Pursuit of Truthiness

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What is Macroeconomics?

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Studying for the comprehensive exam in economics meant wading through a lot of difficult math that still vastly oversimplifies things. It is enough to make anyone wonder, what is the point of it all? This post is my attempt to explain what the point is.  There are a lot of different ways to carve up what a field is, so I will make a brief attempt at several.

End Goal: Most simply, macroeconomics is the study of how to make national economies work well, meaning how to bring about material conditions that make people in general happier.

Intermediate Goals: high GDP growth (more stuff), low unemployment (people who want jobs can get them), and stable prices (a monetary system that facilitates trade). All else equal, these things tend to make people happier, and they are a lot easier to measure than happiness.

Time Frame: We find it useful to divide the field of macroeconomics into growth (long-run) and business cycles (short run), because we think there is little overlap between the best ways to increase long-run growth and the best ways to prevent or reverse sharp declines (recessions). Denying that difference is sometimes seen as denying macroeconomics.

Conclusions: Keynesians think the best way to end recessions is with fiscal policy (government lowering taxes and/or increasing spending).  Monetarists thought we could prevent recessions and high inflation by stabilizing the growth of the money supply; market monetarists now think we can accomplish these goals by stabilizing the expected growth of nominal GDP.  New Classicals think the government can’t really do anything to end recessions.  One can divide macro into many more schools based on such policy conclusions.

History: Recessions in the modern sense (where we have an industrial economy able to recess) begin happening in the early 1800’s, so people begin trying to explain them.  Some like are JS Mill are “under-consumptionists”, saying the economy gets so productive we have trouble consuming all the production or finding useful work for people to do.  Jevons comes up with a sunspot theory, that every 10 years or so sunspots will change the earth’s weather and reduce the productivity of agriculture. A growing thread focuses on the importance of interest rates and money.  The biggest recession of all hit in 1929, leading to the perception that macroeconomics is its own separate crucial field. Governments and public opinion seem to prefer economists who tell them to do something rather than nothing. I can go on with history for a long time, and I haven’t even discussed the history of growth theory, so that is enough for now.

Tools: Often it is not differing goals or conclusions that seperates people but rather the tools they use. Economics began with Adam Smith who was trained as a moral philosopher and whose main tools were eyes to examine the world and a pen to write verbal arguments. David Ricardo turned the profession toward abstract models, looking at a simplified and formalized world about which we can make stronger and more certain statements than we could about the real world in all its complexity. Alfred Marshall brought in graphs and algebra; Jevons and Walras brought calculus. Paul Samuelson showed that most questions in economics could be posed as constrained optimization problems using Lagrangians.  Later economists used the more complex optimization tools of Hamiltonians, dynamic programming and stochastic calculus. Another thread pioneered by Ken Arrow turned up the formalism another notch by using set theory and real analysis; after the 1950’s it is common to speak of theorems and proofs. At any given time some “institutional” or “historical” school is pushing back against the ever-increasing use of math.  Many fear that excess formalism limits the set of questions we think we can answer or even ask. The last great tools-war on the theoretical side is the debate over the use of Dynamic Stochastic General Equilibrium in the 1970’s and 80’s. It is said that many Keynesians objected because they thought the tool would inevitably lead to certain (small-government) conclusions, then stopped objection once it was shown that the tool could be used to support many different conclusions.

There has been a whole separate evolution of tools on the empirical side.  For one thing the quantity and variety of data and the capacity and power of computers has kept expanding. Alongside this has come the gradual development of modern statistics and econometrics.  The many-equation macro models developed in the 1950’s have mostly been displaced by Vector Autoregressions and calibration.

Analogous fields: We have physics envy. We may have succeeded in emulating string theory. The predominant modern paradigm of DSGE uses a mathematical advance to beautifully and elegantly unify of micro, growth, and business-cycle theory.  It also does a poor job of describing the real world.

Stylized facts: Are there any? See jokes.

Jokes: The three scariest words in the English language are “macroeconomists agree that”.  The difference between microeconomics and macroeconomics is that microeconomists are wrong about specific things, while macroeconomists are wrong about things in general.

Written by James Bailey

February 16, 2012 at 9:23 pm

Austrian Econ: Priors

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This weekend I’m going to an Institute for Humane Studies seminar on Austrian economics.  I want to record my priors, what I think I know now about the subject.

First, the very existence of different ‘schools’ of economics such as Austrian or freshwater vs saltwater makes it seem that economics is not a science.  Art, architecture, and philosophy have many such schools, but chemistry and physics do not.  Most especially the “schools” that do exist in science quickly (say by a decade after the death of their founder) either become orthodoxy or die out.  Austrian economics has persisted long after the death of its founders, yet most of it is not orthodox, making economics seem less scientific.  Whether economics should aim to be a science is of course an open question and I think Austrians would say not.

Austrians have been called the “crazy uncles of economics”.  This widespread perception is somewhat odd since circa the 1920’s Austrians were orthodox and respected, and much of their work is part of the core of mainstream economics.  Menger’s role in the marginal revolution is well known, and marginal utility is now at the core of economics.  Hayek’s work on information seems like an important part of modern information economics.  I believe the Austrians were not so keen on math (though I know Hayek used it extensively), and this could explain the divergence; I know even less about old-school “Institutional economics” but I do know that they were marginalized around the same time as the Austrians despite having different ideas and policy conclusions, but sharing the Austrian distrust of math.  Nowadays Austrians have a much bigger popular following than Institutionalists, but this is a mixed blessing.  There is nothing like a legion of internet autodidacts to make orthodox economists (or orthodox anyone) skeptical; even “the Austrian economists’ blog” felt compelled to change its name in the face of their supposed compatriots.

The other parts of Austrian econ I know about (besides opinions on math and empiricism and work on marginalism and information) are money, business cycle theory, and entrepreneurship.  Schumpeter came up with the idea of studying “entrepreneurs” as a distinct or at least extreme class of innovators.  This idea obviously bore much fruit in academic sociology and business, and in politics and the popular imagination.  Innovation is a supremely important topic and entrepreneurship was a good way to study it, but now I wonder if entrepreneurship has been studied so much that diminishing returns leave little to be gained by more study.  I also don’t know how much Schumpeter is considered part of the Austrian school.

I think the Austrian business cycle theory is that central banks set interest rates artificially low, creating a boom in which people invest in the wrong things (things they would not invest in were interest rates at the natural level e.g. subprime mortgage backed securities).  What cannot go on forever must stop, and when it does everyone realizes that much capital (including human capital) is not as productive as we thought, and the economy must reorganize.  This has been a very common narrative in the recent recession, both within economics and outside of it.  Many people, including John Taylor (one of the most prominent living monetary economists) blame the recession at least partly on the Fed keeping rates too low in 03-04.  There have also been widespread claims, overlapping heavily with the interest rate story, that the recession and resulting unemployment are “structural” so that aggregate demand stimulus (fiscal and monetary policy) will be impotent or even counterproductive in fighting the recession.  This is a very intuitive story of recessions with a nice moral, though I don’t believe it explains much of our recent recession.

One question I have is what the ideal Austrian monetary system is.  There seems to be a large overlap between people who like Austrianism and those who like the gold standard, but I thought that Hayek at least preferred free banking.  Another question is what Austrians think caused recessions before there were central banks- are there other causes of malinvestment?  Finally, I have heard Austrians say that a problem of monetary policy is that central banks do not pump money into the economy evenly, but instead in a distortionary way that will favor some kinds of production over others.  This seems like a concern monetary and macroeconomists should take very seriously and I don’t know that they have, though Ben’s money helicopters are one solution I suspect Austrians have other reasons to dislike.

Written by James Bailey

March 24, 2011 at 10:18 pm

Rules of Attraction

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Physics vs. Economics: Gravity edition

Newton discovered his gravity equation by empirical investigation.  He did not derive it from theory, and in fact even once he had observed the relation he offered no hypothesis as to why it worked.  Newton’s gravity implied that objects exerted force instantly by action at a distance, and many believed this could not be true.  The modern explanations of gravity do not in fact use instantaneous action-at-a-distance, rather they posit the curvature of space-time and particles called gravitons which cause the movement observed.

Similarly, economists have used a gravity equation to explain trade between countries.  Trade increases with the income of each country (like the mass of the objects), and decreases with distance.  As an empircal relation it works reasonably well, though not as well as Newton’s gravity equation.  But as stated the economic gravity equation is not derived from theory and it posits the same sort of action-at-a-distance.  After all, countries do not decide to trade a certain amount because they know they have certain incomes and are a certain distance apart.  It is individuals and firms who decide how much they will buy from foreign individuals and firms, and they base their decisions on how much they want specific goods and on how much those goods cost relative to their personal income.

After decades of using the gravity equation in economics, a theoretical backing is being developed to relate the observed action at a distance to individual decision makers – the “gravitons” who are the true proximate cause of trade.  Economists always want to be like physicists and it seems that with regard to gravity the parellel is close.

-Inspired by presenting “A Theoretical Foundation for the Gravity Equation” at Temple’s graduate trade seminar (though the paper is dense and does not get very far in the quest for a foundation).

Written by James Bailey

April 21, 2010 at 12:17 pm