More on the “Nobel Prize” 2022: some insights from Keynes

A new essay on post-Keynesian insights into monetary policy from MPI founder Louis-Philippe Rochon.

“Post-Keynesians have understood the true nature of banks – and of money – for decades.  I would go as far as to say that post-Keynesians better understand central banking than central bankers do. Ain’t that a kicker!!”

Louis-Philippe Rochon
Full Professor of Economics, Laurentian University, Canada
Editor-in-Chief, Review of Political Economy
Founding Editor, Review of Keynesian Economics

It has now been a few weeks since the “Nobel Prize” in economics has been awarded.  The shock is over, and the initial outrage/puzzlement/bewilderment is over, and we can now better reflect on what actually happened.

The decision to award the “Nobel Prize” to former Federal Reserve Chairman Ben Bernanke is not only an odd one (I guess all “Nobel Prizes” in economics are in a way odd for post-Keynesians), but a dangerous one as well. “Nobel Prizes” go a long way in seemingly legitimizing the views of the recipients, and when they are awarded to someone for “research on banks and financial crises” that is fundamentally flawed, incorrect, and quite simply wrong, the results can be disastrous.  In my last blog on Bernanke and the “Nobel Prize”, I dug up a few quotes from 2007 and 2008 where Bernanke was refusing to conceded a crisis was coming. So, yes, I would argue that his “research on banks and financial crises” is flawed. And the consequences of this flawed approach was evident throughout the crisis.

This reminds me precisely of the opening single-paragraph chapter in Keynes’s General Theory, where he says that “the characteristics of the special case assumed by the [neo]classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience” (my emphasis).

Banks are a fundamental component of our explanation of how economies operate.  They are not only at the heart of our views of money creation – the theory of endogenous money – but also of how we can explain output, employment and growth. Without a sound theory of banks, economists cannot explain the real world, and cannot come close to explaining economic growth.  This is why the recent awarding of the “Nobel Prize” to Bernanke is so troublesome.  If economics is about proposing relevant policies, how can you propose policies that can address the real world when you share the view for which Bernanke won the Nobel: for him, banks are mere intermediaries between savers and borrowers.  Banks lend pre-existing deposits: banks do not create money. This is the simple, naïve and irrelevant money multiplier model.

Post-Keynesians have understood the true nature of banks – and of money – for decades.  I would go as far as to say that post-Keynesians better understand central banking than central bankers do. Ain’t that a kicker!! We understand the relationship between lending and debt, and money creation and destruction.  We understand ‘the circuit of money’ – what Schumpeter called ‘monetary analysis’ (as opposed to real analysis, defended by Bernanke), or what post-Keynesians call a monetary theory of production, following Keynes.

Yet, post-Keynesians are not the only ones to reject this child-like view of banking.  In a recent article for the Federal Reserve – a version of it is forthcoming in the Review of Political Economy, economists discuss the outdated model, in a provocatively-titled paper, “RIP Money Multiplier”. In the ROPE paper, the authors accuse textbooks for not being up to date on these key concepts, and highlight two key mistakes in the classroom:

(1) using an outdated description of Fed operations that rely on open market operations instead of focusing on the Fed’s administered interest rates, and (2) relying on the money multiplier equation, which broke down over time and is now no longer definable.

Wait!!! Did we not just award a “Nobel Prize” for these “outdated” ideas? It seems Fed researchers are more qualified to lead the Federal Reserve than Bernanke ever was.

Quite honestly, even the mainstream models today reject Bernanke’s views of banks, incorporating some key endogenous money insights into their modern approach to banking. It took them time, but now many recognize some version of endogenous money. The list of central bankers who now accept this view is getting longer each day.  And yet, the Nobel Committee saw it perfectly OK to give a million US dollars to Ben Bernanke for espousing “outdated” views.

One of my favourite quotes by Keynes, from the Treatise of Money, is one where he says “[Bank] Credit is the pavement along which production travels and the bankers if they knew their duty, would provide the transport facilities to just the extent it is required in order that the productive powers of the community can be employed at full employment.” (John Maynard Keynes - CW VI, page 197).  This is a fundamental quote in the heterodox understanding of endogenous money (see David Fields here).

There is thus an immediate link between bank credit and economic activity: in this post-Keynesian approach, banks are never constrained in their lending by prior deposits, as loans create deposits, and not the other way around. Banks are constrained – as was well understood early on by Joan Robinson – by creditworthy customers.  In other words, at play is the optimism of banks versus the optimism of borrowers, as I argued with Edouard Cottin-Euziol in our New Palgrave entry.

This changes the narrative considerably. And the consequences cannot be more different: in the post-Keynesian version, the role of fiscal policy is to ensure a healthy level of optimism in the economy, by playing on aggregate demand. 

All this is missing in Bernanke’s vision. That’s why he could not see the financial crisis coming, and that’s why he so abysmally failed at managing the financial crisis.

In the end, the Nobel Committee rewarded a vision of capitalism that simply does not exist, and rewarded a theory that is irrelevant to the understanding of our system, and cannot have anything relevant to say.

Next year, perhaps the Nobel Committee will award the economics prize to someone who claims climate change is a myth and there is no need for economists to study it.