Home > Uncategorized > Chicago economics — garbage in, gospel out

Chicago economics — garbage in, gospel out

from Lars Syll

Savings-and-InvestmentsEvery dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

John Cochrane

The problem with this view is, of course, that it is utter and complete nonsense!

What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex-ante and ex-post adjustments. And as further stressed by a famous English economist about the same time, what happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

william-vickrey-1914-1996As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly … those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

As could be expected there is no room in Chicago economics for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply-side policies.

Robert Lucas and other Chicago economists have again and again dismissed even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead — “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” — this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do in their attempts to explain away the fact that the latest economic crises show how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be the government.

Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich. Trying to explain business cycles in terms of ‘rational expectations’ has failed blatantly. Maybe it would be asking too much of freshwater economists like Lucas and Cochrane to concede that, but it is still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas or John Cochrane was. John Maynard Keynes and William Vickrey, on the other hand, will still be known as two of the masters of economics.

  1. May 20, 2019 at 9:51 pm

    It would be worth clearing up that lots of economic laws implicitly assume supply or scaling limits. Sure, if the economy was hitting some fixed capacity in terms of material resources then government would compete with private interests for their allocation. Usually we’re not at capacity, nor is it fixed. But the point is to reveal those assumptions.

    Same with inflation. If production was at capacity and government tried to magic up some money to pay for projects, the money would straight up turn into inflation. That’s rarely the situation. Whether inflation happens is a difficult distributional and flow problem, but outside of war and failed states limited capacity isn’t the main concern.

    And with trade. Mainstream theory down to Ricardo assumes a sloping supply curve, based on some hidden micro-assumption that potato fields or steelworks have declining yield as you try to operate more. And yet we’re in an era of infinitely reproducible IP rights and vanishingly low labor costs. No wonder it creates monopolies.

    Next time you guys write a textbook, call out those implicit scaling assumptions.

    • June 9, 2019 at 6:34 pm

      Good point.

      It is the notion of ‘general equilibrium’ that leads to the zero-sum situation wherein fiscal spending comes at the cost of reduced private spending … which is to say that this notion creates a ‘pie’ of fixed size that can only be divided rather than added to..

      There are no more dangerous ideas in economic theory than the ideas of ‘market equilibria’ and, ‘general equilibrium’ that riddle all of neoclassical economics. These, like ‘preference –er, utility– theory take the focus off of ‘why’ people ‘consume’ –er, ‘use’ economic goods (hiding even ‘why’ these are ‘economic goods’)– and the potential growth paths of markets and economies overall.

      I seldom comment here anymore, but i felt your comment warrants attention and exploration.

  2. Craig
    May 20, 2019 at 10:51 pm

    Neo-classical economics is definitely based on false assumptions, however the real problem is the monopolistic monetary and financial paradigm of Debt Only as the sole form and vehicle for the creation and distribution of money/credit.

    Economists need to focus on the real PARADIGMATIC problem and how it can be resolved for the benefit of every agent individual and commercial….otherwise you’re just riding your favorite hobby horse palliative reform, regurgitating mere critiques and remaining part of the problem.

  3. Rob
    May 22, 2019 at 9:45 am

    [E]conomics is rightly in the midst of a re-think. It was obvious a lot had gone wrong at the time of the financial crisis; it was a professional embarrassment that the worst crash in three generations occurred not too long after economists took over in the cockpit.

    And then just as significantly, a decade on from that crisis, we know that the orthodox economic model (the one that many people call “neoliberal”) is leaving swathes of people in large parts of all western societies dissatisfied.

    Traditional economic models need to be simple to make the maths work, and getting the maths to work has always felt like an important objective. In addition, a huge weight in these models has been put on internal consistency, rather than practical applicability. But it turns out that the world is more complicated than these simplistic assumptions imply.

    This is very clear in the most basic function of economic models, to help us understand the economy. Economists have always produced their models in the form of a kind of virtual black box containing dozens of equations. Into this, they can plug some data and out of the box come projections of how the economy will behave in different circumstances.

    These models have a certain theoretical elegance but there is now an increasing sense that economies do not evolve along a well-defined mathematical path, but in a far more messy way. The individual players within the economy face radical uncertainty; they adapt and learn as they go; they watch what everybody else does. The economy stumbles along in a process of slow discovery, full of feedback loops. (BBC, Evan Davis, 5/22/2019)

    • Frank Salter
      May 22, 2019 at 5:34 pm

      All these models are rejected by the quality calculus as their having any theoretical validity whatsoever.

  4. Ken Zimmerman
    June 2, 2019 at 11:17 am

    Chicago economics is all that you say and more. It is a dismal depiction of how supposedly smart people can wreck society and turn millions of the world’s peoples into paupers or worse.
    I do not accept that this is an “honest” mistake. I believe it was done deliberately. First to help the emerging “super-rich” reach that goal and stay there. Second to crush workers so they had no choice but to accept whatever job and wages offered to them, and force these same workers as consumers to take on monumental debt to maintain a “middle-class” (or at least near middle-class) life style. The money flows will stop any changes in either economic theories or the economists who control the subject (academically and in business). The two must be pushed out simultaneously if there’s to be any chance of saving the world, We’re nearing the point of no return. Rebellion now, or slavery for the next 100 years, or more.

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