Macroeconomic uncertainty

28 October, 2015 at 10:11 | Posted in Economics | 7 Comments

The financial crisis of 2007-08 hit most laymen and economists with surprise. What was it that went wrong with our macroeconomic models, since they obviously did not foresee the collapse or even make it conceivable?

There are many who have ventured to answer this question. And they have come up with a variety of answers, ranging from the exaggerated mathematization of economics, to irrational and corrupt politicians.

0But the root of our problem goes much deeper. It ultimately goes back to how we look upon the data we are handling. In “modern” macroeconomics — Dynamic Stochastic General Equilibrium, New Synthesis, New Classical and New ‘Keynesian’ — variables are treated as if drawn from a known “data-generating process” that unfolds over time and on which we therefore have access to heaps of historical time-series. If we do not assume that we know the “data-generating process” – if we do not have the “true” model – the whole edifice collapses. And of course it has to. I mean, who really honestly believes that we should have access to this mythical Holy Grail, the data-generating process?

“Modern” macroeconomics obviously did not anticipate the enormity of the problems that unregulated “efficient” financial markets created. Why? Because it builds on the myth of us knowing the “data-generating process” and that we can describe the variables of our evolving economies as drawn from an urn containing stochastic probability functions with known means and variances.

This is like saying that you are going on a holiday-trip and that you know that the chance the weather being sunny is at least 30%, and that this is enough for you to decide on bringing along your sunglasses or not. You are supposed to be able to calculate the expected utility based on the given probability of sunny weather and make a simple decision of either-or. Uncertainty is reduced to risk.

But as Keynes convincingly argued in his monumental Treatise on Probability (1921), this is not always possible. Often we simply do not know. According to one model the chance of sunny weather is perhaps somewhere around 10% and according to another – equally good – model the chance is perhaps somewhere around 40%. We cannot put exact numbers on these assessments. We cannot calculate means and variances. There are no given probability distributions that we can appeal to.

In the end this is what it all boils down to. We all know that many activities, relations, processes and events are of the Keynesian uncertainty-type. The data do not unequivocally single out one decision as the only “rational” one. Neither the economist, nor the deciding individual, can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.

wrongrightSome macroeconomists, however, still want to be able to use their hammer. So they decide to pretend that the world looks like a nail, and pretend that uncertainty can be reduced to risk. So they construct their mathematical models on that assumption. The result: financial crises and economic havoc.

How much better – how much bigger chance that we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control – if instead we could just admit that we often simply do not know, and that we have to live with that uncertainty as well as it goes.

Fooling people into believing that one can cope with an unknown economic future in a way similar to playing at the roulette wheels, is a sure recipe for only one thing – economic catastrophe!

7 Comments »

RSS feed for comments on this post. TrackBack URI

  1. Models are one thing – outright corruption and illegal acts are another, and a further problem is the lack of accountability. The Great Recession looks more like a restructuring of the economy than a matter of “error.”

  2. If you had known the bank- finance industry you had been be better prepared. Debts it not only someone elses assets which you leave outside your models. You have to start learning about derivatives, balance-sheets, hedge and leverage and understand why banks always fail down the line. There are no efficient (financial-)markets in the longer run. Since 1980(and 1999) banking is a betting industry working against their customers using their capital.

    E Fama is dead wrong and there is no need for black swan´s to falsify his hypothesis. If he was right there is no need for centralbanks i.e.

  3. Stop knowing nothing, start knowing something
    Comment on Lars Syll on ‘Macroeconomic uncertainty’
    .
    Imagine for a moment there is one world economy and the government consists, as Plato dreamed, of wise philosophers. There is — unfortunately, the government does not understand why — a grave problem: unemployment is rising. Understandably, this crisis shatters the faith in the economic advisers who hitherto all came from the orthodox school.
    .
    So, the Minister for Economic Affairs calls for a heterodox economist and he speaks thus: “You know, Lars, we are unhappy with our previous economic advisers and we have heard that you criticize these DSGE guys for several years now in no uncertain terms. It seems you know better. Are you prepared to help us to solve our current problem?
    .
    “Yes, of course Phil, but let me tell you something important about Heterodoxy first: we do not believe that we have access to this mythical Holy Grail, the data-generating process.”
    .
    “Hm, what does this mean?”
    .
    “It means that we simply do not know. We know this since Keynes’s Treatise on Probability of 1921. We know, for example, that we cannot predict the rate of interest 20 years hence.”
    .
    “No problem, I talked the other day to this physicist Feynman and guess what he told me: The future is unpredictable. I understand quite well that only folks like soothsayers, astrologers, stock market gurus, fear mongers or prophets make predictions.”
    .
    “Yes, this is the core message of Heterodoxy: neither the economist, nor the deciding individual, can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.”
    .
    “I understand, it’s ontological, ignoramus et ignorabimus as du Bois-Reymond always said. But this physicist could at least tell me how the Quarks and the Universe works. Seems he believed more in Hilbert, the axiomatist.”*
    .
    “Heterodoxy is different, you know, we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control. We just admit that we often simply do not know, and that we have to live with that uncertainty as well as it goes.”
    .
    “That is indeed quite honest. Like good old Socrates: I know that I know nothing.”
    .
    “Yes, and that’s really dangerous. Remember, the Athenians poisoned him.”
    .
    “Yes, afterward he became the patron saint of all know-nothings. But let us put Socrates aside, he was a gossiping sitcom sophist not a scientist.”
    .
    “He could be regarded as a forerunner of Keynesianism. After all, he was well aware that many activities, relations, processes and events are of the Keynesian uncertainty-type.”
    .
    “I think I understand uncertainty now, but is there anything heterodox economists know beyond this?”
    .
    “Yes, of course, fooling people into believing that one can cope with an unknown economic future is a sure recipe for only one thing – economic catastrophe!”
    .
    “That’s indeed a bold prediction! But, frankly, Lars, I expected that you could help us to prevent a catastrophe. Let me put it more precisely: we have rising unemployment and some economists say that the wage rate must be lowered others say it must be raised.** What, as a spokesperson of the heterodox school, is your take on this age-old chestnut?”
    .
    “As Keynes said: we simply do not know and it is better to be vaguely right than precisely wrong.”
    .
    “And this was already in 1921 and it is still true.”
    .
    “You got it, Phil!”
    .
    “Yes, Orthodoxy means knowing nothing and Heterodoxy means being proud of knowing nothing.”
    .
    Egmont Kakarot-Handtke
    .
    * See Wikipedia
    https://en.wikipedia.org/wiki/Ignoramus_et_ignorabimus

    ** The average wage rate must rise, see ‘No future for the representative economist’
    http://axecorg.blogspot.com/2015/08/no-future-for-representative-economist.html

  4. The problem with the orthodoxy in economics is that it ignores what we DO know. We actually DO know something about human behaviour. Historians DO know some history. We DO know something about how societies work. People have primary documentary evidence and DO know something – knowledge and lessons ignored because the orthodoxy prefers a one-size-fits-all, and totally fictitious model.

    People say that is fine if the models are good predictors (which they aren’t anyway, but let’s assume they are). Yes, a model that consistently provides good forecasts is the right model, as Friedman says. That is absolutely fine as long as you remember what models are for – to predict. That is to forecast to allow the formulation of policy, such as a national budget. They are not there to provide for explanations of reality. That regards engagement with reality, qualitative and quantitative.

  5. “Yes, of course, fooling people into believing that one can cope with an unknown economic future is a sure recipe for only one thing – economic catastrophe!”

    Is it necessarily? Humanity seems to have survived and prospered – in fits and start at least.

    “Yes, Orthodoxy means knowing nothing and Heterodoxy means being proud of knowing nothing.”

    I would say Orthodoxy means knowing nothing but believing you do, Heterodoxy means knowing nothing but accepting you do.

  6. Actually I meant, Orthodoxy means knowing nothing but believing you do know something, Heterodoxy means knowing nothing but accepting you do know nothing.

  7. Heterodox means opinions or doctrines that go against an official or orthodox opinion not to be against methods per se.

    When it comes to Lars Pålsson Syll, of course it´s up to Lars himself to explain his position in methodological questions
    (which he has done, here and elswhere many times) but of course you don´t get two doctorates in areas like history of economic theory and methodology and about specific analyze methods by like Structural Analytic School of thought, without useing any method yourself.

    He has written tons on this, mostly in Swedish, which few could read of course, where he declared his own standings in those question and he have used it in his own researches.

    As i understand it, it´s pretty clear,that Lars is an Instutionalist,a tradition with specific methods developed under more then 100 years by people like Thorstein Veblen, Wesley Mitchell, and Swedes like Gunnar Myrdal, Johan Henrik Åkerman, Erik Dahmén, to just name a few.

    In philosophy of science Lars is a Critical Realist see:https://en.wikipedia.org/wiki/Critical_realism_(philosophy_of_the_social_sciences).

    And as a student of people like Hyman Minsky and other more or less Post-Keynsian economist he of course got inspired and learned in theory and practice how to use their methods.

    And a plethora of methodologically well-designed, alternative schools, patronisly described as Heterodox Economy,really still exist out there,if one just dig in and read.
    We must also remember that, this so called Heterodoxy nowadays even dominated many places and especally Cambridge University Economics Department for half century with many of the most methodological innovative economist ever seen.

    As alternatives to the dominating patchwork of various ,neoclassical schools (“new-classical/new keynsian” the name of them nowadays) with their trimmed models,but mainly as i see it, all basicly emanating from the simplistic 1870 utility theory (and their more mathematical innovative followers) a theory that already since its inception, have been rebutted long ago by people such as J.S Mill, Veblen and countless others,not to mention, whole the German and American Historical School that was the core in many coutries for a long period.

    Mainstream economics is not what it use to be.I simply can´t see much progress in the economic manstream economics, with maybee some exceptions.Yes models,is better in technical terms,the rise of computers and other devises have made it easier to handle such things.But when it comes to the Core-thinking in Economics (and other social sciences) i sadly can´t say much more,than that it´s been more of regression than progress,with few exceptions for much to long.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Create a free website or blog at WordPress.com.
Entries and comments feeds.