Thomas Carlyle, the Scottish writer, and philosopher, called economics the dismal science. They’re filled with unnecessary complexity, pointless jargon, and theories that have been dead and buried for decades. While economics as a discipline has progressed, the textbooks used today are stuck in the dark ages.
Macroeconomics: An Introduction by Alex M Thomas, though it’s meant to be a textbook, it doesn’t read like one. It’s a brilliant book that weaves classical economic theories with excerpts from wide-ranging Indian literature to highlight the structural, social, and cultural complexities of the Indian economy. It’s one of the very few books to do so.
Apart from just making macroeconomics more relatable, Alex introduces an alternative approach to understanding macroeconomics, which questions the dominant (marginalist) approach. This alternate approach is inspired by the works of the old masters like Adam Smith, David Ricardo, Karl Marx, John Maynard Keynes, and Piero Sraffa.
We learnt a lot while recording the podcast and hope you enjoy listening to the conversation as much as we enjoyed recording it.
Link to the book:
In this episode, we discuss about;
0:00- Introduction
1:27 - About Alex M Thomas
4:51 - What is political economy?
6:35 - Theory of interest rates
10:11- Why should you read this book?
11:29 - The problem with economic teaching
14:41 - How is this book different?
15:41 - The dominant (marginalist) approach
18:57 - How to approach economics
22:32 - The economy as an embedded system
26:10 - Theory of wages
29:52 - Marginalist theory in policymaking
34:15 - Theory of money
44:15 - Modern monetary theory
You can also listen to this episode on the podcast platform of your choice.
Transcript
Hi everybody, welcome to another edition of the Zero Educate podcast. Today we have with us Professor Alex Thomas, who teaches at Azim Premji University. And the interesting thing about Alec Professor Thomas is that he’s come up with a new book called Introduction to Macroeconomics. Now, why are we talking about this book is because of the way it differs from the traditional textbooks that we’ve been reading since we been studying economics as we grew up.
So the first thing that differentiates this book is that this is written by an Indian, and the context of the book is very Indian. The examples that are given in this book are very Indian, so it doesn’t seem foreign and this book touches on a lot of sensitive topics like the role of caste in let’s say labor mobility, the role of gender in a patriarchal society in India and this differentiates this book from every other piece of literature that’s available out there. So in this podcast, obviously Professor Thomas talks about this book in general, but he also delves into the specific chapters to give you guys an understanding of how he thinks about this book and how this book is structured.
And we also touch about topics from outside of the book. Let’s say for example, the modern monetary theory, which has been invoked since he’s written this book. So it came a little after this book. So this is pretty much what we’ve covered in this podcast, and please tune in to look into the integrities of Mr. Alex Thomas’s take on macroeconomics in a very desi and an alternate way.
Abhinav: Hi Alex, thank you for joining us and I’ve had the privilege of going through your book, which is just an amazing piece, and that’s why we decided to come and speak to you. So before we begin with this podcast and start talking about your book, could you just tell us a little about yourself, about where you’re from, how you went into economics, and what you’re doing currently?
Alex: Thanks Abhinav, and I’m very happy to be here. Although I’ve spoken about my book at different universities and colleges, I think this is the first time that I’m talking to a very different audience, who are primarily interested in financial markets. So, and I mean, on the question of financial market, I think it also ties to a little bit about one of the motivations to do economics is when I was a student, I think I was in class 10 or 11 and when I went through the newspapers there used to be this towards the end, 2-3 pages of text where the stock market prices and the names used to be mentioned and I was very curious about hat these prices are, what this pages meant. And I remember actually going to maybe in the holidays to one of the local places where people went to trade. So I did spend some time there. This was in a place called Chettikulangara in Kerala, which falls within the Alappuzha district. So there is some connection between, I think, this podcast somewhere and my motivations to do economics.
And since then, I have pursued economics, various degrees and one of the things that I’ve always been interested in is how to teach economics, because as a student, I often felt that the teaching of economics could improve whether it was about the material, whether it was about the pedagogy, there was always things that I thought one could improve on. And then in this kind of reading and my exposure to various kinds of economics at the University of Hyderabad, I then started pursuing political economy more seriously. And in fact, also related to it, I was also interested in the history of economic ideas. So for my MPhil and my Ph.D., I continued to work on history of economic thought and political economy.
And in fact, many of these elements of political economy and history of economic thought are present in my book, and maybe I’ll just take this opportunity to just show this copy of the book because the kind of illustration that is there in this book, at least in the cover page of the book, also highlights history of economic ideas explicitly. I teach economics at Azim Premji University in Bangalore and I also do research in the areas of political economy and history of economics.
Abhinav: Yeah, thanks for the brief intro. Could you just share that book again because I think there was a blip in between. So we’ll also drop a link in the description for readers who are interested in this book. So I have personally read this book and I really recommend that you go through this book because it’s a very Indianized way of teaching microeconomics to anyone.
Also, before we move on further, there’s a very simple question that I have, could you explain, the history of economic ideas is self-explanatory. Could you explain what political economy means?
Alex: Sure. I mean, I think maybe one of the basic ways of explaining is that what determines if we ask the question, what determines the prices of commodities? And if you ask most students who are going through a mainstream economics education and curriculum, the answer will be demand and supply. And if we dig a little bit further it’ll be some element of utility or marginal utility that students respond with. But if we ask the same question to those working in the political economy tradition, the answer is different. People might say that it is labor theory of value, which essentially means that the prices of commodities are determined by the labor that goes directly and indirectly into the production of commodities.
So I mean, this is just as a kind of brief illustration to talk about the differences between these two schools of thought, in the mainstream school of thought you have utility or some variant of utility as determining prices. Whereas in political economy tradition, you have one of the traditions in political economy, you have labor as determining the prices of commodities. So even with something as basic as what determines the price of commodities, I would say that these two are distinct paradigms which try to explain various kinds of economic phenomena in our society.
Abhinav: Okay. Thank you for that. So I have a very simple question. Let’s say from like an average listener of us. So let’s say I’m a layman, right? And I am only interested in finance or stock markets, for example, and maybe I want to know a little bit about economics. So why should I care about this subject? In the sense that why should I know how economics is taught in school or colleges today, and how your book teaches it differently, and what are your motivations behind this book?
Alex: Yeah. So actually, I mean interestingly, I was having a discussion about the rate of interest with a close friend of mine in the last couple of days. The question of what determines the rate of interest is of importance to people who want to understand the stock market/finance, and also historians of economic thought, particularly who are looking at monetary economics and macroeconomics and certainly for economists in general. And I just want to give a brief overview of the discussion that we had, because I think it sort of ties to the question that you’re asking and then I’ll explain a little bit about what I do in the book.
If you take a sort of large history of how interest rates have been understood, going all the way back to somebody like Thomas Aquinas, who was influenced by Christianity, but also by Aristotle. At the time that Aquinas’s writing, the argument is that any kind of interest rate is bad or you talk about usury is bad and the logic that was given was time belongs to god, so therefore nobody should be able to make a profit off time. Then later there’s been another kind of idea of interest rate, which used to say that it depends on how much you prefer future consumption over present consumption.
This in the literature is sometimes called as time preference. So rate of interest is also being understood as a rate of time preference. Now, there’s another kind of an associated with this is sometimes the idea of equilibrating saving and investment. So people talk about saving and investment and rate of interest as equilibrating savings and investments. And today, central bankers draw upon this kind of idea, the rate of interest is time preference. As also equilibriating saving and investment and it is in this context that the central bankers and economists talk about the natural rate of interest.
Now, the idea of natural rate of interest is a mainstream idea and one of the alternative ideas that has come from the political economy tradition, including economists as famous as Keynes, Is the idea that rate of interest is not, there’s nothing natural about the rate of interest, it’s not determined in any particular market for saving or investment, but rather it is a convention. It is set by people who are in important positions of power. So in the mainstream kind of idea, the rate of interest is determined by the market, by people. Whereas in the alternative political economy tradition, the rate of interest is set by policymakers or people who are in power.
And depending on your theory of the rate of interest, the kind of policymaking that one would do would also differ. Now, having said this, what I wanted to do then was to communicate to people. I mean, primary audience for my book is certainly students who are studying about economics, but also I wanted to talk to people who are generally interested in macroeconomics and the Indian economy. Because for instance, people who want to choose a particular policy or, you want to vote in elections, how do you distinguish between various kinds of economic ideas? So this, I mean, as a kind of input into this kind of thinking, I wanted to give to the readers the idea that there exist multiple paradigms, multiple schools of thought, and economics. Whether it’s microeconomics or macroeconomics, there always exist multiple schools of thought.
And I provide, my readers with two schools of thought. One is the dominant school of thought and the other is the political economy tradition. So in this manner, the readers of this book are able to get a sense of what is the mainstream telling us. What are the kind of critical questions and limitations of this kind of a school of thought and what is political economy telling us, and how are we able to use the political economy tradition to make sense of our surroundings.
Abhinav: Okay. So, Alex, I’m very glad that you touched upon this topic because my next question also emanates from this, the idea that there is a dominant approach, which in your textbook you call the marginalist approach and then I also like how you follow up pluralistic approach in the sense that you tell people that economics is not necessarily one stream of thought. It’s as much as an art, as a science and there are different streams of thought which could be arriving at either similar conclusions or different conclusions, but they would follow completely different parts and all of them could actually be right and all of them could actually be wrong, right?
So in this slide, could you please tell our listeners what is the dominant or the marginalized approach that is being followed today? And could you give some examples of the pluralistic approach that you followed in your book?
Alex: So maybe first I’ll talk a little bit about the teaching of economics itself. And, when I say teaching, it’s not just formal teaching of economics, I think in universities and colleges and in schools. But it’s also economics education in general, what is there on social media, what we get from books in general, when we talk of mainstream economics, we are really talking about literature in general.
One of the things, and especially in India, what we see is that most of the curriculum, and most of the textbooks are written by people who are teaching in America, for instance. So one of the most famous textbooks is that by Manque and earlier it was by Samuelson and two things that they do. One is that in their textbooks, they promote the idea that there is only one school of thought. Which is the school of thought that they’re working in, and which is what is called the Mainstream School of Thought or the Marginalist School of Thought and I’ll explain what that means in a few minutes. And the other kind of issue is that because, and this is not an issue for them because they are teaching American students.
So all the institutions, all the examples are American in nature. But when we choose these books for educating our people here. I think that there is an issue because we are not able to relate to many of these kinds of examples and institutions. Although I think it’s important that we know what these institutions are, but I don’t think it’s primarily, I mean, we need to be able to bring in Indian institutions into a curriculum and this kind of an approach that believes that there is only one school of thought is what is called Monism, generally in the literature.
What I sort of espouse in my book and many others have spoken about it, is the idea of pluralism, which is to say that even when it comes to the question of what determines the rate of interest, what determines prices, what determines inflation, what determines employment, there are at least two schools of thought in economics.
And not just that, in addition, people who work in the alternative traditions continue to publish, continue to do research in these areas, and they have associations, conferences, journals. But when you read textbooks that are mainstream, you don’t get a sense that there exists another school of thought. So my attempt really in my book has been to show to the readers that there exists this school of thought. There’s also a lot of literature in the political economy tradition, and by pluralism, I mean, although in my book I don’t really go into pluralism in all these aspects, I think that what I do in my book is to talk about pluralism with respect to economic theory.
So as I mentioned before, what determines prices? What determines wages? What determines employment? What determines growth? What determines inflation? Let’s say these five different questions. In my book, I show that there are at least two paradigms, two schools of thought, which give different explanations for these questions. And according to me, there are several dissatisfactions, theoretical and conceptual, with the mainstream school of thought. And therefore, my preference has been to adopt the political economy school of thought in trying to make sense of the Indian economy.
Abhinav: Okay. So before we move on, could you just explain in more some simpler terms, basically what the marginalist approach is, because that’s the dominant approach that’s been taught in our schools and what exactly does it mean?
Alex: Yeah, thanks, Abhinav. Actually, I forgot to do that in my previous answer. So let me just go back to a school textbook which is whether it is an ICSE syllabus or the CBSE board. One of the things that people do with respect to the definition of economics is that we are taught that first Adam Smith gave a definition, then Ricardo gave a definition, then Alfred Marshall, then Lionel Robbins, and then Paul Samuelson. By the time it comes to Paul Samuelson, Lionel Robbins, and Alfred Marshall, the definition of economics has changed, and the definition of economics is more to do with allocation. Unlimited wants limited resources and the question of choice. So in the definitions of Marshall, Lionel Robbins, and Samuelson economics has become a signs of choice.
That’s one part. But if you take a look at Smith and Ricardo, economics is understood as a signs of income, a signs of production, signs of how do you distribute what you have produced. So in our school textbooks, and even in latest textbooks, we are taught that the definition of Samuelson is an improvement over the definition of Adam Smith. So this kind of a viewpoint suggests that there is only one economics and we are just improving over the previous economics. So this kind of a viewpoint I challenge in my book by saying that there are two kinds of economics and we have to understand that there are two distinct kinds of economics.
Now, what is this approach that is proposed by people like Marshall, Robbins, and Samuelson. All of them make use of reasoning at the margin. So reasoning at the margin is not something I think human beings do generally, unless we are trained in economics or mainstream economics. But in any case, these economists use terms such as marginal cost, marginal revenue, marginal product, marginal utility, and for instance what is marginal product? The explanation that is provided is that if you have a production process and we employ one additional worker, what is the addition to the total product? So you have one worker gets added, and how much does this one worker add to the total product? So that is how you have marginal product and this kind of a term or concept is used in the context of consumption, then you have marginal utility in the context of revenue, you have marginal revenue in the context of cost, you have marginal cost.
So this module concept is very widespread when it comes to mainstream economics and again as I mentioned earlier, I think that this is just one way of reasoning. But the way in which it has been set up seems to suggest that this is the most rational way of reasoning and the most efficient way of reasoning and this is what leads to certain outcomes.
Abhinav: Thanks for explaining this. I’m glad that you touched upon this topic about multiple definitions of economics existing and every definition coming with its own time, with its own ideologies, with its own reasons. So that brings me to the question that you also talk about in your book, wherein you say that before we move on to what is economics, let’s try to understand why economics, In the sense that what are your motivations behind economics? So what exactly do you mean by that and how much of an impact will it have on someone’s view of economics or understanding of economics?
Alex: Yeah, I mean, in a way my motivation for writing that is because very often we tend to study economics maybe to understand the social world. Sometimes it is to understand the financial market. Sometimes it is for policy making. Sometimes maybe you’re just interested in the subject, but what sometimes seems to be happening is we break what we teach based on what students are interested in. So a management institute might think that it’s not important to teach history of economic thought or economic history because it’s primarily interested in managerial questions. Or a university might think that it is not very important to talk about, let’s say managerial economics or financial economics because it has got more to do with the corporate sector or the financial sector.
But I think what I show in that I think it’s a very small section, is that there are a lot of interconnections in the system. So what happens in the monetary sector has an impact on the financial market. What happens in the financial market has an impact on rural India. What happens in rural India has an impact on inflation and therefore on other prices.
So unless we are able to understand the interconnectedness of many of our phenomena, the education that is then sort of parceled out depending on, you know, what people’s interests are and what the central audience is, sometimes can be piecemeal. So if I’m studying ecological economics, I might just look at certain aspects of the economy and not look at others and what I try to do in the macroeconomics book is that try to give a holistic perspective because otherwise, I feel today information is extremely fragmented and on social media, sometimes we get a new idea and then we work on it, but often we are able to not really see the links between various parts of the economy.
So, which is why, you know, it’s not traditional in the macroeconomics book to even talk about sectoral issues or to talk about more micro issues or individual level issues. But I’ve done that in my book because when we are trying to make sense of the macroeconomy, we also need to be going back sometimes to individual units, sometimes to sectoral units and trying to make that connection sometimes and even pedagogically and even for understanding a topic, I think that it becomes helpful.
So in short, my response is the why economics sometimes makes us fragment our study of economics. And I think that this is detrimental to what is it that we actually want to do, whether it’s journalism, whether it’s policymaking, whether it’s to engage in politics, because of the structural interconnectedness that exists within the economy.
Abhinav: Okay. So initially when we started talking about in this podcast we talked about how currently most of the books are written in the west and it’s okay, right. We’re not blaming them, they’re writing for their own audience, they are coming up with their own ideas and way of understanding their economies. But you, on the other hand, talk about like how one should view the economy as an embedded system, right. Wherein your history of the country, culture, the political power-sharing arrangement, caste, panchayat, gender, et cetera, does play a role and therefore you say that economic outcomes are strongly mediated by social and community norms.
Like could you give an example of this? Let’s say we should talk, let’s say we talk about something as simple as labor mobility, right? Because a lot of western societies will assume that labor mobility does happen. While that may not be the case in India.
Alex: Yeah, actually, thanks Abhinav for highlighting this point because, I mean, I think that people after the ecological kind of revolution and people’s recognition we have, I mean, or many of us have come to take ecological concerns into how we understand economic issues. I think the social concerns are still, I mean, it is an ongoing process and there have been some attempts at it. So for instance, now in certain universities, people, even in Azim Premji University we have a course on feminist economics. There are discussions whether we should have a course on stratification economics or the economics of caste or the economics of gender
and several universities are slowly offering courses in these subjects. But again, as I mentioned before, sometimes they become sort of outside the kind of, you know, core courses and my attempt in this book is whether we teach microeconomics or macroeconomics in India particularly, it is important that we discuss issues relating to caste, gender, religion, these kinds of social factors because they are absolutely central social factors and social characteristics of the Indian economy.
So now to move on to some, a kind of example and some of these discussions I also have in the later chapter, I think it’s chapter seven on employment where I talk about how gender and caste, I mean, how to break down employment when we try to break it down by these two social characteristics.
Abhinav: Could you elaborate this a little, this idea, because this topic of employment is really sensitive and in the news, and I’m sure the listeners want to understand more about your views on this.
Alex: Yeah. So what I do in my book is to, I mean, this is taken from some of the data that is there in the employment-unemployment survey and subsequently worked on by my colleagues at the Center for Sustainable Employment, and they brought out this report called the “State of Working India”.
So what this kind of a data, and this is on page 149, actually show is, depending on your caste, the kind of employment that you get into is very tight to it. So for instance, SC and ST groups are overrepresented in poorly paid occupations, and what you see is that upper castes are overrepresented in well-paid ones.
So there is some kind of a selection happening there and it is somewhat similar to the question of women as well. But now moving back to the first question that you asked, if we are, I mean, the question of wages, I want to go to the question of what determines wages in an economy. Again, if we ask students who have studied mainstream economics and have gone through a mainstream education, most of them are going to tell us that wages are determined by demand and supply of labor, and if you again, probe a little bit further the answer will be that it is wages- real wages are determined by the marginal product of labor, and this is, we are assuming it’s a perfectly competitive economy and equilibrium situation. So again, the idea of marginal productive labor becomes important.
And within this school of thought, your productivity or what you contribute to production is what you get as wages. In the political economy tradition, the argument is that real wages are not determined through market forces but it is determined largely as a product of history and culture. So what the political economy tradition suggests is that even if you have, I mean some kind, even if you think of a competitive economy, still the kind of determinants of wages in the patriarchal society would be such that men are paid more than women, and this is coming out of particular cultural arrangements that we have in society. So on one hand, in the mainstream marginalist tradition, wages are seen to be determined by demand and supply. Whereas in the other political economy tradition, there is a recognition of historical and cultural factors and what I’ve done in my book is because there is this recognition in the political economy tradition of historical and cultural factors, it has been easy for me to introduce the issues of cast and gender that we have in Indian economy within this kind of a framework. Now, I want to just add one more point to this discussion.
One can wonder, you know, one can ask the question, why does it matter? You know, you have two theories, okay, fine. But the implication is that if I’m only exposed to marginalized economics and I believe that wages are determined by the marginal product of labor, then my policy suggestion could be that one, we need to have perfect competition, we need to have more competition in the economy and it also legitimizes, it also justifies when there is a low demand for labor or an excess supply of labor, that it is okay for wages to fall. Now, this is a very kind of problematic thing because what is our concern, our concern in a way should be the wellbeing of people and if so, wages should be, I know what we are interested in, but just to ensure some kind of economic equilibrium. How can we justify the lowering of wages below a certain level? Whereas in the political economy tradition, it is understood that wages have to include, let’s say some aspect of, education for their children, some kind of food, clothing, et cetera, et cetera.
So there is an understanding that this is determined through certain customs in the economy, and it certainly cannot legitimize the lowering of wages below this kind of a customary limit, at least theoretically. Now, politically what happens is a separate matter, but I think that when we are engaging with these kinds of theories what it tells us is whether a particular theory legitimizes certain kind of market forces or government action, and we need to be critical of some of them.
Abhinav: Okay, so at least in the state that you come from Kerala, we see that the government is cognizant of social friction, right. In terms of wages, like the people in Kerala are better paid than other people in the sense that the government does realize that there are social frictions, there are certain floors that have to be maintained. So that’s there.
So there’s another question that I want to ask, right, because I keep looking at all sort of like regulatory outcomes that come into India. So how cognizant do you think are regulators of the problem that there’s associated with political economy, and is there a role that the dominant ideas in the sense that the marginalized ideas also play in policymaking? And how are these things balanced out?
Alex: Okay. So I think this is a very important question, and I don’t think that I have a, you know, full or a complete answer or a good answer for it. But, I mean, what I’m gonna say is probably some thoughts on the question itself, because very often most of the policymakers again are exposed to only, I mean, largely exposed to only mainstream, ideas and thoughts on economics.
So one of the implications certainly would be that if we take a microeconomics textbook, which is dominant again, there is this discussion on labor market, there’s a demand in supply of labor and there it’s very clearly taught to the students that if we put a minimum wage which is above the equilibrium wage, it leads to unemployment.
So the theory is set up in a particular way to argue that any kind of government intervention into the labor market is bad for the workers. Now, if one believes in this view of minimum wages, then it is likely that people will think, and it’s not because of their, you know, because they have a wrong intention in mind because they’ve been taught this. They might think that minimum wages is a bad thing. But whereas on the other hand, I think that if they’re exposed to the political economy tradition there are no two ways about it. It is very clear that these are historic, I mean, historically determined, and it is absolutely necessary that people have recourse to certain necessaries and conveniences in life.
For instance, I would think that today the minimum wage needs to include the cost of the internet because internet ought to be seen as a basic necessity because for many things we need the internet. So if we are talking about the poverty line, if you are talking about minimum wages, how do we bring in, you know, what is necessary for a dignified living?
And so in that sense, it certainly has to be cultural and historical and it cannot be simply biological, where we look at only calories. It certainly has to have a larger end of thing. Now, because you mentioned the state of Kerala in this context, in my book, I also mentioned it, while it’s true that on an average the wages the minimum wages that are given in Kerala are higher than other states, even within the state of Kerala, because of the operation of patriarchy, you notice that the wages for men are there is a disparity between wages between men and women and which is something that I note in the book.
So I think there has to be various ways in which different social issues are brought to the table so that policymakers can, you know, have a better understanding of what can be done. And are not fully convinced by the mainstream theory, and therefore do not or see certain kind of policy options as being inefficient or undesirable.
Abhinav: Okay. And I think your book does play a role in this regard in the sense that exposes anyone who wants to read about macroeconomics, that there could be certain other outcomes, there could be certain other ways of looking at things like obviously the book is very neat and idea and in a very readable format. So it’s obviously not complete in itself, complete in the sense that It touches on everything, but obviously you can’t cover everything in a 200-250 page odd book. But at least it guides the person correctly if he wants to pursue understanding things in this direction. So Alex, now we’ve talked about like interest rates, we’ve talked about wages, et cetera.
Now I want to bring you back to another very interesting topic that most people are always interested, which is money, right. And you have a very interesting take on money and before you like, I want to also tell the readers about the approach that Alex follows in the book. So in, let’s say in this chapter about money, he says that there is a financial architecture in India because we’ve, most people don’t know this financial architecture and the depth of this.
Then he explains the financial architecture, and once he’s explained the architecture, then he answers the money question within that architecture. So, Alex, could you give a brief about why you thought of this and what is the architecture in general, because so that our readers or listeners can get an idea about how you’ve constructed chapters in the book?
Alex: Yeah. So, one of the things, maybe I should start by this, is that traditional macroeconomics books start with goods and commodity market and then talk of the money market. But what I’ve tried to do in my book is to invert that kind of reasoning because again, that kind of a structure of the mainstream book have allowed people to say that there’s something called the real economy, which is the goods and the commodity market.
There’s something called the monetary economy and people like Friedman or people who follow the monetarist tradition and they’ve come in various forms, then have argued that. The monetary sector does not really do anything to the real sector, so money is simply a way money does not alter anything fundamental in the economy.
So there is this idea that what is said in the literature, money is neutral in the long run. So that’s one kind of dominant view of how people have spoken about it. And let me connect this back to the idea of natural rate of interest, because the idea of rate of interest is seen to be determined again within the real or the fundamental sphere and what is the role of monetary policy is not to tinker with that natural rate of interest, but try to set interest rates in tandem or in line with this natural rate of interest. So even the role of monetary policy is tied to what happens in the real sector, so to speak.
But I wanted to challenge this kind of perspective and this comes from, again I’m writing in the tradition of many people who have worked in this line of thinking, including political economists like Marx or subsequently Keynes, Keletsky more recently in the Indian context, people like Krishna Bharadwaj who have engaged with these ideas. Piero Sraffa who is critical of the mainstream economics. So there are many people who have contributed to this tradition, and I’m drawing on many of their work. But it is to challenge this idea of separating neatly and to argue that money is neutral. Instead, I’ve taken a position that is very proximate to the work of Keynes and also to the work of Marx.
But here I use the phrase from Keynes’s writing, which is called a monetary production economy. So I think that whether we are interested in the stock market or whether I’m interested in employment or inflation, I think that it’s important for all of us to view the macro economy or the economy as a monetary production economy where we need to understand the monetary institutions, we need to understand the production conditions.
And that’s the approach that I’ve really followed. And I’ve started off by talking about the monetary aspects and very often, again when we are taught macroeconomics, sometimes we are taught the financial architecture, but yet, we don’t really go much in-depth and for instance, there’s not so much discussion on, let’s say, informal finance. What happens to money lenders or what does the LIC do? What does the RBI do? Who regulates the insurance market? And most people in the stock market have an idea of SEBI and RBI, but there are also other regulators in the system, other players in the market. How thick are these markets? For instance, what is the percentage of Indians who actually invest in the stock market. which is a very, very, very minuscule amount. Also, we know that the percentage of Indians who pay the income tax or who are eligible to pay the income tax is also a very, very, very small amount number because we have a large informal sector. So part of the attempt in this book was we want to understand what happens in let’s say, largely the formal sector by talking about these regulators, but for a full understanding and a correct understanding of the Indian economy it is important that we also engage with what happens in the informal sector, and even the terms formal and informal, I think, needs to be challenged. Is there a better way of trying to characterize them?
Abhinav: Okay. That’s a very interesting take on this. Now I’m gonna bring you back to the core topic of money. So on page 54 of your book, you talk about this concept of money in the sense that there is endogenous approach to money and then there is an exogenous approach. So most books still now have ignored the endogenous approach, but then you also talk about a Bank of England paper that was published in 2014 which explains what this approach is, and it also endorses this approach. So for the interest of our listeners, if you could tell the difference between these two approaches, that would be great.
Alex: Yeah. So I’ll start off maybe with a little bit of, yeah. I mean this time, I shall certainly answer all the questions that you post.
But I want to start off with a little bit of history here because up until certainly the global financial crisis, I think almost all textbooks, except for some textbooks in the alternative heterodox traditions communicated the idea that what we are doing is exogenous money and this is also related to the quantity theory of money idea, which suggests that the central bank’s role is to target the quantity of money in circulation. And it is in that, that context to formalize and to account for the quantity of money that in across the world we have monetary aggregates, M1, M2, M3, and they were then used as inputs into, let’s say, inflation policy, how to understand interest rates. Various kinds of econometric exercises have been carried out within this larger domain of exogenous money.
But when the financial crisis happened, and subsequently many students across the world, many teachers expressed their dissatisfaction in mainstream macroeconomics because a mainstream macroeconomics textbook does not have any discussion on crisis. Even if there is a discussion on, at least up until the financial crisis. Now, even if there’s a discussion on crisis, it is often seen as a one-off thing. It’s seen as an aberration. Whereas if you actually read the work of Keynes or Marx, most of them or people who are working in the heterodox tradition have a full understanding of the fact that a capitalist society is prone to recurrent crisis. And it is only if we have an understanding of what are the potential problems with our society and economy, that we can formulate adequate responses, adequate policies. So if we have a theory that if we have in the mainstream paradigm we don’t discuss crisis at all then we’ll be totally blindsided when something like that happens.
So there was that kind of a demand, and when I say endogenous money, this draws on the work of people like Marx, people like Keynes. Partly I haven’t really engaged with it in this work, but people like Minsky, who have contributed to this, how we understand money. And the fundamental difference is this, in the exogenous money view, people believe that the central bank controls the quantity of money.
In the endogenous money view, people believe that the central banks can only control the rate of interest, and the quantity of money is endogenously created within the money market or the economy. So what is the difference is that in this view, the quantity of money cannot really be determined by the central bank because it varies. If there is a greater demand for money in the economy, money is created through credits and other kind of players in the financial market. So there is no kind of constraint on that. Whereas in the exogenous money view, it is also tied to the idea of rate of interest as being determined in the market.
So the natural rate of interest idea, or the rate of interest as a time preference is sort of aligned with this idea of exogenous money. Whereas if you take the question of endogenous money, the rate of interest is set by the central bank, although there can be multiple theories of the rate of interest, the one that I favor, is that the rate of interest is a conventional variable, which, a historical variable, which is set by people who are in power, to meet certain kind of policy decisions.
It could be relating to the exchange rate, it could be relating to investment, it could be relating to inflation, there are multiple policy agendas and you set the rate of interest based on that. It has got nothing to do with something called the natural rate of interest, it’s got nothing to do with the rate of time.
Abhinav: Okay, so thank you for touching upon this topic. Now, Alex, I think we’ve broadly covered, what’s there in the book, and I think listeners now have an understanding of how yours is an alternate and the easy way of understanding macroeconomics. Now, this one question that’s been bothering me is that, so your book came out and after that there’s been a lot of discussion independently around the world on the modern monetary theory, right. And the book obviously couldn’t touch upon that topic because that topic wasn’t in vogue at that point of time.
So my question to you now is, like what is your, first of all, like for our listeners as well, what is your understanding of the modern monetary theory? And has it had an influence on you? Has it changed the way you think? And if you were to rewrite this book or come up with a new edition, would this find some space in the book?
Alex: Yeah. Thanks for that question, Abhinav. I am no expert on modern monetary theory, but from my reading of it, the sense that I get is that there are many parts of modern monetary theory which align with the kind of alternative view that I’ve put forth in my book.
For one, there is certainly, I mean, it’s closer to the idea of endogenous money and modern monetary theory explicitly rejects mainstream views on public debt. And here I think I want to talk a little bit about the idea of crowding in and crowding out because under the exogenous money kind of framework the assumption is that if the governments are borrowing, it leads, it generates or it puts pressure on the interest rate and the interest rates go up and then it means that it crowds out private investment in the economy because the rate of cost of borrowing has increased. Now, this kind of a view is based on one, the assumption of full employment, and two, based on the idea of how interest rates are determined based on the exogenous idea.
In the Indian context, we have unemployment, we have underemployment, so we are nowhere close to the situation of full employment. That is one empirical feature, but even leaving aside the empirical feature, we go with the endogenous money approach. There is no reason to believe that when the government intervenes in the economy by building schools or hospitals or other socially necessary infrastructure, it will generate an increase in rate of interest, which will push out private players.
And I think here there’s a very important thing I feel sometimes economists also don’t pay attention to is, the rate of interest is a policy variable. The markets are also designed by us so we want to design markets, we want to design monetary policy, we want to design fiscal policy in line with what the society wants. So I think the wellbeing of people in the society should be central. And the reason we teach equilibrium, we have these notions is to ensure this is met. Very often it happens that we seem to want reality to behave like what a theory says and not try to, you know, challenge even our understandings of demand and supply equilibrium.
Now, having, you know, sort of said that, I also want to make the point here about modern monetary theory of the question of public debt, which is tied to this idea of crowding in and crowding out a little bit. That they believe that if an economy can create issues sovereign currency at will, then there is no issue of unemployment. That is the governments can print currency and then use that to employ people, that is one view. So the view that I’ve taken in my book is somewhat similar to it because it’s somewhat associated to the notion of crowding in however, the question of public debt sustainability is something that I do bring up because it is not enough for the government to create money and invest. It also has to produce goods and services either that are beneficial for the economy today or in the future, like education or health where the gestation period is long. So I think the government expenditure has to be meaningful and that is something that I highlight. And the question of what is meaningful also depends on the community.
So I don’t think, I mean, a modern monetary theory I don’t think gets into some of these kinds of specifics. But, I think that many of the things that modern monetary theory says is aligned to many of the policy proposals in my book. But having said that, I would not call modern monetary theory a full kind of alternative theory because it has some understanding of public debt, it has some understanding of currency, of money, of sectoral balances, of inflation. But for instance, it does not have a theory of price, it does not have a theory of income gestation. So what it means is that although modern monetary theory is an alternative kind of approach, it might have to draw upon certain political economy traditions, and align itself with one of these or many of these kinds of theories of price or theories or wages and probably it can do that easily.
But I want to mention another point. I think that some of the mainstream views on modern monetary theory has come largely from the developed or, you know, those economies. And sometimes they view inflation as still understanding it as a kind of, you know, too much of money chasing too few goods, which is, yeah, classic kind of quantity theory of money kind of thing. Although I’m aware, I think that even within modern monetary theory school, there are differences or interpretations. The kind of approach that I have taken in my book for inflation is that we need to understand the cause of inflation.
So for instance, if it is brought about by agricultural prices increasing because of lack of storage facilities, and that shows up in your consumer price index. Changing the quantity of money or changing the interest rate might not have any impact on this kind of an issue. And traditionally, the belief is that inflation has to be done by monetary policy. Inflation management is monetary policy, employment is fiscal policy. But if once we look at the issue or what determines inflation in this context, in this example that I given, this is the Indian case for many, most of the time. Then it’s possible to think of a meaningful fiscal policy, which creates infrastructure that is godowns or storage facilities, and in the process it creates employment and it can also reduce agricultural prices.
So it is, my engagement with political economy has allowed me to see, you know, different kind of solutions rather than seeing fiscal and monetary policy separately, or to even think of a tradeoff between the Phillips Curve tradeoff between inflation and unemployment. And this kind of a view then enables us to work, I think, in a more coherent fashion. First, identifying what is the cause and then to see what kind of policy measures can be done and not blindly see mainstream economic thought as, you know, some kind of eternal truth.
Abhinav: Okay. So thank you Alex, for answering our questions so patiently, and thank you for taking time out to do this. Like I wish you, we at Zerodha, wish you all the best and the success with your book. And, thank you really for doing this.
Alex: Thank you so much.
All opinions expressed in this podcast are solely of the guest. This podcast is for informational and educational purposes only.