A meta-theory of money/macro

I hope the contents of this post live up to the intellectual pretension of a term like ‘meta-theory’. You be the judge.

During the interwar period, John Maynard Keynes wrote three books on money/macro:

1.  A Tract on Monetary Reform (1923)
2. A Treatise on Money (1930)
3. The General Theory of Employment, Interest and Money (1936)

The first book was written in the early 1920s, in the midst of highly unstable price levels in many countries, notably Germany. The second was mostly written at the end of the 1920s, a period of relative stability. The third was written in the midst of the Great Depression, when interest rates were close to zero. A lot happened in that relatively brief 13-year period.

Each book clearly reflects the period in which it was written.  The Tract is basically a monetarist book, focusing on how printing lots of money can lead to high inflation.  It covers the Quantity Theory of Money, as well as related concepts such as the inflation tax, purchasing power parity, and the interest parity condition.  These are the issues that economists focus on when inflation is very high and/or unstable.

The Treatise is probably best thought of as a sort of “New Keynesian” book.  Not literally—Keynes doesn’t assume rational expectations or develop DSGE models of the economy—rather in spirit.  He suggests that the central bank can and should stabilize the price level (not much different from the NK 2% inflation target.)  He suggests that monetary policy is generally enough, but one could conceive of an extreme case when fiscal actions would be needed.  He talks about forward guidance as an additional policy tool, a promise to hold interest rates low for an extended period.  It’s very moderate book, which seems compatible with the consensus view of monetary policy during the 1990s and early 2000s.  While the Tract also advocated price stability, in the Treatise there is clearly a move away from the quantity theory and toward a focus on interest rates as the instrument of monetary policy.

The General Theory is a complex book, and also much more radical.  While monetary policy ideas continue to be covered, the real energy in the book is associated with the more extreme versions of Keynesianism—the paradox of thrift, liquidity traps, favoring fiscal policy over monetary policy, etc.  It represents a move toward ideas associated with post-Keynesianism, or even MMT.  That’s not to say there aren’t mainstream ideas as well; I agree with those who claim that the IS-LM model is pretty clearly envisioned in certain parts of the book.

And yet, to suggest that Keynes’s ideas changed with the times is certainly not much of a meta-theory.  But there’s more.

Other economists went through similar changes.  Knut Wicksell was a famous exponent of a non-quantity theoretic monetary model, which focused on interest rates as the instrument of central bank policy.  And yet just as with Keynes, Wicksell switched to a quantity theoretic approach during the early 1920s.  And just as with Keynes, many economists favored having the central bank target the price level (or occasionally NGDP) during the latter 1920s.  And just as with Keynes, many economists became skeptical of the efficacy of monetary policy during the 1930s, and switched from a quantity theoretic approach to an income/expenditure approach.

OK, so lots of economists shifted with the times.  That’s still not much of a meta-theory.  But there’s more.

It all happened again!  By the early 1980s, much of the world had experienced several decades of high and unstable rates of inflation.  Monetarism was riding high.

By the early 2000s, the world had experienced a “Great Moderation” and New Keynesianism was riding high.

By the early 2010s, many countries were at the zero bound, and various more extreme versions of Keynesianism came back into style, including post-Keynesianism and even MMT.  The paradox of thrift, fiscal stimulus, currency manipulation and other discredited ideas were in vogue.

Here I’ll ask readers to put aside whatever you think of any of the ideas, and view the situation from 64,000 feet.  Isn’t it obvious that this state of affairs is deeply embarrassing for the field of macroeconomics?  Doesn’t this provide ammunition for those who claim that economics is “not a science”?  (A debate I believe is basically meaningless, as “science” has never been clearly defined.)

Suppose that journals like Science and Nature printed lots of global warming pieces during warm years, and lots of global cooling pieces during relatively cool years.  Wouldn’t you want and expect climate scientists to take the long view, and not change their models every time the US and Europe were hit by heat waves or cold winters?

If this cycle had only happened once, say during the interwar years, it would be mildly embarrassing.  But this entire cycle has now happened twice, in an almost identical fashion.  Even worse, the second cycle was accompanied by almost all the top economics departments dropping economic history and/or history of thought from their course requirements.  Whereas this embarrassing state of affairs should have taught us to put more emphasis on learning about how policy mistakes and theoretical modeling interacted in previous cycles; we reacted in exactly the opposite direction.  Our modern economics grad students know even less of economic history than those who studied decades earlier.

We need monetary models that work fine regardless of whether the nominal interest rate is 0% or 100,000%.  For me, that model is market monetarism, but your mileage may vary.

PS.  I’m not an expert on Keynes’s later work, but I’m told that late in his life he shifted back toward the center.