Ricardian vice

17 October, 2018 at 18:50 | Posted in Economics | 1 Comment

history-of-economic-analysis-schumpeter-first-edition Ricardo’s … interest was in the clear-cut result of direct, practical significance. In order to get this he cut that general system to pieces, bundled up as large parts of it as possible, and put them in cold storage — so that as many things as possible should be frozen and ‘given.’ He then piled one simplifying assumption upon another until, having really settled everything by theses assumptions, he was left with only a few aggregative variables between which, he set up simple one-way relations so that, in the end, the desire results emerged almost as tautologies … It is an excellent theory that can never be refuted and lacks nothing save sense. The habit of applying results of this character to the solution of practical problems we shall call the Ricardian Vice.

Sounds familiar, doesn’t it?

Only difference is that today it is seen as a virtue rather than a vice …

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Ketchup economics

16 October, 2018 at 20:09 | Posted in Economics | Leave a comment

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The increasing ascendancy of real business cycle theories of various stripes, with their common view that the economy is best modeled as a floating Walrasian equilibrium, buffeted by productivity shocks, is indicative of the depths of the divisions separating academic macroeconomists …

If  these theories are correct, they imply that the macroeconomics developed in the wake of the Keynesian Revolution is well confined to the ashbin of history. And they suggest that most of the work of contemporary macroeconomists is worth little more than that of those pursuing astrological science …

The appearance of Ed Prescott’ s stimulating paper, “Theory Ahead of Business Cycle Measurement,” affords an opportunity to assess the current state of real business cycle theory and to consider its prospects as a foundation for macroeconomic analysis …

My view is that business cycle models of the type urged on us by Prescott have nothing to do with the business cycle phenomena observed in The United States or other capitalist economies …

Prescott’s growth model is not an inconceivable representation of reality. But to claim that its parameters are securely tied down by growth and  micro observations seems to me a gross overstatement. The image of a big loose tent flapping in the wind comes to mind …

In Prescott’s model, the central driving force behind cyclical fluctuations is technological shocks. The propagation mechansim is intertemporal substitution in employment. As I have argued so far, there is no independent evidence from any source for either of these phenomena …

Imagine an analyst confronting the market for ketchup. Suppose she or he decided to ignore data on the price of ketchup. This would considerably increase the analyst’s freedom in accounting for fluctuations in the quantity of ketchup purchased … It is difficult to believe that any explanation of fluctuations in ketchup sales that did not confront price data would be taken seriously, at least by hard-headed economists.

Yet Prescott offers an exercise in price-free economics … Others have confronted models like Prescott’s to data on prices with what I think can fairly be labeled dismal results. There is simply no evidence to support any of the price effects predicted by the model …

Improvement in the track record of macroeconomics will require the development of theories that can explain why exchange sometimes work and other times breaks down. Nothing could be more counterproductive in this regard than a lengthy professional detour into the analysis of stochastic Robinson Crusoes.

Lawrence SummersSkeptical Observations on Real Business Cycle Theory 

Does using models really make economics a science?​

12 October, 2018 at 17:25 | Posted in Economics | Leave a comment

The model has more and more become the message in modern mainstream economics. Formal models are said to help achieve ‘clarity’ and ‘consistency.’ Dani Rodrik — just to take one prominent example — even​ says, in his Economics Rules, that “models make economics a science.”

bbEconomics is more than any other social science model-oriented. There are many reasons for this — the history of the discipline, having ideals coming from the natural sciences (especially physics), the search for universality (explaining as much as possible with as little as possible), rigour, precision, etc.

Mainstream economists want to explain social phenomena, structures and patterns, based on the assumption that the agents are acting in an optimizing (rational) way to satisfy given, stable and well-defined goals.

The procedure is analytical. The whole is broken down into its constituent parts so as to be able to explain (reduce) the aggregate (macro) as the result of interaction of its parts (micro).

Modern mainstream economists ground their models on a set of core assumptions — basically describing the agents as ‘rational’ actors — and a set of auxiliary assumptions. Together they make up the base model of all mainstream economic models. Based on these two sets of assumptions, they try to explain and predict both individual (micro) and — most importantly — social phenomena (macro).

When describing the actors as rational in these models, the concept of rationality used is instrumental rationality – choosing consistently the preferred alternative, which is judged to have the best consequences for the actor given his in the model exogenously given wishes/interests/goals. How these preferences/wishes/interests/goals are formed is typically not considered to be within the realm of rationality, and a fortiori not constituting part of economics proper.

The picture given by the set of core assumptions (rational choice) is a rational agent with strong cognitive capacity that knows what alternatives she is facing, evaluates them carefully, calculates the consequences and chooses the one — given her preferences — that she believes has the best consequences according to him.

Weighing the different alternatives against each other, the actor makes a consistent optimizing choice and acts accordingly (given the set of auxiliary assumptions that specify the kind of social interaction between ‘rational actors’ that can take place in the model).

So — mainstream economic models basically consist of a general specification of what (axiomatically) constitutes optimizing rational agents and a more specific description of the kind of situations in which these rational actors act. The list of assumptions can never be complete since there will always unspecified background assumptions and some (often) silent omissions (like closure, transaction costs, etc). The hope, however, is that the ‘thin’ list of assumptions shall be sufficient to explain and predict ‘thick’ phenomena in the real, complex, world.

Economics — in contradistinction to logic and mathematics — ought to be an empirical science, and empirical testing of ‘axioms’ ought to be self-evidently relevant for such a discipline. For although the mainstream economist himself (implicitly) claims that his axioms are universally accepted as true and in no need of proof, that is in no way a justified reason for the rest of us to simpliciter accept the claim.

When applying deductivist thinking to economics, mainstream economists usually set up ‘as if’ models based on the logic of idealization and a set of tight axiomatic assumptions from which consistent and precise inferences are made. The beauty of this procedure is that if the axiomatic premises are true, the conclusions necessarily follow. But — although the procedure is a marvellous tool in mathematics and axiomatic-deductivist systems, it is a poor guide for the real world.

The way axioms and theorems are formulated in mainstream economics standardly leaves their specification without almost any restrictions whatsoever, safely making every imaginable evidence compatible with the all-embracing ‘theory’ — and a theory without informational content never risks being empirically tested and found falsified. Used in mainstream economics ‘thought experimental’ activities, it may, of course, be very ‘handy’, but totally void of any empirical value.

Mainstream economic models are nothing but broken pieces models. That kind of models can’t make economics a science

Paul Romer — a flamboyant and hot-headed economist

12 October, 2018 at 09:12 | Posted in Economics | Leave a comment

L’Américain Paul Romer, qui s’est vu décerner lundi le prestigieux prix Nobel d’économie aux côtés d’un de ses compatriotes William Nordhaus, est un économiste flamboyant à la carrière mouvementée, connu pour ses travaux mesurant la part de l’innovation dans la croissance.

mathiness-in-the-theory-of-economic-growth-paul-romer2A 62 ans, il est actuellement professeur à l’Université de New York … Il avait quitté en octobre 2016 le monde universitaire pour occuper le poste de chef économiste de la Banque mondiale (BM). Mais ses critiques à peine voilées de l’institution de Washington l’ont contraint à démissionner en janvier dernier et il est retourné à ses travaux académiques à New York.

En cause, ses prises de position sur un rapport phare de la BM, “Doing business”, publié chaque année, qui passe au crible le cadre réglementaire s’appliquant aux PME dans 190 économies pour évaluer quels sont les pays les plus favorables au lancement d’une entreprise.

Paul Romer laisse entendre que ce classement est influencé par des considérations politiques, citant un changement de méthodologie pénalisant par exemple le Chili, qui, depuis 2013, dégringole dans le classement uniquement par un effet mécanique.

Avant cela, le bouillant économiste avait déjà suscité la polémique avec un article retentissant, “The trouble with macroeconomics”, dans lequel il critiquait ses collègues macroéconomistes, leur reprochant de “faire tourner” des modèles mathématiques sans rapport avec le réel.

Selon lui, considérer la connaissance et l’information comme une ressource crée de la croissance économique. Contrairement aux autres ressources, la connaissance n’est pas seulement abondante, elle est infinie …

Bien que son nom ait été cité plusieurs fois parmi les potentiels lauréats du Nobel, Paul Romer a expliqué qu’il n’avait pas décroché son téléphone aux premiers coups de fil reçus au petit matin, croyant à des appels commerciaux. C’était l’Académie royale des sciences.

“Je ne le voulais pas, mais je l’accepte”, a-t-il alors déclaré, dans un sourire.

La Croix

Paul Romer’s endogenous growth theory — a very short introduction

10 October, 2018 at 21:38 | Posted in Economics | 1 Comment

 
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Paul Romer’s critique of ‘post-real’ economics

9 October, 2018 at 09:13 | Posted in Economics | Leave a comment

 blah_blahIn practice, what math does is let macro-economists locate the FWUTVs [facts with unknown truth values] farther away from the discussion of identification … Relying on a micro-foundation lets an author say, “Assume A, assume B, …  blah blah blah … And so we have proven that P is true. Then the model is identified.” …

Distributional assumptions about error terms are a good place to bury things because hardly anyone pays attention to them. Moreover, if a critic does see that this is the identifying assumption, how can she win an argument about the true expected value the level of aether? If the author can make up an imaginary variable, “because I say so” seems like a pretty convincing answer to any question about its properties.

Paul Romer

Yes, indeed, modern mainstream economics — and especially its mathematical-statistical operationalization in the form of econometrics — fails miserably over and over again. One reason why it does, is that the error term in the regression models used is thought of as representing the effect of the variables that were omitted from the models. The error term is somehow thought to be a ‘cover-all’ term representing omitted content in the model and necessary to include to ‘save’ the assumed deterministic relation between the other random variables included in the model. Error terms are usually assumed to be orthogonal (uncorrelated) to the explanatory variables. But since they are unobservable, they are also impossible to empirically test. And without justification of the orthogonality assumption, there is, as a rule, nothing to ensure identifiability.

In mainstream econometrics, the error term is usually portrayed as representing the combined effect of the variables that are omitted from the model. What one does not say — in a way bordering on intellectual dishonesty — is that this assumption only works when (1) the combined effect is independent of each and every variable included in the model, and (2) the expectational value of the combined effect equals zero. And that is something almost never fulfilled in real-world settings!

‘Modern’ mainstream economics is based on the belief that deductive-axiomatic modelling is a sufficient guide to truth. That belief is, however, totally unfounded as long as no proofs are supplied for us to believe in the assumptions on which the model-based deductions and conclusions build. ‘Mathiness’ masquerading as science is often used by mainstream economists to hide the problematic character of the assumptions used in their theories and models. But — without showing the model assumptions to be realistic and relevant, that kind of economics indeed, as Romer puts it, produces nothing but “blah blah blah.”

Without strong evidence, all kinds of absurd claims and nonsense may pretend to be science. Using math can never be a substitute for thinking. Or as Romer has it in his showdown with ‘post-real’ economics:

Math cannot establish the truth value of a fact. Never has. Never will.

At last — Paul Romer got his ‘Nobel prize’​

8 October, 2018 at 14:29 | Posted in Economics | 9 Comments

Among Swedish economists, Paul Romer has for many years been the favourite candidate for receiving the ‘Nobel Prize’ in economics. This year the prediction turned out right. Romer got the prize (together with William Nordhaus).

The ‘Nobel prize’ in economics has almost exclusively gone to mainstream economists, and most often to Chicago economists. So how refreshing it is that we for once have a winner who has been brave enough to openly criticize the ‘post-real’ things that emanate from the Chicago ivory tower!

Adam Smith once wrote that a really good explanation is “practically seamless.”

Is there any such theory within one of the most important fields of social sciences — economic growth?

Paul Romer‘s theory presented in Endogenous Technological Change (1990) – where knowledge is made the most important driving force of growth – is probably as close as we get.

Knowledge – or ideas – are according to Romer the locomotive of growth. But as Allyn Young, Piero Sraffa and others had shown already in the 1920s, knowledge is also something that has to do with increasing returns to scale and therefore not really compatible with neoclassical economics with its emphasis on decreasing returns to scale.

Increasing returns generated by nonrivalry between ideas is simply not compatible with pure competition and the simplistic invisible hand dogma. That is probably also the reason why neoclassical economists have been so reluctant to embrace the theory whole-heartedly.

Neoclassical economics has tried to save itself by more or less substituting human capital for knowledge/ideas. But Romer’s pathbreaking ideas should not be confused with human capital. Although some have problems with the distinction between ideas and human capital in modern endogenous growth theory, this passage from Romer’s article The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital gives a succinct and accessible account of the difference:

Of the three state variables​ that we endogenize, ideas have been the hardest to bring into the applied general equilibrium structure. The difficulty arises because of the defining characteristic of an idea, that it is a pure nonrival good. A given idea is not scarce in the same way that land or capital or other objects are scarce; instead, an idea can be used by any number of people simultaneously without congestion or depletion.

Because they are nonrival goods, ideas force two distinct changes in our thinking about growth, changes that are sometimes conflated but are logically distinct. Ideas introduce scale effects. They also change the feasible and optimal economic institutions. The institutional implications have attracted more attention but the scale effects are more important for understanding the big sweep of human history.

The distinction between rival and nonrival goods is easy to blur at the aggregate level but inescapable in any microeconomic setting. Picture, for example, a house that is under construction. The land on which it sits, capital in the form of a measuring tape, and the human capital of the carpenter are all rival goods. They can be used to build this house but not simultaneously any other. Contrast this with the Pythagorean Theorem, which the carpenter uses implicitly by constructing a triangle with sides in the proportions of 3, 4 and 5. This idea is nonrival. Every carpenter in the world can use it at the same time to create a right angle.

Of course, human capital and ideas are tightly linked in production and use. Just as capital produces output and forgone output can be used to produce capital, human capital produces ideas and ideas are used in the educational process to produce human capital. Yet ideas and human capital are fundamentally distinct. At the micro level, human capital in our triangle example literally consists of new connections between neurons in a carpenter’s head, a rival good. The 3-4-5 triangle is the nonrival idea. At the macro level, one cannot state the assertion that skill-biased technical change is increasing the demand for education without distinguishing between ideas and human capital.

Paul’s idea about ideas is well worth a ‘Nobel Prize.’ Congratulations Paul!

Krugman and ‘neutral money’

5 October, 2018 at 09:21 | Posted in Economics | 5 Comments

Paul Krugman has repeatedly over the years argued that we should continue to use mainstream hobby horses like IS-LM and AS-AD models. Here’s one example:

Neutrality-of-moneySo 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.

I seriously doubt that Keynes would have been impressed by having his theory being characterized by​ catchwords like “tendency to return to full employment” and “money is neutral in the long run.”

alfa

One of Keynes’ central tenets — in clear contradistinction to the beliefs of mainstream economists — is that there is no strong automatic tendency for economies to move toward full employment levels in monetary economies.

Money does not matter in mainstream macroeconomic models. That is true. According to the ‘classical dichotomy,’ real variables — output and employment — are independent of monetary variables, and so enables mainstream economics to depict the economy as basically a barter system.

But in the real world in which we happen to live, money certainly does matter. Money is not neutral and money matters in both the short run and the long run:

Banks are authorized to create credit, ex nihilo (“out of nothing”) so credit (money) cannot be neutral. In creating credit, a bank creates money that a borrower uses to purchase goods and services that add to aggregate demand and economic growth. Banks are not limited to acting only as intermediaries that move money from savers to borrowers. Importantly, banks also determine how credit and money are allocated. In the real world​, money creation distinguishes banks from other financial intermediaries (e.g., shadow banks) that can extend credit but do not possess the authority to create money. Within the financial sector, only banks are granted this authority. Money is a form of credit, an obligation to pay. In Werner’s (2012) words, “banks are the creators of the money supply” and “this is the missing link that causes credit rationing to have macroeconomic consequences.” In short, finance (banking, money and credit) matter!

John Balder

Give the public debt some respect and end austerity!

3 October, 2018 at 14:05 | Posted in Economics | 12 Comments

The claim that our public debt is excessive has been used as a major justification for austerity – cuts in spending. That massive debt, we are told, 1) must be repaid, 2) threatens our country with bankruptcy, and 3) is a burden on future generations. All these are wrong. Let me explain why …

austerity-george-osborne-desktopBritain’s national currency is managed by our central bank, the Bank of England, owned by the citizens of the United Kingdom (that is, our elected government). As a result, the British government can never default on its bonds. Our government can replace maturing public bonds with new ones. Should private buyers, households and businesses, refuse to purchase the new bonds at the interest rate set by the British government, our government can sell them to the Bank of England …

The debt is nothing more than pieces of paper that the government promises to buy back on a specific date. These pieces of paper can be bought back with new pieces of paper (new bonds) with later buy-back dates. If the private owners of the debt paper do not want the new bonds (new debt paper), our government can sell those new bonds to the Bank of England for cash and use the cash to pay the bond holders.

John Weeks

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases.

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few ask the question if maybe there is also a problem if public debt becomes too low.

darling-let-s-get-deeply-into-debtThe government’s ability to conduct an ‘optimal’ public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market become too small, increased volatility and uncertainty will, in the long run, lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality, it may be argued — especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure — in a longer run — good borrowing preparedness and a sustained (government) bond market.

The question if public debt is good and that we may actually have too little of it is one of our time’s biggest questions. Giving the wrong answer to it will be costly.

Keynes als Investor

3 October, 2018 at 13:31 | Posted in Economics | Leave a comment

BF-AC563A_INVES_D_20120330211508Lange prägten Legenden das Bild des Investors Keynes. Sein Biograf Donald Moggridge etwa berichtet, dass Keynes das Volumen der King’s Chapel, der weltberühmten gotischen Kapelle des Colleges, schätzen ließ, in der Absicht, dort Getreide einzulagern, um es später mit Gewinn zu verkaufen.

Wie Keynes wirklich für das College investiert hat, haben kürzlich zwei Ökonomen untersucht. David Chambers (Cambridge) und Elroy Dimson (London) konnten Abrechnungen und Jahresberichte aus dem Archiv des King’s College einsehen und so die Anlagestrategie von Keynes im Detail rekonstruieren. Ihre Analyse kratzt am Mythos, denn sie zeigt: Keynes hatte anfangs wenig Erfolg. Vor allem aber dokumentiert sie, wie Keynes seine Strategien über die Jahre anpasste und mit welchen er schließlich eine fulminante Rendite erzielte. Diese Lehren sind noch heute von Interesse.

Friedemann & Tilman Bieber/Die Zeit

Why every economics paper should come with a warning label

2 October, 2018 at 18:48 | Posted in Economics | 6 Comments

e8f9b7fec248157b1989085deaa05dde-d7bu3k6It should be part of the academic competences of trained economists to be able to be clear about what their models are for; what the models are about; what the models are capable of doing, and what not; how reliable the models are; what sorts of criticisms have been levelled against the models and how the criticisms have been responded; what alternative models there are; etc. The challenge is not easy, and it is clear that it has not been met with sufficient exuberance and success. The capacity of writing “warning labels” would be part of the needed professional competence. Such warning labels would alert the relevant audiences to the capabilities and limitations of the models …

Exceptional amongst the social sciences is the role of the economics discipline in contemporary society, the intellectual and political authority economics enjoys regardless of its failures. Above, I cited Colander’s confession, “we pretend we understand more than we do” and we could add that economists do so in order to – or with the consequence of – protecting and promoting their socially acknowledged authority. In the worst case, there is a nightmarish scenario on which the more economists are consulted for policy advice, the more they need to pretend to know, and so the higher the likelihood of policies going astray. Avoiding the nightmare would require some smart restructuring of the institutions of the economics discipline.

Uskali Mäki

Spelteori och politik

1 October, 2018 at 15:49 | Posted in Economics | Leave a comment

Ekonomistas har Jesper Roine några ‘spelteoretiska resonemang’ kring den pågående och utdragna regeringsbildningen i vårt land:

The Median Voter Theorem.010Det överlägset mest kända resultatet när det gäller att applicera spelteori på politik är det så kallade medianväljar-teoremet. Enkelt uttryckt säger det att om politik kan beskrivas som att inta en position på en vänster-högerskala och två partier (eller ”block”) konkurrerar om väljarnas stöd så tenderar politiken att konvergera mot det som föredras av medianväljaren. Anledningen är enkel att förstå; om någon placerar sig någon annanstans än i mitten så kan motståndaren alltid placera lite till höger (eller vänster) och få stöd av den majoritet av väljarstödet som per definition finns där. Bara placeringen i mitten har egenskapen att ingen kan ändra sin position och därigenom få ett ökat stöd.

Nu kan man förstås invända att politik är långt mer komplicerat än så här och det är ju sant.

Ja, nog kan man med fog invända att “politik är långt mer komplcerat än så här.” Problemet med det mesta av de ‘spelteoretiska resonemang’ som Roine för är — tack och lov — att de har väldigt lite med verklig spelteori att göra. Som yours truly skriver i Real-World Economics Review artikeln Why game theory never will be anything but a footnote in the history of social science :

Lars Pålsson Syll_06Heavy use of formalism and mathematics easily foster the view that a theory is scientific. But although game theory may produce ‘absolute truths’ in imaginary model worlds, in the real world the game theoretic models are nothing but fables. Fables much reminiscent of the models used in logic, but also like them, delivering very little of value for social sciences trying to explain and understand real-life phenomena. The games that game theory portrays are model constructs, models without significant predictive capacity simply because they do not describe an always much more complex and uncertain reality …

Although some economists consider it useful to apply game theory and use game theoretical definitions, axioms, and theorems and (try to) test if real-world phenomena ‘satisfy’ the axioms and the inferences made from them, we have argued that that view is without warrant. When confronted with the real world we can (hopefully) judge if game theory really tells us if things are as postulated. The final court of appeal for models is the real world, and as long as no convincing justification is put forward for how the inferential bridging de facto is made, model building is little more than hand-waving that give us rather little warrant for making inductive inferences from the model world to the real world.

The real challenge in social science is to accept uncertainty and still try to explain why different kinds of transactions and social interactions take place. Simply conjuring problems away by assuming patently unreal things and treating uncertainty as if it was possible to reduce to stochastic risk, is like playing tennis with the net down. That is not the kind of game that scientists working on constructing a relevant and realist science want to play.

Chicago economics — utterly and completely wrong

1 October, 2018 at 11:01 | Posted in Economics | 5 Comments

Savings-and-InvestmentsEvery dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

John Cochrane

The problem with this view is, of course, that it is utterly and completely wrong!

What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex-ante and ex-post adjustments. And as further stressed by a famous English economist about the same time, what happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

william-vickrey-1914-1996As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly … those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

As could be expected there is no room in Chicago economics for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply-side​ policies.

Robert Lucas and other Chicago economists have again and again dismissed even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead — “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” — this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do in their attempts to explain away the fact that the latest economic crises shows how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be government.

Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich. Trying to explain business cycles in terms of ‘rational expectations’ has failed blatantly. Maybe it would be asking too much of freshwater economists like Lucas and Cochrane to concede that, but it is still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas or John Cochrane was. John Maynard Keynes and William Vickrey, on the other hand, will still be known as two of the masters of economics.

How do models relate to reality?

30 September, 2018 at 10:42 | Posted in Economics | 2 Comments

 

New Keynesian nonsense ‘proofs’

28 September, 2018 at 15:32 | Posted in Economics | 3 Comments

New Keynesians use mathematics to ‘prove’ some very odd stuff … Take, for example, a paper by Campbell Leith and Simon Wren-Lewis entitled Electoral Uncertainty and the Deficit Bias in a New Keynesian Economy. The thrust of the paper is that our particular form of party-based democracy naturally leads to ‘deficit bias’ … The authors identify the root problem to be one of ‘heterogeneity’ — the fact that different political parties will have different views about how to run the country. Let’s look at a snippet from the paper to see how they use maths to support this earth-shattering discovery:

leith wren

This lays bare a fundamental problem with the New Keynesians. Their model reduces the economy — the complexity of which is beyond the limits of human understanding — to a ridiculously simple model which bears no relation to reality. They then selectively prime the model with whatever data provides the desired answer. In this case they have defined a model economy with only two household types and then assume that a political party will ‘solely represent’ the interest of one of them. Is that really what politicians do?

Alan Hutchison

The Leith​ & Wren-Lewis paper is nothing but nonsense on stilts. And worse still — this kind of math-wanking is supposed to be taken seriously!

‘New Keynesian’ economists would be wise to — at least once — read what Keynes himself​ had to say about the kind of  nonsense-methodology they are using:

But I am unfamiliar with the methods involved and it may be that my impression that nothing emerges at the end which has not been introduced expressly or tacitly at the beginning is quite wrong … It seems to me essential in an article of this sort to put in the fullest and most explicit manner at the beginning the assumptions which are made and the methods by which the [results] are derived; and then to state at the end what substantially novel conclusions have​ been arrived at …
Quotation-Kenneth-Boulding-mathematics-economics-Meetville-Quotes-152829I cannot persuade myself that this sort of treatment of economic theory has anything significant to contribute. I suspect it of being nothing better than a contraption proceeding from premises which are not stated with precision to conclusions which have no clear application … [This creates] a mass of symbolism which covers up all kinds of unstated special assumptions.

Letter from Keynes to Frisch 28 November 1935

RBC — nothing but total horseshit!

27 September, 2018 at 14:26 | Posted in Economics | Leave a comment

tobin_2049712cThey try to explain business cycles solely as problems of information, such as asymmetries and imperfections in the information agents have. Those assumptions are just as arbitrary as the institutional rigidities and inertia they find objectionable in other theories of business fluctuations … I try to point out how incapable the new equilibrium business cycles models are of explaining the most obvious observed facts of cyclical fluctuations … I don’t think that models so far from realistic description should be taken seriously as a guide to policy … I don’t think that there is a way to write down any model which at one hand respects the possible diversity of agents in taste, circumstances, and so on, and at the other hand also grounds behavior rigorously in utility maximization and which has any substantive content to it.

James Tobin

Real Business Cycle theory basically says that economic cycles are caused by technology-induced changes in productivity. It says that employment goes up or down because people choose to work more when productivity is high and less when it’s low. This is, of course, nothing but pure nonsense — and how on earth those guys that promoted this theory (Thomas Sargent et consortes) could be awarded The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel is really beyond comprehension.

In yours truly’s History of Economic Theories (4th ed, 2007, p. 405) it was concluded that

the problem is that it has turned out to be very difficult to empirically verify the theory’s view on economic fluctuations as being effects of rational actors’ optimal intertemporal choices … Empirical studies have not been able to corroborate the assumption of the sensitivity of labour supply to changes in intertemporal relative prices. Most studies rather point​ to expected changes in real wages having only rather little influence on the supply of labour.

Rigorous models lacking relevance is not to be taken seriously. Or as Keynes had it — It is better to be vaguely right than precisely wrong …

Keynes e il ruolo dello stato nell’economia

25 September, 2018 at 19:48 | Posted in Economics | Comments Off on Keynes e il ruolo dello stato nell’economia

 

Why capitalism​ always will create bullshit jobs

24 September, 2018 at 14:02 | Posted in Economics | Comments Off on Why capitalism​ always will create bullshit jobs

 

Re-examining economic laws

24 September, 2018 at 11:25 | Posted in Economics | 2 Comments

In mainstream economics, there is a lot of talk about ‘economic laws.’ The crux of these laws that allegedly do exist in economics, is that they only hold ceteris paribus. That fundamentally means that these laws only hold when the right conditions are at hand for giving rise to them. Unfortunately, from an empirical point of view, those conditions are only at hand in artificially closed nomological models purposely designed to give rise to the kind of regular associations that economists want to explain. But — since these laws do not exist outside these socio-economic machines, what is the point in constructing thought experimental models showing these non-existent laws? When the almost endless list of narrow and specific assumptions necessary to allow the ‘rigorous’ deductions are known to be at odds with reality, what good do these models do?

Deducing laws in theoretical models is of no avail if you cannot show that the models — and the assumptions they build on — are realistic representations of what goes on in real life.

Conclusion? Instead of restricting our methodological endeavours at building ever more rigorous and precise deducible models, we ought to spend much more time improving our methods for choosing models!

julianThere is a difference between having evidence for some hypothesis and having evidence for the hypothesis relevant for a given purpose. The difference is important because scientific methods tend to be good at addressing hypotheses of a certain kind and not others: scientific methods come with particular applications built into them … The advantage of mathematical modelling is that its method of deriving a result is that of mathematical​ proof​: the conclusion is guaranteed to hold given the assumptions. However, the evidence generated in this way is valid only in abstract model worlds while we would like to evaluate hypotheses about what happens in economies in the real world … The upshot is that valid evidence does not seem to be enough. What we also need is to evaluate the relevance of the evidence in the context of a given purpose.

The mainstream-heterodoxy divide in Swedish economics

19 September, 2018 at 09:49 | Posted in Economics | Comments Off on The mainstream-heterodoxy divide in Swedish economics

20180919_094444_001-132514322.jpgIn situations with a dominant style of thought and marginal heterodoxies, this creates an exclusionary mechanism that tends to favour the dominant style. I have shown how this is expressed in the analysed evaluation reports through the consensus on a disciplinary conception of quality that aligns with the disciplinary style of reasoning … Sometimes, reviewers are even explicit about work being outside of the mainstream as a sufficient argument against it, which amounts to a sort of pure boundary work that doesn’t spend time on elaborate justification.

Reasons to dislike DSGE models

16 September, 2018 at 18:57 | Posted in Economics | 1 Comment

wrong-tool-by-jerome-awFirst: They are based on unappealing assumptions. Not just simplifying assumptions, as any model must, but assumptions profoundly at odds with what we know about consumers and firms …

Second: Their standard method of estimation, which is a mix of calibration and Bayesian estimation, is unconvincing …

Third: While the models can formally be used for normative​ purposes, normative implications are not convincing …

Fourth: DSGE models are bad communication devices …

Olivier Blanchard

Hatte Karl Marx doch recht?

14 September, 2018 at 23:15 | Posted in Economics | Comments Off on Hatte Karl Marx doch recht?

 

Why Hyman Minsky matters

12 September, 2018 at 09:12 | Posted in Economics | 3 Comments

HymanMinsky2Listen to BBC 4 where Duncan Weldon tries to explain in what way Hyman Minsky’s thoughts on banking and finance offer a radical challenge to mainstream economic theory.

As a young research stipendiate in the U.S. yours truly had the great pleasure and privilege​ of having Hyman Minsky as a ​teacher.

He was a great inspiration at the time.

He still is.

Economic policy — a political matter

10 September, 2018 at 15:33 | Posted in Economics | 3 Comments

toozeWhat kind of financial system do we want? What function should it have? What kind of financial activity do we want to permit or even encourage? These are essential questions for the shaping of economic and social policy at a national and global level. If we leave these questions up to the private sector, we expose ourselves to enormous risks. On the basis of our experience of 2008, we know how to master a massive heart attack in the banking system. But we also know how high the costs of such an intervention are.

The chance for structural reform was missed in 2008 … What we must aim to do is tighten regulations, further raise capital requirements and bolster liquidity buffers to minimize the risk of a bank run. Furthermore, we must extend regulation to non-banks, such as the major asset managers. These are technical matters, but as the fate of Dodd-Frank shows, they cannot be separated from politics … The endless bickering over technicalities is the opposite of what we need: namely a real and powerful banking supervision that does not shy away from fundamental questions and public debate.

Unfortunately, no one with political authority on either side of the Atlantic seems prepared to pose these questions, let alone to take action. After 2008, we know what that means. When things get serious, we are all on the hook.

Adam Tooze

The euro — more pain, more suffering, and more unemployment

9 September, 2018 at 16:08 | Posted in Economics | 3 Comments

The euro was supposed to bring shared prosperity, which would enhance solidarity and advance the goal of European integration. In fact, it has done just the opposite, slowing growth and sowing discord …

matt-kenyon-illustration-009The central problem in a currency area is how to correct exchange-rate misalignments like the one now affecting Italy. Germany’s answer is to put the burden on the weak countries already suffering from high unemployment and low growth rates. We know where this leads: more pain, more suffering, more unemployment, and even slower growth. Even if growth eventually recovers, GDP never reaches the level it would have attained had a more sensible strategy been pursued. The alternative is to shift more of the burden of adjustment on the strong countries, with higher wages and stronger demand supported by government investment programmes …

Across the eurozone, political leaders are moving into a state of paralysis: citizens want to remain in the EU, but also want an end to austerity and the return of prosperity. They are told they can’t have both. Ever hopeful of a change of heart in northern Europe, troubled governments stay the course, and the suffering of their people increases …

Germany and other countries in northern Europe can save the euro by showing more humanity and more flexibility. But, having watched the first acts of this play so many times, I am not counting on them to change the plot.

Joseph Stiglitz

Economics needs a new Reformation

9 September, 2018 at 12:57 | Posted in Economics | 2 Comments

A more pluralist approach would take account of the complexity of markets, the constraints imposed by nature and rising inequality. So what needs to be done?

luther-theses-painting-1080x675Firstly, listen to consumers, because it is pretty obvious that they are unimpressed with what they are getting. The failure of the economics establishment to predict the crisis and its insistence that austerity is the right response to the events of a decade ago has meant the profession has rarely been less trusted …

Secondly, we should stop treating economics as a science because it is nothing of the sort. A proper science involves testing a hypothesis against the available evidence. If the evidence doesn’t support the theory, a physicist or a biologist will discard the theory and try to come up one that does work empirically.

Economics doesn’t work like that. Theories can be shown to work only by making a series of highly questionable assumptions – such as that humans always behave predictably and rationally. When there is hard evidence that disputes the validity of the theory, there is no question of ditching the theory.

Larry Elliott/The Guardian

Secular stagnation and failed interpretations​ of Keynes

7 September, 2018 at 14:01 | Posted in Economics | 3 Comments

Commenting on the Stiglitz-Summers debate on secular stagnation, Roger Farmer writes:

nk-2-2We cannot continue to make unfounded assertions about economic policy using the failed interpretation of the General Theory that evolved from John Hicks’ attempt to reconcile Keynes with the classics. The current manifestation of that approach is so-called New Keynesian Economics, which Summers himself has rightly rejected because it is inconsistent with secular stagnation. But it is not enough to assert that secular stagnation is possible. It is time to confront alternative theories of secular stagnation with empirical evidence, as I have done. The assertion that money wages are downwardly rigid is not, in my view, a credible explanation of persistent unemployment. Nor was it a credible explanation for Keynes, who asserted that his theory did not rely on the assumption of rigid wages …

In my work, expectations – or so-called animal spirits – are a new and independent fundamental that determines the steady-state unemployment rate. When we feel rich, we are rich. And if animal spirits are indeed fundamental, it becomes important to understand the factors that determine swings in confidence.

If a large dose of expansionary fiscal policy is not the answer, what is? My response is that the right way to respond to financial crises is with policies that restore the value of private assets. And the right way to prevent financial crises in the first place is to intervene in the financial markets to moderate swings in asset values and to head off recessions before they happen.

Maintaining that economics is a science in the ‘true knowledge’ business, I cannot but concur with Farmer. We have to remain skeptical of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far, I cannot really see that it has yielded very much in terms of realist and relevant economic knowledge. And there’s nothing new or Keynesian about it.

counterfeit‘New Keynesianism’ doesn’t have its roots in Keynes. It has its intellectual roots in Paul Samuelson’s — partly following in John Hicks’ footsteps — ill-founded ‘neoclassical synthesis’ project, whereby he thought he could save the ‘classical’ view of the market economy as a (long run) self-regulating market clearing equilibrium mechanism, by adding some (short run) frictions and rigidities in the form of sticky wages and prices.

But — putting a sticky-price lipstick on the ‘classical’ pig sure won’t do. The ‘New Keynesian’ pig is still neither Keynesian nor new.

The rather one-sided emphasis of usefulness and its concomitant instrumentalist justification cannot hide that ‘New Keynesians’ cannot give supportive evidence for their considering it fruitful to analyze macroeconomic structures and events as the aggregated result of optimizing representative actors. After having analyzed some of its ontological and epistemological foundations, yours truly cannot but conclude that ‘New Keynesian’ macroeconomics, on the whole,​ has not delivered anything else than ‘as if’ unreal and irrelevant models.

The purported strength of New Classical and ‘New Keynesian’ macroeconomics is that they have a firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing ‘forward-looking’ individuals.

To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations.

And then, of course, there is that weird view on unemployment that makes you wonder on which planet those ‘New Keynesians’ live …

Is secular stagnation nothing but an excuse for flawed economic policies?

6 September, 2018 at 20:46 | Posted in Economics | 3 Comments

Growth_cartoon_05.19.2015_normalThere are many lessons to be learned as we reflect on the 2008 crisis, but the most important is that the challenge was – and remains – political, not economic: there is nothing that inherently prevents our economy from being run in a way that ensures full employment and shared prosperity. Secular stagnation was just an excuse for flawed economic policies. Unless and until the selfishness and myopia that define our politics – especially in the US under Trump and his Republican enablers – is overcome, an economy that serves the many, rather than the few, will remain an impossible dream. Even if GDP increases, the incomes of the majority of citizens will stagnate.

Joseph Stiglitz

In this King Kong vs. Godzilla debate, yours truly sides with Stiglitz. But Larry Summers was, of course, not exactly überjoyed reading this. Here’s his riposte.

Discrimination in the labour market

4 September, 2018 at 15:41 | Posted in Economics | Comments Off on Discrimination in the labour market

In der Forschung zu Arbeitsmarktdiskriminierung existieren zwei theoretische Ansätze, die sich mit den Ursachen für diskriminierendes Verhalten von Arbeitgebern befassen: Theorien der präferenzbasierten und der statistischen Diskriminierung.

discrimination-aliveDer amerikanische Ökonom und Soziologe Gary Becker hat erstmals den Begriff der „taste-based discrimination“ eingeführt um zu beschreiben, dass sich Arbeitgeber bei ihren Einstellungsentscheidungen von persönlichen Präferenzen und Abneigungen gegenüber bestimmten Gruppen leiten lassen. Der Theorie der präferenzbasierten Diskriminierung zufolge diskriminieren Arbeitgeber Angehörige bestimmter Gruppen … aufgrund eigener Abneigung oder aufgrund von antizipierten Vorbehalten von Mitarbeitern oder Kunden …

Demgegenüber sehen Vertreter der statistischen Diskriminierung Zweifel an der Leitungsfähigkeit und Produktivität von Angehörigen bestimmter Gruppen als zentrale Ursache für Diskriminierung. Arbeitgeber haben immer nur unvollständige Informationen über die tatsächliche Produktivität von Bewerbern … Ein klassisches Beispiel für statistische Diskriminierung ist die Diskriminierung von jungen Frauen aufgrund des im Durchschnitt erhöhten Risikos von Arbeitsausfällen infolge von Schwangerschaft und Elternzeit …

Die Ergebnisse unserer Studien zeigen eindeutig, dass Menschen mit Migrationshintergrund in Deutschland bei der Suche nach einem Arbeitsplatz diskriminiert werden …

Auch wenn Arbeitgeber in unserer Studie auf einzelne produktivitätsrelevante Indikatoren wie gute Noten reagieren, lässt sich mit Blick auf die deskriptiven Befunde festhalten, dass Migranten im Vergleich zu deutschen Bewerbern keinen unmittelbaren Nutzen aus besseren Noten, guten Referenzen oder dem Signal eines unbefristeten Arbeitsvertrags ziehen … Für Bewerber mit Ursprüngen in afrikanischen und überwiegend muslimisch geprägten Ländern, die wiederum eine sehr hohe Wertedistanz zu Deutschland aufweisen, spiegelt sich diese Distanz auch in den besonders niedrigen Rückmelderaten wieder. Im Hinblick auf die eingangs erwähnten ökonomischen Theorien finden wir in unserer Studie also mehr Belege für präferenzbasierte Diskriminierung als für statistische Diskriminierung.

Ruud Koopmans, Susanne Veit & Ruta Yemane

The gross substitution axiom

2 September, 2018 at 15:01 | Posted in Economics | 4 Comments

Economics is perhaps more than any other social science model-oriented. There are many reasons for this — the history of the discipline, having ideals coming from the natural sciences (especially physics), the search for universality (explaining as much as possible with as little as possible), rigour, precision, etc.

Mainstream economists want to explain social phenomena, structures and patterns, based on the assumption that the agents are acting in an optimizing (rational) way to satisfy given, stable and well-defined goals.

The procedure is analytical. The whole is broken down into its constituent parts so as to be able to explain (reduce) the aggregate (macro) as the result of the interaction of its parts (micro).

Building their economic models, modern mainstream economists ground their models on a set of core assumptions — describing the agents as ‘rational’ actors — and a set of auxiliary assumptions. Based on these two sets of assumptions, they try to explain and predict both individual (micro) and — most importantly — social phenomena (macro).

gsThe core assumptions typically consist of complete-ness, transitivity,  non-satiation, optimisation, consistency, gross substitutability, etc., etc.

The auxiliary assumptions spatio-temporally specify the kind of social interaction between ‘rational actors’ that take place in the model.

So, the models basically consist of a general specification of what (axiomatically) constitutes optimizing rational agents and a more specific description of the kind of situations in which these rational actors act (making the auxiliary assumptions serve as a kind of specification/restriction of the intended domain of application for the set of core assumptions and its deductively derived theorems). The list of assumptions can never be complete​ since there will always be unspecified background assumptions and some (often) silent omissions (like closure, transaction costs, etc., regularly based on some negligibility and applicability considerations).

The hope is that the ‘thin’ list of assumptions shall be sufficient to explain and predict ‘thick’ phenomena in the real, complex, world.

Empirically it has, however, turned out that this hope is almost never fulfilled. The core — and many of the auxiliary — assumptions turn out to have preciously little to do with the real (non-model) world we happen to live in. And that goes for the gross substitution axiom as well:

The gross substitution axiom assumes that if the demand for good x goes up, its relative price will rise, inducing demand to spill over to the now relatively cheaper substitute good y. For an economist to deny this ‘universal truth’ of gross substitutability between objects of demand is revolutionary heresy – and as in the days of the Inquisition, the modern-day College of Cardinals of mainstream economics destroys all non-believers, if not by burning them at the stake, then by banishing them from the mainstream professional journals …

If the elasticity of substitution between liquid assets and the products of industry is significantly different from zero (if the gross substitution axiom is ubiquitously true), then even if savers attempt to use non-reproducible assets for storing their increments of wealth, this increase in demand will increase the price of non-producibles. This relative price rise in non-producibles will, under the gross substitution axiom, induce savers to substitute reproducible durables for non-producibles in their wealth holdings and therefore non-producibles will not be, in Hahn’s terminology, ‘ultimate resting places for savings’. The gross substitution axiom therefore restores Say’s Law and denies the logical possibility of involuntary unemployment.

Paul Davidson

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