You will recognise yourself from my description. (Or you will recognise others who fit this description).
You are probably very smart. You are probably very well-educated — either formally, or self-educated, and probably both. You spend a lot of time on the internet reading economics blogs and commenting on those blogs. You maybe even have a blog of your own, where you write about economics topics. You are probably politically engaged. You are probably a lefty, but may be a righty, or someone who is not easily categorised on that political spectrum. You probably think of yourself as a critic of economics, or a critic of what you see as orthodox economics. You are probably sympathetic to what you see as heterodox economics.
But you have never once read a first year economics textbook.
You have probably many times told me, or people like me, that I really really should read something you want me to read.
Well now it's my turn.
I think you really really should read a first year economics textbook.
You have invested so much time in thinking about, reading about, and writing about, economics. Don't you think it would make sense to spend a tiny fraction of that time just reading a standard first year textbook, cover to cover? You could do it in one day. Maybe two, if you go really slowly and carefully. They were designed to be read by an average reader who is probably less smart and less motivated and less knowledgeable than you are. It's gonna be a breeze!
Even if you think you won't agree with it. Even if you think it's going to be all horribly wrong.
Because, at the very least, you will better understand how the people you are criticising view the world.
Because, at the very least, you will better understand the language that is used by the people you are criticising.
Because, at the very least, you will better understand what is and is not an idea that is seen as "heterodox" by the people you are criticising.
Because, at the very least, you would make this blog and other blogs better.
(The final straw that lead me to write this post was reading a comment on another blog which said that "loans create deposits" is a heterodox idea. Every first year textbook I can remember reading contains a description of how loans create deposits.)
This is said with the greatest of respect (and I do mean that, because I really do respect the amount of intelligence and effort some of you are putting in). But also with frustration.
Now, a second plea: does anyone know a free online source for any reasonably good and reasonably standard first year textbook? One that covers much the same topics and in much the same way as any of the best-selling first year university textbooks? Because I know you can pick up old editions of paper copies of the best-sellers for next to nothing, but I also know that people are much less likely to do this.
(P.S. Non-economists may be surprised that I haven't said which textbook I would recommend. That's because it doesn't really matter much. They are all fairly similar in coverage and treatment. And they are almost all good, in my opinion.)
Worthwhile Canadian Initiative 
They’re definitely NOT all good. I have 8 macro books sitting in front of me as I write this – McEachern, Jones, Arnold, Hall & Taylor, Frank & Bernanke, Mankiw, Romer and Champ, Freeman & Haslag. I’d say that the last 2 are good.
“Loans create deposits” is a shorthand or dog whistle for the position that reserves don’t determine lending and deposits are not required for banks to make loans. Since this is the position of the Federal Reserve Board economists who write on the subject (or see this BIS report – http://www.bis.org/publ/work297.pdf), it doesn’t seem very heterodox, but it isn’t what is taught in most introductory Macro books (I looked), and Krugman almost had apoplexy about something in this story. He seemed to think this would mean that there were no limits on bank lending, a position with which I doubt the FDIC would agree.
The rules concerning bank lending are specified in the Basel accords, so I still don’t know what he was so upset about. As you well know, Canada has no reserve requirements.
And I agree with Unlearning Economics, that blogging economists have been avoiding dealing with criticism of some sacred cows. Rational expectations would be the leading one, but the whole issue of the validity of using counter-factual assumptions in models and the resulting domains of validity of the results could use some honest discussion.
Then, of course, there’s the perennial favorite – confusion among stocks, flows and integrated flows (like GDP, which is neither a stock nor a flow). The stock of debt and the flow of debt, for instance, are very different things, with different consequences.
Nick,
In his April debate with Steve Keen, Paul Krugman created the impression that he disagreed with the idea that loans create deposits. (I believe a lot of people came away with that impression anyway. (Did you, Nick?)). Personally, I found the notion that Paul Krugman couldn’t express himself in such a way as to disabuse people of such an impression to be almost unbelievable. Could he really not know what happens when you sign up for a loan at a bank branch? That would seem impossible in my view. The idea that some people actually believe Paul Krugman doesn’t understand this seems even more unbelievable. But there you had the MMTers and others bashing him down for it. But that bashing was understandable in my opinion, simply based on a reading of the debate discourse. Worst of all, Paul Krugman is generally one of the best writers in economics – for non-economists anyway – which makes such a misunderstanding doubly bad. How could he make himself so misunderstood on such a simple point, to the point that people then questioned whether or not he does understand such basic banking stuff? I couldn’t believe what I was reading. At a minimum, it was a way out of character example of bad writing on his part. And I can’t help but think his rather poor expression at the time (at least, because I shudder to think he doesn’t know that loans create deposits) was motivated by the same sort of frustration you’re exhibiting here Nick.
I do think there is an unhealthy asymmetry that has developed in the econ blogosphere. Why do economists write blogs, knowing they are at risk of engaging interested non-economists, if they are unwilling to learn anything from non-economists, or if they believe they have nothing to learn, or if they believe there is a tipping point at which no more can be learned? What’s the point? You may as well shut down comments or close them down to your fellow economists. I do think that sort of failure or malfunction of engagement is what’s going on. As much as I’ve come to dislike some of the language machinations and “paradigm” manipulations used by certain “heterodox” banking oriented people, it looks to me like the economics profession is collapsing in on itself in response to this. That’s not healthy.
Nick, see Peter N, and JKH nails it as usual.
JKH: See my 10:52 comment for my views on “loans create deposits”
I agree that PK’s post was less clear than he usually is. And I actually said, in writing my first post in that kerfuffle, that I started writing it because I disagreed with PK on “loans create deposits”. But PK was (implicitly) talking about the long run, and (implicitly) assuming the central bank was doing something like inflation targeting. And in that long run, it’s all very different. So I wrote a series of posts clarifying that. (Actually, in that whole series of posts, and others, I thought I had fully engaged with the MMT (and similar) position, and explained why I thought it was wrong.
I have engaged A LOT with (mostly) MMTers, both in posts and in comments. (And sometimes, just sometimes, I would like to not engage with MMTers, and engage with New Keynesians, and RBC types, and even my fellow MMs, and others who speak my language.)
Peter N: “He seemed to think this would mean that there were no limits on bank lending, a position with which I doubt the FDIC would agree.”
Short run or long run? If the central bank holds a constant interest rate regardless of the amount of loans and deposits and inflation created? Or if the central bank (say) targets inflation? It matters massively. Especially if you ignore reserves.
And even if you do have an absolutely mechanical textbook model with hard reserve ratios, it’s still true that an initial shock to reserves will cause multiple rounds of loans and deposit creation, just not unlimited.
(The final straw that lead me to write this post was reading a comment on another blog which said that “loans create deposits” is a heterodox idea. Every first year textbook I can remember reading contains a description of how loans create deposits.)
But it contains, as far as anyone can tell, a wrong description of it. Piggy-backing off Peter N and JKH, I further cite the following paper from the Fed’s Division of Reasearch & Statistics and Monetary Affairs:
Click to access 201041pap.pdf
The real difference between the heterodox/Post Keynesian/whatever position and the orthodox position is the dominance of capital constraints and the irrelevance of reserves. And yet you have a number of orthodox economists extremely worried that the large increases in reserves will cause runaway inflation, and a larger number at least saying that QE will have to be “unwound” at some point. This isn’t exactly reflected in your standard New Keynesian models, which frequently don’t include money and/or just have the central bank targeting an interest rate, but it’s bizarre and worrying that it should affect commentary on public policy.
As a fun aside, the standard money multiplier in a first year textbook – I’ve got Bernanke’s here, although that might be “intermediate” – has you dividing base money by the reserve requirement. Since Canada’s reserve requirement is 0, the money supply must be undefined. 🙂
Nick Rowe,
It looks like “You will recognise yourself from my description.” was over-optimistic. See Nathan Tankus’s comment, for instance.
Here’s a collection of econ books available online:
deited to embed link here NR
[Thanks Peter, but some of these texts aren’t really standard. For example, it includes a text by that notorious heterodox economist David Andolfatto 😉 NR]
Edmund: “As a fun aside, the standard money multiplier in a first year textbook – I’ve got Bernanke’s here, although that might be “intermediate” – has you dividing base money by the reserve requirement. Since Canada’s reserve requirement is 0, the money supply must be undefined. :)”
you forgot about the desired currency/deposit ratio 😉
“The real difference between the heterodox/Post Keynesian/whatever position and the orthodox position is the dominance of capital constraints and the irrelevance of reserves.”
Think about what happens to the loans-deposit story when you have a central bank that is adjusting the overnight rate to target inflation. That is what modern central banks do, and so that should be the default assumption of modern monetary theory. And ask yourself whether bank capital might be endogenous.
W Peden: Yep! As I should have expected, I seem to have touched a nerve or two, despite trying to write this very carefully.
You assume that there is something called inflation that can be targeted. My more Austrian view is that there are sectors which have inflations relative to other sectors. If you exclusively target one inflation, you open yourself to possibly aggravating some of the other inflations.
Obviously, inflation variation between sectors will give rise to misallocation of capital. This misallocation can be a loss of short term efficiency (say reduced GDP) or a loss of long term efficiency (like an overweight financial sector) or an exaggeration of inequalities (assets inflating relative to goods).
Overuse of GDP as an indicator leads to this sort of thinking.
GDP is NOT spending, nor is it income.
Peter N: “Then, of course, there’s the perennial favorite – confusion among stocks, flows and integrated flows (like GDP, which is neither a stock nor a flow).”
Could you explain what you mean by GDP being neither stock nor flow? Are you referring to measuring it in discrete vs continuous time?
Dear Nick,
I, for one, am very happy that you have engaged A LOT with MMTers. Some blogs won’t. So I thank you for taking the time that you do and discussing your disagreements with that theory. I find it educational even if you find it repetitional.
However, its not really fair to write a fairly provacative post in response to a comment from someone who may be MMT (not sure) and then not expect a lot of ‘engagement’. One of the fundamental criticisms of ‘orthodox’ economics by MMT is that the banking system and the role it plays in today’s economy is not accurately described. I know from my own experience that the idea that loans create deposits was not seriously considered in my first year courses. Or second or third for that matter.
Nick Rowe: “The idea that banks just act as intermediaries between savers/lenders and spenders/borrowers is about long run equilibrium.”
In the long run we are all in debt.
😉
Think about what happens to the loans-deposit story when you have a central bank that is adjusting the overnight rate to target inflation. That is what modern central banks do, and so that should be the default assumption of modern monetary theory.
What does happen? Lending is constrained by the ability of borrowers to pay the higher interest rates – fewer projects are profitable at higher interest rates.
This should be what modern central banks do, but at the zero lower bound they seem to all abandon price targets and move on to quantity targets. So we’re left with them pushing on a monetary rope: in the best case scenario, replacing risky assets with riskless reserves, but in the worst case replacing essentially riskless long term assets with reserves.
Are we all on the same page that the money supply is practically determined by demand for loans at the given short term interest rate, and not limited by reserves which will be supplied effectively without limit by the central bank at the given short term interest rate?
Peter N: Please excuse my (sort-of) Fisking you:
“You assume that there is something called inflation that can be targeted.”
No, there are many different measures, and each could be targeted (but not all at once, of course).
“My more Austrian view is that there are sectors which have inflations relative to other sectors.”
Then I’m an Austrian too.
“If you exclusively target one inflation, you open yourself to possibly aggravating some of the other inflations.”
Agreed. It’s not obvious which target would be best.
“Obviously, inflation variation between sectors will give rise to misallocation of capital.”
Not obvious, but likely true, that different inflation targets might cause different stochastic allocations of capital across sectors, and that some might be misallocations (i.e. less desirable) relative to others.
Sorry, but what has this potentially interesting (though I’m not going to pursue it here) line of discussion got to do with people who haven’t read first year textbooks?
My first physics text was Holliday and resnick. I subsequently used other books to teach when I worked as a lecturer. The striking difference between H&R 1960 was the wordiness of the modern texts. H&R would cover In a few pages of text what would fill an entire chapter in a modern book. Then they would go an in work out more complex problems. So the modern books had the same breadh but not the depth and are laborious to read.
Is there such an example in economics? The issue with economics texts I think is that the earlier texts do have the structure of my old beloved introductory physics book but the material is now actually somewhat wrong.
So let’s forget about free for a moment. Whats the most efficient introductory text that is also correct?
Since there are a lot of people here claiming they never came across the idea that loans create deposits in intro courses or textbooks, I thought it’d be worth chiming in. It was taught in my first year course. I double checked the textbook for that course (Lipsey and Ragan) and found it in there, too. In fact, I remember going through numerical examples to demonstrate the idea in my high school economics class.
So let’s forget about free for a moment. Whats the most efficient introductory text that is also correct?
That’s a tough question, because economics is more like sociology than physics. For an introductory/intermediate textbook that takes a modern approach and starts with concepts used in current modeling – the representative agent, microfoundations – Stephen Williamson’s book springs to mind. In fact, it’s the only one I can think of that does not use IS-LM.
Edmund: “Are we all on the same page that the money supply is practically determined by demand for loans at the given short term interest rate, and not limited by reserves which will be supplied effectively without limit by the central bank at the given short term interest rate?”
The short answer is that we are not all on the same page, and that if you asked a dozen different economists, even those who consider themselves “mainstream”, to give their views on that question, you would get a dozen different answers. Some of those differences would turn out to be semantic, or resolvable after discussion of what each one meant, but others wouldn’t be.
For example, David Glasner and I are both “Market Monetarists” (though that’s a slightly loose label) but we would disagree on that one. My own views are not “mainstream”, but are also not “heterodox” in the same way that you might understand that word. It would take me a full post to lay out my views on that question fully (and part of it would be laying out the semantics) and then I would be fending of criticism from all different sides.
Here’s very roughly the nearest there is to a “mainstream” position (which I disagree with in part):
“The stock of money is determined by the quantity of money demanded given the level of interest rates, the price level, and real income. And that rate of interest is set by the central bank (plus risk etc premia), but the central bank must set that rate of interest in accordance with investment demand and saving supply (i.e. loanable funds) if it wants to maintain its inflation target. So ultimately, the stock of money is determined by the central bank’s inflation target, by saving and investment, and by the non-inflationary productive capacity of the economy (NAIRU output), plus a load of other stuff I’ve forgotten.”
See? Simple one-way causal chains don’t work, in this way of thinking.
Ryan V: thanks very much for chiming in to confirm that point. And I might add that Ragan and Lipsey (that’s the Canadian version, but I think there are loads of versions of Lipsey internationally, and I used it as an undergrad, donks ago) is a very standard and very top-selling text.
GDP is the integral of value adding flows for a defined period. While you could define a GDP flow (and IIR Keen does) I don’t see how you could measure it, given the complexities of imputation and reconciliation.
It certainly isn’t a stock. You can treat it as one if you want to compare it to itself over other periods or with its sector totals, but a true stock has an value at any given point in time, and this value is quantity, not a rate.
This distinction is made more important by the peculiar nature of GDP. Because it combines results from (at least) 3 different forms of accounting and contains a significant component of imputations, it’s difficult to compare it with stocks at known times. The result of accruing across the different systems is only meaningful compared with other examples of itself.
Jon: It’s absolutely the same in economics. This is a pet peeve of mine. They get wordier and wordier, and contain more and more stuff, and get less and less efficient. (Because every instructor insists the text contains lots of stuff on his pet topic, and they daren’t say “no”, and just throw it all in!)
Mankiw is shorter than most, and quite efficient. I don’t know what’s the most efficient.
Peter N: OK. I would say that GDP is strictly a flow, but if you measure any flow in discrete rather than continuous time it becomes a stock, rather than a flow. A PITA theoretically, but not a big deal. GDP is a flow. Stats Canada measures a discrete time stock approximation to that flow.
“Sorry, but what has this potentially interesting (though I’m not going to pursue it here) line of discussion got to do with people who haven’t read first year textbooks?”
Hey, you started it:
“Think about what happens to the loans-deposit story when you have a central bank that is adjusting the overnight rate to target inflation. That is what modern central banks do, and so that should be the default assumption of modern monetary theory. And ask yourself whether bank capital might be endogenous.”
Peter N: touche!
To take an extreme instance of what I’m talking about-
“Economists are generally scientifically illiterate people, which is a shame. You can’t talk about economics if you don’t know physics, engineering, biology nor psychology, sociology and other and other similar subjects.”
http://www.blogger.com/comment.g?blogID=2761684730989137546&postID=1073553551630034628
Economists are such non-experts in economic debates that they shouldn’t even be talking about economics. Leave it to the sociologists, Nick.
Consider the following story:
Someone deposits currency into a bank. The bank keeps a fraction of that currency as a reserve. The rest is excess reserves, which the bank then lends out. The borrowers spend the money, and the sellers deposit the checks. The banks receiving the deposited checks present them for clearing from the bank that made the loan. They now have new reservers, which they now lend.
So, deposits create reserves which allows lending.
Suppose instead that a bank makes a loan and creates a deposit for the borrower. The loan created the deposit. When the borrower spends his new deposit, the sellers receive the funds, and they deposit them, and so the loan has created deposits for the sellers in some other bank. Now, the bank that made the loan may well need to settle up with the banks that received the seller’s deposit, so it borrows whatever reserves are necessary. The central bank creates reserves as needed at the interest rate it sets.
I think the first story is very unrealistic, though it tells us something about reality. I think the second story is a bit more realistic, though not completely. Still, it tells us something about reality, though at the end, it assumes a central bank targeting interest rates.
I think a more realistic understanding of banking sees banks as both seeking to attract deposits and make loans. The notion that deposits just happen and banks are indifferent about borrowing reserves overnight from other banks or having deposit customers is wrong. That some loans are funded with capital, that banks purchase existing bonds, that banks vary the interest rates on deposits and loans, all fit in well with an understanding that banks seek to match deposits and loans.
On the other hand, the notion that banks first accumulate reserves and then lend them is very unrealistic.
But the notion that reserves don’t matter is just an artifact of assuming that central banks target interest rates. Money and banking can exist without central banks. Money and banking can exist with central banks that don’t target interest rates.
On advantage of the first deposit, then excess reserves, then loans, is that this can be modified to understand a central bank that is targeting interest rates. I am not sure how assuming that there is a central bank creating a perfectly elastic supply of reserves at a target interest rate can be used to understand an alternative where there is no central bank or there is no target for the interest rate.
It would take me a full post to lay out my views on that question fully (and part of it would be laying out the semantics) and then I would be fending of criticism from all different sides.
I’m surprised you’ve not had occasion yet to do it, given the frankly shocking comprehensiveness of this blog.
If only it did Mulligan any good.
Why bother with a first year text book? They are simply horrendous.
The best way into neo-classical econ. is to read Romer’s Advanced Macro book and Mas-Colell’s Micro Theory and Hal Varian’s graduate book.
Bill: “On[e] advantage of the first deposit, then excess reserves, then loans, is that this can be modified to understand a central bank that is targeting interest rates. I am not sure how assuming that there is a central bank creating a perfectly elastic supply of reserves at a target interest rate can be used to understand an alternative where there is no central bank or there is no target for the interest rate.”
Exactly! We don’t want to just teach about the here and now. The monetary system has been done very differently in the past, is now being done very differently in other places, and will almost certainly be done differently again in future.
(Parenthetically, that’s what so hard about breaking out of the US recession. People can only see the world through the incredibly narrow-minded perspective of “Fed sets interest rates…” blinkers.)
Lord: and nobody mention that economist at one of the Feds, who I complained about in my other “first year” posts! 😉
I agree that whoever said the mainstream doesn’t teach that loans create deposits should have been a little more clear, after all loans do create deposits in the money multiplier model…but ultimately the reserve ratio limits how much they can create. Now, was this simple point worth getting all angsty over? Absolutely not, you should have understood what he meant.
Furthermore, understand that most of the “heterodox” people who post on your website are not actually heterodox students at a university. They simply follow MMT and know that it belongs to something called a “heterodox” economics, and understand its heterodox because it’s the antithesis to the way mainstream economics does it’s modeling (that is, having nothing to do with the real world). Do they know what institutional economics is? Ie have they read Veblen? Do they know anything about Marx? About Keynes? About Sraffa? etc etc. Do they understand that we see economics as the study of the social provisioning process under capitalism, and that we follow what can be called an institutional and social surplus approach? No, they don’t, they just understand banking and money. Is this sufficient to criticize neoclassical economics? Absolutely. Anyway I’ll stop there, but I will leave you with one paper that is about to be published and addresses your very point, Nick:
Click to access EAEPE-Lee.pdf
From Fred Lee, who is the antithesis of everything you stand for.
Edmund: well, I have written bits and pieces all over the place. And anyone who read them all could get a good sense of my views. But I’ve never put them all together. And my views do evolve over time, as I read, and watch, and think. (We aren’t all set in orthodox stone, you know).
Here’s one. another. a third.
There are loads.
MacroAgro: Are you a grad student in economics who did his undergrad in math or physics or something? (Just a guess.)
I understand why you think like that, but I think you are wrong too. And if you haven’t already done so, and if my guess is even roughly right, you should hold your nose and wade through an intro text. Because not everything can be modelled in formal math. And in some ways, as you move up from first to second to third, fourth, MA, and PhD, all we are doing is less and less stuff in more and more rigour. (That’s not exactly true, but there’s enough truth in it to make it worthwhile reading an intro text.)
I have seen PhD students badly screw up comps, because they blew something that was taught in first year, and they either missed or never understood.
DDJ: I gotta hand it to you. That was a good comment. A couple of years back your comments were cr*p. You have obviously learned stuff. If you can only keep that upward trend going at the same rate for a few more years….you can be running the show, and take over from declining oldsters like myself.
I’ll post the relevant things Fred Lee said here:
II. Heterodox Economists and Mainstream Theory
For the heterodox critics, neoclassical economics does not accurately describe the leading
edge of research carried out at the top universities and published in the top journals. Rather, for
them the appropriate nomenclature is mainstream economics, which includes both neoclassical
economics and the economics at the frontier that builds upon it but also deviates from it in some
ways but never completely breaking away to the point of blasphemy. The critics then argue that
heterodox economists’ knowledge of mainstream theory is inadequate at best, although they
provide no evidence, explanation, or qualification (Colander, 2000, 2003; Colander, Holt, and
Rosser, 2004a, 2004b, 2010; Fontana and Gerrard, 2006; also see Vernengo, 2010). For this to
be the case heterodox economists must either lack the capabilities and training to master
mainstream theory or deliberately decide not to acquire knowledge of it. There is no evidence
that heterodox economists are innately less capable than mainstream economists or that their
training is inferior (since most heterodox economists have been trained in mainstream doctoral
programs.) The latter explanation for inadequate knowledge of mainstream theory is also
questionable but complex as well. There is extensive literature throughout the 20th Century and
especially from the 1970s onwards in which heterodox economists have critically evaluated
mainstream theory in its various historical and contemporary forms over all JEL research areas.4
Part of this literature argues that neoclassical economic theory is incoherent and thus
fundamentally incapable of developing theoretical explanations of the social provisioning
process that are grounded in the real world.
This claim merits further but brief discussion. First, the objects of study of neoclassical
theory, such as preferences-utility, marginal products, demand curves, rationality, relative
scarcity, and homogeneous agents, are ill-defined, have no real world existence, and where
relevant are non-quantifiable, non-measurable. Consequently, the issues and problems for which
the objects are relevant, such as competitive markets, efficiency, and optimality are either
fictitious in that they are unrelated to the real world; or if the issues and problems are clearly
located in the real world, such as prices or unemployment, the objects have no bearing on their
existence. Secondly, the methods used by ‘neoclassical’ economists to develop theoretical
explanations addressing the issues and problems, such as deductive methodology and ontological
and methodological individualism, generally include fictitious objects and utilize concepts that
have no empirical grounding hence no meaning in the real world. Together, they establish that it
is not possible for economists to conjure up any neoclassical theoretical explanations relevant to
the social provisioning process that takes place in the real world. In addition, the neoclassical
theory of the provisioning process, which is as Hirshleifer argues (1985. p. 53) the area of study
of neoclassical economics, is itself is problematical. The core propositions of the theory, such as
scarcity, preferences and utility functions, technology and production functions, rationality,
equilibrium, ontological and methodological individualism, heterogeneous agents, and positivist
and deductivist methodology, have all been subject to intensive heterodox critiques. But even if
the critiques are ignored, it is well known that it is not possible to generate internally coherent
explanations or stories or parables of market activity at either the micro or the macro level; and
even if particular stories (represented in terms of models) of market activities are accepted, such
as general equilibrium, game theory, or IS-LM, they have been shown, on their own terms, to be
theoretically incoherent and empirically unsupported (Eichner, 1983, 1985; Rizvi, 1994; Lawson,
1997; Keen, 2001; Davis 2003; Lee and Keen, 2004; Ackerman and Nadal, 2004; White, 2004;
Petri, 2004; Palacio-Vera, 2005).
The above arguments suggest that because neoclassical theory is not grounded in reality,
does not deal with social considerations, and is internally theoretically incoherent, it lacks truth
and value and contributes nothing to explaining the social provisioning process in a capitalist
economy. That is, neoclassical theory is a pseudoscience with illusory knowledge or pseudoknowledge and hence is not a scientific theory and cannot be a scientific research program. And since the heterodox critics remain silent on this (or even acknowledging the correctness of the
heterodox criticisms), they implicitly accept the above conclusions: that heterodox economists
are extremely knowledgeable about neoclassical economic theory which at one time was the
theoretical frontier and that neoclassical theory including the one-time cutting edge theory is
illusory knowledge. Thus, neoclassical theory was never a rival scientific theory to heterodox
theory because it was not ‘scientific’. But this raises some issues related to the notion of the
leading edge or frontier of research since the critics acknowledge that the frontier maintains
some degree of continuity with neoclassical theory (Colander, 2000, 2005a, 2005b; Colander,
Holt, and Rosser, 2004a, 2004b, 2010). That is, if neoclassical economics is pseudo-knowledge,
then any theoretical developments or deviations based on it are, arguably, questionable if not also
illusory knowledge. Moreover, if neoclassical theory is illusory knowledge, then the mainstream
qua neoclassical theory texts used for undergraduate and graduate instruction contain nothing but
illusory knowledge. With nothing but illusory knowledge behind the frontier, it is not apparent
that a frontier exists at all and hence that the top economics departments are producing and the
top economics journals are even publishing scientific knowledge (Bunge, 1983, 1998; Mahner,
2007).
Since the entire theoretical corpus of neoclassical economics is pseudo-knowledge, it is
not clear why heterodox economists should pay attention to the mainstream frontier advances.
Yet, in contrast to the assertions by the critics, heterodox economists do engage with past and
current mainstream literature, including the cutting edge research.5 Their critical analysis of the
frontier research identified by the critics as classical-evolutionary-behavioral game theory,
evolutionary-behavioral-experimental economics, neuroeconomics, and agent-based complexity
economics indicate that as a whole they are too much based on and embedded with neoclassical
theory to escape being illusory knowledge;6 and if it is pseudo-knowledge, then there is no
reason for heterodox economists to devote their energies to engaging with it. Moreover, a
common feature of the frontier research is its utilization of mathematical techniques and models,
many of which are borrowed from other disciplines. This reliance on techniques and models is
the continuation of a secular trend in which mainstream theory has become increasingly
separated from its subject matter and progressively engaged in articulating properties of
internally generated models.7 Thus, the mainstream’s method of evaluating its fictional theories
is to compare the projected fictional outcomes of a fictional model to actual data, as if this has
any meaning. To circumvent the arguably irrefutable accusation of illusory knowledge, it is not
surprising that mainstream economists and the heterodox critics are increasingly defining
economics as a particular method of inquiry without ideological, theoretical or factual content or
intent to analyze and explain the provisioning process (which raises the unanswered question of
“is this really economics?”). But even this has been subject to criticism by critical realists and
others, in part on the grounds that no method of inquiry is neutral with respect to content.8 So,
given the theoretical and methodological arguments for the rejection of mainstream theory and
method (which the critics have not explicitly rejected), there is little apparent reason for
heterodox economists to pay much attention to mainstream theory:
Heterodox economists take orthodox [mainstream] economics seriously enough to argue
carefully why they choose not to adopt that approach. There is thus an important
asymmetry between orthodox [mainstream] economics and heterodox economics in terms
of engagement (Dow, 2008, p. 16).
In this light, it appears that the critics believe that whatever the mainstream frontier is must be
scientific knowledge that must command the attention of all; that what they think is important
mainstream theory must be uncritically accepted by all heterodox economists; and that the
absence of content and concern about the provisioning process is what makes mainstream
economics scientific (Colander, 2000, 2009b, 2010; Colander, Holt, and Barkley, 2004a, 2004b,
2007-08, 2010; Koppl, 2006; Fontana and Gerrard, 2006; also see Lavoie, 2009).
The heterodox critiques of mainstream economics are not, contrary to the assertions of
the critics, recognized or understood by mainstream economists (Colander, 2009b, 2010). This
is not surprising since they exist in a closed intellectual environment in which their training does
not provide them the capabilities to be theoretically reflective and questioning. They are true
believers so that it is not possible to pursue any heterodox criticism to the point that it leads to
questioning their own beliefs (Earl, 2010). But there is more. It is clear that heterodox and
mainstream economics are fundamentally divided by theory, method, and methodology. In
addition, they are divided by their ‘social’ roles in a capitalist society. Neoclassical economics
did not arise in the 19th Century out of some pre-existing pluralist environment, nor did it
incorporate heterodox ideas. Both classical and neoclassical theories developed within particular
social contexts and neoclassical theory emerged in political opposition to classical economics.
The central issue contested was not theory per se, but theory as a reflection of one’s position on
capitalism. As a consequence of the changes in social structure induced by the industrial
revolution, classical theory, with its production-based, surplus approach was providing aid and
comfort to the class enemies of the larger property owners (both landed and manufacturing), and
this development became more pronounced with the publication of Ricardo’s 3rd edition of On
the Principles of Political Economy and Taxation. And it is important that this was coupled to
organized opposition to capitalism itself. Early neoclassical theory attempted to defend
capitalism through its individualist, exchange-based approach where participants are portrayed as
equals in that all have the same rights and roles in the exchange process as no one would
undertake voluntary exchange unless it was to her benefit. Coupled to a productivity theory of
distribution, this approach eliminated from consideration any examination of inequality, of
exploitation as the source of property owners’ incomes. And, with the housing of economics in
the university, a secure institutional structure could ensure that the prevailing theory would be
supportive of those propertied arrangements that lay behind the university itself. Any opposition
could be contained to fairly mild criticism of the dominant theory and the development of
alternative approaches that did not challenge those arrangements.
Neoclassical theory continued its social role throughout the 20th Century and mainstream
theory has taken on this role as well. In contrast, first Marxism, then Institutionalism and the
left-wing Keynesians, and after 1970 heterodox economics argued that the social provisioning
process can be and should be altered in favor of the disadvantaged, the discriminated, the
unemployed and poorly employed, and the working and dependent classes of society. This
would require more than economic efficiency; it would require altering state-property-social
relationships. It is this threat that emanates from heterodox theory which mainstream theory
must counter; and this ‘social duty’ is inculcated into mainstream economists since the day they
took their first economics classes. The critics fail to acknowledge this fundamental divide
between mainstream and heterodox economics (Henry, 2009; Lee, 2009).
DDJ: Arrgh! That was just a bit too long. But for once, I’m going to let it stand, as a token of my esteem!
“If there is one idea that I would really like people to understand better, it’s the idea of simultaneity. The idea that causation does not always flow in one direction. And that what causes what depends on what we are holding constant for the purposes of analysis. And that depends on the shock, and on short run vs long run. Etc.”
Nice post Nick. I had dinner with my next door neighbor last night. It’s a useful exercise to interact with people who don’t think about economics 24/7. Interestingly the topic of simultaneity in economics came up.
I’d like to add one thing to the wish list, especially when it comes to amateur MMTers. Instead of reading everything under the sun ever written by Marx, Sraffa, Kalecki, Lerner, Kaldor, Robinson, Minsky etc. can they please just curl up with the section on the AD-AS model in plain old Principles of Macroeconomics textbook some night? They don’t have to believe any of it, but if I just had that one model for common macro vocabulary it would make my life so much more pleasant. I know you’re all incredibly intelligent and starting at the elementary end of the field of economics is probably beneath you but I thought I’d ask anyway.
P.S. My first career was in mathematics. When I decided to go into economics I started from the bottom all over again and completed a BA in economics in less than a year. I can’t imagine how the Narayana Kocherlakotas and Steve Williamsons of the world think they can get by without it. My perception is a lot of this fueding between “heterodox” and “neoclassical” economics is between two groups that quite simply have skipped Econ 101 altogether.
Mark, there is almost nothing of value in Econ 101, it sickens me every time a Paul Krugman, Nick Rowe, or Mark Sadowski brings it up. That’s not to say one shouldn’t take it and understand it, in fact I would appreciate it if one was to take macro/micro 101 but as long as someone tells them after the fact that it’s all BS (if you tell them before they won’t bother trying to learn it). that of course may be the problem with the armchair MMTers, why would they bother reading something they know isn’t true, or makes a mockery out of reality?
Mark: “My perception is a lot of this fueding between “heterodox” and “neoclassical” economics is between two groups that quite simply have skipped Econ 101 altogether.”
LOL!
DDJ: ECON1000 is not BS. It’s not the last word on the subject, of course, but it’s not BS.
Of course, at some deeper level, a lot of what all of us think we know is probably BS. But we don’t know which is BS and which isn’t. So we keep on struggling away, and try to make notes of what we think we’ve got figured out so that our kids at least won’t go up the same dead-ends as we did, and those notes in economics are the first year textbook.
Are there people who think intro physics is BS? “WTF? There’s no such thing as a frictionless vacuum. Why is there a Nobel Prize for this sh*t?”
Also: someone, sometime is going to have to explain why I should ever pay attention to MMTers. Do they have policy recommendations? Testable predictions? The sort of stuff that mainstream economics insists upon before printing it in journals and textbooks?
Mr. Gordon, economics is a social science. When econ 101 is reminded of that fact, then you can get back to me. Econ 101 has some useful things to say, I would say the macro has more useful things to say, but the micro is mostly complete hogwash and should be thrown out. Marginal utility, marginal products, hell marginal analysis and utility theory in general makes a mockery out of economics, the only social science that is generally not cited among the other social sciences, and the only social science that almost never cites the other social sciences.
Is that it? Pass.
Stephen Gordon,
“Are there people who think intro physics is BS?”
I can think of a fair few people in the history and sociology of science who believe that. Although they wouldn’t put it that way, they’d say “Most historians and sociologists of science have refuted the notion that physics ‘exists’ in a vacuum from society and therefore is grounded in ‘objective’ reason rather than social constructs based on social ‘influences’ rather than external ‘facts’, so the notion of physical ‘truth’ is misleading.” That’s the polite way of saying, in my trade, that something is a big fantasy/swindle.
Do MMT’ers have policy recommendations? You’re joking right? Don’t worry, you haven’t been paying attention all along.
As far as testable predictions go, “MMT” is simply a description of the monetary operations for a nation that prints its own currency, in addition to some chartalist stuff on the origins of money. It puts more emphasis on history rather than “let me pull something out of my ass and do a regression to see whether it’s valid, and then I’ll send it to a journal”. Where the economist then comes in is to understand the habits of thought/institutions in society today and make policy recommendations based on those understandings. MMT is just an example of what heterodox economics is about, as I said before we care understanding the social provisioning process, in fact heterodox econ can be understood to be a historical science of the social provisioning process. Anyway we simply focus on different things and have our own research agendas, if mainstream economics were to disappear tomorrow it would have no impact on heterodox economics.
Nick,
Here’s Krugman:
“First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn’t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage.”
http://krugman.blogs.nytimes.com/2012/03/30/banking-mysticism-continued/
Is Krugman right or wrong here?
that of course may be the problem with the armchair MMTers, why would they bother reading something they know isn’t true, or makes a mockery out of reality?
This is the sort of thing that blows me away a bit–because how do they know it isn’t true, without knowing anything about it?
DeusDJ: No, I am not joking. Please name a policy implication. And it is a testament to years of seeing this bumph on the internet that I have to ask the question.
And I take it that the second paragraph is a long-winded way of saying “no”.
Your can pick up used copies of early edition textbooks from all the leading authors on Amazon for a couple dollars, I have a small collection.