Economists & ‘New Economic Thinking’

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seen by some economists as either a non-existent school of thought; a swear word used by their opponents, or as a long outdated paradigm which has been abandoned in favour of sticky wage/price models and other developments in the DSGE framework.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

Robert Lucas’ 1976 paper contains some valuable insights, but it also contains several flaws, at least in the way it has been intepreted:

(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.

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  1. #1 by Blue Aurora on April 17, 2012 - 7:56 am

    Apparently, the Lucas critique is actually a footnote to Keynes’s criticisms of econometrics back in 1939-1940. Keynes was not opposed to econometrics so much as critical over the misuse of the normal distribution without a goodness of fit test. It’s actually nothing really that new.

    • #2 by Unlearningecon on April 17, 2012 - 1:10 pm

      Again we are forced back to ‘is there a single major macroeconomic policy insight that wasn’t espoused by Keynes?’

      • #3 by Blue Aurora on April 18, 2012 - 7:19 am

        Yes, but my basic point was that Keynes was opposed to the abuse of the Gaussian distribution, not the concept of econometrics itself. He opposed Tinbergen’s logical foundation to econometrics BECAUSE the Gaussian distribution was being abused. Tinbergen and other econometricians never did a goodness of fit test to check if investment patterns or financial markets fit the normal distribution.

        Read “Probability, Econometrics, and Truth”, or the correspondence J.M. Keynes had with Jan Tinbergen carefully, and you’ll see what I’m talking about.

  2. #4 by Dan on April 17, 2012 - 11:16 am

    Good piece. I’m a bit sceptical about the chances of falsification catching on in economics, though. It doesn’t even really happen much in the natural sciences either, despite what Dawkins says. Most scientists have too much invested in their pet theories to thank incoming debunkers. Economists are even worse because there’s no empirical, closed, ‘hard’ reality for experimental reference. They can cling to their favourite ideas by endlessly reinterpreting theirs and their friends’ models and necessarily partial data. Physicists and most natural scientists work with closed systems. Economies are open systems, despite what neoclassical economists say.

    I agree that economics should be taught in terms of schools of thought — this is something my former PhD supervisor Sheila Dow argues persuasively in her superb book The Methodology of Macroeconomic Thought. But again, if you’ve managed to convince most people that yours is the only version of economics, then you’re unlikely to give up space to newcomers without a fight. Part of the ‘success’ of neoclassical economics, as you quite rightly point out, is its denial that there is any such thing as neoclassical economics. It reminds me of the bit in the Usual Suspects where Keyser Soze says that the greatest trick the devil ever pulled was convincing the world he didn’t exist.

    BTW, Keynes was hostile to econometrics. He called the first serious econometric analysis of his discussion of the determinants of investment, by Jan Tinbergen, ‘charlatanism’ and a ‘mess of unintelligible scribblings’ which produced ‘false precision’. His methodological approach saw economics as ‘essentially a moral science and not a natural science. That is to say, it employs introspection and judgements of value.’ (All quotes by Keynes cited in King (2002) A History of Post-Keynesian Economics Since 1936).

    I suspect that one of the barriers to new economic thinking is persuading economists that social science is different to natural science, for the sort of reasons that Keynes suggests.

    • #5 by Blue Aurora on April 17, 2012 - 12:48 pm

      I recommend reading Hugo A. Keuzenkampf’s “Probability, Econometrics, and Truth”. He was not hostile to econometrics itself, he was hostile to the misuse of the Gaussian distribution when it came to tracking investment in the business cycle. Keynes had a problem with the misuse of the Gaussian bell curve. His opposition to the bell curve was empirically supported by Benoit Mandelbrot. The normal distribution does not come close to depicting financial markets accurately. The statistical techniques for tracking investment need to be reformed.

      • #6 by Dan on April 27, 2012 - 6:18 pm

        Sorry — a bit late in replying. I know a week is an eon in Internet time, but I just came across a pithy summary of why Keynes didn’t like econometrics. It’s really quite a commonly held understanding that Keynes was broadly hostile to econometrics and was not just responding to a specific misuse in one circumstance.

        As Tony Lawson points out here,, Keynes’s dislike of econometrics was central to his philosophical stance, which had a particular view of uncertainty under which many future events simply cannot be understood, being incapable of reduction to numerical values. His philosophical stance derives from the Treatise on Probability. “Unlike the typical natural science, the material to which [economics] is applied is, in too many respects, not homogeneous through time… [T}o convert a model into a quantitative formula is to destroy its usefulness as an instrument of thought” (p.129)

        As Pesaran and Smith point out in the same volume, Keynes thought econometrics was ‘black magic’ or ‘statistical alchemy’ (p.134).

        Whether Keynes was right, of course, is another question.

    • #7 by Unlearningecon on April 17, 2012 - 1:13 pm

      You’re right that the hard sciences aren’t quite the humble havens they are often made out to be by those with physics envy. That’s interesting about Keynes, especially since I’ve been trying to assemble data on long term rates and investment! He wouldn’t approve.

  3. #8 by Will on April 18, 2012 - 2:12 am

    This is a tangent, Unlearning Econ, but I’ve noticed an annoying tendency of economists, over the years. I have a hard time articulating it. It is a tendency to assert the *impossibilty* of proposed changes.

    For example, Malthus’s population theory. It is not just undesirable to better the lot the poor by redistributing wealth. It is *impossible*, because this will increase population, and then everybody will be as poor or poorer as before.

    Or the notion that debt spending cannot employ idle capacity, because it will cause interest rates to rise to completely negate the effect of the spending. Countercyclical policy is *impossible*. Or likewise, the current argument that debt spending cannot be effective, because it will offset private spending by exactly the amount of spending. Or Landsburg’s argument that it’s *impossible* to raise taxes on the wealthy, or Sumner’s similar argument.

    There must be countless other examples. What makes all these arguments similar is that they are based on abstract, questionable assumptions, they all tend to promote do-nothingism, and they all end up being falsified when tested.

    Just thought I’d put that out there.

    • #9 by Unlearningecon on April 18, 2012 - 3:40 pm

      You should read Hirschman’s ‘The Rhetoric of Reaction: Perversity, Futility (the one you highlight), and Jeopardy. He highlights how reactionaries throughout history have all used similar arguments: what you propose will have the opposite effect to what was intended; what you oppose will achieve nothing; what you oppose will destroy the positive aspects of the system. Right wing economics obviously used these 3 as a blueprint.

      • #10 by Will on April 18, 2012 - 9:32 pm

        Ah ha! I will check that out. That strikes me as an insightful line of argument.

  1. Against Analogies « Unlearning Economics

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