Philip Pilkington: The New Monetarism Part III – Critique of Economic Reason

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By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

Dur­ing the Great Depres­sion and the war years mon­e­tary pol­i­cy in Britain had proved large­ly inef­fec­tive. In the mean­time it was shown that gov­ern­ment spend­ing could cure eco­nom­ic depres­sions and return the econ­o­my to full or even super-full employ­ment. After the war most polit­i­cal par­ties in Britain were thus inter­est­ed in using fis­cal pol­i­cy to gen­er­ate full employ­ment rather than rely on the vagaries of mon­e­tary pol­i­cy. (This, it should be said, is the polar oppo­site of our rather more des­per­ate sit­u­a­tion today).

Wily con­ser­v­a­tives, how­ev­er, recog­nised that such poli­cies would mean the expan­sion of gov­ern­ment – which they didn’t like at all. So they tried to res­ur­rect mon­e­tary pol­i­cy as the government’s tool of choice. In 1951 Chan­cel­lor of the Exche­quer Lord But­ler raised inter­est rates half a per cent (from 2% to 2.5%). In the ensu­ing years fur­ther increas­es were ini­ti­at­ed. While the wartime Key­ne­sian poli­cies were firm­ly entrenched and high­ly pop­u­lar, the Con­ser­v­a­tives nev­er­the­less pushed back against them. Their attempts to strength­en the role of mon­e­tary pol­i­cy was the first move in a strate­gic game that was to play out through­out the rest of the 20th cen­tu­ry and beyond.

How­ev­er, as is typ­i­cal through­out his­to­ry, the mon­e­tary poli­cies did not work as intend­ed. Bank advances car­ried on regard­less of the rate increas­es. What was not so typ­i­cal was that much of edu­cat­ed pub­lic opin­ion was now scep­ti­cal of mon­e­tary pol­i­cy, so the Con­ser­v­a­tives found them­selves some­what cor­nered when try­ing to defend it. As is usu­al when mon­e­tary mys­ti­cism fails, its pro­po­nents claimed that it was sim­ply not being imple­ment­ed in the cor­rect way. So the Con­ser­v­a­tive gov­ern­ment launched the Rad­cliffe Com­mis­sion in 1957 to inves­ti­gate mon­e­tary pol­i­cy and how it could be more effec­tive­ly imple­ment­ed.

The Rad­cliffe Com­mis­sion was in no way rad­i­cal. It was set up to defend mon­e­tary pol­i­cy against its detrac­tors and allow it to bet­ter func­tion to counter the high­ly suc­cess­ful Key­ne­sian spend­ing and tax­a­tion poli­cies of the war years. It was chaired by Lord Rad­cliffe, a man of con­ser­v­a­tive dis­po­si­tion who was no fan of Key­ne­sian tax­a­tion poli­cies. How­ev­er, in its very grey­ness the Rad­cliffe Com­mis­sion remained a great leap for­ward for truth and com­mon sense. This was because the com­mis­sion was chaired by most­ly sen­si­ble pub­lic ser­vants and lawyers. There were few econ­o­mists involved that could sab­o­tage the com­mis­sion, engage in obscu­ran­tism and gen­er­al­ly mud­dy the issues.

It is worth not­ing here that this is, in fact, what many econ­o­mists spend a great deal of their work­ing lives doing. This often sur­pris­es peo­ple who have not read pol­i­cy and research papers issued by cen­tral banks and think tanks. Of course, not all econ­o­mists do this. But there are usu­al­ly more than a few sit­ting around cook­ing up this sort of intel­lec­tu­al sewage which they use to bung up pol­i­cy chan­nels, con­fuse the gen­er­al pub­lic and give incom­pe­tent and cor­rupt politi­cians excus­es for their inep­ti­tude. The idea, so far as I can see, is to debunk what should be com­mon sense pol­i­cy mea­sures through high­ly the­o­ret­i­cal (and often wool­ly) argu­ments. The econ­o­mists then claim that most peo­ple are not qual­i­fied to under­stand these argu­ments and that those who are qual­i­fied to under­stand them and still say that they are garbage are incom­pe­tent and should be eject­ed from the debate.

Any­way, there were few sew­er-intel­lec­tu­als on the Rad­cliffe Com­mis­sion who could sab­o­tage the inves­ti­ga­tion and so it pro­ceed­ed as would any inquiry: through detailed inves­ti­ga­tion, con­sid­ered tes­ti­mo­ny and clear-eyed scruti­ny of the facts. The com­mis­sion took two years, a thou­sand pages of oral tes­ti­mo­ny and 750 pages of mem­o­ran­dum from insti­tu­tions and indi­vid­u­als. The find­ings were clear as day: mon­e­tary pol­i­cy was for the most part a dys­func­tion­al lever with which to steer the econ­o­my.

We are dri­ven to the con­clu­sion that the more con­ven­tion­al instru­ments have failed to keep the sys­tem in smooth bal­ance, but that every now and again the mount­ing pres­sure of demand has in one way or anoth­er dri­ven the gov­ern­ment to take action. We envis­age the use of mon­e­tary mea­sures as not in ordi­nary times play­ing any oth­er than a sub­or­di­nate part in guid­ing the devel­op­ment of the econ­o­my.

The report of the Rad­cliffe Com­mis­sion was pes­simistic in the extreme with regards mon­e­tary pol­i­cy. The com­mis­sion found that the cen­tral bank had lit­tle con­trol over the expan­sion of the mon­ey sup­ply and that the veloc­i­ty of mon­ey was extreme­ly vari­able. Basi­cal­ly, what the com­mis­sion found was that the bank­ing sys­tem was large­ly pas­sive in rela­tion to the econ­o­my. Cen­tral banks did not ‘dri­ve’ the econ­o­my at all and any poli­cies they did imple­ment, if they were in any way effec­tive at all, would be whol­ly sub­or­di­nate to real eco­nom­ic vari­ables such as lev­els of pri­vate invest­ment, con­sumer demand and gov­ern­ment spend­ing and tax­a­tion poli­cies.

Need­less to say many econ­o­mists were livid. From their arm­chairs they poured forth their ‘learned’ obscu­ran­tist gob­ble-dee-gook, pedan­ti­cal­ly nit-pick­ing and com­plain­ing of ter­mi­no­log­i­cal incon­sis­ten­cies. In truth, they found that the report threat­ened their roles as High Priests of the econ­o­my as it under­mined much of what they taught. Less­er mor­tals had inves­ti­gat­ed the bank­ing sys­tem and had turned up results that debunked most of their mod­els – includ­ing the ISLM mod­els of the Neo-Key­ne­sian School – and the econ­o­mists did not like this one bit. So they did what any mar­gin­alised aca­d­e­m­ic would do in such a sit­u­a­tion: they crit­i­cised the report in abstract and obtuse terms while sit­ting in their lamp-lit stud­ies, ignored by both sen­si­ble pol­i­cy­mak­ers and the gen­er­al pub­lic.

Before we move on we should note just how rev­o­lu­tion­ary a move it was for these pub­lic ser­vants – Con­ser­v­a­tive pub­lic ser­vants, no less – to peer into the bank­ing sys­tem with a pow­er­ful torch with­out any intel­lec­tu­al dev­ils whis­per­ing in their ear. Today, with our cen­tral banks pop­u­lat­ed by scores of trained econ­o­mists, we could bare­ly imag­ine such a thing. But the Rad­cliffe Com­mis­sion shows that it can be done. Thus, when cer­tain US Con­gress­men call for an audit of the Fed we should go fur­ther – much fur­ther. We should be call­ing for a pub­lic inquiry by peo­ple oth­er than trained econ­o­mists into the struc­ture of the bank­ing sys­tem and the effec­tive­ness of mon­e­tary pol­i­cy. If the econ­o­mists and the cen­tral banks com­plain, we should sim­ply ask what it is that they’re try­ing to hide. And if they claim that mere mor­tals can­not under­stand such intri­ca­cies, we should sub­ject them to pub­lic ridicule for being priest-like fools.

Myths of the Mon­ey Sup­ply

So much for the mon­e­tarists and their fixed sup­ply of mon­ey dri­ving the econ­o­my! What the mon­e­tarists had actu­al­ly found, when their empir­i­cal research was even valid (which it often was not), was that nation­al income – that is, the econ­o­my at large – drove the mon­ey sup­ply and that this was why any cor­re­la­tions they found exist­ed. If nation­al income increased banks would lend in order to accom­mo­date the eco­nom­ic growth tak­ing place. This obser­va­tion, as already stat­ed, is today known as the endoge­nous the­o­ry of mon­ey and is asso­ci­at­ed with Mod­ern Mon­e­tary The­o­ry (MMT) and oth­er Post-Key­ne­sian econ­o­mists, such as Steve Keen.

Fun­ni­ly enough Mil­ton Fried­man actu­al­ly realised this to some extent. In a response to Kaldor he admit­ted that cau­sa­tion could run both ways. In 1969 he wrote:

The feed­back effect of busi­ness on mon­ey, which undoubt­ed­ly also exists, may con­tribute to the pos­i­tive con­for­mi­ty and may also intro­duce a mea­sure of invert­ed con­for­mi­ty.

Per­son­al­ly, I can­not under­stand how Fried­man con­tin­ued to make the case for mon­e­tarism after pub­lish­ing this state­ment. His whole the­o­ry, togeth­er with the pol­i­cy stances rec­om­mend­ed there­by, rest­ed on the sup­posed fact that the growth of the mon­ey sup­ply and the nation­al income were strong­ly cor­re­lat­ed and that the rea­son for this cor­re­la­tion was because increas­es in the mon­ey sup­ply led to increas­es in the nom­i­nal nation­al income (i.e. increas­es in mon­ey could either gen­er­ate eco­nom­ic activ­i­ty if there was excess capac­i­ty or infla­tion if the econ­o­my was at full capac­i­ty). The moment that Fried­man admit­ted that the causal­i­ty might run the oth­er way and that nation­al income (and infla­tion) might dri­ve the expan­sion of the mon­ey sup­ply his whole doc­trine falls apart. The cor­re­la­tions he found could then be explained in pre­cise­ly the oppo­site man­ner – which is exact­ly what the Rad­cliffe Com­mis­sion found and which, today, is exact­ly what the endoge­nous mon­ey the­o­rists argue.

I found myself wrestling with Friedman’s ghost on this point. Was he being cyn­i­cal or sim­ply inco­her­ent? Was he an ide­o­logue pure and sim­ple who fudged his argu­ment to sell his pol­i­tics or was he a rather wit­less thinker who had a ten­u­ous grasp of basic causal log­ic? I wasn’t the first to ask this – many, Kaldor includ­ed, have ques­tioned whether Fried­man and the mon­e­tarists were real­ly seri­ous about what they were say­ing and doing. This was annoy­ing me for quite a few days because I didn’t know what I was to write in this piece. After talk­ing to some friends and email­ing some econ­o­mists I have decid­ed that I must be whol­ly hon­est and admit that I am still not quite sure if Fried­man was being cyn­i­cal or just a bit dim. Per­haps, being part of the same tis­sue, we can­not real­ly sep­a­rate the two. Per­haps those who hide their ide­ol­o­gy beneath the aus­pices of sci­ence real­ly do rea­son in a dif­fer­ent way peo­ple who do not. I will leave that to the read­er to decide on their own. What­ev­er can­not be said, it is cer­tain­ly clear that in mak­ing the above state­ment and con­tin­u­ing to ped­dle his doc­trines, Fried­man and those he coun­selled were under­tak­ing a extra­or­di­nary leap of faith.

QE… Real­ly?

This is arguably where we are today. Quan­ti­ta­tive eas­ing is based on the same prin­ci­ples as the mon­e­tarist doc­trine: increase the mon­ey sup­ply and nation­al income will increase with it because the cor­re­la­tions between these two mea­sures can be explained through recourse to a sim­ple, straight-for­ward chan­nel of cau­sa­tion. And yet once again we have seen the fail­ure of the doc­trine – a fail­ure which would have been obvi­ous to Lord Rad­cliffe and his col­leagues. QE has not done what it was sup­posed to. The banks are flood­ed with reserves and the mon­ey sup­ply has increased dras­ti­cal­ly, yet nation­al income has not fol­lowed suit.

Yet, at the same time, fur­ther rounds of QE are still spo­ken of in solemn tones by cen­tral bankers and the media (the mar­kets, how­ev­er, have been get­ting a bit scep­ti­cal recent­ly…). What’s more, the old mon­e­tarist doc­trines are still taught in eco­nom­ics depart­ments across the world under the guise of the mon­ey mul­ti­pli­er.

What on earth is going on? Are cen­tral bankers and jour­nal­ists being cyn­i­cal or are they just mis­in­formed? Again, I can­not pre­tend to answer that ques­tion; only to raise it. But the gen­er­al pub­lic should be aware of these issues. It’s time to once again crack open the bank­ing sys­tem and take a look inside.

Peo­ple are scep­ti­cal of the sys­tem as it stands. They are scep­ti­cal of the strange oper­a­tions that Bernanke, King and oth­ers are under­tak­ing behind closed doors. Now is the time to allow pol­i­cy­mak­ers and the edu­cat­ed pub­lic a look inside. Now is the time for a new Rad­cliffe Com­mis­sion to inves­ti­gate the effects of the QE pro­grams. We can be sure that a bipar­ti­san com­mis­sion of non-econ­o­mists who seek only the truth – and not con­fir­ma­tion of the bias­es with which they earn their crust – can tell us what all this mon­e­tary shaman­ism is actu­al­ly about.

Fresh air! fresh air!” wrote Niet­zsche, “Keep clear of the mad­hous­es and hos­pi­tals of cul­ture! Away from the sick­en­ing fumes of inner cor­rup­tion and the hid­den rot of dis­ease!” Nietzsche’s refrain can and should be applied today to the mad­hous­es and hos­pi­tals of bank­ing!


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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.