LARS P. SYLL

Polanyi and Keynes on the idea of ‘self-adjusting’ markets

Paul Krugman has repeatedly over the years argued that we should continue to use maistream economics hobby horses like IS-LM and AS-AD models. Here’s one example:

So why do AS-AD? … We do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run.

I seriously doubt that Keynes would have been impressed by having his theory being characterized by​ catchwords like “tendency to return to full employment” and “money is neutral in the long run.”

One of Keynes’s central tenets is that there is no strong automatic tendency for economies to move towards full employment levels.

Money doesn’t matter in mainstream macroeconomic models. That’s true. According to the ‘classical dichotomy,’ real variables — output and employment — are independent of monetary variables, and so enables mainstream economics to depict the economy as basically a barter system.

But in the real world in which we happen to live, money certainly does matter. Money is not neutral and money matters in both the short run and the long run:

The theory which I desiderate would deal … with an economy in which money plays a part of its own and affects motives and decisions, and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted in either the long period or in the short, without a knowledge of the behaviour of money between the first state and the last. And it is this which we ought to mean when we speak of a monetary economy.

J. M. Keynes A monetary theory of production (1933)

The real value of analogue economies

Modelling by the construction of analogue economies is a widespread technique in economic theory nowadays … As Lucas urges, the important point about analogue economies is that everything is known about them … and within them the propositions we are interested in ‘can be formulated rigorously and shown to be valid’ … For these constructed economies, our views about what will happen are ‘statements of verifiable fact.’

The method of verification is deduction … We are however, faced with a trade-off: we can have totally verifiable results but only about economies that are not real …

How then do these analogue economies relate to the real economies that we are supposed to be theorizing about? … My overall suspicion is that the way deductivity is achieved in economic models may undermine the possibility to teach genuine truths about empirical reality.

Social ekonomi — den tredje vägen

Verksamheter inom den sociala ekonomin har allmännytta och/eller medlemsnytta, inte vinstintresse som drivkraft.

 Förskolor, fritidshem, fritidsgårdar, hemtjänst, äldreboenden, biblioteksfilialer, anläggningar inom kultur- och fritidsområdet är exempel på verksamheter som kan drivas av stiftelser, ideella föreningar eller ekonomiska föreningar …

Kunskapen om den sociala ekonomin och dess betydelse för samhällets utveckling är låg i Sverige. Vi tycker att det är dags att få igång en debatt kring den sociala ekonomin och dess möjligheter till gagn både för medborgarna och kommuner …

Den sociala ekonomins styrka inför framtiden består i dess särart. Det ligger i dess natur att aktörerna inom denna del av ekonomin står nära medborgarna och därför har ett ständigt uppdrag att finna lösningar, som är bra både för invid och samhälle.

Verksamheten i den sociala ekonomin måste byggas underifrån. Social ekonomi kan inte beslutas eller kommenderas fram genom beslut uppifrån …

Alltför sällan talar vi om att det finns en tredje del i ekonomin – en tredje väg – en möjlighet att komplettera de offentliga och privata delarna i samhällsekonomin och som på många olika sätt väsentligt bidrar till att förbättra välfärden och öka tillväxten. Denna tredjedel av den sociala ekonomin, är på inget sätt någon ny företeelse. Tvärtom har vi i Sverige, liksom Europa i övrigt, en lång tradition av sammanslutningar där människor går samman för att lösa gemensamma angelägenheter.

Lars Pålsson Syll & Hans Mannefred

Demystifying economics

The first thing to understand about macroeconomic theory is that it is weirder than you think. The heart of it is the idea that the economy can be thought of as a single infinite-lived individual trading off leisure and consumption over all future time …

This approach is formalized in something called the Euler equation … Some version of this equation is the basis of most articles on macroeconomic theory published in a mainstream journal in the past 30 years …

The models may abstract away from features of the world that non-economists might think are rather fundamental to “the economy” — like the existence of businesses, money, and government … But in today’s profession, if you don’t at least start from there, you’re not doing economics.

J W Mason

Yes indeed, mainstream macroeconomics sure is weird. Very weird. And among the weirdest things are those Euler equations Mason mentions in his article.

In a post on his blog, sorta-kinda ‘New Keynesian’ Paul Krugman argues that the problem with the academic profession is that some macroeconomists aren’t “bothered to actually figure out” how the New Keynesian model with its Euler conditions —  “based on the assumption that people have perfect access to capital markets, so that they can borrow and lend at the same rate” — really works. According to Krugman, this shouldn’t  be hard at all — “at least it shouldn’t be for anyone with a graduate training in economics.”

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 ‘New Keynesian’ macromodels gonna help us?

Yours truly’s doubts regarding the macroeconomics modellers’ obsession with Euler equations is basically that, as with so many other assumptions in ‘modern’ macroeconomics, the Euler equations don’t fit reality — and it seems as though I’m not alone holding that view:

This equation underlies every DSGE model you’ll ever see, and drives much of modern macro’s idea of how the economy works …

[T]he Euler Equation says that if interest rates are high, you put off consumption more. That makes sense, right? Money markets basically pay you not to consume today. The more they pay you, the more you should keep your money in the money market and wait to consume until tomorrow.

But what Canzoneri et al. show is that this is not how people behave. The times when interest rates are high are times when people tend to be consuming more, not less.  No matter what we assume that people want, their behavior is not consistent with the Euler Equation … The consumption Euler Equation is an important part of nearly any such model, and if it’s just wrong, it’s hard to see how those models will work.

Noah Smith

In the standard neoclassical consumption model — used in DSGE macroeconomic modeling — 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? Facing an intertemporal budget constraint of the form

c_t + c_f/(1+r) = f_t + y_t + y_f/(1+r),

where c_t is consumption today, c_f is consumption in the future, f_t is holdings of financial assets today, y_t is labour incomes today, y_f is labour incomes in the future, and r is the real interest rate, and having a lifetime utility function of the form

U = u(c_t) + au(c_f),

where a is the time discounting parameter, the representative agent (consumer) maximizes his utility when

u´(c_t) = a(1+r)u´(c_f).

This expression – the Euler equation – implies that the representative agent (consumer) is indifferent between consuming one more unit today or instead consuming it tomorrow. Typically using a logarithmic function form – u(c) = log c – which gives u´(c) = 1/c, the Euler equation can be rewritten as

1/c_t = a(1+r)(1/c_f),

or

c_f/c_t = a(1+r).

This importantly implies that according to the neoclassical consumption model that changes in the (real) interest rate and the ratio between future and present consumption move in the same direction.

So good, so far. But how about the real world? Is the neoclassical consumption as described in this kind of models in tune with the empirical facts? Hardly — the data and models are as a rule inconsistent!

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 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.

Well, that more or less says it all, doesn’t it? Modern mainstream macroeconomics is indeed “weirder than you think.” If an economic model is found to be inappropriately used in research, then it is the model that has to be revised. Economic processes and structures are not about to change just to make the model relevant. Using scientific models is fine, but it has to be done within the limits set by the nature of the beast!

Far fuori il mito del NAIRU

Anche se è diventata una credenza diffusa, la presunta relazione tra la disoccupazione e l’aumento o la riduzione dei tassi d’inflazione si stava sgretolando, in particolar modo negli anni ’90 del Novecento. Nel 2000 la disoccupazione era scesa al di sotto del 4% senza che l’inflazione decollasse. Dall’inizio della Grande Recessione, il divario tra la teoria e la realtà non ha fatto altro che ampliarsi…

Una volta che ci si rende conto di quanto sono fragili le fondamenta del tasso naturale di disoccupazione, si chiariscono altri ragionamenti su come perseguire tassi di disoccupazione che un tempo gli economisti ritenevano impossibili. I salari possono aumentare a scapito dei profitti societari senza provocare inflazione. In effetti, sin dal 2014 stiamo assistendo a un aumento della quota [di produzione] dell’economia che va ai lavoratori.

Meglio ancora, una disoccupazione inferiore non aiuta solo i lavoratori: può spronare una crescita complessiva. Come sostiene l’economista J.W. Mason, man mano che ci avviciniamo alla piena occupazione emergono incentivi per aumentare gli investimenti nella produttività che riduce il quantitativo di lavoro necessario, dato che le aziende cercano di tenere sotto controllo il costo del lavoro quando i lavoratori chiedono di più. Quest’aumento della produttività stimola ancora più crescita.

Più forte spingiamo per migliorare la produzione e l’occupazione, più impariamo quanto possiamo ottenere su quei due fronti. Quell’idea fiduciosa è agli antipodi di un tasso di disoccupazione naturale e inalterabile. Ed è un’idea, una mentalità, che abbiamo bisogno di abbracciare se vogliamo avere una possibilità di riprenderci completamente dalla devastazione della Grande Recessione.

Mike Konczal/Vox

Il NAIRU non regge semplicemente perché non è esistito negli ultimi cinquant’anni. Ma ancora oggi i macroeconomisti “neo-Keynesiani” lo usano nei loro modelli – così come la curva di Phillips, sua cugina – come un mattone fondamentale. Perché? Perché senza di esso i “neo-Keynesiani” dovrebbero rinunciare alla loro visione neoclassica della neutralità della moneta sul lungo periodo – ripetutamente smentita per via empirica – e all’idea semplicistica dell’inflazione come un fenomeno dovuto all’eccesso di domanda.

L’approccio NAIRU non è di interesse meramente teorico. Assolutamente no.

Il vero danno compiuto è che i policymaker che prendono decisioni sulla base dei modelli [che presuppongono il] NAIRU implementano sistematicamente misure di austerità e sterminano l’espansione economica. Spacciare quest’illusione errata dà solo luogo a stagnazione e disoccupazione non necessarie e onerose.

Lars Syll/ReteMMT

DSGE — a scientific illusion

Dynamic stochastic general equilibrium (DSGE) models remain the work-horse models employed by many academics and research departments at central banks … Prior to the Global Financial Crisis the financial sector played no role in these DSGE models. That limitation is now widely acknowledged and numerous aspects of the financial sector have been incorporated into second and later generation DSGE models … Unfortunately, these efforts are misguided because they do not address the fundamental flaw in the microeconomic foundations of these models and this mistake is widely repeated in all later generations of DSGE models.

Many theorists today simply fail to recognize the limitations inherent in starting with the wrong microeconomic foundations; frictionless or perfect barter microeconomic foundations. Consequently, those theorists are now intent on introducing ‘monetary’, ‘financial’ and other ‘frictions’ without acknowledging that those ‘frictions’ are inconsistent with the perfect barter or frictionless microeconomic foundations of their models as well as long established principles of monetary theory …

The misuse of the Walrasian or Arrow-Debreu GE microeconomic foundations, an imaginary world of perfect barter, largely explains why DSGE models proved so inept at understanding or anticipating the GFC and why attempts to now incorporate realistic and relevant features of the financial sector into such models also fail. In these DSGE models, money and the financial sector are converted into a friction and words and economic concepts take on different meanings.

Colin Rogers

If nothing else, the monumental failings and flaws of DSGE models — with or without inessential ‘frictions’ or other amendments — certainly shows the importance of model validation and checking the robustness and realism of assumptions and specifications. Describing modern economies ‘as-if’ consisting of ‘representative’ agents in the guise of self​-employed capitalists in a perfect barter economy is absurd and ultimately bound to fail. DSGE models are simply — from both empirical and methodological points of view — not suited for understanding modern monetary economies.