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DSGE — a scientific illusion

November 28, 2018 5 comments

from Lars Syll

Dynamic stochastic general equilibrium (DSGE) models remain the work-horse models employed by many academics and research departments at central banks … Prior to the Global Financial Crisis the financial sector played no role in these DSGE models. That limitation is now widely acknowledged and numerous aspects of the financial sector have been incorporated into second and later generation DSGE models … Unfortunately, these efforts are misguided because they do not address the fundamental flaw in the microeconomic foundations of these models and this mistake is widely repeated in all later generations of DSGE models.

macroeconomics-14-638Many theorists today simply fail to recognize the limitations inherent in starting with the wrong microeconomic foundations; frictionless or perfect barter microeconomic foundations. Consequently, those theorists are now intent on introducing ‘monetary’, ‘financial’ and other ‘frictions’ without acknowledging that those ‘frictions’ are inconsistent with the perfect barter or frictionless microeconomic foundations of their models as well as long established principles of monetary theory …   Read more…

P-values are no substitute for thinking

November 25, 2018 2 comments

from Lars Syll

A non-trivial part of statistics education is made up of teaching students to perform significance testing. A problem I have noticed repeatedly over the years, however, is that no matter how careful you try to be in explicating what the probabilities generated by these statistical tests really are, still most students misinterpret them.  Read more…

The New Classical counterrevolution​

November 24, 2018 22 comments

from Lars Syll

scrrewIn a post on his blog, Oxford macroeconomist Simon Wren-Lewis discusses if modern academic macroeconomics is eclectic or not. When it comes to methodology it seems as though his conclusion is that it is not:

The New Classical Counter Revolution of the 1970s and 1980s … was primarily a revolution about methodology, about arguing that all models should be microfounded, and in terms of mainstream macro it was completely successful … Mainstream academic macro is very eclectic in the range of policy questions it can address, and conclusions it can arrive at, but in terms of methodology it is quite the opposite.

In an earlier post he elaborated on why the New Classical Counterrevolution was so successful in replacing older theories, despite the fact that the New Classical models weren’t able to explain what happened to output and inflation in the 1970s and 1980s:

The new theoretical ideas New Classical economists brought to the table were impressive, particularly to those just schooled in graduate micro. Rational expectations is the clearest example …

If mainstream academic macroeconomists were seduced by anything, it was a methodology — a way of doing the subject which appeared closer to what at least some of their microeconomic colleagues were doing at the time, and which was very different to the methodology of macroeconomics before the New Classical Counterrevolution. The old methodology was eclectic and messy, juggling the competing claims of data and theory. The new methodology was rigorous!

Wren-Lewis seems to be impressed by the ‘rigour’ brought to macroeconomics by the New Classical counterrevolution and its rational expectations, microfoundations and ‘Lucas Critique’.

I fail to see why.

Wren-Lewis’ portrayal of rational expectations is not as innocent as it may look. Read more…

Kalecki and Keynes on the loanable funds fallacy

November 21, 2018 6 comments

from Lars Syll

kalIt should be emphasized that the equality between savings and investment … will be valid under all circumstances. In particular, it will be independent of the level of the rate of interest which was customarily considered in economic theory to be the factor equilibrating the demand for and supply of new capital. In the present conception investment, once carried out, automatically provides the savings necessary to finance it. Indeed, in our simplified model, profits in a given period are the direct outcome of capitalists’ consumption and investment in that period. If investment increases by a certain amount, savings out of profits are pro tanto higher …

One important consequence of the above is that the rate of interest cannot be determined by the demand for and supply of new capital because investment ‘finances itself.’

The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credits set by banks and determined by supply and demand — as Bertil Ohlin put it — “in the same way as the price of eggs and strawberries on a village market.”  Read more…

In search of causality

November 18, 2018 12 comments

from Lars Syll

dilbert

One of the few statisticians that yours truly have on the blogroll is Andrew Gelman. Although not sharing his Bayesian leanings, I find his open-minded, thought-provoking and non-dogmatic statistical thinking highly recommendable. The plaidoyer below for ‘reverse causal questioning’ is typical Gelmanian:  Read more…

Truth and probability

November 15, 2018 6 comments

from Lars Syll

uncertainty-7Truth exists, and so does uncertainty. Uncertainty acknowledges the existence of an underlying truth: you cannot be uncertain of nothing: nothing is the complete absence of anything. You are uncertain of something, and if there is some thing, there must be truth. At the very least, it is that this thing exists. Probability, which is the science of uncertainty, therefore aims at truth. Probability presupposes truth; it is a measure or characterization of truth. Probability is not necessarily the quantification of the uncertainty of truth, because not all uncertainty is quantifiable. Probability explains the limitations of our knowledge of truth, it never denies it. Probability is purely epistemological, a matter solely of individual understanding. Probability does not exist in things; it is not a substance. Without truth, there could be no probability.

William Briggs’ approach is — as he acknowledges in the preface of his interesting and thought-provoking book — “closely aligned to Keynes’s.”

Almost a hundred years after John Maynard Keynes wrote his seminal A Treatise on Probability (1921), it is still very difficult to find statistics textbooks that seriously try to incorporate his far-reaching and incisive analysis of induction and evidential weight.  Read more…

Take a hard look at the skeletons in the mainstream closet!

November 14, 2018 13 comments

from Lars Syll

lieberAlthough prepared to admit that our empirical research procedures may be based on some very shaky assumptions, [some thoughtful scholars see] no point in saying much about this unless superior alternatives are presented. I understand this concern … Nevertheless, a hard look at the skeletons in the closet is beneficial, especially when there is a propensity to keep the door locked. Nothing is gained by avoiding that which the discipline must face up to sooner or later. If a current procedure appears to be patently wrong, I have not hesitated to indicate this, even if the alternatives remain to develop.

Like Stanley Lieberson, those of us in the economics community who are impolite enough to dare to question the preferred methods and models applied in mainstream economics and econometrics are as a rule met with disapproval. But although people seem to get very agitated and upset by the critique, defenders of “received theory” always say that the critique is “nothing new”, that they have always been “well aware” of the problem, “what Syll points out, we all know; there is nothing new in it; the real issue is to find out the alternative,” and so on, and so on.  Read more…

Econometrics: The Keynes-Tinbergen controversy

November 11, 2018 6 comments

from Lars Syll

Mainstream economists often hold the view that Keynes’ criticism of econometrics was the result of a sadly misinformed and misguided person who disliked and did not understand much of it.

This is, however, nothing but a gross misapprehension.

To be careful and cautious is not the same as to dislike. Keynes did not misunderstand the crucial issues at stake in the development of econometrics. Quite the contrary. He knew them all too well — and was not satisfied with the validity and philosophical underpinning of the assumptions made for applying its methods.

poofKeynes’ critique is still valid and unanswered in the sense that the problems he pointed at are still with us today and ‘unsolved.’ Ignoring them — the most common practice among applied econometricians — is not to solve them.

To apply statistical and mathematical methods to the real-world economy, the econometrician has to make some quite strong assumptions. In a review of Tinbergen’s econometric work — published in The Economic Journal in 1939 — Keynes gave a comprehensive critique of Tinbergen’s work, focusing on the limiting and unreal character of the assumptions that econometric analyses build on:  Read more…

Richard Feynman om mathematics

November 9, 2018 32 comments

from Lars Syll

In a comment on one of yours truly’s posts last week, Jorge Buzaglo wrote this truly interesting comment:

Nobel prize winner Richard Feynman on the use of mathematics:

Mathematicians, or people who have very mathematical minds, are often led astray when “studying” economics because they lose sight of the economics. They say: ‘Look, these equations … are all there is to economics; it is admitted by the economists that there is nothing which is not contained in the equations.

510935-Richard-P-Feynman-Quote-If-all-of-mathematics-disappeared-physics

The equations are complicated, but after all they are only mathematical equations and if I understand them mathematically inside out, I will understand the economics inside out.’ Only it doesn’t work that way. Mathematicians who study economics with that point of view — and there have been many of them — usually make little contribution to economics and, in fact, little to mathematics. They fail because the actual economic situations in the real world are so complicated that it is necessary to have a much broader understanding of the equations.

I have replaced the word “physics” (and similar) by the word “economics” (and similar) in this quote from Page 2-1 in: R. Feynman, R. Leighton and M. Sands, The Feynman Lectures on Physics, Volume II, Addison-Wesley Publishing, Reading, 1964,

 

Calibration — an economics fraud kit

November 8, 2018 9 comments

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 …

fraud-kitIn 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.”

Paul Romer

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.

Read more…

Debunking mathematical​ economics

November 6, 2018 14 comments

from Lars Syll

The belief in the power and necessity of formalizing economic theory mathematically has thus obliterated the distinction between cognitively perceiving and understanding concepts from different domains and mapping them into each other.quote-too-large-a-proportion-of-recent-mathematical-economics-are-mere-concoctions-as-imprecise-as-the-john-maynard-keynes-243582 Whether the age-old problem of the equality between supply and demand should be mathematically formalized as a system of inequalities or equalities is not something that should be decided by mathematical knowledge or convenience. Surely it would be considered absurd, bordering on the insane, if a surgical procedure was implemented because a tool for its implementation was devised by a medical doctor who knew and believed in topological fixed-point theorems? Yet, weighty propositions about policy are decided on the basis of formalizations based on ignorance and belief in the veracity of one kind of one-dimensional mathematics.

K. Vela Velupillai

Indeed. As social researchers, we should never equate science with mathematics. All science entail human judgement, and using mathematical models do not relieve us of that necessity. They are no substitutes for doing real science.   Read more…

Modern economics is sick

November 2, 2018 18 comments

from Lars Syll

mark-blaug-900pxModern economics is sick. Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences for understanding the economic world. Economists have converted the subject into a sort of social mathematics in which analytical rigour is everything and practical relevance is nothing …

If there is such a thing as “original sin” in economic methodology, it is the worship of the idol of the mathematical rigour invented by Arrow and Debreu in 1954 and then canonized by Debreu in his Theory of Value five years later, probably the most arid and pointless book in the entire literature of economics.

The result of all this is that we now understand almost less of how actual markets work than did Adam Smith or even Léon Walras …

Indeed, much of modern microeconomics might be fairly described as a kind of geography that consists entirely of images of cities but providing no maps of how to reach a city either from any other city or from the countryside.

Mark Blaug

Mark Blaug (1927-2011) did more than any other single person to establish the philosophy and methodology of economics a respected subfield within economics. His path-breaking The methodology of economics (1980) is still a landmark (and the first textbook on economic methodology yours truly ever read).  Read more…

Economic reality — a virulent virus afflicting mainstream economics

October 30, 2018 11 comments

from Lars Syll

The WHO today warned of a virulent new virus affecting vulnerable groups in the Mid‐West and Eastern USA. The outbreak, which began in the Mid‐West’s extensive Great Lakes “Freshwater” river system, has recently jumped the “Saltwater” barrier, meaning that the entire population of its target species—“Mainstream” economists—is now at risk.

suzukiSpeaking on behalf of the WHO, Dr Cahuc explained that the virus works by turning off the one genetic marker that distinguishes this species from the rest of its genus, the Human Race. This is the so‐called “Milton” gene (Friedman, 1953), which goes dormant in other Humans as they pass through puberty. Its inactivity reduces their imaginative capacity, making it impossible for them to continue believing in such endearing infantile fantasies as the Tooth Fairy and Santa Claus. While regrettable, this drop in imagination is necessary to prepare Humans for the adult phase of their existence.

“Professor Milton Friedman found a way to re‐activate this gene during PhD training, using his ‘as if’ gene splicing technique”, Dr Zylberberg elaborated. “This enabled a wonderful outpouring of imaginative beliefs by Mainstream Economists, which gave birth to concepts like NAIRU, Money Neutrality, Rational Expectations, and eventually even DSGE models. This wealth of imagination was regarded by Mainstream Economists as a more than sufficient compensation for returning to the child‐like phase of the Human species.”

Steve Keen

Looking at what famous mainstream economists — like e.g. Paul Samuelson and Gerard Debreu — have come up with, there is no indication at all they produce rigorous and successful explanations or predictions of real-world phenomena. In physics, it’s all different. Read more…

Wren-Lewis — the flimflam anti-pluralist

October 30, 2018 7 comments

from Lars Syll

Again and again, Oxford professor Simon Wren-Lewis rides out to defend orthodox macroeconomic theory against attacks from heterodox critics. In one of his latest attacks on heterodox economics and students demanding pluralist economics education he writes:

mainstreampluralismThe danger in encouraging plurality is that you make it much easier for politicians to select the advice they like, because there is almost certain to be a school of thought that gives the ‘right’ answers from the politicians point of view. The point is obvious once you make the comparison to medicine. Don’t like the idea of vaccination? Pick an expert from the anti-vaccination medical school. The lesson of the last seven years, in the UK in particular, is that we want mainstream economists to have more influence on politicians and the public, and not to dilute this influence through a plurality of schools of thought.

And  a couple of years ago he wrote the following:   Read more…

Simon Wren-Lewis’ warped view of ​modern macroeconomics

October 27, 2018 3 comments

from Lars Syll

kThere is something that just does not sit very well with Oxford macroeconomist Simon Wren-Lewis’ view of modern macroeconomics. On more than one occasion has this self-proclaimed ‘New Keynesian’ macroeconomist approvingly written about the ‘impressive’ theoretical insights New Classical economics has brought to macroeconomics. In one of his latest blog posts he once again  shows how devoted  he is to the Chicago übereconomists and their modelling endeavours (emphasis added):

DSGE models are firmly entrenched in academic macroeconomics, and in pretty well every economist that has done a PhD, which is why the Bank of England’s core model is DSGE … Have a look at almost any macro paper in a top journal today, and compare it to a similar paper before the NCCR, and you can see we have been through a methodological revolution … If you are expecting me at this point to say that DSGE models where were macroeconomics went wrong, you will be disappointed … Moving to DSGE involved losses as well as gains. It inevitably made models less rich and moved them further away from the data in areas that were difficult but not impossible to model in a theoretically consistent way. The DSGE methodological revolution set out so clearly in Lucas and Sargent’s paper changed the focus of macroeconomics away from things we now know were of critical importance.

If moving to DSGE meant not being able to tackle things of “critical importance,” and makes economic models “less rich” and further away from real-world data, why still ultimately defend it? And does “consistency” really trump every other model​ consideration? You do, of course, expect that of New Classical Chicago economists. But a ‘Keynesian’ macroeconomist?   Read more…

Wren-Lewis insults medical science

October 26, 2018 5 comments

from Lars Syll

In a discussion today on twitter one discussant was questioning if economics really could be considered a science, adding that in physics — contrary to economics — “there are no different school of thoughts on ‘Newton’s Laws of Motion’. To this Simon Wren-Lewis answered:

Exactly the same is true of mainstream economics. There are also groups who cannot live with the mainstream who form schools of thought, like MMT. But mainstream economics is a science, like medicine.

But that is simply not true as Steve Keen also notes in a reply to Wren-Lewis. Economics is in no way a science similar to physics, Newtonian mechanics or medicine!

‘Laws’ in economics only hold ceteris paribus. That fundamentally means that these laws/regularities only hold when the right conditions are at hand for giving rise to them. Unfortunately, from an empirical point of view, those conditions are only at hand in artificially closed nomological models purposely designed to give rise to the kind of regular associations that economists want to explain. But, really, since these laws/regularities do not exist outside these ‘socio-economic machines,’ what’s the point in constructing these non-existent laws/regularities? When the almost endless list of narrow and specific assumptions necessary to allow the ‘rigorous’ deductions are known to be at odds with reality, what good do these models do?

Take ‘The Law of Demand.’  Read more…

Econometrics and causality

October 25, 2018 26 comments

from Lars Syll

Judea Pearl’s and Bryant Chen’s Regression and causation: a critical examination of six econometrics textbooks — published in Real-World Economics Review no. 65 — addresses two very important questions in the teaching of modern econometrics and its different textbooks — how is causality treated in general, and more specifically, to what extent they use a distinct causal notation.

causation

The authors have for years been part of an extended effort of advancing explicit causal modelling (especially graphical models) in applied sciences, and this article examines to what extent these endeavours have found their way into econometrics textbooks (and Pearl has later come back to the theme in his The Book of Why (2018))

Although the text partly is of a rather demanding ‘technical’ nature, yours truly definitely recommend it for reading, especially for social scientists with an interest in causality.  Read more…

The connection between cause and probability

October 22, 2018 5 comments

from Lars Syll

huntCauses can increase the probability​ of their effects; but they need not. And for the other way around: an increase in probability can be due to a causal connection; but lots of other things can be responsible as well …

The connection between causes and probabilities is like the connection between a disease and one of its symptoms: The disease can cause the symptom, but it need not; and the same symptom can result from a great many different diseases …

If you see a probabilistic dependence and are inclined to infer a causal connection from it, think hard about all the other possible reasons that that dependence might occur and eliminate them one by one. And when you are all done, remember — your conclusion is no more certain than your confidence that you really have eliminated all​ the possible alternatives.

Causality in social sciences — and economics — can never solely be a question of statistical inference. Causality entails more than predictability, and to really in-depth explain social phenomena require theory. Analysis of variation — the foundation of all econometrics — can never in itself reveal how these variations are brought about. First, when we are able to tie actions, processes or structures to the statistical relations detected, can we say that we are getting at relevant explanations of causation.  Read more…

The connection between cause and probability

October 20, 2018 13 comments

from Lars Syll

huntCauses can increase the probability​ of their effects; but they need not. And for the other way around: an increase in probability can be due to a causal connection; but lots of other things can be responsible as well …

The connection between causes and probabilities is like the connection between a disease and one of its symptoms: The disease can cause the symptom, but it need not; and the same symptom can result from a great many different diseases …

If you see a probabilistic dependence and are inclined to infer a causal connection from it, think hard about all the other possible reasons that that dependence might occur and eliminate them one by one. And when you are all done, remember — your conclusion is no more certain than your confidence that you really have eliminated all​ the possible alternatives.

Causality in social sciences — and economics — can never solely be a question of statistical inference. Causality entails more than predictability, and to really in-depth explain social phenomena require theory. Analysis of variation — the foundation of all econometrics — can never in itself reveal how these variations are brought about. First, when we are able to tie actions, processes or structures to the statistical relations detected, can we say that we are getting at relevant explanations of causation.  Read more…

Too much of ‘we controlled for’

October 18, 2018 1 comment

from Lars Syll

The gender pay gap is a fact that, sad to say, to a non-negligible extent is the result of discrimination. And even though many women are not deliberately discriminated against, but rather self-select into lower-wage jobs, this in no way magically explains away the discrimination gap. As decades of socialization research has shown, women may be ‘structural’ victims of impersonal social mechanisms that in different ways aggrieve them. Wage discrimination is unacceptable. Wage discrimination is a shame.

You see it all the time in studies. “We controlled for…” And then the list starts. The longer the better. Income. Age. Race. Religion. Height. Hair color. Sexual preference. Crossfit attendance. Love of parents. Coke or Pepsi. The more things you can control for, the stronger your study is — or, at least, the stronger your study seems. Controls give the feeling of specificity, of precision. But sometimes, you can control for too much. Sometimes you end up controlling for the thing you’re trying to measure …

paperAn example is research around the gender wage gap, which tries to control for so many things that it ends up controlling for the thing it’s trying to measure. As my colleague Matt Yglesias wrote:

“The commonly cited statistic that American women suffer from a 23 percent wage gap through which they make just 77 cents for every dollar a man earns is much too simplistic. On the other hand, the frequently heard conservative counterargument that we should subject this raw wage gap to a massive list of statistical controls until it nearly vanishes is an enormous oversimplification in the opposite direction. After all, for many purposes gender is itself a standard demographic control to add to studies — and when you control for gender the wage gap disappears entirely!” …   Read more…