I was reading an interesting study the other day that helps us understand why the macroeconomic policy debate is so awry at present. The paper – Cognitive dissonance, the Global Financial Crisis and the discipline of economics – by Adam Kessler an economist at a Florida university demonstrates that the mainstream economists who are highly influential in the current policy debate suffer from “cognitive dissonance” which leaves them in denial of the facts. CD leads to dysfunctional opinions and if these opinions carry weight in the public debate the policies implemented are also likely to be dysfunctional. It is a sad testimony that the mainstream of my profession is largely operating in a parallel universe but bringing their crazy ideas to our universe and pressuring governments to follow policies that damage a vast majority of people. One thing that is clear – the majority of these economists never have to carry the costs of their denial and retire on nice pensions. The same cannot be said for the victims of their arrogance and denial.

I have noticed some discussions abroad that criticise Modern Monetary Theory (MMT) on the basis that none of the main proponents have ever actually worked on the operations desk of a central bank. This sort of criticism is in the realm of “you cannot know anything unless you do it” which if true would mean almost all of the knowledge base shared by humanity would be deemed meaningless jabber. It is clearly possible to form a very accurate view of the way the monetary system operates (including the way central banks and the commercial banks) interact without ever having worked in either. However, today, I review a publication from the Bank of International Settlements which dovetails perfectly with the understandings that MMT has provided. It provides a case for why we should abandon mainstream monetary textbooks from the perspective of those who work inside the central banking system.

Several readers have written to me asking me to comment on a recent paper that the New York Federal Reserve released as a Staff Report (May 2011) – A Note on Bank Lending in Times of Large Bank Reserves. Apparently, there is an impression that the federal reserve economists might be seeing the light a bit about the banking system and the way economists think about it. The reason that some readers have concluded that is because the substantive conclusion of the paper is that credit expansion is independent of the level of banking reserves held at the central bank. This conclusion is totally consistent with Modern Monetary Theory (MMT) but is at odds with the standard mainstream macroeconomic view (as taught in textbooks) that relies on the money multiplier to draw a (spurious) connection between bank reserves and the money supply. As you will see – my advice is to be very careful when reading such papers – they are not what they seem. The FRNY paper reaches the correct conclusion using erroneous theory which they partition as a special case arising from the extreme circumstances surrounding the crisis. Even in defining their “model” as a special case, they employ flawed logic. It is a case of being beware of the wolf in sheep’s clothing.

Progressives who comment on macroeconomic matters invariably invoke the ghost of John Maynard Keynes as a motivating influence presumably because the popular perception – albeit shallow – is that Keynes supported generalised fiscal expansion in times of high unemployment. A striking example of this “association” is the recent Australian Fabian Society essay (April 11, 2011) by the Australian Treasurer Wayne Swan – Keynesians in the recovery.

Apparently, the US government has just announced that their budget deficit is the largest in absolute terms. Given that the US makes a net gain of one person every 16 seconds, I guess they recorded a record population today as well. Nine records were also set yesterday by junior athletes at the annual sport’s carnival held by the Charlestown Secondary School (Nevis, US). The latter are certainly more interesting and have more relevance for the health of the community. The fact is that the budget outcome is like a score at a sport’s game. Imagine if the cricket authorities decided to place a limit of how many runs a team could score in the current World Cup. You wouldn’t have much of a game. And then they decided to become austere about it and cut the available runs! Just like the runs on the scoreboard, the budget numbers (dollars) can be whatever it takes. The record deficit is not going to stop any game. The fact is that with the extent of idle capacity that you witness in the US, the record needs breaking again very soon!

It was the last day of the 12th Path to Full Employment Conference/17th National Unemployment Conference in Newcastle, which I host. The papers were interesting all day and I will report on some of them another day. But overnight, the big news was that the US Senate has finally succeeded in forcing the US Federal Reserve Bank to release details of more than 21,000 transactions it made as a reaction to the rapidly escalating global financial crisis. The lending rose to $US3.3 trillion at its peak and dwarfs the volumes involved in QE1 and QE2 amounts. This is relevant to a debate in the banking literature about the separation of monetary policy functions (setting interest rates) and the broader monetary interventions we have been witnessing in this crisis, which bear close similarity to fiscal policy functions. The question is which macroeconomic policy functions should be accountable to the ballot box. My view is all of them!

Yesterday, parachute gangs from the ECB and the IMF were being dropped into various EMU nations whose only problem is that they are members of an unworkable monetary system and happened to get hit by a major demand shock. Today the IMF cavalry are apparently heading to Dublin for a “short, focused consultation”. Conclusion: Ireland is being invaded by hostile forces. I also read rumours overnight that Germans are refusing Euro notes not printed in the Bundesland. It is probably an outright lie of a similar quality to the many being spread by the deficit terrorists seeking to regain their “credibility” (an impossible mission) any way they can. In this context I get many E-mails from people each week telling me that I do not understand that the latest decision by the US Federal Reserve Bank “to flood the world with printed money” is putting it on the brink of insolvency! I also read that in a Bloomberg Business Week feature article today. And people believe this stuff. It is as much a lie as the fallacious stories recently about the US President’s Asian travel costs which the right-wing in the US (Beck, Limbaugh, Savage etc) perpetuated without scrutiny (see this analysis to see how this lie began). Anyway, rest easy … the US Federal Reserve cannot go broke!

I am sick of reading or hearing how brilliant such and such economist is and how they should be regarded as oracles because of this “brilliance”. In all these cases, the reality is usually that these characters have left a trail of destruction as a result of applying their brilliant minds. The terminology is always invoked by financial commentators and the like to elicit some authority in the ideas of the person. Apparently, if someone is deemed brilliant we should take heed of their words and judgements. How could we ever question them? In this neo-liberal era, many such “brilliant” minds have been placed in positions of authority and their influence has shaped the lives of millions of people. The financial and then economic crisis has shown categorically that their mainstream macroeconomic insights are not knowledge at all but religious beliefs that bear no relation to real world monetary systems. But still these characters strut the policy stages – shameless – and, in doing so, continue to destroy the prospects for many. It would be good it they were truly brilliant and could see the destructive consequences of their religious zealotry. Oh to be truly brilliant.