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Market Monetarist Methodology – Markets rather than econometric testing

When I wrote my book on Milton Friedman (sorry it is in Danish…) a decade ago I remember that the hardest chapter to write was the chapter on Friedman’s methodological views. It ended up being a tinny little chapter and I was never satisfied with it. The main reason was that even though I was and continue to be a Friedmanite in my general (macro) economic thinking I did not agree with Friedman methodological views.

My methodological views were – and I guess still are – pretty Austrian. In Ludwig von Mises’ “Human Action” the first sentence of Chapter one is “Human action is purposeful behaviour”. Mises and other Austrian school economists claim (I think more or less rightly) that all economic theory can be deducted from this dictum. That view kind of clashes with Friedman’s positivist thinking – that theory has to be empirically tested.

All in all, Friedman would probably have been happier about today’s Nobel Prizes in economics than I am (See my earlier post). That said, over time I have come to appreciate Friedman’s methodological views more and more and I no longer think that there is such a big conflict Friedman’s methodological views and the views of the Austrians. But yeah, I am pretty much like Friedman – you write one paper on methodology and then you forget about it. So maybe you might want to stop reading now.

However, in my paper on Market Monetarism I tried to find to common methodological views of blogging Market Monetarists. That said, you could have reached a Market Monetarist position coming from a deductive perspective (that is more or less how I have arrived here) or you could have come to your Market Monetarist views via econometric testing that tells you that Market Monetarism is empirically correct (the method Friedman recommend). So when I talk about methodology here it is clearly in a relatively broad sense.

Given that Market Monetarism as an economic school is very young and only really “live” in the blogosphere, it is difficult to discuss a methodological approach. However, there are some common attitudes to methodology among the Market Monetarists.

In particular, I highlight the following methodological commonalities.

1. Sceptical view of “large scale” macroeconomic models. The Market Monetarists tend to dislike the kind of large-scale macroeconomic – typical New Keynesian – models that, for example, most central banks utilise. Rather, Market Monetarists prefer simpler, smaller models and dictums.

2. “Story-telling” and a general case-by-case method of studying empirical facts rather than using econometric models. This is due to the Market Monetarists’ view of the monetary transmission mechanism as basically forward looking. Despite significant progress in econometric methods, common econometric methods basically cannot handle expectations and therefore any econometric study of “causality” is likely to be flawed, as monetary policy works with “long and variable leads”.

3. Market Monetarists’ preferred empirical method is to combine actual knowledge of relevant news about, for example, monetary policy initiatives with analysis of market reactions to such initiatives. As such, Market Monetarists’ methods are highly eclectic.

4. Market data is preferred to macroeconomic data. As markets are assumed to be efficient and forward looking, all available information is already reflected in market pricing, while macroeconomic data is basically historical and as such backward looking.

5. Economic reasoning rather than advanced maths. Market Monetarists base their thinking on rather stringent economic theorising and reasoning but are very critical of the kind of mathematically based models that dominate much of the teaching in economics these days.

That’s my two cents on Market Monetarist methodology, but don’t take it to serious – or at least that is what Deidre N. McCloskey would tell you. McClosky’s book “Knowledge and persuasion in economics” is that latest (of very few) book that I have read on Methodology. In it she tells us (page 32-33):

“Economists march to and fro under different banners, raising huzzahs for different candidates for the Nobel Prize. Party loyalty provides a career. The young upwardly mobile indoctrinated economist (YUMIE) always votes at his party’s call and never thinks of thinking for himself at all. Yet the existence of schools fits poorly with the receive theory of science. The theory most economists espouse says that “findings” will “falsity” the “observable hypothesis derived from higher order hypotheses” and then of course everyone will change his mind. But nobody changes his mind. The number of economists who have abandoned a hypothesis and have admitted so in public is close to zero. But that turns out to be true also of the Science that economists think they are emulating”.

I tell you, she writes like that all through the book! At the end you are slightly embarrassed to be an economist, but then after five minutes of putting down the book you are back to you all sectarian habits. BOOO! The Keynesians are clueless and so are the Austrians!

(BTW BUY that book it is damn good!)

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3 Comments

  1. Jens

     /  October 10, 2011

    To me, it looks like the market monetarists have adopted much of the New Keynesian methodology, and reading Christensen (2011) market monetarists actually seem to have a lot of praise for the New Keynesian approach – or at least the New Keynesian Phillips curve. The New Keynesian framework actually combines economic reasoning AND advanced math. To me, that creates stronger arguments. But anything labelled “Keynesian” seems to be a profanity in market monetarism 🙂

    If the revolutionary market monetarists are to succeed and convince Bernanke et al., why not beat them at their home turf? Hence, if central banks count on various New Keynesian like models, why not start deriving the ideas of market monetarism from the New Keynesian model? Since, market monetarism emphasise level targeting and expectations, why not consider price level targeting, which has gained substantial support in the New Keynesian model?

    Nonetheless, keep of up the good work Lars! Always a pleasure to read your stuff.

    Reply
  2. Jens, we have a deal…this looks like we will be working on a McCallum-Christensen rule in a New Keynesian model set-up;-)

    Reply
  3. Brito

     /  October 31, 2011

    “3. Market Monetarists’ preferred empirical method is to combine actual knowledge of relevant news about, for example, monetary policy initiatives with analysis of market reactions to such initiatives.”

    I would argue that this could be easily tested econometrically, the advantage is that it clarifies the evidence and removes ambigiuity.

    Reply

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