How Not to Do Macroeconomics
A frustrating recurrence for critics of ‘mainstream’ economics is the assertion that they are criticising the economics of bygone days: that those phenomena which they assert economists do not consider are, in fact, at the forefront of economics research, and that the critics’ ignorance demonstrates that they are out of touch with modern economics – and therefore not fit to criticise it at all.
Nowhere is this more apparent than with macroeconomics. Macroeconomists are commonly accused of failing to incorporate dynamics in the financial sector such as debt, bubbles and even banks themselves, but while this was true pre-crisis, many contemporary macroeconomic models do attempt to include such things. Indeed, reputed economist Thomas Sargent charged that such criticisms “reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished.” So what has it accomplished? One attempt to model the ongoing crisis using modern macro is this recent paper by Gauti Eggertsson & Neil Mehrotra, which tries to understand secular stagnation within a typical ‘overlapping generations’ framework. It’s quite a simple model, deliberately so, but it helps to illustrate the troubles faced by contemporary macroeconomics.
The model has only 3 types of agents: young, middle-aged and old. The young borrow from the middle, who receive an income, some of which they save for old age. Predictably, the model employs all the standard techniques that heterodox economists love to hate, such as utility maximisation and perfect foresight. However, the interesting mechanics here are not in these; instead, what concerns me is the way ‘secular stagnation’ itself is introduced. In the model, the limit to how much young agents are allowed to borrow is exogenously imposed, and deleveraging/a financial crisis begins when this amount falls for unspecified reasons. In other words, in order to analyse deleveraging, Eggertson & Mehrotra simply assume that it happens, without asking why. As David Beckworth noted on twitter, this is simply assuming what you want to prove. (They go on to show similar effects can occur due to a fall in population growth or an increase in inequality, but again, these changes are modelled as exogenous).
It gets worse. Recall that the idea of secular stagnation is, at heart, a story about how over the last few decades we have not been able to create enough demand with ‘real’ investment, and have subsequently relied on speculative bubbles to push demand to an acceptable level. This was certainly the angle from which Larry Summers and subsequent commentators approached the issue. It’s therefore surprising – ridiculous, in fact – that this model of secular stagnation doesn’t include banks, and has only one financial instrument: a risk-less bond that agents use to transfer wealth between generations. What’s more, as the authors state, “no aggregate savings is possible (i.e. there is no capital)”. Yes, you read that right. How on earth can our model understand why there is not enough ‘traditional’ investment (i.e. capital formation), and why we need bubbles to fill that gap, if we can have neither investment nor bubbles?
Naturally, none of these shortcomings stop Eggertson & Mehrotra from proceeding, and ending the paper in economists’ favourite way…policy prescriptions! Yes, despite the fact that this model is not only unrealistic but quite clearly unfit for purpose on its own terms, and despite the fact that it has yielded no falsifiable predictions (?), the authors go on give policy advice about redistribution, monetary and fiscal policy. Considering this paper is incomprehensible to most of the public, one is forced to wonder to whom this policy advice is accountable. Note that I am not implying policymakers are puppets on the strings of macroeconomists, but things like this definitely contribute to debate – after all, secular stagnation was referenced by the Chancellor in UK parliament (though admittedly he did reject it). Furthermore, when you have economists with a platform like Paul Krugman endorsing the model, it’s hard to argue that it couldn’t have at least some degree of influence on policy-makers.
Friday, April 11, 2014
By way of Unlearning Economics, who has made the effort of plowing through the details of the paper, read below and see if you've ever had a similar experience while reading some new and allegedly exciting "advance" in macroeconomic theory:
Posted by Mark Buchanan at 11:21 AM
Thursday, April 10, 2014
This article by political scientist Larry Bartels makes fascinating, if depressing, reading. In brief, a forthcoming study shows that the political influence of the wealthy is an order of magnitude larger than that of the poor (with wealthy and poor, of course, defined in a particular way). Democracy isn't the fair and equitable system you might have thought it was (if you were naive enough to think it was.... as, apparently, most political scientists still are).
I've written a little more at Medium.
Posted by Mark Buchanan at 11:44 AM
Wednesday, April 2, 2014
I have an essay coming out in Bloomberg tonight which looks at the fascinating article I recently mentioned by Nick Hanauer and Eric Beinhocker. I've also posted some further discussion over at Medium on one particular aspect of their article -- the notion that capitalism is best understood as an evolutionary process for finding solutions to human problems. It's messy, wasteful, chaotic, and that's precisely why it works -- by allowing a parallel exploration by many minds of the huge space of possible solutions to human problems. Capitalism is an algorithm in much the way evolution is an algorithm (or at least is LIKE an algorithm).
Posted by Mark Buchanan at 4:21 PM
Friday, March 28, 2014
By way of Mark Thoma, an absolutely brilliant paper by economist Paul Pfleiderer of Stanford University looking at how economists use and abuse models. As he points our, if you make the right assumptions (ignoring market "distortions" such as liver disease, DUIs, etc.), then it's possible to show in a rigorous model that "it is optimal for humans to be drinking all of their waking hours." I've written some more over at Medium.
Posted by Mark Buchanan at 1:27 PM
Wednesday, March 26, 2014
I recently stumbled across this fascinating preprint from last year by some computer scientists and applied mathematicians. They show how the taxi system in NYC could be made roughly 40% more efficient (fewer miles driven, lots less pollution, etc) with a taxi sharing system that would help people coordinate their trips. Making it work requires data and algorithms; the 40% improvement could be achieved, in principle, while introducing no more than a 5 minute delay to any person's trip.
Looks like great idea, right in line with the spirit of using information to improve coordination. I've written a short article on the research at Medium.
Posted by Mark Buchanan at 12:48 PM
Monday, March 24, 2014
Economist Chris House wonders why so many physicists are drawn to economics. It's a fair question, and I suppose it must seem strange -- perhaps irritating -- to see people interloping from a foreign field, fully convinced that they'll be able to help out even without formal economics training. Chris thinks the physicists often believe, mistakenly, that they're mathematically superior to economists, and so might be able to sort out some big problems quite easily.
I don't think that's the reason. If anyone does think that, then they're being quite silly. Here's why I think physicists are drawn to economics, over at Medium.com.
Friday, March 21, 2014
In the age of the Internet, and mobile everything, we increasingly need to interact with complete strangers. We don't know them, we can't trust them, yet we'd like to enter into positive exchanges with them, to cooperate and to trade, while protecting ourselves. How can we do it?
Maybe with ROT, by which I of course mean Random Oblivious Transfer, the latest weird idea looming up in quantum cryptography. More at Medium.com.