What killed macroeconomics?

19 Nov, 2021 at 16:44 | Posted in Economics | 17 Comments

The COVID-19 pandemic impelled governments to fall back on “fiscal Keynesianism,” because there was no way that just increasing the quantity of money could lead to the reopening of businesses that were prevented by law from doing so. Fiscal Keynesianism in the big lockdown meant issuing Treasury payments to people prevented from working.risk vs uncertainty

But now that the economy has reopened, the practical rationale for monetary and fiscal expansion has disappeared. Mainstream financial commentators believe the economy will bounce back as if nothing had happened. After all, economies fall into foxholes no more often than individuals normally do. So, the time has come to tighten both monetary and fiscal policy, because continued expansion of either or both will lead only to a “surge in inflation.” We can all breathe a sigh of relief; the trauma is over, and normal life without unemployment will resume.

Monetary policy works in theory but not in practice; fiscal policy works in practice but not in theory. Fiscal Keynesianism is still a policy in search of a theory. Acemoglu, Laibson, and List supply a piece of the missing theory when they note that shocks are “hard to predict.” Keynes would have said they are impossible to predict, which is why he rejected the standard view that economies are cyclically stable in the absence of shocks (which is as useless as saying that leaves don’t flutter in the absence of wind).

The supply and demand models that first-year economics students are taught can illuminate the equilibrium path of the hairdressing industry but not of the economy as a whole. Macroeconomics is the child of uncertainty. Unless economists recognize the existence of inescapable uncertainty, there can be no macroeconomic theory, only prudential responses to emergencies.

Robert Skidelsky

Modern macroeconomics — Dynamic Stochastic General Equilibrium, New Synthesis, New Classical and New ‘Keynesian’ — still follows an ‘as if’ logic of denying the existence of genuine uncertainty and treat variables as if drawn from a known ‘data-generating process’ with known probability distribution that unfolds over time and on which we therefore have access to heaps of historical time-series. If we do not assume that we know the ‘data-generating process’ — if we do not have the ‘true’ model — the whole edifice collapses. And of course, it has to. Who really honestly believes that we have access to this mythical Holy Grail, the data-generating process?

Modern macroeconomics obviously did not anticipate the enormity of the problems that unregulated ‘efficient’ financial markets created. Why? Because it builds on the myth of us knowing the ‘data-generating process’ and that we can describe the variables of our evolving economies as drawn from an urn containing stochastic probability functions with known means and variances.

This is like saying that you are going on a holiday-trip and that you know that the chance the weather being sunny is at least 30​% and that this is enough for you to decide on bringing along your sunglasses or not. You are supposed to be able to calculate the expected utility based on the given probability of sunny weather and make a simple decision of either-or. Uncertainty is reduced to risk.

But as Keynes convincingly argued in his monumental Treatise on Probability (1921), this is not always possible. Often we simply do not know. According to one model the chance of sunny weather is perhaps somewhere around 10% and according to another — equally good — model the chance is perhaps somewhere around 40%. We cannot put exact numbers on these assessments. We cannot calculate means and variances. There are no given probability distributions that we can appeal to.

In the end,​ this is what it all boils down to. We all know that many activities, relations, processes and events are of the Keynesian uncertainty-type. The data do not unequivocally single out one decision as the only ‘rational’ one. Neither the economist, nor the deciding individual, can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.

Some macroeconomists, however, still want to be able to use their hammer. So they decide to pretend that the world looks like a nail, and pretend that uncertainty can be reduced to risk. So they construct their mathematical models on that assumption. The result: financial crises and economic havoc.

How much better — how much bigger chance that we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control — if instead, we could just admit that we often simply do not know, and that we have to live with that uncertainty as well as it goes.

Fooling people into believing that one can cope with an unknown economic future in a way similar to playing at the roulette wheels, is a sure recipe for only one thing — economic catastrophe.

17 Comments »

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  1. See https://www.nakedcapitalism.com/2021/11/the-tesla-financial-complex-financial-times-details-wildly-outsized-speculation-in-tesla-options.html
    .
    《Tesla’s fame and the volatility of its stock have also started to make it a component in some structured investment products, such as “auto-callables”, further enmeshing its shares into the fate of the broader financial ecosystem.
    .
    Auto-callables are complex savings vehicles — particularly popular with Asian investors — where bankers construct an attractive, bond-like fixed return by selling stock options. Historically they have been mostly options on broad stock market indices such as the S&P 500, Hang Seng or Nikkei, but because of falling market volatility some bankers have started to structure them with options on choppier individual stocks. Tesla has emerged as a popular choice.
    .
    “Tesla is perceived as safe because it is big and at the technological vanguard, but it’s incredibly lucrative [for investors] to put into structured products because it is so volatile,” says Simplify’s Green.》

    • Whoops, was this post somehow duplicated?
      .
      Did I lose the response I typed out to Henry’s last comment below?
      .
      Were my main points a) i lived through the 1970s too and remember being more free and b) why don’t inflation swaps and Cost Of Living Adjustments solve nominal inflation, as Israel proved for decades, and c) does our technology reduce “menu costs” of full indexation to zero?
      .
      For example, don’t inflation swaps eliminate inflation risk in contracts, thus allowing budgeting and planning without considering nominal inflation at all?
      .
      Don’t economists owe it to themselves to learn about the inflation insurance risk markets have innovated since the 1970s? Were Treasury Inflation Protected Securities first sold in 1997, for example?

      • A. inflation in the 70s was a hangover from the Vietnam war acerbated by Volcker, John Birch Society ideological anti tax views et al, and the energy crunch supplied by OPEC flexing its desires post being set up by corporatists post WWII.

        B. Increased finalization without any attachment to classical capitalism in offsetting, by hiving of legacy costs to the developing world, due to the time and space factors in legalities and suites which might effect investment sediment and the ramifications for those looking for a bonus based on those expectations e.g. sorta like you.

        C. have you informed yourself about the notion of positive vs negative freedoms – n’est-ce pas?

        • Why can’t the Fed give an inflation-protected basic income to everyone in the world?
          .
          Isn’t the Fed already taking a “public good” externality into consideration when buying and selling in the open market, thus either it is acting irrationally, or is there perhaps an implied General Welfare asset that it can create money against? Why not simply declare a General Welfare asset and value it at the cost of a universal inflation-adjusted basic income?

          • Is that not just another version of NAIRU with the rights to ones labour fully stripped out, thus creating a permanent underclass that the market can price in for rents in perpetuity. It just removes the targeted government polices and throws receivers of the UBI to the wolves, no collective barging power.

            .

            Worse I’m reminded that Milton and like minded discussed the need to diminish democratic voting rights due to the fear recipients would just endlessly vote for anyone that increased the UBI. So you see its a bit more complex than just handing out money and washing ones hands of any and all government social goods.

  2. 《This is like saying that you are going on a holiday-trip and that you know that the chance the weather being sunny is at least 30​% and that this is enough for you to decide on bringing along your sunglasses or not. You are supposed to be able to calculate the expected utility based on the given probability of sunny weather and make a simple decision of either-or. Uncertainty is reduced to risk.》
    .
    What if you can buy an option to reserve a pair of sunglasses for you? Is the Black-Scholes equation still the basis of pricing most financial market options? Would you pay $1 to reserve a pair of sunglasses at your destination, so you didn’t have to bring yours? If the chance of sunny weather decreased, would you be willing to pay more, or less?
    .
    《Fooling people into believing that one can cope with an unknown economic future in a way similar to playing at the roulette wheels, is a sure recipe for only one thing — economic catastrophe.》
    .
    Why so certain? What if you had an inflation-proofed basic income to insure you against (predicted, certain) catastrophes?

    • What “economy” is accomplishec by a financial option, per se? Carry an actual pair of sunglasses with you or buy one at a local store where you travel, should the need arise.
      .
      Making sunk cost investments in tools that are used only when we need them is “normal”. To a very large extent, in the absence of financial predation, this is what ” capital” is: technology-embedding, dedicated sunk-cost investments in durable goods, tools, inventories, knowledge and structures. I have an oven for the rare occasions I bake, plumbing for when I flush, a driveway to store my car — the garage being dedicated to storing too much else.
      .
      I know innovative economists would prefer that I rent my life the better to serve the plutocratic gods of the underworld engulfed in FIRE, but I would prefer not to be so entertained by nonsense.

      • Sure Bruce, but can I construct an “opportunity cost” scenario where carrying sunglasses means you have to leave your umbrella at home, due to space limits or airline baggage weight limits, or whatever? In that case, does finance offer a way to buy an option on sunglasses for a fraction of the sale price of the underlying (i.e. the glasses)? Then you can trade the option, so if it became sunny but you had to cancel your trip, you would sell the option for a gain? And even if you went, and it rained, you could probably still sell the option to recoup some of your premium, while enjoying the insurance of knowing you could have had sunglasses at a set price, had you needed them?
        .
        Am i just running with Lars’ example, to show why options trading volume is higher now than in the underlying? (See https://twitter.com/LizAnnSonders/status/1286648865828077569?s=20 )
        .
        《 I would prefer not to be so entertained by nonsense.》
        .
        Do you run the risk of ignoring what is really going on, right now? Are Intel’s new fab plants financed, because supply chains are just payment chains in reverse?
        .
        Or as an analyst quoted in an article on slashdot today put it: “Moore’s Law is not going to end when we can’t build smaller transistors. It’s going to end when somebody says I don’t want to pay for smaller transistors.”
        .
        Can Intel fund sunk costs by selling bonds at higher and higher prices, repaying the old with new bond sale proceeds, without touching actual chip revenue?

        • Apple is a hedge fund out of Reno Calif … see how it works.

          • See https://www.nakedcapitalism.com/2021/11/the-tesla-financial-complex-financial-times-details-wildly-outsized-speculation-in-tesla-options.html
            .
            《Tesla’s fame and the volatility of its stock have also started to make it a component in some structured investment products, such as “auto-callables”, further enmeshing its shares into the fate of the broader financial ecosystem.
            .
            Auto-callables are complex savings vehicles — particularly popular with Asian investors — where bankers construct an attractive, bond-like fixed return by selling stock options. Historically they have been mostly options on broad stock market indices such as the S&P 500, Hang Seng or Nikkei, but because of falling market volatility some bankers have started to structure them with options on choppier individual stocks. Tesla has emerged as a popular choice.
            .
            “Tesla is perceived as safe because it is big and at the technological vanguard, but it’s incredibly lucrative [for investors] to put into structured products because it is so volatile,” says Simplify’s Green.》

            • A Businesses built around government tax offsets and damn the product.

              • Does their self-driving software crucially lack active learning via spoken driver commands, because of corporate (and academic) groupthink? Can we do better as individuals self-organizing, because we have an inflation-proofed basic income and don’t care about impressing traders to get funding?

                • NO … the software does not and never can have the creative abilities that the human mind has to offer in dealing with unique circumstances. One would need to build roads which takeout all the challenges of a life time of learning and experience to judge risks, on the government dime too, so yet just another subsidy to investors.

                • Atomistic individualism was an a priori concocted post facto ergo propter hoc as the corner stone to the ideological narrative forwarded by antiquarian corporatism rebranded and re-decanted as economic science. Furthermore this so called philosophical outlook is the laughing stock of the philosophical discipline, well known that its only agency is the money behind it and not its intellectual rigor.

                  I mean I can smell the praxeology through my computer screen.

      • ” In that case, does finance offer a way to buy an option on sunglasses for a fraction of the sale price of the underlying ”
        .
        As long a you are prepared to accept the attendant risks.
        .
        You might have excellent meteorological information which might give you an advantage but it won’t be cost free.
        .
        And if the options are priced in a efficient market then you are likely not to gain anything so why bother.
        .

        • Didn’t Fischer Black, of the Black-Scholes option-pricing formula, which is still the starting point for current option pricing, acknowledge in the “Noise” essay that markets are efficient to an arbitrarily-chosen factor of two, 90% of the time? Do those kind of wide error bars (with an upward bias) leave you a lot of room to ride momentum waves or even create them yourself, as Wall Street Bets showed? Are traders right now colluding in chatrooms to short bonds while bullying the Fed into hiking rates, using standard mainstream inflation theory as a convenient excuse? As the Fed tightens, do bond shorts stand to profit handsomely from the inflation story?
          .
          《As long a you are prepared to accept the attendant risks.》
          .
          Are there a million ways to hedge, though? Could I sell a sunglasses option for a future rainy month, which would still be priced higher because theta decays? Finance 101, right? Then, if I’m an institutional trader I can roll out the future rainy month trade if the weather surprises?
          .
          Trying again to address Lars’ problem with the sunglasses risk, has finance figured out how to hedge bets using all sorts of calendar spreads, etc., which economists should be studying rather than dismissing risk as inherently bad, without knowing how these risk markets actually work and how much they drive real economy prices?
          .
          And to leave you with a way out, does inflation-proofing a basic income acknowledge that prices are arbitrary and inflation simply a power play (or as traders put it, “price is a liar”)?

        • “And to leave you with a way out, does inflation-proofing a basic income acknowledge that prices are arbitrary and inflation simply a power play ”
          .
          As if our economies aren’t financialized enough.
          .
          What you suggest would result in spiraling inflation.
          .
          I remember clearly the inflation of the late 1970s and the trouble it caused.
          .
          Even a new system of accounting was devised, “current accounting” as opposed to “historical accounting”. Companies would confusingly produce two sets of accounts.
          .
          Budgeting and planning were virtually impossible.


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