Abstract
This wide-ranging and interesting new book touches upon one of the key failings of modern macroeconomics: Why can we not build models of the macroeconomy which consider the financial sector? This question of course has massive relevance after the global financial crisis of 2007 onward, which took the global economy to the brink—and which, for many economies, has never really been resolved at a structural level even as headline accounting numbers like Gross Domestic Product (GDP) have seemingly improved. Despite the obvious importance of the financial sector in the regular functioning of the modern economy, and the now-apparent dangers that can accrue to the real economy because of finance, much of macroeconomics still posits the financial sector as little more than an efficient intermediary at the nexus of savings, investment, and (as an afterthought) money.
Bruno Ingrao and Claudio Sardoni’s manuscript hopes to advance our understanding as to just why this is the case, offering the long view on the evolution of the profession’s attitudes toward incorporating money and above all finance into macroeconomic models. While the title promises a focus on banks and finance exclusively, in reality this book is best classified under “history of economic thought”—evolving from a series of lectures and courses taught by the authors at Sapienza University of Rome and the University of São Paulo, the chapters trace the various approaches of macroeconomic theorists to money and finance and highlighting the papers of some (but, as we will see, not all) of the key minds shaping macroeconomics in the twentieth century.
Structurally, the book is organized around three separate timeframes: the pre-Great Depression era (roughly up until the 1930s), the long era between the publication of the General Theory by Keynes (1936) and the combined rational expectations/real business cycle (RBC) revolution of the 1980s and the era from the late 1980s to the present, which is characterized by “a renewed interest in the interrelations between the real and financial sectors of the economy” (397). They defend this demarcation by noting that this is a convention in the literature, although it would have been better perhaps to have fine-tuned the tradition, especially with regard to the changes occurring structurally in banking from the 1940s and 1950s to the 1960s and 1970s, or especially the financial globalization of the 1990s which made the 2000s unrecognizable from the point of view of the 1980s. However, as a set of dividers for their real interest, that is, the theory of macroeconomics rather than the practice of finance, these different timeframes prove adequate.
Ingrao and Sardoni, in one of the quirks of the book, prefer to let the theorists speak for themselves, with large block quotes directly from their work describing key concepts. This is most apparent when tracing the early years of macroeconomic theory, with Wicksell, Fisher, Schumpeter, and especially Robertson being allowed to speak directly to the reader with their own formulations of money and credit in the macroeconomy. While this may be a sound way to avoid misinterpretation of such fundamental texts, this approach wears on the reader after a time, especially with regard to Robertson, whose idiosyncratic terminology (Robertson himself called it “strange and barbarous”) could have been placed into more contemporary (conventional) language. The authors make up for this approach by offering deep new analysis on theory in the 1920s and 1930s, shining a spotlight on theorists whom we speak of regularly but perhaps have not actually taken the time to understand (Ramsey and Fisher in particular). Moreover, chapters 2 through 4 also illustrate how the thinking of macroeconomists evolved to fit the most pressing issues of their day, with the deflation of the Great Depression being the overriding concern (much as deflation is the misplaced obsession of central bankers today).
In fact, reading the early chapters, I was disappointed by the emphasis of the authors exclusively on money and how early theorists attempted to build money into macroeconomic models, rather than tackling the questions of the financial sector itself. It was only when reading through these chapters that I realized that it was not the authors, who were so diligent in highlighting the role of savings and money, that I was disappointed with, but the economists of whom they spoke. Indeed, the earliest research highlighted from the twentieth century focused almost exclusively on interest rates and/or the money stock within a larger framing of the macroeconomy, with banks as an institution relegated to the fringes and only discussed in relation to their ability to create money ex nihilo. The broader discussions of credit do not start to appear until Fisher and the Depression-era theorists, but even then, they are tied back into larger questions of the money supply. The breakthroughs of Schumpeter, highlighted at length here, finally start to see the incorporation of credit and the institutions which supply credit as a crucial cog in the macroeconomic machine, a strand of research which holds all sorts of rich insights for modern macroeconomics.
Unfortunately, the epiphanies of Schumpeter were overtaken in short order by the Keynesian revolution, which (as the authors show convincingly) began with some behavioral insights into capital markets and ruminations on the role of the financial sector in Keynes’s own A Treatise on Money. However, the authors approvingly quote Schumpeter, who notes that “the deposit-creating bank loan and its role in the financing of investment without any previous saving up of the sums thus lent have practically disappeared in [Keynes’s] analytic schema” (153, taken from Schumpeter’s History of Economic Analysis). Indeed, in a rather unusual turn for a history of economic thought book, the authors are very harsh on Keynes, making a strong case that the way in which Keynes’s thinking evolved to gradually push out the financial sector was a key flaw in his entire theoretical framework. In their wide-ranging discussion of Keynes in chapters 5 and 6, the authors also take issue with the manner in which Keynes equated liquidity preferences with demand for money, showing how the introduction of banks can sever the link between liquidity and money via the use of loans and reserves (see especially 184–86). Similarly, the authors quote Hicks on the endogeneity of money and how the rate of interest is determined within an interdependent system, meaning that “the alternative between the liquidity-preference theory [of Keynes] and the loanable-funds theory of the interest rate is essentially non-existent” (193).
In part II of the book, focused on the neoclassical synthesis to new Keynesian economics, we see the reality of the financial sector and its institutional make-up coming into play again but once again failing to make headway against the strong currents of the mainstream. In the 1950s and 1960s, the authors provide us with a fairly stark tale of a hero (James Tobin) virtuously attempting to fashion a theory including the financial sector and a villain (Milton Friedman) who once again subsumed banking and finance into a monetary model but then made money itself irrelevant. Chapter 7 finds the authors tipping their hands and giving us a glimpse into where their loyalties are situated, praising James Tobin’s contribution and his “repeated plea to adopt a general equilibrium approach in the modelling of financial markets” (288), and lamenting the fact that Tobin’s research agenda was abandoned by the profession and took macroeconomics into a “dead-end.” Chapter 8 reveals that they put the blame squarely on Milton Friedman, who is praised for his work (with Anna Schwartz) in disentangling the complex threads comprising the Great Depression, but excoriated for his conclusions as a result of this analysis.
The rest of the book, up until the last chapters examining the reintroduction of finance into macroeconomics in the 2000s, is a rueing of the path monetarism set the profession on, in particular the ascendance of RBCs and their emphasis on technology shocks (deleting the possibility of monetary disturbances as a source of cycles). It is only now, postglobal crisis, that the authors see some glimmer of hope in once again tackling the exigencies of finance in broader macroeconomic models, with a brief nod to Minsky and Kindleberger and their critiques of the rationality of financial markets.
The key strength of this manuscript, apart from its detailed and systematic approach to the evolution of macroeconomics, is its highlighting of some lesser-known authors, especially from the 1950s and 1960s. In particular, the shortcomings of Patinkin’s analysis from the 1950s are particularly relevant, as it excluded “any possibility of multiple equilibria reached along alternative adjustment paths, or any vicious spiraling during severe banking or financial crises,” a common failing in most macroeconomic models even today. Perhaps more importantly, the authors shine a spotlight on Gurley and Shaw in chapter 7, a now-forgotten piece written from the point of view of development economics and which contains striking insights on the financial sector and its players as institutions. Focusing on the variety of intermediaries in the financial sector and the changing conditions of technology and preferences, Gurley and Shaw represent a road not taken until the 2000s, one which takes a much more institutional view of finance and of macroeconomics.
There are also some shortcomings and oversights. In the first instance, although there are scattered mentions of Hayek, there is no in-depth treatment of the Austrian contributions to capital theory, focusing on the structure of production and the constraints imposed by timing, which have direct relevance for finance and how the financial sector operates. More importantly, as the authors point out the massive shortcomings in RBC theory and its failure to incorporate money in their last chapters, they also could have brought in insights from Austrian writers on the monetary underpinnings of business cycles as a direct rebuke to the “technology-only” shocks of RBC. Given that Austrians see monetary shocks as underpinning the decisions made by the financial sector (as well as booms and busts), neglecting the writings of Austrian theorists such as Roger Garrison misses some relevant analysis. This also could have formed a more substantive link with Minsky and post-Keynesian authors (conspicuously absent), creating a fuller account on the drivers of financial market irrationality.
Along these lines, a more egregious oversight is a lack of systematic reference to modern central banking. Throughout the book, the institution of the modern central bank is taken as exogenous, a regulator of the money supply and interest rates but which exists outside the economy. At certain points in the book, the authors make trenchant and even brilliant insights on the role of the central bank in money creation, financial crises, and the development of the financial sector in general. For example, the authors refer to Jakab and Kumhof (2015) on money creation running from banks to the central bank and not in reverse; previously, they had noted (quite correctly) that the Federal Reserve system itself was a propagator of shocks during the Great Depression and killed resilience in the US banking sector via centralization (314–15). The authors even note that “it has to be stressed the importance of taking into account the institutional aspects of monetary regimes and financial markets, with due attention to detailed institutional structure” (412). Unfortunately, the neglect of the institution of the central bank throughout the book, and how macroeconomics has incorporated (or failed to incorporate) the institution of central banking into models of the financial sector, is a missed opportunity.
Finally, in addition to these substantive comments, there is one other stylistic quirk that is, to my eyes, questionable; namely, the authors rely on an odd affectation where they do not refer to the first name of any economists (save Milton Friedman!). For some of the giants of economics, there may not have been a reason to refer to John Maynard Keynes or Robert Lucas, but for other, older theorists it would have been good to have them referred to by their full names.
However, these oversights and stylistic choices did not detract from the book; they instead highlighted what a massive undertaking these authors have chosen to embark upon. Indeed, on the whole, this is a very readable book into which clearly a lot of effort and passion has gone. For students or researchers looking to gain an overview of how macroeconomic frameworks have (not) incorporated finance or banking, it will be an indispensable reference.
