Abstract and substantive reasoning for real life economics

I am greatly encouraged by the growing eagerness seen in many parts of the world to move out of arid academic economics into engagement with real life economic issues. However, at times I get the impression that the quest is for a more ‘realistic’ economic theory to deal with real life economic problems. In my thinking academic economics as it is practised at least in the English-speaking world and real life economics are two substantially different entities. Here I shall concentrate on what I consider to be the characteristics of real life economics.

First and foremost, real life economics is professedly part of the larger social enquiry; it belongs to what in earlier days was considered to be ‘political economy’. To put it differently, it is not a mere intellectual exercise to solve problems posed by other academics, and in that sense belonging to a realm largely, and to some extent deliberately, isolated from day to day lives of the vast majority of human beings. With rare exceptions academic economics has been setting up a universe of its own, a universe of discourse, where experts speak to other experts. Real life economics belongs to the realm of ordinary human beings and their day to day experiences.  

Empirical evidence now irrevocably shows banks create money out of thin air

from Lars Syll

This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”.

Richard A. Werner

Uncertain Causes

from Peter Radford

When you throw a feather out of a tenth story window it eventually hits the ground, but only after fluttering about for a while and following an often circuitous route downwards. Throw a ten ton lump of lead out and the route tends to be a lot more direct. Gravity wins the day in both cases. It’s just that in one other forces and environmental effects play a much larger role.

In economics the role of gravity is played by uncertainty. It is the dominant force underlying all action. Most often its presence is best detected by the reaction of people to it: they make plans and seek other ways to offset it. Our institutions, for example, are a way to channel activity along more predictable lines and thus keep uncertainty at bay as long as possible.

Eventually uncertainty wins. It undoes our plans by throwing up an event entirely unexpected. We then have a choice: do we repeat one of our tried and true actions on the basis that it has worked – at least sort of – in the past? Or do we invent a brand new action and see if it works in these new circumstances. Whichever we choose we learn something: either we learn that our old trick has new application, or we learn a new trick.

So uncertainty is a driver of learning. Pushing back the boundaries of the unknown, wherein uncertainty lurks the most, is how we make progress.

Economic Realism

from Peter Radford

Lars Syll seems to have started a perpetual conversation when he posted a comment about Tony Lawson’s longstanding complaints about realism in economics. I don’t want to get dragged into what appears to be an endless, and pointless, debate … but.

The debate is endless because some economists seem to thrive on endlessness. That is to say they react with horror at closure on any topic. Thus arguments begun in the early 1800’s still roil along happily employing at least a few economists who have specialized in whatever it is that stirred the arguments back then. No one seems inclined to end the discussion, instead it is added to the ever increasing inventory of points-of-view-come- theoretical-stances that clutter economics and make it opaque to all but the most intrepid cognoscenti.

Ah, but there are others who have, in their own minds at least, arrived at closure. And that’s where the pointless part comes in.

Real-world homo-economicus

Humans are selfish by nature, as is homo-economicus. What is changed is the conception of the self. Society can define not only the social expression of the self but also the nature of competition for social status and associated allocation of fitness. If society defines money-making as an important goal of life, people will compete to make money. If society defines the goal of life to be serving a supernatural power, people will compete in their service for that supernatural power. Those expressions are not random because their “skeleton” is defined by the biological base of the mind. Nonetheless, culture with experience has freedom to modify its form just as flesh can modify body parts without seriously biasing their skeleton foundation. However this does not mean the self is meaningless and that what matters is the collective identity (homo-social). Social conditioning is not the creation of homogenous beings under controlled experiment. Human beings will have diversity in both inherited biological hardware and their expression based on cultural and personal experience. Those facts will make humans close to homo-economicus in most of their day-to-day life, in terms of selfishness. However because conforming to the morality and ethics defined by one’s culture and experience is likely to be in one’s self-interest, real-world homo-economicus is also likely to have a moral and ethical dimension. It is logical that in small isolated communities individuality will be weak and in large and diversified populations individuality will be highly manifested. This is because in a large population there will be a high diversity in the conditioning environment. Moreover if organizational efficiency is at a lower level, it can also allow for more individuality. If every family and person is independent, in its day-to-day fitness competition, higher individuality will be observed. A higher similarity of the conditioning environment will also create a more uniform mind-set among people living in such a community.

“The failure of economics is due to the use of axiomatic method”

Math and Science have ENTIRELY different methodologies which are suitable to them. Because of the spectacular success of the axiomatic method in Mathematics, people naturally started using the same method for science. This proved to be an equally spectacular failure. The scientific method involves making observations about nature and then GUESSING at laws which generate the observed patterns — that is induction. Later, one can verify these guesses by the means of experiments. To see that scientific laws and mathematical laws are entirely different creatures, do the following simple thought experiment. Consider the Pythagorean Theorem. It would make no sense to draw triangles and measure their sides to verify it, or to attempt to find a counterexample to the law. In contrast, because scientific laws are established on basis of empirical evidence and guesses, EVERY law is subject to empirical verification and has the potential to be refuted empirically. As Popper put it, if there is no potential observation which could conflict with the law, then it is not a scientific law.  The observational and empirical aspect of science means that it cannot be axiomatic. GREAT progress in science resulted PRECISELY from dropping the axiomatic methodology and switching to an observational and inductive process which led to scientific laws which could never be proven, UNLIKE mathematical laws. The failure of economics is due to the use of axiomatic method, which is eminently unsuitable for natural science, as was proven in the course of history.

Asad Zaman

Meme wars at the AEA conference

This January, the rebel economists at Adbusters will head to the American Economic Association conference in Boston to throw off some much-needed sparks. As the largest annual gathering of economists in the U.S., and a magnet for media attention, the AEA conference is the perfect location to light brush fires in people’s minds, stoke debate, and inspire new flare ups of campus activism. From the workshops to the hallways, we’ll shake things up and challenge the dead-end status-quo with the subversive memes and mind-bombs of a new pluralist economics for the 21st century. We’re looking for a few good rebel economists – from students, to educators and beyond – to join in the fun!

Here are the details:

On the limits of cross-country regressions

from Lars Syll

Endogeneity problems are of course nothing new in growth regressions. But what is special here is that policy endogeneity is not just an econometric nuisance, but typically an integral part of the null hypothesis that is being tested. The supposition that governments are trying to achieve some economic or political objective is at the core of the theoretical framework that is subjected to empirical tests. In such a setting, treating policy as if it were exogenous or random is problematic not just from an econometric standpoint, but also conceptually …

The cross-national variation we observe in government ownership is unlikely to be random by the very logic of the theories that are tested. Under the developmental perspective, this variation will be driven by the magnitude of the financial market failures that need to be addressed and the governments’ capacity to do so effectively. Under the political motive, the variation will be generated by the degree of “honesty” or “corruption” of political leaders. I show in this paper that the cross-national association between performance and policy will have a very different interpretation depending on which of these fundamental drivers dominate. Unfortunately, none of these drivers is likely to be observable to the analyst. In such a setting the estimated coefficient on state ownership is not informative about either the positive or the normative questions at stake. It cannot help us distinguish between the develop-mental and political views, because the estimated coefficient on government ownership will be negative in both cases.

Dani Rodrik

Proper use of math in economics

from Lars Syll

27. ii. 06
My dear Bowley,

I have not been able to lay my hands on any notes as to Mathematico-economics that would be of any use to you: and I have very indistinct memories of what I used to think on the subject. I never read mathematics now: in fact I have forgotten even how to integrate a good many things.

But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules — (1) Use mathematics as a short-hand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This last I did often. 

“This real-world attribute straightforwardly invalidates Walras’s Law”

. . . the totality of all goods cannot be traded by the totality of all agents at every single trading moment. Momentary analysis thus facilitates the recognition of an important real-world attribute: continual trade in different goods among different traders.

This real-world attribute straightforwardly invalidates Walras’s Law, understood as the necessary equality of the total value of goods brought to market and the total value of goods taken away from the market at its close. Walras’s Law does not describe an intrinsic quality of market exchange, but results from the stylisation of a single trading round per period during which a given set of agents seeks to trade a given and uniformly priced set of goods among each other. Hence when the identities of goods and traders are in continual flux, as they are in the real world, Walras’s Law fails (Tsiang, 1966). The scrapping of one arbitrarily chosen market facilitated by Walras’s Law has, unsurprisingly, no imaginable counterpart in economic reality. It is an absurdity. Yet it continues to be invoked (e.g. by Brunnermeier and Sannikov, 2011) while textbook LM theory also still employs it to rid itself of the bond market.

Piet-Hein van Eeghen
http://www.paecon.net/PAEReview/issue67/Eeghen67.pdf

The static analysis of the supply and demand model

Note that the supply and demand model is, like much of economics, based on static analysis. Consequently the focus will be on the market equilibrium. It is based on the idea that you have a scenario within which you can have as much costless adjustment as required to achieve some final end state which will be the equilibrium (issues of existence and uniqueness aside). This does not reflect the real world. In reality, there is a starting point, A. This is more than just an initial resource endowment. It also specifies an application of those resources, for example producing and consuming goods and services at some rate of output (as we are actually moving through time). There is also a path to be taken to the endpoint. 

Rigour vs. relevance

from Lars Syll

Reforming economics: pluralism is not enough

from Geoff Davies

Much of the current discussion of reforming economics focusses on the need for pluralism, particularly in teaching curricula, and very recently again on RWER.  Pluralist teaching is seen as challenging, because heterodox economic ideas are diverse, have little coherence, and are to a significant extent mutually incompatible.

This theme crops up frequently in discussions on RWER.  Now Cameron Murray, in the first issue of Inside, published by the Institute for Dynamic Economic Analysis, proposes to identify over-arching themes that can bring out the relationships among the various approaches.  This is commendable but it will not, on its own, result in a reformed economics.

I think the perceived difficulty of teaching heterodox economics comes from expecting too much from the exercise.  It will result in better-educated economists, and that is a very good thing.  Breaking the academic dominance of neoclassical economics would also be a very good thing.  However coherence in economics will not result from trimming and hammering existing fragmented ideas into a new box.

Bayesianism — a ‘patently absurd’ approach to science

from Lars Syll

Back in 1991, when I earned my first Ph.D. — with a dissertation on decision making and rationality in social choice theory and game theory — yours truly concluded that “repeatedly it seems as though mathematical tractability and elegance — rather than realism and relevance — have been the most applied guidelines for the behavioural assumptions being made. On a political and social level it is doubtful if the methodological individualism, ahistoricity and formalism they are advocating are especially valid.”

This, of course, was like swearing in church. My mainstream neoclassical colleagues were — to say the least — not exactly überjoyed.

The decision theoretical approach I perhaps was most critical of, was the one building on the then reawakened Bayesian subjectivist interpretation of probability.

One of my inspirations when working on the dissertation was Henry E. Kyburg, and I still think his critique is the ultimate take-down of Bayesian hubris (emphasis added):

Calling all rebel economists!

from Richard Wolff 

This project is important and long-overdue to undo the narrow orthodoxy that has suffocated diversity and heterogeneity and social criticism within the discipline (sic) of economics. I am glad to spread word about it.  

Calling all Rebel Economists!  

After smothering progress for decades, the mainstream stranglehold on economic thought is finally slipping. With the recent rise of student protest movements like the International Student Initiative for Pluralism in Economics (ISIPE), the demand for real-real world economics is at an all-time high, and a strategic spark may be all it takes for this growing discontent to explode into a global campus revolution. 

This January, the rebel economists at Adbusters will head to the American Economic Association conference in Boston to throw off some much-needed sparks. As the largest annual gathering of economists in the U.S., and a magnet for media attention, the AEA conference is the perfect location to light brush fires in people’s minds, stoke debate, and inspire new flare ups of campus activism. From the workshops to the hallways, we’ll shake things up and challenge the dead-end status-quo with the subversive memes and mind-bombs of a new pluralist economics for the 21^st century. We’re looking for a few good rebel economists – from students, to educators and beyond – to join in the fun! 

Here are the details:

The Ramsey-Keynes dispute

from Lars Syll

Neoclassical economics nowadays usually assumes that agents that have to make choices under conditions of uncertainty behave according to Bayesian rules, axiomatized by Ramsey (1931) and Savage (1954) – that is, they maximize expected utility with respect to some subjective probability measure that is continually updated according to Bayes theorem. If not, they are supposed to be irrational, and ultimately – via some “Dutch book” or “money pump”argument – susceptible to being ruined by some clever “bookie”.

Bayesianism reduces questions of rationality to questions of internal consistency (coherence) of beliefs, but – even granted this questionable reductionism – do rational agents really have to be Bayesian? As I have been arguing elsewhere (e. g. here, here and here) there is no strong warrant for believing so.

In many of the situations that are relevant to economics one could argue that there is simply not enough of adequate and relevant information to ground beliefs of a probabilistic kind, and that in those situations it is not really possible, in any relevant way, to represent an individual’s beliefs in a single probability measure.

The teaching of economics is in crisis.

An international student call for pluralism in economics

It is not only the world economy that is in crisis. The teaching of economics is in crisis too, and this crisis has consequences far beyond the university walls. What is taught shapes the minds of the next generation of policymakers, and therefore shapes the societies we live in. We, over 65 associations of economics students from over 30 different countries, believe it is time to reconsider the way economics is taught. We are dissatisfied with the dramatic narrowing of the curriculum that has taken place over the last couple of decades. This lack of intellectual diversity does not only restrain education and research. It limits our ability to contend with the multidimensional challenges of the 21st century – from financial stability, to food security and climate change. The real world should be brought back into the classroom, as well as debate and a pluralism of theories and methods. Such change will help renew the discipline and ultimately create a space in which solutions to society’s problems can be generated. 

United across borders, we call for a change of course. We do not claim to have the perfect answer, but we have no doubt that economics students will profit from exposure to different perspectives and ideas. Pluralism will not only help to enrich teaching and research and reinvigorate the discipline. More than this, pluralism carries the promise of bringing economics back into the service of society. Three forms of pluralism must be at the core of curricula: 

Calibration and ‘deep parameters’ — a severe case of econometric self-deception

from Lars Syll

One may wonder how much calibration adds to the knowledge of economic structures and the deep parameters involved … Micro estimates are imputed in general equilibrium models which are confronted with new data, not used for the construction of the imputed parameters … However this procedure to impute parameter values into calibrated models has serious weaknesses …

First, few ‘deep parameters’ have been established at all …

Second, even where estimates are available from micro-econometric investigations, they cannot be automatically importyed into aggregated general equlibrium models …

Third, calibration hardly contributes to growth of knowledge about ‘deep parameters’. These deep parameters are confronted with a novel context (aggregate time-series), but this is not used for inference on their behalf. Rather, the new context is used to fit the model to presumed ‘laws of motion’ of the economy … 

Milton Friedman’s critique of econometrics

from Lars Syll

Tinbergen’s results cannot be judged by ordinary tests of statistical significance. The reason is that the variables with which he winds up, the particular series measuring these variables, the leads and lags, and various other aspects of the equations besides the particular values of the parameters (which alone can be tested by the usual statistical technique) have been selected after an extensive process of trial and error because they yield high coefficients of correlation. Tinbergen is seldom satisfied with a correlation coefficient less than 0.98. But these attractive correlation coefficients create no presumption that the relationships they describe will hold in the future. The multiple regression equations which yield them are simply tautological reformulations of selected economic data. Taken at face value, Tinbergen’s work “explains” the errors in his data no less than their real movements; for although many of the series employed in the study would be accorded, even by their compilers, a margin of error in excess of 5 per cent, Tinbergen’s equations “explain” well over 95 per cent of the

University economics departments must share the blame

Financial Times, November 17.
University departments must share the blame 

Sir, The FT is far from alone in, once again and for the umpteenth time, decrying the “scandal” that a section of the financial sector – this time the foreign exchange market ​– has “remained immersed in a culture that subordinates everything to making money” (editorial, November 13). University economics departments cannot escape their share of the blame for this, so crucial have they been in recent years in providing academic justification for this “culture”. 

Economics is, according to the orthodoxy now almost totally dominant in these departments, a discipline whose very identity is inseparable from the calculus of maximisation and minimisation. This standpoint is not limited to those of a neoliberal orientation; on the contrary, among its most dogmatic adherents is the outspokenly non-neoliberal Paul Krugman, who states quite simply that the economist is a “maximising-minimising kind of guy”. 

Krugman is, however, exceptional in his radical views, and the inevitable bias that results from the exclusion from the economics curriculum of alternative approaches is towards turning out students who are ready-primed for incorporation into the “culture” that is revealed with such depressing regularity every time there is a thorough investigation of financial misdemeanours.
Fortunately, an increasing number of economics students are raising their voices against a curriculum which has become, in effect, little more than an indoctrination into that heinous “culture”.

It is about time the managements of economics departments stopped exploiting their freedom to appoint and promote their staff to perpetuate this situation. Let us hope that the demands of their students and of the wider public can begin to force them once more to open their doors to adherents of alternative approaches, and thus to reflect within themselves the debates on economic issues that rage in the world outside.

Hugh Goodacre
University College London and University of Westminster, UK​