A Simple Macroeconomic View

Here's this from the Aleph blog, three years ago:
"Sometimes I think that the Keynesian and Austrian Schools of economic thought can be merged into a consistent synthesis that would disagree about the goals of policy, but largely agree on how economies work. One of the men that would help promote such an idea would be Hymen Minsky."
Here's an attempt to do just that:

1) Prices are sticky and markets (e.g. for labour) don't always clear; there is 'involuntary unemployment'. (Keynes) -- [Evidence? For example, graph of unemployment (x-axis) against inflation (y axis) 1990-2010 is approximately horizontal - ie big changes in unemployment without changes in inflation. the following graph is from Austalia]

2) Fractional reserve banking adds a second class (bank deposits) of money to the first (banknotes issued by the central bank). The second class of money, bank account money is usually created at the same time as debt, causing asset price inflation (Austrians); and deflation (Fisher) when the the two are cancelled out when de-leveraging.
3) Conventional economic thinking tends to ignore asset prices. But increases in credit money lead to increase in asset prices, and these lead to wealth effects which may add to economic instability.

To put it simply, markets (as currently constituted) don't always work, that's why you need a Keynesian response in a 'great depression' scenario. Some of the reasons that markets as currently constituted don't work may be 'Austrian' (ie the markets are distorted by the existence of fractional reserve banking), but the 'Austrian' message tends to be distorted as 'make markets freer, but ignore the privileges of the financial sector and the asset-owning sector', when these sectors are probably the most important distortions. However, there may be other reasons that 'markets don't work' apart from the 'Austrian' ones.


CargoCultist said...

I think the more accurate synthesis of Keynsian and Austrian Economists is that neither has ever managed to produce a complete understanding of the systemic behaviour of fractional reserve banking. That they both have different ways of not understanding it correctly is part of the general confusion at the moment.

The other problem is mixing markets - a distributed mechanism for providing a continuous real time solutions of supply-demand equations with the banking system, which is a way of providing monetary tokens of exchange and temporal flows of the same (loans).

Banknotes incidentally are printed on demand these days, so describing that as a second class of money is no longer as relevant as it would have been during the gold standard era say. It would probably be more accurate to say that reserve based banking can result in monetary inflation or deflation depending on a variety of factors, some of which are continuously changing over time, and some of which are implementation dependent.

David Merkel said...

My only question is this: Keynesian stimulus works when a government's ability to repay is unquestionable. What then, when repayment might imply inflation (from monetization of the debt), or much higher taxes? Or, non-payment would cause many foreign and domestic financial firms to fail?

Stephen Stretton said...

CargoCultist; thanks for the feedback.
I can't comment on completeness of the austrian and keynesian view since commenting on completeness needs a specialist.

I interpret the second paragraph as criticism of my article, right? I am mixing markets, between point 1 and 2-3. It's a good point, thanks.

On point 3, there are two possible reasons for drawing tbe distinction between currency and broad money, or something similar.
Firstly, the 'money multiplier' taught in standard economics textbooks, may be somewhat defunct and it may even depend on the jurisdiction.Consonnant with your comment, the UK doesn't appear to have reserve requirments (however, in China, reserve requirements are used as a macroeconomic tool). If the binding constraints change between jurisdiction or in time, then we have a moving beast tricky to pin down.

Nevertheless, currency is 'naked' whereas deposit money is matched by debts to the bank. So currency represents 'virtual wealth' in a macroeconomic sense, in a way that deposit money does not*. Of course,because of the charging of interest, debt to banks can exceed In addition to 'broad money' ('gross money') we should measure 'net money' (currency adjusted by subtracting any excess of debt over bank money). It was the possible shortage of 'net money' which is another justification for QE.

Stephen Stretton said...

Of course,because of the charging of interest, debt to banks can exceed the bank-created money (there could in principle be a shortage).

Stephen Stretton said...

First the reason why Keynesian stimulus may be effective. If there is a shortage of aggregate demand relative to potential output, the government spending as a consumer of last resort.

There are two possible reasons why Keynesian stimulus might be ineffective.
Firstly, there is the Ricardian equivalence that increased spending may be compensated by future tax rises. But since consumers are to some extent myopic, I think full ricardian equivalence will not hold.

Secondly, confidence may be hit if government borrowing runs out of control. Expectations of future profits, growth etc will be hit and therefore companies will cut back. Government will need to pay more for borrowing, leading to a worse deficit.