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Microfounded DSGE models — a total waste of time!

October 21, 2014 2 comments

from Lars Syll

In conclusion, one can say that the sympathy that some of the traditional and Post-Keynesian authors show towards DSGE models is rather hard to understand. Even before the recent financial and economic crisis put some weaknesses of the model – such as the impossibility of generating asset price bubbles or the lack of inclusion of financial sector issues – into the spotlight and brought them even to the attention of mainstream media, the models’ inner working were highly questionable from the very beginning. While one can understand that some of the elements in DSGE models seem to appeal to Keynesians at first sight, after closer examination, these models are in fundamental contradiction to Post-Keynesian and even traditional Keynesian thinking. The DSGE model is a model in which output is determined in the labour market as in New Classical models and in which aggregate demand plays only a very secondary role, even in the short run.

In addition, given the fundamental philosophical problems presented for the use of DSGE models for policy simulation, namely the fact that a number of parameters used have completely implausible magnitudes and that the degree of freedom for different parameters is so large that DSGE models with fundamentally different parametrization (and therefore different policy conclusions) equally well produce time series which fit the real-world data, it is also very hard to understand why DSGE models have reached such a prominence in economic science in general.

Sebastian Dullien

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Categories: New vs. Old Paradigm

Why did Britain’s political class buy into the Tories’ economic fairytale?

October 20, 2014 6 comments

from Ha-Joon Chang

The UK economy has been in difficulty since the 2008 financial crisis. Tough spending decisions have been needed to put it on the path to recovery because of the huge budget deficit left behind by the last irresponsible Labour government, showering its supporters with social benefit spending. Thanks to the coalition holding its nerve amid the clamour against cuts, the economy has finally recovered. True, wages have yet to make up the lost ground, but it is at least a “job-rich” recovery, allowing people to stand on their own feet rather than relying on state handouts.

That is the Conservative party’s narrative on the UK economy, and a large proportion of the British voting public has bought into it. They say they trust the Conservatives more than Labour by a big margin when it comes to economic management. And it’s not just the voting public. Even the Labour party has come to subscribe to this narrative and tried to match, if not outdo, the Conservatives in pledging continued austerity. The trouble is that when you hold it up to the light this narrative is so full of holes it looks like a piece of Swiss cheese. Read more…

The role of influence

October 18, 2014 Leave a comment

from Neva Goodwin

Herbert Simon received the Nobel Prize in 1978. This fact had little or no influence on subsequent economics textbooks, which sometimes mentioned bounded rationality, but did not reduce their dependence on the old rationality postulate as the foundation for deducing all human behaviour.

Simon was not the first critic to be so dismissed. Decades before behavioral economics came into fashion “alternative” economists were complaining about the unrealism of the neoclassical view of humanity. They especially focused on the fact that, as Smith had so well recognized, people are social animals. Relatively few of our actions are taken completely without regard for what we have seen other people do, or what we expect that other people will think. Even popular books on finance refer to the “herd instinct” in reference to the way investors follow fads and fashions of thought. There appears to be an inborn tendency for people to act as part of some kind of human collective, rather than in isolation. Yet this had no place in the neoclassical understanding of human behaviour.

Read more…

Lies that economics is built on

October 18, 2014 1 comment

from Lars Syll

Peter Dorman is one of those rare economists that it is always a pleasure to read. Here his critical eye is focussed on economists’ infatuation with homogeneity and averages: Read more…

Modern macroeconomics and the perils of using ‘Mickey Mouse’ models

October 15, 2014 12 comments

from Lars Syll

The techniques we use affect our thinking in deep and not always conscious ways. This was very much the case in macroeconomics in the decades preceding the crisis. The techniques were best suited to a worldview in which economic fluctuations occurred but were regular, and essentially self correcting. The problem is that we came to believe that this was indeed the way the world worked.

To understand how that view emerged, one has to go back to the so-called rational expectations revolution of the 1970s … These techniques however made sense only under a vision in which economic fluctuations were regular enough so that, by looking at the past, people and firms (and the econometricians who apply statistics to economics) could understand their nature and form expectations of the future, and simple enough so that small shocks had small effects and a shock twice as big as another had twice the effect on economic activity. The reason for this assumption, called linearity, was technical: models with nonlinearities—those in which a small shock, such as a decrease in housing prices, can sometimes have large effects, or in which the effect of a shock depends on the rest of the economic environment—were difficult, if not impossible, to solve under rational expectations.

Thinking about macroeconomics was largely shaped by those assumptions. We in the field did think of the economy as roughly linear, constantly subject to different shocks, constantly fluctuating, but naturally returning to its steady state over time …

From the early 1980s on, most advanced economies experienced what has been dubbed the “Great Moderation,” a steady decrease in the variability of output and its major components—such as consumption and investment … Whatever caused the Great Moderation, for a quarter Century the benign, linear view of fluctuations looked fine.

Olivier Blanchard

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Seven things that economists could usefully do or call for over the next several years

October 14, 2014 20 comments

from Richard Parker

Without solving . . . Pikettyan meta-issues, the question arises: Are there other things we as economists can do if, like Piketty, we’re concerned (alarmed? appalled?) about current levels and trends of inequality? How – absent meta-solutions – should we or could we move an inequality-reduction agenda forward? What issues or strategies or agendas might help advance absorption of Piketty’s focus on distribution and reframe a mainstream professional and public discourse still fixed almost monocularly on aggregated, rather than a distributionally-differentiated, GDP?

As I contemplated that question in Athens this summer, several possible projects occurred to me as worth at least consideration and debate. Some readers will no doubt find these suggestions too small, too pallid, too technical, or too bureaucratic, but I’m motivated to raise them – rather than more sweeping or heroic responses to Capital – in part by my reading of the ways The General Theory’s lessons were absorbed, initially by academics, then policymakers, and then by elements of the press and wider public, during the first 25 years or so after its publication (about which more shortly).

What academic, government, and policy NGO economists could, in my opinion, usefully do or call for over the next several years includes, at very least, the following:

Read more…

Categories: Uncategorized

Piketty’s blindside: any accounting format reflects the economic theory that defines its categories

October 13, 2014 2 comments

from Michael Hudson

Piketty sought to explain the ebb and flow of polarization by suggesting a basic mathematical law: when wealth is unequally distributed and returns to capital (interest, dividends and capital gains) exceed the rise in overall income (as measured by GDP), economies polarize in favor of capital owners. Unlike the classical economists, he does not focus on rentier gains by real estate owners, their bankers, corporate raiders and financiers, privatizers and other rent seekers.

Piketty is limited by the available statistical sources, because any accounting format reflects the economic theory that defines its categories. Neither the National Income and Product Accounts (NIPA) nor the Internal Revenue Service’s Statistics on Income in the United States define the specific form that the wealth buildup takes. Most textbook models focus on tangible investment in means of production (plant and equipment, research and development). But industrial profits on such investment have fallen relative to more passive gains from asset-price inflation (rising debt-fueled prices for real estate, stocks and bonds), financial speculation (arbitrage, derivatives trading and credit default insurance), and land rent, natural resource rent (oil and gas, minerals), monopoly rent (including patent rights), and legal privileges topped by the ability of banks to create interest-bearing credit.

Read more…

Categories: Piketty's Capital

Large-scale wars, tax reforms and “inverted totalitarianism”

October 12, 2014 1 comment

from Heikki Patomäki 

The world wars of the 20th century constituted major economic and political shocks. Piketty goes so far as to argue that “we can now see those shocks as the only forces since the Industrial Revolution powerful enough to reduce inequality” (p. 8; italics HP). This is a point he repeats several times in the book; he also gives ample statistical evidence on the impact of the world wars on the level of taxation and inequalities (for instance pp. 18-20, p. 41, p. 141, p. 287, p. 471, pp. 498-500).

Piketty, however, is not fully consistent in formulating this point. Counterfactual developments are uncertain. Without the shock of World War I, “the move toward a more progressive tax system would at the very least have been much slower, and top rates might have never risen as high as they did” (p. 500). The war facilitated and speeded up change, but it was not a necessary condition for it. The weakest formulation is this: “[P]rogressive taxation was as much a product of two world wars as it was of democracy” (p. 498). Thus democratization too seems to have played a facilitating role. A problem is, however, that democracy cannot explain the decline of progressive taxation and the re-rise of widening inequalities since the 1970s.

Read more…

Categories: Piketty's Capital

Bounded rationality

October 11, 2014 Leave a comment

from Neva Goodwin

Rationality has become a loaded word in economics, bringing with it the baggage of earlier models that did not anticipate the findings of behavioral economics or take into account other every-day observations. The traditional rationality model includes the assumption that rational behavior is optimizing behavior (“rational economic man maximizes his utility”). In the 1970s an extreme version of this made the further assumption that rational economic actors have “perfect information.” A slightly more modest version says that people will collect information until the perceived costs of acquiring additional information exceed the perceived benefits.

One of the most effective challenges to the traditional assumption of rationality came from Herbert Simon, another non-economist winner of the Nobel Memorial Prize in economics (1978). Considering whether it is indeed possible for people to identify the optimal point at which one should cease gathering additional information, Simon showed that one first needs to have complete knowledge of all possible choices in order to identify that optimal point. Determining what additional information might be out there, and then gathering it, can be very costly in time, effort, and money – if it is even possible. Accordingly, Simon maintained, people rarely optimize. Instead they do what he called “satisficing;” they choose an outcome that would be satisfactory, and then seek an option that at least reaches that standard.

Read more…

Categories: New vs. Old Paradigm

Reading Piketty in Athens

October 10, 2014 4 comments

from Richard Parker

I have been reading Thomas Piketty this past week in Athens, where I came back to assess how Greece is faring half a decade after its economy imploded, initially as a consequence of its own ills and then – in an act of monumental malpractice by Germany, the ECB, and the IMF – the cure imposed.[1]

Signs of recovery are few.

It is hot here, as Mediterranean summers always are – but as thick as the heat is, an air of solemnity and defeat lies far more thickly over this concrete-gray capital and its now concrete-gray people, for whom what we know as the Great Recession has been their Great Depression, where the GDP has contracted 40% in five years and more than a quarter of its workforce can find no paid employment.

Four years ago, tens of thousands of Greeks would turn up regularly, week after week, at Syntagma Square in the heart of Athens to protest, again and again, the terms of the European-and-IMF-designed austerity regime that was the price Greece was being made to pay for loans meant to keep its government and economy afloat.

The streets lack protestors now, filled instead by tourists (more than 20 million visitors are expected this year, nearly two tourists for every Greek citizen) but also with drunks, junkies, and beggars out in alarming numbers of their own. Syntagma Square – jammed when I was here in 2011 with the tents and makeshift lean-tos of young protestors – has been scrubbed clean, the grass and flowers replanted, and new marble steps and benches replacing the stonework that had been chipped and broken to provide rocks to hurl at riot police.[2]

But cross the street from Syntagma Square and walk into the five-star Hotel Grande Bretagne and you suddenly encounter   Read more…

The riddle of induction

October 9, 2014 24 comments

from Lars Syll

Recall [Russell's famous] turkey problem. You look at the past and derive some rule about the future. Well, the problems in projecting from the past can be even worse than what we have already learned, because the same past data can confirm a theory and also its exact opposite …

For the technical version of this idea, consider a series of dots on a page representing a number through time … Let’s say your high school teacher asks you to extend the series of dots. With a linear model, that is, using a ruler, you can run only a single straight line from the past to the future. The linear model is unique. There is one and only one straight line that can project a series of points …

grueThis is what philosopher Nelson Goodman called the riddle of induction: we project a straight line only because we have a linear model in our head — the fact that a number has risen for 1 000 days straight should make you more confident that it will rise in the future. But if you have a nonlinear model in your head, it might confirm that the number should decline on day 1 001 …

The severity of Goodman’s riddle of induction is as follows: if there is no longer even a single unique way to ‘generalize’ from what you see, to make an inference about the unknown, then how should you operate? The answer, clearly, will be that you should employ ‘common sense’.

Nassim Taleb

And economists standardly — and without even the slightest justification — assume linearity in their models …

Categories: methodology

Behavioral economics

October 4, 2014 3 comments

from Neva Goodwin

Neoclassical economics claims to be based entirely on a view of human nature which is not only morally repugnant, but which also both leaves out a great deal about how people actually do operate, while it brings in seriously contrary-to-fact assumptions about what people are capable of. The latter have included assumptions about consistency (including that preferences change slowly, if at all, and that if A is preferred to B and B is preferred to C, then C cannot be preferred to A); about information (people are able to act as if they have perfect information); about self-knowledge (people know what they want, and are best served by getting what they want); and about influence, or power. The last of these assumptions includes the idea that human wants and preferences are endogenous, generated entirely from within; it ignores the extent to which people’s choices and decisions may be manipulated by those who have an interest in persuading the public to buy certain things, or vote in certain ways. It ignores the reality that market economies are rife with powerful actors who do have such an interest, in both the economic and the political spheres.  Read more…

‘Infinite populations’ and other econometric fictions masquerading as science

October 2, 2014 6 comments

from Lars Syll

pulling_a_rabbit_out_of_a_hat_by_candiphoenixes-d3ee5jaIn econometrics one often gets the feeling that many of its practitioners think of it as a kind of automatic inferential machine: input data and out comes casual knowledge. This is like pulling a rabbit from a hat. Great — but first you have to put the rabbit in the hat. And this is where assumptions come in to the picture.

The assumption of imaginary “superpopulations” is one of the many dubious assumptions used in modern econometrics, and as Clint Ballinger has highlighted, this is a particularly questionable rabbit pulling assumption:

Inferential statistics are based on taking a random sample from a larger population … and attempting to draw conclusions about a) the larger population from that data and b) the probability that the relations between measured variables are consistent or are artifacts of the sampling procedure.

However, in political science, economics, development studies and related fields the data often represents as complete an amount of data as can be measured from the real world (an ‘apparent population’). It is not the result of a random sampling from a larger population. Nevertheless, social scientists treat such data as the result of random sampling.   Read more…

Categories: New vs. Old Paradigm

new issue of Economic Thought

October 1, 2014 Leave a comment

Economic Thought - History, Philosophy, and Methodology
An open access, open peer review journal from the World Economics Association

Vol 3, No 2, 2014     Download issue 

J.M. Keynes, F.A. Hayek and the Common Reader
Constantinos Repapis          1          abstract

Reconciling Ricardo’s Comparative Advantage with Smith’s Productivity Theory
Jorge Morales Meoqui          21         abstract

The Theory of the Transnational Corporation at 50+
Grazia Ietto-Gillies          38          abstract

A commentary on Grazia Ietto-Gillies’ paper
John Cantwell           58          abstract

Reply to John Cantwell’s Commentary on Grazia Ietto-Gillies’ paper
Grazia Ietto-Gillies          67          abstract

If ‘Well-Being’ is the Key Concept in Political Economy...
Claudio Gnesutta          70          abstract

New Keynesianism — a macroeconomic cul-de-sac

September 29, 2014 1 comment

from Lars Syll

Macroeconomic models may be an informative tool for research. But if practitioners of “New Keynesian” macroeconomics do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its tasks. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics will continue to consider its ultimate argument as a mixture of rather unhelpful metaphors and metaphysics. Maintaining that economics is a science in the “true knowledge” business, I remain a skeptic of the pretences and aspirations of “New Keynesian” macroeconomics. So far, I cannot really see that it has yielded very much in terms of realistic and relevant economic knowledge.  Read more…

Categories: New vs. Old Paradigm

The psychological “foundations” for neoclassical economics

September 27, 2014 14 comments

from Neva Goodwin

When I was beginning my studies in this field economist Robert Solow commented to me that the great strength of economics is that it is fully axiomatized; the entire edifice can be deduced from the basic rationality axiom, which says that rational economic man maximizes his utility. The origin of this axiom is often traced back to Smith, whose most widely quoted phrase comes from a passage in which Smith approvingly notes that merchants take what, today, we would call, a protectionist position – doing so, not with any thought for the good of society, but because their security and profit is tied to domestic industry. Thus, he says, the merchant “is in this as in many other cases, led by an invisible hand to promote an end which is no part of his intention.”[1] Excerpts such as this have been used as a justification for the 20th century economic model’s vision of an ideal world in which a society comprised of entirely self-interested economic actors would make the society as a whole better off, and the idea that pursuit of self-interest is the only thing that is done by rational economic actors – and that anything else is irrational. Read more…

Econometrics — still lacking a valid ontological foundation

September 25, 2014 4 comments

from Lars Syll

Important and far-reaching problems still beset regression analysis and econometrics – many of which basically are a result of an unsustainable ontological view.

complex-research-terminology-simMost econometricians have a nominalist-positivist view of science and models, according to which science can only deal with observable regularity patterns of a more or less lawlike kind. Only data matters and trying to (ontologically) go beyond observed data in search of underlying real factors and relations that generate the data is not admissable. All has to take place in the model of the econometric mind, since the real factors and relations according to the econometric (epistemologically based) methodology are beyond reach, since they, allegedly, are both unobservable and unmeasurable. This also means that instead of treating the model-based findings as interesting clues for digging deepeer into real structures and mechanisms, they are treated as the end points of the investigation.

As mathematical statistician David Freedman writes in Statistical Models and Causal Inference (2010): Read more…

Categories: New vs. Old Paradigm

Normative foundations of scarcity

September 22, 2014 7 comments

from Asad Zaman and the WEA Pedagogical Blog

In my paper of this name (which has been published in Real-World Economics Review, issue no. 61, 26 September 2012, pp. 22-39), I show that the apparently objective concept of scarcity is built on THREE normative assumptions. This argument destroys one of the basic ideas strongly argued in most conventional texts, that economics is a POSITIVE study of facts of our economic existence, and does not involve value judgement. The three normative pillars on which scarcity stands as the fundamental principle of economics are the following:

ONE: Private Property.
This is a cultural norm. For example, the Cherokee constitution states that the lands of the Cherokee Nations shall remain common property. If there is a cultural norm of sharing public resources, then the issue of scarcity would not arise (or at least, would be much less frequent). Anthropologists have shown that there is no starvation in subsistence societies because of strong norms of sharing. If the society as a whole has enough food, then EVERYBODY will get to eat. Note the violent contrast with the private property norm. In conventional economics, the Pareto principle embodies the normative idea that the right to property takes precedence over the right to life. If a poor man is starving, the rich man is NOT obligated to provide for him.

TWO: Consumer Sovereignty
Economists argue the we SHOULD not question consumer preferences as to where they come from and whether they are legitimate. Also, economists argue that we SHOULD design an economic system which fulfills ALL preferences (to the extent possible). Obviously if we differentiate between legitimate demands, and idle desires, scarcity would be much reduced. As Gandhi said, there is enough for everyone’s need, but not enough for everyone’s greed. The noxious NORMATIVE idea that the right of the super-rich to private jets trumps the right of the poor hungry child to bread is what leads to scarcity becoming the foundation of economics. If we change our norms to advocate and encourage simple lifestyles, and also consider the goal of an economic system to be that of taking care of the NEEDS of ALL, instead of maximizing the wealth of the wealthy. the problem of scarcity would not arise.  read more

Categories: New vs. Old Paradigm

Existence of transmission mechanisms

September 21, 2014 1 comment

from Gustavo Marqués

According to the dominant view of financial markets, access to easy credit driven by central banks in both the U.S. and the developed countries of the European Union, should have led to economic growth. The transmission mechanism is the following: availability of easy credit (at rates of zero or near zero interest) will raise the price of stocks (including real estate within this category), generating a wealth effect that will in turn increase consumption and the GDP. See some testimonies.

“Before the current turmoil began, Federal Reserve Chairman Ben Bernanke’s hope was that rising asset prices would lead to a ‘wealth effect’ that would encourage the American consumer to start spending again, and thus help the American economy finally leave the ‘Great Recession’ behind” (Keen, 2013, p. 3).

Alan Greenspan has been even more explicit.  Read more…

Categories: The Economy, Uncategorized

Mainstream economics teaching in the late 20th Century

September 20, 2014 12 comments

from Neva Goodwin

There are some true and useful things to be learned in standard 20th century economics, such as the basic concepts of supply and demand intersecting to create wages and prices. However if you ever took an economics course you may have since discovered that many other things also affect prices, such as advertising, or consumers’ lack of information. And wages involve even more complicated human interactions, habits and expectations. These complexities and exceptions don’t get much hearing in introductory courses – and, surprisingly, they get even less at the upper levels, where, instead, progressively more mathematics are imposed on a progressively more abstract picture of an economy. Meanwhile the students are also being taught a lot that is dangerous. Here are some of the take-aways from the standard economics course: Read more…

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