A concise overview with timeline.
Economics is not about predicting stock markets, exchange rates, or GDP. Its aim is to make sense of human interaction in the small and the large.
Marek Hlavac’s online course Nobel Prize-Winning Contributions to Economics provides an overview over the work of deep economic thinkers.
In the Boston Review, Dani Rodrik discusses neoliberalism and argues that
mainstream economics shades too easily into ideology, constraining the choices that we appear to have and providing cookie-cutter solutions.
Rodrik emphasizes that sound economics implies context specific policy recommendations.
And therein lies the central conceit, and the fatal flaw, of neoliberalism: the belief that first-order economic principles map onto a unique set of policies, approximated by a Thatcher–Reagan-style agenda.
But he also stresses that the
principles [of economics] are not entirely content free. China, and indeed all countries that managed to develop rapidly, demonstrate their utility once they are properly adapted to local context. Conversely, too many economies have been driven to ruin courtesy of political leaders who chose to violate them.
In Rodrik’s view
[e]conomists tend to be very good at making maps, but not good enough at choosing the one most suited to the task at hand.
On his blog, Gilles Saint-Paul comments on the publication process in economics.
Of course I was wrong in all accounts. The publication process in economics is not a publication process, it is a validation process by which we acquire a certain rank in a certain pecking order. Submitting a paper to a journal has nothing to do with research dissemination, it is far more similar to taking an exam or participating in a sports competition. The actual dissemination takes place mostly orally, in seminars and conferences; these seminars and conferences are also important validation events, because they allow authors to signal some of their characteristics that may influence their position in the pecking order, while not being easy to infer from their papers.
Now, when you take an exam as a student, you are graded by your professor, not by a fellow student – who would be a competitor if this exam is actually a contest. …
Yet this is the way our own profession is organized. Each submission is “peer reviewed’, that is, it has to be accepted by anonymous referees who happen to be participating in the same beauty contest as the author(s), most often in the same subcategory. At a minimum, as believers of cost-benefit analysis, we should consider that the journal editors and referees themselves perform a cost-benefit analysis when deciding whether or not to publish a paper. I must say that if I apply such a theory to explain my own experience with acceptances and rejections, I easily get an R2 of 80 %.
In a paper, Ricardo Reis defends macroeconomics against various critiques. He concludes:
I have argued that while there is much that is wrong with macroeconomics today, most critiques of the state of macroeconomics are off target. Current macroeconomic research is not mindless DSGE modeling filled with ridiculous assumptions and oblivious of data. Rather, young macroeconomists are doing vibrant, varied, and exciting work, getting jobs, and being published. Macroeconomics informs economic policy only moderately and not more nor all that differently than other fields in economics. Monetary policy has benefitted significantly from this advice in keeping inflation under control and preventing a new Great Depression. Macroeconomic forecasts perform poorly in absolute terms and given the size of the challenge probably always will. But relative to the level of aggregation, the time horizon, and the amount of funding, they are not so obviously worst than those in other fields. What is most wrong with macroeconomics today is perhaps that there is too little discussion of which models to teach and too little investment in graduate-level textbooks.
In the Journal of Economic Literature, Ariel Rubinstein discusses Dani Rodrik’s “superb” book “Economics Rules.” The article nicely articulates what economics and specifically, economic modeling is about. Some quotes (emphasis my own) …
… on the nature of economics:
[A] quote … by John Maynard Keynes to Roy Harrod in 1938: “It seems to me that economics is a branch of logic, a way of thinking”; “Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world.”
[Rodrik] … declares: “Models make economics a science” … He rejects … the … common justification given by economists for calling economics a science: “It’s a science because we work with the scientific method: we build hypotheses and then test them. When a theory fails the test, we discard it and either replace it or come up with an improved version.” Dani’s response: “This is a nice story, but it bears little relationship to what economists do in practice …”
… on models, forecasts, and tests:
A good model is, for me, a good story about an interaction between human beings …
A story is not a tool for making predictions. At best, it can help us realize that a particular outcome is possible or that some element might be critical in obtaining a particular result. … Personally, I don’t have any urge to predict anything. I dread the moment (which will hopefully never arrive) when academics, and therefore also governments and corporations, will be able to predict human behavior with any accuracy.
A story is not meant to be “useful” in the sense that most people use the word. I view economics as useful in the sense that Chekhov’s stories are useful—it inspires new ideas and clarifies situations and concepts. … [Rodrik] is aware … “Mischief occurs when economists begin to treat a model as the model. Then the narrative takes on a life of its own and becomes dislodged from the setting that produced it. It turns into an all-purpose explanation that obscures alternative, and potentially more useful, story lines”.
A story is not testable. But when we read a story, we ask ourselves whether it has any connection to reality. In doing so, we are essentially trying to assess whether the basic scenario of the story is a reasonable one, rather than whether the end of the story rings true. … Similarly, … testing an economic model should be focused on its assumptions, rather than its predictions. On this point, I am in agreement with Economics Rules: “. . . what matters to the empirical relevance of a model is the realism of its critical assumptions”.
… on facts:
The big “problem” with interpreting data collected from experiments, whether in the field or in the lab, is that the researchers themselves are subject to the profession’s incentive system. The standard statistical tests capture some aspects of randomness in the results, but not the uncertainty regarding such things as the purity of the experiment, the procedure used to collect the data, the reliability of the researchers, and the differences in how the experiment was perceived between the researcher and the subjects. These problems, whether they are the result of intentional sleight of hand or the natural tendency of researchers to ignore inconvenient data, make me somewhat skeptical about “economic facts.”
On his blog A Fine Theorem, Kevin Bryan discusses the history of economic thought leading from the classical economists and Walras to Arrow and Debreu.
My read of the literature on GE following Arrow is as follows. First, the theory of general equilibrium is an incredible proof that markets can, in theory and in certain cases, work as efficiently as an all-powerful planner. That said, the three other hopes of general equilibrium theory since the days of Walras are, in fact, disproven by the work of Arrow and its followers. Market forces will not necessarily lead us toward these socially optimal equilibrium prices. Walrasian demand does not have empirical content derived from basic ordinal utility maximization. We cannot rigorously perform comparative statics on general equilibrium economic statistics without assumptions that go beyond simple utility maximization. From my read of Walras and the early general equilibrium theorists, all three of those results would be a real shock.
In separate blog posts, Russ Roberts and John Cochrane have called for humility on the part of economists. Asking “What do economists know?,” Roberts and Cochrane point out—correctly—that economics is not as strong on quantification as some economists and many pseudo economists pretend, and as is often expected from economists.
Economics is not the same as applied statistics although the latter can help clarify, at least to some extent, the empirical relevance of economic theories. Correlation does not imply causation. Identifying assumptions that aim at establishing causal claims based on correlation analysis deserve skepticism, especially when the process that led to the empirical results remains in the dark (see notes on replicability here, here, here).
Sound economics heavily relies on consistency checking, or bullshit detection in Cochrane’s words. It insists on keeping accounting identities in mind and never forgetting about incentives. And it is acutely aware of the fact that good models are nothing more than consistent stories—but at least they are consistent stories.
On his blog, Tyler Cowen summarizes the economics in Theodor Herzl’s “The Jewish State.”
Herzl favored selling European homes and businesses of departing Jews and buying land in Argentina or Palestine, at a profit, through a land acquisition company incorporated in London. Poor Jews from Romania and Russia would supply cheap labor and be rewarded by their own houses eventually. Herzl favored short working weeks, a democratic monarchy or the aristocratic republic of Renaissance Venice.
The Economist reviews core ideas in economics. The introductory article to a new series points out that
economists’ fundamental mission is not to forecast recessions but to explain how the world works.
It argues that economists have delivered and it discusses six exemplary areas of economic research:
- Nash equilibrium (article, August 20);
- Mundell-Fleming trilemma (article, August 27);
- Minsky financial instability (article, July 30);
- Stolper-Samuelson trade effects on wages (article, August 6);
- Keynes fiscal multiplier (article, August 13); and
- Akerlof et al information asymmetries (article, July 23).
Refreshingly, the article argues that
[t]hese breakthroughs are adverts not just for the value of economics, but also for three other things: theory, maths and outsiders.
I agree. But the value of economics also derives from more elementary insights, related to, for example,
- budget and resource constraints;
- the information content of prices;
- public choice; or
- the link between monetary aggregates and the general price level.
Today, these latter insights might appear even more trivial than those picked by The Economist. But they are central, and emphasizing them might lead to different policy conclusions than the common focus on economic frictions and aggregate demand.
A report in The Economist confirms what some economists always knew: The findings of laboratory experiments conducted by economists are not very reliable—but much more so than those conducted in medicine, psychology or genetics.
Three opinion leaders in the blogosphere have laid out how they think about the macroeconomy. They talk about “models” but unfortunately don’t deliver. Instead, they provide lists of beliefs or facts to be explained. Economics is a science precisely because it has progressed beyond such lists. Economists build models—consistent, well-structured and clearly specified (and thus, mathematically formulated) stories.
But here are the lists: Scott Sumner’s “Musical Chairs model” (blog):
In the short run, employment fluctuations are driven by variations in the NGDP/Wage ratio.
Monetary policy drives NGDP, by influencing the supply and demand for base money.
Nominal wages are sticky in the short run, and hence NGDP shocks cause variations in employment in the same direction.
In the long run, wages are flexible and adjust to changes in NGDP. Unemployment returns to the natural rate (currently about 5% in the US.)
Tyler Cowen’s “model” (blog):
In world history, 99% of all business cycles are real business cycles. No criticism of RBC can change this fact. Furthermore the propagation mechanism for a “Keynesian business cycle” (arguably a misleading phrase) also relies on RBC theory.
In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks. I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics. Sometimes central banks tighten when they shouldn’t, and this leads to a recession, due mainly to nominal wage stickiness.
Workers are laid off because employers are often (not always) afraid to cut their nominal wages, for fear of busting workplace morale, or in Europe often for legal and union-related reasons.
Overall I favor a nominal gdp rule for monetary policy. But most of its gains would come in a few key historical episodes, such as 1929-1932, or 2008-2009. In most periods I don’t think we know what the correct monetary policy should be, nor do we know that it matters. Still, that uncertainty does not militate against an ngdp rule.
Once workers are unemployed, nominal wage stickiness is no longer the main reason why they stay unemployed. In fact nominal wage stickiness is largely taken out of the equation because there is no preexisting nominal wage contract for these workers. There may, however, be some residual stickiness due to irrational reservation wages, also known as voluntary unemployment due to stupidity. (You will find a different perspective in Scott’s musical chairs model, which I may cover more soon.)
Monetary stimulus to be effective needs to be applied very early in the job destruction process of a recession. It is much harder to put the pieces back together again, so urgency is of the essence.
The successful reemployment of workers depends upon a matching problem, a’la Pissarides, Mortensen, and others. Yet this matching problem is poorly understood, and it can involve a mix of nominal and real imperfections. Sometimes it is solved more quickly than expected, such as in the recent UK experience, and other times more slowly than expected, as in current Spain. Most of the claims you will read about this reemployment of workers are wrong, enslaved to ideology or dogmatism, or at the very least unjustified. Hardly anyone wants to admit this.
Really bad recessions involve deficient aggregate demand, negative shocks to intermediation, some chronic supply-side problems, negative wealth effects, and increases in the risk premium, all together. It is hard to find a quick fix. Furthermore models where AS and AD curves are independent and separable are often misleading, despite their analytic convenience.
Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent. The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.
You should neither rule out nor overstate the relevance of Hayek and Minsky. Their views have much in common, despite the difference in ideological mood affiliation and who — government or the market — gets blamed for the downturn. For really bad recessions, usually both institutions are complicit to say the least.
The Economist’s Free Exchange response to Cowen’s model (blog):
Supply-side policy is hard. Why is America the richest large economy in the world? Well, because output per person has grown at about 2% per year, on average, for a very long time. How did it manage that? I have a long list of policy choices and characteristics and historical accidents that I believe contributed, but I would find it very difficult to say which of those factors were most important. If someone gave me free reign over the German economy and asked me to raise its output per person to American levels, I know the sorts of things I would do, but I have a low level of confidence that I could succeed, or even close much of the gap, within a generation.
That doesn’t mean that supply-side policy should be ignored. Supply-side reforms (of the sort this newspaper tends to favour) are politically difficult to achieve, but many of them are probably at least somewhat useful and should be undertaken whenever the political environment is amenable (though with very modest expectations regarding detectable effects on growth).
With supply-side policy, the precision of a policy action is not the problem; accuracy is. With demand-side policy, it is the opposite: it is pretty easy to meet broad policy goals, so long as you’re not too concerned about hitting them square on the nose.
We know what an economy with way too much demand looks like. It has high and accelerating inflation.
We know what an economy with way too little demand looks like. It has high unemployment and deflation.
Within those two extremes, it can be tricky to identify exactly where an economy stands: how close or far away from potential output it is.
Both too much and too little demand are economically costly, but history suggests that too little demand is far more economically costly and politically risky than too much demand. So policy should err on the side of too much demand rather than too little.
The determined use of monetary policy is almost always going to be sufficient to generate the right sort of “too much demand”. But an independent central bank might not always be able to muster the appropriate determination. In some cases a central bank may flounder until a clear political consensus emerges supporting the determined use of monetary policy.
It is generally unwise for countries to sacrifice monetary-policy autonomy, either by adopting a constraining exchange-rate regime or by introducing an excessive level of capital-account openness.
In countries with autonomous monetary policy, which are stuck at the zero lower bound on interest rates, fiscal policy is almost by definition too tight, and it is probably quite difficult to conduct fiscal stimulus in a way that generates long-run economic costs. That is because the long-run supply-side and fiscal benefits of getting off the ZLB are probably pretty large.
Fiscal policy is subject to political constraints, and it may be easier to introduce a large stimulus in emergency situations if the pre-emergency public-debt burden is low. That suggests that prudence in normal times is a good idea (though do remember point number 10).
Don’t subsidise debt.
The level of financial- and banking-sector liberalisation at which it can be demonstrated persuasively that further liberalisation will generate net benefits is probably not that high.
The movie Inside Job portrays as
- evil: Feldstein, Hubbard, Paulson, Rubin, Summers, Wall Street, … ;
- clueless or not convincing: Bernanke, Campbell, Geithner, Greenspan, Mishkin, Portes, … ;
- aware (at least ex post): Buiter, Johnson, Lagarde, Lo, Partney, Rogoff, Roubini, Strauss-Kahn, Tett, Wolf, … .
Economics and economists are considered part of the problem rather than the solution. While the movie
- depicts Ragu Rajan as the hero,
it is silent about the fact that Rajan is one of the most prominent economists.
In MIT’s Rise to Prominence: Outline of a Collective Biography, Andrej Svorenčík summarizes facts about the MIT economics department. A part of the abstract:
By reconstructing the network of MIT economics PhDs and their advisers, this article furnishes evidence of how MIT rose to prominence as documented by the numerous ties of Nobel laureates, Clark medalists, elected officials of the American Economic Association or the Council of Economic Advisers to the MIT network. It also reveals the MIT economics department as a community of self-replicating economists who are largely trained by a few key advisers who were mostly trained at MIT as well. MIT has a disproportionate share of graduates who remain in American academe, which may be an important factor in MIT’s rise to prominence. On a methodological level this article introduces collective biography, or prosopography, a well-established historiographical method, to the field of the history of economics.