Scientific progress … is frequently the result of observation that something does work, which runs far ahead of any understanding of why it works.
Not within the economics profession. There, deductive reasoning based on logical inference from a specific set of a priori deductions is “exactly the right way to do things”. What is absurd is not the use of the deductive method but the claim to exclusivity made for it. This debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic: inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics …
The belief that models are not just useful tools but are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face. That blindness made a big contribution to our present crisis, and conditions our confused responses to it.
The ‘deductivist blindness’ of mainstream economics explains to a larger extent why it contributes to causing economic crises rather than to solving them. But where does this ‘deductivist blindness’ of mainstream economics come from? To answer that question we have to examine the methodology of mainstream economics.
The insistence on constructing models showing the certainty of logical entailment has been central in the development of mainstream economics. Insisting on formalistic (mathematical) modeling has more or less forced the economist to give upon on realism and substitute axiomatics for real world relevance. The price paid for the illusory rigour and precision has been monumentally high
This deductivist orientation is the main reason behind the difficulty that mainstream economics has in terms of understanding, explaining and predicting what takes place in our societies. But it has also given mainstream economics much of its discursive power – at least as long as no one starts asking tough questions on the veracity of – and justification for – the assumptions on which the deductivist foundation is erected. Asking these questions is an important ingredient in a sustained critical effort at showing how nonsensical is the embellishing of a smorgasbord of models founded on wanting (often hidden) methodological foundations.
The mathematical-deductivist straitjacket used in mainstream economics presupposes atomistic closed-systems – i.e., something that we find very little of in the real world, a world significantly at odds with an (implicitly) assumed logic world where deductive entailment rules the roost. Ultimately then, the failings of modern mainstream economics has its root in a deficient ontology. The kind of formal-analytical and axiomatic-deductive mathematical modeling that makes up the core of mainstream economics is hard to make compatible with a real-world ontology. It is also the reason why so many critics find mainstream economic analysis patently and utterly unrealistic and irrelevant.
Although there has been a clearly discernible increase and focus on ’empirical’ economics in recent decades, the results in these research fields have not fundamentally challenged the main deductivist direction of mainstream economics. They are still mainly framed and interpreted within the core axiomatic assumptions of individualism, instrumentalism and equilibrium that make up even the ‘new’ mainstream economics. Although, perhaps, a sign of an increasing – but highly path-dependent – theoretical pluralism, mainstream economics is still, from a methodological point of view, mainly a deductive project erected on a foundation of empty formalism.
There was an unusual degree of consensus among economists about what would happen if Britain voted for Brexit in the referendum on June 23 last year. The language used by the International Monetary Fund was typical: It expressed fears of an “abrupt reaction,” adding that this “may have already begun” …
What happened instead was that Britain enjoyed the best growth of any major advanced economy in 2016 … Andy Haldane compared the pitfalls of economic prediction to the single most famously wrong weather forecast in British history, made on the BBC on Oct. 15, 1987. A woman had called the BBC to say she was worried there was a hurricane on the way. “Don’t worry, there isn’t,” the weatherman responded. That night, 22 people died amid hurricane-force winds …
The reason this poses a deep intellectual crisis for macro-economics is that the entire point of the field, as it has developed since the work of John Maynard Keynes in the 1930s, is to prevent just this sort of severe downturn. Keynes once spoke of a future in which economists would be “humble, competent people on a level with dentists” … It seems to me, though, that what macroeconomists do is really most like bomb disposal. Uniquely in the social sciences and humanities, macroeconomics was developed with a specific, real-world purpose, and a negative purpose to boot: to stop anything like the Great Depression from ever happening again. Given this goal — to avert systemic crises and downturns — the credit crunch and the Great Recession were, for macroeconomics, an intellectual disaster.
In retrospect, the failure of the discipline to predict and prevent the crisis was based on deep conceptual faults. One of these concerned a mysterious refusal to engage with the role of the banking and finance system in the economy. Another was the assumption that the discipline makes about individual motivations, assuming that individuals “optimize” their decision-making to behave, in economic terms, rationally. This is a convenient intellectual shortcut for building models, but it is also a fiction, as we know not just from our own human experience but even from within economics itself, where microeconomics has recently made exciting progress in the study of human irrationality, bias and cognitive error. It is a matter of provable fact that our decision-making is not entirely rational. Economic models built on the premise of our rationality will always have a creaky underpinning.
Reading Lancaster’s article is certainly a very worrying confirmation of what Paul Romer wrote a couple of months ago — modern macroeconomics is becoming more and more a total waste of time.
One of the problems with macroeconomics that Lancaster
doesn’t discuss is its obsessive mathematization since WW II. This has made mainstream neoclassical economists more or less obsessed with formal, deductive-axiomatic models. Confronted with the critique that they do not solve real problems, they often react as Saint-Exupéry’s Great Geographer, who, in response to the questions posed by The Little Prince, says that he is too occupied with his scientific work to be be able to say anything about reality. Confronting economic theory’s lack of relevance and ability to tackle real problems, these economists retreat to the wonderful world of economic models. They enter the tool shed — and stay there. While the economic problems in the world around us steadily increase, they are rather happily playing along with the latest toys in the mathematical toolbox.
Instead of making the model the message, I think we are better served by economists who more than anything else try to contribute to solving real problems. And then the motto of John Maynard Keynes is more valid than ever:
It is better to be vaguely right than precisely wrong
Lynn Parramore: Do you think there are lessons in what has happened in the Eurozone for students of economics and the way the subject is taught?
Mario Seccareccia: Yes, indeed. Ever since the establishment of the modern nation-state in the late eighteenth and nineteenth centuries, the creation of the euro was perhaps the first significant experiment in modern times in which there was an attempt to separate money from the state, that is, to denationalize currency, as some right-wing ideologues and founders of modern neoliberalism, such as Friedrich von Hayek, had defended. What the Eurozone crisis teaches is that this perception of how the monetary system works is quite wrong, because, in times of crisis, the democratic state must be able to spend money in order to meet its obligations to its citizens. The denationalization or “supra-nationalization” of money with the establishment that happened in the Eurozone took away from elected national governments the capacity to meaningfully manage their economies. Unless governments in the Eurozone are able to renegotiate a significant control and access money from their own central banks, the system will be continually plagued with crisis and will probably collapse in the longer term.
And I thought I had seen them all …
The 2017 OECD Economic Survey of Sweden — presented today in Stockholm by OECD Secretary-General Angel Gurría and Sweden’s Minister of Finance Magdalena Andersson — points out that income inequality in Sweden has been rising since the 1990s.
I would say that what we see happen in Sweden is deeply disturbing. The rising inequality is outrageous – not the least since it has to a large extent to do with income and wealth increasingly being concentrated in the hands of a very small and privileged elite.
Source: Statistics Sweden and own calculations
A society where we allow the inequality of incomes and wealth to increase without bounds, sooner or later implodes. The cement that keeps us together erodes.
The development in Sweden is going in the wrong direction. The main difference compared to UK and US is really that the increasing inequality in Sweden (going on continuously for 30 years now) started from a lower starting point.
The OECD survey confirms that Sweden is no longer the model country it once was, in the heydays of the 60s and 70s. It’s no longer the country of Olof Palme. Just as in so many other OECD countries, neoliberal ideologies, economists and politicians have crushed the Swedish dream that once was.
It’s sad. But it’s a fact.
Hans Rosling (1948-2017)
The trouble is, too many theorists — especially in the mainstream of the discipline — have drifted far from the real world. Their ambition has been to build mathematically elegant and internally consistent models of the economy, even if that requires wholly unrealistic assumptions. Granted, just as maps have to simplify complex terrain, theoretical models must ignore aspects of reality to be any use. But there’s a line between simplification and gross distortion, and modern macroeconomics has crossed it.
Before the 2008 financial crisis, for example, the standard models more or less ignored finance. No banks, no indebtedness, no leverage. As a result, they couldn’t make sense of the worst global recession since the 1930s …
Given such spectacular failures, you’d think the profession would have gone back to the drawing board. It hasn’t …
Whenever an economist says “in our model,” beware. Demand to know what assumptions the model makes, and question those assumptions as severely as the theorists test for valid inference — because valid inference from bogus assumptions is useless. Where possible, and in the same spirit, pay closest attention to empirical and historical research.
In just about every branch of science, theoretical research has been crucial to achieving breakthroughs. In macroeconomics, it has held progress back. To stop the discipline fading into irrelevance, this will have to change.
The editors of Bloomberg View are, of course, absolutely right.
Unfortunately, there are many kinds of useless ‘post-real’ economics held in high regard within the mainstream economics establishment today. Few — if any — are less deserved than the macroeconomic theory/method called calibration.
In physics it may possibly not be straining credulity too much to model processes as ergodic – where time and history do not really matter – but in social and historical sciences it is obviously ridiculous. If societies and economies were ergodic worlds, why do econometricians fervently discuss things such as structural breaks and regime shifts? That they do is an indication of the unrealisticness of treating open systems as analyzable with ergodic concepts.
The future is not reducible to a known set of prospects. It is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be. Reading Lucas, Sargent, Prescott, Kydland and other calibrationists one comes to think of Robert Clower’s apt remark that
much economics is so far removed from anything that remotely resembles the real world that it’s often difficult for economists to take their own subject seriously.
Or as Paul Romer put it in his masterful attack on ‘post-real’ economics last year:
Math cannot establish the truth value of a fact. Never has. Never will.
So instead of assuming calibration and rational expectations to be right, one ought to confront the hypothesis with the available evidence. It is not enough to construct models. Anyone can construct models. To be seriously interesting, models have to come with an aim. They have to have an intended use. If the intention of calibration and rational expectations is to help us explain real economies, it has to be evaluated from that perspective. A model or hypothesis without a specific applicability is not really deserving our interest.
Without strong evidence all kinds of absurd claims and nonsense may pretend to be science. We have to demand more of a justification than rather watered-down version of “anything goes” when it comes to rationality postulates. If one proposes rational expectations one also has to support its underlying assumptions. None is given, which makes it rather puzzling how rational expectations has become the standard modeling assumption made in much of modern macroeconomics. Perhaps the reason is that economists often mistake mathematical beauty for truth.
But I think another reason is that calibration economists are not particularly interested in empirical examinations of how real choices and decisions are made in real economies. In the hands of Lucas, Prescott and Sargent, rational expectations has been transformed from an – in principle – testable hypothesis to an irrefutable proposition. Believing in a set of irrefutable propositions may be comfortable – like religious convictions or ideological dogmas – but it is not science.
So where does this all lead us? What is the trouble ahead for economics? Putting a sticky-price DSGE lipstick on the calibrationists’ Real Business Cycle pig sure won’t do. Neither will just looking the other way and pretend it’s raining. The biggest problem in macroeconomics today is that macroeconomists don’t care about facts. As long as they can build consistent mathematical models they’re happy. If the consistency is applicable to the real-world doesn’t seem to bother them.
If macroeconomic models – no matter of what ilk – build on microfoundational assumptions of representative actors, rational expectations, market clearing and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Trying to represent real-world target systems with models flagrantly at odds with reality is futile. And if those models are New Classical Real Business Cycle calibrations or ‘New Keynesian’ makes very little difference.
No matter how brilliantly silly DSGE models mainstream macroeconomists come up with, they do not help us working with the fundamental issues of modern economies. Using that kind of models only confirms Robert Gordon‘s dictum that today
rigor competes with relevance in macroeconomic and monetary theory, and in some lines of development macro and monetary theorists, like many of their colleagues in micro theory, seem to consider relevance to be more or less irrelevant.
As the Bloomberg View editors say — “this will have to change.” Until then we have to continue wonder what is the raison d’être of macroeconomics if it has nothing to say about the real world and the economic problems out there?
Lydon: You say newspapers make us stupid, and I’m not quite clear why.
Taleb: Because they always give you an explanation to events so that you have the feeling that you know what’s going on. They tell you the stock market went down, because of fear of a recession, and that’s false causation with uncertainty there. They check their facts, but you can’t check their causes. So, you have the feeling of over-causation from newspapers. That’s number one, the first one.
The second one: newspapers aren’t going to tell you “we had 280 deaths on the roads today in America”. They’re going to tell you about the plane crash killing 14 people. So, you have misrepresentation of the math of risks. They are driven by the sensational. And the statistical and the sensational are not the same in our modern world.
There’s a third thing about newspapers. Supplying someone with news reduces his understanding of the world. It’s more complicated than I can go into here, but let me tell you how I cope with it. I don’t mind knowing the news, but I go by a social filter. I eat lunch and dinner with other people. (I try to. I still have people who won’t eat lunch or dinner with me, even after writing the Black Swan). And I make sure. You can eavesdrop on conversations and stuff like that. I can tell if something is going on.
If there’s an event of significance, I know about it. And then I go to the web, or go buy a paper sometimes, or something like that.
All these pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.
Perhaps the reader feels that this general, philosophical disquisition on the behavior of mankind is somewhat remote from the economic theory under discussion. But I think not. Tho this is how we behave in the marketplace, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future.
I dare say that a classical economist would readily admit this. But, even so, I think he has overlooked the precise nature of the difference which his abstraction makes between theory and practice, and the character of the fallacies into which he is likely to be led.
This is particularly the case in his treatment of Money and Interest.
Sad, sad, sad, news reached us today. One of Sweden’s greatest actors ever — Björn Granath — passed away today, aged 70. He made many great performances, but the one that has stayed with me more than any other is the portrait of the rebel Erik in Pelle the Conqueror (1987).
“We’ll set out and conquer the world.”