In a recent post Ezra Klein says that one of the problems with modern macro is that there is not enough historical evidence and experimenting occurring to validate certain views of the world. He says:
“The great challenge of macroeconomics is that it does not lend itself to experiments. The builders of early jet aircraft could develop prototypes and send test pilots up to test their results. But policymakers can’t very well take the same chances with their nations’ economies, because the consequences are much greater if they get it wrong. You can risk crashing a prototype jet airplane, but you can’t risk crashing an entire national economy.
As such, macroeconomists have to rely on natural experiments to understand how the economy really works, examining how different countries pursuing different policies at different times and in different circumstances get different results.”
I don’t agree with the gist of his post. I think the problem in modern macro is that it is driven largely by ideology and confirmation bias. A plane does not fly because of ideology or personal biases. It flies because we know, for a fact, that an object can generate enough thrust to overcome its weight resulting in lift. Obviously, it’s more complex than that, but it’s not something that’s theoretical or in need of experimentation. This common understanding of flight creates a basis for understanding within the engineering community. Engineers don’t debate so much why a plane files, but rather, the optimal way to fly.
In macroeconomics, we do the opposite. There is no firm set of agreed upon understandings. No one agrees how the plane flies. Instead, we mostly just debate the optimal way to fly. We’re basically just throwing sheets of metal into the sky without actually working from an agreed upon foundation for why that piece of metal may or may not fly. So we do some incredibly silly things. For instance, it’s preposterous that the money multiplier is taught in school. It’s preposterous that the concept of a currency issuing nation going bankrupt is still trotted out in economic debates. These should not even be topics of debate because anyone familiar with the operational realities of money knows they are void of value.
I created Monetary Realism because I recognized this flaw in macroeconomics. There’s too much politics and too much ideology muddying the debates. Modern macro needs a firm set of understandings from which to base future experiments. And yes, the experiments are fine so long as they’re based on a firm understanding of the actual monetary system and how it operates. But I fear that too many of our experiments over the years have been based on an ideology and political preference as opposed to a firm understanding. We shouldn’t apologize for that as Ezra Klein does. We should be enraged by it.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.