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Identifying optimised policies
Bottom up or top down?


Hector McNeill1
SEEL

Monetarism, Keynesianism and Supply Side Economics (KMS) are all aggregate demand model-based approaches (ADM) to policy. All consist of sweeping statements based on the assumptions of "aggregate demand management"; they are all top down, direct from the centre policies through interventions and impositions in different market segments.

KMS policies create winners, losers and some segments that remain in a neutral policy impact status. However, the common outcome is an erosion in real incomes and an increase in inequalities. As fair weather policies, in crises the use of the same policy instruments end up concentrating income and wealth in a tiny section of the constituency and create serious issues related to income distribution inequality and in particular poverty.

This is why in initiating the development of the Real Incomes Approach in 1975, I avoided the aggregate or macro approach because the impact of KMS demonstrates that the microeconomic foundations are inadequate and reflect an inability to adapt to the range of conditions facing economic units. For this reason I went back to basics to analyse microeconomic operation, participant motivations, gaps, needs and the ability to perform in satisfying the identified needs. The macroeconomic model has to be based on such an analysis in order for the macreoconomic gaps and needs to be related to microeconomic possibilities so as to hold out the feasibility of practical solutions. Without this vital linkage policy cannot apply policy instruments to influence the appropriate policy targets that assist all economic units sustain real income growth and securing improved income distribution so as to reduce inequalities.

Inflation
MMJ-Monetary Mumbo Jumbo

The general confusion and unconvincing nature of the Quantity Theory of Money, the darling of central banks, is a major cause of decadence in economic wellbeing and instability while the obvious beneficiaries are the banks themselves.

Conclusions on QTM

Hector McNeill - Real Incomes Approach:

"As it stands QTM is not a full explanation of the impact of money on the economy since it does not provide any of the deterministic relationships between the use of money, interest rates and purchasing power and, one must add, it does not provide any explanation on the influence of foreign trade and the value of money reflected in exchange rates."

"The QTM is unsatisfactory as a working model and it needs a lot more work."


Alasdair Macleod - GoldMoney.com

"Forget velocity of money circulation"

"It is therefore nonsense to conclude that velocity is a vital signal of some sort. Monetarism is at the very least still work-in-progress until monetarists finally discover velocity is no more than a factor to make their equation balance."

" A small slip perhaps on the way to a sensible conclusion; but it is indicative of the false mechanisation of human behaviour by modern macro-economists.

However, it should also be noted that is impossible to square the concept of velocity of circulation with one simple fact of everyday life: we earn our salaries once and we dispose of it. Thatís a constant velocity, give or take, of one."

The main factor undermining real incomes is inflation. This was the original target of the Real Incomes Approach because KMS policy instruments were unable to tackle slumpflation that appeared in the mid 1970s as a result of major rises in the international price of petroleum. At the time I was in Brazil and was able to observe the collapse of a KMS macroeconomic policy. One stark reality was that inflation was not the result of excessive demand but rather the result of companies factoring in the expectation of price rise projections and then raising their own prices in line with their own projections so as not to "lose out" in the future, in terms of real incomes. In other words the main cause of ongoing and rising inflation was the pricing decisions taken by individual companies. Once this spiral had started the macro-environment reflected this. The confusion on the part of KMS economists is their insistence in considering this to be a macroeconomic market ADM phenomenon as distinct from a supply side microeconomic phenomenon. So supply side conditions and decisions were generating the macroeconomic reflection of this process.

Therefore as early as 1976 it was obvious that the rate of increase in inflation was directly related to individual economic unit pricing decisions. The KMS solution was to raise interest rates to very high levels causing a significant portion on business to fail and households and farmers to lose their properties. This was the result of macroeconomists and policy planners slavishly following the mumbo-jumbo of the Quantity Theory of Money which at the same time never being able to explain how it works. The leading monetary guru Milton Friedman could never explain how raising money volumes translates into higher prices. The answer is what I have described above but paradoxically the monetarists assumed some osmotic effect rather than admit to the significance of individual pricing decisions. To do so would rob the QTM of its mystique and central role in ADM policies and finally establish that inflation is a supply side phenomenon.

In the mid 1970s two alternatives to KMS were developed largely to tackle inflation and raise productivity. These were what became known as Supply Side Economics and the Real Incomes Approach. Unfortunately, the approach that gained acceptance and was applied was Supply Side Economics which is, in reality, based on the ADM approach as a fiscal variant based on lower marginal tax rates. This was applied and it failed under the Reagan administration gaining the name of Reagonomics or "trickle down economics". The evidence shows that economic units were exposed to the same top down confusion as reigns under KMS policies and the fundamental problem is that the impact peters out and loses traction. Policy provides no business rules whereby economic units can optimise performance to sustain growth in real incomes robbing the policy of its supply side credentials.

The Real Incomes Approach has never been applied but it is the only macroeconomic approach that possesses policy instruments that provide economic units with the business rules to optimise growth and sustain real incomes growth on the basis of a truly supply side solution. The risks of introduction are minimal becasue it can be introduced on a selective basis within a sector or even class of company (e.g. by number of employees or turnover) and then expand as required across the sectors and economy. KMS policies on the other hand continue to be applied to the whole economy in a high risk massive socio-economic experiment which never appears to come to any fundamental conclusions other than the policy needs to be changed to correct self-imposed distortions.

Even today, politicians and many economists promote policies that at their heart are "tickle down" variants but they seldom are able to explain how this works in practical terms or how it will correct the unacceptable characteristic of KMS policies in continuing to generate winners, losers and others and exacerbating the growing inequality of incomes. Political agendas might consider this to be a "price worth paying", but for what? Economists need to provide solutions that secure the wellbeing of all of the population so as to place policy on a constitutional and economic foundation to gain a general acceptance and benefit as opposed to the approval of select interest groups who remain on the winning side. Economists should not be buying into the political agenda so as to end up with models that reflect the assumptions of political and social philosophies as if these have some scientific credence. Economists need to work to come up with workable quantitative models to describe in a transparent fashion how human motivations and actions translate into quantitative impacts on the wellbeing of others in society. Not to do so, as a basis for adding transparency to dialogues and options for policy makers, reduces economics to a bag of tricks to be used at will by politicians and which, as the track record shows, prejudices the prospects of too many econonomic units and families.