On debt and effective demand in the eurozone

27 Jun, 2012 at 17:52 | Posted in Economics | Comments Off on On debt and effective demand in the eurozone

 

Socialdemokratin bäddade för dagens massarbetslöshet

27 Jun, 2012 at 15:23 | Posted in Politics & Society | Comments Off on Socialdemokratin bäddade för dagens massarbetslöshet

Att förstå drivkrafterna för den politiska och ideologiska utvecklingen de senaste 25 åren tillhör samtidshistoriens mest utmanande uppgifter.
För några dagar sedan gästades ABF-huset i Stockholm av LO:s förre chefsekonom P-O Edin och tidigare ordföranden Bertil Jonsson som tillsammans med Leif Hägg skrivit boken Så tänkte vi på LO – och så tänker vi i dag.
Edin inledde med att ställa frågan vem som hade trott på någon som 1985 givit följande framtidsscenario:

Att man i dag skrivit in i den svenska grundlagen att låg inflation går före full sysselsättning
Att samhället bekostar friskolor för Livets Ord
Att samma fastighetsskatt gäller för villor i Djursholm och Hultsfred
Att de finansiella marknaderna avreglerats
Att Televerket är börsnoterat – och marknaderna för post, el och apotek är avreglerade
Att vård och omsorg kan bedrivas av vinstmaximerande företag, vars vinster hamnar i skatteparadis
Att stora delar av det kommunala bostadsbeståndet har sålts ut till privata ägare
Och – dessutom – att det socialdemokratiska partiet i slutändan inte haft några allvarliga invändningar på någon av punkterna

Svar: Ingen.

Ingen kunde nånsin förutspå den här utvecklingen.
Så hur kunde det då bli så här?
Läs mer

Why more debt can be the solution to the debt crisis

27 Jun, 2012 at 11:51 | Posted in Economics | Comments Off on Why more debt can be the solution to the debt crisis

One of the common arguments against fiscal policy in the current situation – one that sounds sensible – is that debt is the problem, so how can debt be the solution? Households borrowed too much; now you want the government to borrow even more?

What’s wrong with that argument? It assumes, implicitly, that debt is debt – that it doesn’t matter who owes the money. Yet that can’t be right; if it were, we wouldn’t have a problem in the first place. After all, to a first approximation debt is money we owe to ourselves … Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person’s liability is another person’s asset.

It follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past.

To see my point, imagine first a world in which there are only two kinds of people:
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Prayer Of The Heart

27 Jun, 2012 at 10:09 | Posted in Varia | Comments Off on Prayer Of The Heart

 

Put null hypothesis significance testing where it belongs – in the garbage can!

26 Jun, 2012 at 17:40 | Posted in Statistics & Econometrics | 2 Comments

A couple of weeks ago I had a very interesting luncheon discussion with professor Deirdre McCloskey on her controversy with Kevin Hoover on significance testing. It got me thinking about where the fetish status of significance testing comes from and why we are still teaching and practising it, despite its obvious inadequacies.

A non-trivial part of teaching statistics is made up of learning students to perform significance testing. A problem I have noticed repeatedly over the years, however, is that no matter how careful you try to be in explicating what the probabilities generated by these statistical tests – p values – really are, still most students misinterpret them.

A couple of years ago I gave a statistics course for the Swedish National Research School in History, and at the exam I asked the students to explain how one should correctly interpret p-values. Although the correct definition is p(data|null hypothesis), a majority of the students either misinterpreted the p value as being the likelihood of a sampling error (which of course is wrong, since the very computation of the p value is based on the assumption that sampling errors are what causes the sample statistics not coinciding with the null hypothesis) or that the p value is the probability of the null hypothesis being true, given the data (which of course also is wrong, since it is p(null hypothesis|data) rather than the correct p(data|null hypothesis)).

This is not to blame on students’ ignorance, but rather on significance testing not being particularly transparent (conditional probability inference is difficult even to those of us who teach and practice it). A lot of researchers fall pray to the same mistakes. So – given that it anyway is very unlikely than any population parameter is exactly zero, and that contrary to assumption most samples in social science and economics are not random or having the right distributional shape – why continue to press students and researchers to do null hypothesis significance testing, testing that relies on weird backward logic that students and researchers usually don’t understand?

Statistical significance doesn’t say that something is important or true. And since there already are far better and more relevant testing that can be done (see e. g. here and  here), it is high time to give up on this statistical fetish. 

Jan Garbarek revisited

26 Jun, 2012 at 16:34 | Posted in Varia | Comments Off on Jan Garbarek revisited

This week I’ve had more than 300 unique visitors on my Jan Garbarek post. For the benefit of those who still haven’t found their way to it – here it is again!

Die Arroganz der Macht (IV)

26 Jun, 2012 at 14:11 | Posted in Politics & Society | Comments Off on Die Arroganz der Macht (IV)

 

Die Arroganz der Macht (III)

26 Jun, 2012 at 14:05 | Posted in Politics & Society | Comments Off on Die Arroganz der Macht (III)

 

Die Arroganz der Macht (II)

26 Jun, 2012 at 14:01 | Posted in Politics & Society | Comments Off on Die Arroganz der Macht (II)

 

Die Arroganz der Macht (I)

26 Jun, 2012 at 13:46 | Posted in Politics & Society | Comments Off on Die Arroganz der Macht (I)

 

Economics – a discipline that has forgotten much of what it once knew

25 Jun, 2012 at 21:01 | Posted in Economics | Comments Off on Economics – a discipline that has forgotten much of what it once knew

A couple of days ago I had a piece on why mainstream economists have tended to go astray in their “shed of tools” and actually thereby contributed to causing todays’s economic crisis rather than to solving it.

J Bradford DeLong – professor of economics at Berkeley – writes on a related theme on Project Syndicate:

It is the scale of the catastrophe that astonishes me. But what astonishes me even more is the apparent failure of academic economics to take steps to prepare itself for the future. “We need to change our hiring patterns,” I expected to hear economics departments around the world say in the wake of the crisis.

The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders …

Yet that is not what economics departments are saying nowadays.

Perhaps I am missing what is really going on. Perhaps economics departments are reorienting themselves after the Great Recession in a way similar to how they reoriented themselves in a monetarist direction after the inflation of the 1970’s. But if I am missing some big change that is taking place, I would like somebody to show it to me.

Perhaps academic economics departments will lose mindshare and influence to others – from business schools and public-policy programs to political science, psychology, and sociology departments. As university chancellors and students demand relevance and utility, perhaps these colleagues will take over teaching how the economy works and leave academic economists in a rump discipline that merely teaches the theory of logical choice.

Or perhaps economics will remain a discipline that forgets most of what it once knew and allows itself to be continually distracted, confused, and in denial. If that were that to happen, we would all be worse off.

Dutch books, money pumps and Bayesianism

25 Jun, 2012 at 15:52 | Posted in Economics, Theory of Science & Methodology | Comments Off on Dutch books, money pumps and Bayesianism

Neoclassical economics nowadays usually assumes that agents that have to make choices under conditions of uncertainty behave according to Bayesian rules (preferably the ones axiomatized by Ramsey (1931), de Finetti (1937) or Savage (1954)) – that is, they maximize expected utility with respect to some subjective probability measure that is continually updated according to Bayes theorem. If not, they are supposed to be irrational, and ultimately – via some “Dutch book” or “money pump” argument – susceptible to being ruined by some clever “bookie”.

Bayesianism reduces questions of rationality to questions of internal consistency (coherence) of beliefs, but – even granted this questionable reductionism – do rational agents really have to be Bayesian? As I have been arguing elsewhere (e. g. here and here) there is no strong warrant for believing so, but in this post I want to make a point on the informational requirement that the economic ilk of Bayesianism presupposes.

In many of the situations that are relevant to economics one could argue that there is simply not enough of adequate and relevant information to ground beliefs of a probabilistic kind, and that in those situations it is not really possible, in any relevant way, to represent an individual’s beliefs in a single probability measure.

Say you have come to learn (based on own experience and tons of data) that the probability of you becoming unemployed in Sweden is 10%. Having moved to another country (where you have no own experience and no data) you have no information on unemployment and a fortiori nothing to help you construct any probability estimate on. A Bayesian would, however, argue that you would have to assign probabilities to the mutually exclusive alternative outcomes and that these have to add up to 1, if you are rational. That is, in this case – and based on symmetry – a rational individual would have to assign probability 10% to becoming unemployed and 90% of becoming employed.

That feels intuitively wrong though, and I guess most people would agree. Bayesianism cannot distinguish between symmetry-based probabilities from information and symmetry-based probabilities from an absence of information. In these kinds of situations most of us would rather say that it is simply irrational to be a Bayesian and better instead to admit that we “simply do not know” or that we feel ambiguous and undecided. Arbitrary an ungrounded probability claims are more irrational than being undecided in face of genuine uncertainty, so if there is not sufficient information to ground a probability distribution it is better to acknowledge that simpliciter, rather than pretending to possess a certitude that we simply do not possess.

I think this critique of Bayesianism is in accordance with the views of John Maynard Keynes’ A Treatise on Probability (1921) and General Theory (1937). According to Keynes we live in a world permeated by unmeasurable uncertainty – not quantifiable stochastic risk – which often forces us to make decisions based on anything but rational expectations. Sometimes we “simply do not know.” Keynes would not have accepted the view of Bayesian economists, according to whom expectations “tend to be distributed, for the same information set, about the prediction of the theory.” Keynes, rather, thinks that we base our expectations on the confidence or “weight” we put on different events and alternatives. To Keynes expectations are a question of weighing probabilities by “degrees of belief”, beliefs that have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents modeled by Bayesian economists.

Teaching macroeconomics in the aftermath of the crisis

24 Jun, 2012 at 18:11 | Posted in Economics, Theory of Science & Methodology | Comments Off on Teaching macroeconomics in the aftermath of the crisis

Simon Wren-Lewis has a piece on his blog on how teaching macroeconomics after the crisis looks:

I was asked the other day how macroeconomics teaching at Oxford had changed as a result of the Great Recession of 2008-9. My answer, which was not much, seemed a little surprising at first …

So why was my answer not much? Because although the crisis has added material, nothing has really been thrown away as a consequence of what has happened. We have not, either individually or collectively, decided that the Great Recession implies that some chunk of what we used to teach is clearly wrong and should be jettisoned as a result. Speaking for myself and my second year undergraduate lectures, quite the opposite is the case. As Paul Krugman has pointed out many times, recent developments have in many ways been a vindication of the basic Keynesian model that lies at the heart of any undergraduate macro course.

Indeed, I would go even further. The mess we are currently in is due in part to policy makers ignoring this basic macroeconomic analysis.

To be honest, this citation really gets me rather gobsmacked. First of all because I find its rather self-congratulatory and complacent attitude unwarranted. But also – re Krugman – because it, at least to my reading,  seems to be in bad accordance with what Krugman has repeatedly said after the finance crisis, e. g. in his speach at the Eastern Economic  Association: Read more

On the poverty of the neoclassical “representative actor”

24 Jun, 2012 at 10:40 | Posted in Economics, Theory of Science & Methodology | Comments Off on On the poverty of the neoclassical “representative actor”

The purported strength of new-classical and new-Keynesian macroeconomics is that they have firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing “forward-loooking” individuals.

To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if – after having swallowed the sour grapes of the Sonnenschein-Mantel-Debreu-theorem – these economists want to resurrect the omniscient walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world (how that could even be conceivable is beyond my imagination, given that the ongoing debate on microfoundations, if anything, shows that not even we, the economists, can come to agreement on a common model).

Following the greatest economic depression since the 1930s, the grand old man of modern economic growth theory, Nobel laureate Robert Solow, on July 20, 2010, gave a prepared statement on “Building a Science of Economics for the Real World” for a hearing in the U. S. Congress. According to Solow modern macroeconomics has not only failed at solving present economic and financial problems, but is “bound” to fail. Building dynamically stochastic general equilibrium models (DSGE) on “assuming the economy populated by a representative agent” – consisting of “one single combination worker-owner-consumer-everything-else who plans ahead carefully and lives forever” – do not pass “the smell test: does this really make sense?” One cannot but concur in Solow’s surmise that a thoughtful person “faced with the thought that economic policy was being pursued on this basis, might reasonably wonder what planet he or she is on.”

Already in 2008 Solow had – in “The State of Macroeconomics” (Journal of Economic Perspectives 2008:243-249) – told us of what he thought of microfounded “modern macro”:

[When modern macroeconomists] speak of macroeconomics as being firmly grounded in economic theory, we know what they mean … They mean a macroeconomics that is deduced from a model in which a single immortal consumer-worker-owner maximizes a perfectly conventional time-additive utility function over an infinite horizon, under perfect foresight or rational expectations, and in an institutional and technological environment that favors universal price-taking behavior …

No one would be driven to accept this story because of its obvious “rightness”. After all, a modern economy is populated by consumers, workers, pensioners, owners, managers, investors, entrepreneurs, bankers, and others, with different and sometimes conflicting desires, information, expectations, capacities, beliefs, and rules of behavior … To ignore all this in principle does not seem to qualify as mere abstraction – that is setting aside inessential details. It seems more like the arbitrary suppression of clues merely because they are inconvenient for cherished preconceptions …

Friends have reminded me that much effort of ‘modern macro’ goes into the incorporation of important deviations from the Panglossian assumptions … [But] a story loses legitimacy and credibility when it is spliced to a simple, extreme, and on the face of it, irrelevant special case. This is the core of my objection: adding some realistic frictions does not make it any more plausible than an observed economy is acting out the desires of a single, consistent, forward-looking intelligence …

It seems to me, therefore, that the claim that ‘modern macro’ somehow has the special virtue of following the principles of economic theory is tendentious and misleading … The other possible defense of modern macro is that, however special it may seem, it is justified empirically. This strikes me as a delusion …

So I am left with a puzzle, or even a challenge. What accounts for the ability of ‘modern macro’ to win hearts and minds among bright and enterprising academic economists? … There has always been a purist streak in economics that wants everything to follow neatly from greed, rationality, and equilibrium, with no ifs, ands, or buts … The theory is neat, learnable, not terribly difficult, but just technical enough to feel like ‘science’. Moreover it is practically guaranteed to give laissez-faire-type advice, which happens to fit nicely with the general turn to the political right that began in the 1970s and may or may not be coming to an end.

Why have other ways of doing macro (purportedly) died out and the microfoundations approach become so dominant?
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Why neoclassical “Walt Disney-economics” still gets me totally gobsmacked

23 Jun, 2012 at 20:05 | Posted in Economics | 4 Comments

Price rigidities of all kinds are common in real economies. The nodal point in the macroeconomic debate between different “schools” today, however, is not their existence, but rather that even if they did not exist, our economies would not turn into the kind of Panglossian full employment equilibrium fiction world that neoclassical macroeconomists seems to take more or less for granted.

The final court of appeal for macroeconomic models is the real world, and as long as no convincing justification is put forward for how the inferential bridging de facto is made between model and reality, most neoclassical macroeconomic modelbuilding is little more than “hand waving” that give us rather little warrant for making inductive inferences from models to real world target systems. If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around. As Keynes has it:

Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the natural science, the material to which it is applied is, in too many respects, not homogeneous through time.

If macoeconomic models – no matter of what ilk – assume representative actors, rational expectations, market clearing and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Macroeconomic theorists ought to do some ontological reflection and heed Keynes’ warnings on using thought-models in economics:

The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. Any other way of applying our formal principles of thought (without which, however, we shall be lost in the wood) will lead us into error.

People calling themselves macroeconomists ought to be rather embarrassed by the fact that the kind of microfounded dynamic stochastic general equilibrium models they use, cannot incorporate such a basic fact of reality as involuntary unemployment!
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