What Will New Economic Thinking Look Like?

Alejandro Nadal

The crisis that erupted in 2007 has generated interest in re-thinking economics. As Mark Blyth noted earlier this week, one of the more visible efforts in this respect is the creation of the Institute for New Economic Thinking, INET, committed to promote “new thinking about how to reform our economic system and get economists to better serve our policy makers and our society”. That is certainly a good objective, but you still need to define several key words in that sentence, beginning with “economic system” and “policy makers”.

On the very positive side, INET’s executive director Rob Johnson says the Institute is still defining “on the fly what new economic thinking means”. This good news leaves the doors open for truly innovative thinking. On the other hand, several participants in the first INET conference in King’s College mention the magic words, “shifting paradigms”.

I hope INET offers the opportunity for something a bit more ambitious than just a shift in paradigm, especially if a narrow definition of “paradigm” is used. After all, when we change paradigms, we are still playing the same ball game. It is perhaps more appropriate to think of changing of ball park altogether. And if this is the task at hand, then we need to reconsider the basic building blocks of theory, as well as the nature of our discourse and the boundaries of our field. Let me give one example related to money and ethics.

It is no secret that economic theory has a problem with money, that “portentous issue” (Arrow and Hahn 1971:338). At the starting point of all price theory is the abstraction that puts money outside the field of analysis. This is accompanied by the postulate that commodities are physically determined. Then value theory restores the unit of measure that allows economic discourse to move on to price determination. This is true for classical political economy (and its contemporary Sraffian version). And it certainly is true for neoclassical general equilibrium theory (GET).

When linking monetary and value theory in GET, relative prices are determined first (in terms of physical rates of substitution) and, in a second stage, monetary prices are determined (say, with a version of the Cambridge money equation). Back in 1965 both Patinkin and Hahn showed this procedure was deeply flawed. Today general equilibrium theory remains essentially a theory of barter economics (or a theory where all exchanges are ruled out). At least Debreu (1959 Chapter 2, footnote 3) was frank about this. Can you imagine what people’s reactions would be if told that the most sophisticated model for market theory that economists can put on the table is limited to non-monetary economies?

Integrating monetary theory with value theory remains an esoteric field. Considerable time and effort has gone into solving this problem (for example, using overlapping generations models and search theory), but the results are still unsatisfactory.

It can be argued that macroeconomic theory takes a different starting point and does not examine the value of the common unit of account in terms of a value theory. Perhaps one exception is found in Keynes who thought it was natural “to enquire wherein the peculiarity of money lies as distinct from other assets” (GT, Chapter 17 on “The Essential Properties of Interest and Money”). As we know, this “mysterious chapter” (as Joan Robinson called it) generated more questions than answers.

In other terms, the concept of money remains fuzzy. Now, that’s something that most economists would hate to admit in public. So here’s an idea: new economic thinking cannot continue to abstract from money as a starting point. Money, it can be said, is arguably the most important “economic object” and thus it is truly amazing that economic theory could even think this abstraction is necessary. New economic thinking needs to start afresh in this problem area.

A way to approach this is to understand how prices and money were thought of before economics got in the way. In strong contrast with economic theory, we must stop thinking of money as a simple transactions technology. It is something much more complicated. This probably entails looking at money as a political and ethical object. This leads us into the critical issue of the relations between ethics and economics, a key component of new economic thinking. This is part of my research agenda and will be the theme of a later entry on this blog.

These are all relevant questions, for as Keynes warned one December night in 1935 “the difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds”.

Arrow, K. and F. Hahn (1971)
General Competitive Analysis. San Francisco: Holden Day.

14 Responses to “What Will New Economic Thinking Look Like?”

  1. Max says:

    Alejandro, good post.
    I wonder if you’ve seen the work of Jonathan Nitzan and Shimshon Bichler, and their monograph, Capital as Power, which theorizes capital as totally separate from the productive economy, akin to Veblen’s distinction between industry and finance. A PDF of the whole book is available here: http://bnarchives.yorku.ca/259/
    Mostly, their book has been met with silence. I first encountered their work on the political economy of Israel and American imperialism in the Middle East, The Global Political Economy of Israel, which struck me as far and away the best book on Middle East political economy I’d ever read — and I study the region and especially the Israel-Palestine conflict closely. Worth checking out.

  2. Thanks Max for the reference. I was not aware of this book. Looking forward to reading this. I wonder how the book deals with the notion that capital is a social relation, and that comes directly from Marx. The problem is that Marx does seem to go astray from his own intuitions; when he does that, he talks and walks like an economist.

  3. Mark Blyth says:

    “Money, it can be said, is arguably the most important “economic object”

    Careful Alejandro…this line of thought ends up in a difficult place…

    a “Friedman-esque” one… :-)

  4. Paul says:

    I wonder what you think of the work by the likes of Ricardo Lagos and Stephen Williamson that is trying to find a new way to incorporate money into general equilibrium?

  5. Rob Johnson says:


    You may want to look at the recent work by Brad Delong on Say and J.S. Mill on Money. Also see the chapter in The Marxist Reader from the Theory of Surplus Value that Robert Tucker introduced and Tom Ferguson suggested to him.


  6. Money is a medium of exchange and store of value.

    “Can you imagine what people’s reactions would be if told that the most sophisticated model for market theory that economists can put on the table is limited to non-monetary economies?”

    Heres a reaction: I think more than a new paradigm is needed.

  7. Mark: thanks for reminding me! I see how that statement takes one (but only apparently) in the direction of Milton, not the one who gave us Paradise Lost (pun intended). I think Friedman didn’t examine with some degree of detail the relation between value theory, fiat money and its role as medium of exchange and store of value.

    Rob: on Brad de Long’s reference to Mill on Say’s law. Of course, in addition to the broken link between purchases and sales, there is a key sentence in that passage: nobody wants to hold money for its own sake (strange in Mill’s world of money as a commodity). Aside from this, Mill is a great example of someone who views money as a technology. Check this passage also from his Principles: “It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without.” Of course, we know today, thanks to the study of pair-wise exchanges (Ostroy and Starr) this is not true. On Marx, well, he also had a strange monetary theory, and Marxist orthodoxy prevented a serious development of his important insights (particularly in Contribution).

    As for money in general equilibrium, I think both Lagos and Stephenson have to rely on very strong assumptions to get any kind of result (among other things, the traditional problems in terms of poor stability results are assumed away). Hahn’s problem is still valid: GE models always have room for non-monetary solutions.

  8. Tom, remember that old dictum from textbooks: Money is what Money Does? It went on to say that money was a unit of account, a medium of exchange and a store of value. It never told us that by definition ALL commodities play these three roles! And, as Clower once remarked, a barter economy is an economy in which all commodities play the role of money. Thus, the three functions are not enough to specify a concept of money. You’re right: we need more than just refining paradigms.

  9. Alejandro –

    Thanks for your reply. Let me fill you in on the cause of my disappointment and interested in there being economic theory which is useful to practitioners.

    As a regional planner for 35 years, I worked with localities on economic development in Virginia’s Northern Shenandoah Valley. A mostly rural area up through the 1970’s became part of the Washington, D.C. MSA by 2000.

    Household incomes grew, but were always outstripped by the cost of housing. Our region exported labor to the MSA and imported it from adjoining rural areas. Between 1980 and 1990 the area had a net gain of 500 manufacturing jobs which. In the period, 5,000 jobs were lost and 5,500 gained. Localities and the State worked hard to compete and were successful, but commuting distances got greater, as the differential between local wages paid and the cost of housing.

    Employers in a service economy like Metro D.C. could pass on higher wages necessitated by higher housing costs, but globally competitive manufacturing could not. Post 9/11, things got worse as Northern Virginia employment expansion related to the “Homeland Security” ramp-up pushed housing prices higher and brought big developers to the region.

    It looked like textbook inflation, too much money chasing too few goods. Later – in the bust,we learned it was fueled by cheap money and relaxed/non-existent lending standards that were an accelerant to housing values. There had been a housing boom-bust that ended in the early 1990’s, but that wasn’t driven by easy money.

    Credit issues showed first in the fact that people were upside-down in their vehicle loans. Commuting 60,000 miles a year will burn out a car in three years. When financed for five, the solution was to roll debt over into the next car. Though seen as a stressor, it was not recognized in economic terms for the weakness it represented and how households were
    using credit to keep afloat.

    Appreciation in housing was one thing that everyone was going for. People were experiencing boom and bust in 401Ks and after the dot.com bust, many people went to real estate. That has not ended well. The local papers are on life support due to the shrunken economy. Housing foreclosure ads keep them alive.

    Reviewing the last 30 years, having had continuous access to the economic data for the local and greater regions, and understanding the role of credit and, what can only be seen as failed economic policy, my question is: Why was the build up of debt and the risk that that created not recognized?

    At the 2010 American Association of Geographers Annual Meeting, in the Regional Studies Association sponsored Plenary Session by Paul Krugman I asked Mr. Krugman whether or not any of the economists had Excel spreadsheets to add up debt and keep track of its impact? He didn’t have an answer.

    The business, growth. innovation treadmill has run out and left a huge debt overhang. It appears that the service economy was an illusion. Great value is not created by emailing things back and forth. Businesses that earn based on transactions can become parasitic.

    Cities – municipal corporations last hundreds of years. Many cities have been in existence for centuries and today benefit from the infrastructure investments hundreds of years ago. It is rare for a business corporation to last 50 years.

    The profit motive is strong, but it can only play out in a community. The community motive has lead to civilizations which have economic relationships, internally and externally. Community infrastructure takes a long time to build. Human capital also takes generations to build. Both can be easily destroyed in war or natural disaster.

    Community economies are not quickly built. One can learn from another, perhaps speed up the process, but the profit motive is very short-sighted unless it is tempered by cultural and religious values.

    Outside of physics, mathematical modeling has many shortcomings, as the data is always inadequate. I’ve worked with data a lot as a planner and my experience is that, the closer I got to it, the more it disappeared. The match between the data and what was on the ground often varied significantly.

    Certainly, data must be acquired and used, but a new economics should contribute to the understanding of human community perpetuation, not short term profits for transitional technology.

    Economics must be a watchdog to ferret out illusions of growth due to debasement of currency and the inflation of assets. Kicking the can down the road should not be an economic principle.

    Economics is, on inspection, a great disappointment. Planning has many failures as well. Suburban sprawl and dependence on the automobile has led to great malinvestment in the U.S. The “The Reduction of Urban Vulnerability: Revisiting 1950s American Suburbanization as Civil Defence” by Kathleen A Tobin, Purdue University, Cold War History, Vol.2, No.2, January, 2002

    The use of the social sciences for defense/war/exploitation is not why people go into these fields, but being objective, one can see that is the nature of the greater game. Resources fund their own agenda. Don’t confuse me with the facts, my mind is made up.

    Hope this is a contribution to the discussion.

  10. Chris Cook says:

    In my view money is, like capital, a social relationship. I think of the former as static value, and the latter as dynamic value, where value is ‘money’s worth’, whatever that may be.

    My take on ‘real world’ Economics – based upon practical experience of markets and enterprises over 35 years up to top level, and getting on for ten years thinking about it – is here.


    Also this presentation at a University of Strathclyde seminar


    I think that a new networked, decentralised and dis-intermediated economy is already evolving from the ground up, and that we are close to a tipping point in its evolution.

  11. Chris Cook says:

    Correction: capital being static value, and money being dynamic value…..

  12. Kevin P. Gallagher says:

    Excellent commentary. One thread not touched on here is the fact that James Tobin actually does bring money into the “equation.” Not sure that helped much, this time. Perry Mehrling discusses this in his new book, “The New Lombard Street: How the Fed Became the Dealer of Last Resort.” Tobin has a 1969 piece titled “A General Equilibrium Approach to Money.” This of course has become the key knit between Hicks and the DSGE models. Mehrling applauds Tobin for seeing that money is actually a “thing” in an economy but faults Tobin for assuming that all assets are liquid and thus riskless. Mehrling points to Minsky’s as the dissenting road not taken. Minsky didn’t catch on. As Mark (Blyth) says below, because his more insightful models don’t wrap up into a pretty and “coherent” model.

  13. The problem is that Tobin’s “general equilibrium” is in reality a modified IS-LM model. This is OK, after all the IS-LM model is in reality a GE model to which it is possible to add some “frictions”. But from the viewpoint of monetary theory, there is no explicit price formation process, and certainly not one in which the demand for money would play any role. In addition, there is no room for transactions’ analysis and the role of money as a means of exchange. The Hahn conundrum remains valid. In fact, Hahn had already criticized Tobin and Baumol for launching models in which the positive price of (fiat) money is assumed, but not explained.

  14. Guys – The results are the proof that the theory can’t explain what has happened. How many economists can dance on a decimal point?