Cowen on the Austerity Facts Foofaraw

I don’t wish to respond point-by-point to some of the writings in the blogosphere, but given the above, Ryan Avent also is not looking deeply enough.  Both he and Brad Plumer did not see that the posts in question clearly distinguished between spending cuts and “austerity” (Brad did issue what is arguably a correction.)  I admire both bloggers and read them regularly, but these two posts both fail; here are some comments from Veronique.  I would say there is a dominant narrative, repeated many times in not always precise language, which people find it very hard to think outside of.

Most of the time “austerity” is a misleading word and more precise concepts — readily intelligible I might add — are available.  There really are some times when we should relabel austerity as “mostly tax increases,” but many people are reluctant to do so.

via Economic growth is not contractionary, and other confusions about stimulus and spending — Marginal Revolution.

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Austerity Facts?

Russ Roberts wants the facts:

Which nations in Europe have slashed government spending? I suppose “slash” is an ambiguous term but when you write  that the experiment has been tried, don’t you have to show that spending has at least been cut or reduced, right? Maybe some European states have slashed the growth rate in government spending? Is that what he means? If so, shouldn’t different words be used? And either way, should there be some facts on this “experiment.” The word implies something scientific. But it all appears to be going on in the mind of the writer rather than in the real world

I’d like some facts. I have seen many articles on austerity. I can’t remember seeing any that suggest that government spending in any European country has actually fallen. Yes, there is talk of spending cuts or cuts in growth rates. But I’d like to see the data that shows the cuts have actually been implemented.

Me too. Where should I look?

Music to My Ears

Roman Frydman and Michael Goldberg at the FT’s Economist’s Forum:

Behavioural economists have uncovered much evidence that market participants do not act like conventional economists would predict “rational individuals” to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it. They interpret their empirical findings to mean that many market participants are irrational, prone to emotion, or ignore economic fundamentals for other reasons. Once these individuals dominate the “rational” participants, they push asset prices away from their “true” fundamental values.

I’ve been harping on this error for years, but it has seemed to me that economists generally don’t grok what the error is. It’s good to see economists who get it.

New at Cato Unbound: Scott Sumner on the Monetary Flubs that Caused the Crash

This month’s edition of Cato Unbound on “The Monetary Lessons of the Not-So-Great Depression” kicks off with a probing, provocative essay by headliner Scott Sumner, “The Real Problem Was Nominal.” He says things like this:

We cannot hope to understand what happened late last year without first recognizing that the proximate cause of the crash was not a financial crisis, but rather a steep decline in nominal spending. Like any other fall in aggregate demand, this represented a failure of monetary policy. Severe demand-side recessions are almost never the result of special interest politics — the losses are too great and too widespread — but instead represent an intellectual failure by well-meaning public servants and the academic economists who advise them.

And this:

The real problem was not a “real” problem at all. It was a nominal problem, and the severe intensification of the debt crisis was a symptom of an ordinary Humean nominal shock. Furthermore, monetary policy was not “easy” but rather was highly contractionary in the only sense that matters, that is, relative to the stance expected to hit the Fed’s implicit nominal targets.

On deck we’ve got James Hamilton, George Selgin, and Jeff Hummel.

Causes of the Crisis

Critical Review has started a new blog “Causes of the Crisis” featuring contributors to the journal’s stellar issue on the topic. The papers in CRs special issue add up to the best and most comprehensive autopsy of the financial collapse available anywhere. The blog looks terrific too. Some excerpts…

David Colander:

Using models within economics or within any other social science, is especially treacherous. That’s because social science involves a higher degree of complexity than the natural sciences. The reason why social science is so complex is that the basic unit in social science, which economists call agents, are strategic, whereas the basic unit of the natural sciences are not. Economics can be thought of the physics with strategic atoms, who keep trying to foil any efforts to understand them and bring them under control. Strategic agents complicate modeling enormously; they make it impossible to have a perfect model since they increase the number of calculations one would have to make in order to solve the model beyond the calculations the fastest computer one can hypothesize could process in a finite amount of time.

[…]

This recognition that the economy is complex is not a new discovery. Earlier economists, such as John Stuart Mill, recognized the economy’s complexity and were very modest in their claims about the usefulness of their models. They carefully presented their models as aids to a broader informed common sense. They built this modesty into their policy advice and told policy makers that the most we can expect from models is half-truths. To make sure that they did not claim too much for their scientific models, they divided the field of economics into two branches—one a scientific branch, which worked on formal models, and the other political economy, which was the branch of economics that addressed policy. Political economy was seen as an art which did not have the backing of science, but instead relied on the insights from models developed in the scientific branch supplemented by educated common sense to guide policy prescriptions.

In the early 1900s that two-part division broke down, and economists became a bit less modest in their claims for models, and more aggressive in their application of models directly to policy questions. The two branches were merged, and the result was a tragedy for both the science of economics and for the applied policy branch of economics.

Vernon Smith:

Hayek made a similar charge [to Krugman’s in his long NYT piece] in his Nobel Lecture of December 11, 1974, The Pretence of Knowledge:

… the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

Although Hayek saw the problem as stemming from an inappropriate “scientistic” attitude, he explicitly wanted “…to avoid giving the impression that I generally reject the mathematical method in economics.” Rather, his main message was that

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible…The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Economic scientists have precious little understanding of this rule governed complex order, and how to keep it on its demonstrated long term path of growth and human betterment without suffering too irreparably from the kind of unpredictable reverses that we are now mired in. Less pretence and a commitment to learn from the new data being generated as I write, will be both humbling and informative, after the inevitable human political impulse to blame one’s long standing political adversaries has run its course.

I look forward to posts from the other contributors.

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.

The Trouble with Public Choice: Too Generous to Politicians

Matt Yglesias recently admitted in a blog post to increasing bafflement about “the high degree cynicism and immorality displayed in big-time politics.” Today Matt says some libertarians “responded to that post by deciding they should be condescending and give me a little less in Public Choice Economics 101. That, however, misunderstands what I’m trying to say about the subject.” Which is what?

The formal model of the self-interested legislator is very easy to understand. What I’m saying is hard to understand is the actual psychology of this kind of behavior. I think I now have a much better grasp than I once did of what’s going on inside the heads of people who have ideological beliefs I disagree with. But I find it very difficult to extend my powers of moral imagination to the kind of people who hold high political office in the United States.

I’m with Matt. I too find it hard to get inside the heads of politicians, and I don’t find rational choice assumptions very illuminating in this regard. By insisting that politicians are motivated by considerations no different than businessmen or anybody else, public choice economists have helped slay the pernicious myth that politicians are generally warmly other-regarding public servants. But the economist’s assumption of motivational uniformity fails to capture that politicians do in fact seem to be really odd people who don’t seem to be primarily motivated by the same considerations that motivate most of us most of the time. The incentives of the political process create a kind of filter that selects for individuals extraordinarily fixated on power and status and extraordinarily motivated to keep it. If this is right (anyone know of personality studies of politicans?), then the problem with standard public choice is that it gives too much credit to politicians by assuming they’re like everyone else and therefore it fails to capture just how exceptionally prone politicians are to narcissism, motivated cognition, self-deception, and brazen lying.

I find I almost always side with those defending empirically-informed motivational realism against a priorist rational choice/public choice types. (The dispute here between classic public choicers Mike Munger and Anthony de Jasay against empirically-informed political philosopher Jerry Gaus is illustrative. Jerry’s right, I think.) So I agree with Matt that politicians are probably odd, and in a bad way. But then I wonder what Matt takes the general lesson of that to be. Maybe if I thought about it longer, I could imagine a story in which this doesn’t tend to imply skepticism about the efficiency and justice of a system in which politicians are given a great deal of discretion to shape individual and public life, but I can’t think of one right now. So I’m curious what Matt takes to be the broader implications of the idea that “we’re fated to be ruled by the sort of people who are really desperate to cling to power.”