A Man’s World: Is Gender the Key Explanatory Factor Behind the Modelling Tendency in Economics?

Some time ago I made a remark that the bias toward mathematical modelling in economics might have to do with the male bias of the discipline. More specifically, I argued that models provided a stand-in for the economist’s own person — their ‘I’, as it were. I then went on to write,

Males in contemporary society have a far greater need to assert themselves as static ‘Is’ than females. An attack on models can easily be taken as an attack on one’s masculinity while, more radical still, an attack on modelling in general can be taken as an attack on contemporary representations of masculinity.

I got quite a few comments on this. They were all positive, all from men and all sort of said “oh, I’d never thought of that before — it makes quite a bit of sense”. Well, today I’m going to lay out the argument of the essay that I referenced. It is entitled Explaining Modern Economics (as a Microcosm of Society) and it is by Vinca Bigo.

One or two things before I begin. The essay contains quite a bit of psychoanalytical theory. Nothing too controversial, mostly object relations stuff. But I know that some people will roll their eyes and think that both the author and I are engaged in psychobabble. In other cases I might be inclined to agree. People are all too often ready to use psychological pseudoscience to simply beat up on others — I cringe whenever I hear of particular social groups being designated as ‘narcissistic’ or ‘psychopathic’. But I don’t think that is what Bigo is doing here.

Rather she is trying to understand why (mostly male) economists try to conceive of the world in what can only be described as a fantasmatic way. After all, what is a fantasy if not an act of imagining into being a world or elements of a world that have no real existence? And what is economic modelling if not this? What Bigo is trying to grasp is what emotional needs such fantasies satisfy and why these emotional needs are disproportionately found in males.

Bigo starts off by describing the idea of separation in object relations theory. It runs something like this: when human beings are babies they find it difficult to distinguish between themselves and the external world. This is extremely obvious in that human babies do not even have very sufficient control over their own limbs. Thus, the limits that I perceive on the boundaries of what is me and what is not me — that is, the boundaries between what my mind has control over and what it doesn’t — is not at all clear to human babies.

For this reason human babies psychologically perceive their primary caregiver — usually the mother — as being part of themselves; i.e. as being a component of the world over which they control. They cry for food. Food appears. They cry because they soil themselves. The feeling of being soiled disappears.

When the baby begins to become aware that a separation must take place and that the primary caregiver is actually a different person than themselves — i.e. a foreign Other — anxiety ensues. This is known in object relations theory as ‘separation anxiety’ and although it is a rather unpleasant part of the maturation process it is absolutely essential to the formation of a coherent personality. Indeed, think of the popular cultures jokes about people who never truly navigate this separation — I think here, specifically, of the character Buster in the television show Arrested Development, but this is certainly a comedy archetype.

Bigo notes that as the baby matures it often finds what are known as ‘transitional objects’. That is, objects of affection — like teddy bears or beloved rugs — that allow the child to feel like they have some control over something resembling a primary caregiver. In psychoanalytical theory such objects are manifestations of defences against anxiety. This is all quite normal so far as development goes but there are cases in which children develop fantasy reactions against such anxiety. Fantasies of omnipotence — especially concerned with the predicting of the future — are, as Bigo notes, quite common in this regard.

Anyway, Bigo goes on to apply this to the modellers. She claims that their rejection of non-modelling economics is a sort of rejection of the Other and their desire for depiction is a defence against an anxiety associated with Uncertainty. This is where I disagree with Bigo. I don’t think that there is anything particularly pathological going on here — although I think that the underlying issues are pretty much in line with what she is talking about.

She thinks that mathematical modelling is about excluding non-mathematical approaches. I think that this is only secondary. The primary reason it is so importance is because it reestablishes a relationship of total control. Much like in the case of a transitional object, a mathematical model builds a little world, a closed system, over which the modeller is omnipotent. What results therefrom is first and foremost a fantasy of control.

Again, this is not pathological per se. After all, something similar is going on when adults play with model trains sets or engage in stamp collection. These activities are in no way pathological provided they are not causing the person psychological pain — as might happen if the person became overly obsessive about stamp collection. But they are activities that probably have their roots in some sort of transitional object relation.

The problem that I would highlight is not with the psychology but rather with the economics; the economists tend to treat these little fantasies as representing reality. This is especially obvious when they apply them directly to data using macroeconometric regression techniques. This is an epistemological error bordering, frankly, on socially-sanctioned delusion.

But what about the gender question? Well this is where I fully agree with Bigo’s conclusions and will let her state her position herself as she summarises it better than I could.

Anxiety resulting from the processes of separation of the sort described above affects most, if not all, of us to varying degrees. But there is a systematic tendency for it to be experienced more starkly by boys, and ultimately by men. Gender identities are formed mostly out of family relations. Typically, the mother–child relation is the earliest most important one. Clearly,there is an asymmetry, as (usually) girls are cared for by adults of the same gender, whereas boys are not. This bears crucially on the processes of separation, or of coming to recognise and accept differences. Boys react and develop by registering their difference from the mother, and the emphasis becomes precisely that of (a sense of) separateness. This process is said to involve a degree of necessary differentiation and rejection (also involving splitting), as well as desire and/or envy.

Girls, on the other hand, in identifying with the same sex carer, will tend to develop a more relational way of being, seeking continuity over rupture. They react by perceiving sameness, and the emphasis becomes that of interdependence (association or relationality), rather than independence. Conversely, mothers are close to their infant sons, but they view their male children as different (both physically/bodily and socially, and in many ways of which they are not easily conscious), and do not share with them the same sense of ‘oneness’ that they experience with their daughters. (pp18-19)

I think that this is basically correct and explains a lot about the different (generic) psychological profiles about the average man and the average woman (exceptions are not sins, of course!). But men are far more sensitive about maintaining control over the world in a very narrow manner than women. They tend to be worse at seeing things in different and nuanced ways. And they have a marked tendency to try to provide totalising explanations so as to feel a sense of oneness and omnipotence with the world around them**.

This is, of course, where modelling in general and macroeconometric modelling in particular come in. They provide the tools to construct such fantasies of oneness and completeness. After all, a closed model has no uncertainty, nothing that is not fully understood and articulated and when it is applied econometrically the game becomes to get the highest score (t-statistic or R-squared or whatever) and thus — please note the potential double-meaning here — the closest ‘fit’ with the real world. That such an enterprise should produce nothing of genuine relevance is entirely besides the point because the point is to construct a fantasy world, not to engage with the real one.

 

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** I do not want to be seen here as engaging in crude male-bashing of the kind so often found in feminist circles; indeed typical female psychological development leads to its own blindspots and shortcomings — it’s rather difficult to be perfect, thank you very much! What I’m really trying to point to is that in economics these male psychological blindspots have, in a sense, gone completely mad and gotten completely carried away with themselves. Some of this may be due to the tendency to exclude women from the discipline, but I think that is more so an effect than a cause; most of it is probably more so due to the status economics holds in society. Without going into too much detail, economics is something of a Totem in contemporary society and Totems tend to be obsessively and ridiculously masculine endeavors.

Some Metaphors Are Better Than Others: Deirdre McCloskey and the Capital Debates

Well, my previous piece on the work of Deirdre McCloskey generated some discussion. I just thought that perhaps I should lay out what I find problematic about her work.

The problem with McCloskey is that she practices a sort of false postmodernism of the most insipid kind. Now, I’m not one to throw around that term too much — I greatly admire many of the post-structuralist philosophers. What I mean when I say that is that McCloskey reduces everything to literary criticism and then consigns rational debate to the bin.

I think that this is disingenuous in the extreme because, of course, she herself as a working economist does think that some theories are more true than others that are more false. But the discourse in her books shuts the debate down before it reaches this stage. Consider the following passage on the Cambridge Capital Controversies from her book The Rhetoric of Economics,

The metaphor [of ‘capital’] got out of its coffin in an alarming fashion in the Debate of the Two Cambridges in the 1960s. The violence of the combat suggests that it was about something beyond mathematics or fact. The combatants hurled mathematical reasoning and institutional facts at each other, but the important questions were those you would ask of a metaphor: Is it illuminating, is it satisfying, is it apt? How do you know? How does it compare with other economic poetry? Do we want to talk this way? Why not? After some tactical retreats by Cambridge, Massachusetts, on points of ultimate metaphysics irrelevant to these important questions, mutual exhaustion set in, without decision. Daniel Hausman, a philosopher of economics, noted this in his book on the subject (1981) and nearly saw why. The reason there was no decision reached was that the important questions were literary, not mathematical or statistical (or philosophical). The debaters were answering the wrong questions, as though showing mathematically or statistically that a woman cannot be a summer’s day. No one noticed. The continued vitality of the idea of an aggregate production function (in the face of mathematical proofs of its impossibility) and the equal vitality of the idea of aggregate economics as practiced in parts of Cambridge, England (in the face of statistical proofs of its impracticality), would otherwise be a mystery. (p45)

“Oh, those silly old economists!” we are supposed to say, “how on earth didn’t they realise that they were really just dealing with metaphors?” After a chuckle we go back to our respective camps without having really said anything at all.

The problem with the above paragraph is that the debaters were not as silly as McCloskey thinks. Joan Robinson, who kicked off the debate, knew exactly what it was all about. Indeed, I would say that Joan Robinson had one up on McCloskey because she saw that what was at issue here was only secondarily a question of metaphor. Primarily it was a question of a literary trope that McCloskey seems unaware of; that is, an ’empty’ or ‘floating signifier‘**. Floating signifiers are words without defined meanings. And this is precisely what Robinson found the idea of ‘capital’ to be. (It is also what Sraffa sought to avoid by using a neo-Ricardian framework — in this view, which Robinson adhered to, capital is quite clearly defined as dated labour inputs; or ‘dead labour’, to use Marx’s metaphor).

But of course this all gets buried because McCloskey — doing some rather half-hearted literary excavation — wants to insist that its all about metaphor. Well, let’s take the metaphorical aspects of the Capital Debates then.

The question then becomes which is a more apt metaphor for capitalist society? Is the notion that every person gets compensated exactly in line with the marginal product they produce a superior metaphor to the idea that capital and labour struggle over the social product? That is not an airy fairy question. There is an answer to such a question. But McCloskey seems to imply that there isn’t. She pretends that all metaphors have the same standing. But this is nonsense.

Let’s show why this is nonsense by taking two different metaphorical sentences about modern capitalism.

(1) Modern capitalism is like a machine that grinds over the globe, taking in underdeveloped societies at the front and spitting them out with higher levels of development out the back.

(2) Modern capitalism is like a turtle that gets up out of the ocean and climbs on the beaches of underdeveloped societies before plodding along for a while and then finally falling asleep in the sun of a newly developed country.

Now, are these two metaphors equally valid? Of course not! Metaphor (1) contains information that actually describes some features of modern capitalism. Metaphor (2) is a confused hodge-podge that conveys nothing of relevance about contemporary capitalism. If it were read out of context Metaphor (2) might be considered a sort of absurdist or surrealist joke, while Metaphor (1) would not be out of place in a glossy magazine like The Economist. One metaphor conveys information better than the other — which tries to scramble communication for surrealistic laughs.

So, back to the Capital Debates. Which metaphor is better for describing the world we live in? Well, let’s see. We know from recent empirical work by James Galbraith and his team that income inequality largely tracks the upswings and downswings in financial markets. Well now, the marginalist would have to then say that the marginal productivity of capital tracks the stock market.

Okay, but I would say that the stock market is more so speculative because it crashes all the time and it’s P/E Ratios are all over the place. Indeed, if the marginal productivity of capital tracked the stock market it would be terribly volatile, wouldn’t it? It seems to me highly unlikely that the production share of capital goes through such swings. In which case the stock market is more likely a redistributive mechanism that is utilised by those with already existing economic power and thus the “division of the social product” metaphor seems a better fit.

Now, all that considered, the Cambridge UK theory is looking a lot more plausible than the old marginal productivity theory. Not only that but it appears ever more pressing given that we are faced with such horrendous income inequalities today.

In an ideal world, where both sides of these debates had an equal say in the halls of academia and policy, McCloskey’s relativism would be a harmless distraction. But if it were ever taken seriously today it would simply mean that we should all just stop arguing rational points at all. After all, it’s only a whole pile of metaphors! And the Capital Debates are really just about people with different metaphorical constructions about how the world works (no they are not… but let’s play along…)! We’re never going to agree, anyway, so what’s the point!?

I’ll tell you who wins the day should that nonsense ever be accepted: the group with the most institutional power. That is, the group of economists from out of which McCloskey comes. In another essay McCloskey defends the Greek sophists. She paints a nice picture but she forgets to mention one thing: the sophists were trained to wield the power of the state over their fellow men. And as the great filmmaker Errol Morris once said:

Well, someone comes up to you and says “I’m a postmodernist” or “I don’t care about truth” or “Truth is subjective and there are all kinds of different versions of truth, your truth, my truth, someone else’s truth”, and then you say to them “Oh, so it doesn’t matter to you who pulled the trigger? It doesn’t matter to you whether someone committed murder or not? Or someone in jail is innocent or not? That’s just a matter of personal opinion?” I strongly think that our intuition is that it does matter. It matters a great deal what happens in the world.

In her relativism McCloskey forgets that, well, some people are in jail just as some economists find it more difficult than others to get jobs and publications.

 

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** Actually McCloskey probably is aware of ‘floating signifiers’ as her emphasis on the ‘oomph’ factor in empirical work deploys such a floating signifier. The question then becomes: why did she want to veneer over this aspect of the debates? The answer, I would say, is because she wants to remain above and beyond these debates while providing a ‘metacommentary’ but if she actually studied them properly she would be forced to realise that some of the participants were not as naive as she thinks that they were. In that case she might — shock! — have to actually take a side in the debate by weighing up the logic and completeness of the arguments put forward.

 

Empty Rhetoric: On the Work of Deirdre McCloskey

Yesterday I read a short pamphlet by Deirdre McCloskey entitled The Secret Sins of Economics. You can get it here for free in PDF form. A friend of mine told me a while ago that I would like McCloskey. He told me she writes very well and has a take on economics similar to my own.

Well, he was half correct; she does write very well. I would also say that she is quite well read. But her take on economics is very far from my own. In the pamphlet she claims that the two things that economics is often attacked for by other social sciences is not its gravest sin; these two things are, of course, quantification and mathematisation.

I certainly agree on the first point. There is nothing wrong with quantification in economics. Indeed, properly handled data analysis can give us insights into what is going on in the economy. But I think the Samuelsonian tendency toward mathematisation was extremely problematic in that the form began to take over from the content in any number of ways.

She doesn’t seem to mind this much. She says that the often bizarre formal arguments concocted by economists sometimes lead to relevant insights. Rather strangely she then cites one of the most extreme manifestations of this: namely, Gary Becker.

Becker (Nobel 1992), a professor of economics and sociology at the University of Chicago, asks, for example, why people have children. Answer: because children are durable goods. They are expensive to produce and maintain, over a long period of time, like a house. They yield returns over a long future, like a car. They have a poor second-hand market, like a refrigerator. They act as a store of value against future disasters, like pawnable gold or your diamond ring. So (you will sense a logical leap here; David Hume noticed the same leap in Mandeville and Hobbes), the number of children that people have is a matter of cost and benefit, just like the purchase of a house or car or refrigerator or diamond. A prudent parent decides whether to invest in many children or few, extensively or intensively, early or late, just like investing in a durable good. (p23)

She then goes on to defend this as such,

If you think this is funny stuff you are not alone. But think again: there’s no doubt that Prudence does affect at least part of the decision to have children, to emigrate, to attend church, to go to college, to commit a murder, not to speak of buying a house or a car or a loaf of bread. (ibid)

I just don’t think that is a viable defence for the kind of muck that comes out of Chicago School micro. (McCloskey herself is a dyed-in-the-wool Chicagoite who recommends that people read Thomas Friedman [I tried to detect irony, but to no avail…]). Admitting that Prudence plays a part in peoples’ decision to have children does not lead to the conclusion that we should start thinking about children as durable goods.

Indeed, what is at issue here — and McCloskey is all too ready to point this out when it suits her case — is the transfer of a metaphor. Children = durable goods. What’s more, it’s a rather ugly metaphor. But perhaps most importantly it’s a very limiting metaphor. It dictates a research program that is emptied of any interesting content. It also has overtones of commercialism and commodification that indicate the user of the metaphor has probably absorbed it un-self-critically from the dominant discourse of the day.

There is more than a little ideology at work in attempts to compare offspring, church attendance or the act of murder with commercial activity. Just to highlight the arbitrariness of such activity I could just as easily compare commercial activity to generating offspring, attending church or the act of murdering — but the metaphor only flows in one direction because commercial activity is the ideology of our day.

This is all tied to the fact that, at one point, she paints economists as being noble warriors standing up against entrenched interests. I assume that she has been caught rather by surprise to have seen deregulated banks engage in massive fraud all under the blessing of Chicago’s own Efficient Markets Hypothesis. No, the reality is that most economists are dupes of the powers-that-be who absorb toxic metaphors into their work that are geared toward justifying nasty and sometimes criminal behavior.

She also goes on to say that economics has libertarian tendencies. Well, I’ve never seen them. Does treating children like durable goods sound libertarian to you? Well, it doesn’t to me. It sounds objectifying and gratuitous. Most of McCloskey’s type of economics is about social control — it is about viewing people as objects to be manipulated through trickery and ruse into conforming to behavior that the economist deems the fittest.

McCloskey’s rhetoric is high-flown, but on matters of substance her arguments are often thin gruel. You see, McCloskey is correct: rhetoric is important. But it is not enough. Well conceived rhetoric does not forgive sloppy argument — and this little pamphlet is full of that. Consider this little passage — one your might recognise from some time spent listening to right-wing talk radio,

And very many normal people of leftish views, even after communism, even after numerous disastrous experiments in central planning, even after trying to get a train ride from Amtrak or service from the Postal Service… think Socialism Deserves a Chance. (p18)

Yes, the vastly under-invested in Amtrak is proof that state transport infrastructure is equivalent to centrally planned socialism. Presumably the good professor has never been to, say, Germany or France. McCloskey’s writing is full of this sort of stuff. In her lectures a critical tone and a smarter-than-thou attitude will be interrupted by asides praising garbage theories like monetarism or Purchasing Power Parity.

McCloskey’s style is reminiscent of Keynes’ or Joan Robinson’s, but the substance of many of her arguments is reminiscent of a cartoon conservative — and to be clear: this is not really about politics, rather it is about accepting arguments like the Amtrak one above. These arguments are ultimately based on the ideology that is contained in all that silly micro stuff you encounter in undergraduate economics — the stuff that almost every non-heterodox economist you meet loves with all their heart, thinking as they do that it imbibes them with secrets about the social world that no one else understands.

This, I think, is why McCloskey is, for all intents and purposes, acceptable to the mainstream: she justifies the rubbish that pours out of the profession. She paints the profession in a glowing light — her references to the fake Nobel Prize invoke genuflection — and then criticises it on a few points that no one within it believe in anyway.

McCloskey’s main problem is with econometrics, specifically the use of significance tests. She correctly points out that if you do good research and show a strong correlation the ‘significance’ of this correlation is really a secondary matter altogether. Trying to become more and more certain about the ‘significance’ of the correlation is a rather silly thing to do indeed.

This then ties to McCloskey’s point that the data is non-ergodic and that this is real issue when dealing with economic data. She provides a nice example,

Or consider public opinion polls about who is going to win the next presidential election. These always come hedged about with warnings that the “margin of error is 2% plus or minus.” So is the claim that prediction of a presidential election six months before it happens is only 2% off? Give me a break. What is being reported is the sampling error (and only at conventional levels of significance, themselves arbitrary). An error caused, say, by the revelation two months down the road that one of the candidates is an active child molester is not reckoned as part of “the error.” You can see that a shell game is being performed here. The statement of a “probable error” of 2% is silly. A tiny part of all the errors that can afflict a prediction of a far-off political event is being elevated to the rhetorical status of The Error. “My under streetlight sampling theory is very bright, so let’s search for the keys under the streetlight, even though I lost them in the dark.” Get serious. (p52)

I agree entirely, of course. But the reason that this nonsense is used runs far deeper than economists not ‘getting’ what McCloskey is saying. It goes to the point that nonsense like monetarism cannot be defended without confusing causation with correlation and Purchasing Power Parity cannot be defended without somehow bulldozing over the empirics. Junk econometrics allows economists to continue making bad arguments that are not commensurate with the data and then throwing up a great deal of statistical dust so that no one can ever truly question them.

McCloskey’s style and her wit reminded me at first of Joan Robinson. But her arguments were simply not up to Robinson’s standards. The insights in McCloskey’s work are few and far apart — and those with any real bite, like the argument against significance testing, have been made elsewhere before (better, it should be added). I get the impression that this is due to McCloskey’s place in the profession.

She doesn’t really do economic theory, so far as I can see. Rather she brings some literary clout to a generally illiterate group. For that she is allowed to rail against significance testing — something that very few economists would defend with gusto anyway. It is an awful pity that McCloskey never decided to use her intelligence and wit to question some of the Chicago dogma. I think the results could have been rather interesting. But then, if she had chosen this path, she might not have been invited to the right parties.

More on the Job Guarantee and Wage Price Inflation

I’ve got quite a response to my last piece on the Job Guarantee program and it’s possible influence on wage-price spirals. Some of the kickback I received is, I think, based on a misunderstanding. A few people seemed to think that the JG program itself might induce a wage-price spiral. This is not what I was saying at all.

What I was really saying is that a JG program, as it provided continuous full employment, would lead to a sharp increase in worker bargaining power. If an external shock — like an oil price shock or a substantial currency devaluation — caused inflation to bounce workers may then try to push the costs of the inflation onto capitalists through increases in wages. The capitalists may then try to push these costs back onto the workers and other capitalists by raising prices. So, the causality runs,

JG Program => Tight Labour Markets => Increased Worker Bargaining Power => Potential Tinderbox Scenario Where a Wage-Price Spiral May Occur

Now, Neil Wilson said that I have no evidence that this would happen. Well, as with all applied economics I can never prove this beyond a shadow of a doubt. I am engaged in crystal ball-gazing to some extent here. But I can show historical correlations that imply that the mechanisms that I outline have the potential to do what I say that they might do.

First, let’s look at the relationship between labour markets and unemployment. As Nate Silver has shown there is a strong negative correlation between the unemployment rate and support for unions. You can see this in the regression plot posted below.

For those not use to reading regression plots, the closer the dots (observations) bundle around the line the more correlation there is between the two variables. An upward-sloping line indicates positive correlation while a downward-sloping line indicates negative correlation.

What the graph shows is that the higher unemployment is, the lower is support for unions. Conversely we can say that the lower unemployment then the higher the support for unions. So, if the JG program wipes out unemployment altogether we can say that there is a good chance that support for unions goes up. This is the increase in worker bargaining power that I outlined in the causal argument above.

But what about the theory that increased worker bargaining power leads to a potential for wage-price inflation? Well, first we must ask: how would this occur? The answer to that question is simple: workers would engage in strikes to try to get pay hikes. Do we have evidence to support this? Of course we do! Matias Vernengo has laid the whole thing out in a post here. But the key graph is probably this one,

If you don’t believe me that the increase in strike is strongly correlated with unionisation rates check out this graph.

As Vernengo notes,

That’s is why higher commodity prices in the 1970s, including the oil shocks, led to high inflation back then, but has had a marginal impact this time around. This also suggests that the low inflationary pressures in recent times – Bernanke’s Great Moderation – have less to do with Central Bank ‘credible’ policies than with the attack on unions and workers’ rights.

Indeed!

So, let’s recap. The causality runs like this,

JG Program => Zero Unemployment => Support For Unions => Unionisation => Potential For Wage-Price Inflation

Now, again I am saying: why risk this? If anything might unwind a JG program after it was put in place it would be inflation. It would surely be one of the first things on the board for cuts. Indeed, it would probably be pointed to as the cause of inflation by conservative economists. They would say, “Oh, but we told you that silly program would cause demand to rise too high and spark inflation”. And so it would likely be dismantled even if the source of the inflation was not the JG itself.

Why not instead just include measures in the JG package that minimise the risk of the above scenario playing out? What have we got to lose by tacking some combination of TIPS and MAPS onto the JG program? I really do not see a strong argument against considering this.

The Job Guarantee, Wage-Price Inflation and Alternative Solutions

Before I start this post I should make one thing abundantly clear: I strongly support the idea of a Jobs Guarantee (JG) program. I think that the benefits it might bring to society so far outweigh its potential drawbacks that implementing it should be a no-brainer not simply for anyone with progressive tendencies, but for anyone who believes that people should have the right to be independent and earn a living for themselves and their families.

I have always thought of the economics of the JG program as being similar to the economics of unemployment benefits. Indeed, the JG should really just be seen as a superior version of the dole that replaces handouts with an opportunity to work, grow and develop rather than being forced to sit idle when factors outside of one’s own control force you out of the labour market.

Most of the objections to the JG program (it increases worker bargaining power; it adds aggregate demand to the economy that is not backed by production; it redistributes income via price changes etc) could equally be leveled at unemployment benefits — indeed, they are by extreme right-wingers — and when I hear many of them coming out of the mouths of self-styled progressives it makes me a little queasy. Often I can only attribute these objections to fear in the face of a new idea.

But I think that a very real criticism raised against the JG is that it might increase an economic tendency toward wage-price spirals. Again, the same could just as easily be said about unemployment insurance, so this is not really a good objection against the idea per se. Nevertheless it does bear some thinking about. So, how might the JG program lead to an increased tendency toward wage-price spirals?

When the JG program is in full swing — i.e. when aggregate demand is low and unemployment high — all it can really do is set a floor beneath which wages cannot fall. Although wages tend to be extremely sticky in recessions anyway — and indeed as we have known since Keynes this is likely a blessing rather than a curse — the JG would certainly make them ‘more sticky’ as people would not fear being laid off nearly as much as they do when they have to fall back on dole handouts.

When the economy is at full employment, however, the JG could increase tendencies toward wage-price spirals. The fear associated with being laid off would be reduced and that would buttress worker bargaining power by just that much more. This certainly adds to the risk of a wage-price spiral. But again, it doesn’t increase the risk all that much. After all, at full employment workers really don’t fear the sack all that much anyway.

The real risk of a wage-price spiral is always and everywhere when exogenous factors increase prices. The two that come to mind are (i) substantial currency depreciations and (ii) increases in input costs, such as oil or other commodities. Wage-price spirals then tend to kick in as workers and capitalists try to use their market power to distribute the resulting inflation. Workers try to fob the price increases onto capitalists through wage hikes, while capitalists try to fob it onto workers and competing capitalists through price increases.

It is in such an environment that a JG could prove to greatly increase the tendency toward wage-price spirals. Such spirals are always a sort of battle fought between workers and capitalists and the more confident and self-assured both sides are, the more they will feel ready to duke it out. A JG program would greatly increase worker confidence and in doing so would add fuel to the fire under circumstances conducive to a wage-price inflation.

So, what institutions can we put in place to ensure that wage-price spirals do not happen? Broadly speaking there are two solutions: tax-based incomes policies (TIPS) and market anti-inflation plans (MAPS). The former is associated with Paul Davidson and Sidney Weintraub while the latter is associated with Abba Lerner and David Colander.

TIPS are based on simple taxation policies that try to protect against wage-price spirals. Basically, the idea is to penalise anyone trying to raise wages. The government sets an acceptable level of wage increases — usually pegged to measures of productivity — and then imposes a tax on any increase above and beyond this. It is typically company profits that are to be taxed, so the onus is on the capitalist to ensure that wages do not rise.

I think the basic principle here is solid but the implementation should be done somewhat differently. Personally, I would like to see taxation applied to wage and price increases. What’s more I would like to see workers and capitalists penalised. I think that in the case of wage increases beyond given levels of productivity increases workers should see their income tax rise while any price rises that are in excess, say, of some measure of input costs — i.e. price rises that seek to profit from rising inflation or seek to pass too much of the inflation on as price increases and not enough on as profit decreases — should lead to increased taxes on the offender. Taxing price increases, however, may prove rather complicated and this is where the MAPS approach might prove better.

MAPS is a slightly more sophisticated approach. Basically the government would issue a certain amount of MAPS credits to firms. These credits would then be used by the firms any time they wanted to increase prices. The amount of MAPS credits in existence would be tied, again, to the overall level of productivity in the economy (specifically they would be tied to a value added measure of output growth). The firms could then trade the MAPS credits between themselves. So, firms that were decreasing their prices through productivity gains and new technology would sell their credits to firms that were seeing price increases. Such a system would disincentivise inflation using market mechanisms.

TIPS is certainly a more straight-forward approach. It is certainly more hands-on — and would meet with far greater resistance from both unions and firms — but it is direct and, once the details are worked out, rather simple to administrate as the already-existing taxation system can be used. MAPS has an air of complexity about it reminiscent of Abba Lerner’s early work on market socialism — out of which it undoubtedly developed.

Personally, I think that some combination of the two would work wonders. On the wage side, I think that the TIPS would be quite effective. It would be simple to implement through the income tax system and it would provide an immediate disincentive for workers to engage in overenthusiastic bargaining. (If they want redistribution they must then lobby the government to adjust its taxation regime).

Meanwhile, the MAPS would probably work better on the price side. It would encourage firms to contain costs as best they could and would incentivise downward pressure on prices from productivity gains.

Finally, a note on implementation. These measures would best be introduced in a relatively deflationary period with low wages and low prices — i.e. a high unemployment period. Why? Because no one would even notice that much. Since wage and price increases had slowed to a halt anyway no one would notice the new institutional changes coming online. But then when the inflation barrier began to be approached these changes would kick in and be so strongly in place that the debate about whether they are fair or not would already be over.

Of course, this assumes that policymakers can be so forward looking as to deal with problems long before they arise. That is why I propose that some combination of MAPS and TIPS be included in any JG program that is sold to governments. This would also provide a credible case against opponents who claim that JG programs are not concerned with inflation and are just another product of the Keynesian tendency to see deflation behind every bush and inflation as an imaginary devil that never makes an appearance on the scene.

Update: I have laid out the argument empirically in a new post here.

BBC Radio Program on George Berkeley

BBC Radio 4 have released a fantastic discussion with three contemporary Berkeley scholars as a podcast on their website. I cannot recommend the discussion enough. I want to here run through some of the points raised by the commentators in a critical manner.

First of all, I highly recommend that listeners pay close attention to the discussion of Berkeley’s theory of vision which begins around the 10.00 mark. Berkeley’s theory, which is wholly empirical, is far superior to the others that were being promoted in his day. For Berkeley, vision was an empirical rather than an a priori activity. In a sense, we learn to see. A baby probably has a highly disorganised vision and only comes to order their world in a practical fashion after some time.

In this regard one of the commentators brings up Molyneux’s problem. This is the thought experiment wherein we ask if a person who suffered from blindness all their lives had their sight returned would they be able to distinguish a cube from a square given that they know both through touch. Berekely said that they would not and he was right. As the Wikipedia article says,

In 2003, Pawan Sinha, a professor at MIT in Boston, set up a program in the framework of the Project Prakashand eventually had the opportunity to find five individuals who satisfied the requirements for an experiment aimed at answering Molyneux’s question experimentally. Prior to treatment, the subjects —aged 8 to 17— were only able to discriminate between light and dark, with two of them also being able to determine the direction of a bright light. The surgical treatments took place between 2007 and 2010, and quickly brought the relevant subject from total congenital blindness to fully seeing. A carefully designed test was submitted to each subject within the next 48 hours. Based on its result, the experimenters concluded that the answer, in short, to Molyneux’s problem is “no”. Although after restoration of sight, the subjects could distinguish between objects visually almost as effectively as they would do by touch alone, they were unable to form the connection between an object perceived using the two different senses. The correlation was barely better than if the subjects had guessed. They had no innate ability to transfer their tactile shape knowledge to the visual domain. However, the experimenters could test three of the five subjects on later dates —5 days, 7 days, and 5 months after, respectively— and found that the performance in the touch-to-vision case improved significantly, reaching 80% ~ 90%.

It should be noted that Berkeley’s theory of vision is today in line by what would be known as the phenomenological approach — especially as seen in the work of Maurice Merleau-Ponty. I especially encourage anyone interested to read his excellent Phenomenology of Perception (available here).

Around the 19.00 mark one of the commentators tries to claim that Berkeley’s main theories are not much affected by the idea of God. I strongly disagree with this and one of the other commentators soon sets this right. I would like to say, however, that this reaction is interesting. I often see it when discussing Berkeley. The person discussing the philosophy quickly wants to shut down any questions about God or anything of that sort. It is a very strange, knee-jerk emotional reaction and while I have some ideas about why atheism has become an ideology with such extensive emotional investment for many today I think here is neither the time nor the place to discuss it.

The discussion of Berkeley’s work De Motu that follows is very limited and I wish it could have been more extensive. It is painted as some sort of simplistic idealist version of the standard theory of dynamic motion when what Berkeley was really putting forward was something more akin to the relativistic theory of space of Mach and Einstein.

At 33.20 the discussion of a “kind of dualism” in Berkeley thought that divides minds and ideas is very interesting. But, as the commentator notes carefully, we are not dealing here with a dualism of substances. Rather we have a single substance — mind — and separate qualities within that mind — ideas, abstractions, language and so forth.

Finally, I think it is nice that the program noted (at around the 38.00 mark) that Hume had no idea what Berkeley was talking about when he set out to basically take over his philosophy. To my mind, Hume, although his work on causality was noteworthy, was ultimately a second-rate Berkeley. He was completely unable to form a coherent metaphysical system and instead posited a form of Skepticism that he himself admitted was impossible to believe in without going mad.

Apart from that, it’s great to see that Berkeley is getting attention in philosophical circles. Apparently I’m not the only one that sees enormous promise in his philosophy — one which has been buried for so long by what can only be described as prejudice.

Thinking Makes It So: The IMF Bailout of the UK in 1976 and the Rise of Monetarism

Monetarism began it’s rise to world prominence in the ever-conservative Bundesbank in 1974. But it would be the government of Margaret Thatcher in the UK, elected in 1979, that would truly launch monetarism in central banking. After Thatcher’s monetarist experiment undertaken between 1979 and 1984 every economics student would be taught to recite the various monetary aggregates by heart for at least a decade or two.

This is what accounts for the monetarist bent we see in the economists of the last generation. Basically any economist trained between roughly 1980 and 1995 would be heavily exposed to monetarist dogma. And only those that read alternative accounts of money creation — namely, the theory of endogenous money — would be fully immunised. This explains, for example, why certain economists that champion Keynesian policies — like Paul Krugman — actually speak in monetarist tones.

But it was the Labour government of James Callaghan that paved the way for the monetarist dogma. The short version of the story runs something like this: in 1976 Callaghan needed a $3.9bn loan from the IMF because he was concerned that the value of the sterling was about to crash. The IMF insisted that Callaghan undertake austerity policies and that he establish a monetary target for the central bank. This is how monetarism entered the UK.

As shorthand this is pretty much accurate. But to understand the history in more depth we must consider the role of the financial markets and the financial press — two institutions that had been ‘converted’ to monetarist dogma pretty much the moment the sustained inflation of the 1970s broke out. In order to explore this I will draw on an excellent paper by Aled Davies entitled The Evolution of British Monetarism 1968-1979.

The debate surrounding monetarism began in 1968 when journalists in Britain and the US began to pay attention to Milton Friedman. This was partly because of Friedman’s communicative abilities but it was also partly because of the inflationary pressures that were beginning to build in the world economy at that time — mostly due to trade union entrenchment, upward movements in commodity prices and large deficits in the US to finance the Vietnam War. Even at this stage institutions like the OECD and the IMF were paying attention.

The financial sector already had began to take note; not so much because of monetarism’s supposed predictive capacity but rather because key institutions were investigating the aggregates. One could not hope for a better illustration of Keynes’ ‘beauty contest’ theory of financial markets. The market in which this imitative behavior most important was the market for British government debt. Davies gives us an idea of how this imitative behavior spread,

[M]onetarist interpretations began to proliferate more generally within the financial markets, providing clues to future economic growth and inflationary pressures likely to emerge. This was led by circulars and bulletins such as those published by W. Greenwell & Co., Pember & Boyle (written by Brian Griffiths), and Joseph Sebag & Co. (Alan Walters). The writers of these circulars demonstrate the significant personal and conceptual overlap between academic-, City-, and political-monetarism. Brian Griffiths was a lecturer in Economics at the LSE (1968-76) and Professor of ‘Banking and International Finance’ at City University (1977-85). Alan Walters was a Professor of Economics at the LSE (1968-76). Both of these, alongside Gordon Pepper, were senior advisors to the Conservative Party in opposition and in Government. (p10)

By the time the inflation in the UK had taken off due to the first oil price hike in 1973-1974 some of these commentators were writing letters to Prime Minister Harold Wilson saying that if he didn’t balance the government budget the UK would fall into the abyss of a hyperinflation. This was complete nonsense, of course, because the inflation wasn’t due to an unbalanced government budget at all. Rather it was due to the rising price of oil and the wage-price spiral that accompanied it. But the City of London, unfortunately, was on the side of the hyperinflationists even though the Treasury Department remained unconvinced.

The Chancellor of the Exchequer Denis Healey, however, took the monetarist critique and turned it into his own: he alleged that the monetarists were correct in their diagnosis and that the imbalanced budget had been the result of the previous Conservative government’s misguided fiscal stimulus programs. Talk about giving them the rope that they would eventually hang you with!

By 1975 the financial markets — most notably the foreign financial markets upon whom the strength of the sterling depended — had become convinced that the best manner to understand the viability of the UK’s economy was to focus on the monetary aggregates. In order for the government to appease the foreign exchange markets and foreign holders of UK government debt they had to appear to be trying to keep the money supply under control. Since these two markets had an enormous impact on the value of the sterling the government already found itself needing to drum up the monetarist rhetoric. As Davies writes,

Civil servants and Bank officials consciously expressed the view that the influence of ‘monetarist’ ideas amongst investors were a significant limitation on the Government’s policies. In a note from the Downing Street Policy Unit in January 1976 the Prime Minister was informed that ‘some people in the City…(whether correctly or incorrectly does not matter) believe that a rising money supply leads to inflation.’ (p17)

Because the Bretton Woods system had broken down only a few years before the financial markets needed a metric by which to judge whether government policies were ‘sustainable’. That metric became the money supply. This was a classic example of a rather unimportant variable becoming important merely because people began to think it important. In 1977 Treasury Minister Denzil Davies summed the situation up perfectly when he said,

[W]e should do all we can do to keep M3 within the announced target during this financial year. It matters not, it seems to me, that the definition of M3 is arbitrary; that the commitment to the IMF is in terms of Domestic Credit Expansion (although everyone knows that DCE is irrelevant when a country is in a balance of payments surplus); and that an increase in the money supply caused by “printing money” may be of a different nature to an increase caused by inflows. All this, no doubt, is good stuff for a seminar. Unfortunately, those people who have the power to move large sums of money across the international exchanges believe, on the whole, that “money counts”. The fact that it may not count as much as they think it does, seems to me to be somewhat irrelevant. (p25)

By 1976, with inflation raging and monetarism important because of the very fact that it was believed, the government felt the sterling to be faltering. They were concerned about a massive speculative attack that would crash the currency and send inflation skyward. It was at this point that the Callaghan government approached the IMF for a loan.

The Treasury hated the idea, but the Callaghan government felt compelled to accept it. And with that the government had trapped itself. By positing the need for a target without the intention of seriously pursuing it they had sealed their fate. They could now be chastised for not meeting a target which was, as those working in the Treasury at the time knew well, impossible to meet because the money supply was impossible to control (i.e. it was endogenous and determined by other variables).

In 1979 Thatcher would rise to power with full intentions to meet the targets she set, no matter what the cost. The fact that she failed spectacularly and monetarism was thrown in the dustbin after 1984 was of secondary importance; the dogma had done it’s job — it had justified the demolition of British manufacturing and the gutting of trade unions — and anyone exposed to economic ideas in this era was forever infected.

So, what can we learn from all this today? Well, certainly that the finance sector has a remarkable ability to spread ideas which become important simply for the fact that they are believed. Unfortunately, however, financiers have a very immediate and obvious interest in seeing the government tackle inflation — as it eats into their earnings — but they have no very immediate and clear incentive to have the government reflate the economy.

Nevertheless, it is clear that most of the financial community are coming around to Keynesian-ish ideas today and for those of us who want to see those sorts of policies enacted that cannot be a bad thing at all. Apart from that I think that there is much of aesthetic interest in the monetarist saga; if nothing else it shows us just what a hall of mirrors we live in, with ideas taking on a life of their own through the simple act of people pretending to take them seriously.

The New Monetarism

About a year and a half ago I wrote a three-part series on monetarism which I published on Naked Capitalism. It might be of interest to readers so I include links below.

The New Monetarism Part I — The British Experience

The New Monetarism Part II — Holes in the Theory

The New Monetarism Part III — Critique of Economic Reason

When Marxists Deploy the Quantity Theory of Money and Other Economic Nonsense

It’s truly infuriating to watch left-wingers talk absolute nonsense when discussing the economy. I encounter it all too often. What you generally get is a hodge-podge of incoherent economic ideas — usually incorporating the worst aspects of right-wing doctrines like monetarism — topped off with a general hand-wave that, well, capitalism is full of ‘contradictions’ and doesn’t work anyway so what’s the use of discussing it in any detail.

Joan Robinson — probably the Post-Keynesian economist who dealt with the left in the most depth (I think others just get peeved) — noted this time and again. In her Open Letter From a Keynesian to a Marxist she mocked the tendency of left-wing economists to simply worship at the feet of Marx rather than trying to figure out what was good and what was bad in his analysis. A classic example of this is the following two paragraphs,

Again, suppose we each want to recall some tricky point in Capital, for instance the schema at the end of Volume II. What do you do? You take down the volume and look it up. What do I do? I take the back of an envelope and work it out.

Now I am going to say something still worse. Suppose that, just as a matter of interest, I do look it up, and I find that the answer on my old envelope is not the one that is actually in the book. What do I do? I check my working, and if I cannot find any error in it, I look for an error in the book. Now I suppose I might as well stop writing, because you think I am stark staring mad.

Robinson was completely right, of course. Most Marxists have no interest in figuring out what is good and what is bad economic analysis. Rather they are just interested in ideology. Any old silliness that can buttress their ideological and political claims can be brought into service.

I saw a rather egregious example of this today when I watched a video entitled What’s Driving Inflation in Venezuela?. I’ve posted the video below so that readers can view it. In it a sociologist tries to explain the inflation in Venezuela. Some of the reasons he gives are entirely nonsensical.

For example, he claims that because the economy is reliant on oil revenues that arrive to the country in the form of dollars this is a key determinate of inflation. Yeah, I know… what on earth is he saying? Only an incredibly primitive economic theory would claim that an increase in foreign reserves due to an trade surplus would generate inflation. A trade surplus leads to an inflow of foreign reserves and increases the value of the domestic currency. This allows for cheaper imports and puts downward pressure on prices.

But as you continue viewing it becomes clear where all the confusion comes from: the sociologist is espousing the quantity theory of money. Okay, this theory doesn’t tell us that a trade surplus leads to inflation but that is only because he doesn’t understand it properly. But it is quite obvious from listening to him that all of his views are centered around the quantity theory of money — this is the only solid pillar in his otherwise haphazard framework for interpreting economic events.

This reminded me of another Joan Robinson quote. This time from her book Economic Philosophy. It runs like this,

Marxist critics have understood that Keynes’ theory leads to conclusions which from their point-of-view are reactionary. They therefore deny the logic of his analysis and even find themselves in alliance with the protagonists of the humbug of finance which Keynes first attacked. For instance, Professor Baran [a prominent Marxist economist] is not content with showing that an economic system that can maintain prosperity only by expenditure on armaments is a menace to humanity, morally abhorrent and politically disreputable; he also has to bring in the Quantity Theory of Money to show that it cannot work because Government expenditure causes inflation. (p90)

Reading quotes like the one Robinson mentions and watching videos like that posted below one wonders what exactly people who consider themselves Marxists actually take out of Marx’s writings. You see, Marx was an adherent of Thomas Tooke’s theory of money — which ran directly contrary to the quantity theory. Here is a quote from the second chapter Marx’s early work Critique of Political Economy lambasting Ricardo’s quantity theory of money and saying that it was a tautology that had no ability to explain the underlying cause of price changes,

Ricardo’s monetary theory proved to be singularly apposite since it gave to a tautology the semblance of a causal relation.

The typical refrain now would be to say: “Oh, if only they read their Marx properly!”. But I don’t buy this at all. I think that Marx is a muddle. And I think that Robinson is correct: Marx is not read to be understood; he is read to endow the reader with a mystical sense that some sort of Truth has been accessed.

A New Era of Central Banking?

As I noted in my last post the Bank of England have released an official policy document that concedes that much of Post-Keynesian endoegnous money theory is indeed correct. Interestingly, they have also released some Youtube clips with the authors where they expound on their work in more details. You can watch these videos at the BoE website here.

The videos are fascinating. The language the authors use — which contains references to ‘fiat money creation’ and money as IOUs — is straight out of either David Graeber’s book Debt: The First 5000 Years or MMT. If I were to guess I would say that it is some combination of both.

This is an enormous step forward. But I found it particularly interesting how young the authors in the videos were. One of them must be in his early 30s or so. It seems that the younger folks in the BoE are finally starting to ‘get it’.

Now, the question is where this might take the BoE if it begins to spread. There are two paths that can be taken now that they’ve gotten the basic mechanics of money creation correct. The first path, is that they see this as part and parcel of the New Keynesian paradigm. That is, they will integrate these insights into the standard ISLM model by modifying the upward-sloping LM curve to represent instead a Taylor Rule. This is precisely what New Keynesian authors like David Romer have already done.

If this path is taken then nothing much will change. In such a conception of the world the central bank will be seen to be fully in control of the economy through the use of their interest rate policies. In more theoretical terms this would imply a linear relationship between the interest rate and investment. Obviously today that does not square with the facts. Since 2008 central banks the world over have completely lost control over the economy (whether they ever had such control is an altogether different question). The BoE, however, could chalk this up as some sort of ‘anomaly’ and continue to consider the interest rate an omnipotent Archimedean lever outside of certain very specific conditions.

From the explicit statements by the Bank so far this path seems the more likely. But there is another path that their new understanding could lead BoE economists down; that is, they might begin to see the central bank less as an institution whose goal is to steer the economy and more as an institution that is there to provide funding and advice to the government. This is, as I have noted before, what the BoE was actually set up to do. Indeed, most central banks — with the notable exception of the Fed (this history is complicated, I won’t get into it) — were set up to fund governments.

By this reading the state is primarily responsible for the management of economic activity. Thus fiscal policy and not monetary policy would be the key policy lever by which government officials steer the economy — not monetary policy. If this path were pursued the BoE would take an altogether different role in macroeconomic management. It would advise government on how best to use its fiscal levers to steer the economy and  it would provide it with funding. The central bank would then become a sort of watchdog on government activity.

This is actually how the BoE largely functioned between 1945 and the beginning of the monetarist era in the late 1970s. The Tory-led Radcliffe Commission of 1957 — discussed here — had found that monetary policy was a fairly ineffective tool at managing the economy and it became fairly widely accepted that the BoE should take a different role in macroeconomic management.

The question now becomes: which path with the BoE take? Will it reign in a new era in central banking and macroeconomic understanding? Or will it fall back on New Keynesian nostrums and integrate their new understanding of monetary operations into the old Gospels? The answer to this question will depend on the skill, the honesty and the integrity of those working in the Bank.

If all they want is a false sense of power — wherein they can appear to be the Masters of the Economy but are in fact no such thing — then they can swallow the New Keynesian soporific. But if they want to be honest with themselves, policymakers and the general public — that is, if they want to act like enlightened individuals — then they will have to reinterpret their role in macroeconomic management altogether. Perhaps a more cynical and succinct formulation of this question might be: who do the BoE want to impress; the general public with their enlightened attempts to steer the economy… or the City of London with their false pronouncements that they control all?

Bank of England Endorses Post-Keynesian Endogenous Money Theory

Well, the Bank of England has finally come out and said it: loans create deposits; banks create money and don’t simply lend out savings; and the money multiplier in the economics textbooks is false. Actually, we’ve known this for a long, long time. While the BoE report references much Post-Keynesian work — including early work by Nicholas Kaldor and Basil Moore’s path-breaking 1988 book Horizontalists and Verticalists — they would have done well to look up the findings of the Radcliffe Commission in the UK in 1957 (I have written about this extensively here).

It is fantastic that the BoE has finally decided to lay its cards on the table and be honest with the public about how money is created. Unfortunately though, the report is not willing to make certain concessions. For example, it largely paints the Quantitative Easing programs as being effective — which they were not — and it also claims that the BoE still sets the variable that has the most influence on money creation; that is, the interest rate. This latter point ties into the whole debate surrounding the so-called ‘natural rate of interest’ (which I have dealt with extensively here).

With regards to the central bank’s power to control lending the BoE authors insist that the “ultimate constraint on lending” is monetary policy. They explain how this functions as such,

The interest rate that commercial banks can obtain on money placed at the central bank influences the rate at which they are willing to lend on similar terms in sterling money markets — the markets in which the Bank and commercial banks lend to each other and other financial institutions… Changes in interbank interest rates then feed through to a wider range of interest rates in different markets and at different maturities, including the interest rates that banks charge borrowers for loans and offer savers for deposits. By influencing the price of credit in this way, monetary policy affects the creation of broad money. (p8)

Now, the functionality of the mechanism that the BoE authors describe is perfectly in keeping with Post-Keynesian endogenous money theory — it is also perfectly in keeping with recent innovations (if we can call them that) in the New Keynesian literature by the likes of David Romer who replace the vertical-sloping LM curve in the ISLM model with a Taylor interest rate rule. But to a Post-Keynesian the characterisation of the setting of interest rates as being the “ultimate constraint on lending” is complete nonsense. Just to get a sense of the BoE authors’ belief in the borderline omnipotence of the central bank let us once again quote them in the original,

The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. (p1)

Actually no. The amount of money created in the economy is ultimately dependent on the demand for credit! Yes, the supply price of this credit — that is, the interest rate — will influence the demand for credit; but if we have learned anything from the economic stagnation of the past few years it is that the demand for credit is what truly drives credit creation and the supply price of credit is of secondary importance. Messing around with the supply price of this credit has very different affects, say, post-2008 as it did, say, at the beginning of the housing boom.

So, what decides the demand for credit? There are any number of different things that drive credit demand. Speculative excesses in the property or stock market might lead to substantially increased demand for credit as investors borrow money to speculate. Inflationary wage-price spirals may also drive the demand for credit as firms borrow money to meet increasing wage bills. But if we were to give one single determinate that is likely the most important in considering the demand for credit I would say: income growth. Yes, that’s right: GDP growth.

At this point we encounter the classic Keynesian accelerator effect where increases in income cause increases in investment which in turn cause increases in income and so on in a circular fashion. What central banks do in such cyclical upswings or downswings of income and investment is of secondary importance.

Now, here’s a controversial thought: what if the BoE authors actually understand this? We know that they have read the endogenous money literature which states all of this quite explicitly. Also, any time I encounter central bank economists they seem very pessimistic about their ability to spur lending. But what if in their official documents they simply cannot bring themselves to say it out loud?

Perhaps we should think of the central bank as a corporate institution that, like any corporate institution, seeks both funding/revenue and influence. And then perhaps we should understand their bald assertions that they are almost omnipotent in their creation of credit money not simply as self-aggrandisement — although there is surely an element of that — but as a sort of public relations exercise deisgned to keep the public interested and the politicians listening.

After all, it would be a strange emperor that would reveal his own nudity in front of his subjects. But still, the BoE — which is surely the most honest of the central banks — should certainly be given credit for at least giving its loyal subjects a little grin and a wink as it parades in front of us in its birthday suit.

Update: It looks like some young economists in the BoE are very intent on getting this message out. They have even created some Youtube videos explaining the reality of money. Wow!