Hur går det till att spekulera? “Priserna på finansmarknaden sätts efter en annan logik än varor i vår vardag”, säger professor Lars Pålsson Syll. Vi möter också portföljförvaltaren Alf Riple i Malmö som arbetar med att placera pengar så att de ger så stor avkastning som möjligt.
The unpopularity of the principle of organic unities shows very clearly how great is the danger of the assumption of unproved additive formulas. The fallacy, of which ignorance of organic unity is a particular instance, may perhaps be mathematically represented thus: suppose f(x) is the goodness of x and f(y). It is then assumed that the goodness of x and y together is f(x) + f(y) when it is clearly f(x + y) and only in special cases will it be true that f(x + y) = f(x) + f(y). It is plain that it is never legitimate to assume this property in the case of any given function without proof.
J. M. Keynes “Ethics in Relation to Conduct” (1903) [h/t Robert Skidelsky]
Since econometrics doesn’t content itself with only making optimal predictions, but also aspires to explain things in terms of causes and effects, econometricians need loads of assumptions — most important of these are additivity and linearity. Important, simply because if they are not true, your model is invalid and descriptively incorrect. It’s like calling your house a bicycle. No matter how you try, it won’t move you an inch. When the model is wrong — well, then it’s wrong.
Paul Krugman has often been criticized by people like yours truly for getting things pretty wrong on the economics of John Maynard Keynes.
Surely we don’t want to do economics via textual analysis of the masters. The questions one should ask about any economic approach are whether it helps us understand what’s going on, and whether it provides useful guidance for decisions.
So I don’t care whether Hicksian IS-LM is Keynesian in the sense that Keynes himself would have approved of it, and neither should you.
The reason for this rather debonair attitude seems to be that history of economic thought may be OK, but what really counts is if reading Keynes gives birth to new and interesting insights and ideas.
No serious economist would question that explaining and understanding “what’s going on” in our economies is the most important task economists can set themselves — but it is not the only task. And to compare one’s favourite economic gadget model to what “austerians” and other madmen from Chicago have conjured up, well, that’s like playing tennis with the nets down, and we have to have higher aspirations as scientists.
Although I have a lot of sympathy for Krugman’s view on authority, there is also a somewhat disturbing and unbecoming coquetting in his attitude towards the great forerunners he is discussing. Krugman is a great economist, but it smacks not so little of hubris to simply say “if where you take the idea is very different from what the great man said somewhere else in his book, so what?” Physicists arguing like that when discussing Newton, Einstein, Bohr or Feynman would not be taken seriously.
Krugman’s comment on this issue is interesting, however, because it sheds light on a kind of inconsistency in his own art of argumentation. During a couple of years Krugman has in more than one article criticized mainstream economics for using to much (bad) mathematics and axiomatics in their model-building endeavours. But when it comes to defending his own position on various issues, he usually himself ultimately falls back on the same kind of models. Models that actually, when it comes to methodology and assumptions, have a lot in common with the kind of model-building he otherwise criticizes. And although Krugman repeatedly says that he is a strong believer in “simple models,” those models are far from simple (at least not in any interesting meaning of the word).
But I think the absolute all-time low in Krugman’s response is this remarkable passage:
Has declaring uncertainty to be unquantifiable, and mathematical modeling in any form foolish, been productive? Remember, that’s what the Austrians say too.
I won’t comment on the shameful guilt-by-association part of the quote, but re uncertainty it’s absolutely gobsmacking how Krugman manages to mix up the ontological question — is the economy permeated by calculable risk or by genuine and often uncalculable uncertainty — with the epistemological question — how do we manage to analyze/understand/explain/model such an economy. Here Krugman seems to say — much in the spirit of Robert Lucas — that if reality is uncertain and non-ergodic, well then let’s just pretend it’s ergodic and susceptible to standard probabilistic analysis, so that we can go on with our FORTRAN programs and mathematical models! In other areas of science that would rightfully be considered fraud, but in “modern” neoclassical mainstream economics it’s obviously thought of as an unprobematical and justified procedure.
And then, of course, not really trying to clinch the deep theoretical issue at stake, Krugman for the n:th time puts forward his IS-LM gadget interpretation of economics.
Being able to model a “gadget world” — a world that somehow could be considered real or similar to the real world — is not the same as investigating the real world. Even though all theories are false, since they simplify, they may still possibly serve our pursuit of truth. But then they cannot be unrealistic or false in any way. The falsehood or unrealisticness has to be qualified.
No matter how many convoluted refinements of concepts made in the gadget model, if the “successive approximations” do not result in models similar to reality in the appropriate respects (such as structure, isomorphism etc), the surrogate gadget system becomes a substitute system that does not bridge to the world, but rather misses its target.
So — constructing gadgets like IS-LM macroeconomic models as “stylized facts” somehow “successively approximating” macroeconomic reality, is a rather unimpressive attempt at legitimizing using fictitious idealizations for reasons more to do with model tractability than with a genuine interest of understanding and explaining features of real economies. Many of the model assumptions made in IS-LM models and “New Keynesian” DSGE models are restrictive rather than harmless and could a fortiori anyway not in any sensible meaning be considered approximations at all.
Where does all this leave us? Well, I for one, is not the least impressed by Krugman’s gadget interpretation of economics. And if labels are as uninteresting as he says — well, then I suggest Krugman and other “New Keynesians” stop calling themselves Keynesians at all. I’m pretty sure Keynes would have appreciated not having his theories and thoughts being referred to by people having preciously little to do with those theories and thoughts.
Studying great forerunners like Keynes may help us to construct better and more relevant economic models – models that really help us to explain and understand reality. So when Krugman writes
Second — and this plays a surprisingly big role in my own pedagogical thinking — 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
I would certainly recommend him to compare his own statement with what Keynes himself wrote:
Though we all started out in the same direction, we soon parted company into two main groups. What made the cleavage that thus divided us?
On the one side were those who believed that the existing economic system is in the long run self-adjusting, though with creaks and groans and jerks, and interrupted by time-lags, outside interference and mistakes … These economists did not, of course, believe that the system is automatic or immediately self-adjusting, but they did maintain that it has an inherent tendency towards self-adjustment, if it is not interfered with, and if the action of change and chance is not too rapid.
Those on the other side of the gulf, however, rejected the idea that the existing economic system is, in any significant sense, self-adjusting. They believed that the failure of effective demand to reach the full potentialities of supply, in spite of human psychological demand being immensely far from satisfied for the vast majority of individuals, is due to much more fundamental causes …
The gulf between these two schools of thought is deeper, I believe, than most of those on either side of it realize. On which side does the essential truth lie?
The strength of the self-adjusting school depends on its having behind it almost the whole body of organized economic thinking and doctrine of the last hundred years. This is a formidable power. It is the product of acute minds and has persuaded and convinced the great majority of the intelligent and disinterested persons who have studied it. It has vast prestige and a more far-reaching influence than is obvious. For it lies behind the education and the habitual modes of thought, not only of economists but of bankers and business men and civil servants and politicians of all parties …
Thus, if the heretics on the other side of the gulf are to demolish the forces of nineteenth-century orthodoxy … they must attack them in their citadel … Now I range myself with the heretics. I believe their flair and their instinct move them towards the right conclusion. But I was brought up in the citadel and I recognize its power and might … For me, therefore, it is impossible to rest satisfied until I can put my finger on the flaw in the part of the orthodox reasoning that leads to the conclusions that for various reasons seem to me to be inacceptable. I believe that I am on my way to do so. There is, I am convinced, a fatal flaw in that part of the orthodox reasoning that deals with the theory of what determines the level of effective demand and the volume of aggregate employment …
The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years … Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.
John Maynard Keynes (1929)
Paul Krugman wonders why no one listens to academic economists …
One answer is that economists don’t listen to themselves. More precisely, liberal economists like Krugman who want the state to take a more active role in managing the economy, continue to teach an economic theory that has no place for activist policy.
Let me give a concrete example.
One of Krugman’s bugaboos is the persistence of claims that expansionary monetary policy must lead to higher inflation. Even after 5-plus years of ultra-loose policy with no rising inflation in sight, we keep hearing that since so “much money has been created…, there should already be considerable inflation” … As an empirical matter, of course, Krugman is right. But where could someone have gotten this idea that an increase in the money supply must always lead to higher inflation? Perhaps from an undergraduate economics class? Very possibly — if that class used Krugman’s textbook.
Here’s what Krugman’s International Economics says about money and inflation:
“A permanent increase in the money supply causes a proportional increase in the price level’s long-run value. … we should expect the data to show a clear-cut positive association between money supplies and price levels. If real-world data did not provide strong evidence that money supplies and price levels move together in the long run, the usefulness of the theory of money demand we have developed would be in severe doubt …
A permanent increase in the level of a country’s money supply ultimately results in a proportional rise in its price level but has no effect on the long-run values of the interest rate or real output.”
This last sentence is simply the claim that money is neutral in the long run, which Krugman continues to affirm on his blog …
You might think these claims about money and inflation are unfortunate oversights, or asides from the main argument. They are not. The assumption that prices must eventually change in proportion to the central bank-determined money supply is central to the book’s four chapters on macroeconomic policy in an open economy …
So these are not throwaway lines. The more thoroughly a student understands the discussion in Krugman’s textbook, the stronger should be their belief that sustained expansionary monetary policy must be inflationary. Because if it is not, Krugman gives you no tools whatsoever to think about policy …
Liberal Keynesian economists made a deal with the devil decades ago, when they conceded the theoretical high ground. Paul Krugman the textbook author says authoritatively that money is neutral in the long run and that a permanent increase in the money supply can only lead to inflation. Why shouldn’t people listen to him, and ignore Paul Krugman the blogger?
Det första rådet vid en finansiell härdsmälta är att det finansiella systemet bör repareras omedelbart. Det är hjärtat i marknadsekonomin. En finanskris kan inte hävas förrän kreditgivningen åter fungerar. Andra stimulansåtgärder blir till föga hjälp så länge som bankerna är förlamade …
Det andra rådet säger att de så kallade automatiska stabilisatorerna i den offentliga sektorns budget bör få verka i största möjliga utsträckning. Vid varje kris skjuter budgetunderskottet av sig självt i höjden som följd av växande offentliga utgifter för högre arbetslöshet och sjunkande skatteintäkter när konsumtion och sysselsättning krymper …
Detta andra råd kan synas enkelt och självklart. Men ingen svensk finansminister har öppet och helhjärtat vågat anamma principen att lämna över budgetspakarna till den finanspolitiska autopiloten, minst av allt vid djup kris. Ofta har man gjort tvärtom: dragit i den budgetpolitiska nödbromsen och stramat åt – och därmed förvärrat det ekonomiska läget …
Vår finanskris i början av 1990-talet demonstrerade den kritiska dynamiken på ett slående sätt. Då utmålades de automatiskt växande budgetunderskotten som tecken på ansvarslös och slapp finanspolitik – inte som tecken på väl fungerande stötdämpare. Experter från IMF på besök i Stockholm bidrog till den felaktiga tolkningen genom att rekommendera finanspolitisk åtstramning mitt under brinnande kris.
Förhoppningsvis finns det en bättre förståelse i dag. Även IMF har svängt, ångrat sin budgetsyn från 1990-talet och går nu ut med det allmänna rådet att inte strama åt. Budgetunderskotten måste få växa raskt under de närmaste krisåren för att hålla världsekonomin – liksom vår ekonomi – på rätt köl.
Hoppas nu att ordföranden i Finanspolitiska rådet erinrar sig vad professorn skrev …
Keynes’s insights have enormous practical importance, according to Lance Taylor and Duncan Foley [who jointly received the Leontief Prize for Advancing the Frontiers of Economic Thought at Tufts University’s Global Development and Environment Institute on Monday.]
But isn’t Keynes now mainstream? No, say Foley and Taylor. The mainstream still sees economies as inherently moving to an optimal equilibrium … It still says demand causes short-run fluctuations, but only supply factors, such as the capital stock and technology, can affect long-run growth.
EVEN PAUL KRUGMAN, a self-described Keynesian, Nobel laureate, and New York Times columnist, writes in the 2012 edition of his textbook: “In the long run the economy is self-correcting: shocks to aggregate demand affect aggregate output in the short run but not in the long run” …
Keynes saw capitalism’s general state as allowing almost arbitrary unemployment: hence his “General Theory.” Full employment was a lucky exception.
To Taylor, calling full employment the general state and allowing one unlucky exception turns Keynes upside down. And look where this confusion has brought us, he adds. Take the current eurozone disaster. For two decades, the European Union bureaucracy in Brussels, the German Council of Economic Experts, and a chorus of others, branded Germany, the “sick man of Europe,” as suffering from a sclerotic supply side: rigid labor unions, impediments to layoffs, a burdensome welfare state. But German labor costs to produce output sank steadily, and Germany generated huge trade surpluses — hardly signs of a sclerotic supply side. Yet growth has barely averaged 1 percent a year since 2000.
I can’t but agree with Taylor and Foley here. To a large degree one does get the impression that Krugman thinks he is a Keynesian because he is a stout believer in John Hicks IS-LM interpretation of Keynes.
In a post on his blog, self-proclaimed “proud neoclassicist” Paul Krugman has argued that “Keynesian” macroeconomics more than anything else “made economics the model-oriented field it has become.” In Krugman’s eyes, Keynes was a “pretty klutzy modeler,” and it was only thanks to Samuelson’s famous 45-degree diagram and Hicks’s IS-LM that things got into place. Although admitting that economists have a tendency to use ”excessive math” and “equate hard math with quality” he still vehemently defends — and always have — the mathematization of economics:
I’ve seen quite a lot of what economics without math and models looks like — and it’s not good.
However, being a student of Hyman Minsky, yours truly very much doubt that IS-LM is an adequate reflection of the width and depth of Keynes’s insights on the workings of modern market economies.
Almost nothing in the post-General Theory writings of Keynes suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought. In Keynes’s canonical statement of the essence of his theory — in the famous 1937 Quarterly Journal of Economics article — there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. John Hicks, the man who invented IS-LM in his 1937 Econometrica review of Keynes’ General Theory — “Mr. Keynes and the ‘Classics’. A Suggested Interpretation” — returned to it in an article in 1980 — “IS-LM: an explanation” — in Journal of Post Keynesian Economics. Self-critically he wrote that ”the only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate.”
IS-LM is typically set in a current values numéraire framework that definitely downgrades the importance of expectations and uncertainty — and a fortiori gives too large a role for interests as ruling the roost when it comes to investments and liquidity preferences. Reducing uncertainty to risk — implicit in most analyses building on IS-LM models — is nothing but hand waving. According to Keynes we live in a world permeated by unmeasurable uncertainty — not quantifiable stochastic risk — which often forces us to make decisions based on anything but “rational expectations.” Keynes rather thinks that we base our expectations on the “confidence” or “weight” we put on different events and alternatives. To Keynes expectations are a question of weighing probabilities by “degrees of belief,” beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modeled by “modern” social sciences. And often we “simply do not know.”
IS-LM not only ignores genuine uncertainty, but also the essentially complex and cyclical character of economies and investment activities, speculation, endogenous money, labour market conditions, and the importance of income distribution. Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.
Sure, “New Keynesian” economists like Krugman — and their forerunners, “Keynesian” economists like Paul Samuelson and (young) John Hicks — certainly have contributed to making economics more mathematical and “model-oriented.”
But if these math-is-the-message-modelers aren’t able to show that the mechanisms or causes that they isolate and handle in their mathematically formalized macromodels are stable in the sense that they do not change when we “export” them to our “target systems,” these mathematical models do only hold under ceteris paribus conditions and are consequently of limited value to our understandings, explanations or predictions of real economic systems.
The kinds of laws and relations that “modern” economics has established, are laws and relations about mathematically formalized entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made mathematical-statistical “nomological machines” they are rare, or even non-existant. Unfortunately that also makes most of contemporary mainstream neoclassical endeavours of mathematical economic modeling rather useless. And that also goes for Krugman.
In recent blogposts Paul Krugman has come back to his idea that it would be great if the Fed stimulated inflationary expectations so that investments would increase. I don’t have any problem with this idea per se, but I don’t think it’s of the stature that Krugman seems to think. But although I have written extensively on Knut Wicksell and consider him the greatest Swedish economist ever, I definitely – since Krugman portrays himself as “sorta-kinda Keynesian” – have to question his invocation of Knut Wicksell for his ideas on the “natural” rate of interest. Krugman writes (emphasis added):
Start with the very simplest view of how Fed policy affects the economy: the Fed sets short-term interest rates, and other things equal a lower rate leads to higher output; the “natural rate” of interest … is the rate at which output equals potential, that is, at which there are neither inflationary nor deflationary pressures …
What does this tell us? First of all, that there is nothing “artificial” or “unnatural” about low interest rates; they’re low because demand is low, and the Fed is responding appropriately. If anything, the “unnatural” situation is that rates are too high, because they’re constrained by the zero lower bound (rates can’t go below zero, except for some minor technical bobbles, because people can always just hold cash).
Second, the Fed’s inability to get rates as low as they should be justifies a search for policies that can fill this policy gap. Fiscal stimulus is one such policy; unconventional monetary policies of various kinds are another. Actually, the natural policy — natural in a Wicksellian sense, and also the one that in terms of standard economics should produce the least distortion — would be a credible commitment to higher inflation.
Now consider what Keynes himself wrote in General Theory:
In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest¾namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s ‘natural rate of interest’, which was, according to him, the rate which would preserve the stability of some, not quite clearly specified, price-level.
I had, however, overlooked the fact that in any given society there is, on this definition, a different natural rate of interest for each hypothetical level of employment. And, similarly, for every rate of interest there is a level of employment for which that rate is the ‘natural’ rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment. Thus it was a mistake to speak of the natural rate of interest or to suggest that the above definition would yield a unique value for the rate of interest irrespective of the level of employment. I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.
I am now no longer of the opinion that the [Wicksellian] concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.
Paul Krugman has on his blog tried to explain why we should still use the neoclassical hobby horse Aggregate Supply-Aggregate Demand model:
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.
Actually, this is the same unsubstantiated stuff you find in all of the “fairly Keynesian” Greg Mankiw’s textbooks.
Well, THIS “fairly Keynesian” guy is not impressed. And I doubt that Keynes himself would have been impressed by having his theory being characterized with catchwords like “tendency to return to full employment” and “money is neutral in the long run.”
As Taylor and Foley convincingly argue — Krugman is no real Keynesian.
Added GMT 1630: In case you still think that Keynes shared Krugman’s concern of getting 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” — well, have a look at this 1934 BBC radio address by Keynes, and you will certainly come to think differently [h/t Sandwichman].
Statistical Science is not really very helpful for understanding or forecasting complex evolving self-healing organic ambiguous social systems – economies, in other words.
A statistician may have done the programming, but when you press a button on a computer keyboard and ask the computer to find some good patterns, better get clear a sad fact: computers do not think. They do exactly what the programmer told them to do and nothing more. They look for the patterns that we tell them to look for, those and nothing more. When we turn to the computer for advice, we are only talking to ourselves …
Mathematical analysis works great to decide which horse wins, if we are completely confident which horses are in the race, but it breaks down when we are not sure. In experimental settings, the set of alternative models can often be well agreed on, but with nonexperimental economics data, the set of models is subject to enormous disagreements. You disagree with your model made yesterday, and I disagree with your model today. Mathematics does not help much resolve our internal intellectual disagreements.
Starka offentliga finanser är en absolut förutsättning för tillväxt och fler jobb. Det inser man nu i Frankrike, Irland, Italien, Portugal, Spanien, Storbritannien och inte minst Grekland. Runtom i Europa väntar tuffa budgetsaneringsprogram. Det vet vi i Sverige efter de krisår vi gått igenom framför allt under 90-talet – eller borde veta. För oss socialdemokrater är det självklart: Sverige ska tillbaka till överskott …
Det Europa behöver är en ny och stram Stabilitets- och tillväxtpakt byggd på tydliga regler och sanktioner som tvingar Europas länder att sanera sina statsfinanser … Det måste finnas konsekvenser för medlemsländer som bryter mot pakten. Det bör övervägas om medlemsländer som bryter mot pakten ska få ta del av EU-medel …
För Sveriges del är det oerhört viktigt att euron blir framgångsrik. Det är viktigt för Europas ekonomiska framtid. Vi är fortfarande positiva till euron som politiskt projekt och är övertygade om att den kan bidra till handel, jobb och långsiktig tillväxt …
Europa behöver en ny och stram Stabilitets- och tillväxtpakt och fler ansvarstagande europeiska regeringar.
Herre du milde!
Har för mig att Östros fick ett nytt jobb också för ett par veckor sedan …
Based on the [quantity theory of money equation MV = PQ] holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent) during this period? …
During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q).
So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of Money …
And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:
•A glooming economy after the financial crisis
•The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds.
Anyone still believing in Say’s Law? Just wondering …