Wren-Lewis and Krugman — flimflam defenders of economic orthodoxy

30 april, 2014 kl. 14:45 | Publicerat i Economics | 1 kommentar

The teaching of economics has recently been in the news. One reason is the activities of Manchester University undergraduates who have formed the Post-Crash Economics Society to protest the monopoly of mainstream neoclassical economics in university lecture halls. A second reason is criticism of the neoclassical reasoning in Thomas Piketty’s runaway best seller Capital in the Twenty-First Century.


This criticism and calls for including heterodox economic theory in the curriculum have prompted a defense of mainstream economics from Princeton University’s Paul Krugman and Oxford University’s Simon Wren-Lewis. Both hail from the mainstream’s liberal wing, which muddies the issue because it is easy to conflate the liberal wing with the critics. In fact, the two are significantly different and their defense of mainstream economics is pure flimflam …

The mainstream’s flimflam defense involves a two-pronged response. The first prong is an assertion that mainstream economics is already a big tent that incorporates Keynesian economics. The second prong is the oversights that led mainstream economists to miss the crisis have been fully corrected. There was no deep conceptual failure, only a myopic failure to observe the real-world rise of shadow banking …

Krugman’s freshwater – saltwater characterization is profoundly misleading regarding the intellectual state of mainstream economics. Whereas the freshwater metaphor makes sense, the saltwater metaphor does not. The true saltwater school is the now eviscerated Cambridge (UK) School of economics that was home to the likes of Joan Robinson and Nicholas Kaldor. The MIT School is better described as brackish (or even putrid) water.

Why brackish? Because it has retained the nonsense of marginal productivity distribution theory while discarding the foundations of Keynesian economics. The essence of Keynes’ economics was the liquidity preference theory of interest rates and rejection of the claim that price and nominal wage flexibility would ensure full employment. New Keynesians abandon both. They replace liquidity preference theory with loanable funds interest rate theory and they use price and nominal wage rigidity to explain cyclical unemployment.

I have long argued that the new Keynesian nomenclature is a cuckoo tactic because it captures the Keynesian label while having nothing to do with Keynes, in a manner similar to the cuckoo which lays its eggs in other birds’ nests. In my view, it is better labeled new Pigovian economics since it relies on market imperfections and frictions, which were the hallmarks of Pigou’s economic thinking. That makes for bitter irony as Pigou was Keynes’ greatly respected intellectual opponent in the 1930s and his thinking now passes under the Keynesian banner, displacing Keynes’ own ideas.

Thomas Palley

Flytta inte mer makt till Bryssel

30 april, 2014 kl. 14:02 | Publicerat i Politics & Society | Kommentarer inaktiverade för Flytta inte mer makt till Bryssel


Yours truly har idag, tillsammans med några andra medlemmar i Junilistans förtroenderåd, en artikel i Aftonbladet där vi argumenterar mot att allt mer av den politiska makten flyttas över till EU-institutioner utan egentlig demokratisk förankring i de europeiska folken.

Euler’s method in Excel and Matlab (student stuff)

30 april, 2014 kl. 08:32 | Publicerat i Statistics & Econometrics | Kommentarer inaktiverade för Euler’s method in Excel and Matlab (student stuff)


Mindless statistics

30 april, 2014 kl. 07:55 | Publicerat i Statistics & Econometrics | Kommentarer inaktiverade för Mindless statistics

Knowing the contents of a toolbox, of course, requires statistical thinking, that is, the art of choosing a proper tool for a given problem. Instead, one single procedure that I call the “null ritual” tends to be featured in texts and practiced by researchers. Its essence can be summarized in a few lines:

The null ritual:
1. Set up a statistical null hypothesis of “no mean difference” or “zero correlation.” Don’t specify the predictions of your research hypothesis or of any alternative substantive hypotheses.
2. Use 5% as a convention for rejecting the null. If significant, accept your research hypothesis. Report the result as p < 0.05, p < 0.01, or p < 0.001 (whichever comes next to the obtained p-value).
3. Always perform this procedure …

gigThe routine reliance on the null ritual discourages not only statistical thinking but also theoretical thinking. One does not need to specify one’s hypothesis, nor any challenging alternative hypothesis … The sole requirement is to reject a null that is identified with “chance.” Statistical theories such as Neyman–Pearson theory and Wald’s theory, in contrast, begin with two or more statistical hypotheses.

In the absence of theory, the temptation is to look first at the data and then see what is significant. The physicist Richard Feynman … has taken notice of this misuse of hypothesis testing. I summarize his argument:

Feynman’s conjecture:
To report a significant result and reject the null in favor of an alternative hypothesis is meaningless unless the alternative hypothesis has been stated before the data was obtained.

Feynman’s conjecture is again and again violated by routine significance testing, where one looks at the data to see what is significant. Statistical packages allow every difference, interaction, or correlation against chance to be tested. They automatically deliver ratings of “significance” in terms of stars, double stars, and triple stars, encouraging the bad afterthe-fact habit. The general problem Feynman addressed is known as overfitting … Fitting per se has the same
problems as story telling after the fact, which leads to a “hindsight bias.” The true test of a model is to fix its parameters on one sample, and to test it in a new sample. Then it turns out that predictions based on simple heuristics can be more accurate than routine multiple regressions … Less can be more. The routine use of linear multiple regression exemplifies another mindless use of statistics …

We know but often forget that the problem of inductive inference has no single solution. There is no uniformly most powerful test, that is, no method that is best for every problem. Statistical theory has provided us with a toolbox with effective instruments, which require judgment about when it is right to use them … Judgment is part of the art of statistics.

To stop the ritual, we also need more guts and nerves. We need some pounds of courage to cease playing along in this embarrassing game. This may cause friction with editors and colleagues, but it will in the end help them to enter the dawn of statistical thinking.

Krugman’s childish parables — neat, plausible, and wrong

28 april, 2014 kl. 10:43 | Publicerat i Economics | 20 kommentarer

In his latest blog, Paul Krugman slings off at non-mainstream Economists …

Krugman trash what he accurately sees as “an upwelling of frustration on the part of heterodox economists” …

No need for change, boys and girls: mainstream economics has everything under control. We missed the crisis just because we failed to observe the shenanigans in the shadow banking system. Once we realised our observational errors, we had all the necessary tools and knew what to do. (Oh, and what the rebels said would happen didn’t anyway, so there!)

As usual, Krugman’s reasoning is neat, plausible, and wrong …

[T]he real frustration heterodox economists feel is the frustration that comes from trying to make an almost immoveable intellectual object move. In the 1960s, critics successfully exposed fundamental flaws in Neoclassical economics, as Samuelson himself admitted:

“If all this causes headaches for those nostalgic for the old-time parables of neoclassical writing, we must remind ourselves that scholars are not born to live an easy existence. We must respect, and appraise, the facts of life.”

But what happened? Nothing!


Decades later, the same childish parables are still taught in textbooks like Krugman’s that are derivatives of Samuelson’s original, with no evidence that these “old-time parables” were ever even challenged.

My take from this history was that the only real chance to cause fundamental change in economics comes during crises. But the experience of the Great Recession has shown that even that isn’t necessarily enough to dislodge the orthodoxy.

A major factor here is the existence of progressive economists on the fringe of the orthodoxy, especially mainstreamers like Krugman himself …

Krugman might rightly rail against this nonsense in print and sensibly argue for expansionary policy during a deleveraging crisis, but apart from the IS-LM model itself, the tools he uses were first developed by ultra-orthodoxers like Barro: rational expectations, “Dynamic Stochastic General Equilibrium” models, the whole kaboodle.

Had these ultra-orthodoxers been the mainstream, then the need for drastic change to the core of economics would have been obvious. But instead, the far more reasonable Krugman is the public face of orthodox economics. He still uses the orthodox core, but is skilled at adding kinks — imperfect competition, “frictions” that slow down the march to equilibrium, and so on — to better match real world data. The impact is that once the crisis passes, the core of economics survives the crisis, with a few added kinks.

Steve Keen

The war on poverty

28 april, 2014 kl. 08:55 | Publicerat i Economics | 1 kommentar

unemployment-line-great-depression_large_image1The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years… Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.

J. M. Keynes (1929)

Gamle Tommy

27 april, 2014 kl. 22:15 | Publicerat i Varia | 1 kommentar


[h/t Jan Milch]

The neoclassical production function — bogus science

27 april, 2014 kl. 15:39 | Publicerat i Economics | 1 kommentar


The Neoclassical Production Function (NPF) makes sense in a simple context. Suppose you are an entrepreneur with a fruit orchard. You can pay to have fruit trees planted. That is your capital. After a while the fruit trees mature, and you hire workers to pick and sell the fruit. That is your labor. The function Y = f(K,L), which says that output is a function of capital and labor, is a reasonable model that can help to predict your decisions and the share of income that goes to your workers.

Economists from Ricardo to Piketty have wanted to describe the relationship between economic growth and income distribution in terms of simple laws. For the past fifty years or so, the NPF has been the go-to tool for economists trying to do this. Mathematically, it is very elegant for that purpose.

But thinking of the economy in terms of an aggregate NPF has many problems, including the following:

1. Capital aggregation. There is a huge, huge literature on this (see “Cambridge capital controversies”). The result was that the economists who claimed that you cannot construct a meaningful aggregate out of different types of capital equipment won the theoretical battle but lost the practical war. That is, those who use capital aggregation admit that it is bogus, but they go ahead and do it anyway. It’s a matter of “I need the eggs” …

4. Capital proliferation. Over the past fifty years, economists have conceptualized many types of capital. We now have human capital, social capital, organizational capital, institutional capital, environmental capital, network capital, consumer capital, cultural capital, knowledge capital, innovation capital, and so on … But these multiple forms of capital mess with the simple NPF and with the correspondence between theoretical concepts and real world data …

So, should we use the NPF to guide economic policy to try to achieve the best balance among growth and the distribution of income? Some possibilities:

(1) The criticisms of the aggregate NPF are not important, so that policy conclusions are still sound.

(2) Some of the criticisms are devastating, but we need some tool to guide policy, and until something better comes along our best choice is the aggregate NPF.

(3) Some criticisms are devastating, and as a result we should be very cautious and humble about making policy pronouncements based on our understanding of the NPF.

To me, (3) makes the most sense. But that is not a popular position at the moment.

Arnold Kling

Endogenous growth theory

26 april, 2014 kl. 10:00 | Publicerat i Economics | 3 kommentarer

shawsurfingIf you have an apple and I have an apple and we exchange these apples then you and I will each have one apple.

But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas.

George Bernard Shaw

Miss Blue

25 april, 2014 kl. 18:57 | Publicerat i Varia | Kommentarer inaktiverade för Miss Blue


Krugman’s gadget interpretation of economics

25 april, 2014 kl. 17:30 | Publicerat i Economics | 5 kommentarer

gadget-freak_logo (Kopie)




Commenting on the critique put forward by yours truly and a couple of other heterodox economists re Piketty and the neoclassical concept of capital, Paul Krugman today writes on his blog:

You fairly often find heterodox economists insisting that to accept the idea that capital and labor are paid their marginal products, even as a working hypothesis to be modified when you address things like executive pay, is to accept that high inequality is morally justified. But that’s obviously not the case: there are plenty of economists who are willing to use marginal-product models (as gadgets, not as fundamental truth) who don’t at all accept the sanctity of the market distribution of income. So this complaint is, in its own way, as much of a distortion as the right-wing claim that anyone who so much as mentions inequality is a Marxist.

Besides, again, not really trying to clinch the deep theoretical issue at stake, Krugman for the n:th time puts forward his gadget interpretation of economics.

Krugman’s argumentation illustrates well an idea of science advancing through the use of successive approximations.  Start with simple gadget models and then successively approximate reality to get at the ”fundamental truth.” But is this really a feasible methodology?

All empirical sciences use simplifying or unrealistic assumptions in their modeling activities. That is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons.

Theories are difficult to directly confront with reality. Economists therefore build models of their theories. Those models are representations that are directly examined and manipulated to indirectly say something about the target systems. But models do not only face theory. They also have to look to the world.

Being able to model a ”gadget world” — a world that somehow could be considered real or similar to the real world — is not the same as investigating the real world. Even though all theories are false, since they simplify, they may still possibly serve our pursuit of truth. But then they cannot be unrealistic or false in any way. The falsehood or unrealisticness has to be qualified.

Explanation, understanding and prediction of real world phenomena, relations and mechanisms  cannot be grounded (solely) on a gadget analysis . Some of the standard assumptions made in neoclassical economic theory – on rationality, information handling and types of uncertainty – are not possible to make more realistic by de-idealization or successive approximations without altering the theory and its models fundamentally. If we cannot show that the mechanisms or causes we isolate and handle in our models are stable, in the sense that what when we export them from our gadget models to our target systems they do not change from one situation to another, then they only hold under ceteris paribus conditions and a fortiori are of limited value for our understanding, explanation and prediction of our real world target system.

The obvious ontological shortcoming of a basically epistemic — rather than ontological — approach such as ”successive approximations” is that similarity or resemblance tout court do not guarantee that the correspondence between model and target is interesting, relevant, revealing or somehow adequate in terms of mechanisms, causal powers, capacities or tendencies. No matter how many convoluted refinements of concepts made in the gadget model, if the ”successive approximations” do not result in models similar to reality in the appropriate respects (such as structure, isomorphism etc), the surrogate gadget system becomes a substitute system that does not bridge to the world, but rather misses its target.

So — constructing gadgets like “minimal” or ”IS-LM” macroeconomic models as “stylized facts” somehow “successively approximating” macroeconomic reality, is a rather unimpressive attempt at legitimizing using fictitious idealizations for reasons more to do with model tractability than with a genuine interest of understanding and explaining features of real economies. Many of the model assumptions standardly made by neoclassical macroeconomics are restrictive rather than harmless and could a fortiori anyway not in any sensible meaning be considered approximations at all.

Where does all this leave us? Well, I for one, is not the least impressed by Krugman’s gadget interpretation of economics. Krugman — still — hasn’t come up with a tenable explanation to why mainstream economics goes on as if the capital controversy has never occurred, or why he and other leading neoclassical economists — still — treat  ‘capital’ as if it was a well-defined and consistent concept — which it is not, as admitted by Samuelson et consortes almost fifty years ago.

Added 19:00 GMT: For those who need a refresher on the capital debates, Matias Vernengo has a short, accessible, and informative introduction here.

Krugman’s misleading trivialization of the capital controversy

24 april, 2014 kl. 17:56 | Publicerat i Economics | 16 kommentarer

Paul Krugman today comments on some ”leftist” critiques of Piketty:

(T)hey’re disappointed that Piketty’s book relies mainly on conventional, mainstream economics.

And it’s mostly true. For the most part Piketty works with an “aggregate production function” in which labor works with a stock of capital to produce output, and both labor and capital are paid their marginal product …

capital-gainsThere are a few economists on the left who seem to believe that:

1. You need to believe in the existence of a perfectly well-defined aggregate measure of capital to believe in the marginal productivity theory of income distribution;
2. If you believe in, or even use, marginal productivity theory, you are conceding that capitalists deserve their income.

Neither of these things are true. Nothing about marginal productivity theory depends on the exact truth of a simple aggregate production function with capital defined by a single number. And saying that capital gets its marginal product in no way says that the people who own that capital deserve what they get.

On the inequality issue, Krugman is absolutely right. It would be preposterous to allege that mainstream economics couldn’t explain it or consider it bad. And I doubt if any serious ”leftist” economist really maintains such a view.

But — as so often — Krugman trivializes the more theoretical point. In this case it’s the concept of capital and the Cambridge controversy over it. As every mainstream textbook on growth theory and most neoclassical economists, Krugman just chooses to turn a blind eye to it and pretend it’s much fuss about nothing. But Krugman et consortes are wrong!

The production function has been a powerful instrument of miseducation. The student of economic theory is taught to write Q = f(L, K) where L is a quantity of labor, K a quantity of capital and Q a rate of output of commodities. He is instructed to assume all workers alike, and to measure L in man-hours of labor; he is told something about the index-number problem in choosing a unit of output; and then he is hurried on to the next question, in the hope that he will forget to ask in what units K is measured. Before he ever does ask, he has become a professor, and so sloppy habits of thought are handed on from one generation to the next.

Joan Robinson

And as Edwin Burmeister admitted already fifteen years ago:

It is important, for the record, to recognize that key participants in the debate openly admitted their mistakes. Samuelson’s seventh edition of Economics was purged of errors. Levhari and Samuelson published a paper which began, ‘We wish to make it clear for the record that the nonreswitching theorem associated with us is definitely false’ … Leland Yeager and I jointly published a note acknowledging his earlier error and attempting to resolve the conflict between our theoretical perspectives … However, the damage had been done, and Cambridge, UK, ‘declared victory’: Levhari was wrong, Samuelson was wrong, Solow was wrong, MIT was wrong and therefore neoclassical economics was wrong. As a result there are some groups of economists who have abandoned neoclassical economics for their own refinements of classical economics. In the United States, on the other hand, mainstream economics goes on as if the controversy had never occurred. Macroeconomics textbooks discuss ‘capital’ as if it were a well-defined concept — which it is not, except in a very special one-capital-good world (or under other unrealistically restrictive conditions). The problems of heterogeneous capital goods have also been ignored in the ‘rational expectations revolution’ and in virtually all econometric work.

Edwin Burmeister

The 1% that matters

24 april, 2014 kl. 09:55 | Publicerat i Politics & Society | 3 kommentarer


(h/t David Ruccio)

Krugman still thinking about Sweden — and still only gets it partly right

21 april, 2014 kl. 11:33 | Publicerat i Economics | 23 kommentarer

As I reported last week, Sweden is according to Statistics Sweden in a state of deflation. The inflation rate was -0.6 percent in March.

To a large extent the deflation is caused by tight monetary and fiscal policies  pursued by Sweden’s  Central Bank and the government. With a very defensive fiscal policy and a targeted inflation rate set at a very low level, real inflation has during the last 2-3 years been very close to zero, and now even negative. Another consequence of the austere fiscal and monetary policies is that overall unemployment is still at almost 9 % and youth unemployment close to 26 %.

This is deeply worrying. On this Krugman and yours truly seem to agree:

I’m still thinking about Sweden’s slide into deflation, which actually offers several lessons relevant to the rest of us.

First, it’s an object lesson in the power of sadomonetarism, the desire of many monetary officials to raise interest rates … In 2010 Sweden had high unemployment and low inflation; Econ 101 level macro should have said that this was no time to raise rates. Yet the Riksbank went ahead and did so anyway. Why?

It now says that it was all about financial stability, about fears of excessive house prices and borrowing. But that’s not what it was saying at the time! The bank’s governor did a chat in December 2010 in which he declared that it was about inflation:

”If the interest rate isn’t raised now, we’ll run the risk of too much inflation further ahead. This wouldn’t be good for the economy. Our most important task is to ensure that we meet our inflation target of 2%.”

Strange to say, however, when inflation started coming in well below the target, the Riksbank just kept raising rates, and switched to the financial stability justification.

Krugman’s argumentation, however, gives a somewhat too simplistic view of the problems facing the Swedish economy today. And just pooh-poohing deeply felt concerns and fears of a housing bubble with conspiracy theories (”excuses”) is debating economic policies analogous to playing tennis with the nets down.

So let’s try to get the full — and somewhat more complicated — picture right.

Lars E. O. Svensson — former deputy governor of the Riksbank — has repeatedly during the last year lambasted the Swedish Riksbank for having pursued a policy during the last fifteen years that has increased unemployment in Sweden:

The conclusion from the analysis is thus that the actual monetary policy has led to substantially lower inflation than the target and substantially higher unemployment than a policy that would have kept the policy rate unchanged at 0.25 percent.

The Riksbank has more recently justified the tight policy by maintaining that a lower policy rate would have increased the household debt ratio (debt relative to disposable income) and would have increased any risks connected with the debt. But, as I have shown … this is not true. A lower policy rate would have led to a lower debt ratio, not a higher one. This is because a lower policy rate increases the denominator (nominal disposable income) faster than the numerator (nominal debt). Then the debt ratio falls …

In summary, the Riksbank has conducted a monetary policy that has led to far too low inflation, far too high unemployment, and a somewhat higher debt ratio compared to if the policy rate had been left at 0.25 percent from the summer of 2010 until now. This is not a good result.

By the way, the latest report The Swedish Economy by the National Institute of Economic Research includes a very interesting special study, ”The Riksbank has systematically overestimated inflation,” which may be important in this context. In an analysis of the Riksbank’s inflation forecasts, the NIER shows that Riksbank forecasts have systematically overestimated inflation. The NIER concludes that “[t]he Riksbank’s overestimation of inflation has contributed to overly tight monetary policy with higher unemployment and lower inflation than would have been the case if, on average, its inflation forecasts had been on the mark.”

Why the majority of the Executive Board so systematically has exaggerated inflation risks so systematically is a question that may be worth returning to.

The Swedish Riksbank has according to Lars E. O. Svensson been pursuing a policy during the last fifteen years that in reality has made inflation on average more than half a percentage units lower than the goal set by the Riksbank. The Phillips Curve he estimates shows that unemployment as a result of this overly “austere” inflation level has been almost 1% higher than if one had stuck to the set inflation goal of 2%.

What Svensson is saying, without so many words, is that the Swedish Fed for no reason at all has made people unemployed. As a consequence of a faulty monetary policy the unemployment is considerably higher than it would have been if the Swedish Fed had done its job adequately.

So far, so good — I have no problem with Svensson’s — or Krugman’s — argument about the inadequacy of the Swedish inflation targeting policies.

However, what makes the picture more complicated than Krugman — and Svensson — wants to admit, is that we do have a housing bubble in Sweden — it’s not just a figment of imagination the ”bad guys” use to intimidate us with. [That said, I, of course, in no way want to imply that central bank interest rate targeting (and/or accommodations) is the best way to counteract housing bubbles. Far from it.]

The increase in house loans – and house prices – in Sweden has for many years been among the steepest in the world.

Sweden’s house price boom started in mid-1990s, and looking at the development of real house prices since 1986, there are obvious reasons to be deeply worried:

Source: Statistics Sweden

The indebtedness of the Swedish household sector has also risen to alarmingly high levels, as indicated by the figure below (based on new data published earlier this year by Statistics Sweden, showing the development of household debts/disposable income 1990 – 2012):

Source: Statistics Sweden

As a result yours truly has been trying to argue with ”very serious people” that it’s really high time to ”take away the punch bowl.”

The Swedish housing market — with a high level of prices and household indebtedness — has become increasingly fragile during the last two decades. A ‘Minsky moment’ actually doesn’t seem to be that far away, and we may sooner than we think face a deflationary house price spiral driving the economy to a classic Fisher-Keynes-Minsky debt deflation crisis.

And this is the part of the story that Krugman doesn’t want to admit gives some credence to the arguments put forward recently by the Riksbank.

”Simple” models may sometimes help you think clearly about matters. But sometimes it’s also absolutely imperative to get the full picture. As H. L. Mencken once famously had it:

There is always an easy solution to every problem – neat, plausible and wrong.

Added 22 & 23 April: There’s more on the rather heated Swedish debate herehere, and here.

Self-righteous Chicago drivel — far from everything you need to know about economics

20 april, 2014 kl. 22:21 | Publicerat i Economics | 1 kommentar

In 2007 Thomas Sargent gave a graduation speech at University of California at Berkeley, giving the grads ”a short list of valuable lessons that our beautiful subject teaches”:

1. Many things that are desirable are not feasible.
2. Individuals and communities face trade-offs.
3. Other people have more information about their abilities, their efforts, and their preferences than you do.
4. Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.
5. There are trade offs between equality and efficiency.
6. In an equilibrium of a game or an economy, people are satisfied with their choices. That is why it is difficult for well meaning outsiders to change things for better or worse.
Lebowski.jpg-610x07. In the future, you too will respond to incentives. That is why there are some promises that you’d like to make but can’t. No one will believe those promises because they know that later it will not be in your interest to deliver. The lesson here is this: before you make a promise, think about whether you will want to keep it if and when your circumstances change. This is how you earn a reputation.
8. Governments and voters respond to incentives too. That is why governments sometimes default on loans and other promises that they have made.
9. It is feasible for one generation to shift costs to subsequent ones. That is what national government debts and the U.S. social security system do (but not the social security system of Singapore).
10. When a government spends, its citizens eventually pay, either today or tomorrow, either through explicit taxes or implicit ones like inflation.
11. Most people want other people to pay for public goods and government transfers (especially transfers to themselves).
12. Because market prices aggregate traders’ information, it is difficult to forecast stock prices and interest rates and exchange rates.

Reading through this list of ”valuable lessons” things suddenly fall in place. As Noah Smith writes:

10 out of Sargent’s 12 ”lessons” are cautions against trying to use government to promote equality or help people … But I think that when this kind of list is put forth as a ”summary of economics”, it does a disservice to the profession. It reinforces the notion that econ is basically a form of political advocacy, and that it’s main value-add is to innoculate us against communism … Econ has become a much more technocratic field, and new theories and discoveries have made the question of ”government vs. markets” a much less simple one … Sargent, of course, knows that, and is just playing to a very particular audience of what he takes to be starry-eyed, wet-behind-the-ears, do-gooding Berkeley hippies. But it would be nice if bloggers did not hype lists like this as ”everything you need to know about economics”.

This kind of self-righteous neoliberal drivel has again and again been praised and prized. And not only by econ bloggers and right-wing think-tanks.

Out of all 74 persons that have been awarded ”The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel,” 28 have been affiliated to The University of Chicago — that is 37 %. The world is really a small place when it comes to economics …

I’m a Believer

19 april, 2014 kl. 17:21 | Publicerat i Varia | Kommentarer inaktiverade för I’m a Believer


Old love never rusts …

Ensam i Berlin

19 april, 2014 kl. 09:47 | Publicerat i Varia | Kommentarer inaktiverade för Ensam i Berlin

ensam-i-berlin-2Hans Falladas roman Ensam i BerlinJeder stirbt für sich allein i original — är precis som föregångaren Hur skall det gå med Pinnebergs? en enastående bra roman. Den tyska nazismens förtyck och brutalitet skildras här i all sin nakna hemskhet. Så vad kan vara bättre än att få detta mästerverk i påskgåva? I en litterärt bevandrad familj riskerar man aldrig långa helger utan intressant förströelse. Så nu får den n:te omläsningen av Röda rummet och Martin Bircks ungdom anstå ytterligare några dagar …

Lower wages is NOT the solution

17 april, 2014 kl. 21:19 | Publicerat i Economics | 5 kommentarer

In connection with being awarded The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2011 – Thomas Sargent, in an interview with Swedish Television, declared that workers ought to be prepared for having low unemployment compensations in order to get the right incentives to search for jobs.

This old mercantilist idea has very little support in research, since it has turned out to be exceedingly difficult to really get clear cut results of causality on the issue. However, the Swedish right-wing finance minister – Anders Borg – appreciated Sargent’s statement and declared it to be a “healthy warning” for those who wanted to increase compensation levels.

workers-wages-vsIn an article published in today’s Dagens ETC it is documented how one of Sweden’s more well-known and influential economists, Lars Calmfors, for 25 years has written out the same prescription — lower wages — for solving no matter what problem facing our economy.

Sargent’s, Borg’s and Calmfors’s view is symptomatic. As in the 1920s, more and more right-wing politicians — and some economists — suggest that lowering wages is the right medicine to strengthen the competitiveness of their faltering economies, get the economy going, increase employment and create growth that will get rid of the towering debts and create balance in the state budgets.

But, intimating that one could solve economic problems by impairing unemployment compensations and wage cuts, in dire times, should really be taken more as a sign of how low the confidence in our economic system has sunk. Wage cuts and lower unemployment compensation levels – of course – do not save neither competitiveness, nor jobs.

What is needed more than anything else in these times is stimulus and economic policies that increase effective demand.

On a societal level wage cuts only increase the risk of more people getting unemployed. To think that that one can solve economic crisis in this way is a turning back to those faulty economic theories and policies that John Maynard Keynes conlusively showed to be wrong already in the 1930s. It was theories and policies that made millions of people all over the world unemployed.

It’s an atomistic fallacy to think that a policy of general wage cuts would strengthen the economy. On the contrary. The aggregate effects of wage cuts would, as shown by Keynes, be catastrophical. They would start a cumulative spiral of lower prices that would make the real debts of individuals and firms increase since the nominal debts wouldn’t be affected by the general price and wage decrease. In an economy that more and more has come to rest on increased debt and borrowing this would be the entrance-gate to a debt deflation crises with decreasing investments and higher unemployment. In short, it would make depression knock on the door.

The impending danger for today’s economies is that they won’t get consumption and investments going. Confidence and effective demand have to be reestablished. The problem of our economies is not on the supply side. Overwhelming evidence shows that the problem today is on the demand side. Demand is – to put it bluntly – simply not sufficient to keep the wheels of the economies turning. To suggest that the solution is lower wages and unemployment compensations is just to write out a prescription for even worse catastrophes.

Därför har den svenska järnvägen havererat

15 april, 2014 kl. 13:45 | Publicerat i Politics & Society | Kommentarer inaktiverade för Därför har den svenska järnvägen havererat

urNu krävs det en kriskommission för att rädda de svenska järnvägarna och den svenska tågtrafiken, skriver yours truly och fem andra experter i Dagens Samhälle.

Sweden hit by deflation — a sad and worrying reminder of the impotence of mainstream economics

14 april, 2014 kl. 22:24 | Publicerat i Economics | 3 kommentarer

irvingSweden is according to new statistics from  Statistics Sweden in a state of deflation. The inflation rate was -0.6 percent in March.

To a large extent the deflation is caused by tight monetary and fiscal policies  pursued by Sweden’s  Central Bank and the government. With a very defensive fiscal policy and a targeted inflation rate set at a very low level, real inflation has during the last 2-3 years been very close to zero, and now even negative. Another consequence of the austere fiscal and monetary policies is that overall unemployment is still at almost 9 % and youth unemployment close to 26 %.

This is deeply worrying.

So yours truly thought he should give the Swedish Fed and the Swedish finance minister – Anders Borg –  a suggestion for reading …

Zoltan Pozsnar and Paul McCulley have written an absolutely splendid essay on what a liquidity trap means and why mainstream neoclassical economics has nothing to offer in way of solving the problems that it brings along – and why it is so important to get hold of the insights that Fisher, Keynes, Minsky and Krugman have given us on debt-deflation processes and liquidity traps:

A liquidity trap is a circumstance in which the private sector is deleveraging in the wake of enduring negative animal spirits caused by the bursting of joint asset price and credit bubbles that leave privatesector balance sheets severely damaged. In a liquidity trap the animal spirits of the private sector cannot be revived by a reduction in short-term interest rates because there is no demand for credit. This effectively means that conventional monetary policy does not work in a liquidity trap …

Deleveraging can be rational for an individual household. It can be rational for an individual corporation. It can be rational for an individual country. However, in the aggregate it begets the paradox of thrift1: what is rational at the microeconomic level is irrational at the community, or macroeconomic, level.

This is not to say that the private sector should not deleverage. It has to. It is a part of the economy’s healing process and a necessary first step toward a self-sustaining economic recovery.

However, deleveraging is a beast of a burden that capitalism cannot bear alone. At the macro level, deleveraging must be a managed process: for the private sector to deleverage without causing a depression, the public sector has to move in the opposite direction and re-lever by effectively viewing the balance sheets of the monetary and fiscal authorities as a consolidated whole.

Fiscal austerity does not work in a liquidity trap and makes as much sense as putting an anorexic on a diet. Yet, “diets” are the very prescriptions that fiscal austerians have imposed (or plan to impose) in the U.S., U.K. and Eurozone. Austerians fail to realize, however, that everyone cannot save at the same time and that in liquidity traps, the paradox of thrift and depression are fellow travelers that are functionally intertwined.

Historically, austerity has only worked when accompanied by monetary easing – where wealth effects and stronger private demand for credit helped offset the effects of fiscal austerity – and/or a weaker currency – which helped steal others’ demand.

In a liquidity trap, however, austerity cannot work because monetary policy is neither functioning correctly nor able offset lost demand, and weak currencies work only at a time of strong global demand and only for individual countries, not for several major countries at one time. Imposing austerity without potential offsets and at a time of weak global aggregate demand is deflationary, which makes deleveraging much harder, balance sheet repair much slower and recovery much less likely to achieve. In a liquidity trap, governments have no logical option but to borrow and to invest.

How could governments borrow more if government debt is also a problem everywhere? Would it not be irresponsible to increase borrowing at a time of record government debt levels? Fiscal austerians are quick to invoke age-old textbook orthodoxies: (1) that additional borrowing will be too much for future generations to handle, citing the law of Ricardian equivalence; (2) that increased borrowing will crowd out private sector borrowing and will most likely delay the economic recovery; and (3) that bond investors will stop buying and send yields higher.

However, in the topsy-turvy world of liquidity traps, these textbook orthodoxies do not apply, and acting irresponsibly relative to orthodoxy by increasing borrowing will do more good than harm. Austerians argue that reducing deficits and putting nations’ fiscal houses in order will help growth through confidence. However, Ricardian equivalence does not work in reverse! It is not confidence, but Godley’s tyranny of arithmetic that matters: someone simply has to borrow and invest to fill missing demand.

Crowding out, overheating and rising interest rates are also not likely to be a problem as there is no competition for funds from the private sector. For evidence, look no further than the impact of government borrowing on long-term interest rates in the U.S. during the Great Depression, or more recently, Japan …

Held back by concerns borne of these orthodoxies, however, governments are not spending with passionate purpose. They are victims of intellectual paralysis borne of inertia of dogma that, in the present circumstances, do not apply. As a result, their acting responsibly relative to orthodoxy and going forth with austerity may drag economies down the vortex of deflation and depression.

The importance of fiscal expansion and the impotence of conventional monetary policy measures in a liquidity trap have profound implications for the conduct of central banks. This is because in a liquidity trap, the fat tail risk of inflation is replaced by the fat tail risk of deflation. In turn, the fatness of the deflation tail is a function of the government’s willingness and ability to pump-prime, i.e. to borrow and spend.

Added 19 April: Paul Krugman comments on the Swedish situation.

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