Twofish's Blog

January 10, 2009

The End of Monetarism and Mathematical Economics

Filed under: china, finance — twofish @ 6:02 pm

I think we’ve reached the limits of the monetarist view of economics.  Monetarists argue that only interest rates matter, and that in looking at an economy, you should ignore everything else.  The trouble with that is 1) I think it’s obviously not true and 2) even if it were true, it’s totally useless for what is going on now.  The US has lowered interest rates to zero at which point monetarism becomes useless and you have to think of something else.

My own feeling is that we’ve also reached the end of the line for “mathematical economics.”  This is the notion that you can understand an economy by just looking at charts of numbers rather than looking at the institutions within an economy.  Again, the trouble is that 1) it’s obviously not true and 2) even if it was true, it is useless.  Telling China to “raise household consumption” is an utterly useless piece of advice if you offer no ideas as to how to go about doing that.

The whole idea of a “saving glut” is an example of tunnel vision.  If someone thinks that the only that thing matters are interest rates and quantifible numbers than “savings glut” is the only answer people can provide for what happened, but that is because they stuck to a theroretical view of the world that rejects looking at anything else, and I think that it useless way of looking at the world in part because it is self-contradictory.

Suppose you end up saying “Chinese save too much, they should save less.”  At that point you are stuck because without looking at things other than interest rates, you can’t come up with ways to have them save less.  And if you can come up with ways to have Chinese save less, then you probably also could have come up with ways to have better things done with those savings.



  1. Hi 2Fish

    Some monetarists are nothing more than immature Keynesians who’s views are restricted by some rules they believe to be valid in every circumstance/environment. Others are capitalists who love low interest rates in bad times but hate taxes (thus public recession spending – but do like public spending achieved by lobby procedures).

    Even Keynes only talked about monetary stimulus in his Treatise on Money and it took him some time to realise that the next steps were deficit spending and maximization of the propensity to spend. In an indebted society like the US there’s really no alternative to avoid bananas; however without the right protectionist measures, this US policy will be in vain and their surplus-neighbours will profit most from it.

    Your criticism on mathematical economics reminds me of a comment Samuelson made on Keynes main work. He said that Keynes’ work was chaotic and cannot be understood. I thought of this as quite symptomatic for Samuelson who was highly math oriented in his work and wanted to lay down every economic action in a rule. He was unable to seize the meaning of the chaotic element in Keynes’ main work as being very representative for the real world.

    This whole neo-libertarian experiment has allowed capitalism to move too far in the direction of accumulation and a redistribution cannot be reached without recognition of the main drivers. Global labour distribution made it possible for wages to become retarded in developed countries. The phenomenon wasn’t obvious because the loss of purchase power in wages was compensated by credit growth which sustained consumption.

    As a final point, I wonder why China has to spend its reserves to stimulate the world economy, while money market funds, banks and companies sit on about $ 90 trillion cash waiting to be invested. Oh wait, I forgot the holy cow of the West: absentee ownership.

    Comment by geert — January 11, 2009 @ 8:53 am

  2. sorry that had to be $ 9 trillion cash

    Comment by geert — January 11, 2009 @ 9:45 am

  3. This is a very simplistic view of monetarism and the practice of quantitative analysis and modeling generally. New Keynsians use “mathematical” tools, too, as do modern day socialists. I assume the author is not advocating a return to policy analysis and forecasting based on a package of slogans. We will be far better off if those seeking to reform the financial architecture consider both qualitative and quantitative aspects of their ideas. If one goes back to read the details of meaningful analysis of the savings glut as one aspect of monetary relationships that produced excesses, much of them in the US and China, things would clearly not be as one sided as the typically low-end reporting coming out of many otherwise reputable publications where it comes to covering this. The other side of the coin is the coverage of all of this in China, where ironically the slogan of “increase private consumption!” without offering any substantive ideas as to how this to be achieved appears most frequently. The Chinese language content is equally as bad in actually explaining what went wrong in the US – “consumers in the US need to save more, and there needs to be more regulation!”. There are deeper systemic relationships at play here that need real explanation and understanding beyond the kind of finger pointing approach that says it was Greenspans fault one day, the SEC’s fault the next, the fault of the Chinese the next month, and eventually that of the Europeans. Clearly, the availability of cheap credit was an enabling factor, and one that can be modeled quantitatively, ironically, as can the systemic risks of 30x leverage and the lax policy environment. I would hope that those in Beijing, Washington and Brussels will have a quantitative basis for their discussions as to how to reform the system. This would be far more constructive than finger pointing. Paulson will be gone soon, and those in Beijing who are pointing back at him (ironically after having been the ones to have decided where to send Chinese national savings) will still be there. Let’s hope a change in the line up changes to tone and the basis for discussion. Let’s not throw out our “mathematical” economics. There were many practitioners who predicted outcomes such as the past 6 months years ago (some in the US, some in China, some in the EU, etc….), but their were drowned out by the voices of others with deep vested interests in the bilateral status quo. Don’t forget path dependencies on both sides of the US-China equation either. Many people used “mathematical” economic tools to evaluate them years ago, and did, as it turns out, make strenuous and detailed recomendations to governments on both sides as to how they might be reversed. There was, and is, a lack of political will to face them, and the current situation is what we get.

    Comment by Rumba — January 11, 2009 @ 2:04 pm

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