Macroeconomics and reality

10 Aug, 2020 at 11:09 | Posted in Economics | 3 Comments

crotty Why would an academic profession sanction the use of theories based on crassly unrealistic assumptions? It is not an intuitively attractive idea. One suspects that the underlying reason is: economists are, in the main, committed to the defense of propositions that cannot be generated by models based on realistic assumptions. For example, a long string of unrealistic assumptions are necessary to generate the desired conclusion that unregulated financial markets perform optimally …

Milton Friedman was not only an economist; he was an energetic conservative political activist as well. His positivist methodology made it possible for conservative economists to use an absurd set of assumptions that no one would accept as a reasonable description of real- world capitalism to generate wide-spread acceptance of the proposition that unregulated capitalism is an ideal system.

Economics may be an informative tool for research. But if its practitioners do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its task. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics like James Crotty — and yours truly — will continue to consider its ultimate arguments as a mixture of rather unhelpful metaphors and metaphysics.

The marginal return on its ever higher technical sophistication in no way makes up for the lack of serious under-laboring of its deeper philosophical and methodological foundations.

A rigorous application of economic methods really presupposes that the phenomena of our real-world economies are ruled by stable causal relations. Unfortunately, real-world social systems are usually not governed by stable causal mechanisms or capacities. The kinds of ‘laws’ and relations that economics has established, are laws and relations about entities in models that presuppose causal mechanisms being invariant, atomistic, and additive. But — when causal mechanisms operate in the real world they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it as a rule only because we engineered them for that purpose. Outside man-made ‘nomological machines’ they are rare, or even non-existent.


  1. Unregulated financial markets are figuring out how to insure against “unstable combinations where the whole is more than a mechanical sum of parts”. Derivatives fit that description; more money emerges from securitization than goes in. Most of the time these emergent, privately-created IOUs trade at par with Federal Reserve dollars but in a crisis the Fed will buy the privately-created IOUs directly and redeem them at face value (or close), creating new Fed dollars as needed.
    Once we understand this dynamic, we can use the Fed to insure us all against panics.

    • The Fed who cried wolf . . . where will that story end — probably with Red Riding Hood eaten by the wolf!

      • Admittedly, my story assumes a stable relationship between the Fed and the world’s preferred unit of final settlement. My claim is that someone will always fulfill the role of world’s top bank, and the Fed just has to have an unlimited currency swap line with whatever bank that might be. But currently the Fed’s relation to the world’s reserve currency is more sure than anything claimed by mainstream economists. Sell-side research (i.e. big bank research departments) at least are aware of the Fed’s status and trade accordingly. We too can take advantage of the Fed’s twice-market-tested unlimited liquidity to give each of us an unconditional basic income …

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