Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 5 February 2018

Academic knowledge about economic policy is not just another opinion

Does the financial crisis reveal that economists are at the leeches and mercury stage of their subject, and as a result policy makers and the public have every right to ignore what they say? Does the fact that economists working in finance failed to recognise the prospect of a systemic crisis, and that macroeconomists both took finance for granted and as a result failed to investigate financial-real links, mean that we should ignore what economists say when it comes to Brexit?

Speaking for my own subject, I think the financial crisis does raise serious questions about the methodology macroeconomists rely on, as I have explained at length elsewhere. But does it mean that everything macroeconomists have learnt in the last 80 years is virtually worthless, or at least no better than the opinion of the average politician? Why don’t we look at what has happened since the financial crisis.

Macroeconomists, having learnt the lessons of the 1930s, immediately recommended that policy makers do three things after the crisis: cut interest rates sharply, embark on fiscal stimulus and bailout banks. Policy makers took that advice in 2009, and as a result we avoided another Great Depression. Many said that rising government debt was sure to send interest rates on that debt rising: academic economists using basic ideas from Keynes said they would not and they were proved right. Many others said that Quantitative Easing (central banks creating money to buy government debt) would cause hyperinflation, but again academic economists looking at more modern New Keynesian models said that was nonsense and again they were right.

You might claim that in all this economists were just advocating what was obvious. The acid test came in and after 2010, when fiscal stimulus turned to austerity. What evidence we have suggests this move was opposed by a majority of academic economists, a majority that grew over time. There was a minority that supported austerity, at least for a time, and they gained a lot of publicity because politicians latched on to what they had to say. But the majority followed both textbook and state of art economics, and this majority was right. The recovery would have been stronger and faster if politicians had gone with this majority.

If we look back before the financial crisis at UK macro policy, we can again look at the record of economics compared to politicians. The obvious place to start is with the 364 economists, who despite all attempts by politicians and think tanks to suggest otherwise were right: tight fiscal policy in the 1981 budget delayed a proper recovery by over a year. We can look at the following recession in the early 1990s. A key driver behind that was the UK joining the ERM at far too strong an exchange rate. Here it gets personal. With colleagues at the National Institute I undertook what was acknowledged at the time to be the most comprehensive analysis of the appropriate entry exchange rate, and we argued that our entering at the then current rate was folly. We were ignored, and as a result the UK was the first to be kicked out of the ERM in 1992.

The next time the UK had to decide to join in this case the ultimate fixed exchange rate regime, the Euro in 2003, it was the economics that persuaded the Labour government not to join. In this case macroeconomic analysis played a critical role in making the right decision.

All this suggests to me that macroeconomics, if we compare it with medicine, is well beyond the bloodletting stage. It would be very surprising if we were not, given 80+ years of study and the huge amounts of data now available. Of course that does not mean academic macroeconomics will not make mistakes, and of course unconditional forecasters of the kind you read about endlessly in the papers will always get things wrong: our own models tell us they will. But when it comes to macroeconomic policy, experience suggests you are much more likely to get economic policy right if you ask an academic macroeconomist than if you ask anybody else. [1]

The other key thing to say is that the discussion above has virtually nothing to do with the long term impact of Brexit, which depends on international trade. The key bit of analysis that means trade with the EU cannot be simply replaced with trade elsewhere are gravity equations. Gravity equations do not come from theory but from the data: countries are much more likely, even today, to trade with near neighbours than far away countries after allowing for other factors. So when Rees-Mogg suggests that the Treasury must have fiddled the numbers, when the government’s analysis confirms those of other studies that Brexit will be costly for all of us, we know he is slandering civil servants for his own political gain. That he is also the favorite to replace May as leader of the Conservative party tells you all you need to know about the current mess the UK is in and why it is in this mess.

Of course we do not condemn engineering science when a new bridge wobbles or an oil rig fails, and we do not say that all medical science is nonsense when medics get things wrong, as they frequently do. But with economics, there are too many people who either want to replace the mainstream with their own school, or who like Rees-Mogg want to discredit economics because they suggest his preferred policy is harmful. As a result, whenever economics does make mistakes, as it will, there will be plenty of people around who want to bury the whole discipline. But when you look at all the evidence and not just one observation, as economists are trained to do, you find that you are better off following the advice of academic economists when it comes to economic policy than anyone else.

[1] The argument that academic economists should be modest or humble when giving their views should be seen in this light. They should certainly be honest about their own views compared to their colleagues, and they should also if they are given the opportunity express the uncertainties. But being modest and humble should never mean leaving politicians unchallenged when they proclaim economic nonsense. 





15 comments:

  1. I entirely agree with you here; a wholly reasonable stance to take.

    However, the mistake is to think that the economics is the decider; in other words if the economics says we will benefit then that closes the discussion. It doesn't.

    With a subject like immigration, much commented by you in this blog, the economic benefits are clear as you say but that doesn't mean that immigration is a good thing. If it is measured, that is if it is at such a rate as it can be absorbed, then it may be fine. But if it is not and people see that the rate of increase is changing the culture then they may be inclined, and indeed do, ignore the economics and plump for control. In your eyes they may be wrong, and even stupid, but these arguments cannot be dismissed so easily.

    Economic welfare is not the ultimate criterion in order to judge many issues; it is an important consideration but not an overriding one.

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  2. I don't know who Dan Davies is, but I like the cut of his jib.

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  3. I came into the financial crisis and unsure what the expansive policy followed by Darling would do (blow up the deficit, hyper inflation etc etc). I read Paul Krugman, Simon etc and others all the way to the hard money Von Mises school, they all made testable predictions and in some cses showed their working. I am a scientist, and the results are undeniably in. Did we see hyper inflation in the UK or USA? Did growth stall when austerity was applied? DId growth pick up when austerity was released? No person honest with themselves can but say that Simon et all, were right ergo their models are right. I might disagree with Simon about politics but when smart but cynical people deny the data we are in trouble.
    We see it in the oppostion to understanding climate change, pollution and plastic.
    Smart cynics whipping up the mob against the 'elite' and their 'expertise' goes back to Clodius. It collapsed the Roman Republic and unchecked it will do for us. Its the reason why people feared democracy could not last. The prominence of the Rees-Moggs of this world suggest we are at the end stage of democracy and the beginning of authoritarian rule enforced by the mob (known as the will of the people).

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  4. A broad pool of mainstream economists, backed by the Treasury, did predict a recession following the June 2016 Referendum:

    http://www.bbc.co.uk/news/uk-politics-eu-referendum-36355564

    Even in medicine - which is far from being a hard science - there's burgeoning debate about the financial interests behind diagnosis and treatments. The over prescription of statins is likely a direct consequence of expert research funded and backed by drug companies that make huge amounts of money from statins.

    Economics as a public interest discipline has been discredited through the actions of some of its vocal and overpaid practitioners - many of whom didn't bother to read Keynes.

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  5. I agree with every word of this but remain puzzled by what I perceive as your hostility to pluralism- apologies if I misunderstand your position. Pluralism simply means examining a range of perspectives and approaches, it certainly does not mean that 'anything goes' or that no attempt should be made to distinguish between wheat and chaff. Good policy making requires eclecticism and an understanding of different world views, of selecting the right tools for the job in hand, and considering the various states of evidence. Often knowledge of an alternative suggests a different approach that might otherwise be overlooked, and there can be genuine insights for greater understanding from Austrian, Marxist, feminist, behaviourist, Neo-classical, Keynesian, institutionalist etc Hostility to alternatives, challenge or the insistence on a sole methodology is the antithesis of a dynamic science trying to progress, no matter how bad the behaviour of some heterodox economists. Critical evaluation of alternatives and diversity of approaches, extracting the best from these for an issue according to analysis and evidence, is at the heart of good policy making. This is something well recognised by the Government Economic Service, see for example the excellent blog at https://quarterly.blog.gov.uk/2017/08/08/economics-in-government-more-open-more-diverse-more-influential/

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  6. You can tell that economists understand that Economy thing better than the rest of us by the way they can forecast the future economy and thereby make themselves vastly rich at the stroke of a pen (or press on a keyboard).
    I am sure Professor Lewis, knowing more about this than anyone else in Oxford, has already mortgaged his house and staked the lot on the outcomes of the current economic policy.
    Why would he not?

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  7. Did you choose the number of years carefully ? "Everything that macroeconomists have learned in the past 80 years" means "everyting macroeconomists have learned since "The General Theory ..." was published.

    Economists learned the lesson of the 30s during the 30s. The claim that macroeconomists have learned something useful in the past 80 years is markedly stronger than the claim that macroeconomists have some useful things to say.

    For years, I have an open challenge for something which is not in The General Theory ... , not price stickiness, and actually true. It hasn't been met.

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  8. Now note gravity equations (not in Keynes). As you say, they are empirical regularities not derived from theory. For 45 years, macroeconomists have been fascinated by the argument that atheoretic empiricism is a mistake. The success of gravity equations is just more evidence that macroeconomics took a wrong turn.

    But mainly note the odd coincidence of "Keynesian" and "80 years". You would be in a much stronger position if you had typed 90 or even 85.

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  9. Oh no a third comment. There is nothing *New* Keynesian about the claim that monetary policy will not cause inflation if the economy is in a liquidity trap. That's in the General Theory. It was clarified by Hicks. The argument can be phrased as "expanding the supply of high powered money won't change much, because we are a horizontal part of the LM curve".

    That which is (relatively) new is the idea that credible promises about monetary policy to be implemented when the economy is out of the liquidity trap will affect the economy while it still is in the liquidity trap. Sadly, the evidence has not been kind to that hope. The result of analysis is "It depends on what investors believe which we can't guess". This isn't a new inconclusion.

    However, the appealing logic of Krugman (followed by Woodford) convinced some people that it was OK to give up on trying to convince politicians to Fiscally stimulate and turn to non standard monetary policy.

    This was a mistake. The cost was low, as there was no hope of making politicians see reason. But neat theory was a distraction. Equations in which the outcome depends on an unknowable variable add nothing, but they influenced thought.

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  10. "Many others said that Quantitative Easing (central banks creating money to buy government debt) would cause hyperinflation, but again academic economists looking at more modern New Keynesian models said that was nonsense and again they were right."

    QE caused hyperinflation in asset markets. Did NK theorists see that coming? It may have sown the seeds of the next crisis.

    "Macroeconomists, having learnt the lessons of the 1930s, immediately recommended that policy makers do three things after the crisis: cut interest rates sharply, embark on fiscal stimulus and bailout banks. "

    Which "mainstream" are we talking about? Many mainstream economists believed in policies contrary to the above. I think Simon is bending, stretching and rewriting history somewhat.

    "...you find that you are better off following the advice of academic economists when it comes to economic policy than anyone else."

    Simon has to be kidding!


    Henry Rech

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    1. The biggest FU of all came in 2011 and 2013 when in the direct aftermath of the crisis Sargent and Fama were awarded 'Nobel' prizes for their "contributions to the advancement of humanity"; there should have been some very serious questions asked about their work and some soul searching in the profession.

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  11. a majority that grew over time. There was a minority that supported austerity, at least for a time, and they gained a lot of publicity because politicians latched on to what they had to say. But the majority followed both textbook and state of art economics, and this majority was right. The recovery would have been stronger and faster if politicians had gone with this majority.


    Can we assume for just one moment that the Tories ignored historical wisdom and in fact knew what sort of outcome they required. After tarring New Labour with overspending, which was a patent lie, later admitted in an interview between Andrew Neil and George Osborne, because he was no longer in office, that as the evidence proves New Labour's spending averaged 3% of GDP all through their term of office.

    This lie was deliberate deception in order to substantiate their claim to cut public expenditure, for which there was no good reason whatsoever, except that it fitted nicely into their agenda of transferring public services into the private sector and to asset strip the state, the Naylor report spells it all out for you, yes that is the NHS but demonstrates in detail what they have been doing all along.

    This whole charade, even down to the EU chaos is being deliberately carried out to fit their ultimate agenda, and its time people woke up in this country as to what is really going on instead of navel gazing.

    https://www.youtube.com/watch?v=7c4NQvAK5CI

    Think what you like about this video, but why are so many meetings around the world held in secret, and why do people constantly feel powerless, when we are told by big business and government that they want to empower us??????

    There are so many institutes now that peddle Neo-Liberal propaganda as though it were gospel, The Koch Brothers and the Cato institute being just one example.



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  12. "Many others said that Quantitative Easing (central banks creating money to buy government debt) would cause hyperinflation, but again academic economists looking at more modern New Keynesian models said that was nonsense and again they were right."

    The nonsense is in the sticky price rational expectations optimisation model. In 2008 credit channels had frozen up, we were facing a very serious deflationary situation in the real economy which we had not seen for over a generation. People in the know did not bring out their sticky price rational expectations optimisation models at this point. The real innovation actually took place in Japan which had seen this situation arise almost 10 years earlier - and Bernanke himself and a few others, together with his knowledge of the 1930s, followed the Japanese experience very closely. The Japanese drew on very old practice - in fact what we call unconventional monetary policy has a long tradition in Japan that goes back even before their 1930s counter-depression policy.

    The New Keynesian model was a distraction in understanding the big problems building up in capitalist countries during the so-called Great Moderation, did not offer real tangible guidance in how to deal with the crisis once it happened, and does not offer any real leadership in how to go from here.

    NK.

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  13. "Gravity equations do not come from theory but from the data"

    But data from galaxies show that gravity equations are wrong. You have to invent dark matter to try to keep them. Dark matter is theory, not data. Your analogy is telling because economics, like gravity equations, ignores the huge increases in the money supply from the private sector. Economists still assume neutrality of money but data disproves them ...

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  14. Hey, don't knock mercury. It really does cure syphilis (if it doesn't kill you first). Just like austerity/internal devaluation eventually does realign real exchange rates (as even Krugman concedes in a recent blog.

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