By Philip Pilkington, a writer and research assistant at Kingston University in London. You can follow him on Twitter @pilkingtonphil
The blogoshpere includes quite a few mainstream academic economic blogs. Most of the “debate” on these blogs, together with that in the mainstream academic departments that they mirror, focuses issues of aggregation; issues that have become central to the research paradigm of mainstream economics, which has been falling to ever new lows since the 1970s Rational Expectations “Revolution”. “How,” they ask each other, “do we ensure that our macroeconomic models contain and accommodate perfectly rational agents optimising their utility?” The questions of, for example: what relevance this might have; of whether agents are actually rational in reality; indeed, of what the term “rational” means beyond “acting as economists think people should act” are rarely raised and are thought crude by the mainstream academics. This discourse resembles less a gathering of scientists actively engaged in discovery of new and interesting truths and more a collection of theologians debating logically consistent stupidities founded on imaginary constructions.
Here we look at a post, “How Effective is Fiscal Policy?” at Crooked Timber by one Robert Farmer, a professor of economics at UCLA. The title is misleading because the post is mostly concerned with broadly different approaches to macroeconomics and less concerned with the actual effectiveness of fiscal policy – which, of course, is an empirical question.
A Farmer and a Strawman
Let us start with seems to be the first requirement of orthodox economic discourse: to completely misrepresent a classic work of macroeconomics. The victim is usually John Maynard Keynes and our present post is no different. Farmer writes:
[T]he General Theory does not contain an explanation of unemployment that is consistent with rational behavior by profit seeking firms in the labor market. There is no coherent theory of unemployment in the General Theory; there is simply an assertion that households are not on their labor supply curves.
There is no need to bore the reader too much with the details here, but this is an oft made criticism of the General Theory made by mainstream economists during and after the 1970s and the so-called Rational Expectations Revolution. It is not remotely true.
In Chapter 19 of the General Theory, Keynes lays out a number of reasons why effective demand might remain at an insufficient level to support full employment. Indeed, the whole purpose of this chapter, absolutely central to Keynes’ argument, is to show that “perfect markets” – i.e. flexible wages and prices – are not sufficient to ensure full employment. Here are five of the maybe six or seven reasons given by Keynes in this chapter for the interested reader to consider:
1. If wages falls the marginal propensity to consume will also fall because this, for Keynes, is dependent on nominal, not real, income. Even if prices adjust downwards, workers will save more relative to their income because, assuming a level of realism ignored by modern economists, they make calculations about saving and consumption based on their nominal wage. If investment is not increased to make up the gap – and there is no reason to assume that it will be – aggregate demand will fall by the same amount.
2. As wages and prices fall, total real indebtedness rises. This may result in bankruptcies and otherwise put strains on companies’ balance-sheets. Today this has become known as “debt deflation”, but it was already present in Chapter 19 of the General Theory.
3. Expectations are important and if wages/prices are expected to fall further entrepreneurs will postpone investing in new capital goods in order to avail of the lower future prices.
4. Likewise, price instability will make it very difficult for entrepreneurs to make business calculations going forward which may induce them to invest less.
5. If wages and prices fall, those in society with more savings – i.e. the wealthier members of society – will hold more of the wealth, as the real value of the stock of savings increases. Since wealthier people have a lower propensity to consume, total aggregate demand will likely fall.
Some of these points are subject to the absurd “rational expectations” critiques that the mainstream economists peddle – i.e. they are not consistent with the actions of agents who, for all intents and purposes, know the future. Some of them are not. But regardless, the point is clear: Keynes does give very clear reasons why unemployment might remain despite wage-price adjustments. If some do not like these reasons and reject them due to their own apriori beliefs about “human rationality” that they build into their work, this is their own choice, but that does not justify dismissing Keynes by falsely claiming he didn’t deal with the issue of unemployment.
Filling in Imaginary Holes
After trying to airbrush out critical parts of economic classics, the next step in what passes for economic debate in mainstream academia is to fill in the gaps that result. This is done through reference to logical constructions that exist elsewhere in the profession, usually built or sanctioned by its key players. In the case of our present discussion the model referenced is the Dynamic Stochastic General Equilibrium model (DSGE) – we will not get into this model here as it is neither interesting nor useful.
The strange thing about our present case, however, is that the author seems to have a fair grasp of the history of the development of these ideas – despite his contextual reading of this history being somewhat perverse. In addition to criticising Keynes based on the author’s own methodological demands (and, we should note, getting this largely wrong), the author goes on to criticise the neoclassical-Keynesians for not getting Keynes “right”.
The author raises the issue, which so many heterodox economists insist on time and again, that the neoclassical Keynesians after WWII had perverted Keynes’ overarching message in the General Theory. He mentions the names of Joan Robinson and Axel Leijonhufvud, two economists that played a very prominent role in criticising not only a certain type of “Keynesian” economics that arose after the war, but also a certain style of economic theorising of which the present author is most definitely a part. Unfortunately, the author, echoing these criticisms as mere historical sound bites rather than substantive critiques, completely scrambles what these critics were trying to say.
Both of these authors were, in actual fact and in contrast to what the author alludes to, trying to show that Keynes’ style of economic theorising was dynamic, practical and based in historical rather than logical time. In short, these authors tried to rescue the tradition that Keynes handed down of actual dealing with historical change and dynamic processes rather than building castles in the sky. For Keynes and these authors the purpose of economics was not to construct toy-models of the economy that, while logically consistent, were completely useless, but to explain actual historical processes as they happened. Joan Robinson especially thought that economics was a tool to study the process of historical change and development in all its contradictions and ambiguities, rather than to construct models based on what she called “metaphysical” or “apriori” reasoning – rational expectations and rational agent models which have no basis in empirical reality being a prime example of this.
Such a tradition of realism and practical engagement was also, as Robinson and Leijonhufvud tirelessly pointed out, what Keynes himself tried to promote. Robinson in particular often pointed to the following quote from the General Theory that seems completely lost on Farmer and his cloistered colleagues:
The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organised and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. Any other way of applying our formal principles of thought (without which, however, we shall be lost in the wood) will lead us into error. It is a great fault of symbolic pseudo-mathematical methods of formalising a system of economic analysis that they expressly assume strict independence between the factors involved and lose all their cogency and authority if this hypothesis is disallowed; whereas, in ordinary discourse, where we are not blindly manipulating but know all the time what we are doing and what the words mean, we can keep “at the back of our heads” the necessary reserves and qualifications and the adjustments which we shall have to make later on, in a way in which we cannot keep complicated partial differentials “at the back” of several pages of algebra which assume that they all vanish. Too large a proportion of recent “mathematical” economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.
We do not merely point this out to show that Farmer’s grasp of the history of ideas is rather watery, but also to show that the methodology which he advocates is completely irrelevant to approaching real economic questions. Farmer, and all those in academia and on the “sophisticated” blogs that write and speak like him, are not really interested in the real world. They prefer to construct, as Keynes called them, “a maze of pretentious and unhelpful symbols… as imprecise as the initial assumptions they rest on” which they can then study in the candlelight, bouncing their shadows off the wall until they finally emerge from their caves as Philosopher Kings with ready-made answers to hand down to the finite, temporal mortals who live, breathe and trade in the open air.
The inevitable result is that the pronouncements that these academics make are completely arbitrary and idiosyncratic as they will be dependent upon whatever the author has, due to personal taste, decided to be the most important aspect of a given model. Because they do not study real economic data and trends without an intellectual filter (a model), they have no scientific standard by which to eliminate useless information and keep relevant information. So, instead they simply focus on one aspect of the economic scene – usually arbitrary and often peripheral to the flow of real events – and elevate it above all else.
Farmer does exactly that. He claims that fiscal policy, of any level that he deems acceptable, only provides a short-term boost to the economy and ignores structural problem. Again, for rationalist believers in the scientific method this is largely an empirical question and can be examined with reference to the great government spending programs of the past. But let us for a moment take a look at this issue of structural problems, which certainly do exist in real economies today, but which do not seem to be what Farmer and his colleagues are pontificating about from behind the altar of rational expectations.
The structural issues of Farmer and his colleagues do not refer to, for example: trade deficits due to international currency arrangements and capital flows; growing wealth inequality due to a decline in the wage-bargaining power of workers; or a bloated and out-of-control financial sector that has basically taken control over the political process in Farmer’s own native land. No, Farmer and his colleagues generally mean something to do with insufficient incentives for private firms – sorry, we should say: rational private firms (in an otherwise nicely balanced economy with no nasty antagonisms that is full of rational people living in perfect harmony with one another). Farmer, for example, after alluding to these problems with incentives which he has plucked out of his models and elevated to the status of deus ex machina concludes that the central bank, and I quote, should adopt “the goal of influencing the relative price of assets, with the goal of boosting real aggregate demand”. Yes, you read that right: Farmer wants the central banks to reflate asset prices to boost spending in the economy.
Frankly, it seems likely that most educated people who read the newspapers are more in touch with the economic realities of the last few years than Farmer appears to be. So, rather than discussing the gigantic and well-documented asset price bubbles that inflated across the world over the past two decades, sustained sufficient effective demand to maintain high employment for a short period and finally burst, leading to economic chaos and turmoil, I will allow readers to judge that conclusion for themselves.
But they should consider that it is this style of economic thinking, one that I hope to have thrown some light on in the preceding paragraphs, that has led to what can only be called a complete perversion of rationality, reason and even common sense among intelligent and educated people. With that, one more quote from Farmer who, speaking of those who claim that given the present unemployment crisis the government should spend more to support demand and employment, writes that such solutions “smack of religion; not science”. Sometimes, perhaps, it is best to let irony ring in the ears only of those that can hear it rather than trying to force on the deaf.