Monday, 9 January 2012

Mistakes and Ideology in Macroeconomics

Imagine a Nobel Prize winner in physics, who in public debate makes elementary errors that would embarrass a good undergraduate. Now imagine other academic colleagues, from one of the best faculties in the world, making the same errors. It could not happen. However that is exactly what has happened in macro over the last few years.
                Where is my evidence for such an outlandish claim? Well here is Nobel prize winner Robert Lucas

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash.  It has no first-starter effect.  There's no reason to expect any stimulation.  And, in some sense, there's nothing to apply a multiplier to.  (Laughs.)  You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. 

And here  is John Cochrane, also a professor at Chicago, and someone who has made important academic contributions to macroeconomic thinking.

Before we spend a trillion dollars or so, it’s important to understand how it’s supposed to work.  Spending supported by taxes pretty obviously won’t work:  If the government taxes A by $1 and gives the money to B, B can spend $1 more. But A spends $1 less and we are not collectively any better off.

Both make the same simple error. If you spend X at time t to build a bridge, aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time, so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.
                But surely very clever people cannot make simple errors of this kind? Perhaps there is some way to re-interpret such statements so that they make sense. They would make sense, for example, if the extra government spending was permanent. The only trouble is that both statements were made about a temporary fiscal stimulus package. Brad DeLong tries very hard along these lines (see here for example), but just throws up inconsistencies.
                I prefer to just note that if any undergraduate or graduate student in the UK wrote this in an exam, they would lose marks. The more interesting question for me is why the errors were made. Of course everyone is human, including the best economists. (And if they were not among the very best economists, I would not be talking about these errors in a blog.) You get to be a brilliant economist or physicist by having great ideas, not by never making mistakes. But I think it is still the case that we cannot imagine members of a physics department making such errors. What is different about macro?
I want to suggest two answers. The first is familiarity with models. I cannot imagine anyone who teaches New Keynesian economics, or who talked to people who teach New Keynesian economics, making this mistake. This is because, in these models, we do have to worry about aggregate demand. We focus on consumption smoothing, and Ricardian Equivalence, and teach it from the start. I often tell my first year undergraduate students that if they write anything like ‘Ricardian Equivalence says fiscal stimulus will never work’, they are in danger of failing.
Lack of familiarity does not necessarily imply believing something is wrong. In a separate piece, Cochrane writes 

“New-Keynesian” thought is devoted to defending the importance of monetary policy, and incorporating specific frictions in the equilibrium tradition, not to rescuing the ancient view that fiscal stimulus is important and abandoning that tradition.  

This is broadly true for New Keynesian theory when monetary policy is unconstrained (see Kirsanova, T, Leith, C and Wren-Lewis, S (2009), Monetary and Fiscal Policy Interaction: The current consensus assignment in the light of recent developments, Economic Journal, Vol 119) but not when interest rates are stuck at a lower bound. Cochrane is not saying New-Keynesian theory is wrong, but implies incorrectly that it suggests fiscal stimulus will not work.
                Lack of familiarity with New Keynesian economics may be partly explained by the history of macroeconomic thought that I briefly noted in an earlier post. As New Keynesian theory is an ‘add-on’ to the basic Ramsey/RBC model, it is possible to teach macro without getting round to teaching New Keynesian theory. However, what many people find difficult to understand is how monetary policy (or at least monetary policy as seen by pretty much every central bank) could be regarded as an optional add-on in macroeconomics.
                The second difference between physics and macro that could lead to more mistakes in the latter is ideology. When you are arguing out of ideological conviction, there is a danger that rhetoric will trump rigour. In the next paragraph Cochrane writes

These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said, “We are all Keynesians now,” just as Keynesian policy led to the inflation and economic dislocation of the 1970s--unexpected by Keynesians but dramatically foretold by Milton Friedman’s 1968 AEA address. Keynes disdained investment, where we now all realize that saving and investment are vital to long-run growth. Keynes did not think at all about the incentives effects of taxes. He favored planning, and wrote before Hayek reminded us how modern economies cannot function without price signals.   Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience.  If we forget all that, we could repeat the economics of postwar Britain, of spend-and-inflate Latin America, and of bureaucratic, planned India.

Let’s not worry about where the idea that Keynes disdained investment comes from, or any of the other questionable statements here. This is just polemic: Keynes=fiscal expansion=planning=macroeconomic failure.  It is guilt by association. What on earth does fiscal expansion have to do with planning? Well, they are both undertaken by the state.
I have argued elsewhere that the problem too many macroeconomists have with fiscal stimulus lies not in opposing schools of thought, or the validity of particular theories, or the size of particular parameters, but instead with the fact that it represents intervention by the state designed to improve the working of the market economy. They have an ideological problem with countercyclical fiscal policy. But the central bank is part of the state, and it intervenes to improve how the economy works, so this ideological view would also mean that you played down the role of monetary policy in macroeconomics. So ideology may also help explain a lack of familiarity with the models central banks use to think about monetary policy. In short, an ideological view that distorts economic thinking can lead to mistakes. 

48 comments:

  1. excellent post, sign-posted to by Chris Dillow incidentally.

    I have to say the painful and possibly wilful misrepresentation of Keynesian economics is not restricted to professors of economics - policy makers I come across also twist and mis-apply Keynes through their particular ideological blinkers and end up with a tangled mess just as often as Nobel-winning economists!

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  2. I think the point is that we have a problem, I say 'we' even if I am not an economist, because economic theories influence political economic choices which influence the life of most of us.

    My personal opinion is that the blame game isn't useful in solving this problem. It makes the two sides of the controversy much more rigid and unwilling to seat around the table (even if virtual) and discuss it.
    In ancient India used to organize public debates and who lost the debate should convert to the view of the other.
    Of course I am not asking this (it appears to me a bit to much...) but to find a way for making the main representatives of the two sides to seat side by side for some days and discussing all this stuff openly and publicly would be useful in my opinion.

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    1. "My personal opinion is that the blame game isn't useful in solving this problem. It makes the two sides of the controversy much more rigid and unwilling to seat around the table (even if virtual) and discuss it.
      In ancient India used to organize public debates and who lost the debate should convert to the view of the other."

      I'm sorry, but who are these mythical 'flexible' Chicago economists?

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  3. I am glad to hear that some form of real-world economics prevails in Britain but it leaves me yet more puzzled at the embrace of austerity both there and in continental Europe. No one on your side of the pond, any more than ours, appears to have heard of the paradox of thrift.

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  4. Reading Cochrane has made me realize that economists in his camp (I'll use Krugman's terms "Freshwater economists" or "Freshies") can't get over the 1970s. It's their view that the 1970s is the economic period Keynesianism is "missing" in the sense that it fails to explain it. Conversely, the Great Depression, the recent financial crisis, and the Japanese lost decade on the other hand are periods that Freshies seem to struggle explaining themselves. I'm curious for my own education about your understanding of Keynes - how do you explain the 1970s? And why is Cochrane's (or the Freshwater camp's) explanation wrong?

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  5. Keynesianism didn't 'fail' in the'70s-the price of THE commodity in our economy rose sharply, and we (the US, anyway) tried to inflate it away-hence,"stagflation",as OPEC was not confused, and raised prices to compensate. The US economy sucked-except,for some reason, in Texas and Louisiana. When, in the early '80s, the price of oil tanked, the situation reversed itself. When the price of the commodity which affects all others is dropping like a rock( from nearly $50 bbl to $11 in three years, IIRC)you can have a great credit expansion without inflation -"Morning in America!" In Texas,however, the joke was that a bird, unlike a Texas oilman, could make a deposit on a new Mercedes. The Murchisons (owners of the Dallas Cowboys)went broke, John Connelly(yes,the former Governor in the limo with JFK) went broke...

    What's so complicated about this? How does it invalidate Keynes?

    The '70s were just an excuse- the indictment of Keynes is ideologically driven, period. I think of it as part of an ideological,political,social, and economic counter-revolution.

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    1. "Keynesianism didn't 'fail' in the'70s-the price of THE commodity in our economy rose sharply, and we (the US, anyway) tried to inflate it away-hence,"stagflation",as OPEC was not confused, and raised prices to compensate. The US economy sucked-except,for some reason, in Texas and Louisiana. When, in the early '80s, the price of oil tanked, the situation reversed itself. When the price of the commodity which affects all others is dropping like a rock( from nearly $50 bbl to $11 in three years, IIRC)you can have a great credit expansion without inflation -"Morning in America!" In Texas,however, the joke was that a bird, unlike a Texas oilman, could make a deposit on a new Mercedes. The Murchisons (owners of the Dallas Cowboys)went broke, John Connelly(yes,the former Governor in the limo with JFK) went broke..."

      The key point here is that monetary policy and fiscal policy CANNOT do anything about an actual resource shortage. Attempting to do so is how Zimbabwe got hyperinflation, incidentally. We effectively had a resource shortage in the US in the 1970s due to OPEC "closing the spigots". Now we have one worldwide as we hit peak oil.

      Most economists are absolutely crappy at analyzing situations with genuinely scarce resources (as opposed to common, but not infinite, resources). To my knowledge, some of the environmental economists have tried.

      Actual resource shortages must be dealt with by restructuring the economy to stop requiring the use of the resources. This almost inevitably means *government intervention*.

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    2. Yep. The attack on Keynesianism in the 70s was ideologically driven garbage.

      The true problem int he 70s was a real resource shortage. This is something Keynes himself would have understood, but sadly the government of the day didn't understand it. *JIMMY CARTER* understood it, but nobody listened to him...

      "Most economists are absolutely crappy at analyzing situations with genuinely scarce resources (as opposed to common, but not infinite, resources). To my knowledge, some of the environmental economists have tried."
      Yep. It's not a coincidence that environmental economics started in the 70s. Unfortunately, the establishment ignored them for decades.



      "Actual resource shortages must be dealt with by restructuring the economy to stop requiring the use of the resources. This almost inevitably means *government intervention*."
      Yes -- or intervention by an organization or actor as powerful as the government (so, you know, a consortium of major corporations could probably do it).

      It's also possible for it to adjust via individual action. In fact, it's inevitable; as the scarcity of the resource becomes clear, everyone will do their damnedest to get off of it. This is actually happening with the mass installation of solar panels and the switch to electric cars. The problem is that the individual, uncoordinated reaction to a real resource scarcity happens *TOO SLOWLY* -- it happens over the course of *multiple decades*, while the real resource scarcity can happen practically overnight.

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  6. How would anyone know if Physics professors made elementary errors ?
    Something a little similar happened recently in theoretical population genetics, the study of things like height or blood pressure that are affected by a large number of diff genes (as opposed to say blood type or thallasemia of Cystic fibrosis, which are essentially one gene)
    In a paper in PNAS, E Lander and coworkers show that for the last 20 years or so, geneticist - who are very math oriented in this subfield - have been making basic errors in their assumptions.

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  7. We are in a time at here in the states where ANY countercyclical efforts be it monetary or fiscal is met with a well orchestrated media campiagn to discredit.

    It is amazing how a handful of motivated billionaires with a neo-Austrian bent can through the use of "think-tanks" and PR flacks cause an entire nation for forget the value of both Friedman and Keynes. Sad times...where are the WMD?

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  8. Excellent post (Krugman sent me here). I do have one very rude question. What is the basis for your view that Cochrane is a very good economist ? I have not followed his work for the past 2 decades. I recall a JPE lead article in which he claimed he could tell how far below the maximium utility is by examining a first order condition. That struck me as a fail undergraduate intro micro level mistake (although obviously an editor and 2 referees had different views). Have you considered the possiblity that the emperor has no clothes and that Cochranes 2009 howlers are up to his normal level ?

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  9. If the government taxes A by $1 and gives the money to B, B can spend $1 more. But A spends $1 less and we are not collectively any better off.

    That assumes that the $1 taken from B is the consumption $ and not his capital - therefore the assumption is false as it does not apply to the rich who can pay the additional tax and continue spending at usual level

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  10. Here I am again. The doc by Cochrane which, I claim demostrates all sorts of ignorance about maximization is http://www.nber.org/papers/w2730

    One Krugman thought is that it is unfortunate thT, when economists think of the antural sciences, they think of physics. Tis is relevant. I can name a NobelLaureate in biochemistry (prize chemistry) who made a Cochrane 2009 level howler. Kary B Mullis. When he got the prize, he claimed that there was no convincing evidence tthat HIV caused AIDS. In fact there was such evidence (now amounting to rock solid proof due to the use of PCR a revolutionary technology for which K Mullis was awarded the Nobel prize).

    Physics is unusual, because introducotry physics has an agreed curiculum. Biology is very scientific (that is pretty theories which don't fit the data don't get any respect). But it is huge and messy and biochemists can make fools of themselves outdpside of their sub fields.

    Physics is not just succesfuk-- it is simple until it becomes incomprehensible (but still simple in that there aren't a bunch of different sub disciplines of similar status let alone schools of thought).

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  11. Lucas's statement is literally true in a full-employment RE model with one consumption good and in which the government spending is used on that consumption good. But why let an actuak model get in the way of a generous helping of libel...

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    1. Boy, that's a stupid model. It's been well understood forever that there are more than one consumption good, that government spending tends to be on different things than private spending, and that almost no economy has full employment.

      Saying "But it's true if cows are spherical" is not a defense. Lucas is pathetic.

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  12. A recent book by a Columbia B school professor-former Goldman quant-for,er physicist looks at the difference between models and theory by looking at physics, philosophy and then financial theory and Econ modeling. Interesting and easy read called Models.Behaving.Badly. ( yea, the title has the periods in it) just finished it yesterday.

    As for this debate, it's been great fun. Megan McArdle even finally weighed in over at The Atlantic ( she's a Booth School graduate)

    Welcome to the next year of U.S. Presidential economic policy "debate"

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  13. I don't have a background macroeconomics but do know some math and need a clarification: aggregate demand will rise at time t, but won't there be a net negative effect after time t? If you subtract off a smoothed version of a function from that function you should get a transient positive increase and then a dip below 0 for some period, resulting in a running integral that approaches 0 over time (assuming your smoothing "window" has an area of 1). So is this really an argument about borrowing against the future because we need stimulus now?

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    1. Remember the real world. The reason we're doing the bridge now is that employs resources that would otherwise go unused. There is also a multiplier effect: having money in the hands of the previously unemployed, who will probably spend it, puts further idle resources to use.

      The effect is greater if the bridge has a positive economic value (which would be nice). During the Depression things were so bad that it would have paid to pay some people to bury money and allow others to dig it up. We blithely imagine we can do better than that.

      The result is that the taxes to pay for the investment are levied on an economy that is at a higher level of production than it would have been without it. In your terms, you are subtracting from a different function.

      The effect you describe would occur if there were no idle resources, so that a dollar spent on A had to cause the dollar not to be spent on B.

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  14. Perhaps I'm missing something really obvious but, isn't it necessary to explain how the public consumption smooths before you can claim that aggregate demand changes?

    If I'm consumption smoothing I reduce my savings in the period of the tax rise, in the identity Y=C+I+G...yes C doesn't decrease by X but (C+I) can so in Lucas' language, it's a wash.

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    1. C+I can decrease by X but doesn't. The rise in G causes Y to increase allowing savings to rise to finance the original I.

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    2. A Keynesian would argue that Cochrane and Lucas are wrong when desired savings are higher than desired investment.

      So C+S falls by X but I increases by X. (G increases by X if you prefer not to count investment by government in I). Savings which had nowhere to go are put to work by government investment.

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  15. Chris G - You are correct, over time there must be a reversion to zero.

    What I find interesting is the same people who claim nobel prize winners must be morons for making that zero sum argument are quite happy to take the view that the effect of stimulus will always be positive because expectations had not anticipated the bridge.

    "Fool me once, shame on you, fool me twice shame on me."

    So at the end of T the bridge is built and the villagers acclaim the politician for the marvellous bridge and aggregate demand has risen during T. The only person upset is A who paid for it.

    So the politician starts talking about how wonderful it would be to have another bigger brighter bridge.

    And that is where A reduces his expenditure to pay for the first bridge and saves in anticipation of having to pay for the second bridge. He also decides he should avoid declaring all that income which is why he was forced to pay for the bridge in the first place. So he reduces his visible outgoings still further in t+1. This means aggregate demand over t and t+1 is less than if neither bridge had been built.

    But I guess Nobel prize winners need to make that explicit whilst Oxford professors do not.

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    1. The effect of stimulus is positive *because it employs people who would otherwise be unemployed*. That is why it is always effective to spend money on bridges *when there are unemployed bridge-builders*.

      Not because we need more bridges, necessarily; altough the bridge might come in handy, the key is that the bridge-builders will spend their money on food, clothing, shelter, etc. And nobody expected *that* money to be spent. Got it?

      In other words, you don't understand macro. GIVING MONEY AWAY to poor people would actually work during a depression. Once you hit full employment, then stimulus doesn't work.

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    2. (Technically, "full resource usage"; if you hit full usage of oil before you hit full employment, additional stimulus will only succeed if it's targeted at production which doesn't require oil)

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    3. You do not *have to* give money to an out-of-work bridge builder to build a bridge (or useless new city) that nobody wants to stimulate demand.

      Simply give the money (in limited amounts) to the bridge builder do simply spend. As long as he/she does not save or invest speculatively) then demand is increased.

      In an economy where there is over supply, as is the case at this time, then its win-win. At some time the money printed needs to be partially recouped through a tax on the suppliers.

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  16. @sargenz: I see what you're saying although it seems to come down to a matter of actual numbers since the factors you cite are of course not the only ones.

    If the goal is increased unemployment and gdp, and we're in a slump due to mutually-reinforcing factors such as low demand and fewer jobs, and monetary policy can't be used to counter those factors since we're already at the 0 bound, then stimulus makes sense, even if there's a small cost related to what you're talking about. My lay understanding is that those costs should be more than offset by the aggregate benefit to the economy. We're talking about a time-dependent system...

    As a metaphor, if I'm broke, I'd rather borrow against future earnings than be homeless by getting a loan eg, even if I have to pay interest on that loan. Sure I can still look for a job as a homeless person, but it'd be a lot harder to get one than if I actually had a place to live and clean myself etc.

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    1. Chris G - you have it exactly right. In a recession due to deficient demand, the intertemporal pattern of aggregate demand is wrong. By increasing government spending temporarily we can shift that pattern to combat the recession. Monetary policy, when not stuck at the zero lower bound, does the same thing.

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    2. Chris G: your metaphor: "if I'm broke, I'd rather borrow against future earnings than be homeless by getting a loan eg, even if I have to pay interest on that loan. Sure I can still look for a job as a homeless person, but it'd be a lot harder to get one than if I actually had a place to live and clean myself etc"....is a dangerous one! It simply suggests that borrowing itself is good when one is without funds regardless of really having calculated whether one could pay it back. This is a big mistake made all the time!

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    3. Its not a good idea to spend on useless infrastructure because that would create a dangerous over supply of useless infrastructure manufacturing specialists. When the infrastructure is built the supply chain becomes over time itself a waste of resources and skills. Factories that can make railway parts that nobody wants or needs.

      Its better to simply give the money away to people willing to spend it and not save or invest it.
      These people must and will make careful decisions about what to buy and thus a supply of useful manufacturing facilities is created, rather than useless capacity.

      Caveat - the way money is given away needs to be limited and calculated to avoid infinite bubbles and moral hazard where people expect limitless money for nothing. We are talking about a basic income - *carefully controlled* amounts at regular intervals that is recouped through tax on supply-side profits. I repeat psychological effects on actual people and infinite money expansion are the main, and very very serious issues. But, the effect is increased demand to economies where supply is plentiful.

      AT present there are plenty of consumers who are not already saturated with goods and services to make this work.



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  17. Sorry, I mean increased employment*

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  18. Simon I read an article at CNBC that I found interesting-it's about China and it's plans to do some fiscal policy.

    While it plans to do some monetary easing as well-cutting about 75 basis points-the focus is on fiscal stimulus; monetary policy it is feared could be inflationary.

    I wrote a piece on this wondering-irnonically had failled by not listening to Scott Sumner...

    http://diaryofarepublicanhater.blogspot.com/2012/01/guess-hsbc-and-china-havent-read-scott.html

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  19. Simon in the latest Sumner has a new hit piece on you and Krugman. He employs some pretty bad arguments like if you say such things about Lucas you are claiming that the Nobel Prize means nothing.

    He also comes up with a very strange defintion of saving.

    "the part of income not “spent” is saved, which means it’s spent on investment projects. Remember that S=I, indeed saving is defined as the resources put into investment projects. So the tax on consumers will reduce their ability to save and invest."

    When I question this defintion this is what he comes up with, " S=I is not a theory, it’s an identity. As far as I know it’s assumed true in every single macro textbook"



    Sumner's latest hit piece on Keynesianism http://diaryofarepublicanhater.blogspot.com/2012/01/there-scott-sumner-goes-again.html

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  20. The problem with this post is that it equates economics to physics. In physics they have this really cool thing called "repeatable experiments" that is noticeably lacking in macro.

    You should have started,

    "Imagine a respected history professor, Fred, doesn't start with the same assumptions as another respected history professor, John. Gosh, Fred is an idiot."

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  21. LOL on the comparison to physics. Economics is several orders of magnitude away from physics. A more apt comparison would be Toni Morrison criticizing Saul Bellow.

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  22. On the comparison of economics to physics, it is apt insofar as in both disciplines there are standard models that are used to explain the relevant phenomena, which are taught to students and should be well understood by academics in the field.

    Now, you may say (with some justification) that the models used in physics have a firmer basis in reality than do the models used in economics, but the point is that Lucas and Cochrane don't seem to understand the model in question (and I say that as someone who regards Lucas as a genius, though not on the Einstein level!).

    It would be like a prominent physicist making a statement like, "nothing can ever move because Newton's laws state that for every action there is an equal and opposite reaction, so whenever there is a force applied to an object there must be an equal force that cancels it out. Since there is no net force force, the object doesn't move." Now, it's a while since I studied physics, but I'm pretty sure an argument such as this would be fallacious, and I would be surprised to hear a Nobel-prize winning physicist making such an argument, even to a lay audience.

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    1. The problem is that by using physics as the example it suggests the model is more credible than it could possibly be in theory, or in fact is, in practice. Newton's laws weren't founded on the assumption that the gravitational constant is -9.8 m/s, rather, the constant was derived from first principles and verified experimentally. The same is not true for the "fiscal multiplier" or any other immeasureable economic quantity. It appears the sumner/lewis debate is partially a quibble about what some textbook "model" assumes this quantity to be. Nobody ever argued that g!=-9.8m/s.

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    2. the 'fiscal multiplier' does not exist

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  23. A proposal on how to improve economic debate http://europlay.blogspot.com/2012/01/one-debate-to-rule-them-all.html

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  25. economics, like physics, has become a highly specialized science, and only very few people in this world can master most (if not all) of it.

    I'm not sure I can name anyone like that since perhaps Keynes, Paul Samuelson, James Tobin. Anyone around today would qualify?

    How much do Lucas and Krugman know about dynamic econometrics? How much do Cochrane and Fama know about economic geography? It is a mistake to ask Lucas what he thinks about unemployment, it is a mistake to ask Krugman about over-identifying restrictions, etc.. But then journalists will ask them, and unwisely they may sometimes venture into territory they don't know.

    What did I just say? Lucas doesn't know his basic macro? No, not really, because throughout his career he has dismissed political advice and has concerned himself with deeper questions relating to the very long run or to existence or to mulitiplicity, etc.. so no, he cannot and should not be expected to be able to give sound advice on macro policy. So why do they give interviews, why do they write in blogs? vanity, presumption, etc.. and of course the politically charged atmosphere.

    When Prescott came to Hong Kong to give his (lucrative) post-Nobel speech he had slides about the Qin dynasty and read it as if it were the "Queen dynasty," that's just who they are, very, very specialized and not particularly educated about things other than their research topic. Mistakes by these giants of the profession are just what you'd expect from them when they venture out into the "real world".

    And physicists? please! a relative of mine who heads one of my home country's most advanced research team told me he had a creationist in the team, an American (obviously?), and the funniest bit is that the guy sitting at the desk next to him is a fossil hunter at weekends.

    Physics was my strong subject before I switched to economics, I will never let anyone say it's a harder science, oooooh no, that's a big myth, you know planes do fly but that's not thanks to Newton's theories (let alone Einstein's, naturally). And economies recover from great depressions with or without Keynes (it takes longer).

    The truth is only the ignorant expect Lucas, Fama, Cochrane, Krugman, to be mistake-free. To quote from my home country's best humorist (and translated for you), this dialog:

    -- what do you mean you don't know? don't they teach you anything at school?
    -- no, they don't, if you'd been you'd know.

    P.S. some 15 years ago, as an undergrad, I attended a conference in Edinburgh, you were very funny, you're a good man.

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  26. This is also wrong:

    "But the central bank is part of the state,"

    In the US we only adopted the Fed after ensuring that it would represent the interests of those people actually OWN SHIT. The Fed say "independence" and what it means is "finger on the scales to make sure we don't become England."

    I've now read 3 posts and found straight up instances where you have an engrained bias that doesn't understand that hegemony trumps the state.

    The state exists because it ensures the very people who matter - the rich competent businessmen - run the state - and the state, and monetary policy exists to serve their interests +1.

    Let me say it this way, without the state, there would be roads, and the state exists because it went to the people who would build roads without the state, and promised to build roads.

    The masses desire for roads is real, but one way or the other, only a few people actually make it happen, and they are not the public employees, they are the private interests, the public employees promise to serve.

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    1. Ah, but here's the problem. And I've explained this before. The problem is not the hegemony. The problem is when the rich competent businessmen are replaced by rich demented morons. This has happened in the US.

      Veblen describes the decay process in _Theory of the Leisure Class_ -- it is the change from "industrialists" to "financiers" in his terminology.

      The trouble is that the demented financiers do not actually know anything about anything. (Ours have gone so far that they don't even know about laws or accounting -- that's for their hired guns -- only about how to steal things.) They are quite incapable of running the country for their own benefit or anyone else's.

      They are upper class twits, in Monty Python's terms. The real fight is over whether the rich competent businessmen who know something about what they're doing (Warren Buffet types, perhaps) will prevent the loot-and-steal types at Bain Capital etc. from destroying the whole system.

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  27. I think you have misread Lucas. In his argument GDP increases with one bridge. but that's it! There is no further effects, the 'multiplier' is exactly 1. The reason is simple: The bridge builders get a temporary income from the Gov' for building the bridge. They split this between consumption and savings. But the boost in consumption is offset by the decline in consumption by the people being taxed.

    A multiplier of 1 is of course just what you would expect in a world with idle resources. The Keynesian magic comes from the fact that you get something more. And Lucas simple argument is that this something extra is zero if the bridge builders and the taxed people have the same propensity to consume.

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    1. Perhaps this is taking Lucas' informal remarks a bit too seriously, but he says: "You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge." It does seem like the implication is that there is zero net change to GDP. The statement "in some sense there is nothing to apply the multiplier to" also strongly suggests he means there is no net effect on GDP. Although Keynes did consider multiplier effects important, the most basic Keynesian point about fiscal policy is that fiscal policies (such as "balanced-budget" stimulus) with a multiplier of 1, or even less than 1, can increase GDP in a situation where resources aren't fully employed. The truly bizarre thing about Lucas' remarks is that he seems to think this can't be so, based on a simplistic argument that can be seen to involve neglecting intertemporal considerations.

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  28. In the post, the author is using a very cheap trick. In his opinion, at time t output rises because people will partly postpone the decrease in consumption due to taxes. And, we have to believe, in his opinion the world ends at time t, otherwise the smoothed decrease in consumption continues at time t+1, when there's no government spending anymore. The sum of all of these must be equal to government spending, that's budget constraint. Duh.

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  29. You don't get capital release (spending) equally by all players. When player A has a much larger pot than those of players B, player A is more likely to hoard resources (capital), than return it into the system. That same capital distributed more evenly flows more readily. Tax may or may not stimulate depending on the actions of the state. Greater wage parity does stimulate. What we have now is massive resource hoarding by a small group of wealth controllers. The best way to get equilibrium back in a system that has become more uneven is to give more labour powers.

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  30. Seems like a bit of a dry argument, since what we need is to spend and not tax. That is, assuming the goal is to actually help the economy recover.

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