There Is No General Money Problem In Economics


By Don Ross

Alex Rosenberg asks for an explanation of why I’m not worried about the “invisibility” of money in “economic theory”. I’m not entirely sure why he thinks there’s something here we should be worried about. He clearly seems to think that the absence of money in some leading macroeconomic models has produced false predictions, specifically of recent bouts of inflation in the US that didn’t happen.

It’s telling that Rosenberg doesn’t refer, as I did, to “economic models”. He suggested in his previous piece that he thinks that some economic theory is fundamental, and that the problem resides in the fact that that theory doesn’t feature money as an element. He says that this fundamental theory is microeconomic.

I agree that there is such a thing as theory in economics that warrants being called “fundamental” and that this theory is microeconomic. However, it isn’t an empirical theory. It’s a body of applied mathematics that inter-defines a body of concepts for consistent use in building economic models. Specifically, the theory tells us how to represent marginal effects of changes in incentives on consumption and production. It defines consumption and production as classes of functions that take prices among their arguments. As Rosenberg says, in general these are exchange prices, not money prices. I see no reason why they should be money prices. People don’t consume money; they consume things they exchange for money. And although the Federal Reserve and various other agents spend some resources producing money, these expenditures are hardly central to the price dynamics of general markets.

Rosenberg might think that money should appear in micro theory because macro theory is based on it, so that the absence of money in micro theory implies the absence of money in macro theory. As a Keynesian I don’t think that macro theory must be grounded in micro theory, but it’s true that many macroeconomists hold that view (though I could make a long list of influential macroeconomists who don’t). But even people who think that macro requires microfoundations don’t insist that nothing can be added as arguments in utility or production functions applied at macro scales that doesn’t appear in such functions applied at micro scales. The production functions of the “representative agents” these microfoundations enthusiasts construct take as arguments various aggregates that are not typically found in micro models applied at micro scales.

I keep using the word “applied” above. This is important. Rosenberg talks blithely about what “economic theory predicts”. Along with such important economists as Edward Leamer and David Colander, I don’t think that economic theory by itself predicts any empirical events at all. It provides scaffolding for building models, and then models must be used to identify empirically measurable variables. It’s interpreted models, not abstract theory, that can be used for prediction. Your microfounded model is micro theory until you interpret its elements in a macro model.

There is no such thing as a master economic model to be used for prediction of everything that interests economists. Yes, macroeconomists used a favorite general model for advising central banks prior to the 2008 crisis that didn’t have money as an element. That was because they were trying to predict things central banks were trying to control – ratios of savings to capital installation – that they thought were insensitive to money fluctuations in the relevant time horizon. After 2008 central banks widened their functions to include operations for which money does matter, so now they use models that do include elements to be interpreted in terms of money.

Lots of clearly ‘mainstream’ economic models include money, and always have. Here’s one of thousands of examples I could have chosen. Patrick Bolton and Haizhou Huang model (some) inflation as resulting from the fact that governments inject new money in part by purchasing assets, where the purchases in question aren’t distributed uniformly across potential sellers. Their model constructs this as analogous to a firm financing itself by issuing new equity: if preferred shareholders can buy these at less than their cost on the open market, the value of existing shares is diluted. This is a kind of microfoundational reasoning, with citizens in a country modeled as if they were shareholders in a firm. This counts as perfectly respectable economic modeling in anyone’s eyes, even to someone who might think that the model misses some crucial features of a real economy. But it is obviously about money. It can generate the prediction that a very large fiscal stimulus, such as President Biden’s, might avoid generating inflation that a smallerinjection would have, because it reaches a wider proportion of the ‘shareholders’.

Rosenberg recognizes that economists disagree with one another over whether Biden’s stimulus will be inflationary. But then he says that some monolithic “economic theory” keeps uniformly predicting inflation from every fiscal stimulus. The fact is that different models, all consistent with the theory that specifies economic logic, make different predictions. Assessing these against one another requires situation-specific judgment, not application of a master algorithm called ‘economics’.


About the Author

Don Ross is interested in economics; economic methodology; experimental economics of risk and time preferences, addiction and impulsive consumption; gambling behaviour; addiction policy; cognitive science; game theory philosophy of public policy; philosophy of science and scientific metaphysics.

Alex Rosenberg's Money Problems is here

EJ Spode's response  is here

Diane Coyle's response is here

Don Ross's response is here

Alex Rosenberg's response to these is here