I hope the contents of this post live up to the intellectual pretension of a term like ‘meta-theory’. You be the judge.
During the interwar period, John Maynard Keynes wrote three books on money/macro:
1. A Tract on Monetary Reform (1923)
2. A Treatise on Money (1930)
3. The General Theory of Employment, Interest and Money (1936)
The first book was written in the early 1920s, in the midst of highly unstable price levels in many countries, notably Germany. The second was mostly written at the end of the 1920s, a period of relative stability. The third was written in the midst of the Great Depression, when interest rates were close to zero. A lot happened in that relatively brief 13-year period.
Each book clearly reflects the period in which it was written. The Tract is basically a monetarist book, focusing on how printing lots of money can lead to high inflation. It covers the Quantity Theory of Money, as well as related concepts such as the inflation tax, purchasing power parity, and the interest parity condition. These are the issues that economists focus on when inflation is very high and/or unstable.
The Treatise is probably best thought of as a sort of “New Keynesian” book. Not literally—Keynes doesn’t assume rational expectations or develop DSGE models of the economy—rather in spirit. He suggests that the central bank can and should stabilize the price level (not much different from the NK 2% inflation target.) He suggests that monetary policy is generally enough, but one could conceive of an extreme case when fiscal actions would be needed. He talks about forward guidance as an additional policy tool, a promise to hold interest rates low for an extended period. It’s very moderate book, which seems compatible with the consensus view of monetary policy during the 1990s and early 2000s. While the Tract also advocated price stability, in the Treatise there is clearly a move away from the quantity theory and toward a focus on interest rates as the instrument of monetary policy.
The General Theory is a complex book, and also much more radical. While monetary policy ideas continue to be covered, the real energy in the book is associated with the more extreme versions of Keynesianism—the paradox of thrift, liquidity traps, favoring fiscal policy over monetary policy, etc. It represents a move toward ideas associated with post-Keynesianism, or even MMT. That’s not to say there aren’t mainstream ideas as well; I agree with those who claim that the IS-LM model is pretty clearly envisioned in certain parts of the book.
And yet, to suggest that Keynes’s ideas changed with the times is certainly not much of a meta-theory. But there’s more.
Other economists went through similar changes. Knut Wicksell was a famous exponent of a non-quantity theoretic monetary model, which focused on interest rates as the instrument of central bank policy. And yet just as with Keynes, Wicksell switched to a quantity theoretic approach during the early 1920s. And just as with Keynes, many economists favored having the central bank target the price level (or occasionally NGDP) during the latter 1920s. And just as with Keynes, many economists became skeptical of the efficacy of monetary policy during the 1930s, and switched from a quantity theoretic approach to an income/expenditure approach.
OK, so lots of economists shifted with the times. That’s still not much of a meta-theory. But there’s more.
It all happened again! By the early 1980s, much of the world had experienced several decades of high and unstable rates of inflation. Monetarism was riding high.
By the early 2000s, the world had experienced a “Great Moderation” and New Keynesianism was riding high.
By the early 2010s, many countries were at the zero bound, and various more extreme versions of Keynesianism came back into style, including post-Keynesianism and even MMT. The paradox of thrift, fiscal stimulus, currency manipulation and other discredited ideas were in vogue.
Here I’ll ask readers to put aside whatever you think of any of the ideas, and view the situation from 64,000 feet. Isn’t it obvious that this state of affairs is deeply embarrassing for the field of macroeconomics? Doesn’t this provide ammunition for those who claim that economics is “not a science”? (A debate I believe is basically meaningless, as “science” has never been clearly defined.)
Suppose that journals like Science and Nature printed lots of global warming pieces during warm years, and lots of global cooling pieces during relatively cool years. Wouldn’t you want and expect climate scientists to take the long view, and not change their models every time the US and Europe were hit by heat waves or cold winters?
If this cycle had only happened once, say during the interwar years, it would be mildly embarrassing. But this entire cycle has now happened twice, in an almost identical fashion. Even worse, the second cycle was accompanied by almost all the top economics departments dropping economic history and/or history of thought from their course requirements. Whereas this embarrassing state of affairs should have taught us to put more emphasis on learning about how policy mistakes and theoretical modeling interacted in previous cycles; we reacted in exactly the opposite direction. Our modern economics grad students know even less of economic history than those who studied decades earlier.
We need monetary models that work fine regardless of whether the nominal interest rate is 0% or 100,000%. For me, that model is market monetarism, but your mileage may vary.
PS. I’m not an expert on Keynes’s later work, but I’m told that late in his life he shifted back toward the center.
READER COMMENTS
marcus nunes
Nov 28 2020 at 9:42pm
“We need monetary models that work fine regardless of whether the nominal interest rate is 0% or 100,000%. For me, that model is market monetarism, but your mileage may vary.”
In his 1981 book “Essays on and in the Chicago Tradition”, Don Patinkin (page 245) claims that an integral part of the Chicago monetary tradition in the 30s and 40s was the thought “the government has an obligation to undertake a countercyclical policy. The guiding principle of this policy is to change M so as to offset changes in V, and thus generate the full-employment level of aggregate demand”.
Scott Sumner
Nov 28 2020 at 10:30pm
It’s too bad that tradition has faded away in recent years.
Michael Pettengill
Dec 1 2020 at 6:28pm
Velocity is so low, M2 and MZM is paid to workers less than once a year. M1 is paid to workers less than 4 times per year. These are the lowest velocities on record by a lot. “Normal” would be at least twice as high.
This is thrift. Those with cash are not paying workers to work.
Keynes solution was paying workers to build capital. If workers are not being paid to work, then government simply pays workers to work building capital. Post civil war, building railroads off the transcontinental railroads. Post WWI building Good Roads to serve the Post Office RFD Parcel Post delivery. In the 30s, building electric and telephone service to every business and home. Post WWII building defense, the Eisenhower defense highway system, plus building 100,000 nuclear weapons. Not to mention creating lots of human capital with the GI Bill, and housing capital.
The way you get full employment is to pay workers to build capital.
That does drive down the price of capital down to about the original labor cost depreciated.
Michael Sandifer
Nov 28 2020 at 10:09pm
This seems plausible and I’ve had similar thoughts, though not as detailed. I probably just picked this concept up from some of your previous posts.
I’m curious, if you wish to comment, as to whether you think the misuse of representative agent models is one problem with economic theory over more recent decades? I don’t buy the idea of risk aversion at the macro level, for example, though I think it probably exists at the micro level. I think there’s a lot of fallcy of composition going on with the representative agent approach, though I don’t think it’s completely useless. Of course, heterogenous agent models seem to be getting more popular.
Scott Sumner
Nov 28 2020 at 10:33pm
No, I think the big problem on the right is assuming price flexibility, and on the left the problem is assuming that monetary policy works through interest rates.
I have no problem with the representative agent concept, although I don’t care for most of the actual models.
Michael Sandifer
Nov 28 2020 at 11:27pm
The assumption of price flexibility is particularly baffling, since it’s obvious that measures of inflation, for example, move more slowly than changes in real GDP. The same is true of wage and ECI data versus output. I mean, it’s right there in the most basic data on FRED.
The interest rate confusion would be more understandable if it didn’t involve probabably the most basic mistake one can make in economic thinking, which is ignoring supply and demand and focusing on prices, which are reflect supply and demand. I was guilty of that myself, until reading market monetarist writers. I didn’t make that mistake outside of monetary policy, but for some reason, I came out of macro 101 with the idea that interest rates were central. I think it’s probably because I implicitly assumed interest was the price of money, rather than the price of credit.
Garrett
Nov 29 2020 at 12:00pm
Sometimes it feels like Market Monetarism is just a simple extension of Supply and Demand and other models feel almost pretentious by comparison.
Scott Sumner
Nov 29 2020 at 12:34pm
That’s right.
Thomas Hutcheson
Nov 29 2020 at 7:36pm
The problem is confusing interest rates as an instrument with interest rates as a target. [Now even as an instrument “interest rates” can be a poor target because the idea is often equated with rates paid on ST USG debt so that QE is seen as a different kind of target rather than just a different asset whose interest rage can be though of as being manipulated to achieve the desired trajectory of the Price level and of employemnt.]
Thomas Hutcheson
Nov 29 2020 at 7:42am
I don’t see anything necessarily embarrassing about the macroeconomic theories shifting with circumstances as they do not purport to be discovering physical processes (like the effects of the increase of CO2 in the atmosphere) that operate over centuries.
Partial theories of how to control the rudder of a ship might well change depending on what kind of weather is expected.
Michael Sandifer
Nov 29 2020 at 11:22am
Would you travel on a ship in which the captain only had a partial theory in how to control the rudder of a ship?
From my perspective, this is far worse than embarrassing. I think macroeconomists have actually done a great deal to destabilize much of the world economy since getting involved in monetary policy. That’s why I increasingly favor experimenting with truly privatizing banking and monetary policy. I have very, very little faith that government economists will get this right anytime soon.
Mark Brady
Nov 29 2020 at 8:34pm
Scott, you write, “And yet just as with Keynes, Wicksell switched to a quantity theoretic approach during the early 1920s.” Are you saying that Keynes switched to a quantity theoretic approach during the early 1920s, or merely that this had hitherto been his approach? Thank you.
Scott Sumner
Nov 30 2020 at 1:07pm
Mark, I’m saying that at least he put more emphasis on this approach in the early 1920s. I’m not an expert on his writings from the teens, but I do recall reading at least one piece from that period that was more interest rate focused.
tpeach
Nov 30 2020 at 11:30pm
I’m about half way through the General Theory. So far the message seems to be lower spending + sticky nominal wages -> less employment -> less spending -> repeat etc. And under the gold standard, when people try and save more it does depress spending. Quite Sumner-esque, except the rise in money demand is expressed as a rise in unplanned inventory investment.
In the same way that Keynesian economics was the first coherent theory regarding the causes of a shortfall in nominal spending and the possible remedies, I think Market Monetarism is the first to describe the same thing under a fiat money regime with an inflation (or NGDP) targeting central bank. In a way it’s like Keynesian economics for the 21st century 🙂
Scott Sumner
Dec 1 2020 at 2:16pm
I once wrote a paper arguing that Keynesianism is basically a gold standard model.
I’m not sure that the GT was the first model of aggregate demand; previous models tended to use different terms.
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