Thursday, September 11, 2014

Piketty and the Money View

I recently picked up Capital and the 21st Century again. And what's striking to me, on revisiting it, is the contrast between the descriptive material and the theory used to make sense of it.

Piketty’s great accomplishment is the comprehensive data on wealth he has compiled, going back to the 18th century. He deserves nothing but praise for making that data easily accessible. (You could think of his project as an iceberg, with most of the substance hidden below the waterline in the online appendixes.) I have not seen any serious doubts raised about the accuracy of this data; and the descriptive generalizations he draws from it, while not above criticism, are obviously based in a deep study of the concrete historical material. But the connections between this material and the theoretical claims it's mixed in with -- r > g and all that -- are tenuous at best.

It’s important to remember that all the underlying data is in nominal terms. All the empirical material in the book relates to stocks and flows of money. But when he turns to explain the patterns he finds in this data, he does it in terms of physical inputs to physical production. The money wealth present in a country is assumed to correspond to the physical capital goods, somehow converted to a scalar quantity. And the incomes received by wealth owners is assumed to correspond to a physical product somehow attributable to these capital goods. I am hardly the first person to suggest that this is not a sensible way to explain trends in private wealth as measured in money, and the money-income derived from it. But what I haven’t seen people say — even people who jump at the chance to revisit the Cambridge Capital Controversies — is the remarkable difference in the attitudes of Piketty the historian and Piketty the economic theorist to data. Shifts in the scale and distribution of private wealth are described on the basis of years of meticulous study of the tax records of various countries. But the production processes that are supposed to explain these shifts are described without any data at all, purely deductively.  You would think that if Piketty believed that the share of property income in total income depends on physical production technologies, returns to scale, depreciation, etc., then at least half the book would be taken up with technological history. You’d think he would spend as much energy studying the inputs and outputs associated with different degrees of mechanization of major production processes, how long is the useful life of different kinds of buildings in different eras and how much annual maintenance they require, and so on. After all, these are the kinds of factors that he believes — or claims to believe — drive the money-wealth outcomes the book is about. In fact, of course, these topics are not discussed at all. Terms like “production” and “depreciation” are black boxes, pure mathematical formalism. You would think that Piketty, who presents himself as a historian and is admirably critical of the deductive character of so much of economics, would have hesitated before staking so much on deductive, evidence-free claims about physical production.

Because when you take a step back and think about it, this is what Piketty has done:  He has carefully described the historical evolution of monetary wealth, and then postulated an imaginary physical reality that exactly matches that evolution. It’s a kind of economic preformationism, or like the folk psychology that tries to explain your actions by imagining a little homunculus in your head that is choosing them.  The “real economy” in Piketty is just a ghostly mirror-image of the network of money payments and money claims that is actually observed.

* * *

Let me give a concrete example. Piketty shows that around 1800, the wealth-income ratio was relatively low in the United States -- about 300% of national income, compared with 600-700% in England and France. About half of this difference was the lower value of agricultural land, which totaled about 150% of national income in the US and over 300% in both England and France. Piketty suggests that this is because the great abundance of land in the New World meant that its marginal product was relatively low. This sounds reasonable enough -- but it flies in the face of Piketty's larger argument about the capital share. His big theoretical claim is that the capital share is determined by the growth rate of cumulated savings relative to the growth rate of income. And this only works if the return on "capital" is relatively insensitive to its scarcity or abundance. (This is the question of the elasticity of substitution between capital and labor, which has dominated economists' debates about the book.) If having more land makes the share of land rents in national income go down, why won't the growth of "capital" similarly push down its return?

This isn't meant as a gotcha. Piketty frankly acknowledges the problem. He suggests two possible solutions: First, constant returns might only apply over some range of capital-output ratios. Beyond that that range, further accumulation might make capitalists as a group poorer rather than richer. Second, it might be easier to substitute between labor and modern capital goods, than between labor and agricultural land. Both these assumptions sound reasonable, altho I think they are both more problematic than they seem at first glance. But that's not the argument I want to have right now. The point I want to make now is that Piketty just takes it for granted that behind the smaller flow of money going to land owners in US circa 1800, there must have been a smaller physical flow of output coming off the marginal piece of land. Of course this isn't logically necessary -- the money-value of agricultural land will also depend on the legal rights associated with land ownership, the terms on which new land can be acquired, the ease with which land can be sold or borrowed against, etc. Presumably the same physical mix of land, tools and people would have led to a different share of money income being claimed as land rents if frontier land in the early United States had been owned by a few large landlords, instead of being freely distributed to white families by the government. But these types of explanations are not even considered. For Piketty, behind each flow of money there must be an identical flow of stuff.

The other strange thing is that, despite his insistence that money flows are fully explained by physical conditions of production, Piketty shows no interest in investigating those conditions. The numbers on the level and composition of money wealth in US are meticulously sourced and documented. The claims about physical production conditions, on the other hand, are entirely speculative. There is no shortage of material you could turn to if you wanted to ask whether whether land was really more abundant, in an economically meaningful sense, in the early US than in France or Britain, or if you wanted to know if adding an acre to an 1800-era American farm would increase its output proportionately less or more than adding an acre to a similar-sized British or French farm. But Piketty doesn't even gesture at this literature.

* * *

I draw two conclusions. First, it's hard to say anything sensible about the book until you realize it consists of two distinct, almost unrelated projects. There is the historical data on money wealth and money incomes. And then there is the whole rigamarole of "laws of capitalism." The book is mostly written as if the latter somehow distill or summarize the former, but they are really very loosely articulated. Let me give one more quick -- but important -- example. You might think that with all the huffing and puffing about r > g, the data would tell a story in which the share of wealth in national income rises in periods when r is relatively high and g is relatively low, and falls when g is high and r is low. But the data tell no such story.

The great fall in the capital share took place between 1913 and 1950, according to Piketty. But his own data show that this was the period of the highest returns to capital, and the lowest growth rates, in the whole 240 years the book covers. I've reproduced his graph of r in the UK below; the figures for other Western European countries look similar. Meanwhile, he gives an average growth rate for Western Europe over 1913-1950 of 1.4%, compared with 1.8% in the high-capital share 19th century, and 2.1% in the period of rising capital shares since 1970. This is exactly the opposite pattern that we would expect if r and g were the central actors in the story.


Of course Piketty has an answer for this too: The fall in the capital share in the first half of the 20th century is explained by the World Wars and the destruction of the old social order in Europe. No doubt -- but if factors like these dominate the historical trajectory of wealth and income, why not tell your story in terms of them, instead of a few dubious equations from the orthodox growth model? Unfortunately, discussion of the book has been almost entirely about the irrelevant formalism. I think that is why the conversation has been so noisy yet advanced so little. To return to the earlier metaphor, it's as if everyone is ignoring the iceberg and talking about a little igloo built on top of it.

My second conclusion is that the disconnect between the two different Pikettys shows, in a negative way, why what I've been calling the money view is so important. The historical data assembled in Capital in the 21st Century is a magnificent accomplishment and will be drawn on by economic historians for years to come. Many of the concrete observations he makes about this material are original and insightful. But all of this is lost when translated into Piketty's preferred theoretical framework. To make sense of the historical evolution of money payments and claims, we need an approach that takes those payments and claims as objects of study in themselves.

Tuesday, August 19, 2014

Liquidity Preference on the F Line

Sitting on the subway today, I was struck by the fact that the three ads immediately opposite me were all for what you might call liquidity services. On the left was an ad for "personal asset loans" from something called Borro: "With this necklace ... I funded my first business," says a satisfied customer. Next to it was an MTA ad trumpeting the fact that you can pay your fare with a credit card. And then one from AptDeco.com, which I guess is a clearinghouse for used furniture sales, with the tagline "NYC is now your furniture store."


the Borro ad was the next one to the left
This was interesting to me because I've just been thinking about the neutrality of money, and what an incoherent and contradictory idea it is.

The orthodox view is that the level of "real" economic activity is determined by "real" factors -- endowments, tastes, technology -- and people simply hold money balances proportionate to this level of activity. In this view, a change in the money supply can't make anyone better or worse off, at least in the long run, or change anything about the economy except the price level.

Just looking at these ads shows us why that can't be true. First of all, the question of what constitutes money. All three of these ads are, in effect, inviting you to use something as money that you couldn't previously. Without the specialized intermediary services being hawked here, you couldn't pay the startup costs of a business with a necklace (what's this thing made of, plutonium?), or pay for a subway ride with a promise to pay later, or pay for much of anything with a used couch. And this new liquidity has real benefits -- otherwise, no one would be buying it, and it wouldn't be worth the cost of producing (or advertising) it. The idea -- stated explicitly in the Borro ad -- is that the liquidity they provide allows transactions to take place that otherwise wouldn't. The ability to turn a piece of jewelry or a car into cash allows people to use productive capacities that otherwise would go to waste.

And of course this makes sense. The orthodox view is that money is useful -- there must be a reason that we don't live in a barter world, and more than that, that all this huge industry of liquidity provision exists. But money, for some reason, is not subject to the same kind of smoothly diminishing returns that other useful things are. There is a fixed amount you need, you can't get by with less, and there's no benefit at all in having more. The problem is worse than that, since the standard view is that money demand is strictly proportionate to the volume of transactions. But, which transactions? Presumably, the amount of economic activity depends on the availability of money -- that's what it means to say that money is useful. And furthermore, as these ads implicitly make clear, some transactions are more liquidity-intensive than others. No one is offering specialized intermediary services to help you buy a hamburger. So both the level and composition of economic activity must depend on money holdings. But in that case, you can't say that money holdings depend only on the volume of activity -- that would be circular. In a world where money is used at all, it can't be neutral. An increase in the money supply (or better, in liquidity) may raise prices, but it won't do so proportionately, since it also enables people to benefit from increasing their money holdings (or: shifting toward more liquid balance sheet positions) and to carry out liquidity-intensive transactions that were formerly unable to.

This is a very old issue in economics. The idea that money should be neutral is as old as the discipline, and so is this line of criticism of it. You can find both already in Hume. In "Of Money," he lays out the argument that money must be neutral in the long run, since it is just an intrinsically meaningless unit of measure; real wealth depends on real resources, not on the units we count them in. Unlike most later writers, he follows this argument to its logical conclusion, that any resources devoted to liquidity provision are wasted:
This has made me entertain a doubt concerning the benefit of banks and paper-credit, which are so generally esteemed advantageous to every nation. That provisions and labour should become dear by the encrease of trade and money, is, in many respects, an inconvenience; but an inconvenience that is unavoidable, and the effect of that public wealth and prosperity which are the end of all our wishes. ... But there appears no reason for encreasing that inconvenience by a counterfeit money, which foreigners will not accept of in any payment, and which any great disorder in the state will reduce to nothing. There are, it is true, many people in every rich state, who having large sums of money, would prefer paper with good security; as being of more easy transport and more safe custody. ... And therefore it is better, it may be thought, that a public company should enjoy the benefit of that paper-credit, which always will have place in every opulent kingdom. But to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities, and thereby heightening their price to the merchant and manufacturer. And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce.
You can find similar language in "On the Balance of Trade":
I scarcely know any method of sinking money below its level [i.e. producing inflation], but those institutions of banks, funds, and paper-credit, which are so much practised in this kingdom. These render paper equivalent to money, circulate it throughout the whole state, make it supply the place of gold and silver, raise proportionably the price of labour and commodities, and by that means either banish a great part of those precious metals, or prevent their farther encrease. What can be more shortsighted than our reasonings on this head? We fancy, because an individual would be much richer, were his stock of money doubled, that the same good effect would follow were the money of every one encreased; not considering, that this would raise as much the price of every commodity, and reduce every man, in time, to the same condition as before. ...
It is indeed evident, that money is nothing but the representation of labour and commodities, and serves only as a method of rating or estimating them. Where coin is in greater plenty; as a greater quantity of it is required to represent the same quantity of goods; it can have no effect, either good or bad, taking a nation within itself; any more than it would make an alteration on a merchant’s books, if, instead of the Arabian method of notation, which requires few characters, he should make use of the Roman, which requires a great many. 
From this view -- which is, again, just taking the neutrality of money to its logical conclusion -- services like the ones being advertised on the F train are the exact opposite of what we want. By making more goods usable as money, they are only contributing to inflation. Rather than making it easier for people to use necklaces, furniture, etc. as means of payment, we should rather be discouraging people form using even currency as means of payment, by reducing banks to safe-deposit boxes.

That was where Hume left the matter when he first wrote the essays around 1750. But when he republished "On the Balance of Trade" in 1764, he was no longer so confident. [1] The new edition added a discussion of the development of banking in Scotland with a strikingly different tone:
It must, however, be confessed, that, as all these questions of trade and money are extremely complicated, there are certain lights, in which this subject may be placed, so as to represent the advantages of paper-credit and banks to be superior to their disadvantages. ... The encrease of industry and of credit ... may be promoted by the right use of paper-money. It is well known of what advantage it is to a merchant to be able to discount his bills upon occasion; and every thing that facilitates this species of traffic is favourable to the general commerce of a state. But private bankers are enabled to give such credit by the credit they receive from the depositing of money in their shops; and the bank of England in the same manner, from the liberty it has to issue its notes in all payments. There was an invention of this kind, which was fallen upon some years ago by the banks of Edinburgh; and which, as it is one of the most ingenious ideas that has been executed in commerce, has also been thought advantageous to Scotland. It is there called a Bank-Credit; and is of this nature. A man goes to the bank and finds surety to the amount, we shall suppose, of a 1000 pounds. This money, or any part of it, he has the liberty of drawing out whenever he pleases, and he pays only the ordinary interest for it, while it is in his hands. ... The advantages, resulting from this contrivance, are manifold. As a man may find surety nearly to the amount of his substance, and his bank-credit is equivalent to ready money, a merchant does hereby in a manner coin his houses, his household furniture, the goods in his warehouse, the foreign debts due to him, his ships at sea; and can, upon occasion, employ them in all payments, as if they were the current money of the country.
Hume is describing something like a secured line of credit, not so different from the services being advertised on the F line, which also offer ways to coin your houses and household furniture. The puzzle is why he thinks this is a good thing. The trade credit provided by banks, which is now "favourable to the general commerce of the state," is precisely what he was trying to prevent when he wrote that the best bank was one that "locked up all the money it received."Why does he now think that increasing liquidity will stimulate industry, instead of just producing a rise in prices that will "reduce every man, in time, to the same condition as before"?

You can't really hold it against Hume that he never resolved this contradiction. But what's striking is how little the debate has advanced in the 250 years since. Indeed, in some ways it's regressed. Hume at least drew the logical conclusion that in a world of neutral money, liquidity services like the ones advertised on the F train would not exist.


[1] I hadn't realized this section was a later addition until reading Arie Arnon's discussion of the essay in Monetary Theory and Policy from Hume and Smith to Wicksell. I hope to be posting more about this superb book in the near future.

Thursday, August 14, 2014

Innovation in Higher Ed, 1680 Edition

Does anybody read Bagehot's Lombard Street any more? You totally should, it's full of good stuff. It's baffling to me, as a sometime teacher of History of Economic Thought, that most of the textbooks and anthologies don't mention him at all. Anyway, here he's quoting Macaulay:
During the interval between the Restoration and the  Revolution the riches of the nation had been rapidly increasing. Thousands of busy men found every Christmas that, after the expenses of  the year's housekeeping had been defrayed out of the year's income, a surplus remained ; and how that surplus was to be employed was a question of some difficulty. In … the seventeenth century, a lawyer, a physician, a retired merchant, who had saved some thousands, and who wished to place them safely and profitably, was often greatly embarrassed. … Many, too, wished to put their money where they could find it at an hour's notice, and looked about for some species of property which could be more readily transferred than a house or a field. A capitalist might lend … on personal security : but, if he did so, he ran a great risk of losing interest and principal. There were a few joint-stock companies, among which the East India Company held the foremost place : but the demand for the stock of such companies was far greater than the supply. … So great was that difficulty that the practice of hoarding was common. We are told that the father  of Pope, the poet, who retired from business in the City about the time of the Revolution, carried to a retreat in the country a strong-box containing near twenty thousand pounds, and took out from time to time what was required for household expenses... 
The natural effect of this state of things was that a crowd of projectors, ingenious and absurd, honest and knavish, employed themselves in devising new schemes for the employment of redundant capital. It was about the year 1688 that the word stock-jobber was first heard London. In the short space of four years a crowd of companies, every one of which confidently held out to subscribers the hope of immense gains, sprang into existence… There was a Tapestry Company, which would soon furnish pretty hangings for all the parlors of the middle class and for all the bedchambers of the higher. There was a Copper Company, which proposed to explore the mines of England, and held out a hope that they would prove not less valuable than those of Potosi. There was a Diving Company, which undertook to bring up precious effects from shipwrecked vessels, and which announced that it had laid in a stock of wonderful machines resembling complete suits of armor. In front of the helmet was a huge glass eye like that of Polyphemus ; and out of the crest went a pipe through which the air was to be admitted. … There was a society which undertook the office of giving gentlemen a liberal education on low terms, and which assumed the sounding name of the Royal Academies Company. In a pompous advertisement it was announced that the directors of the Royal Academies Company had engaged the best masters in every branch of knowledge, and were about to issue twenty thousand tickets at twenty shillings each. There was to be a lottery : two thousand prizes were to be drawn; and the fortunate holders of the prizes were to be taught, at the charge of the Company, Latin, Greek, Hebrew, French, Spanish, conic sections, trigonometry, heraldry, japanning, fortification, book-keeping, and the art of playing the theorbo.
Many of Macaulay's examples, which I've left out here, are familiar, thanks to Charles Mackay and more recent historians of financial folly. (Including everyone's favorite, the company that raised funds "for an Undertaking which in due time shall be revealed.") The line about Pope is also familiar, at least to reader of The General Theory: Keynes cites it as an illustration of the position of the wealth-holder in a world where the rentier had been successfully euthanized. But I, at least, had never realized that the diving suit was a product of the South Sea bubble. And I'd never heard of this spiritual ancestor of Chris Whittle and Michelle Rhee.

It would be interesting to learn more about the claims that were made for this company, and what happened to it. Alas, Google is no help. Although, "Royal Academies Company" turns out to be a weirdly popular phrase among the Markov-chain text generators that populate fake spam blogs. (Seriously, guys, this is poetry.) We can only hope that today's enterprises that promise to give gentlemen a liberal education on low terms  (or at least an education in japanning and/or ski area management) will vanish as ignominiously.

Sunday, August 3, 2014

Strange Defeat: An Exchange

My EPW article with Arjun prompted an interesting exchange with Parag Waknis. Since the letters, like the article, are behind a paywall, I'm reposting them here, below the fold. Waknis' letter is first, followed by our response.


Thursday, July 31, 2014

Strange Defeat

Following up on the previous post, below the fold is an article Arjun and I wrote last year for the Indian publication Economic and Political Weekly, on how liberal New Keynesian economists planted the seeds of their own defeat in the policy arena. 

I should add that Krugman is very far from the worst in this respect. If I criticize my soon-to-be colleague so much, it's only because of his visibility, and because the clarity of his writing and his genuinely admirable political commitments make it easier to see the constraints imposed by his theoretical commitments. You might say that his distinct virtues bring the common vices into sharper focus.


The Call Is Coming from Inside the House

Paul Krugman wonders why no one listens to academic economists. Almost all the economists in the IGM Survey agree that the 2009 stimulus bill successfully reduced unemployment and that its benefits outweighed its costs. So why are these questions still controversial?

One answer is that economists don’t listen to themselves. More precisely, liberal economists like Krugman who want the state to take a more active role in managing the economy, continue to teach  an economic theory that has no place for activist policy.

Let me give a concrete example.

One of Krugman’s bugaboos is the persistence of claims that expansionary monetary policy must lead to higher inflation. Even after 5-plus years of ultra-loose policy with no rising inflation in sight, we keep hearing that since so “much money has been created…, there should already be considerable inflation.” (That’s from exhibit A in DeLong’s roundup of inflationphobia.) As an empirical matter, of course, Krugman is right. But where could someone have gotten this idea that an increase in the money supply must always lead to higher inflation? Perhaps from an undergraduate economics class? Very possibly -- if that class used Krugman’s textbook.

Here’s what Krugman's International Economics says about money and inflation:
A permanent increase in the money supply causes a proportional increase in the price level’s long-run value. … we should expect the data to show a clear-cut positive association between money supplies and price levels. If real-world data did not provide strong evidence that money supplies and price levels move together in the long run, the usefulness of the theory of money demand we have developed would be in severe doubt. 
… 
Sharp swings in inflation rates [are] accompanied by swings in growth rates of money supplies… On average, years with higher money growth also tend to be years with higher inflation. In addition, the data points cluster around the 45-degree line, along which money supplies and price levels increase in proportion. … the data confirm the strong long-run link between national money supplies and national price levels predicted by economic theory. 
… 
Although the price levels appear to display short-run stickiness in many countries, a change in the money supply creates immediate demand and cost pressures that eventually lead to future increases in the price level. 
… 
A permanent increase in the level of a country’s money supply ultimately results in a proportional rise in its price level but has no effect on the long-run values of the interest rate or real output. 

This last sentence is simply the claim that money is neutral in the long run, which Krugman continues to affirm on his blog. [1] The “long run” is not precisely defined here, but it is clearly not very long, since we are told that “Even year by year, there is a strong positive relation between average Latin American money supply growth and inflation.”

From the neutrality of money, a natural inference about policy is drawn:
Suppose the Fed wishes to stimulate the economy and therefore carries out an increase in the level of the U.S. money supply. … the U.S. price level is the sole variable changing in the long run along with the nominal exchange rate E$/€. … The only long-run effect of the U.S. money supply increase is to raise all dollar prices.
What is “the money supply”? In the US context, Krugman explicitly identifies it as M1, currency and checkable deposits, which (he says) is determined by the central bank. Since 2008, M1 has more than doubled in the US — an annual rate of increase of 11 percent, compared with an average of 2.5 percent over the preceding decade. Krugman’s textbook states, in  unambiguous terms, that such an acceleration of money growth will lead to a proportionate acceleration of inflation. He can hardly blame the inflation hawks for believing what he himself has taught a generation of economics students.

You might think these claims about money and inflation are unfortunate oversights, or asides from the main argument. They are not. The assumption that prices must eventually change in proportion to the central bank-determined money supply is central to the book’s four chapters on macroeconomic policy in an open economy. The entire discussion in these chapters is in terms of a version of the Dornbusch “overshooting” model. In this model, we assume that

1. Real exchange rates are fixed in the long run by purchasing power parity (PPP).
2. Interest rate differentials between countries are possible only if they are offset by expected changes in the nominal exchange rate.

Expansionary monetary policy means reducing interest rates here relative to the rest of the world. In a world of freely mobile capital, investors will hold our lower-return bonds only if they expect our nominal exchange rate to appreciate in the future. With the long-run real exchange rate pinned down by PPP, the expected future nominal exchange rate depends on expected inflation. So to determine what exchange rate today will make investors willing to holder our lower-interest bonds, we have to know how policy has changed their expectations of the future price level. Unless investors believe that changes in the money supply will translate reliably into changes in the price level, there is no way for monetary policy to operate in this model.

So  these are not throwaway lines. The more thoroughly a student understands the discussion in Krugman’s textbook, the stronger should be their belief that sustained expansionary monetary policy must be inflationary. Because if it is not, Krugman gives you no tools whatsoever to think about policy.

Let me anticipate a couple of objections:

Undergraduate textbooks don’t reflect the current state of economic theory. Sure, this is often true, for better or worse. (IS-LM has existed for decades only in the Hades of undergraduate instruction.) But it’s not much of a defense, is it? If Paul Krugman has been teaching his undergraduates economic theory that produces disastrous results when used as a guide for policy, you would think that would provoke some soul-searching on his part. But as far as I can tell, it hasn’t. But in this case I think the textbook does a good job summarizing the relevant scholarship. The textbook closely follows the model in Dornbusch’s Expectations and Exchange Rate Dynamics, which similarly depends on the assumption that the price level changes proportionately with the money supply. The Dornbusch article is among the most cited in open-economy macroeconomics and international finance, and continues to appear on international finance syllabuses in most top PhD programs.

Everything changes at the zero lower bound. Defending the textbook on the ground that it's pre-ZLB effectively concedes that what economists were teaching before 2008 has become useless since then. (No wonder people don’t listen.) If orthodox theory as of 2007 has proved to be all wrong in the post-Lehmann world, shouldn’t that at least raise some doubts about whether it was all right pre-Lehmann? But again, that's irrelevant here, since I am looking at the 9th Edition, published in 2011. And it does talk about the liquidity trap — not, to be sure, in the main chapters on macroeconomic policy, but in a two-page section at the end. The conclusion of that section is that while temporary increases in the money supply will be ineffective at the zero lower bond, a permanent increase will have the same effects as always: “Suppose the central bank can credibly promise to raise the money supply permanently … output will therefore expand, and the currency will depreciate.” (The accompanying diagram shows how the economy returns to full employment.) The only way such a policy might fail is if there is reason to believe that the increase in the money supply will subsequently be reversed. Just to underline the point, the further reading suggested on policy at the zero lower bound is an article by Lars Svennson that calls a permanent expansion in the money supply “the foolproof way” to escape a liquidity trap. There’s no suggestion here that the relationship between monetary policy and inflation is any less reliable at the ZLB; the only difference is that the higher inflation that must inevitably result from monetary expansion is now desirable rather than costly. This might help if Krugman were a market monetarist, and wanted to blame the whole Great Recession and slow recovery on bad policy by the Fed; but (to his credit) he isn’t and doesn’t.

Liberal Keynesian economists made a deal with the devil decades ago, when they conceded the theoretical high ground. Paul Krugman the textbook author says authoritatively that money is neutral in the long run and that a permanent increase in the money supply can only lead to inflation. Why shouldn't people listen to him, and ignore Paul Krugman the blogger?


[1] That Krugman post also contains the following rather revealing explanation of his approach to textbook writing:
Why do AS-AD? First, you do want a quick introduction to the notion that supply shocks and demand shocks are different ... and AS-AD gets you to that notion in a quick and dirty, back of the envelope way. 
Second — and this plays a surprisingly big role in my own pedagogical thinking — we do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run. That’s a relatively easy case to make in AS-AD; it raises all kinds of expositional problems if you replace the AD curve with a Taylor rule, which is, as I said, essentially a model of Bernanke’s mind.
This is striking for several reasons. First, Krugman wants students to believe in the "self-correcting economy," even if this requires teaching them models that do not reflect the way professional economists think. Second, they should think that this self-correction happens through "price flexibility." In other words, what he wants his students to look at, say, falling wages in Greece, and think that the problem must be that they have not fallen enough. That's what "a return to full employment via price flexibility" means. Third, and most relevant for this post, this vision of self-correction-by-prices is directly linked to the idea that money is neutral in the long run -- in other words, that a sustained increase in the money supply must eventually result in a proportionate increase in prices. What Krugman is saying here, in other words, is that a "surprising big" part of his thinking on pedagogy is how to inculcate the exact errors that drive him crazy in policy settings. But that's what happens once you accept that your job as an educator is to produce ideological fables.


Tuesday, July 15, 2014

Ancient Economists: Two Views

John Cochrane, reporting from the NBER Summer Institute:
The use of ancient quotations came up several times. I  complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant."  Ivan Werning really complained about this in Paul Beaudry's presentation. What does this complex piece of well worked out "21st century economics" have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn't. (In his view, it did, so why belittle it?) 
Physics does not write papers about "the Newton-Aristotle debate." Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It's especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in "secular stagnation." I haven't checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place. 
Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let's stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists. 
But, tying it all up, perhaps I'm just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about "this is what they really meant." Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.
(via Suresh, who was also there.)

For the case in favor of ancient economists, here is Axel Leijonhufvud:
According to Sir Peter Medawar
A scientist's present thoughts and actions are of necessity shaped by what others have done and thought before him: they are the wave-front of a continuous secular process in which The Past does not have a dignified independent existence of its own. Scientific understanding is the integral of a curve of learning; science therefore in some sense comprehends its history within itself.
... Not every field of learning can claim to "comprehend its history within itself." For the current state of the art to be the "integral of past learning" in Medawar's sense, the collective learning process must be one that remembers everything of value and forgets only the errors and the false leads. But this requires the recognized capability to decide what is correct or true and what is in error or false. These decisions, moreover, must compel general assent. Once an answer is arrived at, it must be generally agreed to be the answer. The field must be one in which answers kill questions so definitively that the sense of alternative possibilities disappears. ... 
A science, or a subfield within it, may come to approximate these conditions because of its positive successes. But two other mechanisms that are not so nice will also be at work. First, the people in the field agree that certain questions, which they would have a hard time deciding, are somebody else's responsibility. So economics among the social sciences, like physics among the natural sciences, had first pick of problems and left the really hard ones, on which their methods did not give them a firm grip, for the younger sister disciplines to deal with as best they might. Second, the insiders to the field will agree to exclude some people who refuse to assent to the manner in which certain important questions have been settled. Both the exclusion of undecidable questions from the field of inquiry and the exclusion of undecided people from the professional group help to achieve collective concentration and intensive interaction within the group. … 
These reflections … offer some suggestions about when scientists might find the history of their field relevant and useful to current inquiry. One suggestion is to look for situations when a research program has bogged down, when anomalies have cropped up that cannot be reduced to or converted into ordinary puzzles within the paradigm. Another is to look for cases in which three conditions seem to be met:
a) certain central questions cannot be decided in a way that commands assent,
b) the (for the time being) undecidable questions cannot very well be left for somebody else to worry about, and
c) the people who withhold their assent from some popular suggested answer cannot be ignored or excommunicated.

... Economists are wont to reduce everything to choices. Economics itself develops through the choices that economists make. To use the past for present purposes, we should see the history of the field as sequences of decisions, of choices, leading up to the present. Imagine a huge decision tree, with its roots back in the time of Aristotle, and with the present generation of economists -- not all of them birds of a feather! -- twittering away at each other from the topmost twigs and branches. 
The branching occurs at points where economists have parted company, where problematic decisions had to be made but could not be made so as to command universal assent. The two branches need not be of equal strength at all; in many cases, universal agreement is eventually reached ex post so that one branch eventually dies and falls away. The oldest part of the tree is, perhaps, just the naked trunk; but the sap still runs in some surprising places. 
If you want to translate Medawar's image of science into my decision tree metaphor, you will have to imagine his sciences as fir trees -- with physics, surely, as the redwood – majestic things with tall, straight trunks and with live branches only at the very top. Economics, in contrast, would come out as a rather tangled, ill-pruned shrub … 
As long as "normal" progress continues to be made in these established directions, there is no need to reexamine the past … Things begin to look different if and when the workable vein runs out or, to change the metaphor, when the road that took you to the "frontier of the field" ends in a swamp or in a blind alley. A lot of them do. Our fads run out and we do get stuck occasionally. Reactions to finding yourself in a cul-de-sac differ. Tenured professors might often be content to accommodate themselves to it, spend their time tidying up the place, putting in a few modern conveniences, and generally improving the neighborhood. Braver souls will want out and see a tremendous leap of the creative imagination as the only way out -- a prescription, however, that will leave ordinary mortals just climbing the walls. Another way to go is to backtrack. Back there, in the past, there were forks in the road and it is possible, even plausible, that some roads were more passable than the one that looked most promising at the time. At this point, a mental map of the road network behind the frontier becomes essential.

Friday, July 4, 2014

The Rentier Would Prefer Not to Be Euthanized

Here’s another one for the “John Bull can stand many things, but he cannot stand two percent” files. As Krugman says, there's an endless series of these arguments that interest rates must rise. The premises are adjusted as needed to reach the conclusion. (Here's another.) But what are the politics behind it?

I think it may be as simple as this: The rentiers would prefer not to be euthanized. Under capitalism, the elite are those who own (or control) money. Their function is, in a broad sense, to provide liquidity. To the extent that pure money-holders facilitate production, it is because money serves as a coordination mechanism, bridging gaps — over time and especially with unknown or untrusted counterparties — that would otherwise prevent cooperation from taking place. [1] In a world where liquidity is abundant, this coordination function is evidently obsolete and can no longer be a source of authority or material rewards.

More concretely: It may well be true that markets for, say, mortgage-backed securities are more likely to behave erratically when interest rates are very low. But in a world of low interest rates, what function do those markets serve? Their supposed purpose is to make it easier for people to get home loans. But in a world of very low interest rates, loans are, by definition, easy to get. Again, with abundant liquidity, stocks may get bubbly. But in a world of abundant liquidity, what problem is the existence of stock markets solving? If anyone with a calling to run a business can readily start one with a loan, why support a special group of business owners? Yes, in a world where bearing risk is cheap, specialist risk-bearers are likely to go a bit nuts. But if risk is already cheap, why are we employing all these specialists?

The problem is, the liquidity specialists don’t want to go away. From finance’s point of view, permanently low interest rates are removing their economic reason for being — which they know eventually is likely to remove their power and privileges too. So we get all these arguments that boil down to: Money must be kept scarce so that the private money-sellers can stay in business.

It’s a bit like Dr. Benway in Naked Lunch:
“Now, boys, you won’t see this operation performed very often and there’s a reason for that…. You see it has absolutely no medical value. No one knows what the purpose of it originally was or if it had a purpose at all. Personally I think it was a pure artistic creation from the beginning. 
“Just as a bull fighter with his skill and knowledge extricates himself from danger he has himself invoked, so in this operation the surgeon deliberately endangers his patient, and then, with incredible speed and celerity, rescues him from death at the last possible split second….
Interestingly, Dr. Benway was worried about technological obsolescence too. “Soon we’ll be operating by remote control on patients we never see…. We’ll be nothing but button pushers,” etc. The Dr. Benways of finance like to fret about how robots will replace human labor. I wonder how much of that is a way of hiding from the knowledge that what cheap and abundant capital renders obsolete, is the capitalist?


EDIT: I'm really liking the idea of Larry Summers as Dr. Benway. It fits the way all the talk when he was being pushed for Fed chair was about how great he would be in a financial crisis. How would everyone known how smart he was -- how essential -- if he hadn't done so much to create a crisis to solve?


[1] Capital’s historic role as a facilitator of cooperation is clearly described in chapter 13 of Capital.

Thursday, July 3, 2014

Boulding on Interest

Kenneth Boulding, reviewing Maurice Allais's  Économie et intérêt in 1951:
Much work on the theory of interest is hampered at the start by its unquestioned assumption that "the" rate of interest, or even some complex of rates, is a suitable parameter for use in the construction of systems of economic relationships, whether static or dynamic. This is an assumption which is almost universally accepted and yet which seems to me to be very much open to question. My reason for questioning it is that the rate of interest is not an objective magnitude... The rate of interest is not a "price"; its dimensions are those of a rate of growth, not of a ratio of exchange, even though it is sometimes carelessly spoken of as a "price of loanable funds." What is determined in the market is not strictly the rate of interest but the price of certain "property rights." These may be securities, either stocks or bonds, or they may be items or collections of physical property. Each of these property rights represents to an individual an expected series of future values, which may be both positive and negative. If this expected series of values can be given some "certainty equivalent" ... then the market price of the property determines a rate of interest on the investment. This rate of interest, however, is essentially subjective and depends on the expectations of the individual; the objective phenomenon is the present market price... 
It is only the fact that the fulfilment of some expectations seems practically certain that gives us the illusion that there is an objective rate of interest determined in the market. But in strict theory there is no such certainty, even for gilt-edged bonds; and when the uncertainties of life, inflation, and government are taken into consideration, it is evident that this theoretical uncertainty is also a matter of practice. What is more, we cannot assume either that there are any "certain equivalents" of uncertain series for it is the very uncertainty of the future which constitutes its special quality. What this means is that it is quite illegitimate even to begin an interest theory by abstracting from uncertainty or by assuming that this can be taken care of by some "risk premium"; still less is it legitimate to construct a whole theory on these assumptions … without any discussion of the problems which uncertainty creates. What principally governs the desired structure of assets on the part of the individual is the perpetual necessity to hedge -- against inflation, against deflation, against the uncertainty in the future of all assets, money included. It is these uncertainties, therefore, which are the principal governors of the demand and supply of all assets without exception, and no theory which abstracts from these uncertainties can claim much significance for economics. Hence, Allais is attempting to do something which simply cannot be done, because it is meaningless to construct a theory of "pure" interest devoid of premiums for risk, liquidity, convenience, amortization, prestige, etc. There is simply no such animal. 
In other words: There are contexts when it is reasonable to abstract from uncertainty, and proceed on the basis that people know what will happen in the future, or at least its probability distribution. But interest rates are not such a context, you can't abstract away from uncertainty there. Because compensation for uncertainty is precisely why interest is paid.

The point that what is set in the market, and what we observe, is never an interest rate as such, but the price of some asset today in terms of money today, is also important.

Boulding continues:
The observed facts are the prices of assets of all kinds. From these prices we may deduce the existence of purely private rates of return. The concept of a historical "yield" also has some validity. But none of these things is a "rate of interest" in the sense of something determined in a market mechanism.  
This search for a black cat that isn't there leads Allais into several extended discussions of almost meaningless and self-constructed questions… Thus he is much worried about the "fact" that a zero rate of interest means an infinite value for land, land representing a perpetual income, which capitalized at a zero rate of interest yields an infinite value… This is a delightful example of the way in which mathematics can lead to an almost total blindness to economic reality. In fact, the income from land is no more perpetual than that from anything else and no more certain. … We might draw a conclusion from this that a really effective zero rate of interest in a world of perfect foresight would lead to an infinite inflation; but, then, perfect foresight would reduce the period of money turnover to zero anyway and would give us an infinite price level willy-nilly! This conclusion is interesting for the light it throws on the complete uselessness of the "perfect foresight" model but for little else. In fact, of course, the element which prevents both prices from rising to infinity and (private) money rates of interest from falling to zero is uncertainty - precisely the factor which Allais has abstracted from. Another of these quite unreal problems which worries him a great deal is why there is always a positive real rate of interest, the answer being of course that there isn't! … 
Allais reflects also another weakness of "pure"interest theory, which is a failure to appreciate the true significance and function of financial institutions and of "interest" as opposed to "profit" - interest in this sense being the rate of growth of value in "securities," especially bonds, and "profit" being the rate of growth of value of items or combinations of real capital. Even if there were no financial institutions or financial instruments ... there would be subjective expected rates of profit and historical yields on past, completed investments. In such a society, however, given the institution of private property, everyone would have to administer his own property. The main purpose of the financial system is to separate "ownership" (i.e., equity) from "control," or administration, that is, to enable some people to own assets which they do not control, and others to control assets which they do not own. This arrangement is necessitated because there is very little, in the processes by which ownership was historically determined through inheritance and saving, to insure that those who own the resources of society are … capable of administering them. Interest, in the sense of an income received by the owners of securities, is the price which society pays for correcting a defect in the otherwise fruitful institution of private property. It is, of course, desirable that the price should be as small as possible - that is, that there should be as little economic surplus as possible paid to nonadministering owners. It is quite possible, however, that this "service" has a positive supply price in the long run, and thus that, even in the stationary state, interest, as distinct from profit, is necessary to persuade the nonadministering owners to yield up the administration of their capital.
This last point is important, too. Property, we must always remember, is not a relationship between people and things. it is a relationship between people and people. Ownership of an asset means the authority to forbid other people from engaging in a certain set of productive activities. The “product” of the asset is how much other people will pay you not to exercise that right. Historically, of course, the sets of activities associated with a given asset have often been defined in relation to some particular means of production. But this need not be the case. In a sense, the patent or copyright isn’t an extension of the idea of property, but property in its pure form. And even where the rights of an asset owner are defined as those connected with some tangible object, the nature of the connection still has to be specified by convention and law.

According to Wikipedia, Économie et intérêt,  published in 1947, introduced a number of major ideas in macroeconomics a decade or more before the American economists they're usually associated with, including the overlapping generations model and the golden rule for growth. Boulding apparently did not find these contributions worth mentioning. He does, though, have something to say about Allais's “economic philosophy" which "is a curious combination of Geseel, Henry George and Hayek,” involving “free markets, with plenty of trust- and union-busting, depreciating currency, and 100 per cent reserves in the banking system, plus the appropriation of all scarcity rents and the nationalization of land.” Boulding describes this as “weird enough to hit the jackpot.” It doesn’t seem that weird to me. It sounds like a typical example of a political vision you can trace back to Proudhon and forward through the “Chicago plan” of the 1930s and its contemporary admirers to the various market socialisms and more or less crankish monetary reform plans. (Even Hyman Minsky was drawn to this strain of politics, according to Perry Mehrling's superb biographical essay.)What all these have in common is that they see the obvious inconsistency between capitalism as we observe it around us and the fairy tales of ideal market exchange, but they don’t reject the ideal. Instead, they propose a program of intrusive regulations to compel people to behave as they are supposed to in an unregulated market. They want to make the fairy tales true by legislation. Allais’ proposal for currency depreciation is not normally part of this package; it's presumably a response to late-1940s conditions in France. But other than that these market utopias are fairly consistent. In particular, it's always essential to reestablish the objectivity of money.

Finally, in a review full of good lines, I particularly like this one:
Allais's work is another demonstration that mathematics and economics, though good complements, are very imperfect substitutes. Mathematics can manipulate parameters once formulated and draw conclusions out which were already implicit in the assumptions. But skills of the mathematician are no substitute for the proper skill of the economist, which is that of selecting the most significant parameters to go into the system.

Monday, June 30, 2014

Varieties of Keynesianism

Here’s something interesting from Axel Leijonhufvud. It’s a response to Luigi Pasinetti’s book on Keynes, but really it’s an assessment of the Keynesian revolution in general.

There really was a revolution, according to Pasinetti, and it can be dated precisely, to 1932. Leijonhufvud:
By the Spring of that year, Keynes had concluded that the Treatise could not be salvaged by a revised edition. He still gave his “Pure Theory of Money” lecture series which was largely based on it but members of his ‘Circus’ attended and gave him trouble. The summer of that year appears to have been a critical period. In the Fall, Keynes announced a new series of lectures with the title “The Monetary Theory of Production”. The new title signaled a break with his previous work and a break with tradition. From this point onward, Keynes felt himself to be doing work that was revolutionary in nature. 
What was revolutionary about these lectures was that they weren’t about extending or modifying the established framework of economics, but about adopting a new starting point. A paradigm in economics can be thought of as defined by the minimal model — the model that (in Pasinetti’s words) “contains those analytical features, and only those features, which the theory cannot do without.” Or as I’ve suggested here, the minimal model is the benchmark of simplicity in terms of which Occam’s razor is applied.

For the orthodox economics of Keynes’s day (and ours), the minimal model was one of “real exchange” in which a given endowment of goods and a given set of preferences yielded a vector of relative prices. Money, production, time, etc. can then be introduced as extensions of this minimal model. In Keynes’ “monetary production” model, on the other hand, the “analytical features which the theory cannot do without” are a set of income flows generated in production, and a set of expenditure flows out of income. The minimal model does not include any prices or quantities. Nor does it necessarily include exchange — it’s natural to think of the income flows as consisting of profits and wages and the expenditure flows as consumption and investment, but they can just as naturally include taxes, interest payments, asset sales, and so on.

I don’t want to suggest that the monetary production paradigm has ever been as well-defined as the real exchange paradigm. One of Leijonhufvud’s main points is that there has never been a consensus on the content of the Keynesian revolution. There are many smart people who will tell you what “Keynes really meant.” With due respect (and I mean it) I’m not convinced by any of them. I don’t think anyone knows what Keynes really meant —including Keynes himself. The truth is, the Hicks-Patinkin-Samuelson version of Keynes is no bastard; its legitimate paternity is amply documented in the General Theory. Pasinetti quotes Joan Robinson: “There were moments when we had some trouble in getting Maynard to see what the point of his revolution really was.” Which doesn’t, of course, means that Hicks-Patinkin-Samuelson is the only legitimate Keynes — here even more than  in most questions of theory, we have to tolerate ambiguity and cultivate the ability to hold more than one reading in mind at once.

One basic ambiguity is in that term, “monetary production.” Which of those words is the important one?

For Pasinetti, the critical divide is between Keynes’ theory of production and the orthodox theory of exchange. Pasinetti’s production-based Keynesianism
starts from the technological imperatives stemming from the division and specialization of labor. In this context, exchange is derivative, stemming from specialization in production. How it is institutionalized and organized is a matter that the minimal production paradigm leaves open (whereas the exchange paradigm necessarily starts by assuming at least private property and often also organized markets). Prices in the production paradigm are indices of technologically determined resource costs and, as such, leave open the question whether the system does or does not have a tendency towards the full utilization of scarce resources and, in particular, of labor. …
The exchange paradigm relies on individual self-interest, on consumer’s sovereignty, and on markets and private property as the principal institutions needed to bring about a socially desirable and harmonious outcome. In putting the division of labor and specialization at center stage, the pure production model, in contrast, highlights the “necessarily cooperative aspects of any organized society…
To an unsympathetic audience, I admit, this could come across as a bunch of commencement-speech pieties. For a rigorous statement of the pure production paradigm we need to turn to Sraffa. In Production of Commodities by Means of Commodities he starts from the pure engineering facts — the input-output matrices governing production at current levels using current technology. There’s nothing about prices, demand, distribution. His system “does not explain anything about the allocation of resources. Instead, the focus is altogether on finding a logical basis for objective measurement. It is a system for coherent, internally coherent macroeconomic accounting.”

In other words: We cannot reduce the heterogeneous material of productive activity to a single objective quantity of need-satisfaction. There is no such thing. Mengers, Jevons, Walras and their successors set off after the will-o-the-wisp of utility and, to coin a phrase, vanished into a swamp, never to be heard from by positive social science again.

The question then is, how can we consistently describe economic activity using only objective, observable data? (This was also the classical question.) Sraffa answers in terms of a “snapshot” of production at a given moment. Or as Sen puts it, in a perceptive essay, he is showing how one can do economics without the use of counterfactuals.

For Pasinetti, Keynes’ revolution and Sraffa’s anti-subjectivist revival of classical economics — his effort to ground economics in engineering data — were part of the same project, of throwing out subjectivism in favor of engineering. Leijonhufvud is not convinced. “Keynes was above all a monetary economist," he notes, "and there are good reasons to believe” that it was monetary and not production that was the key term in the “theory of monetary production.” Keynes made no use of the theory of imperfect competition, despite its development by members of his inner circle (Richard Kahn and Joan Robinson). Or consider his famous reversal on wages — in the General Theory, he assumed they were equal to the marginal product of labor, which declined with the level of output. But after this claim was challenged Dunlop, Tarshis and others, he admitted there was no real evidence for it and good reason to think it was not true. [1] The fact that JMK didn’t think anything important in his theory hinged on how wages were set, at least suggests that production side of economy was not central to his project.

The important point for us is that there is one strand of Cambridge that rejects orthodoxy on the grounds that it misrepresents a system of production based on objective relationships between inputs and outputs, as a system of exchange based on subjective preferences. But this is not the only vantage point from which one can criticize the Walrasian system and it’s not clear it’s the one occupied by Keynes or by Keynesianism — whatever that may be.

The alternative standpoint is still monetary production, but with the stress on the first word rather than the second. Leijonhufvud doesn’t talk much about this here, since this is an essay about Pasinetti. But it’s evidently something along the lines of Mehrling’s “money view” or “finance view.” [2] It seems to me this view has three overlapping elements: 1. The atomic units of the economy are money flows (and commitments to future money flows), as opposed to prices and quantities. 2. Quantities are quantities of money; productive activity is not measurable except insofar as it involves money payments. 3. The active agents of the economy are seeking to maximize money income or wealth, not to end up with some preferred consumption basket. Beside Mehrling, I would include Minsky, Paul Davidson and Wynne Godley here, among others.

I’m not going to try to summarize this work here. Let me just say how I’m coming at this.

As I wrote in comments to an earlier post, what I want is to think more systematically about the relationship between the network of financial assets and liabilities recorded on balance sheets, on the one hand, and the concrete social activities of production and consumption, on the other. What we have now, it seems to me, is either a “real” view that collapses these two domains into one, with changes in ownership and debt commitments treated as if they were decisions about production and consumption; or else a “finance” view that treats balance-sheet transactions as a closed system. I think the finance view is more correct, in the sense that at least it sees half of the problem clearly. The "real" view is a hopeless muddle because it tries to treat the concrete social activity of production and consumption as if it were a set of fungible quantities like money, and to treat money commitments as if they were decisions about production and consumption. The strength of the finance view is that it recognizes the system of contingent money payments recorded on balance sheets as a distinct social activity, and not simply a reflection of the allocation of goods and services. To be clear: The purpose of recognizing finance as a distinct thing isn’t to study it in isolation, but rather to explore the specific ways in which it interacts with other kinds of social activity. This is the agenda that Fisher dynamics, disgorge the cash, functional finance and the other projects I’m working on are intended to contribute to.


[1] It’s a bit embarrassing that this “First Classical Postulate,” which Keynes himself said "is the portion of my book which most needs to be revised," is the first positive claim in the book.

[2] Mehrling prefers to trace his intellectual lineage to the independent tradition of American monetary economics of Young, Hansen and Shaw.  But I think the essential content is similar.