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Monetary Macroeconomics


Some years ago, in the aftermath of the “great financial crisis” (GFC) of the first decade of the twentieth century, Paul Krugman famously remarked that “most macroeconomics of the last thirty years was spectacularly useless at best and positively harmful at worst”. It is the premise of this set of lectures that it is possible to do better, much better.

The title of the course is significant, as Keynes once said in a similar set of circumstances. Great stress is laid on matters largely ignored in the literature referred to by Krugman, such as endogenous money, the importance of credit creation by the banking system, and the source of profit. In the end macroeconomics is monetary macroeconomics, nothing more, nothing less.

Section 1: Methodological Problems in Monetary Macroeconomics

The discipline of macroeconomics, as still taught every day in colleges and universities world-wide, has been unsuccessful in coping with the severe real world economic problems of recent times. There are several methodological problems with the mainstream approach that account for this. Firstly, the underlying premise of neoclassical economics that beneath the "veil of money" economic activity is fundamentally barter exchange. Money and credit inevitably take a back seat. Another problem is the virtual identification of economic theory with differential and stochastic calculus, employed in physics and engineering but inappropriate in social theory. Similarly, reliance on statistical probability theory (econometrics) as the main empirical method. Theorems about probabilities from the natural world do not apply in the social. Finally, the intellectual incoherence of all attempts to derive capital theory. What might be possible remedies? (1) Use explicitly macroeconomic methods rather than trying to build up macro results from non-monetary microeconomics. (2) Restrict attention to relatively small models. (3) Take seriously the notions of endogenous money and bank credit creation. (4) Make use of "only two fundamental units of quantity - money-value and employment" (Keynes), avoiding the quagmire of capital theory.

Section 2: Numerical Methods

Given the disarray in the economics mainstream it seems clear that one way forward is simply to take a step back, and return to the practice of monetary macroeconomics in the style of the old masters of the genre, such as Keynes, the later Hicks, and the Post Keynesians. But, having said this, does it mean that there is nothing that the methods and technology of the twenty-first century can add? Of course not. For example, current technology provides ample scope for the use of numerical methods (computer simulation). This lecture suggests that non-stochastic simulation techniques in discrete time are particularly useful. These provide several advantages; a theoretical method that can handle fundamental uncertainty, a robust empirical method based on the principle of abduction rather than induction and, nonetheless, a way for beginning researchers to retain and usefully deploy many of the technical skill sets labouriously acquired in graduate school.

Section 3: What is Money

The commonsense point of view is that economic activity in the enterprise economy is all about money - making money, spending money, saving money - and so forth. Yet many of the social science and business disciplines involved in the study of economic activity pay far less attention to this "most important institution in capitalist society" (Ingham) than it deserves. There are theories about what money does - economic theories about money and inflation, political theories about money and power, sociological theories about money's cultural significance. What is missing, however, is any detailed discussion of the ontology of money. What is "money", how does it come into being, and what is its nature?

Section 4: The Widget Puzzle

There have always been dissenters from the orthodox approach to monetary theory. It is not simply a twenty-first century phenomenon - although matters have come to a head following the global crisis of the last decade. There are also obvious analogies between the current state of political economy and the comparable watershed of the 1930s. This was similarly a period in which, in the absence of an effective response to crisis by orthodoxy, various heterodox approaches proliferated. Then and now, a central problem, mooted by Keynes's "brave ... heretics" and Robertson's "monetary cranks" alike, is the deceptively simple question of whether or not there is enough money in existence to purchase the full value of output. This is a genuine problem, but never seems to have been successfully posed by would-be monetary reformers. Orthodox economics has therefore always been able to elide the issue, in both macroeconomic and microeconomic contexts, by such devices as the concept of the velocity of circulation. The "widget puzzle" in this lecture, however, provides a fully worked out numerical example of an endogenous money process which makes clear the nature of the problem.

Section 5: Alternative Theories of Interest Rate Determination

Mainstream theoretical economists do not think of the interest rate as being determined primarily in the monetary and financial sphere as more practical market participants might do. The theorists believe there is a "natural rate" of interest determined entirely by non-monetary factors. According to Wicksell, the originator of this concept over a century ago: "This natural rate is roughly the same thing as the real interest of actual business ... {think} ... of it as the rate ... determined by supply and demand if real capital were lent in kind without ... money". However, if barter exchange is a myth then the natural rate of interest must also be a myth. How could there be any "actual business" without a money of account and credit creation? This lecture discusses and evaluates various alternative theories of interest determination put forward over the years, including the orthodox loanable funds theory, liquidity preference theory associated with Keynes, and so-called Post Keynesian "horizontalism".

Section 6: Interest and Profit

In monetary macroeconomics it is important to distinguish between the real rate of interest on money and the profitability of business enterprise. If the former is a monetary phenomenon, as claimed by Keynes, the latter is in the nature of a "surplus" over and above the costs of production, including financing costs. There must therefore be an inverse relationship between the real rate of interest and the average or aggregate mark-up. Neoclassical/mainstream theory is confused on this issue due to ontological uncertainty about both concepts. This lecture, however, develops a synthetic theory of profit and of the functional distribution of income in general, which is able to illustrate these points.

Section 7: Monetary Policy and Income Distribution

How does monetary policy, and macroeconomic policy more generally, affect the distribution of income? This depends to some extent on what we actually mean by the distribution of income. There are a number of possibilities. Are we interested, for example, in the personal distribution of income - equality versus inequality? Or, in what is sometimes called social justice (emphasis on the word social ), meaning distribution among groups arranged by some sort of collective attribute, such as age, class, ethnicity, gender, national origin and so on. Also relevant, within a primarily capitalist system, is the functional distribution of income - between profit, interest, and wages. Another key question, then, is whether, and to what extent, the different concepts of income distribution are related. In this lecture, we turn again to numerical methods which help predict the effects on the functional distribution, at least, when there are monetary policy changes.

Section 8: Alternative Theories of Economic Growth and Inflation

There are two alternative views about how to promote economic growth. We develop two generic growth equations, each including the trade balance, the primary budget deficit, and the domestic investment/savings balance, to explain the underlying arguments. The first illustrates a "Keynes's-type" theory, focusing on demand growth. This validates the idea that fiscal expansion leads to growth, that investment drives saving (the "paradox of thrift") and that a trade surplus leads to growth ("monetary mercantalism"). The second approach leads to a "classics-type" theory, stressing capital accumulation and supply. However, this yields seriously anomalous results, and does not provide a solid foundation for the classical theories of trade, saving, and public finance. There are also multiple theories of inflation, those descended from the quantity theory, from Wicksell, and also various theories of "cost push" or "conflict" inflation. If money is endogenous there is plenty of scope for the latter. Also the parameters of both the money demand and (endogenous) money supply functions must be relevant. These are literally measures of "liquidity preference" - on both sides of the money market.

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