Book review: A new take on macroeconomics

Professor Robert Skidelsky’s 2019 book, “Money and Government: the Past and Future of Economics” (Penguin), is both radical and conservative. It is radical in that it runs against the grain of the economic orthodoxy of the last several decades. It is conservative in that it endeavors to restore economics to the older tradition of “political economy” (in the true sense of that much-abused term) and the fundamental insights of thinkers “whose greatness, for all their differences, lay in the fact that they were more than economists.” This might sound radical too, but Skidelsky’s list of such thinkers is comprised exclusively of household names like Smith, Mill, Hayek and Keynes.

 width=Although it is written in Skidelsky’s accessible style, this complex book will not command a mass audience—even though its messages deserve it. Like many good books, its strength is less in its novelty, then in its powerful re-framing of existing ideas into a persuasive argument.

The book’s title is apt: Skidelsky wants to restore the importance of money and government to our understanding of the economy. In his view, these concepts were the great casualties of the monetarist (and supply-side) revolution, extending from the 1970s until the 2008 crash (and, in many circles, until today). In simplistic terms, monetarism is the idea, most closely associated with the economist Milton Friedman, that control of the money supply is the main tool by which the government should manage the economy.

It is easy enough to grasp the need to revitalize the argument for the role of government. The pre-crash era saw states fail to tame stagflation, government become “the problem” and markets unleashed from regulation on a scale without parallel since before World War I. Clearly, government is in need of some rehabilitation in economic theory.

Demand more from government

But money? The need to rehabilitate the role of money might not seem immediately obvious. How could the role of money have been underplayed in a theory known as “monetarism,” which has as its central conceit the belief that mismanagement of the money supply is the main driver of inflation and economic dislocation?

Skidelsky’s argument is that monetarism’s narrow focus on money negates its independent role as a store of value.  What monetarism ignores is the central Keynesian insight that money is a hedge against uncertainty, and that under pervasive uncertainty, money will be saved rather than invested, weakening the economy and leading to under-employment.  The key here is to understand where money comes from.  Governments do not create money, argues Skidelsky. Rather, banks do through the production of credit. And what drives credit is demand.

So, the right model of the economy is one that emphasizes the demand for money, rather than its supply.  Monetarism focuses on the wrong side of the equation. “Supply-side” economics suffers from a similar problem: an over-emphasis on the supply of inputs, including labor and commodities, that drive the economy, without due attention to the demand for goods and services. This does not mean ignoring the supply side, of course; supply constraints also matter.

If demand and spending are the central problems—as perceived by Keynes when analyzing the Great Depression—then monetary policy, which focuses on the supply of funds, cannot solve them. We have to understand why demand is weak. And demand is weak in the current era, argues Skidelsky (to brutally shorten a long argument), because of inequality and the debilitation of the state.

Richer people control more and more of global wealth, but they do not spend this wealth in ways that generate broad demand. This was papered over in the lead-up to the crash: Poorer people depended on the rise of credit to cushion stagnant wages, but debt is ultimately unsustainable without wage growth or redistribution of wealth.

If people cannot or will not spend their money, then the state must step in. It can do this through deficit financing or a balanced budget, in which taxes are increased to offset higher spending. What matters is to push the economy to use available resources rather than allowing them to lie idle. Under conditions of uncertainty, the unique role of the state is to support demand, not to focus on the money supply.

Toward a new macroeconomics

Unsurprisingly, Skidelsky rejects fiscal austerity. He also favors more state investment, partly through a self-financing public investment bank. Most radically, he rejects central bank autonomy to set interest rates, which he believes should emerge from a political bargain that balances the goals of maximizing output and managing inflation.

Other aspects of Skidelsky’s macroeconomics are relatively uncontroversial: For example, he says governments should adopt a counter-cyclical fiscal policy. In other words, they should maintain a balanced budget for recurrent expenditures, while using debt to finance capital investment at a rate roughly equivalent to growth in output. Debt levels matter less than whether the ratio of debt-to-GDP remains more or less constant. This policy is in line with current thinking that stable debt-to-GDP ratios create the perceived fiscal space to respond to fiscal crises.

An open question is whether these macroeconomic prescriptions are applicable to emerging markets.  Given that mismanagement of state corporations is rife in many emerging markets, the advice to take more spending off-budget to independent public investment banks needs careful consideration, as does the idea that monetary policy should be further politicized. Emerging markets with weak currencies and tighter constraints on access to financing are not able to be as cavalier as rich countries about deficits and debt.

Nevertheless, a macroeconomic philosophy that emphasizes building and sustaining demand through equitable fiscal policies is relevant everywhere. Skidelsky’s economic history is as good a guide as one could hope for when trying to understand what we know, and don’t, about macroeconomics a decade after the financial crisis.

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