Heterodoxy and The Economist


When I started this blog, almost exactly one year ago today, my thought was to provide commentary on the financial events of the day, using the Financial Times as my primary source of information about those events.

I felt, as Mr Skinner writes in his letter today, that the public does not know much about banking. He recommends starting from the text “Where Does Money Come From?”, which seems to me fine advice. But the hard thing, as always, is applying such textbook knowledge to the real world events of the day; that’s what I was determined to do in the blog.

I started from a distinct point of view, what I call the “money view”, that I had distilled from my reading of past economic thinkers—especially Minsky, Copeland, Hawtrey, and (late) Hicks. But I was also keenly aware that their thinking was for their own times, and that new thinking would be needed for the new world of today. (Modern finance was the most obvious lacuna.) The challenge I posed myself was to attempt such new thinking, in real time and in public, using the blog.

The money view is certainly not a majority perspective, and never has been, at least among academics. (Practitioners, especially central bank practitioners, are another story; think Goodhart and Borio, for example.) But neither is the money view necessarily heterodox, at least as heterodoxy is catalogued by the Economist: neo-chartalist, market monetarist, and Austrian.

All banking is a swap of IOUs, so the neo-chartalists are correct to remind us that all the Fed can do is swap assets. (The Fed is, after all, a bank.) It does not follow, however, that such swaps have no real effects. When a bank swaps its IOU with me, the bank gets an illiquid asset and I get purchasing power that I didn’t have before. The same goes for the Fed, when it swaps its own IOUs with banks.

Base money—a liability of the Fed—is better money than bank money (M1) or shadow bank money, so the market monetarists are certainly correct to remind us that Fed swaps have real effects. It does not follow, however, that sufficient swapping can stabilize nominal GDP. The quantity equation is an identity, and neither velocity nor the money multiplier is necessarily a constant (nor even a stable function).

In a capital-using economy, illiquidity is a fact of life, so the Austrians are correct to remind us of the limits of central bank legerdemain. It does not follow, however, that there is nothing to fear from private bank legerdemain. What Hawtrey called the inherent instability of credit (and Minsky formulated as the Financial Instability Hypothesis) can certainly be exacerbated by unwise central bank policy, but central banks are also bankers’ banks, not just instruments of state power. The real institutional alternative to the Fed is not some idealized world of free banking but rather private central banking, i.e. J.P. Morgan.

Notwithstanding these critical comments, it is important to emphasize that each of these heterodox schools exist, and persist, because it is organized around some essentially correct insight about how the banking system works. Further, the reason the Economist is writing about them is not the internet, but rather the ongoing financial crisis. The internet is just a technology that makes these insights more easily available. The public does not know much about banking, but not until the crisis did the public realize that their ignorance was potentially life-threatening.

The problem is that, so far as I can see, each of the heterodox schools has part of the truth, not the whole thing. The same could be said about the orthodoxy against which the heterodox schools define themselves (and of course also about the money view itself). We don’t therefore want to choose which school to belong to; rather we want to determine which of these correct insights provides the most useful explanatory frame for whatever issue is currently at hand. Today it might be one; tomorrow it might be another. That is what the debate is about, or should be anyway.

Thinking in real time and in public about the financial events of the day has absorbed a lot more of the past year than I thought it would. Looking back, I find that it was worth it. I know more today than I did a year ago; that’s what matters.

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