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Macroeconomic blindspots

from Lars Syll

There was an unusual degree of consensus among economists about what would happen if Britain voted for Brexit in the referendum on June 23 last year. The language used by the International Monetary Fund was typical: It expressed fears of an “abrupt reaction,” adding that this “may have already begun” …

What happened instead was that Britain enjoyed the best growth of any major advanced economy in 2016 … Andy Haldane compared the pitfalls of economic prediction to the single most famously wrong weather forecast in British history, made on the BBC on Oct. 15, 1987. A woman had called the BBC to say she was worried there was a hurricane on the way. “Don’t worry, there isn’t,” the weatherman responded. That night, 22 people died amid hurricane-force winds …

6a00e551f080038834019affbd1c2a970bThe reason this poses a deep intellectual crisis for macro-economics is that the entire point of the field, as it has developed since the work of John Maynard Keynes in the 1930s, is to prevent just this sort of severe downturn. Keynes once spoke of a future in which economists would be “humble, competent people on a level with dentists” …  It seems to me, though, that what macroeconomists do is really most like bomb disposal. Uniquely in the social sciences and humanities, macroeconomics was developed with a specific, real-world purpose, and a negative purpose to boot: to stop anything like the Great Depression from ever happening again. Given this goal — to avert systemic crises and downturns — the credit crunch and the Great Recession were, for macroeconomics, an intellectual disaster.  

In retrospect, the failure of the discipline to predict and prevent the crisis was based on deep conceptual faults. One of these concerned a mysterious refusal to engage with the role of the banking and finance system in the economy. Another was the assumption that the discipline makes about individual motivations, assuming that individuals “optimize” their decision-making to behave, in economic terms, rationally. This is a convenient intellectual shortcut for building models, but it is also a fiction, as we know not just from our own human experience but even from within economics itself, where microeconomics has recently made exciting progress in the study of human irrationality, bias and cognitive error. It is a matter of provable fact that our decision-making is not entirely rational. Economic models built on the premise of our rationality will always have a creaky underpinning.

John Lancaster

Reading Lancaster’s article is certainly a very worrying confirmation of what Paul Romer wrote a couple of months ago —  modern macroeconomics is becoming more and more a total waste of time.

One of the problems with macroeconomics that Lancaster
doesn’t discuss is its obsessive mathematization since WW II. This has made mainstream neoclassical economists more or less obsessed with formal, deductive-axiomatic models. Confronted with the critique that they do not solve real problems, they  often react as Saint-Exupéry’s Great Geographer, who, in response to the questions posed by The Little Prince, says that he is too occupied with his scientific work to be be able to say anything about reality. Confronting economic theory’s lack of relevance and ability to tackle real problems, these economists retreat to the wonderful world of economic models. They enter the tool shed — and stay there. While the economic problems in the world around us steadily increase, they are  rather happily playing along with the latest toys in the mathematical toolbox.

Instead of making the model the message, I think we are better served by economists who more  than anything else try to contribute to solving real problems. And then the motto of John Maynard Keynes is more valid than ever:

It is better to be vaguely right than precisely wrong

  1. patrick newman
    February 13, 2017 at 12:01 pm

    The failure of the Treasury and the OBR to forecast economic performance even within normal tolerance of accuracy is well known and is almost a running joke. The distinct failure of economic Armageddon to make a post Brexit appearance is also a nail in the coffin of conventional economic thinking but the main problem was the near total corruption of the politicians with economic responsibilities such as Ms Le Garde and George Osborne who contorted pessimistic predictions to suit their own political agenda. This was a reason I voted Brexit. There will be many consequences of Brexit but economic disaster is unlikely to be one of them.

  2. C-R D
    February 13, 2017 at 4:46 pm

    I see two problems in this argument: An error on the part of economists, and another from their critics. The first is due to the claim that economic agents maximize their utility function; this a lie that must be evacuated from economic theory; to that effect see:
    URI:https://mpra.ub.uni-muenchen.de/id/eprint/75030
    The second is the too-frequent reproach that economists failed to predict the 2007-2008 crach as if economists were endowed with the ability to make accurate prediction in a complex (chaotic) systems.Take a look at:
    URI:https://mpra.ub.uni-muenchen.de/id/eprint/70725.
    Is it not time that we figure out how to reformulate the theory?

    • February 13, 2017 at 6:46 pm

      It is an easy matter to reformulate the existing theory of microeconomics. It is far more difficult to get anyone to listen. For instance, there is no such thing as a downward sloping demand curve. It takes impossible assumptions to derive one even theoretically; and, among these impossibilities, is the notion that consumers will not reformulate their total budgets for any basket of goods when faced with price changes among the goods in the baskets. This leads to such ridiculous notions as when the price of food goes up people shift their expenditures but never their budgets for food.

      The fact is: true rationality requires forethought about consequences; and incorporating sensible ideas about how such forethought leads to budget formation, not an assumption that budgets themselves do not change. That confuses budgets with fixed incomes, an entirely different matter.

      • February 15, 2017 at 1:47 am

        “For instance, there is no such thing as a downward sloping demand curve. ”

        I am not sure what you mean by this. I have a quibble with the upward-sloping supply curve (in the cases of labor and foreign currency demands, it should be “V-Shaped” rather than monotonically increasing. I wasn’t aware of a similar problem on the demand side, though. I assume you are talking about product-specific demand where a given product is small compared with the economy as a whole?

  3. February 13, 2017 at 7:31 pm

    “Uniquely in the social sciences and humanities, macroeconomics was developed with a specific, real-world purpose, and a negative purpose to boot: to stop anything like the Great Depression from ever happening again. Given this goal — to avert systemic crises and downturns — the credit crunch and the Great Recession were, for macroeconomics, an intellectual disaster. / In retrospect, the failure of the discipline to predict and prevent the crisis was based on deep conceptual faults. ”

    So I keep saying Keynes’s error-correcting logic anticipated post-war PID cybernetics control theory, and no-one here takes a blind bit of notice!

    Against Romer, Keynesian macro-economics was not and is not a waste of time. The discipline has failed because of its deep conceptual error of treating all maths, economic functions, specialist’s motivations and corrective feed-backs as being of one type rather than each being a complex variable with four. It has thus attempted to correct by growth in financial business what Keynes sought to correct by government investment in social infrastructure: the one steering by price adjustment, the other resetting the course to correct accumulating unemployment.
    .

  4. antireifier
    February 13, 2017 at 7:46 pm

    Many years ago I engaged in written public debate with an economist who eventually wrote that (macro)economics is NOT a science. He stopped responding to me when I suggested that when seeking guidance, reading the entrails of chickens would be as successful as listening to (macro)economists. I actually trust the weather reports more. My current pet peeve is so-called independent central banks.

  5. February 14, 2017 at 11:30 am

    In most respects, modern economics takes its framework from the Enlightenment, as did those who wrote the US Constitution and the UN’s Human Bill of Rights. Religious tolerance replaces religious orthodoxy. National sovereignty and nationalism replaces scattered Medieval kingdoms. Contract replaces status (aristocratic). Capitalists joined aristocrats in political control. And eventually displaces aristocrats. Urban life replaces the countryside. Science displaces religion as the controlling factor in knowledge and the thoughts of people. The notion of progress replaces the past golden age (the Garden of Eden).Individual initiative and control replaces the idea of social initiative and social control. The pursuit of character growth and wisdom is replaced by the pursuit of wealth and physical enjoyment (the pursuit of happiness).

    Modern economics added these things. A love for and dependence on axiomatic thinking and problem solving. A love of mathematics and dependence on mathematical modeling. Then, modern economists created a unique version of science. Mathematically (which is not a science) based, heavily focused on axioms (fundamental assumptions about the world assumed to be true), and de-emphasizing observation. This version of science is wholly inconsistent with science as created in the 15th-17th centuries. Why invent it? 1) to pretend to be physicists; 2) to use mathematics as a gate keeper and shield (mathematicians know economists misuse mathematics, but most lay persons do not); 3) to take credit for making society better, somehow.

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