Why Has Heterodox Economics Become Orthodox On Wall Street?

I recently noted that heterodox economics is not so heterodox anymore.¹ There’s been a growing trend, especially on Wall Street, in the use of heterodox economic models and particularly Post-Keynesian Economic models. What’s the cause of this surge in popularity? I think it’s derived from two primary sources:

Orthodox economic models largely ignore the financial system (though this has improved recently) and construct theoretical world views. For a market practitioner, whose world is comprised of financial balance sheets and income statements, the orthodox economic views just don’t have that much value. Theory, quite simply, has no place for the person whose job relies on understanding the world as it is.² Unlike a tenured professor, market practitioners don’t have the time to wait for some theory or experiment to play out. We need real-world understandings that are useful in understanding the world as it is and not the world as some economic theory thinks it might be.

Heterodox models, Post-Keynesian in particular, are accounting models that properly model the stock flow consistent relationships in the financial system.³ Accounting is central to finance for obvious reasons. And constructing models of the accounting that reflect the relationships between households, firms and governments is crucial to being able to decipher how the economy impacts the financial markets. This is just flow of funds analysis. This means that Post-Keynesians use a model that understands basic empirical relationships within the financial system. For instance, when all those famous economists over the last 5 years said that banks might “lend out” their reserves leading to a risk of high inflation, Post-Keyensians said this was wrong because it’s not stock-flow consistent. There is no transmission mechanism by which banks multiply or “lend out” their reserves to the non-bank public. This was just real-world accounting and ideas like this led to some very crucial understandings about how the economy and financial system would be impacted by policies like QE.