The doublethink with which mainstream economists are able to ‘embrace’ new economic thinking and simultaneously shout down any attempt at, well, new economic thinking, is quite incredible. For example, see the infamous Krugman/Keen debate, where Krugman behaved startlingly similarly to his usual opponents on the right, even despite his own essay readily acknowledging the failure of economics in the crisis. Mark Thoma also had a similar reaction to Keen, but he then went on to write an essay praising new economic thinking.
In fairness to Thoma, his essay appears to acknowledge that economists like him are set in their ways and cannot embrace change on the scale required, but of course this in itself isn’t encouraging. Why can’t they change their ways? Why carry on if you strongly suspect your paradigm is flawed? I am reminded of a Richard Dawkin’s documentary, where he spoke of a scientist who had been working on a theory for the best part of his career. A new scientist arrived at his place of work, and falsified the theory – the older scientist, however, thanked him. This type of attitude would be helpful in economics.
Watching economists react to Keen’s work, and the work of others, I feel there are a few major barriers to economists accepting new economic thinking; once these are addressed they, hopefully, will find it easier.
Identifying Neoclassical Economics
Neoclassicism is seen by some economists as either a non-existent school of thought; a swear word used by their opponents, or as a long outdated paradigm which has been abandoned in favour of sticky wage/price models and other developments in the DSGE framework. So the first step towards engaging sympathetic neoclassicals is convincing them that their school exists.
I have commented on this briefly before, but I think that Christian Arnsperger & Yanis Varoufakis’ essay on this subject is excellent. It identifies neoclassicism as a methodology, rather than as the ‘rational self maximising, perfectly informed’ agent criticism that economists are so able to brush off with appeals to higher level work. That neoclassical economics uses methodological core of individualism, instrumentalism (preference satisfaction) and equilibration is hard to dispute, and so is an important starting point different schools to engage each other in both directions.
The Lucas Critique
(1) It has given grounds for economists to revert to their old mantra of ‘that’s OK in practice, but does it work in theory?‘ Krugman’s first post on Keen mentions that there is ‘a lot of implicit theorising’ in his paper – in other words, there are no microfoundations. Krugman uses this as grounds to dismiss the overwhelming empirical relationship between private debt and other economic variables.
(2) In practice, application of the Lucas Critique has basically amounted to the use of rational expectations and representative agents, rather than any deep change in economic modelling. There is a great discussion of the flaws in these approaches here, but that’s not necessarily relevant – what matters is that the LC is only applied sparingly.
(3) There is no empirical evidence to support it’s application – that is, it doesn’t appear to be useful when developing new theories or policies.
(4) The most important criticism of Lucas’ paper is that he suggests we model based on the ‘deep parameters’ of human behaviour. As anyone with even a passing familiarity with anthropology and history should know, these parameters simply don’t exist. You can find people throughout history behaving in any number of ways, both as societies and as individuals – even the most basic instincts, such as the need for sustenance and reproduction, have been overcome by environment (abstinent monks, lent, self sacrifice). The fact is that, for economists, ‘deep parameters of human behaviour’ seems to mean nothing more than the individualist, instrumentalist core outlined by Arsnperger & Varoufakis. This is as vulnerable to the Lucas Critique as any other theory or methodology.
So what are we left with? In essence, a suggestion that using a model for policy might have unintended consequences. This is true, and unfortunate, but it’s the reality of the social sciences, and has been known for a long time.
The ‘It Doesn’t Matter’ Mentality
Economists sometimes acknowledge that a model is flawed, but assert that the real world still behaves as if it corroborates with their models. This mentality can be found in one of my textbooks:
…[the student] rightly assumes that few firms can have any detailed knowledge of marginal revenue or marginal cost. However, it should be remembered that marginal analysis does not pretend to describe how firms maximise profits or revenue. It simply tells us what the output and price must be if they do succeed in maximising these items, whether by luck or judgement.
And also in Nick Rowe, defending exogenous money on the grounds that:
So the central bank must stop them creating loans and deposits out of thin air. The central bank will raise its rate of interest by whatever it takes to stop banks creating loans and deposits out of thin air. It is exactly as if the banks were reserve-constrained and couldn’t create money out of thin air.
This is one of those positions that I find it hard to articulate a response to. Of course it matters that we get the mechanics of a system right, otherwise we simply don’t have a model of the system – we’ve got something else! This is what I’ve been trying to get at with useful assumptions – useful ones simply eliminate a complication, whereas ones that are essentially hypotheses about how agents behave can be falsified in their own right. Economists seem to enjoy clinging to the ‘hypothesis’ variety of assumption, and this needs to stop.
There are some other important traps economists fall into – three of which I mentioned in my post on how to unlearn economics. From the perspective of accepting new economic theories, however, these three (and maybe the third one in the aforementioned post) are the most important – if they are not addressed, heterodox and mainstream economists will continue to talk past each other.