Debunking Macroeconomics

The failure of neoclassical models to warn of the economic crisis has led to some rare soul searching in a discipline not known for such introspection. The dominant reaction within the profession has been to admit the failure, but to argue that there is no need for a drastic revision of economic theory. I reject this comfortable conclusion, and argue instead that this crisis illustrates the point made beforehand by Robert Solow, that models in which macroeconomic pathologies are impossible are not adequate models of capitalism. Hicks’s critique of his own IS-LM model also indicates that, though pathologies can be imposed on an IS-LM model, it is also inappropriate for macroeconomic analysis because of its false imposition of equilibrium conditions derived from Walras’ Law. I then focus upon what I see as the key weakness in the neoclassical approach to macroeconomics which applies to both DSGE and IS-LM models: the false assumption that the money supply is exogenous. After outlining the alternative endogenous money perspective, I show that Walras’ Law must be generalized for a credit economy to what I call the “Walras-Schumpeter-Minsky Law”. The empirical data strongly supports this perspective, emphasizing the need for a “root and branch” reform of macroeconomics.