How Not to Do Macroeconomics

Posted by Unlearningecon in Economics on April 10, 2014
Blogger Ref Link http://www.p2pfoundation.net/Transfinancial_Economics

A frustrating recurrence for critics of ‘mainstream’ economics is the assertion that they are criticising the economics of bygone days: that those phenomena which they assert economists do not consider are, in fact, at the forefront of economics research, and that the critics’ ignorance demonstrates that they are out of touch with modern economics – and therefore not fit to criticise it at all.
Nowhere is this more apparent than with macroeconomics. Macroeconomists are commonly accused of failing to incorporate dynamics in the financial sector such as debt, bubbles and even banks themselves, but while this was true pre-crisis, many contemporary macroeconomic models do attempt to include such things. Reputed economist Thomas Sargent charged that such criticisms “reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished.” So what has it accomplished? One attempt to model the ongoing crisis using modern macro is this recent paper by Gauti Eggertsson & Neil Mehrotra, which tries to understand secular stagnation within a typical ‘overlapping generations’ framework. It’s quite a simple model, deliberately so, but it helps to illustrate the troubles faced by contemporary macroeconomics.
The model
The model has only 3 types of agents: young, middle-aged and old. The young borrow from the middle, who receive an income, some of which they save for old age. Predictably, the model employs all the standard techniques that heterodox economists love to hate, such as utility maximisation and perfect foresight. However, the interesting mechanics here are not in these; instead, what concerns me is the way ‘secular stagnation’ itself is introduced. In the model, the limit to how much young agents are allowed to borrow is exogenously imposed, and deleveraging/a financial crisis begins when this amount falls for unspecified reasons. In other words, in order to analyse deleveraging, Eggertson & Mehrotra simply assume that it happens, without asking why. As David Beckworth noted on twitter, this is simply assuming what you want to prove. (They go on to show similar effects can occur due to a fall in population growth or an increase in inequality, but again, these changes are modelled as exogenous).
It gets worse. Recall that the idea of secular stagnation is, at heart, a story about how over the last few decades we have not been able to create enough demand with ‘real’ investment, and have subsequently relied on speculative bubbles to push demand to an acceptable level. This was certainly the angle from which Larry Summers and subsequent commentators approached the issue. It’s therefore surprising – ridiculous, in fact – that this model of secular stagnation doesn’t include banks, and has only one financial instrument: a risk-less bond that agents use to transfer wealth between generations. What’s more, as the authors state, “no aggregate savings is possible (i.e. there is no capital)”. Yes, you read that right. How on earth can our model understand why there is not enough ‘traditional’ investment (i.e. capital formation), and why we need bubbles to fill that gap, if we can have neither investment nor bubbles?
Naturally, none of these shortcomings stop Eggertson & Mehrotra from proceeding, and ending the paper in economists’ favourite way…policy prescriptions! Yes, despite the fact that this model is not only unrealistic but quite clearly unfit for purpose on its own terms, and despite the fact that it has yielded no falsifiable predictions (?), the authors go on give policy advice about redistribution, monetary and fiscal policy. Considering this paper is incomprehensible to most of the public, one is forced to wonder to whom this policy advice is accountable. Note that I am not implying policymakers are puppets on the strings of macroeconomists, but things like this definitely contribute to debate – after all, secular stagnation was referenced by the Chancellor in UK parliament (though admittedly he did reject it). Furthermore, when you have economists with a platform like Paul Krugman endorsing the model, it’s hard to argue that it couldn’t have at least some degree of influence on policy-makers.
Now, I don’t want to make general comments solely on the basis of this paper: after all, the authors themselves admit it is only a starting point. However, some of the problems I’ve highlighted here are not uncommon in macro: a small number of agents on whom some rather arbitrary assumptions are imposed to create loosely realistic mechanics, an unexplained ‘shock’ used to create a crisis. This is true of the earlier, similar paper by Eggertson & Krugman, which tries to model debt-deflation using two types of agents: ‘patient’ agents, who save, and ‘impatient agents’, who borrow. Once more, deleveraging begins when the exogenously imposed constraint on the patient agent’s borrowing falls For Some Reason, and differences in the agents’ respective consumption levels reduce aggregate demand as the debt is paid back. Again, there are no banks, no investment and no real financial sector. Similarly, even the far more sophisticated Markus K. Brunnermeier & Yuliy Sannikov - which actually includes investment and a financial sector – still only has two agents, and relies on exogenous shocks to drive the economy away from its steady-state.
Whither macroeconomics?
Why do so many models seem to share these characteristics? Well, perhaps thanks to the Lucas Critique, macroeconomic models must be built up from optimising agents. Since modelling human behaviour is inconceivably complex, mathematical tractability forces economists to make important parameters exogenous, and to limit the number (or number of types) of agents in the model, as well as these agents’ goals & motivations. Complicated utility functions which allow for fairly common properties like relative status effects, or different levels of risk aversion at different incomes, may be possible to explore in isolation, but they’re not generalisable to every case or the models become impossible to solve/indeterminate. The result is that a model which tries to explore something like secular stagnation can end up being highly stylised, to the point of missing the most important mechanics altogether. It will also be unable to incorporate other well-known developments from elsewhere in the field.
This is why I’d prefer something like Stock-Flow Consistent models, which focus on accounting relations and flows of funds, to be the norm in macroeconomics. As economists know all too well, all models abstract from some things, and when we are talking about big, systemic problems, it’s not particularly important whether Maria’s level of consumption is satisfying a utility function. What’s important is how money and resources move around: where they come from, and how they are split – on aggregate – between investment, consumption, financial speculation and so forth. This type of methodology can help understand how the financial sector might create bubbles; or why deficits grow and shrink; or how government expenditure impacts investment. What’s more, it will help us understand all of these aspects of the economy at the same time. We will not have an overwhelming number of models, each highlighting one particular mechanic, with no ex ante way of selecting between them, but one or a small number of generalisable models which can account for a large number of important phenomena.
Finally, to return to the opening paragraph, this paper may help to illustrate a lesson for both economists and their critics. The problem is not that economists are not aware of or never try to model issue x, y or z. Instead, it’s that when they do consider x, y or z, they do so in an inappropriate way, shoehorning problems into a reductionist, marginalist framework, and likely making some of the most important working parts exogenous. For example, while critics might charge that economists ignore mark-up pricing, the real problem is that when economists do include mark-up pricing, the mark-up is over marginal rather than average cost, which is not what firms actually do. While critics might charge that economists pay insufficient attention to institutions, a more accurate critique is that when economists include institutions, they are generally considered as exogenous costs or constraints, without any two-way interaction between agents and institutions. While it’s unfair to say economists have not done work that relaxes rational expectations, the way they do so still leaves agents pretty damn rational by most peoples’ standards. And so on.
However, the specific examples are not important. It seems increasingly clear that economists’ methodology, while it is at least superficially capable of including everything from behavioural economics to culture to finance, severely limits their ability to engage with certain types of questions. If you want to understand the impact of a small labour market reform, or how auctions work, or design a new market, existing economic theory (and econometrics) is the place to go. On the other hand, if you want to understand development, historical analysis has a lot more to offer than abstract theory. If you want to understand how firms work, you’re better off with survey evidence and case studies (in fairness, economists themselves have been moving some way in this direction with Industrial Organisation, although if you ask me oligopoly theory has many of the same problems as macro) than marginalism. And if you want to understand macroeconomics and finance, you have to abandon the obsession with individual agents and zoom out to look at the bigger picture. Otherwise you’ll just end up with an extremely narrow model that proves little except its own existence.

The Trillion Dollar Coin: A Debt Solution for the People

Published on Friday, January 18, 2013 by YES! Magazine

 

Far from being a gimmick, having the U.S. Treasury mint high-denomination coins is a solution that cuts to the root of America’s financial problems. And Benjamin Franklin would have liked it, too.

by Ellen Brown

On Friday, January 11, economist and New York Times columnist Paul Krugman urged the White House to mint a platinum coin worth $1 trillion, as a counter to what was then a threat to block federal spending that Congress had already approved. (Republicans made good on that threat yesterday, putting the United States in danger of default.)

We have forgotten the role that money issued directly by the government has played in our history.

The White House responded by saying the trillion dollar coin is off the table, because the Federal Reserve declared that it “wouldn’t view the coin as viable.”
Even Krugman called the coin idea “silly.” He just thought it was less silly—and less dangerous—than playing with the debt ceiling.
But it is not silly. We have forgotten the role that money issued directly by the government has played in our history. The American colonists did not think it was silly when they escaped a grinding debt to British bankers and a chronically short money supply by printing their own paper scrip, an innovative solution that allowed the colonies to thrive.
Many people believe that the U.S. government creates its own money. This is not true. Today, the Federal Reserve creates trillions of dollars on its books and lends them at near-zero interest to private banks, which then lend them back to the government and the people at market rates. We have been brainwashed into thinking that it makes more sense to do this than for the government to simply create the money itself, debt- and interest-free.
In fact, the trillion dollar coin represents one of the most important principles of popular prosperity ever conceived: nations should be free to create their own money without incurring debt. Some of our greatest leaders, including Benjamin Franklin, Thomas Jefferson, and Abraham Lincoln, promoted this essential strategy. They realized that the freedom to print money offers a way to break the shackles of debt and free the nation to realize its full potential.

While a commoner might get 10 to 20 years for robbing a bank, bank executives get huge bonuses for robbing us.

Money creation is an all-important power that has been fought over for centuries, in a largely secret battle between governments and private banks. For the last two and a half centuries, the banks have had the upper hand, making us forget that any other option exists. But we are learning the great secret of money: that how it gets created determines who has the power in society—we the people, or they the bankers.
It is no secret who has that power today. Witness the great bailout of 2008 that rewarded banks for making irresponsible and fraudulent gambles in the subprime mortgage scandal. None of the bankers responsible served time in jail. Then there was the robosigning scandal, in which banks skipped important steps in the process of foreclosing on the homes of ordinary Americans, and came away with a slap on the wrist. Now we are seeing the LIBOR scandal unfold, in which traders at the Swiss financial services company UBS were convicted of colluding with other banks to tweak interest rates for their own financial benefit. We can make an educated guess as to how this too will turn out for them (hint: well). While a commoner might get 10 to 20 years for robbing a bank, bank executives get huge bonuses for robbing us.
We may rail against the banks and demand change, but change will not come until we grasp the fundamental secrets that are the foundation of their power: those who create the nation’s money control the nation, and nearly the entire money supply today is created by banks in concert with the Federal Reserve.

Remembering our roots

Everyone knows that Benjamin Franklin played an important role in the founding of the United States. Fewer know his views on the printing of money. “Experience, more prevalent than all the logic in the World,” he wrote, “has fully convinced us all, that [paper money] has been, and is now of the greatest advantages to the country.”
When the British forbade new issues of paper scrip by the colonial governments, Franklin went to London and argued that issuing their own money was responsible for the colonies’ prosperity.
The response of the king, leaned on by the Bank of England, was to ban all issues of paper scrip. Without their paper money, the money supply collapsed, and the economy sank into a deep recession. The colonists then rebelled. They won the revolution, but the bankers retained the power to create money by setting up a banking system like that dominated by the Bank of England.
Fourscore and six years later, in 1862, President Abraham Lincoln boldly took back the power to create money during the Civil War. To avoid exorbitant interest rates of 24 to 36 percent, he decided to print money directly from the U.S. Treasury as U.S. Notes or “greenbacks.” The issuance of $450 million in greenbacks was the key to funding not only the North’s victory in the war but an array of pivotal infrastructure projects, including a transcontinental railway system.
After Lincoln was assassinated, however, the greenback program was quickly discontinued. Repeated popular attempts by farmers and laborers to revive it failed. They were opposed by a wave of banker activism to maintain the banks’ control over the printing of money, which had been established by the National Bank Act of 1863.
In 1872, New York bankers sent a letter to every bank in the United States. The letter, as quoted by Lynn Wheeler in Triumphant Plutocracy: The Story of American Public Life from 1870 to 1920, read in part:

Dear Sir: It is advisable to do all in your power to sustain such prominent daily and weekly newspapers…as will oppose the issuing of greenback paper money, and that you also withhold patronage or favors from all applicants who are not willing to oppose the Government issue of money. Let the Government issue the coin and the banks issue the paper money of the country. [T]o restore to circulation the Government issue of money, will be to provide the people with money, and will therefore seriously affect your individual profit as bankers and lenders .

Bank-created money, including paper bills and now electronic money, could be rented to the people at a profit. The people’s debt-free money was limited to coins, which today compose less than one ten-thousandth of M3, the broadest measure of the money supply.
Lincoln’s assassination and the abandonment of debt-free greenbacks marked the exchange of physical slavery for what has been called “debt peonage” or “wage slavery.” Today, as a result, the American government and American people are so heavily mired in debt that only a radical overhaul of the monetary system can free us.

Gimmick or game-changer?

This is the real context and backstory of the trillion dollar coin. The stakes are much higher than just fending off the debt ceiling. We the people need to take back the power to issue our own money, and we can’t do it with nickels and dimes. We’re going to need coins bearing some very large numbers.

The coin could put within the government’s grasp the power to solve its debt problems once and for all.

The idea of minting large-denomination coins to solve economic problems seems to have first been suggested by a chairman of the Coinage Subcommittee of the U.S. House of Representatives in the early 1980s. He pointed out that the government could pay off its entire debt with some billion-dollar coins. The Constitution gives Congress the power to coin money and regulate its value, and sets no limit on the value of the coins it creates.
That may have been true then, but in legislation initiated in 1982, Congress chose instead to impose limits on the amounts and denominations of most coins. The one exception was the platinum coin, which a special provision allowed to be minted in any amount for commemorative purposes.
An attorney named Carlos Mucha, who at the time was blogging under the pseudonym “ Beowulf ,” proposed issuing a platinum trillion dollar coin to capitalize on this loophole, after he heard me mention the trillion dollar coin in a Thom Hartmann interview. At first, he said, it was just an amusing exercise. But with the endless gridlock in Congress over the debt ceiling, it got picked up by serious economists as a way to checkmate the deficit hawks.
Philip Diehl , former head of the U.S. Mint and co-author of the platinum coin law, confirmed that the coin would be legal tender:

In minting the $1 trillion platinum coin, the Treasury Secretary would be exercising authority which Congress has granted routinely for more than 220 years. The Secretary authority is derived from an Act of Congress (in fact, a GOP Congress) under power expressly granted to Congress in the Constitution (Article 1, Section 8).

Warren Mosler, one of the founders of Modern Monetary Theory (MMT), reviewed the idea of the trillion dollar coin and concluded it would work operationally. And Joe Firestone pointed out that the trillion dollar coin has far greater game-changing potential than mere political maneuvering. The coin could put within the government’s grasp the power to solve its debt problems once and for all, replacing austerity with the abundance enjoyed by our forefathers.
The invariable objection to government-issued money is that it will lead to hyperinflation. The trillion dollar coin can evoke images of million-Deutschemark notes filling wheelbarrows. But as economist Michael Hudson points out:
Every hyperinflation in history has been caused by foreign debt service collapsing the exchange rate. The problem almost always has resulted from wartime foreign currency strains, not domestic spending.
And as professor Randall Wray observes, the coin would not circulate in the general economy. Instead, it would be deposited in the government’s account and held at the Fed, so it could not inflate the circulating money supply.
As far as spending goes, the fact that the Treasury has money in its account doesn’t mean Congress could or would go wild spending the funds. The budget would still need congressional approval. To keep a lid on spending, Congress would just need to abide by some basic rules of economics. It could spend on goods and services up to full productive capacity without creating price inflation (since supply and demand would rise together). After that, it would need to tax—not to fund the budget, but to shrink the circulating money supply and avoid driving up prices with excess demand.

Time to take back the money power

The current political stalemate cannot be solved with the thinking that created it. There is simply not enough money in the system to fund the services that Americans desperately need, create full employment, pay down the debt, and keep taxes affordable. The money supply has shrunk by $4 trillion since 2008, according to the Fed’s own website.

The massive push from educational campaigns such as those organized by Occupy Wall Street, Strike Debt, and the Free University is starting to lift the veil from our eyes.

The only real solution to the unemployment created by this shrinkage is to add more money to the economy, and that means that someone needs to create it. Either the Fed does this in the way that it is currently done, by adding the money nearly interest-free to the balance sheets of banks to be lent to the government and the people at interest; or the Treasury does it and adds the money to the government’s account debt- and interest-free.
After a century of domination by the Federal Reserve, it is time we tried something new. In flatly rejecting the Treasury’s legal tender, the Fed as representative of the banks is asserting itself to be more powerful than the elected representatives of the people. If the Fed won’t acknowledge the coins created by the government, perhaps the government needs to charter a publicly owned bank that will.
We have a chance today to end the charade of big money gridlock politics, as well as the reign of the big banks. But the current government is so thoroughly captured by the bank-created money of our time that it is unlikely to take action without pressure from the people. Our ignorance on these issues has played into the hands of the 1 percent, who are dependent on the current system for their wealth and power. However, the massive push from educational campaigns such as those organized by Occupy Wall Street, Strike Debt, and the Free University is starting to lift the veil from our eyes.
We have the power to choose prosperity over austerity. But to do it, we must first restore the power to create money to the people.

This work is licensed under a Creative Commons License

Ellen Brown developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest of eleven books, she turns those skills to an analysis of the Federal Reserve and “the money trust.” She shows how this private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. She is president of the Public Banking Institute, http://PublicBankingInstitute.org, and has websites at http://WebofDebt.com and http://EllenBrown.com.