Origin of Specious
Macroeconomic Theory and Operational Reality
Alexander Douglas | Lecturer in Philosophy at Heythrop College, London
Monday, August 3, 2015
Alexander Douglas — Macroeconomic Theory and Operational Reality
Origin of Specious
Macroeconomic Theory and Operational Reality
Alexander Douglas | Lecturer in Philosophy at Heythrop College, London
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24 comments:
As encouraging as this is, fantasy land economics never goes away, swatting at the goofiness is a game of whac-a-mole
I heard a nice, intuitive and very easy argument recently that puts loanable funds to bed. No fancy mathematics, no convoluted diagrams, just a straight simple argument that goes like this:
When the government borrows, from whom does it borrow? The private sector who have funds in the financial system, right? The government borrows these funds and spends it directly back into the economy. Where do these spent funds find their way to? Back into the private sector who on aggregate have the same amount of funds in the financial system that they had prior to the government borrowing. Where else can the government spending and private funds go, but back into the financial system? So government borrowing cannot decrease the amount of funds available. If anything, it will crowd in spending by sustaining aggregate demand.
I don't know if this is fully MMT consistent or even if it indeed captures many of the nuances, but I've been using it recently and it's convinced everyone who's heard it. I even used it on a retired Greek econometrician (not Yanis!) who said he couldn't see the flaw in the argument but was nevertheless insistent that it couldn't work like that.
John, this is correct. In the unlikely event that all government securities issuance is taken by the non-bank domestic private sector, then deposits (M1) remains the same after government spending into the domestic economy. This should be obvious to anyone that can do basic arithmetic and understands basic accounting.
But generally not all tsys (gilts) are purchased by the non-bank domestic private sector using deposit accounts. Banks buy securities for their inventories as do foreign governments that have accounts with the cb, in which case bank deposits are not affected and government credits to bank deposits (M1) from spending is net positive.
According to MMT, securities issuance is simply a reserve drain that leaves the amount of non-government net financial assets unchanged in aggregate. Only the composition of assets changes. It is just portfolio shifting to take advantage of interest.
This is where people get hung up. They find it difficult to understand that government is not borrowing from the private sector when it issues securities, which seems intuitively to involve competing for funds. I have found that even smart people have difficulty getting beyond this even when the operations are explained.
First, endogenous money is a stretch from many people to get, and secondly, distinguishing the currency issuer from currency users. I can't figure out why it is so difficult for many. Some get it right away as being obvious even though they didn't have a clue about the mechanics before.
"What this tells you is that the Bank of England sets its policy interest rate "
But libertarians cannot believe this (this what makes them libertarians) ... the key word here is "sets".. as in "the government SETS..."
This is anathema to a libertarian, which btw is a philosophy, and this guy is a philosopher so it would be nice of him to acknowledge how f-ed up this philosophy is...
The problem is L-I-B-E-R-T-A-R-I-A-N-I-S-M ....
John you are ignoring the role and functions of the Primary Dealers in the process... like Dan has been doing (for simplification perhaps...)
Its like this guy says:
"Let’s be clear on the institutional, operational facts before we start..."
He is making a good point and the Dealers are part of the 'institutional, operational facts"...
rsp,
Matt,
You're right, I'm missing out the functions of primary dealers, which is a nuance (admittedly a pretty big nuance) that most regular people wouldn't factor in anyway. The argument I laid out above is directed at everyday folk who are bamboozled by all the stuff about crowding out. And supposing you used the above simple argument, how many economists, let alone regular people, would argue back at you the role of primary dealers and all the other intricate monetary plumbing, which I hazard to guess they don't understand?
I think if you start with the "institutional, operational facts" from get go you'll lose people. It's best not to introduce general relativity with differential geometry until you've given them an intuitive understanding of space-time, then they can relate all the advanced mathematics to what is physically intuitive (I remember sitting in a seminar in which a brilliant mathematician, who'll go unnamed, was laughed at by the general relativists because he let some obscure topological reasoning get in the way of something that was so physically obvious that it was almost painful to watch).
The stuff about institutions and operations can be left for a couple of weeks. In any case, I've yet to see a good piece written for the average joe on the institutional and operational facts that doesn't raise a lot more questions than it answers. This stuff is not intellectually difficult; it is conceptually troubling. That is where people get uneasy in accepting it. If surgeons, software engineers and particle physicists don't get it, it's not because they're mentally lacking. They have yet to be painted a rival picture that is as conceptually easy to grasp as the masterpiece that captivates all before it.
Matt,
I think I have an answer to the perennial question posed: Are they stupid, are they ignorant or are they shills? Given the fact that the economics and finance curricula are dramatically different to what they were pre-eighties: little economic history, almost no history of economic thought, nothing on competing schools of thought (just neoclassical), I think we can say that these people are ignorant of the real world. There has been a deliberate campaign of obfuscation and indoctrination in education, resulting in highly intelligent people like Krugman saying manifestly absurd stuff. Friedman and his Chicago school monetarists were knowing shills, but in their wake they have left nothing but illiterate propagandists.
Maybe, but my point wasn't just to swat at the silliness. It was to show that there is now a wealth of official operational literature showing that these theories are deficient. This didn't used to be the case - we had to take the word of monetary 'insiders'. So maybe things will change in economics now.
John I also think their libertarian ideology is at work here too...
so you might have a person who has the technocratic training to understand these operaitonal systems... but if they are hell bent libertarians, once they read "government sets...." they check right out... they cease mental engagement... it goes right back to "loanable funds" like "funds" exist in the ether and somehow both the govt and non-govt sectors are on an equal plane and "competing" for the same funds in the ether or however their deranged libertarian brains work...
rsp,
The dealers participate in the auctions as broker-dealers. They take offers from subscribers and bid on their behalf. There is no reason in principle why entire auctions would be subscribed by owners of deposit accounts that would be debited for payment.
The BDs are also market makers. As market makers, the BDs pick up the residue of undersubscribed auctions for their inventories, which they expand and contract based on conditions in markets.
Mankiw wouldn't deny what you say - funds borrowed by the government (or private borrowers for that matter) are returned to the stock of loanable funds. But increasing bids for the stock of funds drives up the interest rate. So when the money is returned, it's only available to borrow at a higher rate.
The question is why you should then see government borrowing as pulling back supply rather than pushing up demand. Mankiw does explain this in the textbook I quoted. 'Loanable funds' means 'funds available to the private sector'. When the government borrows funds, it makes them temporarily unavailable to the private sector. When it spends what it has borrowed, the funds are again available for private borrowing, but only at a *higher interest rate*. Thus government borrowing reduces the stock of funds available *at a given interest rate*.
I'm not defending Mankiw’s analysis, as my post should have made clear! But I'm not sure your counterargument quite hits the mark.
In reality of course the government has to make sure there's always enough liquidity to keep the market makers accepting bids at rates consistent with monetary policy (which the DMO document I cited clearly states). It would be silly to try to set rates in the money markets and then let them be arbitraged away in the bond markets!
But loanable funds assumes a fixed supply of liquidity, so that rates can be bid up in both the money market and the bond market. It's operationally false, but I guess it's logically consistent... Up to a point.
Even that is a specious argument because the interest rate would drop with the return of funds to the stock of loanable funds that was diminished by the flow to tsy purchases through the flow of spending. So interest rates would rise one day and fall the next. Is there any empirical evidence for this? Of course not, unless the policy rate changes. Conventional economists just make stuff up.
This is like the dumb market analysis that forgets there are two sides to every trade and just focuses on one.
Agreed! And thanks for sharing my post, btw.
The way I have seen the argument go is that the cb sets the policy rate based on its perception of supply and demand in the money market, so the policy rate and yield curve mirror the market. The cb doesn't act independently of the market but is market-responsive. Of course, the cb can err but the market will set them straight. This is the basis of bond vigilantism.
Evidence?
They claim it is self-evident.
That was a brilliant piece of work, Alex, and I will be sharing more of your work. Very nicely stated.
After putting it up here, I saw that Stephanie Kelton also shared it.
axdouglas,
Tom is quite right. Why wouldn't the interest rate drop back to the initial rate when the funds are returned? The supply has returned to the initial amount, so why shouldn't the rate? Indeed, you'd think Mankiw would argue this very position as an elementary example of supply and demand in action.
Mankiw's argument doesn't make any sense. He has to be able to do better than this, and if he can't then his arguments are hollow. This is nothing but dogmatism. No matter how theoretically and empirically hollow their arguments, the rival arguments, no matter how powerfully explanatory, are dismissed with a simple wave of the hand.
A couple of months back, the Bank of England released reports on how money is endogenously created by the private banking sector. What was the effect? Nothing. Nearly all the academic economists couldn't care less. Truly amazing! This inability to deal with the real world is seldom encountered outside of religious and national fanaticism.
Thanks very much. It was very nice to see the great Stephanie Kelton sharing my post. I am very grateful to you both. It's rare for philosophers to attract any interest from people outside philosophy!
Tom is indeed right, and so are you. I'm very interested, from a philosophical point of view, in understanding the condition of economics. It's just a shame it causes so much misery to the victims of misguided policy.
Many years ago, at a time when I was certainly incapable of appreciating or doing it true justice, I read Joan Robinson's little book on economic philosophy. Time to reread it, I think.
On the whole, I'd say that economics is a simple reflection of the social relations present. Neoliberal finance capitalism is preeminent and it needs a systematised body of thought that can defend its unreal world, all the better if it can be "proven" scientifically with the kind of simpleminded nineteenth century mathematics that economists think is useful.
My contention is that economics is really a form of philosophy, as are psychology and the other social science. The natural and life science have largely but not completely spun off from philosophy, but they are still closely connected with philosophy through philosophy of science, for example. What scientists think they are doing influences what they do. But psych and the social science are still quite speculative in their approach for the simple reason that the subject matter doesn't easily lend itself to quantification because quality supervenes and quality tends to complexify human affairs in that human value matters differently.
Psychology and the social sciences remain largely speculative, resting on assumptions that don't have an empirical warrant. To the degree they are not experimental, they are also not causal explanations. The so-called science in them is mostly based on correlation that supposedly speaks for a hypothesis but not exclusively. Correlations are plausible explanations, like various interpretations or a text. There are also issues with the statistical reasoning, as Lars Syll tireless points out. In these fields there is no agreed upon best explanation as there is in the natural sciences.
Moreover, both the natural and life sciences have paradigms that determine normal science and anomaly, in the Kuhnian sense, so it is rather simple to distinguish what is settled from cutting edge. Neither psychology nor the social sciences including economics do and there are competing frameworks within which questions are raised and issues approached.
In addition, there is naïve philosophy and critical philosophy. As Socrates famously said, the unexamined life is not worth living. But few examine their philosophies, which everyone must have as framework for meaning and interpretation of experience, even if one only posits it as a heuristic. Most people take their worldview as reality, however, and argue with others over "reality" when they are really arguing naively about views.
Much of conventional economics is based on naïve philosophy, both as stated assumptions and hidden assumptions. This is true of some approaches to psychology and social science, too. B. F. Skinner in psych, and Gary Becker in economics, but Becker's rational choice theory has infected social science, too. Methodological individualism, which tacitly assumes ontological individualism, is a philosophical position, too, that leads to, for example, to homo economicus and ignores homo socialis.
Everyone's worldview fits into some ordinarily long ago elaborated philosophical framework that is acquired through enculturation. This remains naïve until subjected to critical analysis from the angle of metaphysical, ontological, ethical and aesthetic, which analysis assumes logic as a prerequisite, just as science assume math as a prerequisite.
Very nicely put, Tom. If I ran a publishing house or was an editor, I'd sign you up, tout suite!
"When the government borrows funds, it makes them temporarily unavailable to the private sector. "
But that's the point. It doesn't. It just moves them from one private sector operator to another. Just as with taxation - because of course the government 'borrowing' is a form of taxation where the taxpayer has a special receipt for the tax they paid which forms part of their wealth and which attracts an ongoing income.
So there isn't any less supply, and because the government has borrowed and spent, there is immediately less demand.
So even under its own logic the interest rate the pressure for the interest rate is downwards under supply and demand - particularly has the savings market has to 'clear'.
Therefore the government has to borrow and spend continually to stop the interest rate going down.
I think a lot of this is pointless. Loanable Funds is wrong then it means it is wrong. It is pointless to say "if loanable funds was right then.." It's not right, money is endogenous. We are really arguing over how many angels dance on a pinhead.
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