I’m starting now on what will I think be the hardest and most controversial chapter of my book – the argument that the search for a macroeconomic theory founded on (roughly) neoclassical micro, which has been the main direction of macro research for 40 years or so, was a wrong turning, forcing us to retrace our steps and look for another route. As always, comments and criticisms accepted with gratitude.
Refuted doctrines
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Micro-based macro
We are now all Friedmanites, Lawrence Summers, (former US Treasury Secretary, now Director of the White House’s National Economic Council, and prominent New Keynesian economist) and
At the end of the 19th century, British Liberal politician Sir William Harcourt observed “we are all socialists now”. Harcourt was referring to a radical land reform measure that had been denounced as socialist when it was introduced, but was generally accepted by the time he was speaking (a couple of years later). Harcourt’s point was applicable to the whole trend of economic and social policy, in Britain and elsewhere, from the 1867 Reform Bill that gave millions of working class men the vote (women had to wait until after World War I) to the crisis of the 1970s. From progressive income taxes to publicly-owned infrastructure services (both prominent items in the 10-point program of the Communist Manifesto)) ideas that were unthinkable in mainstream politics became issues of political contention and then established institutions.
As a pithy summary of the way ideas that were once radical become acceptable, and are ultimately embodied in conventional wisdom, Harcourt’s quip has never been bettered. As a result, it has been reused many times over.
One of the most notable adaptations of Harcourt was that of Time Magazine in 1965, which noted, following the successful use of fiscal policy to stabilize the economy that “we are all Keynesians” now. This statement was made by Keynes’ greatest modern critic, Milton Friedman (though he later said it had been taken out of context). Even more famously, it was repeated by Richard Nixon in 1971.
But whereas Harcourt was speaking at the beginning of a nearly a century of reform that did indeed take economic policy in a socialist, or at least social-democratic direction, Nixon’s statement marked the end of the era of Keynesian dominance.
In fact, Nixon was citing Keynes’ aversion to the gold standard (a “barbarous relic”) as a justification for abandoning the pegging of the US dollar to gold, which was a central feature of the Bretton Woods system of fixed exchange rates that had underpinned Keynesian economic management since World War II. The outcome was not a system of stable exchange rates backed by a basket of commodities rather than gold, as Keynes had proposed, but the complete breakdown of Bretton Woods and a shift to the floating exchange rate system advocated by the greatest critic of Keynesian economics, Milton Friedman.
In the course of the 1970s, Friedman and his supporters, centred on the University of Chicago, won a series of political and intellectual victories over the Keynesians. Following the failure of attempts to stabilise the economy using Keynesian fiscal policy, governments around the world switched to Friedman’s preferred remedies based on controlling the growth of the monetary supply. Even though this did not work particularly well, and was later replaced by policies based on managing interest rates, the resurgence of the Chicago School was not reversed. Their case against government intervention, both to stabilise the macroeconomy and to address market failures in particular industries, was widely accepted.
The Keynesians conceded Friedman’s central points: and that macroeconomic policy can affect real variables, like the levels of employment and unemployment, only in the short run. They sought to develop a ‘New Keynesian’ economics, by showing that, given small deviations from the competitive market assumptions of the basic neoclassical economics model, it would be possible to explain the recurrence of booms and recessions and to justify the modest stabilisation policies pursued by central banks during the Great Moderation. Because prominent representatives of this group were located at Princeton and Harvard on the East Coast of the US, and at Berkeley on the West Coast, they were sometimes called the ‘saltwater school’ as opposed to the ‘freshwater school’, located in the lakeside settings of Chicago and Minnesota.
Members of the freshwater school sought to push Friedman’s conclusions even further, arguing that macroeconomic policy could not be beneficial even in the short run. They tried to show that government intervention could only add uncertainty and instability to the economic system, and that, in the absence of such intervention, economic fluctuations like booms and slumps were actually good things, reflecting economic adjustments to changes in technology and consumer tastes. The resulting models went by various names, but the most popular was ‘Real Business Cycle Theory’.
Despite their often heated disagreements, saltwater and freshwater economists were in agreement on one fundamental point: that macroeconomic analysis must be based on the foundations of neoclassical microeconomics. And, although they disagreed about economic policy, these disagreements could be contained within a very narrow compass. With a handful of exceptions, both schools took it for granted that macroeconomic management should be implemented through the monetary policies of central banks, that the only important instrument of monetary policy was the setting of short-term interest rates and that the central goal of monetary policy should be the maintenance of low and stable inflation. Granting these premises, saltwater economists argued that stability could only be achieved if central banks paid attention to output and employment as well as inflation, while the freshwater school favored an exclusive focus on price stability.
The global financial crisis did not so much confirm or refute the elaborate arguments of the competing schools as render them irrelevant. The saltwater school could claim vindication for their view that the economy is not inherently stable, but their models had little to say about the kind of crisis we have actually observed, driven by an interaction between macroeconomic imbalances and massive financial speculation.
The freshwater-saltwater disputes were similarly irrelevant to the policy debate which was conducted in terms that would be familiar to someone who had not looked at an economics book since 1970. (In fact, the freshwater side of the dispute rapidly reverted to arguments from the 19th century, which had been debunked by Keynes and Irving Fisher).
As Gregory Clark of UC Davis observed ‘ The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.’
If we are to develop a macroeconomic theory that can help us to understand, and hopefully prevent the recurrence of, crises like the current one, and help us to improve policy responses, economics must take a different road from that it has followed since the 1970s. The appealing idea that macroeconomics should develop naturally from standard microeconomic foundations must be recognised as a distraction. In its place, we must accept, in the language of systems theory that macroeconomic phenomena are emergent, arising from complex interactions of behaviors we do not fully understand, but must nevertheless respond to.
John Quiggin 
Matthew Yglesias agrees, citing the final paragraph in Reduction in Economic Theory.
Signs of going viral?
Steve Keen has a link in his blog to a paper ““No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models”;
http://mpra.ub.uni-muenchen.de/15892/
The first part of the title is ironic. The paper is about 12 economists who did see the crisis coming. Steve Keen gets a mention and I for one can’t blame him for blowing his trumpet a little. John Quiggin probably made some predictions which might well qualify him for this list too? JQ, can give any links back to any of your predictions before the GFC?
More pertinently, JQ, do you count yourself (in terms of general theory and praxis) among these heterodox economists?
The problem I have is that you make a distinction between a free market economist and new Keynesians and you assume that these two ingredients make up the bulk of the academic literature.
In fact, there has always been a second school of new Keynesians – one that, while it generally relies on the all-powerful Central Bank to step into the breach, it also makes provision for a larger fiscal role in cases where the Federal monetary role went off the rails.
Fiscal intervention can be done with the aid of taxes and spending to smooth out short term fluctuations (called contra-cyclical policies) or it can be done through “discretionary” measures which involve new tax or spending policy initiatives. This has largely been a formal part of Treasury’s literature, which has always insisted on contra-cyclical policy.
I believe that old Keynesians are still in the majority
So, both salt and fresh water fish are out of water Good to hear.
JQ,
I like your clear statement on the need for new theoretical research and your preference for rigorous theoretical research. There is one point though, which I believe opens the way for more school of thought talk. It concerns the term ‘neo-classical’. I have no reason or evidence to believe that this term is unambiguously defined, although it might be useful for authors of books on the history of economic thought as a name for a historical epoch.
@Ikonoclast
I think this piece sums up the issues. OTOH, I’ve never been attracted by the “heterodox” label
I think, in this chapter, you could discuss, briefly, misapplication of the ‘moral hazard’ argument.
A problem with the ‘moral hazard’ argument for not bailing out a bank is that it is individuals that make decisions, not an entity like a bank. Lehman Brothers not being bailed out might have punished the bankers who made the bad decisions to a small extent, relative to not bailing them out, but the decision of not bailing them out punished an incredible number of innocents. First, the shareholders and more junior staff were relatively innocent victims, but more importantly the rest of the world that has been suffering the repercussions since, most of whom were totally innocent. The ‘moral hazard’ argument in these circumstances is nothing more than a collective punishment argument. Unfortunately, unlike the Nazi use of collective punishment in WWII, I don’t think those who made the bad decisions really care that much about those who have been punished collectively. Moral hazard would be better addressed by changes to laws that allow the decision maker to be punished for foolish and negligent decisions. I doubt that this will happen because who will finance the lobbyists for this law change.
@Freelander
Watch it Freelander or someone will mention that that silly Godwins law (real soon…) I was going to suggest myself, collective punishment isnt really the same as letting Lehman’s fail. The only moral hazard I can see was when we let Goldman and AIG stay with taxpayers help. I have a moral objection to that and they are still a hazard.
We have to let AIG and Goldman stay with taxpayers help, unfortunately. However, those at the top should have lost big and shareholders should have lost their shirts and bondholders too, according to any short falls. The government should have taken it over and, as required to keep the system going, guaranteed those who had purchased their products. That protects the systemic risk. Unfortunately, to save people from the systemic risk those at the top got generous bonuses. To do it the right way the law has to be different. A government regulator has to be able to step in in a way that does not reward poor management or shareholders or bondholders, but which does address the system wide risks. And I agree they are still a hazard, but if they too failed we would be in a worse situation and when it is all over it would happen again with new firms with new names.
I think that it is now clear that the models of Neoclassical Economics are falsified. They fail to describe the empirical reality of the economy and they fail as predictive theories. If some are not happy with the tag “Neoclassical Economics” then we can say that Equilibrium modelling in economics has been falsified. In the long term, a move to non-equilibrium modelling will be required to maintain policy relevance.* What I am saying is that policy relevance, real or perceived, must be grounded in empirically validated theory or it is ultimately worthless.
* I’ll put one caveat on that. Globally, due to idelogical and religious reaction, we might not move to empirically based models for our economic and climate programs. However, if we fail to so move then there will be NO economy and NO global civilization left to speak of at all.
@Alice
By the way, I had no intention of comparing the former US Secretary of the Treasury to a Nazi, even if some think his then leader resembled a certain person with a moustache. I was just making the point that if you want collective punishment to work, those you really want to punish must have some emotional connection to those being punished.
Freelander
Collective punishment was used by British colonists as they rampaged through Aboriginal lands from 1788 to 1920’s. It seems to always suggest violent retribution – not merely shifting costs/harm onto univolved innocents.
It seems a strange device to explore the issues of bailout and moral hazard?
Ikonoclast @9.
“If some are not happy with the tag “Neoclassical Economics” then we can say that Equilibrium modelling in economics has been falsified.”
I don’t think you can say that, Ikonoclast. You seem to have a particular example of an equilibrium model in mind.
To illustrate, there have been ‘sun spot equilibria’ models for a long time. These models have very different properties to the late 19th century model and in particular the macro models.
Without specification of the model and the equilibrium concept, the term ‘equilibrium model’ has become meaningless. We are no longer in 1940.
Further, Ikonoclast, I don’t believe hat the methodology of natural science is ever going to be a role model for economics. In contrast to water, which always flows down hill, a human being can walk half-way down hill and then turn around and walk up again.
The purpose of some models is merely to develop useful concepts. Their usefulness derives from a check on their internal logical consistency within the context of a model. For example, in the link referenced by JQ there is a national accounting identity. This is an equilibrium condition. JQ says that there is no particular theory underlying it. Well, in some sense I agree. But in another I don’t. On what grounds are the categories picked?
You can sail a yacht without adjusting the main but you won’t win races. Perhaps the same could be said about countries using central bank interest rates as the sole means of economic control. This is particularly true when central banks ignore the globalization of the world economy and persist on trying to control inflation measured in terms of the currency of their countries. (Instead of some trade weighted measure based on the currencies of the countries they trade with.
It is suggested that part of the cause of the GFC was the combination of large, chronic, unsustainable trade deficit on the part of the US and the large, chronic, unsustainable trade surpluses of China and Japan. The problem was recognized well before the GFC but action solve this problem was inhibited WTO rules that were based on an almost religious belief that free markets were the answer to everything.
I am not suggesting that we go back to the economic world as it was in the 1960’s. What I am suggesting that economics needs to become more nuanced and pragmatic and less driven by those seeking the economic answer to everything.
For example, we certainly need WTO policies that allows countries like the US and Australia to deal with their chronic trade deficits. (One of the ironies of the WTO is that a key argument for free trade is that it encourages innovation – While WTO rules are all about restricting what countries can do to solve their trade problems.)
In Australia, we need to insist that the Reserve Bank, Free Trade Commission and government have to be part of the same team. It is ridiculous to have the government working to stimulate the economy while the reserve is already talking about slowing the economy down.
It was also ridiculous to have the Reserve bank putting on the economic brakes during the recent boom while unemployment was still over 4%. All this did was take the pressure off business to make more effective use of the low skilled people in our society. Staying with inflationary pressure for longer may have allowed us to build a less inflation prone economy.
@John Davidson
I think the trade deficit story is just a ‘lets blame the Chinese’ story. In fact the US should be happy that the Chinese have been so generous in subsidising them and now have a major problem in getting their trillion dollars back intact. The low interest rates etc. certainly helped things, and the main culprit there was monetary policy, but the real problem was the clever commission and bonus motivated decision makers introducing the lending of money to people who obviously couldn’t pay, in a way that wouldn’t become undeniable for a couple of years, and then recycling those mortgages as triple A bonds (with the help of rating agencies) using the magic of CDOs and CDSs so they could get more money to do the same thing with. It had all the hallmarks of a Ponzi scheme. Poor Bernie is in jail for a similar rort but the evil doers in this case (to use a Bushism) don’t even have to worry about the law and have most of their money in the case of Lehman Bros or are getting bonuses in the other cases.
@Alice
Alice, with a bit of luck there will one day be a similar law for introducing comparisons to G W Bush and his administration.
@John Davidson
Re: co-ordinating fiscal policy with the Reserve Bank, I think they are doing fine. The Reserve Bank is only talking about starting to bring interest rates back to more normal levels next year and, after all, Ken Henry is one of the board members so it is not as if Treasury and the Bank don’t talk and try to co-ordinate. Over dramatic use of monetary policy (in the US) is one component of what got us in trouble in the first place. For over dramatic use of monetary policy look at the history across the Tasman, particularly under Brash. Loose monetary policy doesn’t seem so good at fixing an ailing economy but tight monetary policy sure can kill a healthy one. And loose monetary policy creates inflation or bubble problems when an economy starts off just fine. I think our Reserve Bank has a pretty good record of handling monetary policy without unnecessary drama.
@Freelander
Freelander – by saving Goldmans and AIG we have provided an impicit guarantee that the same faulty methods will continue in our financial markets. We guaranteed the biggest will not be made to carry the consequences of their own risk taking and excess surplus removal (remunerations) from the companies they pretend to run for the benefits of shareholders. We have, through “protection”, protected the very behaviours that caused the financial crisis.
I know it would have caused pain (lots), but it might have made every other complacent well fed (too well) financial executive sit up and pay attention to whats appropriate in running a company on behalf of shareholders and what isnt.
Lessons if you like, collective punishment of you like, but what on earth are we doing bring back the anti christ of protection when these are the very people who said they didnt need it and we didnt need it. If its protection we are resucitating, let it go to small businesses not large ones.
They can fail IMHO. I dont care who they are connected to by power and influence and financial trading links. We do not need them as much as we think. We just never tried to do without them and we should. This is nothing more than the tariff walls of the 1920s only we have built those same walls around one sector and one sector alone. In lots of ways its not even as fair or equitable as the protection of the 1920s. Itds enslavement of taxpayers to those who never needed it for any productive reasons.
@Freelander
With a little bit of luck Freelander…
@Alice
The problem is that the ones that make the decisions almost alway walk away largely intact and with most of their ill gotten gains. Most of those at the top of Enron are still quite wealthy with the money they got from running Enron. Same is probably true with those from Lehman Bros. Thats why there needs to be new laws, and significantly sizeable punishments, so that when they do the wrong thing they do end up making a loss. As it stands at the moment even if the worst happens to them they come out ahead. Under these conditions there is no reason for them to change their behaviour. That’s why the moral hazard argument is so totally vacuous. Sure it may mean they miss out on one more round of unearned bonuses but to do that it creates an incredible amount of collateral damage. For much of business doing the wrong thing even if you get caught is profitable. A good example of that is a certain software company.
@Freelander
Well that is interesting Freelander …of course they walk away. I wonder where the management of Long Term Capital managemnt is today, I wonder where Michael Milken is today, Bond is out of jail, Rivken is dead but only did weekend detention, Skase is dead but never got before a court, Bloody Jodie Rich has managed to avoid jail time, Eddy Groves isnt anywhere near a jail yet (nor is he likely to be), Rodney Adler – is he out (what does it matter – he is still in business)? What about the HIH gang? Where are they? Richo the “persuader” ex “offset alpine profiteer and tax scammer” now in bed with the wealthy property developers, Ells and McGurks and that other one who dines at the Forum in Leichhardt. Hellicar, the most morally bankrupt blonde in corporate life that ever breathed has been slapped with a lecttice leaf.
They keep walking away with dirt on their hands in this country and a bare whisker of a reprimand.
Corporate crime has no effective punishment (at least not in Australia – the land of the free).
@Alice
And that’s the real problem!
Yes – it is the problem, Freelander.
John, it’s interesting that while the macro wars have started again (a bit like the Hundred Year’s War, a series of on- and off-again conflicts), there are never any micro wars. Yet, if representative optimising-agent macroeconomics has failed as an explanation for the whole economy, why hasn’t optimising-agent microeconomics failed as an explanation for firms and industries?
It is this microeconomics that forms the basis of the design of emissions trading schemes (or carbon taxes), proposals to tax traffic congestion, indeed pretty much all of tax policy, proposals to break up Telstra, and so on. There is a lot at stake.
Assuming that neoclassical economics is just fine, for practical purposes, for analysis of firms and industries (yes I know you can’t aggregate individual demand functions to get market demand functions except in special cases; no one cares in practice), just what is it about the whole economy that turns a useful body of analysis into something worse than useless?
Maybe (to reprise the literature of the 70s and 80s) it’s because for macro you need to incorporate money in the analysis, but money is conveniently not needed for micro. But this is just re-stating the question.
@Freelander
The trouble with depending on interst rates changes as the major tool for controlling the economy is that it is a blunt instrument that causes a lot of collateral damage. For example, increasing interest rates may slow down inflation measured in terms of $Aus but it contributes to inflation when it is measured in terms of the currencies of our competitors and customers as well as inflating the cost of capital for Australian companies that have to compete in the global economy. Hardly a good result for a country with a chronic balance of payments problem
In addition, changing interest rates is not the only tool that can be used to fight inflation. It will often make more sense to understand what is causing a particular burst of inflation and then take appropriate targeted action.
We need a team effort to handle the economy and a willingness to use a wide range of solutions to our problems of inflation, trade balance etc. We are not going to get the best solutions while the RBA feels free to change interest rates without the agreement of the economic team or the government.
So given all these dead ends, what are the most promising research programs in macroeconomics today? And do you see academic conservatism as an obstacle to their development?
why don’t they care? is it sheer laziness, inertia or ideological convenience? would you cross a bridge built by engineers with this sort of attitude?
Gerard, to be precise, you can’t be sure that you can aggregate individual demand functions to get market demand functions, except in special cases. But it could still happen in theory, and in practice, market demand functions do tend to look like what you would expect them to look like if you could aggregate.
Who is this guy?
http://www.dailytelegraph.com.au/news/breaking-news/academic-claims-gfc-was-business-as-usual/story-e6freuyi-1225777486783
And can someone tell me what the difference is between a “tax cut” and a one of tax refund, except the former has to be wound back.
@John Davidson
I agree John Davidson – inflation is a complex animal – it can affect different commodities or be only driven by one input and not others…its interesting that inflation can take these quite different forms (and be driven by one resource even) but the treatment by central banks is actually very blunt as you say.
Could I suggest that the problem is not that macro models are/aren’t derived from micro foundations, but the “neoclassical” nature of those foundations.
By contrast, there is a growing area of econophysics and of political economy devoted to micro-agent-based modelling/simulation of economies on the assumption that the micro agents act more or less at random, or according to simple rules, yet which still produces rich and emergent macroeconomic phenomena.
The difference is that a simulationist method is not wedded to the idea that the economy is one rational individual writ large (one consumer purchasing one commodity, as Steve Keen puts it). The research program is explicitly modelled upon the thermodynamics of gases, where the random behaviour of umpteen individual molecules nevertheless leads to simple ideal gas laws.
See the recent comment article in Nature, The Economy needs Agent Based Modelling, the seminal book by Moshe and Machover Laws of Chaos: A Probabilistic Approach to Political Economy (whole book available as pdf) and the recent paper by Wright, Implicit Microfoundations for Macroeconomics.
nice links James. I had the Santa Fe people and ABCE in mind when I was asking Prof Quiggin about what he saw as being the more promising directions in future research, although I think some work by Krugman and others on the spatial economy also deals with emergent phenomena and is inspired by mathematical ecology. The thermodynamics of gas have inspired current research in the modeling of traffic and I’d expect that this sort of thing would have already broken into the mainstream of economics more than it has.
But Krugman also pointed out (and if I had time I’d google the quote), that you don’t get tenure or top-journal publications by coming up with something new and interesting, but by making minor embellishments on what is already well established.
I think that the idea that the neoclassical foundation that “the economy is one rational individual writ large” is what Uncle Milton meant by “special cases” – the Sonnenschein-Mantel-Debreu condition that everybody has identical preferences allows individual demand curves to be aggregated into a country’s demand curve. But as computers become more powerful I would expect modelers to stop relying on that type of simplification.
@Ernestine Gross
Ernestine, strictly speaking I am a layperson on economic matters so I may be talking through my hat. Having said that, I have a basic tertiary degree (BA) and this did include literature, media and science subjects. I have also read extensively out of my specific subject areas and might mention authors like Adam Smith, Marx, Bacon and Hume.
Based on my general understanding of the arts and sciences I try (in matters in which I am still a layperson) to assess the various claims of exponents in various fields, for example in climate science or economics.
My touchstone is empiricism in general and scientific empiricism in particular. I’ll let the Wikipedia sum it up for me or rather us.
“In philosophy, empiricism is a theory of knowledge which asserts that knowledge arises from experience. … Empiricism emphasizes the role of experience and evidence, especially sensory perception, in the formation of ideas, while discounting the notion of innate ideas (except in so far as these might be inferred from empirical reasoning, as in the case of genetic predisposition).
In the philosophy of science, empiricism emphasizes those aspects of scientific knowledge that are closely related to evidence, especially as discovered in experiments. It is a fundamental part of the scientific method that all hypotheses and theories must be tested against observations of the natural world, rather than resting solely on a priori reasoning, intuition, or revelation.”
I understand your general objection to my line of reasoning but I don’t accept your objection in toto. You complain that, Ernestine, strictly speaking I am a layperson on economic matters so I may be talking through my hat. Having said that, I have a basic tertiary degree (BA) and this did include literature, media and science subjects. I have also read extensively out of my specific subject areas and might mention authors like Adam Smith, Marx, Bacon and Hume.
Based on my general understanding of the arts and sciences I try (in matters in which I am still a layperson) to assess the various claims of exponents in various fields, for example in climate science or economics.
My touchstone is empiricism in general and scientific empiricism in particular. I’ll let the Wikipedia sum it up for me or rather us.
“In philosophy, empiricism is a theory of knowledge which asserts that knowledge arises from experience. … Empiricism emphasizes the role of experience and evidence, especially sensory perception, in the formation of ideas, while discounting the notion of innate ideas (except in so far as these might be inferred from empirical reasoning, as in the case of genetic predisposition).
In the philosophy of science, empiricism emphasizes those aspects of scientific knowledge that are closely related to evidence, especially as discovered in experiments. It is a fundamental part of the scientific method that all hypotheses and theories must be tested against observations of the natural world, rather than resting solely on a priori reasoning, intuition, or revelation.”
I understand your objection to my line of reasoning but I don’t accept your objection. I think philosophically and empirically it is refutable. You said “I don’t believe that the methodology of natural science is ever going to be a role model for economics. In contrast to water, which always flows down hill, a human being can walk half-way down hill and then turn around and walk up again.”
Let us examine your statement. In simple terms you are saying one of two things.
(A) Hydraulics is simple (relatively speaking). Human behaviour is far more complex. Both are natural phenomena but there are far too many unknown variables to predict human behaviour.
(B) Hydraulics deals with physical phenomena. Human behaviour is influenced by more than physical phenomena. Thus it logically follows that human behaviour is influenced (at least partially) by other phenomena of metaphysical or supernatural origin.
If your proposition is (B). I can say that I respect your position (though I do not agree with it). Further I would say that you are being logically consistent with respect to your a priori assumptions.
However, if your proposition is (A), you need to show more caution about assuming that human behaviour (singly or in aggregate) is too complex and unpredictable to be amenable to explication by the methods of natural science.
Without letting this answer drag on too long, I would say that mass behaviour of humans and their various economic systems can almost certainly be found to obey system-specific laws. (I mean laws true within a certain general system like Western Capitalism.
The problem with equilibrium models of the economy is that they don’t match reality. These models are unempirical. The real system does not act like any of the equilibrium models. If any model does not model reality then it is an academic exercise at best.
The Dahlem report says it well. I hope the long link posts correctly.
Click to access Dahlem_Report_EconCrisis021809.pdf
Oops, sorry, a paste went wrong and doubled up part of my text.
@fredn
Fred – you only need read about the company Kates keeps and where he publishes…
Kates is a stooge writer for Quadrant..you may as well write him off ..one of those who keep yelling “lower taxes lower taxes”…the same type that seem to think CEOs salaries are competitive and workers should have no rights..
Enough said…and he apparently mistakenly thinks he has a clue about the business cycle but I bet he didnt see GFC coming …oh no. Likely a waste of acedmic space.
http://www.quadrant.org.au/blogs/qed
@John Davidson
I agree that interests are over used by central banks around the world. I don’t agree that the RBA tends to willfuly work at cross purposes to sensible actions by Treasury and Government. If the Government willfully persists in doing something silly, however, I think the RBA, to the extent that voting of the board allows will try to mitigate the harm that is done.
Amongst the tendency to over use of monetary instruments by central banks, I tend to prefer our RBA to say the NZ equivalent or the Federal Reserve in the US. The RBA tends to use a much more steady hand. And this is good because changes to interests rates can turn profitable businesses into bankrupt ones or encourage unwise borrowing and asset bubbles, the collateral damage you mention.
I agree there are other instruments. But I think that monetary instruments are still important, long term, when it comes to keeping the inflation rate stable. I suspect that they tend to be overused for fine tuning.
@fredn
Fred – This Kates guy is now busy writing pretty uninspiring articles for Quadrant attempting to turn the blame for the GFC from the over liberal liberals and mad de-regulators and excessive money flowing to the wealthy from the Wall st casino and an eroded tax constraint on them (the wealthy) ….to …wait for it…Keynesianism.
No they dont want Keynesianism, even if it works much better than the nonsense theories Quadrant have been publishing for Corporatesville and Coalsville and the right dishonourables for god knows how many years now. Quadrant and IPA publish garbage, using lackeys posing as academics for their masters, usually large employers like CEOs and Sir Lunchalots who usually have their hands in the economic till big time and they dont want to take them out and see a more balanced approach.
The amazing thing is the articles are never very well written either..must be on a piece rate.
@Freelander
We have run with a chronic balance of payments problem for years. To make matters worse the RBA has had Australian interest rates well above the OECD average every time I have looked. My perception is that central banks were spooked by stagflation and haven’t really understood how the role of interest rates has to change in a more globalized, freer trading world.
Perhaps my problem is that I’m a chemical engineer who has spent a lot of time sorting out control and other problems. I guess I would hate to have been a problem solver who wasn’t allowed to consider some solutions because they didn’t have the big tick from the fossils in the Chicago school of chem eng.
Perhaps you should be asking how our economic management system should be set up to seek out and implement the best answers to controlling the economy? I would be disappointed if your answer was a system that gave the RBA control of interest rates.
@John Davidson
John – I imagine there would be no greater torture for a problem solver..(waiting for a tick from the Chicago school of chem engineering – especially if you thought the Chicago school were absolutely terrible engineers).
@gerard
Gerard, Krugman has indeed done some interesting work with similar emergent models in his spatial economy studies; which makes it all the more a shame that he’s not going the whole hog now, instead saying “I, for one, am not going to banish maximization-and-equilibrium from my toolbox”. If he did, he could drag half the profession with him and become the 21st century’s paradigm-shattering John Maynard Keynes, IMHO. Instead, as Keen points out, it seems like he’s never going to get the complex systems thing.
On the other hand, I don’t have a pseudo-nobel or a record of successful predictions as Krugman does, so we shall see!
@John Davidson
I think far to much notice has been taken of Milton Friedman’s ideas and have little time for the Chicago Collective (or School as it likes to call itself), but that doesn’t mean monetary policy is totally irrelevant. As recent event have demonstrated, for the problems we were/are in fiscal policy was the solution. As for long term interest rates, Australian rates have been higher, on average over the years, than US rates because the Americans have been subsidised by the rest of the world using them as a reserve currency. Savings rates, the size of the economy, stability of the exchange rate and many factors come into play in determining long term interest rates. The central bank has limited influence over keeping the long term interest rate down, below a certain point, over the long run. It is just not something they can control over the long run. Except to do harm.
Freelander,
I think you have entirely misread the situation.
The GFC/credit crunch has required different responses because it manifests itself differently in different countries. This is what angers me about people who take an ideological line to economics.
In Australia the credit flows were maintained so demand management through automatic stabilisers, stimulus package and confidence (think of the confidence multiplier) were in effect.
In the US, fiscal policy is less effective because the financial system is broken and the problem is not on the demand side.
Rushing headlong into the “fiscal policy is always the solution” crowd is very dangerous for the long-term health of an economy
Sorry for the above post as “SG”. It is just that I used my personal computer and because I have been away for so long I forgot my name while my work computer saved my name.
SG, keep an eye on U.S. exports to China which totalled more than $30 billion for the first six months of 2009 and going up.
@SG
Sean – you say “Rushing headlong into the “fiscal policy is always the solution” crowd is very dangerous for the long-term health of an economy.”
Sean G, I havent met a single soul like that in here (and if you can point one out Ill put a bet against) but I have met plenty of liberals who want no intervention at all..half the problem of economics is the extremism of the tribes. Original message lost and the tribes worship effigies. In my view, there has been overreliance on a de-regulation, freeing of markets, privatisation of public sectors pervading policy for at least 30 years and a strong preference for the dabblings of the all powerful RBA and its inflation target (who is watching unemployment here?) notwithstanding concurrent use of fiscal policy. I dont think anyone really advocates “fiscal policy is the only solution” but to get some balance back and some broadening of the indicators (like unemployment, rising inequality) which are actually taken into account in policy would be much more sensible.
Alice, you should have mentioned any increase in welfare payments to the most disadvantaged in society, ie the unemployed, is a Christian act.
Dear Readers;
Usually I would place this in the Weekend Reflections thread – but it doesn’t seem to have be provided recently… Hope JQ doesn’t mind… :))
I have just published a new entry on the Left Focus blog. The entry considers recent commentary by the important progressive US economist Joseph Stiglitz. Specifically I address arguments regarding whether or not GDP is the most appropriate measure of social and economic progress.
Furthermore I consider the case for further economic stimulus – in Australia, in the US – and worldwide…
Your contributions to the debate would be welcome – either at our Facebook page- or better still at the Left Focus blog itself…
see: http://leftfocus.blogspot.com/
and
http://www.facebook.com/home.php#/group.php?gid=58243419565
You’re also all welcome to JOIN our Left Focus support group on Facebook too (
URL above)
sincerely,
Tristan Ewins (Left Focus Moderator)
Tristan Ewins, I’m sure the host welcomes you but as for the economic stimulus it should be viewed as a ‘Keynesian economic miracle’ for if market forces were left to their own devices then the world would have entered into a long and protracted worldwide recession and possibly a deep depression.
At the risk of repeating myself, I want to take issue (once again) with Ernestine’s refusal to accept “neoclassical economics” as a term for a definable school of economics. I hope we can debate this politely but robustly. Ernestine, I find your resistance to this term scientifically and philosophically untenable. However, I may have misunderstood the grounds of your rejection. Bear with me as I argue this through. Do you also resist all (or some) other general labels such as Classical, Marxist, Keynesian, Austrian, Monetarist, New Keynesian etc.?
Neoclassical is a broad term for sure. To take some examples from other fields, if we are to reject a term like “neoclassical economics” then we would also have to reject a term like “Protestantism” or even contrasting terms like “plants” and “animals”. In doing so we would be rejecting a standard method of classification which applies not only throughout the sciences but also through much of philosophy and the humanities. This is the process of classification first by major divisions based on shared major characteristics and then on down through the sub-divisions of shared intermediate and finally minor characteristics. Biology provides a well known example with the current Linnaean or perhaps I should say the “New Linnaean” system.
If a person refuses to accept both the general convention and the specific pragmatic values of classification or if that person refuses to accept an otherwise widely accepted term (in both academic and lay literature) then this can render it impossible to engage that person in logical debate in the arena of the disputed term or terms. There can be cases where refusal to accept a term is defensible. This refusal, to be defensible, must be based on a rejection of the term for being idiosyncratic rather than generally accepted, or on the term being an outcome of a demonstrable misclassification, or on the term being an outcome of spurious differentiation. I do not accept that the rejection of the broad term “neoclassical economics” (for a broad school, “phylum” or perhaps “class” of economic theory) fits any of these defensible rejection criteria. However, Ernestine, you may be able to offer an argument in this area.
Often, lacking a defensible rejection as above, the refusal to accept a term reveals a refusal to debate what the holder self-perceives as a “natural” and thus undebatable position. This often occurs in the arenas of ideology, religion or political economy where a personal belief system (self-perceived to be absolutely true, natural and unquestionable) is threatened by any attempt at debate. Debate is shut down before it can begin. The neatest way is to deny that the opponent’s terms have any meaning content. Thus if a person believes there is only “economics” (in the sense of current mainstream economics) then from this “self-evidently natural” viewpoint the attempt to delineate major defining characteristics and thus different schools of economics is ruled out of court straight away. If a person is raised and educated exclusively in one culture that person simply cannot conceive that other cultures exist. Further that person cannot recognise that their own culture is particular and peculiar and requires a defining label for shorthand reference just as tables and chairs require defining labels. However Ernestine, this may be an unfair characterisation of your position. I await replies on this and other points.
The Wikipedia states;
“As expressed by E. Roy Weintraub, neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches:
1. People have rational preferences among outcomes that can be identified and associated with a value.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of full and relevant information.”
From these normative abstractions (which empirically speaking are quite absurd), neoclassical economics has developed the general equilibrium model. Ernestine has challenged me to nominate which particular equilibrium model I am referring to. Frankly, I must admit I am on shaky ground here. I am, as I admitted, a layperson in economic matters. I only have one life (an argument JQ advanced on his own behalf in another context recently in this blog) so I cannot for example become expert in economics or climate science as well as follow my own fields and endeavours. There are only so many hours in the day. Thus in economics I cannot necessarily nominate species of equilibrium models just I cannot nominate all the physical equations necessary to prove the greenhouse hypothesis.
Nevertheless, in each case, as a BA in the arts and sciences, I can apply my general philosophic and scientific understanding to assess the arguments of experts (and cranks) in each field. As I noted in an earlier post, my touchstone is empiricism in general and scientific empiricism in particular. I also understand that philosophical, metaphysical and speculative theories are necessary too. I understand that some of these theories may progress to the point of being proto-scientific theories and eventually scientific theories. (I follow Karl Popper in this regard.) I assess the general theories and hypotheses of experts and cranks (without prejudging which is which) in these and other fields by the following general criteria.
1. Is the theory philosophical, metaphysical and speculative? Does it show evidence of major unempirical, normative, essentialist or a priori assumptions?
2. If the answer to 1 is “yes”, does the theory explicitly recognise this aspect of its own nature or does it deny its own metaphysical assumptions?
3. If the metaphysical theory recognises its metaphysical assumptions it may yet be useful as general philosophy or even useful specifically as a guide to developing at least a proto-scientific theory.
4. Excluding the above, is the theory empirically based and thus a scientific theory amenable to empirical testing?
5. Does the general theory and the data gathering and testing of that general theory (where I am not a specialist in that particular field) fit with my general understanding of the scientific method?
6. Does the theory make predictions and are these predictions being borne out by subsequent data?
Taking those above criteria and applying them to climate science and “neoclassical economics” respectively, I can make the following judgements. Climate science is a science. “Neoclassical Economics” is an abstract, metaphysical and unempirical model which furthermore fails to explain the empirical events in a real economy. Equilibrium modelling of the economy (in any specific form) is now a fully refuted approach. Whilst making this judgement, I do not make the a priori assumption that Ernestine seems to do in implying that economics can never be scientific or at least have scientific or quantifiable elements. Dynamic modelling of the sort being undertaken by Steve Keen promises to be a far more fruitful approach and already deserves the title of a proto-scientific theory which “neoclassical” or “orthodox” economics does not.
Ernestine’s example (comparing water flowing all the way down a hill to a man walking half way down and then walking back up) is actually a marvellous analogy for the boundary between hard scientific and philosophic enquiry and the need to be aware of both and the uses of both. The behaviour of the water we can take as being describable by hard science equations. The behaviour of the man is an aggregate and part of it perhaps cannot be described (as yet anyway) by hard science. However, if we look at the man and designate the source of his volition as an “x factor” of unknown origin and operation we can still examine much of the rest of his actions in hard scientific terms. For example, we can use various methods to calculate the energy he uses in walking halfway down the hill and walking back up it. We can scientifically describe how his body gets this energy from food and uses it in the muscles. We could go on.
We could even begin investigating if his volitional behaviour (for want of a better term at this point) is as mysterious and capricious as it first appears. With repeated observation we might find that turning midway to walk back up the hill is based in a statistically significant way on certain attractive or repulsive stimuli. A pretty girl appears at the top of the hill and calls out to him. He goes back up. A loquacious professor with antediluvian theories appears at the bottom of the hill. Our man turns back and scurries over the hill to make his escape. Alternatively, he may have been told walk up and down the hill randomly for an experiment and thus may be attempting consciously to make random decisions. With enough data it might be interesting to discover whether his decisions are truly random or show patterns in themselves or correlations with external events despite his instructions.
I would be interested to know whether Ernestine accepts or rejects rational preference and utility maximisation theory (leaving aside whether we call it “neoclassical economics” or not. Ernestine’s implied rejection of strict determinism and scientific quantification in her man-on-the-hill analogy would also imply a rejection of Weintraub’s points. Let’s look at them again.
1. People have rational preferences among outcomes that can be identified and associated with a value.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of full and relevant information.”
Points one and two have a distinctly robotic and deterministic flavour. There is also a strange sense of inherent contradiction. Human agents are free and rational therefore they MUST at all times behave in a rational, utility maximising manner. There are so many philosophical and definitional problems along with normative assumptions and internal contradictions affecting these statements that they can be comprehensively demolished but it would take too long here and now.
The final clinching point is that these essentialist assumptions are unnecessary and even obstructive to any proper research program. We make no essentialist assumptions about the “will” or “motivation” of atoms in physics and we should make none about humans in economics. In each case we should observe behaviour and correlations and develop (if possible) dependable laws. Then we should test those laws against long run empirical reality. Essentialist assumptions or investigations into human rationality, emotion, logic, will and so on belong in philosophy and in psychological novels but not in economics.
@Michael of Summer Hill
‘Keynesian economic miracle’, I like it.