Summary: Our elites use economics to run America. David Graeber shows that these theories are broken, but they well serve our elites. Too bad about all the damage to America caused by bad public policy based on flawed theories. In the first part, Graeber describes the limits and flaws in current economic theories. This is part two, the important conclusion.
“Against Economics – Part 2 of 2.”
By David Graeber in the New York Review of Books, 5 December 2019.
Reposted with their generous permission. Headings added.
Review of Money and Government: A Challenge to Mainstream Economics
Where part one ended.
{There has been} an endless war between two broad theoretical perspectives …. Is money best conceived of as a physical commodity, a precious substance used to facilitate exchange, or is it better to see money primarily as a credit, a bookkeeping method or circulating IOU – in any case, a social arrangement? …What we call “money” is always a mixture of both, and, as I myself noted in Debt: The First 5,000 Years
Part two: start with the bad news.
To put it bluntly: QTM is obviously wrong. Doubling the amount of gold in a country will have no effect on the price of cheese if you give all the gold to rich people and they just bury it in their yards, or use it to make gold-plated submarines (this is, incidentally, why quantitative easing, the strategy of buying long-term government bonds to put money into circulation, did not work either). What actually matters is spending.
Nonetheless, from Jean Bodin’s time to the present, almost every time there was a major policy debate, the QTM advocates won. In England, the pattern was set in 1696, just after the creation of the Bank of England, with an argument over wartime inflation between Treasury Secretary William Lowndes, Sir Isaac Newton (then warden of the mint), and the philosopher John Locke. Newton had agreed with the Treasury that silver coins had to be officially devalued to prevent a deflationary collapse; Locke took an extreme monetarist position, arguing that the government should be limited to guaranteeing the value of property (including coins) and that tinkering would confuse investors and defraud creditors.
Locke won. The result was deflationary collapse. A sharp tightening of the money supply created an abrupt economic contraction that threw hundreds of thousands out of work and created mass penury, riots, and hunger. {See this report by the NY Fed.} The government quickly moved to moderate the policy (first by allowing banks to monetize government war debts in the form of bank notes, and eventually by moving off the silver standard entirely), but in its official rhetoric, Locke’s small-government, pro-creditor, hard-money ideology became the grounds of all further political debate.
According to Skidelsky, the pattern was to repeat itself again and again, in 1797, the 1840s, the 1890s, and, ultimately, the late 1970s and early 1980s, with Thatcher and Reagan’s (in each case brief) adoption of monetarism. Always we see the same sequence of events:
- “The government adopts hard-money policies as a matter of principle.
- Disaster ensues.
- The government quietly abandons hard-money policies.
- The economy recovers.
- Hard-money philosophy nonetheless becomes, or is reinforced as, simple universal common sense.”
A theory that always fails, but is always politically useful
How was it possible to justify such a remarkable string of failures? Here a lot of the blame, according to Skidelsky, can be laid at the feet of the Scottish philosopher David Hume. An early advocate of QTM, Hume was also the first to introduce the notion that short-term shocks – such as Locke produced – would create long-term benefits if they had the effect of unleashing the self-regulating powers of the market:
“Ever since Hume, economists have distinguished between the short-run and the long-run effects of economic change, including the effects of policy interventions. The distinction has served to protect the theory of equilibrium, by enabling it to be stated in a form which took some account of reality. In economics, the short-run now typically stands for the period during which a market (or an economy of markets) temporarily deviates from its long-term equilibrium position under the impact of some ‘shock,’ like a pendulum temporarily dislodged from a position of rest. This way of thinking suggests that governments should leave it to markets to discover their natural equilibrium positions. Government interventions to ‘correct’ deviations will only add extra layers of delusion to the original one.”
There is a logical flaw to any such theory: there’s no possible way to disprove it. The premise that markets will always right themselves in the end can only be tested if one has a commonly agreed definition of when the “end” is; but for economists, that definition turns out to be “however long it takes to reach a point where I can say the economy has returned to equilibrium.” (In the same way, statements like “the barbarians always win in the end” or “truth always prevails” cannot be proved wrong, since in practice they just mean “whenever barbarians win, or truth prevails, I shall declare the story over.”)
At this point, all the pieces were in place: tight-money policies (which benefited creditors and the wealthy) could be justified as “harsh medicine” to clear up price-signals so the market could return to a healthy state of long-run balance. In describing how all this came about, Skidelsky is providing us with a worthy extension of a history Karl Polanyi first began to map out in the 1940s: the story of how supposedly self-regulating national markets were the product of careful social engineering. Part of that involved creating government policies self-consciously designed to inspire resentment of “big government.” Skidelsky writes …
“A crucial innovation was income tax, first levied in 1814, and renewed by [Prime Minister Robert] Peel in 1842. By 1911–14, this had become the principal source of government revenue. Income tax had the double benefit of giving the British state a secure revenue base, and aligning voters’ interests with cheap government, since only direct taxpayers had the vote…. ‘Fiscal probity,’ under Gladstone, ‘became the new morality.'”
In fact, there’s absolutely no reason a modern state should fund itself primarily by appropriating a proportion of each citizen’s earnings. There are plenty of other ways to go about it. Many – such as land, wealth, commercial, or consumer taxes (any of which can be made more or less progressive) – are considerably more efficient, since creating a bureaucratic apparatus capable of monitoring citizens’ personal affairs to the degree required by an income tax system is itself enormously expensive. But this misses the real point: income tax is supposed to be intrusive and exasperating. It is meant to feel at least a little bit unfair. Like so much of classical liberalism (and contemporary neoliberalism), it is an ingenious political sleight of hand – an expansion of the bureaucratic state that also allows its leaders to pretend to advocate for small government.
The one major exception to this pattern was the mid-twentieth century, what has come to be remembered as the Keynesian age. It was a period in which those running capitalist democracies, spooked by the Russian Revolution and the prospect of the mass rebellion of their own working classes, allowed unprecedented levels of redistribution – which, in turn, led to the most generalized material prosperity in human history. The story of the Keynesian revolution of the 1930s, and the neoclassical counterrevolution of the 1970s, has been told innumerable times, but Skidelsky gives the reader a fresh sense of the underlying conflict.
How economics got into this hole.
Keynes himself was staunchly anti-Communist, but largely because he felt that capitalism was more likely to drive rapid technological advance that would largely eliminate the need for material labor. He wished for full employment not because he thought work was good, but because he ultimately wished to do away with work, envisioning a society in which technology would render human labor obsolete. In other words, he assumed that the ground was always shifting under the analysts’ feet; the object of any social science was inherently unstable.
Max Weber, for similar reasons, argued that it would never be possible for social scientists to come up with anything remotely like the laws of physics, because by the time they had come anywhere near to gathering enough information, society itself, and what analysts felt was important to know about it, would have changed so much that the information would be irrelevant. Keynes’s opponents, on the other hand, were determined to root their arguments in just such universal principles.
It’s difficult for outsiders to see what was really at stake here, because the argument has come to be recounted as a technical dispute between the roles of micro- and macroeconomics. Keynesians insisted that the former is appropriate to studying the behavior of individual households or firms, trying to optimize their advantage in the marketplace, but that as soon as one begins to look at national economies, one is moving to an entirely different level of complexity, where different sorts of laws apply. Just as it is impossible to understand the mating habits of an aardvark by analyzing all the chemical reactions in their cells, so patterns of trade, investment, or the fluctuations of interest or employment rates were not simply the aggregate of all the microtransactions that seemed to make them up. The patterns had, as philosophers of science would put it, “emergent properties.”
Obviously, it was necessary to understand the micro level (just as it was necessary to understand the chemicals that made up the aardvark) to have any chance of understand the macro, but that was not, in itself, enough.
The counter-revolutionaries, starting with Keynes’s old rival Friedrich Hayek at the LSE and the various luminaries who joined him in the Mont Pelerin Society, took aim directly at this notion that national economies are anything more than the sum of their parts. Politically, Skidelsky notes, this was due to a hostility to the very idea of statecraft (and, in a broader sense, of any collective good). National economies could indeed be reduced to the aggregate effect of millions of individual decisions, and, therefore, every element of macroeconomics had to be systematically “micro-founded.”
One reason this was such a radical position was that it was taken at exactly the same moment that microeconomics itself was completing a profound transformation – one that had begun with the marginal revolution of the late nineteenth century – from a technique for understanding how those operating on the market make decisions to a general philosophy of human life. It was able to do so, remarkably enough, by proposing a series of assumptions that even economists themselves were happy to admit were not really true. Let us posit, they said, purely rational actors motivated exclusively by self-interest, who know exactly what they want and never change their minds, and have complete access to all relevant pricing information. This allowed them to make precise, predictive equations of exactly how individuals should be expected to act.
Surely there’s nothing wrong with creating simplified models. Arguably, this is how any science of human affairs has to proceed. But an empirical science then goes on to test those models against what people actually do, and adjust them accordingly.
This is precisely what economists did not do. Instead, they discovered that, if one encased those models in mathematical formulae completely impenetrable to the noninitiate, it would be possible to create a universe in which those premises could never be refuted. (“All actors are engaged in the maximization of utility. What is utility? Whatever it is that an actor appears to be maximizing.”) The mathematical equations allowed economists to plausibly claim theirs was the only branch of social theory that had advanced to anything like a predictive science (even if most of their successful predictions were of the behavior of people who had themselves been trained in economic theory).
This allowed Homo economicus to invade the rest of the academy, so that by the 1950s and 1960s almost every scholarly discipline in the business of preparing young people for positions of power (political science, international relations, etc.) had adopted some variant of “rational choice theory” culled, ultimately, from microeconomics. By the 1980s and 1990s, it had reached a point where even the heads of art foundations or charitable organizations would not be considered fully qualified if they were not at least broadly familiar with a “science” of human affairs that started from the assumption that humans were fundamentally selfish and greedy.
These, then, were the “microfoundations” to which the neoclassical reformers demanded macroeconomics be returned. Here they were able to take advantage of certain undeniable weaknesses in Keynesian formulations – above all its inability to explain 1970s stagflation – in order to brush away the remaining Keynesian superstructure and return to the same hard-money, small-government policies that had been dominant in the nineteenth century.
They try again. And fail again.
The familiar pattern ensued. Monetarism didn’t work; in the UK and then the US, such policies were quickly abandoned. But ideologically, the intervention was so effective that even when “new Keynesians” like Joseph Stiglitz or Paul Krugman returned to dominate the argument about macroeconomics, they still felt obliged to maintain the new microfoundations.
The problem, as Skidelsky emphasizes, is that if your initial assumptions are absurd, multiplying them a thousandfold will hardly make them less so. Or, as he puts it, rather less gently, “lunatic premises lead to mad conclusions”:
“The efficient market hypothesis (EMH), made popular by Eugene Fama…is the application of rational expectations to financial markets. The rational expectations hypothesis (REH) says that agents optimally utilize all available information about the economy and policy instantly to adjust their expectations…. Thus, in the words of Fama,…’In an efficient market, competition among the many intelligent participants leads to a situation where…the actual price of a security will be a good estimate of its intrinsic value.’ [Skidelsky’s italics]”
In other words, we were obliged to pretend that markets could not, by definition, be wrong – if in the 1980s the land on which the Imperial compound in Tokyo was built, for example, was valued higher than that of all the land in New York City, then that would have to be because that was what it was actually worth. If there are deviations, they are purely random, “stochastic” and therefore unpredictable, temporary, and, ultimately, insignificant. In any case, rational actors will quickly step in to sweep up any undervalued stocks. Skidelsky drily remarks:
“There is a paradox here. On the one hand, the theory says that there is no point in trying to profit from speculation, because shares are always correctly priced and their movements cannot be predicted. But on the other hand, if investors did not try to profit, the market would not be efficient because there would be no self-correcting mechanism….
“Secondly, if shares are always correctly priced, bubbles and crises cannot be generated by the market….
“This attitude leached into policy: ‘government officials, starting with [Federal Reserve Chairman] Alan Greenspan, were unwilling to burst the bubble precisely because they were unwilling to even judge that it was a bubble.’ The EMH made the identification of bubbles impossible because it ruled them out a priori.’
If there is an answer to the queen’s famous question of why no one saw the crash coming, this would be it.
Failing is OK if helps our elites!
At this point, we have come full circle. After such a catastrophic embarrassment, orthodox economists fell back on their strong suit – academic politics and institutional power.
In the UK, one of the first moves of the new Conservative-Liberal Democratic Coalition in 2010 was to reform the higher education system by tripling tuition and instituting an American-style regime of student loans. Common sense might have suggested that if the education system was performing successfully (for all its foibles, the British university system was considered one of the best in the world), while the financial system was operating so badly that it had nearly destroyed the global economy, the sensible thing might be to reform the financial system to be a bit more like the educational system, rather than the other way around. An aggressive effort to do the opposite could only be an ideological move.
It was a full-on assault on the very idea that knowledge could be anything other than an economic good.
Similar moves were made to solidify control over the institutional structure. The BBC, a once proudly independent body, under the Tories has increasingly come to resemble a state broadcasting network, their political commentators often reciting almost verbatim the latest talking points of the ruling party – which, at least economically, were premised on the very theories that had just been discredited. Political debate simply assumed that the usual “harsh medicine” and Gladstonian “fiscal probity” were the only solution; at the same time, the Bank of England began printing money like mad and, effectively, handing it out to the one percent in an unsuccessful attempt to kick-start inflation.
The practical results were, to put it mildly, uninspiring. Even at the height of the eventual recovery, in the fifth-richest country in the world, something like one British citizen in twelve experienced hunger, up to and including going entire days without food. If an “economy” is to be defined as the means by which a human population provides itself with its material needs, the British economy is increasingly dysfunctional. Frenetic efforts on the part of the British political class to change the subject (Brexit) can hardly go on forever. Eventually, real issues will have to be addressed.
Economics is broken.
Economic theory as it exists increasingly resembles a shed full of broken tools. This is not to say there are no useful insights here, but fundamentally the existing discipline is designed to solve another century’s problems. The problem of how to determine the optimal distribution of work and resources to create high levels of economic growth is simply not the same problem we are now facing: i.e., how to deal with increasing technological productivity, decreasing real demand for labor, and the effective management of care work, without also destroying the Earth. This demands a different science.
The “microfoundations” of current economics are precisely what is standing in the way of this. Any new, viable science will either have to draw on the accumulated knowledge of feminism, behavioral economics, psychology, and even anthropology to come up with theories based on how people actually behave, or once again embrace the notion of emergent levels of complexity – or, most likely, both.
Intellectually, this won’t be easy. Politically, it will be even more difficult. Breaking through neoclassical economics’ lock on major institutions, and its near-theological hold over the media – not to mention all the subtle ways it has come to define our conceptions of human motivations and the horizons of human possibility – is a daunting prospect. Presumably, some kind of shock would be required. What might it take? Another 2008-style collapse? Some radical political shift in a major world government? A global youth rebellion? However it will come about, books like this – and quite possibly this book will play a crucial part.
If you missed it, see part one: The limits and flaws in our economics.
———————————–——-
About the author: David Graeber
David Graeber is a Professor of Anthropology at the London School of Economics. He studies Madagascar, Europe, North America, theories of value, money, debt, politics, manners, magic, class, social movements, and social theory. He is the author of many books, most recently …
- Toward An Anthropological Theory of Value: The False Coin of Our Own Dreams
(2001).
- Debt: The First 5,000 Years
(2011).
- The Democracy Project: A History, a Crisis, a Movement
(2013).
- The Utopia of Rules: On Technology, Stupidity, and the Secret Joys of Bureaucracy
(2015).
- Bullshit Jobs: A Theory
(2018) – well worth reading!
(2001).
(2013).
(2015).
(2018) – For More Information
Ideas! For shopping ideas, see my recommended books and films at Amazon. Also, see Chapter One of a story about our future: “Ultra Violence: Tales from Venus.”
If you liked this post, like us on Facebook and follow us on Twitter. See all posts about economic theory, about Keynesian economics, Austrian economics, faux economics, economic stimulus programs, and especially these …
- About the state of economic science, and advice from a famous economist.
- Keynes comments on our new-found love of austerity.
- Ed Dolan talks to us about modern monetary theory. Can it save us?
- Ed Dolan Asks: What Does it Mean for Fiscal Policy to be “Sustainable”? MMT and Other Perspectives.
- Warnings from Keynes and Kipling about our mad empire.
- Economists are wrong: America does not need more people to stay prosperous.
- Listen to the minority of economists who say that Free trade is wrecking America.
Some good books about economics
Debt: The First 5,000 Years
J is for Junk Economics: A Guide to Reality in an Age of Deception
Turbo-Capitalism: Winners and Losers in the Global Economy
@FM
What’s your thoughts on a regular 50yr Jubilee cycle on the economy?
Question: What is money? A means of exchange, store of wealth, a source of power, a facilitation of commerce, etc. To me it has become a battleground between need and greed or how to share power. And greed is winning and harming those in need. The power of money mainly lies in the hands of a few–way too few. Some mechanism for a fairer distribution needs to be implemented. The money game has been won by the few. We need a new game. That is what today’s politics are all about. The rich only seem to care about protecting their own kingdoms. Revolution is now in the wind.
Here is a apropos article in today’s Wall Street Journal of interest.
https://www.wsj.com/articles/popeyenomics-why-you-do-what-you-do-11575676430?mod=hp_opin_pos_3
We might all live better if we if believed and lived by this motto: “To be rich is to know you have enough”. Unfortunately, such virtue may be beyond us. God does not value us for the money we have stored up.
“”But God said to him, ‘You fool! This very night your life will be demanded from you. Then who will get what you have prepared for yourself?’—Luke 12:20
Larry-
I appreciated the last two articles, and I agreed with a lot of what Graeber says.
One way to implement solutions with a broader multi-disciplinary approach is by re-examining / re-thinking the math behind the models and simulations used in current economic theory. Instead of regression (past-looking) modeling to predict future behavior, there are ways to look at more real-time algorithms that take into account behavioral economics. Bayesian monte carlo simulation is one such technique that is only available now because of big data.
Modern marketeers are using this everyday to upsell, cross-sell, and retain customers and monopolizing our time wasted on Netflix, Facebook, Google, etc… Some quants are using it successfully to find the gaps in the stock market and hedge against the Feds QE moves.
On the down-side, the challenge is how to do this when politics and academics are involved- it gets really messy when you’re adding the assumptions and perceived entitlements.
On the up-side, it can help to minimize the flash-to-bang (velocity of money, slow response times, bureaucratic inertia, etc…) in the current system.
I would not be surprised if the next level of economics embeds some of these techniques.
Implementing is way above my paygrade.
-Mike
Mike,
I suggest looking through some economics journals. They are knee-deep in the math you suggest, and more. But I think this is a dead end, playing with numbers to produce pre-determined results – about poorly understood phenomena.
“against the Feds QE moves.”
The Fed ended its Quantitative Easing ion 29 October 2014. Fed assets have increased slightly (8%) since August, but with zero effect on the stock market. This is the problem with these models. People play with equations but often have little understanding of the phenomena they are modeling.
Mike, I’ve read some of the journals that Larry mentioned. All I will say is “that way lies madness” for the reasons that Larry already gave. Too many people playing with too much math to derive their preferred benefits without regard for possible negative consequences.
Mike: “Implementing is way above my paygrade.”
Amen, brother, Me too!
Mike,
I should have pointed to this: the website of the National Bureau of Economic Research. An endless stream of papers, with as much cutting edge math as anyone could wish. Few useful insights, unfortunately.
Larry- Thanks for the links.
Pluto- Agreed. That’s the limitations of the authors last couple of paragraphs. Using behavioral economics into macro or policy has another set of morals on its own. That’s what I was referring to with marketeers getting us hooked on Facebook or Google- another set of madness.
Is economics simply spending money, spending money, oh and more spending money and going into perpetual debt? Spend on junk because nothing else will suffice, debase the currency and lower the cost to zero or whichever negative number in order to make the money and resources you’ve collected worth less and less every year so that you’ll spend and clear cut every resource. No consideration for maintenance or valuing the past is given any serious consideration. Just ride the spending and fad carousel perpetually until maybe retirement. Good news all around from the world of enlightened economics.
vamdex,
I suggest reading more actual economics and less right-wing propaganda. I have seldom seen a comment packed with so much misinformation.
“Is economics simply spending money, spending money, oh and more spending money and going into perpetual debt?”
No, it’s not. Glad to have cleared that up for you.
“Spend on junk because nothing else will suffice”
It works like this: in a free nation, people work and spend their money on what they want. In the tyranny of your dreams, you get to tell people how to spend their money.
“debase the currency”
Total nonsense. The US dollar’s value vs. other currencies (the only meaningful measure) is unchanged since 1988. It is down 11% since 1973 – good, since it was wildly overvalued there. It’s still overvalued, an inimical side-effect of being the major reserve currency (which is why nobody else wants their currency to have that role).
“lower the cost to zero or whichever negative number”
Interest rates are set by the free market, except during brief period of Fed action. Rates are low now – just as they were during the 19th century era of gold-backed currencies – because that’s what market forces set them at. See more about that here.
Don’t care how they spend their money, but I’m sure a great many want their existence subsidized with the taxes. Sure those taxes will only be paid by rich people. Isn’t that how we got the income tax, oh but it won’t go over the original highest rate of 7%, wink wink.
We are more under the tyranny of ads, social media influencers and marketers. In the tyranny of Edward Bernays and the NYC ad men, people are convinced what is popular at the time, spend their money, and junk it in two to three years time for the “popular” styles of NYC, DC and LA. That is the modern person, a perpetual fad chaser, willing to go into debt, money they theoretically don’t have, for home, car and yes junk.
“They could shrink their massive balance sheet to push up rates to whatever level they desire. This would be a hammerblow to the economy. That would be stupid. The Fed’s governors and professional staff are not stupid.”
So is it a free market or does the Fed set an interest rate to keep you spending because of the oh so scary deflation, the biggest boogeyman of all. Gotta lend, lend, lend to keep the credit/debt machine going. How else to grow an economy to infinity?
vamdex,
If you want actual info, see my first reply to you. It will dispell some of your misinformation. But you haven’t, making replying to you a waste of time.
You’re just making stuff up, based on propaganda you read. If you have anything sensible to say, it will be posted. No more rants will appear, as they waste readers’ time.
cryptos will win
Please let me point out one incontrovertible fact: the Quantity Theory of Money has rock-solid support in the data. It is an excellent description of the relationship between the quantity of money, the amount of real economic activity in a country, and the price level, in the long run.
Let P be the price level. Let Y be real GDP, i.e. the total amount of actual goods and services produced in the economy. P*Y will then be nominal GDP.
Let M be the quantity of money. Let V be the velocity of money, i.e., the average number of times a single unit of currency is used for a transaction in a single year.
The quantity theory states that PY = MV. What does this mean? It means that there is a certain amount of work to be done by currency–providing a medium for an amount of transactions equal to Y. Each dollar can be used V times. So if the amount of work to be done Y stays the same, and V stays the same, and the amount of money goes up, then you need to use more money for each transaction. If you have less money, then you need to use less money for each transaction.
What does it mean to use more money or less money for each transaction? It means that the price level will go up, or down. I.e., there will be inflation, or deflation.
OK, that’s the theory. How does it hold up in the data? Extremely well, at time horizons longer than 5-10 years. In almost every single country for which data exists, the relationship between price-level growth (inflation) and the difference between money supply growth and real GDP growth (has the supply of money outstripped demand?) over a 30-year time horizon is not only positive, but THE SAME–a 1-to-1 relationship. This is a remarkable empirical fact and can be counted as a big win for the Quantity Theory.
At the same time, Quantity Theory DOES fail for short-run predictions. For time horizons less than about 5 years, it is a poor predictor of the direction and amount of inflation. Other factors such as momentum from investor expectations and demand-pull inflation are much more important determinants. But lengthen the time horizon, and all these short-run disturbances average out. Quantity Theory wins, in the long run.
Now, our guest author may believe that Quantity Theory has been abused to support bad policy choices in the past. Perhaps this is true. But to claim that Quantity Theory fails empirically is to spread ignorance among the people.
Matt,
I suggest you re-read the post. You appear to have totally missed the point.
“At the same time, Quantity Theory DOES fail for short-run predictions”
Re-phrased: every time QTM has been used to guide economic policy, it has failed.
Now, let me address one follow-up question you may have, and which the author indeed alludes to: If Quantity Theory works, then why hasn’t Quantitative Easing led to massive inflation?
This is a good question. To answer it, first we need to be precise about what Quantitative Easing is. It has been a massive (REALLY massive) expansion of the Monetary Base. The Federal Reserve bank has created vast new sums of “Federal Reserve Dollars,” i.e. dollars in banks’ “checking accounts” with the Federal Reserve. It has put these onto the balance sheets of banks by using them to purchase vast quantities of not only U.S. Treasury Notes, as is common practice in day-to-day “open market operations”, but also less liquid, riskier assets like corporate bonds and Mortgage-Backed-Securities. The amount of assets on the Fed’s balance sheet has expanded from approximately 1 trillion dollars in 2008 to over 4 trillion dollars today. “Federal Reserve Dollars,” the deposits banks have in their accounts at the Federal Reserve bank itself, have expanded from a very small fraction of the total Monetary Base (alongside physical cash) to 25-50% of it.
The key to understanding why this hasn’t caused massive inflation is the following–the Monetary Base is NOT the same thing as the Money Supply. In our fractional reserve banking system, commercial banks MULTIPLY the Monetary Base by making loans and only holding a fraction of the currency that backs them up in reserve. Historically, the supply of money, depending on whether you only count circulating cash and checking account balances, or also count things like savings account balances and money market account balances, has been between 3 and 12 times larger than the monetary base.
During quantitative easing, this “money multiplier” has declined from around 3 to around 1 for the strictest definition of money. In other words, banks have NOT been loaning out the new monetary base the Fed has created. They are holding it on their balance sheets as “excess reserves”.
As a result, the growth rate of the money supply really has not increased remarkably as a result of quantitative easing.
Why are the banks holding excess reserves? Two reasons. First, after the financial crisis, banks WANTED excess reserves. They wanted an extra cushion to be able to pay out withdrawals from either the public or fellow financial institutions and to appear “strong” at a time when many big banks were in serious trouble. They were also not eager to loan out the funds because the recession meant that there were few low-risk opportunities available.
Second, for the first time in its history, the Federal Reserve is paying banks interest on their Federal Reserve Dollar balances. While the economy was bad, this rate was very small, close to zero. As the economy recovered, it was raised to over 2% per year! It has been lowered more recently and now sits somewhere a bit less than 2%. In other words, the Federal Reserve is PAYING the banks to sit on their reserves and not make more loans.
If the banks DID make as many loans as they legally COULD with the amount of reserves they are holding, the money supply WOULD increase dramatically. THEN we probably would see an increase in inflation.
Please notice, nowhere in this whole story is there any indication of a failure of the Quantity Theory.
Matt,
“If Quantity Theory works, then why hasn’t Quantitative Easing led to massive inflation?”
Please don’t give giant (600 word) lectures unless asked. I wrote a dozen posts explaining that – back when people actually cared.
Start your own blog if you would like to give econ lectures.
As you wish, Larry. But you’re spreading ignorance. Your guest author’s argument is equivalent to saying “Challenger crashed, therefore rocket science is BS.” And also, “Surface wind speed can also affect a rocket’s trajectory at launch, therefore the Law of Gravity is debunked.”
No matter how bad the policy, criticism based on obvious fallacy is unlikely to lead to better policy.
Matt,
“Your guest author’s argument is equivalent to saying “Challenger crashed, therefore rocket science is BS.”
That’s too silly to bother responding to. Since you don’t appear to have much grasp of these issues, I suggest you instead post links to what actual economists say about these matters. There is enough diversity there to provoke useful discussion.
Great article, Larry! I wish we had a better way out of the mess of our current economic policies but at least some people have a better understanding of how we got there.
Pluto,
You go to the heart of the matter. History, even diagnosis, is nice to have. But it doesn’t help much unless it points to solutions. Which this doesn’t.
Nor do I have any useful ideas, or even pointers to those that do.
Graber has a fascinating conclusion to his review. He states:
“The problem of how to determine the optimal distribution of work and resources to create high levels of economic growth is simply not the same problem we are now facing: i.e. how to deal with increasing technological productivity, decreasing real demand for labor and the effective management of care work, without destroying the earth.”
He goes on to add “…the microfoundations of current economics are precisely what is standing the way of this. Any new viable science will either have to draw on the accumulated knowledge of feminism, behavioral economics, psychology and even anthropology to come up with theories based on how people actually behave or once again embrace the notion of emergent levels of complexity–or most likely both.”
I am fully on board with embracing the notion of emergent levels of complexity.
But what about drawing on the accumulated knowledge of feminism, behavioral economics, psychology and even anthropology? Is he talking his own book here or is he on to something?
James,
“But what about drawing on the accumulated knowledge of feminism, behavioral economics, psychology and even anthropology? Is he talking his own book here or is he on to something?”
Nicely said! As a social scientist (anthropologist), he believes these fields have insights that can inform economics. I’m skeptical that “feminism” (a political project or social movement) can contribute much to economics, other than adding to its already immense burden of ideological spin. Behavioral economics is already a growing part of economics, although new and so as yet immature.
Color me skeptical that psychology or anthropology can help in the foreseeable future. Adding their miscellany bag of discordant and unproven ideas to the stew of economics will imo diminish its utility. That is, economics would then become more like the other social sciences – an ideologically-driven field with weak methodology, of little practical utility.
I imagine the author’s intention was along the lines of “you could use social sciences to compensate for the deficiencies in orthodox economic theory, which may be more feasible as an intellectual project than completely discarding orthodox economic theory, garbage though it may be.”
Thanks for posting this. I read it when it first linked to at Naked Capitalism and a second reading was very useful.
30 years ago, I largely accepted libertarian economics, and reality has shown it to be as utopian as Marxism. I really appreciate Michael Hudson’s work these days and similar heterodox economists.
Hudson, coming from a very Marxist perspective (and he is Trotsky’s godson), spent time working in Wall Street decades ago and saw how false much of economics was. It was very enlightening.
MMT seems to have it correct. Of course, the oligarchs would rather keep us enslaved instead of freeing us from debt peonage.
The 1930s German economic miracle largely should have shown the world that much of economic thought was wrong…..
Gaius,
“MMT seems to have it correct.”
I’m amazed at the speed with which economic fads take hold, based on their political utility. This has been the pattern for over a century. People seize each new wave, treating it like the Law Of Gravity – despite the lack of supporting evidence. I see the people commenting here – Left and Right – trotting out their theories like they were Moses down from the mount.
Here are some posts about MMT.
Gaius:
Why should we trust a government/State that issues its own sovereign currency to use such awesome power in the interests of its own people?
“”of course the oligarchs would rather keep us enslaved instead of freeing us from debt peonage.”
Would our present State-based oligarchs (for example, intelligence agency heads, or Federal Reserve Board bureaucrats) have any interest in also keeping us enslaved through using the instruments of MMT ( to automatically fund endless wars or endlessly bail out private mega banks the world over)?
Has MMT really taken a serious look at the/social relationships of highly centralized State power (The assumption that the Fed and Treasury will supposedly operate only in our interests)
Has MMT really taken a serious look at the expansion of State power under neo-
liberalism?
Who should control the power of financing the State?
,
James,
“Why should we trust a government/State that issues its own sovereign currency to use such awesome power in the interests of its own people?”
I suggest that you read the Constitution. The govt is not an alien ruler. We have elections every two years, electing officials from county sheriffs to the President.
My biggest question is what economic systems actually work, beside Keynesianism? Part of my confusion with the last two days posts has been due to my lack of economic knowledge.
Also, have you been paying attention to Tucker Carlson? He has continued on his populist route since your January posts. People are lining up to try to destroy him at this point, claiming that he is a ‘white nationalist, ‘whatever that means at this point; im pretty sure that this claim is bullcrap. I was wondering what your viewpoint is on him.
Issac,
“My biggest question is what economic systems actually work, beside Keynesianism?”
It depends what you mean by “economic systems.” Free market capitalism “works.” Various forms of managed capitalism work better. “Keynesian economics” is the current theoretical paradigm, which has many schools within it. Most sciences only have one ruling paradigm at a time.
As Kuhn said, paradigms cannot be disproven – only replaced. So we use Keynesian theory, despite attempts to use older (failed but politically useful) systems, until something better comes along.
Today’ world sounds like ancient Rome. Whatever system keeps the masses fed and amused and the ruling class in power is the one that will be used until the whole thing collapses by its own inertia or attracts a new set of conquering barbarians. Thus Spoke Zarathustra.
Michael,
“Today’ world sounds like ancient Rome.”
Which Rome? Rome lasted 1,230 years, and had many different systems. Subsidized or free grain (the Cura Annonae) was distributed in Rome for 600 years (beginning 123 BC). The gladiator games ran for 740 years, from 264 BC.
“until the whole thing collapses by its own inertia or attracts a new set of conquering barbarians.”
I don’t believe there is much historical support for that commonly believed myth, or that historical summary tells anything significant about Rome or America. If America lasts half as long as Rome, it would be a fantastic accomplishment.
Thanks Larry.
“I don’t believe there is much historical support for that commonly believed myth, or that historical summary tells anything significant about Rome or America. If America lasts half as long as Rome, it would be a fantastic accomplishment.”
Yes, American lasting half as long as Rome would be a fantastic accomplishment. And if we assume we are in the second half of the Roman Empire the show should be over soon.
Michael,
“And if we assume we are in the second half of the Roman Empire the show should be over soon.”
There is little basis for that analogy, no matter how much it is repeated.
Rome peaked roughly 100AD, and remained awesome through the second C. It was shattered in the Third Century. Diocletian stabilized the East, by creating a different political and social regime. By the end of the Fifth century, the West was a wreck. That long decline – in every metric – created the 6thC crash that finished what remained of Rome.
The US today has nothing like that history. Our problems are those of the beginning of the late Roman Republic.
If we follow their path, we will grow in wealth and power – but lose the Republic and become decadent. We can only guess this plays out, as history “doesn’t repeat, only rhymes.”
See this post: America isn’t falling like the Roman Empire. We’re falling like the Roman Republic.
Superb and richly provocative article. Thank you!
Much I could comment on but I’ll limit it to this paragraph, near the end, where Graeber says, ‘The “microfoundations” of current economics are precisely what is standing in the way of this. Any new, viable science will either have to draw on the accumulated knowledge of feminism, behavioral economics, psychology, and even anthropology to come up with theories based on how people actually behave, or once again embrace the notion of emergent levels of complexity – or, most likely, both.’
It will need to draw as well on the accumulated knowledge of ecology, and the 3.8 billion years or so of production, consumption, growth, coordination and exchange that sustain the tissue-thin web of life that sustains everything we count, measure and value.
Can we envision reality-based economics?
gfriend,
“Can we envision reality-based economics?”
I believe it is too harsh to say that modern economics is not “reality-based.” It is sees the world in terms of abstractions, and analyzes it by reductionism — as do all the sciences. That’s why we have multiple physical sciences and multiple social sciences. Even inside physics, relativity and quantum mechanics have contradictory views of the world – but both are “reality-based.”
Eventually, someone will develop a better method – perhaps tomorrow, perhaps in 3019 AD. Until then we’ll have to stumble along with the tools we have, as have all our ancestors since we came down from the trees.
Dr.Dambisa Moyo.
This is an interesting You Tube. She is an outsider, come in and says some hard truths, but some are of course debatable.
I am writing from an Australian prospective, so bear that in mind. Here in Australia we are so cash strapped we have added International Education into the tourism figures, why – tourism is falling, I know my wife worked in tourism for a decade and still has friends in the business, she also has an excellent insight as she changed career to Tax Agent and does their accounts.
I work in International Student education (part time), the fees are A$12-15,000 per semester, these degrees and Masters are often sub-standard and not even valued by the students, plagiarism is so rife we turned “turn it in” off, as too many students were failing and that would stop International Students coming. The students do the courses for Permanent Residency, why would you listen to an Australian Lecturer spouting yesterdays theories, while his bankrupt University is out begging the Third World for students, while the students Father pays their child’s fees, accommodation and often even buys an investment houses (the students sublets).
Australia is dependant on International Students (fees and young workers), building more houses we invest ever more in and digging up minerals.
Karl Juncker quoted in the You Tube ” we all know what to do, it is just how to get elected afterwards”.
The parts about the academic power, and cloaking the discipline in dense math are spot-on.
Note- I did quantum mechanics and the math supporting wave mechanic computational models for my physical science grad school education, so I know what math looks like.
The “academic power” part is also made worse by the dawning of “political-economics” as a “stand-alone” discipline, and that those profs call themselves economists. That action alone destroyed huge parts of the discipline- that I find hard to call a science.
Economics now is politics disguised with math and dollar signs, in many cases, especially when government policy gets into the mix.
I have posted on some economics blogs (with maybe a bit more belligerent tone) about this issue and have most of my posts removed by the academic “economists”.
On theories/models- you always have to remind yourself (as the user of a model) what the assumptions of the model are. They are almost always narrower (i.e. more able to be wrong) than you think. Care is required.
Excellent post.