Now is The Winter of Our Discontent. New Zealand's Alternatives to Negative Interest Rate Policy

In this earlier piece I outlined how the economic crisis which is starting to hit New Zealand is being viewed by decision makers (the Reserve Bank, the Government, probably Treasury), why they're taking the action they are (introducing NIRP, a negative interest rate policy), and why this is absolutely the wrong solution. Economist Prof. Steve Keen shows why NIRP will lead to (and has done in other countries) higher interest rates for existing debtors (e.g. mortgage holders) and explains why he thinks it is "the stupidest economic policy dreamt up in the past 100 years" here.

Now I examine where the fundamental problem lies and where possible alternatives can come from, which I doubt are on the radar of these decision makers. Perhaps they should be.

Nix the Neoclassicals

The first thing we need to do is get out from under the thrall of the 'neoclassicals'; economists and other professionals who received training in neoclassical economics, who only view the world through a neoclassical lens {1}.

Neoclassical economists or those trained in these black arts now occupy most senior roles in University economics departments, business management, banking (including Central Banks), the public sector (e.g. Treasury), the media (economics writers), politics, and are advisers to governments; that is, the institutions that control society. We now see the results of this in their response to New Zealand’s pending economic crisis, NIRP, the most extreme application of monetarism and interest rate manipulation possible. It’s just a big, dangerous, experiment.

The best possible outcome of this experiment would be a doubling down on the problem that is already the biggest systemic risk to New Zealand’s economy. Private debt. That is debt owed by business and households. As Keen shows here our private debt is currently at about 180% of GDP, over six times the levels we had in the 1960s. As he says:

It’s mainly household debt ... used to drive up house prices and make people think they’re prosperous ... that is the unconscionable debt we should never have allowed to happen in the first place ... it rose from 30% [of GDP] in 1990 to virtually 100% today, and that is all money which has inflated house prices. It’s done nothing productive for the economy. It’s been irresponsible lending by the banks and it has to end.

A worse outcome, but more likely given global conditions, is an increased private debt for some (those who want and can obtain new debt), while never achieving NIRP’s architects’ goal of growth. And leaving existing debtors with increased interest rates while simultaneously discouraging savings. Even worse is the potential for NIRP to cause deflation, because every extra dollar used to repay new-debt is a dollar not available for the consumption they are hoping to stimulate with NIRP. Neoclassical’s can’t see this.

Much of what will happen is out of the hands of New Zealand policy makers because we have always been at the mercy of global-trade storms. But they could at least start looking for solutions that won’t make things worse.

So where do we go for solutions?

A good place to start would be to get macro- and micro-economic models that are fit for purpose. There is a large and extensive critique of neoclassical economics. Steve Keen’s Debunking Economics (1st ed. 2001; 2nd ed. 2011) is one of the better known; it’s a comprehensive and devastating analysis of neoclassical economics, the many invalid assumptions needed to make it ‘work’, and the models they employ. It includes an over 400 entry bibliography for those who like to check primary sources.

For me, Keen’s most damning and succinct criticism of neoclassical economics is:

Virtually every concept that is taught as gospel in the text books has been proved to be unsound in the original literature. {2}

Neoclassical economics mathematics is in a poor state. Though is looks sophisticated, and entire fat postgraduate textbooks have been written in neoclassical mathematics, almost all of it is irrelevant. {3} If what Keen says is true {4}, and I accept his arguments, this is a shocking statement. I give one example below which shows that a upward sloping supply curve cannot exist! Goodbye one side of the supply/demand curves.{5} Keen also shows the demand curve doesn’t exist either, which is to say that one of the fundamental relationships underpinning neoclassical microecomic theory is not real.

Ultimately what it means is we must turn away from just about every economist trained in the west from about 1985 until today. There may be some non-orthodox economists in Universities, Central Banks and the other institutions and we need to seek them out if they exist, though for 30 years it’s been a hard time getting promotion for openly critical non-orthodox economists, so there won’t be many in senior positions; senior roles today are filled with people trained at the height of the neoclassical / neoliberal mania. Alternative thinkers will be like priests hiding in mid-17th Century priest-holes; dug deep and keeping out of sight.

Keen’s critique raised a firestorm of protest at the time from neoclassical economists, including a public debate between Nobel Prize winning economist and New York Times columnist Paul Krugman and Keen (who will never get a Nobel Prize – I doubt he wants one; dubious company) which is worth a read. Just search for 'Keen Krugman debate'. Krugman and co. gave the distinct impression of barely hanging on with their fingernails, especially as they had to defend against the complete failure of all their models to predict the 2007/8 housing collapse and subsequent Global Financial Crisis (GFC). Keen had published before the GFC warning of an impending crisis, had explained the failure mechanism, and explained why neoclassical economists would never foresee this type of event; because there are so many flaws in their models and the assumptions used to build them.

Keen expands on his critique, in part as a response to the Krugman et. al. debate, in the second edition of Debunking Economics (2011). To my mind Keen came out ahead, both in the debate and by the success of his model. I’m not an economist, but with an engineering mathematics background I was able to follow the debate because Keen explains so much using mathematics and first principles, supplemented with detailed but accessible discussion. This is the beauty of Debunking. Keen has opened the mysteries of economics - or more accurately exposed the house-of-straw construction of neoclassical economics - to people who have some knowledge of advanced calculus, and he’s supplemented this with easily navigable text.

Ultimately we need to turn to the so-called unorthodox economists; the following are some alternatives I’ve been looking at:

Prof. Steve Keen - economist (predicted the 2008 Global Financial Crisis)

Prof. Michael Hudson - economist (University of Missouri)

Prof. James Galbraith – economist (University of Texas)

Dr. Ann Pettifor - economist (predicted the 2008 GFC)

Prof. Richard Woolf - economist (beware: Marxist economist!)

Dr. Yanis Varoufakis - economist, politician (beware: Socialist!)

Prof. Stephanie Kelton - economist (beware: champion of MMT!)

There are others. 

We need to look at what these people can offer in a detailed and nuanced way, not the sound-bite criticism we get in the media. Kelton, for example, has been heavily criticised for her championing of Modern Monetary Theory (MMT). From my reading, MMT is not arguing for unlimited money printing (unlike how nearly all critics say), but how that money is distributed (see Kelton here and here for example, and here for more); what is clear is Kelton and other MMT advocates do not believe that governments should just print money ad infinitum, though this is the meme that follows them around. The MMT school needs to be looked at with a more open mind. Keen has done some work modelling MMT with his Minsky software modelling tools and this is producing some interesting results; it needs closer examination.

But I come back to my initial argument that neoclassicals are not the people to undertake this work. There is just too much cognitive dissonance to be overcome.

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{1} Neoclassical economics is better known as mainstream economics, a clever language devise to make the general public believe alternative economic schools are probably cranks. Which is exactly why the other name for neoclassics is orthodox economics.

{2} Keen, S., Debunking Economics, p.18, 2nd ed., (2011)
https://www.zedbooks.net/shop/book/debunking-economics/

{3} Neoclassical-economics mathematics is like using algebra and geometry (both elegant and rich areas of maths) instead of the tools of non-linear dynamics to model dynamic complex systems like nuclear processes and weather. Neoclassical's consider the economy to be at or near equilibrium at all times; if academic economics was functioning properly the starting point would be the assumption of a dynamic complex system. And then the appropriate tools to model it. 

For people with some first year University calculus behind them, I'll give an example that surprised me. In this example they didn't even use the wrong tool; they used the right tool incorrectly. Early economic researchers misused the chain rule in the original research, so of course they came up with the wrong result. No problem you might think. It will be fixed in later research, which is what happens in properly functioning science. Except it wasn't. The incorrect result was perpetuated throughout the literature and became one of the foundations of microeconomics today. And it's wrong! - See {5} below.

{4} According to Keen, who taught in University economics departments for many years, the mathematical tools taught by economics departments excludes (I’m sure mathematicians, engineers and scientists - for whom these tools are bread and butter, will be surprised to learn this – I was) the advanced calculus of ordinary- and partial-differential equations, mechanics and non-linear dynamics, and apparently they learn nothing about complexity or computer programming. None of this is taught! If this is still true how can these people hope to build effective macro- and micro-economic models of what is obviously a complex system - the economy. Their answer lies in their assumptions which are too absurd to go into here – you’ll have to read Debunking.

{5} As a fun example of some of the problems with neoclassical economics for those who do have a basic grounding in advanced calculus (this isn’t actually that advanced) Keen shows how a misuse of the chain-rule in early economic research (pg 76, 2nd ed. Debunking Economics) totally undermines the entire basis of supply-side economics, namely the upward-sloping supply curve. Correctly applying the chain-rule proves that a upward supply-curve doesn’t exist. 

I say 'fun example', but this is actually a very serious problem for neoclassicals, which is one of the many reasons Keen had so much pushback. But for those of us with some advanced mathematics (especially in calculus) his arguments are clear and without question correct. Debunked is filled with these sorts of problems. Another example: Keen shows how the downward-sloping demand curve theory is equally flawed and can't exist because the theory contradicts itself!