Properties of arguments — validity and soundness

25 May, 2023 at 10:14 | Posted in Theory of Science & Methodology | Leave a comment

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Using formal mathematical modelling, mainstream economists sure can guarantee that the conclusions hold given the assumptions. However, the validity we get in abstract model worlds does not warrant transfer to real-world economies. Validity may be good, but it is not enough.

Mainstream economists are proud of having an ever-growing smorgasbord of models to cherry-pick from (as long as, of course, the models do not question the standard modelling strategy) when performing their analyses. The ‘rigorous’ and ‘precise’ deductions made in these closed models, however, are not in any way matched by a similar stringency or precision when it comes to what ought to be the most important stage of any economic research — making statements and explaining things in real economies. Although almost every mainstream economist holds the view that thought-experimental modelling has to be followed by confronting the models with reality — which is what they indirectly want to predict/explain/understand using their models — they then all of a sudden become exceedingly vague and imprecise. It is as if all the intellectual force has been invested in the modelling stage and nothing is left for what really matters — what exactly do these models teach us about real economies.

No matter how precise and rigorous the analysis, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forward one single iota if they do not stand the acid test of relevance to the target.  Proving things ‘rigorously’ in mathematical models is not a good recipe for doing an interesting and relevant economic analysis. Forgetting to supply export warrants to the real world makes the analysis an empty exercise in formalism without real scientific value. In the realm of true science, it is of little or no value to simply make claims about a model and lose sight of reality.

To have valid evidence is not enough. What economics needs is sound evidence. The premises of a valid argument do not have to be true, but a sound argument, on the other hand, is not only valid but builds on premises that are true. Aiming only for validity, without soundness, is setting the economics aspiration level too low for developing a realist and relevant science.

Irrational Exuberance — Robert Shiller’s modern classic

24 May, 2023 at 19:20 | Posted in Economics | 5 Comments

Irrational Exuberance | Princeton University PressAt the beginning of the year 2000, a book titled Irrational Exuberance was published. The American economics professor and Nobel laureate Robert Shiller warned that the extensive deregulation in the financial market that had taken place since the Thatcher-Reagan era had led to a rapid credit expansion. Banks and financial institutions saw a skyrocketing increase in lending, and the pursuit of gaining larger market shares led to neglecting creditworthiness checks and accepting poor customer relationships. Above all, the values of IT stocks were disproportionately high. It would inevitably lead to a financial crisis.

Shiller was proven right. Less than two months after the book was published, the usual happened. The bubble burst, and the financial market crisis became a reality.

Because human memory is short, new concerns reappeared after a few years. The crisis that the American economy once again found itself in had its origins in the speculative bubble that developed in the American housing market between 1997 and 2006. Despite falling interest rates and construction costs, housing prices rose by an average of 85 per cent over the ten years when the bubble was inflated.

The underlying pattern is the same in almost all financial crises. For some reason, a shift occurs (war, innovations, new rules, and more) in the economic cycle that leads to changes in banks’ and companies’ profit opportunities. Demand and prices rise, pulling more and more parts of the economy into a kind of euphoria. More and more people get involved, and soon speculative frenzy – whether it’s about tulip bulbs, properties, or mortgages – becomes a reality. Sooner or later, someone sells to cash in their profits, triggering a rush for liquidity. It’s time to jump off the carousel and convert securities and other assets into cash. A financial emergency arises and spreads. Prices begin to decline, bankruptcies increase, and the crisis accelerates, turning into panic.

To prevent the final crash, credit is tightened, and calls for a lender of last resort who can guarantee the supply of the demanded cash and restore confidence arise. If that fails, the crash becomes a reality.

Like his predecessors Hyman Minsky and Charles Kindleberger, Shiller emphasizes that bubbles are an inevitably recurring feature in an economy with essentially unregulated markets. But Shiller also argues that our contemporary reevaluation of work and wealth plays a role. Over the past decades, people’s perception of their role in the economy has undergone a decisive transformation. From viewing work as the foundation of our well-being based on a Protestant work ethic, the idea of expecting to make money through investments has spread increasingly. Today’s hero is not the hardworking industrial labourer but the smart investor for whom money is no longer a means but an end in itself. According to Shiller, this rethinking is the underlying cause of the crisis. This is where the heart of darkness lies.

That Shiller emphasizes the psychological aspects is not surprising, considering that he is a leading representative of the research field in financial economics called behavioural finance.

As a young science, economics was closely intertwined with other disciplines such as philosophy and psychology. Adam Smith, for example, was one of the foremost moral philosophers of his time. Over time, many economists deliberately sought to distance themselves from other sciences. Economic science would build on its own foundations instead of relying on the shaky grounds that immature and unscientific psychology could provide.

However, in recent times, more and more economists have realized the need to base their models on more realistic psychological foundations. Behavioural economics has quickly established itself as a sustainable part of the field of economics, with significant influence, particularly in financial economics. Neglecting the deep psychological dimensions of financial markets is increasingly seen as playing ‘Hamlet’ without the Prince of Denmark.

In traditional economic wisdom, the hypothesis of efficient markets has long been central. The hypothesis essentially states that the prices established in financial markets correspond to the fundamental values of the economy because all investors are rational and eliminate the existence of prices that deviate from fundamentals.

However, behavioural finance has been able to demonstrate that the depiction of investors as rational is difficult to reconcile with facts drawn from real financial markets. Investors seem to trade based more on noise than information. They extrapolate from short-term trends, are sensitive to how problems are presented, are poor at revising their risk assessments, and often overreact to mood swings. As a result, an asset’s price and its actual value can deviate for an extended period. Irrationality is not irrelevant in financial markets.

In Irrational Exuberance, Shiller demonstrates, based on his own empirical research on the fluctuations of the financial market, that stock value fluctuations were significantly higher than what is consistent with the hypothesis of an efficient market. And when different types of actors interact with each other, we cannot always expect the market to be efficient. To understand what happens in the financial market, we need to try to gain knowledge of how real investors behave. Behavioural finance has already taken us a long way in that regard.

So, what can be done to minimize the risk of future crises? Financial market participants evidently generate costs that they themselves do not bear. When the foremost economist of our time, John Maynard Keynes, advocated for the introduction of a general financial transaction tax after the stock market crash in 1929, it was because he believed that the market should bear the costs that its instability, imbalances, and disruptions give rise to. Those who, in their pursuit of profit, are willing to take unnecessary risks and cause lasting damage to the economy, must themselves contribute to paying the bill. It should hurt. And it should hurt if the lesson is to be learned.

Shiller emphasizes, just like Keynes, that when it comes to crisis solutions, one must distinguish between the short and long term. In the short-term perspective, it is necessary to mitigate the effects of price declines in housing and other assets through various measures. There are no guarantees that it will help, but fundamentally, there are no sustainable alternatives. Doing nothing would only fuel an already somewhat paralyzing uncertainty. When the house is engulfed in flames, we cannot simply stand on the sidelines and discuss the best method to extinguish it. Fires – like financial bubbles – have a nasty ability to spread.

In the long term, it is clearly beneficial for asset prices to fall back to a level that corresponds to their real value. A decrease in the price of one’s house does not make it less habitable. However, if the wheels of the economy were to come to a halt, the consequences would be very real.

Shiller argues forcefully for a solution he calls financial democracy, which he sees as a powerful remedy. Sound financial principles should be extended to encompass larger parts of society. It’s not only financial market participants who should have access to good information and expertise. Instead of avoiding all risks – which would be devastating to a society’s vitality and creativity – we should learn to manage insurable risks in a rational way. The basic idea is that extensive institutional changes, improved financial advice, increased transparency, freely accessible financial databases, and more should reduce the long-term risk of speculative bubbles emerging.

It is doubt, not belief, that creates new knowledge. Shiller’s research has strongly shown that we cannot both have our cake and eat it too. As long as we have an economy with unregulated financial markets, we will also be prone to periodically recurring crises.

Shiller provides us with both a map and a compass, and his proposals can actively contribute, together with stricter regulation of the financial market, to reducing the risks of costly financial system crises in the long run. However, if we reflexively refuse to see the extent of the problems, we will once again be helpless when the next crisis looms.

‘Self-adjusting’ markets

24 May, 2023 at 15:30 | Posted in Economics | 2 Comments

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

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.

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

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One of Keynes’s central tenets is that there is no strong automatic tendency for economies to move towards full employment levels.

Money doesn’t matter in mainstream macroeconomic models. That’s true. According to the ‘classical dichotomy,’ real variables — output and employment — are independent of monetary variables, and so enable 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:

The theory which I desiderate would deal … with an economy in which money plays a part of its own and affects motives and decisions, and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted in either the long period or in the short, without a knowledge of the behaviour of money between the first state and the last. And it is this which we ought to mean when we speak of a monetary economy.

J. M. Keynes A monetary theory of production (1933)

Universalism vs tribalism

24 May, 2023 at 15:17 | Posted in Politics & Society | Leave a comment

Moral universalism: Global evidence | CEPRIt’s now an article of faith that universalism, like other Enlightenment ideas, is a sham that was invented to disguise Eurocentric views that supported colonialism. When I first heard such claims some fifteen years ago, I thought they were so flimsy they’d soon disappear. For the claims are not simply ungrounded: they turn Enlightenment upside down. Enlightenment thinkers invented the critique of Eurocentrism and were the first to attack colonialism, on the basis of universalist ideas …

In the last few years the Enlightenment has been held responsible for most of our misery, just as a century ago, the source for contemporary suffering was called modernity. Something big, after all, must be to blame. Enlightenment-bashing may have begun in American universities, but its reach has swept through the culture in much of the Western world …

They forget that the Enlightenment emerged from a blasted landscape, on a continent soaked with blood. Those who dismiss Enlightenment thinkers as naive or optimistic not only ignore their writings; more importantly, they ignore the history that formed the background to their thought.

Susan Neiman

Wokeism and the commodified academic industry

23 May, 2023 at 14:52 | Posted in Education & School, Politics & Society | Leave a comment

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The problem with identity politics and wokeism

23 May, 2023 at 09:44 | Posted in Politics & Society | Leave a comment

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The limited epistemic value of ‘variation analysis’

23 May, 2023 at 07:20 | Posted in Statistics & Econometrics | 8 Comments

R-Squared: Definition, Calculation Formula, Uses, and LimitationsWhile appeal to R squared is a common rhetorical device, it is a very tenuous connection to any plausible explanatory virtues for many reasons. Either it is meant to be merely a measure of predictability in a given data set or it is a measure of causal influence. In either case it does not tell us much about explanatory power. Taken as a measure of predictive power, it is limited in that it predicts variances only. But what we mostly want to predict is levels, about which it is silent. In fact, two models can have exactly the same R squared and yet describe regression lines with very different slopes, the natural predictive measure of levels. Furthermore even in predicting variance, it is entirely dependent on the variance in the sample—if a covariate shows no variation, then it cannot predict anything. This leads to getting very different measures of explanatory power across samples for reasons not having any obvious connection to explanation.

Taken as a measure of causal explanatory power, R squared does not fare any better. The problem of explaining variances rather than levels shows up here as well—if it measures causal influence, it has to be influences on variances. But we often do not care about the causes of variance in economic variables but instead about the causes of levels of those variables about which it is silent. Similarly, because the size of R squared varies with variance in the sample, it can find a large effect in one sample and none in another for arbitrary, noncausal reasons. So while there may be some useful epistemic roles for R squared, measuring explanatory power is not one of them.

Harold Kincaid

Although in a somewhat different context, Jon Elster makes basically the same observation as Kincaid:

Consider two elections, A and B. For each of them, identify the events that cause a given percentage of voters to turn out. Once we have thus explained the turnout in election A and the turnout in election B, the explanation of the difference (if any) follows automatically, as a by-product. As a bonus, we might be able to explain whether identical turnouts in A and B are accidental, that is, due to differences that exactly offset each other, or not. In practice, this procedure might be too demanding. The data or he available theories might not allow us to explain the phenomena “in and of themselves.” We should be aware, however, that if we do resort to explanation of variation, we are engaging in a second-best explanatory practice.

Modern econometrics is fundamentally based on assuming — usually without any explicit justification — that we can gain causal knowledge by considering independent variables that may have an impact on the variation of a dependent variable. As argued by both Kincaid and Elster, this is, however, far from self-evident. Often the fundamental causes are constant forces that are not amenable to the kind of analysis econometrics supplies us with. As Stanley Lieberson has it in Making It Count:

LiebersonOne can always say whether, in a given empirical context, a given variable or theory accounts for more variation than another. But it is almost certain that the variation observed is not universal over time and place. Hence the use of such a criterion first requires a conclusion about the variation over time and place in the dependent variable. If such an analysis is not forthcoming, the theoretical conclusion is undermined by the absence of information …

Moreover, it is questionable whether one can draw much of a conclusion about causal forces from simple analysis of the observed variation … To wit, it is vital that one have an understanding, or at least a working hypothesis, about what is causing the event per se; variation in the magnitude of the event will not provide the answer to that question.

Trygve Haavelmo was making a somewhat similar point back in 1941 when criticizing the treatment of the interest variable in Tinbergen’s regression analyses. The regression coefficient of the interest rate variable being zero was according to Haavelmo not sufficient for inferring that “variations in the rate of interest play only a minor role, or no role at all, in the changes in investment activity.” Interest rates may very well play a decisive indirect role by influencing other causally effective variables. And:

the rate of interest may not have varied much during the statistical testing period, and for this reason the rate of interest would not “explain” very much of the variation in net profit (and thereby the variation in investment) which has actually taken place during this period. But one cannot conclude that the rate of influence would be inefficient as an autonomous regulator, which is, after all, the important point.

This problem of ‘nonexcitation’ — when there is too little variation in a variable to say anything about its potential importance, and we can’t identify the reason for the factual influence of the variable being ‘negligible’ — strongly confirms that causality in economics and other social sciences can never solely be a question of statistical inference. Causality entails more than predictability, and to really in-depth explain social phenomena requires theory.

Analysis of variation — the foundation of all econometrics — can never in itself reveal how these variations are brought about. First, when we are able to tie actions, processes, or structures to the statistical relations detected, can we say that we are getting at relevant explanations of causation. Too much in love with axiomatic-deductive modelling, neoclassical economists especially tend to forget that accounting for causation — how causes bring about their effects — demands deep subject-matter knowledge and acquaintance with the intricate fabrics and contexts. As Keynes already argued in his A Treatise on Probability, statistics (and econometrics) should primarily be seen as means to describe patterns of associations and correlations, means that we may use as suggestions of possible causal relations. Forgetting that, economists will continue to be stuck with a second-best explanatory practice.

Economic methodology — Lawson, Mäki, and Syll

22 May, 2023 at 14:24 | Posted in Economics | Leave a comment

We are all realists and we all — Mäki, Cartwright, and I — self-consciously present ourselves as such. The most obvious research-guiding commonality, perhaps, is that we do all look at the ontological presuppositions of economics or economists.

what if i told you research methods meme | The LoveStats BlogWhere we part company, I believe, is that I want to go much further. I guess I would see their work as primarily analytical and my own as more critically constructive or dialectical. My goal is less the clarification of what economists are doing and presupposing as seeking to change the orientation of modern economics … Specifically, I have been much more prepared than the other two to criticise the ontological presuppositions of economists—at least publically. I think Mäki is probably the most guarded. I think too he is the least critical, at least of the state of modern economics …

One feature of Mäki’s work that I am not overly convinced by, but which he seems to value, is his method of theoretical isolation (Mäki 1992). If he is advocating it as a method for social scientific research, I doubt it will be found to have much relevance—for reasons I discuss in Economics and reality (Lawson 1997). But if he is just saying that the most charitable way of interpreting mainstream economists is that they are acting on this method, then fine. Sometimes, though, he seems to imply more …

I cannot get enthused by Mäki’s concern to see what can be justified in contemporary formalistic modelling endeavours. The insights, where they exist, seem so obvious, circumscribed, and tagged on anyway …

As I view things, anyway, a real difference between Mäki and me is that he is far less, or less openly, critical of the state and practices of modern economics … Mäki seems more inclined to accept mainstream economic contributions as largely successful, or anyway uncritically. I certainly do not think we can accept mainstream contributions as successful, and so I proceed somewhat differently …

So if there is a difference here it is that Mäki more often starts out from mainstream academic economic analyses accepted rather uncritically, whilst I prefer to start from those everyday practices widely regarded as successful.

Tony Lawson

Tony Lawson and Uskali Mäki are both highly influential contemporary students of economic methodology and philosophy. Yours truly has learned a lot from both of them. Although to a certain degree probably also a question of temperament, I find Lawson’s critical realist critique of mainstream economic theories and models deeper and more convincing than Mäki’s more ‘distanced’ approach. Mäki’s detached style probably reflects the fact that he is a philosopher with an interest in economics, rather than an economist. Being an economist it is easier to see the relevance of Lawson’s ambitious and far-reaching critique of mainstream economics than it is to value Mäki’s often rather arduous application of the analytic-philosophical tool-kit, typically less ambitiously aiming for mostly conceptual and terminological ‘clarifications.’

The field of economics has long been hailed as a bastion of rationality and objectivity, offering insights into the workings of present-day complex economic systems. However, questions about the foundations of economics and its prevailing methodological approach. have to be raised. My own critique challenges traditional assumptions and argues for a more pluralistic and realistic understanding of economic phenomena.

• The problem of formalism
One of my key criticisms centres around the excessive reliance on formal models and mathematical abstractions within mainstream economics. The discipline’s preoccupation with mathematical rigour often leads to a detachment from real-world complexities, rendering economic models divorced from actual human behaviour. Economists should embrace a more open-ended approach that acknowledges the limitations of formalism and places a greater emphasis on empirical observations and qualitative analysis.

• Assumptions and simplifying idealizations
Many of the assumptions and simplifying idealizations that underpin mainstream economic models — perfect rationality, market efficiency, and equilibrium — do not accurately reflect the messy realities of human decision-making and market dynamics. Economists have to have a more nuanced understanding of human behaviour that acknowledges the presence of bounded rationality, social norms, and institutional constraints. By incorporating these factors, economic models can better capture the complexities of economic systems.

• Pluralism and interdisciplinarity
Economics should embrace a more pluralistic approach, drawing insights from various disciplines such as sociology, psychology, history, and ecology. By integrating diverse perspectives, economists can develop a richer understanding of economic phenomena and avoid the pitfalls of narrow and reductionist thinking. Complex problems require holistic and multidimensional approaches.

• Policy implications
Overlooking real-world complexities and relying on overly simplified models — typical of mainstream economics — can lead to seriously misguided policy prescriptions. A more context-sensitive and pragmatic approach to policy-making —  taking into account the specific institutional, cultural, and historical factors at play — is needed. This shift in policy orientation can lead to more effective interventions and address the concerns of more or less marginalized communities that are often excluded from mainstream economic discourse.

• Advancing the discipline
While mainly posing challenges to the foundations of mainstream economics and the severe real-world limitations of its methodology, my critique also provides an opportunity for the discipline to evolve and grow. By embracing a more pluralistic and realistic framework, economics can address the criticisms and broaden its analytical toolkit. This would involve reevaluating many of the standard approaches, fostering interdisciplinary collaborations, and promoting critical engagement with alternative heterodox economic theories. Challenging the dominance of deductive-axiomatic formalism and advocating for a pluralistic approach, do also create space for a more realistic and nuanced understanding of economic phenomena. While my critique of mainstream economics and its underlying methodology is often — as is Mäki’s and Lawson’s — met with resistance, it is necessary if we want to be able to reimagine economics as a discipline that is more in tune with the complexities of the real world and better equipped to tackle the pressing social and economic challenges we face today.

Lönerna driver inte inflationen

22 May, 2023 at 10:27 | Posted in Economics | Leave a comment

Stephanie Kelton har blivit en fixstjärna för vänstern och kritiker till gängse nationalekonomisk teori. I helgen besökte hon Stockholm. Hon är kritisk till hur inflationen bekämpas: ”Räntehöjningar är ett väldigt trubbigt verktyg” …

Stephanie Kelton (livestream) – Town Hall SeattleKelton besöker Stockholm mitt under en internationell inflationskris. Första frågan till henne under intervjun ett par timmar före hennes medverkan på konferensen blir därför hur inflationen borde bekämpas.

– ECB försöker nu ta fram statistik för att besvara frågan om hur mycket av inflationen som drivs av efterfrågan, fördröjningar i försörjningskedjor samt kriget i Ukraina och hur mycket som beror på att företag tar tillfället i akt att höja priser mer än kostnaderna och öka sin avkastning.

På samma sätt har banker och rating-firman Moody’s gjort liknande mätningar i USA, säger Stephanie Kelton.

– Man får olika svar beroende på vilka som gör analyserna. Men det alla har gemensamt är att de säger att det är väldigt lite kvar av inflationen som beror på att vi spenderade för mycket på åtgärder för att hjälpa människor under pandemin. Det är mestadels ute ur systemet – i den utsträckning det någonsin fanns där, säger Stephanie Kelton.

Finns det någon risk idag för en löne-pris-spiral, alltså att höjda löner skulle driva på inflationen?

– Det fanns aldrig några bevis alls på att en löne-pris-spiral höll på att ta tag i USA. Det fanns mycket retorik, men inga bevis på det.

Vad gäller fackföreningar som, likt de svenska, säger sig ta ansvar genom att kräva mindre löneökningar än vad som kan kompensera för inflationen, säger hon:

– Jag vet inte tillräckligt om vad som driver inflationen här, men när folk kämpar med ökade levnadsomkostnader är inte lösningen att minska deras reallöner. Jag skulle hellre försöka hitta andra sätt att hålla tillbaka inflationen.

Dagens Arena

Mainstream model fitting

22 May, 2023 at 10:11 | Posted in Varia | Leave a comment

Robert Lucas (1937-2023)

21 May, 2023 at 10:46 | Posted in Economics | 2 Comments

Robert Lucas, ganador del premio Nobel de Economía en 1995, murió a los 85  añosEconomic theory, like anthropology, ‘works’ by studying societies which are in some relevant sense simpler or more primitive than our own, in the hope either that relations that are important but hidden in our society will be laid bare in simpler ones, or that concrete evidence can be discovered for possibilities which are open to us which are without precedent in our own history. Unlike anthropologists, however, economists simply invent the primitive societies we study, a practice which frees us from limiting ourselves to societies which can be physically visited as sparing us the discomforts of long stays among savages. This method of society-invention is the source of the utopian character of economics; and of the mix of distrust and envy with which we are viewed by our fellow social scientists. The point of studying wholly fictional, rather than actual societies, is that it is relatively inexpensive to subject them to external forces of various types and observe the way they react. If, subjected to forces similar to those acting on actual societies, the artificial society reacts in a similar way, we gain confidence that there are useable connections between the invented society and the one we really care about.

Robert Lucas

Although plenty of more or less hagiographic obituaries have acknowledged Lucas ‘brilliance’ and ‘influence’, I find it more appropriate to just honestly address the reasons his whole project to reform macroeconomics was such a blatant failure.

Neither yours truly, nor anthropologists, will recognise anything in Lucas’ description of economic theory even remotely reminiscent of practices actually used in real sciences, this quote still gives a very good picture of Lucas’ methodology.

60088455All empirical sciences use simplifying or unrealistic assumptions in their modelling activities. That is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons.

The implications that follow from the kind of models that people like Robert Lucas — according to Ed Prescott, ‘the master of methodology’ — are always conditional on the simplifying assumptions used — assumptions predominantly of a rather far-reaching and non-empirical character with little resemblance to features of the real world. From a descriptive point of view, there is a fortiori usually very little resemblance between the models used and the empirical world. ‘As if’ explanations building on such foundations are not really any explanations at all, since they always conditionally build on hypothesized law-like theorems and situation-specific restrictive assumptions. The empirical-descriptive inaccuracy of the models makes it more or less miraculous if they should — in any substantive way — be able to be considered explanative at all. If the assumptions that are made are known to be descriptively totally unrealistic (think of e.g. ‘rational expectations’) they are of course likewise totally worthless for making empirical inductions. Assuming — as Lucas — that people behave ‘as if’ they were rational FORTRAN programmed computers doesn’t take us far when we know that the ‘if’ is false.

The obvious shortcoming of a basically epistemic — rather than ontological — approach such as ‘successive approximations’ and ‘as if’ modelling assumptions, is that ‘similarity’, ‘analogy’ or ‘resemblance’ tout court do not guarantee that the correspondence between model and target is interesting, relevant, revealing or somehow adequate in terms of mechanisms, causal powers, capacities or tendencies. No matter how many convoluted refinements of concepts are made in the model, if the successive ‘as if’ approximations do not result in models similar to reality in the appropriate respects (such as structure, isomorphism, etc), they are nothing more than ‘substitute systems’ that do not bridge to the world but rather misses its target.

Economics building on the kind of modelling strategy that Lucas represents does not produce science.

It’s nothing but pseudo-scientific cheating.

The thrust of this realist rhetoric is the same both at the scientific and at the meta-scientific levels. It is that explanatory virtues need not be evidential virtues. It is that you should feel cheated by “The world is as if T were true”, in the same way as you should feel cheated by “The stars move as if they were fixed on a rotating sphere”. Realists do feel cheated in both cases.

Alan Musgrave

Contrary to what some überimpressed macroeconomists seem to argue, I would say the recent economic crisis and the fact that Chicago economics has had next to nothing to contribute to understanding it, shows that Lucas and his New Classical economics — in Lakatosian terms — is a degenerative research program in dire need of replacement.

Mainstream economic theory has long been in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. This modelling activity is considered useful and essential. Since fully-fledged experiments on a societal scale as a rule are prohibitively expensive, ethically indefensible or unmanageable, economic theorists have to substitute experimenting with something else. To understand and explain relations between different entities in the real economy the predominant strategy is to build models and make things happen in these “analogue-economy models” rather than engineering things happening in real economies.

In business cycles theory these models are constructed with the purpose of showing that changes in the supply of money “have the capacity to induce depressions or booms” [Lucas 1988:3] not just in these models, but also in real economies. To do so economists are supposed to imagine subjecting their models to some kind of “operational experiment” and “a variety of reactions”. “In general, I believe that one who claims to understand the principles of flight can reasonably be expected to be able to make a flying machine and that understanding business cycles means the ability to make them too, in roughly the same sense” [Lucas 1981:8]. To Lucas models are the laboratories of economic theories, and after having made a simulacrum-depression Lucas hopes we find it “convincing on its own terms – that what I said would happen in the [model] as a result of my manipulation would, in fact, happen” [Lucas 1988:4]. The clarity with which the effects are seen is considered “the key advantage of operating in simplified, fictional worlds” [Lucas 1988:5].

On the flip side lies the fact that “we are not really interested in understanding and preventing depressions in hypothetical [models]. We are interested in our own, vastly more complicated society” [Lucas 1988:5]. But how do we bridge the gulf between the model and the ‘target system’? According to Lucas, we have to be willing to “argue by analogy from what we know about one situation to what we would like to know about another, quite different situation” [Lucas 1988:5]. Progress lies in the pursuit of the ambition to “tell better and better stories” [Lucas 1988:5], simply because that is what economists do.

We are storytellers, operating much of the time in worlds of make believe. We do not find that the realm of imagination and ideas is an alternative to, or retreat from, practical reality. On the contrary, it is the only way we have found to think seriously about reality. In a way, there is nothing more to this method than maintaining the conviction … that imagination and ideas matter … there is no practical alternative” [Lucas 1988:6].

Lucas has applied this mode of theorizing by constructing “make-believe economic systems” to the age-old question of what causes and constitutes business cycles. According to Lucas the standard for what that means is that one “exhibits understanding of business cycles by constructing a model in the most literal sense: a fully articulated artificial economy, which behaves through time so as to imitate closely the time series behavior of actual economies” [Lucas 1981:219].

To Lucas business cycles is an inherently systemic phenomenon basically characterized by conditional co-variations of different time series. The vision is “the possibility of a unified explanation of business cycles, grounded in the general laws governing market economies, rather than in political or institutional characteristics specific to particular countries or periods” [Lucas 1981:218]. To be able to sustain this view and adopt his “equilibrium approach” he has to define the object of study in a very constrained way. Lucas asserts, e.g., that if one wants to get numerical answers “one needs an explicit, equilibrium account of the business cycles” [Lucas 1981:222]. But his arguments for why it necessarily has to be an equilibrium is not very convincing. The main restriction is that Lucas only deals with purportedly invariable regularities “common to all decentralized market economies” [Lucas 1981:218]. Adopting this definition he can treat business cycles as all alike “with respect to the qualitative behavior of the co-movements among series” [1981:218].

Postulating invariance paves the way for treating various economic entities as stationary stochastic processes (a standard assumption in most modern probabilistic econometric approaches) and the possible application of “economic equilibrium theory.” The result is that Lucas’ business cycle is a rather watered-down version of what is usually connoted when speaking of business cycles.

Based on the postulates of “self-interest” and “market clearing” Lucas has repeatedly stated that a pure equilibrium method is a necessary intelligibility condition and that disequilibria are somehow “arbitrary” and “unintelligible” [Lucas 1981:225]. Although this might (arguably) be requirements put on models, these requirements are irrelevant and totally without justification vis-à-vis the real-world target system. Why should involuntary unemployment, for example, be considered an unintelligible disequilibrium concept? Given the lack of success of these models when empirically applied, what is unintelligible, is rather to pursue in this reinterpretation of the ups and downs in business cycles and labour markets as equilibria. To Keynes, involuntary unemployment is not equatable to actors in the labour market becoming irrational non-optimizers. It is basically a reduction in the range of working options open to workers, regardless of any volitional optimality choices made on their part. Involuntary unemployment is an excess supply of labour. That unemployed in Lucas’ business cycles models only can be conceived of as having chosen leisure over work is not a substantive argument about real-world unemployment. Sometimes workers are not employed. That is a real phenomenon and not a “theoretical construct … the task of modern theoretical economics to ‘explain’” [Lucas 1981:243].

All economic theories have to somehow deal with the daunting question of uncertainty and risk. It is “absolutely crucial for understanding business cycles” [Lucas 1981:223]. To be able to practice economics at all, “we need some way … of understanding which decision problem agents are solving” [Lucas 1981:223]. Lucas – in search of a “technical model-building principle” [Lucas 1981:1] – adapts the rational expectations view, according to which agents’ subjective probabilities are identified “with observed frequencies of the events to be forecast” are coincident with “true” probabilities. This hypothesis [Lucas 1981:224]

will most likely be useful in situations in which the probabilities of interest concern a fairly well defined recurrent event, situations of ‘risk’ [where] behavior may be explainable in terms of economic theory … In cases of uncertainty, economic reasoning will be of no value … Insofar as business cycles can be viewed as repeated instances of essentially similar events, it will be reasonable to treat agents as reacting to cyclical changes as ‘risk’, or to assume their expectations are rational, that they have fairly stable arrangements for collecting and processing information, and that they utilize this information in forecasting the future in a stable way, free of systemic and easily correctable biases.

To yours truly, this seems much like putting the cart before the horse. Instead of adapting the model to the object – which from both ontological and epistemological considerations seems the natural thing to do – Lucas proceeds in the opposite way and chooses to define his object and construct a model solely to suit his own methodological and theoretical preferences. All those – interesting and important – features of business cycles that have anything to do with model-theoretical openness, and a fortiori not possible to squeeze into the closure of the model, are excluded. One might rightly ask what is left of that we in common sense meaning refer to as business cycles. Einstein’s dictum – “everything should be made as simple as possible but not simpler” falls to mind. Lucas – and neoclassical economics at large – does not heed the implied apt warning.

The development of macro-econometrics has according to Lucas supplied economists with “detailed, quantitatively accurate replicas of the actual economy” thereby enabling us to treat policy recommendations “as though they had been experimentally tested” [Lucas 1981:220]. But if the goal of theory is to be able to make accurate forecasts this “ability of a model to imitate actual behavior” does not give much leverage. What is required is “invariance of the structure of the model under policy variations”. Parametric invariance in an economic model cannot be taken for granted, “but it seems reasonable to hope that neither tastes nor technology vary systematically” [Lucas 1981:220].

The model should enable us to posit contrafactual questions about what would happen if some variable was to change in a specific way. Hence the assumption of structural invariance, that purportedly enables the theoretical economist to do just that. But does it? Lucas appeals to “reasonable hope”, a rather weak justification for a modeller to apply such a far-reaching assumption. To warrant it one would expect an argumentation that this assumption – whether we conceive of it as part of a strategy of “isolation”, “idealization” or “successive approximation” – really establishes a useful relation that we can export or bridge to the target system, the “actual economy.” That argumentation is neither in Lucas nor – to my knowledge – in the succeeding neoclassical refinements of his “necessarily artificial, abstract, patently ‘unreal’” analogue economies [Lucas 1981:271]. At most, we get what Lucas himself calls “inappropriately maligned” casual empiricism in the form of “the method of keeping one’s eyes open.” That is far from sufficient to warrant any credibility in a model pretending to explain the complex and difficult recurrent phenomena we call business cycles. Providing an empirical “illustration” or a “story” to back up your model does not suffice. There are simply too many competing illustrations and stories that could be exhibited or told.

As Lucas has to admit – complaining about the less than ideal contact between theoretical economics and econometrics – even though the “stories” are (purportedly) getting better and better, “the necessary interaction between theory and fact tends not to take place” [Lucas 1981:11].

The basic assumption of this “precise and rigorous” model therefore cannot be considered anything else than an unsubstantiated conjecture as long as it is not supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented. This is the more tantalizing since Lucas himself stresses that the presumption “seems a sound one to me, but it must be defended on empirical, not logical grounds” [Lucas 1981:12].

And applying a “Lucas critique” on Lucas’s own model, it is obvious that it too fails. Changing “policy rules” cannot just be presumed not to influence investment and consumption behaviour and a fortiori technology, thereby contradicting the invariance assumption. Technology and tastes cannot live up to the status of an economy’s deep and structurally stable Holy Grail. They too are part and parcel of an ever-changing and open economy. Lucas’ hope of being able to model the economy as “a FORTRAN program” and “gain some confidence that the component parts of the program are in some sense reliable prior to running it” [Lucas 1981:288] therefore seems – from an ontological point of view – totally misdirected. The failure in the attempt to anchor the analysis in the alleged stable deep parameters ‘tastes’ and ‘technology’ shows that if you neglect ontological considerations pertaining to the target system, ultimately reality kicks back when at last questions of bridging and exportation of model exercises are laid on the table. No matter how precise and rigorous the analysis is, and no matter how hard one tries to cast the argument in “modern mathematical form” [Lucas 1981:7] they do not push science forward one single millimetre if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not per se say anything about external validity.

References

Lucas, Robert (1981), Studies in Business-Cycle Theory. Oxford: Basil Blackwell.

– (1986), Adaptive Behavior and Economic Theory. In Hogarth, Robin & Reder, Melvin (eds) Rational Choice (pp. 217-242). Chicago: The University of Chicago Press.

– (1988), What Economists Do.

Syll, Lars (2016), On the use and misuse of theories and models in economics.

Postcolonial theory in perspective

20 May, 2023 at 23:25 | Posted in Politics & Society | 1 Comment

Links is niet woke, Susan Neiman | 9789047715597 | Boeken | bol.comMany of the theoretical assumptions which support the most admirable impulses of the woke come from the intellectual movement they most despise. The best tenets of woke, such as the insistence on viewing the world from more than one geographical perspective, come straight from the Enlightenment. Contemporary rejections of this period usually go hand in hand with not much knowledge of it. But you can’t hope to make progress by sawing at the branch you don’t know you are sitting on.

It is now an article of faith that universalism, like other Enlightenment ideas, is a sham that was designed to disguise Eurocentric views which supported colonialism. These claims are not simply ungrounded: they turn the Enlightenment upside down. Enlightenment thinkers invented the critique of Eurocentrism and were the first to attack colonialism — on the basis of universalist ideas. When contemporary postcolonial theorists rightly insist that we learn to view the world from the perspective of non-Europeans, they are echoing a tradition that goes back to 18th-century thinkers, who risked their livelihoods, and sometimes their lives, to defend those ideas.

This is not merely a historical matter: we need Enlightenment ideas if we have any hope of moving forward against what are politely called the authoritarian tendencies of the present. But there is no time for politeness when many elected leaders around the world are openly undermining democracy.

Susan Neiman

Vad kan du om ekonomi?

20 May, 2023 at 18:11 | Posted in Economics | 1 Comment

För att få svar på det kan du ju testa ekonomiquizet i dagens Sydsvenskan!

Postmodernism & Pedophilia

19 May, 2023 at 19:29 | Posted in Politics & Society | 1 Comment

Jean-Paul Sartre, Roland Barthes, Simone de Beauvoir, Gilles et Fanny Deleuze … Jack Lang … André Glucksmann, et bien d’autres encore; tous font partie des 69 intellectuels français qui, aux côtés de l’écrivain Gabriel Matzneff … ont signé une tribune publiée le 26 janvier 1977. D’abord dans Le Monde puis dans Libération pour défendre trois hommes incarcérés depuis plus de trois ans pour avoir abusé sexuellement de mineurs de moins de 15 ans.

‘Trois ans de prison pour des caresses et des baisers, cela suffit !’ écrivaient les signataires.

Ils demandaient la relaxe des trois hommes au prétexte que les enfants n’avaient pas été victimes de la moindre violence, mais, au contraire, qu’ils étaient consentants.

Le 23 mai 1977, dans les pages “Opinions” du Monde, 80 intellectuels français parmi lesquels Jean-Paul Sartre, Michel Foucault, Roland Barthes, Simone de Beauvoir … Jacques Derrida … signent un autre texte pour demander que la loi décriminalise les rapports sexuels entre les adultes et les enfants de moins de 15 ans.

 Cécile de Kervasdoué et Fiona Moghaddam

International Women's Day: An ode to Simone de Beauvoir - Philosophy -  University of Kent It has to be said that Beauvoir’s interest in these matters was not purely theoretical … She was dismissed from her teaching job in 1943 for “behavior leading to the corruption of a minor.” The minor in question was one of her pupils at a Paris lycée. It is well established that she and Jean-Paul Sartre developed a pattern, which they called the “trio,” in which Beauvoir would seduce her students and then pass them on to Sartre …

Beauvoir’s “Lolita Syndrome” … offers an evangelical defence of the sexual emancipation of the young … Beauvoir posits Bardot as the incarnation of “authenticity” and natural, pure “desire,” with “aggressive” sexuality devoid of any hypocrisy. The author of “The Second Sex” is keen to stress sexual equality and autonomy, but she also insists on the “charms of the ‘nymph’ in whom the fearsome image of the wife and the mother is not yet visible.”

Andy Martin/New York Times

Understanding MMT

19 May, 2023 at 11:37 | Posted in Economics | 3 Comments

Twitter \ Modern Money Memes (ModernMoneyMeme@)MMT is, first and foremost, a balance sheet approach to macroeconomics. At its very core lie reserve accounting, then deposit accounting, and then sectoral balances accounting. There is very little behaviour in any of this. Equilibrium rules as all balances balance – in both flows and stocks – and there are no assumptions apart from the existence of a central bank, a Treasury, a banking system and some households and firms. MMT can only be learned by mastering its balance sheet approach. It can only be engaged by discussing the balance sheet operations it puts forward. It is here where value is added …

First of all, the main insight of MMT is that the mainstream has the sequence wrong. Whereas they assume that government expenditure is financed by taxes, MMT assumes that government spending is financed by money creation. MMT stresses that the central bank, empowered by the law and serving the state, is the monopoly issuer of currency … This logically means that the state has to spend before taxes can be paid … When taxpayers pay their taxes (or banks buy government bonds on the primary market), they first need to have state money.

Dirk Ehnts

Fiscal deficits always lead to an increase in the supply of financial assets held in the nongovernmental sector of the economy. This real-world fact, of course, constitutes a massive problem for mainstream (textbook) macroeconomic theory with its models building on ‘money multipliers’ and ‘loanable funds.’

The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credit, determined by supply and demand — as Bertil Ohlin put it — “in the same way as the price of eggs and strawberries on a village market.”

In the traditional loanable funds theory — as presented in mainstream macroeconomics textbooks — the amount of loans and credit available for financing investment is constrained by how much saving is available. Saving is the supply of loanable funds, and investment is the demand for loanable funds and is assumed to be negatively related to the interest rate.

As argued by Ehnts, there are many problems with the standard presentation and formalization of the loanable funds theory. And more can be added to the list:

1 As already noticed by James Meade decades ago, the causal story told to explicate the accounting identities used gives the picture of “a dog called saving wagged its tail labelled investment.” In Keynes’s view — and later over and over again confirmed by empirical research — it’s not so much the interest rate at which firms can borrow that causally determines the amount of investment undertaken, but rather their internal funds, profit expectations and capacity utilization.

2 As is typical of most mainstream macroeconomic formalizations and models, there is pretty little mention of real-world​ phenomena, like e. g. real money, credit rationing and the existence of multiple interest rates, in the loanable funds theory. Loanable funds theory essentially reduces modern monetary economies to something akin to barter systems — something they definitely are not. As emphasized especially by Minsky, to understand and explain how much investment/loaning/crediting is going on in an economy, it’s much more important to focus on the working of financial markets than staring at accounting identities like S = Y – C – G. The problems we meet on modern markets today have more to do with inadequate financial institutions than with the size of loanable-funds-savings.

3 The loanable funds theory in the “New Keynesian” approach means that the interest rate is endogenized by assuming that Central Banks can (try to) adjust it in response to an eventual output gap. This, of course, is essentially nothing but an assumption of Walras’ law being valid and applicable, and that a fortiori the attainment of equilibrium is secured by the Central Banks’ interest rate adjustments. From a realist Keynes-Minsky point of view, this can’t be considered anything else than a belief resting on nothing but sheer hope. [Not to mention that more and more Central Banks actually choose not to follow Taylor-like policy rules.] The age-old belief that Central Banks control the money supply has more and more come to be questioned and replaced by an “endogenous” money view, and I think the same will happen to the view that Central Banks determine “the” rate of interest.

4 A further problem in the traditional loanable funds theory is that it assumes that saving and investment can be treated as independent entities. To Keynes, this was seriously wrong:

gtThe classical theory of the rate of interest [the loanable funds theory] seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shifts​, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.

There are always (at least) two parts to an economic transaction. Savers and investors have different liquidity preferences and face different choices — and their interactions usually only take place intermediated by financial institutions. This, importantly, also means that there is no “direct and immediate” automatic interest mechanism at work in modern monetary economies. What this ultimately boils done to is — iter — that what happens at the microeconomic level — both in and out of equilibrium —  is not always compatible with the macroeconomic outcome. The fallacy of composition (the “atomistic fallacy” of Keynes) has many faces — loanable funds is one of them.

5 Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.

What is “forgotten” in the loanable funds theory, is the insight that finance — in all its different shapes — has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, simply isn’t enough.

All real economic activities nowadays depend on functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channelling​ money/savings/credit — are more or less left in the dark in modern formalizations of the loanable funds theory.

kaleckiIt should be emphasized that the equality between savings and investment … will be valid under all circumstances. In particular, it will be independent of the level of the rate of interest which was customarily considered in economic theory to be the factor equilibrating the demand for and supply of new capital. In the present conception investment, once carried out, automatically provides the savings necessary to finance it. Indeed, in our simplified model, profits in a given period are the direct outcome of capitalists’ consumption and investment in that period. If investment increases by a certain amount, savings out of profits are pro tanto higher …

One important consequence of the above is that the rate of interest cannot be determined by the demand for and supply of new capital because investment ‘finances itself.’

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