A few years ago, two economics professors, Quamrul Ashraf and Oded Galor, published a paper, “The ‘Out of Africa’ Hypothesis, Human Genetic Diversity, and Comparative Economic Development,” that drew inferences about poverty and genetics based on a statistical pattern …
When the paper by Ashraf and Galor came out, I criticized it from a statistical perspective, questioning what I considered its overreach in making counterfactual causal claims … I argued (and continue to believe) that the problems in that paper reflect a more general issue in social science: There is an incentive to make strong and dramatic claims to get published in a top journal …
Recently, Shiping Tang sent me a paper criticizing Ashraf and Galor from a data-analysis perspective … I have not tried to evaluate the details of Tang’s re-analysis because I continue to think that Ashraf and Galor’s paper is essentially an analysis of three data points (sub-Saharan Africa, remote Andean countries and Eurasia). It offered little more than the already-known stylized fact that sub-Saharan African countries are very poor, Amerindian countries are somewhat poor, and countries with Eurasians and their descendants tend to have middle or high incomes.
It appears to me that one great cause of our difference in opinion, on the subjects which we have so often discussed, is that you have always in your mind the immediate and temporary effects of particular changes—whereas I put these immediate and temporary effects quite aside, and fix my whole attention on the permanent state of things which will result from them.
On this issue Keynes agreed with Malthus, and it was probably the debate between Ricardo and Malthus that Keynes was thinking about when he formulated his most well-known aphorism, in A Tract on Monetary Reform (1923):
But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.
I dessa tider — när ljudrummet dränks i den kommersiella radions tyckmyckentrutade ordbajseri och fullständigt intetsägande pubertalflamsande tjafs — har man nästan gett upp.
Men det finns ljus i mörkret! I radions P2 går varje lördagmorgon ett vederkvickelsens och den seriösa musikens Lördagsmorgon i P2.
Och nu är även söndagarna räddade!
I programmet Text och musik med Eric Schüldt — som sänds på söndagsförmiddagarna i P2 mellan klockan 11 och 12 — kan man lyssna på seriös musik och en programledare som har något att säga och inte bara låter foderluckan glappa. Vilken lisa för själen.
I söndags spelades filmmusik av Zbigniew Preisner och vår egen Stefan Nilsson. Den senares musik till Ingmar Bergmans och Bille Augusts Den goda viljan är bland det vackraste och mest suggestiva i filmmusikväg som gjorts.
Tack Eric för alla dessa fantastiska program. Du är ett ljus i mörkret!
- Karl Marx, Das Kapital (1867)
- John Maynard Keynes, General Theory (1936)
- Kenneth Arrow, Social Choice and Individual Values (1951)
- John Kenneth Galbraith, The Affluent Society (1958)
- Amartya Sen, Collective Choice and Social Welfare (1970)
- Nicholas Georgescu-Roegen, The Entropy Law and the Economic Process (1971)
- Michal Kalecki, Selected Essays on the Dynamics of the Capitalist Economy (1971)
- Paul Davidson, Money and the Real World (1972)
- Hyman Minsky, John Maynard Keynes (1975)
- Tony Lawson, Economics and Reality (1997)
There are unfortunately a lot of mainstream economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse is that some of them even think that these rigidities are the reason John Maynard Keynes gave for the high unemployment of the Great Depression. This is of course pure nonsense. For although Keynes devoted substantial attention to the subject of wage and price rigidities in General Theory , he certainly did not hold that view.
Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute ‘cyclical’ unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.
In any specific labour market, lower wages could, of course, raise the demand for labour. But a general reduction in money wages would leave real wages more or less unchanged. The reasoning of the classical economists was, according to Keynes, a flagrant example of the ‘fallacy of composition.’ Assuming that since unions/workers in a specific labour market could negotiate real wage reductions via lowering nominal wages, unions/workers in general could do the same, the classics confused micro with macro.
Lowering nominal wages could not – according to Keynes – clear the labour market. Lowering wages – and possibly prices – could, perhaps, lower interest rates and increase investment. But to Keynes it would be much easier to achieve that effect by increasing the money supply. In any case, wage reductions was not seen by Keynes as a general substitute for an expansionary monetary or fiscal policy.
Even if potentially positive impacts of lowering wages exist, there are also more heavily weighing negative impacts – deteriorating management-union relations, expectations of on-going lowering of wages causing delay of investments, debt deflation, etc.
So, what Keynes actually did argue in General Theory, was that the classical proposition that lowering wages would lower unemployment and ultimately take economies out of depressions, was ill-founded and basically wrong.
To Keynes, flexible wages would only make things worse by leading to erratic price-fluctuations. The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labour market.
The classical school [maintains that] while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc …
The classical theory … is best regarded as a theory of distribution in conditions of full employment. So long as the classical postulates hold good, unemployment, which is in the above sense involuntary, cannot occur. Apparent unemployment must, therefore, be the result either of temporary loss of work of the ‘between jobs’ type or of intermittent demand for highly specialised resources or of the effect of a trade union ‘closed shop’ on the employment of free labour. Thus writers in the classical tradition, overlooking the special assumption underlying their theory, have been driven inevitably to the conclusion, perfectly logical on their assumption, that apparent unemployment (apart from the admitted exceptions) must be due at bottom to a refusal by the unemployed factors to accept a reward which corresponds to their marginal productivity …
Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment – if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight – as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.
J M Keynes General Theory
Commenting on the state of standard modern macroeconomics, Willem Buiter argues that neither New Classical nor New Keynesian microfounded DSGE macro models have helped us foresee, understand or craft solutions to the problems of today’s economies:
The Monetary Policy Committee of the Bank of England I was privileged to be a ‘founder’ external member of during the years 1997-2000 contained, like its successor vintages of external and executive members, quite a strong representation of academic economists and other professional economists with serious technical training and backgrounds. This turned out to be a severe handicap when the central bank had to switch gears and change from being an inflation-targeting central bank under conditions of orderly financial markets to a financial stability-oriented central bank under conditions of widespread market illiquidity and funding illiquidity. Indeed, the typical graduate macroeconomics and monetary economics training received at Anglo-American universities during the past 30 years or so, may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding. It was a privately and socially costly waste of time and other resources.
Most mainstream macroeconomic theoretical innovations since the 1970s … have turned out to be self-referential, inward-looking distractions at best. Research tended to be motivated by the internal logic, intellectual sunk capital and aesthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works …
Both the New Classical and New Keynesian complete markets macroeconomic theories not only did not allow questions about insolvency and illiquidity to be answered. They did not allow such questions to be asked …
Charles Goodhart, who was fortunate enough not to encounter complete markets macroeconomics and monetary economics during his impressionable, formative years, but only after he had acquired some intellectual immunity, once said of the Dynamic Stochastic General Equilibrium approach which for a while was the staple of central banks’ internal modelling: “It excludes everything I am interested in”. He was right. It excludes everything relevant to the pursuit of financial stability.
The Bank of England in 2007 faced the onset of the credit crunch with too much Robert Lucas, Michael Woodford and Robert Merton in its intellectual cupboard. A drastic but chaotic re-education took place and is continuing.
I believe that the Bank has by now shed the conventional wisdom of the typical macroeconomics training of the past few decades. In its place is an intellectual potpourri of factoids, partial theories, empirical regularities without firm theoretical foundations, hunches, intuitions and half-developed insights. It is not much, but knowing that you know nothing is the beginning of wisdom.
Reading Buiter’s article is certainly a very worrying confirmation of economics becoming more and more a total waste of time. But why are all these macro guys wasting their time and efforts on these models? Besides simply having the usual aspirations of being published, I think maybe Frank Hahn gave the truest answer back in 2005, when interviewed on the occasion of his 80th birthday, he confessed that some economic assumptions didn’t really say anything about “what happens in the world,” but still had to be considered very good “because it allows us to get on this job.”
So by using a representative-agent, perfect-foresight, complete-markets model, David is ignoring a bunch of things that we know can totally change the answers to the exact policy questions David is thinking about.
So what should we do instead? One problem is that models with things like heterogeneity, stochasticity, and imperfect markets are a lot more complicated, and therefore harder to apply in quick or casual way. If we insist on using models with those elements, then it’s going to be very hard to write blog posts thinking through monetary policy issues in a formal way. Maybe that’s just the sad truth.
Yes indeed, isn’t it a shame that David Andolfatto’s and other mainstream economists’ models have to somehow relate to the real world? How much easier things would have been if only reality had the courtesy to mimic mainstream economists’ models …
Living in the U.S. you soon find out that it’s a country with exceptionally many gifted and bright people. But, unfortunately, it is also a country where a moron with lots of money may run for president — and where, sadly enough, a lot of other morons obviously will vote for him …
Paul Krugman has a piece up on his blog this week arguing that the ‘discipline of modeling’ is a sine qua non for tackling politically and emotionally charged economic issues:
You might say that the way to go about research is to approach issues with a pure heart and mind: seek the truth, and derive any policy conclusions afterwards. But that, I suspect, is rarely how things work. After all, the reason you study an issue at all is usually that you care about it, that there’s something you want to achieve or see happen. Motivation is always there; the trick is to do all you can to avoid motivated reasoning that validates what you want to hear.
In my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.
So when Krugman and other ‘modern’ mainstream economists use their models — standardly assuming rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative agents with homothetic and identical preferences, etc. — and standardly ignoring complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc. — we are supposed to believe that this somehow helps them ‘to avoid motivated reasoning that validates what you want to hear.’
Yours truly is, to say the least, far from convinced. The alarm that sets off in my brain is that this, rather than being helpful for understanding real world economic issues, sounds more like an ill-advised plaidoyer for voluntarily taking on a methodological straight-jacket of unsubstantiated and known to be false assumptions.
Taking part of the debate on microfoundations among macroeconomists these days, I wonder if Heinz-Peter Spahn isn’t more on the right track than those who desperately offer more or less contrived defenses of the microfoundationalist programme:
The crucial point however is: market conditions, which are presupposed in the model of intertemporal choice, are not given in reality. Distributing consumption optimally over time depends on the possibility of individuals to lend money on their permanent income, if temporary periods of low market income are to be bridged. Because this perfect financial market does not exist, consumption behaviour necessarily depends strongly on current income. Consumers know that their future expected income is distorted by spells of unemployment, the occurrence of which is hard to predict though; these quantity constraints are important also for firms …
Professional modern economics appear to suffer from schizophrenia as in the field of financial-market economics all these deviations from the Utopian ideal market are well known (information asymmetries etc.), which are stubbornly ignored when it comes to talk about macroeconomics in NKM [New Keynesian Macroeconomics]. The assumption of complete markets means that all agents’ intertemporal budget constraints always are satisfied, bankruptcies and insolvencies are impossible. The NKM world is populated by agents who never default … Basically, NKM designs a non-monetary economy … Questions regarding financial instability cannot be answered within this models, they cannot even be asked …
NKM faces an uncomfortable trade-off. On the one hand, General Equilibrium Theory has shown that preferences and behaviour of heterogeneous agents cannot simply be aggregated. Variances between individuals matter! The Sonnenschein-Mantel-Debreu problem states that choices may not be transitive; the representative agent’s ranking differs from individual rankings; reactions to shock may be different … On the other hand, if people are assumed to be identical, NKM may keep the representative agent, but as a consequence the model has no interaction of agents, no distribution problems, no asymmetric information and no meaningful stock market.
The critique so far may appear as unfair as it neglects the various refinements that were proposed in order to develop and improve the basic model set-up … But these extensions of NKM – due to the Walrasian method – yield many precisely-looking results … but do not grasp the impact of bank credit on goods demand, market income and employment in a typical monetary economy.