‘That’s OK in Practice, But Does it Work in Theory?’

This is so often mentioned in the context of economics that it is a cliche. However, I thought a list of confused quotes from economists trying to explain how reality is wrong might be both amusing and instructive to the state of the discipline. Most of them speak for themselves, although I’ll offer some comment on the more confused/ing ones.

(1) A commenter on Chris Auld’s blog, on hearing that demand isn’t a ‘law’ because it goes up when stock prices go up:

…simply observing price and quantity data can’t tell us much about the underlying structural relationship. This is a famous identification problem in economics. The law of demand is a statement about the structural relationship, not the observed correlation in the data.

(2) Preston McAfee and John McMillan, expressing incredulity when confronted with evidence from surveys that people behaved ‘irrationally':

Statements about the winner’s curse come close to asserting that bidders are repeatedly surprised by the outcomes of auctions, which would violate basic notions of rationality.

(3) Scott Sumner, defending the EMH:

I know of no explanation for the 1987 bubble.  The collapse (comparable to 1929) occurred when the overall economy was doing fine.  Some argue for “computer trading,” as if computers have free will.  I am not saying they are wrong, but then the correct term would be “really stupid computer programmers.”  If correct, this is a good argument against the EMH position.  But even here, one must be careful not to push things too far.  At the time EMH opponents probably assumed more than just a inexplicable price change—they probably assumed that the bubble’s peak represented irrational exuberance.  Were stock prices too high before the 1987 crash?  We had no way of knowing then, and we still don’t really know.  There is enormous uncertainty about what the stock market should be trading at, based on “fundamentals.”

Reality doesn’t exist! We don’t know anything! Anyway, where was I? Oh yeah, the EMH is correct.

(4) Scott Sumner, on hearing that MMT actually *gasp* looks at the real world:

I wasn’t able to fully grasp how MMTers (“modern monetary theorists”) think about monetary economics (despite a good-faith attempt), but a few things I read shed a bit of light on the subject.  My theory is that they focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the ‘hot potato phenomenon’.

(5) A commenter at Angry Bear, when presented with evidence that flat out contradicts the Laffer Curve:

Mike can not do a comparison with what the Laffer Curve is doing. Its Apples and Oranges. The Laffer Curve is a realtionship, thats why there is no numbers on it, and it can applied at any point in time. 

Unfalsifiable. Gotcha.

(6) Ben Bernanke, discussing Irving Fisher’s ‘Debt-Deflation’ theory:

Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.

Of course, it’s not possible the banking system works completely differently to your theory.

(7) Eugene Fama, with the best defense of the EMH I have ever seen:

Fama: I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.

…what happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

John Cassidy: Surely the start of the credit crisis predated the recession?

Fama: I don’t think so. How could it? People don’t walk away from their homes unless they can’t make the payments. That’s an indication that we are in a recession.

(8) And of course, the classic: Milton Friedman in his reality denying essay:

The articles on both sides of the controversy [regarding marginalist analysis]…concentrate on the largely irrelevant question of whether businessmen do or do not in fact reach their decisions by consulting schedules, or curves, or multivariable functions showing marginal cost and marginal revenue.

How does neoclassical economics instill this level of cognitive dissonance in people?  It’s probably the way things like information asymmetry and irrationality are presented as deviations from idealised conditions, rather than as being central to an understanding of the economy. This leads economists to see reality itself as a deviation from their perfect models, and hence dismiss results that conflict with their theories as anomalies.

So a question for defenders of economics: do people from other disciplines behave similarly? Would you be able to find a list of equally absurd statements from other sciences, social or otherwise? If the answer is no, surely it suggests that something is wrong with economics?

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  1. #1 by atm0spheric on January 10, 2012 - 1:26 pm

    Every discipline has its genuine experts, its wannabees and its run-of-the-mill practitioners.

    If you use a rule of thumb without tracing its credentials back to the fundamentals as they apply in your example, you may be applying it wrongly. Where are your credentials?

    If you can trace your conclusions back to relevant fundamentals whether they are rule-of-thumb stature or different, you can claim to be an expert. But you can still be wrong.

    If you know when the situation exceeds the scope of the discipline, and you can still build a (possibly novel) conclusion from relevant foundations, you know what you are doing – you are an expert. And you know you could still be wrong.

    • #2 by Unlearningecon on January 10, 2012 - 2:12 pm

      ‘Every discipline has its genuine experts, its wannabees and its run-of-the-mill practitioners.’

      These quotes vary from Nobel Prize winners to internet commenters and a couple of ‘run of the mill’ economists. It was intended to be a broad cross-section to demonstrate how pervasive the problem is.

      • #3 by atm0spheric on January 10, 2012 - 5:56 pm

        Indeed. Anybody can get it wrong. The difference is when an expert gets it wrong there’s more likely to be an interesting reason.

        Economics is no different. Economists are also human.

        Thanks for the giggles.

  2. #4 by Chris Auld on January 10, 2012 - 5:14 pm

    I will comment only on point (1), drawn from my blog.,

    The person commenting on my blog correctly asserted that the correlation between quantities and prices generally does not generally reveal the causal effect of price on quantity. In econometric jargon, the causal relationship we would like to estimate is the “structural” relation, which do not know if all we can observe is a correlation. That does not mean that we cannot estimate demand curves—thousands of demand curves estimates are presented in the peer-reviewed literature every year.

    Econometricians stand accused of the crime of thinking “absurdly” that correlation does not imply causation. Guilty as charged.

    • #5 by Unlearningecon on January 10, 2012 - 5:22 pm

      Actually the original comment was one on the structural relationship – it was noted that if people are speculating, increased price will often lead to increased demand. This is a valid causal link with ample empirical evidence.

      Having said that, perhaps that wasn’t the best comment to use as an example. There are better ones, such as some economists reaction to Card-Krueger.

  3. #6 by Tom Addison on January 13, 2012 - 9:27 pm

    Dear University,

    I’d like a refund for my economics degree.

    Regards,

    Tom

  4. #8 by Ralph Musgrave on January 14, 2012 - 12:30 pm

    Unlearningecon, That’s a very clever post above. It strikes a strong chord with me and for two reasons.

    1. Ricardianism is based on what strikes me as a totally unrealistic assumption, namely that the average household knows what the deficit is as a proportion of GDP and plans it’s current and future spending with a view to smoothing out consumption over the years, etc etc. That assumes a level of economic literacy in the average household which is straight out of cloud cuckoo land. Plus I’ve never seen any evidence produced by Ricardians to back their claim that that’s how households behave. I.e. it’s theory that academics like, not reality.

    2. A recent Worthwhile Canadian Initiative post claimed that national debt is a burden that can be passed on to future generations if old people in each decade impose a burden on younger people, who in turn then impose a burden on their own children etc etc. See the following URL (which was just the first of three posts on this topic)

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/debt-is-too-a-burden-on-our-children-unless-you-believe-in-ricardian-equivalence.html

    This sparked of a HUGE debate – hundreds of comments. But no one was THE SLIGHTEST BIT INTERESTED (apart from me) as to whether, given an increase in government debt, the above “burden passing” behaviour actually increases. I tried to raise some interest in the question as to what the empirical evidence actually showed, but to little avail.

    • #9 by Unlearningecon on January 14, 2012 - 12:45 pm

      1. I do not consider Ricardian equivalence worthy of formal debate. It is ridiculous, has 0 empirical evidence supporting it and even Ricardo didn’t believe it.

      2. Haven’t made my mind up with this future generations things. Strikes me that borrowing money can’t use up real resources from the future and if the government can issue its own currency then the debt is a wash.

      • #10 by atm0spheric on January 14, 2012 - 11:01 pm

        If society owes me a massive debt (eg. I have massive savings) and I leave it to my heirs, it implies that future generations have an obligation to keep my heirs in luxury.

        It rather depends on who the debt is owed to – which is why it is a wash when it is public debt owed by citizens to taxpayers.

  5. #11 by mikethemadbiologist on February 12, 2012 - 4:23 pm

    To answer your question, we typically don’t see this kind of behavior in biology, not because we’re more virtuous, but because confronting theory with data is expected behavior. Most biological problems, at some level, require integration of multiple subdisciplines, if not other branches of science, and that helps ‘humble’ deductive mathematical modelers (who seem to be running the show in economics, at least from this dilettante’s perspective).

    • #12 by Unlearningecon on February 14, 2012 - 1:59 am

      Thanks, that’s a good post, and thanks too for your recent link.

  6. #13 by D R on February 12, 2012 - 8:29 pm

    I think you are being unfair to lump Bernanke in with the others. If you read Bernanke, you find out that his whole point is that historical view was deficient. That’s why he writes things like “was less influential”– he is drawing a contrast to more current thinking.

    • #14 by Unlearningecon on February 14, 2012 - 1:57 am

      Fair play to Bernanke in that case, although the argument itself still highlights economists’ tendency to respond with theory when confronted with data.

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