A New Institutional Macroeconomics?

We had Keynsianism which was based on fiscal policy.  We have Monetarism which was based on monetary policy.  Will we have a new macro paradigm which is based on legal and institutional policy?

I was inspired by Scott Sumner's response to a comment about Japan's massive underground cash economy that I made on his blog.

Doc Merlin, I did my dissertation on currency hoarding and the underground economy.  The ratio of the tax rate to the interest rate is the number of years you can hoard income in cash before you would have been better off paying taxes. In the US that ratio correlates with the cash/GDP ratio over time. That ratio is high in Japan for two reasons; high taxes and low interest. So hoarding cash to evade taxes is profitable. Ironically, the liquidity trap may make their underground economy bigger.

... and also from De Soto's work.
If interest rates are low and taxes are high and if regulation is too onerous people on the whole will avoid the open economy and hide their activities. This will cause GDP will shrink. Transactions rates will slow in the formal economy, and go into the less efficient informal economy.  Formalness is not binary; it is a continuum.  For example if a company would like to go public to gain access to capital, but can't because of the expense of SarOx, it is being less efficient than it could be.  If chooses to avoid going public because the cost of complying with regulation is more than not complying, the entire future economy fails to realize the gains it would have had.

Also, now we have a good way out of a liquidity trap: tax cuts and economic deregulation.  (If the multiplier of fiscal stimulus is less than one as some studies are saying, its also a good idea to cut spending along with the taxes.)

Anything this gives me some examples of things that would help the US get out of a liquidity trap if we were to find ourselves in one:

• Lowering minimum wage
  
  
• Removing regressive taxes (Social security tax and medicare in the US, for example.)
  
  
• Suspending Sarbane-Oxley
  
  

I wonder when this new macro will come about and what it will look like.

Re:Does macro need a paradigm shift

This is in response to Scott Sumner's post on his blog, which I recommend reading.


1.

a. First of all, I agree that we need a common, more formal definition of what it means for money to be "tight" or "loose." I think it will be impossible to define what we mean by 'tight/loose money' because of the basic differences in paradigm between the different economic views. Its not that we are all on separate pages; we are reading out of different books.

b. I disagree that your views are that far from the norm, you are fairly standard for a monetarist school economist. Its rather that the econ-blogosphere tends towards the heterodox.

2. This plot suggests that the money supply wasn't that different than normal. AMB was same as normal at the start of the recession M1 and M2 were also.


3. CPI saw a small bump, but PPI had a massive spike.

So, I guess, yes, wrt actual commodities, money was tight, but in an absolute sense, money was not tight (M2 didn't drop appreciably).
That makes me think the 'tight money' story isn't true, because 'tight money' would cause deflation not huge PPI inflation.

4. M2 grew at a much faster rate than M1 (as would be expected) and AMB grew much faster than either of those. To me this looks like a huge push to de-leverage and get out of certain types of assets and get into cash. Also this fits the story of the Fed buying up bank assets.

5. I don't buy the TIPS story, precisely because there was a global push to get out of securities and into cash to avoid bankruptcies.

6. There is no six.

7. I think the 'recalculation' story explains this recession better than a 'tight money' story. Businesses made bad bets, their income was too low for their assets and then they had to de-lever, and switch to more profitable/less expensive business plans. This also somewhat fits John Geanakoplos's theory.

8. It seems to me that the Fed's basic problem is that it is ignoring markets in an attempt to fix them. It can't properly price interest rates which results in either gluts or shortages of money/credit.