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Causal explanation of autonomy and invariance of regression relationships

from Asad Zaman

Brief History of Econometrics: Launched in early 20th Century by Ragnar Frisch, econometric methodology was strongly shaped by the Cowles Commission (CC) in the 1960’s. The CC approach relied on structural equations, which embodied causal information known in advanced to the researcher. The goal was estimation of causal effects, and not discovery or assessment of the hypothesized causal structures. The oil shock of the 1970’s led to dramatic failures of macroeconomic regression models, leading to general distrust of econometric methodology. Two major critiques emerged.  read more

Brief history of econometrics

April 26, 2021 5 comments

from Asad Zaman

Launched in early 20th Century by Ragnar Frisch, econometric methodology was strongly shaped by the Cowles Commission (CC) in the 1960’s. The CC approach relied on structural equations, which embodied causal information known in advanced to the researcher. The goal was estimation of causal effects, and not discovery or assessment of the hypothesized causal structures. The oil shock of the 1970’s led to dramatic failures of macroeconomic regression models, leading to general distrust of econometric methodology. Two major critiques emerged. The Sims critique argued that hypothesized causal structures were false, and should be abandoned. We should go back to a purely descriptive analysis, looking for patterns in the numbers, without any reference to the real world phenomena represented by these numbers. Directly opposite was the Lucas critique which said that regression models were based on surface relationships between the numbers and ignored the deeper causal structures which drive these relationships. Regression models would fail when economic regimes underwent structural change – precisely when they were most needed. Neither approach has led to successful macro models. Models based on both approaches, as well as more conventional macro models, failed dramatically in the Global financial crisis. The fundamental problem lies in the failure of econometrics to incorporate causal inference correctly.

Causal Explanation of Autonomy & Invariance of Regression Relationships

Causal versus Positivist Econometrics

April 17, 2021 1 comment

from Asad Zaman

Defining Feature of Real Econometrics

We can define “Real Econometrics” as being the search for causal relationships within a collection of variables. There exists an enormous amount of confusion about what exactly is a causal relationship. We will take a simple and practical approach, developed by Woodward in his book on “Making Things Happen”. Given a collection of variables X,Y,Z1,Z2,…,Zn, we will say that X is a cause of Y if we can create changes in Y by changing the values of X. This is a “practical” definition in the sense that if we learn about causal relationship, we can use it to create changes in the world around us.

Why is there confusion about causality?

Children (and animals) are born with the ability to learn about causal relationships, and to use them to bring about desirable changes in their external environment. Since understanding of causation is built deeply into us, ordinary people find it difficult to understand why philosophers are so confused about causality. We need to discuss this issue because dominant methodology of statistics and econometrics is built on foundations of a philosophy (logical positivism) which is a source of enormous confusion. However, students should not worry if they fail to understand the source of this confusion. The point of trying to explain this is to explain why conventional statistics and econometrics is wrong. It does not matter for learning real statistics.  read more

Econometrics versus reality

March 31, 2021 10 comments

from Asad Zaman

Underlying Philosophy of Science

Many important structures of the real world are hidden from view. However, as briefly sketched in previous lecture on Ibnul Haytham: First Scientist, current views say that science is only based on observables. Causation is central to statistics and econometrics, but it is not observable. As a result, there is no notation available to describe the relationship of causation between two variables. We will use X => Y as a notation for X causes Y. Roughly speaking, this means that if values of X were to change, then Y would have a tendency to change as a result. This is not observable for two separate reasons. ONE because it is based on a counterfactual. In another world, where the value of X was different from what was actually observed in our current world, this change would exert pressure on Y to change. TWO X exerts an influence on Y, but there are other causal factors which are also involved. Thus Y might not actually change in the expected direction because the effect of X  might be offset by other causal factors which we have not accounted for. For both of these reasons, causality is not directly observable.

Achieving Conceptual Clarity  read more

Critique of Rajan on debt

February 2, 2021 6 comments

from Asad Zaman 

“my views are based on insights acquired from MMT, but  .  . . . . . . . . . . . ”         

In this post, I will provide a critique of Raguram Rajan’s article “How Much Debt is Too Much?”. (Alternative link to Rajan’s article)

The article opens with a description of the governments “opening their coffers, to support small households and firms” in the COVID era. Required spending has been on the order of 15-20% of the GDP, and the article examines the extent to which government can finance this extra expense by borrowing at low interest rates from the private sector.

The language reminded me Robin Hood and his team swooping down on government convoys laden with coffers of gold. In face of this generosity by the government, it seems churlish to examine their coffers, to see if they contain gold, or just paper promises. Rajan’s theories are based on archaic understandings of money as gold. Rajan’s article assumes, without discussion, the following premises:

  1. Government are like households. Spending must by financed by taxes or borrowing.
  2. Borrowing from private sector increases the amount of money available for government spending.
  3. Government ability to pay off the debt created by private borrowing depends on the interest rate, and on its capabilities to raise revenues (by taxation or borrowing) in the future.

All three of these propositions are false, as would be evident to readers of my earlier post on ABC’s of MMT. It is worth clarifying that my views are based on insights acquired from MMT, but need not coincide with the official doctrines of MMT.

To begin with, we must ask why . . .  read more

Marilyn & the Goats: A new solution to an old problem

January 21, 2021 2 comments

from Asad Zaman

Introduction: In a previous lecture, we gave a New Definition of Probability. In this lecture, we will show how this definition enables us to resolve the massive amount of controversy which surrounds an apparently simple probability puzzle, known as the Monty-Hall problem. The book The Power of Logical Thinking, quotes cognitive psychologist Massimo Piattelli Palmarini: “No other statistical puzzle comes so close to fooling all the people all the time [and] even Nobel physicists systematically give the wrong answer, and that they insist on it, and they are ready to berate in print those who propose the right answer.” Before proceeding to discuss this problem, we review the key features of our new definition:

  1. Probability is a feature of external reality, not an aspect of our ignorance/knowledge.
  2. Probability exists PRIOR to occurrence of random event.
  3. Probability is EXTINGUISHED after event occurs.  Read more

A new definition of “probability”

January 13, 2021 4 comments

from Asad Zaman

An article by Alan Hajek in Stanford Encyclopedia of Philosophy lists six major categories of definitions. Many more are possible if causality is also taken into account. These definitions conflict with each other, and face serious problems as interpretations of real-world probabilities. The basic definition of probability we will offer in this lecture falls outside all of these listed categories. Before going on to present it, we briefly explain why there is such massive confusion about how to define probability.  read more 

Why do we need pluralism in times of disruption? A practical guide

January 7, 2021 1 comment

from Asad Zaman

Today we are going through a period of disruption due to the COVID-19 pandemic that impacts us individually and collectively in an unprecedented manner. Because we see how interconnected we are, the sense of unity, solidarity in time of crisis is necessary. So why bother with pluralism in the first place?

Introductory remarks about pluralism and the new normal

We are currently in an unprecedented moment in human history. Although humanity went through several pandemics and disruptions, this is the first time that all the globe is equally affected by the virus, and everyone, everywhere, has to deal with the lock-down and its consequences. Our normal is gone, and we do not know what is ahead of us. The world as we knew it is not there, and there is little left of the “normal” to hold on to. We see the health devastation around us, and worry about the galloping economic crisis, and the social impact of both. We are all urgently seeking for any leftover certainty we can get. This is why it is so important to have standards and to have some objective basis for our understanding of what is happening with us, our societies and economies under the risk of COVID-19. All the more, given the highly politicised debates about coronavirus, misinformation, and fake news spreading – we need something reasonable to ground ourselves in this new reality. A pluralist tolerance to everyone’s right to personal freedom of choice, autonomy, affirmation of differences of perspectives seems to be the last wanted thing right now – especially in science – in navigating through these disruptive times. But is it?  read more

Debt, levered losses, & unemployment

December 29, 2020 Leave a comment

from Asad Zaman

A previous post on “Causes of the Global Financial Crisis” provided a detailed summary of the first three chapters of “House of Debt” by Mian and Sufi. This post provides a brief summary of Chapters 4 and 5, in which they present a theoretical framework which explains why leveraged debt leads to high unemployment following a shock to asset prices. The main insight is that the problem is caused by interest-based debt contracts which put most of the risks of default on the weaker party (borrowers), and very little on the stronger party (lenders). Equitable risk sharing between lenders and borrowers would provide a solution.

Background: In the Keynesian Revolution and the Monetarist Counter-Revolution, I have explained how high and persistent unemployment after the Great Depression led to Keynesian insight that government interventions are required to create full employment. This is in conflict with the supply side view, which insists the free markets automatically lead to full employment of all productive resources, including labor. The Reagan-Thatcher era created a counter-revolution against Keynesian theory, and re-implanted the rejected supply side view at the heart of the economic theory. Accordingly, policy responses to the Global Financial Crisis were based on the wrong dogmas. Chapters 4 & 5 of HoD describes the Supply Side view, explains why it is wrong, and then provides an alternative theory to explain the GFC: the Levered Losses framework. read more

Differentiating social, market, and government debts

December 25, 2020 Leave a comment

from Asad Zaman

In a previous post on “ABC’s of MMT”, I explained the basics of MMT as a preliminary to a critique of Raghuram Rajan’s article on “How Much Debt is Too Much?”. A significant part of the discussion on this post consisted of debates over words and their meanings. My use of words like assets, savings, wealth, liability, and debt was contested, and alternative usages were offered. It seems necessary to pause for a discussion of these terminological confusions, prior to going on Rajan’s article. This is because part of the critique is about the terminology used by Rajan. Standard terminology is based on false analogy between the government and the household. In a previous post on “The Power of False Names”, I have explained how the use of misleading terminology can lead to severe misunderstandings and wrong policies.

A deeper understanding of contested meanings of debt, liability, assets, savings, wealth, and related terms, emerges from the study of the history of debt in David Graeber’s “Debt: The First Five Thousand Years”.  Graeber writes that “Arguments about who really owes what to whom have played a central role in shaping our basic vocabulary of right and wrong.” One of the key arguments of Graeber is that there are two kinds of debt.  read more

ABC’s of Modern Monetary Theory (MMT)

December 13, 2020 20 comments

from Asad Zaman

I was overwhelmed by the level of ignorance displayed by distinguished economist Raghuram Rajan in his article entitled “How Much Debt Is Too Much?” published recently in Project Syndicate on Nov 30, 2020. I had meant to write a critique of the article, but to do so requires starting from the very beginning. In this post, I go over some basic MMT concepts, in order to prepare the ground for this critique. There are now many good videos explaining these basics. I will go over six questions discussed in the first ten minutes of “Modern Money & Public Purpose 1: The Historical Evolution of Money and Debt” by Professor L Randall Wray. Learning the answers to these questions provides foundations for understanding MMT which are evidently missing in Rajan’s paper. Professor Wray asks us to decide on True/False for the following six statments:

  • Q1:Just like a household, a nation has to raise money to finance its spending through income or borrowing.
  • Q2:The role of taxes is to provide finance for government spending
  • Q3:The national government borrows money from the private sector to finance the budget deficit
  • Q4:By running budget surpluses, the government takes pressure off the interest rates because more money is available to the private sector for investment projects
  • Q5:Persistent budget deficits will burden future generations with inflation and higher taxes
  • Q6:Running budget surpluses will provide the government with the resources needed to finance spending on retirement benefits for the ageing population in the future

It is easy to score the quiz because  . . read more

Economics as moral philosophy

December 6, 2020 29 comments

from Asad Zaman

Among the many dimensions I have listed in “New Directions in Macroeconomics”, the most important is the moral dimension. If we take Adam Smith as the founder, economics was born as a branch of moral philosophy. However, modern economists claim that the subject is purely positive and scientific, and makes no value judgments. Before we can discuss moral dimensions of economic theories, we must counter this claim, and establish that, contrary to claims made by economists, the subject is deeply and inherently normative. The level of cognitive dissonance required to maintain that economics is objective and value free is much greater than that required to maintain that the earth is flat. How apparently rational and sane people can hold such a stance is in itself a puzzle. I have attempted to provide an explanation of this puzzle in Section 2 of “Islam’s Gift: An Economy of Spiritual Development”.

Because economists deny their existence, it is necessary to unearth and expose the norms at the foundations of modern economics, in order to create the room for rational discussion of alternatives. In “The Normative Foundations of Scarcity”, I have displayed three major normative assumptions, all of which are required to make scarcity the foundation of economics.  read more

Complexity Economics

December 4, 2020 120 comments

from Asad Zaman

Classical Physics, the model for modern economics, was based on the ideas of stability and permanence of astronomical orbits; see Mirowski (1992). Deeper examination of astrophysics led to the replacement of this view by big bang which gave birth to the universe, and increasing entropy, which will lead to its heat death. “Equilibrium” just appears as a temporary and local phenomenon in an evolving and chaotic universe.

Complexity economics takes non-equilibrium seriously. Constantly evolving systems may never be in equilibrium and may even lack a tendency towards equilibrium. The mode of analysis required for such systems cannot be based on the kind of mathematic currently dominant in the economics profession. Complex systems theory was pioneered in the 1980s and 1990s by a small team at the Santa Fe Institute led by W. Brian Arthur. Some of the key elements of this approach to economics can be described as follows:

  1. Computational Aspects: It is essential to understand how closely our analytical methods correlate with our computational abilities. Just as tensor calculus enabled the discovery of relativity by Einstein, the computer power today enables us to explore consequences of behavioral assumptions far beyond the capabilities of mathematical formulae. Even the mechanics of human motion cannot be captured in formulae, but can be expressed and represented as a linked network on computers. Similarly, computers today allow us to capture and analyze dynamics of extremely complex systems.
  2. Complex Features: Brian Arthur et al. (1997) describe several features of complex systems which create models of types not easily accessible by conventional analytical tools and techniques. These include: read more

Ecological Economics

November 28, 2020 2 comments

from Asad Zaman

Eurocentric history portrays the West as advanced, rational, scientific, and democratic, while the East is superstitious, unscientific, autocratic, and backwards. This poisonous philosophy enabled the incredibly brutal and ruthless violence required for the conquest of the globe, and continues to sustain extremely exploitative economic systems. A partial antidote is World Systems theory which portrays all human beings, nations, and cultures, as joint participants in weaving the rich fabric of human history. Ecological economics goes further to take the entire humanity as one element of the biosphere and geosphere of our planet. All of the biological species have their “economics” where they consume and produce, directly or indirectly affecting other species. All of these economies are closely interlinked. Viewed in this light, the environment crisis is easily seen as being due to human beings’ predatory consumption of vast proportions of the biosphere and the geosphere, without any compensatory productive replenishment.

Conventional economics assumes that . . . read more

Developments in money and finance absent from conventional macro textbooks.

November 2, 2020 3 comments

from Asad Zaman

Somebody aptly quipped that ‘Trying to understand the economy without understanding money and finance is like trying to understand how birds fly, without taking the wings into account”.

The Hegelian anti-thesis of the orthodox economic position that money is neutral, is the idea that “money is everything”. Economics is just the analysis of monetary flows, both within a society, and globally. Karl Marx describes the change in perspective via the formulae C-M-C’ versus M-C-M’. In the first paradigm, commodities C are sold to get money M, in order to buy another set of commodities C’. This picture of a barter economy, in which money just facilitates exchange, is at the heart of modern economics; this is why money does not matter. However, in a capitalist economy, M(oney) is used to produce commodities C, and these are sold for more money M’. Money is the goal of production and sales, not an instrument for exchange of commodities. An economy where the drive for profits is the main motivation for productions and purchases, requires an entirely different analysis.

In his classic work on “The Long Twentieth Century: Money, Power, and the Origins of Our Times”, Giovanni (1994) describes how the accumulation of capital (wealth, money) has been the central driver of history over the past several centuries. Giovanni provides a wealth of historical details and a global context to support this thesis, based on a world-systems perspective. Many other authors, writing from many different perspectives, have documented how “money makes the world go around”.

In particular, Minsky’s (1986) analyses of this phenomena are of special importance from the economic point of view.  read more

Political Economy

September 30, 2020 1 comment

from Asad Zaman

This is a sequence of posts on “New Directions in Macroeconomics“, which discusses the numerous directions of research which must be incorporated to create a viable Macroeconomics for the 21st Century. We have previously discussed “Post-Keynesian Economics“, and “Modern Monetary Theory“. This post discusses the necessity of re-incorporating politics into economics.

Once we recognize the importance of history and institutions, it becomes clear that economic problems cannot be separated from politics and society. The interplay of class interests, and their relative power, is of essential importance in understanding political and economic structures of society. Current commitment to methodological individualism has blinded economists to these aspects, and left them unable to explain burning issues like the rapid rise of income inequality in the wake of financial de-regulation. There are many different perspectives from which the inter-relationships between politics and economics can be analyzed.  read more

Modern Monetary Theory

September 22, 2020 46 comments

from Asad Zaman

This continues from the previous post on Post-Keynesian Response. A large number of contributions from different areas need to be integrated to build an economics for the 21st Century. For an acknowledgement of the failure of 20th Century Macro from one of its architects, see Romer’s Trouble With Macro. This post explains Modern Monetary Theory briefly.

Since the time of Keynes, major changes have taken place in the global financial system. Against wishes of Keynes, Bretton-Woods created a dollar centered system based on notional exchangeability of dollars for gold. The Nixon Shock in 1971 removed the gold backing from dollars, leading to the modern world of floating exchange rates. Dramatic changes in the monetary exchange systems and financial institution play no role in orthodox modern macroeconomics, since money and finance are not (supposedly) part of the real economy. Taking the nature of modern money and the financial institutions into serious considerations leads to many important insights which lie at the core of MMT. Three major innovations lie at the foundations of this theory. These are summarized below:

Endogenous Money: MMT reflects an institutional perspective on the creation of money. When Central Banks set discount rates, they lose control of the quantity of money, which must be issued in amounts required to equilibrate the demand/supply of money at the policy rate. Private creation of money depends on bank-lending, which in turn depends on the investment climate. Bank credit depends on expectations, sound collaterals, and also a keeping-up-with-the-Joneses effect – if everyone is lending, banks cannot afford to stay out. Theories of endogenous money underlie Minsky’s Financial Fragility Hypothesis, which suggests that the money creation process is inherently destabilizing because private credit is expanded at the top of the business cycle and contracted at the bottom, exactly the opposite of what is required for good economic management.

Functional Finance: read more

Post-Keynesian Response

September 4, 2020 10 comments

from Asad Zaman

This continues from previous post on New Directions in Macroeconomics. Among the heterodox responses to the crisis in economic theory created by the Global Financial Crisis 2007, we will briefly discuss the following:  Post-Keynesian Economics, Modern Monetary Theory, Political Economy, Evolution of Global Finance, Ecological Economics, Complexity Economics, Islamic Economics. This post is about Post-Keynesian Economics.

The response of mainstream macroeconomists to this crisis has been disappointing; see for example Antara Haldar (2018) “Economics: The Discipline that refuses to change”. The failure of classical economics in the Great Depression of 1929 led Keynes to the create the field of macroeconomics, which was revolutionary many different ways. Unfortunately, as Romer remarks, the profession went backwards, losing hard-won insights. All of the revolutionary Keynesian insights (discussed in greater detail below) have since been rejected by the orthodoxy.  Similarly, there has been little or no response to the demonstrated failure of macroeconomic models following the Global Financial Crisis. read more

Four narratives about central banks

June 27, 2020 3 comments

from Asad Zaman

The previous post (Three Mega-Events Which Shape Our Minds) explains the importance of history in shaping the world we live in. Historical events (facts) by themselves are not meaningful until they are linked together into a coherent narrative. The mortar which connects the facts must be supplied by our minds, and can never be asserted with certainty. The fact that we can never be certain about the narratives which connect and explain history has led to two polar mistakes. The positivist mistake is to renounce narratives, and focus solely on the facts. This makes it impossible to make sense of history, which deprives us of a rich storehouse of human experience. In effect, it means that we must start afresh every day, since the past makes no sense. The other extreme is the post-modern view that anything goes. Since we can never be certain, all narratives we create to connect and explain historical facts are equally valid. Neither of these extremes is correct. We cannot operate without narratives, because all of our actions are based on goals, and on judgments regarding the relative efficacy of different actions in achieving these goals.  read more

Three mega-events which shape our minds

June 22, 2020 2 comments

from Asad Zaman

What is the nature of the world in which I live? As I look around me, I see walls, windows, doors, and furniture. But these are insignificant parts of the world as constructed by my mind. I conceptualize the world through the teachings of history, according to which human history started in the remote past, with hunter-gatherers. I have a smattering of knowledge of the ancient civilizations of Sumeria and Babylon, and much more of the Roman Empire. The rise of Christianity, Islam, the Ottoman Empire, the Industrial Revolution in England.  The NARRATIVE, or the stories woven around these events, and my own place – or that of my ancestors – within these events, shapes my identity, my allegiances, and also my hopes, visions and projects for the future. These narratives guide me about what is worth spending my life and efforts on.  For my present purposes, the important thing to note is that all of this history comes to me via reading of accounts, or listening to oral presentations by teachers and scholars. I did not experience the two world wars, or Hiroshima and Nagasaki, or the “Era of Darkness” described by Shashi Tharoor,  but these events are of major importance in my mental landscape.

History creates the world we live in, far more than the bricks and mortar of the buildings around us, and far more than the rivers, mountains, jungles and oceans that we see. But what is history, and where does this history come from? I was taught that history is just a sequence of facts about the world – dates and events – just one damn thing after another. However, this positivist and reductionist view is extremely harmful to our quest for understanding the world, and our own place in this world.  Due to the influence of positivism, we confuse the NARRATIVE, or the story woven around the historical facts, with the facts themselves. This leads to the false belief that past history is engraved in stone and cannot be changed. While it is true that the events of history are fixed and cannot be changed, we can exercise considerable creative licence in terms of the stories we tell to explain these events. In particular, the stories told by the victors and vanquished are dramatically different, and listening to both sides gives us an idea of how much flexibility exists in interpreting the same events from multiple points of view. read more