Mirowski’s concern to disabuse his readers of the notion that the wing of neoliberal doctrine disseminated by neoclassical economists could ever be reformed produces some of the best sections of the book. His portrait of an economics profession in haggard disarray in the aftermath of the crisis is both comic and tragic …
Little in the discipline has changed in the wake of the crisis. Mirowski thinks that this is at least in part a result of the impotence of the loyal opposition — those economists such as Joseph Stiglitz or Paul Krugman who attempt to oppose the more viciously neoliberal articulations of economic theory from within the camp of neoclassical economics. Though Krugman and Stiglitz have attacked concepts like the efficient markets hypothesis … Mirowski argues that their attempt to do so while retaining the basic theoretical architecture of neoclassicism has rendered them doubly ineffective.
First, their adoption of the battery of assumptions that accompany most neoclassical theorizing — about representative agents, treating information like any other commodity, and so on — make it nearly impossible to conclusively rebut arguments like the efficient markets hypothesis. Instead, they end up tinkering with it, introducing a nuance here or a qualification there. This tinkering causes their arguments to be more or less ignored in neoclassical pedagogy, as economists more favorably inclined toward hard neoliberal arguments can easily ignore such revisions and hold that the basic thrust of the theory is still correct. Stiglitz’s and Krugman’s arguments, while receiving circulation through the popular press, utterly fail to transform the discipline.
Perhaps the most dangerous impact of neoliberalism is not the economic crises it has caused, but the political crisis. As the domain of the state is reduced, our ability to change the course of our lives through voting also contracts. Instead, neoliberal theory asserts, people can exercise choice through spending. But some have more to spend than others: in the great consumer or shareholder democracy, votes are not equally distributed. The result is a disempowerment of the poor and middle. As parties of the right and former left adopt similar neoliberal policies, disempowerment turns to disenfranchisement. Large numbers of people have been shed from politics.
Chris Hedges remarks that “fascist movements build their base not from the politically active but the politically inactive, the ‘losers’ who feel, often correctly, they have no voice or role to play in the political establishment”. When political debate no longer speaks to us, people become responsive instead to slogans, symbols and sensation. To the admirers of Trump, for example, facts and arguments appear irrelevant.
Eminent statistician David Salsburg is rightfully very critical of the way social scientists — including economists and econometricians — uncritically and without arguments have come to simply assume that they can apply probability distributions from statistical theory on their own area of research:
We assume there is an abstract space of elementary things called ‘events’ … If a measure on the abstract space of events fulfills certain axioms, then it is a probability. To use probability in real life, we have to identify this space of events and do so with sufficient specificity to allow us to actually calculate probability measurements on that space … Unless we can identify [this] abstract space, the probability statements that emerge from statistical analyses will have many different and sometimes contrary meanings …
Kolmogorov established the mathematical meaning of probability: Probability is a measure of sets in an abstract space of events. All the mathematical properties of probability can be derived from this definition. When we wish to apply probability to real life, we need to identify that abstract space of events for the particular problem at hand … It is not well established when statistical methods are used for observational studies … If we cannot identify the space of events that generate the probabilities being calculated, then one model is no more valid than another … As statistical models are used more and more for observational studies to assist in social decisions by government and advocacy groups, this fundamental failure to be able to derive probabilities without ambiguity will cast doubt on the usefulness of these methods.
Wise words well worth pondering on.
As long as economists and statisticians cannot really identify their statistical theories with real-world phenomena there is no real warrant for taking their statistical inferences seriously.
Just as there is no such thing as a ‘free lunch,’ there is no such thing as a ‘free probability.’ To be able at all to talk about probabilities, you have to specify a model. If there is no chance set-up or model that generates the probabilistic outcomes or events – in statistics one refers to any process where you observe or measure as an experiment (rolling a die) and the results obtained as the outcomes or events (number of points rolled with the die, being e. g. 3 or 5) of the experiment – there strictly seen is no event at all.
Probability is — as strongly argued by Keynes — a relational element. It always must come with a specification of the model from which it is calculated. And then to be of any empirical scientific value it has to be shown to coincide with (or at least converge to) real data generating processes or structures – something seldom or never done!
And this is the basic problem with economic data. If you have a fair roulette-wheel, you can arguably specify probabilities and probability density distributions. But how do you conceive of the analogous ‘nomological machines’ for prices, gross domestic product, income distribution etc? Only by a leap of faith. And that does not suffice. You have to come up with some really good arguments if you want to persuade people into believing in the existence of socio-economic structures that generate data with characteristics conceivable as stochastic events portrayed by probabilistic density distributions!
Many mainstream economists seem to think the idea behind Modern Monetary Theory is new and originates from economic cranks.
New? Cranks? How about reading one of the great founders of neoclassical economics – Knut Wicksell. This is what Wicksell wrote in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise), 1936 (1898), p. 68f:
It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank …
A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system …
We intend therefor, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers. A thorough analysis of this purely imaginary case seems to me to be worth while, for it provides a precise antithesis to the equally imaginay case of a pure cash system, in which credit plays no part whatever [the exact equivalent of the often used neoclassical model assumption of “cash in advance” – LPS] …
For the sake of simplicity, let us then assume that the whole monetary system of a country is in the hands of a single credit institution, provided with an adequate number of branches, at which each independent economic individual keeps an account on which he can draw cheques.
What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity – MMT describes a fiat currency system that almost every country in the world is operating under.
And here’s another well-known economist with early ideas of the MMT variety:
[Bendixen says the] old ‘metallist’ view of money is superstitious, and Dr. Bendixen trounces it with the vigour of a convert. Money is the creation of the State; it is not true to say that gold is international currency, for international contracts are never made in terms of gold, but always in terms of some national monetary unit; there is no essential or important distinction between notes and metallic money; money is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like confusing a theatre ticket with the performance. With the exception of the last, the only true interpretation of which is purely dialectical, these ideas are undoubtedly of the right complexion. It is probably true that the old ‘metallist’ view and the theories of regulation of note issue based on it do greatly stand in the way of currency reform, whether we are thinking of economy and elasticity or of a change in the standard; and a gospel which can be made the basis of a crusade on these lines is likely to be very useful to the world, whatever its crudities or terminology.
J. M. Keynes, “Theorie des Geldes und der Umlaufsmittel. by Ludwig von Mises; Geld und Kapital. by Friedrich Bendixen” (review), Economic Journal, 1914
In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the legal status given to them by government and the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. Hence spending becomes the prime mover and taxing and borrowing is degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not the major problem, since fiat money means that governments can always make more of them.
Financing quantitative easing, fiscal expansion, and other similar operations, is made possible by simply crediting a bank account and thereby – by a single keystroke – actually creating money. One of the most important reasons why so many countries are still stuck in depression-like economic quagmires is that people in general – including most mainstream economists – simply don’t understand the workings of modern monetary systems. The result is totally and utterly wrong-headed austerity policies, emanating out of a groundless fear of creating inflation via central banks printing money, in a situation where we rather should fear deflation and inadequate effective demand.
Regression to the men is nothing but the universal truth of the fact that whenever we have an imperfect correlation between two scores, we have regression to the mean.
We forget – or willfully ignore – that our models are simplifications of the world …
One of the pervasive risks that we face in the information age … is that even if the amount of knowledge in the world is increasing, the gap between what we know and what we think we know may be widening. This syndrome is often associated with very precise-seeming predictions that are not at all accurate … This is like claiming you are a good shot because your bullets always end up in about the same place — even though they are nowhere near the target …
Financial crises – and most other failures of prediction – stem from this false sense of confidence. Precise forecasts masquerade as accurate ones, and some of us get fooled and double-down our bets.
One of the best examples of this ‘masquerading’ is the following statement by Robert Lucas (Wall Street Journal, September 19, 2007):
I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.
Milton Friedman’s Permanent Income Hypothesis (PIH) says that people’s consumption isn’t affected by short-term fluctuations in incomes since people only spend more money when they think that their life-time incomes change. Believing Friedman is right, mainstream economists have for decades argued that Keynesian fiscal policies therefore are ineffectual.
As shown over and over again for the last three decades, empirical facts totally disconfirm Friedman’s hypothesis. The final nail in the coffin is new research from Harvard:
Unemployment is a particularly good setting for testing alternative models of consumption because it causes such a large change in family income. A literature starting with Akerlof and Yellen (1985), Mankiw (1985) and Cochrane (1989) has argued that because ignoring small price changes has a second-order impact on utility, a rule of thumb such as setting spending changes equal to income changes may be “near-rational.” More recently, many researchers have documented evidence of an immediate increase in spending in response to tax rebates and similar one-time payments …
We compare the path of spending during unemployment in the data to three benchmark models and find that the buffer stock model fits better than a permanent income model or a hand-to-mouth model …
To summarize, we find that families do relatively little self-insurance when unemployed as spending is quite sensitive to current monthly income. We built a new dataset to study the spending of unemployed families using anonymized bank account records from JPMCI. Using rich category-level expenditure data, we find that work-related expenses explain only a modest portion of the spending drop during unemployment. The overall path of spending for a seven-month unemployment spell is consistent with a buffer stock model where agents hold assets equal to less than one month of income at the onset of unemployment. Because unemployment is such a large shock to income, our finding that spending is highly sensitive to income overcomes the near-rationality critique applied to prior work. Finally, we document a puzzling drop in spending of 11% in the month UI benefits exhaust, suggesting that families do not prepare for benefit exhaustion.
So — now we know that consumer behaviour is influenced by short-term fluctuations in incomes and that this is true even if consumers know that their situation may well change in the future.
Since almost all modern mainstream macroeconomic theories are based on PIH –standardly used in formulating the consumption Euler equations that make up a vital part of ‘modern’ New Classical and New Keynesian macro models — these devastating findings are extremely problematic.
In many modern macroeonomics textbooks one explicitly adapt a ‘New Keynesian’ framework, adding price rigidities and a financial system to the usual neoclassical macroeconomic set-up. Elaborating on these macromodels one soon arrives at specifying the demand side with the help of the Friedmanian Permanent Income Hypothesis and its Euler equations.
But if people — not the representative agent — at least sometimes can’t help being off their labour supply curve — as in the real world — then what are these hordes of Euler equations that you find ad nauseam in these ‘New Keynesian’ macromodels gonna help us?
My doubts regarding macro economic modelers’ obsession with Euler equations is basically that, as with so many other assumptions in ‘modern’ macroeconomics, Euler equations, and the PIH that they build on, don’t fit reality.
In the standard neoclassical consumption model people are basically portrayed as treating time as a dichotomous phenomenon – today and the future — when contemplating making decisions and acting. How much should one consume today and how much in the future? The Euler equation used implies that the representative agent (consumer) is indifferent between consuming one more unit today or instead consuming it tomorrow. Further, in the Euler equation we only have one interest rate, equated to the money market rate as set by the central bank. The crux is, however, that — given almost any specification of the utility function – the two rates are actually often found to be strongly negatively correlated in the empirical literature!
From a methodological pespective yours truly has to conclude that these kind microfounded macroeconomic models are a rather unimpressive attempt at legitimizing using fictitious idealizations — such as PIH and Euler equations — for reasons more to do with model tractability than with a genuine interest of understanding and explaining features of real economies. Mainstream economists usually do not want to get hung up on the assumptions that their models build on. But it is still an undeniable fact that theoretical models building on piles of known to be false assumptions — such as PIH and the Euler equations that build on it — in no way even get close to being scientific explanations. On the contrary. They are untestable and hence totally worthless from the point of view of scientific relevance.
Ganong’s and Noel’s research finally shows that mainstream macroeconomics, building on the standard neoclassical consumption model with its Permanent Income Hypothesis and Euler equations, has to be replaced with something else. Preferably with something that is both real and relevant, and not only chosen for reasons of mathematical tractability or for more or less openly market fundamentalist ideological reasons.
Oh, horrible, oh, horrible, most horrible!
What a tragedy — and what shame, all those Americans with more than two brain cells must feel today. I do suffer with them through this nightmare.
The unsurpassed rock MASTERPIECE.