Wednesday, November 4, 2009


Thanks for the update, Kevin.


"Unfortunately, macroeconomics has been in utter disarray since the Keynesian consensus broke down in the 1970s."


"Keynesianism was the economics of the world from around 1940 through the 1970s, but in the 1960s and 1970s came this extraordinary and quite unexpected inflation. And that took the bloom off the [Keynesian] rose. The Keynesian schema, which had tremendously wide acceptance, had no theory of inflation.... Since then, no new view that anyone can agree on has emerged, and there has been a vacuum in terms of a defining picture of what the hell economics is.... In the history of economic thought there has never been such a prolonged period of intellectual disagreement."

Not heard much on the topic lately. Until today. In a comment on Scott Sumner's Does macro need a paradigm shift?, Kevin Donoghue wrote:

So in my view you can only expect to see agreement on what tight money means when there is agreement on the appropriate model. That seems to be much farther away than it was in the 1970s when students could look at papers by Tobin and Friedman and say, what’s the argument about, the length and variability of lags, is that all? Fine tuning bad, coarse tuning good. There was a mainstream then, with only Austrians and Post-Keynesians and suchlike outside it. There is no mainstream now....

Not yet, Kevin. I'm workin' on it.

Inflation, the father of disarray, can be explained readily. But it is necessary first to distinguish "money" as a factor of production distinct from "capital," much as Adam Smith distinguished "labor" and "capital" from Quesnay's "land".

Once money is established as a factor of production, the factor cost of money gets a category of its own. Thereafter it is easier to observe the cost associated with the use of credit in our economy. This is an essential step. For the use of credit creates an extra layer of cost in our economy. And excessive reliance on credit makes that extra cost excessive.

Moreover, as long as we refuse to look at the cost associated with credit-use, we remain unable to see the cause of the inflation.

Economists and pundits continue to utter "money'n'credit" like a single word. But the more we rely on credit for the spending that we do, the greater the cost of using money. Everyone worries about the burden of government debt and the cost we pass to the next generation. No one seems to worry that the private sector is accumulating comparable costs. Greater costs. And no one seems to realize that much of what happens in our economy happens as a result of policy. Or rather people realize it, but don't relate it to the excessive reliance on credit.

● Disarray, caused by inflation.

● Inflation, caused by an unidentified factor cost.

● The factor cost, identified as the cost of interest associated with credit-use.

● Excessive reliance on credit, a problem because excessive costs result.

● A growing part of all spending makes use of credit, so that growing interest costs are embedded in all costs.

● The problem is excessive reliance on credit.

● We must reduce our reliance on credit.

● Excessive reliance on credit is a result of economic policies that discourage the increase of money-in-circulation but encourage the use of credit.

● Policy is the cause of the problem.

● Policy is the problem.

● Adherence to policy is the problem. We always and only depend on the Federal Reserve to fight inflation. We always and only depend on fiscal policy, tax policy mostly, to stimulate growth.

● A new and different approach to policy is required.

● We must use accelerated repayment of debt to fight inflation: Tax policy to fight inflation.

● This policy will result in a reduction of spending-money.

● We must offset that reduction by increasing the circulation of non-credit money: Monetary policy to stimulate growth.

The Fed's "quantitative easing" is a step in this direction. But I am not confident that the Fed understands why the QE was necessary.

1 comment:

The Arthurian said...

I want to emphasize the point that existing policy associates monetary policy with inflation-management and fiscal policy with growth-management.

My recommendations reverse the application of policy tools. I want to associate fiscal policy with inflation-management, and monetary policy with growth-management.

I don't say we must abandon existing policy. I say we must achieve balance where balance is absent.