The danger in ignoring money and monetary policy

In “What Good are Economists?” Robert Shiller asks:

Since the global financial crisis and recession of 2007-2009, criticism of the economics profession has intensified. The failure of all but a few professional economists to forecast the episode – the aftereffects of which still linger – has led many to question whether the economics profession contributes anything significant to society. If they were unable to foresee something so important to people’s wellbeing, what good are they?

Nonetheless, whenever a crisis loomed in the last century, the broad consensus among economists was that it did not. As far as I can find, almost no one in the profession – not even luminaries like John Maynard Keynes, Friedrich Hayek, or Irving Fisher – made public statements anticipating the Great Depression.

As the historian Douglas Irwin has documented, a major exception was the Swedish economist Gustav Cassel. In a series of lectures at Columbia University in 1928, Cassel warned of “a prolonged and worldwide depression.” But his rather technical discussion (which focused on monetary economics and the gold standard) forged no new consensus among economists, and the news media reported no clear sense of alarm.

Cassel got it “right” because he didn´t underestimate the power of monetary policy (in his day the “environment” was defined by the gold standard).

Sixty years ago, Leland Yeager wrote “A Cash-Balance Interpretation of Depression”:

The usual account of inflation or depression stresses too much or too little demand for goods and services. It is enlightening to reverse the emphasis by focusing on the demand and supply of money. The present paper views depression as an excess demand for money, in the sense people want to hold more money than exists. It views an inflationary boom as an excess supply of money, in the sense that more money exists than people want to hold.

In recent times, the “environment” has been defined by “Inflation Targeting” and money has “disappeared” from the conversation (models). Scott Sumner just wrote:

Back in 2002, Bennett McCallum did a really nice survey piece on contemporary monetary economics.  The best parts are his insights into some of the controversial issues, but I’d like to focus on something else…

Here’s McCallum, with adjustments:

A striking feature of the typical models in the NBER and Riksbank conferences is that they include no money demand equations or sectors. That none is necessary can be understood by reference to the following simple three-equation system.

In his introduction to the Yeager Volume, George Selgin writes:

Does the success of a capitalist economy depend on the nature of its monetary arrangements? It may surprise readers who are not also economists to learn that, at least according to two influential twentieth-century schools of economic thought [Keynesian and New Classical], it does not.

Let´s hope the newly minted Monetary Program at Mercatus Center, under the direction of Scott Sumner helps change things!

HT Becky Hargrove

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