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What should we do with econometrics?

January 19, 2018 Leave a comment

from Lars Syll

Econometrics … is an undoubtedly flawed paradigm. Even putting aside the myriad of technical issues with misspecification and how these can yield results that are completely wrong, after seeing econometric research in practice I have become skeptical of the results it produces.

deb6e811f2b49ceda8cc2a2981e309f39e3629d8ae801a7088bf80467303077bReading an applied econometrics paper could leave you with the impression that the economist (or any social science researcher) first formulated a theory, then built an empirical test based on the theory, then tested the theory. But in my experience what generally happens is more like the opposite: with some loose ideas in mind, the econometrician runs a lot of different regressions until they get something that looks plausible, then tries to fit it into a theory (existing or new) … Statistical theory itself tells us that if you do this for long enough, you will eventually find something plausible by pure chance!

This is bad news because as tempting as that final, pristine looking causal effect is, readers have no way of knowing how it was arrived at. There are several ways I’ve seen to guard against this:

(1) Use a multitude of empirical specifications to test the robustness of the causal links, and pick the one with the best predictive power …

(2) Have researchers submit their paper for peer review before they carry out the empirical work, detailing the theory they want to test, why it matters and how they’re going to do it …

(3) Insist that the paper be replicated. Firstly, by having the authors submit their data and code and seeing if referees can replicate it (think this is a low bar? Most empirical research in ‘top’ economics journals can’t even manage it). Secondly — in the truer sense of replication — wait until someone else, with another dataset or method, gets the same findings in at least a qualitative sense …

All three of these should, in my opinion, be a prerequisite for research that uses econometrics (and probably statistics more generally … Naturally, this would result in a lot more null findings and probably a lot less research. Perhaps it would also result in fewer attempts at papers which attempt to tell the entire story: that is, which go all the way from building a new model to finding (surprise!) that even the most rigorous empirical methods support it.

Unlearning Economics

Good advise, underlining the importance of never letting our admiration for technical virtuosity blind us to the fact that we have to have a cautious attitude towards probabilistic inferences in economic contexts.   Read more…

Broad unemployment in Europe: the last two years. Two graphs.

January 19, 2018 Leave a comment

broad 3Eurostat made new data on broad unemployment available. For some countries (Ireland, Greece, Switzerland), these show a less rosy picture than the ‘normal’ unemployment data. Only the Czech Republic has low normal as well as low broad unemployment though Poland, Hungary, Bulgaria (!) and Germany seem to be heading that way. Altogether, labor slack is still immense. At this moment, wage increases are still low in non-Eastern European countries. Considering the slack this might stay so for a while, though there are more opportunities to obtain a better paying job. Read more…

The Volatility Index and Heisenberg’s uncertainty principle

January 18, 2018 12 comments

from Donald MacKenzie and the London Review of Books

The VIX, or Volatility Index, is Wall Street’s fear gauge. I first started paying attention to it in the late 1990s. Back then, a level of around 20 seemed normal. If the index got to 30, that was an indication of serious market unease; over 40 signalled a crisis. The highest the VIX ever got was during the 1987 stockmarket crash, when it reached 150. In the 2008 global banking crisis, it peaked at just below 90.

The US economy has gradually recovered from the banking crisis, and the newly legislated tax cuts will further boost corporate profitability. These effects, though, are now ‘priced in’: share prices have already risen to reflect them. Tax cuts aside, the political system remains largely paralysed. The Federal Reserve seems likely to continue raising interest rates, which usually isn’t good news for the price of shares, and is beginning the process of weaning markets off the flood of cheap money that has helped inflate share prices. The tax cuts will most likely increase the Federal deficit. Add in a president who is the very opposite of calm (and who is under FBI investigation), and you might expect the VIX to be approaching the sweaty-palmed 30s. It isn’t. As this issue of the LRB went to press, the VIX was 9.8. It has been low for many months, and shows no clear sign of increasing.

Donald Trump would no doubt attribute the low readings to investors’ confidence in his leadership. But I have my doubts. There is an alternative explanation. Heisenberg’s uncertainty principle is often taken to mean that whenever you measure something, you alter it. In the everyday world, you can usually set this aside: I don’t worry about the effect of the speedometer on how fast my car’s wheels turn or on how its engine runs. You can’t ignore it, though, in economic life. As Charles Goodhart argues, if a measurement device is widely used, it stops being a simple economic speedometer. In the financial markets, it becomes part of how traders think, and can then begin to affect how they act.

Read more here in the LRB

Neoclassical economics is great — if it wasn’t for all the caveats!

January 18, 2018 3 comments

from Lars Syll

I think that modern neoclassical economics is in fine shape as long as it is understood as the ideological and substantive legitimating doctrine of the political theory of possessive individualism. As long as we have relatively-self-interested liberal individuals who have relatively-strong beliefs that things are theirs, the competitive market in equilibrium is an absolutely wonderful mechanism for achieving truly extraordinary degree of societal coordination and productivity. We need to understand that. We need to value that. And that is what neoclassical economics does, and does well.

Of course, there are all the caveats to Arrow-Debreu-Mackenzie:

adb_poster_red_kickitover1   The market must be in equilibrium.
2   The market must be competitive.
3   The goods traded must be excludable.
4   The goods traded must be non-rival.
5   The quality of goods traded and of effort delivered must be known, or at least bonded, for adverse selection and moral hazard are poison.
6   Externalities must be corrected by successful Pigovian taxes or successful Coaseian carving of property rights at the joints.
7   People must be able to accurately calculate their own interests.
8   People must not be sadistic–the market does not work well if participating agents are either the envious or the spiteful.
9   The distribution of wealth must correspond to the societal consensus of need and desert.
10 The structure of debt and credit must be sound, or if it is not sound we need a central bank or a social-credit agency to make it sound and so make Say’s Law true in practice even though we have no reason to believe Say’s Law is true in theory.

Brad DeLong

An impressive list of caveats indeed. Not very much value left of “modern neoclassical economics” if you ask me …  Read more…

What Martin Sandbu gets wrong about neoclassical macro-economics

January 17, 2018 1 comment

Martin Sandbu is, in the Financial Times, wrong about neoclassical macroeconomic models. Let me explain by responding to his text, paragraph by paragraph. No links, I might add these later.

What do macroeconomists actually do? Without an answer to that question, it is difficult to articulate what they might be doing wrong. The rebuilding macroeconomic theory project is useful also to non-economists — perhaps especially to them — because it takes the time to dwell on how macroeconomists do what they do, in order to argue what they must do better.

Two points.

  • Sandbu answers this question by discussing what some macroeconomists do. To be precise: what neoclassical macroeconomists do. Stock and flow consistent modelling is left out of the discussion. NBER business cycle analysis is left out of the discussion. The kind of models which people like Steve Keen develop are left out of the discussion. Flow of Funds analysis as performed at national banks is left out of the discussion. Reduced form models and, in fact, ‘VAR’ models are left out of his discussion, too. It is about a very limited part of what macro-economics is all about  

Read more…

What’s the matter with America?

January 17, 2018 32 comments

from David Ruccio

US-wages-bottom50-top1

Last week, Thomas Frank welcomed Paul Krugman to the ranks of those who believe that the American working-class in recent decades has often voted against its fundamental economic interests by supporting conservative Republicans.   Read more…

Simon Wren-Lewis — anti-pluralist mainstream flimflam defender

January 15, 2018 14 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 his latest attack 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…

Former AIG director Martin Feldstein warns of stock and housing bubbles

January 15, 2018 2 comments

from Dean Baker

That’s one of the things we learn from reading Robert Samuelson’s Washington Post columntoday, although Samuelson identifies Feldstein only by his professorship at Harvard, not his moonlighting work on AIG’s board. (In addition to requiring a massive government bailout during Feldstein’s tenure as a director, AIG was also rocked by an accounting scandal that forced the resignation of its Maurice Greenberg, its longtime CEO.) I’m one of those old-fashioned types who think that track records should matter in assessing the accuracy of economists’ assessments, which is why it is appropriate to mention AIG here.

While it would have been enormously valuable if a person of Feldstein’s prominence had warned of the housing bubble back in 2003 or 2004, before it had grown so large as to pose a major threat to the economy, his warning now is off the mark according to some of us who did see the earlier bubbles. High stock prices and housing prices are justified by extraordinarily low interest rates we have been seeing in the last decade.

While this could change (interest rates could rise) it would not be nearly as harmful to the economy as the collapse of the housing bubble in 2007-2009 or the collapse of the stock bubble in 2000-2002. Unlike in those two earlier periods, the high asset prices in these markets are not driving the economy. Investment and housing construction are not especially strong, so there is no reason to think they would plummet even if prices in both markets were to fall 20 or 30 percent. Consumption is somewhat high, and could fall back 1-3 percentage points of GDP in response to the loss of wealth implied by these sorts of declines. That would slow growth, but need not lead to a recession.

Prosperity as human development, not wealth

January 15, 2018 12 comments

from Asad Zaman

The main thesis of our lecture is that our quest for prosperity has failed to deliver the sought-after goals because we have misunderstood the meaning of prosperity , and looked for it where it cannot be found. We base our economic policies on modern economic theory, which is based on the amazing assumption that human beings act to maximize lifetime consumption, since this is the sole source of human welfare. Human beings are far more generous and cooperative than the assumptions of economic theory allow for. Even more important is Richard Easterlin’s discovery that enormously increased levels of consumption do not bring about corresponding increases in happiness. Consumption only brings short-run happiness; long-run happiness has no correlation with consumption, and is far better correlated with character traits like generosity and gratitude. Mindless pursuit of wealth, implemented by policies to maximize growth, has led to increasing misery, instead of prosperity . Growth-oriented policies have destroyed family lives, engaging all members in production of wealth, and they have damaged our environment, destroying the future of our species for short run gains.his damage be reversed? Can we improve human lives and welfare, and also stave off the impending environmental crisis? At the core of the crisis we face is the prioritization of wealth over human beings. A market economy cheapens human beings because it is based on the idea that human lives are commodities for sale in the labor market. Reversing these priorities requires the recognition that all human lives are infinitely precious, with amazing potentials and capabilities for growth in dimensions unknown. Taking this principle seriously would require re-writing all economics textbooks, and radically re-organizing our economic, political and social institutions. Taking collective responsibility to ensure that all members of a society get the chance to develop their capabilities would be a new definition of prosperity , very different from GNP per capita, which is the current focus of policy makers across the globe.  read more

Trump trashes the United States while Xi tries to build a “sustainable China”

January 14, 2018 3 comments

from Richard Smith and issue 82 of the RWER

As Trump walked away from the Paris climate accord, Xi announced his intention to “take the driver’s seat in international cooperation to respond to climate change”. Not only that but Xi’s government has also pledged to wipe out the last vestiges of poverty in China by 2030 and turn China into a “moderately prosperous society” where the basic needs of all including jobs, housing, and healthcare, are met. Trump, as we know, has different priorities: tax cuts for the rich.

In short, the contrasts between Donald Trump and Xi Jinping could hardly be more striking. Little wonder, then, that more and more people around the world look to China to take the lead to save us from climate collapse. 

Systemic drivers of destruction

Alas, that is not going to happen. I don’t doubt Xi’s earnest intentions. But for all of that, I’m going to argue here that Xi Jinping cannot lead the fight against global warming because he runs a political-economic system characterised by systemic growth drivers – the need to maximise growth beyond any market rationality, the need to maximise employment, and the need to maximise consumerism – which are, if anything, even more powerful and even more eco-suicidal than those of “normal” capitalism in the West, but which Xi is powerless to alter.

Read more…

Dani Rodrik’s Ten Commandments

January 13, 2018 17 comments

from Lars Syll

Moses-and-the-Ten-Commandments-GettyImages-171418029-5858376a3df78ce2c3b8f56dDani Rodrik is not satisfied with the critique of mainstream economics put forward by yours truly and other mostly non-orthodox economists. So he has put up a list of ten commandments for economists, hoping thereby to somehow ‘save’ mainstream ‘the model is the message’ economics from the critique. The two central commandments are

3. Make your model simple enough to isolate specific causes and how they work, but not so simple that it leaves out key interactions among causes.

4. Unrealistic assumptions are OK; unrealistic critical assumptions are not OK.

Although this may look as good advice, it turns out it really says nothing at all.

Rodrik’s ten commandments portray economics as advancing through a judicious selection from a continually expanding library of models, models that are basically seen as simplifications designed to show specific mechanisms at work.  Read more…

On the real-world irrelevance of game theory

January 12, 2018 8 comments

from Lars Syll

It has been argued that some ascription of rationality plays a crucial role in particular in game theoretic modeling from a participant’s point of view. However, ascribing some kind of ideal reasoning process symmetrically to all players in the game, it becomes very unclear whether we as analysts can truly adopt a participant’s attitude to such an idealized interaction. After all, we are as a matter of fact only boundedly rational and not perfectly rational beings ourselves …

Game TheoryAccording to the way we normally use the common knowledge assumption along with that of symmetrically rational, and, for that matter, perfectly rational individuals, each and every individual is assumed to reason the same way about the game. We in effect have reduced the problem of reasoning in an interactive situation to the reasoning of a representative ideal individual who knows the game in full and shares this knowledge by virtue of the common knowledge assumption with each and every other participant. The game theorist and the participants in the game are in the same situation. Everybody comes exactly to the same conclusions as everybody else when thinking about the game before the specific play of the game starts.

In sum, as far as the reasoning itself is concerned we are not talking about some interactive reasoning practice. It is rather an ideal type of reasoning to which all ideal type reasoners are assumed to “converge.” It is the reasoning of a representative ideally rational individual.
Hartmut Kliemt 

Read more…

The elephant in the world

January 12, 2018 1 comment

from David Ruccio

E4

One of the most important stories I read, but did not write about, while I was away was the launch of the World Inequality Report 2018.*

Read more…

Disruptive technologies and sustaintech investments

January 11, 2018 2 comments

from Mari Alejandra Madi

On a global level, to achieve the 2˚C agreed upon during the Paris Agreement, a decrease in emissions of 40-70 percent (relative to 2010) should be obtained by 2050. According to Bloomberg New Energy Finance, 2017 global green investments exceeded 2016´s total of $287.5 billion. With strong government policy support, China has experienced a rapid increase in sustainable investments over the past several years and nowadays this country is the leader of global renewable investments. Besides, as of 2017, giant wind projects spread between the U.S., Mexico, U.K., Germany and Australia.

Considering the global market at the beginning of the 21st century, sustainable or green investments have gone through three stages—Envirotech, Cleantech and Sustaintech (2017 White Paper, Tsing Capital Strategy & Research Center).

First, the envirotech stage has been driven by environmental technology in addition to government policy and regulations. Envirotech investments have aimed to address traditional environmental issues, such as solid waste treatment, water treatmen and renewable energy.  Considering the related business models, the envirotech business has been characterized by capital intensive investments reliant on scaling up for competitive advantage.  read more 

Time for another crash?

January 10, 2018 15 comments

from Lars Syll

shiller

On Black Friday 1929 market fundamentalist wet dreams of eternal growth took a serious hit. The stock market bubble exploded and crashed.

Today​ we have a stock market situation much reminding of that in 1929. The Shiller P/E ratio is now even higher than that year. Those of us who know our Keynes-Fisher-Kindleberger-Minsky and have not completely forgotten all about economic​ history are starting to worry …

Why does it cost so much to read heterodox economics?

January 10, 2018 3 comments

from Edward Fullbrook

The current issue (January 8, 2018) of the Heterodox Economics Newsletter lists the current issues of 16 English language journals, with each linked to the newsletter’s website where there is a link for each article in these new issues.  For each journal, I picked one article to try to read.  Here is what I found.  Read more…

Some 1921 remarks about National Income

January 9, 2018 5 comments

In 1921 King, Macaulay and Mitchell published their milestone Income in the United States: Its Amount and Distribution, 1909-1919’ which estimated time series of nominal and real income in the USA. Why did they measure this? The last sentence of their introduction reads: “Last but most interesting of all, we shall consider the way in which the National Income is distributed among individuals”. Distribution was paramount. The authors were also well aware of the limited nature of their estimates of monetary income: it was not a measure of welfare or prosperity. To quote them again: “Following common practice once more, we do not count as part of the National Income anything for which a price is commonly not paid. On this score we omit several of the most important factors in social well-being, above all the services of housewives to their families” (they go on to present a very rough monetary estimate of the value of these services). Even the depletion of national resources is already discussed: “No systematic deduction from the National Income is made in our estimates to cover depletion of natural resources. Doubtless this item is of considerable size as well as of peculiar interest.”. Still, if we want to measure the distribution of income or sectoral differences the monetary estimates are the way to go. Nowadays, GDP contains many non-monetary imputations. interestingly, the UK Office for National Statistics is publishing estimates of nominal income without these imputations. Look here for a very recent ONS study. The reason: ‘the national accounts measure of RHDI can differ from the perceived experience of households’. These monetary accounts are among other things a better gauge of the distribution of monetary income (wages, profits) than the normal national accounts: back to 1921. It makes one wonder why, later, these imputations were introduced and our focus changed from distribution to growth.

Some suggestions for reorienting economics and philosophy of economics

January 9, 2018 27 comments

from Gustavo Marqués

If it is assumed that (a) both agents and theorists are aware they are facing an uncertain context, and (b) they hold epistemic and ontological beliefs consistent with this state of affairs, the proper way to approach economic phenomena should be very different from those that guide current modeling practice. Particularly, instead of mechanisms or economic regularities that keep running independently of agents’ expectations, the decisive role of lobbyists within open-ended and uncertain processes based on expectations should be incorporated into the analysis. The following assumptions could be the philosophical core of a new conceptual framework for economics:

1) There are economic processes based on expectations and characterized by radical uncertainty. Agents involved in such processes act in two different ways (as decision-makers or as lobbyists).

2) Ex-ante knowledge of invariant sequences of events is generally not possible (because there are few if any sequences of this kind); more importantly, such knowledge is unnecessary as support and justification for the implementation of economic policies.

3) The role of theoretical practice is to identify the many feasible “branches” of a “tree of plausible outcomes” as well as the restrictions that each sequence of events faces.

4) It is not known (and it is not possible to know) ex-ante what “branches” of the tree (what sequences of feasible alternative events) will prevail. Science cannot help us with this.

5) Other types of knowledge (common and practical knowledge as well as practical skills) are crucial for shaping those processes. It is a sort of know-how knowledge, closer to management and administration than to scientific economics.

6) Although – as was shown in point (3) – theoretical practice has an important role to play in shaping processes, what is crucial in this endeavor is another practice, which we denote as lobbying (interventional) practice, which is performed by a wide range of economic players (mostly different kind of interest groups who are able to operate on the relevant context and agents’ expectations).  Read more…

Tesla, Amazon, and Bitcoin

January 9, 2018 12 comments

from Dean Baker

The soaring price of Bitcoin is a useful lesson about markets for people who seem to very quickly forget the last lesson. Bitcoin, a digital algorithm, backed by absolutely nothing, has been selling for more than $16,000.

Perhaps Bitcoin’s price will double or triple again. After all, who knows how badly people need digital currencies that are not really currencies? But more likely the market will run out of people who are willing to trade real money for nothing. At that point Bitcoin’s price will plunge and may approach its underlying value of zero.

In the meantime the price surge shows us that markets are capable of enormous amounts of irrationality. This is helpful for people who can’t remember the stock bubble at the end of the 1990s. Favored stocks, like AOL, often reached price to earnings ratios in the stratosphere, if they even had earnings. In AOL’s case, its market valuation topped out at more than $220 billion in December of 1999. When it was sold to Verizon sixteen years later the company was worth just over $4 billion. Many other high flyers of the bubble years, like Webvan and Pets.com, simply went out of business.

For those who consider 1999 and 2000 the distant past, we need only go back to 2006 and 2007 when subprime mortgage backed securities (MBS) all got top investment grade ratings from the bond rating agencies. These MBS were worth just a small fraction of their face value a couple of years later after the housing bubble burst. Nonetheless, “informed” investors placed trillions of dollars in MBS assuming them to be almost as safe as U.S. government bonds.  Read more…

Is economics becoming an evolutionary science? Veblen at the 2018 ASSA conference

January 8, 2018 7 comments

In 1898 Thorstein Veblen asked ‘Why isn’t economics an evolutionary science?’. At the ASSA 2018 conference Avsar, Duroy and Scorsone mused about this. Below, the abstracts of their papers. Here, Mark Thomas about this.

Avsar’s article is, with its link to neurology, truly Veblenian in spirit. An interesting question is: it seems that the behavior of hunter-gatherers, who have little property as they can’t carry it with them, have behavior that is more economic rational than the behavior of people with a lot of property. Does the institution of property itself destroy economic rationality? And if so, how does this relate to market behavior?

Duroy’s article is about the question if selfish behavior, which sometimes is good for individuals, destroys groups on which these people depend for survival. We might call this the Trump-effect.

Scorsone might give more attention to the work of Norbert Elias, who states that changing interdependencies does not only change institutions but also people themselves.

Rojhat B. Avsar: Read more…