• Expert Opinion

The difficulties facing the world's economies require macroeconomic solutions. But what can macroeconomics tell us about the causes and possible solutions for our current problems?

The relationship between the problems in the global economy and the understanding of those problems by way of macroeconomic theory seems to be crucial.

Although the connection between economic conditions and our understanding of those conditions is of paramount importance, no consensus exists concerning the theories which are meant to make our understanding clear. In many ways, the discord among theorists of macroeconomics returns us to the arguments between the classical (and neo-classical) ideas of behavior in markets, and their nemesis the Keynsians.

In classical theory the rational individual rules in the marketplace. The forces of supply and demand structure the individual's behavior such that it is always rational to want "more." Reason requires that the market participant only needs know the current price and quantity at which commodities are being exchanged. In a very mechanical way the price and quantity at which commodities are being exchanged informs the individual how "more" can be obtained. Unfettered by over-regulation on the part of government, the market would "guarantee" that full employment would prevail because supply would create its own demand (Say's Law). Whatever is earned must be spent or saved. Money that is saved will be invested in capital projects. It would be irrational to hoard money. Money never lies fallow. The market would thus regulate itself.

Keynes, and his followers, rejected this classical view of market behavior. In the depression of the 1930s capital was not being invested in such a way as to create full employment. Roosevelt, following Keynsian theory, justified high tax brackets (over 90%) and governmental work projects because, the president argued, the investing classes were not fulfilling their social/economic function. Instead of investing they were hoarding their wealth. For some reason , the investing classes were behaving "irrationally." The explanation for the aberrant behavior of the investing classes occupied Keynes' attention throughout the depression, and led to the critique of classical market behavior.

Perhaps hoarding money was not irrational in advanced market economies. New communication systems disseminated market information much faster than in the classical era of the 18th and 19th centuries.
This could be beneficial for rational market decisions, but it could also alter market behavior. Faster communications could bring news of opportunities for capital investment, but they could also inform investors of the dangers of investing at any particular time. Market decisions would have to be made in a global arena, rather than the dispersed, local markets of the previous centuries. The global arena would precipitate other behavior than anticipated in the classical market model.

Keynes' "discovery" of new market behavior in advanced economies became the cornerstone of macroeconomic thought. According to Keynes, it was "expectations" that drove market behavior. In the global arena information moved with such speed, and with so many secondary consequences (the rippling effect), that events occurring around the world could engender dangerous market conditions everywhere. The anticipation of these potential dangers would impact investing decisions.

Armed with mountains of data from global sources, the major investors might reasonably wait to put their capital at risk when world markets simultaneously collapse. Under extreme conditions in world markets, hoarding cash might not be irrational. In the 1930s such behavior might have been practiced by wealthy individuals. In the current climate financial institutions accomplish the same end by maintaining high reserves on their books. In both cases the result has been a stagnant job market with little relief in sight. Does macroeconomic theory help in finding a solution in this current crisis?

In the 1930s the government tried to use fiscal policy primarily to address the problem of unemployment (thus the high tax brackets). Today monetary policy is being used. Bernanke, the Fed chairman, has been able to reduce short-term interest rates to zero, at least as a limit. Moreover, he has attempted to inflate the economy by using a policy known as Quantitative Easing. So far, these policies have only inflated the equity markets, but have done little to ease unemployment. His efforts have not motivated the large economic institutions to loosen up the reserves they have accumulated and start hiring. Has macroeconomic theory failed when it has depended so heavily on monetary policy?

Perhaps the solution lies in the policy alternative used by Roosevelt. If fiscal policy is used to tax companies holding cash reserves, their decision would have to be to begin hiring or lose those reserves to the tax collector. This incentive would be especially effective, considering the market behavior that has emerged in advanced economies, and which have proven the classical theory of the 18th and 19th centuries to be a contemporary chimera.

This article provided courtesy of Dr. William Wallis who specializes and teaches Comparative Politics, Political Theory, Political Science Methods, and Political Economy at Cal State Northridge.