Saturday, January 23, 2010

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.

Friday, January 22, 2010

Macro Cube - 3

In the last post, I covered 6 of the 12 edges of the macro cube. These were:

1) AB : Folk Keynesian (FK)
2) BC : Keynesian (K)
3) CD : Minsky-like Post-Keynesian (MPK)
4) DA : Functional Finance (FF)
5) BQ : Neo-Wicksellian (NW)
6) QR : Monetarist (Mo)

Let's cover the other 6 now.

7) CR : This is a set of theories that shares its preference for monetary solutions over fiscal ones in most cases with the neo-Wicksellian orthodoxy. However, some new dimensions are introduced. Some versions try to consider credit and the financial system; at any rate cash is an explicit feature of the economy. Money is thought to be especially privileged and could be exogenous or endogenous. Some versions of the theory have money as privileged as it is a medium of exchange/store of value (Nick Rowe, here and here). Others privilege it as it a medium of account (Bill Woolsey, here - though he is an MD theorist proper) or a numeraire. Some, like Brad De Long, worry about liquidity traps that may render monetary policy ineffective in extreme cases. Others, like Willem Buiter, worry that the tying up of a medium of exchange with a numeraire (or a 1 to 1 conversion between reserves and currency) unnecessarily curtails monetary policy options. At all times, the attempt is to merge Keynesian and Neoclassical views of money and the economy with heavy doses of disequilibrium. I will call these guys the 'Monetary Keynesians' (MK). The intellectual fountainheads of this theory are surely Irving Fisher (in the post-depression era) and Don Patinkin.

Now you may wonder how one can place an avowed monetarist like Nick Rowe in the same theory as an unabashed Keynesian like Don Patinkin. They are united, I believe, with their 'disequilibrium' and Keynesian approach to money. Remember, that the Keynes of 1930 was somewhat different from the Keynes of 1936. And of course, we have a spectrum - one third of the way from C to R is Patinkin, a further one-third away is Rowe. De Long is somewhere in between. This set of theories is very interesting and intellectually very attractive, though it may privilege money by just a tad too much.

8) RS: Alright, another interesting set of people and ideas. They treat the economy as if it is in disequilibrium, treat people as making sub-optimal choices and will yet not trust the government with fiscal stimulus, and only grudgingly with monetary actions. These have to be theorists who are skeptical of the government on not just utilitarian, but also moral grounds. Two distinct set of theories and theorists fit the bill almost perfectly - the Old Chicago (OC) school and the Free Bankers (FB). What I call Old Chicago is a set of people who had a unique and divergent take on the economy, but who were at the University of Chicago between the wars and formed one side of the intellectual opposition to Keynes - Frank Knight, Jacob Viner and Henry Simons. This forms the first wave of the Chicago-School, before the Friedman-Stigler era. They insisted on analytical rigour, yet regarded the future as inherently uncertain and volatile and defended capitalism on moral grounds.

The free bankers are a set of theorists who believe that private banks should have the right to have their own currencies and should operate with the minimal but hard constraint of full-reserve banking. Not only does this make money 'free' and 'sound', it also decentralizes monetary policy in a way that no central bank could hope to achieve. While some of the free bankers are general anarchists (Rothbard, David Friedman), the one I'm really looking at for the purpose of macro theory is George Selgin. He merged his understanding of Hayek and Leland Yeager to privilege money, but only just, and tried to show the tenuous links between 'free money' and 'sound money'. OC/FB theorists are sometimes likely to recommend a gold standard.

9) SP: Now, we have the Austrians (A). They understand that the economy may sometimes be in disequilibrium, but absolve such disequilibria of any great damages. They warn instead of greater future damages if credit bubbles are not allowed to die their natural death. Credit bubbles and the ensuing recessions are thought to arise from irrational investment decisions in the real sector and considered non-monetary, but may be stoked or aggravated by an irresponsible central bank. Deflations are not feared. Money is neutral for all practical purposes - though again, a central bank might create unnecessary illusions. This is a 'liquidationist' view of recessions - which prevents moral hazard problems but takes no account of the loss of social welfare and wealth, considering it a necessary readjustment. Governments and central banks don't have much of a role in such readjustments - though they can make it worse by unnecessarily stoking inflation through monetary and fiscal measures. Hence, neither are recommended. This is a quirky, consistent, far-right view that is unnecessarily fearful of government action and does not consider the demand-side at all. The Austrian theory of heterogeneous capital, sectoral re-adjustment and government skepticism has a ring of truth to it. But worrying about inflation in a crisis might just be akin to - as Robert Skidelsky put it - crying 'Fire' in Noah's flood, and adherence to the gold-standard is too deflationist.

Krugman blames them for much of the damage caused by the Hoover-Mellon administration in the Great Depression. Though that might be uncharitable, the Austrians are far too right for my liking, despite some interesting ideas. Rothbard and Bohm-Bawerk are the canonical Austrians. Hayek, I would place at vertex S, as a Neo-Austrian.

10) PQ : What lies between the New Classicals and the New Monetary Consensus? Why, the New Chicago (NCh) guys, of course. By this, I refer to Robert Lucas, Robert Barro, John Cochrane and everyone else who believes that markets almost always self-correct, fiscal policy is useless due to corruption and/or Ricardian equivalance and monetary policy may be used, but only judiciously. These are essentially the third generation of Chicago economists - the first being Knight et al, the second being Friedman-Coase-Stigler et al. As theorists who refuse to leave rational expectations and optimization, and would rather treat recessions as some "episodes" (Lucas) or "residuals" (Barro) they are far-right, far too theoretical and seemingly more concerned with precision than relevance. Though they are far too trusting of the efficiency of markets, some of their more sombre ideas have meat - as can be witnessed in this recent interview, for example.

11) AP: Between socialist fiscalism and the New Classicals - the most left-wing and the most right-wing of our theories here - there can't be any one cogent theory. So, I will use the 'spectrum' view of things one more time. As we move from left to right, on a path that eschews monetary policy and doesn't have a good disequilibrium theory of the economy, we will first meet some naive centrists who would think of deficit spending in crises but not of interest rate cuts. There aren't many academics who would hold this view, but enough laymen. They are fiscalists, but trust markets to do the job in normal times. They aren't very interesting.

But further down right, there's a set of theories that is very non-monetary and equilibrium-driven in its approach but favours fiscal policy, albeit not deficit spending. Yes, we are talking about the 'cut-taxes-please' Supply Siders (SS) - people like Jude Wanniski and Arthur Laffer. Krugman once called them snake-oil theorists, and I am tempted to agree. We should remember, though, that when times are good focusing on the productive capacity of the economy as opposed to simply consumer demand might be important. In a crisis, this theory has nothing to add.

12) SD: This is a rather broad spectrum too, with the Neo-Austrians on the right and the Post-Keynesians on the left. But there are many common themes that unite them. One is surely the idea of heterogeneous capital that makes monetary aggregates irrelevant and credit risk important. The other is a distrust of the financial sector, as well as of monetary policy's effectiveness in solving problems arising out of the financial or the real economy. The result - you often see these theorists worry about excessive credit, moral hazard, big banks and inflation expectations. For this crisis, whether they blame the government or the financial sector is more or less a question of political ideology rather than theory, for the theory is often the same. Apart from the Austrians and the Old Chicago school, this is also the set of people most likely to recommend the gold standard as a way to prevent the potential debauchment of the price level by central banks. If you begin from S and start moving to D, you might first encounter Joseph Schumpeter, then someone like V Anantha Nageswaran and further to the left, Simon Johnson and James Kwak of the Baseline Scenario blog. It's a very interesting set of theories, but one that I find most useful when I consider them along with the Monetary Keynesians.

I don't really know what to call them - Real & Financial Disequilibrium (RFD) theorists is the best I can come up with.

Phew, all edges done. The faces for the next post.

Macro Cube -2

Ok, let's begin with a quick recap of the last post. I tried to categorize macro theories along three axes -

1. Does the theory use/believe in equilibrium and optimization? (E/O)
2. Does the theory recommend monetary stimulus in abnormal times? (M)
3. Does the theory recommend fiscal stimulus in abnormal times? (F)

Then, on the (E/O, M, F) co-ordinate space, I placed the 8 vertices of the resultant cube as follows

A (1,0,1) : Socialist Fiscalism (SF)

B (1,1,1) : Neo-Keynesian (NK1)

C (0,1,1) : Disequilibrium Keynesian(DK)

D (0,0,1) : Post-Keynesian (PK)

P (1,0,0) : New Classical (NC) Q (1,1,0) : Neoclassical/ New Monetary Consensus (NMC)

R (0,1,0) : Monetary Disequilibrium (MD) S(0,0,0) : Neo-Austrian (NA)

Let's begin with the edges of the cube now.

1) AB : Between the Neo-Keynesians and the socialist fiscalists, we have people who may or not recommend central bank action but definitely recommend fiscal initiatives to boost consumer spending and reduce unemployment, in good times and bad. This is a left-of-centre view that that Arnold Kling calls 'Folk Keynesian' and Paul Krugman once disparagingly called 'Vulgar Keynesian'. I will go with the Arnold Kling nomenclature (FK). It does not have much currency among academic scholars, though it is often the dominant popular view of the macro-economy. It strives for the right aims, but recommends the wrong policy actions and has confused theoretical underpinnings. Unfortunately, if you hold such a view in India, you would be considered 'centrist'.

2) BC : Recommend strong government action of monetary and fiscal kinds in crises, mild government action otherwise. Since I am running out of various prefixes, I am going to simply call it Keynesian (K). Jim Tobin and his brand of Keynesian teaching at Yale in the 70s is the best example of such a theory. Tobin was also the flag-bearer of the Keynesian defence against the Monetarist onslaught and made the first concerted efforts at integrating asset markets with macro-economic theory. More recently, Christy Romer & George Akerlof can be said to be of a true Keynesian persuasion. It is a comprehensive, coherent and attractive theory, but one that was surely called into question during the stagflation of the 70s (though the Keynsians would like to attribute that to the one-time but significant oil supply shock of the era) .

3) CD : Minsky inspired Post-Keynesian theorists. They try to integrate the financial instability hypothesis with the theory of endogenous money. I don't know what to call them but I can think of no better example than Steve Keen, who blogs at Debtwatch. Keen goes one step further than incorporating Minsky, Graziani and Moore into Keynes. He also tries to incorporate the debt-deflation hypothesis of Irving Fisher and Schumpeter's non-linear dynamical version of the economy. It is a difficult, perhaps fruitless research program but one that resonates with economic reality often enough to not be discarded. Keen is more left-wing than I think he should be, but there is no denying that his insights are ignored by the mainstream macro to its own disadvantage. This, actually, is about as left as I am willing to go.

4) DA : Functional Finance (FF) Theorists. This is the view that combines Chartalism (government deficits are necessary for the existence of a monetary economy) and strong fiscal dominance (Treasury >> Central Bank) with the notion of boosting consumer demand for employment and as a result asks for the government to do whatever it can fiscally to keep the economy up and running and happy. Abba Lerner is its foremost theorist and he summarized the view most succintly when he asserted that balanced budget constraints apply to individuals, not governments. More recently, one can find something similar espoused by Joseph Stiglitz when he recommended that the way out of the Asian crisis was more, not less, government spending. It is the policy proposition that resulted when a Machiavellian Republican president arm-twisted a reputed Keynesian/monetary theorist. It usually results in consumer profligacy, and has been strongly criticized in various ways by many scholars, including Ken Rogoff here (his open letter to Joe Stiglitz following the latter's book Globalization And Its Discontents).

5) BQ : This is the equilibrium theory that keeps an open mind to fiscal stimulus in bad times, but prefers monetary methods a lot more as it asserts that fiscal policy multipliers may be minimal due to a multitude of reasons. It is perhaps the dominant graduate school orthodoxy, and I will call these theorists neo-Wicksellian (NW) - as Nick Rowe does - for its obsession with the short-term interest rate. Inflation and output targeting is the goal, through rule-based or discretionary methods. The leading theorists are pretty much the who's who of modern monetary macroeconomics. One third of the way from B to Q, you will find Stan Fischer and Olivier Blanchard. A further one-third and you have John Taylor and Jordi Gali. ( I was a little off in saying that John Taylor was at vertex Q - Robert Hall is probably a better bet for that slot.) Somewhere in between, you will find Alan Greenspan's policies as the Fed chair. Though it is not an obnoxiously free-market-supporting theory as some like to characterize it, it has rightly taken a hit in this crisis for its predilection with equilibrium and the risk-free rate. Abstracting out of cash, credit risk and the financial system are model-simplifications that this theory needs to abandon.

6) QR : Finally, the Monetarist (Mo) view. Economy may be in equilibrium or disequilibrium, but central banks can always do enough to render fiscal policy unnecessary. The velocity of money (V) is either a constant, or increases in the money supply (M) and/or quantitative easing can always overcome a drop in the V so that the nominal GDP (M*V) can always be targeted and stabilized. Since discretionary policy may be subject to various errors and political pressures, a pre-announced targeted path of nominal expenditure or monetary aggregates is the best central bank policy. Money is exogenous, non-neutral in the short run but neutral in the long run. I probably shouldn't even bother to say it, but Milton Friedman is the canonical Monetarist. It is an attractive, theoretically sound view but one that was called into question in the Volcker recession. It's main problem is that it too abstracts away from credit risk (and hence does not pay enough attention to V).

Let me stop here and leave the other 6 edges and the 6 faces for the next couple of posts.

Thursday, January 21, 2010

The Macro Cube - 1

After a long time, back to macro. Even the most cursory of observers of the recent macroeconomic debates must have noticed that the field is far from settled. Some debates are academic, some political, some on theory and others on applications of that theory. How is one to make sense of all the theories and opinions flying past us? How does one decide, if one can't catalogue?

Allow me to present the completely new and original (and hopefully useful) Macro-Cube. This is also my first attempt at having anything remotely pictorial on this blog - hope it goes well.

Right, so let's get down to business. What is this cube? Very simplistically, it tries to catalogue theories (and the ideologies they entail) along three axes. These axes are each represented by a question.

1. Does the theory depend on/utilize equilibrium and optimization as major tools/concepts? (Equilibrium/Optimization)
2. Does the theory recommend monetary policy/stimulus in abnormal times? (M recommended)
3. Does the theory recommend fiscal policy/stimulus in abnormal times? (F recommended)

Why these three? Well, the first because of all methodological simplifications used by economists, equilibrium and optimization are the ones that seemingly introduce the greatest distortions from reality, and the ones that look most disposable in non-normal times. The second and the third are obvious - the macroeconomics of business cycles would have little relevance to the general society if it were not for the policy implications/ predictions that it makes. These policies usually stack up along the broad lines of fiscal or monetary initiatives, and the major macro theories also diverge along these lines.

Now, what do we do about these axes? Along each axis, a binary answer of 1 or 0 answers each of the above questions in a yes or no. This gives us a total of 8 polar points, or the 8 vertices of the cube. The resultant truth table is drawn in a manner that will be familiar to anyone conversant with boolean logic. For example, if your theory says that economic actors can be assumed to optimize and the economy is usually in equilibrium, and you strongly recommend both fiscal and monetary correctives anyway, you are a (1,1,1) or you lie on vertex B of the cube - and so on.

Clearly, various points within the cube, on each edge or face or even inside, represent points of view and theories that are somewhere in between the polar theories. What are the vertices and where do the more prominent theories fall?

A (1,0,1) : Theory that utilizes equilibrium and optimization, and recommends fiscal actions but not monetary. I understand it as a set of various theories that don't think a central bank or monetary policy is too important independently, recommend its subservience to the finance ministry or the treasury, want this treasury to run a bunch of fiscal initiatives in good times and bad, and think that the economy will be on track - if only the government is allowed to micromanage the macro-economy. From the description itself, this is a rather non-coherent theory - perhaps an unfair characterization on my part. Forgive this as a model simplification - I am less convinced of the existence of this vertex than any other. Let's call this vertex Socialist Fiscalism and move ahead after noting that sensible theorists and practitioners should have nothing to do with this rather naive view of the economy.

B (1,1,1) : Theory that utilizes equilibrium and optimization, and recommends both fiscal and monetary policy when times are non-normal. This should not be hard to guess. This is the classic Neo-Keynesianism of Solow, Samuelson and Modigliani and the IS-LM cross. It was the dominant paradigm for a long time and it is what introductory macro courses in most business schools still teach. One might wonder why the theory recommends strong government action though its methods of equilibrium and optimization entail self-correcting and complete markets. Well, the trick that the Neo-Keynesians used was to take sticky prices and wages from Keynes and use it to explain recessions and justify government action. As a result, this theory suffers from some incoherence due to a lack of micro-foundations but still has a lot of offer by way of policy recommendations in bad times.

C (0,1,1) : Alright, things get interesting here. Now we have a theory that discards equilibrium and optimization and hence recommends both monetary and fiscal initiatives depending on the conditions. I will call this 'Disequilibrium Keynesianism'. I can think of no better example of such a theory than Hyman Minsky's financial instability hypothesis, which Minsky proposed after extensive study of Keynes's General Theory and the financial system. It is the most 'left-wing' theory that I find myself in strong agreement with. In a financial crisis this theory looks very attractive but what one must keep in mind is - do we have reason to be so trustful of the government and so distrustful of markets on the average (or even in a crisis).

D (0,0,1) : Disequilibrium, monetary initiatives not useful in a recession, hence fiscal stimulus. This is classic Post-Keynesianism. Keynes's chief rationale for a fiscal stimulus was the liquidity trap argument. Post-Keynesians are wont to believe either that the economy is frequently in a liquidity trap or, more subtly, that money is endogenous and hence exogenous monetary actions by the central bank are useless. Or both. Paul Davidson, the Circuitists, and the Chartalists are good examples. On the left-right spectrum, these guys fall slightly left of Minsky and though they have several good and arguable ideas, they are more skeptical of the market economy than they should be.

P (1,0,0) : Equilibrium, self-correcting and optimizing markets, government policy either ineffective or actively damaging and hence not recommended. Right, we're talking about the New Classicals here. To me, this is a theory that prefers theoretical coherence over correspondence with reality. Money is thought to be neutral even in the short-run. Recessions are either sudden large vacations or real-sector phenomena that will correct soon enough or something equally implausible. Of course, most of the big names associated with New Classical macro are more moderate and nuanced in their thought but I think Thomas Sargent and Ed Prescott can still be placed firmly on vertex P. This is the most right-wing of our theories here, and the one most sanguine about markets - I don't find most of its views attractive.

Q (1,1,0) : The economy is mostly in equilibrium, economic actors optimize, monetary policy can be effective in the short run, but fiscal policy almost certainly isn't. This shouldn't be hard to guess either. This is the standard Neo-Classical view of the economy. This is the view of the first ever macro-model of the economy, of Irving Fisher before the Great Depression and before the debt-deflation hypothesis. This is also the theory of Taylor-rule based inflation targeting monetary policy that resulted from the uneasy truce between New Classicals and the New Keynesians. Following the good people of the Levy Institute, I will call it the New Monetary Consensus. Examples? None better than John Taylor and Michael Woodford. Closer to home - Ajay Shah. This is the standard macro-view backing mainstream capitalist thought, though a lot of its assumptions and conclusions are quite questionable. This is as right-wing as I get.

R (0,1,0) : The economy could be in disequilibrium, this disequilibrium is fundamentally monetary in nature and hence the solution is monetary, not fiscal. This is another interesting point of view and one that I would have been unexposed to had I not been following some blogs. These are the Monetary Disequilibrium theorists, and their fountainhead should surely be Leland Yeager. Yeager combined the fiscal suspicion of Hayek with the monetary theory of Keynes and created a new theory that is rather attractive and woefully under-explored by the mainstream. Money is thought to be completely exogenous, and the central bank can always help things by slashing interest rates, quantitative easing or by de-linking reserves and currency.

S (0,0,0) : Ladies and gentlemen, welcome the Neo-Austrians. I take the name from one of the various terms that Arnold Kling has used for his rather novel take on things. It says that the economy is frequently in disequilibrium, but that these disequilibria are the natural process of the evolution of the economy and government tinkering is either ineffective or damaging. Money is neither neutral, nor privileged - for what good does monetary policy do when the adjustment is hypothesized to be inter-sectoral and in real (not just monetary) terms? Fiscal policy can be subject to corruption, or can stoke and aggravate moral hazard or inflation problems. It is an interesting proposition, though I find it most useful when considered together with the Disequilibrium Keynesianism of vertex C.

So there you have it - descriptions of the 8 polar cases. I thought of such a cube for the first time about two months back but only now have been able to comprehensively place theories and theorists along the proper vertices, edges and faces of the cube. And if you found the vertices interesting (or are wondering just where the hell Friedman and the Monetarists went), wait for the next post which will be about these in-between theories.