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.

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