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posted on 12 November 2015

Keynesian New Economics

by Dirk Ehnts, Econoblog101

As macroeconomics was transformed in response to the Depression of the 1930s and the inflation of the 1970s, another 40 years later it should again be transformed in response to stagnation in the industrial world.

Larry Summers wrote these lines in a recent article at the Washington Post. Since I have been doing research on "Keynesian New Economics" in response to the crisis, let me briefly summarize what I came up with.

  1. methodology: Keynesian New Economics should be based on a balance sheet view of the world. We know for some considerable time that money spent creates incomes; we also know that it makes sense to examine private, public and external sector and their respective net debt balances as well as the changes thereof

  2. equilibrium: we have to move away from the idea that markets clear because supply equals demand at some equilibrium price; this is not how labour markets or the money market work. So, two out of three markets do not work with this neoclassical closure but instead rely on different mechanisms

  3. money: student and scholars need to present the way actual monetary systems work; how is central bank money created/destroyed? what about government bonds? what about endogenous bank money (=deposits)?

  4. NIPA/FOF/BOP: understanding the interactions of the economic subjects should be at the core of Keynesian New Economics. National Income and Product Accounts, Flow-of-Funds and Balance of Payments need to be explained step-by-step so that it is clear which parts are moving and which are reflections of changes elsewhere. In a financial system run by double entry book-keeping, not all entries arise from rational behaviour of individuals. This is especially so for aggregated like the current account of a nation or the public debt.

  5. policy: we have to understand that public debt is something fundamentally different from private debt. While in a sovereign monetary system the government cannot run out of money, this is a big problem for the private sector (or parts of it). Fiscal policy can have unwanted side effects (like current account deficits), but it is not the expansionary fiscal spending per se that is bad. Monetary policy has in effect been used to finance one private sector bubble after the other and apparently cannot do so anymore because we hit the zero lower bound. More government spending is needed for the private sector to create the next big leap forward.

There is a long way to go, but some economists already started (here is a simple model which incorporates issues 1-5). If economics fails to reform, the times of economists as influential advisers of policy makers will be over.

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