Mainstream economics — replete with arrant nonsense

27 Sep, 2021 at 15:13 | Posted in Economics | 2 Comments

Chair of the Federal Reserve - WikipediaMainstream 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

2 Comments

  1. “Is the author, Rudd, attacking a very mainstream, strawman definition of inflation expectations in equally mainstream ways?”

    I suspect so. So we will have a distraction, and then circle back to where we were.

  2. 》I argue that using inflation expectations to explain observed inflation dynamics is unnecessary and unsound: unnecessary because an alternative explanation exists that is equally if not more plausible, and unsound because invoking an expectations channel has no compelling theoretical or empirical basis and could potentially result in serious policy errors.
    .
    Is this paper a clever attempt to hide a good old mainstream solution à la Volcker to inflation, in superficially heterodox clothing?
    .
    Is the author, Rudd, attacking a very mainstream, strawman definition of inflation expectations in equally mainstream ways?
    .
    Is Fischer Black’s definition of inflation expectations in “Noise” way too heterodox for Rudd to contemplate?
    .
    》 I think that the price level and rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules. If people believe that certain changes in the money stock will cause changes in the rate of inflation, that may well happen, because their expectations will be built into their long term contracts.
    .
    In other words, why wouldn’t agents hedge inflation?
    .
    Right now as I write, for instance, why aren’t economists blogging about how to hedge rising energy costs by buying and selling European Natural Gas options?


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