Economist Brian Easton says the old ways of thinking about the macroeconomy have been found wanting, but the alternative is not clear

Economist Brian Easton says the old ways of thinking about the macroeconomy have been found wanting, but the alternative is not clear

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.


Macroeconomics – understanding how the economy as a whole works – appears to be going through a time of exceptionally great turbulence. There is always a robust debate, but today it is more confused. That may not be the impression you get from the commentariat, who echo the past conventional wisdom, but it is the reality for more sophisticated economists.

It is even difficult to set out exactly what is going on, especially within the limitations of column space. Perhaps a key issue is that since the 1980s there has been a tendency to assume that the economy works in a way in which fiscal policy and monetary policy can be operated independently of one another. That meant that monetary policy could maintain price stability while fiscal (tax and public spending) policy could focus only on medium-term stability of aggregate production. Fiscal interventions could do little about short-term fluctuations which was beneficial in the medium term. We might call this paradigm ‘Monetarism’. On the other hand, Keynesians have an account of the economy which led to the policy conclusion that fiscal and monetary policy should be co-ordinated.

It is a long story about how we got to the 1980s and after, but part of the background is that as American economics became hegemonic, the particularities of the US institutional framework were assumed. Because of the way that the Fed, Congress and the presidency are organised it is practically difficult to coordinate fiscal and monetary policy in the US. This is not as true in New Zealand and many other jurisdictions.

Another factor is that Monetarism raises the significance of banks who have an interest in promoting their self-importance. Abhijit Banerjee and Esther Duflo were not alone when they wrote ‘[t]he “economists” in public discussion ... on TV and the press – chief economists of Bank X or Firm Y – are, with important exceptions, primarily spokespeople for their firm’s economic interests who often feel free to ignore the weight of the evidence.’ So the public perception is distorted, especially as journalists do not know any better.

While Monetarism was the dominant policy framework, many economists remained Keynesian. Some on them in policy positions would even confess ‘actually I am a Keynesian’ and try to moderate policies from this perspective. They were able to compromise because, the odd shambles aside, the policy recommendations were not that different during the Great Moderation of the affluent economies 1990s and early 2000s.

That is no longer true. The serious fracturing began at the time of the Global Financial Crisis. It is claimed that no one predicted it. That is true among the Monetarist commentariat but there were numerous Keynesians who did expect a financial crisis – even me. (We just could not predict when it would happen.) The Monetarists froze in disbelief so it was the Keynesians who led the response. (Sadly neoliberals used the crisis to reduce the size of some states with the redistributional consequence of increasing inequality.)

The standard prescription for stagnation is to reduce interest rates in order to stimulate investment (and borrowing for consumption). Now the rates are getting very low, that it seems they may need to be be negative; that is difficult to do (but not impossible, to a limited extent). In any case, low rates do not seem to be stimulating the economy much.

The Keynesians went for ‘quantitative easing’ (in former days it was called ‘open market operations’, although it did not usually operate to the extent it does today). QE requires a degree of cooperation between fiscal and monetary policy. Essentially it involves the government injecting spending power by tax cuts and expenditure increases and the monetary authority funding the resulting public deficit.

This means the public is increasing its holdings of highly liquid government assets. It is uncertain what the effect will be in the long run. (If you are certain, you have not been following closely enough.)

And so the world economy staggered though the post-GFC decade, which ended with the Covid Crisis. That has disrupted supply chains (as in the case of tourist operators not having any business.) An aside, both the standard Keynesian and Monetarist models use a single commodity, which tacitly assumes that resources, production and labour can be relatively quickly and smoothly redeployed. In practice they can’t.

So we have had governments intervening at much a more micro-level – reminiscent of the Muldoon era. That is true for this government. The National Opposition does not seem to disagree although it argues over which interventions; ACT has been largely silent rather than critical. The government’s additional spending, much of which is income support (and easily reversed when prosperity returns) is funded by borrowing.

So recent operations contradict the assumptions that were made in the 1980s – that fiscal policy should not try to deal with short term fluctuations, while monetary policy should not try to operate independently of fiscal policy.

The size of the head-space shift is extraordinary. A recent Economist briefing simply takes the previous paragraph as given without a skerrick of a mention of the Monetarist paradigm. But if ‘the covid-19 pandemic is forcing a rethink in macroeconomics’ the subtitle of the article is a chilling ‘It is not yet clear where it will lead.’

The briefing well illustrates the problem because, while it implies that the Monetarist dominance is over, it offers a confusion of possible policy responses. Moreover, by focusing on policy, it does not pay much attention to why the world economy is in so much difficulty – why, for instance, the economic growth rate has slowed down (which, presumably, is related to why low interest rates are not leading to an investment boom). Also, and dangerously, there is not much attention to the role of the external sector which plays a fundamental role in small open economies such as New Zealand.

If it is any comfort, during the 1930s ‘Keynesian’ policies were being pragmatically implemented before the Keynesian paradigm had been properly articulated.

What I am reporting then, is progress. We are no longer trapped into the Monetarist thinking framework, although there are still a lot of parts of it which are implicitly accepted or on which our institutional arrangements are based, meanwhile much of the the commentariat use a Monetarist framework.

The discussion on the rising level of government debt and the need to get it down echoes crude Monetarism. Of course we should be concerned about the level of public debt and have a strategy to restrain it in the long run, But if the strategy is followed too early, as popular prescriptions propose, the economy will stagnate. Much as it did over the last decade when the immigration boom and private sector borrowing boom are excluded.

On the other hand we do not yet have a coherent alternative. Instead we are making a series of ad hoc decisions, some of which are probably right, some of which may get us into dreadful problems in the future.


Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

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17 Comments

QE certainly has a strong correlation with the stock indices. Maybe the inequality mentioned isn't from reducing the state, but the excessive corporate welfare...

The majority of mainstream economists seem to believe in the money multiplier and the loanable funds theory of money, neither of which exist in reality. As economist Prof Bill Mitchell has said many times "university economics courses teach fake knowledge" and mainstream economists also "suffer from groupthink" he says.

"meanwhile, the the commentariat use a Monetarist framework"

And the alternatives are?

The doubt of the future is understandable considering the application of theories with flawed assumptions.
But here's a thought - taking Stephanie Kelton's MMT, the purpose of tax changes from funding government spending to managing inflation and public behaviour. what kind of future then does that look like?

"The Monetarists froze in disbelief so it was the Keynesians who led the response."

This wasn't a freeze in disbelief the plan was for unsustainable businesses to fail, but then Lehman Brothers failed. Lehman failure terrified all the other banks and overnight Keynes was back in fashion. Direct market intervention (QE) to sustain fragile existing lenders (TBTF banks) is the new normal. Instead of a quick correction, a decade spent funneling public support for corporate welfare and here we are.

There is one major truth in finance which is being willfully disregarded - " What cannot be paid off must be written off "

Good article, lacking the typical arrogance of those convinced their particular insight is the way ahead. My particular view is that we fudged through the GFC and last ten years a whole lot better than anyone expected, through a hybrid pragmatic monetarist/Keynesian approach. QE was invented on the hoof, and that and significant interventions to prop up banks and enterprises. Corporate welfare? Not really, it’s been about maintaining high employment levels and that’s been successful too. Negative consequence of wealth disparity are nowhere near as bad as high unemployment, and consequent high income disparity.

Easton steadfastly fails to address the energy issue - and only does a superficial 'resources.

I put much of this stuff in front of him before I was banned from Pundit (and my complaint to the P/Council was buried; if I was him, I'd disassociate myself). But he studiously avoids what underwrites 'the economy'. Could it be he just doesn't understand? Doesn't matter which style of economist you are, you have to understand the Limits to Growth, physics, and our current point on the trajectory

The study of economics is generally broken down into two disciplines
Microeconomics
Macroeconomics

Then there is Behavioural Economics
Richard Thaler is considered one of the founding fathers of behavioral economics.

In the last 2 months we have seen the introduction of 2 more
Experimental Economics (from Auckland Unversity)
Now we have Momentum Economics

Financial Moimentum is a term out of Technical Analysis otherwise known as Charting and Chartists

Some years ago a visiting Technical Analyst "expert" was sitting beside me watching a live chart of the ASX200 index and SFE200 Future. He loaded up a live Chart and overlaid two momentum indicators. One was a Stochastic Indicator, the other was Bollinger Bands. The Stochastic Indicator rose up and penetrated through the 80% overbought line, stayed above it for some time. Then it turned and fell back down below the overbought thresh-hold. I don't know the working of Bollinger Bands, but according to this expert it confirmed his Stochastic indicator. So he went short and sold the market. Five minutes later the market turned and exploded back up through the Stochastic. The chart simply redrew itself and shifted the overbought line up to a new setting. He lost a lot of money. That's momentum for you. I remain unconvinced to this day.

In the old days, adopting Keynisian economics (printing money and spend it to fund government spending) did result in hyper inflation. If supply equals demand, the increasing money supply that stimulates demand more than it can supply must result in inflation. That is true in any closed economic environment. And often, the increasing in supply is very limited and restricted and over much longer time than is the increase in demand (which can be very fast: put money in someone pocket and you have the effective demand).
Globalisation has changed the dynamic as supply is now immediately met by imports from (largely) China and other developing countries. In effect, deficit spending in developed countries is strongly stimulating for developing countries (as their spending ended up using untapped or under utilized resources in those countries).
The moment this dynamic changes, we will be back to hyper-inflation.

As we have seen in Japan, if a population has a high propensity to save then inflation will also remain low. Money created by the government can also be used to reduce the high levels of household debt in NZ, (sectoral balances), this also is not inflationary.

Do you know much about Japan? I noted one thing looking at Japanese data. Most of the government massive deficit (something like 80% of it) is spent on health care. As CPI measures what family spends their income on, I suspect that it will not capture any spending on health care (free health care means that Japanese are not spending anything on it, so even if its costs inflated by 300% it will be zero to CPI). That provides a better explanation on how Japan can have such a massive deficit yet no CPI. the deficit is spent on items that are not captured by CPI.
Also, while Japanse do cut expenditure and are savers, their real income has been declining too. And I suspect their declining income has a a greater impact on cutting spending (after all they literally have less money to spend) than their tendency to save.

Well a currency issuing government can never truthfully say that it cannot fund healthcare because it doesn't have the money to do so, it can only say that the resources are not available to it. If the resources are available to be put to work then it is not inflationary. Why are our DHBs all running deficits? They must have the capacity to do more but the funding is not there.

Inflation peaked about 25-27% in ONE year in 1970s in UK and NZ
Please define "hyper" which is usually ref to Weimar Republic or Zimbabwe or Venezuela.
1970s economic crises and high inflation were, as most acknowledge, due not to government spending or Unions "power" but to oil price quadrupling twice

In the 1970s and 1980s, New Zealand had a very poor track record of price stability. Annual inflation had been around 10 to 15 percent since the early 1970s (figure 1), and was considerably higher than inflation in our main trading partners. A key driver of high inflation in New Zealand over this period was government spending, accommodated by generally loose monetary policy (Grimes, 1996). (from the RBNZ website: https://www.rbnz.govt.nz/research-and-publications/speeches/2018/speech2...)

Nice reference to "journalists, who do not know any better"
Hence we have Katie Bradford as "economics" correspondent, who never asks Equab what he thinks and I am pretty sure, has no qualification or experience in the subject.
Monetarism to me is "hands off government" - as in, do not want government doing redistribution. Basically OECD stopped ding redistribution (or favouring it) in 1975, since when economics, realism, commons sense and the ruling class are all synonyms and so is TINA. So, National presents all its policies as in best interests of all, when of course it turns out the top 30% take home the goodies.