Monday, February 6, 2012

Why Economists Are Right

Here's an excellent piece by David Levine in the Huffington Post. There are some related ideas in this article of mine. Excerpting from the latter:
But prediction need not always be the criterion for success of an economic model. Clearly, if we are judging a forecasting model, we want it to predict well, in some well-defined sense. But in other cases forecasting is not the name of the game. In arbitrage pricing, under some assumptions the model implies that changes in asset prices cannot be successfully forecast. By the criterion of prediction, the model is indeed a total failure. It tells you that a monkey could do as well at predicting asset prices as an economist who understands the model. Yet the model is actually not a failure, as it teaches us something interesting.

With financial crises, a similar issue arises. By its nature, a financial crisis is an unpredictable event. We could have an excellent model of a financial crisis. The people living in the model world where the financial crisis can happen know it can happen, but they can't predict it, otherwise they could profit in advance from that prediction. Similarly, an economist armed with the model will not be able to predict a crisis in the real world. A nice example is in Ennis and Keister (2010), which is a variant of a Diamond-Dybvig (1983) banking model. In Ennis and Keister’s world, a rational and benevolent policymaker and a set of rational consumers live in an environment where a banking panic can happen. When the policymaker sees the beginnings of a panic, he or she starts to intervene, but rationally discounts the severity of the panic until the panic is too full-blown to actually prevent. Thus, the panic can happen even if the policymaker has the right model, and the policymaker with the right model indeed cannot predict the panic.


  1. I don't understand this:
    "We could have an excellent model of a financial crisis. The people living in the model world where the financial crisis can happen know it can happen, but they can't predict it, otherwise they could profit in advance from that prediction. Similarly, an economist armed with the model will not be able to predict a crisis in the real world."

    I'm pretty sure this does not hold when you have incomplete markets. For instance:

    - The economy could lack the proper instruments to avert the crisis. i.e. it's hard to take certain short positions.

    - It may be more profitable to (say) ride a bubble than to attack it, at least for a while (whereas an economist could recognize that there was a bubble). I'm thinking of a model like Abreu Brunnermeier, where bubbles are known by all, but not common knowledge.

    - In models of systemic risk, you could recognize the potential for a crisis in, say, high leverage or excessive borrowing in foreign currency. Yet this is all privately optimal, even if everyone knows it makes a crisis more likely.

    1. Perhaps my comment was too harsh. I agree with many of your points about evaluating models. I just don't agree that financial crises are inherently unpredictable, at least in broad terms (though I agree that they are unlikely to be precisely predictable).

  2. according to Levine's logic, civil engineers should not be able to design safe highways, but they can. they build a curve and then post a speed limit.

    predicting a financial crash is not building a forecasting model, it is asking, what are the speed limits? One doesn't need to project that on 10/2812 the Dow will fall

    One only needs speed limits, but in all the macro models you won't find any. You have Buffett and Munger warning about CDOs etc., but they were pretty much alone.

    When private debt was expanding as rapidly as it was under Greenspan (and the $$$ that were giving us "growth" were coming entirely from home equity withdrawals) we were off the road, driving at an excessive rate of speed. Any economists worth his hood should have seen what was happening. The post mortems are clear.

    One could go on, but what is the point. Greenspan and the Very Serious People rationalized all of this as "free markets," and were not about to cross their bonus earning supports at Goldman Sachs.

    One could go on about all the other speed limits being broken (lack of investment, decline in r & d, and wages---Frum has some interesting wage information up in his takedown today of Murray)

    My two cents is that Keynes is right but the moral hazard of Keynesian solutions is the devil in the details. You get the Dick Cheney caliber of politicians who announce that deficits don't matter for solely political ends (and an academic undertaking that responds by sitting on its hands) and you have signaled to any rational investor, get out, were nuts, investment declines and tomorrow is guaranteed to be worse than today.

    Macro ought to give up modeling and instead, first, agree on speed limits.

    1. This guy is either stupid or disingenuous. I suspect stupid, because he reads like JLD.

    2. disingenuous

      I run a massive hedge run and have a number of people comment for me on an the economic blogs, creating fear, doubt, and uncertainty with with such disinformation in the financial markets, all to open up trading opportunities

      I think this is only fair, since Williamson and Cochrane, among others, use their blogs to court favor with right wing ideologues in hopes of future gov't appointments, etc.

      IOW, fair is fair. I am using people who are manipulating to manipulate.

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  4. The arguments by David Levine lie on the borderline of disingenuous and stupid. I do not think anybody was complaining that macro models cannot forecast a financial crisis - the complaint was that many macro models rule out the very possibility of a financial crisis.

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    1. 1. Read Krugman's New York Times magazine piece, or Quiggin's "Zombie Economics," which was the basis for the piece I linked to above. Their point is that, now that we have seen the financial crisis, and since macroeconomists could not predict it, using their models or their insightful logic, that we should throw much of modern macro out and start over, with Hicks (1937) as a base. That's pretty clear.

      2. Anyone who would call David disingenuous and stupid is disingenuous and stupid. His RePec ranking is a lot higher than yours (and mine too).

    2. You claim that the financial crisis was unpredictable. Yet if Levine and you are right, how come that Dean Baker and Roubini have realized that there is a bubble on the housing market years before it burst?

      You can defend contemporary macroeconomics as much as you like, the above examples show that it failed to predict a PREDICTABLE crisis. In any real science theories which are unrelated to the data and lack any prediction power would immediately land in the waste bin.

      Now I read my Minsky, Fisher and Tobin, as the stuff they wrote actually has something to do with real world.

  6. But the rot in macroeconomics goes deeper than that. We all remember a few years ago the theather of absurd of a Nobel prize winner giving a presidential address at the AEA arguing that we should not worry about business cycle fluctuations after all household idiosyncratic risks are irrelevant for the planner's welfare function (perhaps because markets are complete, beh!). To top it off the madness, nobody laughed him out of the conference room.

    1. one could argue that, save for Keynes, there haven't been any important contributions in economics, at least any that can get translated into action.

      Look at this blog

      Williamson says, trust me, my model shows inflation is coming and then he gets bent out of shape when people say, "not so fast, why should we trust you when your model missed the bigger, main event, the Lesser Depression?"

      Williamson also gets ugly when you ask him why does he favor creditors over debtors. The Fed is supposed to maintain stability of all prices.

      Insofar as I can tell, Williamson has never said peep about the incredible rise in housing prices under Greenspan and their drop. There was price instability that really damaged the economy.

      What did Williamson's models tell him then? Nothing insofar as I can tell.

  7. No arbitrage etc. do not make point-wise predictions, but they do have testable implications in terms of probability distributions. You could still ask whether research up until the crisis was biased towards models that assigned very too low a probability to such an event.

    VV Chari has a nice testimony to congress about the state of macro where he actually admits this was the case. He also gives a good explanation for why, which is the fact that, indeed, such crises were absent from typical post-war business cycles in the US. From that perspective, the crisis was informative about what kind of models were interesting and it did point out that these were different from the models most widely used before.

    Link to Chari's testimony:

    1. Yes, that's useful. Obviously the crisis changed views about what the important research questions are, and how we should develop our models. Compare conference programs in economics before and after the crisis, and look at the specific papers, and you'll see how it matters. So, the fact that the crisis occurred changed views about what the important research questions are, but it should not change our views about economic methodology, or how we use the economic theory and empirical methods we have acquired over the last 40 years or so.

    2. Raghuram Rajan has an essay at Project Syndicate making the point that we have "a fundamental growth problem."

      "If this diagnosis is correct, advanced countries need to focus on reviving innovation and productivity growth over the medium term . . . "

      Since innovation and productivity growth are not even on the horizon in monetary macro, which claims it cannot even see the problems, of what use are your theory and methods?

      Keep in mind that around here to suggest we need more investment and r & D is stupid and disingenuous

  8. "Anyone who would call David disingenuous and stupid is disingenuous and stupid. His RePec ranking is a lot higher than yours (and mine too)."

    Sorry for using the 'S' word, but that is a stupid argument! I am sure that no person in their right mind would be able to argue that RePec rankings have anything to do with an economist's propensity to make disingenuous arguments (Note: disingenuous = insincere, deceitful, devious, dishonest).

    David is fighting a straw man. The criticism on our profession is that financial crisis were zero probability events in many macro models. Alas, the criticism is correct and relevant.

    1. So? Stop whining about the faults of macroeconomists and go work on these problems.

    2. We are going to work on the problems.

      Bullard and others are the problem.

      Did you see the mug shot of Bullard in the Post, today? One picture worth a thousand words. Now Bullard is a guy who can tell them, "Let them eat cake."

      We have one month of data and a mountain of work before us to put people back to work and Bullard wants to raise interest rates and cut off any recovery out of fear of inflation.

      Seems reasonable to me to ask,if you want me to trust your model, explain why it didn't show, forecast, predict, use whatever dodge word you want, the Lesser Depression.

      Seems to me you are playing a game of heads I win, tales you loose, otherwise.

      It is also fascinating to me to be called stupid because I believe that private debt was too high and that many of our problems stem from inadequate investment and insufficient research and development

      Imagine that, being called stupid for advocating more investment and more research and development.

      And I guess I was disingenous to point out that all the Very Serious People like Bullard did not ring the bell when Cheney said deficits don't matter.

      You can obtain a lot of powerful, negative evidence from a Google search.

      John Kay has, btw, written excellent essays at both the FT and INET rebutting Levine.

      Of course, reading the FT or INET is probably "stupid," as well.

    3. You mistake whining for criticism. The poster already pointed out the problem of contemporary macroeconomics, a belief in perfect markets.
      So they created a world without debt-deflation spirals, a world without multiple forms of market failure based on irrationality, imperfect competition and imperfect information.

      As I already said, if you read Fisher or Minsky you learn more about what has happened in the last years than if you read any contemporary macro paper.

    4. Minsky and Keen make more sense than anyone

      Minsky taught at Wash U, but Williamson,surprise, never mentions him

  9. And by the way, being smart does not deter people to write stupid papers and make dumbass economic arguments. Bob Lucas is certainly smarter than me, but at some point in his life, he thought his legacy would not become a joke for the future generations if he wrote a paper using a representative household to discuss the welfare cost of macroeconomic fluctuations. Talk about bad decision making, lack of common sense and ignorance of how the economy works!

    1. I look forward to reading your paper.

    2. "Talk about bad decision making, lack of common sense and ignorance of how the economy works!"

      Obviously you didn't get it. The little exercise that Lucas did is very useful. It helps you think about the costs of business cycles and tells you what models you might use to think about the problem. What you say is precisely the point. There are key issues related to heterogeneity that are not captured with a representative household. Lucas I'm sure would say the same thing.

    3. the costs of business cycles

      wow, without that model I had no idea that people are devastated by job loss and financial ruin.

      get out of college in the wrong year and your entire life is stunted, economically.

      who would have thought.

      Lucas, obviously didn't, and I have never read 50 words that he wrote about how to best: (1) avoid such (he ducks on this because he is unable to predict such; and (2) what to do about it (his answer is always, nothing, we have to worry about overdoing, causing inflation, and, heaven forbid, hurting rich creditors.

    4. "...I have never read 50 words that he wrote about..."


    5. Here is a good measure of how useless this exercise by Lucas was

      Stiglitz (2012):

      In that brief moment when the rising tide was indeed rising, millions of people believed that they might have a fair chance of realizing the “American Dream.” Now those dreams, too, are receding. By 2011, the savings of those who had lost their jobs in 2008 or 2009 had been spent. Unemployment checks had run out. Headlines announcing new hiring – still not enough to keep pace with the number of those who would normally have entered the labor force – meant little to the 50 year olds with little hope of ever holding a job again.

      Indeed, middle-aged people who thought that they would be unemployed for a few months have now realized that they were, in fact, forcibly retired. Young people who graduated from college with tens of thousands of dollars of education debt cannot find any jobs at all. People who moved in with friends and relatives have become homeless. Houses bought during the property boom are still on the market or have been sold at a loss. More than seven million American families have lost their homes.

      Seven million home foreclosures---I wonder if that appears in the Lucas model?

    6. Sure, but that's not the problem that Lucas was trying to address with the model. Go ask Lucas today what he thinks about the relative merits of studying business cycles and economic growth, and see what he says. I don't want to put words in his mouth, but the last time I talked to him, I had the impression that he is as troubled as you are by how the world looks today. He may have some different solutions, but that's the key thing we're discussing here. Forget about what the guy wrote in the 1980s and how you think it applies to now. He knows it doesn't apply directly, just like you do.

    7. "Seven million home foreclosures---I wonder if that appears in the Lucas model?"

      Sure, if it affects their consumption. Wow, you people are obsessed with an article you've clearly never read.

    8. 1) Go ask Lucas today what he thinks about the relative merits of studying business cycles and economic growth?

      Since Lucas claims not to be able to foresee developing problems in the business cycle, why was there ever any relative merit in studying business cycles? Minsky told us we were going to end up in this boat!!!

      2) Out of probably madness, I am actually involved in starting up a new mfg. adventure here in the Gateway city. Thus, one of you readers might actually be interested in our real challenges. They are not European style socialism. That would help. We could quit our day jobs and have health insurance.

      In order they are:

      1) location---every part we need is made in China, Japan, Korea, or Taiwan, etc. IOW the cost or friction with dealing with suppliers is incredible. To interact with parts suppliers is beyond a nightmare. I never see you talk about this cost of free trade, which crushes small businesses and start ups by moving suppliers 10K miles away.

      2) Intellectual Property. Although everything we propose to do seems obvious, it is equally clear that a lot of people are out there who will claim it was their idea. They are not actively moving any product to market; they just file and wait, hoping to use a .44 cent stamp to extort.

      3) lack of knowledge. We are not innovators we are going to be adapters. The choke point for us is knowledge on familiar technogy (wifi v radio v cell phone signal) Here I really fault U of Mo. We at one time had ag agents in every Mo. county. We now need tech agents, etc. IOW info which we ought to be able to easily access is too costly and expensive

      4) trust. We are highly vulnerable to anyone with more financing just pushing us aside. The dishonesty of big american businesses makes going to market an absolute nightmare. Any potential "distribution channel" partner is just a nightmare. There are so many ways for us to get screwed it isn't funny. And, based on first hand knowledge, that growth in dishonesty has been geometric since the start of the Reagan revolution.

      Of the four, trust is probably the most important. If we could trust a distribution channel out task would be a lot lot easier.

  10. To be sure, Lucas revisited his paper from the 80s about the welfare cost of fluctuations and presented a more nuanced view acknowledging the work of Storesletten, Krusell and others on models with uninsured idiosyncratic risk.

  11. Lucas' pathetic paper about the welfare costs of the business cycle served only one purpose, to claim that it is lower that it actually is (I think the number he came up with was that people would be willing to give up around 5% of their total discounted income in order to totally smooth out the business cycle). Obviously he doesn't give a sh*t about the plight of unemployed people.

    Add heterogenity, imperfect capital markets based on asymmetric information (somebody should ask the Chicago boys why capital isn't allocated via auction markets until they admit that informational-incentive issues are the reason) and you will get a far larger number with the obvious political implications of some moderate level of unemployment insurance as well as aggregate demand management. And we have arrived at the main issue, that the neoclassical folks believe in Say's Law.

    1. there ought to be a federal statute requiring economists who blog to state under oath and on their blog whether they believe in Say's law and the Ricardian Equivalence.

      5000 years ago man built the great pyramids. Since then, we have been able to do pretty much whatever we want. Look at T3 in the Beijing airport (Terminal 3 (T3) was completed in February 2008, in time for the Beijing Olympics. This colossal expansion includes a third runway and another terminal for Beijing airport, and a rail link to the city-center. At its opening, It was the largest man made structure in the world in terms of area covered, and a major landmark in Beijing representing the growing and developing Chinese city. The expansion was largely funded by a 30 billion yen loan from Japan and 500-million-euro (USD 625 million) loan from the European Investment Bank (EIB). The loan is the largest ever granted by the EIB in Asia; the agreement was signed during the eighth China-EU Summit held in September 2005.)

      The only tricks are how to finance such.

      Where I really depart from Williamson is that his POV is just toxic to progress.

      Were there is no vision the people perish. Vision in his models or on this site.

    2. "...aggregate demand management. And we have arrived at the main issue, that the neoclassical folks believe in Say's Law."

      No, that's not where I arrive, for sure.

    3. Good Lord, Anon 11:10 is dense. And who do suppose first studied dynamic asymmetric information? Yep, Lucas.

  12. Anonymous Feb 6, 2012 10:14 PM

    You understand that there is a trade off between safety and 'usefulness'?

    One can set the speed limit on a highway at 5 mph and nobody will ever die of a car crash and car crash damages are going to be really mild. But that is not necessarily better than having the current limits and knowing that some people will eventually die and cars will be destroyed

    Likewise, one can regulate financial markets to the extreme that you need to put a downpayment of 80% to buy a house. Is that desirable? You tell me.

    You also don't know much about recent history.
    In the early 2000's the concern was not that the US was accumulating too much debt but quite the opposite! Greenspan had been the chairman of the Fed for many years at that time.


    1. Exactly. For example, the Canadian financial system is very safe. It's also highly concentrated, and people in Canada complain about high transactions fees, and high management fees for investment accounts. The Canadian banking system has seen three bank failures since 1900 - one in the 1920s and a couple of small ones in the 1980s. But it's not clear that the US system is worse. There are recurring crises, tangled regulation, and corruption here in the US financial system. But the system is also highly innovative, and New York is the largest center for world financial activity. There's a tradeoff.

    2. fees---our biggest fee, FDIC insurance, is hidden from the consumer, as are our taxes and other losses for periodic bailouts of the FDIC---for example, all those bonds we sold to pay off the insurance fund when Carter, Reagan and Bush so mismanaged the S&L industry.

      So who pays more---my estimate, the US consumer by far.

      One of the really sad chapters in American politics was the day after Carter lost the Mass primary to Kennedy.

      Carter called the head of the FSLIC and its general counsel, Frank Gailor, to the White House and ordered the FSLIC to remove limits on the interest that S&Ls paid depositors, in an attempt to make savers happy and buy votes. Gailor told me about the meeting in late 1982.

      Carter was told that it would bankrupt the industry, whose income was fixed because they held only fixed interest rate mortgages.

      The end result was the Depository Institutions Deregulation and Monetary Control Act of 1980 which ended the old Req Q and bankrupted the S & L industry in one month. This is also when the modern money market fund was born.

      The attack on the thrifts was a well coordianted plan of the banking and investment banking industry to eliminate competition and to turn home mortgages into securities which could be repackaged and sold, earning fees for the investment banks. Before 1980, almost all mortgages where held by local S & Ls. In sum, crony capitalism at its worst.

      If one wants the truth about the Lesser Depression, they need to go back to when Volcker was fired because the Reagan administration because of his resistence to this whole scheme.

  13. We all know that looking at the road just ahead causes one to over steer and drive erratically.

    Thus,it seems to me that a very substantial argument exists the Fed's whole model is one of over steering with much to narrow a focus on the near short run. Instead of attempting to control prices, for example, short term, I would suggest that the Fed should instead adopt policies directed toward entirely different measures.

    For example, what sort of policies would the Fed have to pursue to reduce and then maintain private debt to 100% of GDP?

    What sort of policies would the Fed have to pursue to raise business investment to above the historic trend line as a % of of GDP (if Cowen is right about the low hanging fruit being gone doesn't it follow that future growth would require investment to go above historic trend)?

    New economic thinking suggests to me that we might well want to have substantially larger down payments, especially because of the mis-allocation of capital we now have in housing. There seems to be agreement that too much capital has gone into housing instead of saving and investment.

    Economics could learn here from firefighting and medicine. Both realize that sometimes you have to take contra indicated actions, for the long run good. Firefighters start fires and physicans put patients in comas.

    Printing money and regs requiring high down payments at the same time would be a very interesting combination and certainly is a better idea than raising interest rates.

    Remember, Friedman only ever said one sensible thing in his life. Low interest rates show a lack of money.

    1. With such great insight, one must wonder why you toil in anonymity. I on the other hand, resign myself to snipe from the shadows. Alas.

    2. maybe insights/may be not, but a hell of a lot of good and unanswered questions.

    3. Beauty is in the eye of the beholder I guess.

    4. Sport, truth like art, is in the eye of the beholder.

      Jim Williams, Midnight in the Garden of Good and Evil

  14. "Exactly. For example, the Canadian financial system is very safe... But it's not clear that the US system is worse."

    Surely the fact that US taxpayers had to come to the rescue of the banks to the tune of hundreds of billions of dollars means the US system is "worse". And wasn't the innovation you are lauding instrumental in the failure of the free market experiment in deregulation and laissez-faire financial markets?

    1. "Surely the fact that US taxpayers had to come to the rescue of the banks to the tune of hundreds of billions of dollars means the US system is "worse"."

      No, that's not for sure. You actually have to write down the model and do the welfare calculation. It may well be that we would be better off if the bailouts had not occurred, of course - moral hazard and all that - but policymakers were worried about systemic risk. Maybe systemic risk is not a problem, but there's no "surely" about this at all.

    2. since Canada per cap income is higher than the US, and they have universal health care and a long life span, good luck on that calculation

    3. ToBeOrNotToBeAnonymousFebruary 8, 2012 at 2:21 PM

      actually per capita income in Canada is about 20 percent lower than in the USA... but hey why let facts get in the way now, you have a point to prove!


      says contra

    5. FactsRFactsAnonymousFebruary 8, 2012 at 7:31 PM

      Household income data does not include employee's benefits. Therefore, by looking at Median Household income you will miss part of the picture. GDP per capita, however, includes all forms of compensation. Compensation of employees is about 65% of GDP in both US and Canada. US GDP per capita is 20% higher than Canada. Therefore, compensation of employee in the US is 20% higher than in Canada. QED.

  15. Replies
    1. As usual, Noah says nothing useful or correct.

    2. You're just jealous 'cause I'm handsome and get all the chicks. ;)

  16. And it means that critics of the econ profession who say "You economists didn't pay enough attention to models of financial crises" can still be right, even if Levine is right!

    Great trump card

    Thanks Noah!!!!

  17. Professor William

    On 2/7 you wrote in your post The Artist Replies:

    "Krugman/deLong et. al. are supplying understandable explanations, policy proposals and predictions in a situation where there is a big demand for this among educated people interested in economic issues."

    But how do you know it's right?

    My question for you is straight forward.

    You missed the Lesser Depression. Above you claim you couldn't see it.

    Thus, how do we know your are right.

    All I can see are statements designed to gain favor with the Republicans, which support the conclusion that you are driven by incentive caused bias.

    You never even show empathy for the victims of Greenspan (and Bush). You get into public fights, which you loose badly, with Delong and Krugman and yet you never say "peep" when John Taylor invites Greenspan to an event and agrees, in advance, to put whatever the dude says in a book.

    IOW you attacks aren't "neutral." If you said a pox on both Krugman Delong and Taylor Cochrane Lucas, someone might listen to you. But, you have instead thrown you lot in with partisan hacks (Taylor and Cochrane)

    But, the biggest indictment is you never, ever talk about Minsky, who was from Wash U., and who got the Lesser Depression right.

    You and I have had part of the Minsky discussion, when you said your were against inflation because it hurt creditors (speculators), and there is you true blindspot or bias--you favor creditors (speculators)

    If so, then why should we pay attention to your models or ideas when you claim now to be able to see/foresee what I don't know (inflation?).

    IOW, we don't have a failure to communicate here, we have a more fundamental problem: trust.

    You have, seriously dude, done nothing to engender trust. If you told me tomorrow the sun will come up, I wouldn't believe you.

    1. You should relax.

      As Mr. Williamson has said many times, he is not in the business of forecasting. Roubini and company are in that business. But then, they should be judged by their record, which does not only include the last crisis.

      There are all sort of crazy people making crazy forecasts at every point in time. The fact that sometimes some of those predictions get validated does not magically turn them into sensible people who we should blindly trust.

      Besides, if you don't trust Mr. Williamson, why do post questions to him?
      And you were expecting him to answer you?

    2. "All I can see are statements designed to gain favor with the Republicans, which support the conclusion that you are driven by incentive caused bias."

      No, I support my President, and can't see how I could vote for any of the clowns running against him.

      "But, the biggest indictment is you never, ever talk about Minsky, who was from Wash U., and who got the Lesser Depression right."

      That was the old Wash U days. Minsky was not a serious economic scientist.

    3. You need to drop the "serious economist" schtick. You seem to dismiss anyone you disagree with as "not serious" or out of touch. Minsky had a valuable insight relevant to understanding the economy even if you can't find a way to squeeze it into a framework you understand and operate with.

    4. Minsky had an insight, but no evidence. He basically said "finance matters" and then spent several hundred pages saying it again and again.

      Minsky is the first refuge of the inept.

    5. "If you told me tomorrow the sun will come up, I wouldn't believe you."

      Good. Let me sell you some insurance contracts that pay off if the sun doesn't rise. I can cut Steve in on the profits, and I'm certain he'll tell you the sun will rise.

    6. Noah has an extraordinary paragraph up on his blog, picking up Cochrane's litter.

      "But then came the Bush years, and America doubled down on the Milton Friedman program with more tax cuts, more deregulation, more privatization. And income stagnated, stocks stagnated, and growth was lackluster, while debt and inequality resumed the explosive growth of the Reagan years. By the eve of the financial crisis, the Republican narrative was looking pretty shopworn."

      If Williamson and Lucas were really concerned about economic growth that the welfare of the average American, these are the subjects they would be tackling with the zest of Giant's linebacker.

      Instead we get a virulent version of the Very Serious People/Republican narrative here

    7. I guess this idotic remark about Minsky not being a serious economist is related to the lack of mathematics in his writings.
      Strange that right-wing economists do not understand that mathematics merely helps to formalize your thoughts. Great left-wing economists like Krugman or Stiglitz say all the time that you gotta be able to put the result of a theoretical models into prose. If you are not able to do it you have not understood your model.

      Back to Minsky, his financial instability paper provides a lot of insight into the financial crisis. Sure, it is no fancy general equilibrium model with beautiful mathematics (plus a lot of unrealistic assumptions) but that's more of an asset than a liability.

  18. The comments expressed here fall in one of two extremes.

    On one hand some people refuse to accept that there is progress in economics, and that Lucas, Prescott, Cochrane and others have contributed to this progress. Unfortunately people on both sides of the ideological aisle prefer to frame current economic debates in 1930's terms (Keynes vs. Hayek vs. Mises, etc.) as if nothing has changed since then in our understanding of the economy.

    On the other hand others practice a type of totalitarianism where ideas that are not expressed in a particular way are ignored and discarded dispite any intrinsic value they may have. This practice throws in the dustbin some very interesting insights offered by economic historians, institutional economists, post-keynesian economists, austrian economists, people researching organizational behavior, and in general ideas arrived at through deduction rather than induction.

    I (like to) think that most economists, at least the good ones (and Repec ranking may or may not be a good indicator) fall somewhere in-between

  19. David explicitly states that the role of Behavioral Economics and Neuroeconomics, as of today, contributes to modern economic theory and does not replace it:

    "Another main theme of this book is that behavioral economics can contribute to strengthening existing economic theory, but, at least in its current incarnation, offers no realistic prospect of replacing it." - pg 8 ch 9 <>

    More succinctly, he thinks the best Behavioral Economics can do is determine the effectiveness of ether subsidies or taxes. Go to his website and read his work.

    From what I gather, the reason why he thinks this way is because of the fundamental puzzle behind learning theory:

    "[Behavioral Economics] talks extensively of biases and errors in decision making. Yet the great mystery to learning theorists is not why people learn so badly – it is why they learn so well." - pg 7, Ch 8 <>

    He also seems to think that level-k theory is something to look at, for contributing to economic theory, in the future.

  20. *Quotes are from his article, "Is Behavioral Economics Doomed?"

    It didn't seem to pop up - my bad.

  21. "New York is the largest center for world financial activity."

    Actually, London does more volume (notional) in FX, government bonds, and credit derivatives which probably makes it a larger financial centre. See the BIS Triennial Survey for the FX data.


  22. On a side note, I'm studying Economics at the U of M and I discovered Steve's website because we are using his book in my Macro class. My hope is to study Game Theory in Grad School.

    Kudos to you Steve. I love the book and you explain things very well, but it was way too pricy at my bookstore. Yet I'm disappointed with the constant attacks at other Economists on this blog. It serves no purpose other than mud-slinging - this is not productive. DeLong and the rest shouldn't do it ether, of course. So I hope you would strive be above them. Besides, their posts usually attract Sea Cucumbers to comment on them. I'm worried that the same will happen here.

    It would help if people could feel the costs of posting ridiculous things, but alas Anonymous posts happen.

    1. Hi Andrew. Which U of M? There are a lot. Sorry about the pricing for the book. As I told my students the other day, the publisher determines that, and I have no control over it. If I were well-off enough, I would give it away, but I have to educate my three sons.

    2. Oh! Sorry I'm so used to just rolling it off of my tongue. I'm privileged enough to study at the University of Minnesota. The statement about the price was meant to be jovial. It's not like it's the only book in the bookstore that costs a fortune. Also I figured you had little control over the cost.

      My main gripe was the attacks on other Economists. If you do feel the need, please try and make it productive. I understand that this Econ blog, or any other, should not be taken as serious Economics, but it would still be nice if there were at least some productive banter - if there were to be banter at all. Landsburg seems to do it fairly well.

  23. Hi Stephen,

    You write, "Minsky was not a serious economic scientist." Yet Minsky elaborated a theory of the finance/credit structure of contemporary capitalist economies and presented a fair amount of data supporting this theory. He had a model, and that model illuminates significant aspects of the recent financial crisis.

    Minsky's theory is "falsifiable" to invoke Popper's defining conception of science. So, what is your defining conception of science? Must a "serious economic scientist" build models with micro-foundations whose agents optimize in the face of some reasonably well-defined probability distribution? (which is not to say that Minsky's model couldn't be recast in these terms).

    1. "...a theory of the finance/credit structure of contemporary capitalist economies"

      To call that a theory is ridiculous. You should know better.

  24. First let’s debunk common misconceptions.
    1. The theory of rational expectations does not postulate that people do not make errors. It postulates that these errors are not systematic. Errors are systematic when they are predictable. To use a sports analogy, it would be like shooting from the same spot the ball too hard, past the basket, over and over, game after game. It is easy to see that systematic errors can occur in the long-run only if people are incapable of learning.
    2. As an average relationship, rational expectations are applicable even if most people do make systematic errors, so long as a few are able to recognize this fact and exploit it. So suppose that most stock traders systematically overreact to bad news but a few recognize this and decide to go long when others go short and vise-versa. Then stock prices will behave AS IF they are traded by a group of individuals that exhibit rational expectations even if most individuals do not.
    3. Like Levine mentions, making an accurate forecast can be a matter of luck (people who have elevated Roubini to divine status should remember that) unless their record is consistent, and unless their specific prediction is derived from a detailed theory that can be generalized and used by others (rather than on a hunch). Otherwise Ron Paul, who has been predicting a financial meltdown since the 1980s, should be considered a master economist. Keep predicting a crisis and over a course of 80 years chances are you will eventually be correct.

    All this is important because it shows that rational expectations are appropriate under very broad assumptions. Unless people are incapable of learning, which means that educators are scam artists, I can think of only one case where they are less likely to hold: for events that are relatively infrequent (and thus the cost of systematic errors is smaller and the opportunities to learn fewer) and when it is not easy for the few that “know better” to exploit the systematic errors of others ("The big short" by Lewis is quite informative). The problem is that conducting this discussion in public is extremely difficult. People who have no understanding of the terminology leave the discussion with a completely distorted view of the issues.

  25. Like Levine mentions, making an accurate forecast can be a matter of luck

    We all know that even a broken clock is right twice a day. We also know who is not even fairly attempting to tell time (and I would argue this includes all freshwater economists).

    I do not consider it a matter of luck that a civil engineer knows to put a speed limit sign on a curve

    The issue really is that simple: Does macro economics know enough to put up speed limit signs? Caution signs?

    The answer is plainly, "No."

    It is also pretty plain that the calling has no plan, design, or intent to do such, for the work is too hard so against the self interest of a lot of the profession, or both.

    You put up speed limits and Goldman Sachs brokers will see their incomes go down, threatening potential consulting fees. We all get the Game.

    I believe it perfectly fair to ask, "What is the optimal level of private debt and/or the private debt to income ratio?" I believe it perfectly fair to ask, what is the optimal level of private investment, as a % of GDP, to promote maximum growth and job creation. Same as to public and private R & D?

    Now, we all know whose toes are going to be stepped on by the answers (and thus why we don't have the answers).

    I believe it fair to ask, given that the Fed permitted price instability in housing, what steps should it be responsible for taking to repair the damage it did to millions of Americans? Why should the fed's policies favor creditors instead of debtors?

    In sum, I would argue that the Fed is a man with a hammer that looks to near to the front of the car and lazily oversteers.

    1. A civil engineer knows to put a speed limit but it is not quite clear what the "optimal" speed limit is. There is no theory for that (most speed limits were set at a level that reduces demand for oil following the 1970s oil shocks). Here is the thing. Home prices are X. Some people believe X is right. Some believe X+y is right. Others believe X-y is right. Chances are, quite a few people will eventually be right in the end. That says nothing. Some people will be right about the magnitude also (Krugman admitted he wasn't). Those I may pay more attention to. If they have am objective process that produced the quantitative prediction I may start believing they are onto something. Short of that, luck seems the better explanation.

      Now I don't know of anyone who believes that asking the questions you pose is wrong. In fact I would start by asking, is there an "optimal" level of whatever, under what criteria, and whether policy-makers are likely to know that better than anyone else. Now my question is that if there is a theory that can predict the optimal level of whatever and at least a few smart-people can figure it out, why do they not try to exploit deviations from the optimal thereby eliminating that deviation (see point 2 in previous comment), in which case there would be no need for regulators to step in. These are not easy questions to answer, and anathemas do very little in promoting the discussion.

    2. I forgot to mention that the optimal investment rate question has been asked and answered(see golden rule saving rate in Wikipedia). However, achieving this without turning into China in terms of coercion is not easy.

    3. CA:

      1) I intentionally selected a curve. Civil engineers know the optimal speed limits for curves.

      2) I know it is hard. That's why I said the Fed and Macro was lazy.

      3) Your discussion of the lack of need of regulators stepping in is totally disingenuous, for as you point out, forcing savings may require coercion.

      In that regard, look at the Lesser Depression which was caused by an explosion and collapse of private debt. No one but the gov't can take away the punch bowl.

      The same is true for other known, overall measures of economic health such as investment and research and development as a percent of GDP.

      4) Thank you for confirming the dishonesty of Lucas and the macro profession. Lucas said in his famous speed that macro had the answers. He didn't. He lied and you let him.

      5) In honor of the refusal of Macro to defrock Greenspan, I have just announced the Gateway rule and corollary.

      As you know, Greenspan recently wrote, with the approval by silence of Williamson:

      Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.

      This lead Crooked Timber to write, "With notably rare exceptions, Russian Roulette is a fun, safe game for all the family to play."

      The Gateway Rule:

      With notably rare exceptions, macro economists who write, publish, or blog do such only to promote their narrow personal, financial, or political interests or bias.

      The corollary:

      With notably rare exceptions, macro economists who say they write, publish, or blog to inform others or the public are lying for they really only write, publish, or blog to promote their narrow personal, financial, or political interests or bias.

      IOW, no one has agency problems more than macro

    4. So let's stop listening to macroeconomists and start looking for answers from Ron Paul, Michelle Bachman, Michael Moore and the like. How ridiculous. In any case, until you prove that you are not "lying" when you write

      "Civil engineers know the optimal speed limits for curves."

      then I will resume conversation. Until then I will stop wasting my time interacting with someone who is more interested in winning an argument (in his mind of course), rather than learning from his interactions with others.

    5. For the record, I am in favor of reasonable regulation especially when asymmetric information is prevalent, and am in favor of creating tax incentives that promote saving so I could not have discussed "the lack of need of regulators for stepping in" as you claim. Moreover given Greenspan's famous-now phrase about an "irrational exuberance" it is hardy likely that Greenspan was a RE guy. Who is the liar now?

    6. CA

      You ask, "So let's stop listening to macroeconomists . . .?

      No, as per Buffett and Munger, I advocate that the reader should do as I am trying to do and that is adopt a series of checklists so as to avoid the psychology of human misjudgment.

      Have you read Munger's speech at Harvard on economics and the Psychology of Human Misjudgment?

      It is a great tool. For example, I just do read former gov't officials, left or right, because of incentive cause bias. I pay no attention to Greenspan, Summers, Taylor, Rhomer, etc. The incentive is too great for "spin." In fact, Summers is such a cull that I was writing the FT and others before Obama's election, saying we should have none of him. Now, that 44 cent stamp is viewed as a satisfactory investment.

      I pay no attention to current Fed employees, but I do pay attention to Fed papers like the recent white paper on housing. Given instutional constraints, Bernanke can not say Keen is right, but when you read "headwinds" because of the scope of private debt and a missing 300/400 billion in private spending, you can see the publication is a far as the Fed can go in giving a true picture. It has to be able, later, to say, "We told you so, when . . . "

      That leaves a very narrow, very useful field. Krugman, DeLong, Keen, the Soros effort, INET, Stiglitz, Noah, that's about it.

      If you asked me to sum up what they are saying it is:

      1) we have no model that tells us what to do about the level of private debt to GDP and no tools for the task either.

      2) having no other choices or options, we should just blow it out in a massive Keynesian stimulous and hope it works

      I agree.

    7. typo I just do not read former gov't officials

    8. Anonymous, I have no objection to what you wrote. Look, do I think that sometimes it is better to put an arbitrary speed limit ahead of the dangerous curve even if there is no model that predicts what that limit should be? Absolutely. I do believe that sometimes pulling a number out of a (reasonably constructed) hat is better than waiting until you have everything figured out. And this is something on which our host and I do not see eye to eye. My issues with Krugman and you are the following:
      1) When you do so you have to be very cautious and incremental in your approach.
      2) You should also be working on constructing a model that can give you some answers rather than turning the practice of pulling numbers out of hats the norm.
      3) You should not resort to ad hominem attacks to make pulling numbers out of a hat seem more credible than it is.

    9. CA:

      When you do so you have to be very cautious and incremental in your approach.

      At full employment, etc. maybe

      At the end of the World, where we are, No. We are at a Bruce Willis moment in the movies