View Full Version : How Did Economists Get It So Wrong?
Lengthy but insightful piece which may be of interest to some. ;)
Richard's $.02 :munchin
How Did Economists Get It So Wrong?
Paul Krugman, NYT, 2 Sep 2009
I. MISTAKING BEAUTY FOR TRUTH
II. FROM SMITH TO KEYNES AND BACK
III. PANGLOSSIAN FINANCE
IV. THE TROUBLE WITH MACRO
V. NOBODY COULD HAVE PREDICTED . . .
VI. THE STIMULUS SQUABBLE
VII. FLAWS AND FRICTIONS
VIII. RE-EMBRACING KEYNES
So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.
Paul Krugman is a Times Op-Ed columnist and winner of the 2008 Nobel Memorial Prize in Economic Science. His latest book is “The Return of Depression Economics and the Crisis of 2008.”
http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?pagewanted=1&em
Very interesting indeed!
I noticed this on the last page:
First, many real-world investors bear little resemblance to the cool calculators of efficient-market theory: they’re all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic. Second, even those who try to base their decisions on cool calculation often find that they can’t, that problems of trust, credibility and limited collateral force them to run with the herd.
I think that's an important point, but the article does not mention a couple of related issues.
First, dishonesty. How does one apply cool calculations when the underlying information is, to put it politely, utter nonsense? Enron was an example. More recently, CMOs (collateralized mortgage obligations) made up of sub-prime NINJA loans (No income, no job, and (no) assets) consisted of multiple layers of lies. The first layer resided in the underlying loans - these were not loans, they were fictions that would never be repaid. The second layer of lies came from the rating agencies, in collaboration with the issuers, who represented that securities made up of garbage were transformed into investment gold with a AAA rating.
While the subject far exceeds the scope of one little post, our economy is (IMO) suffocating under a vast layer of lies and misrepresentations. Rational investment under such conditions is problematic - and likewise economic analysis.
The second problem is the divide between economic theory and physical reality. We often hear the term "growth", but economics does not consider the implications. Example: if San Antonio has 1.2 million people and grows at 2.6% annually, then in about 30 years it will have 2.4 million people. In another 30, that will grow to 4.8 million, and so forth. Physical systems do not and cannot support endless growth - ultimately, we would wind up with a spherical mass of humanity expanding at the speed of light. Of course, knowing precisely where such expansion fails is the problem!
I have four issues with economists.
I can barely keep up with them:confused: so they activate most of my myriad insecurities.:(
As social scientists, they have skills with which they can get lucrative jobs in the private sector related directly to their training. (No, I'm not at all bitter from the fact that I've got a gazillion and one pieces of useless information in my head--I can take on a room full of inebriated knuckleheads in a game of team trivia. "What is an oscillation overthruster?")
They, IMO, greatly under estimate the power of the human unconscious, culture, political ideology, and gendered identity.
Consequently, none of their charts, tables, or graphs look anything like this <<LINK (http://www.cpearson.ws/images/500px-Symbol_of_Chaos.svg.png)>>.
FWIW, a life-long friend is an associate professor of economics at a small college in New England. He is, hands down, the most intelligent person I know. I asked him for his take on the article linked in the OP. His take on the piece--posted with his consent--follows.Yes...I agree with everything that it says.
When I was in grad school I specialized in microeconomics, but we also had to take courses in macroeconomics. I thought the macro models were something of a joke (when I was in school we studied the "real business cycle" or RBC models that the article mentions). Most of us who were on the micro side thought that the macroeconomic models and theories were essentially useless and had little relationship to real life.
At the time I thought that maybe I didn't understand the models well enough -- I assumed that I must be missing some important idea that would make the models more meaningful. I distinctly remember having conversations with other grad students where I would ask what the RBC model was good for, and nobody could come up with a coherent answer. It became a running joke that the macro people cared more about mathematical models than reality.
Two years ago a student from here applied to grad school. As an undergraduate he had liked macro, but I told him he would hate macro in grad school because the classes don't have anything useful to say. The next year I got an email from him where he said I was right and that the courses were a waste of time.
One problem with macro is that there is very limited data -- only a few variables (unemployment, inflation, GDP, etc.) for only about 50 years or so. That means that everyone has limited ability to test their models against real life, so they rely on math that looks elegant -- this is what Krugman means when he talks about beautiful models.
In contrast, in microeconomics there is a huge amount of data from the census, surveys, tax and business records, consumer buying patterns, etc., and it is fairly easy to design experiments to get even more data. This means that micro models have a tougher hurdle to prove that they are relevant -- pretty math alone is not enough to get by.
It is too bad I didn't pursue macroeconomics to learn it well enough to write a comprehensive critique -- I would be famous now.