This blog has always believed (along with few others) that for economics to go forward we need to really sort out our economics education. This crisis is about fixing our econ education as much as it is about fixing all the jazz like macro policy, financial institutions etc. If we don’t fix the former and jus keep the focus on latter as is the case, it will just be a ban aid solution, True, education will not ensure that there will be no crisis in future but it will just make us realise that economics is hardly a linear subject and needs to be studied with other disciplines.
What we have instead is highly siloisation of economics where you just study standard stuff without any politics, history, society etc meshed in the curriculum. Even worse is siolisation within economics. One is just a macro person, other is just a micro person, yet another is a finance person and so on. One may not need to know anything about the other. This blogger too has been a victim of this siloisation, a huge limitation which does not just go away thanks to years wasted in silos.
Ironically, this silo creation is one of the crucial reasons behind the crisis and acts as a hindrance to solve the issues. This silo is between monetary economics persons and finance persons. How do you fix the issues going forward without understanding the linkages. This blog has written about this silo issue earlier as well.
In a recent post, Prof Peter Mehrling mentions how attempts are being made to limit this bifurcation:
In retrospect, it is easy to see why most observers didn’t see the crisis coming. The crisis was a stress test of shadow banking, “money market funding of capital market lending”. In most universities, including mine, monetary economics and financial economics are separate fields with their own specialized language and faculty, and the regulatory apparatus is similarly bifurcated. But the world isn’t.
As a consequence of the crisis, money people now realize that they have to learn some finance, and finance people now realize that they have to learn some money. Division of labor that made sense in an earlier time by bringing into sharp focus the essential elements of the system serves today instead to prevent us from seeing new essential elements, simply because they are in the periphery of our gaze.
A recent workshop on “Implementing Monetary Policy” shows this learning process in action, from the money side. How should we think about the role of the central bank in a world where money markets and capital markets are not separate but rather fully integrated, and not only domestically but also globally? Is the Fed Funds rate still the right target, or should we be focusing on something else, maybe even the Reverse Repo Rate?
A recent report on “Market-Based Finance” shows this learning process in action, from the finance side. How should we think about role of the securities regulator in a world where monetary markets and capital markets are not separate but rather fully integrated, and not only domestically but also globally? Clearly traditional regulatory focus on agency problems and asymmetric information is no longer enough, but how exactly is a securities regulator supposed to help stem systemic financial fragility?
The closing two sentences of the latter report hit the nail right on the head, according to me: “the greatest risk has been and remains the insufficiently deep understanding of the system in both its conceptual and data dimensions. To close these gaps and move towards a more robust regulatory framework requires continued engagement with the system on national and international levels.” New economic thinking is needed, including thinking about new kinds of data that heretofore have been on the periphery of our vision.
From this perspective, the biggest challenge is not just for money people and finance people to learn from each other. The way we think about money and the way we think about finance both have to change as well. If money people only learn traditional finance, and finance people only learn traditional money, then we get nowhere. Money and finance are both moving targets, and that’s the biggest challenge.
How do we handle these moving targets? He points to a example where things are being missed by both camps:
So what finance and what money should money people and finance people, respectively, be trying to learn?
A great example, according to me, is provided by the recent BIS paper on ”Helicopter Money.” The authors draw attention to the institutional fact that short term interest rates are determined in the market for bank reserves. Helicopter money would amount to a massive increase in the supply of bank reserves, but with what consequence for the rate of interest? If the central bank continues present practice of setting the floor on short term interest rates by paying interest on reserves, then the rate of interest stays wherever the central bank sets it. The fact that cash pays no interest does not mean it is a free lunch because excess cash becomes excess bank reserves, which do pay interest.
“The ‘decoupling’ of interest rates from reserves is obviously well known to central banks but, surprisingly, it has not yet found its way into textbooks and economic thinking more generally.” This gem, which the authors bury in the middle of the paper, is the key point for present purposes. New thinking about money is needed, by both money people and finance people. It’s not in the textbooks, or the heavily vetted academic journals, precisely because it is new. So don’t look there. Look instead to the writings of practitioners, whose daily engagement with the workings of the actual system forces development of new thinking, pragmatically. They have jobs to do, and when conventional thinking doesn’t help, they have to find other ways of thinking.
Actually current textbooks are mostly away from the reality we have been living in for past 10 years or so.
Lot has to be done to stop making economics a silo subject. Ironically the way forward for economics is to go backward when economics was taught more holistically. I am pretty sure that scholars who studied economics earlier would be really surprised and disappointed to see this super specialisation nature of the subject which is obviously not going anywhere..