Many mainstream economists seem to think the idea behind Modern Monetary Theory is new and originates from economic cranks.
New? Cranks? How about reading one of the great founders of neoclassical economics – Knut Wicksell. This is what Wicksell wrote in 1898 on “pure credit systems” in Interest and Prices (Geldzins und Güterpreise), 1936 (1898), p. 68f:
It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank …
A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system …
We intend therefor, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers. A thorough analysis of this purely imaginary case seems to me to be worth while, for it provides a precise antithesis to the equally imaginay case of a pure cash system, in which credit plays no part whatever [the exact equivalent of the often used neoclassical model assumption of “cash in advance” – LPS] …
For the sake of simplicity, let us then assume that the whole monetary system of a country is in the hands of a single credit institution, provided with an adequate number of branches, at which each independent economic individual keeps an account on which he can draw cheques.
What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the “pure credit economy” is a reality and not just a theoretical curiosity – MMT describes a fiat currency system that almost every country in the world is operating under.
In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover and taxing and borrowing is degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not the major problem, since fiat money means that governments can always make more of them.
As financial markets slide toward disaster, scarcely pausing to celebrate the “success” of the Greek election or the deal to recapitalize Spanish banks, the euro project is finally revealing its fatal flaw. One country poses an existential threat to Europe – and it is not Greece, Italy or Spain. Every serious proposal to resolve the euro crisis since 2009 – haircuts for bank bondholders, more realistic fiscal consolidation targets, jointly guaranteed eurobonds, a pan-European bailout fund, quantitative easing by the European Central Bank – has been vetoed by Germany, and this pattern looks likely to be repeated next week.
Nobody should be surprised that Germany has become the greatest threat to Europe. After all, this has happened twice before since 1914. To state this unmentionable fact is not to impugn Germans with original sin, but merely to note Germany’s unusual geopolitical situation. Germany is too big and powerful to coexist comfortably with its European neighbors in any political structure ruled purely by national interests. Yet it isn’t big and powerful enough to dominate its neighbors decisively, as the U.S. dominates North America or China will dominate the Far East.
Wise German politicians recognized this inherent instability after 1945 and abandoned the realpolitik of national interest in favor of the idealism of European unification. Instead of trying to create a “German Europe” the new national goal was to build a “European Germany.” Unfortunately, this lesson seems to have been forgotten by Angela Merkel. Whatever the intellectual arguments for or against German-imposed austerity or the German-designed fiscal compact, there can be no dispute about their political import. Merkel’s stated goal is now to create a “German Europe,” with every nation living, working and running its government according to German rules.
In a new piece on the ongoing discussion of macroeconomics, professor Wren-Lewis yesterday wrote:
What I want to say in summary is this. Microeconomists are right in many of their criticisms, but what they often fail to see is the root cause of the problem. This is that macroeconomic policy is highly political, with strong ideological implications. Ideology and politics distort macroeconomics as a science. Yet despite this, there is – and for many years has been – a substantial body of analysis that most macroeconomics would sign up to, and which has sound empirical backing.What is this substantial body of analysis? It is what used to be called the new neoclassical synthesis … For a closed economy, its details are well represented in Romer’s graduate textbook, for example. This body of analysis has important gaps and omissions, of course, such as a naive and simplistic view of the financial sector. However … the financial crisis itself showed up this incompleteness, but did not invalidate most of what was in the synthesis. Indeed, events since the crisis have provided significant empirical support for the Keynesian elements of that synthesis.
“[T]he financial crisis itself showed up this incompleteness, but did not invalidate most of what was in the synthesis.” Really?
The financial crisis of 2007-08 hit most laymen and economists with surprise. What was it that went wrong with our macroeconomic models, since they obviously did not foresee the collapse or even make it conceivable?
The root of our problem ultimately goes back to how we look upon the data we are handling. In modern neoclassical macroeconomics – dynamic stochastic general equilibrium, new synthesis, new-classical and new-Keynesian – variables are treated as if drawn from a known “data-generating process” that unfolds over time and on which we therefore have access to heaps of historical time-series. If we do not assume that we know the “data-generating process” – if we do not have the “true” model – the whole edifice collapses.
Modern macroeconomics obviously did not anticipate the enormity of the problems that unregulated “efficient” financial markets created. Why? Because it builds on the myth of us knowing the “data-generating process” and that we can describe the variables of our evolving economies as drawn from an urn containing stochastic probability functions with known means and variances.
After thoroughly neglecting anything resembling a real-world finance system, one can’t just go on as if nothing has happened and simply append financial considerations to neoclassical macromodels where finance more or less is equated to the neoclassical thought-construction of a “market for loanable funds.”
Both ontologically and epistemologically founded uncertainty makes any hopes of being able to consistently integrate financial crises into neoclassical macroeconomic models totally unfounded, since those models are based on assumptions of rational expectations, representative actors and dynamically stochastic general equilibrium – assumptions that convey the view that markets – give or take a few rigidities – are efficient!
Finance has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies, and – as Johan Åkerman used to say – acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, just isn’t enough.
LPS feminist? Ja visst!
[The banks] stand between the real borrower and the real lender. They have given their guarantee to the real lender; and this guarantee is only good if the money value of the asset belonging to the real borrower is worth the money which has been advanced on it.
En av de främsta spelteoretikerna i världen – Ariel Rubinstein vid Tel Aviv University och New York University – tar i ett samtal med Russ Roberts (EconTalk) upp en intressant diskussion om vad spelteorin, så här nästan sextio år efter von Neumann och Morgenstern publicerade Theory of Games and Economic Behavior, egentligen har åstadkommit. Enligt Rubinstein egentligen inte speciellt mycket.
För yours truly kommer detta som en sentida bekräftelse på något jag hävdade redan för tjugo år sedan, i min första doktorsavhandling – Samhälleliga val, värde och exploatering. Där gjorde jag ungefär samma värdering som Rubinstein, vilket då i etablerade neoklassiska ekonomkretsar – milt uttryckt – inte var speciellt uppskattat:
Vid upprepade tillfällen har det funnits anledning att kritisera de uppställda axiomen (transitivitet, fullständighet, konsistens, neutralitet, oberoende, monotonicitet m m) och problemlösningsförslagen (Nashlösning, harsanyis baysianska lösning, Rubinsteins förhandlingslösning, maximinkriteriet m m). Även själva analysförfarandet (fixeringen vid Paretovillkoret, den bakåtvända induktionen, osäkerhetsmomentets behandling m m) har ifrågasatts. Många gånger verkar matematisk elegans ha varit viktigare som utgångspunkt för de gjorda beteendeantagandena, än realism och relevans.
Det lär nog bli svårare att vifta bort samma tankar när de nu, tjugo år senare, formuleras av en av spelteorins egna giganter
In a post the other day I was complaining – after having read a piece by Simon Wren-Lewis – about macroeconomists that go on teaching macroeconomics after the crisis as if nothing really happened in the Great Recession 2008-9.
Noah Smith now also has reacted on Wren-Lewis gobsmacking picture of the state of macroeconomics:
I’m pretty sure that Wren-Lewis’ statement that “nothing has really been thrown away” applies to the journals too. Four years after a huge deflationary shock with no apparent shock to technology, asset-pricing papers and labor search papers and international finance papers and even some business-cycle papers continue to use models in which business cycles are driven by technology shocks. No theory seems to have been thrown out. And these are young economists writing these papers, so it’s not a generational effect …
If smart people don’t agree, it may because they are waiting for new evidence or because they don’t understand each other’s math. But if enough time passes and people are still having the same arguments they had a hundred years ago – as is exactly the case in macro today – then we have to conclude that very little is being accomplished in the field. The creation of new theories does not represent scientific progress until it is matched by the rejection of failed alternative theories.
The root problem here is that macroeconomics seems to have no commonly agreed-upon criteria for falsification of hypotheses. Time-series data – in other words, watching history go by and trying to pick out recurring patterns – does not seem to be persuasive enough to kill any existing theory. Nobody seems to believe in cross-country regressions. And there are basically no macro experiments …
So as things stand, macro is mostly a “science” without falsification. In other words, it is barely a science at all. Microeconomists know this. The educated public knows this. And that is why the prestige of the macro field is falling. The solution is for macroeconomists to A) admit their ignorance more often … and B) search for better ways to falsify macro theories in a convincing way.
“So as things stand, macro is mostly a “science” without falsification. In other words, it is barely a science at all.” That almost sounds as an answer to my post from yesterday – Is economics really a science?
In cycle after cycle the same script is acted out. An asset bubble begins inflating, together with its associated credit bubble. The lead singers of the free market school strike up their familiar song: markets know best, markets are efficient, there are no bubbles, let the markets run. While asset prices rise and credit expands, the doctrine of market efficiency reigns supreme. But immediately as asset prices begin falling and the credit bubble begins contracting, the singers swiftly change tune. The free-marketeers cast aside their message and, without even the decency to blush, strike up a new song: central banks must cut rates, governments must stimulate, credit must not contract, asset prices must not be allowed to fall. While the lead singers flip from song to song, apparently unaware of their discordant lyrics, the backing singers maintain a constant comical chant: markets are stable, markets are stable, markets are stable.
For a field of study aspiring to the status of a science today’s economic consensus is in a risible state, both internally inconsistent and entirely in conflict with the experimental evidence. Had Isaac Newton subjected himself to these standards he would have given us three laws of gravity: one telling us how an apple behaves when thrown up into the air; another quite different law telling us how it then falls back to earth; and a third law telling us the apple never moves at all.
Lena Sommestad – ordförande för (s)-kvinnor – om euron:
Sorgligast av allt, som jag ser det, är att Europa idag borde vara en kontinent på topp – inte en kontintent i kris.
Europa hör nämligen till de regioner i världen som just nu har den minsta försörjningsbördan i form av barn och gamla. Potentialen för ekonomisk tillväxt är därmed utomordentligt god. Inte minst i det krisdrabbade Sydeuropa är befolkningsstrukturen fördelaktig.
Problemet är bara att en betydande del av den stora, arbetsföra befolkningen i södra Europa går arbetslös – på grund av en fullständigt misslyckad och felriktad monetär politik.
Historiens dom över dagens europeiska politiker kommer att bli hård. Det var ett stort missgrepp att införa euron, men det är ett lika stort missgrepp att idag envist hålla fast vid en valutaunion som driver in Europa i en allt djupare politisk, ekonomisk och social kris.
Ekonomins dyrbaraste resurs är människor. Europa har idag tidernas största generation välutbildade, kunniga medborgare – men deras kunskaper tas inte till vara. Det borde vara dags för Europas socialdemokrater att samlas för en ny ekonomisk politik; en politik som tar vara på Europas dyrbara mänskliga resurser, innan det är för sent.