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Macroeconomic uncertainty

from Lars Syll

The financial crisis of 2007-08 hit most laymen and economists with surprise. What was it that went wrong with our macroeconomic models, since they obviously did not foresee the collapse or even make it conceivable?

There are many who have ventured to answer this question. And they have come up with a variety of answers, ranging from the exaggerated mathematization of economics to irrational and corrupt politicians.

0But the root of our problem goes much deeper. It ultimately goes back to how we look upon the data we are handling. In ‘modern’ macroeconomics — Dynamic Stochastic General Equilibrium, New Synthesis, New Classical and ‘New Keynesian’ — variables are treated as if drawn from a known ‘data-generating process’ that unfolds over time and on which we, therefore, have access to heaps of historical time-series. If we do not assume that we know the ‘data-generating process’ – if we do not have the ‘true’ model – the whole edifice collapses. And of course, it has to. I mean, who really honestly believes that we should have access to this mythical Holy Grail, the data-generating process?

Modern macroeconomics obviously did not anticipate the enormity of the problems that unregulated ‘efficient’ financial markets created. Why? Because it builds on the myth of us knowing the ‘data-generating process’ and that we can describe the variables of our evolving economies as drawn from an urn containing stochastic probability functions with known means and variances.

This is like saying that you are going on a holiday trip and that you know that the chance the weather being sunny is at least 30% and that this is enough for you to decide on bringing along your sunglasses or not. You are supposed to be able to calculate the expected utility based on the given probability of sunny weather and make a simple decision of either-or. Uncertainty is reduced to risk.

But as Keynes convincingly argued in his monumental Treatise on Probability (1921), this is not always possible. Often we simply do not know. According to one model the chance of sunny weather is perhaps somewhere around 10% and according to another – equally good – model the chance is perhaps somewhere around 40%. We cannot put exact numbers on these assessments. We cannot calculate means and variances. There are no given probability distributions that we can appeal to.

In the end, this is what it all boils down to. We all know that many activities, relations, processes and events are of the Keynesian uncertainty-type. The data do not unequivocally single out one decision as the only ‘rational’ one. Neither the economist nor the deciding individual can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.

wrongrightSome macroeconomists, however, still want to be able to use their hammer. So they decide to pretend that the world looks like a nail, and pretend that uncertainty can be reduced to risk. So they construct their mathematical models on that assumption. The result: financial crises and economic havoc.

How much better – how much bigger chance that we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control – if instead, we could just admit that we often simply do not know and that we have to live with that uncertainty as well as it goes.

Fooling people into believing that one can cope with an unknown economic future in a way similar to playing at the roulette wheels, is a sure recipe for only one thing – economic catastrophe!

  1. Ikonoclast
    December 1, 2019 at 9:12 pm

    I understand the current system is a mess and leading us to disaster. What do you propose?

    I understand your reasoning at the philosophical, logical and empirical levels. I do not understand probability mathematics and uncertainty concepts very well but I take it on trust that you do. It’s very clear that conventional macroeconomists do not understand probability mathematics and uncertainty concepts correctly or do not pay proper attention to these issues, being blinded by their discipline’s ideology. This is clear from their results and how empirical events extensively refute their theories.

    However, at the social-democratic level (if that is what you accept as a reasonable governance model), we still need policies and governance, if we are to be a society and civilization at all, rather than settle for anarchism or barbarism.

    At some point you need to offer possible alternatives to the current system of political economy. These may be either one-after-the-other “tinkering” changes to be tested empirically or a thoroughgoing manifesto for a new political economy. Maybe you have done this in some of your writings. If so a link would be helpful, thanks.

  2. Helen Sakho
    December 1, 2019 at 10:45 pm

    We remain entrenched in the same old positions. Blind to the catastrophic situation that faces most of humanity and to the reality that we have nothing new to offer to anyone. Will this ever change? One remains sceptical.

  3. December 2, 2019 at 5:19 am

    “the reality that we have nothing new to offer to anyone”

    Speak for yourself Helen. For me, the book Economy, Society, Nature, is something new being offered.

    I do wonder, on this blog site, if a new, promising approach appeared would anybody recognise it as such? The experiment is in progress.

    As to the subject of the above article, I would be rather briefer. Mainstream economists exclude debt from their fancy models. This makes them blind to the build-up and collapse of excessive debt.

    • Frank Salter
      December 2, 2019 at 9:05 am

      The answer to your question on a new approach is simple, It is not being recognised.

      The only approach which are able yodeal with changes in time is by solving equations in time as they respond over time. The only approaches I know are Kaldor’s using Verdoorn’s Law, models using numerical solutions being solved over time and my analytical solution, “Transient Development”. Transient Development’s mathematical solutions provides abstract production theory. It predicts every known empirical feature found in economics but that appears to be being ignored. I would like to understand why this is.

      • postkeynesian spain
        December 3, 2019 at 2:59 pm

        Frank Salter, sorry, but i read your work and is a bullshit…

        You need to understand the capital controversies for example.

      • postkeynesian spain
        December 3, 2019 at 3:04 pm

        I really think that someone should say this but nobody wants to say it, but your work is very bad and has no future, it is the cruel reality.

        You can keep writing here again every day, but nobody will answer/listen to you…

      • postkeynesian spain
        December 3, 2019 at 3:06 pm

        I really believe that someone should say this but nobody wants to say it, but your work is very bad and has no future, it is the cruel reality.

        You can keep writing here every day, but nobody will answer/listen…

      • Frank Salter
        December 3, 2019 at 4:30 pm

        Well postkeynesisn you have strong views. Saying some thing is BS is easy. If you have read my analysis then you clearly have not understood it. If you think the maths is wrong explain why. Explain why when the maths predicts all the so called economic laws can you claim it to be wrong? Give reasons so I can correct your errors of thinking.

      • postkeynesian spain
        December 3, 2019 at 9:20 pm

        You use pseudomagnitudes.

        I said: “You need to understand the capital controversies for example”.

      • Frank Salter
        December 4, 2019 at 10:15 am

        I use real magnitudes not pseudo. Labour-time is a measure of a real quantity. Every definition of productivity requires it. If you mean I have developed an abstract theory with the algebraic variables represent real quantities having both magnitude and units of quantity.

        I do understand the capital controversies. My mathematics produces a relationship which proves that the neoclassical equations are false to fact.

      • postkeynesian spain
        December 5, 2019 at 2:17 pm

        okay, you bring me an example and i take!

        Working time is only time, working time cannot be used for a production function, because there is no relationship between work time and production. You can have different products with the same manufacturing time.

      • Frank Salter
        December 5, 2019 at 6:07 pm

        I’m sorry but you are wrong. The quantity calculus shows how output decomposes into labour-time and productivity.

    • December 2, 2019 at 11:45 am

      “I do wonder, on this blog site, if a new, promising approach appeared would anybody recognise it as such? ”

      Apparently not. Even Geoff is still talking “mainstream”: the ignored “debts” being created out of nothing and repaid in the same nothing. (As against created when we spend credit and communally repaid by restoring what we have consumed).

      The “new, promising approach” of seeing and admitting the truth when we are environmentally behind on our repayments? Academics, it seems, rarely admit anything not already certified in a “respectable” publication. Even Newton and Einstein needed sponsors.

      • Robert Locke
        December 2, 2019 at 1:44 pm

        How long did it take for a Copernican view of the planets to become acceptable, count the centuries? And that wasn’t social science.

      • December 2, 2019 at 2:54 pm

        According to Wikipedia, about one. Printing was new then, but even even with the internet tiny acorns take a long time to grow into mighty oaks, and they won’t if you don’t plant them.

        When one of our daughters was little, we saw her to see the floods, and she worried us to death trying to get up close to see it better. The more we tried to draw her back, the more she struggled to get up close. In the end we said, “Well, jump in, then”. She moved back!

        I’m very tempted, on this blog, to say the opposite of what I mean to see if that will get my point across.

      • Frank Salter
        December 2, 2019 at 3:33 pm

        Copernicus published in 1543. Galileo had to recant in 1615. So about half a century.

      • December 2, 2019 at 11:12 pm

        Robert, we’re not talking about the Vatican trying to ignore Copernicus. We’re talking about people who claim to be hungry for an alternative approach. They may or not believe any particular new approach, but first they have to recognise that there is one (or more). You can see my comment was triggered by (yet another) implication or claim that no-one has a new approach to offer.

      • December 2, 2019 at 11:20 pm

        Dave, I’m not sure I follow you, but you seem to claim I’m mainstream for *describing* the nature of modern token money. But more substantively, how can we spend credit before credit is created? Token money is precisely a token of credit (and its corresponding debt). And if you think I endorse the enormous environmental ‘debt’ we have accumulated you gravely misunderstand me.

      • Robert Locke
        December 3, 2019 at 11:29 am

        Read Pius IX, syllabus of errors, 1864, and see what “errors” the pope listed. Mass printing occurred during the Reformation, so people were not waiting around for a new information technology, it was already there and being utilized in the 16th century. Even university scholarship, remember cambridge up was founded in 1543.

      • Robert Locke
        December 3, 2019 at 11:47 am

        Here are the last four errors on the 1864 list that the pope denounced, which was tough on liberal Catholics.

        X. ERRORS HAVING REFERENCE TO MODERN LIBERALISM

        77. In the present day it is no longer expedient that the Catholic religion should be held as the only religion of the State, to the exclusion of all other forms of worship. — Allocution “Nemo vestrum,” July 26, 1855.Big Error

        78. Hence it has been wisely decided by law, in some Catholic countries, that persons coming to reside therein shall enjoy the public exercise of their own peculiar worship. — Allocution “Acerbissimum,” Sept. 27, 1852. Big Error

        79. Moreover, it is false that the civil liberty of every form of worship, and the full power, given to all, of overtly and publicly manifesting any opinions whatsoever and thoughts, conduce more easily to corrupt the morals and minds of the people, and to propagate the pest of indifferentism. — Allocution “Nunquam fore,” Dec. 15, 1856.

        80. The Roman Pontiff can, and ought to, reconcile himself, and come to terms with progress, liberalism and modern civilization.- -Allocution “Jamdudum cernimus,” March 18, 1861. Perhaps Pius was right, where did a belief in progress, liberalism, and modern civilization get us after 1864.

  4. December 2, 2019 at 6:15 am

    Here is a book everyone should read. It is great!
    “Utopia for Realists” by Rutger Bregman
    Translated from the Dutch byElizabeth Manton, 2016
    Bloomsbury Publishing
    ISBN; 978-1-4088-9321-0

    • December 2, 2019 at 8:54 am

      Dear John, here is another one that I can wholeheartedly recommend:

      Uncertainty and Economics: A Paradigmatic Perspective
      Routledge
      (Frontiers of Political Economy)
      ISBN-13: 978-0367076030

      This example from the book shows what uncertainty (properly understood) offers in terms of enhancing our understanding of economics and the economy (though the chapter on DSGE is much more fun, I have to admit): https://www.s-e-i.ch/Projects/AssetPrices/Documents/Type1.htm

      • Meta Capitalism
        December 2, 2019 at 11:27 am

        $40 for a Kindle book is outragious. One thing is certain, few will pay to read an overpriced book.

      • December 2, 2019 at 11:33 am

        I am sorry for the price … it wasn’t my choice. But the publisher has a clear first-come-first-pay-a-lot strategy. Therefore, those who are patient will have it; plus, a free copy is always available for reviewers (and quite many libraries hold it now). Anyway, the content is clearly worth more or less any price ;-).

      • December 3, 2019 at 11:48 am

        Hello Christian, My recommendation has a heavy political message, which is why it is so relevant. Is yours a polemic too? I thought DSGE is a non starter today.

  5. December 2, 2019 at 10:30 am

    Lars, you say ” I mean, who really honestly believes that we should have access to this mythical Holy Grail, the data-generating process?”

    You might like to reflect on the fact that they Keynes of 1930 was the Keynesian probability theorist of 1921, but the Keynes of 1936 had introduced a second data-generating process operating on a slower timescale. One cannot predict the sum of myriad price changes but one can predict the order of events: that past price changes will have preceded present unemployment and approaching environmental catastrophe.

  6. Dave Raithel
    December 2, 2019 at 1:07 pm

    “According to one model the chance of sunny weather is perhaps somewhere around 10% and according to another – equally good – model the chance is perhaps somewhere around 40%.” In what sense are they “equally good?” They do not yield the same predictions, so they are not equal in that sense. Is anyone keeping track of the number times Model 10% is correct contra Model 40%? Or would that just be another instance of mistakenly believing I am pulling data from a data generating process? (Nobody was counting BEFORE I showed up, so who really knows what was in the urn jar before I started looking?) I have never disputed Syll’s central contention that what’s passed off as “economic science” is often only and just ideology obscured by mathematics. I generally agree. I just never really understand his arguments.

    • December 2, 2019 at 1:33 pm

      Dear Dave, the argument is ontological: what’s the fabric of the object you investigate? Is it something that sits there and waits to be “discovered” (in that case you can apply the idea of data generating processes, dgp) or is it constantly created, destroyed and re-created by human creativity and ingenuity. If the latter applies there is no place for a dgp. Economics is probably better described by the latter but most economists pretend to be dealing with the former. I don’t agree with Lars, btw., on the sunshine example which is more deterministic in complexity disguise than truly uncertain. W.r.t. DSGE I couldn’t agree more with him: http://et.worldeconomicsassociation.org/papers/the-lucas-critique-a-lucas-critique/

  7. Craig
    December 2, 2019 at 4:58 pm

    Uncertainty ye shall always have with you, however it helps to understand and abide by the following:

    The willingness and ability to mentally integrate the truths in seeming opposites, i.e. wisdom,

    The willingness and ability to focus on and observe the present and recognize and decipher solutions from such, i.e. the pragmatic aspect of wisdom,

    The willingness and ability to perceive essences and their significance, i.e. the paradigmatic perception of wisdom and

    The willingness and ability to recognize the wisdom of always maintaining an ethic of integration in one’s thinking and investigations, i.e. the wisdom of wisdom.

    “It’s the monetary and financial paradigm, stupid”.

  8. EDWARD K ROSS
    December 2, 2019 at 8:51 pm

    In reply to Lars Syll December 1,2019 and those who have responded to it.

    “THE FINANCIAL CRISIS OF 2007-08 hit most laymen and economists with surprise. What was it that went wrong with our macroeconomic models, since they obviously did not foresee the collapse or even make it conceivable?”

    In response to the above, I have repeatedly written that many of my old uneducated friends, who had lived through the 1930s great depression were aware that sooner or later the economy was in danger of collapsing unless steps were taken to prevent the crash.

    From my perspective and logic as a member of the public the answer is they began their understanding of the problem from lived experience and what amounts to empirical evidence.
    Certainly these people could not predict when it would happen, but they could see that we were on a crash course, that was likely to create major problems for many people.

    From my practical experience and observation, the lesson that can be learnt from my old friends is, the importance of experience and observation of the economy, before discussing theory. As for models, far to often they do not connect to the present real world. Apart from that most of the posts offer plenty of food for thought.Ted

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