New Keynesian DSGE models and the ‘representative lemming’

16 Feb, 2017 at 10:21 | Posted in Economics | Comments Off on New Keynesian DSGE models and the ‘representative lemming’

If all agents are supposed to have rational expectations, it becomes convenient to assume also that they all have the same expectation and thence tempting to jump to the conclusion that the collective of agents behaves as one. The usual objection to representative agent models has been that it fails to take into account well-documented systematic differences in behaviour between age groups, income classes, etc. In the financial crisis context, however, the objection is rather that these models are blind to the consequences of too many people doing the same thing at the same time, for example, trying to liquidate very similar positions at the same time. Representative agent models are peculiarly subject to fallacies of composition. The representative lemming is not a rational expectations intertemporal optimising creature. But he is responsible for the fat tail problem that macroeconomists have the most reason to care about …

axelFor many years now, the main alternative to Real Business Cycle Theory has been a somewhat loose cluster of models given the label of New Keynesian theory. New Keynesians adhere on the whole to the same DSGE modeling technology as RBC macroeconomists but differ in the extent to which they emphasise inflexibilities of prices or other contract terms as sources of shortterm adjustment problems in the economy. The “New Keynesian” label refers back to the “rigid wages” brand of Keynesian theory of 40 or 50 years ago. Except for this stress on inflexibilities this brand of contemporary macroeconomic theory has basically nothing Keynesian about it.

The obvious objection to this kind of return to an earlier way of thinking about macroeconomic problems is that the major problems that have had to be confronted in the last twenty or so years have originated in the financial markets – and prices in those markets are anything but “inflexible”.

Axel Leijonhufvud

And still mainstream economists seem to be impressed by the ‘rigour’ brought to macroeconomics by New-Classical-New-Keynesian DSGE models and its rational expectations and micrcofoundations!

It is difficult to see why.

Take the rational expectations assumption. Rational expectations in the mainstream economists’ world implies that relevant distributions have to be time independent. This amounts to assuming that an economy is like a closed system with known stochastic probability distributions for all different events. In reality it is straining one’s beliefs to try to represent economies as outcomes of stochastic processes. An existing economy is a single realization tout court, and hardly conceivable as one realization out of an ensemble of economy-worlds, since an economy can hardly be conceived as being completely replicated over time. It is — to say the least — very difficult to see any similarity between these modelling assumptions and the expectations of real persons. In the world of the rational expectations hypothesis we are never disappointed in any other way than as when we lose at the roulette wheels. But real life is not an urn or a roulette wheel. And that’s also the reason why allowing for cases where agents make ‘predictable errors’ in DSGE models doesn’t take us any closer to a relevant and realist depiction of actual economic decisions and behaviours. If we really want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make we have to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations than childish roulette and urn analogies.

‘Rigorous’ and ‘precise’ DSGE models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented.

keynes-right-and-wrong

No matter how precise and rigorous the analysis, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forwards one single millimeter if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not say anything about real world economies.

Proving things ‘rigorously’ in DSGE models is at most a starting-point for doing an interesting and relevant economic analysis. Forgetting to supply export warrants to the real world makes the analysis an empty exercise in formalism without real scientific value.

Mainstream economists think there is a gain from the DSGE style of modeling in its capacity to offer some kind of structure around which to organise discussions. To me that sounds more like a religious theoretical-methodological dogma, where one paradigm rules in divine hegemony. That’s not progress. That’s the death of economics as a science.

Paul Samuelson’s balanced budget religion

15 Feb, 2017 at 12:17 | Posted in Economics | 2 Comments

paulI think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked, [it] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [and then] in every short period of time. If Prime Minister Gladstone came back to life he would say “oh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.

Paul Samuelson

Samuelson’s statement makes me come to think of the following passage in Keynes’ General Theory:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is com­monly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authori­ty, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

Wonder why …

Dani Rodrik a heterodox economist? You must be joking!

13 Feb, 2017 at 18:47 | Posted in Economics | 3 Comments

I discussed long ago what it means to be heterodox in economics. Bob Kuttner, who I once saw giving a talk at the New School (in the 1990s), a very sharp journalist that knows quite a bit about economics, sings the praises of Dani Rodrik as an heterodox economist …

hqdefaultRodrik is, or was a few years ago at least, in what Colander, Holt and Rosser refer to as the cutting edge of the profession … which is to say he is heterodox in the same way that Joe Stiglitz or Paul Krugman are heterodox. They are willing to suggest that some imperfections make the laissez-faire dream of the most fundamentalist neoclassical authors somewhat overstated. But as much as Krugman and Stiglitz accept the conventional macro model, with the natural rate hypothesis, the same is true for Rodrik, which essentially accepts the basic Heckscher-Ohlin-Samuelson trade model (for a critique go here). He is a moderate neoclassical economist; a potty trained one if you will, but certainly not heterodox.

Matias Vernengo

1390045613Economics students today are complaining more and more about the way economics is taught. The lack of fundamantal diversity — not just path-dependent elaborations of the mainstream canon — and narrowing of the curriculum, dissatisfy econ students all over the world. The frustrating lack of real world relevance has led many of them to demand the discipline to start develop a more open and pluralistic theoretical and methodological attitude.

Dani Rodrik has little understanding for these views, finding it hard to ‘understand these complaints in the light of the patent multiplicity of models within economics.’ Rodrik shares the view of his colleauges Paul Krugman, Greg Mankiw and Simon Wren-Lewis — all of whom he approvingly cites in his book Economics Rules — that there is nothing basically wrong with ‘standard theory’ and ‘economics textbooks.’ As long as policy makers and economists stick to ‘standard economic analysis’ everything is fine. Economics is just a method that makes us ‘think straight’ and ‘reach correct answers.’

Writes Rodrik in Economics Rules:

Pluralism with respect to conclusions is one thing; pluralism with respect to methods is something else … An aspiring economist has to formulate clear models … These models can incorporate a wide range of assumptions … but not all assumptions are equally acceptable. In economics, this means that the greater the departure from benchmark assumptions, the greater the burden of justifying and motivating why those departures are needed …

Some methods are better than others … For some these constraints represent a kind of methodological straitjacket that crowds out new thinking. But it is easy to exaggerate the rigidity of the rules within which the profession operates.

Young economics students that want to see a real change in economics and the way it’s taught, have to look beyond Rodrik, Mankiw, Krugman & Co. Those future economists who really want something other than the same old mainstream neoclassical catechism; those who really don’t want to be force-fed with mainstream neoclassical deductive-axiomatic analytical formalism, have to look elsewhere.

Just as Stiglitz and Krugman, Rodrik likes to present himself as a kind of pluralist anti-establishment economics iconoclast, but when it really counts, he shows what he is — a mainstream neoclassical economist fanatically defending the relevance of standard economic modeling strategies. In other words — no heterodoxy where it really would count.

Almost all the change and diversity that Rodrik applauds only takes place within the analytic-formalistic modeling strategy that makes up the core of mainstream economics. All the flowers that do not live up to the precepts of the mainstream methodological canon are pruned. You’re free to take your analytical formalist models and apply it to whatever you want – as long as you do it using a modeling methodology acceptable to the mainstream. If you do not follow this particular mathematical-deductive analytical formalism you’re not even considered doing economics. “If it isn’t modeled, it isn’t economics.” This isn’t pluralism. It’s a methodological reductionist straightjacket.

In Rodrik’s world “newer generations of models do not render the older generations wrong or less relevant,” but “simply expand the range of the discipline’s insights.” I don’t want to sound derisory or patronizing, but although it’s easy to say what Rodrik says, we cannot have our cake and eat it. Analytical formalism doesn’t save us from either specifying the intended areas of application of the models, or having to accept them as rival models facing the risk of being put to the test and found falsified.

The insistence on using analytical formalism and mathematical methods comes at a high cost — it often makes the analysis irrelevant from an empirical-realist point of view.

No matter how many thousands of models mainstream economists come up with, as long as they are just axiomatic variations of the same old mathematical-deductive ilk, they are not heterodox in any substantial way, and they will not take us one single inch closer to giving us relevant and usable means to further our understanding and explanation of real economies.

The ‘deductivist blindness’ of modern economics

12 Feb, 2017 at 18:10 | Posted in Economics | 2 Comments

Scientific progress … is frequently the result of observation that something does work, which runs far ahead of any understanding of why it works.

aimageNot within the economics profession. There, deductive reasoning based on logical inference from a specific set of a priori deductions is “exactly the right way to do things”. What is absurd is not the use of the deductive method but the claim to exclusivity made for it. This debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic: inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics …

The belief that models are not just useful tools but are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face. That blindness made a big contribution to our present crisis, and conditions our confused responses to it.

John Kay

The ‘deductivist blindness’ of mainstream economics explains to a larger extent why it contributes to causing economic crises rather than to solving them. But where does this ‘deductivist blindness’ of mainstream economics come from? To answer that question we have to examine the methodology of mainstream economics.

The insistence on constructing models showing the certainty of logical entailment has been central in the development of mainstream economics. Insisting on formalistic (mathematical) modeling has more or less forced the economist to give upon on realism and substitute axiomatics for real world relevance. The price paid for the illusory rigour and precision has been monumentally high

wrong-tool-by-jerome-awThis deductivist orientation is the main reason behind the difficulty that mainstream economics has in terms of understanding, explaining and predicting what takes place in our societies. But it has also given mainstream economics much of its discursive power – at least as long as no one starts asking tough questions on the veracity of – and justification for – the assumptions on which the deductivist foundation is erected. Asking these questions is an important ingredient in a sustained critical effort at showing how nonsensical is the embellishing of a smorgasbord of models founded on wanting (often hidden) methodological foundations.

The mathematical-deductivist straitjacket used in mainstream economics presupposes atomistic closed-systems – i.e., something that we find very little of in the real world, a world significantly at odds with an (implicitly) assumed logic world where deductive entailment rules the roost. Ultimately then, the failings of modern mainstream economics has its root in a deficient ontology. The kind of formal-analytical and axiomatic-deductive mathematical modeling that makes up the core of mainstream economics is hard to make compatible with a real-world ontology. It is also the reason why so many critics find mainstream economic analysis patently and utterly unrealistic and irrelevant.

Although there has been a clearly discernible increase and focus on ’empirical’ economics in recent decades, the results in these research fields have not fundamentally challenged the main deductivist direction of mainstream economics. They are still mainly framed and interpreted within the core axiomatic assumptions of individualism, instrumentalism and equilibrium that make up even the ‘new’ mainstream economics. Although, perhaps, a sign of an increasing – but highly path-dependent – theoretical pluralism, mainstream economics is still, from a methodological point of view, mainly a deductive project erected on a foundation of empty formalism.

Macroeconomic blindspots

10 Feb, 2017 at 19:16 | Posted in Economics | 2 Comments

There was an unusual degree of consensus among economists about what would happen if Britain voted for Brexit in the referendum on June 23 last year. The language used by the International Monetary Fund was typical: It expressed fears of an “abrupt reaction,” adding that this “may have already begun” …

What happened instead was that Britain enjoyed the best growth of any major advanced economy in 2016 … Andy Haldane compared the pitfalls of economic prediction to the single most famously wrong weather forecast in British history, made on the BBC on Oct. 15, 1987. A woman had called the BBC to say she was worried there was a hurricane on the way. “Don’t worry, there isn’t,” the weatherman responded. That night, 22 people died amid hurricane-force winds …

6a00e551f080038834019affbd1c2a970bThe reason this poses a deep intellectual crisis for macro-economics is that the entire point of the field, as it has developed since the work of John Maynard Keynes in the 1930s, is to prevent just this sort of severe downturn. Keynes once spoke of a future in which economists would be “humble, competent people on a level with dentists” …  It seems to me, though, that what macroeconomists do is really most like bomb disposal. Uniquely in the social sciences and humanities, macroeconomics was developed with a specific, real-world purpose, and a negative purpose to boot: to stop anything like the Great Depression from ever happening again. Given this goal — to avert systemic crises and downturns — the credit crunch and the Great Recession were, for macroeconomics, an intellectual disaster.

In retrospect, the failure of the discipline to predict and prevent the crisis was based on deep conceptual faults. One of these concerned a mysterious refusal to engage with the role of the banking and finance system in the economy. Another was the assumption that the discipline makes about individual motivations, assuming that individuals “optimize” their decision-making to behave, in economic terms, rationally. This is a convenient intellectual shortcut for building models, but it is also a fiction, as we know not just from our own human experience but even from within economics itself, where microeconomics has recently made exciting progress in the study of human irrationality, bias and cognitive error. It is a matter of provable fact that our decision-making is not entirely rational. Economic models built on the premise of our rationality will always have a creaky underpinning.

John Lancaster

Reading Lancaster’s article is certainly a very worrying confirmation of what Paul Romer wrote a couple of months ago —  modern macroeconomics is becoming more and more a total waste of time.

One of the problems with macroeconomics that Lancaster
doesn’t discuss is its obsessive mathematization since WW II. This has made mainstream neoclassical economists more or less obsessed with formal, deductive-axiomatic models. Confronted with the critique that they do not solve real problems, they  often react as Saint-Exupéry’s Great Geographer, who, in response to the questions posed by The Little Prince, says that he is too occupied with his scientific work to be be able to say anything about reality. Confronting economic theory’s lack of relevance and ability to tackle real problems, these economists retreat to the wonderful world of economic models. They enter the tool shed — and stay there. While the economic problems in the world around us steadily increase, they are  rather happily playing along with the latest toys in the mathematical toolbox.

Instead of making the model the message, I think we are better served by economists who more  than anything else try to contribute to solving real problems. And then the motto of John Maynard Keynes is more valid than ever:

It is better to be vaguely right than precisely wrong

Why governments should run deficits

10 Feb, 2017 at 11:09 | Posted in Economics | 10 Comments

 

Lynn Parramore: Do you think there are lessons in what has happened in the Eurozone for students of economics and the way the subject is taught?

darling-let-s-get-deeply-into-debtMario Seccareccia: Yes, indeed. Ever since the establishment of the modern nation-state in the late eighteenth and nineteenth centuries, the creation of the euro was perhaps the first significant experiment in modern times in which there was an attempt to separate money from the state, that is, to denationalize currency, as some right-wing ideologues and founders of modern neoliberalism, such as Friedrich von Hayek, had defended. What the Eurozone crisis teaches is that this perception of how the monetary system works is quite wrong, because, in times of crisis, the democratic state must be able to spend money in order to meet its obligations to its citizens. The denationalization or “supra-nationalization” of money with the establishment that happened in the Eurozone took away from elected national governments the capacity to meaningfully manage their economies. Unless governments in the Eurozone are able to renegotiate a significant control and access money from their own central banks, the system will be continually plagued with crisis and will probably collapse in the longer term.

Lynn Parramore

Factoring polynomials the Californian way (personal)

9 Feb, 2017 at 20:14 | Posted in Varia | 1 Comment

 

And I thought I had seen them all …

The Swedish model is dying

8 Feb, 2017 at 21:59 | Posted in Economics | 4 Comments

The 2017 OECD Economic Survey of Sweden — presented today in Stockholm by OECD Secretary-General Angel Gurría and Sweden’s Minister of Finance Magdalena Andersson — points out that income inequality in Sweden has been rising since the 1990s.

sweden-2017-oecd-economic-survey-growing-moreequal-12-638

inequalities-have-widened

I would say that what we see happen in Sweden is deeply disturbing. The rising inequality is outrageous – not the least since it has to a large extent to do with income and wealth increasingly being concentrated in the hands of a very small and privileged elite.

gini sweden 1980to2012
Source: Statistics Sweden and own calculations

A society where we allow the inequality of incomes and wealth to increase without bounds, sooner or later implodes. The cement that keeps us together erodes.

The development in Sweden is going in the wrong direction. The main difference compared to UK and US is really that the increasing inequality in Sweden (going on continuously for 30 years now) started from a lower starting point.

The OECD survey confirms that Sweden is no longer the model country it once was, in the heydays of the 60s and 70s. It’s no longer the country of Olof Palme. Just as in so many other OECD countries, neoliberal ideologies, economists and politicians have crushed the Swedish dream that once was.

It’s sad. But it’s a fact.

News media and knowledge

8 Feb, 2017 at 09:09 | Posted in Varia | Comments Off on News media and knowledge


Hans Rosling (1948-2017)
RIP

Why not make macroeconomics a science?

7 Feb, 2017 at 15:51 | Posted in Economics | 2 Comments

The trouble is, too many theorists — especially in the mainstream of the discipline — have drifted far from the real world. Their ambition has been to build mathematically elegant and internally consistent models of the economy, even if that requires wholly unrealistic assumptions. Granted, just as maps have to simplify complex terrain, theoretical models must ignore aspects of reality to be any use. But there’s a line between simplification and gross distortion, and modern macroeconomics has crossed it.

64f5d94d9836c6a09b5d2009f0d4634a845bb2d7ba56bbaa16176c2fd0e958c0Before the 2008 financial crisis, for example, the standard models more or less ignored finance. No banks, no indebtedness, no leverage. As a result, they couldn’t make sense of the worst global recession since the 1930s …

Given such spectacular failures, you’d think the profession would have gone back to the drawing board. It hasn’t …

Whenever an economist says “in our model,” beware. Demand to know what assumptions the model makes, and question those assumptions as severely as the theorists test for valid inference — because valid inference from bogus assumptions is useless. Where possible, and in the same spirit, pay closest attention to empirical and historical research.

In just about every branch of science, theoretical research has been crucial to achieving breakthroughs. In macroeconomics, it has held progress back. To stop the discipline fading into irrelevance, this will have to change.

Bloomberg View Editorial Board

The editors of Bloomberg View are, of course, absolutely right.

Unfortunately, there are many kinds of useless ‘post-real’ economics held in high regard within the mainstream economics establishment today. Few — if any — are less deserved than the macroeconomic theory/method called calibration.

In physics it may possibly not be straining credulity too much to model processes as ergodic – where time and history do not really matter – but in social and historical sciences it is obviously ridiculous. If societies and economies were ergodic worlds, why do econometricians fervently discuss things such as structural breaks and regime shifts? That they do is an indication of the unrealisticness of treating open systems as analyzable with ergodic concepts.

The future is not reducible to a known set of prospects. It is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be. Reading Lucas, Sargent, Prescott, Kydland and other calibrationists one comes to think of Robert Clower’s apt remark that

much economics is so far removed from anything that remotely resembles the real world that it’s often difficult for economists to take their own subject seriously.

Or as Paul Romer put it in his masterful attack on ‘post-real’ economics last year:

Math cannot establish the truth value of a fact. Never has. Never will.

So instead of assuming calibration and rational expectations to be right, one ought to confront the hypothesis with the available evidence. It is not enough to construct models. Anyone can construct models. To be seriously interesting, models have to come with an aim. They have to have an intended use. If the intention of calibration and rational expectations  is to help us explain real economies, it has to be evaluated from that perspective. A model or hypothesis without a specific applicability is not really deserving our interest.

Without strong evidence all kinds of absurd claims and nonsense may pretend to be science. We have to demand more of a justification than rather watered-down version of “anything goes” when it comes to rationality postulates. If one proposes rational expectations one also has to support its underlying assumptions. None is given, which makes it rather puzzling how rational expectations has become the standard modeling assumption made in much of modern macroeconomics. Perhaps the reason is that economists often mistake mathematical beauty for truth.

But I think another reason is that calibration economists are not particularly interested in empirical examinations of how real choices and decisions are made in real economies. In the hands of Lucas, Prescott and Sargent, rational expectations has been transformed from an – in principle – testable hypothesis to an irrefutable proposition. Believing in a set of irrefutable propositions may be comfortable – like religious convictions or ideological dogmas – but it is not  science.

So where does this all lead us? What is the trouble ahead for economics? Putting a sticky-price DSGE lipstick on the calibrationists’ Real Business Cycle pig sure won’t do. Neither will just looking the other way and pretend it’s raining. The biggest problem in macroeconomics today is that macroeconomists don’t care about facts. As long as they can build consistent mathematical models they’re happy. If the consistency is applicable to the real-world doesn’t seem to bother them.

If macroeconomic models – no matter of what ilk –  build on microfoundational assumptions of 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. Trying to represent real-world target systems with models flagrantly at odds with reality is futile. And if those models are New Classical Real Business Cycle calibrations  or ‘New Keynesian’ makes very little difference.

No matter how brilliantly silly DSGE models mainstream macroeconomists come up with, they do not help us working with the fundamental issues of modern economies. Using that kind of models only confirms Robert Gordon‘s  dictum that today

rigor competes with relevance in macroeconomic and monetary theory, and in some lines of development macro and monetary theorists, like many of their colleagues in micro theory, seem to consider relevance to be more or less irrelevant.

As the Bloomberg View editors say — “this will have to change.” Until then we have to continue  wonder what is the raison d’être of macroeconomics if it has nothing to say about the real world and the economic problems out there?

Why reading newspapers makes you stupid

7 Feb, 2017 at 12:19 | Posted in Politics & Society | 1 Comment

Lydon: You say newspapers make us stupid, and I’m not quite clear why.

Taleb: Because they always give you an explanation to events so that you have the feeling that you know what’s going on. They tell you the stock market went down, because of fear of a recession, and that’s false causation with uncertainty there. They check their facts, but you can’t check their causes. So, you have the feeling of over-causation from newspapers. That’s number one, the first one.

The second one: newspapers aren’t going to tell you “we had 280 deaths on the roads today in America”. They’re going to tell you about the plane crash killing 14 people. So, you have misrepresentation of the math of risks. They are driven by the sensational. And the statistical and the sensational are not the same in our modern world.

cw5is4bxeaa6kziThere’s a third thing about newspapers. Supplying someone with news reduces his understanding of the world. It’s more complicated than I can go into here, but let me tell you how I cope with it. I don’t mind knowing the news, but I go by a social filter. I eat lunch and dinner with other people. (I try to. I still have people who won’t eat lunch or dinner with me, even after writing the Black Swan). And I make sure. You can eavesdrop on conversations and stuff like that. I can tell if something is going on.

If there’s an event of significance, I know about it. And then I go to the web, or go buy a paper sometimes, or something like that.

Christopher Lydon interview with Nassim Nicholas Taleb

Uncertainty and the pretty, polite techniques of economics

6 Feb, 2017 at 18:13 | Posted in Economics | 2 Comments

All these pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.

check-your-assumptionsPerhaps the reader feels that this general, philosophical disquisition on the behavior of mankind is somewhat remote from the economic theory under discussion. But I think not. Tho this is how we behave in the marketplace, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future.

I dare say that a classical economist would readily admit this. But, even so, I think he has overlooked the precise nature of the difference which his abstraction makes between theory and practice, and the character of the fallacies into which he is likely to be led.

This is particularly the case in his treatment of Money and Interest.

John Maynard Keynes

A Swedish giant has left us

5 Feb, 2017 at 20:28 | Posted in Varia | Comments Off on A Swedish giant has left us

Sad, sad, sad, news reached us today. One of Sweden’s greatest actors ever — Björn Granath — passed away today, aged 70. He made many great performances, but the one that has stayed with me more than any other is the portrait of the rebel Erik in Pelle the Conqueror (1987).

“We’ll set out and conquer the world.”

Why economists don’t know what every baby knows about scientific methods

5 Feb, 2017 at 16:04 | Posted in Economics | Comments Off on Why economists don’t know what every baby knows about scientific methods

scientificmethod__92804.1338919332.1280.1280

Limiting model assumptions in economic science always have to be closely examined since if we are going to be able to show that the mechanisms or causes that we isolate and handle in our models are stable in the sense that they do not change when we “export” them to our “target systems”, we have to be able to show that they do not only hold under ceteris paribus conditions and a fortiori only are of limited value to our understanding, explanations or predictions of real economic systems.

Our admiration for technical virtuosity should not blind us to the fact that we have to have a cautious attitude towards probabilistic inferences in economic contexts. Science should help us penetrate to the causal process lying behind events and disclose the causal forces behind what appears to be simple facts. We should look out for causal relations, but econometrics can never be more than a starting point in that endeavour, since econometric (statistical) explanations are not explanations in terms of mechanisms, powers, capacities or causes. Firmly stuck in an empiricist tradition, econometrics is only concerned with the measurable aspects of reality. But there is always the possibility that there are other variables – of vital importance and although perhaps unobservable and non-additive, not necessarily epistemologically inaccessible – that were not considered for the model. Those who were can hence never be guaranteed to be more than potential causes, and not real causes. A rigorous application of econometric methods in economics really presupposes that the phenomena of our real world economies are ruled by stable causal relations between variables. A perusal of the leading econom(etr)ic journals shows that most econometricians still concentrate on fixed parameter models and that parameter-values estimated in specific spatio-temporal contexts are presupposed to be exportable to totally different contexts. To warrant this assumption one, however, has to convincingly establish that the targeted acting causes are stable and invariant so that they maintain their parametric status after the bridging. The endemic lack of predictive success of the econometric project indicates that this hope of finding fixed parameters is a hope for which there really is no other ground than hope itself.

Real world social systems are not governed by stable causal mechanisms or capacities. The kinds of “laws” and relations that econometrics has established, are laws and relations about entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made “nomological machines” they are rare, or even non-existant. Unfortunately that also makes most of the achievements of econometrics – as most of contemporary endeavours of mainstream economic theoretical modeling – rather useless.

Let’s take an example to illustrate my point. Say we have a diehard neoclassical model (assuming the production function is homogeneous of degree one and unlimited substitutability) such as the standard Cobb-Douglas production function (with A a given productivity parameter, and k the ratio of capital stock to labor, K/L) y = Akα , with a constant investment λ out of output y and a constant depreciation rate δ of the “capital per worker” k, where the rate of accumulation of k, Δk = λy– δk, equals Δk = λAkα– δk. In steady state (*) we have λAk*α = δk*, giving λ/δ = k*/y* and k* = (λA/δ)1/(1-α). Putting this value of k* into the production function, gives us the steady state output per worker level y* = Ak*α= A1/(1-α)(λ/δ))α/(1-α). Assuming we have an exogenous Harrod-neutral technological progress that increases y with a growth rate g (assuming a zero labour growth rate and with y and k a fortiori now being refined as y/A and k/A respectively, giving the production function as y = kα) we get dk/dt = λy – (g + δ)k, which in the Cobb-Douglas case gives dk/dt = λkα– (g + δ)k, with steady state value k* = (λ/(g + δ))1/(1-α) and capital-output ratio k*/y* = k*/k*α = λ/(g + δ). If using a model with output and capital given net of depreciation, we have to change the final expression into k*/y* = k*/k*α = λ/(g + λδ). Let’s say we have δ = 0.03, λ = 0.1 and g = 0.03 initially. This gives a capital-output ratio of around 3. If g falls to 0.01 it rises to around 7.7. We reach analogous results if we use a basic CES production function with an elasticity of substitution σ > 1. With σ = 1.5, the capital share rises from 0.2 to 0.36 if the wealth-income ratio goes from 2.5 to 5, which according to some economists is what actually has happened in rich countries during the last forty years.

Being able to show that you can get these results using one or another of the available standard neoclassical growth models is of course — from a realist point of view — of very limited value. As usual — the really interesting thing is how in accord with reality are the assumptions you make and the numerical values you put into the model specification.

Kids — somehow — seem to be more in touch with real science than can-opener-assuming economists …

A physicist, a chemist, and an economist are stranded on a desert island. One can only imagine what sort of play date went awry to land them there. Anyway, they’re hungry. Like, desert island hungry. And then a can of soup washes ashore. Progresso Reduced Sodium Chicken Noodle, let’s say. Which is perfect, because the physicist can’t have much salt, and the chemist doesn’t eat red meat.

Campbell's_Soup_with_Can_OpenerBut, famished as they are, our three professionals have no way to open the can. So they put their brains to the problem. The physicist says “We could drop it from the top of that tree over there until it breaks open.” And the chemist says “We could build a fire and sit the can in the flames until it bursts open.”

Those two squabble a bit, until the economist says “No, no, no. Come on, guys, you’d lose most of the soup. Let’s just assume a can opener.”

Die Mauer ist weg

5 Feb, 2017 at 12:17 | Posted in Varia | 1 Comment

 

CEZ7_cGWIAAZRNb Anything you can say about the Berlin Wall is — to paraphrase one of my intellectual heroes — at the same time both too much and not enough.

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