Macro Cube - 4

At the end of all the heavy-duty categorising of the last three posts, this is what the modified Macro Cube looks like. It is now labelled at the vertices and edges with the theories that they represent. These are

NC: New Classical ; NCh: New Chicago

NMC: New Monetary Consensus

NW: Neo-Wicksellian ; NK: Neo-Keynesian

FK: Folk Keynesian ; SF: Socialist Fiscalism

SS: Supply Side ; A: Austrian ; NA: Neo-Austrian

OC/FB: Old Chicago, Free Bankers

MD: Monetary Disequilibrium Theory

Mo: Monetarist ; MK: Monetary Keynesian

DK: Disequilibrium Keynesian ; K: Keynesian

MPK: Minsky-like Post Keynesian ; PK: Post Keynesian ; FF: Functional Finance Theorists

RFD: Real & Financial Disequilibrium

Now there's only the faces and one rather interesting diagonal to go. The faces are easier : these are a collection of theories that a very broad view/consensus represents and not any one theory.

1) SF - NK - DK - PK : This face has Keynes written all over it, and the unifying factor is their fondness for fiscal solutions. This is a left-of-centre view that has a few things going for it. I will call it Social Democrat (SD) macro. The leading theorist would be Joseph Stiglitz and the leading practitioner, Gunnar Myrdal.

2) NK - DK - MD - NMC: These theories are a collection of Neoclassical and Keynesian views of the economy that assign a special role to money and prefer monetary solutions to crises, but are ok with fiscal ones too. I will call it Wicksellian/New-Keynesian (WNK) macro, for a variety of reasons.

Knut Wicksell was the first modern macro theorist, and he tried to assimilate a wide range of the prevailing macro thoughts of his era into a cohesive framework, while coming up with the ideas of a natural rate of interest (through which he integrated the real sector and the monetary sector) and even endogenous money creation. He was inspired by the Austrian and the Ricardian views of the economy, but yet ended up influencing both Keynes and Schumpeter. Endogenous money seems to place him close to the Post Keynesians, while a focus on the short term interest rate places him firmly in Neo-Classical category. His debate with Fisher seems to indicate a Keynesian view of the economy, while his fondness for Walras indicates a Classical view. I have no doubt that had he followed rather than predated Keynes and modern central banks, he would be trying to come up with a theory that is in equal parts equilibrium and disequilibrium, equal parts Neoclassical and Keynesian. Hence, Wicksell.

The New Keynesians - I have struggles to place them somewhere. Everyone post Samuelson who may focus on aggregate demand - from Joseph Stiglitz to Michael Woodford - are called New Keynesians. I believe that's not a helpful way of looking at things. I understand New Keynesian theory as one that tries to integrate the Neo-Classical view of the economy with the Keynesian view. The equilibrium and rational expectations based efforts resulted into the neo-Wicksellian framework. But there are others, who modify these efforts in many interesting ways. Ben Bernanke and Mark Gertler, with their financial accelerator and credit channel view of monetary policy. Robert Gordon, with his distinctions between markets that approximate Neoclassical auction markets and those that don't. And Edmund Phelps, the granddaddy of them all, with his adaptive expectations view of multi-period optimization by economic actors. Even Greg Mankiw, who in this excellent essay expresses dislike for the complete markets and rational expectations view of the world. Phelps, Gordon, Bernanke, Mankiw - these are the true New-Keynesian theorists. And they lie in the middle of that MD-NMC-NK-DK face of the cube.

So, I will call this the Wicksellian/New-Keynesian (WNK) macro theory. I am also convinced that a less sophisticated version of WNK is the macro of my favourite political philosopher John Stuart Mill, as evidenced by his stance in the Bullionist controversy.

3) NC - NMC - MD - NA: This is a bunch of people united by their distrust of fiscal policy and in general the government, though they may approve of judicious monetary policy. I will call this Walrasian/Classical Liberal (WCL) macro. This is more or less the 'Classical' view that Keynes disapproved of and that forms the most direct political opposition to a social democrat system. For the most sophisticated macro-model of this view - one that tries to incorporate asset prices into general equilibrium - we have to turn towards Fischer Black. This paper summarizes some of more important ideas of Black's magnum opus, which has been referred to approvingly recently by Tyler Cowen. Margaret Thatcher would be the leading politician whose government had a WCL approach to the economy.

4) NC - NA - PK - SF: This divergent group of theories is united by a distrust of expansionary monetary policy, a focus on production and supply rather than consumer demand, and not much else. I am going to call them Non-Monetary theorists and leave it at that.

5) NC - NMC - NK - SF: A group of theories with widely divergent politics but united by the model-simplification of equilibrium and optimization. Various versions of freshwater, saltwater and socialist thoughts keep indulging into such models but if we are to truly make sense of the world economy, equilibrium must go.

6) NA - MD - DK - PK: The best for the last. How does one unite Hayek and Keynes? Or listen to Bill Woolsey and Steve Keen at the same time? Or indeed, Schumpeter and Patinkin? Well you drop the assumption of equilibrium, open your mind to monetary aggregates, interest rates and credit risk at the same time, and try to incorporate balance sheets and the financial system into your version of the macro-economy. Incredibly difficult to formalize, but incredibly fruitful to conceive and follow. The disequilibrium dudes, of all hues, are the ones you turn to in a crisis in the modern financial economy.

And on this face, there is a very interesting diagonal: the one that leads us from Hayek (NA) to Minsky (DK). Along the diagonal, from Hayek(right) to Minsky(left of cente), you will successively find - Hayek, Arnold Kling (Recalculationist), Tyler Cowen (Austro-Keynesian), Willem Buiter (the golden mean), Axel Leijonhufvud (Keynesian) and then Minsky. Oh, and somewhere between Leijonhufvud and Minsky, I suspect, you will find Keynes himself.

Arnold has been arguing for some time that markets are self-correcting but they are slow adaptive systems, that monetary policy is useless in what is essentially a sectoral adjustment following over-investment into some sectors, and that inflation is round the corner. Tyler sympathises with Arnold's view but is less convinced about the ineffectiveness of monetary policy and generally less skeptical of government intervention.

Buiter is essentially a monetary theorist, but one who balances his fondness for monetary aggregates and interest rates with a keen understanding of the banking system, a deep respect for moral hazard problems and a healthy deference to the 'financial instability due to leverage' view of Minsky. To top it all, unlike most macro theorists, he never forgets to consider the international political economy when he makes a theoretical point or a policy recommendation. He also wrote the definitive essays on what I believe is the best way out of the current crisis, but more on that later.

Leijonhufvud proposes a 'corridor hypothesis' view of things in which the markets and the financial system self-correct if disturbances are small but can go out of range when exposed to large disturbances with no surety of coming back on their own. He was among the initial Keynesian theorists who expressed a dissatisfaction with the 'equilibrium' version of things. Not surprising then, that he has been appropriated both by Arnold Kling (of the real-disequilibrium story) and Nick Rowe (of the monetary disequilibrium story).

So that's it, the faces are all done. One could make a couple of further groups. If you combine Wicksellian/New-Keynesian macro with Social Democrat macro, you get Aggregate Demand (AD) macro. The single greatest insight of Keynes was to introduce and privilege demand in macro discussions, and Keynes is what SD and WNK macro have in common. AD macro abhors the gold standard and endorses the modern banking system with regulations. Unsurprisingly, if you combine Non-monetary and WCL macro, you get Aggregate Supply (AS) macro. AS macro is sympathetic towards either the gold standard, or full-reserve banking with no lender of last resort or deposit insurance, or free banking. Or all.

And finally, if you combine WCL and WNK macro, you get the old Classical view of the economy, which Keynes mis-characterized somewhat. Jean Baptiste Say did not believe in the Say's Law, David Ricardo disagreed with Ricardian equivalence and David Hume can be thought of as the first monetarist. The Classicals were skeptical of fiscal actions but not monetary, and had a more sophisticated (or paradoxically, more intuitive) understanding of disequilibrium than many modern mainstream macroeconomists.

I agree most with Disequilibrium and WNK macro, and in the next and final post of the series I will explain why.