Wednesday, November 27, 2013

Janet Yellen and the Bankruptcy of Modern Macroeconomics

Janet Yellen is very well qualified to be the next Chairperson of the Federal Reserve.  No question about it.  She is one of the smartest economists on the planet.  The problem is she toils in a field that is intellectually bankrupt and politically motivated -- modern macroeconomics.

She knows modern macroeconomics as well any other academic around.  But, knowing modern macroeconomics is like knowing Grimm's Fairy Tales.  Modern macroeconomics bears little resemblance to the macro economies that it purports to analyze. The idea that only a dramatic expansion of sovereign debt is the prescription for a country choking in debt is patently ridiculous.  Yet, that is the number one prescription remedy proposed by Yellen and Paul Krugman and others of the modern macroeconomic stripe.

Whether one speaks of the Eurozone or it's twin -- the United States -- the modern macroeconomist lives in the simple world of the Keynesian cross diagram, put forth over a napkin by Richard Kahn (a student of Keynes) in 1928 to explain some of the ideas of John Maynard Keynes.  Nearly 100 years later, things haven't progressed much intellectually.  Most academic research in macroeconomics uses the method of "proof by assumption" to reach conclusions similar to Kahn's napkin demonstration.  If you just say that it works, then it works.  That pretty much sums up modern macroeconomics.

The problems in the US and the Eurozone stem from two broad facts: 1)  Government spending is facilited by massive, unprecedented and unsustainable increases in sovereign debt; 2) The micro-economics environment is being strangled through regulations, taxes, laws, and other rules of the road that make it almost illegal to hire employees and virtually impossible to run a private business.  The result: economic stagnation.  The pitiful economic condition of the US and Europe continues to puzzle the modern macroeconomist and it's no wonder.

Capitalism and free markets made the US the economic wonder of the world.  Obama and his predecessors seem intent on destroying this capitalist icon and they appear to be succeeding.  Europe has long been in the tank and has chugged ahead in the past only because of the awesome strength of the US economy, which pulled an unwilling and socialist Europe along.  The locomotive has stopped pulling and the train has slowed to a crawl. That won't change.

Meanwhile academics continue to push for more sovereign debt and more restrictions on the private economy.  Why not?   Most academics make their money, one way or another, from bureaucracies that don't have to compete in the private sector.  So, modern academics have only the faintest understanding of competitive markets.  Most academics don't believe in free markets anyway, so they live in the right space for their beliefs.

In the long run, only free markets really produce anything that anyone wants to consume.  We will be seeing soon what happens in health care when free markets are abolished by law.  We already know what happens in Europe when free markets are outlawed.

So, expect Janet Yellen to continue to call for more expansion in the Fed balance sheet (equivalent to increasing sovereign debt through the Fed) and more calls for higher US fiscal deficits and larger taxes on the private sector.  Like her fellow academics, Yellen sees little role for the private sector in the economy of her dreams.