Posts Tagged ‘Paul Krugman’

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You remember the dialogue:

Queen: Slave in the magic mirror, come from the farthest space, through wind and darkness I summon thee. Speak! Let me see thy face.

Magic Mirror: What wouldst thou know, my Queen?

Queen: Magic Mirror on the wall, who is the fairest one of all?

Magic Mirror: Famed is thy beauty, Majesty. But hold, a lovely maid I see. Rags cannot hide her gentle grace. Alas, she is more fair than thee.

I was reminded of this particular snippet from Snow White and the Seven Dwarfs while reading the various defenses of contemporary macroeconomic models. Mainstream macroeconomists failed to predict the most recent economic crisis, the worst since the Great Depression of the 1930s, but, according to them everything in macroeconomics is just fine.

There’s David Andolfatto, who argues that the goal of macro models is not really prediction; it is, instead, only conditional forecasts (“IF a set of circumstances hold, THEN a number of events are likely to follow.”). So, in his view, the existing models are mostly fine—as long as they’re supplemented with some “financial market frictions” and a bit of economic history.

Mark Thoma, for his part, mostly agrees with Andolfatto but adds we need to ask the right questions.

we didn’t foresee the need to ask questions (and build models) that would be useful in a financial crisis — we were focused on models that would explain “normal times” (which is connected to the fact that we thought the Great Moderation would continue due to arrogance on behalf of economists leading to the belief that modern policy tools, particularly from the Fed, would prevent major meltdowns, financial or otherwise). That is happening now, so we’ll be much more prepared if history repeats itself, but I have to wonder what other questions we should be asking, but aren’t.

Then, of course, there’s Paul Krugman who (not for the first time) defends hydraulic Keynesianism (aka Hicksian IS/LM models)—”little equilibrium models with some real-world adjustments”—which in his view have been “stunningly successful.”

And, finally, to complete my sample from just the last couple of days, we have Noah Smith, who defends the existing macroeconomic models—because they’re models!—and chides heterodox economists for not having any alternative models to offer.

The issue, as I see it, is not whether there’s a macroeconomic model (e.g., dynamic stochastic general equilibrium, as depicted in the illustration above, or Bastard Keynesian or whatever) that can, with the appropriate external “shock,” generate a boom-and-bust cycle or zero-lower-bound case for government intervention. There’s a whole host of models that can generate such outcomes.

No, there are two real issues that are never even mentioned in these attempts to defend contemporary macroeconomic models. First, what is widely recognized to be the single most important economic problem of our time—the growing inequality in the distribution of income and wealth—doesn’t (and, in models with a single representative agent, simply can’t) play a role in either causing boom-and-bust cycles or as a result of the lopsided recovery that has come from the kinds of fiscal and monetary policies that have been used in recent years.

That’s the specific issue. And then there’s a second, more general issue: the only way you can get an economic crisis from mainstream models (of whatever stripe, using however much math) is via some kind of external shock. The biggest problem with existing models is not that they failed to predict the crisis; it’s that the only possibility of a crisis comes from an exogenous event. The key failure of mainstream macroeconomic models is to exclude from analysis the idea that the “normal” workings of capitalism generate economic crises on a regular basis—some of which are relatively mild recessions, others of which (such as we’ve seen since 2007) are full-scale depressions.  What really should be of interest are theories that generate boom-and-bust cycles based on endogenous events within capitalism itself.

With respect to both these issues, contemporary mainstream macroeconomic models have “stunningly” failed.

I imagine that’s what the slave in the magic mirror, who simply will not lie to the Queen, would say.

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The following post was contributed by Richard McIntyre, in response to Alan Blinder’s review of Jeff Madrick’s book, Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World, in the New York Review of Books.*

Alan Blinder is certainly correct that politicians generally use economic research findings for support not illumination. After that, his critique of Jeff Madrick’s Seven Bad Ideas is not so accurate.

Three examples: (1) Blinder defends the “invisible hand” as one of the “great thoughts of the human mind” and attributes it to Adam Smith. It is neither. Smith uses the term precisely once in The Wealth of Nations and does not use it to mean that free competitive markets produce efficiency. Paul Samuelson invented the modern version of the “invisible hand” in his famous 1948 textbook.1 That book was deliberately written to please free-market advocates given the red-baiting that had doomed a similar and failed textbook by Laurie Tarshis.2 In most economics texts, the treatment of market failure comes long after the celebration of market virtues, and with much less conviction, and usually by the point in the semester where most students are just trying to survive the course.

(2) The Chicago School is fully incorporated into mainstream macroeconomic models. Blinder wants to portray the Chicago school as somehow marginal to the mainstream but nearly all the intermediate textbooks portray the macroeconomic debate as between Classical and “Keynesian,” and then New Classical and New Keynesian models. (The Keynesian models have little to do with what Keynes actually wrote but that is another story.) The Keynesian “defense” against the Chicago school attack beginning in the 1970s was basically to accommodate it. This is best seen in the professional transition of Larry Summers from antipathy to grudging respect to ungrudging admiration for Milton Friedman.3

(3) Efficient-market theory was something more than a prop for right-wing politicians. As Donald Mackenzie has demonstrated, these models actually changed the way finance works. Fama and other efficient-market theorists provided tools that led to the creation of derivatives markets and a powerful ideological defense of them.4

I could go on. There may be problems with Madrick’s book but they are not the ones Blinder identifies, nor are economists quite so powerless as Blinder makes them out to be. Liberals like Alan Blinder and Paul Krugman are willing to criticize parts of the orthodoxy but not orthodoxy itself, perhaps because they and their colleagues at elite schools benefit enormously from the influence they have as players within that orthodoxy.

Those of us in the provinces may be freer to notice that the emperor wears very little clothing.

 

1Gavin Kennedy, “Paul Samuelson and the invention of the modern economics of the Invisible Hand,” Journal of the History of Economic Ideas, no. 3 (2010): 105-20.

2Yann Giraud, “The Political Economy of Textbook Writing: Paul Samuelson and the making of the first ten editions of Economics (1945-1976),” THEMA Working Papers, 2011-18; David Colander and Harry Landreth, “Political Influence on the Textbook Keynesian Revolution: God, Man, and Laurie (sic) Tarshis at Yale,” in O. F. Hamouda and B. B. Price, eds., Keynesianism and the Keynesian Revolution in America: A Memorial Volume in Honour of Lorie Tarshis (Cheltenham: Edward Elgar, 1998), pp. 59–72.

3John Cassidy, How Markets Fail: The Logic Of Economic Calamaties (New York: Picardo, 2009), pp. 83-84.

4Donald Mackenzie, An Engine Not A Camera: How Financial Models Shape Markets (Cambridge: MIT Press, 2008).

 

*McIntyre is Professor of Economics and Political Science at the University of Rhode Island. His book, Are Worker Rights Human Rights? was published in 2008 by the University of Michigan Press.

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Mainstream economics has been a disaster, especially since the crash of 2007-08. It wasn’t able to predict the onset of the crisis. It didn’t even include the possibility of such a crisis. And it certainly hasn’t been a reliable guide to getting out of the crisis.

And yet economist after economist has been stepping forward—even on the liberal side of things—to try to convince us that things are pretty much OK in the land of mainstream economics.

Just the other day, Paul Krugman tried to convince us that, leaving aside the failure to predict the crisis or even envisioning the possibility of a crisis occurring, mainstream models “did a pretty good job of predicting how things would play out in the aftermath.” The problem, for Krugman, all comes down to the “bad behavior” of some economists who have been more interested in defending partisan turf than in getting things right.

Now, Mark Thoma wants to argue that the macroeconomic models—including the “dynamic stochastic general equilibrium” models that have become the stock-in-trade of mainstream macroeconomics for the past couple of decades—are just fine. The problem, as Thoma sees it, is not with the theory or the models but with the questions economists have been asking.

What neither Krugman nor Thoma wants to admit is those very same models—hydraulic IS-LM in the case of Krugman, the rational expectations, dynamic optimizing, and representative agents of DSGE—actually direct the behavior of economists and delimit the questions they can ask. Those models are so many theoretical lenses on the world, which determine how the economists who use them interpret the world.

I understand: Krugman and Thoma desperately want to keep the precious baby. But that also means we’re stuck with the increasingly dirty bathwater.

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You know the story: Xi and his San tribe are “living well off the land.” They are happy because of their belief that the gods have provided plenty of everything, and no one among them has any wants. One day, a Coca-Cola bottle is thrown out of an airplane and falls to Earth unbroken. But the bottle eventually causes unhappiness within the tribe, leading the elders to believe it’s an “evil thing” which the gods were “absent-minded” to send them. Xi then travels to  the edge of the world and throws the bottle off the cliff. He then returns to his tribe and receives a warm welcome from his family.

I wonder if Paul Krugman expects to receive a warm welcome from the economics family after throwing the prediction bottle over the cliff.

Hardly anyone predicted the 2008 crisis, but that in itself is arguably excusable in a complicated world. More damning was the widespread conviction among economists that such a crisis couldn’t happen. Underlying this complacency was the dominance of an idealized vision of capitalism, in which individuals are always rational and markets always function perfectly.

I actually agree with Krugman on this point. Economic prediction is, in fact, impossible and the really crazy feature of mainstream economic models is the fact that endogenous crises simply can’t occur. Exogenous factors, sure, but nothing internal to the models can lead to a crash. Their idealized vision of capitalism, absent an external event (such as a credit crunch or an increase in the price of oil), simply leads to a full-employment, price-stable equilibrium.

But, wait, doesn’t the entire edifice fall when—on its own terms—the ability to correct predict is dispensed with? The whole rationale of giving up realistic assumptions about the economic system has been the ability to accurately and correctly predict the movements of the economy. That’s the mantle of predictive science that has been used, since at least the mid-1950s, to expunge all other economic theories and approaches from the discipline.

Mainstream economists can’t have it both ways: to celebrate their models for their predictive ability and then to dispense with prediction when, as in 2007-08 (just as in 1929), their models clearly failed. We need something better.

As for their track record since the crisis broke out, well, they haven’t fared much better—at least to judge by where we stand right now. Krugman, for his part, wants to stick with the hydraulic mechanisms of the textbook economic models, which “did a pretty good job of predicting how things would play out in the aftermath,” and declare that “too many influential” economists must be crazy.

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Right now, mainstream economists are both congratulating themselves and bemoaning their fate.

Mainstream economists (such as Justin Wolfers and Paul Krugman) are congratulating themselves for having achieved a virtual consensus on the positive effects of fiscal stimulus. But they’re also complaining about the fact that the rest of the world (such as politicians, central bankers, and others) doesn’t seem to be listening to their expert advice.

Just two quick comments on this approach to consensual economics:

First, of course there’s a consensus among mainstream economics! That’s what their theories and models are supposed to do: produce and reproduce a consensus in terms of the basic analysis of macroeconomic events (although, of course, there can still be disagreements about particular aspects, such as the exact size of the fiscal multiplier and so on). And anyone who doesn’t use those models, and therefore reaches a different set of conclusions, is declared to be outside the mainstream, and therefore not worth reading or being listened to.

Second, how is it possible to declare—in the midst of the Second Great Depression—that mainstream economics has been an unqualified success? To arrive at such a conclusion would mean to overlook, at a minimum, the role that mainstream economics played in creating the conditions for the crash of 2007-08, in failing to include even the possibility of such a crash in their models, and in confining themselves to a package of monetary and fiscal policy measures—and not to even consider the possibility of larger, structural changes—as tens of millions of people lost their jobs, were stripped of their wealth, and were pushed further and further down the economic ladder.

Those engaged in consensual economics are, it seems, too busy congratulating themselves and bemoaning their fate to want to recognize the gorilla in the room.

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I know. I wrote I wouldn’t be able to comment on Thomas Piketty’s book, Capital in the Twenty-First Century, until I found the time to read it, which won’t happen until the semester is over.

But the debate about the book is taking off and I simply don’t have the patience to wait until my lectures are over and final grades turned in. So, permit me, for the time being, to comment on the commentary.

Thomas Palley has observed that “Neoclassical economists have always talked of capital (K). The forbidden subject is capitalism.” Yes, but, even in talking of capital, they have a problem, one that was addressed during the 1960s in the Cambridge capital controversy. As Joan Robinson argued (and as my students used to learn in Principles of Microeconomics), capitalist income (total profit as the return on capital) is defined as the rate of profit multiplied by the amount of capital. But the measurement of the “amount of capital” involves adding up quite incomparable physical objects – adding the number of assembly-lines to the number of shovels, for example. That is, just as one cannot add heterogeneous “apples and oranges,” we cannot simply add up simple units of “capital,” unless one knows the price of capital, which is the rate of profit. Thus, you can’t use the amount of capital (as in the neoclassical aggregate production function) to determine the rate of return on capital—unless you already know the rate of profit.

That’s the thorny problem Paul Krugman simply sidesteps in defending Piketty’s use of the aggregate production function. Even Paul Samuelson had to concede the validity of Robinson’s critique.

But Krugman is right in arguing “you really don’t need to reject standard economics either to explain high inequality or to consider it a bad thing.” I agree. What’s interesting is that, as Piketty shows, it’s possible to analyze and criticize inequality using some of the tools of neoclassical economics. Not easy but it’s possible. Which means that neoclassical economists, for the most part, choose not to try to analyze and criticize inequality. In other words, the fact that they don’t spend much of their time—in teaching, research, and offering policy advice—in analyzing and criticizing the grotesque levels of inequality we’ve seen in recent decades is, in part, an ethical question. They could but they don’t.

And that’s perhaps an even more damaging critique of mainstream economics than the capital controversy itself.

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Is there any academic economics book that has elicited as much interest in the past decade (and perhaps longer) than Thomas Piketty’s Capital in the Twenty-First Century?

All kinds of friends, colleagues, and former students have been asking me about it and sending me links. And, everywhere I turn, there seems to be a new review of the book.

To be honest, I just received my copy of the book. I haven’t read it yet and probably won’t be able to find the time to do so until the semester is over. (But, as I indicated, I will be teaching it in the fall.) So, while I’ll hold off on commenting on the content of the book itself until I’ve had a chance to carefully work my way through it, I do want to mention a couple of things.

First, my sense is the book is generating so much attention precisely because of a certain nervousness out there, the fact that capitalism is facing a legitimacy crisis right now. The capitalists’ project of becoming a universal class seems to have become derailed in the midst of the Second Great Depression, and Piketty’s discussion of the return of inherited wealth in the second Gilded Age speaks directly to that concern.

Second, many of the reviews I’ve read imply—and often explicitly state—that “our” views about capitalism are being challenged by the general rise in inequality and, in particular, by Piketty’s focus on the returns to capital. Paul Krugman’s essay in the New York Review of Books is a good example: “The result has been a revolution in our understanding of long-term trends in inequality.” “This is a book that will change both the way we think about society and the way we do economics.” “We’ll never talk about wealth and inequality the same way we used to.” (Emphasis added in all cases.) And so on.

Excuse me but who is this “we” and “our”? I expect I’ll learn a lot from reading Piketty’s book (especially since it includes such evocative phrases as “the past tends to devour the future”) but, please, there are a lot of us who have been writing and teaching about capital and inequality for a very long time. They are central to how we’ve long understood and analyzed the changing dynamics of capitalist economies. I doubt, therefore, that Piketty’s book will contribute to a revolution in our understanding of long-term trends in inequality or in how we think about society and the way we do economics.

But clearly Piketty’s book may have that effect on how other people make sense of capital and inequality—economists who have spent their careers ignoring what their less-orthodox colleagues have been writing and teaching for many, many years.