Robert Mundell: nothing optimal

Noted neoclassical mainstream economist, Robert Mundell, has died at the age of 88 years.  Mundell won a Nobel (Riksbank) prize in economics for his extension of general equilibrium theory as applied to Keynesian macroeconomics into the international arena.  Whereas the neoclassical equilibrium version of Keynes’ macromodel (called ‘bastardised Keynesianism’ by Joan Robinson) described a ‘closed’ economy (i.e. no trade and cross border capital flows), Mundell and colleague Marcus Fleming developed an equilibrium model for an ‘open’ economy (that had international trade and cross-border money and capital flows).

The irony of the Mundell-Fleming equilibrium model is that it showed that there was no equilibrium possible!  A capitalist economy cannot simultaneously maintain a stable or fixed exchange rate with other currencies, as well as free movement of capital across borders and then expect that monetary policy can be used to control the level of interest rates and the money supply in one economy. Mundell-Fleming found that an economy can only maintain two of the three options at the same time. This principle is frequently called the “Mundell–Fleming trilemma.”

For Marxist economics, this result is no surprise because capitalist economies do not tend to equilibrium as the neoclassical mainstream religiously believes.  Capitalist economies, as they accumulate, tend to disequilibrium because of the anarchy of capitalist competition and the uneven development of capitals seeking profit.  So any attempt to control one aspect of that disequilbrium will only increase disequilbrium elsewhere.  If you have a bucket with three holes and only two stoppers, it just leaks faster out of the hole without one.

No national economy is an island, so when governments opt to try and manage their own monetary and fiscal policies, and at the same time, allow free movement of capital across borders, Mundell-Fleming told them that they had to stop trying to fix their currency rates and allow ‘floating currencies’.  Unfortunately, floating currencies, given the disequilibrium of capitalist accumulation only leads to regular and recurring devaluations in countries with weak investment and trade balances and huge cross-border capital flows. 

Canadian born Mundell also won his Nobel prize for his optimal currency union theory.  This theory purported to show the conditions needed to ensure a stable currency union of several states that would allow the convergence in productivity levels and per capita income within a single currency union.  Mundel was a great advocate of the setting-up of the euro, which he reckoned, with ‘free markets’ and ‘flexible labour’ alongside free capital movement, would mean that economies in the Eurozone could tend towards convergence and equilibrium.  Also, the currency union would mean that rogue governments (like Greece) would no longer control monetary policy which would become the province of an ‘independent’ central bank (ECB).

Again ironically, the optimal currency union theory proved not be optimal at all!  Instead of economies converging towards equilibrium with higher incomes per capita, capitalism operates unevenly and tends to disequilibrium and divergence.  As a result, in the Euro single currency area, since 1999 productivity levels between the northern core and southern periphery have widened, not narrowed.

See my posts here.

Mundell’s equilibrium theories proved the opposite of his expectations.  They show disequilibrium not equilibrium as the tendency; they show why national governments cannot manage their own economies successfully with fiscal and monetary policy; and why capitalist currency unions do not function ‘optimally’.

In a way, Mundell recognised this, by eventually advocating a return to ‘managed’ exchange rates, or the gold standard (fixing currency rates to the price of gold); and, of course, the ultimate solution: a world currency.  He feared stagnation in capitalist economies and so advocated the classic ‘supply-side’ solution of cutting corporate and personal taxes to boost private investment and spending.  Under capitalism, however, none of these ‘solutions’ can work or be achieved.

10 thoughts on “Robert Mundell: nothing optimal

  1. I‘d take it even further saying all of neoclassical economics is based on totally unrealistic assumptions to begin with.
    It is a highly constructed theory based on the idea of equilibrium which in turn is based on a ˋutility theory of value‘ driven by consumer‘s behaviour and markets that could never be immune to business cycles. It is nothing but a playground for aloof academic banter detached from any social reality designed to defend capitalist generated inequalities

    1. Indeed, very interesting. However the ECB does admit that some member states have shown persistently weaker GDP growth performances and/or stronger inflation and unit labor costs than others. Which means that with or without a single currency, fixed or flexible exchange rates, gold standard etc. the inherent divergence in competitiveness and labor productivity and real production costs is what causes trade imbalances and uneven development. In the case of a single currency those imbalances will be reflected in persistent current account deficits because eurozone counties do not have national currencies which can absorb the shocks of sudden stops of capital inflows. This is why the ECB concludes that “to avoid large imbalances in the future, inefficiencies in economic structures and rigidities in structural adjustment need to be identified at an early stage and addressed by national policies”. In short – impose austerity more strictly and readjust labor costs, push wages down to increase competitiveness.

      1. Agreed. Also the ECB complains continuously that monetary policy has to overcompensate in the absence of supportive fiscal measures. They recognise that the reliance on monetary policy alone to protect the Euro has impacted weaker economies.

  2. Correct me if I’m mistaken, but Marx demonstrated in book II of Das Kapital that capitalism can never reach equilibrium due to its very design (incapacity to maintain Departments in equilibrium even in a scenario of simple exchange, with zero profit rate), not because of “greed” by the capitalists.

    That’s why even the proposals of “zero growth capitalism”/absolute stagnation capitalism by the likes of the Club or Rome are doomed to fail.

    1. I’d put it that Rosa Luxemburg showed that Marx didn’t fail in his “failed” attempts to show how capitalism produced and reproduced its mode of production. (the false belief of many “marxists”). Rather, he succeeded in demonstrating the inherent equilibrium of its mode of production, its need to reproduce the basis of its existence: renewal and expansion of its reserve army of labor, which is to say its dependence on theft and violence. As he presciently makes clear in Grundrisse and elsewhere, if permitted to mature to its full potential, it would devolve into a conditions much like the present. The neoliberal form of imperialism is the historic epitome of the capitalist system.

      1. There are a number of typos (my trade mark) in the above comment, but one of them is critical: “equilibrium in the second sentence should of course read “disequilibrium”.

      2. The fact that capitalist investment continuously overshoots or undershoots leading to disproportionality and losses to individual investors is not fundamental, but part and parcel of capitalism. What is different is when investment generally undershoots, that is there is a now a general retrenchment in investment disrupting the general circulation of commodities which is important, as is the reason for this to happen, the absolute fall in the rate of profit.

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