DSGE models — worse than useless

18 March, 2019 at 17:41 | Posted in Economics | 2 Comments

 dirkAmong other conceptual absurdities, such as the assumption that economic actors consist of identical omniscient ‘rational agents’ all of whom have perfect information about prices and quantities everywhere in the global economy, DSGE models generally incorporate the erroneous ‘veil of barter’ notion and ignore the functioning of real monetary systems …

DSGE models represent the distilled essence of the past three decades of dominant macroeconomic theory. Yet they are, to put it bluntly, nonsense, There is only one representative agent — no meaningful discussion of debt can take place in such a theoretical frame. These models are worse than useless — they are misleading.

Dirk Ehnts is, of course, absolutely right. DSGE models are worse than useless — and still,​ mainstream economists seem to be überimpressed by the ‘rigour’ brought to macroeconomics by New-Classical-New-Keynesian DSGE models and its rational expectations and microfoundations!

It is difficult to see why.

‘Rigorous’ and ‘precise’ DSGE models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge,​ no decisive empirical evidence has been presented.

keynes-right-and-wrong

Proving things ‘rigorously’ in DSGE models is at most a starting-point 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.

Mainstream economists think there is a gain from the DSGE style of modelling in its capacity to offer the one and only structure around which to organise discussions. To me, that sounds more like a religious theoretical-methodological dogma, where one paradigm rules in divine hegemony. That’s not progress. That’s the death of economics as a science.

California dreaming (personal)

18 March, 2019 at 16:57 | Posted in Varia | Leave a comment

 

Yes, indeed, looking out through my library windows into​ The Magistrate’s Park, the sky is grey, rain keeps falling, and Spring seems to be far, far, away. Although it’s almost forty years now since I was a research student at the ​University of California, on a day like this, I sure wish I was back in Berkeley Marina, Tilden Park, Telegraph Avenue, Yosemite, Joshua Tree …

La femme qui est dans mon lit

18 March, 2019 at 16:20 | Posted in Varia | Leave a comment

 

Cette chanson a été un produit de la collaboration entre Serge Reggiani et Georges Moustaki. Les vers du commencement sont d’un poème de Charles Baudelaire.

Hyman Minsky and the IS-LM obfuscation

17 March, 2019 at 11:18 | Posted in Economics | 39 Comments

As 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.

The concepts which it is usual to ignore or deemphasize in interpreting Keynes — the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …

miThe glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …

The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …

The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …

If we are to believe Minsky — and I certainly think we should — then when people like Paul Krugman and other ‘New Keynesian’ critics of MMT and Post-Keynesian economics think of themselves as  defending “the whole enterprise of Keynes/Hicks macroeconomic theory,” they are simply wrong since there is no such thing as a Keynes-Hicks macroeconomic theory!

There is nothing in the post-General Theory writings of Keynes that suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thoughts. In Keynes’s canonical statement of the essence of his theory in the 1937 QJE-article there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. So, of course,​ there can’t be any “vindication for the whole enterprise of Keynes/Hicks macroeconomic theory” — simply because “Keynes/Hicks” never existed.

To be fair to Hicks, we  shouldn’t forget that he returned to his IS-LM analysis in an article in 1980 — in Journal of Post Keynesian Economics — and self-critically wrote:

sir_john_hicksThe only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous …

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect … It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

In his 1937 paper Hicks actually elaborates four different models (where Hicks uses I to denote Total Income and Ix to denote Investment):

1) “Classical”: M = kI   Ix = C(i)   Ix = S(i,I)

2) Keynes’ “special” theory: M = L(i)   Ix = C(i)    I = S(I)

3) Keynes’ “general” theory: M = L(I, i)   Ix = C(i)   I = S(I)

4) The “generalized general” theory: M = L(I, i)   Ix =C(I, i)  Ix = S(I, i)

It is obvious from the way Krugman and other ‘New Keynesians’ — what a gross misnomer — draw their IS-LM curves that they are thinking in terms of model number 4 — and that is not even by Hicks considered a Keynes-model! It is basically a loanable funds model, that belongs in the neoclassical camp and which you find reproduced in most mainstream textbooks.

Hicksian IS-LM? Maybe. Keynes? No way!

MMT — modern monetary realism

16 March, 2019 at 11:39 | Posted in Economics | 40 Comments

MMT is not, as its opponents seem to think, primarily a set of policy ideas. Rather, it is essentially a description of how a modern credit economy actually works – how money is created and destroyed, by governments and by banks, and how financial markets function. Nor is MMT new: it is based on the work of John Maynard Keynes, whose Treatise on Money pointed out back in 1930 that “modern States” have functioned this way for thousands of years.

Abrahamian-Long-ver-imgFrom this description, certain straightforward facts flow. Governments create money by spending and extinguish it via taxation. It follows, therefore, that a large country, borrowing in its own currency, cannot be forced into default. That is why the US is not Greece, and cannot become Venezuela or Zimbabwe.

Does this mean that “deficits don’t matter”? I know of no MMT adherent who has made such a claim. MMT acknowledges that policy can be too expansionary and push past resource constraints, causing inflation and exchange-rate depreciation – which may or may not be desirable. (Hyperinflation, on the other hand, is a bogeyman, which some MMT critics deploy as a scare tactic.)

But the issue with budget deficits isn’t interest rates, which remain under government control. Nor is it the possible crowding out of private investment, which assumes that the pool of finance is fixed. The issue is real resources. Here, MMT’s proposed job guarantee would keep real resource use exactly at the level required for full employment – not less, but also not more.

J K Galbraith

Veckans dumstrut — finansminister Magdalena Andersson

16 March, 2019 at 09:07 | Posted in Economics | 2 Comments

Redan nu frågar sig ekonomer vilka motiv regeringen har för att inte satsa mer och låna mer, särskilt som räntorna ligger under nollpunkten och alla ser att Sverige behöver rejäla investeringar i allt från infrastruktur till vård och välfärd.

dumstrut1Men en intervju med affärstidningen Bloomberg har dock finansminister Magdalena Andersson sagt att hon kommer att ha en bra förklaring till att hon inte öppnat plånboken. Det blir spännande att höra den, inte minst för socialdemokratiska politiker och väljare runt om i landet.

De lär inte vara nöjda med skicket på vägarna, längden på vårdköerna eller storlekarna på förskolans barngrupper. Att socialförsäkringarna inte håller måttet, tågen står stilla, pensionerna är låga och ungdomarna inte har någonstans att bo jublar ingen över …

Frågan Magdalena Andersson till slut måste svara på är varför en socialdemokratiskt ledd regering under fem år låtit bli att göra av med pengar, trots att alla sett att behoven finns.

Daniel Swedin / Aftonbladet

Det verkar än en gång som om före detta studenter från Handelshögskolan i Stockholm har rejäla kunskapsluckor. Kanske borde man sluta lära ut monetaristiskt Chicago-nonsens från 70-talet och istället följa med i teoriutvecklingen. Lite ‘functional finance’ och MMT kanske inte skulle skada även på maktelitens lekskola …

Den ­svenska utlandsskulden är historiskt låg och statsskulden ligger snart under 30%.

Ett lands statsskuld är sällan en orsak till ekonomisk kris, utan snarare ett symtom på en kris som sannolikt blir värre om inte underskotten i de offentliga finan­serna får öka.

Med tanke på de stora utmaningar som Sverige står inför är finansministerns tal om ansvar för statsbudgeten minst sagt oansvarigt. I stället för att ”värna om statsfinanserna” borde rege­ringen se till att värna om samhällets framtid.

I am I said

15 March, 2019 at 19:22 | Posted in Varia | Leave a comment

 

The need for class politics

15 March, 2019 at 19:13 | Posted in Politics & Society | 6 Comments

The Marxian idea of class does matter. For one thing, it is an objective fact that millions of people live lives of poverty, unfreedom and insecurity because they lack access to capital.

0*LU4hw4S7RjzIlsmgAnd for another, it does help explain the popularity of Corbynism among the so-called “middle-class”: at the last election, 35% of “ABs” voted Labour. Many people even in erstwhile good professions have no hope of owning property and face stress and domination from their managerialist overlords. The harm caused by class division extends far up the income ladder. Even quite posh people are working class – however many avocados they eat – and many of them vote accordingly.

You might argue that if so many people are working class then the definition is useless. Far from it. The fact that they are vindicates Marx’s claim that “the lower strata of the middle class sink gradually into the proletariat.” It also means that class makes for a less divisive type of politics. Whilst identity politics risks splitting us into countless hostile groups – made more bitter because they are personalized – class politics can unite most of us. And it can do so in a more humane way. Class is a matter of social structure, not of goodies against baddies. This should take personalities out of political discourse and so permit more sober analysis. I know it is an odd thing to say given the historical record, but Marxism has the potential to be a more civilized type of politics than we currently have.

Stumbling and Mumbling

Funeral Ikos

15 March, 2019 at 15:49 | Posted in Varia | Leave a comment

 

tavenerIf thou hast shown mercy
unto man, o man,
that same mercy
shall be shown thee there;
and if on an orphan
thou hast shown compassion,
that same shall there
deliver thee from want.
If in this life
the naked thou hast clothed,
the same shall give thee
shelter there,
and sing the psalm:
Alleluia.

New MMT macroeconomics textbook

14 March, 2019 at 19:25 | Posted in Economics | 13 Comments

wrayThis book presents a comprehensive, university level study course in Macroeconomics from a Modern Monetary Theory (MMT) perspective.

Our approach is grounded in the operations of real-world institutions, and our approach clearly identifies the policymaking capacity of central governments. The pedagogy thus starts by putting the currency-issuing government​ at the forefront.

We want students to understand how a modern monetary system operates, how the government and non- government sectors interact, how the central bank and the banks interact, how the labour market works, how trade and capital flows impact on economic outcomes and much more.

Students will appreciate what the capacities of a currency-issuing government are and how fiscal and monetary​y policy can be used purposefully to enhance the well-being of the nation.

Unlike earlier pluralist approaches to macroeconomics in which the teaching sequence begins with an exposition of the standard mainstream macroeconomics (dominated by the New Keynesian approach) and only then qualifies that conceptual structure and framing with some ‘real world’ criticisms and quibbles, we feel students are better informed if we build the narrative from the ground up, based on an understanding of how the monetary​ system actually operates. In adopting that approach, we are informed by our view that the mainstream macroeconomic approach does not provide coherent knowledge upon which to understand those real-world​ monetary operations.

I’ll be back with a review.

Labor’s share — the ‘stylized fact’ that isn’t a fact at all

14 March, 2019 at 16:49 | Posted in Economics | 2 Comments

jonvollrAccording to one of the most widely used textbooks on mainstream theories of economic growth, one can for the United States “calculate labor’s share of GDP by looking at wage and salary payments and compensation for the self-employed as a share of GDP. These calculations reveal that the labor share has been relatively constant over time, at a value of around 0.7.”

But is this “classic stylized fact” — that the labour share is relatively constant over time at around two-thirds — really true? One would, I guess, certainly have doubts after reading Piketty and taking part in the present discourses on economic inequality.

Sometimes a little data can do wonders. So let’s have a look at a couple of graphs that give us some:

fredgraph

re

The relative share between labour and capital has obviously not remained relatively constant over time. The trend during the last five decades has been that labour’s share has declined. The workers’ slice of the pie has decreased.

Time to rewrite the textbooks? Hope so!

How to get published in top economics journals …

14 March, 2019 at 12:50 | Posted in Economics | 3 Comments

The reality is that the mainstream follow a formulaic approach to publications in macroeconomics that goes something like this:

    Quantitative-Sensory-Research-Questionnaire-Content-1030x404

  • Assert without foundation – so-called micro-foundations – rationality, maximisation, rational expectations – imposed assumptions about human behaviour that no sociologist or psychologist would remotely recognise.
  • These foundations cannot deal with real world people so assume there is just one infinitely-lived agent!
  • Assert efficient, competitive markets as the optimality benchmark against which all other states will be assessed – in other words, abstract from the reality of existence.
  • Write some trivial mathematical equations and solve – professional mathematicians shrink with embarrassment when they see the naive formality that economists think is state of art.
  • Policy shock the optimal ‘solution’ to ‘prove’, for example, that fiscal policy is inneffective (Ricardian equivalence) and austerity is good. Perhaps allow some short-run stimulus effect.
  • Get some data but realise poor fit – add some ad hoc lags (price stickiness etc) to improve ‘fit’ but end up with identical long-term results – of course, once you add these ad hoc lags the ‘micro founded’ framework, which is the ‘authority’ that is used to claim ‘scientific’ standing is abandoned.
  • Irrespective of that abandonment, maintain pretense that micro-foundations are intact – after all it is the only claim to intellectual authority that these mainstream economists have – which is no claim at all in reality.
  • Publish articles that reinforce starting assumptions.
  • Get appointments, promotion
  • Write commissioned reports (with fees and sponsors largely undisclosed) about how stable the financial sector etc is – parade the reports as independent academic research – and demand more deregulation, cutting of income support systems etc under the guise of ‘structural reform’.
  • Knowledge quotient of all this – ZERO – GIGO.
  • Bill Mitchell

Der Himmel über Berlin

13 March, 2019 at 18:29 | Posted in Varia | Leave a comment

 

Love’s Secret

13 March, 2019 at 17:52 | Posted in Varia | Leave a comment

 

lovessecret-williamblakepoe

Can a Central Bank ever run out of money?

13 March, 2019 at 17:31 | Posted in Economics | Leave a comment

 

(h/t: Stephanie Kelton)

Mainstream nonsense about budget deficits

13 March, 2019 at 13:54 | Posted in Economics | 8 Comments

The standard mainstream textbook argument about budget deficits goes something like this: Assume that total output is given. If government expenditures are increased, then this has to be met by an equally large decrease in investment, which can only come forth by rising interest rates. ‘Crowding out’ reduces public saving and causes interest rates to rise. Then, applying the logic of the Solow growth model, it is concluded that (Mankiw, Macroeconomics, 8th ed., p. 221)

the long-run consequences of a reduced saving rate are a lower capital stock and lower national income. This is why many economists are critical of persistent budget deficits.

Now, what’s wrong with this? Everything! To a considerable extent because the reasoning is based on the loanable funds theory — which has no room for the simple fact that the rate of interest is not determined by the demand for and supply of capital since investment basically finances itself.

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 credits set by banks and 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.”

loanIt is a beautiful fairy tale, but the problem is that banks are not barter institutions that transfer pre-existing loanable funds from depositors to borrowers. Why? Because, in the real world, there simply are no pre-existing loanable funds. Banks create new funds — credit — only if someone has previously got into debt! Banks are monetary institutions, not barter vehicles.

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, investment is the demand for loanable funds and assumed to be negatively related to the interest rate. Lowering households’ consumption means increasing savings via a lower interest.

That view has been shown to have very little to do with reality. It’s nothing but an otherworldly mainstream model fantasy. But there are many other problems as well with the standard presentation and formalization of the loanable funds theory:

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.

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.

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 an 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.

A further problem in the traditional loanable funds theory is that it assumes that saving and investment can be treated as independent entities. This is 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 in 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.

Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and 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 a 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 mainstream formalizations of the loanable funds theory.

The Weight

12 March, 2019 at 20:40 | Posted in Varia | Leave a comment

 

Is MMT nothing but Knapp + Lerner + Minsky + Vertical IS curve?

12 March, 2019 at 14:03 | Posted in Economics | 21 Comments

Turning to Brad’s challenge, some of the answers will now be obvious. Do we accept the elements he lists as fundamental to MMT?

Knapp: yes indeed. He’s always been there …

Lerner: dealt with above. What we reject is the aggregate demand approach to full employment and price (and financial) stability. As Minsky argued in the 1960s, pump-priming might get you to full employment but it will never produce sustainable full employment because it will generate financial and price instability. You have to use the Job  Guarantee​ …

Minsky: Yep, he was there from the beginning …

vertical IS curveVertical IS: Now that is a leap. The ISLM framework is completely incoherent. It is not stock-flow consistent. Even its creator—John Hicks—said he could no longer make any sense of it … But I think all Brad means is that MMT rejects the notion that by changing interest rates the central bank can move the economy to full employment by stimulating interest-sensitive spending. And if that is what he means, I whole-heartedly agree.

Unlike Krugman, MMT argues this impotence is not restricted to the “lower bound” of zero interest rates. What MMT has always argued is that when the Fed lowers its rate target, we cannot say for sure whether the Fed is stepping on the gas or hitting the brakes. It depends. One factor that matters a lot is what is the ratio of government debt to nongovernment debt …

MMT has always recommended abandoning any attempt to fine-tune the economy through central bank interest rate policy. We prefer a permanently fixed rate … For me it is the permanent fixing that really matters, and I like a low rate but do not insist on zero.

So there you go, Brad, the ball’s in your court. We seem to be on the same page.

And by the way, I like Brad’s recent call for all the neoliberal Democrats to step aside and let the progressives following MMT take over.

L. Randall Wray

One of my favourite libraries

12 March, 2019 at 12:41 | Posted in Varia | 2 Comments

malmo_stadsbibl

The City Library of my hometown — Malmö — is an architectural gem. Surrounded by splendid views of the idyllic park setting — and with its extensive collection of foreign language books, journals and newspapers — it is well worth visiting any day of the year!

How to make economics a relevant science again

11 March, 2019 at 18:00 | Posted in Economics | 8 Comments

Economists are struggling to explain recent productivity developments, the implications of rising inequality, the impact of persistently negative interest rates in the eurozone … and the sudden slowdown in European growth …

None of this is a huge surprise, given the profession’s embrace of simplistic theoretical assumptions and excessive reliance on mathematical techniques that prize elegance over real-world applicability …

perfectly-good-econ-theoryAll of this should tell economists that there is plenty of room for improvement, and that they need to expand the scope of their analysis to take into account human interactions, distributional effects, financial-economic feedback mechanisms, and technological change. But this cannot just be about devising new analytical models within the field; economists also must incorporate insights from other disciplines that the profession has overlooked.

A discipline long dominated by “high priests” must now adopt a more open mindset … Without significant adjustments, mainstream economics will remain two steps behind changing realities on the ground, and economists will be risking a further loss of credibility and influence. In an era of concern about climate change, political upheavals and technological disruption, the shortcomings of mainstream economics must be addressed posthaste.

Yes indeed — what shall mainstream economists do when the modelling​ assumptions made are shown to be harmful and not even remotely matching reality?

What shall mainstream economists do when university students all over Europe and US are increasingly beginning to question if the kind of economics they are taught — mainstream neoclassical economics — really is of any value — and some even question if economics really is a science at all?

How do we re-establish credence and trust in economics as a science?

I think five changes are absolutely decisive if we want to rethink economics and make it a truly pluralist, relevant and realist science:

(1) Stop pretending that we have exact and rigorous answers on everything. Because we don’t. We build models and theories and tell people that we can calculate and foresee the future. But we do this based on mathematical and statistical assumptions that often have little or nothing to do with reality. By pretending that there is no really important difference between model and reality we lull people into thinking that we have things under control. We haven’t! This false feeling of security was one of the factors that contributed to the financial crisis of 2008.

(2) Stop the childish and exaggerated belief in mathematics giving answers to all important economic questions. Mathematics gives exact answers to exact questions. But the relevant and interesting questions we face in the economic realm are rarely of that kind. Questions like “Is 2 + 2 = 4?” are never posed in real economies. Instead of a fundamentally misplaced reliance on abstract mathematical-deductive-axiomatic models having anything of substance to contribute to our knowledge of real economies, it would be far better if we pursued “thicker” models and relevant empirical studies and observations.

(3) Stop pretending that there are laws in economics. There are no universal laws in economics. Economies are not like planetary systems or physics labs. The most we can aspire to in real economies is establishing possible tendencies with varying degrees of generalizability.

(4) Stop treating other social sciences as poor relations. Economics has long suffered from hubris. A more broad-minded and multifarious science would enrich today’s altogether too autistic economics.

(5) Stop building models and making forecasts of the future based on totally unreal microfounded macromodels with intertemporally optimizing robot-like representative actors equipped with rational expectations. This is pure nonsense. We have to build our models on assumptions that are not so blatantly in contradiction to reality. Assuming that people are green and come from Mars is not a good – not even as a “successive approximation” – modelling​ strategy.

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