Why don't Economists understand money? (Conference 2013)

http://www.positivemoney.org/
Prof Victoria Chick, Emeritus Professor of Economics, University College London, addressed the question: "Why Don't Academics Understand Money?" at the Positive Money conference in January 2013. She said there has been a regression in the way economics has been taught. This 18 mins video gives some very interesting insights.

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Positive Money is a not-for-profit research and campaign group. They work to raise awareness of the connections between our current monetary and banking system and the serious social, economic and ecological problems that face the UK and the world today. In particular they focus on the role of banks in creating the nation's money supply through the accounting process they use when they make loans - an aspect of banking which is poorly understood. Positive Money believe these fundamental flaws are at the root of - or a major contributor to - problems of poverty, excessive debt, growing inequality and environmental degradation. For more information, please visit: http://www.positivemoney.org/

Animation by Henry Edmonds

The question was phrased very generally - why don't academics understand money

and I have chosen actually to look at it from the standpoint of academic economists because I am one

and that's what I know and there are some interesting things I think to say about that.

And the rest of the academics would look to us for answers claiming that it was our area of expertise

and we ought to be able to enlighten them.

And it is a very strange fact of fate that I have been in this business long enough

for the kind of understanding that you've been exposed to today and through where money comes from and this new book,

to constitute a return to what I was taught as an undergraduate.

Dennis Robertson, Cambridge economist used to say, "highbrow opinion is like a hunted hare.

If you stand in the same place long enough it will come around again".

Well, it has come around again and so the shocking thing to me is the amount of energy

that people in Positive Money and NEF and places like that have to expend

to get a point of view across which was taught to me as an undergraduate and then forgotten.

So there has been a regression from the understanding you are presented with today

and which pertained in the late fifties and early sixties and now we are fighting to restore that understanding.

And that´s a very peculiar state of affairs and I hope,

just to give you a few ideas, no more than that, as to how it might have come about.

The question has to be treated in two parts, according to a very strange split

in the way that money is talked about in academic economics.

First of all, it has a role to play in what we call macroeconomics, and I think most of you have got a pretty good idea of what that is,

it is the theory of the economy as a whole, and the policies that you might use to change the economy in some way from time to time.

And then, quite separate from macroeconomics, there are always courses in money and banking,

the macroeconomics is sort of thought of as a core part of economics and money and banking are kind of an optional slightly frivolous thing

that some people spend a little time thinking about.

So, what I have to say will fall into those two parts. But they are, it turns out, connected.

In macroeconomics money in the mainstream of economics has a very limited sphere of influence.

And it doesn't connect at all well even with the kind of money and banking

which is taught as this frivolous option that I spoke of

Keynes, John Maynard Keynes, in his famous letter to George Bernard Shaw, said when he was writing the General Theory,

that he thought that what he was writing would revolutionise the way the world thought about economic problems.

And later on, in a small article, he spelt out what was different

about the kind of economics he was creating, from what had gone before. He said,

"I want to talk about a money production economy, and the kind of economics that we have been doing, is about a real exchange economy."

That was his basic contrast, that was what he thought would be his big revolution.

His was a theory in which money permeated the entire economy.

Labour bargains for money wages, saving and investment were analysed by him in money terms, the rate of interest

was a monetary phenomenon, and it was determined by exchanges of money assets.

All these aspects are missing from today's mainstream economics as they were,

from the economics which surrounded Keynes when he was writing.

We have gone back in mainstream economics, to talking about a real exchange economy

which has an extremely limited role for money.

Classical economics, or pre-Keynesian economics, models everything in real terms. It's real wages,

that is to say, the amount of goods wages can buy, and so on down the line.

And money is only brought in at the very last minute to determine prices. So the role of money is separate

from this whole analysis of the real economy, has this little role to play, in determining the price level.

The term "pure economics" as used by Alfred Marshall and Walras,

meant the economics of this real economy, this barter economy.

So by implication, money is profoundly impure I suppose.

And the idea was that money was neutral. It didn't really affect these real relationships.

All it did was determine prices,

and prices could be anything; didn't really matter. The real relationships were set up by the system elsewhere,

without money, the pure economy, the barter economy, the exchange economy.

And this kind of system, dividing the economy between the real and the monetary, was known as the classical dichotomy,

and on the monetary side, you had the Quantity Theory of Money;

the quantity of money determined prices, full stop, end of story.

Not very interesting actually, for a role for money.

Now, Keynes showed that the Quantity Theory of Money was based on

enormously restrictive assumptions, which were very unlikely to pertain in practice.

But Milton Friedman, whose name I am sure you know too, was able to use the Quantity Theory of Money,

as the foundation of his monetarist revolution in the late sixties, early seventies.

And, as I am sure you know, the monetarist revolution touched the heart of Margaret Thatcher, and found its way into monetary policy.

Monetarism, you may not know, but you ought to, is also the basis of the construction of the Euro.

Can't have been very good then, can it? [laughter from audience]

And determines the way that the ECB is doomed to function,

and is responsible for inflation-targeting more generally in the Western world

and it could be said, to be the foundation also of Quantitative Easing, though that interpretation is open to some dispute.

So monetarism, and the Quantity Theory of Money and the classical dichotomy

are all over Western economies like a kind of skin disease, quite extraordinary.

And the Keynesian story, in which money influences everything that happens, has been forgotten,

which is I think, a tragedy.

Now, this simple, sequestered role of money, in an analysis which uses the classical dichotomy,

gives rise to some wonderful supporting rhetoric. After all it must be more interesting to study the real economy

than the monetary economy, the real economy as the pure economy.

Money is imagined to be only a veil thinly drawn across the real economy, and not affecting anything.

And anybody who thinks that it does affect anything is subject to money illusion, which is a terrible mental illness. [laughter from audience]

Now how does this happen? What is the appeal of this way of analysing the economy, when we know actually,

if we keep our common sense about us, that money does affect everything?

Well, one reason as pertains to academic economics and not to common sense people like yourselves,

is that economics does not really understand its discipline to be historically-situated. It thinks of itself as covering universal truths,

and it, therefore, fails to recognise the institutional basis of its theories.

The Quantity Theory of Money was devised in the days of circulating gold coin,

not in the days when banks were overwhelmingly the suppliers of money.

And yet, the Quantity Theory of Money has been carried forward, and as I told you, has influenced major institutions to this day.

The idea that money should have something to do with the determination of prices has a certain intuitive appeal,

and of course it does have something to do with the determination of prices,

but the Quantity Theory of Money says that its only function is to determine prices,

and prices are determined solely by the quantity of money, and that is going far too far.

Another possibility of explaining how macroeconomics has come to this pass is sheer laziness.

Hayek, an unlikely source for what I am going to read to you, put it like this,

"The task of monetary theory is much wider than is commonly assumed.

Its task is nothing less than to cover a second time the whole field which is treated by pure theory"

- pure theory, real theory - "under the assumption of barter, and to investigate what changes in the conclusions of pure theory are made necessary".

So if you want to take money seriously, you have to do the whole thing again.

I think Keynes did do the whole thing again, and he's been wiped off the face of mainstream economics.

He's not taught, nobody knows what he said, nobody reads his book.

We have regressed to pre-Keynesian economics.

Now, let me return to this separation between macroeconomics and money and banking that's enshrined in the academic curriculum.

As I said, when I was a student in the late fifties and the early sixties, it was widely understood, absolutely taken for granted,

that the causality went from loans to deposits. Loans create deposits.

Now, students are all taught that banks lend on deposits, that deposits create the ability to lend, and banks respond to that.

This is a regression, which people like Ben are trying to redress, or reverse.

And again I try to think of reasons why this idea of deposits pre-existing and determining the volume of loans, has such a tremendous appeal,

and why the idea that loans create deposits is so difficult for people to grasp.

One factor is that there is a great fault in the language that we use,

or a great bias in the language that we use in relation to banking.

The word "deposit" is a hangover from the days of the goldsmiths, who took bags of gold for safekeeping,

and you will find if you look closely, that much of the neo-classical theory of banking, still regards these as kinds of glorified safes,

which they clearly are not.

Add to this the failure to understand banks as a system, as an interrelated system.

You heard much in the breaking of the crisis about a lack of systemic understanding; of risks that the banks were running.

If one did think systemically, one would realise easily, that the cheque you deposit in your bank, came from somebody else's deposit.

It's not new money at all. It's just moving around.

And then if you think systemically or macroeconomically about banks, there are very few sources of new money to the system,

except when banks are all expanding their balance sheets together, and that's what you've seen in the graphs,

those such powerful graphs, that have been shown to you.

So the language is bad. And we also speak of banks "lending money".

Banks do not lend money. It may feel like that when you get a loan, but that's not what they are doing.

They don't have a pot of money which they are passing on. What they are doing is accepting your IOU,

and agreeing to pay your outgoings while you don't have any money in your own account;

in an overdraft system. In a loan system they simply write-up your account.

Now, we've spent the whole morning talking about that, and you know that, but this leads us to another point which is very powerful,

which illustrates that it's in the bankers' interest not to let you know what they are doing because you really wouldn't like it.

They have too much power.

And others, including academic economists, might not like the power of bankers to be recognised either,

they know that if they expose the bankers they will be in deep trouble and their funding will be cut and all kinds of terrible things will happen to them

so they go along with it. You've all seen, "Inside Job", I take it. It's a kind of "inside job" problem.

Furthermore, there's a long history of wanting to believe that money is something real.

The idea that bankers can manufacture money with the flick of a pen is just too unpalatable.

And that leads to rejecting it. The idea that it should depend for its moneyness only on the fact that we all accept it is just too freaky for words.

So it doesn't come into the textbooks.

It would also make it very clear that money is very fragile. Once that trust is breached, the whole thing could collapse.

But then, finally, there is a connection between that macroeconomic separation of money from the rest of the economy,

and the difficulty of making people understand that banks create money out of nothing,

and that loans are the engine of the creation of money.

A deep-seated and longstanding idea in macroeconomics is that saving is necessary before you can have investment.

Read the reports of the World Bank and they all talk about insufficient saving for development.

It's absolute nonsense, if the banks can create money.

And it was the ability of banks to create money out of nothing, that led Keynes to say, "No, saving is not the engine of growth in the economy, investment is.

Investment comes before saving. And it's the banks that permit that to happen."

So that brings me full circle to tie those two strands together, they are related, and if macroeconomics is going to regress to a pre-Keynesian form,

so also did the understanding of banking have to regress, and that is what has happened, and what our brave heroes are trying to reverse.

Thank you. [applause]