Back in Keynes’s days, academics and practitioners weren’t as siloed as they are today – Interview with Professor Perry Mehrling: Part 1

Professor Mehrling (PhD in Economics from Harvard University, MSc in Econometrics and Mathematical Economics from LSE) is a monetary economist and a historian of economic thought. Lifting useful observations from the financial worlds of the past, such as Bagehot’s or that of Bretton Woods, Professor Mehrling’s research and teaching open a fascinating window onto today’s financial world and make sense of its complexities.  His views have influenced policy-makers at central banks, financial regulators and broader financial market participants in the US and beyond. He is the author of several well-received books – including The New Lombard Street: How the Fed became the dealer of last resort – and a number of academic papers while his highly-rated online Coursera course has attracted more than a hundred thousand people from all walks of life.

In October 2018 the MNB Department at the Corvinus University of Budapest was delighted to welcome Professor Mehrling who delivered an enthralling presentation on the challenges of monetary policy and shared additional thoughts, peppered with personal reflections, on broader topics during an interview. This blog post is the first of two covering the interview, and focuses on the basics of the money view and its relationship with economics and finance. The next post will delve into the global currency system and challenges facing central banks.

Eszter Baranyai (EB): Your name tends to be closely associated with the money view. How would you describe the money view at its simplest?

Perry Mehrling (PM): At its most basic the money view emphasises two concepts. First, the so-called survival or settlement constraint, namely that in a payment system participants need to acquire cash for a point in time to honour their obligation to pay, and they may do this using credit – hence both the payment and the credit systems are of crucial importance. Second, the budget constraints of the intermediary – or dealer – determines the market price of credit, in both money and capital markets. In other words, the levels of inventory at dealers have a direct bearing on market prices. Dealers – and how they make money – play a central role in the model.

Also, the money view tends to view the world in balance sheet terms: each entity, be it bank or individual for example, is thought of as a balance sheet – assets and corresponding liabilities.

Market practitioners from banks and central banks (rather than theoretical macroeconomists) have long appreciated these points; nevertheless I see my contribution over the past two decades or so as largely twofold. I connected the dots and I systematised the points – with the latter essential for pedagogical purposes. It is therefore now possible for students to appreciate how the financial world works in practice without having to spend 5-10 years as a market practitioner.  A further confirmation of the practical nature of the money view is that it – unlike typical macroeconomic models – does not make many assumptions.

EB: Where does the money view sit with respect to economics and finance?

PM: In what we may call the economics view, the past determines the present, insofar as current production is the consequence of capital investments made in the past.

In finance the future determines the present as current capital values are measured by looking ahead: forecasting future income flows and discounting them back to the present.

The money view in contrast to both the economics and the finance views looks mainly at the present only. At the end of the day cash inflows need to be sufficient to cover cash outflows – a period much too short for elasticity of production or consumption, the usual subject matter of economics.

Also, macroeconomists tend to think of nation states as units of analyses, GDP areas and decision-making units (the triple coincidence). Whereas this approach may have been appropriate in the 1950s and the ISLM models of those days, today’s world is significantly more global, in fact in this respect much more similar to the world 100 years ago than that of 50 years ago.  Contrary to economics, the money view takes a global view.

EB: An important message from the money view is that liquidity – provided by dealers – has its price and this has not been appreciated in economics and finance. Do you see a possibility to fold the money view into the more traditional economics and finance theories rather than keeping it as a separate lens?

PM: I think macroeconomists will be the last group of people to adopt the money view but of course that would be the ultimate goal. Interestingly, in fact, the money view concept is not alien to economics in its earlier form. Keynes can be viewed as a money view economist, partly because at the time academics and practitioners weren’t as siloed as they are today. Keynes – very much a man of the City (London’s financial district) – was thinking in balance sheet terms, demonstrated by his thoughts on spending and income.

Unfortunately, later the growth view – DSGE models – took over macroeconomics. Earlier in my career I taught macroeconomics but with the rise of DSGE models I chose not to as I had serious doubts about their usefulness. The choice to turn away from macroeconomics probably had a negative impact on my career at the time. Nevertheless, based in my office in the basement of Barnard College, I took pleasure in turning to my Money and Banking course (i.e. the money view). Due to little interest from other colleagues, I didn’t have to worry about stepping on others’ toes and, in any case, I prefer to be in competition with a problem rather than with others. I had also taught finance but later preferred to focus on money and banking.

EB: With a background in both mathematics/econometrics and history, what is your view on the criticism[1] sometimes levelled at mainstream economics, notably that mathematical models play an unduly large role in the field to the detriment of other approaches and necessary elements, such as developing data, undertaking qualitative research or studying history?

PM: Mathematics is a crutch, not an enemy. It helps conceptualise ideas, repeated calculations enable the development of intuition.

That said, mathematics is far from enough on its own and I do sympathise with the students who are pushing for more, even if at times they struggle to spell out what exactly they are after.

The crux of the problem is that typical macroeconomics has drifted away from the real world. Finance is also reliant on mathematics, yet seldom do we hear accusations of that field’s overreliance on mathematics, quite simply because those models are useful. My classes often start with an FT article and exams also include a recent FT article that students need to be able to explain to their grandmother using the balance sheet method.

EB: The money view has garnered much interest worldwide. What role did the crisis have in its growing popularity?

PM: I had developed the money view prior to the crisis and was in fact planning to go on a sabbatical year to write a book about it.  But as the crisis unravelled I felt it was my duty to assist the public sector in its response. The decision to come out of my comfort zone of books, research and teaching and into the public arena was not an easy one. In any case, my main value-add was that I saw the crisis not just as one of solvency but, importantly, also as one of liquidity – a point not adequately recognised by many. I wrote a letter to the Financial Times that engendered huge interest from both the Congress and the Fed.

In 2010 I then published my book titled „The New Lombard Street: How the Fed became lender of last resort”, in which I talk about the route to the crisis, the Fed’s changing role and the importance of the money view. The book continues to be bought worldwide.

Nevertheless, what really made a big difference in the popularity of the money view among the wider public was the recording of my money and banking course by the Institute for New Economic Thinking and its upload onto Coursera.  People from around the world – with many from Asia and Europe – and from backgrounds as diverse as IT or law took the online course. I think that the popularity of the course lies in enabling the wider public – even with little economic background – to understand how the financial system works, and giving them a common language in which to speak to each other. It demonstrates that the operational jobs – which some may have regarded as tedious – are indeed important. So much so, that in fact during the crisis theoretical economists knew little how to respond to the crisis while money market specialists did.

Eszter Baranyai

[1] The relationship between mathematics and economics is discussed in more depth (in Hungarian) on our blog here and here, and footage of a conference on the reformation of economics (in English) together with a short summary are available here.

The second part of the interview can be read here.

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