The Failure of Economic Policy

Economics-UmbrellaEconomics needs to get rid of its “dismal science” status, to really become a relevant scientific approach to understand and eventually solve the major socio-economic as well as geo-political issues of the contemporary world. Louis-Philippe Rochon and Sergio Rossi take a look at the way ahead.

Around the world, in developing as in developed economies, we are witnessing the failure of economic policy, and its inevitable consequences: low economic growth, increased financial fragility, high unemployment, stagnant wages, increasing income and wealth inequalities, and a deteriorating environment.

On the fiscal policy side, the many years of austerity programmes have resulted in immeasurable harm, which will take decades to undo. Governments have either by choice or by law shunned the use of fiscal policy to address the mounting problems of a neoliberal regime that has benefited the very few. The solution that is proposed along these faulty lines is more austerity, despite a recent study by the International Monetary Fund supporting the notion that austerity has done more harm than good.

On the monetary policy side, central banks in many countries have brought interest rates near to zero with little success. For heterodox economists, such an outcome was predictable, as lowering rates of interest in the absence of increasing public spending amounts to nothing more than pushing on a string. As such, central banks have had to rely on so-called unconventional monetary policies. Yet, even these policies have proven to be of limited use. Indeed, quantitative easing has not led to increased bank lending for productive investment – an outcome predicted by many post-Keynesians and other heterodox economists – although it has inflated the price of longer-term securities and thereby acted as a sort of incomes policy in favour of the rentier class.

The latest monetary policy tool, negative interest rates, will most likely also result in failure, relying again on a misinterpretation of banks’ behaviour. By taxing reserves, central banks are hoping banks will begin lending those reserves and induce various economic activities to support growth. Yet, as post-Keynesians know all too well, banks cannot lend reserves: money and reserves are endogenous with regard to economic activity. In other words, banks will not lend to firms, and firms will not borrow from them, unless there is a long-lasting increase in effective demand on the market for produced goods and services. Hence, rather than trying to stimulate the supply side of the economic system – as has been done, in vain, by neoclassically-inspired policies – governments and central banks should coordinate their efforts focusing on the demand side of the economy, where consumption and investment are the key for economic growth.

In calling out the failure of current economic policies to induce economic growth, we must point out that it is the failure of those policies inspired by neoclassical theory. As such, we should not be surprised by their failure. After all, Keynes himself, in the single-paragraph first chapter of his General Theory of Employment, Interest and Money (1936), reminds us that neoclassical theory can be “disastrous if we attempt to apply it to the facts of experience.” As a matter of fact, after now more than three decades of applying policies inspired by neoclassical theory, its consequences have been indeed “disastrous” around the world, and particularly in Europe since 2010, when the euro-area crisis burst dramatically.

The solutions to the economic ills all over the world are certainly not simple.

To be sure, a complex world requires complex solutions, and above all an understanding of how the real world actually operates on economic grounds. It is fitting, therefore, on the 80th anniversary of the publication of Keynes’s General Theory that we reflect upon its continued relevance. The world may have become increasingly complex, but the insights provided by Keynes, as well as by many others working along his lines, such as Michał Kalecki, Piero Sraffa, Joan Robinson and Nicolas Kaldor, can still guide the questions we ask, as well as the answers we provide. It is indeed time, as Skidelsky tells us, for “The Return of the Master”.

We owe it to ourselves and to our students, both now and in the future, to propose a coherent alternative to the dominant – yet failing – paradigm in economic analysis and policy making.

Economics needs to get rid of its “dismal science” status, to really become a relevant scientific approach to understand and eventually solve the major socio-economic as well as geo-political issues of the contemporary world.

It is with this goal in mind that we brought together some of the best scholars in the discipline to produce a textbook that would introduce students in the first year of their studies in economics. The result of this collective effort is An Introduction to Macroeconomics: A Heterodox Approach to Economic Analysis, which offers students a glimpse into heterodox economics, with a view to show the highly relevant insights that this approach to a variety of economic issues provides to anybody interested in solving these issues for the common good.

Rochon Introduction


An Introduction to Macroeconomics: A Heterodox Approach to Economic Analysis is out now.

Examination copies are available for course leaders – please email with course details.

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