result that current policies will reduce the unemployment rate without a run-up in the private sector’s debt—“business as usual,” in the words of our report’s title.

The policies weighed in the second scenario do not perform much better, despite a looser fiscal stance. Finally, our third scenario illustrates that a small, tax-financed increase in government investment could lower the unemployment rate significantly—by about one-half of 1 percent. A stimulus package of this size might be within the realm of political possibility at this juncture. However, our results lead us to surmise that it would take a much more substantial fiscal stimulus to reduce unemployment to a level that most policymakers would regard as acceptable.

With quantitative easing winding down and the latest payroll tax-cut measures set to expire at the end of this year, pressing questions loom about the current state of the US economic recovery and its ability to sustain itself in the absence of support from monetary and fiscal policy.

This “Modest Proposal” by authors Varoufakis and Holland outlines a three-pronged, comprehensive solution to the eurozone crisis that simultaneously addresses the three main dimensions of the current crisis in the eurozone (sovereign debt, banking, and underinvestment), restructures both a share of sovereign debt and that of banks, and does not involve a fiscal transfer of taxpayers’ money. Additionally, it requires no moves toward federation, no fiscal union, and no transfer union. It is in this sense, say the authors, that it deserves the epithet modest.

To stabilize the debt crisis, Varoufakis and Holland recommend a tranche transfer of the sovereign debt of each EU member-state to the European Central Bank (ECB), to be held as ECB bonds. Member-states would continue to service their share of debt, reducing the debt-servicing burden of the most exposed member-states without increasing the debt burden of the others. Rigorous stress testing and recapitalization through the European Financial Stability Facility (in exchange for equity) would cleanse the banks of questionable public and private paper assets, allowing them to turn future liquidity into loans to enterprises and households. And the European Investment Bank (EIB) would assume the role of effecting a “New Deal” for Europe, drawing upon a mix of its own bonds and the new eurobonds. In effect, the EIB would graduate into a European surplus-recycling mechanism—a mechanism without which no currency union can survive for long.

Four Fragile Markets, Four Years Later

In this brief, Research Scholar Greg Hannsgen and President Dimitri B. Papadimitriou focus on the risks and possibilities ahead for the US economy. Using a Keynesian approach and drawing from the commentary of other observers, they analyze publicly available data in order to assess the strength and durability of the expansion that probably began in 2009. They focus on four broad groups of markets that have shown signs of stress for the last several years: financial markets, markets for household goods and services, commodity markets, and labor markets. This kind of analysis does not yield numerical forecasts but it can provide important clues about the short-term outlook for the country’s economic well-being, and cast light on some longer-run threats. In particular, dangers and stresses in the financial and banking systems are presently very serious, and labor market data show every sign of a widespread and severe weakness in aggregate demand. Unless there is new resolve for effective government action on the jobs front, drastic cuts in much-needed federal, state, and local programs will become the order of the day in the United States, as in much of Europe.