Michael Parkin and his former colleague at the University of Western Ontario, David Laidler, were the leading monetarist economists in Canada, and they were world renowned for their work. They are still ardent monetarists, Parkin somewhat more so than Laidler.
Parkin had a commentary in today’s Financial Post. I focus on his commentary for it highlights what is wrong with monetarism and its sibling, neoclassical economics.
The basic premise of monetarists is that the rate of inflation depends over time solely on the growth rate of the money supply. Neoclassical economics goes one step further and assumes that markets are inherently stable and adjust relatively quickly, in the absence of any new shocks, in particular those resulting from government policies. As Joe Stiglitz has argued, one would have thought that these simple ideas would have been found seriously lacking following the near-death experience of financial markets in 2008. But as Parkin’s commentary indicates, these views are once more on the ascendancy, as if nothing of any importance happened in 2008 and 2009, other than policy errors by governments.
I will highlight just a few of Parkin’s arguments. For example: “the limited direct effect that monetary policy appears to have on the course of real GDP, the output gap and the unemployment rate…Too vigorous a direct pursuit of output and employment objectives in the short term might end up spilling onto rising inflation as the real economy remains stubbornly unresponsive.”
In other words, interest rates and monetary policy have little impact on investment and consumer spending decisions. This also implies that Ben Bernanke and the US Federal Reserve have been wrong in trying to stimulate aggregate demand and the real economy in the US.
However, interest rates do have such impacts. And monetarist economists such as Parkin ignore the effects on confidence and the resulting feedback loop on spending decisions. Interest rates do affect the real economy, and their effect can be substantial because of the role and importance of confidence.
At a later point in his commentary, Parkin states: “If a rise in the interest rate leads to inflation falling below target, a swift reversal and cut in the interest rate will correct the problem.”
The problem is not just having the inflation rate falling below target. The more serious problem is unemployment rising sharply – check out the early 1980s. But monetarists never really consider unemployment to be as serious an issue as the rate of inflation, and they never do factor in the social, health and other economic consequences of high rates of unemployment. The very low rates of unemployment during Bill Clinton’s second term did more to reduce the incidence of poverty in the US than all anti-poverty programs.
Moreover, Parkin does not explain how the swift reversal will correct the problem. Most likely he believes that a change in monetary policy will immediately affect inflation expectations, and as a result the rate of inflation will adjust quickly to the changing expectations. In reality, the “correction” results from the effect lower interest rates have on the real economy and unemployment. But Parkin has already ruled this out.
Finally, Parkin argued: “There are two asymmetries that make inflation a worse risk than the risk of retarding output and employment growth. The first is the asymmetry of how far off course the inflation rate might go. Natural real forces limit the fall in output and employment while there is no natural upper limit to inflation.”
“Natural real forces” is just a euphemism for saying that markets are inherently stable and self-correcting – the neoclassical assumption.
Does Parkin really believe that in the absence of the fiscal stimulus and the dramatic actions of Ben Bernanke in 2008-09, the US economy would have recovered painlessly and quickly form the shock of the near collapse of financial markets?
From a purely theoretical, academic perspective, it is unfortunate that the US Government and Federal Reserve intervened in 2008. In the absence of such intervention, the US and most other economies would be mired today in a depression with unemployment rates in the 20% plus range, and the arguments espoused by Parkin and many others likely would have been buried once and for all.
Fortunately, from a humanitarian perspective, there was intervention on a large and unprecedented scale. One can only imagine the social turmoil world-wide if the US Government and Federal Reserve had listened to the likes of Michael Parkin and other staunch monetary and neoclassical economists? The “Arab spring” would have looked like a stroll through a park.
The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.