Two things led to this blog today. First, the IMF has once again been lecturing the world on economic policy. In the Global Financial Stability Report and the World Economic Outlook Update – both released yesterday (July 16, 2012) the IMF has downgraded their growth forecasts again yet is hanging on to the myth that austerity is the path to resolution and that the deficit reductions underway are appropriately growth supporting. Doesn’t anyone in the IMF understand logic? One cannot on the one hand admit that growth is falling below previous forecasts yet on the other hand claim that policy which caused growth to slump is growth supporting. Second, Anna Schwartz died in New York on June 21, 2012. The two events can be linked.

In the last week, it was alleged that economists such as the IMFs Olivier Blanchard were alleged to be working in the tradition of Hyman Minsky, which by association inferred that they were on top of the crisis – foresaw it, understand why it occurred and offer the best ways out of the mess. Please read my earlier blog – Revisionism is rife and ignorance is being elevated to higher levels – for an introduction to this issue. I argued that this attempted association is plainly false and Blanchard’s monetary economics is more in the Monetarist tradition, which is the anathema to the endogenous money framework that Hyman Minsky worked within. This is no small issue. The economists mentioned are often in leading positions (media, universities, policy) and influence the way the public (and students) think about the policy choices available. By promoting erroneous understandings of the way the monetary system operates, such economists become part of the problem not the solution, no matter if they are currently opposing fiscal austerity. If only they were operating in the tradition of Minsky!

As more people become aware of Modern Monetary Theory (MMT), extreme reactions emerge to basic concepts that, in any reasonable sense, should evade such reactions. For example, when the concept of the Job Guarantee (JG) is explained the reactions include hysterical comments such as “This is Socialism”; “MMT advocates the government employing everyone – they are stealth Communists”; “MMT is Communism in disguise”; and the rest. I get several E-mails along these lines per week – all which go into the trash immediately – so why bother sending them! I also get many (polite) E-mails suggesting that we (MMTers) should adopt a compromise line and embrace the ideas of those, who while clearly holding ideas that are inconsistent with MMT, do advocate government-led stimulus in the present context. Apparently we should also use terminology that is consistent with the mainstream to minimise the chasm that has to be be crossed to jettison that orthodoxy and accept MMT. These tactical suggestions have resonated once again in the current little dispute about whether various economists, who operate in the New Keynesian paradigm are channeling Minskian ideas. The suggestion is that, while they might not have foreseen the crisis and hold to various theoretical concepts that are inconsistent with MMT development, we should, as a matter of strategy, form alliances with these economists because they are now advocating policy more or less similar to that proposed by MMTers. So our common purpose should be prioritised over our theoretical differences. I disagree. History shows us that it is very dangerous to develop a new approach by minimising the differences between it and the dominant, but erroneous paradigm just to make it easier for adherents of the latter to embrace the former.

Sometimes I read things and consider either I live in a parallel universe or the writers do. I always conclude the latter. There is an increasing number of articles and commentaries coming out which aim to re-write history in favour of the writer’s reputation or that of his/her mates. Revisionism, which includes the practice of personal reincarnation is rife at present. Everybody seemed to predict the crisis. Even those that clearly in their own writing didn’t have a clue that the trouble was coming predicted it. As part of this process, key organisations that should be learning from the crisis such as the BIS are demonstrating that they are in an educational void. They have become just another propaganda machine. And so the crisis continues as ignorance is elevated to higher levels.

I was going to write about the so-called fiscal cliff today and would have shown that the only thing that might fall of the said cliff would be real GDP growth should the US Congress actually not extend the tax cuts and impose the spending cuts. The US economy would follow the lead from the British economy and double-dip in 2013 as sure as day follows night (or is it the other way round). The most elementary exposition of what we might call – ECO101 Macroeconomics – would tell us that. One person’s spending is another person’s income and so on. I note that some economists are arguing that ECO101 Macroeconomics is alive and well because it has had a an impeccable record in the current crisis. In my recent blogs – Fiscal austerity damages real growth and prolongs the financial downturn and Neo-liberalism has failed but we still don’t get it – I have argued that the mainstream of my profession has failed – both in anticipating the emerging crisis and providing credible solutions to remedy it. So have I overstated that claim, given that ECO101 Macroeconomics is the go-to approach at present? The problem is that while there are some leading economists who are arguing against harsh fiscal austerity at present at the basis of their reasoning is a thoroughly mainstream approach which has helped create the problem. I don’t think their version of ECO101 Macroeconomics provides the answers. There is some common ground with Modern Monetary Theory (MMT) but an even deeper incongruence.

One of the puzzles that accompany this gruelling economic crisis is why neo-liberal economic thinking, which when applied caused the crisis and has delivered very little to so many, remains the dominant paradigm in economic policy making and has managed to turn a disaster for practitioners of that ideology into a triumph. How is it that the leading voices now are preaching exactly the same policies that caused the crisis as the solution to the crisis. Is there that much asymmetry? I noted a recent comment on my blog (Tom) that raised issues relating to the philosophy of science along the lines of how are we to judge whether the mainstream macroeconomics paradigm has failed. I understand the demarcation issues involved and the problems of “truth testing”. But we can take a more simple approach to the question. Here are two ways we know that the mainstream approach failed – they didn’t have a clue what was happening in the years leading up to the crisis and now they are scrambling in a stunned state to add banks and financial markets to their defective models. The problem is that they are just building more defective approaches. But the continued dominance demonstrates that their failures are not yet fully understood.

It is unsurprising that my profession has suddenly became enamoured with studies of financial cycles. Up until the GFC mainstream macroeconomics (theories and models) mostly ignored financial markets and banking, thinking that they were largely peripheral to understanding the business cycle. The only linkage between the financial sector and the real economy that was considered was via interest rates – the impact on investment spending and the demand for loanable funds to fund investment impacting back onto interest rates. Even within this limited context, the theories developed were hopelessly deficient and incapable of explaining anything that relates to the real economy. But now – more brash than ever – my profession is busily conjuring up financial markets to fit into their Dynamic Stochastic General Equilibrium (DSGE) models, despite these models being next to useless. In March 2009, Willem Buiter said that DSGE models “excludes everything relevant to the pursuit of financial stability.” More recent research from the BIS (link below in the text) has highlighted some salient facts about the relationship between financial cycles and business cycles. What that research implies is that push for fiscal austerity is without foundation and will not only damage the real economy but will, in the process, prolong the financial downturn and prevent a resolution that could provide the springboard for sustainable growth.