Why Tyler Cowen Doesn’t Understand the Economy: It’s the Debt, Stupid
In a recent post Tyler Cowen makes an admirable effort to lay out his overarching approach to thinking about macroeconomics, revealing the assumptions underlying his understanding of how economies work. (Even more salutary, this has prompted others to do likewise: Nick Rowe, Ryan Avent.)
Cowen’s first assertion:
In world history, 99% of all business cycles are real business cycles.
This may be true, but it is almost certainly immaterial to the operations of modern, financialized monetary economies. He acknowledges as much in his second assertion:
In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks. I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.
That paper, which revisits and revises Friedman and Schwartz’s Monetary History, is clearly foundational to Cowen’s understanding of how economies work, so it bears examination — in particular, its foundational assumptions. The Romers state one of those assumptions explicitly on page 134 (emphasis mine):
…an assumption that trend inflation by itself does not affect the dynamics of real output. We find this assumption reasonable: there appears to be no plausible channel other than policy through which trend inflation could cause large short-run output swings.
This will (or should) raise many eyebrows; it certainly did mine. Because: it completely ignores the effects of inflation on debt relationships.
It’s as if Irving Fisher and Hyman Minsky had never written.
Assuming “inflation” means roughly equivalent wage and price increases, at least over the medium/long term (yes, an iffy assumption given recent decades, but…), inflation increases nominal incomes without increasing nominal expenditures for existing debt service. (Yes, with some exceptions for inflation-indexed debt contracts.) Deflation, the reverse. Nominal debt-service expenditures are (very) sticky. Or described differently: inflation constitutes a massive ongoing transfer of real buying power from creditors to debtors — and again, deflation the reverse.
“No plausible channel”?
Excepting one passing and immaterial mention of government debt, the the words “debt” and “liability” do not appear in the Romer and Romer paper, and it has only two passing mentions of “assets.” It’s as if balance sheets did not exist — which in fact they do not in the national accounting constructs then existing, that the Romers, Friedman, Schwartz, and presumably Cowen today are using in their mental economic models and in the “narrative” approach to explaining economies that Friedman, Schwartz, and the Romers explicitly champion.
If you go further and allow that wages and prices can inflate at different rates (which you must, given recent decades), you have extremely large and changing differentials between price inflation, wage inflation, and (especially) asset-price inflation.
All of these inflation dynamics are assumed away, made invisible and immaterial, in Romer and Romer — hence largely, at least presumably so, in Cowen’s understanding of economies. It is explicitly assumed (hence concluded) that those dynamics have no “real” effect. As in Romer and Romer, the words “debt,” “liability,” and “asset” are absent from Cowen’s “macroeconomic framework.” (Though he does give a polite if content-free nod to Minsky in his ninth statement.)
This explains much, in my opinion, about Cowen’s — and many other mainstream economists’ — flawed understanding of how economies work.
Cross-posted at Asymptosis.
Steve, not entirely off topic. Per numbers developed by two otherwise totally antagonistic Bruce’s, that is me and Krasting, it would appear that what we could calle “Real Public Debt” meanng US debt held by non US Fed actors (mostly the SSA and the Fed) the nominal amount of that debt is more like $10 trillion than $18 and the nominal interest rate on it averages around 2.2%. Or just a fraction above the Fed’s inflation target and so hoveing around ZERO in real terms. Which makes the cost of existing Real Public Debt Service over the medium term almost literally nothing. Until of course if matures and rolls over at whatever the then currrent real/nominal interest rate.
Like I said I don’t know how this intersects with your argument, which I admit i didn’t have time to read in full, but it interests me greatly that people are weeping and wailing about a long term debt load that amounts to a zero interest loan. Because near as I can tell the yield curve for current issued Treasuries is still trending downwards from that 2.2%.
Thoughts? Even if they are “Go away kid! You are bothering me!”
Yes, off topic cause private debt is much more pertinent to this post.
But in any case I think you and I are in total agreement on “public” debt, per our discussions here:
” This explains much, in my opinion, about Cowen’s — and many other mainstream economists’ — flawed understanding of how economies work. ”
More and more I’m becoming convinced that most of these guys have long understood the implications of debt-fueled growth ( in asset values and distribution , especially ) perfectly well. It’s just too obvious , and they can’t all be that dumb.
On the other hand , faking ignorance and manufacturing distracting alternative explanations serves their interests to the extent that it facilitates the continuation of business-as-usual for as long as possible – long enough so that the top 1% ends up owning 70% or more of national wealth , rather than the measly 40% they own today. Heck , that’s not even a majority share.
Ownership of the “commanding heights” , combined with an educated workforce you can compel to work at slave wages – what’s not to like about that ? Thus , “Big Lie Economics”.
Yes. Everything you said.