Wednesday, 18 September 2013

RECENT HISTORY OF ECONOMIC THOUGHT


This is another blog-post bouncing off of a Marginal Revolution's article - that one about the alternation of the Right and the Left in producing the freshest, most interesting economic ideas.

Kevin Drum, blogging at Mother Jones, answers one of Prof. Cowen's concerns about the supposed lack of interesting stuff on the Left since 2009 and their spending time arguing against dangerous Republican economic dogmas by pointing out that fighting dangerous dogmas might not be glamorous or ground-breaking but it is still a necessity and a public good.

But I was personally more interested in the sketch of economic thought Prof. Tyler Cowen proposes.


Now, I realise that I know actually less than I'd like about the history of economic thought, especially post-WWII. I thus certainly know a lot less than Tyler Cowen on the topic. But it still didn't sit right with me.

Tyler says: "Throughout the 1970s and most of the 1980s, the so-called “right wing” was right about virtually everything on the economic front. Most of all communism, but also inflation, taxes, (most of) deregulation, labor unions, and much more, noting that a big chunk of the right wing blew it on race and some other social issues. The Friedmanite wing of the right nailed it on floating exchange rates.


Arguably the “rightness of the right” peaks around 1989, with the collapse of communism. After that, the right wing starts to lose its way.


Up through that time, market-oriented economists have more interesting research, more innovative journals, and much else to their credit, culminating in the persona and career of Milton Friedman.

(...)
Starting in the early 1990s, the left wing is better equipped, more scholarly, and also more fun to read. (What exactly turned them around?) In the 1990s, the Quarterly Journal of Economics is suddenly more interesting and ultimately more influential than the Journal of Political Economy, even though the latter retained a higher academic ranking. The right loses track of what its issues ought to be".


A fair and balanced point of view, surely? Who can complain about both sides being given their comeuppance in turn? And even Noah Smith thought it was a rather fair description (see the comment section of the MR article).

Well, I disagree.

Let's start with the fact that the 70s and 80s were the times proving the Right to be right. I've done my own sketch of historical thought but, in my humble opinion, the 70s and 80s were mostly proving the Left wrong, or rather over-simplistic, not necessarily proving the Right right.

The 70s and the early 80s were a time of stagflation. Back then, the Left was dominated by 'naive' Keynesian and they applied solutions designed to answer an AD shock to a Supply shock. Compounding that mistake by allowing a wage-price spiral to take hold and, yes, the 70s and 80s proved the Left to be wrong.

But was the Right right? Let's review some of Milton Friedman's main ideas.

Friedman is most famous for reviving the quantity theory of money and establishing Monetarism. But, in its simplest description, Monetarism seems tautological to me. If inflation is due to excessive money supply and the proof of excessive money supply is inflation then what have we explained?

We have the same issue today with defining monetary policy as 'tight' or 'loose'. Market Monetarists who advocate more actions by Central Banks simply point out the low inflation number and say "this is proof that money supply is tight". Those that might prefer an end to QE and other unorthodox practices point out to very low interest rates and the growth of the Fed's balance sheet and say "this is proof that money supply is loose".

Now, I am not neutral and I think the market monetarists have the better point but I do acknowledge that the phrasing "low inflation = tight money" is self-referencing.

Going back to Friedman, he is famous for proposing his k-percent rule i.e. the idea that "the stock of money [should be] increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical needs" (Friedman, 1960).

Needless to say, such a rule would be highly damaging and force the monetary policy to be entirely pro-cyclical i.e. it would actually worsen recessions! Quite the achievement!

Now, Friedman's statistic work on the role of monetary policy and his book with Anna Schwartz, A Monetary History of the United States (1963) which was an examination of the role of the money supply and economic activity in the U.S. history, are rightly seen as influential. He showed how money supply fluctuations contributed to economic fluctuations. And, with David Meiselman during the 1960s, he demonstrated the primacy of the money supply over investment and government spending in determining consumption and output, a conclusion that went against the economic beliefs of the times.

Furthermore, his work on the Philip Curve etc meant that his model and theories could handled a case of stagflation when the Keynesian ideas of the times couldn't.

Finally, while his Permanent Income Hypothesis has proven brittle/incomplete when tested in real life, it was a worthy attempt at trying to elucidate the foundations of private consumption, a rather important task if we want to understand and tame the business cycle.

But, despite the quality of the research and some of its ground-breaking aspects, I think that the political recommendations he made were mostly wrong-headed and thus I maintain that Tyler Cowen is being overly generous in saying that the 70s and 80s proved the Right to be right.

And, frankly, I do not see how anyone can say that the Right was right on taxes and deregulation! The US and the UK have been trying Supply side economics for 40 years right now and the least that can be said about it is that tax cuts for the rich and unfettered freedom for Big Business haven't exactly trickled down.

Now, this does not mean that people do not mind taxes (they mind them very much indeed and I will write about this soon) or that over-regulation cannot kill a sector or depress the economy but I personally think that neither the Right nor the Left have been very good at balancing the competing demands of their various constituents as far as these things are concerned.

With regards to the idea that, after a burst of good stuff in the 90s and till 2009, the Left is now losing its intellectual stamina, I agree with Kevin Drum i.e. even if a lot of time and energy has to be spent fighting stupid ideas (austerity!), on things like inequality and its consequences for growth or the consequences of automation on ownership of the means of production, left-leaning economists are the only ones willing to even talk about these subjects. Many Right-leaning economists (Raghu Rajan, John Cochrane, Greg Mankiw when he defends the 1%) keep insisting our problems are all about deficits, labour market rigidities and skill mismatch...

But, these economists are not the only present-day right-leaning thinkers. Personally, on top of the left-leaning economists investigating inequalities, I would mention that Market Monetarism in its various forms (i.e. whether NGDP targeting or Miles Kimball's negative interest rates) is mostly right-wing, bold, rather new and that it might even be correct.