Professional journalists learn the admirable skill of commenting on current events pretty much at the same time as they unfold, sometimes even before. Nothing happens very long before the Daily Telegraph discovers how it proves the villainy of our age; no event long precedes the Daily Mail’s deciding which pornographic images will best illustrate it. Academics, however, work differently. They formulate their ideas in the hope that they will later serve as comments upon some unknown event. This is what has happened with this piece, by Alex Rosenberg and Tyler Curtain.
Ostensibly, it is about the news that the United States government is looking to appoint a new Federal Reserve chair. But this is just used as an opportunity to restate a point Rosenberg has made many times in articles going back to the early 80s. The point is that economics is not a science. It is not a science because it lacks predictive power. Rosenberg and his new accomplice go on to list some of the reasons for this. Social institutions are complex and change in ways that are hard to foresee. Technological developments are unpredictable.
These premises are hardly earth-shattering, and it is unlikely that the conclusion will be more exciting. To be fair, Rosenberg has more interesting things to say about why microeconomics might be in principle incapable of having much predictive power. It’s all to do with microeconomics being basically a formalization of folk psychology. But here he and Curtain are talking about macroeconomics, and their reasons for denying the predictive power of that are no different from those given by most people. This includes those people who think the solution must lie in placing macro theory on a solid basis of microeconomics – the thing towards which Rosenberg has spent much of his career encouraging scepticism.
At any rate, here is what Rosenberg and Curtain have to say about the upcoming Fed appointment:
An effective chair of the central bank will be one who understands that economics is not yet a science and may never be. At this point it is a craft, to be executed with wisdom, not algorithms, in the design and management of institutions. What made Ben S. Bernanke, the current chairman, successful was his willingness to use methods — like “quantitative easing,” buying bonds to lower long-term interest rates — that demanded a feeling for the economy, one that mere rational-expectations macroeconomics would have denied him.
This interpretation of Bernanke’s role as central banker has been banged into shape to fit R&C’s points about economics and prediction. But, despite this, it does not fit. Obviously Bernanke would not have drawn his crisis-management policies from rational expectations theory; that theory basically ruled out the global financial crisis as impossible. But it is absurd to claim that QE and other Bernankist innovations were based on ‘feeling’ rather than economic theory as a whole, of which there is a great deal beyond rational expectations theory (and a good deal of which criticizes rational expectations theory).
In fact, Bernanke’s response to the financial crisis was informed at every stage by his theoretical work on the Great Depression. Why did Bernanke think the Fed played such a key role in preventing another Great Depression? Because he bought into Milton Friedman’s argument that the Depression was caused by bad monetary policy. Friedman argued historically, but he interpreted his historical case study using economic theory, as did Bernanke in his major dissertation. As successor to Bernanke, Janet Yellen, Larry Summers, or whoever it is will undoubtedly draw upon theories of her/his own.
More importantly, Bernanke’s belief that the Fed can do anything at all to control the money supply is based on his commitment to the theory of exogenous money – the theory that the money supply can be at least partly controlled from outside the economy by a monetary authority.
There is a rival theory – the endogenous money theory. According to this theory, private banks within the economy have almost total control over the money supply. This may not always have been true, but it is true now, because financial innovations allow banks to escape any reserve requirements placed upon them by the monetary ‘authority’. A weaker version of the theory claims only that banks create deposits first and look for reserves later. But at any rate, since banks profit by creating debt, if uncontrolled they will always ratchet it up to breaking point, leading to bubbles, inflation, and eventually crises like that of recent memory. Also they will favour speculation over investment and create money wherever it will get them the highest rate of profit, not where it will be most genuinely productive for the economy as a whole (e.g. rising house prices do not add to GDP, but they get the banks more interest on higher mortgages, and, being easily collateralized, expose them to less risk).
Plausibly, if this is true, the role of the central bank should be very different from what it currently is. The question becomes whether society needs something much more politically radical than new central bank instruments and targets. On the moderate end, we – the public, via whatever democratic institutions were required – could control debt-financing from the borrowing side rather than the lending side. On the radical end, we could seize control of the money supply from the banks and give it to a transparent, regulated authority. Regulating the banks will not work, since governments will always be tempted to relax the regulations and capitalize on the temporary windfall of Potemkin prosperity (e.g. George Osborne right now).
Clearly, then, it is a matter of utmost policy importance whether money is exogenous or endogenous. But this cannot come down to a ‘feeling for the economy’. Nothing perceived in the bowels can decide the issue. The only way to decide it is to treat economics like a science – an empirical science if not necessarily a mathematical one. We need to look at how the financial sector works. Then we need to see which theory fits the data better.
Or I can just tell you now. The endogenous theory is right, at least in the big Western economies. So, anyway, I’m led to believe by Steve Keen, the Positive Money people, Ann Pettifor and others referred to in earlier blogs. Preserving our current monetary system will preserve an economy that serves all and only the short-term interests of the banking sector. It will preserve all the effects it has produced so far: instability, credit bubbles, massive inflation in specific markets like housing, rocketing debt levels with occasional seizures of debt-deflation, increasing inequality, overconsumption, no move to a low-carbon economy even with the best-intentioned governments and citizens, investment that gavages the economy with some goods while starving it of others, and many other comforts of modern life. The theory that tells us this accounts for the economic realities much better than its rival. But the rival is preferred, partly because it is heavily promoted by those who stand to gain by maintaining the status quo.
Compared with matters like this, the question of whether macroeconomics is enough of a science to please the philosophers seems to shrink into insignificance.