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Post-Keynesian macroeconomic foundations for Comparative Political Engelbert Stockhammer December 2020

POST-KEYNESIANECONOMICS SOCIETY Post-Keynesian macroeconomic foundations for Comparative

Ver. 3.00 Oct. 2020

This WP builds on PKES WP#1809.

Engelbert Stockhammer King’s College London Virginia Woolf Building, 22 Kingsway, London, WC2B 6NR, UK tel: +44 (0)20 7848 6697 email: [email protected]

Abstract. Since the global and the ensuing weak growth in macroeconomic issues has grown within Comparative Political Economy (CPE). The dominant Varieties of approach focuses on how different institutional arrangements contribute to competitiveness and thus has a strong supply-side focus, which is complementary with modern mainstream . Baccaro and Pontusson (2016) have suggested basing CPE on post-Keynesian theory of and growth. This paper generalises their point and makes a systematic case for post-Keynesian (PK) foundations for CPE. It highlights the PK theory of and finance and that PKE analyses inequality as well as financial relations as based on class and power relations. The paper identifies the analysis of financialisation, financial cycles, the understanding of neoliberal growth models and the political economy of central banks as areas where PKE can provide specific insights for CPE.

Keywords: post-, comparative political economy, growth models, financial instability

Acknowledgements. Earlier versions of the paper were presented at the workshop Growth models, Koln, at the University of the West of England and at the IPEG conference. The paper has benefited from discussions there and from comments by Joseph Baines, Louis Daumas, Karsten Kohler, Paul Lewis, Inga Rademacher, and James Wood . The usual disclaimers apply.

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Introduction

Political Economy approaches assert that economic, social and political factors have to be analysed in conjunction. Comparative Political Economy (CPE) is the field that studies differences in institutions, and economic outcomes across countries. It asks questions like why some countries have higher incomes or than others, why there are different degrees of inequality, and how these relate to differences in the institutions structuring industrial relations, financial systems and regimes. CPE therefore a theory of institutions and as well as theory of how the economy works. One key question that divides economic theories is whether growth should be understood driven mostly by (slowly changing) supply-side factors like the skills of the workforce and the speed of technological progress or by the (more volatile) demand side, i.e. spending decisions of firms, and . The answer to this question has far reaching implications for economic analysis, but most importantly shapes the interpretation of economic crises. Are they due to exogenous unforeseeable shocks that bring about temporary deviations from an otherwise stable growth path (as implied by most supply-side theories)? Or are they the endogenous outcome of systemic forces that lead to boom bust cycles, as non-mainstream versions of demand-side analyses suggest?

These questions matter to CPE as they are necessary to understand countries’ economic performances and to evaluate economic policies, but CPE rarely confronts them head on. Schwartz and Tranoy argue that over decades there has been a slow shift in CPE from macroeconomic approaches that emphasise economic instability and issues of political legitimacy to neoinstitutional approaches, in particular the (VoC) approach, that presuppose (stable) outcomes which allow for multiple institutional equilibria. 1 This has moved CPE closer to with its supply-side focus and an interpretation of market as inherently stable. The global financial crisis and the ensuing weak growth has re-ignited interest in macroeconomic issues of growth, distribution and stability and thus the question of the economic

2 underpinning for CPE. Baccaro and Pontusson propose basing CPE on post-Keynesian (PK) theory of demand regimes and use the cases of Germany, Sweden and the UK to analyse export-led and debt- led growth models.2 In a reply Hope and Soskice argue that the more mainstream New Keynesian

(NK) theory, which is based on methodological individualism, features a supply-side determined long-run equilibrium and regards financial crises as caused by exogenous shocks, is a more appropriate foundation.3.

This paper is a reply to this controversy and makes a systematic case for post-Keynesian economics

(PKE) as macroeconomic foundation for the comparative analysis of . It argues that CPE lacks adequate macroeconomic foundations; it needs an analytical framework that allows an analysis of the potential instability of growth in a financialised economy and the power relations that underpin inequality as well as financial relations. PKE, in contrast to NKE, offers a (Kaleckian) theory of demand regimes that allows for -led as well as -led demand regimes, partially used by

Baccaro and Pontusson. Importantly, PK theory of money and finance that enables an analysis of financialisation that considers the dysfunctional aspects of finance and the emergence of (Minskyan) financial instability. It has a focus on the demand side of growth, but considers growth as path- dependent with (Kaldorian) technological progress is induced by demand pressures. Together this forms a basis for an analysis of growth models that is more appropriate than mainstream economics for a world characterised by distributional conflict and financial crises.

The paper is at the same time highly sympathetic to and critical of Baccaro and Pontusson. I argue that PKE has more to offer that Baccaro and Pontusson realise, in particular regarding finance and financial instability. The paper discusses several specific areas where a PKE approach can make contributions to CPE debates. First, the PK analysis of endogenous financial instability has implications for our understanding of financialisation.4 Second, we argue that, contrary to what

Baccaro and Pontusson assert, neoliberal growth models are premised on wage-led demand regimes and that the stagnation tendencies they encounter in the face of rising inequality are compensated

3 by debt-driven or export-driven stimulation, both of which give rise to unstable regimes. Third, endogenous financial instability has implications for the political economy of central banks. They act as lender of last resort for private financial institutions as well as governments, which gives them a distinct form of financial power. The overall PK vision of capitalist dynamics is one of intrinsically unstable growth process, where class relations, financial instability and activity shapes the growth path of economies.

Like most scholarly works, this article seeks to contribute to a specific academic debate. It thereby highlights specific logical and empirical implications of certain macroeconomic arguments and expose analytical shortcomings of particular theories, here the VoC approach. However, the difference between NK and PK macroeconomic theories is not only relevant for academic debates.

Macroeconomic theory matters because it enables . It has immediate and important implications for government policy and for what CPE has to say about economic policies in era of secular stagnation with ongoing social, distributional and economic crises. The paper thus highlights when PKE and NKE suggest different policy proposals for governments and central banks.

A clarification on the geographical scope of this paper is in place. Much of CPE is concerned with advanced economies and the debates which this paper seeks to contribute to refer to the European and US experiences. This paper shares this Eurocentrism for reasons of space. The PK approach does have several elements that are important for understanding the experience of developing economies. In particular Latin American ,5 which offers a theory divergent growth of advanced and developing economies based on structural differences of economies reliant on import of , is a close relative of PKE and the PK theory of finance offers a theory of the hierarchy of and of financial instability based of volatile financial flows.6 We will briefly touch upon these issues in section 4, but otherwise the paper develops its argument with respect to the US and European experience.

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The paper is structured as follows. Section 2 situates PKE and CPE within the historical development of the political economy approach. Section 3 discusses recent debates on the role of in CPE. Section 4 presents NK theory and the three-equation model advocated by

Hope and Soskice. Section 5 set out the core features of the PK analysis of distribution, finance and path dependent growth. Section 6 highlights contributions of PKE to CPE on financialisation and financial cycles, for the interpretation of neoliberal growth models, and for the political economy of central banking. Finally, section 7 concludes.

From Political Economy to and Comparative

Political Economy

While the main objective of this paper is to clarify the contributions PKE can make to CPE, many of the arguments here will also be relevant to other areas of political economy. Political Economy started as a holistic approach in the 19th century that aimed at unified analysis of social, economic and political issues. Towards the late 19th and early 20th century under the influence of neoclassical theory economics turned into ‘pure economics‘ and a disciplinary bifurcation occurred, with economics becoming a distinct discipline from political sciences and .7 The Political

Economy agenda, which runs across academic disciplines, thus also split along disciplinary lines.

Within economics the PK and Marxist traditions pursued a political economy approach. Economics experienced a broadening of its theories with the of the 1930s, in particular the emergence of a separate field of macroeconomics, and then a narrowing with the Monetarist counterrevolution of the 1970s, which delegitimized non-mainstream approaches and macroeconomic theory. To survive in an hostile academic environment modern non-mainstream economics has increasingly relied on formal modelling, which makes with political in the social sciences more difficult. This is true for PKE, but also applies to other non-

5 mainstream approach, which (since the 1970s) include Evolutionary, Institutionalist and Feminist

Economics. It is symptomatic that these approaches typically use the term ‘heterodox economics‘ rather than Political Economy as a unifying label.

Within the social sciences the fields of International Political Economy (IPE), Comparative Political

Economy and formed in part to overcome the disciplinary divide. Among these

IPE and Economic Sociology have an eclectic understanding of modern non-mainstream economics;

CPE, in the form of VoC, has gone furthest in drawing on mainstream economics. But the gap between heterodox economics and CPE is also reflected in Ben Clift’s excellent book Comparative

Political Economy.8 It has an insightful discussion of 19th century economic theory and debates, but ends it coverage of economics debates with the controversy between Keynes and Hayek in the

1930s and lacks a coverage of contemporary heterodox economics. This paper argues Political

Economy research in economics as well social sciences became impoverished as a consequence of the disciplinary split. Modern CPE, in particular the VoC approach, builds on contemporary mainstream economics and incorporates its shortcomings. Contemporary heterodox macroeconomics and specifically PKE offers a valuable alternative that can enrich CPE.

It is noteworthy that debate on the macroeconomic foundations of IPE has also begun. Blyth and

Matthijs argue that IPE has been unable to anticipate and analytically deal with the global financial crisis and its economic and political fallout.9 This is because while (American) IPE has developed its , leaning on modern mainstream economics, it lacks in its treatment of the macroeconomy. They propose the term macroeconomic regime, which they define with regards to the “the main target variable for a country’s macroeconomic policy”.10 Effectively, they distinguish between a Keynesian (full ) and neoliberal ( stability) policy goals, but offer limited discussion of different macroeconomic theories.

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The macroeconomics of current Comparative Political Economy

While at the inception of CPE, Andrew Shonfield had a focus on demand formation, economic stability and political legitimacy and, similarly, Peter Hall’s early work was concerned with demand ,11 in subsequent debates CPE moved gradually in the direction of microeconomic questions and a supply side focus. Schwartz and Tranoy trace this gradual shift and argue that it has resulted in a neglect of fallacy of composition problems and financial instability.12 The culmination of this development is the VoC approach, which regards as core reference point for the establishment of a viable variety of capitalism its ability to generate competitiveness.13 VoC takes a firm-centric view, analyses firms as a set of relations that includes those to their employees, embodied in industrial relations and training systems, the relations between owners and stake holders (corporate governance), relations to its financiers and to competing firms. All these are shaped in part by national regulations and policies which constitute the constraints that firms face. There exist complementarities between different sets of institutions, which led VoC to distinguish liberal, coordinated and mixed market economies. The subtitle of Hall and Soskice’s famous book encapsulates the approach: the institutional foundations of . VoC offers an institutionally nuanced supply-side analysis of economic performance, centred around the concept of competitiveness that highlights the possibility of multiple institutional equilibria. Traditional concerns of Keynesian macroeconomics like caused by demand deficiencies or crises and financial instability are not at the core of its research agenda.

In an attempt to reconstitute CPE Baccaro and Pontusson suggest an approach that builds on PK macroeconomic theory of demand regimes and develop this into an analysis of growth models which highlights the interaction between distributional changes, demand formation and export performance. They identify Germany as an export-led growth model and the UK as - led,with Sweden as an intermediate case and Italy as case of stagnation.14 Their growth models are

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‘more numerous and more unstable’ than traditional VoC analyses.15 They conceive the growth models as underpinned by social coalitions and a hegemonic social bloc, which is based on sectoral , and illustrate this with reference to coalitions around export interests. This is an important step away from static VoC classifications that tries to grapple with instability, but there is clear asymmetry in the depth with which export orientation is covered and an absence of an analysis of financialisation and thus the debt-led growth model.

In a reply Hope and Soskice welcome the discussion of demand issues but argue that the modern

New Keynesian mainstream economics is a more appropriate foundation. They specifically suggest the three-equation model, a textbook version of NKE.16 This model is anchored in a supply-side determined long-run equilibrium with providing a stabilising function. This will be discussed in more detail in the next section. As much of the VoC literature does not discuss its macroeconomic underpinning Hope and Soskice’s work is welcome in that it makes explicit the implicit macroeconomic assumptions of the VoC approach. There is a basic complementarity between NKE and VoC in that both share a supply-side focus, despite different research agendas.

Demand formation plays a secondary (short-run) role; in a longer perspective only institutions and other supply-side factors like technology matter. Issues like financial stability or the demand effects of rising inequality were sidelined until recently.

While VoC plays a strong role within CPE, there is a substantial and growing literature that has moved beyond VoC. In doing so many CPE authors take a positions and asks questions very close to those of PKE, at times they build explicitly on PKE. Colin Crouch proposed the concept of ‘privatized

Keynesianism’ to describe a regime where private consumption (rather than ) is credit financed. Colin Hay uses the term ‘Anglo-liberal growth model’ to describe more specifically how rising asset and withdrawal gives rise to a growth model based on credit creation.17 This is very close to the PK concept of debt-driven growth to be discussed later. In their discussions of the Euro crisis Andreas Noelke and Magnus Ryner prominently feature PK

8 contributions and specifically the juxtaposition of export-driven and debt-driven growth models and how their interaction generates systemic instability.18 Baccaro and Pontusson’s interest in PKE thus is symptomatic for a growing engagement of CPE and IPE with macroeconomic issues and theories.

However these attempts are as of yet eclectic and limited in scope. They explain specific episodes but do not reflect systematically on the macroeconomic foundations of CPE. Crouch and Hay explicitly analyse the UK or Anglo-Saxon experience during the pre-2008 boom and do not attempt a systematic theory of finance. Our argument is that the best developed stream within CPE, the VoC approach, is closely wedded to parts of contemporary mainstream economics, which hampers its ability to comprehend the changes brought about by financialisation and thus fails to understand the instability of neoliberal varieties of capitalism. CPE needs to consider its macroeconomic foundations more systematically and in particular how it explains economic growth process and crises.

New Keynesian Economics and the three-equation model

Hope and Soskice make the case for New Keynesian, i.e. mainstream economic, foundations for CPE.

To appreciate the significance of Hope and Soskice’s proposal, we to situate NK theory in the context of competing economic paradigms and their changing dominance over time. In the face of the Keynes had called for an overhaul of both and economic theory. Starting with the Keynesian arguments indeed influenced policy making in the postwar era. Immediately after the publication of the General Theory the debate on its interpretation began.19 led the mainstream side by proposing the ISLM model to marry neoclassical and Keynesian arguments.20 This model became an essential building block of the

Neoclassical-Keynesian Synthesis that dominated economics textbooks in the postwar era. The

Synthesis regarded Keynesian arguments as a special case of the neoclassical general equilibrium

9 model that arises when wage and price are not fully flexible, for example due to collective bargaining agreements that prevent immediate wage adjustments. Such wage and price rigidities occur in the short run, but market forces would force wage or price change over longer periods. Analytically it posited that in the short run involuntary unemployment was possible and thus the economy had

Keynesian features, whereas in the long run markets would clear and the economy would thus be represented by neoclassical general equilibrium where all markets clear, i.e. there is . Theoretically the Keynesian revolution was thus domesticated and for a few decades an uneasy truce between the (mainstream) Keynesians and the neoclassicals emerged and gave rise to the distinct fields of (Keynesian) macroeconomics and (neoclassical) . This truce ended with the New Classical revolution of the 1970s and 80s, an important dividing line in the development of modern economics. The New Classicals postulated that macroeconomics needs to be based on microfoundations with rational, maximising individuals and via the price mechanism. In other words, macroeconomics had to be built on strictly neoclassical assumptions. This transformed the field of macroeconomics, but it also impacted the discipline of economics by marginalising approaches that did not adhere to methodological individualism (such as

PKE).

NKE emerged from the New Classical counterrevolution of the 1970s by accepting methodological individualism and the requirement for microfoundations of macroeconomics, but argued that wage and price rigidities can arise even in a world of perfectly rational individuals if they face transaction costs or information asymmetries. If changing prices is costly, e.g. because it requires physically changing price tags or printing menus, or if management uses as an incentive mechanism to elicit higher effort by workers, optimising behaviour will not result in clearing markets. In other words, NKE is an attempt to reformulate some Keynesian arguments, such as that involuntary unemployment can occur and government deficit spending can be socially useful, within a strict neoclassical optimising framework. NKE has changed over time. In the 1980s and 90s NKE analysed specific instances of market failures, such as involuntary unemployment and credit .21 In the

10 course of the 2000s NKE moved closer to neoclassical general equilibrium models (technically: NK

Dynamic Stochastic General Equilibrium models). An important feature of these is that and financial crises are understood as the result of exogenous shocks to an that has self-healing and will revert to its supply-side equilibrium.

The three-equation model, which Hope and Soskice suggest as the macrofoundation of CPE, is a simplified textbook version of the NK model. It is widely used for monetary policy discussions and consists of the following three macroeconomic relations: First, a demand equation, which summarises the goods market equilibrium and portrays as, in the short run, determined by demand and depending negatively on the . Second, a , which is derived from the labour market, links and output. Higher levels of economic activity come with higher employment, which leads to higher inflation. Third, a monetary policy reaction function that depicts how central banks react to changes in inflation and output. Central banks are assumed to be either inflation targeting or following a , i.e. they responding to higher inflation (or more precisely: deviation of actual inflation from the CB inflation target) by increasing the interest rate.

We want to highlight two important features of the model. First, while demand plays a key role in these models in the short run, in the long run they are supply-side side determined. In the words of

Hope and Soskice: “the supply side of the economy (…) pins down the equilibrium levels of output and unemployment in the medium run”.22 The model is a version of the natural rate of unemployment or NAIRU (non-accelerating inflation rate of unemployment) models. This is the unemployment rate at which inflation is stable and it only depends on labour market institutions such as the degree of collective bargaining, the structure of the welfare state and the organisational strengths of labour unions, but not on demand factors or actual unemployment. The Phillips curve gives a short-run off between inflation and unemployment, but in the long run, the economy gets back to the equilibrium unemployment rate. In other words, government spending can manipulate economic activity in the short run, but eventually the economy returns to its equilibrium.

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The model belongs to the Synthesis tradition with a Keynesian short run and a neoclassical long run.

For economic policy this means that if governments want to lower unemployment beyond the short term, they need to pursue labour market reform rather than demand management. The NAIRU theory thus has justified the of labour markets and weakening social protection.23

Second, the three-equation model does not explicitly model the financial sector. The key financial variable is the interest rate, which is set by the . Financial variables, such as debt, debt or asset prices do not feature in the model; portfolio decisions or speculative dynamics are absent. This approach implicitly assumes that financial markets are operating smoothly, i.e. changes in the central banks base rate passed on to lending interest rates. Asset price bubble or booms in private sector lending are regarded as exogenous, which only makes sense if financial markets are regarded as relatively stable and efficient. Importantly the three-equation model does not allow CPE analyses to incorporate endogenous financial instability. This is reflected in the pre-crisis version of the macroeconomics textbook by Carlin and Soskice,24 where only a single, short section25 is devoted to bank runs (due to asymmetric information and panics) and discussed largely as a historical phenomenon.26 Short, the three-equation model is about consumer price inflation and central bank policy, not about financial instability.

Hope and Soskice advocate basing CPE on the NK three equation models. Indeed, we notice a strong complementarity between the institutional focus of VoC and the supply-side focus of NKE. While

VoC does not primarily aim to explain economic performance, but rather analyses institutional differences and similarities across countries, it clearly shares some ideas about the working of the economy with NKE. By not considering demand side developments and focussing on institutions,

VoC implicitly assumes that actual demand growth will adjust to the institutional supply-side equilibrium, which is why VoC and NKE make good companions. There is however a substantial difference in how NKE and VoC conceive of these supply-side institutions. To illustrate this, consider the labour market. For NKE labour market institutions such as collective bargaining lead to wage

12 rigidities and consequently unemployment. There is usually a unique (liberal), socially optimal institutional equilibrium. In contrast, in VoC institutions play a more constructive role and different sets of institutional arrangements can deliver similar results in terms of competitiveness. There are

(at least) two institutional equilibria that allow for competitive outcomes. However, NKE and VoC share a neglect of financial instability and the role of demand for growth beyond the short run.

Post-Keynesian Economics

PKE is the stream of Keynesianism which emphasises analytical differences to and in particular rejects methodological individualism. 27 It has its origins in the circle of collaborators of Keynes (Robinson, Kaldor, Kahn), who discussed drafts of Keynes’ General Theory. Michal Kalecki had independently developed arguments very similar to those of Keynes, but his work got translated to English only later.28 Keynes’ own analysis emphasised short-run dynamics and argued that in a world of fundamental decisions, in particular regarding expenditures and financial portfolio allocations, will not be fully rational as the future is unknown, but will depend on social norms (business sentiment), simple heuristics and social-psychological phenomena. These result in herding behaviour which can temporarily stabilise norms, but can also give rise to cyclical dynamics if these heuristics include projecting current price movements into the future. As a consequence, market economies will in general not have a self-adjusting mechanism and, specifically, will not guarantee full employment. Rather the level of employment will depend on investment decisions, which determine and output via the process.

Business cycle fluctuations thus are primarily understood as driven by changes in investment expenditures due to changes in expectations and to financial markets prone to .

PKs endorsed the more radical elements of Keynes and rejected the neoclassical-Keynesian

Synthesis. The project was to develop a distinctly Keynesian theory that breaks with rational

13 behaviour assumptions and market clearing models. They sought to generalise Keynes’ (short-run) theory of into a theory of growth and distribution. This involved a criticism of

(neoclassical) marginal theory that posits that wages and profits are determined by technological factors and households’ preferences, which culminated in the Cambridge Capital

Controversies.29 PKE went beyond Keynes in three respects. First, the neo-Ricardian and Kaleckian streams drew on the tradition of classical Political Economy and its class analysis and interpret income distribution as the outcome of social struggles and power relations. In their macroeconomic models income distribution plays a core role. Second, monetary Keynesians developed further

Keynes’ analysis of fundamental uncertainty, liquidity and endogenous .

Hyman Minsky formulated this into the Financial Instability Hypothesis of endogenous financial cycles (to be discussed below). Third, Kaldor’s argument of cumulative causation clarified mechanisms how supply constraints adjust to demand pressures over longer periods. PKE formed a distinct school of thought in the 1970s, when under the Monetarist and New Classical counter- revolution mainstream economics narrowed theoretically and methodologically as PKs rejected the requirement of rational behaviour microfoundations for macroeconomics.30

For the purpose of contrasting it to NKE we will highlight four features of PKE (to be discussed in more depth below).31 First, income distribution plays a key role in PKE. Distribution is understood to reflect power relations and PKE offers a flexible theory of demand regimes that allows for wage-led as well as profit-led demand regimes. Second, financial instability is regarded as an intrinsic feature of market economies. This is due to the credit-driven creation in PKE and the assumption that in a world with fundamental uncertainty actors will adopt simple behavioural rules

(often called heuristics), that are prone to herd behaviour and can generate boom-bust cycles in financial asset prices. Third, PKE asserts that demand matters in the short as well as in the long run.

It specifically rejects the notion that economic activity is anchored in the long run in some natural rate of unemployment. This is because induced technological progress and on the labour market ensure that supply side adapts, at least to some extent, to demand. Fourth, this has

14 important implications for the effectiveness of government policies. Post-Keynesians assert that will be highly effective in times of financial crises as they have demand-side as well as supply-side effects. 32

Distribution and demand regimes

PKE builds on a long tradition in political economy that highlights the importance of income distribution, in particular between profits and wages.33 Distribution lost centre stage with the shift from political economy to modern economics (at the end of the 19th/early 20th century) and mainstream macroeconomics has until recently not considered income distribution as an important factor (but was concerned with the effect of interest rates or prices on demand). In contemporary PK debates the Bhaduri-Marglin model has become an important reference point in analysing the interaction of income distribution and demand formation and has been used Baccaro and

Pontusson.34 Its contribution is to offer a general framework that allows wage-led as well as profit- led demand regimes and clarifies under which conditions they arise. An increase in (for a given labour productivity and income) is likely to have expansionary effects on consumption (as workers typically will have higher marginal propensities to consume), but it may have negative effects on investment (as profit margins get squeezed) and on exports (as higher wages negatively impact on competitiveness). The sum of these different effects, which determine whether demand is wage led or profit led, will depend on institutional factors, such as the degree of inequality, the and pension system, and the structure of the financial system, which shape how much firms rely on retained profits for investment finance, how prominently demand versus cost factors feature in management’s perceptions and can change over time. The model sheds light on different assumptions in economic paradigms. While mainstream and Marxists theories (often

15 implicitly) assume profit-led demand regimes, post-Keynesians tend to assume wage-led demand regimes.

The Bhaduri-Marglin model has become a benchmark model in PK debates and it has inspired numerous empirical studies to identify demand regimes in different countries.35 These studies differ in econometric estimation strategy.36 A majority of studies find that the consumption effect of a change in the dominates the investment effect; in other words the domestic components of the demand regimes tends to be wage led.37 But net exports may turn total demand profit led, in particular for small open economies. This is because the size of the net export effect will depend on the degree of openness of an economy (and on whether the export industry operates in sectors where via prices is prevalent).

The distinction between domestic and external effects and that domestic and total (open-economy) demand regimes may differ has important implications and can give rise to a fallacy of composition.

While individual countries can have profit-led demand regimes because of exports, for the world economy overall the export effects will cancel out. In other words while individual countries may be able to export their way out of a crisis via wage cuts (or internal devaluation as it is euphemistically called these days), the world economy overall cannot. Stockhammer, Onaran and Ederer have argued with respect to the Euro area that many of its member states have profit-led demand regimes because of net exports.38 However, most of their trade is within Europe, thus the overall

(European) demand is wage led. Thus a prisoners’ dilemma-type situation will arise, where for individual countries it may be advantageous to cut wages (because of export effects), collectively this may reduce demand as consumption demand falls in all countries and competitiveness gains cancel out due to simultaneous wage restraint. This is useful for understanding demand developments since the Euro crisis, where Troika policy recommendations were biased towards internal devaluation and wage cuts. This policy has resulted in rising European export surpluses, but weak domestic demand,39 with an overall weak growth performance of the Euro area.

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How large are these effects? Stockhammer, Onaran and Ederer find, for the Euro area, that a one percentage point increase in the wage share may raise consumption by 0.4% of GDP, reduce investment (if at all) by 0.1% and raise net export by 0.15%. The total effect would be +0.15% of

GDP. In other words, these effects are modest in size. Moreover, Stockhammer and Wildauer report that effects of financial variables such as household debt and real estate price have, in the recent past, been orders of magnitude larger.40 In other words the Bhaduri-Marglin model does not claim that income distribution is the most important determinant of growth. But even a modestly wage- led demand regime has important theoretical implications for the labour market equilibrium.41 If demand is wage led, this means that wage cuts will lead to reduction in consumption demand which dominates the investment effect. This had been discussed by Keynes in chapter 19 of the General

Theory.42 Keynes framed his analysis in terms of money wages rather than in terms of the wage share, but the core argument is the same. If wage cuts lower consumption expenditures (and investment is slow to react or insensitive to the wage cut), then a wage cut will not stimulate aggregate demand. If aggregate demand is falling, firms will have no reason to hire more workers.

This could be offset if the fall in prices (which is likely to come with a fall in wages) has an expansionary effect, but there is no general reason (in a closed economy) to expect to have expansionary effects. In an indebted economy the opposite is likely. Short, a wage cut in a will not lead to an increase in employment. The labour market will not have the self-healing properties of a stable equilibrium.

The prominence of distributional issues in PKE contrasts with the absence of distribution in the three-equation model. While Hope and Soskice claim that “the three-equation model is perfectly consistent with the income distribution being a determinant of consumer expenditure”,43 this is misleading, since a wage-led demand regime fits uneasily with the three-equation model. The three- equation model assumes a stable equilibrium (given central bank intervention), thus it side steps the destabilising effects of a wage cut (or distributional changes) highlighted by Keynes. Short, the three- equation model is not designed to illustrate Keynes’ perverse effects of wage cuts in a recession,

17 whereas the Bhaduri-Marglin model can readily illustrate the contractionary effects of wage cuts in a wage-led economy.

Finance and financial instability

A second important difference between PKE and the NK three-equation model is with regards to the role of finance. PKE views the financial system as a source of instability. This is for two reasons: first, fundamental uncertainty implies that ’ expectations cannot be fully rational. Expectations about the future are social conventions rather than based on fundamentals as the relevant fundamentals and facts are not yet existing. People will thus resort to simple behavioural rules

(heuristics), they will be driven by what Keynes called animal spirits.44 Importantly these behavioural rules will include social norms and comparisons. This can give rise to herding behaviour as people copy each others’ behaviour. One important convention (or heuristic) is extrapolative expectations, i.e. the assumption that the past trends continue. For financial markets that means that if asset price increase this heuristic leads to the expectation of further growth, which can result in a speculative boom.45 If the bubble gets pricked, prices will fall and uncertainty rise; risky assets will be sold off.

As consequence the (or more generally: liquid and safe assets) will increase sharply. In a financial crisis there will thus be a sudden increase in liquid assets preference and flight to safety.

Second, money is regarded as created endogenously by commercial banks as a side effect of their lending decisions. Therefore, loans create deposits.46 This gives modern economies a high degree of flexibility as long as banks’ animal spirits suggest that it is profitable (and safe) to lend. Investment is thus not constrained by , but rather the availability of credit. However, credit for investment

(or more broadly: -related activities) is only one option. Banks can also channel credit towards financial asset and real estate transactions, which can fuel financial bubbles.47

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PK theory thus regards financial instability and the emergence of financial cycles as a systemic feature of monetary production economies, with as the most important pioneer.

There are two core mechanisms that can give rise to financial cycles, which will both be in operation in actual economies.48 First, Minsky’s original writing focuses on a debt cycle driven by business investment. In the course of a tranquil period, firms will become more optimistic. They will increase investment and start to accept higher leverage. In Minsky’s terminology an increasing number of firms move from hedge to speculative financial structures. As debt has to be serviced out of the current cash flow this increases the fragility of the economy. Demand shocks that impact on firms’ cashflows or increases in the interest rate may push firms towards bankruptcy. At the core the cycle mechanism consists of a procyclical leverage and a debt-burdened demand regime: during a boom firms need more external finance, but the resulting higher leverage leads to a negative effect of debt on demand; the interaction of the two effects can give rise to endogenous cycles. Note that this cycle mechanism puts non-financial and their debt at the centre of the story. A second mechanism, more recently developed, is based on asset prices and speculative behaviour on financial markets. As investors follow simple behavioural rules (as global optimisation is not feasible in an uncertain world), some investors, often called momentum traders or chartists, will form expectations about future asset price and capital gains based on past performance, setting in motion bubble dynamics. During a boom these investors will make higher profits than more conservative

(fundamentalist) investors, which encourages emulation by other investors. An asset price boom will thus lead to a recomposition of portfolios towards risky assets ( and the demand for money declines), which puts a downward pressure on interest rates. The asset price boom, however, is fragile as it is built on the expectation of further capital gains and comes with riskier portfolios and higher leverage. Once the bubble bursts there will be a flight to liquidity, i.e. an abrupt increase in the demand for money and safe assets, which drives up interest rates. These boom-bust dynamics are often discussed with respect to stock markets, but arguably the same mechanisms operate on housing markets, which have a larger macroeconomic impact.

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These two financial cycle mechanisms differ in that the debt cycle are about business investment and expected future cash flows, whereas the speculative cycles are about financial asset prices and expected capital gains. Importantly, both mechanisms, which are complementary, share that they conceive of financial cycles as endogenous cycles that emerge spontaneously without the need for an exogenous shocks. Similar mechanisms have also been discussed by New Keynesians in the 1980s, in noise trader models.49 But they are not part of three-equation model or standard NK models, which treat financial bubbles, as the outcome of exogenous shocks. Since the global financial crisis, various NK authors have tried to analyse why the self-healing properties of the seems paralyzed. Key to that has been the notion of the zero lower bound, i.e. that the central bank cannot set nominal interest rate below zero.50 However, from our perspective the key question is whether financial crisis are due to exogenous and thus unforeseeable shocks or whether they are, as Minsky claims, systemic features. This issue has a direct policy correspondence in the question whether financial crises are predictable (from the point of view of policy makers). In fact, leading crisis indicators, in particular bank capital ratios, liquidity ratios and house price growth, did predict the

2008 crisis.51

The supply side: path dependence and unemployment hysteresis

A key feature of the three-equation model and indeed of all neoclassical theories is that it is rooted in a supply-side determined long-run equilibrium. PKE has a very different view of long-run growth in that it asserts that demand factors, in particular animal spirits and social norms affecting business investment, also play an important role in a growth context. Supply constraints matter but supply is elastic and will adjust to demand pressures to some extent.52 There are two channels to ensure this:

First, the available technology and machinery is not simply taken as given, but responds to demand and output developments. In particular productivity growth is not only determined by exogenous

20 factors (such as the extent of research and development activities), but in part driven by demand growth via learning by doing and dynamic (the so-called Kaldor-Verdoorn ) and induces labour productivity growth.53 Kaldor refers to this as a cumulative growth process where increased demand feeds into increased productivity growth, i.e. shifts supply side constraints. Second, on the labour market, PKs typically accept the existence of a short-run Phillips curve, but regard the NAIRU, i.e. the unemployment rate at which inflation is stable, as endogenous to economic performance. Cyclical unemployment will turn into structural unemployment.54 As a consequence unemployment hysteresis arises: in a severe recession there will not only be an increase of actual unemployment, but also of the NAIRU. The macroeconomic implication of this is that the system has a memory and demand shocks have a long lasting impact on employment.55

PKE thus conceptualises the growth process as path dependent. This notion is also employed by CPE scholars, however, with a somewhat different meaning. CPE scholars often refer to path dependence as institutional persistence. Once established institutions, such as a certain type of welfare state or the bank-based financial systems developed during late industrialisation, become a permanent feature of an economy because they give a rise to political constituency, which supports them and generate constraints on firm behaviour. In PKE path dependence refers to demand shocks having lasting effects, e.g. a severe recession like the one 2008 altering the subsequent growth path and giving way to secular stagnation.

An important consequence of path-dependent growth is that it has strong implications for the ability of the state to shape economic growth, in particular in the face of recessions. In models with a unique supply-side determined equilibrium there is not much fiscal policy can do. However, things are very different in a path-dependent economy. Such an economy will not see a swift return to the original equilibrium but may experience periods of prolong stagnation. A sharp crisis will not be followed by an energetic recovery but by weak growth.56 One specific issue where this surfaces is the ongoing debate on the size of fiscal multipliers, i.e. the effect of a change government spending on

21

GDP, during a crisis. According to NK theory fiscal multipliers are modest (typically below or around one) and short-lived. For a year or two the effects of government spending may be substantial, but beyond that the economy will revert to its supply-side determined natural rate equilibrium.

Government expenditures are ineffective over long periods. In the language of macroeconomists, long-run fiscal multipliers are zero. However, if growth is path dependent, this opens the door for government spending (but also various private sector shocks) to have long-lived effects. More specifically, PKE argues that deep recessions, in particular financial crises, will leave lasting scars on the economy. They cause a drop in the level of income, but they will also impact the subsequent growth path as supply adjusts to lower growth. From this perspective the so-called secular stagnation that followed the global financial crisis is not surprising, but an indication that demand shocks have long-lasting effects. The flipside of this is that fiscal policy will be particularly effective during such crises. Indeed there is mounting evidence that fiscal multipliers are substantially larger in times of recession than during the upswing of the economic cycle57 and the International

Monetary Fund famously admitted having underestimated the size of fiscal multipliers during the global financial crisis.58 As demand stimulation will affect the supply side via unemployment hysteresis and induced productivity growth, the effects of fiscal policy are long lasting.59 In contrast to NKE thus PKE perceives of government policies not only as cyclical stabilisation, but there is a potential for state-led growth strategies.

Much of PKE is concerned with advanced economies. However, there are also versions of (or close relatives to) PKE that address the developing economies. Latin American structuralism and the balance of payment constraint growth models have a close affinity to PKE.60 They argue that there are capital and technology constraints in developing economies, in particular capital goods need to be imported. Thus a crucial element of the elastic supply conditions discussed above depends on the ability to import machinery. As consequence the often forms a constraint for growth as investment goods need to be imported, which requires access to foreign exchange. The structuralist view of is less benign than the Ricardian view. Developing countries

22 mostly export basic goods (agricultural or low-tech manufacturing goods), which tend to have a higher price and lower income elasticity than the exports of advanced economies. This may trap developing economies in low income equilibria. The market mechanism will not guarantee upgrading of these economies.

Modern versions of structuralism as well as of PK theory further emphasise financial asymmetries between developing and advanced economies. Financial markets are typically less liquid and financial institutions weaker. This means that opening up the can easily result in capital flows that are large relative to domestic finance and subject countries to the international financial cycle.61 Importantly firms and governments of developing countries often cannot borrow from abroad in their own . Thus the Minskyan debt cycle takes a particular twist as debt is foreign currency denominated and (because of international capital inflows) highly procyclical. Thus the currency appreciates during the boom, easing the debt burden, inflating asset prices and encouraging (imported) luxury consumption. The boom gets amplified, but relies on foreign currency debt. Once growth slows down, so do capital inflows and the currency depreciates, increasing the real debt burden. These capital flow reversals have been a reoccurring feature of crises in developing economies, in particular in the East Asian financial crisis. Keynesian liquidity preference suggests a flight to safety during a crisis, which will mean flight to the major international reserve currencies.

Thus international capital flows and the associated hierarchy of currencies pose additional constraints on growth and economic policy in developing economies.

Contributions of PKE to CPE

CPE deals with questions of economic performance across countries as well as with institutional diversity across countries and how the two interact. CPE thus needs an understanding how the economy works as well as how institutions work. At the core of our argument is the assertion that

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CPE, in particular the VoC approach, has based its economic analyses on mainstream economics.

This limits the analysis of the relation between distribution and growth and neglects the role that finance plays in modern economies. It overstates the stability of capitalist growth process and understates the potential effectiveness of government interventions. PKE offers an approach that highlights the instability of the growth process and lends itself to an analysis of income distribution and power relations. This section highlights specific areas where PKE can offer valuable insights for debates in CPE.

Financialisation

Financialisation is one of the major structural changes of capitalist economies over the last decades, and is by now subject of rapidly growing literature across several academic disciplines. I will argue that VoC has structural problems in understanding the changes brought about by financialisation that are linked directly to its theoretical framework, which has the notion of institutional at its core. Its analysis of finance has thus focussed on how businesses finance investment and how financial relations impact on training and labour relations. The core distinction VoC has drawn on is between (arms-length) market-based financial systems and

(relationship-based) bank-based financial systems. These correspond to and complement other institutions in the liberal and coordinated market economies, respectively. In particular, the bank- based financial system allows forms of patient finance to firms, which enables them to provide long- term contracts with and training for its workers. In contrast, the market-based financial systems in liberal market economies created finance with shorter time horizons and financial instruments that are frequently valued at markets. Overall this has resulted in a functionalist treatment of finance, in relation to achieving competitiveness rather than a systematic engagement with current activities of financial institutions. Two issues are worth highlighting: first, as a consequence of the functionalist

24 corporate finance focus, the analysis of financial instability has long been neglected in VoC analyses.62 Second, households’ financial relations and balance sheets have been sidelined as they do not impact competitiveness directly. The focus on competitiveness has hampered CPE’s understanding of the impact of financialisation.

So what were the effects of financialisation? Financialisation has structurally impacted various sectors of the economy and, ultimately, changed macroeconomic dynamics. For businesses it meant shareholder orientation and came with a shift in the power balance between owner, management and workers (or more generally: stakeholders), which is reflected in changes in corporate governance and increased dividend payments and share buybacks.63 For households, it came with, in many countries, dynamically increasing household debt, which was driven by mortgage debt and to a growing importance of capital-based pension systems. For the financial sector it led to a shift away from financing business to mortgage finance, a shift towards fee generating activities (‘securitisation’) and a rise of non-bank financial institutions (shadow banking).64 This shift from lending to businesses towards mortgage lending and financial engineering

(investment banking) is reflected in bank balance sheets.65 Macroeconomically, it has contributed to rising income inequality and to the return of the financial cycle.

The focus on corporate finance by VoC makes it hard to appreciate a key change in lending practices: banks have moved towards financing of financial asset transactions and real estate transactions rather than financing business. This shift of finance from businesses to households and real estate has powerful social and economic effects. Household debt, which has been found to be linked to the severity of recession,66 is predominately mortgage debt. Real estate is widely accepted as collateral and thus provides a powerful lever for real estate bubbles and the price growth also leads to credit growth. But housing also has an important ideological function.67 Not all of CPE follows VoC closely, but analyses remain partial. Seabrooke and Schwartz propose an analysis of varieties of residential capitalism where they highlight links between political preferences around housing and social policy.

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They offer a richer institutional typology of countries based on homeownership and housing finance, but their analysis describes institutional outcomes and they do not analyse the macroeconomic implications of the central role of housing and boom bust cycles.68 Johnston and Regan offer an analysis of the determinants of house prices that emphasises the impact of wage bargaining coordination and the wage pressures that emanate from non-tradable sectors on house prices.69 The macroeconomic effects of financialisation, in particular house price cycles, are not part of these analyses.

PKE have made major contribution to the analysis of financialisation. First, PK economists have been at the forefront of analysing the impact of financialisation on income distribution, this fits with the emphasis of the distributional dimension of finance in PKE. Hein gives an PK analytical framework for the analysis of financialisation and distribution. Dunhaupt provides econometric evidence for the impact of financialisation on the wage share. Kohler, Guschanski and Stockhammer disentangle different dimensions of financialisation and find that financial liberalisation and rentier payments by non-financial business have had the strongest impact on the wage share.70 Second, they have analysed the impact of financialisation and shareholder value orientation on business investment.

Stockhammer provides evidence for the negative impact of shareholder value orientation on macroeconomic investment for major economies. Orhangazi and Tori and Onaran provide firm-level evidence of that effect for US and European firms respectively.71 Third, PKE offers a framework to analyse the macroeconomic impact of financialisation. These include a return of financial cycles and, once we consider the impact of financialisation in conjunction with rising income inequality, the emergence of two neoliberal growth models.

The return of financial cycles and the debt driven growth model

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Baccaro and Pontusson have pioneered the use of growth models in CPE debates. They argue that under the influence of VoC CPE has given excessive weight to questions of institutional configurations and supply-side phenomena. In contrast Baccaro and Pontusson focus on the demand side of the economy and, drawing on PK macroeconomics highlight the impact of the distribution of income between capital and labour on demand. They apply their analysis to the cases of Germany,

Sweden, Italy and the UK. All four of these, they argue, had a wage-led growth model in the postwar era, but responded differently to distributional changes since 1980. Germany pursued wage suppression to further its competitiveness and thus embarked on an export-led growth model; the

UK followed a consumption-led growth model, which was fuelled by rising household debt. Sweden, with its importance of knowledge-based sectors, was able to pursue a balanced growth path with both consumption and exports growing, whereas Italy is interpreted as case that was unable to find a new growth driver and they hypothesize that this related to the Euro membership, which has led to an ‘equilibrium of fear’ that renders Italian exports uncompetitive but there are substantial sectoral interests against leaving the Euro. From a PK perspective this is a welcome application of demand regimes to CPE, but we note two analytical shortcomings, one related to the treatment of the finance-led growth models, the other related to the impact of income distribution (to be discussed in the following section)

Baccaro and Pontusson analyse the UK as a ‘consumption-led growth model’ fuelled by credit growth. This recognises the importance of credit to households, but they fail to explain why credit to households has grown. Conceptually they treat household debt as consumer debt, but in fact most of household debt (typically 90% in advanced economies) is mortgage debt. Thus most household debt is not taken out to finance consumption but for housing transactions. Nor would banks be likely to lend to households to the extent that they have done purely based on the households desire to consume more. Banks lend based on collateral and expected repayment. As real estate is accepted as collateral banks will lend in times of rising house prices. Thus to understand household debt dynamics, it is key to understand house prices.72 Baccaro and Pontusson move away from the VoC

27 focus on corporate finance, acknowledge the role of household debt, but have little to say about its drivers and therefore fail to offer a general account of financial instability.

PKE provides a systematic theory of endogenous (re-occuring) financial instability. Historically financial cycles have played an important role for economic stability and the Keynesian/Fordist period of tight financial regulation has been rather exceptional in that financial crises (banking crises and exchange rate crises) have been rare.73 The era of financial deregulation has resulted in a return of financial crises. Mainstream economics (including the New Keynesian three-equation model) regards these as the results as (unforeseeable) exogenous shocks. In contrast Minsky and the PKs interpret them as a re-occuring systemic feature. Since the global financial crisis there is a growing

(mainstream as well as PK) literature that empirically substantiates the view that financial crises are indeed part of regular cycles. Claudio Borio notes that private credit growth and real estate prices are the two key financial variables correlated with the financial cycle and notes that financial cycles tend to be longer than regular business cycles.74 Glaeser surveys house price bubbles in the USA.75

Mian, Sufi and Verner provide evidence that increases in household debt leads to positive growth effects in the short run, but after three years these effects turn negative.76 All of this is suggestive of cyclical dynamics.

From a Minskyan perspective the USA and UK experienced a house price cycle, which was facilitated as is often the case during financial booms by financial innovation, in particular mortgage securitisation.77 Real estate price cycles can arise when households and developers (and their banks) form extrapolative expectations. 78 During the boom an increasing number of households and their banks will adopt the conventional assumption that house prices keep increasing. As real estate is accepted as collateral the rising house prices also come with rising household debt levels, a small, but macroeconomically important part of this rising household debt will feed into consumption expenditures and residential investment, thus driving a boom in real growth. In the run up of the global financial crisis this was amplified, in particular in the USA, by securitisation of mortgage and

28 moving them off balance sheets. During the boom financial fragility of households is increasing and rising consumption will start to depend on rising house prices. Once house price growth flattens the boom collapses. Effectively, households during the boom had been acting as speculators, who took out loans in expectation of future capital gains (i.e. house price increases), even if households typically have a different self-perception and consider their investment in real estate assets as safe.

Once real estate prices start to fall and credits standards tightens, households have to engage in a lengthy and painful deleveraging process that requires them to reduce consumption expenditures

(and in many cases default on their mortgage payments).

The interpretation of growth models

Baccaro and Pontusson build on PK macroeconomics and the Bhaduri Marglin model, but they take some analytical shortcuts. PKE distinguishes between demand regimes and growth models, whereas

Baccaro and Pontusson conflate the two. Demand regimes describe the effects of a change in income distribution on demand (and its components consumption, investment and net exports).79 If an increase in the wage share leads to an increase in demand the regime is called wage led. The definition of this regime is independent of the actual change in the wage share. A growth model is defined with respect to the main driver of growth, e.g. a debt-driven growth model is one where changes in debt actually contributed substantively to actual growth outcomes. Baccaro and

Pontusson collapse the two concepts and refer to the Fordist period as a wage-led growth model, which went into crisis in the 1970s. By implication, they conceive of neoliberalism as a shift to a profit-led growth model. Specifically they state “Some heterodox economists use “financialization” as an umbrella term for institutional or regulatory changes that have moved advanced capitalist economies onto a profit-led growth path”.80 However, this is misleading. In fact most PK economists argue that demand regimes in most major economies remain wage led in the neoliberal era.81 The

29 emergence of debt-driven growth models is understood as a demand stimulation within a wage-led demand regime due to rising real estate prices. While neoliberalism and financialisation have changed the growth model, they have not changed the demand regime.

This may seem like a pedantic distinction, but it has material implications for the interpretation of neoliberalism and for economic policy. If neoliberal economies were indeed profit led, then a wage cut in a recession would have positive effects on demand and, presumably, on employment. If demand is wage led, then the wage cut in a recession will contribute to a prolonged stagnation. Thus the Troika’s strategy of internal devaluation via wage restraint will be assessed differently. But it also leads to different interpretations of the performance of countries. If Germany had a profit-led demand regime in the last decades (as Baccaro and Pontusson assert), then the Hartz reforms, which contributed to weak wage growth, would have stimulated the economy. If it was wage-led (as

Stockhammer, Hein and Grafl claim) then the Hartz reforms help to explain why Germany had one of the weakest growth performances of the Euro area (prior to 2008).82 Most PKs interpret neoliberal growth models as debt-driven or export-driven within a wage-led demand regime. This amplifies potential instabilities of the regimes in the face of crisies and downward wage pressure and raises fallacy of composition problems for national wage policies.

PKE offers an analysis of the impact of financialisation and inequality on growth models that differs from Baccaro and Pontusson’s. Lavoie and Stockhammer emphasise that both the export-driven and debt-driven growth models are based on financialisation and they are both unstable. This is straightforward for the debt-driven growth model which relies on domestic financialisation in the form of real estate booms and the causal mechanisms described above. An important implication of this is that the downturn of the cycle and the stagnation with the deleveraging should be interpreted as part of the debt-driven growth model. Debt-driven growth and debt-driven stagnation are two sides of the same coin. But also the seemingly more industrial export-driven growth models rely on financialisation. The flip side of the growing current account surpluses of export-driven growth is the

30 rising external debt of their trade partners. While the periodic exchange rate realignments during the put a limit on the extent of international trade imbalances, in the era of neoliberalism, the limit becomes the ability of the debt-driven economies to mobilise credit. In other words, external financialisation (the liberalisation of international financial flows) is a precondition for export-driven growth. There is an important asymmetry in the instability that the two growth models generate. While the debt-driven growth model relies on growing household debt within its own national economy, the export-driven growth model generates trade imbalances that rely on growing foreign liabilities of their trade partners. In other words, the instability is to some extent externalised.

Central bank policy and the political economy of money

PK theory of financial instability also has important implications for the role of central banks. Central bank policy and its interaction with wage bargaining structures has featured prominently in CPE debates in the 1990s. This was in response to shifts in mainstream economics and policy making that regarded price stability as the primary objective of the central bank and argued that independent central banks were best suited to fight inflation. They could use monetary policy, i.e. interest rates, to counter inflationary pressures without regards to the short-term social costs. As monetary policy was neutral with respect to output over the longer period, this would help create a low inflation environment without damaging long-term growth. CPE analyses highlighted the central role of wage bargaining institutions and qualified the claim that monetary policy was always neutral with respect to long-term growth. Peter Hall and Robert Franzese argued the effectiveness of central bank signalling depended on wage bargaining institutions.83 That is because in coordinated bargaining systems unions would internalise wage restraint as they anticipate central bank reactions to high wage demands. European unification would effectively lead to decentralisation of wage bargaining

31 and thus undermined central bank effectiveness. Torben Iversen develops a non-linear model of the interaction of central bank policy and wage bargaining system and argues that non-accommodating

(conservative) monetary policy would result in higher unemployment under medium degrees of bargaining centralisation.84 He concludes that central bank policy does have real effects. CPE contributions have added institutional detail to mainstream macroeconomic analysis and thereby modified some key conclusions.

While the nuanced analysis of the impact of wage bargaining is welcome, these CPE analyses accept the premises of mainstream economics and take a narrow view of the role of central banks. Price stability rather than financial stability is put to centre stage. With the benefit of hindsight it is telling that concerns about cross-border financial flows and instability on sovereign debt markets (as they erupted in the Euro crisis) did not feature in Hall and Franzese’s and Iversen’s analyses of European monetary integration. They take as starting point that the purpose of the central bank is to ensure price stability, thus downplay their role in ensuring financial stability. It either presupposes that financial markets are intrinsically stable or that any potential instability can be taken care of by microprudential regulation. Consequently the political economy of the central bank lender of last resort function is not discussed. This downplays the range of instruments that central banks have but also understates the power they possess.

PKE offers an analysis of money as created by lending decisions of banks. This statement presupposes the existence of a monetary system. PKs endorse a credit view of money, but several post-Keynesians have also contributed to (chartalist) state theories of money that emphasise that money is not a private institution, but issuing money is part of state authority.85 While historically this was closely tied to imposing tax liabilities and with them a currency in which they have to be paid as well, in today’s economy the dialectic between state authority and banking interests shape the financial system. Which institutions are allowed to offer deposits, to what extent they are part of deposit insurance schemes, whether they are allowed to borrow from the central bank, short to

32 what extent a financial institution’s liabilities are guaranteed as substitutes to central bank money depends on state policies. This has surfaced in 2008 when the Federal Reserve decided to extend the range of institutions which can access emergency liquidity. Financial institutions will issue different forms of assets and liabilities. The central bank sits at the apex of the hierarchy of monies and decides where on the hierarchy different private institutions (or their assets) are.86

Periodically reoccurring financial crises have important implications for both the range of policy instruments of a central bank but also for its position of power. Katharina Pistor highlights in her

Legal Theory of Finance87 that while during normal (non-crisis) times debt commitments have to be honoured, in times of crisis the enforcement of all legal obligations may result in the self destruction of the financial system. Thus central banks often act as lender of last resort and thereby suspend normal market rules. In 2008 Lehman Brothers were allowed to go bankrupt, with devastating effects. Thereafter western governments and central banks were committed to the survival of systemically important financial institutions. If in times of acute crisis part of the rules get suspended, the question is: for whom exactly? At this point the hierarchical structure of finance and the power relations underlying monetary authority become apparent. In times of crises the law is enforced asymmetrically (some financial institutions are bailed out, others forced into bankruptcy).

It is national sovereigns (and their central banks) which, in times of crisis, have the power to issue money and thus save (or not) different institutions and actors. Short, the lender of last resort role is not only an issue for financial stability, but also a power relation.

These power relations are about the stratifications of different players within private financial actors, but it also applies to states. Central banks are now routinely acting as lenders of last resort for private financial institutions. However, historically, they had been founded as funders of the governments.88 Much of modern macroeconomics is built on the assumption that monetary and fiscal policy can and should be strictly separated. A part of this is ruling out direct government financing by the central bank (as this would create moral hazard problems and anyways be unable to

33 generate growth in the medium term). The importance of this can hardly be overstated in context of the Euro crisis. While the Fed and the BoE used Quantitative Easing to indirectly finance government expenditures, the ECB initially refused to play this role. It relied on (private) ratings of government bonds and threatened not to accept some member states’ debt. This arguably explains the escalation of Euro crisis. Among the advanced economies, the Euro area was unique in that the financial crisis turned into a sovereign debt crisis.89 This created a situation where southern

European governments had to submit to the Troika rescue packages and impose on economies in recession. The sovereign debt crisis ended after the ECB committed to ‘doing whatever it takes’, i.e. buying government debt from states under pressure. There is little in the three- equation model to help understand the centrality of the readiness of central banks to commit to buying government debt.

From a policy perspective the CPE of central banking understates the range of policy instruments that central banks have. Since around 1980 the set of policy instruments has been purposefully restricted and central banks have tried to influence credit volumes through transactions. However, historically credit guidance and banking regulation have been used to steer the economy and since the crisis central banks have re-discovered instruments to counteract financial bubbles and lending booms. Specifically, it downplays the significance of the central bank balance sheet. The central bank is a bank and as such it can lend and it can buy financial assets. Since

2008 Quantitative Easing has effectively been used to indirectly finance governments as most of the assets acquired are government bonds (these are bought on the secondary market, thus it does not constitute direct government financing). Central banks could also be used to, say, finance direct transfers to households (“QE for the people”), to directly finance government expenditures (say government investment) or financing a National Investment Bank.

Short, CPE has so far failed to fully appreciate the impact of financialisation and in particular the significance of financial instability. The VoC approach, analytically centred around the concept of

34 competitiveness, has conceptual blind spots as regards household debt and the dysfunctional aspects of finance. The shift to lending to households and the return of financial crises thus has been underappreciated. Baccaro and Pontusson go part of the way of reconceptualising comparative capitalism in terms of growth models and incorporate debt-led growth, but without a systematic analysis of housing and financial cycles. I have argued that PKE offers a useful starting point for the macroeconomic analysis for that because if offers both financial instability and a framework to analyse neoliberal growth models. PKE theory of money and finance highlights systemic instability as well as power relations which arise from the fact that the central sits at the apex of a hierarchy of money. Central banks act as lenders of last resort, both for private banks and for state, but who they lend to, as revealed in the Euro crisis, is a power relation as well as a key macroeconomic role.

Conclusion

CPE is the study of institutions and economic performance across countries. It requires a theory of the economy as well as a theory of politics and institutions. Much of current CPE, in particular the

VoC approach, rely explicitly or implicitly on mainstream economics. This paper has argued that this leads to an overstatement of the stability of the market systems and fails to appreciate the changes brought about by financialisation, namely the return of financial cycles. PKE is proposed as an alternative economic grounding of CPE. It offers, first, a theory of demand regimes that allows for wage-led as well as profit-led demand regimes, which has been extended to analyse debt-driven and export-driven growth models. This aspect has already been recognized by CPE research, in particular through the work of Baccaro and Pontusson. However, their approach lacks an analysis of financialisation and financial instability. PK theory of finance is based credit-created money and atheory of endogenous financial cycles. It thus offers an enhanced understanding of the process of financialisation like the shift to financial asset transactions and the return of financial cycles. Finally,

PKE is based on the concept of fundamental uncertainty and pursues a class-analytic approach that

35 regards income distribution as the outcome of power relations, but also its theory of finance and central banking incorporate power relations.

The overall vision of capitalism that emerges from the PK approach is one of a dynamic system in an uncertain world. The growth path is not anchored in an institutional equilibrium, but rather one where growth dynamics, financial structures, power relations, institutions and state interventions co-evolve. Demand regimes may generate periods of growth as well as systemic instability. Political coalitions will form around growth models and states that stabilise an unstable economy. The growth path is temporarily stabilised by institutions and state interventions, but these serve many purposes, in particular crystallising power relations and enabling class compromise, they will not always be conducive to growth over longer periods. A key source of instability is the financial sector.

Asset prices and credit volumes, in an uncertain world, are guided by expectations and social conventions, which will often lead to overreactions and speculative bubbles. Financial instability thus is a pervasive feature of capitalism, but they are more than merely cyclical effects. First, financial crises leave long lasting scars on the economy because of hysteresis effects. Second, in times of acute crisis states often intervene and thereby critically shape the distribution of costs of recessions and the path to recovery or stagnation. States also mediate distributional conflicts (or reinforce social domination) and they can shape the sectoral composition of the economy.

This paper has emphasised the analytical contributions of PKE relative to NKE and tried to illustrate how it can help illuminate areas where CPE has deficiencies in explanation. However what is at stake her is not merely a matter of academic elegance and explanatory power. Ultimately, the choice of macroeconomic theory allows to interpret economic and social problems and therebe frame policy interventions. In a time of secular stagnation with slow-growing economies, a large debt-hangover and persistent income inequality the question is what CPE has to offer in terms of policy analysis and advise. Orthodox economic policies have arguably exacerbated these social crises, e.g. in the Euro crisis. While NKE offers a vision of limited but targeted intervention,90 it remains wedded to a vision

36 of market efficiency that discourages radical policies. The PK focus on financial instability, persistent involuntary unemployment and the possibility of wage-led growth allows a broader set of policy proposals that may include QE for the people, growth via public development banks, job guarantee programs, substantive redistribution and state-led innovation and decarbonisation policies. In short,PK macroeconomic analysis not only offers a richer understanding of macrodynamics than NKE it also enables CPE to develop a richer set of policy interventions.

1 Herman Schwartz and Bent Tranoy, “Thinking about thinking about Comparative Political Economy: From macro to micro and back,” Politics and Society 47, no. 1 (2019): 23–54

2 Lucio Baccaro and Jonas Pontusson,” Rethinking Comparative Political Economy: the growth model perspective,” Politics and Society 44, no. 2 (2016): 175-207

3 David Hope and , “Growth models, Varieties of Capitalism, and macroeconomics,” Politics and

Society 44 2 (2016): 209–226

4 Natascha van Zwan, “Making sense of financialization”, Socio-Economic Review, 12, 1 (2014), pp. 99-129

5 The classical statement is Raul Prebisch, The of Latin America and its Principal

Problems, (New York, United Nations 1950); a modern macroeconomic formulation is Mario Cimoli and

Gabriel Porcile, Technology, structural change and BOP-constrained growth: a structuralist toolbox. Cambridge

Journal of Economics, 38, no. 1 (2014), 215-23

6 For currency hierarchies see E.g. Luiz Fernando de Paula, Barbara Fritz and Daniela M. Prates, “Keynes at the periphery: Currency hierarchy and challenges for economic policy in emerging economies,” Journal of Post

Keynesian Economics, 40, no.2 (2017)), 183-202; for a Minskyan discussion of the East Asian financial crisis see

Philip Arestis and Murray Glickman, Financial crisis in Southeast Asia: dispelling illusion the Minskyan way,”

Cambridge Journal of Economics 26, No. 2 ( 2002), pp. 237-260

7 Ben Clift, Comparative Political Economy. States, Markets and Global Capitalism. (London: Palgrave

MacMillan, 2014) chap. 1

8 Clift, Comparative Political Economy

37

9 and Matthias Matthijs, “Black Swans, Lame Ducks, and the mystery of IPE's missing macroeconomy, “ Review of International Political Economy, 24, no. 2 (2017), 203-231

10 Blyth and Matthijs, Black Swans, p. 208

11 Andrew Shonfield, Modern Capitalism. The Changing Balance of Public and Private Power, (Oxford, OUP

1965); Peter Hall, Governing the Economy, (Oxford, OUP 1986)

12 Schwartz and Tarnoy, “Thinking about thinking about Comparative Political Economy”

13 Peter Hall and David Soskice, An introduction to Varieties of Capitalism, in: Peter Hall and David Soskice

(eds), Varieties of Capitalism, (Oxford: Oxford University Press 2001), pp 1-68

14 Baccaro and Pontusson “Rethinking Comparative Political Economy”

15 Baccaro and Pontusson “Rethinking Comparative Political Economy”, 176

16 Carlin and Soskice Macroeconomics and the Wage Bargain. A Modern Approach to Employment, Inflation and the Exchange Rate. (Oxford: Oxford University Press 1990) Wendy Carlin and David Soskice,

Macroeconomics. Imperfections, Institutions and Policies. (Oxford: Oxford University Press 2006)

17 Colin Crouch, Privatised Keynesianism: an unacknowledged policy regime. British Journal of Politics and

International Relations 11 (2009), 382-99; Colin Hay, Pathology without crisis? The strange demise of the

Anglo-liberal growth model. Government and Opposition 46, no. 1 (2011), 1-31. See also Jason Heyes, Paul

Lewis and Ian Clark, Varieties of capitalism, neoliberalism and the economic crisis of 2008-? Industrial Relations

Journal, 43, no. 3 (2012): 222-241.

18 Andreas Nölke, ”Economic causes of the Eurozone crisis. The analytical contributions of Comparative

Capitalism’, Socio-Economic Review 14, no. 1 (2016): 141-61 and Magnus Ryner, Europe's ordoliberal iron cage: critical political economy, the euro area crisis and its management, Journal of European , 22, no. 2

(2015):275-294

19 , The General Theory of Employment, Interest and Money. The Collected Writings of

John Maynard Keynes, Volume VII. (Cambridge: Macmillan, 1973).

20 John Hicks, Mr Keynes and the Classics: A Suggested Interpretation. Econometrica 5 (1937): 147-59

38

21 Gregory Mankiw and , .2 vols. (Cambridge: MIT Press, 1991) and B.

Snowden, H. Vane, and P. Wynarczyk. A Modern Guide to Macroeconomics: An Introduction to Competing

Schools of Thought. (Northampton, MA: Edward Elgar 1994)

22 Hope and Soskice, Growth Models, p. 219

23 OECD, The OECD Jobs Study. (Paris: OECD 1994); Paul, Krugman, “Past and Prospective Causes of High

Unemployment,” In: Federal Reserve Bank of Kansas City (ed): Reducing Unemployment: Current Issues and

Policy Options. (Kansas City: Federal Reserve Kansas City 1994. ) ; Horst Siebert, “Labor Market Rigidities: At the Root of Unemployment in Europe,” Journal of Economic Perspectives 11, 3 (1997): 37-54

24 Wendy Carlin and David Soskice, Macroeconomics. Imperfections, Institutions and Policies. (Oxford: Oxford

University Press 2006),

25 Section 3.1.5 of Carlin and Soskice, Macroeconomics. Of a total of 800 pages two pages are devoted to issues of financial instability.

26 The of the book has an entry for ‘financial bubble’ (referring to section 3.1.5), but none for financial crisis. For debt the only entry in the index is ‘debt, government’, but there is no entry for private debt or debt cycles. There is no reference to Minsky. Wendy Carlin and David Soskice, Macroeconomics. Institutions,

Instability, and the Financial System. (Oxford: Oxford University Press, 2015) post-crisis textbook, which features instability and the financial system in the title (aimed at a more undergrad audience than the 2006 textbook), devotes three full chapters to the financial sector and financial instability and summarises the recent New Keynesian literature on financial instability, briefly mentioning Minsky (but no other post-

Keynesians). These chapters cover the importance of investment banking and mortgage lending, and they highlight momentum trading and the financial accelerator as key mechanisms. They claim that those financial mechanisms can readily be integrated into the three equation model. However, in fact they represented as exogenous shifts of the and the model does nothing to elucidate these mechanisms.

27 Philip Arestis, The Post-Keynesian Approach to Economics: An Alternative Analysis of Economic Theory and

Policy. (Cheltenham: Edward Elgar 1992) , Foundations of Post-Keynesian Economic Analysis.

(Aldershot: Edward Elgar 1992); Thomas Palley, Post Keynesian Economics. Debt, Distribution and the Macro

Economy. (London: Macmillan1996); Marc Lavoie, Introduction to Post Keynesian Economics. (New York:

39

Palgrave Macmillan 2009); Eckhard Hein and Engelbert Stockhammer (eds). A Modern Guide to Keynesian

Economics and Economic Policies, (Cheltenham: Edward Elgar 2011); Eckhard Hein, Distribution and Growth

After Keynes. A Post-Keynesian Guide. (Edward Elgar: Cheltenham 2014)

28 Michal, Kalecki, Theory of Economic Dynamics. (New York: Press, 1965)

29 Scott Moss, The end of orthodox capital theory. In: Edward Nell (ed): Growth, Profits and . Essays in the Revival of Political Economy. (Cambridge: Cambridge University Press 1980) pp. 64-79, John King, A of Post Keynesian Economics since 1936. (Edward Elgar 2002), chap. 4

30 John King, A History of Post Keynesian Economics since 1936 (Cheltenham Edward Elgar 2002).

31 PK discussions of the three-equation model include: Alfonso Palacio-Vera, The ‘modern’ view of macroeconomics: some critical reflections. Cambridge Journal of Economics 29, no. 5 (2005), 747-767; Philip

Arestis and Malcolm Sawyer. A critical reconsideration of the foundations of monetary policy in the new consensus macroeconomics framework, Cambridge Journal of Economics, 32, no. 5 (2008), 761-779; Giuseppe

Fontana and Mark Setterfield (eds): Macroeconomic Theory and Macroeconomic Pedagogy. (Palgrave 2009);

Marc Lavoie, Book review: Carlin, Wendy and David Soskice (2015): Macroeconomics: Institutions, Instability, and the Financial System. European Journal of Economics and Economic Policies: Intervention 12, no. 1 (2015):

135-42

32 Many PK arguments can also be formulated in a NKE framework. PKE and NKE are estranged cousins in that they both descend from the Keynesian revolution. The main theoretical dividing line is that NKE accepts that macroeconomics be based on rational behaviour microfoundations, whereas PKE has institutional foundations.

In the aftermath of the global financial crisis issues of financial instability have featured prominently in NKE and the issue of hysteresis has also received renewed attention. For example , Eugenio

Cerutti, and , Inflation and activity–Two explorations and their monetary policy implications. NBER Working Paper No. 21726 (2015) come very close to PK positions on hysteresis and path dependence. However these features are not part of three-equation model which is rooted in a pre-crisis NK world, which is anchored in supply-side equilibrium and analyses financial crises as exogenous shocks. It is thus not a satisfactory macroeconomic basis for an analysis of post-Fordist economic dynamics.

40

33 Most of the discussion of demand regimes focuses on the distribution between capital and labour. However, there are also extensions that consider pay differentials and the paid and un-paid care economy See

Elissa Braunstein, Irene van Staveren and Daniele Tavani, “Embedding care and unpaid work in macroeconomic modelling: a structuralist approach,”. 17, no. 4 (2011): 5-31; Özlem Onaran, Cem Oyvat, and Evrydice. Fotopoulou, "The effects of gender inequality, wages, concentration and fiscal policy on macroeconomic performance", Greenwich Papers in Political Economy 71 (2019)

34 Amit Bhaduri and Stephen Marglin, “Unemployment and the real wage: the economic basis for contesting political ,” Cambridge Journal of Economics, 14 no. 4 (1990): 375-93

35 For example: Engelbert Stockhammer, Özlem Onaran, and Stefan Ederer, “Functional income distribution and aggregate demand in the Euro area,” Cambridge Journal of Economics, 33, no. 1 (2009): 139-159; Servaas

Storm and C. W. M. Naastepad, Macroeconomics Beyond the NAIRU. (Harvard: Press 2012);

Özlem Onaran and Giorgos Galanis, “Income distribution and growth: a global model,” Environment and

Planning, 46, no.10 (2014): 2489-2513.

36 Robert Blecker, “Wage-led versus profit-led demand regimes: the long and the short of it,” Review of

Keynesian Economics, 4, no. 4 (2016), 373–390; Engelbert Stockhammer, “Wage-led versus profit-led demand: what have we learned? A Kalecki-Minsky view,” Review of Keynesian Economics 5, no. 1 (2017): 25-42

37 There is mixed evidence for the demand regime of the USA, with some studies, in particular those employing reduced form demand equations, reporting profit led demand regime.

38 Engelbert Stockhammer, Özlem Onaran, and Stefan Ederer, “Functional income distribution and aggregate demand in the Euro area”. Cambridge Journal of Economics, 33, 1 (2009): 139-159 (2009)

39 Engelbert Stockhammer, “Neoliberal growth models, monetary union and the Euro Crisis. A post-Keynesian perspective”. 21, no. 4 (2016.): 365-79

40 Engelbert Stockhammer and Rafael Wildauer, “Debt-driven growth? ,”

41 Engelbert, Stockhammer, “Is there an equilibrium rate of unemployment in the long run?,” Review of

Political Economy 16 , no. 1 (2004), pp. 59-77; Christian R. Proano, Peter Flaschel, Hans-Martin Krolzig and

Mamadou Bobo Diallo Monetary policy and macroeconomic stability under alternative demand regimes,”

Cambridge Journal of Economics, Vol. 35, no. 3 (2011), pp. 569–585

41

42 Keynes discussed changes in nominal wages whereas Bhaduri and Marglin analyse changes in the wage share; John Maynard Keynes, General Theory.

43 Hope and Soskice, “Growth models”, p. 219

44 There are similarities and differences between a PK understanding of animal spirits and that of behavioural economics. For example and Robert Shiller, Animal Spirits. How Human Drives the

Economy and Why It Matters for Global Capitalism. (Princeton: Press, 2009) prominently feature animal spirits. They use the term to describe waves of synchronised irrational (e.g. exuberant) behaviour. Rational behaviour serves as the yardstick. In contrast, PKE rational behaviour is regarded as impossible as probability distributions for future outcomes are not known. Thus non-rational (rather than irrational) behaviour is pervasive..

45 See Reiner Franke and Frank Westerhoff, Taking stock: rigorous modeling of animal spirits in macroeconomics. Journal of Economic Surveys 31, no. 5(2017): 1152–1182 for a survey of analytical models of animal spirits.

46 This view is in contrast to , which argued that deposits create loans. While central banks initially endorsed Monetarism, many, for example the Bank of England, now do accept endogenous money creation; see Michael McLeay, Amar Radia and Ryland Thomas, “Money creation in the modern Economy,” BoE

Quarterly Bulletin 54, no. 1 (2015): 14-27.

47 Dirk Bezemer, “Schumpeter might be right again: the functional differentiation of credit,” Journal of

Evolutionary Economics 24, 5 (2014): 935–950

48 See Maria Nikolaidi and Engelbert Stockhammer, “Minsky models. A structured review”, Journal of Economic

Surveys 31, 5 (2017): 1304-31 for a survey of Minsky models)

49 Andrej Shleifer and Lawrence Summers, “The Noise Trader Approach to Finance,” Journal of Economic

Perspectives 4, 2 (1990): 19-34; De Grauwe, who sits somewhere between New Keynesian models and

Behavioural Economics, has developed speculative models in a series of papers. Paul De Grauwe and C.

Macchiarelli, “Animal spirits and credit cycles,” Journal of Economic Dynamics & Control 59 (2015): 95–117 model animal spirits as self-fulfilling movements of optimism and pessimism in a heterogeneous setting include a banking sector and debt. They do not refer to Minsky.

42

50 Brad DeLong and Lawrence Summers, “Fiscal policy in a depressed economy,” Brookings Papers on Economic

Activity, 44, no. 1 (2012):33-297 and Wendy Carlin and David Soskice, “Stagnant productivity and low unemployment: stuck in a Keynesian equilibrium,” Oxford Review of Economic Policy, 34, 1–2 (2018), 169–194.

51 Ray Barrell, Philip Davis, Dilruba Karim, and Iana Liadze, Bank regulation, property prices and early warning systems for banking crises in OECD countries, Journal of Banking & Finance, 34, no. 9 (2010), 2255-2264

52 Steven Fazzari, Piero Ferri. and Anna Maria Variato (2020): ‘Demand-led growth and accommodating supply’, Cambridge Journal of Economics, 44, no. 3, 583–605

53 Servaas Storm and C.W.M. Naastepad, “Wage-led or profit-led supply: wages, productivity and investment”

In: Marc Lavoie and Engelbert Stockhammer, (eds): Wage-led growth. An Equitable Strategy for Economic

Recovery, London: Palgrave Macmillan, 2013), pp. 100-124; R. Vergeer and A. Kleinknecht, ‘The impact of labor market deregulation on productivity: A panel data analysis of 19 OECD countries (1960-2004)’, Journal of Post-

Keynesian Economics, 33, no. 2 (2011), p. 369-404

54 In a simple NAIRU model, the NAIRU will depend on the autonomous wage and profit claims of labour and capital. If those wage or profit claims change in response to changes in the actual wage, this is sufficient for the

NAIRU to be endogenous.

55 In the NK NAIRU theory unemployment hysteresis results only in the extreme case where the long-term unemployed have no effect on wages at all (Stephen Nickell, “Unemployment: Questions and Some Answers,”

Economic Journal 108 (1998): 802-816). In this case a change in actual unemployment corresponds to a change in the NAIRU. In contrast, the PK wage norm argument implies hysteresis as a pervasive feature and there will be different degrees of hysteresis depending on the adjustment speed of the wage norm and the duration of the (Peter Skott, Fairness as a source of hysteresis in employment and relative wages. Journal of

Economic Behavior and Organization 57 (2005), 305-31; Engelbert Stockhammer, “Is the NAIRU a Monetarist,

New Keynesian, Post Keynesian or Marxist theory?” Metroeconomica 59, no.4 (2008), 479-510; Engelbert

Stockhammer, “Wage norms, and unemployment. A Post Keynesian view,” Oxford Review of Economic Policy 27, 2(2011), 295–311 and Thomas Michl, “Hysteresis in a Three-Equation Model,” Eastern

Economic Journal, 44, 2(2016), pp. 1-18.).

43

56 Valerie Cerra and Sweta Saxena, “Growth dynamics: The myth of economic recovery,”

98, no 1 (2008), 439–457.

57 Alen Auerbach, and Yuriy Gorodnichenko, ‘Fiscal Multipliers in Recession and Expansion’, in Fiscal Policy after the Financial Crisis, edited by and Francesco Giavazzi (Chicago: University of Chicago

Press 2013)

58 Olivier Blanchard and David Leigh “Growth Forecast Errors and Fiscal Multipliers,” International Monetary

Fund Working Paper WP13/1 (2013)

59 Bradford DeLong and Lawrence Summers , “Fiscal policy in a depressed economy,” Brookings Papers on

Economic Activity, 44, 1 (2012), 33-297

60 e.g. M. Cimoli, and G. Porcile, “Technology, structural change and BOP-constrained growth: a structuralist toolbox,” Cambridge Journal of Economics, 38, no. 1 (2014), 215-23; José Antonio Ocampo, Codrina Rada, and

Lance Taylor, Growth and Policy in Developing Countries. A Structuralist Approach. (New York: Columbia

University Press 2009. )

61 Anina Kaltenbrunner, Bruno Bonizzi and Raquel Almeida Ramos (eds): Emerging Economies and the Global

Financial System: Post-Keynesian Analysis. (Routledge, forthcoming)

62 Bob Hancké, Martin Rhodes, and Mark Thatcher, (2009) Beyond Varieties of Capitalism. In: Bob Hancké (ed).

Debating Varieties of Capitalism. A Reader. (Oxford University Press, 2009), pp 273-300, give a twelve item list of shortcomings of VoC, but the treatment of the financial sector and the absence of financial instability concerns is not mentioned.

63 William Lazonick, and Mary O'Sullivan, Maximizing shareholder value: a new for corporate governance. Economy and Society 29, no. 1 (2000), 13-35

64 Eugenio Caverzasi, Alberto Botta and Clara Capelli “Shadow banking and the financial side of financialisation,” Cambridge Journal of Economics, vol 43, no. 4 (2019), pp. 1029–1051

65 Ismail Ertürk and Stefano Solari, “Banks as Continuous Reinvention,” New Political Economy, 12, no. 3

(2007). 369-88; for a longer perspective see Oscar Jordá, Moritz Schularick and A M Taylor “The great mortgaging: housing finance, crises and business cycles,” Economic Policy 31, 85 (2016): 107-52

44

66 Atif Mian, Amir Sufi, A. and Emil Verner Household Debt and Business Cycles Worldwide, Working Paper

21581, (National Bureau of Economic Research 2015)

67 Matthew Watson, “House price Keynesianism and the contradictions of the modern subject,”

Housing Studies 25, no. 3 (2010): 413-26; James Wood, The integrating role of private homeownership and mortgage credit in British neoliberalism. Housing Studies, 33, no. 7 (2018): 993-1013 2010, Wood 2018)

68 Herman Schwartz and Len Seabrooke, “Varieties of residential capitalism in the International Political

Economy: Old welfare states and the new politics of housing,” Comparative European Politics, 6 (2008), 237–

261

69 Alison Johnston and Aidan Regan. “Global finance, labor politics, and the political economy of housing prices,” Politics and Society 45, no. 3 (2017), 327-5.

70 Eckhard, Hein, "Finance-dominated capitalism and re-distribution of income: a Kaleckian perspective,"

Cambridge Journal of Economics, 39, no. 3 (2015), 907-934; Petra Dünhaupt, P. ‘The effect of financialization on labor’s share of income’ Cambridge Journal of Economics 41, no. 1 (2017), 283-306; Engelbert

Stockhammer, “Determinants of the wage share. A panel analysis of advanced and developing economies,”

British Journal of Industrial Relations 55, no. 1 (2017), 3-33; Karsten Kohler, Alexander Guschanski, and

Engelbert Stockhammer, “How does financialisation affect functional income distribution? A theoretical clarification and empirical assessment,” Cambridge Journal of Economics 43, no. 4 (2019), 937-74

71 Engelbert Stockhammer, “Financialization and the slowdown of accumulation,” Cambridge Journal of

Economics 28, no. 5 (2004), 719-41; Özgür Orhangazi, “Financialisation and capital accumulation in the non- financial corporate sector: A theoretical and empirical investigation on the US economy: 1973–2003,”

Cambridge Journal of Economics 32 (2008), 863–886; Daniele Tori and Özlem Onaran, “The effect of financialization and financial development on investment. Evidence from firm-level data for Europe,”

Cambridge Journal of Economics 42, no. 5 (2018), 1393–1416;

72 Engelbert Stockhammer and Rafael Wildauer, "Expenditure Cascades, Low Interest Rates or Property

Booms? Determinants of Household Debt in OECD Countries", Review of 5, no. 2 (2018),

85-121

45

73 Charles P. Kindleberger, Manias, Panics, and Crashes: A History of Financial Crises. (New York: Basic Books

1978), C., Reinhart, and K. Rogoff. This Time is Different: Eight Centuries of Financial Folly. (Princeton, NJ:

Princeton University Press 2009), Charles Goodhart, Financial crises. In: D. Chambers and E. Dimson, (eds):

Financial Market History: Reflections on the Past for Investors Today. (CFA Institute Research Foundation,

2016). Pp. 187–2042016)

74 Claudio Borio, The financial cycle and macroeconomics: what have we learnt? BIS Working Papers 395

(Geneva: Bank for International Settlements 2012)

75 Edward Glaeser, “A nation of gamblers: real estate speculation and American history,” American Economic

Review: Papers & Proceedings 103 no.3 (2013): 1–42

76 Atif Mian, Amir Sufi, A. and Emil Verner Household Debt and Business Cycles Worldwide, Working Paper

21581, (National Bureau of Economic Research 2015)

77 James Crotty, “Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’”, Cambridge Journal of Economics 33 (2009), 563–580

78 More technically, the condition for reoccurring asset price cycle requires the interaction of fundamentalist traders and extrapolative expectations traders. Roberto Dieci and Frank Westerhoff. ”A Simple Model of a

Speculative Housing Market,” Journal of 22, no. 2 (2012): 303–29. Soon Ryoo,

”Household Debt and Housing Bubbles: A Minskian Approach to Boom-Bust Cycles,” Journal of Evolutionary

Economics 26, no. 5 (2016): 971–1006 gives a full PK macro model with real estate cycles; Engelbert

Stockhammer and Christina Wolf “Building blocks for the macroeconomics and political economy of housing,”

Japanese Political Economy 45, 1-2 (2019), 43-67.

79 We focus here on demand regimes with respect to income distribution. However, demand regimes can also be defined with respect to other variables, in particular, there is a distinction between debt-led and and debt- burdened demand regimes, depending on whether changes in debt have a positive or negative effect on GDP.

See also Eckhard Hein, Walter Paternesi Meloni and Pasquale Tridico, 2020. “Welfare models and demand-led growth regimes before and after the financial and economic crisis,” Review of International Political Economy https://doi.org/10.1080/09692290.2020.1744178

80 Baccaro and Pontusson “Rethinking Comparative Political Economy”, 186.

46

81 Marc Lavoie and Engelbert Stockhammer, “Wage-led growth: concept, theories and policies,” In: Marc

Lavoie and Engelbert Stockhammer (eds): Wage-led growth. An Equitable Strategy for Economic Recovery,

(London: Palgrave Macmillan 2013), pp. 13-39; Eckhard Hein, and M Mundt, 2013. Financialisation, the financial and economic crisis, and the requirements and potentials for wage-led recovery. In: Marc Lavoie and

Engelbert Stockhammer (eds), Wage-led growth. An Equitable Strategy for Economic Recovery, London:

Palgrave Macmillan, pp. 153-186; Özlem Onaran and Giorgos Galanis, “Income Distribution and Growth”.

82 Engelbert Stockhammer, Eckhard Hein, and Lucas Grafl, “ and the effects of changes in functional income distribution on aggregate demand in Germany,” International Review of

25 1 (2011): 1-23. A fuller discussion of the political economy of European growth models can be found in:

Engelbert Stockhammer, Cedric Durand and Ludwig List, “European growth models and working class restructuring before the crisis. An International post-Keynesian Political Economy Approach,” Environment and

Planning A 48, no. 9 (2016): 1804–1828

83 Peter Hall, and Robert Franzese, “Mixed Signals: Central Bank Independence, Coordinated Bargaining, and

European Monetary Union”, International Organization 52, no. 3 (1998): 505-35

84 Torben Iversen, “Wage Bargaining, Central Bank Independence, and the Real Effects of Money”,

International Organisation 52, no. 3 (1998): 469-504

85 L. Randall Wray, Credit and State Theories of Money: The Contributions of A. Mitchell Innes. (Cheltenham:

Edward Elgar, 2004). See also Geoffrey Ingham, The Nature of Money. (Cambridge: Polity Press, 2004), chapter

2

86 Stephanie Bell, “The role of the state and the hierarchy of money,” Cambridge Journal of Economics, 25, no.

2 (2001), 149–163. Peter Mehrling, The inherent hierarchy of money. In Lance Taylor, Armon Rezai and Tom

Michl (eds), Social Fairness and Economics. Economic Essays in the Spirit of Duncan Foley. (Routledge 2013)

87 Katharine Pistor, “A legal theory of finance,” Journal of Comparative Economics 41, no. 2 (2013): 315-330

88 Charles Goodhart, The Evolution of Central Banks. (Cambridge, MA: MIT Press, 1988)

89 Paul De Grauwe, “The European Central Bank: Lender of Last Resort in the Government Bond Markets?”,

CESifo Working Paper, No. 3569 (2011); Stockhammer “Neoliberal growth models, monetary union and the

Euro Crisis”.

47

90 Olivier Blanchard, Giovanni Dell’Ariccia and Paolo Mauro, Rethinking Macroeconomic Policy. IMF Staff Position Notes SPN/10/03 (2010)

48