Monetary Macroeconomics: A New Approach (Routledge International Studies in Money and Banking, 15)

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This is a direct application of the so-called neoclassical school of economics that was developed during the late nineteenth and early twentieth centuries. While this school continues to dominate textbooks in the field, there is a growing scholarly trend that seeks to criticize, complement or even replace some of its main assumptions. We can see how the problems play out in both corporate finance and asset pricing theory. Corporate finance concerns the financing of firms. This theorem makes a number of highly unrealistic assumptions, among them the assumption that markets are efficient, and that there are no taxes.


Alongside many other results in economics, it may therefore be considered as useless for predictive purposes; or even as dangerous, once used for such purposes nonetheless Egidi In a detailed study of the Modigliani-Miller theorem, Hindriks has argued, however, that the value of highly idealized models in economics may lie in their providing counterfactual insights, just as in physics. Despite the fact that vacuum is rare in reality, the law is not uninformative, because it allows us to associate observed phenomena to the extent to which an unrealistic assumption must be relaxed.

Similarly, if one of the assumptions that the Modigliani-Miller theorem makes is the absence of taxes, the observed relevance of capital structure may well have to be explained as resulting from particular tax regimes. Explanation by concretization works if models and reality share at least a few concrete features. Econophysics uses physics methods to model financial markets see Rickles for an overview.

Where traditional models of crises include individual investors with beliefs and desires modelled by probability distributions and utility functions, econophysics models capture crises the way physicists model transitions of matter from fluid to solid state Kuhlmann Next, consider asset pricing theory. Most models assume that returns follow Gaussian random walks, that is, stochastic processes in discrete time with independent and identically distributed increments.

This means that extreme events such as financial crises are far less improbable than the models assume. Both neo-classical models and behavioral economics capture uncertainty as probabilistic uncertainty, consequently ignoring Knightian uncertainty Knight see also decision theory. The philosophy of science literature that pertains to financial economics is, however, still fairly small.

James D. Hamilton

Having considered the epistemic and scientific challenges of finance, we now turn to the broad range of compelling ethical challenges related to money and finance. The present part is divided into three sections, discussing 1 the claim that financial activities are always morally suspect, 2 various issues of fairness that can arise in financial markets, and 3 discussions about the social responsibilities of financial agents.

Throughout cultural history, activities that involve money or finance have been subject to intense moral scrutiny and ethical debate. It seems fair to say that most traditional ethicists held a very negative attitude towards such activities.

We will here discuss three very sweeping criticisms, respectively directed at the love of money the profit motive , usury lending at interest , and speculation gambling in finance. At the heart of many sweeping criticisms of money and finance lies the question of motive.

The forms of world money

It has been the subject of much moral criticism throughout history and continues to be controversial in popular morality. There are three main variations of the criticism.

18. Monetary Policy

A first variation says that there is something unnatural about the profit motive itself. For example, Aristotle argued that we should treat objects in ways that are befitting to their fundamental nature, and since money is not meant to be a good in itself but only a medium of exchange see section 1. A similar thought is picked up by Marx, who argues that capitalism replaces the natural economic cycle of C—M—C commodity exchanged for money exchanged for commodity with M—C—M money exchanged for commodity exchanged for money.

A second variation of the criticism concerns the character, or more precisely the vice, that the profit motive is thought to exemplify see also virtue ethics. To have a love for money is typically associated with selfishness and greed, i. Another association is the loss of moral scruples so that one is ready to do anything for money. The financial industry is often held out as the worst in this regard, especially because of its high levels of compensation. Allegations of greed soared after the crisis, when financial executives continued to receive million-dollar bonuses while many ordinary workers lost their jobs Piketty , McCall A third variation of the criticism says that the profit motive signals the absence of more appropriate motives.

Kant argued that actions only have moral worth if they are performed for moral reasons, or, more specifically, for the sake of duty. Thus it is not enough that we do what is right, we must also do it because it is right Kant Both of these principles seem to contrast with the profit motive which therefore is rendered morally problematic Bowie , Maitland There are two main lines of defensive argumentation. This argument is typically viewed as a consequentialist vindication of the profit motive see also consequentialism : positive societal effects can morally outweigh the possible shortcomings in individual virtue Flew A second argument is more direct and holds that the profit motive can exemplify a positive virtue.

For example, there is the well-known Protestant work ethic that emphasizes the positive nature of hard work, discipline and frugality Long , Wesley The profit motive can, on this view, be associated with virtues such as ambition, industry, and discipline. According to Max Weber , the Protestant work ethic played an important role in the development of capitalism. But it is not clear whether any of these arguments can justify an exclusive focus on profits, of course, or rather give permission to also focus on profits under certain circumstances.

If having a love of money seems morally suspect, then the practice of making money on money—for instance, lending money at interest—could seem even worse. This is another sweeping criticism directed at finance that can be found among the traditional ethicists. As the practice started to become socially acceptable, usury came to mean the charging of excessive rates of interest. However, modern Islam still contains a general prohibition against interest, and many countries still have at least partial usury laws, most often setting an upper limit on interest rates.

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What could be wrong with lending at interest? While he allowed that money is a useful means for facilitating commercial exchange, Aristotle thought that it has no productive use in itself and so receiving interest over and above the borrowed amount is unnatural and wrong Politics , b. A related argument can be found in Aquinas, who argued that money is a good that is consumed on use.

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Although a lender can legitimately demand repayment of an amount equivalent to the loan, it is illegitimate to demand payment for the use of the borrowed amount and so adding interest is unnatural and wrong Summa Theologica , II—II, Q Some more promising arguments concern justice and inequality. For example, as early as Plato we see the expression of the worry that allowing interest may lead to societal instability The Republic , II.

It may be noted that the biblical condemnations of usury most straightforwardly prohibit interest-taking from the poor. One idea here is that we have a duty of charity to the poor and charging interest is incompatible with this duty.

A third idea, which is prominent in the protestant tradition, is that lending often involves opportunism or exploitation in the sense of offering bad deals to poor people who have no other options Graafland The Islamic condemnation of interest, or riba , adds an additional, third line of argument which holds that interest is essentially unearned or undeserved income: Since the lender neither partakes in the actual productive use of the money lent, nor exposes him- or herself to commercial risk, the lender cannot legitimately share in the gains produced by the loan Ayub , Birnie , Thomas Based on this argument, contemporary Islamic banks insist that lenders and borrowers must form a business partnership in order for fees on loans to be morally legitimate Ayub , Warde Economists have over the years given several retorts to this argument.

Some economists stress that lending also involves risk e. The gradual abandonment of the medieval usury laws in the West is typically attributed to a growing acknowledgment of the great potential for economic growth unleashed by easy access to capital.

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One could perhaps say that history itself disproved Aristotle: money indeed proved to have a productive use. In a short text from , Bentham famously poked fun at many of the classical anti-usury arguments and defended the practice of charging interest from a utilitarian standpoint Bentham However, this does not mean that worries about the ethics of charging interest, and allegations of usury, have disappeared entirely in society.

As noted above, usury today means charging interest rates that seem excessive or exorbitant. For instance, many people are outraged by the rates charged on modern payday loans, or the way in which rich countries exact interest on their loans from poor countries Baradaran , Graeber , Herzog a. These intuitions have clear affinities with the justice-based arguments outlined above. A sweeping criticism of a more contemporary nature concerns the supposed moral defects of speculation.

This criticism tends to be directed towards financial activities that go beyond mere lending. Critics of the capitalist system often liken the stock market to a casino and investors to gamblers or punters Sinn , Strange In any case, the underlying assumption is that the similarities between modern financial activities and gambling are morally troublesome. On some interpretations, these concerns are similar to those raised above. For example, some argue that speculators are driven by the profit motive whereas investors have a genuine concern for the underlying business enterprise Hendry This latter argument is similar to the complaint about undeserved income raised in particular by Islamic scholars Ayub , Warde This is morally problematic when the risks not only affect the gambler him or herself but also society as a whole.

When the value of such derivatives fell dramatically, the financial system as a whole came to the brink of collapse. We will return to this issue below in section 4. A related interpretation concerns the supposed short-sightedness of speculation. Modern disclosure requirements force companies to publish quarterly earnings reports. The myopia of finance is typically blamed for negative effects such as market volatility, the continuous occurrence of manias and crashes, inadequate investment in social welfare, and the general shortsightedness of the economy e.

Defenders of speculation argue that it can serve a number of positive ends. To the extent that all financial activities are speculative in some sense, of course, the ends coincide with the function of finance more generally: to channel funds to the individuals or companies who can use them in the most productive ways.

Let us now assume that the existence of financial markets is at least in general terms ethically acceptable, so that we can turn to discuss some of the issues involved in making them fair and just for all parties involve. We will focus on three such issues: deception and fraud honesty , conflicts of interest care for customers , and insider trading fair play. Some of the best-known ethical scandals in finance are cases of deception or fraud.

Other scandals in the industry have involved deceptive marketing practices, hidden fees or costs, undisclosed or misrepresented financial risks, and outright Ponzi schemes see section 2.

James D. Hamilton

While these examples seem obvious, on further examination it is not easy to give an exact definition of financial deception or fraud. The most straightforward case seems to be deliberately misrepresenting or lying about financial facts. However, this assumes that there is such a thing as a financial fact, i.

In light of the socially constructed nature of money and finance see section 1 , this may not always be clear. Less straightforward cases include simply concealing or omitting financial information, or refraining from obtaining the information in the first place. But is access to adequate information enough? A complication here is that the weaker party, especially ordinary consumers, may have trouble processing the information sufficiently well to identify cases of fraud.

This is a structural problem in finance that has no easy fix, because financial products are often abstract, complex, and difficult to price. Therefore, full autonomy of agents may not only require access to adequate information, but also access to sufficient know how, processing ability and resources to analyze the information Boatright One solution is to require that the financial services industry promotes transparent communication in which they track the understanding of ordinary consumers de Bruin b, Shiller Due to the problems just noted, the majority of ordinary consumers refrain from engaging in financial markets on their own and instead rely on the services of financial intermediaries, such as banks, investment funds, and insurance companies.

But this opens up new ethical problems that are due to the conflicts of interest inherent in financial intermediation. Interestingly, some argue that the whole industry of actively managed investment funds may be seen as a form of fraud. According to economic theory, namely, it is impossible to beat the average returns of the market for any given level of financial risk, at least in the long term.

Therefore, funds who claim that they can do this for a fee are basically cheating their clients cf. Hendry , Kay The interests referred to are typically taken to be financial interests, so the obligation of the fiduciary is basically to maximize investment returns. In any case, it is often thought that fiduciary duties go beyond the ideal of a free market to instead give stronger protection to the weaker party of a fragile relationship.