Calibration — an economics fraud kit
from Lars Syll
In his well-written and interesting article The Trouble with Macroeconomics, Paul Romer goes to a frontal attack on the theories that have put macroeconomics on a path of ‘intellectual regress’ for three decades now:
Macroeconomists got comfortable with the idea that fluctuations in macroeconomic aggregates are caused by imaginary shocks, instead of actions that people take, after Kydland and Prescott (1982) launched the real business cycle (RBC) model …
In response to the observation that the shocks are imaginary, a standard defence invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that “the more significant the theory, the more unrealistic the assumptions.” More recently, “all models are false” seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favourite.
The noncommittal relationship with the truth revealed by these methodological evasions and the “less than totally convinced …” dismissal of fact goes so far beyond post-modern irony that it deserves its own label. I suggest “post-real.”
There are many kinds of useless ‘post-real’ economics held in high regard within mainstream economics establishment today. Few — if any — are less deserved than the macroeconomic theory/method — mostly connected with Nobel laureates Finn Kydland, Robert Lucas, Edward Prescott and Thomas Sargent — called calibration.
In physics, it may possibly not be straining credulity too much to model processes as ergodic – where time and history do not really matter – but in social and historical sciences it is obviously ridiculous. If societies and economies were ergodic worlds, why do econometricians fervently discuss things such as structural breaks and regime shifts? That they do is an indication of the unrealisticness of treating open systems as analyzable with ergodic concepts.
The future is not reducible to a known set of prospects. It is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be. Reading Lucas, Sargent, Prescott, Kydland and other calibrationists one comes to think of Robert Clower’s apt remark that
much economics is so far removed from anything that remotely resembles the real world that it’s often difficult for economists to take their own subject seriously.
Instead of assuming calibration and rational expectations to be right, one ought to confront the hypothesis with the available evidence. It is not enough to construct models. Anyone can construct models. To be seriously interesting, models have to come with an aim. They have to have an intended use. If the intention of calibration and rational expectations is to help us explain real economies, it has to be evaluated from that perspective. A model or hypothesis without a specific applicability is not really deserving our interest.
Without strong evidence, all kinds of absurd claims and nonsense may pretend to be science. We have to demand more of a justification than this rather watered-down version of ‘anything goes’ when it comes to rationality postulates. If one proposes rational expectations one also has to support its underlying assumptions. None is given, which makes it rather puzzling how rational expectations has become the standard modelling assumption made in much of modern macroeconomics. Perhaps the reason is that economists often mistake mathematical beauty for truth.
In the hands of Lucas, Prescott and Sargent, rational expectations have been transformed from an – in principle – testable hypothesis to an irrefutable proposition. Believing in a set of irrefutable propositions may be comfortable – like religious convictions or ideological dogmas – but it is not science.
So where does this all lead us? What is the trouble ahead for economics? Putting a sticky-price DSGE lipstick on the RBC pig sure won’t do. Neither will just looking the other way and pretend it’s raining.
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Real-World Economics Review Blog 
If one starts from (that is, if one accepts) general equilibrium theory then some undefined shock is necessary to depart from the equilibrium condition. Equilibrium implies that everything being accounted for will NOT change. A shock has to be introduced or equilibrium must be denied.
When properly applied, calibration is a valid procedure. What is wrong with conventional economic analysis is the total failure to understand the nature of abstraction and the requirements of the quantity calculus and dimensional analysis. As the forms of production functions are extended to other economic concepts, I will use these as the example of what actually transpires.
No production function is dimensionally valid. The Cobb-Douglas function has fractional exponents. It is NOT an abstract description of a theory. Quantity calculus proves this. It is therefore a concrete expression for a set of data. As such it may be usefully employed. Unfortunately, economists lacking the knowledge and understanding of the quantity calculus attribute abstraction to production functions and then introduce calibration. If they were starting with an abstract relationship it would be calibration, but all they do is record the concrete nature of their data.
So the discussion in the blog only continues the failure to grasp the real problem — economists do NOT understand the true requirements of abstract quantity theory. That data can be fitted successfully by arbitrary functions does NOT imply theoretical justification in any way — the opposite is a MAJOR category error.
For guys who claim to be math honchos using non dimensionally homogeneous equations is seriously bush league. The experience of math physics teaches that, though highly complex, systems can often be successfully modeled by a small number of equations. It’s surprising how constraining each added governing equation can be. For example, in fluid mechanics, the continuity equation, which says voids cannot appear inside the fluid or at a wall, is highly constraining. Combined with momentum conservation, a few fluid constitutive equations, and initial data, and you have the basis for fluid dynamic modeling.
My point is, if you find the correct model equations, it doesn’t take much more than that to make real predictive progress. When you see a discipline wallowing around getting no where prediction wise, the problem isn’t insurmountable complexity. Often it’s failure to build the right simple model. Steve Keen’s approach comes to mind but there are certainly others.
What does this blog post tell us? It tells us that not integrating policy with philosophy is the road to hardening orthodoxy. It also tells us that economic theory has not consciously recognized the ultimate integrative concept that will bring the discipline into the modern age.
Quantum physics tells us that in reality “nothing ever touches”. This is anathema to our temporal universe habituated senses, but is paradoxically the actual truth. The cosmos is actually one seamless whole that simultaneously we experience as separateness…..and the only way to resolve this is to cognite on the one philosophical concept that being an expression of duality ultimately integrated to the point of thirdness greater oneness, that is grace as in a flowing wholeness/oneness/process…..is necessary to make sense of that paradox, and that aligning policy with that concept is simply the temporal universe expression of logic.
Lars, religious dogma is more open and honest about its predictions. It is either heaven, or hell that people will go to. In-betweenness is also possible if the higher authorities are not sure of one’s final destination, or in the presence of a long queue. Let us call the latter option “repressed inflation”. Where do Economists stand?
Even though I’m in agreement with virtually all of the heterodox theoretics being presented on this blog I’m the only one here who is comfortably willing and able to talk about monetary and economic POLICY because no one else here is confident enough to do so, and the reason for that is they have not yet recognized the philosophical concept upon which the new economic philosophy and paradigm needs to be based.
When you do a thorough exegesis of that concept and see how it fits seamlessly within the legitimate operations of economics, resolves its deepest and most chronic problems, replaces the dominance and primacy of the current structurally dominant entity and its paradigm (private finance/Debt Only) and defines the new paradigm itself…you become the one eyed man in the country of the blind.
I know a little about the one eyed man in a village becoming the source of all wisdom, but I do truly admire the Ethiopian one-eyed, wounded, old but fierce female tigers who scare the hell out of their male counterparts to defend their loved ones working co-operatively and teaching their young ones to do the same in battle.
God knows when these Economists will be confident enough or wise enough to develop better philosophies to leave behind for anyone!
Helen,
Maybe they will become wise enough if they contemplate that debt jubilees are are monetary grace as in gifting, and that government deficits are grace as in monetary abundance instead of austerity. Also, if they contemplate that a universal dividend is monetary grace as in directness instead of via re-distributive taxation (directness versus via the church only was the major aspect of grace expressed in the Protestant Reformation).
Maybe they will become wise enough if they contemplate that the reciprocality of the discount/rebate policy is grace as in graciousness, benevolence, lack of bias and relationship as opposed to the dominance by uneconomic costs by finance that businesses must pass on in order to attempt to be profitable in a system of individual monetary scarcity and systemic austerity.
Maybe if they study the signatures of imminent and accomplished paradigm change it will help as well.
With the above comments in mind, one thing missing from today’s policy debates is the fact that problems often require a two step solution. For example if one falls into quicksand the short term effort must focus on getting out. Only then can one ponder the long term question of how to avoid such traps.
A Jubilee for example will likely help us escape from our current zombie economic state. Per se, it will not be permanent so we will need a long term policy also.
We have both problems. Current leadership does not view our existing debt zombie structure as a trap, and so they scoff at Jubilee as a solution. If we are not trapped short term, why worry about avoiding such traps long term?
Models and modelling have been part of my professional work for over 40 years. I’ve never used a model that wasn’t calibrated. Let me explain. The heart of a model is the relationships among variables encoded into the model. These are gathered from various data bases as well as input from persons and groups involved in the areas depicted in the models. These are generally depicted mathematically, although narrative (historical) models are both possible and effective. The preference for mathematical models is I suspect an expression of the dominance of numerical thinking inherited from the cultural shift toward scientific thinking in numbers of the last several centuries. Models are calibrated by comparing model output with an independent data source. These sources could be historical data, expert opinions, results from different types of models, etc. A model is considered calibrated when its results are consistent with the benchmark tools, as determined by the modelers’ judgement. Most modelers prefer consistency with all or most benchmarks. This comparison is repeated as necessary. When results are not consistent with benchmarks, the modeler alters the relationships in the model and tries again. No model is perfectly consistent with benchmarks, but some consistently perform better than others. In seminars on modeling, I emphasize that modeling is like artillery. Artillery brings shells closer to the target by collating observations of spotters in several locations. In this way the shells gradually fall nearer the target and some strike the target.