from Lars Syll
Modern neoclassical economics relies to a large degree on the notion of probability.
To at all be amenable to applied economic analysis, economic observations allegedly have to be conceived as random events that are analyzable within a probabilistic framework.
But is it really necessary to model the economic system as a system where randomness can only be analyzed and understood when based on an a priori notion of probability?
When attempting to convince us of the necessity of founding empirical economic analysis on probability models, neoclassical economics actually forces us to (implicitly) interpret events as random variables generated by an underlying probability density function.
This is at odds with reality. Randomness obviously is a fact of the real world. Probability, on the other hand, attaches (if at all) to the world via intellectually constructed models, and a fortiori is only a fact of a probability generating (nomological) machine or a well constructed experimental arrangement or “chance set-up”.
In probabilistic econometrics randomness is often defined with the help of independent trials – two events are said to be independent if the occurrence or nonoccurrence of either one has no effect on the probability of the occurrence of the other – as drawing cards from a deck, picking balls from an urn, spinning a roulette wheel or tossing coins – trials which are only definable if somehow set in a probabilistic context. Read more…
from David Ruccio
from Lars Syll
A complete modeling system which yields definitive predictions (or at least multiple equilibria) requires the following conditions: given structures with fixed (or at least predictably random) interrelations between separable parts (e.g., economic agents) and predictable (or at least predictably random) outside influences. Such a system is … a‘closed’ system. Such a system, correctly applied, promotes internal consistency but risks inconsistency with the nature of the economic system unless that too is closed …
from Asad Zaman and the WEA Pedagogical Blog
Reviewers have called it a 700-page punch in the plutocracy’s gut. The title of Thomas Piketty’s magnum opus suggests that he is updating Das Kapital, to bring Marx into the 21st century. Piketty documents a sharp increase in income inequalities over the last 25 years, not only in the US, but also in Canada, Britain, Australia, New Zealand, China, India, Indonesia and South Africa, with people with the highest incomes far outstripping the rest of society. However, he goes far beyond the compilation of statistics and provides a grand unified theory about the deep forces which have shaped human history over centuries. His analysis points out a fundamental conflict between free markets and democracy, directly contrary to widely accepted conventional wisdom that the two go together.
As one illustrative statistic, the bottom 80 per cent of the US population has only five per cent of the wealth, while the top five per cent has 72 per cent. This level of inequality matches the inequality levels seen around the Great Depression. Why is there so much inequality, and why does it continue to rise? Piketty’s answer is brilliantly simple: r > g. The ‘r’ is the rate of return to wealth. This is the profit that the wealthy can make when they invest. The ‘g’ is the growth rate of the economy, currently around 3.3 per cent, globally. There are two types of people in the economy. The wealthy earn money by investing their wealth, while rest must work for a living. If return to wealth is larger than the growth rate, the wealthy grow richer faster than the growth of the economy, while the earnings of the salaried classes grow at a slower rate. As a natural consequence, the rich get richer, while the bottom 99 per cent gets squeezed. read more
from David Wessel in the Wall Street Journal
The typical man with a full-time job–the one at the statistical middle of the middle–earned $50,383 last year, the Census Bureau reported this week.
The typical man with a full-time job in 1973 earned $53,294, measured in 2014 dollars to adjust for inflation.
You read that right: The median male worker who was employed year-round and full time earned less in 2014 than a similarly situated worker earned four decades ago. And those are the ones who had jobs.
This one fact, tucked in Table A-4 of the Census Bureau’s annual report on income, is both a symptom of an economy that isn’t delivering for many ordinary Americans and at least one reason for the dissatisfaction, anger, and distrust that voters are displaying in the 2016 presidential campaign. read more
from Lars Syll
Internal coherence is one way of adjudicating among theories, but so is correspondence to everyday life. Too much realism may kill analysis, but too little realism is unscientific. If theoretical coherence alone were all that mattered, then the only constraint on theoretical exercises would be the human imagination. Interesting
puzzles would replace pragmatic solutions to problems encountered in the world — arguably, an accurate characterization of most contemporary economic theory. Economists must steer a course between (allegedly) pure description and the mere recording of events, on the one side, and self-indulgent mental gymnastics on the other …
Parsimony won out over thoroughness … By myopically pursuing only the formal aspects of the discipline, economics was reduced to its present state, in which we continually know more and more about less and less.
Mainstream economic theory today is in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. Read more…
from Lars Syll
Whereas increasing the difference between a model and its target system may have the advantage that the model becomes easier to study, studying a model is ultimately aimed at learning something about the target system. Therefore, additional approximations come with the cost of making the correspondence between model and target system less straight- forward. Ultimately, this makes the interpretation of results on the model in terms of the target system more problematic. We should keep in mind the advice of Whitehead: “Seek simplicity and distrust it.”
A ‘good model’ is to be understood as a model that achieves an equilibrium between being useful and not being too wrong. The usefulness of a model is clearly context-dependent; it may involve a combination of desired features such as being understandable (for students, researchers, or others), achieving computational tractability, and other criteria. ‘Not being too wrong’ is to be understood as ‘not being too different from reality’.
An interesting article underlining the fact that all empirical sciences use simplifying or unrealistic assumptions in their modeling activities, and that that is not the issue – as long as the assumptions made are not unrealistic in the wrong way or for the wrong reasons. Read more…
from Lars Syll
In most aspects of their lives humans must plan forwards. They take decisions today that affect their future in complex interactions with the decisions of others. When taking such decisions, the available information is only ever a subset of the universe of past and present information, as no individual or group of individuals can be aware of all the relevant information. Hence, views or expectations about the future, relevant for their decisions, use a partial information set, formally expressed as a conditional expectation given the available information.
Moreover, all such views are predicated on there being no un-anticipated future changes in the environment pertinent to the decision. This is formally captured in the concept of ‘stationarity’. Without stationarity, good outcomes based on conditional expectations could not be achieved consistently. Fortunately, there are periods of stability when insights into the way that past events unfolded can assist in planning for the future.
from Asad Zaman and the WEA Pedagogy Blog
Ever since its origins in industrialising England, the capitalist economic system has always been subject to crises. There are countless theories as to the causes, consequences, and possible remedies for these. Karl Marx was among the earliest and most famous critics of capitalism. He argued that the source of the wealth produced by capitalism was the labour of the workers. The capitalists use their power to make profits by exploiting workers, depriving them of their due shares of profits. Capitalismrequires growth to prosper, and this could only come by increasing exploitation. Crises would occur when workers would be oppressed beyond their limits. Eventually, these crises would destroy capitalism as the workers revolted against this unfair system.
Of course, these ideas are anathema to capitalists. During my own studies of economics in universities, a shallow caricature of Marxist economics was presented, only to be ridiculed and dismissed. Much later, I learned to my great surprise, that Marxist ideas are strongly supported by empirical evidence as well as standard capitalist economic theories. Capitalist theory argues that in free markets with perfect competition, both capital and labour earn according to their productivity, so that there is no exploitation. Textbooks pass silently over the fact that huge and increasing concentration of capital in a small number of hands makes free markets and perfect competition impossible. Textbooks also close their eyes to the reality of unemployment rates (currently at an amazingly high 23 per cent in the USA, if we include discouraged workers). Instead, neoclassical theories tell us that all workers will automatically find work in a dynamic free market economy, and blame unemployment on clumsy government interventions. read more
from Thomas Palley
August’s Employment Report showed the unemployment rate fell to 5.1 percent and creation of 173,000 new jobs. Predictably, the decline in the unemployment rate has triggered calls for higher interest rates from Wall Street Hawks on grounds that higher core inflation is just around the corner. That is the same call we heard when the unemployment rate was much higher, and it is the same call we heard in the past two business cycles.
Federal Reserve policymakers should ignore the Hawks and stop being afraid of tight labor markets. In a market economy, that is the way workers get a raise. There is no reason for the Fed to rock the boat and risk confiscating the raise working families have waited for so long. That is the message this Labor Day weekend.
Though the unemployment rate fell, headline job creation was actually below expectations. Moreover, private sector job creation was only 140,000, which is much weaker than recent months. Read more…
from Lars Syll
The more interesting discussion is the one about the definition of truth. The philosopher Bertrand Russell has written something on truth about a century ago in his book The Problems of Philosophy (ch. XII):
“It will be seen that minds do not create truth or falsehood. They create beliefs, but when once the beliefs are created, the mind cannot make them true or false, except in the special case where they concern future things which are within the power of the person believing, such as catching trains. What makes a belief true is a fact, and this fact does not (except in exceptional cases) in any way involve the mind of the person who has the belief.”
Truth, Russell says, is correspondence with facts. If minds do not create truth or falsehood, but only beliefs, then I would argue that models are beliefs. They can be true when they correspond to the facts. So, there is hope! Models can be right after all! … A model is an abstraction, but as such it can be right. Of course, there is no proof that a model that has been right today will be right tomorrow, but that only makes economics an art.
Interesting reading that Read more…
from Lars Syll
Evidence-based theories and policies are highly valued nowadays. Randomization is supposed to control for bias from unknown confounders. The received opinion is that evidence based on randomized experiments therefore is the best.
More and more economists have also lately come to advocate randomization as the principal method for ensuring being able to make valid causal inferences.
I would however rather argue that randomization, just as econometrics, promises more than it can deliver, basically because it requires assumptions that in practice are not possible to maintain.
Especially when it comes to questions of causality, randomization is nowadays considered some kind of “gold standard”. Everything has to be evidence-based, and the evidence has to come from randomized experiments. Read more…
from Dean Baker
Andrew Ross Sorkin seems prepared to pronounce Ken Rogoff to be prescient once again with his prediction that China would run into a debt crisis. Rogoff’s past claims to prescience might be viewed as somewhat questionable. He, along with co-author Carmen Reinhardt, famously argued that countries face a severe slowdown in growth when their debt to GDP ratios exceed 90 percent. It turned out that this claim was driven by an error in an Excel spreadsheet, nonetheless it was used to justify austerity in the euro zone, the United States and elsewhere. This austerity did help to worsen the downturns caused by the collapse of asset bubbles, in effect contributing to the crisis that Sorkin credits Rogoff with predicting. Read more…
Econ 101 textbooks are misleading more than a million students a year in the U.S. alone because they leave the lasting impression that markets could solve all our economic problems if only they were left to themselves. Not even the horrendous sub-prime mortgage-crisis bailout in 2008 and 2009, amounting to trillions of dollars, shook the professions’ faith that the markets know best. They continue to invoke the “invisible hand” metaphor coined by Adam Smith in 1776, without conceding that the global economy has undergone several revolutions and changed profoundly during the intervening centuries. Outdated metaphors will not help but only hinder any effort to understand where we have gone wrong, and why, and what to do about it.
Happily, some students are beginning to see the disconnect between the idealized, theoretical version of economics thought on blackboards and its real-world variant. That is exactly why students walked out of Gregory Mankiw’s Principles of Economics (Econ 10) class at Harvard in 2011,1 and provided him a written explanation for this symbolic gesture: Read more…
from Mark Weisbrot
As the ever-lengthening U.S. election season begins to heat up, it is interesting to compare the U.S. and Europe regarding the evolution of their politics since the world financial crisis and recession (2008-09). In Europe, there has been quite a bit of political upheaval, with center-left parties often losing a large part of their voters. In Greece, to take the most dramatic example, the Panhellenic Socialist Movement (PASOK) is now polling just 3 percent of the electorate, after decades of wining around 40 percent or more of the vote. There have been significant losses of popularity for similar center-left parties in Spain, Italy, France and other countries — although some have yet to materialize in elections. In Greece, the leftist Syriza party has gotten most of the disaffected voters and took power this year; in Spain, the newly created leftist Podemos party shot up to the top quickly, although it has fallen some in polls recently. In France it has been the extreme right National Front that gained most, and in Italy, the new populist Five Star Movement. Read more…
from Lars Syll
The U.S. economy has, on the whole, done pretty well these past 180 years, suggesting that having the government owe the private sector money might not be all that bad a thing. The British government, by the way, has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.
But is the point simply that public debt isn’t as bad as legend has it? Or can government debt actually be a good thing?
Believe it or not, many economists argue that the economy needs a sufficient amount of public debt out there to function well. And how much is sufficient? Maybe more than we currently have. That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.
Krugman is absolutely right.
Why? Read more…
From the comfortable obscurity of academia to become one of the most recognised politicians on the planet
from The Observer
The island of Aegina is just 17 miles from Athens, a mere 40 minutes’ dash on a hydrofoil. Owing to its proximity to the Greek capital, it’s less a tourist island than a second-home sanctuary for wealthy Athenians, but it boasts several impressive classical sites and a distinguished history. Not only was it briefly the capital of a newly liberated Greece in the 19th century but back in the 7th century BC it was the first Greek state to mint its own coins.
Given Greece’s current predicament, trapped in the euro and an ever-expanding debt crisis, that last fact is a monetary irony not lost on one particular wealthy Athenian on Aegina. Sitting on top of a hill a few minutes’ drive from the port is the holiday home of Yanis Varoufakis. He is the former finance minister of Greece, although that’s hardly a description that befits the man’s legend. Gikas Hardouvelis is also a former finance minister of Greece, but no one has heard of him.
It would be more accurate to say that Varoufakis is the former finance minister of Greece who took on the global banking system, the European political elite and, in the minds of many, the great god of capitalism itself. His is a story so full of drama and symbolism that it contains more than a hint of Greek myth.
An economics professor by occupation, he went in a few months from the comfortable obscurity of academia to become one of the most recognised politicians on the planet. read much more
from Maria Alejandra Madi and the WEA Pedagogical Blog
The expansion of neoliberalism in the last four decades has increasingly expressed the tensions between the expansion of the market economy and the consolidation of a new way of life. Indeed, the neoliberal way of life can be apprehended if considering Karl Polanyi´s concern about the way in which the economy relates to social organization and culture and the impacts of social and political institutions in relation to human livelihood. In his opinion, since the proper self-regulation of the market entails that nothing must be allowed to inhibit the formation of markets, the institutional patterns and principles of behavior turn out to adjust perfectly.
Taking into account the current effects of the neoliberal modernization process on the way of life, Karl Polanyi´s critique of the liberal myth and of the disruptive forces inherent to the self-regulated markets it is inspiring to think about the deep impacts of neoliberal policies and institutions on livelihoods. In accordance to Polanyi, the centrality of the market entails that “Nothing must be allowed to inhibit the formation of markets, nor must incomes be permitted to be formed otherwise than through sales” (Polanyi 1944: 69). In other words, labor, land and money turn out to be seen as commodities and are produced for sale. As the commodity fiction proves to be the vital organizing process, the self-regulated markets demand the institutional separation of society into an economic and a political sphere. In other words, the commodity fiction implies that the market economy demands the institutional separation of society into an economic and political sphere, that is, in the market society the social relations are embedded in the economy rather than the economy embedded in social relations. read more
from Lars Syll
“New Keynesian” macroeconomist Simon Wren-Lewis has a post up on his blog, discussing how evidence is treated in modern macroeconomics (emphasis added):
It is hard to get academic macroeconomists trained since the 1980s to address this question, because they have been taught that these models and techniques are fatally flawed because of the Lucas critique and identification problems. But DSGE models as a guide for policy are also fatally flawed because they are too simple. The unique property that DSGE models have is internal consistency. Take a DSGE model, and alter a few equations so that they fit the data much better, and you have what could be called a structural econometric model. It is internally inconsistent, but because it fits the data better it may be a better guide for policy.
Being able to model a credible world, a world that somehow could be considered real or similar to the real world, is not the same as investigating the real world. Read more…
from Jamie Morgan’s “Piketty’s Calibration Economics: Inequality and the Dissolution of Solutions?” – an open access paper in current issue of Globalizations
In the neoliberal age, we have naturalised the rich. However, the success of Thomas Piketty’s Capital in the Twenty-First Century has done a great deal to legitimate a rather differently inflected concern. It is now permissible to ask: can we, should we, afford the rich? Growing income and wealth inequality have gradually become areas of public concern, but this concern has become more acute, and more politically febrile, in the wake of the global financial crisis. The election victory by Syriza in Greece, and the Occupy Movement speak directly to this. Austerity responses to the crisis have distributed the fallout costs to the many from the few who benefitted most from the preceding decades. Meanwhile, central bank policy responses have created new opportunities for the global rich to become even richer.1 To a large degree, the idea that the rest of us are dragged along in the wake of the wealthy has been exposed as a myth. Read more…