Policy Unpacked #4 – Rethinking post-crash economics

Policy Unpacked logoSince the Global Financial Crisis questions have been asked about the adequacy of dominant approaches to economic analysis. Are they sufficient to help us understand the economy or do they need supplementing or reformulating?

This is an important question for policy not simply because of the debate over austerity but also because economic ideas and arguments are increasingly influential when seeking to shape, justify or change policy more generally.

Students at a number of British universities have sought to question whether the economics curriculum they are offered for their undergraduate degree is adequate. This week the Post-Crash Economics Society at Manchester University published a report seeking to make the case for a more pluralist, critical and broad-based economics education.

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On the impact of economic ideas

Supply and demand graphYesterday Noah Smith discussed whether economists’ ideas and arguments have much of an influence on policy and practice. He used an edited version of a famous quote from Keynes as his jumping off point. He then considered whether we can credibly claim that any living economist has significant influence over the path of public affairs. He mentions Paul Krugman, Robert Barro, Martin Feldstein and Greg Mankiw. These are high profile economists who are leading candidates for influence. If they aren’t influential then perhaps no economist is.

Smith differentiates influence on public opinion from influence on elites. He notes that the general public is quite frequently strongly opposed to ideas that have a strong hold within the economics community – such as free trade being a good idea or rent control being a bad idea.

Smith concludes that while there might be some dead economists whose ideas still hold sway – Friedman’s libertarianism being the prime example – whichever way you slice it living economists aren’t demonstrably influential. They are not, in Smith’s assessment, anywhere near as influential as “writers”.  [Read more…]

Never mind possibilities for our grandchildren, what about our children?

Revisiting-Keynes-PecchiIn 1930 Keynes wrote his famous essay Economic Possibilities for our Grandchildren. In the essay he made a range of predictions about what the world would be like a hundred years hence. At the heart of the exercise was the impact of increasing productivity and rates of economic growth compounded over several decades. The result would be hugely expanded levels of economic output. In this respect he was correct, although in fact he rather underestimated the rate of growth in economic output over the subsequent 80 years.

But Keynes also envisaged a world in which productivity growth would be such as to create permanent technological unemployment. That is, it would not require all the available labour force to produce all the goods required to satisfy human need. As a consequence, a few people would be fully employed but most people would only have to work part-time. The later would appreciate the sustaining contribution of those who worked full time, for the benefit of all, but there was no longer a need for everyone to devote themselves so exclusively to the pursuit of mammon. The part-timers could turn their minds to higher things: they could devote time to other voluntary activities or cultivate the virtues of the arts and literature.

A few years ago Pecchi and Piga edited very interesting book called Revisiting Keynes in which a selection of leading economists provided their perspective on what Keynes got wrong and what he got right. A fairly obvious criticism of Keynes’ position is its liberal elitist bias and its rather disdainful attitude towards “trade”. Equally, his chronology was a bit wonky, if you take “grandchildren” literally. But two more profound criticisms meant that he was, overall, rather wide of the mark. [Read more…]

Name a book that changed your life

Earlier this evening Umair Haque tweeted:

 

My response was:

If anyone ever asks me a question like this I always respond with Stewart’s book, even though I can hardly remember what it says anymore.

Having tweeted, it all went a bit Proustian. Memories of the book, when and where I read it, came flooding back. And I considered whether I could really say it changed my life. [Read more…]

Looking to the past on expectations of the future

Broken magic crystal ball and finance arrowThe way in which economic agents form expectations about the future is one of the most important issues in economics. All economic theory has to take a position on the matter, whether it is discussed explicitly or the treatment is left implicit.

For three decades now the rational expectations hypothesis has dominated, despite a persistent strand of criticism. The more tenacious and optimistic advocates of the REH might take the view that it has something meaningful to say about how people actually make decisions. A more common position is to adopt an instrumentalist as if position. The latter approach is more credible, though nonetheless still problematic.

In a post yesterday at Noahpinion Noah Smith reviews developments in the theorisation of expectations. The stranglehold of the REH is undoubtedly weakening. A range of alternative approaches are now available and being actively explored. Much of this new thinking is inspired by the concern for decision-making biases and heuristics that characterises behavioural economics. Concepts such as recency bias or information cascades are invoked.

These ideas may well bring us closer to an understanding of how expectations are formed in the real world. But they open up the prospect of irrational market movements that is nothing short of alarming for those committed to a vision of markets as a process of orderly and predictable adjustment.

Smith notes that in looking for alternatives to REH not only can we draw on new theoretical resources but we can also look back to earlier approaches. Here Friedman’s approach based upon adaptive expectations is identified as relevant.

I would advocate stepping back even further. [Read more…]

The maths question in economics

Over at Noahpinion last week a post on the role of maths in economics generated plenty of comment.* This followed the award of the “Nobel Prize” in Economics to Shapley and Roth for work that is, in almost anyone’s book, highly mathematical. Noah Smith identified a number of reasons for using maths in economic analysis, each of which could be a good or a bad reason, depending on circumstance. His broad conclusion is that:

Math is not always the most appropriate tool in economics. But the more real successes economics achieves, the more good math it will use.

He argued that there are times when it would be appropriate to make less use of maths in economics. The argument here is summarised as:

The only time not to use math in econ is when we haven’t found the right math yet.

And in practice, I find that a few of the people calling for less math in economics … don’t seem to have any such goal in mind. There are a few people out there who would rather econ stay imprecise forever – so that nobody will ever be proved wrong or right, and we can let a million flowers bloom, and everyone’s scholarly opinion about the economy will be equally valid.

This is a debate that I spent some time thinking about a while ago. I have written a little about it in relation to the specific applied field of housing economics. It was interesting to revisit the topic for the first time in a while.

It strikes me, though, that this brief flurry of interest in the maths question is framing the discussion a bit too narrowly and missing some of the significant points. [Read more…]

On the wisdom of free capital markets

With the discussions over the future of the Eurozone at a critical phase, David Cameron yesterday started to make helpful noises about exercising a veto if British interests were not protected. And when he says British interests, it seems he primarily means protecting the status of the City of London as the pre-eminent financial centre in Europe. It is, of course, no great surprise that the Conservatives seek to protect the interests of the financial elite who are, after all, their major financial backers. But we need to hold on to the idea that it wasn’t so long ago that equating the interests of the City with the interests of Britain was being severely questioned. And those camped out at St Paul’s act as a continuing reminder.

Cameron’s comments led me to wonder how that rebalancing of the British economy away from finance and an over-inflated housing market was going.

We desperately need to take seriously the broader debate not only about rebalancing but also about the influence of the capital markets on broader social development and human welfare. [Read more…]