Nonsense economics

from Lars Syll

It is, perhaps, not uninteresting to point to some of the economic implications which are included in “perfect foresight”. It will immediately be recognized that this assumption could never lie at the basis of the theory of equilibrium, and they who attribute this to such authors as Walras and Pareto, who are included as representatives of equilibrium theory, are in error. ln the first place, strange to say, it happens that even material assertions can be made about such an economy on the basis of the assumption of perfect foresight.They are fundamentally of the negative type. For example, no lotteries or gambling will exist, for who would play if it were well-established where the profit went? Telephone, telegraph, newspapers, bills, posters, etc. would, likewise, be superfluous, obviously; but, also, the very important industries, based on them, with all their affiliated industries, would be absent. Only packages and letters implying documentary evidence would need to be delivered by post, for to whom would letters be written? The tale need not be carried further, for it is obvious how little considered are the “fundamental assumptions” so frequently employed in theoretical economics, where really a matter of nonsense is at issue.

Oskar Morgenstern

Economics departments — turning out generation after generation of idiot savants

from Lars Syll

Paul Samuelson once claimed that the ergodic hypothesis is essential for advancing economics from the realm of history to the realm of science.

That view on what constitutes economics doesn’t please neither yours truly nor Nassim Taleb, who writes (emphasis added):

The attack of the robots: economists’ silly fantasies

from Dean Baker

Economists are not very good at economics. We know this because we had a huge housing bubble that collapsed, which almost none of them saw. The pre-crash projections from the Congressional Budget Office imply that this downturn has already cost us more than $7.6 trillion, or $25,000 per person. This could have been prevented if we had economists in policy positions who understood how the economy worked.

But even if economists aren’t very good at dealing with the economy, they still can provide value to society. In particular they can be a great source of entertainment. That’s how we should view the story that robots will take all of our jobs and leave most of the population unemployed.

This story has become a popular theme lately among Washington policy types. There are important people from across the political spectrum running around town wringing their hands over the prospect that the economy may not provide jobs for large segments of the labor force.

The first aspect of this story that should impress people is that many of the same people have been wringing their hands about the exact opposite problem, most likely without even knowing it.

A point is reached … when a continuously modified hypothesis becomes difficult to entertain seriously.”

from Peter Radford

I came across this whilst reading Sharon McGrayne’s history of Bayesian theory, its a quote attributed to the statistician Jerome Cornfield:

“A point is reached … when a continuously modified hypothesis becomes difficult to entertain seriously.”

How apt.

For much of economics.

Looking back over the history of the development of economic theory, more precisely theories since we have such an abundance of them, we cannot but be struck by one constancy: that they are all updated regularly. This updating is not to replace them because they have proven to be incorrect, but to modify them sufficiently to prolong their life despite the evidence. It is, apparently, intellectually cheaper to tinker than to replace.

This is especially true of the array of ideas that loosely can be called neoclassical theory. It is a mishmash of ideas that are known to be false or highly questionable or utterly divorced from reality, yet are still used as a basis for thinking and modeling economies. It is an archeologists dream. 

Econometrics and the art of putting the rabbit in the hat

from Lars Syll

In econometrics one often gets the feeling that many of its practitioners think of it as a kind of automatic inferential machine: input data and out comes casual knowledge. This is like pulling a rabbit from a hat. Great — but first you have to put the rabbit in the hat. And this is where assumptions come in to the picture.

The assumption of imaginary “superpopulations” is one of the many dubious assumptions used in modern econometrics, and as Clint Ballinger has highlighted, this is a particularly questionable rabbit pulling assumption:  

Preferences that make economic models explode

from Lars Syll

Commenting on experiments — showing time-preferences-switching framing effects — performed by experimental economist David Eil, Noah Smith writes:

Now, here’s the thing…it gets worse … I’ve heard whispers that a number of researchers have done experiments in which choices can be re-framed in order to obtain the dreaded negative time preferences, where people actually care more about the future than the present! Negative time preferences would cause most of our economic models to explode, and if these preferences can be created with simple re-framing, then it bodes ill for the entire project of trying to model individuals’ choices over time.

This matters a lot for finance research. One of the big questions facing finance researchers is why asset prices bounce around so much.

Why Wall Street shorts economists and their DSGE models

from Lars  Syll

Blogger Noah Smith recently did an informal survey to find out if financial firms actually use the “dynamic stochastic general equilibrium” models that encapsulate the dominant thinking about how the economy works. The result? Some do pay a little attention, because they want to predict the actions of central banks that use the models. In their investing, however, very few Wall Street firms find the DSGE models useful …

This should come as no surprise to anyone who has looked closely at the models. Can an economy of hundreds of millions of individuals and tens of thousands of different firms be distilled into just one household and one firm, which rationally optimize their risk-adjusted discounted expected returns over an infinite future? There is no empirical support for the idea. Indeed, research suggests that the models perform very poorly …

Why does the profession want so desperately to hang on to the models?