Home > Uncategorized > Modern macroeconomics — totally messed up

Modern macroeconomics — totally messed up

from Lars Syll

Until a few years ago, economists of all persuasions confidently proclaimed that the Great Depression would never recur. In a way, they were right. After the financial crisis of 2008 erupted, we got the Great Recession instead. Governments managed to limit the damage by pumping huge amounts of money into the global economy and slashing interest rates to near zero. But, having cut off the downward slide of 2008-2009, they ran out of intellectual and political ammunition.


Economic advisers assured their bosses that recovery would be rapid. And there was some revival; but then it stalled in 2010. Meanwhile, governments were running large deficits – a legacy of the economic downturn – which renewed growth was supposed to shrink. In the eurozone, countries like Greece faced sovereign-debt crises as bank bailouts turned private debt into public debt.

Attention switched to the problem of fiscal deficits and the relationship between deficits and economic growth. Should governments deliberately expand their deficits to offset the fall in household and investment demand? Or should they try to cut public spending in order to free up money for private spending?

Depending on which macroeconomic theory one held, both could be presented as pro-growth policies. The first might cause the economy to expand, because the government was increasing public spending; the second, because they were cutting it. Keynesian theory suggests the first; governments unanimously put their faith in the second.

The consequences of this choice are clear. It is now pretty much agreed that fiscal tightening has cost developed economies 5-10 percentage points of GDP growth since 2010. All of that output and income has been permanently lost. Moreover, because fiscal austerity stifled economic growth, it made the task of reducing budget deficits and national debt as a share of GDP much more difficult. Cutting public spending, it turned out, was not the same as cutting the deficit, because it cut the economy at the same time.

Robert Skidelsky 

Indeed, there are many kinds of useless economics held in high regard within the mainstream economics establishment today. Few are less deserved than the post-real macroeconomic theory — mostly connected with Finn Kydland, Robert Lucas, Edward Prescott and Thomas Sargent — called Real Business Cycle theory (RBC).

In Chicago economics, one is cultivating the view that scientific theories have nothing to do with truth. Constructing theories and building models is not even considered an activity with the intent of approximating truth. For Chicago economists, it is only an endeavour to organize their thoughts in a ‘useful’ manner.

What a handy view of science!

What these defenders of scientific storytelling ‘forget’ is that potential explanatory power achieved in thought experimental models is not enough for attaining real explanations. Model explanations are at best conjectures, and whether they do or do not explain things in the real world is something we have to test. To just believe that you understand or explain things better with thought experiments is not enough.

Without a warranted export certificate to the real world, model explanations are pretty worthless. Proving things in models is not enough — not even after having put ‘New Keynesian’ sticky-price DSGE lipstick on the RBC pig.

Truth is an important concept in real science — and models based on meaningless calibrated ‘facts’ and ‘assumptions’ with unknown truth value are poor substitutes.

  1. patrick newman
    August 23, 2017 at 12:26 pm

    “Cutting public spending, it turned out, was not the same as cutting the deficit, because it cut the economy at the same time.” – neatly put but the position is worse. Austerity – cutting benefits and public services produces a catalogue of negative effects both on demand, net public expenditure and on productivity not to mention adding to human misery. Even sacking public servants can result in a net increase of public spending for several years when all the financial effects are added up. Cuts to public services are in many cases just passing on costs to other public services – e.g. social services v NHS(health), cutting road maintenance will produce higher costs down the road, literally. And so on ad infinitum.

  2. August 25, 2017 at 7:21 am

    Two points. First, science is not unique or even first in western societies. Colin Scott writes this about James Bay Cree knowledge construction,

    Do Cree hunters practice science? The answer to this question would seem to depend on whether one defines science according to universal features, or culturally specific ones. If one means by science a social activity that draws deductive inferences from first premises, that these inferences are deliberately and systematically verified in relation to experience, and that models of the world are reflexively adjusted to conform to observed regularities in the course of events, then, yes, Cree hunters practice science—as surely all human societies do.

    Anthropologists also know that the “first premises” can originate from most anywhere. For the Cree, many have spiritual or trans-dimensional origins. Magic and myth play a role for the Cree. But the knowledge thus constructed has shown itself as competent, reliable, and practical as knowledge from western versions of science.

    So, beginning with the premise that markets are magical is not nonsense or useless. But the Cree hunter asks is the magic confirmed by his and others’ experience? For economists, is the magic of markets confirmed by their and others’ experience with and about markets? Based on my reading of economic research the answer to that question is — sometimes, yes, sometimes, no.

    Second point. Confirming or not confirming premises and experience is not simple or straightforward. In the case of magic markets, as noted above sometimes that’s confirmed, sometimes not. It’s for this reason that this answer cannot be based on a single set of experiences, of a single observer, from one perspective, using one tool or method. Science is in all respects a collective activity. As is all human knowledge and learning. Steven Sloman and Phillip Fernback confirm this in their book “The Knowledge Illusion: Why We Never Think Alone,”

    Our intelligence resides not in individual brains but in the collective mind. To function, individuals rely not only on knowledge stored within our skulls but also on knowledge stored elsewhere: in our bodies, in the environment, and especially in other people. When you put it all together, human thought is incredibly impressive. But it is a product of a community, not of any individual alone. Humans are not individuals. Cannot be individuals.

    • August 25, 2017 at 10:21 am

      A nice reflection, Ken. I’m not disagreeing with you, but I think in your last paragraph the word “environment” needs a bit of unpacking. Unless the way knowledge is stored “elsewhere” is perceptible there is no way it can activate and combine with the knowledge in our own skulls, hence the importance not only of writing but of activities, diagrammatic theorising, art and technology.

      • August 26, 2017 at 12:42 pm

        Dave, wonderful comment. Mostly, when anthropologists use the term environment they refer to anything that influences humans that is not human. But this has limitations, since humans are physical bodies. How human is separated from non-human is a prime focus of anthropologists. Historians, especially historians of science and technology consider this question also. That literature is 200 years and millions of pages deep. On your second point, particularly anthropologists focus on both “rational” and “non-rational” beliefs and actions. This puts so called non-rational aspects of human life such as art, mythology, religion, and storytelling on an equal footing with rational actions such as science and scholarship. Historians till recently have focused on written language and scholarship. But that changed in the 1960’s and 1970’s with social history, history of technology, and everyday history.

  3. robert locke
    August 25, 2017 at 10:15 am

    The French saying is, de la discussion jaillit la lumiere.

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