LARS P. SYLL

Mainstream economics — replete with arrant nonsense

Mainstream economics is replete with ideas that “everyone knows” to be true, but that are actually arrant nonsense. For example, “everyone knows” that:

• Aggregate production functions (and aggregate measures of the capital stock) provide a good way to characterize the economy’s supply side;

• Over a sufficiently long span—specifically, one that allows necessary price adjustments to be made—the economy will return to a state of full market clearing; and,

• The theory of household choice provides a solid justification for downward-sloping market demand curves.

None of these propositions has any sort of empirical foundation; moreover, each one turns out to be seriously deficient on theoretical grounds. Nevertheless, economists continue to rely on these and similar ideas to organize their thinking about real-world economic phenomena. No doubt, one reason why this situation arises is because the economy is a complicated system that is inherently difficult to understand, so propositions like these—even though wrong—are all that saves us from intellectual nihilism …

Is this state of affairs ever harmful or dangerous? One natural source of concern is if dubious but widely held ideas serve as the basis for consequential policy decisions. In this note, I examine one such idea, namely, that expected inflation is a key determinant of actual inflation.

Jeremy Rudd, Board of Governors of the FRS

Reinstating the gold standard

Ninety years ago Keynes could congratulate Great Britain on finally having got rid of the biggest ”barbarous relic” of his time — the gold standard. He lamented that

advocates of the ancient standard do not observe how remote it now is from the spirit and the requirement of the age … [T]he long age of Commodity Money has at last passed away before the age of Representative Money. Gold has ceased to be a coin, a hoard, a tangible claim to wealth … It has become a much more abstract thing – just a standard of value; and it only keeps this nominal status by being handed round from time to time in quite small quantities amongst a group of Central Banks.

Ending the use of fiat money guaranteed by promises for currencies once more backed by gold is not the way out of the present economic crisis. Far from being the sole prophylactic against the alleged problems of fiat money, as the ‘gold bugs’ maintain, a return to gold would only make things far worse. So yours truly — just as Keynes did — most certainly rejects any proposals for restoring the gold standard.

The ‘gold bugs’ seem to forget that we actually have tried the gold standard before – in the era more or less between 1870 and 1930 – and with disastrous results!

Implementing a new gold standard today would only lead to a generally falling price level. Sounds great? If you think so, read what Keynes wrote already ninety years ago in Essays in Persuasion:

Of course, a fall in prices, which is the the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real assets is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy.

Allowing this debt deflation process — the analysis of which was later developed by Irving Fisher and Hyman Minsky — would land us in a situation where output and wages would fall and unemployment and the real burden of debt would increase. The only winners would probably be banks and financial institutes.

So why would anyone want to reinstate a gold standard? The best surmise is probably that it’s a question of ideology and politics. Libertarians and market fundamentalists that advocate a return to gold, want to restrict the possibilities of governments to intervene in the economy and — even harder than with ‘independent’ central banks — force countries to pursue restrictive economic policies that at all costs keep inflation down.

Still not convinced of why a return to gold is a bad idea? Then, at least, remember what Keynes wrote in The Economic Consequences of Mr Churchill (1925):

We stand midway between two theories of economic society. The one theory maintains that wages should be fixed by reference to what is ’fair’ and ’reasonable’ as between classes. The other theory–the theory of the economic juggernaut–is that wages should be settled by economic pressure, otherwise called ’hard facts’, and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the chance consequences of the journey to individual groups. The gold standard, with its dependence on pure chance, its faith in the ’automatic adjustments’, and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine. I think that they are immensely rash… in their comfortable belief that nothing really serious ever happens. Nine times out of ten, nothing really does happen–merely a little distress to individuals or to groups. But we run a risk of the tenth time (and stupid into the bargain), if we continue to apply the principles of an economics, which was worked out on the hypothesis of laissez-faire and free competition, to a society which is rapidly abandoning these hypotheses.

So, next time you want to come up with some new idea on how to solve our economic problems with a magic gold bullet, remember new economic thinking starts with reading old books! Why not start with the best there are — those written by John Maynard Keynes.

The great debt debate — Thomas Piketty and Michael Hudson

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‘New Keynesian’ macroeconomics — worse than useless

Macroeconomic models may be an informative tool for research. But if practitioners of ‘New Keynesian’ macroeconomics do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its tasks. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics will continue to consider its ultimate argument as a mixture of rather unhelpful metaphors and metaphysics. Maintaining that economics is a science in the ‘true knowledge’ business, yours truly remains a skeptic of the pretenses and aspirations of ‘New Keynesian’ macroeconomics. So far, I cannot really see that it has yielded very much in terms of realistic and relevant economic knowledge.

Keynes basically argued that it was inadmissible to project history on the future. Consequently an economic policy cannot presuppose that what has worked before, will continue to do so in the future. That macroeconomic models could get hold of correlations between different ‘variables’ was not enough. If they could not get at the causal structure that generated the data, they were not really ‘identified.’ Dynamic stochastic general euilibrium (DSGE) macroeconomists — including ‘New Keynesians’ — has drawn the conclusion that the problem with unstable relations is to construct models with clear microfoundations where forward-looking optimizing individuals and robust, deep, behavioural parameters are seen to be stable even to changes in economic policies. As yours truly has argued in a couple of post (e. g. here and here), this, however, is a dead end.

Here we are getting close to the heart of darkness in ‘New Keynesian’ macroeconomics. Where ‘New Keynesian’ economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they have to put a blind eye on the emergent properties that characterize all open social systems – including the economic system. The interaction between animal spirits, trust, confidence, institutions etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed also on their own terms. And although one may easily agree with e.g. Paul Krugman’s emphasis on simple models, the simplifications used may have to be simplifications adequate for macroeconomics and not those adequate for microeconomics.

In microeconomics we know that aggregation really presupposes homothetic an identical preferences, something that almost never exist in real economies. The results given by these assumptions are therefore not robust and do not capture the underlying mechanisms at work in any real economy. And models that are critically based on particular and odd assumptions – and are neither robust nor congruent to real world economies – are of questionable value.

Even if economies naturally presuppose individuals, it does not follow that we can infer or explain macroeconomic phenomena solely from knowledge of these individuals. Macroeconomics is to a large extent emergent and cannot be reduced to a simple summation of micro-phenomena. Moreover, even these microfoundations aren’t immutable. The ‘deep parameters’ of ‘New Keynesian’ DSGE models — ‘tastes’ and ‘technology’ — are not really the bedrock of constancy that they believe (pretend) them to be.

So I cannot concur with Paul Krugman, Mike Woodford, Greg Mankiw and other sorta-kinda ‘New Keynesians’ when they more or less try to reduce Keynesian economics to “intertemporal maximization modified with sticky prices and a few other deviations.”

If there is one thing that distinguished Keynes’ economic analysis from that of his predecessors, it was his rejection of the idea of a unique full employment equilibrium to which a market economy will automatically return when it experiences a shock. Keynes argued that an economy could shift from a full-employment equilibrium to a persistent slump as the result of the interaction between objective macroeconomic variables and the subjective ‘animal spirits’ of investors and other decision-makers. It is this perspective that has been lost in the absorption of New Keynesian macro into the DSGE framework.

John Quiggin

Top 100 Economics Blogs

10. Naked Capitalism

46. Stumbling and Mumbling

63. Lars P Syll | Non-ergodic, realist and relevant economics

66. Real-World Economics Review Blog

74. Greg Mankiw’s Blog

Mainstream economics has sadly made economics increasingly irrelevant to the understanding of the real world. Trying to contribute in making economics a more realist and relevant science, yours truly launched this blog in March 2011.

Now, ten years later and with millions of page views on it, yours truly’s blog is ranked on Top 100 Economics Blogs.

I am — of course — truly awed, honoured and delighted.