Macro Wars – the Rise of the True “Salt Water” School

A war’s been brewing ever since the beginning of the financial crisis.  Some have called the recent battles in macroeconomics the “macro wars”.  And this war has been defined as being between the “salt water” school (the US Universities on the coasts primarily – MIT, Berkeley, etc) and the “fresh water” school (the schools in the mid-west  like the Chicago School).  The “fresh water” schools are basically Monetarists while the “salt water” schools are referred to as Keynesians of some sort.   But Thomas Palley a Post-Keynesian, has cited an important distinction.  He’s pointed out that the so-called “salt water” school is actually more of a “brackish water” school.  In other words, they make a big mess out of many of JM Keynes’s original points and so calling themselves Keynesians is kind of like calling a donkey a horse.

This is important to note because once you understand the “New Keynesian” “salt water” views you realize that they actually have more in common with the “fresh water” guys than you might think.  The salt water really is brackish water!  For instance:

  • Both schools adhere to some version of general equilibrium.
  • Both schools utilize loanable funds and quantity theories of money.
  • Both schools reject the importance of endogenous money and banking.
  • Both schools utilize the concept of a “natural rate of interest”.
  • Both schools use marginal product theory.
  • Both schools rely on some version of the efficient market hypothesis and rational expectations.

These aren’t minor similarities.  They are hugely important overlapping underpinnings.  And so this brings up an even more interesting entrant into the war – the Post-Keynesians, who are of the true “salt water” school of Cambridge, UK.  Yes, this is a global war and not merely one between American economic schools.  The Post-Keynesians reject all of the above views.  And in my view, it is the true “salt water” school, the Post-Keynesians, who the fresh water and brackish water schools should be most afraid of.  Our army is small at present, but our arsenal is powerful because it is grounded in reality and not myth.

It should be no surprise that the Post-Keynesians are having their voices heard in this debate.  After all, we got so much right after the financial crisis that you’d have to have a hole in your head to brush our real-time predictions off as unimportant.  But this isn’t about predictions.  This is really about having a realistic framework for understanding the economy and money so we can all better understand the world we live in.  And the Post-Keynesians are proving that the framework makes a great deal of sense.  And now people in important places are beginning to question the foundation of many of the overlapping ideas between the brackish school and the freshwater school.

I said it a year ago and I’ll say it again today – the Macro Wars aren’t really between the American schools.  The real macro wars are global in nature and it is the true “salt water” Post-Keynesians who are the biggest threat to the brackish and fresh water schools.  Hopefully they will continue to fight amongst themselves and ignore us.  That way they won’t even know we’ve defeated them until the war is practically over.




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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    Palley’s last few posts have been great. It’s like he’s playing with his food before he decides to swallow it whole.

  • Benedict_Cumberbatch

    The internet has changed the battlefield. These wars used to be fought in the economic journals. Now they are fought on the internet where views are democratized. It’s nice to see that the ideological econ journals are no longer in control.

  • Dinero

    could you please give a definition of the natural state of interest, is it what Keynes called the marginal efficiency of capital.

  • Cullen Roche

    The natural rate of interest is basically the rate of interest at which the economy is in equilibrium and output equals potential. Keynes rejected this concept in the General Theory saying:

    I am now no longer of the opinion that the [Wicksellian] concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.

    So Krugman isn’t even consistent with Keynes on this matter and neither are the New Keynesians.

    In essence, it boils the monetary system down to one pool of money and one interest rate. Once we get that interest rate to the “right” level then the economy will clear. In a Krugman “liquidity trap” (Keynes also used the term liquidity trap differently than Krugman and New Keynesians use it) you have to boost expectations to reduce the real rate of interest since they claim that the natural rate must be sharply negative in an environment like the present. Let’s just say it’s a stretch of the imagination….

  • Cullen Roche

    Agreed. His last one was particularly succinct.

  • jayedcoins

    So, it seems to me, that if Keynes were alive today and driving discussions and taking sides, he probably wouldn’t be Keynesian or New Keynesian, but closer to a Post-Keynesian! As you have pointed out in the past, Cullen, there are many instances where Keynes showed us that he understood operation realities (though they are different today than they were then) that a lot of those practicing in his namesake don’t (or do a bad time showing it, at best).

    One thing that has stuck with me about Keynes as he relates to a Post-Keynesian viewpoint was the post you did quoting where Keynes pretty clearly indicates that he understood the idea of — spending is a function of income relative to desired savings.

    Methinks that JMK in 2014 would look at things like QE, IS/LM, ZLB/liquidity trap, and see them from the same lens as Monetary Realism.

    Okay, he might give a little more rope to IS/LM as a useful ad-hoc model, substituting a loanable funds concept as the LM driver for the derivation of all possible combinations of bank qualifications for lending linking up with the demand of said qualified borrowers… but that’s just because I like that idea. :-p

  • Benedict_Cumberbatch

    The views of Monetary Realism are very consistent with the true Keynes. The foundation and focus on investment, the importance of stylized facts, the centrist views on politics, etc are all things that Keynes would have embraced.

    The entire concept of Keynesian economics is wrong in the common jargon today. Most people think of Keynes as a socialist or solely in favor of demand driven economics when he was really quite conservative, business focused and rejected socialism.

    Cullen is no Keynes (sorry), but there are similarities.

  • The Other Matt

    I realize the genie will likely never go back into the bottle, but could the old school dogma come back into favor “in some recognized fashion” — if the status quo were able to dramatically reduce Shadow banking and Eurodollar money creation?

  • Geoff

    With all due respect to Keynes, too many groups use his name. Keynesians, New-Keynesians, Post-Keynesians, give me a break.

    The Post-Keynesian school needs to change its name pronto.

    Monetary Realism is cool but I think it’s taken. :)

  • Cullen Roche

    Ha. Yes, Beowulf suggested the “San Diego” school. :-)

  • Geoff

    San Diego would certainly count as a true “Salt Water” school. But there is no need for students to wear a suit and tie to the beach. Come on, man.

  • Cullen Roche

    Good point. As a Seeking Alpha commenter once said:

    “what kind of douche wears a suit to the beach?”.


  • LVG
  • Dinero

    So what is the natural that you refer to , what is the denomintor and what is the numerator.

  • Geoff

    The diagram below says that there are three founding members of the Post Keynesian school (Joan Robinson, Abba Lerner and Hyman Minsky).

    So you could call it the RAH! school but I think there are other people who are missing from this list such as Mitchell Innes and Frederick Soddy.

  • Anonymous

    Your definitly right about this, but there are a few small details I think you get wrong.

    “The “fresh water” schools are basically Monetarists while the “salt water” schools are referred to as Keynesians.”

    Fresh water (RBC) are even further away from reality than Monetarists. They basically don’t beleive it is possible to explain anything that happens in the macro economy, everything is “real” shocks. “Salt water” New Keynesians are actually the monetarists, the consensus in salt water circles was that it was best to rely on monetary policy for the 20 years before the crisis. They still believe once we get out of the “liquidity trap” monetary policy will go back to being all powerful.

    “He’s pointed out that the so-called “fresh water” school is actually more of a “brackish water” school.”

    I think you mean “salt water” here?

    “Both schools reject the importance of endogenous money and banking.”

    DSGEs do have endogenous money, though it is only there so they can ignore the effects of the financial system. Michael Woodford has talked about this. This is actually one of the earlier victories of PK economics, as they were talking about endogenous money way before anyone else.

    Since the crisis there have been a bunch of mainstream models that include finance, but they don’t say anything intersting. This is actually another weakness of modern DSGE focused macro, you can design a model that does whatever you want it to. See the idiocy about raising internest rates to raise inflation for an example.

    I only bring these up because your critics are likely to jump on these minor mistakes and ignore the bigger picture. Keep up the fight for realism in economics!

  • Cullen Roche

    Thanks. Yes, minor typo in there on salt water vs fresh water. Oops.

    Unfortunately, I don’t really have the time nor the space to do a full rundown of the views here so I am being a bit vague by necessity. I appreciate your clarfications.

  • Tom Brown

    “Fresh water (RBC) are even further away from reality than Monetarists.”

    Krugman quoted an RBCer the other day, Ed Prescott:

    “It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.” — Ed Prescott

    “New Keynesians are actually the monetarists”

    But don’t NKers try to eliminate money entirely from some of their models? I thought that’s what Woodford does and its’ one of the things that the MMs don’t like. I sounds like Cochrane (a “traditional” monetarist?) also has a beef with NK models.

    BTW, Rowe has a new post up in which he “pledges his help” to the NKers and their “conspiracy,” but in the comments pretty severely criticizes them as well. He links to a Simon Wren-Lewis post in there which is interesting too… with comments by Nick Edmonds, and James Galbraith amongst others.

  • LVG

    The New Keynesians embrace monetary policy, but they’re not traditional monetarists. Monetarists reject fiscal policy while New Keynesians generally embrace some form of it. Monetarists literally think you can steer the economy through the Central Bank while New Keynesians generally take a more open-minded view of things including forms of fiscal policy.

    I think the Market Monetarists are now carrying the “Mainstream” Monetarist torch. The old Monetarist school is dead. They’ve all evolved into Market Monetarists.

  • Tom Brown

    “The old Monetarist school is dead. They’ve all evolved into Market Monetarists.”

    But Cochrane isn’t an MMist. What would you call him?… in light of his seeming agreement with Stephen Williamson recently (as one of the so-called “Neo-Fisherite” rebels), perhaps a “New Monetarist?” (That’s what Williamson calls himself I think).

    Thanks for the breakdown. That agrees with my understanding too, regarding fiscal policy, although I don’t think that MMist reject that fiscal has an impact. Sumner says it’s undone by “monetary offset” with a competent CB. And Rowe had this interesting thing to say once:

    If I were a Big Government guy, I would still want (the government’s) central bank to make Say’s Law true in practice. Especially since it would free up the rest of the government to do all the other big things I would want the government to do, without the constraint of managing AD:
    and this:
    Tom: “I think he’s worried that if MMists are right [I'm talking about Mike Sax], that this will eliminate the justification for having a gov with an expansionist fiscal policy, …”
    Remember as well, it would also eliminate the justification for having a government with a contractionist fiscal policy: “Aggregate Demand is too high! We must cut government spending!”
    Fiscal policy is not about the average size of government over time; it is about volatility in the size of government over time.

    So that’s not inconsistent with what you say, but it indicates that using monetary over fiscal is a preference for the MMists, not that they think fiscal couldn’t theoretically be used. I’ve seen Sumner make a similar statement.

  • SS

    You can understand the two schools by seeing how they view the business cycle fluctuations. Monetarists generally think that recessions are caused by excess money demand and therefore the cause and solution is monetary in nature. New Keynesians have a more traditional Keynesian perspective on recessions where recessions are caused by a shortfall in aggregate demand (paradox of thrift type thinking) and generally think you can fill that aggregate demand gap through lots of different policies.

  • SS

    It’s worth noting that there’s a lot more overlap in these two views of the world than many people might think.

    As Cullen noted, “brackish water” is probably a better description of the “salt water” school. They’re influenced by Milton Friedman in more ways than they like to admit.

  • pliu412
  • Geoff

    That was excellent! I think James Galbraith may be associated with M M T but I won’t hold that against him. :)

  • Cullen Roche

    I think Galbraith is happy to align himself with much of the descriptive elements of MMT, but he outright rejects the Job Guarantee. Here’s what he says:

    “. . . To come back to the job-guarantee approach, I think asking the government to create jobs directly is not a robust solution. The problem is that the program goes right into the budget firing line, where it will get chopped up. That was the experience with CETA, the Comprehensive Employment and Training Act, back in the 1970s.
    “So I prefer to think in terms of how to get decentralized institutions doing useful things, with their own funding streams, so that you can create jobs that endure. Education, health care, social services, home care, neighborhood conservation.”

    There was never really a resolution on whether you can be “MMT” without the JG, but I would argue that rejecting the JG is an explicit rejection of the concept of the central tenet of MMT which is that the govt causes involuntary unemployment by not filling in the gap leftover by a lack of government spending. This is basically the reason why I ultimately rejected MMT. It’s the idea as Mosler says:

    “Involuntary unemployment is evidence that the desired H(nfa) of the private sector exceeds the
    actual H(nfa) allowed by government fiscal policy.

    To be blunt, involuntary unemployment exists because the federal budget deficit is too small.”

    Involuntary unemployment is not caused by the deficit being too small. It is caused by capitalists maintaining a buffer stock of unemployed people to manage their own business risks. The SOLUTION might be more NFA, but it is not the CAUSE. And it’s certainly not the result of a government currency monopoly. That’s just nonsense.

  • Geoff

    Cool. I think there is plenty of room under the PK umbrella for both MR and M M T, despite their extreme focus on the size of the govt deficit.

  • Tom Brown

    There’s more too that Galbraith thread, with a reply by Simon and Rowe and comments by Edmonds among others:

  • Tom Brown

    Geoff, O/T: I thought of you when replying to Nathanael here. It wasn’t necessary to describe it the way I did, but I’ve seen people make that argument that Nathanael put forward more than once, and I don’t think it’s quite right.

  • Alberto

    Any economic school which doesn’t consider that we’re about 7,5 billions (and increasing) and living in a finite world with finite resources (which are depleted at a faster rate than natural replacement) cannot answer to the problems of today. It’s time to build a totally new economic theory. One of the few which is trying is Charles A.S. Hall, Professor Emeritus at Syracuse:

  • Johnny Evers

    Isn’t there a ‘classicist’ schools which views recessions as being caused by things outside the system — an oil embargo, a war, a demographic event, political corruption, weather, deterioration in social capital, changes in job participation, etc.
    So if you have a shortage of oil, for example — you can fiddle with interest rates, or you can try to ‘stiumulate’ the economy with tax cuts or deficit spending — but you’d be better off trying to find alternate sources, or, as we did in the 1980s, establish ourselves as the military defender of the oil fields.
    This has always made the most sense to me.
    You can look at today’s economy and see several events that are limiting are growth.

  • Tom Brown

    There were classical economists: Adam Smith, David Ricardo, John Stuart Mill, Jean-Baptiste Say, Karl Marx, etc. One of the things they espoused was the “Labor Theory of Value.” I think that died with them: after the marginal revolution.

    Maybe what you’re looking for is RBC? From what I understand (which isn’t much), this group started off as regular neo-classicists, but then jumped on the “Lucas critique” in a big way… so far that they went well past Friedman, etc. Ed Prescott is one of them. Kydland is another. Ed’s the one that says it’s a “scientific fact” that the CB doesn’t make any difference whatsoever. RBCers are all about “real shocks.” I think they also claim there’s no such thing as stickiness: wages, prices and debts are all perfectly flexible in their world.

    Well, I’ve butchered history and economics pretty thoroughly there… I think my work is done here! :D

  • Tom Brown

    Also, Lars Christensen, in making fun of RBCers put it like this: there is no involuntary unemployment to an RBCer. If productivity takes a dive it must be from a real shock or more likely lazy workers all decided to take holiday at the same time. I’m paraphrasing there. He said he was joking… kind of.

  • Johnny Evers

    I was reading the Undercover Economist who divided the two camps into the Keynesians and the Classicists, who believe recessions are caused by outside shocks.

    ‘Lazy workers’ … economists get into pejoratives. More neutral to say people are getting out of the job market or working less or finding themselves without the right skills or losing jobs to overseas workers — and ask what can be done.
    The last time we had a serious economic debate in politics was 1992 with Perot.

  • Tom Brown
  • Johnny Evers

    I find your arguments to be on target.
    Generally, I find discussions about resources and socio/political, scientific/educational, cultural factors to be far more interesting than any of the economic schools cited in this post.
    Keynesians, Post-Keynesians and Moneterarists — maybe the arguments are so bitter because the distinctions are so narrow and ultimately meaningless as far as having any real impact on the economy.

  • Johnny Evers

    Tom, I don’t even think there is a business cycle.
    At least not in the sense that you can predict what will happen next with any certainty just by looking at the cycle.

  • Tom Brown

    I don’t know if either the RBCers or the Austrians (with their own business cycle theory: ABCT), say you can predict what will happen in the “cycle.” I’m pretty sure Austrians wouldn’t say that… they don’t like predictions in general AFAIK (although they make them sometimes anyway: like Bob Murphy predicting hyperinflation).

    Also, you might like this: it seems Sadowski has a special place in his heart for RBCers:

    I’ve wagered my whole economic life on the defeat of RBC. … Kydland and Prescott’s work is a tough sell to me. You don’t seem to get it. As far as I’m concerned they are the dark side. I’ll combat with every ounce of energy I have into the darkest corners of hell

    I knew I had to save that quote when I saw it! :D

  • A H

    Yeah I meant, that New Keynesians policywise are closer to monetarists.

  • JK

    Cullen, are you sure about this?: “Involuntary unemployment is not caused by the deficit being too small. It is caused by capitalists maintaining a buffer stock of unemployed people to manage their own business risks.”

    It sounds like you’re suggesting that ‘capitalists’ (< you should define that) are purposely colluding to maintain an unemployed buffer stock. No doubt an unemployed buffer stock has some benefits for employers by keeping wage-pressure lower, but it seems to me that unemployment is systemic and endogenous, not a purposeful choice made by colluding capitalists. Besides lobbying efforts, aren't businesses generally making hiring decisions at the micro level?

    Care to elaborate?

  • Cullen Roche

    They’re not colluding. It’s that the market for goods never clears. Capitalists always carry inventories or a buffer of supply that won’t clear. There is no price at which markets clear completely because that’s just a completely unrealistic presentation of how the goods market works. And this means that capitalists have costs they haven’t covered. So, in the aggregate, some output goes unsold which is the equivalent of some unemployment remaining. If capitalists could hire everyone then they wouldn’t be managing their risks because they’d be assuming that the goods market clears permanently and that they can afford to maintain full employment. Instead, they know the goods market doesn’t clear so unemployment results.

    This has nothing to do with government deficits. It’s a function of any capitalist economy. I think Mosler and MMT factually misrepresent this point. Do you disagree?

  • JK

    Ahhh, I see what you mean now. I hadn’t thought about it that way before…. that in the aggregate goods will never clear because keeping a bufferstock of inventories is part of what capitalists do.

    Does this necessarilly cause unemployment? It would seem so. I will be thinking about this!

  • Cullen Roche

    I’ll certainly be interested to hear if you have any further thoughts on this. Always love your open-minded approach to things.

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