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The mess at the heart of the EU

July 4, 2018 26 comments

from Lars Syll

austerity22

The EU establishment has been held to account for the euro mess, for austerity policies that turned recession into depression, for the galloping inequality, and for the millions and millions of unemployed.

The EU austerity policies bread understandable and righteous anger — but also ugly far-right xenophobic political movements taking advantage of the frustration that austerity policies inevitably produce. Ultimately this underlines the threats to society that austerity policies and mass unemployment are.

The neoliberal austerity policies pursued in the EU is deeply disturbing. When an economy is already hanging on the ropes, you can’t just cut government spendings. Cutting government expenditures reduces the aggregate demand. Lower aggregate demand means lower tax revenues. Lower tax revenues mean increased deficits — and calls for even more austerity. And so on, and so on.

Without a conscious effort to counteract the inevitable forces driving our societies towards an extreme income and wealth inequality, our societies crackle. It is crucial to have strong redistributive policies if we want to have stable economies and societies. Redistributive taxes and active fiscal policies are necessary ingredients for building a good society.  Read more…

Probability and rationality — trickier than you might think

July 3, 2018 12 comments

from Lars Syll

The Coin-tossing Problem

My friend Bengt says that on the first day he got the following sequence of Heads and Tails when tossing a coin:
H H H H H H H H H H

And on the second day he says that he got the following sequence:
H T T H H T T H T H

184bic9u2w483jpgWhich day-report makes you suspicious?

Most people I ask this question says the first day-report looks suspicious.

But actually,​ both days are equally probable! Every time you toss a (fair) coin there is the same probability (50 %) of getting H or T. Both days Ben makes equally many tosses and every sequence is equally probable!

The Linda Problem

Linda is 40 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations.

Which of the following two alternatives is more probable?  Read more…

Paul Krugman — a math-is-the-message-modeler

July 1, 2018 55 comments

from Lars Syll

In a post on his blog, Paul Krugman argues that ‘Keynesian’ macroeconomics more than anything else “made economics the model-oriented field it has become.” In Krugman’s eyes, Keynes was a “pretty klutzy modeler,” and it was only thanks to Samuelson’s famous 45-degree diagram and Hicks’ IS-LM that things got into place. Although admitting that economists have a tendency to use ”excessive math” and “equate hard math with quality” he still vehemently defends — and always has — the mathematization of economics:

I’ve seen quite a lot of what economics without math and models looks like — and it’s not good.

Sure, ‘New Keynesian’ economists like Mankiw and Krugman — and their forerunners, ‘Keynesian’ economists like Paul Samuelson and (young) John Hicks — certainly have contributed to making economics more mathematical and “model-oriented.”

65547036But if these math-is-the-message-modelers aren’t able to show that the mechanisms or causes that they isolate and handle in their mathematically formalized macromodels also are applicable to the real world, these mathematical models are of limited value to our understandings of real-world​ economies.

When it comes to modeling philosophy, Krugman defends his position in the following words (my italics): Read more…

Krugman’s formalization schizophrenia

June 30, 2018 4 comments

from Lars Syll

In an article published last week, Nicholas Gruen criticized the modern vogue of formalization in economics and took Paul Krugman as an example:

He’s saying first that economists can’t see what isn’t in their models – whereas Hicks and pretty much every economist until the late twentieth century would have understood the need for careful and ongoing reconciliation of formal modelling and other sources of knowledge. More shockingly he’s saying that those who smell a rat at the dysfunctionality of all this should just get over themselves. To quote Krugman:

“You may not like this tendency; certainly economists tend to be too quick to dismiss what has not been formalized (although I believe that the focus on models is basically right).”

It’s ironic given how compellingly Krugman has documented the regression of macroeconomics in the same period that saw his own rise via new trade theory. I think both retrogressions were driven by formalisation at all costs, though, in the case of new classical macro, this mindset gave additional licence to the motivated reasoning of the libertarian right. In each case, economics regresses into scholastic abstractions, and obviously important parts of the story slide pristine invisibility to the elect.

Responding to the article, Paul Krugman yesterday rode out to defend formalism in economics:  Read more…

The main reason why almost all econometric models are wrong

June 29, 2018 5 comments

from Lars Syll

Since econometrics doesn’t content itself with only making optimal predictions, but also aspires to explain things in terms of causes and effects, econometricians need loads of assumptions — most important of these are additivity and linearity. Important, simply because if they are not true, your model is invalid and descriptively incorrect.  And when the model is wrong — well, then it’s wrong.

The assumption of additivity and linearity means that the outcome variable is, in reality, linearly related to any predictors … and that if you have several predictors then their combined effect is best described by adding their effects together …

catdogThis assumption is the most important because if it is not true then even if all other assumptions are met, your model is invalid because you have described it incorrectly. It’s a bit like calling your pet cat a dog: you can try to get it to go in a kennel, or to fetch sticks, or to sit when you tell it to, but don’t be surprised when its behaviour isn’t what you expect because even though you’ve called it a dog, it is in fact a cat. Similarly, if you have described your statistical model inaccurately it won’t behave itself and there’s no point in interpreting its parameter estimates or worrying about significance tests of confidence intervals: the model is wrong.

Andy Field

Let me take the opportunity to elaborate a little on why I find these assumptions of such paramount importance and ought to be much more argued for — on both epistemological and ontological grounds — if at all being used.  Read more…

Marginal productivity theory

June 28, 2018 4 comments

from Lars Syll

The correlation between high executive pay and good performance is “negligible”, a new academic study has found, providing reformers with fresh evidence that a shake-up of Britain’s corporate remuneration systems is overdue.

jpgimageAlthough big company bosses enjoyed pay rises of more than 80 per cent in a decade, performance as measured by economic returns on invested capital was less than 1 per cent over the period, the paper by Lancaster University Management School says.

“Our findings suggest a material disconnect between pay and fundamental value generation for, and returns to, capital providers,” the authors of the report said.

In a study of more than a decade of data on the pay and performance of Britain’s 350 biggest listed companies, Weijia Li and Steven Young found that remuneration had increased 82 per cent in real terms over the 11 years to 2014 … The research found that the median economic return on invested capital, a preferable measure, was less than 1 per cent over the same period.

Patrick Jenkins/Financial Times

Mainstream economics textbooks usually refer to the interrelationship between technological development and education as the main causal force behind increased inequality. If the educational system (supply) develops at the same pace as technology (demand), there should be no increase, ceteris paribus, in the ratio between high-income (highly educated) groups and low-income (low education) groups. In the race between technology and education, the proliferation of skilled-biased technological change has, however, allegedly increased the premium for the highly educated group.  Read more…

Why the euro cannot be saved

June 27, 2018 18 comments

from Lars Syll

The euro may be approaching another crisis. Italy, the eurozone’s third largest economy, has chosen what can at best be described as a Euroskeptic government. This should surprise no one. The backlash in Italy is another predictable (and predicted) episode in the long saga of a poorly designed currency arrangement, in which the dominant power, Germany, impedes the necessary reforms and insists on policies that exacerbate the inherent problems, using rhetoric seemingly intended to inflame passions.

euroItaly has been performing poorly since the euro’s launch. Its real (inflation-adjusted) GDP in 2016 was the same as it was in 2001. But the eurozone as a whole has not been doing well, either … If one country does poorly, blame the country; if many countries are doing poorly, blame the system … The euro was a system almost designed to fail. It took away governments’ main adjustment mechanisms (interest and exchange rates); and, rather than creating new institutions to help countries cope with the diverse situations in which they find themselves, it imposed new strictures – often based on discredited economic and political theories – on deficits, debt, and even structural policies.

The euro was supposed to bring shared prosperity, which would enhance solidarity and advance the goal of European integration. In fact, it has done just the opposite, slowing growth and sowing discord …

The central problem in a currency area is how to correct exchange-rate misalignments like the one now affecting Italy. Germany’s answer is to put the burden on the weak countries already suffering from high unemployment and low growth rates. We know where this leads: more pain, more suffering, more unemployment, and even slower growth …

Across the eurozone, political leaders are moving into a state of paralysis: citizens want to remain in the EU, but also want an end to austerity and the return of prosperity. They are told they can’t have both. Ever hopeful of a change of heart in northern Europe, troubled governments stay the course, and the suffering of their people increases …

Germany and other countries in northern Europe can save the euro by showing more humanity and more flexibility. But, having watched the first acts of this play so many times, I am not counting on them to change the plot.

Joseph Stiglitz

The euro has taken away the possibility for national governments to manage their economies in a meaningful way — and in Italy, just as in Greece a couple of years ago, the people have had to pay the true costs of its concomitant misguided austerity policies.  Read more…

Noah Smith’s unicorn defence​ of economics

June 26, 2018 10 comments

from Lars Syll

Unlike the old neoclassical theories, game theory concerns strategic interaction between different people. It can encompass things like wage bargaining, fraud and lots of other things that neoclassical equilibrium glosses over or leaves out.  And in game theory, free markets full of rational actors can easily, even regularly, lead to inefficient outcomes that require government intervention.

Noah Smith/Bloomberg

unicorn“Free markets full of rational actors.” Sounds great does it not? The problem? In the real world,​ there is no such thing! Defending mainstream economics against its critics with game theoretical unicorns actually only confirms how justified the critic is.

Half a century ago there was​​ widespread hopes game theory would provide a unified theory of social science. Today it has become obvious those hopes did not materialize. This ought to come as no surprise. Reductionist and atomistic models of social interaction — such as those mainstream economics and game theory are founded on — will never deliver sustainable building blocks for a realist and relevant social science. That is also the reason why game theory never will be anything but a footnote in the history of social science.  Read more…

How to be a great economist

June 24, 2018 40 comments

from Lars Syll

The master-economist must possess a rare combination of gifts …​ He must be mathematician, historian, statesman, philosopher—in some degree. He must understand symbols and speak in words. He must contemplate the particular, in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must be entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood, as aloof and incorruptible as an artist, yet sometimes as near to earth as a politician.

John Maynard Keynes

Economics students today are complaining more and more about the way economics is taught. The lack of fundamental diversity — not just path-dependent elaborations of the mainstream canon — and narrowing of the curriculum, dissatisfy econ students all over the world. The frustrating lack of real-world relevance has led many of them to demand the discipline to start developing a more open and pluralistic theoretical and methodological attitude.

There are many things about the way economics is taught today that worry yours truly. Today’s students are force-fed with mainstream neoclassical theories and models. That lack of pluralism is cause for serious concern.

Read more…

Statistics and econometrics are not very helpful for understanding economies

June 23, 2018 27 comments

from Lars Syll

leamer1 zoomedA statistician may have done the programming, but when you press a button on a computer keyboard and ask the computer to find some good patterns, better get clear a sad fact: computers do not think. They do exactly what the programmer told them to do and nothing more. They look for the patterns that we tell them to look for, those and nothing more. When we turn to the computer for advice, we are only talking to ourselves …

Mathematical analysis works great to decide which horse wins, if we are completely confident which horses are in the race, but it breaks down when we are not sure. In experimental settings, the set of alternative models can often be well agreed on, but with nonexperimental economics data, the set of models is subject to enormous disagreements. You disagree with your model made yesterday, and I disagree with your model today. Mathematics does not help much resolve our internal intellectual disagreements.

Ed Leamer

Indeed. As social researchers, we should never equate science with mathematics and statistical calculation. All science entail human judgement, and using mathematical and statistical models don’t relieve us of that necessity. They are no substitutes for thinking and doing real science. Or as a great German philosopher once famously wrote:  Read more…

Econometric inconsistencies

June 22, 2018 6 comments

from Lars Syll

In plain terms, it is evident that if what is really the same factor is appearing in several places under various disguises, a free choice of regression coefficients can lead to strange results. It becomes like those puzzles for children where you write down your age, multiply, add this and that, subtract something else, and eventually end up with the number of the Beast in Revelation.

deb6e811f2b49ceda8cc2a2981e309f39e3629d8ae801a7088bf80467303077bProf. Tinbergen explains that, generally speaking, he assumes that the correlations under investigation are linear … One would have liked to be told emphatically what is involved in the assumption of linearity. It means that the quantitative effect of any causal factor on the phenomenon under investigation is directly proportional to the factor’s own magnitude … But it is a very drastic and usually improbable postulate to suppose that all economic forces are of this character, producing independent changes in the phenomenon under investigation which are directly proportional to the changes in themselves ; indeed, it is ridiculous. Yet this is what Prof. Tinbergen is throughout assuming …

J M Keynes

Keynes’ comprehensive critique of econometrics and the assumptions it is built around — completeness, measurability, independence, homogeneity, and linearity — is still valid today.  Read more…

The microfoundations crusade

June 21, 2018 6 comments

from Lars Syll

I think the two most important microfoundation led innovations in macro have been intertemporal consumption and rational expectations. I have already talked about the former in an earlier post … [s]o let me focus on rational expectations …  [T]he adoption of rational expectations was not the result of some previous empirical failure. Instead it represented, as Lucas said, a consistency axiom …

UnknownI think macroeconomics today is much better than it was 40 years ago as a result of the microfoundations approach. I also argued in my previous post that a microfoundations purist position – that this is the only valid way to do macro – is a mistake. The interesting questions are in between. Can the microfoundations approach embrace all kinds of heterogeneity, or will such models lose their attractiveness in their complexity? Does sticking with simple, representative agent macro impart some kind of bias? Does a microfoundations approach discourage investigation of the more ‘difficult’ but more important issues? Might both these questions suggest a link between too simple a micro based view and a failure to understand what was going on before the financial crash? Are alternatives to microfoundations modelling methodologically coherent? Is empirical evidence ever going to be strong and clear enough to trump internal consistency? These are difficult and often quite subtle questions that any simplistic for and against microfoundations debate will just obscure.

Simon Wren-Lewis

On this argumentation I would like to add the following comments:  Read more…

Contrast explanations in economics

June 20, 2018 14 comments

from Lars Syll

For all scholars seriously interested in questions on what makes up a good scientific explanation, Alan Garfinkel’s Forms of Explanation (Yale University Press 1990) is a must-read. A lot of recent work done within different realist schools in theory of science — e.g. Roy Bhaskar, Andrew Collier, Richard W Miller and Tony Lawson — issue not so little from questions and problems posed by Garfinkel. Especially his advocacy of contrast explanations and critique of methodological individualism and other forms of reductionism are still unsurpassed.

Given this, it is almost scandalous that this modern classic is not reprinted. I was lucky to get a copy from an antiquarian, but of course, this is a book that should have been reprinted long ago!

For those who want to further explore the meaning and potential of contrast explanations, Jamie Morgan’s and Heikki Patomäki’s article in Cambridge Journal of Economics last year is highly recommended reading.

On randomness and probability in economics

June 18, 2018 15 comments

from Lars Syll

Modern mainstream economics relies to a large degree on the notion of probability. To at all be amenable to applied economic analysis, economic observations 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?

slide_1When 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.’

Just as there is no such thing as a ‘free lunch,’ there is no such thing as a ‘free probability.’  Read more…

The Permanent Income Hypothesis

June 17, 2018 13 comments

from Lars Syll

150514006_4Milton Friedman’s Permanent Income Hypothesis (PIH) says that people’s consumption is not affected by short-term fluctuations in incomes since people only spend more money when they think that their lifetime incomes change. Believing Friedman is right, mainstream economists have for decades argued that Keynesian fiscal policies, therefore, are ineffectual.

As shown over and over again for the last three decades, empirical facts totally disconfirm Friedman’s hypothesis. The final nail in the coffin is recent research from Harvard:

We compare the path of spending during unemployment in the data to three benchmark models and find that the buffer stock model fits better than a permanent income model or a hand-to-mouth model …

Using rich category-level expenditure data, we find that work-related expenses explain only a modest portion of the spending drop during unemployment. The overall path of spending for a seven-month unemployment spell is consistent with a buffer stock model where agents hold assets equal to less than one month of income at the onset of unemployment. Because unemployment is such a large shock to income, our finding that spending is highly sensitive to income overcomes the near-rationality critique applied to prior work. Finally, we document a puzzling drop in spending of 11% in the month UI benefits exhaust, suggesting that families do not prepare for benefit exhaustion.

Peter Ganong & Pascal Noel

So — now we know that consumer behaviour is influenced by short-term fluctuations in incomes and that this is true even if consumers know that their situation may well change in the future.  Read more…

Economics for the 21st century

June 13, 2018 20 comments

from Lars Syll

1. Change the goal: from GDP growth to the Doughnut.

For over half a century, economists have fixated on GDP as the first measure of economic progress, but GDP is a false goal waiting to be ousted. The 21st century calls for a far more ambitious and global economic goal: meeting the needs of all within the means of the planet. Draw that goal on the page and – odd though it sounds – it comes out looking like a doughnut …

raworth2. See the big picture: from self-contained market to embedded economy.

Exactly 70 years ago in April 1947, an ambitious band of economists crafted a neoliberal story of the economy and, since Thatcher and Reagan came to power in the 1980s, it has dominated the international stage. Its narrative about the efficiency of the market, the incompetence of the state, the domesticity of the household and the tragedy of the commons, has helped to push many societies towards social and ecological collapse. It’s time to write a new economic story fit for this century – one that sees the economy’s dependence upon society and the living world …

3. Nurture human nature: from rational economic man to social adaptable humans.

The character at the heart of 20th century economics—‘rational economic man’—presents a pitiful portrait of humanity: he stands alone, with money in his hand, a calculator in his head, ego in his heart, and nature at his feet. Worse, when we are told that he is like us, we actually start to become more like him, to the detriment of our communities and the planet. But human nature is far richer than this, as emerging sketches of our new self-portrait reveal: we are reciprocating, interdependent, approximating people deeply embedded within the living world …  Read more…

Swiss sovereign money referendum

June 7, 2018 35 comments

from Lars Syll


The people behind the proposal​ in Switzerland​ are effectively trying to get gold back into the monetary system.

This is an extremely​ bad idea.

Eighty-seven years ago Keynes could congratulate Great Britain on finally having got rid of the biggest ”barbarous relic” of his time – the gold standard. He lamented that  Read more…

Krugman’s modelling flimflam

June 6, 2018 12 comments

from Lars Syll

Paul Krugman has a piece up on his blog arguing that the ‘discipline of modeling’ is a sine qua non for tackling politically and emotionally charged economic issues:

You might say that the way to go about research is to approach issues with a pure heart and mind: seek the truth, and derive any policy conclusions afterwards. But that, I suspect, is rarely how things work. After all, the reason you study an issue at all is usually that you care about it, that there’s something you want to achieve or see happen. Motivation is always there; the trick is to do all you can to avoid motivated reasoning that validates what you want to hear.

economist-nakedIn my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.

Hmm …  Read more…

From Wicksell to Le Bourva and MMT

June 4, 2018 7 comments

from Lars Syll

MMTComparing the limited work of Wicksell, Le Bourva, and MMT, we find that they share many similarities. Obviously, the institutions and issues being discussed have changed during the decades these scholars were writing, yet all three views agree on some fundamental issues. The methodology is quite similar, with a strong focus on balance sheets opposed to theoretical models based on assumptions that are necessary for the mathematics to work. There is also a strong consensus that monetary theory is positive, not normative. Further relevant areas of agreement are found with respect to: the idea of Chartalism when it comes to the origin and value of money; the endogeneity of money regarding bank creation of deposits; the role of the money market in the economy and the missing link to inflation; the monetary circuit and the link from debt to income; and the effects of deficit spending.

Some minor differences occur when it comes to the question of why banks do not expand unlimited credit if they can. While Wicksell believes that the interbank-market debt of banks expanding their loan books relatively faster than other banks should stop further bank loan creation, Le Bourva agrees with Kalecki and sees rising risk as the major factor. In Wray (2012), it is creditworthiness and access to reserves at low costs that limit the extension of loans.

Dirk Ehnts & Nicolas Barberoux

Most mainstream economists seem to think the idea behind Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with.

New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:   Read more…

Anti-Blanchard

June 3, 2018 1 comment

from Lars Syll

Olivier Blanchard’s intellectual path, exploring different avenues – sometimes non-linear, sometimes even contradictory – can be considered as the personification of the controversial​ evolution of mainstream macroeconomic research during the last three decades …

9781292160504Assessing this complex intellectual path, nevertheless, also helps to understand why Blanchard’s analyses are ultimately limited by the mainstream framework, and by the role he decided to play in its defense. The primary limitation of the mainstream analysis, in our view, concerns the neoclassical reliance on price movements as leading the economy towards an optimal use of the available amount of labor and other productive resources. This reliance is also apparent in the old IS–LM diagram, advocated by Krugman and other members of the mainstream and that Blanchard readmits at least in the educational field …

This is a typical feature of almost all of the latest evolutions in Blanchard’s thought and more generally in current mainstream analysis: they fall within the branch of neoclassical doctrine that several years ago was sharply defined, and cricitized, as imperfectionist (Eatwell and Milgate 1982). According to this line of research, while in the best of all possible​ worlds the spontaneous movement of market prices would bring the economy towards a neoclassical competitive general equilibrium, actual markets are inhibited from fulfilling this task by the presence of ‘frictions’, ‘rigidities’, ‘asymmetric information’ or ‘incorrect expectations’ concerning future movements of prices. In fact, the critique of the neoclassical theory of capital has shown that even if all ‘market imperfections’ were removed, there would be no guarantee of achieving a full employment equilibrium simply through spontaneous price movements. In the case of the IS–LM model, for example, the problem concerns not only adjustments in price expectations but also the impossibility of proving the existence of an inverse relationship between the interest rate and investment. The non-existence of this relation, among other things, also causes a sense of perplexity concerning the confidence that Blanchard and other mainstream scholars continue to place in the ability of monetary policy to ensure convergence towards full employment.

Read more…