Macro Cube - 5

By the last post, we were done with all vertices, edges faces and even a diagonal of the macro cube.

The interesting faces were

1. Social Democrat (SD) : SF - NK - DK - PK

2. Wicksellian / New Keynesian (WNK) : NK - NMC - MD - DK

3. Walrasian / Classical Liberal (WCL) : NC - NMC - MD - NA

4. Disequilibrium : NA - MD - DK - PK

I had said my own view of the macro-economy and understanding resonates and draws most heavily from the Disequilibrium and the WNK views. Let me explain why.

Based upon whatever little I have understood, there seems to be a case for :

1) Privileging money over other goods, but only just.

2) Privileging aggregate demand in the short run, but only just.

3) Privileging the banking and financial system as having special properties, but only just.

4) Privileging disequilibrium and non-optimization as the usual state of the economy, but only just.

5) Being wary of excessive leverage and short-term debt, but only just.

6) Healthy trust of the markets and skepticism of the government, without giving into the temptation of policy nihilism.

I find this set of principles best satisfied in the Disequilibrium and WNK versions of the economy. For a near- compulsive centrist and a non-believer in ideas in that try to re-invent the wheel (like me), this view presents two additional advantages. One, it is just the right distance of right from centre. Two, trying to incorporate it into the mainstream should not be too difficult - one needs to begin with the saltwater orthodoxy and infuse it with heavy dollops of disequilibrium and the financial system.

I believe that the economist who best represents such a school of thought is Willem Buiter. Buiter wrote a set of four essays (1, 2, 3, 4) in September last year that anyone interested in solutions to the crisis must read. Buiter's classifies his recommendations for fiscal stimulus into a broad framework of 'equitization of debt', a set of strategies that boosts aggregate demand while reducing leverage. Apart from Buiter, the ones that make most sense to me in the crisis and in general are - Raghuram Rajan, Barry Eichengreen, Kenneth Rogoff, Janet Yellen, Tyler Cowen and Rajiv Sethi.

Rajan was among the initial advocates of the brilliant solution of systematically important financial entities being partially financed by securities that convert automatically from debt to equity when there is substantial systemic risk. There's a fabulous interview here. Eichengreen's coverage of the crisis as well as his take on the gold standard as the proximate cause of the great depression are terrific. Rogoff has co-authored the book that is now almost universally considered the bible on financial crises and is the most reasonable among those that warn of sovereign defaults due to fiscal profligacy. Yellen was Buiter's favourite for the Fed Governor post and has a series of excellent thoughts/ speeches on the crisis. Tyler Cowen's macro is as eclectic and delightful as the rest of his thoughts and Rajiv Sethi is the most financially nuanced of those who try to model the economy as a non-linear dynamical system.

There are some common frameworks that unite and inform the macroeconomics of this seemingly disparate set. One is a keen understanding of banks and financial markets. The other is a habit of looking at international capital flows and political economy while analysing and recommending policies. The third, and most important, is a commitment to policy centrism and epistemic openness.

The cube has helped me place the confusing views of a large number of economists that I read in a somewhat more cogent framework. Scott Sumner, for example, is a monetary disequilibrium (MD) theorist who believes in rational expectations. I think it's rather impossible to be any kind of a disequilibrium theorist with a belief in ratex so I bump him up to Mo (Monetarist) from MD. Bryan Caplan's macro is a Disequilibrium/WCL mongrel that will resonate with that of Prof. J R Varma. If you're concerned how the Paul Krugman who recommended inflationary expectations as a way out of the Japtrap is now such an avowed fiscalist, you need only to realise that the macro of Krugman the MIT-trained theorist is WNK but that of Krugman the political polemicist is firmly SD - overall, he is simply a Keynesian (K).

And if you read and find both Krugman and Caplan persuasive, may I suggest the Disequilibrium - WNK space that I place myself into?