Econophysics

20 August, 2018 at 15:15 | Posted in Economics | 1 Comment

Unfortunately, nothing is more dangerous than dogmas donned with scientific feathers. The current crisis might offer an excellent occasion for a paradigm
change, previously called for by prominent economists like John Maynard Keynes, Alan Kirman and Steve Keen. They have forcefully highlighted the shortcomings
and contradictions of the classical economictheory, but progress has been slow. The task looks so formidable that some economists argue that it is better to stick with the implausible but well-corseted theory of perfectly rational agents than to venture into modelling the infinite number of ways agents can be irrational.

miracle_cartoonPhysicists, however, feel uncomfortable with theories not borne out by (or even blatantly incompatible with) empirical data. But could the methodology of physics really contribute to the much-awaited paradigm shift in economics? …

Econophysics is in fact a misnomer, since most of its scope concerns financial markets. To some economists, finance is a relatively minor subfield and any contribution, even the most significant, can only have a limited impact on economics science at large. I personally strongly disagree with this viewpoint: recent events confirm that hiccups in the financial markets can cripple the entire economy.

From a more conceptual point of view, financial markets are an ideal laboratory for testing several fundamental concepts of economics. Are prices really such that supply matches demand? Are price moves primarily due to news? (The answer to both these questions seem to be clear “no” … As I will try to illustrate, the very choice of the relevant questions, which ultimately leads to a deeper understanding of the data, is often sheer serendipity: more of an art than a science. That intuition, it seems to me, is well nurtured by an education in the natural sciences, where the emphasis is on mechanisms and analogies, rather than on axioms and theorem proving.

Jean-Philippe Bouchaud

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The rational expectations hoax

18 August, 2018 at 16:29 | Posted in Economics | Leave a comment

how-many-irrational-assumptions-are-needed-for-economist-to-use-rational-expectationsA lot of mainstream economists still stick with ‘rational expectations’ since they think it has not yet been disconfirmed. They are, of course, entitled to have whatever views they like — after all, it is, to say the least, difficult to empirically disconfirm the non-existence of Gods …

But for the rest of us, let’s see how rational expectations really fare​ as an empirical assumption. Empirical efforts at testing the correctness​​s of the hypothesis have​​ resulted in a series of empirical studies that have more or less concluded that it is not consistent with the facts. In one of the more well-known and highly respected evaluation reviews made, Michael Lovell (1986) concluded:

it seems to me that the weight of empirical evidence is sufficiently strong to compel us to suspend belief in the hypothesis of rational expectations, pending the accumulation of additional empirical evidence.

And this is how Nikolay Gertchev summarizes studies on the empirical correctness of the hypothesis:

More recently, it even has been argued that the very conclusions of dynamic models assuming rational expectations are contrary to reality: “the dynamic implications of many of the specifications that assume rational expectations and optimizing behavior are often seriously at odds with the data” (Estrella and Fuhrer 2002, p. 1013). It is hence clear that if taken as an empirical behavioral assumption, the RE hypothesis is plainly false; if considered only as a theoretical tool, it is unfounded and self-contradictory​.

For more on the issue, permit me to self-indulgently recommend reading my article Rational expectations — a fallacious foundation for macroeconomics in a non-ergodic world in Real-World Economics Review no. 62.

“I never learned maths, so I had to think”

17 August, 2018 at 20:54 | Posted in Economics | 2 Comments

Professors may find themselves ill-prepared for the macro classroom. To become academics they had to answer erudite questions posed by more senior members of the discipline. To become good teachers of introductory macro, they have to give clear answers to muddled students. That requires an intuitive feel for the subject. It is not enough to crank through the equations.

rowe Indeed, Mr Rowe attributes part of his success as a teacher to his shortcomings as a mathematician. He quotes Joan Robinson, another clear expositor of macroeconomics: “I never learned maths, so I had to think.” Because the answers did not leap out at him from the equations, he had to dwell on the economic behaviour underneath the algebra.

Macroeconomics is difficult to teach partly because its theorists (classical, Keynesian, monetarist, New Classical and New Keynesian, among others) disagree about so much. It is difficult also because the textbooks disagree about so little.

The Economist

On tour

14 August, 2018 at 12:35 | Posted in Economics, Varia | Leave a comment

Touring again. Regular blogging to be resumed during the weekend.

Easterlin’s paradox or why economic growth does not make us happier

12 August, 2018 at 16:02 | Posted in Economics | 3 Comments

In Easterlin’s (1974) seminal paper, he finds that within any one country, in cross sectional studies, there was a strong correlation between income and happiness. One would easily conclude that money can buy happiness. However, looking at a cross section of countries, one comes to a different conclusion …

For 10 of the 14 countries surveyed, the happiness ranking is about the same, even though the income per capita changes by a factor of 30 from $140 to $2,000 …

easterlinThe finding of strong correlation between income and happiness disappears when comparisons are made across countries. Similarly, there is no correlation between happiness and income in the long run within a single country … Easterlin (2001) cites several studies which show that, despite tremendous increases in GNP per capita, the level of happiness in European and Latin American has remained virtually constant over decades.

The startling implication of these empirical findings is that the stress being placed on economic growth is entirely misplaced. Growth has no clear relation to happiness. The profession of economics, as well as policy makers all over the world are directly threatened by these findings, which suggest radical changes in how to organise economic affairs …

The implicit proposition of utility theory that the sole route to happiness is maximisation of consumption contradicts with the empirical evidence: this proposition is true only in the short run. This short run validity creates a dangerous illusion of long run validity; understanding this has dramatic policy implications. If happiness is determined by relative comparisons, then one can achieve greater happiness by reducing inequalities, and also by reducing the standards of living for everyone. This will lower the benchmark and make it easier for everyone on the planet to be happy in comparison with this benchmark.

Asad Zaman & Mehmet Karacuka

So much for value-free economics

12 August, 2018 at 15:28 | Posted in Economics | 1 Comment

Back in 1992, New Jersey raised the minimum wage by 18 per cent while its neighbour state, Pennsylvania, left its minimum wage unchanged. Unemployment in New Jersey should — according to mainstream economics textbooks — have increased relative to Pennsylvania. However, when economists David Card and Alan Krueger gathered information on fast food restaurants in the two states, it turned out that unemployment had actually decreased in New Jersey relative to that in Pennsylvania. Counter to mainstream demand theory we had an anomalous case of a backward-sloping supply curve.

And, of course, all those non-ideological and value-free scientific economists out there were überjoyed and prepared to revise their theories …

jp-imgresI’ve subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.

David Card

Money in perspective

12 August, 2018 at 13:17 | Posted in Economics | 4 Comments

keWhen the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.

Modern macro — a total waste​ of time

11 August, 2018 at 11:33 | Posted in Economics | 2 Comments

While one can understand that some of the elements in DSGE models seem to appeal to Keynesians at first sight, after closer examination, these models are in fundamental contradiction to Post-Keynesian and even traditional Keynesian thinking. The DSGE model is a model in which output is determined in the labour market as in New Classical models and in which aggregate demand plays only a very secondary role, even in the short run.

In addition, given the fundamental philosophical problems presented for the use of DSGE models for policy simulation, namely the fact that a number of parameters used have completely implausible magnitudes and that the degree of freedom for different parameters is so large that DSGE models with fundamentally different parametrization (and therefore different policy conclusions) equally well produce time series which fit the real-world data, it is also very hard to understand why DSGE models have reached such a prominence in economic science in general.

Sebastian Dullien

Neither New Classical nor ‘New Keynesian’ microfounded DSGE macro models have helped us foresee, understand or craft solutions to the problems of today’s economies. But still most young academic macroeconomists want to work with DSGE models. UnknownAfter reading Dullien’s article, that certainly should be a very worrying confirmation of economics — at least from the point of view of realism and relevance — becoming more and more a waste of time. Why do these young bright guys waste their time and efforts? I think maybe Frank Hahn gave the truest answer when interviewed on the occasion of his 80th birthday, he confessed that some economic assumptions didn’t really say anything about ‘what happens in the world,’ but still had to be considered very good ‘because it allows us to get on this job.’

Abba Lerner and the nonsense called ‘Ricardian equivalence’

9 August, 2018 at 10:43 | Posted in Economics | 9 Comments

According to Abba Lerner, the purpose of public debt is “to achieve a rate of interest which results in the most desirable level of investment.” He also maintained that an application of Functional Finance will have a tendency to balance the budget in the long run:

There is no reason for assuming that, as a result of the continued application of Functional Finance to maintain full employment, the government must always be borrowing more money and increasing the national debt …

dec3bb27f72875e4fb4d4b62daebb2fd161b36392c1a0626f00cfd2ece207d84Full employment can be maintained by printing the money needed for it, and this does not increase the debt at all. It is probably advisable, however, to allow debt and money to increase together in a certain balance, as long as one or the other has to increase …

Since one of the greatest deterrents to private investment is the fear that the depression will come before the investment has paid for itself, the guarantee of permanent full employment will make private investment much more attractive, once investors have gotten over their suspicion of the new procedure. The greater private investment will diminish the need for deficit spending …

As the national debt increases it acts as a self-equilibrating force, gradually diminishing the further need for its growth and finally reaching an equilibrium level where its tendency to grow comes completely to an end. The greater the national debt the greater is the quantity of private wealth.

Abba Lerner

According to the Ricardian equivalence hypothesis, the public sector basically finances its expenditures through taxes or by issuing bonds, and bonds must sooner or later be repaid by raising taxes in the future.

If the public sector runs extra spending through deficits, taxpayers will according to the hypothesis anticipate that they will have to pay higher taxes in future — and therefore increase their savings and reduce their current consumption to be able to do so, the consequence being that aggregate demand would not be different to what would happen if taxes were raised today.

Describing the Ricardian Equivalence in 1989, Robert Barro writes (emphasis added):

The substitution of a budget deficit for current taxes (or any other rearrangement of the timing of taxes) has no impact on the aggregate demand for goods. In this sense, budget deficits and taxation have equivalent effects on the economy — hence the term, “Ricardian equivalence theorem.” To put the equivalence result another way, a decrease in the government’s saving (that is, a current budget deficit) leads to an offsetting increase in desired private saving, and hence to no change in desired national saving.

Ricardian equivalence basically means that financing government expenditures through taxes or debts is equivalent since debt financing must be repaid with interest, and agents — equipped with rational expectations — would only increase savings in order to be able to pay the higher taxes in the future, thus leaving total expenditures unchanged.

There is, of course, no reason for us to believe in that fairy-tale. Ricardo himself (!) didn’t believe in Ricardian equivalence. In ‘Essay on the Funding System’ (1820) he wrote:

We are too apt to think that the war is burdensome only in proportion to what we are at the moment called to pay for it in taxes, without reflecting on the probable duration of such taxes. It would be difficult to convince a man possessed of £20,000, or any other sum, that a perpetual payment of £50 per annum was equally burdensome with a single tax of £1000.

That the theory does not fit the facts we already knew. Studies that have empirically tried to test the theory have over and over again confirmed how out of line with reality Ricardian equivalence is. This only underlines that there is, of course, no reason for us to believe in that fairy-tale. Or, as Nobel laureate Joseph Stiglitz has it:

Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.

Italia: troppo grande per fallire, troppo grande per scamparla

6 August, 2018 at 14:41 | Posted in Economics | Leave a comment

L’euro ha tolto la possibilità ai Governi nazionali di gestire in modo significativo le loro economie e in Italia, proprio come in Grecia un paio di anni fa, le persone hanno dovuto pagare i veri costi delle erronee e concomitanti politiche di austerità.

2069559cc162edf1c8c17edda43e8f6c Durante l’ultimo decennio, il dispiegarsi delle ripetute crisi economiche in Eurolandia ha mostrato al di là di ogni dubbio che l’euro non è solo un progetto economico, ma è soprattutto un progetto politico. Oggi l’euro ci forza a ciò che la rivoluzione neoliberista degli anni ’80 e ’90 non è riuscita a realizzare.

Gli Europei vogliono veramente privarsi della propria autonomia economica, imporre salari più bassi e tagliare il benessere sociale al minimo manifestarsi di un problema economico? La crescente disuguaglianza di reddito e uno Stato federale sono cose che fanno davvero parte dei nostri sogni? Ne dubito.

La storia dovrebbe agire come deterrente. Durante gli anni ’30 le nostre economie non uscirono dalla depressione finché la follia di quel tempo il gold standard fu gettata via nella spazzatura della storia. Si spera che l’euro faccia presto la stessa fine.

Gli economisti hanno la tendenza a rimanere affascinati dalle loro teorie e dai loro modelli e dimenticano che dietro ai loro grafici e alle loro astrazioni c’è un mondo reale, con persone reali. Persone reali che devono pagare un caro prezzo a causa di dottrine e raccomandazioni fondamentalmente sbagliate.

Lars Syll/Rete MMT

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