Heterodox economics

Marginal revolutionaries

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

Dec 31st 2011


POINT UDALL on St Croix, one of the US Virgin Islands, is a far-flung, wind-whipped spot. You cannot travel farther east without leaving the United States.

Visitors can pose next to a stone sundial commemorating America’s first dawn of the third millennium. A couple namedSigi + Ricky” have added a memento of their own, an arrowstruck heart scrawled on the perimeter wall in memory of “us”.

Warren Mosler, an innovative carmaker, a successful bond-investor and an idiosyncratic economist, moved to St Croix in 2003 to take advantage of a hospitable tax code and clement weather. From his perch on America’s periphery, Mr Mosler champions a doctrine on the edge of economics: neo-chartalism, sometimes called “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.

The neo-chartalists are not the only people telling governments mired in the aftermath of the global financial crisis that they could make things better if they would shed old inhibitions.

Market monetarists” favour more audacity in the monetary realm. Tight money caused America’s Great Recession, they argue, and easy money can end it. They do not think the federal government can or should rescue the economy, because they believe the Federal Reserve can.

The “Austrianschool 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.

You tell me it’s the institution

These three schools of macroeconomic thought differ in their pedigree, in their beliefs, in their persuasiveness and in their prospects. Yet they also have a lot in common. They have thrived on the back of massive disillusion with mainstream economics, which held that the economy would grow steadily if central banks kept inflation low and stable, and that there were no great gains in the offing from fiscal expansion, nor any great cause for concern over financial instability. And they have benefited hugely from blogging.

Economics, perhaps more than any other discipline, has taken to blogs with gusto. Mainstream figures such as Paul Krugman and Greg Mankiw have commanded large online audiences for years, audiences which include many of their peers. But the crisis has made the academic establishment fractious and vulnerable. Highly credentialed economists now publicly mock each other’s ignorance and foolishness. That has created an opening for the less decorated members of the guild, and the truly peripheral.

In the blogosphere anywhere can be, as the title of Mr Mosler’s blog has it, “The Center of the Universe”.

In a world beset by doubt, there are great opportunities for those happy to pursue their beliefs to their logical conclusions and thrillingly thoroughgoing in the way they do so.

Is fiscal stimulus not working? Then do more of it, say the neo-chartalists. Are monopolies and price controls a problem? Then get rid of the central bank’s monopoly in setting the price of credit and the supply of government money, say the Austrians. Damn the torpedoes and never mind the naysayers—acolytes in the comments section will sort them out.

What’s more, put 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.

The clearest example of the power of blogging as a way of getting fringe ideas noticed is “The Money Illusion”, a blog by Scott Sumner of Bentley University, in Waltham, Massachusetts. In the wake of the financial crisis Mr Sumner, a proponent of market monetarism, felt he had something to say, but no great hope of being heard.

We’d all love to see the plan

And so on February 2nd 2009 he started to blog. He was not, he admitted, a “natural blogger”, which is to say his posts were long, tightly-argued and self-deprecating (“consider me an eccentric economist at a small school taking potshots from the sidelines”). But he attracted thoughtful comments and replied in kind. On February 25th, he earned a link from Tyler Cowen, a professor at George Mason University whose “Marginal Revolutionblog is widely respected. And one month after he started Mr Krugman devoted a short post to rebuffing him.

To be noticed by Mr Krugman is a big thing for a blogger; all the current heterodoxies court such attention, with neo-chartalists churning up his comment threads and Austrians challenging him to set-piece debates. The more Mr Krugman wrestles with them, the more attention they garner—a correlation that has made him wary. “I’ll link to any work I find illuminating, whoever it’s from,” he writes. “I’ll link to work I think is deeply wrong only if it comes from someone who already has a following.” Otherwise, “why give him a platform?”

Mr Sumner’s blog not only revealed his market monetarism to the world at large (“I cannot go anywhere in the world of economics without hearing his name,” says Mr Cowen).

It also drew together like-minded economists, many of them at small schools some distance from the centre of the economic universe, who did not realise there were other people thinking the same way they did. They had no institutional home, no critical mass. The blogs provided one. Lars Christensen, an economist at a Danish bank who came up with the name “market monetarism”, says it is the first economic school of thought to be born in the blogosphere, with post, counter-post and comment threads replacing the intramural exchanges of more established venues.

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 callnominal GDP (NGDP), as opposed to “realGDP, 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 (“realgrowth) 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.

The market monetarists point out that their 5% 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.

A real solution

If the target were not believed, the Fed would have to do whatever it takes to hit it. That might includeheroicpurchases of assets, on a bigger scale than anything yet tried by the Fed or the Bank of England. Even then, people might refuse to spend the newly minted money, or the banks might also refuse to lend it.

But there are ways to make people spend, say market monetarists like Bill Woolsey of The Citadel, a military college in South Carolina. The Fed could impose a fee on bank reserves, leaving banks to impose a negative interest rate on their customers’ deposits. That might simply serve to fill up sock-drawers as people took the money out of their accounts. But eventually, instead of hoarding currency, they would spend and invest it, bidding up prices and, with luck, boosting production.

Thanks largely to Mr Sumner’s campaign, a growing number of mainstream economists—including Mr Krugmannow favours looking at a change to NGDP targeting. At its November meeting the Fed’s policy committee discussed the pros and cons of such a moveremarkable in itself for an idea so marginal just a couple of years ago. It did not, though, sweep all before it.

Some committee members worried that switching to a new targeting regime could “risk unmooring longer-term inflation expectations”. If inflation were allowed to rise to 5%, for example, people might regard that as permanent and set wages accordingly, even as output returned to normal. To show its mettle, the Fed would then have to restrict growth; the costs of proving its seriousness might swamp the benefits of the new regime.

Blogging has served Mr Sumner well, both as a medium of expression and as a venue for drawing together like-minded colleagues. But blogs are not the only way to promote unorthodox ideas. To help spread the neo-chartalist gospel, Mr Mosler ran as an independentTea-Party Democrat” in the 2010 Senate race in Connecticut, his home state.

His belief that America is “grossly overtaxed” is one that common-or-garden tea-partiers would happily endorse; his belief that fear of national insolvency is a mirage and that there is plenty of scope for borrowing more would have them reaching for their pitchforks—or at least their balanced-budget amendments. His campaign did not meet with electoral success.

Candidate Mosler’s boast was that he was “right on the money”. A country with its own central bank can generate an unlimited supply of money and guarantee demand for it by requiring it as payment for taxes. That gives the state scope to spend without worrying about going bust, Mr Mosler argues. It can always pay its bills, because it prints the stuff with which bills are paid.

The policy conclusions neo-chartalism draws from this owe a lot to Abba Lerner, John Maynard Keynes’smilitant 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”.

One reason for this extraordinary tolerance towards red ink is straightforward macroeconomics. If firms, households and the rest of the non-government sector collectively refuse to spend all that they earn, they must lend the remainder to someone else. They cannot collectively lend more to each other than they borrow. So they must lend to the government instead. Private underspending creates both a need for fiscal stimulus and a simultaneous demand for the government liabilities a stimulus entails. Eventually, Lerner argued, the public would accumulate so much of this government paper that it would feel wealthy enough to spend again, sparing the government the need for further stimulus.

What if the public refused to spend, but also spurned government bonds, for fear perhaps of default? That cannot happen, according to the neo-chartalists, because the government can print the money these securities promise to pay. Such a response summons hyperinflationary nightmares of the Weimar Republic, or Zimbabwe.

But neo-chartalists would argue that those regimes resorted to the printing press as a way to grab more resources than the private sector was willing to yield. The government and the private sector combined wanted to buy more than the economy could produce.

In Lerner’s scheme, printing money serves a different role. It gives the private sector something to hold, should it not wish to buy things. Printing money is not a way to increase the deficit. It is simply an alternative way to finance a deficit of given size, one big enough to keep employment up, but—cruciallysmall enough to keep prices flat.

This insouciance towards debt opens up Mr Mosler’s ideas (which he used to callsoft currency economics”) to all sorts of criticism. But its application has made him a lot of money. He turned a profit of over $50m for his fund and his clients buying Italy’s lira bonds in the early 1990s, when prominent economists flagged the danger of default. In 1996 he earned them over $100m after he pledged to buy more of a certain type of Japanese paper than the government had issued. And his bank made a monthly return on required equity of over 10% in 2011 largely by buying American Treasury bonds, betting against celebrated investors like Bill Gross of Pimco, the world’s largest bond fund, who sold his fund’s Treasuries in early 2011 before recognising his mistake later on.

You say you’ll change the constitution

In the neo-chartalist view of the world, fiscal policy comes to resemble monetary policy. When the Treasury spends, it adds to the supply of money in circulation.

When it taxes, it withdraws money. So for neo-chartalism to work as intended, budget-makers must both tighten policy once demand has been restored and inflation threatens and also be credible in their commitment always to do so.

Otherwise self-fulfilling expectations of inflation will take root, as they did in the 1970s. That period of stagflation demonstrated the need to leave macroeconomic stabilisation to forward-looking technocrats—central bankersthought responsive to economic news and unresponsive to political demands. If you can imagine fiscal policymakers in Congress allowing the economy to be run in such a way, then you too can be a neo-chartalist.

Clearly the tea-partiers who would not party with Mr Mosler during his Senate bid will have none of this. Ron Paul, the libertarian Texas congressman whose 2008 presidential campaign was one of the foundations of the tea party, and whose 2012 campaign is currently enjoying an enthusiasm few would have predicted, is a balanced-budget zealot, and from his pulpit as chair of a House subcommittee on monetary policy lambasts quantitative easing as “financial malfeasance”; indeed he advocates abolishing the Fed itself.

Mr Paul thus shows his colours as an advocate 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. Its adherents (including Mr Paul’s fellow Republicans Paul Ryan and Michele Bachmann) differ a lot in their preoccupations and prescriptions. But they 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 waymalinvestmentorchestrated 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.

Scholars such as Lawrence White of George Mason University see in this the grounds for replacing central banks with “free banking” in which private institutions take deposits and issue their own banknotes without government permission or protection. To make these liabilities credible, free banks would probably have to make them redeemable into something else, such as gold. As a consequence, banks will hesitate before expanding too quickly, lest their gold reserves come under threat. This, Mr White argues, would impose a natural check on overexpansions of credit.

The resurgence of Austrian analysis is not merely a web-based phenomenon. In 1981 Margit von Mises approved the establishment of an institute in the name of her late husband, Ludwig von Mises, one of the giants of the Austrian tradition of economic thinking.

The Mises Institute set up shop at Auburn University in Alabama, attracted by a couple of “Austrian-friendly" faculty members and a timber owner willing to donate money to the cause. From early days in the shadow of the football stands, the institute now boasts its own amphitheatre, conservatory, recording studio and library. At one of the institute’s soirées, accompanied by a recital on its Bösendorfer piano, Vienna may not seem so very far away. Yet the institute’s impressive web presence, with ever more signing up for its online classes, makes its ideas, if not its ambience, available to all.

Austrians still struggle, however, to get published in the principal economics journals. 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.

According to Leland Yeager, a fellow-traveller of the Austrian school who once held the Mises chair at Auburn, it is “an embarrassing excrescence” that detracts from the Austrians’ other ideas. 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.

Brother you have to wait

America is suffering from a shortfall of spending. Both market monetarism and the neo-chartalists are right about that. They disagree about whether the best response is monetary or fiscal.

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.

This is probably true. But it makes it hard for the market monetarists to clinch their case.

Until a central bank truly commits to their policy, they cannot prove their point. But until they prove their case, central banks will be reluctant to commit to their policy.

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. But these side effects give Austrian economists the heebie jeebies—and also worry the neo-chartalists, who are not convinced that private spending stimulated by easy money will restore full employment. Yet Austrians and market monetarists are united in their distaste for neo-chartalist fiscal stimulus. Mr Sumner considers it wasteful; the Austrians, downright harmful.

Meanwhile mainstream economists continue to look at all the options askance, though not equally so. Some, particularly on the left, are getting quite enthusiastic about the market monetarists’ NGDP targeting. Few are as keen on neo-chartalism. The late Bill Vickrey, a Nobel prize-winner, had sympathy for its take on debt, but it remains largely confined to academic redoubts in Kansas City, Missouri and Newcastle, New South Wales. As for the Austrians, Brad DeLong, a Keynesian Berkeley professor who also blogs, has called an acquaintance with their ideas a useful part of a diversified intellectual portfolio. But his frequent comrade in arms, Mr Krugman, does not seem to have revised his view that their business-cycle theory is “as worthy of serious study as the phlogiston theory of fire”.

His analogy implies that economics, like chemistry and physics, makes enough intellectual progress to allow economists to ignore some old thinkers. But is economics that kind of science?

Its practitioners cannot run controlled experiments on whole economies. The natural experiments that might help falsify theories do not come around often. And when they do, the refutations provided are only ever partial.

What is more, intellectual schools are not simply about the rights and wrongs of specific cases. Compared to the oxygen theory that replaced it, quasi-alchemical phlogiston provided a poor account of combustion. But it captured an idea about the tendency of the world to require replenishment on which its immediate successor was silent, and which prefigured some ideas that thermodynamics would bring to science most of a century later.

The bygone and the marginalised always look strange. But would it not also be strange to imagine that, in 30 or 50 years, economic historians will look back on the current crisis and say that mainstream macroeconomics offered the best analysis and prescriptions that could have been conceived? If they agree that it did not, then there seems a chance that they will think perspectives outside the mainstream might have helped.

Decades ago macroeconomics resembled an “intellectual witch’s brew”, according to Olivier Blanchard, chief economist of the International Monetary Fund. It contained “many ingredients, some of them exoticmany insights, but also a great deal of confusion”.

Things then became more rigorous and refined: disagreements remained, but within set limits. Now, on the blogs, the economic conversation boils and bubbles again. That ferment is surely spreading into the academy—and in time some new quintessence will be brought forth, perhaps from materials now considered base.

Global Finance’s Supply-Chain Revolution

Andrew Sheng


HONG KONG – In March 2011, the catastrophic earthquake, tsunami, and nuclear disaster that hit Japan halted production of key components on which many global supply chains depend. The sudden disruption of these essential materials from the production process forced a reassessment of how these supply chains function.

But such vulnerabilities are not confined to the manufacturing sector. The finance industry, too, has suffered its own nearsupply chain meltdown in recent times.

The failure of Lehman Brothers in 2008 not only roiled global financial markets, but also brought global trade practically to a standstill as wholesale banks refused to fund each other for fear of counterparty failure. The simple banking system of the past, one based on retail savings being concentrated in order to fund the credit needs of borrowers, had evolved into a highly complex – and globalsupply chain with knock-on risks of disruption comparable to those seen in Japan last spring.

Financial supply chains and those in the manufacturing sector share three key featuresarchitecture, feedback mechanisms, and processes – and their robustness and efficiency depend upon how these components interact.

In today’s financial architecture, as with other supply chains, interdependent networks tend to concentrate in powerful hubs. For example, just two financial centers, London and New York, dominate international finance, and only 22 players conduct 90% of all global foreign-exchange trading. Such concentration is very efficient, but it also contributes to greater systemic risks, because, if the leading hubs fail, the whole system can collapse.

Open feedback mechanisms ensure a supply chain’s ability to respond to a changing environment, but, in the case of financial supply chains, feedback mechanisms can amplify shocks until the whole system blows up. The Lehman Brothers collapse triggered just such an explosion, with the financial system saved only by government bailouts.

Finally, the processes within supply chains, and the feedback interactions between them, can make the system greater or smaller than the sum of its parts. Since a complex network comprises linkages between many sub-networks, individual inefficiencies or weaknesses can have an impact on the viability of the whole.

Like manufacturing supply chains in the wake of the Japanese disruption, financial supply chains face formidable pressures to re-engineer and adapt as the global economic balance shifts towards emerging markets. As that happens, billions of consumers will enter these countries’ middle classes, new social networks will evolve, and climate change will become a growing factor in global commerce.

In addition, major regulatory reforms will impose new and higher costs on the financial sector. Banks and other institutions are also under pressure to devise new financial products that can help the real sector to manage more complex risks and enable investment in areas such as green technology and infrastructure for developing economies.

Moreover, global financial stability now depends upon greater cooperation at the international level, with tighter enforcement of rules at the national level. It is also clear that emerging markets are searching for alternative growth models that are green and sustainable. Their financial sectors will have to operate very differently from the current model, which is driven by consumption.

In a world in which both consumption and finance must grow more slowly to cope with global resource and environmental constraints, what role can finance play in reducing addictive consumption, funded by unsustainable leverage? And, given that financial institutions will have to monitor and manage risk in a radically different manner, both for themselves and their customers, what is the role of distribution in a world where consumption, savings, and investment will accelerate in volatility?

Financialproduction” is currently a top-down process. Instruments are designed in such a way that their sales generate more profits for financial engineers than for end users. But the rise of interactive social networking has made financial innovation more bottom-up. Millions of bank customers using mobile phones can provide immediate feedback on which products and services they like or dislike. In the future, client-service and transaction-management systems will receive more input from customers more frequently, so that product design is shaped interactively.

The current strategy in the financial sector drives excessive competition by increasing market share at rivals’ expense, often breaking trust with customers for the sake of short-term gains. Yet the financial sector has, in previous eras, proven that it can operate as a public good by providing trustworthy, efficient services. The winning financial supply chains of the future will instill confidence that they offer safe, stable, and efficient services to the most clients.

Innovation in the last century focused on processes, products, and services. Today, the financial sector needs innovation of a higher order, involving business models, strategy, and management approaches that restore trust in finance. Just as Steve Jobs of Apple transformed the computer industry through lifestyle products and highly reliable, user-friendly, and “cool services, financial institutions will have to introduce new value chains that create confidence by adapting to the growing needs of new markets.

Given such profound changes, financial leaders should think about how to orchestrate a new financial supply chain – the “killer app” for our still new century.

Andrew Sheng, President of the Fung Global Institute, Hong Kong, and the Chief Adviser to the China Banking Regulatory Commission, is a former Chairman of the Securities and Futures Commission of Hong Kong.