Saturday, December 29, 2012

The Role of Money in Mainstream Macro

"In practice, of course, the purists were unable to deliver, and the new tricks involve the 'modern macroeconomists' in ad hoc assumptions of their own that are at least as objectionable as the Keynesian macroeconomic generalizations that [Michael] Wickens objected to. We have already encountered one example, the 'Gorman preferences' needed to make the representative agent at least minimally plausible... Two others are equally incredible. The first is the 'no-bankruptcies' assumption in Walrasian models and the related 'No Ponzi' conditon that is imposed on D[ynamic] S[tochastic] G[eneral] E[quilibrium] models. This eliminates the possibility of default, and hence the fear of default (since these are agents with rational expectations, who know the correct model, and hence know that there is no possibility of default), and hence the need for money, since if your promise to pay is 'as good as gold', it would be pointless for me to demand gold (or any other form of money) from you. Money would be at most a unit of account, but never a store of value. The second is the unobtrusive postulate of 'complete financial markets', smuggled into Michael Woodford's Interest and Prices(Woodford 2003, p. 64), which means that all possible future states of the world are known, probabilistically, and can be insured against: this eliminates uncertainty, and hence the need for finance..." -- J. E. King, The Microfoundations Delusion: Metaphor and Dogma in the History of Macroeconomics (2012: p. 228)

This quote is the lead in a recent post by Robert Vienneau putting forth the question, “Can General Equilibrium Theory find a role for money?” During my first semester in a PhD Economics program, application of the ‘No Ponzi’ condition appeared almost universal in macroeconomic models. At points I tried to raise the question of how removing this condition would impact results from the various models. Although a sufficient answer, at least for me, was not forthcoming, it appeared as though that condition was necessary to ensure a general equilibrium existed.

As for the inclusion of ‘complete financial markets’, I am not yet familiar with Woodford’s book, mentioned above. Having worked in financial markets for a few years, the notion of probabilistic uncertainty is not only false but completely misses an important aspect of investing. The purpose of holding various levels of cash over time is specifically because future states and their probabilities are unknown.

On the whole, general equilibrium models appear to remain consistent with the classical view of commodity trade, C-M-C' (a commodity is sold for money, which buys another, different commodity with an equal or higher value). Meanwhile two other views, put forth to account for a financial sector by Marx, have been largely ignored:

1) M-C-M' (money is used to buy a commodity which is resold to obtain a larger sum of money)
2) M-M' (a sum of money is lent out at interest to obtain more money, or, one currency or financial claim is traded for another. "Money begets money.")
Based on my initial exposure to advanced macroeconomics, it appears true that “money would be at most a unit of account, but never a store of value.”

1 comment:

  1. Thanks for this interesting article. Frankly speaking, I don’t know much about macro economics but I like to get to know about different theories and possible variants of the future development. Really, there are few strong financial models which people use for centuries but our future is so unpredictable so technologies can break even such strong things. However, I think that M-C-M and MM models will continue their existence. People will always borrow money and use personal loan with bad score to make more money and invest their funds for profit.