Unsustainable Processes

The three-country model thus depicted fairly well what happened in the Eurozone after the sub-prime crisis. It also provided a formalized justification for Godleys (1992) opposition to the Maastricht Treaty. His main objections were that the Treaty proposed an independent central bank that would neither advance funds to central or national governments nor purchase sovereign bonds, and that the Treaty had no place for a strong central government pursuing counter-cyclical policies. This, for Godley, was an unsustainable set-up and a recipe for future disasters.

Godley has been called a ‘Cassandra of the Fens’, for instance, forecasting a huge rise in the number of unemployed workers as a result of Margaret Thatcher’s economic policies. Perhaps his best-known piece describing an impending economic disaster, at least in the USA, is the report that he published for the Levy Economics Institute in January 1999, appropriately titled Seven Unsustainable Processes (Godley 1999c). This piece is considered by many to be the announcement, justified by economic analysis, that the Clinton boom years of the late 1990s were about to come to an end. Furthermore, many of the unsustainable processes described in the 1999 paper were still present in the 2000s, and so some observers also consider this paper to be a warning that the growth associated with the US housing boom of 2001-2006 was to peter out, as it did with the sub-prime financial crisis. The seven unsustainable processes occurring in the USA at the end of the 1990s were the following:

(1) the fall in private saving into ever deeper negative territory, (2) the rise in the flow of net lending to the private sector, (3) the rise in the growth rate of the real money stock, (4) the rise in asset prices at a rate that far exceeds the growth of profits (or of GDP), (5) the rise in the budget surplus, (6) the rise in the current account deficit, (7) the increase in the United States’s net foreign indebtedness relative to GDP (ibid.: 4).

Godley was much preoccupied with the rising indebtedness of the private sector caused by the household sector, tying it with the huge surpluses that the government sector was then accumulating, making use once again of the fundamental identity (S - I) + (T - G) + CAB = 0, as previously described. There was indeed a recession in the USA in 2001. By September 2005, Godley argued that the housing market was about to peak, as the institutional changes in the mortgage industry that had driven up housing prices had about exhausted their effects, thus predicting a catastrophic fall in net lending as a proportion of income, and hence another recession, unless the government took steps to raise the public deficit to no less than 8.5% of GDP.^[1]

While Godley was silent on current affairs for many years after he arrived at the Levy Institute, the Seven Unsustainable Processes paper launched an uninterrupted series of frequent medium-term forecasts and analyses, underlining a variety of explosive ratios, either with Godley on his own, or with various co-authors such as Randall Wray, Dimitri Papadimitriou, and Bill Martin, but mainly with Alex Izurieta, Claudio Dos Santos, and Gennaro Zezza. The latter had visited Cambridge as a student in the mid- 1980s and had been asked by Godley to work with him. In the 1990s, Zezza provided a great deal of help to Godley in setting up the US model, which he now runs at the Levy Institute, as well as the web platform devoted to the SFC approach.

The model Godley used for his strategic analyses was based on the analysis of private expenditure rather than its individual components (consumption, investment, and the change in the stock of inventories), and is therefore strongly connected to the New Cambridge approach. Private expenditure was modelled as depending essentially on past expenditures, current and past disposable income, financial wealth, and the change in consumer debt, mortgage debt, and business debt, as well as the change in stock market prices and housing prices. The relevance of changes in household and business debt for economic activity also reflects empirical observations that Godley made when being at the Treasury. Thus, the circle is completed.

• [1] For more comments on Godley’s unsustainable processes, see Bibow (2012).