Webonomics

Crossposted from The Stars Hollow Gazette

The Economist has recently published an article describing 3 schools of Economic thought that have gained prominence recently because of their advocacy on blogs.  Indeed, being a political blog reader you may not be aware that there are more Economic blogs and they are more active and have better traffic than political ones like this.

Two of my favorites are Naked Capitalism (Yves Smith) and EconoMonitor (Nouriel Roubini) but I also frequent Krugman and Felix Salmon as well as a few others.

To summarize briefly before I excerpt some of The Economist’s descriptions of each school, the 3 Schools are Modern Monetary Theory (neo-Chartalism), Austrian (Austerian), and Market Monetarism.  I would say the article is more sympathetic to the 3rd school than the others though you may disagree.

Also I’m not quite sure what they consider “mainstream”, but in fact the Friedmanite Freshwater School has been thoroughly discredited by the abject failure of their models to predict events.  It is not science of any sort, but the faith based mystical mutterings of rattle shaking Shamen.

Heterodox economics, Marginal revolutionaries

The crisis and the blogosphere have opened mainstream economics up to new attack

The Economist

Dec 31st 2011

This invisible college of bloggers focuses first on the level of spending on American products: America’s domestic output, valued at the prices people pay for it. This is what economists call “nominal” GDP (NGDP), as opposed to “real” GDP, which strips out the effects of inflation. They think the central bank should promise to keep NGDP on a steady upward path, rising at, say, 5% a year. Such growth might come about because more stuff is bought (“real” growth) or because prices are higher (inflation). Mr Sumner’s disinhibition is to encourage the Fed not to care which of the two is doing more of the work.

Central banks set targets to make their currencies credible and their policies predictable. The target for many is to keep consumer prices growing at 2% a year or thereabouts. For the past few decades that has largely succeeded in stabilising inflation; but in the current crisis it has singularly failed to stabilise the economy. In America NGDP plunged over 11% below its pre-crisis path and remains there; what people buy at the prices they pay for it is much less than most would want.

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(P)ut into the context of a pathetic response to the current crisis, the ideas offered by these very different schools all take on a similar form: that policymakers are overly worried about something that should concern them less. The Austrians see the bogeyman as deflation, the fear of which inflates bubbles. The market monetarists, diametrically opposed, see exaggerated fear of inflation. And the economy is getting too little help from fiscal stimulus, according to neo-chartalists, because of the government’s superstitious fear of insolvency.

Modern Monetary Theory

The neo-chartalists believe that because paper currency is a creature of the state, governments enjoy more financial freedom than they recognise. The fiscal authorities are free to spend whatever is required to revive their economies and restore employment. They can spend without first collecting taxes; they can borrow without fear of default. Budget-makers need not cower before the bond-market vigilantes. In fact, they need not bother with bond markets at all.

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The policy conclusions neo-chartalism draws from this owe a lot to Abba Lerner, John Maynard Keynes’s “militant prophet”. Lerner believed governments should judge their fiscal policy by its economic results-its impact on jobs and inflation-and ignore any red ink it might spill. Governments should seek high employment and stable prices, much as the Fed does today. But instead of relying on monetary policy to meet these objectives, they should use fiscal policy instead. If private spending is too strong, pushing up prices and threatening inflation, the government should raise taxes or cut its own spending. If, on the other hand, private spending is too weak, jeopardising jobs, the government should cut taxes or increase its own spending.

So far, so Keynesian. But most Keynesians, anxious to appear fiscally responsible, say that budget deficits in bad times should be offset by surpluses in good times, keeping the level of debt seemly. Lerner admitted this might not be possible. Private spending might be chronically weak. If so, the government should run chronic deficits, adding continuously to the national debt. Lerner did not see that as much of a problem, though he recognised that many others were “easily frightened by fairy tales of terrible consequences”.

Austrian Economics

The “Austrian” school of economics, which traces its roots to 19th-century Vienna, is more sternly pre-Freudian: more inhibition, not less, is its prescription. Its adherents believe that part of the economy’s suffering is necessary, an inevitable consequence of past excesses. They do not think the Federal Reserve can rescue the economy. They seek instead to rescue the economy from the Fed.

(A)dvocate(s) of Austrian economics-a resurgent school of thought that, unlike market monetarism, has not been doing much to change the minds of most mainstream economists but, unlike neo-chartalism, has built up a broad constituency on and through the web… agree that interest rates should reflect the fundamental forces of thrift rather than the whims of central bankers.

The Austrian school’s thinking centres on the way “malinvestment” orchestrated by central banks distorts the business cycle. By keeping interest rates artificially low, central banks trick entrepreneurs into believing that society is more abstemious than it really is. The entrepreneurs then embark on ambitious, long-gestation investment projects, only to discover that the men and materials they require are otherwise engaged in the production of more immediate gratifications. Once this realisation dawns, the entrepreneurs abandon their follies, firing their workers. If wages are flexible and workers mobile, this bust need not be too bad. But misguided attempts by the government or the Fed to prevent unemployment will delay the necessary reshuffling of labour from industries too tied up in the future to those catering to the needs of the present.

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Most economists do not share their admiration for the gold standard, which did not prevent severe booms and busts even in its heyday. And their theory of the business cycle has won few mainstream converts. … While it provides insights into booms and their ending, it fails to explain why things must end quite so badly, or how to escape when they do. Low interest rates no doubt helped to inflate America’s housing bubble. But this malinvestment cannot explain why 21.8m Americans remain unemployed or underemployed five years after the housing boom peaked.

Market Monetarism

The market monetarists point out that their 5% (NGDP) target is consistent with inflation of about 2%, provided the economy grows at about 3% a year, its rough average for the pre-crisis years. If growth slowed to 1%, inflation would have to be permanently higher, ie 4%. If output suffered a one-time drop, inflation might have to surge temporarily above 5%. But as growth returned to normal, inflation would recede.

In pursuing this target, the central bank would use many of the same tools as today: tweaking the short-term interest rate and, when that reaches zero, increasing NGDP by printing new money to buy more assets (ie, quantitative easing). And the very creation of the NGDP target would make such intervention more effective, Mr Sumner says. If people expect the central bank to return spending to a 5% growth path, their beliefs will help get it there. Firms will hire, confident that their revenues will expand; people will open their wallets, confident of keeping their jobs. Those hoarding cash will spend it or invest it, because they know that either output or prices will be higher in the future.

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The market monetarists argue that fiscal stimulus should be redundant, because a central bank can always revive spending-if it sets its mind to it. If the Fed’s efforts have disappointed, it is not because market monetarism is wrong, but because the Fed is not sufficiently committed to the cause.

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The market monetarists do not fret about the side effects of the activism they seek, which can misdirect capital, inflate bubbles and seduce people into over-borrowing.

So, if I may be permitted to summarize, Austrians believe that over-supply of money is what causes busts and depressions, Market Monetarists think that vigorous application of monetary stimulus can solve them, and Modern Monetary Theorists think that the amount of money available to the economy is mostly irrelevant and that aggregate demand should be managed to provide predictable levels of employment and growth.

As always the specters of Weimar and Zimbabwe are raised, but those are special cases where money was manufactured for the sole purpose of speculating in external currencies, NOT the internal economy.  In Germany’s case it was the necessity of purchasing gold (external currency) to fulfill their Versailles reparations obligations.  In Zimbabwe it was so the corrupt political elite could ex-patriate their stolen wealth.