The visible hand in economics

Arnold Kling rips into economists

Posted on: October 23, 2008

Over at Econlog Arnold Kling takes to task virtually all mainstream Macroeconomists for there “description” of the current economic crisis. This combined with my reading last night on reductionism in economics (I think it was Robert Frank Kevin Hoover – although I have now forgotten as it was an essay in a larger book) currently has me on the back foot – even though I’m a strong methodological (and even an ontological) individualist there are obviously issues with the current application of reductionism in economics.

However, let met put down some of the key bits from the Kling.

First the criticism of current descriptions:

many economists breathlessly cited high short-term interest rates in interbank lending markets as an indicator of credit markets “freezing up.” However, as some Minneapolis Fed economists point out, the volume of lending does not indicate such a freeze

Very key point. The reason I have focused on rates instead of volumes of credit as been a result of timing – the rate is out right now, the volume numbers appear later. Given what I think has happened to the supply or demand of credit I felt that the change in the interest rate would give me an indication of what has happened to volumes – however, if the data is released and this isn’t the case we DO have to re-evaluate things.

Where are the stories of businesses canceling projects because of lack of funding?

One thing I would add is that there is a greater incentive to put cancellations in the paper during a recession, as it feeds on the public urge for “information”. As a result, even if the stories came out – i’d rather look at what happens to consents and work put in place.

Where in the textbooks is “liquidity preference” a demand for Treasury securities? Where in the textbooks does it say that injecting capital into banks is a policy tool?

One thing I would point out here is that liquidity is an factor economists have studied – especially following the collapse of Japan. However, given the lack of a integrated “general theory” of macroeconomics it is hard to look at these subsets of monetary theory in perspective with the rest of the economy. Hell, is our view of labour markets and goods markets even very well integrated nowadays?

But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men’s urge for mathematical masturbation

That quote is gold. That is definitely going to be a quote of the day at some point ;)

Personally I think he is partly right and partly wrong with this statement. The focus on mathematical models is a useful thing – as it allows us to clarify what we are describing and in what ways it works.

However, I think his main point stems from the scarcity of knowledge – there is only so many economists who can only work on so many things. As a discipline he feels we have focused “too much” on abstract mathematics and too little on “important policy issues” – so we haven’t balanced the trade-off in a way that is consistent with the social good, given economists private incentives.

This could very much be true. However, I always think that if we don’t have a clear understanding of why (which comes from the maths) then our policy conclusions will be weaker. Furthermore, I’m not even convinced that economists should make policy conclusions, we should just be describing reality.

This brings me to where I think he is right – our models of the current crisis are NOT good enough, and as a result, we can’t even do the descriptive role very well.

Economists ought to admit that we do not know much about what is going on today

Economists never know what is going on today – the best we can do is frame issues in order to try and understand them. The difficulty is that this involves conjectures – we have to guess what has happened to some variables, which involves models of there own and value judgments. We are far better at explaining what has happened – once the data is actually available.

Now, as Arnold Kling said, we don’t have the models, so we can’t conjecture what is happening clearly. This is worse than not knowing what is going on – we don’t even have the capacity to form a good partial view.

I’m not sure if I fully agree with the pessimism show here – but he raises a lot of very good points. Something for economists to chew on no doubt.

13 Responses to "Arnold Kling rips into economists"

Sounds like he’s dead right, to me.

Mainstream macroeconomics seems unable to integrate macro and micro (as if they never influenced or affected each other) and is utterly devoid of understanding of the economy’s capital structure (which is, after all, what an economy is) or of the effect of time, time preference and the central banks’ credit inflation on that structure.

But don’t worry, there’s help. :-)

Robert Murphy’s recent article on the Austrian theory of capital structure, using a small-island where the only production is sushi, is a very easy introduction. You can read it here.

And if you prefer stochastic calculus porn, then Roger Garrison’s charts and Power Point display is an easy educational tool.

Or head here for something more comprehensive.

Hope that helps. :-)

“Mainstream macroeconomics seems unable to integrate macro and micro”

The last 30 years of macroeconomic study has been about trying to integrate macro and micro economics – that is where all the “stochastic calculus porn” comes from.

Arnolds issue was that the effort involved building this integration has not been sufficient to understand issues that are currently battering the economy. Some people may take this to mean that we need to invest more in integrating the disciplines – but Arnolds feeling is that there are issues where you can’t reduce Macro from Micro, and this is what he is berating us for.

Peter, the representative-agent models that Arnold talks about ARE macro’s attempt to integrate micro: building up from micro foundations. I suspect that ought make you more depressed rather than less though.

The final 4 paragraphs of Kling’s post made the quotes.js that I use on my homepage…

“macro’s attempt to integrate micro: building up from micro foundations”

Macroeconomics is definitely a mess – but I still feel that micro-foundations are the way to go. I feel that we have a problem of “partial knowledge” at the moment – I don’t think the direction of change is wrong (which is what I think Arnold Kling is implying).

He talks more about the issues here:

http://econlog.econlib.org/archives/2008/10/work-safe_readi.html

I’ll have to think about it and then write another post. Conveniently I’m in the middle of a methodology book, which means that this sort of stuff is exciting me at the moment :)

I’m totally in favour of microfoundations; I’m just unconvinced that Euler equations are the best way of going about it.

I need to get a copy of Cowen’s macro textbook sometime.
If you haven’t read it, Larry White’s Theory of Monetary Institutions is also very good.

I’d be more a fan of the Austrian story if I could be convinced that it didn’t rely on businessmen being persistently stupid in misperceiving a monetary inflation as a real change in time preference. I don’t mind political models based on voters being persistently stupid (see Caplan) as the costs of stupidity there are externalized. I don’t like models of high consequence individual behaviour based on stupidity.

See Caplan, and follow his link to Cowen.

“I’m totally in favour of microfoundations; I’m just unconvinced that Euler equations are the best way of going about it.”

Excuse my ignorance (once again) – but what’s wrong with Euler equations. I realise that sometimes the stability conditions can be a bit restrictive, but apart from that I’ve always thought they were quite elegant.

You read me a little too literally there, Matt.

I’d be more a fan of the Austrian story if I could be convinced that it didn’t rely on businessmen being persistently stupid in misperceiving a monetary inflation as a real change in time preference.

But it doesn’t.

There’s three arguments to make here.

One is this: it’s more that each entrepreneur are in a sort of “prisoner’s dilemma” — even if they see the bubble, there’s still only one way they can respond to it. Murphy talks about that briefly in this audio interview, and Brian Stanly argues the point here</a.

There’s another way to respond: One way of thinking about it is to ask how, in the present situation, our entrepeneurs would know what the ‘natural rate’ of interest would be? What would be the ‘natural rate’ of time preference? In the absence of the central bank, how would one know?

What, for example, is the ‘natural rate’ of interest now?

And a third, related point, is Gene Callahan’s point that in a time of easy credit creation, even the rational entrepreneur has no choice about paying for the resources whose prices have been bid up in the bubble – if the owner of Sensible Software wants to stay in busines then, astute though he might be about what the central bank is doing, he has no choice but to pay the prices for his resources that have been bid up by Dotty Dotcom. Read his argument here: ‘But What About Expectations’ in the article ‘Times are Hard: On the Causes of the Business Cycle.’

The PD argument comes from Carilli and Dempster. I didn’t buy the story when I first saw the paper presented at GMU, but I’m happy to give it another read.

Investors don’t need to know precisely the right natural rate of interest; they just have to know that the Fed is inflating. And that’s not hard to figure out from monetary aggregates. Any reason they wouldn’t get it right on average?

The Callahan argument sounds like it reduces to the Carilli and Dempster argument, but I’ll have to give it a look.

“You read me a little too literally there, Matt.”

Ahh I see, you aren’t criticising the actual method of dynamic optimisation – just the way mainstream economists currently do it (insofar as the assumptions they make surrounding what is optimised and knowledge). Is that it?

there is stochastic calculus porn outside of financial economics? My interest in macro has been tweaked:)

You did International agnitio – you must have seen the scope ;)

The Effectiveness of “Traditional” Neoclassical Economics in Solving current problems

My name is Jeffrey M Doyle. I ATTENDED THE UNIVERSITY OF MICHIGAN, ANN ARBOR AND MICHIGAN STATE UNIVERSITY, RECEIVING MY Ph.D. IN 1977.

FOR OVER THIRTY YEARS MY [AND OTHERS] IDEAS WERE DISMISSED AS UNPROVEN AND NOT RELEVANT. TODAY MOST
OF WHAT I PROPOSED IN A 1977 PH.D. DISSERTATION HAS NOT ONLY GAINED ACCEPTANCE BUT IS BEING ACTIVELY
PROMOTED AND PUT INTO PRACTICE. BETTER LATE THAN NEVER.

IN TERMS OF OUR ECONOMY, WE ARE CURRENTLY IN THE WORST SHAPE SINCE THE GREAT DEPRESSION OF 1929. HARD
CORE, DEEPLY ENTRENCHED ADVOCATES OF NARROWLY DEFINED ECONOMICS WILL STAUNCHLY DEFEND THEIR
ICONIC VIEWS-EVEN IN THE FACE OF ONE DISMAL FAILURE AFTER ANOTHER. GALILEO’S REWARD FOR PROVING THAT
THE EARTH ORBITED THE SUN INSTEAD OF THE OPPOSITE SCENARIO ESPOUSED BY THE VATICAN, LED TO A LIFETIME OF
HOUSE ARREST.

Hence, while mainstream economics may be defined in terms of the “rationality-individualism-equilibrium” nexus, heterodox economics may be
defined in terms of a “institutions-history-social structure” nexus. Note that there is a different emphasis in distinguishing mainstream and
heterodox economics in this way than is involved in distinguishing them as closed-system and an open-system approaches respectively. It is
often claimed that neoclassical theory is appropriate as a tool only under certain limited conditions, where there is “perfect” or “near-perfect”
competition. While there is a large body of neoclassical analysis of imperfect competition, this terminology may be seen as incorporating the
assumption that non-competitive markets represent minor deviations from an ideal or perfect norm

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