One of the more lively papers delivered at this week's 75th Anniversary Lionel Robbins Conference in London was by the LSE's Charles Goodhart: The Continuing Muddles of Monetary Theory: A Steadfast Refusal to Face Facts (PDF). Goodhart believes monetary economics has "a long way yet to go", and few economists "have bothered much to relate theory to reality." Here's the abstract to his short paper:
Lionel Robbins was much concerned about the methodology of economic science.
When he discussed the desirable relationship between theory and ‘reality’, two of the
three examples that he presented where the theoretical analysis was not sufficiently
based on a knowledge of historical fact were taken from monetary economics.
Indeed, monetary theory has remained prone to such shortcomings ever since.
Amongst the worst are:-
(1) IS/LM: the monetary authorities set the monetary base, and the interest rate is
determined in the market;
(2) The monetary base multiplier of bank deposits, and the role of reserve ratios;
(3) The current three equation neo-classical consensus, which not only assumes
perfect creditworthiness for all agents, but also an essentially non-monetary
system, e.g. no need for banks;
(4) The standard theory of the evolution of money.
Monetary economics can only get better, but it has a long way yet to go.