Flaws and Frictions

I was pretty impressed with much of Krugman’s NYT Magazine magnum opus. Macro is a mess. Now, this isn’t what Krugman was saying, but I think his account of the disagreements on fundamental questions exposes macro as a proto-science at best.

Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision — that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What’s probably going to happen now — in fact, it’s already happening — is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.

There’s already a fairly well developed example of the kind of economics I have in mind: the school of thought known as behavioral finance.

One might have thought Krugman was going to do something like acknowledge the immensely important point, associated with economists such as Ronald Coase and Douglass North, that market institutions in which “frictions” or transactions costs are relatively low are the exception rather than the rule. Markets are not only not frictionless, frictions generally keep markets from getting off the ground at all. When frictions are managed sufficiently to get markets up and going, that’s because they are embodied in a complexly interlocking set of institutions and organizations which make this possible. A scientific economics might seek to explain how it is that embodied markets achieve otherwise impossible feats of social coordination.

The “flaw” part of “flaws and frictions” is a little loaded. It’s an annoying habit of economists to hold on to homo economicus as a standard for rationality even after they have conceded that homo economicus is a more or less useless over-idealization. That we don’t live up the standard of more or less useless over-idealizations obviously does not imply that we are somehow defective. Be that as it may, one might have thought the recognition that a useless over-idealization of rationality does not apply to us might lead one toward a more sophisticated idea of the way minds and markets work together. There are, for example, the profound Hayekian points that individuals are computationally bounded, that expertise is local, that markets enable coordination by conveying otherwise inaccessible information, that epistemic and practical norms are both cause and effect of institutional structure, etc. Maybe we could look at experimental work, such as Vernon Smith’s, that explores how real people operate in different kinds of market structures.

It’s not like Hayek, Coase, North, and Smith don’t have Nobel prizes! But Krugman ignores the best of existing “flaws and frictions” economics and jumps straight to “behavioral finance,” which I’m fairly sure is the same old shit Krugman is complaining about — elegant models of counterfactual worlds — with ad hoc emendations to improve fit with the history the actual world.

Krugman should go further, but he won’t. He should say that beginning without “flaws and frictions” — assuming at the start unbounded perfectly rational agents and zero transactions costs — has all the virtues of theft over honest labor. An economics based on those assumption is ipso facto unscientific. The same goes for ad hoc variations on these assumptions. What sciences do is explain. (Sorry Milton.) And scientific explanation is largely a matter of detailing the causal mechanisms underpinning observed regularities.

“Freshwater” economics is not a science. It is a sometimes illuminating exercise in modeling counterfactual worlds. Insofar as “saltwater” economics recognizes that the need for a better account of human psychology and transactions costs in embodied institutions, it is better. But, so far, it isn’t. So far, “behavioral” macro is mere aspiration. It’s not something anyone is actually doing in a systematic way.

Maybe the most important conclusion I drew from Krugman’s piece is the politics of the freshwater/saltwater divide is complete nonsense. To seriously acknowledge “flaws and frictions” is to acknowledge that some institutions create friction while others reduce it; that some institutions enhance the salience of certain “flaws” while others work around them; etc. Having recently read a bunch of “Keynes was right” pieces, it seems pretty clear that lots of left-leaning economists are mistaking flawlessness and frictionlessness as necessary premises in the argument for limited government intervention in market institutions. But the upshot of flaws and frictions could very well be that we shouldn’t expect very much from government intervention. It seems pretty clear to me that Keynes’ characterization of the role of not-exactly-rational “animal spirits” in recessions is a very small part of an adequate general account of the way the quirks of human psychology tend to scale up to the macro level. The inference from flaws and frictions to Keynesian technocracy tends to be embarrassingly hasty.

The fact is, macro isn’t close to resembling a real science. (“The economy,” nationalistically construed, isn’t even close to resembling a subject of scientific investigation!) But we can’t count on elite economists to admit it, since their claim to authority on matters of public policy stands or falls with their claim to scientific expertise.

44 thoughts on “Flaws and Frictions”

  1. Why do chemist do experiments in labs? Why do they carefully control the weights of reactants? Why do they sometimes run experiments in a vacuum?Perhaps they, literally, want to remove frictions so they can get to the heart of the matter; to test a theory. I don't see how abstracting from frictions in economics is any different or psuedo-scientific.If your theory depends on a friction, then your model of that theory should include it. If it doesn't then its a test of the model to replicate what we see in the real world in the frictionless model. If a frictionless model replicates real life then the friction can't be very important.Why do you, and Krugman I guess, believe these particular pet frictions matter so much? Have you built models and demonstrated that they better reproduce the data? I didn't think so. But you're in good company because Krugman hasn't either.In fact many Keynesian style frictions have been modeled and they haven't been shown to fit the data. Krugman's thin case, and yours I guess, rests on the theoretical possibility that these frictions matter when the economy is in a liquidity trap. A very liberal definition of a liquidity trap puts the economy in one once every 20 years. In the best case, then, a “scientific” macroeconomics, as you describe it, would explain 5% more of the data.PS – I have no clue why the fresh/salt water thing comes up these days. The distinction intellectually went away by the 90's and it doesn't exist geographically. Everybody doing macro research (as opposed to economic history or trade) uses the same techniques and everyone is open to considering the effect of frictions of any stripe.

  2. “If a frictionless model replicates real life then the friction can't be very important.”There are infinite models that reproduce the data. Which one should I pick? One that reproduces the data by accurately modeling the mechanisms that produced it, or one that doesn't? If it's good, explanatory causal-mechanical model, it will both accurately retrodict and predict. But if a model retrodicts, it may or may not be explanatory or predictive. Continuously readjusting non-explanatory models to fit new data isn't what a science does. I'm sure we have a lot of differences. Using “reproducing the data” as a criterion for theory selection is a problem if the data are arbitrary or orthogonal to explanation. Suppose the data concern my history of influenza. Suppose we come up with a model that fits the data. Are we any closer to a general theory of influenza? I think macro data are like that.

  3. Will, it's difficult for me to even imagine how an approach consistent with your criticisms would begin to extract information from the time series data that macroeconomists (sadly) are forced to use. Experiments are great: I've run a few, but they aren't going to replace BEA data. More generally, my sense is that you are asking too much. Macroeconomists have to be able to write something down that is both tractable (i.e. they can't model the interaction of every conceivably relevant institution at the same time) and part of a broader research program. Your “useless over-idealization” facilitates both of these and minimizes the ad hockery which you correctly disparage. Whether we should call macroeconomics “scientific” is a different question and perhaps not one that is going to be of interest to macroeconomists qua macroeconomists.

  4. Ryan, My hunch is that the histories of economies are like the histories of individual people. You can have as much time-series data as you want about an individual person, but you're just not going to be able to use it to make useful scientific generalizations about people. Actually, economies are not much like people. They are kinds. That two things are both people entails that they will be extremely similar. That two things are economies does not.

  5. Macroeconomists are aware of these problems of testing models. In the end its impossible to construct a model without considering the data its suppose to replicate, but we still try.But this is beside the point of your post. Macroeconomists will never be able to generate their own data to test their models. If this is your definition of science, then, yeah, macro isn't a science… and it never can be no matter what “frictions and flaws” we add to theory.

  6. Astronomy doesn't generate its own data either. I don't have a problem with astronomy. I think my deeper worry is that a lot macroeconomics doesn't actually study really scientifically study-able. The problem isn't so much that it ignores flaws and frictions, but that the stuff it tries to theorize aren't kinds with features sufficiently general and invariant to support induction. But I don't think I want to say anything quite that strong.

  7. Perhaps macro economics is an entirely emergent phenomenon, and we shouldn't expect to find any answers when we scale up from the micro level.

  8. The inference from flaws and frictions to Keynesian technocracy tends to be embarrassingly hasty.While this is often true, I don't think Krugman actually argues for “Keynesian technocracy” is his article, and it seems rather uncharitable to pick at the omissions in his article only to turn around and then impute unfavorable implications that aren't really there.

  9. There are, for example, the profound Hayekian points that individuals are computationally bounded, that expertise is local, that markets enable coordination by conveying otherwise inaccessible information, that epistemic and practical norms are both cause and effect of institutional structure, etc.

    Yes. But once this is acknowledged it's no longer possible to invoke the first or second welfare theorems plausibly. For this reason it will always remain difficult to persuade most free-market supporters – nobody wants to say “well we're sort of confident we're right”, everybody wants to claim “my math proves you're wrong!“. Likewise for the other side of the fence, who prefer results that show optimality under technocratic intervention.It is easy to find self-described Hayekians who proclaim that markets expose otherwise inaccessible information. It is troublingly difficult to find such Hayekians who then realise that the rug of Pareto optimality just got pulled out under them. (One day Kling or another GMU blogger might deign to rigorously explain just how GMU's masonomics actually models competition under the market failures they claim to accept, but I wouldn't bet on it. )Aggravating this political problem is the nasty reality that many economic results are not robust when relaxing idealized conditions, and display dramatically different behavior under roughly similar conditions (the example taught in many textbooks is the Bertrand vs. Cournot duopolies, but I could go on here). So it comes down to what effects once chooses to accept. Sadly, arguing “A, B, and C effects should be included in the model, but your D, E, and F effects are insignificant and can be discarded!” is hardly a convincing display of academic superiority.

  10. I assume when you say you'd like to see a Masonomics macromodel, you mean an analytical one of the still-ascendant variety. My question is: Why? All it would build off of is the assumption that private actors are better-incentivized to act efficiently on price signals than government actors. If you accept this premise, then you should be able to see where the Masonomics position comes from without a model. If you don't accept this premise, then you probably would probably find the assumptions of a Masonomics model unsatisfying.

  11. I am all for economists trying to be as “scientific” as possible. We can only work with the empirical evidence available, or not at all. The danger is simply the false satisfaction that, now that they've paid homage to the scientific method, suddenly their results are as irrefutable as a cystallography-confirmed-structure. My problem, therefore, is not Krugman's data-inspired observations, but how much conviction he often has in them.

  12. I'd like to see a rigorous Masonomics model precisely because its current forms tend to invoke efficiency and optimality results, while claiming to have disposed of the idealized assumptions necessary for deriving said results. It's possible that there is some sophisticated reasoning underlying this missing step, but it''s never made explicit anywhere.In this particular case, the idea that price signals contain reliable market information is, of course, an optimality result. You can't assume away price-setters and price-fixers and then claim victory over idealized Chicago modelling. Likewise, the very idea that multiple incentivized private actors produce an optimal equilibrium is an optimality result: the most famous result in economics! What happened to “market failure”?Masonomists say they accept the reality of market failure. We are told that the market will find a way around prisoner's dilemmas, lemon markets, etc., but how this process is proposed to work is silently omitted, and it is baldly assumed that the resulting equilibrium will be desirable.You wrote “[if] you accept this premise, then you should be able to see where the Masonomics position comes from without a model.” But what we see is a premise ripped straight from Chicago. What we don't see is how the never-elaborated model is supposed to avoid the weaknesses of Chicago idealization. The missing step is precisely the crucial step that's suppose to distinguish the GMU school from Chicago! This is exactly the problem.

  13. Oh, geez: “In astronomy they explicitly assume invariance of the laws of nature. Can't we macroeconomists?” Sure, go ahead: I have no objection to assuming the invariance of, e.g., the laws of gravity, chemical reactions, fluid dynamics, that sort of thing across all sorts of societies and time periods.Oh, that's not what you meant? You meant the invariance of the decision-making processes, the institutional structures, and the histories that both embody, all of which collectively result in what we think of as “economies”? Well, gosh, no, you *don't* get to assume those. Because it's pretty damn ridiculous.

  14. To be fair, I'm not sure they're claiming Pareto optimality, nor that price signals are “reliable” in the sense of being perfectly accurate. The public choice criticism of intervention in particular doesn't seem to make the claim that without the median voter and a lot of government rent-seeking, we would be in the best of all possible worlds. I read it as more akin to saying, “hey, if you think transaction costs and imperfect information and bounded rationality lead to suboptimal results by private actors, think about how much worse they get in a voting environment.”It's also not clear to me the premise Peter Twieg refers to is one that Chicago political economists always hold — you'll see the argument made that both market and government action are Pareto optimal.

  15. If we're talking about a tradeoff between market coordination and government coordination, then the “optimal” mixture doesn't have to assume that prices always contain reliable information, or that markets always clear, or that market power doesn't exist, etc. etc. All one needs to say is that if we turned over some market operations to the government – and not an ideal benevolent social planner, but the actual political institutions which we live with today – then we would be worse off. If we only have two options in a given market – pure market coordination or pure government coordination – one doesn't need to fulfill some ideal conditions to qualify as having achieved the feasible optimum… one merely needs to have one choice lead to a more efficient outcome than the other. Thus the optimal result doesn't imply perfect coordination on some ideal production possibility frontier, but simply a result which is better than the set of alternative feasible results under different policy regimes and sets of institutions.Masonomics does not have to use Chicago-style modeling assumptions to guarantee its results, but if you really wanted an analytical model it would probably would for the sake of tractability – the exact virtue which explains their continuing popularity. We don't have Masonomics models for roughly the same reason why we don't have (many?) robust general equilibrium behavioral models – not because economists hate the possibility of market failure, but because incorporating heterogeneity, non-maximizing behavior, and human cognition into models is often difficult to the point of being unproductive.

  16. Douglass North was one of my professors when I studied Economics at Wash. U. I remember one of the first days I had a class with him and he referred to macro as “Applied Astrology.” His approach to economic history simultaneously helped me understand why free markets are so uncommon, why state institutions are necessary to functioning markets, and why the government's most effective place in the market is at the margins. Krugman would do well to learn from him.

  17. @Peter TweigIf we only have two options in a given market – pure market coordination or pure government coordination – one doesn't need to fulfill some ideal conditions to qualify as having achieved the feasible optimum… one merely needs to have one choice lead to a more efficient outcome than the other.Yes, yes. You said so already. 😉 But my point is that you will find that Masonomic arguments for the greater efficiency of the market solution often rely implicitly on Chicago idealization. It's an insidious and persistent habit that only becomes clear that one demands an explicit model.It's well-known, for instance, that rational-choice theory is notoriously weak at actual empirical content – while the RCT account of regulatory capture and rent-seeking is intuitively plausible, theoretical models of such technocrats are remarkably dissimilar to real-life technocrats actually behave (in other words: it's not enough to cherrypick bureaucratic failures and then glibly invoke public choice; one also needs to explain why successful programs succeed at the level they do. This is science. It turns out to be difficult). But none of this is obvious unless one starts demanding an actual model of, e.g., what technocrats are proposed to maximize (income? status? power? no glib unquantified status models, please). Without an explicit specification, technocrats can be conveniently asserted to do anything the theorists wants, like being eternally less motivated than a private-sector decisionmaker. Notice that this sort of assertion makes no goddamn sense without the underlying implication that technocrats maximise something that the theorist has compared, but isn't telling you.That's the government. As for the market… look at it this way – given that we have allegedly accepted market failures and live in a second-best world of market power, institutionalized firms, etc., I could rewrite the your words asAll one needs to say is that if we turned over some government operations to the market – and not an ideal efficient rational market, but the actual corporate institutions which we live with today – then we would be worse off.In essence, you need an explicit account of how government and market behave, or you don't get to claim that one is better than the other. Sorry. That means modelling market failure explicitly, not shelving it away under “problems for market entrepreneurs to solve”.Market failure! The central problem is after all market failure, or we'd all be Chicago libertarians. Likewise, we don't get to invoke the Chicago dodge of tractability; Chicago economists invoke tractability to dismiss empirically insignificant deviations – we who have admitted market failure have condemned ourselves to modelling the problem, failures and all.

  18. I'm serious in my criticism. You remind me of a child dressing up in grown-up people's clothes pretending to go to work.I have a hunch why this is. As a person who studied philosophy you probably intersected with the philosophy of science a decent amount and probably feel like you have a grasp of the issues at hand. But your approach was orthogonal and tangential, possibly only picking up the most interesting, controversial, and thought provoking pieces dealing largely with epistemological problems. Given your background in particular, I'd further speculate that you probably intersected heavily with the layman works of the Austrians and some of the Monetarists. The Austrians in particular have always been a counter-orthodoxy group, with sometimes bizarre ideas about the nature of the science. Criticisms that are valid and also not correct, or correct and invalid.This is what counter-orthodoxy scientists do. In every field. Then shortly after coming out with a half dozen criticisms, everyone returns to doing what they were doing before. The point is not to change, but to install doubt and encourage caution, such that a more precise explanation can be developed. It is to offer a balance and stark contrast to the hundreds of other pieces that come out that move forward the progress just a bit.The problem is, these conclusions come from a point of massive expertise and background within the field and these arguments are at the extreme technical end. When a person who is ignorant of all this blindly falls into it, that person can sometimes wrongly repeat conclusions of the field based on preexisting biases, and then apply those criticisms wrong.This is a error that is repeated over and over in every field where experts can exist. Two of the most dangerous and popular today are within Climatology and Evolutionary Biology. It happens in your field too. How many people do you know have claimed that philosophy is crap and pointed to the post-modernists? Or that said art is meaningless, then pointed to something modern? Or that blogging is just about posting pictures of your cat? That pundits are useless because they just can say whatever they want, be wrong, and not be punished for it. The thing is, yes, every single one of these statements is a somewhat controversial truism in the fields they apply. But when an Expert says “Everything we do is wrong and we know nothing” he means this in a completely different way from an outsider who says that a field is crap. The problem is not that he said the same truth, applied the same facts, or listed the same arguments, but that the meaning of the conclusion is wrong.And it applies here as well. YES, economics has problems. YES Macroeconomics has problems. One of the biggest of which is that EVEN THOUGH it has some 'good' explanations for some REALLY IMPORTANT things, the result is not always the one predicted! Often times they don't have a 'good' reason why!The same can be said of Seismology. I don't see people pissing on Plate tectonics because we don't know when the next Earthquake is going to hit.You're missing all the critical points below that point that build up to these conclusions. You see the controversy but not the consensus.Above you said you respect astronomy, so I'll try to attach to that. The Sun is the single most important object in our solar system. I have a feeling that we have a better understanding and predictions for the previous recession then we do for explaining why the sunspots have not returned.What does this say about the nature of Astronomy? About the nature of Economics? 75% of the universe is composed of Dark Energy, a subject we know basically 'nothing' about, or even if it exists. What does this say about Cosmology?I think my biggest complaint is that your criticisms here are not-unique to the object. It reads like a mad-libs. The points are not invalid, untrue, or even unimportant; just in the larger picture it has less and a different meaning then what you are putting into it.

  19. Seems like figuring out where to actually draw the boundaries around an “economy” is a potentially interesting yet neglected area of study, with all sorts of interesting practical applications.

  20. David, You may be arguing with somebody, but not with me. I accept the there are situations in which (a) markets fail to emerge at all, (b) markets fail to work with perfect efficiency, (c) markets fail to find ways around market failures, (d) governments correct market failures, (e) governments fail to work with perfect efficiency, (f) government try but fail to correct market failures, (g) government failure hampers the efficiency of markets, (h) government failure prevents markets from emerging at all, etc. Things like “prisoners dilemmas” and “lemon markets” depend on people behaving in certain ways. The PD payoff matrix doesn't apply to a situation where people really trust each other. Asymmetrical information isn't a problem when people are honest and feel obliged to tell others things they ought to know. The point being that whether there is a problem for a market to find a way around, or for a government to solve, depends on whether there is a problem. We don't get to assume problems any more than we get to assume them away. Diagnosing the function or malfunction of real institutions isn't something you can do from an armchair. But I'm starting to sound like a sociologist.

  21. Right on. You need to make a case for invariance. The fact that preferences and habits of decisionmaking and so forth vary with institutional structure, and vice versa, sure doesn't lend itself to tractable mathematical modeling. But neither does the fact that I am now imagining the taste of a peach. Facts first!

  22. David – I'm not sure what to make from your post when you're so strenuously asserting that market failure exists, but fail to completely acknowledge government failures as well.. or at best you seem to write them off as curious artifacts of rational choice models that audaciously assume that technocrats are maximizing something other than social welfare. I also don't understand the repeated insistence that Masonomics must be making Chicago-style assumptions about economic actors… moving away from RCT doesn't throw the role of prices out the window and leave us in an uncertain world where we just can't be justified in believing that Silicon Valley couldn't be ordered just as well by Congressional fiat. The arguments in favor of markets aren't nearly as brittle as you seem to believe.Given your disdain for the assumptions built into Chicago-style models, I doubt there will ever be an analytical model that will satisfy you as an approximation of the Hayekian knowledge problem and government versus market incentives. This would be okay if it weren't for the fact that you seem to hold this against economists, as if they simply are choosing not to let go of simplistic assumptions. This is not the case – the modeling issue, as I said, is about tractability. Either you take simplicity and tractability or you take nothing at all, pretty much.

  23. Scott Sumner is less impressed with Krugman's effort.Finding out, yet again, that macro-economics has major problems is hardly news. What is more interesting is particular problems in understanding financial markets and instruments. Even so, the implied notion that is fairly rampant at the moment that scepticism about government intervention stands or falls on the health of macro-economics is, to put it mildly, not an intellectual superior position to poor old macro.

  24. I think a significant part of the failure was the inability of economists to take the witchcraft factor into consideration. I'm thinking of Wittgenstein here, that philosophy is the battle against the bewitchment of our intelligence by language. In the case of the financial market, it was the bewitchment of their intelligence by mathematics. How else to explain the effect of the Li formula on that market? See, Recipe for Disaster: The Formula that Killed Wall Street. http://www.wired.com/techbiz/it/magazine/17-03/

  25. Will,1. You have misunderstood science and especially economics qua (quasi-)science. Science generates if-then statements that have predictive power. Science does not explain. It especially does not explain causality. Starting from that position of epistemological modesty, it's simply irrelevant whether macro models' starting assumptions correspond well to the real world. Nope, what matters is not whether the assumptions are realistic, but instead whether the if-then statements generated by deduction from those assumptions have strong predictive power. Non-Euclidean geometry has some crazy assumptions (well, one missing realistic assumption), but nonetheless somehow generates if-then statements with high predictive power.Critics of macro (and econ generally) really are missing the point when they criticize macro's admittedly silly assumptions. You instead should be focusing on whether the if-then statements fit the data.2. It's a waste of time to debate whether economics is a “science.” So what if it is, so what if it isn't? It tries to generate predictive hypotheses. It does a pretty good job at it. If science, then [what?]. If not science, then [what?]. Angels dancing on a pin….3. This statement of yours is just false. Regardless of whether a “science,” macro will be persuasive so long as its if-then statements have predictive power.”But we can’t count on elite economists to admit it, since their claim to authority on matters of public policy stands or falls with their claim to scientific expertise.”3. The distance between the freshwater and the saltwater econocamps is less than popularly imagined. The market drive toward product differentiation is esp strong in the academic market.

  26. Krugman ignores Hayek, Coase, North, and Smith because of his methodological approach:”Economic theory is essentially a collection of models. Broad insights that are not expressed in model form may temporarily attract attention and even win converts but they do not endure unless codified in a reproducible – and teachable – form. You may not like this tendency; certainly economists tend to be too quick to dismiss what has not been formalized (although I believe that the focus on models is basically right). Like it or not, however, the influence of ideas that have not been embalmed in models soon decays.” (Krugman, P. 1995. Development, Geography and Economic Theory. Cambridge: MIT Press. p.27)

  27. But the upshot of flaws and frictions could very well be that we shouldn’t expect very much from government intervention.Or it could st as well be that we can expect a lot from government intervention! The question becomes, under what circumstances? I mean, I think holding up Hajek's thinking on the importance of information in market economies, and the way localized decisions propagate into the macro world is a bit of grasping at straws. Hajek was writing before we understood the importance of systematic (ie. predictable) biases in human cognition. When I read Hajek now I'm struck by the profundity of his insight about the importance of price, and his naivety about how people process questions of value. When Keynes (and even economists like Thorsten Veblen, and John K. Galbraith) made claims about “animal spirits”, or “It is better to fail conventionally than to succeed unconventionally.”, their underlying point, though expressed with more pith and less rigor, sounds a lot like confirmation bias. Which is (I think) Krugman's point. Today, we have a rigorous and 'lab tested' basis for believing a) that agents in markets are not rational, and b) for reasoning about those biases. A small idea, like Keynes' paradox of thrift illustrates the point nicely. The paradox of thrift arises when a large number of local decision makers deciding between savings and consumption find themselves irrationally restrained by the 'anchoring effect' or 'focusing effect' (where recent information is emphasized over a longer term view). Keynes observed this behavior during the early years of the depression. It's much in evidence recently. What to do? Getting out of this non-optimal equilibrium involves acting to counter the widespread bias. Which means collective action. Which means government intervention.

  28. The glaring oversight of this argument is the failure to acknowledge that government agents are subject to cognitive bias as well. It's a case study in the Nirvana Fallacy – “markets fail, therefore government”… and we haven't even touched on the public choice critiques of what policies the government (as opposed to an idealized beneficent social planner) likely WOULD implement. I know it sounds harsh, but any argument for intervention which proceeds along these lines is simply not worth being taken seriously.

  29. I think Peter's being a bit dogmatic. Really? “any argument for intervention which proceeds along these lines is simply not worth being taken seriously.”? I tried to get at the entirely reasonable criticism he's making where I wrote The question becomes, under what circumstances? . But I'll punt the ball a bit further down field by asserting that as champions of liberty we can't have our cake and eat it too. It seems awkward to hold the following two positions simultaneously: i. that nothing the government can do will have any effect, and ii. that everything government does has a bad outcome. The arguments for the first conclusion — that individuals will factor in government actions thereby neutralizing it–seem to run counter to the arguments Peter's making–that government agencies are as subject to cognitive bias as anyone, and will enact policies that have bad outcomes. There's a case for the G-man, now and then.I think it's fair enough to make the following claims. Free market capitalism–words ordered for priority–is the best approach to managing scarcity we've ever come up with, and works really well. Except when it doesn't. And when it doesn't, it's not the fault of free market capitalism. It's because us semi-evolved simians aren't good enough for it. But where none of us, as individuals, is tall enough to grab the banana, we can overcome our base natures from time to time, and work together (monkey pyramid, go!). I think a slightly better way to think of it is to say that any collective action needs to be justified on its merits. How? Well, as in the case of (say) financial market crises, or even something as banal as a good ol' fashioned bank run, we can apply the grease of our monkey minds to the machinery of the (as Will puts it) “sometimes illuminating … counterfactual worlds”. We're gonna make mistakes. We're gonna forget. It isn't going to be perfect or lovely or soviet-ice-cream-on-every-street-corner, but it's at least reasonable, no?

  30. Because astronomy's case is so damn compelling? Because we know that the laws of nature are the same everywhere in the universe? Because you've gone there and checked?I suspect the difference between astronomy and macroeconomics is we have very few intuitions about the former and lots about the latter. When an astronomer makes crazy assumptions to get her result, we shrug our shoulders because whatever she's making a assumptions about are so unfamiliar. Economists make assumptions about human psychology and other stuff that everyone thinks they know about. Our crazy simplifications are more obvious and more intimately unreasonable.

  31. Meteorology was the example that came to my mind reading Krugman's piece. Suppose there were two competing schools of thought as to how storms develop, school #1 was getting all the glory and prestige, and then a big hurricane came along that did a lot of damage. Does that mean we should pay more attention to school #2 instead of school #1? Only if the two schools were seriously claiming to be able to *prevent* hurricanes and we had some reason to think this was technically feasible.When it comes to depressions, macro is more successful as a descriptive science than as a prescriptive one. Krugman's essay omitted a hugely likely possibility which is: nobody knows how to prevent depressions. Really big crashes come around so infrequently, have so many contributing factors and are so specific to their local circumstances that we just don't have a solid, well-tested theory about how to stop them. Which almost goes without saying. Sure, there are policies in place, but if they work at “preventing a depression” the depression doesn't happen so we have no way of knowing that they worked; we can't logically distinguish “it worked” from “we had a lucky run”. We only notice the failures. From one point of view, 70 years without a depression is a pretty good run and indicates we're doing something right. It's only a problem if you think preventing all depressions is possible. Krugman apparently thinks it is, so he wants to make sure the next team has the right combination of strategies from Team A and Team B. But if he's mistaken, then this crash only tells us that economists are fallible with respect to giving advice that will entirely prevent depressions. Just as meteorologists are fallible with respect to hurricane-prevention advice. It doesn't necessarily mean the field is in crisis; it might just mean we should dial back our unreasonable expectations a bit.

  32. This is a joke, right?The movements of heavenly bodies prompt *extremely* intuitive, yet false, astronomical theories; a heliocentric solar system is about as classic a case of a counterintuitive scientific finding as you can get, up there with inertia.Whereas one of the constants throughout the emergence of modern markets is the outrage they provoke precisely because they seem *unnatural*.As for why most of the natural sciences, collectively understood, have earned epistemic authority in a way that economics has not: they're part of a web of belief that impinges on empirical experience so thoroughly and pervasively that about the only alternative to physics & chemistry getting things more or less “right” (however you cash out “right”) is to presume that something like a Cartesian Demon is just messing with us, or we're in the Matrix, or something. (And those possibilities have no practical implications.)What's more, this tight integration between basic science, engineering, and everyday problem-solving doesn't merely validate the corpus of knowledge at any given time; it also helps us when trying to evaluate the *institutional epistemic authority* of various methods for the producing and distributing knowledge.

  33. I'm slightly puzzled by your claim that science is explanation. Suppose some scientists (or not-scientists depending on your definition) tried to get together and just predict something. Anything. It doesn't really matter what it is. Lo and behold, they come up with a surprisingly accurate predictive model of the phenomenon they are considering, with one problem – they learn basically nothing about the causal mechanisms at play. The assumptions of the model are simply unrealistic.Leaving issues of semantics aside, is there something fundamentally wrong with this? The scientists above aren't claiming to do anything more than predict, and they predict successfully.Now, I _don't_ think this is the position modern macro is in. As best as I can tell, macro has failed as a predictive science. I also don't think that explaining causal relationships is worthless – it tends to do a good job of predicting, in fact. It's just not strictly necessary for prediction, which seems to be a legitimate endeavor, whether or not you want to call it science.

  34. See my reply to pushmedia1 above/below/whatever, first.Ok, now: I actually agree with you that Wilkinson goes astray when he attempts to prescribe a particular alternative approach that would be “better science.” But his *criticisms* are on-target. Your response is actually the one that proves too much, because it could be made just as strongly on behalf of Christian apologetics, astrology, Lysenkoism, Marxist dialectics, acupuncture, chiropractics, natural law, Freudian psychotherapy, … in short, any discursive practice that combines reasoned disagreement with a method of processing this disagreement into an acknowledged “canon.”Now, Wilkinson wants to use the science/not-science distinction to separate astronomy from astrology; I actually think that particular dichotomy muddles things more than it helps. As I said in my reply to pushmedia1, we need an approach that blends pragmatism and social epistemology: what we want to know is *which* bodies of “expertise” warrant epistemic authority *and in which contexts*. So: look to the web of belief and action; how the knowledge-producing communities impinge upon the knowledge-using communities, the feedback mechanisms between theory and practice (what's taken as “disconfirming,” what isn't); that sort of thing.When we do that, we see that physics and chemistry, through their interpenetration with engineering and problem-solving more prosaically, haven't just made predictions or offered plausible explanations; their claims have become so thoroughly integrated within everything we do that we confirm, if not their “truth,” then at least their reliability, every time we wake up and turn on a light-switch.Macro-economics? Not so much. Sure, I'm sure you and pushmedia1 see DSGE models confirmed in what you read in the news and in history, but plenty of others just as smart as you think that *completely incompatible* approaches make sense of things, and that macro-astrology would be just as persuasive as macro-economics if it put as much brainpower and CPU cycles into refining the models to fit the data. Sure, it's crazy to think that the differential gravitational fields of heavenly bodies determines our fates in the way that such a macro-astrology would say … but then, it's just as crazy to think that our economy is populated by agents acting out their parts in the solution to an infinite-period stochastic game of utility-function maximization.

  35. Part of the problem with using “prediction” as a criteria for success, with macro, is that without causal understanding you have no way of knowing when your predictions will *stop* being good. You have no way of knowing how robust this predictive capacity is, or will become. Suppose somebody correctly predicts the core inflation rate, 1 year in advance, 20 years running. The next year he makes a guess about the current account deficit. Without causal understanding, why should we think his inflation-predicting ability will transfer over? Only a theory about the *causal interrelatedness* of the phenomena would let us say that, and that's precisely what we're saying he doesn't have in the hypo. Precisely because what we call “the economy” is the result of a vast number of processes, all shaped by institutions that are never fully at rest, this is a real problem. All the more so since macro “expertise” is typically used as a justification for public policy: that is, actions that by their nature change what's being predicted.

  36. I don't disagree. Predicting without understanding causal relationships certainly isn't easy. But it isn't strictly impossible. For macroeconomics, it probably is near enough impossible to forget about though.

  37. (a little old, but…)Actually, in Astronomy the invariance of the laws of nature is subject to verification. The most flashy example I'm aware of is that in supernovas, all of the elements in the periodic table, including the really short half-life elements, are produced. These elements decay according to their individual nature, and that decay can be observed through the fall-off in the brightness of their spectrum lines. Each of the elements always decays at exactly the rate it would on Earth, no matter where in the observable universe the supernova occurs.

  38. Ah, friction, dissipation, entropy production. Life in the non-equilibrium world is so unpredictable…Your comment: 'Continuously readjusting non-explanatory models to fit new data isn't what a science does. ' is too optimistic.I guess by 'causal mechanical' you mean dynamical models, and explicitly not regression or stochastic schemes? If so, fitted models like the ones I mentioned are still the best tools available in some noisy physical sciences, I'm thinking hydrology in particular, and older but still used atmospheric subgrid parameterisations.Nevertheless, you're right to prefer a dynamical approach where available. I suspect though, as others in the thread have noted, that the system is simply unpredictable at some of the time scales we'd like it to be, and that it might turn out that simple models explain most of the predictable variance.

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