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Archive for March 26th, 2009

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just to let me down and mess me around?

Mark Thoma has a followup to his earlier excerpt post of the article I posted below. When it showed up in my Reader, I got all excited and such. But, like Tony Macauly of The Foundations, I feel a little used.

Let me preface this by saying that I imagine Thoma has more thoughts about the article than what he posts, and that as a macroeconomist, he is merely trying to speak to the parts of the article related to his expertise. The problem is, by my reading, these were not the most important parts. Thoma writes,

First, academic economists have taken a lot of grief for not predicting the crisis, but realize that very few academic economists do forecasting. There are two uses of economic and econometric models, one is to use the models to understand how the world works, the other is to use the models to forecast. And while, of course, one of the goals of understanding the economy is to be able to predict it, it is simply not something most academic economists do…

Second, the economists who do forecasting need better data. If we are we are going to forecast the immediate future accurately, we need data that are timely and informative…

But there must be some way we can get a better picture of what is going on contemporaneously than we have now, and I think we need to investigate how to make that happen. The data as they exist now are fine for academic researchers who are looking backward and do not necessarily need the very latest months worth of data, though even in this setting this is sometimes a problem, but for forecasting our data are inadequate…

I do think it’s something we should put some thought into, and if there’s a way to do substantially better at getting an accurate picture of the current economy than we have now, something that would be of great benefit to policymakers, forecasters, and people trying to make economic decisions in the private sector, it would be well worth pursuing.

Maybe this data stimulus would be worth pursuing, but I have a couple points in response:

1) Kaletsky’s argument concerns the models and their assumptions, not just the fact that they were wrong. Academic economists, by building models, enable the forecaster to wreak havoc, in so far as these models and assumptions suck, which seems to have happened.

2) What about Taleb’s black swans? How would better data deal with that?

3) Macroeconomics is not crisis-oriented anyway, and again, that goes back to the models.

So, I think Thoma (whom I really respect, given that he has at least 5 more years of education plus around 20 more years of experience than I, not to mention a few years of blogging experience) is missing the point to a degree. I hope he enters into a dialogue with other aspects of Kaletsky’s argument in future posts.

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Via Mark Thoma, an excellent analysis from Anatole Kaletsky on the failure of the economics profession. The article is long, and I will quote at length:

Was Adam Smith an economist? Was Keynes, Ricardo or Schumpeter? By the standards of today’s academic economists, the answer is no. Smith, Ricardo and Keynes produced no mathematical models. Their work lacked the “analytical rigour” and precise deductive logic demanded by modern economics. And none of them ever produced an econometric forecast (although Keynes and Schumpeter were able mathematicians). If any of these giants of economics applied for a university job today, they would be rejected…

But economics should recognise that, as a discipline, it cannot be about predicting, but is instead about explaining and describing. Smith, Ricardo and Schumpeter explained why market economies generally work surprisingly well, often in defiance of common-sense expectations. Others have explained why capitalist economies can fail very badly and what then needs to be done. This was the mission of Keynes, Milton Friedman, Walter Bagehot and, in his way, Karl Marx. And the economists who got us into this mess saw themselves as the self-proclaimed successors of these great theorists…

What the “madmen in authority” heard this time was the distant echo of a debate among academic economists begun in the 1970s about “rational” investors and “efficient” markets. This debate began against the backdrop of the oil shock and stagflation and was, in its time, a step forward in our understanding of the control of inflation. But, ultimately, it was a debate won by the side that happened to be wrong. And on those two reassuring adjectives, rational and efficient, the victorious academic economists erected an enormous scaffolding of theoretical models, regulatory prescriptions and computer simulations which allowed the practical bankers and politicians to build the towers of bad debt and bad policy.

It was, of course, always recognised that economies may fail to satisfy the conditions for “perfectly efficient” markets; that there are frequently “market failures” due to lack of competition, uneven disclosure of information, tax distortions and so on…In the absence of such explicit evidence of market failure it was taken as axiomatic that competitive markets would deliver rational and efficient results…

The scandal of modern economics is that these two false theories—rational expectations and the efficient market hypothesis—which are not only misleading but highly ideological, have become so dominant in academia (especially business schools), government and markets themselves. While neither theory was totally dominant in mainstream economics departments, both were found in every major textbook, and both were important parts of the “neo-Keynesian” orthodoxy, which was the end-result of the shake-out that followed Milton Friedman’s attempt to overthrow Keynes. The result is that these two theories have more power than even their adherents realise…

The rational expectations hypothesis (REH), developed by two Chicago economists, Robert Lucas and Thomas Sargent in the 1970s, asserted that a market economy should be viewed as a mechanical system that is governed, like a physical system, by clearly-defined economic laws which are immutable and universally understood. Despite its obvious implausibility and the persistent attacks on it, especially from the left, REH has continued to be regarded by universities and funding bodies as the most acceptable foundation for serious academic research…

Why did this abstract theory become so powerful and why is its influence still so damaging? The answer lies in the interaction of economics and political ideology…Although there was never any empirical evidence for REH, the theory took academic economics by storm for two reasons. First, the assumptions of clearly-defined laws and identical expectations were easily translated into simple mathematical models…Models based on rational expectations, insofar as they could be checked against reality, usually failed statistical tests…if the theory doesn’t fit the facts, ignore the facts…How could the world have allowed such crassly unscientific attitudes to dominate a serious academic discipline…?

The answer lies, ironically, in the fact that economics is so politically important: the second great merit of rational expectations lay in its key ideological conclusion—that deliberate policies of macroeconomic stimulus by governments and central banks could never reduce unemployment and would merely exacerbate inflation. That government activism was doomed to failure was exactly what politicians, central bankers and business leaders of the Thatcher and Reagan periods wanted to hear…from this powerful position it was able to conquer the entire academic world…

To make matters worse, rational expectations gradually merged with the related theory of “efficient” financial markets. This was gaining ground in the 1970s for similar reasons—an attractive combination of mathematical and ideological tractability. This was the efficient market hypothesis (EMH), developed by another group of Chicago-influenced academics, all of whom received Nobel prizes just as their theories came apart at the seams…

Why did such discredited theories flourish? Largely because they justified whatever outcomes the markets happened to decree…

So what is to be done? There are two options. Either economics has to be abandoned as an academic discipline, becoming a mere appendage to the collection of industrial and social statistics. Or it must undergo an intellectual revolution…economists must re-open their subject to a range of speculative approaches, drawing insights from history, psychology and sociology, and applying the methods of historians, political theorists and even journalists, not just mathematicians and statisticians…

The most widely publicised recently has been behavioural economics…Partly because of this ideological compatibility, academic economics has not found it too difficult to embrace the behavioural approach.

More challenging to the orthodoxy of academic economics have been approaches that rejected the principle that economic behaviour could be described by precise mathematical relationships at all…

Even more striking examples of the cognitive dissonance in academic attempts to use mathematics as a basis for “scientific” economics are provided by Frydman and Goldberg in Imperfect Knowledge Economics. IKE, as the authors call their research programme, explicitly challenges the assumption of rational expectations that there is, at least in theory, a “right” model of how the economy works. Instead IKE draws on the insight of Keynes and Hayek that the fundamental problems of macroeconomics all derive ultimately from one inexorable fact: a capitalist economy is far too complex for any of its participants to have any exact knowledge, especially about future events, even if markets are perfectly efficient…

All such heterodox approaches have two features in common—they reject the ideological orthodoxies of rational expectations and efficient markets and the equally stifling methodological demand that economic insights must be expressed in mathematical formulae…

Economics today is a discipline that must either die or undergo a paradigm shift—to make itself both more broadminded, and more modest…Smith, Keynes, Hayek, Schumpeter and all the other truly great economists were interested in economic reality…Their analytical tools were words, not mathematics. They persuaded with eloquence, not just formal logic…

Academic establishments fight hard to resist such paradigm shifts, as Thomas Kuhn, the historian of science who coined the phrase in the 1960s, demonstrated. Such a shift will not be easy, despite the obvious failure of academic economics. But economists now face a clear choice: embrace new ideas or give back your public funding and your Nobel prizes, along with the bankers’ bonuses you justified and inspired.

I think his analysis is much more satisfying than Keen’s, which was in the recent RWER that I posted about earlier. I don’t need to say much more, other than that I think he gets it exactly right.

Meanwhile, in the neo-classical-osphere, Paul Krugman objects on a silly point:

Ahem. Via Mark Thoma, Anatole Kaletsky writes:

Smith, Ricardo and Keynes produced no mathematical models.

Now, I have Marshall McLuhan John Maynard Keynes right here. Let’s ask him…

Keynes used simple mathematical models — and he didn’t assume perfect rationality. But The General Theory is very much a book with a model-building, mathematical sensibility.

I think Krugman is referring to an economic model of Keynes, but incorrectly terms it a mathematical model. I don’t see anything calculus-related in it. And, I think Krugman is just taking exception for the hell of it. Oh, well…some of them may never come around, even if they saw all of this coming (or claim to).

And, as a final note, mad props to Mark Thoma for bringing these arguments into the mainstream.

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Can’t believe I beat Sean to the punch on this one (h/t Mark Thoma). Forbes has an article about how the recession is affecting underground economies, talking with sociologist Sudhir Venkatesh. The whole article is interesting, but I only have time for a couple excerpts:

“The recession is engendering more violence,” says Venkatesh, a professor at Columbia University. “There’s far greater competition for whatever meager resources there are. The folks down on Wall Street peddling drugs, they’re fighting. The sex workers are trying as hard as they can to retain their clients”….

Today Venkatesh is watching black market workers slip into despair along with the rest of the population affected by the economy. Lest legal workers consider this a distant problem, one conclusion of Venkatesh’s work is that the underground and mainstream economies are intimately entwined. “The boundaries are fluid, particularly in the global city where the black market has become instrumental–one might even say vital–to the overall economy,” he says. In New York City illegal workers serve sex, drugs and takeout to the wealthiest members of society–or at least they did until financial sector layoffs began in 2008…

Venkatesh is struck by how much the black market resembles the wider society in which it is enmeshed. In the same Parisian banlieues that erupted in riots in 2005, he observed an “almost aristocratic,” highly centralized criminal operation. In the ghettos of Chicago, by contrast, he observed underground workers convene an ad hoc court to solve a dispute. His dismisses the “culture of poverty” theory, which suggests that poor blacks in America don’t work because they don’t value employment. “People in America want to work,” he says. They do so ever so industriously, even when they’re breaking the law.

Venkatesh should be a familiar name if you’ve read Freakonomics- he was the guy who found out that drug dealers make the minimum wage too. The full article details his research methodology, which is rigorous and on-the-ground.

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