Krugman’s formalization schizophrenia

28 Jun, 2018 at 10:17 | Posted in Economics | 7 Comments

In an article published last week, Nicholas Gruen criticized the modern vogue of formalization in economics and took Paul Krugman as an example:

He’s saying first that economists can’t see what isn’t in their models – whereas Hicks and pretty much every economist until the late twentieth century would have understood the need for careful and ongoing reconciliation of formal modelling and other sources of knowledge. More shockingly he’s saying that those who smell a rat at the dysfunctionality of all this should just get over themselves. To quote Krugman:

“You may not like this tendency; certainly economists tend to be too quick to dismiss what has not been formalized (although I believe that the focus on models is basically right).”

It’s ironic given how compellingly Krugman has documented the regression of macroeconomics in the same period that saw his own rise via new trade theory. I think both retrogressions were driven by formalisation at all costs, though, in the case of new classical macro, this mindset gave additional licence to the motivated reasoning of the libertarian right. In each case, economics regresses into scholastic abstractions, and obviously important parts of the story slide pristine invisibility to the elect.

Responding to the article, Paul Krugman yesterday rode out to defend formalism in economics:

forWhat about new trade theory? What us new trade theorists did was say, “It looks as if there’s a lot going on in world trade that can’t be explained in existing formal models. So let’s see if there’s a different approach to modeling that can make sense of what we see” …

Now, we can argue about how much good this formalization did. I still believe that the formal models provided a level of clarity and legitimacy to trade discussion that wasn’t there before.

Now, this is not — as shown in Gruen’s article — the first time Krugman has felt the urge to defend mainstream formalization. In another post up on his blog, Krugman argues that the ‘discipline of modeling’ is a sine qua non for tackling politically and emotionally charged economic issues:

economist-nakedIn my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.

So when Krugman and other ‘modern’ mainstream economists use their models — standardly assuming rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative agents with homothetic and identical preferences, etc. — and standardly ignoring complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc. — we are supposed to believe that this somehow helps them ‘to avoid motivated reasoning that validates what you want to hear’ and provide ‘legitimacy.’

Yours truly is, to say the least,straight jacket far from convinced. The alarm that sets off in my brain is that this, rather than being helpful for understanding real-world economic issues, sounds more like an ill-advised plaidoyer for voluntarily taking on a methodological straight-jacket of unsubstantiated and known to be false assumptions.

Krugman, as we all know, can at times be a harsh critique of economic formalism. That is, other people’s formalism. His own, and other ‘New Keynesians’ formalizations, he always seems to find some handy justification for.

Contrary to the impression Krugman wants to convey, his and other ‘New Keynesians’ modelling strategy has a lot in common with that of people like Robert Lucas and Thomas Sargent. ‘New Keynesian’ macroeconomic models build on Real Business Cycle foundations,  regularly assuming representative actors, rational expectations, market clearing and equilibrium. But if 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.,


  1. I posted a comment on Krugman’s blog post which I would like to copy here in case someone is interested in reading and commenting on it.

    Prof. Krugman affirms: “But one thing new trade theory certainly didn’t do was lend support to really bad ideas, or induce policy paralysis. And another thing it didn’t do was divert trade economists away from studying the real world.”

    I would argue this is exactly what the new trade theory did. Mainstream international trade theory is very much influenced by a fundamental misunderstanding of David Ricardo’s famous numerical example in chapter 7 of the Principles. See here:
    This led to a flawed understanding of the notion of comparative advantage.

    It was this flawed notion of comparative advantage and the associated textbook trade model which could not explain international trade. Instead of addressing this flaw directly, the new trade theory directed the attention of international trade theorists towards inventing hyper-abstract trade models with unrealistic assumptions. As a result, economists have lost the capacity of explaining the merits and consequences of free trade to their fellow citizens.

  2. Lars,
    I think you are being too hard on Krugman. His last comment in his blog was:
    “… should be that formalism is there to open your mind, not close it, and if the real world seems to be telling you something inconsistent with your model, the problem lies in the model, not the world.”
    I mostly agree with your comments on formalism, but you sometimes seem to want to throw the baby out with the bath water.
    I met Nick Gruen’s father, Fred, once. I was a first year economics student (1971). I lived a fifteen minute drive down the road from the university and would often thumb a ride in. One morning this fellow pulled over an offered me a lift. He asked me about what I was studying and what I thought of the faculty. Little did I know who he was. (He was an economics professor at the university.) He was a very charming man.

    • I think you are excusing Krugman too much Henry. What Krugman seems to say if is the model you use is not the right one, choose another one. By this he means another formalistic rational choice model. Most of what Krugman ‘wrote’ was 80-80 per cent model – and where there is prose – explaining Model. For example in his 1998 liquidity trap article, when he is not talking about his model, it is amazing how casual it is in and how thin in actual content it is. Don’t expect to find an informed and interesting discussion of how Japan found itself in that position. What you get instead is a presentation of ISLM and representative agent models.

      Models and choosing models should not the way you carry out research. You should not let models dictate conclusions. And you do not take a model off the shelf that you think fits your conclusions. You build up your conclusions up from what can be known – which should be facts, quantitative and unquantifiable. And there should be a wide ranging and informed discussion of what these facts are. And then you say, “from what we can know, this is what we do know”. And there might not (and very appropriately) even be a model at all.

      Nick Gruen is also a wonderful economist. A good writer, a clear and critical thinker, someone who is wary of gimmick and truly interested in getting to the heart of what is really going on.

      • Nanikore,
        I pretty much agree with everything you say. However.
        ” You build up your conclusions up from what can be known – which should be facts, quantitative and unquantifiable.”

        How is this done without messing about without models? Relationships between variables have to be characterized. This amounts to model building.
        “And there might not (and very appropriately) even be a model at all.”
        I think you are fooling yourself. There may not be a formal model out in front, but somewhere in play there is model which encapsulates the behaviours that the real world exhibits. Even Keynes developed such a model and it came close to being formalized. He would not go that far, knowing/believing the real world is far too complex. However, there is a framework there that can be applied to the macroeconomy. I don’t see the problem with playing with models as long as you keep well in mind their limitations and Krugman seems to be saying such. And I agree with him when he says they can be a way to open up thinking rather than close it down.

        • Henry, maybe there is a formal model somewhere out there if people think that is so important.

          But what if you were convicted of a crime. Would you like it if the judge ruled “our (sticky price rational expectations optimisation) model says you did it’. That is what I mean when I say if you carry out an investigation ultimately you get to the point where you ask yourself: from what can be known – this is what we do know. We may have to make some deduction when it comes to the relationships – although as much as possible this should be done with facts. For example you might get a lot of (mostly likely unquantifiable) primary material from bank meetings or reports that say things like “we will lower interest rates because of this…”. But I do not think that taking a model off the shelf should be the way you make the deduction of why the banks reduced interest rates. It should most certainly not guide any deduction you make. (There is nothing wrong however, AFTER the analysis, saying that your conclusions appear to conform with a theory or model.) But the theory should emerge after a lot of observation – not mathematical deduction.

          The point is I believe that ‘formalisation at all costs’ has come at a big cost. I do not believe that simply replacing one formal model with another one is the answer. And I think this is the point Nick Gruen is making. I would like to see more people working on economic issues down in the archives and out doing fieldwork. And I do not believe that a formal model in the near future will be capable of incorporating both quantitative and non-quantifiable but verifiable facts.

          This is what people like Yutaka Kosai did in the late 90s, early 2000s with regards to Japan’s liquidity trap. You are going to learn far more about the causes of low interest rates this way than ‘playing around with models’.

          To the contrary, I would argue that more pluralism in methodology and more questioning about why we use what we use – including where this methodology came from and why it came to dominate discourse would “open up thinking rather than close it down”. For example, I do not believe it is a coincidence that classical/utilitarian economics emerged in Victorian Britain during the growth of its empire and industrial revolution. But even if I am wrong, questions should be asked about why it emerged when and where it did – and why did it become and remain so dominant. I think there also needs to be questions about where this formalisation fetish came from and why it happened. In other social sciences, ironically where a lot of this was applied early on, it was abandoned by the late 1960s. Why did it continue economics and become even worse?

          Just a clarification of something I said above, ISLM is not strictly speaking a rational choice model – the intention was not to conflate them.

          • Nanikore,
            Again, I pretty much agree with everything you say. And I suspect Krugman would too. However, I would not have too much empathy with the kind of models he likes playing with. I think that is more the issue here.

  3. Once again an attempt to connect “real people” to macroeconomics. Real people are a microeconomics phenomena. Aggregate people are macro- and you can’t expect them to behave in the same way!

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