Saturday, February 15, 2014

Economic Discourse: Focus on the Problem, Not the Model

This post is inspired by two observations:

  • Phil Pilkington is onto something important in recent posts regarding the utility of macro-economic modeling.  Specifically, he observes that macro-economics is an open system in which precise experiments and firm conclusions are impossible.  
  • Personally, I have observed good economic discussions devolve into overly wordy, time-wasting theoretical slogs.  In my experience, this happens when either:
    --Tangential economic models are introduced, and the frame of reference for the discussion is changed inappropriately.
    --The discussion is based upon unrealistic assumptions. 

Inappropriate Use of Math and Statistics

Pilkington's posts:
This is where economics has erred since at least the turn of the 19th century. The early marginalists occupied two groups. One were the Walrasians who, following Leon Walras, were perfectly content to confine themselves to barren speculation of unrealistic nonsense provided it was done in a nice, formal mathematical manner. The other group were the Marshallians who tried to bring such abstract speculation down to earth...
A good example of a closed system is a controlled scientific experiment. By setting the experiment up so that it is continuous through time (ergodic) and is not interfered with by outside forces, the experimenter ‘closes’ the system upon itself. For realists, any data then generated by this experiment can reliably be used to make inferences about the future. 
An open system, on the other hand, is open to change, fluctuation and new trends emerging. It is also not closed to outside forces interfering. The realists think that open systems are what we generally deal with in the social sciences, including economics. We cannot reliably use data generated in such open systems to make predictions about the future because, for example, although inflation and wages may be strongly correlated over a certain time period they may not be in the next time period...
Unfortunately, reality is staring me in the face, and it’s telling me that we don’t need more complicated models. 
If I go to the trouble of fixing up a model, say by adding counterparty risk considerations, then I’m implicitly assuming the problem with the existing models is that they’re being used honestly but aren’t mathematically up to the task. 
If we replace okay models with more complicated models, as many people are suggesting we do, without first addressing the lying problem, it will only allow people to lie even more. This is because the complexity of a model itself is an obstacle to understanding its results, and more complex models allow more manipulation …

Timewasting Discussions

There are two specific topics which drive me crazy:
  1. Any discussion about the IS/LM model.  Krugman is a big proponent of this, but he generally labels his columns discussing IS/LM as "nerdy".  I have concluded that this is because the IS/LM model only makes things much more complicated than they need to be.
  2. Any discussion with Market Monetarists.  These inevitably start with the unrealistic assumption that the "Fed" can do whatever it wants in terms of controlling the economy.  Managing expectations by making pronouncements is generally the means by which they can exercise this power.  Any conversation discussing such a mythical economy goes in circles.
Here are some examples:

No: Saving Does Not Increase Savings

Here, Asymptosis attempts to clarify the various senses in which the terms saving and savings are used in macroeconomics.  All goes relatively well until he throws in this:
The IS/LM model seems to be inescapably based on the misconception detailed above — that more saving results in more savings hence, because of supply and demand for loanable funds, lower interest rates.  But: if Krugman’s constantly repeated assertions are correct, that model seems to perform very well.  Why is this true? What am I not understanding? 
At this point, the focus of the discussion shifts from What do the terms saving and savings represent in macroeconomics? to How does the IS/LM model work?  The latter question is perhaps worthy of a separate post, but only detracts from the main topic of the current post.

Terminal Demographics 

Here, Interfluidity attempts to discuss the causes of inflation in the 1970s.  He engages with several Market Monetarists, and the results are an extremely long discussion that will make your head spin.  The problem is that the Market Monetarism uses 100 sentences where 1 will do.   Here is an exchange I had with a Market Monetarist in the comments of the referenced post:
Me: To say that the macro-economy can or should be managed through this one tool (interest rates) is not reasonable. We could just as well say that the inflation of the 1970s could have been prevented by raising taxes, or decreasing public expenditures, or wage and price controls, or breaking OPEC, etc…
Market Monetarist: True, fiscal policy was expansionary in fiscal years 1964 through 1968. The cyclically adjusted Federal budget balance was reduced from (-0.5%) of potential GDP in fiscal year 1963 to (-4.4%) in fiscal year 1968, and the deficit was increased annually during that time:http://www.cbo.gov/sites/default/files/cbofiles/attachments/43977_AutomaticStablilizers3-2013.pdfBut a 10% income surtax was enacted in 1968 and remained effective through 1970. The cyclically adjusted budget balance rose to (-1.1%) by fiscal year 1970 and remained in the relatively narrow range of (-2.7%) to (-1.3%) from fiscal year 1971 through 1982. In fact despite the image of a deficit prone decade the 1970s were one of the most fiscally responsible decades on record with gross Federal debt setting a post WW II record low of 32.5% of GDP in fiscal year 1981 (President Carter’s last budget).
“…or wage and price controls,…”
Wage and price controls were in effect from 1971Q3 through 1974Q1, and core inflation did fall from an average of 5.0% in the year before they were implemented to 3.1% during Phases 1 and 2. But as they were relaxed it bounced back up. During Phase 3 and 4 it reached 4.2% and 6.1% respectively. And in the year after they were ended core inflation averaged 10.1%. Wage and price controls interfere with relative price adjustments ensuring they will be abandoned and that aggregate inflation will return with some catch up inflation to boot.
“…or breaking OPEC, etc.”
Total energy expenditures as a percent of GDP rose from 8.0% in 1970 to 13.7% in 1980, a change of 5.7 points.
http://www.eia.gov/totalenergy/data/annual/pdf/sec1_13.pdfThe EIA doesn’t have total energy expenditure data from before 1970 but the price of crude petroleum in 2005 dollars was $4.46 per barrel according to the World Bank dataset and this was less than in any year in 1960-69 and was down from 26.6% from its price of $6.08 a barrel in 1965:
So chances are very good that total energy expenditures in 1970 as a percent of GDP had fallen from the level they had been in 1965 and yet core inflation had had already risen from 1.3% in 1965 to 4.7% in 1970, and continued to accelerate reaching 9.2% in 1980:
http://research.stlouisfed.org/fred2/graph/?graph_id=109579&category_id=0In contrast total energy prices as a percent of GDP rose from 5.9% in 1999 to 9.9% in 2008, an increase of 4.0 points, and yet core inflation only rose from 1.3% to 2.3%.
So in the Great Inflation a change in total energy expenditures of 5.7 points resulted in an increase in core inflation of 7.9 points and in the 2000s a change in total energy expenditures of 4.0 points resulted in an increase in core inflation of 1.0 points.
This shouldn’t be surprising because research shows that commodity price increases are not an important causal factor in long-term inflation:
http://www.bostonfed.org/economic/ppb/2011/ppb111.pdfDo Commodity Price Spikes Cause Long-Term Inflation?
Geoffrey M. B. Tootell
May 2011
“This public policy brief examines the relationship between trend inflation and commodity price increases and finds that evidence from recent decades supports the notion that commodity price changes do not affect the long-run inflation rate. Evidence from earlier decades suggests that effects on inflation expectations and wages played a key role in whether commodity price movements altered trend inflation. This brief is based on a memo to the president of the Federal Reserve Bank of Boston as background to a meeting of the Federal Open Market Committee.”
This is not a productive discussion. It's more like a filibuster, and fits a dysfunctional pattern I've observed.


Post a Comment

<< Home