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Macroeconomic machine dreams

from Lars Syll

Many mainstream macroeconomists  hold on to the hope that they will not be doomed forever to always ‘fight the last war,’ but instead, building on timeless microfoundational rules — Lucas ‘deep parameters’ — they will be able to predict upcoming problems before they happen. Adding some new little twist to the DSGE model will make all the difference …

What these economists ‘forget,’ however, is that to produce these n:th variations of the basic DSGE model, they still have to make ridiculously simplifying assumptions to make the models ‘forecast’ anything.

This is nothing but the age-old machine dream of neoclassical economics — an epistemologically founded cyborg dream that disregards the fundamental ontological fact that economies and societies are open — not closed — systems.

The empirical and theoretical evidence is clear. Predictions and forecasts are inherently difficult to make in a socio-economic domain where genuine uncertainty and unknown unknowns often rule the roost. The real processes that underly the time series that economists use to make their predictions and forecasts do not confirm with the assumptions made in the applied statistical and econometric models. Much less is a fortiori predictable than standardly — and uncritically — assumed. The forecasting models fail to a large extent because the kind of uncertainty that faces humans and societies actually makes the models strictly seen inapplicable. The future is inherently unknowable — and using statistics, econometrics, decision theory or game theory, does not in the least overcome this ontological fact. The economic future is not something that we normally can predict in advance. Better then to accept that as a rule “we simply do not know.”  

In an interesting discussion on the hopelessness of accurately modeling what will happen in the real world, Nobel laureate Kenneth Arrow – in Eminent Economists: Their Life Philosophies (CUP 1992) – pretty well sums up what the forecasting business is all about:

It is my view that most individuals underestimate the uncertainty of the world. This is almost as true of economists and other specialists as it is of the lay public. To me our knowledge of the way things work, in society or in nature, comes trailing clouds of vagueness … Experience during World War II as a weather forecaster added the news that the natural world as also unpredictable. An incident illustrates both uncertainty and the unwillingness to entertain it. Some of my colleagues had the responsibility of preparing long-range weather forecasts, i.e., for the following month. The statisticians among us subjected these forecasts to verification and found they differed in no way from chance. The forecasters themselves were convinced and requested that the forecasts be discontinued. The reply read approximately like this: ‘The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.’

  1. Garrett Connelly
    July 4, 2016 at 10:46 pm

    What kind of economist?

    A doctor who knows neighborhoods are living entities that cannot be torn down and rebuilt, even with great landscaping?

    A doctor who knows debt financing destroys democracy, which is a tool, not a form of government.

    Information-age macro economics models an economy that heals Earth, focuses distributed human intelligence and has way more fun than perpetual deficit funded war.

  2. July 5, 2016 at 6:11 am

    Planning is distinct from forecasting. Actually, a forecast I know is wrong can be useful in planning. And if I know why it’s wrong it becomes even more useful in planning.

    Second, forecasting a single value for something like the price of natural gas sold in tomorrow’s daily gas market is not only foolish but a waste of time. But forecasting a range of prices for tomorrow based on history, gas moving in pipelines, amount of gas hedged and the strike price, etc. can be useful. How to assess the types and degrees of usefulness is the real question here.

    Economists who attempt to forecast have one major problem that makes all I’ve just said irrelevant for their forecasting work. Economists don’t believe in planning. Their discipline actually substitutes theory for planning. A recipe for confusion and failure.

  3. Jorge Buzaglo
    July 5, 2016 at 2:10 pm

    Establishments and elites themselves have already been blaming economists and “experts” for their collective failure (see e.g. the long quote below from an article by a knowledgeable member, Jean Pisany-Ferry). Heterodox economists should be busy providing alternatives (to the elites and their economists and “experts”).

    “(…) Why this angry attitude toward the bearers of knowledge and expertise? The first explanation is that many voters attach little value to the opinions of those who failed to warn them about the risk of a financial crisis in 2008. Queen Elizabeth II spoke for many when, on a visit to the London School of Economics in the autumn of 2008, she asked why no one saw it coming. Furthermore, the suspicion that economists have been captured by the financial industry, expressed in the 2010 movie Inside Job, has not been dispelled. Ordinary people feel angry about what they regard as a betrayal by the intellectuals.
    “Most economists, let alone specialists in other disciplines, regard such accusations as unfair, because only a few of them devoted themselves to scrutinizing financial developments; yet their credibility has been seriously dented. Because no one pled guilty for the suffering that followed the crisis, the guilt has become collective.
    “The second explanation has to do with the policies advocated by the cognoscenti. Experts are accused of being biased, not necessarily because they are captured by special interests, but because, as a profession, they support the mobility of labor across borders, trade openness, and globalization more generally.
    “There is some substance in this argument: although not all economists, and certainly not all social scientists, advocate international integration, they are undoubtedly more inclined toward highlighting its benefits than the average citizen is.
    “This points to the third and most convincing explanation: while experts emphasize the overall benefits of openness, they tend to disregard or minimize its effects on particular professions or communities. They regard immigration – to which Cameron attributed the Leave campaign’s victory – as a net benefit for the economy; but they fail to pay attention to what it implies for workers who experience downward wage pressure or for communities struggling with a scarcity of affordable housing, crowded schools, and an overwhelmed health system. In other words, they are guilty of indifference.
    “This criticism is largely correct. Economists (and policymakers) tend to look at issues in the aggregate, to take a medium-term perspective, and to assume that markets work well enough to absorb a large part of adverse shocks. Their perspective clashes with that of people who care more about distributional issues, have different (often shorter) time horizons, and are wary of monopolistic behavior.
    “If economists and other experts want to regain their fellow citizens’ trust, they should not be deaf to these concerns. They should first be humble and avoid lecturing. They should base their policy views on the available evidence, rather than on preconceptions. And they should change their minds if the data do not confirm their beliefs. This largely corresponds to what researchers actually do; but when speaking to the public, experts tend to oversimplify their own views.
    “For economists, humility also implies listening to people from other disciplines. On immigration, they should hear what sociologists, political scientists, or psychologists have to say about what coexistence in multicultural communities may entail.
    “Second, experts should be more granular in their approach. They typically should examine policies’ impact not only on aggregate GDP in the medium term, but also on how policies’ effects are distributed over time, across space, and among social categories. A policy decision can be positive in the aggregate but severely harmful to some groups – which is frequently the case with liberalization measures.
    “Third, economists should move beyond the (generally correct) observation that such distributional effects can be addressed through taxation and transfers, and work out how exactly that should happen. Yes, if a policy decision leads to aggregate gains, losers can in principle be compensated. But this is easier said than done.
    “In practice, it is often hard to identify the losers and to find the right instrument to support them. To argue that problems can be solved without examining how and under what conditions is sheer intellectual laziness. To tell people who have been hurt that they could have been spared the pain does not give them any less reason to complain; it just fuels resentment of technocratic experts.
    “Because growing public distrust of the cognoscenti provides fertile ground to demagogues, it poses a threat to democracy. Academics and policymakers may be tempted to respond by dismissing what looks like a celebration of ignorance and retreating into ivory towers. But this would not improve matters. And there is no need to surrender. What is needed is more honesty, more humility, more granular analysis, and more refined prescriptions.” See: https://www.project-syndicate.org/commentary/brexit-voters-ignoring-experts-by-jean-pisani-ferry-2016-07

    • July 6, 2016 at 5:35 am

      There are two distinct views presented by those who those who study expertise, “expert experts” about what it is and how it works. One says expertise is just a name for actions and actors that explain these actions and actors and the results of those actions and actors. The other says experts have more knowledge and understanding of certain parts of the world than do the ordinary citizen. Actually, I think expertise is both. That’s why fearing and distrusting experts is important, but so is listening to their advice and making use of that advice as circumstances call for it. The central uncertainty is then when and how to combine these two expertise in practice. Both forms fail. The naming is applied wrongly, and assumed superior knowledge is often found wanting. Both forms create uncertain results and both forms often ignore other “non-expert” ways of life and approaches to problem resolution. So how do we combine these in daily life? We combine them by insisting that some other standard or set of practices always controls expertise of both forms. I believe that standard should be political. Others may insist on religious or philosophical standards. In all this the problem economists’ face is they have by their own actions forfeited both types of expertise. More and more non-economists refuse to apply the name expert to economists or economics. And those same non-economists reject the notion that economists have more or greater knowledge of the economy that they themselves. In fact, often just the opposite claim is made. This makes the use of economic “expertise” in actual daily life impossible, and more frightening makes its use dangerous.

  4. dmf
    July 5, 2016 at 4:56 pm

    “In this week’s programme, a question of trust – why do people have a tendency to distrust experts and expertise? It has been made much of in the UK’s Brexit campaign to leave the European Union. ‘People in this country have had enough of experts,’ claimed Leave campaigner Michael Gove. What’s behind this lack of faith in authority?
    The Zoo team discover that the difficulty of evaluating expertise is a problem we all face – because to really understand what’s going on, you have to know what you don’t know, and it’s easier to spot the flaws in other people’s reasoning and knowledge than to see it in ourselves. But then forecasting is a tricky business, and the experts don’t always get it right. So, who to trust?”

    • David Chester
      July 5, 2016 at 5:13 pm

      As it is written on the US dollar note: “In God we trust” — others pay cash!

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