Principal Plot: Inflation Is Not Proceeding from Large Scale Money Growth as Monetarists Would Expect. Keynesians Are Not Providing a Complete Enough Explanation to Laymen as to Why That Is So. Frustration and Name-Calling Ensues.
And a Subplot: Warren Buffett Walks into a Bar. . . .
Over recent months, an intense debate between two opposing schools of economics has reached a crescendo. The relationships—at least in print—among members of the so-called saltwater school of economists (those leaning towards Keynesian fiscalism, and more-managed forms of capitalism) and economists in the freshwater or Chicago school (broadly favoring less-regulated, free-market economies with an emphasis on monetary matters) has never been overly warm. But the degree of name calling and apparent unwillingness to find common ground has come to a head since the beginning of the year—especially following the U.S. economic profession’s annual conference the first weekend after the New Year’s break.
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With the World Economic Forum at Davos on tap for this week, providing yet another occasion to read tea leaves and tout theories, it is a good time to consider whether polarization of opinion isn’t as much of a problem as polarization of income and wealth in the developed world. Is the almost complete absence of consensus among mainstream economists yielding drama but paralyzing decision?
To my view, the answer to the foregoing is a decisive yes. So, I have decided to tackle the issue with a bit of humor, together with my own explanation of the underlying problems and suggestions for how to go about reaching a very elusive meeting of great minds.
The debate as it proceeds each week in what I now title Real Economists of the Ivory Tower provides an often amusing diversion for its wonkish audience—but I am afraid it will never be successful mass entertainment.
Its cast—Paul, John, Robert, Brad, Simon, Scott, Tyler, and others—can fling their credentials and arguments at one another, but if you don’t know who I am referring to in this sentence, I doubt you would DVR the series. (Fortunately, we all have a guy named Mark—who happens to be a new colleague of mine in our work at The Century Foundation—to keep everyone honest, so you can always head over to his invaluable blog if you miss any episodes.)
Economist cat fights, alas, seem never to involve sex. There’s money, but no bling. And the typical insults run the gamut from “you weren’t listening during Econ 101? to “you are so out of it that you can’t even understand what I am saying.”
That economists don’t understand what each other are saying, of course, comes as no surprise to laymen—as everyone else can’t understand them either.
So, with that in mind, and as technical as the subject matter may be (this is, actually, a serious essay), I’ll do my best to present in plain language the problem that is the source of the foregoing drama. For more advanced readers, I will provide a somewhat unconventional explanation of a possible middle ground that I will call, for now, an Exogenous Supply Incongruity (so named as to make certain no one understands me either until they read on).
The Synopsis to Date
In the major nations of the developed world—first in Japan, over a period of nearly two decades, then in the United States, beginning in 2008, and now (however reluctantly) in Europe—monetary authorities (central banks) have been massively increasing the portion of the money supply over which they have direct influence in an effort to revive their economies. In a conventional cyclical downturn, it is received knowledge that looser money encourages additional economic activity (spending, investment, employment, etc.) by making money cheaper and discouraging saving/hoarding.
Cheap and ample money would also encourage lending, and thereby would be expected to increase broad money supply—and, ultimately, to induce inflation across economic sectors.
In response to economic collapse, central banks have now gone well beyond conventional methods of expanding money supply, including purchasing investment assets (typically government issued or insured) in the open markets and pushing cash out to the sellers of those instruments, in the expectation that they will do something with that that cash to improve economic activity. This action is known as quantitative easing, which is a fancy term for what desperate central banks must resort to when they’ve already dropped short-term interest rates to essentially zero (the so-called zero lower bound, beyond which conventional monetary policy is obviously useless).
A limited amount of re-inflation itself is generally regarded as being a net positive to the recovery of an economy, especially after a debt binge such as we experienced in the 2000’s. The principle concern in this regard, however, is not to induce runaway inflation—something that is bad for a whole host of reasons that I do not need to go into here (especially because a majority of Euro-American economists and politicians appear to be preternaturally so afraid of inflation that one must assume that they all must know exactly why that is—or perhaps not, but I digress).
In any given developed nation, along with inflation, one would expect to see the value of that nation’s currency fall in relation to those of others that are not experiencing similar rates of inflation—thus furthering inflation in imported goods and making the inflating economy more competitive relative to those other countries. One would also then expect interest rates to rise in order to maintain levels of real (inflation adjusted) returns, thus getting things off the zero bound and back to normal.
The problem today is that, not only have conventional and extreme/unprecedented forms of monetary easing failed to restart brisk growth in developed economies, but massive monetary growth has not resulted in sustainable inflation, either. To be sure, there have been spikes in U.S., U.K., and European inflation (and slowing deflation in Japan—which is how you need to measure things over there), but they have arisen from expectations that quantitative easing would surely result in sustained inflation—not the actual thing itself.
And when inflation failed to materialize on a sustained basis in the United States (primarily because wages refused to track inflation in commodity and other goods to which excess liquidity flowed in an attempt to shelter money from expected inflation), the dollar refused to devalue. Instead of causing interest rates to rise, U.S. policy to date has seen interest fall to historically low levels in anticipation of not inflation, but rather—if anything—deflation.
All of this has, understandably, sent the freshwater crowd into a defensive tizzy of the sort you might hear from the religious right in response to taunts like “God is dead.” (Of course, the gods of the Chicago school are dead, which is unfortunate, because I’d love to hear Friedman and Hayak chime in on all of this.)
Trying hard to make the facts on the ground fit into theories and models that freshwater economists have spent their careers studying and advancing is a tough business under the current circumstances. Not only are they up against the dreaded zero bound, and the arguments from the other side regarding the existence of a “liquidity trap” (in which excess liquidity tends to exacerbate matters), but the failure of the economy in the first place can be arguably laid at the doorstep of the freshwater crowd, following a quarter-century of road-testing various forms of the supply side-oriented consumerism they directly or indirectly advocate.
The dramatic foil for the supply-siders is provided by demand-oriented Keynesian economists, and so-called New Keynesians, who for that same twenty-five-year period have been forced to endure the slings and arrows hurled at them from colleagues whom they still regard as contrarian newcomers. Full disclosure: while I am one-quarter of Austrian lineage (a joke about . . . well, too complicated, let’s just say I think there is some degree of moral hazard in “free money”), the other three-quarters of my economic orientation is very much Keynesian. But I am doing my best to be evenhanded here, even critical with respect to those with whom I otherwise agree.
The dramatic conflict in our new reality show: it is hard to ignore that aggregate U.S. and global demand is inadequate to foster a robust recovery. Even the supply side/monetarists agree. The issue is how to address that imbalance (and its related imbalances).
Thus far, and I am deliberately over-simplifying, the fiscalist Keynesian response has been a lot of “I told you so” combined with calls for governments to spend more money on direct employment to drive demand (I have made similar calls—without, I hope, any vindictive rejoinders). It is also suggested that governments borrow as necessary to finance that spending, on the theory that long-term interest rates have never been lower, excess labor has not been more abundant since the Great Depression, and there is a pretty good history of government spending serving to re-prime private sector economic activity.
The position of the saltwater school is thoughtful, pragmatic, and often quite insightful with regard to the flaws in the arguments of the Chicagoans. But the debate has stalled, partly because instead of persuading and finding common ground, the obvious (at least to me) victor is seeking its intellectual spoils. I am a businessman first and a writer on macroeconomics second, and while this stuff may be par for the course in academia, we are not getting the deal done. We are not finding the consensus necessary for those with less knowledge (our political leaders) to be able to trust that there is one, and adopt it.