LARS P. SYLL

Wren-Lewis on internal consistency

The example is the derivation of a benevolent policy maker’s preferences from the utility function of the representative consumer assumed as part of the model, a line of research initiated by Michael Woodford.

Before getting on to the values point, let me note that it is a good example of the primacy of internal consistency in microfoundations rather than the Lucas critique. Before Woodford’s work, microfoundations macroeconomists were embarrassed that they typically assumed an ad hoc objective function for the policy maker choosing between the bads of deviations in inflation from target or deviations of output from its natural rate. Typically, results were presented with alternative values for the policy maker’s preferences between the two. But if the policy maker was benevolent and the model is internally consistent, shouldn’t this objective function reflect the utility function of the representative consumer in the model? What Woodford showed was how this could be done, and better still how it implied the form of objective function, quadratic, that had previously been used on an ad hoc basis. The preference between output and inflation deviations was now an implication of the model.

It was, it is important to admit, an exciting breakthrough. We could now tell policymakers that, if this is the utility function of the representative consumer, and the model was a good representation of reality (yes, I know), this is how you should be trading off output and inflation losses. It was a literature I participated in with colleagues. The derivations were hard and tedious to do, and could take pages of algebra, but within a year every macro paper of this kind had switched from ad hoc objective functions to derived objective functions. If you were doing macro and wanted the paper published in a good journal, this is what you had to do.

Simon Wren-Lewis

Wooh. We’ve put a lot of work and time into modelling this in an internally consistent way into our macromodels, so it sure has to be an exciting and interesting breakthrough …

I’ll be dipped!

This is, of course, basically a question of methodology. And it shows the danger of neglecting methodological issues — issues mainstream economists regularly have almost put an honour in neglecting.

Being able to model a credible world, a world that somehow could be considered somehow ‘similar’ to the real world is not the same as investigating the real world.  The minimalist demand on models in terms of ‘credibility’ and ‘consistency’ has to give away to stronger epistemic demands. Claims in a ‘consistent’ model do not per se give a warrant for exporting the claims to real-world target systems.

Questions of external validity are important more specifically also when it comes to microfounded macromodels. It can never be enough that these models somehow are regarded as internally consistent. One always also has to pose questions of consistency with the data. Internal consistency without external validity is worth nothing.

Yours truly and people like Tony Lawson have for many years been urging economists to pay attention to the ontological foundations of their assumptions and models. Sad to say, economists have not paid much attention — and so modern economics has become increasingly irrelevant to the understanding of the real world.

Within mainstream economics — to which Wren-Lewis and his New Keynesian ‘consistent’ macromodelling certainly belong — internal validity is still everything and external validity nothing. Why anyone should be interested in that kind of theories and models is beyond imagination. As long as mainstream economists do not come up with any export-licenses for their theories and models to the real world in which we live, they really should not be surprised if people say that this is not science, but autism!

To have ‘consistent’ models and ‘valid’ evidence is not enough. What economics needs are real-world relevant models and sound evidence.  Aiming only for ‘consistency’ and ‘validity’ is setting the economics aspirations level too low for developing a realist and relevant science.

Economics is not mathematics or logic. It’s about society. The real world. Forgetting that, economics is really in dire straits.

Economic models often comprise not single, but sets of, equations, each of which is notoriously found to have little relation to what happens in the real world. One question that nevertheless keeps economists occupied with such unrealistic models is whether the equations formulated are mutually consistent in the sense that there ‘exists’ a vector of values of some variable, say one labelled ‘prices’, that is consistent with each and all the equations … As such the notion is not at all a claim about the world but merely a (possible) property that a set of equations may or may not be found to possess.

RBC methodology — three decades of intellectual regress

Neoclassical economics is known for its illicit use of garbled language which hides and convolutes instead of explains … An interesting example is the chapter by Edward Prescott, titled ‘RBC Methodology and the Development of Aggregate Economic Theory’ (ungated version). Let’s first give the floor to him (emphasis added), mind that ‘leisure’ means ‘measured unemployment’.:

“What turned out to be the big breakthrough was the use of growth theory to study business cycle fluctuations … based on micro theory reasoning, dynamic economic theory was viewed as being useless in understanding business cycle fluctuations. This view arose because, cyclically, leisure and consumption moved in opposite directions. Being that these goods are both normal goods and there is little cyclical movement in their relative price, micro reasoning leads to the conclusion that leisure should move procyclically when in fact it moves strongly countercyclically. Another fact is that labor productivity is a procyclical variable; this runs counter to the prediction of micro theory that it should be countercyclical, given the aggregate labor input to production. Micro reasoning leads to the incorrect conclusion that these aggregate observations violated the law of diminishing returns. In order to use growth theory to study business cycle fluctuations, the investment-consumption decision and the labor-leisure decision must be endogenized. Kydland and Prescott (1982) introduced an aggregate household to accomplish this. We restricted attention to the household utility function for which the model economies had a balanced growth path, and this balanced growth path displayed the growth facts. With this extension, growth theory and business cycle theory were integrated. It turned out that the predictions of dynamic aggregate theory were consistent with the business cycle facts that ran counter to the conclusion of those using microeconomic reasoning”

Translation: “Depressions are caused because people want to work less. Yes, we measure unemployment and it goes up when spending declines. But by assuming a ‘balanced growth path’ we define this away: the growth path is by assumption balanced so no unemployment exists and what we measure is leisure, not unemployment. People (sorry, ‘the representative consumer’) sometimes suddenly want to work a lot less, hence 25% unemployment (sorry, leisure) in countries like Greece and Spain and during the Great Depression in the USA. Hey, problem solved (and f*** the statistics)!”

Merijn Knibbe

New Keynesian ‘tweaking’ won’t do the job

Whereas the Great Depression of the 1930s produced Keynesian economics, and the stagflation of the 1970s produced Milton Friedman’s monetarism, the Great Recession has produced no similar intellectual shift.

This is deeply depressing to young students of economics, who hoped for a suitably challenging response from the profession. Why has there been none?

Krugman’s answer is typically ingenious: the old macroeconomics was, as the saying goes, “good enough for government work”  … Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models. But there are serious problems with Krugman’s narrative …

The New Keynesian models did not offer a sufficient basis for maintaining Keynesian policies once the economic emergency had been overcome, they were quickly abandoned …

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved …

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job.

Robert Skidelsky

Skidelsky’s article shows why we all ought to be sceptic of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far it has been impossible to see that it has yielded very much in terms of realist and relevant economic knowledge. And — as if that wasn’t enough — there’s nothing new or Keynesian about it!

‘New Keynesianism’ doesn’t have its roots in Keynes. It has its intellectual roots in Paul Samuelson’s ill-founded ‘neoclassical synthesis’ project, whereby he thought he could save the ‘classical’ view of the market economy as a (long run) self-regulating market clearing equilibrium mechanism, by adding some (short run) frictions and rigidities in the form of sticky wages and prices.

But — putting a sticky-price lipstick on the ‘classical’ pig sure won’t do. The ‘New Keynesian’ pig is still neither Keynesian nor new.

The rather one-sided emphasis of usefulness and its concomitant instrumentalist justification cannot hide that ‘New Keynesians’ cannot give supportive evidence for their considering it fruitful to analyze macroeconomic structures and events as the aggregated result of optimizing representative actors. After having analyzed some of its ontological and epistemological foundations, yours truly cannot but conclude that ‘New Keynesian’ macroeconomics, on the whole, has not delivered anything else than ‘as if’ unreal and irrelevant models.

The purported strength of New Classical and ‘New Keynesian’ macroeconomics is that they have firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing ‘forward-looking’ individuals.

To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim — has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if these economists want to resurrect the omniscient Walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world.

And then, of course, there is that weird view on unemployment that makes you wonder on which planet those ‘New Keynesians’ live …

Reward work, not wealth

Eighty-two​ percent of the wealth generated last year went to the richest one percent of the global population, while the 3.7 billion people who make up the poorest half of the world saw no increase in their wealth, according to a new Oxfam report released today …

Billionaire wealth has risen by an annual average of 13 percent since 2010 – six times faster than the wages of ordinary workers, which have risen by a yearly average of just 2 percent. The number of billionaires rose at an unprecedented rate of one every two days between March 2016 and March 2017.

It takes just four days for a CEO from one of the top five global fashion brands to earn what a Bangladeshi garment worker will earn in her lifetime. In the US, it takes slightly over one working day for a CEO to earn what an ordinary worker makes in a year.

Oxfam