Why It's A Big Problem That Economists Still Don't Understand Money

the financial crisis. Well that was, like, that's the same month, yeah, that or maybe October two tho eight I started Business Insider, and we really I always thought it was like the best time in terms of career timing wise, because there was just so much to cover in those days. Absolutely, and the best part was because everything that was happening was so unusual and so new. You were sort of on an even footing with people who have been covering

it for years and years and years. Everyone was trying to figure out what was going on at exactly the same time. Yeah, I my thoughts exactly. And then I think the subsequent years, the last decade or so has

also been incredibly interesting. I mean, obviously the news has slowed down a bit, but I think one of the I guess positive aspects of the post crisis era has been this major rethinking about all kinds of conventional wisdom, all of the standard dogma about economics and which direction should policy go and what framework should best be used. They're really coming under even still today, pretty intense, uh

scrutiny and just sort of rethinking of everything. I mean, I'm not sure I would call it a positive development because all these questions of economic orthodoxy are sort of coming up because people think that economic orthodox ey hasn't actually worked, and we still have sluggish economic growth, and we still have lots of problems in the international financial systems, so people are really trying to figure out what has gone wrong. But from a financial media perspective, yes, yes,

it's been very interesting. Yeah, I think that's a good distinction. It's not good that the post crisis economies, especially in developed in the developed world, have been so mediocre, sluggish, mediocre wage growth, etcetera. But from our seats, from our vantage points, it's certainly been been a time of sort of a great opening up of the possibilities and lots

of chances to explore different ideas. Yeah, and it's not you know, it's an unusual time when you see headlines like the failure of central banks, and we see those all the time, Right, that's sort of almost a given at this point in time, with everyone talking about fiscal stimulus,

exactly right. So today I'm very excited about our guest because he's probably one of the best positioned people to talk about the history of economic ideas, rethinking economic dogma, anticipating where policy will go, and UH, during a period of such a profound change. We're going to be speaking to Robert Skidelski. He's a member of the House of Lords, but he's mostly known for having been the most famous

and authoritative biographer of John Maynard Keynes. He's written extensively about Canes and his work, and he is the author of a fairly new book. It's called Money and Government, a Challenge to Mainstream Economics, and it's about this. It's about the history of the ideas that led us up to the global financial crisis, and it's a discussion of where things are going to go next. So sort of

the perfect guest for this moment. UH, Robert Skidelski, thank you very much for joining us, and thank you for asking so let's start with our intro. When you look at the post crisis era and you see all these different debates going on about the new frameworks and new ideologies and new approaches, are you heartened by it? I mean, I mentioned as a positive. It's not positive that we've had such sluggish growth and that the old dogmas have failed.

But do you feel excited by the possibilities that this is created in terms of new directions and economic thinking. Well, we're in an interesting transition stage, n Tree. I mean, I always recall that that that old adage the old world is dying and the new world is powerless to be born. I mean the old world of economic policy I think suffered some pretty devastating blows both in two thousand and eight, and really area of policy to lift economy is back to anything like vigorous growth, since that

is most economy economies. There's a dissatisfaction with the orthodoxy. Um, there's political discontent with the orthodoxy, and that is shown right through the political systems of the world. But there's no agreed consensus on where to go from here everything all you know, lots of ideas are being put forward. There's a lot of turmoil, then new developments and economics

which try to address some of the problems. The political theorists, social scientists, anthropologists, they're all feeling they've got something to say, but there's no no unified doctrine of economics to carry us forward. So just to set the scene a little bit, what is it do you that you think economists actually got wrong about the two financial crisis, because I think that will inform some of your thinking about where we

might go from here. Well, I think the thing they got mainly wrong was their their view of financial markets as efficient mechanisms for the allocation capital. I think the orthodox view was that you know, with with a minimum minimum regulation, financial markets would be efficient and therefore you couldn't get crises like like the crisis that happened. There was also the view that derivative markets and that whole process would spread risk so individual institutions would be less

likely to fail. As I said that that really came out of the Chicago's School Eugene Farmer, and the view that financial markets are efficient. I mean that was a subset of the view that all markets are efficient provided governments kept out in other words, of markets, and that markets were properly competitive, and you couldn't do better. And then one further requirement. Provided that money was controlled, there

was very little that could go wrong. Of course, there could be shocks which were unanticipated and couldn't be anticipated, and that's always possible, but leaving the shocks aside, things would run pretty smoothly and there would be some sort of optimization going on right through the economic system. And so I think that was the core mistake. Because markets aren't efficient. Um, They're always going to have frictions and severe mis dysfunctions, and it's the task of governments to

correct them. And if governments give up that function, then things are quite likely to go wrong. The title of your book, Money in Government, is really interesting, and you actually very early on in your book you go into detail about theories of money, what money is, where money came from, Why is this important? Why is the sort of I mean, both Tracy and I are interested in this.

We've had several episodes about questions of the nature of money, but you obviously put a very front and center in laying out your book this concept of what is money, Why was that, Why why did you do that? And why what what do economists in your view, get wrong there. Well, you see, I think money has a double function and always has and that's sort of accepted, but only one of the functions has been stressed. I mean, on the one hand, money is what you need to buy things.

If you don't have any money, you know, you can't get the things you need. But it also has a different function, which is what economists call a store of value, that is as a hedge against uncertainty. And when the money you earned is being stored, it's not being spent. So when uncertainty increases, people spend less, and so businessmen

sell less, the market shrinks, you get depressions. So I think what happens is that once you have a shock, or even if people don't think that the future is going to be too bright and start in st starting in investing and spending in the expectation that tomorrow will be better than today. Um, they think tomorrow might well be worse than today, and so they start storing what wealth they have. And money is is a prime way of storing wealth, and so it's always had that function.

That's why you need to look to money always to understand why things go wrong and why here is uncertainty are so bad. Um for for economic life, money is the key. If you didn't have uncertainty, money would only have one function, which is to exchange goods with each other. So what you describe there, obviously, and you know I mentioned at the beginning that you're, among other things, very well known for your biographical work of John Maynard Keynes.

It shouldn't be a new idea. I mean, what you just said there is something that you know, many people or that Canes wrote about nearly a hundred years ago. But what is it about his writing and what is it about that conception of money that even as recently as well right now, somehow economists are still missing because it sounds pretty intuitive store of value, everyone saves, spending goes down. How is this something that economists still aren't

truly internalizing in their understanding of the world. Well, I think you know, you have to dig into the bedrock of economic theory. I mean, if you look at a textbook, and this is the way I think economics has been taught and conceived from very early days. You have a theory of what you might call a real economy, in which goods have produced and exchange for other goods and

money isn't there. Money gets introduced as a sort of disturbing influence quite late at chapter six or chapter seven, and then and and so the all the old courses in economics were theories of value and theories of money, and the two things are kept separate. And one of the things cass did, which was crucially important, he says, you've got to bring in money on the ground floor, because money has an influence of its own. It's not just something that has an influence when other things go wrong.

Money is always a factor. It's always a possibility. People always have a possibility of retreating to money. And the world is uncertain. I think Caine's thought of uncertainty is much more prevalent than orthodox economists did, and especially economists in more recent times, they've always thought of the future as being in some sense calculable. You know. You you you find that people in economists and even financial journalists,

they rarely talk about uncertainty. They talk about risk and you know, this thing risks this or this policy risks something, as though you could calculate it. But in many cases you can't calculate what the risk is. You haven't got a number for it, and I think one of the things Cain said was, well, we pretend we have probabilities of of things happening um and and our institutions are

based on that pretense. But when the belief in those probabilities break down, then you know that the whole of the whole of people's thinking, then simply they panic because they no longer have an anchor. Economics is responsible for

misleading people about the cultulability of future events. I think it's it's a huge it's an absolutely huge weakness in the way economics is done because in some situations there is no uncertainty, there's all very little uncertainty, but in others, in the in terms of the macroeconomic economy, the uncertainty is a huge I mean, just look at what people

are trying. They're they're looking into the entrails of the future and trying to work out where China is going to go up, the political repercussions of Russia and the Ukrainia, will the disturbances in Hong Kong affect people's views of growth in East Asia and the stability of China. And then in Europe, what's going to be the effect of

Brexit and will populists gain ground? What about Trump the sort of you know, errant or wandering cause in all this, and then they still have models in which you have rational expectations, in which people know what the probability of all these possibilities is. And that seems to be just

the wrong mindset. And of course it minimizes the role of government, because if you agents and markets have enough information to act rationally and on the whole win their bets on the future, then government doesn't really need to play a very big part. It should get out of the way as much as possible. It should make sure that there's no fraud, no corruption, that markets remain competitive. It should do a bit of welfare, have a safety net. But beyond that, there's no obvious case made out for

government to intervene in these benign processes. So, in the theory of the real economy, sort of classical economics, goods are exchanged for goods, everyone acts rationally, and the market comes to an equilibrium without the need for government interference. But the Kanes argument or your argument, is that money changes that equation because it can act as a store of value and basically allow people to store up their

spending because of uncertainty. So I'm curious if you were to factor in the fact that money was impacting the economy itself, how different would developed market economies actually look and what role would the government have in such an economy. Yeah, that's just that the one thing you mentioned attains in his view of equilibrium. You can think of what's happened. What happens when when people stopped to be more uncertain

about things, is that they increase their precautionary saving. That's why you don't get a bounce back to a position of optimal equilibrium. What happens is that you do get an equilibrium, but it's an inferory equilibrium. And I think Kane's introduced to two economics, the notion of multiple equilibriate and you can easily get stuck in an inferior equilibrium. And I think roughly speaking, we have been um over much of the world since two thousand and eight, and

there's no obvious way back to an optimal equilibrium. And that's why I think he would argue governments have two functions. One is to prevent the collapses in the in the first instance UM, and the second is to use macroeconomic policy um very vigorously to offset the increase in precautionary saving. I in other words, the government governments have to desave and under the situations, and and of course monetary policy

also comes into the picture. What I would say is that Kyne's thought that fiscal policy was more powerful both in prevention and in cure the monetary policy. Going to this sort of pre crisis period, a lot of the sort of dominant economic ideology, a lot of them it

would have been. I think the term that people uses New Caynsian and New Caynesian School of economics or New Caynsian models, and my impression of it is that I think it's a it's an attempt to extract some insights from Canes, such as perhaps the need for fiscal stimulus from time to time, but to ultimately shoehorned back into the classical school of economic thinking, in which everything is calculable and everything sort of restores itself to equilibrium in

the ideal state. What do this sort of New Caynesian school anomists misunderstand about the economist from whom they draw their name. Well, you see, it's a good question that I think they bought the rational expectations model, but they added frictions of one kind or another. And with frictions you get some policy space because things don't sort of just optimally very quickly. If they don't adjust quickly, then they may adjust to a different equilibrium, so to speak.

In the end, sure the economies will resume their equilibrium of growth path, but a lot of damage can be done in the interval, and it's not clear that you'll really resume at the place you want to, and and

so that creates a policy space. So I think Mucinsians would, let's say, in working out their fiscal rules and monetary rules, they would they would always allow for some central bank and and physical intervention, especially central bank intervention to steady the cycle, and and and so you know, I think that's what happened. That's what orthodox central banking policy was about.

It allowed space for smoothing, cyclical smoothing. Would you, I feel very purist rational expectations person, you don't need But that was because of sluggishness of response. I don't think

they should have called themselves Kansian. I mean, I don't think that had anything to do with these actually, but they want to distinguish themselves from the hard line Chicago school, so they created a bit of extra policy space, but it proved much too weak, both to stop prevent the crash of two thousand and eight or to bring about recovery. So Joe and I alluded to this in our intro.

But nowadays, you know, it's fairly normal to see on a daily basis headlines such as, you know, the failure of central banks or um central banks face quantitative failure. The shock and awe era for central banks is over, and it does feel like there is more focus on fiscal stimulus, not least in Europe. Does it feel like we're moving in the right direction to you in the sense that we are moving to a more active role for governments or do you feel that we're doing this

without a cohesive economic theory actually behind that move? Yeah, well, I feel the second of it. We're doing it blindly. It was always it was always a delusion to believe that central banks could take the place of God months in the management of the matter economy, and there many reasons why they couldn't, but one of the obvious ones, as they lacked the legitimacy to do so, macro policy

is a responsibility of government. It can't be outsourced because monetary interventions by central bankers have political and social consequences. People have talked about those, the fact that quantitative easing and buying of assets, I mean the people who have been selling the assets that people have had the assets, and so in a way, you know, it's increased inequality. And now that's a political consequence of a policy for

which someone ought to be held accountable. But the central banks aren't held accountable because they're they're said to be neutral, politically neutral, but that was always a mistake. They may be individually central bankers may individually be politically politically neutral, but their policies do have political consequences, and so that's one reason why central bank role has to be diminished

in the macro economy. What they should do, and what they are set up to do, is to regulate the financial system, regulate the affairs of their member member banks, and that is a key role which they rather neglected before the crash because they thought that the financialism didn't need much regulation. So I think you have to rethink the role of central banks. But what we haven't done is to really properly we think the role of fiscal policy.

We're drifting back into into into fiscal policy in words like stimulus and things and words like that are being used. But when when to stimulate by, what means to stimulate? What rules fiscal policy should be subject to, Because we need rules, because rules are something that that improves certainty, that reduces uncertainty. So we need all those things. But we've forgotten, we've forgotten what physical policy is, and so that's where we have to think pretty hard. Yeah, I

wanted to connect this to what you were saying. You sort of anticipated my question when you said rules designed to prevent or reduce uncertainty. And again, and maybe it goes back to this sort of new Candian way of thinking. We talk about fiscal stimulus as though, okay, we can pretend to identify some output gap and if we spend this amount of money and then it multiplies the net or turn us to full potential, as if that's a noble number, and then we get the economy back on course.

It sounds like what you're saying, and it sounds like in terms of this sort of Canzian idea of the sort of incalculable uncertainties. That it's not about replacing a certain quantity of money per se or getting us to some full idea of employment, but that the presence of government as an actor in the economy that can come in with force, they can reduce uncertainty. It's not about

the amount of dollars. It's that there is this institution that doesn't have to be swayed by the whims of animal spirits, the ball and bear cycle, and can just present be a be a stabilizing force. Yeah, I think I agree with that. The difficulty is that they may not be swayed by the business type animal spirits, but

they're certainly swayed by politics. And that was really what brought the old old Kanes in constitution if you like, crashing down the fact is that, you know, and lead to Milton Friedman's critique that politicians, they vote, vote hungry, and they'll make promises for spending irrespective of the real needs of the cycle at a particular time. And you've seen that going on today. I fiscal policies coming back,

but not in the way I would approve. I mean, look at look at what's happening in the British general election. Both parties making huge spending promises, not not by any means of the Conservatives saying we were wrong about austerity, we should have done it differently, but just to win votes. So they compete in the in the number of billions they're promising to spend. Now that is going to discredit

fiscal policy again. So what what my idea is is that fiscal policy should be made as automatic as possible. And you have a very valuable concept in the idea of the automatic stabilizers. I think automatic stabilizers can be made more powerful. I mean automatic fiscal stabilizers more powerful, so you wouldn't really be driven back to calculating output

gaps and multipliers, all of which are pretty uncertain. But you would do say something like, well, look, we have a public sector job guarantee, and we have and and and this acts as a buffer stock for labor in the economy, and it increases that not that you know that the stock swells when the economy turns down, and it automatically diminishes when the economy recovers. I mean, we have automatic stabilizers at the moment, they're quite weak, and

I'd like to strengthen them. I don't think I can explain all this in one minute, but I think that's the way we ought to be going. The other way I think we ought to be going is I think we ought to revive the idea of public investment. State investment was a huge stabilizing force in the sixties and seventies, but is shrunk as a percentage of total investment because people now have the idea that all state investment is bound to turn sides, you know, does not not going

to pay for itself. Well, I think you need to actually work out what what things are investment, what will pay for themselves, what will benefit the economy, and what you ought to cover just from revenue. Those are things

that are still in the melting pub. So you mentioned the general election in the UK, and I think when we talk about fiscal stimulus, part of the obstacle that governments will face is most of the population, certainly in the US, is distrustful of the way the government actually spends public money, even though, as you point out, there's a history of public investment actually being a stabilizing force and overall social good in you know, the fifties and sixties.

Why do you think we got to a place where lots and lots of people just think that there is no role for the government when it comes to this type of economic stabilization or this type of investment. Why are people so distrustful of the government when as as you very clearly lay out, there is potentially an economic role for them. Well, you know, I think Robert Schiller should put his finger on it. I mean, people believe narrative, and if a narrative gains hold, it shapes the way

they think about reality. The narrative that really got hold in the seventies and eighties was really the Freedman narrative that governments are just spent thris and that if you leave if you leave macro policy to them, they'll just inflate the economy in order to ease their construct their

spendings constraints. And I think that kind of narrative got hold that, you know, and it was combined with another narrative, which is that politicians are like just their utility maximizes, but what the utility they maximizes is their own private utilities. And that was in line with the general motivational structure of neoclassical economists. So they're always going to be corrupt. They're always going to think about their own interests and

not the public. Those two things coming together, uh, sort of have created a view of government which I think colors public debate. And yet in the United States there's always been actually a huge role of government. I mean, people don't understand that most of modern contemporary digital technology is a really all based that comes out of the US government military spending. And you know, government's had a

huge role all the way through. Yet that's that's become silent and ignore and instead you have these stupid things about governments of build roads that never lead anywhere, and you know, all that kind of stuff. I'm going to ask a question. It might be very controversial, and you should tell me if the if it's if it's an appropriator,

you don't want to answer it. But nonetheless, you know, you're talking about rethinking fiscal policy and UM, that it can't just be one of these things where when times are bad, suddenly politicians uh proposal laundry list, and that

we need more permanent role. And you mentioned a public jobs guarantee is one way of a source of permanent public stability, very strong UM countercyclical stabilizing measure, and one group of economists who talk about it, the public jobs guarantee these days of the U M M tars, the modern monetary theorists, and I've noticed in your book that you actually mentioned them fairly early on in your in

your argument they got a prominent place. Would if Canes were here, would he find a sort of a would they be kindred spirits to him of the various factions out there right now in your view? Or is that

going too far? Well? You see, I think that was a Cane's reaction to an early version of modern monetary there, which was his reaction to Aber Learner's paper of ninety two, I think, in which which was called functional theory of functional Finance, in which a Learner was basically using this argument that you don't use the tax system in order to get revenue, but to drain the economy of money, and you need to do that when you're in a

situation of inflation or incipient inflation. In other ways, what Leerner was saying is that government spend money because they've got banks that printed for them, and and it's a myth that they have to apply to the people for in order to spend rather, they're spending creates the taxes which they may have to then raise in order to stop inflation and pains. His reaction to that was to say, well, technically, yeah, that argument is correct, but it's simply not practical politics

to recommend it. I and I and I go along with that. And what I'd say, in addition to what Kane said, is that although it's a myth that governments have to apply to the people for taxes or get them issue debt, it's a necessary myth of our limited government, because otherwise, what's to stop the state just spending what it wants for whatever purposes it chooses to. In other ways, it's part of the part of the constitution of limited

government that this myth should be there. And so um, I would say, some myths are very useful if you want to avoid despotism, and one shouldn't really attack this myth just on technical grounds that in fact that's not what governments actually have to do. One should be aware of the political functions of this particular view of the relationship between government and its taxpayers and creditors. Yes, so that's the way I would I would deal with modern

monetary theory. But where it's been extremely useful is to point out another myth, which is that the government's government space a fiscal constraint whenever they unbalanced the budget. Now that I think has been the orthodoxy, and it's been one of the big arguments for balancing, that government should balance their books. And I think modern monetary theory has been foremost in pointing out that this is not the case. In that sense, It's been very useful. So I don't

think I think it is controversial. I doubt if modern monetary theory will become a dominant theory of fiscal finance in the next few years. In fact, you can do what you need to do on the fiscal front without having to use modern monetary theory. This was going to be my next question actually, So if you were to write an essay right now on what economic orthodoxy would actually look like in ten years time, what's your best guess. Is it a continuation of the existing system or going

back to more of a pure Canes model. What do you think it will look like? The economic consensus, Well, I don't think there's any linear path to better economics. In fact, I'm not sure that economics as it now exists will be with us in fifty years time at all. I mean, there'll be economists, but there will be attached different subjects. That's probably my view of how how it will go. But otherwise it all depends on what happens

in events. As one of our former prime ministers used to say, events there boy will decide how thought goes. And that's sort of entirely true, but I think there's a large element of truth in it. If we have new shocks um to the world economy, that will stimulate thought. I think otherwise the economics may not be in the center of the rethinking of how you deal with economies. You see that that's that's maybe a bit paradoxical, but we're much much more aware of the fragility of liberal

democratic societies. It's not not clear to me that economics gives any particular answer to that. And all economics should be able to say is we must not allow crashes like two thousand and eight to happen. We should not allow so much inequality to exist, We should not be prepared for such long periods of subnormal capacity utilization. And

what are the policies that can prevent those calamitism? And misfortunes, and so economics has to rethink the role of government, and it's not clear that economics is the best place to do that, which is why I'm not sure that the economics really deserves to be the queen of the social sciences as full family from Paul, and I know that's not answering your question properly, but I don't think

it's got a simple answer. No, that's great. I think it's a perfect answer, Robert, thank you for joining us. That was that was fantastic. Really enjoyed that. Well, I enjoyed. I enjoyed talking to Thank you so much by Tracy. I really liked his answer to your last question. Actually, I thought that was kind of the perfect place, which is that economists have some insight, but that maybe thinking about oh, economics is going to give us the answers to sort of what ails is now at a time

when so much is obviously on the political side. I thought it was very insightful. Yeah, it kind of reminded me of a couple earlier All Thoughts episodes that we've done, where we always pointed out how I don't want to

use the word primitive, but I guess how simple. Some of the models that economics is actually built on are like this notion of the equilibrium between two sets of goods and the market will always move to that point, and it doesn't actually take into account a the existence of money or be the sort of behavioral economics aspect of stuff where people don't always behave rationally. It's sort of it's it's weird and sometimes frightening to think that a lot of the way the world works is still

built on these outdated models. Yeah, and from what I understand, and he talks about this in his book, and I've heard a lot of people say it, it's like many economists not only don't know how banks work, but don't feel that that's particularly important. Again because banks are seeing as just sort of this extension of money, and of money is just this technology to sort of intermediate person a in person B or bank is just to intermediate

to people. Are two entities. You don't really need to know how they work, even though the financial crisis obviously showed that you can't really understand the modern world without understanding what banks do. The other thing I really liked about that discussion, and by the way, I knew an MMT question was coming up. It was only a matter

of time. But but one of the criticisms of m m T is that even if you say that the government, you know, isn't limited by a sort of household budget, it's only limited by inflation when it comes to spending, that doesn't overcome the problem of political will or a achieving a political consensus. And Lord Skidelski is quite clear on one way that maybe you could get to that point,

which is his idea of automatic stabilizers. So if you say, when X happens, why is going to come into effect, you sort of bypass the twoing and throwing of Congress or parliament or whatever when it comes to actually figuring out what to do. Yeah, I mean the question is, and I think it sort of sums it up is political leaders in developed markets tried to solve that problem with the creation of independent central banks and the hope that economic stabilization could be taken out of the hands

of politicians. But of course, as he points out, central banks have their own ay, they have a credibility problem because they're not really accountable to the public in the same way, so they're not really they're only in a very sort of indirect sentence, and leaning so much on

monetary policy has distributional consequences that aren't ideal. So, you know, no one really knows what the sort of post post crisis future looks like, but it sounds like, if we can sort of summarize it, it's how do you build a system that's robust? How do you build a system that's uh powerful economic stabilizers while maintaining some sort of democratic accountability to it? Big questions, big episode of odd blots. Yeah, no, no, easy answers. All right, this has been another episode of

the ad Thoughts Podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't Thal? You could follow me on Twitter at the Stalwart And you should definitely follow our guests on Twitter. Lord Robert Skidelski, he is at our Skidelski. Also be sure to check out his new book, It's Really Good. Be sure to follow our producer on Twitter, Laura Carlson.

She's at Laura M. Carlson, as well as this week's substitute producer to for Foreheads at Foreheads T and be sure to follow the Bloomberg Head of podcast Francesca Levi at Francesca Today, and all of Bloomberg's podcasts can be found under the handle at podcasts. Thanks for listening.