On Friday Simon Wren-Lewis discussed whether New Keynesians made a Faustian pact when they decided to engage new classical economists on their own modelling territory. He concludes that New Keynesians were not compelled against their will to adopt modelling devices such as rational expectations and inter-temporal optimisation at the individual level. These modelling techniques were perceived as an improvement on existing practice. But it may nonetheless have turned out in retrospect to have been a strategy that carried significant costs. New Keynesians may be less able to shed light on fast moving events in the real world than they might otherwise have been.
A couple of weeks ago Martin Wolf blogged on the way in which modern macroeconomics has neglected the explicit and integrated treatment of the financial sector. The consequences of this omission have turned out to be of enormous practical significance. It left analysis mostly blind to a range of important real world developments. He provided a brief summary of the characteristics of the banking system that he considers economics students need to be familiar with.
This is a theme developed by Professor Wendy Carlin in the revision of her textbook currently under development. She blogged about the aim of the project a year ago. The revision seeks to move instruction beyond a three equation model which does not explicitly incorporate money or credit. The approach retains that three equation model at its heart, but grafts on to it a financial sector that is, rather than a gross simplification, relatively rich in institutional detail. The motivation is that the model needs to be able to explain how changes in financial markets shifted and intensified risk in ways that ultimately precipitated the financial crisis and the subsequent macroeconomic turbulence.
It strikes me that this is an important project. Rather than leaving consideration of the impact of a highly developed financial system to more esoteric later study – if it is ever studied at all – it starts students off with an appreciation of the fundamental significance of finance for the functioning of the macroeconomy. [Read more...]
When I first studied macroeconomics the Stagflation era of the 1970s and the death of Keynesianism were still being quite hotly debated. They were still contemporary events. Well, they were contemporary events in the way that the election of Tony Blair is a contemporary event for us today – it seems like just yesterday for the lecturers but has almost no significance for the students because they were far too young at the time.
At an empirical level the death of Keynesianism was intimately associated with the breakdown of the Phillips curve. The trade-off between inflation and unemployment had been at the heart of macroeconomic management. The death of Keynesianism was hastened at a theoretical level by the Lucas critique and the rise of rational expectations.
But the death of Keynesian was also tied up with the argument that the nature of the macroeconomy is such that government attempts to fine-tune demand were inevitably doomed. Active policy has its effects only with a significant lag – 12 or 18 months. Governments were succumbing to the temptation to ‘fine-tune’ before they’d let previous changes work their way through the system. As a consequence the economy was forever under- or overshooting. Volatility was greater than it would have been if governments had resisted fiddling around. This is a practical argument, but it is also an ontological argument. It is about the very nature of the economy.
This old argument came to mind when we saw yesterday that asking prices for housing in London had increased by 10% over the last month, according to Rightmove. That follows a sharp upturn in prices in the previous month. The London average now stands at a truly eye-watering £544,232. [Read more...]
The more I think about economic policy the more I think that there isn’t a big enough dose of interpretivism applied to it. This thought recurred yesterday reading George Osborne’s set piece speech in which he, as Isabel Hardman of the Spectator put it, “trashed” Plan B. I think trash-talk would perhaps be a better description of his approach.
One thing that – some – economists have learnt from the Great Recession of 2007-08 is that our understanding of the economy is rather more partial than had hitherto been assumed. That doesn’t mean that economists don’t have interesting and useful things to say. But the economy can behave in ways that economists found difficult to read. Some would say this means models need to be refined, respecified, recalibrated. Other would take a more radical stance and say that the economy and economics needs to be rethought. Conventional models and methods don’t have room for some of the characteristics that are fundamental to the way the economy functions. Chris Dillow highlighted some key points last week in the context of a post about the difficulties of forecasting.
If you were thinking about it in terms of narratives you might suggest that what is needed is a change of root metaphor. [Read more...]
Next weekend Bristol will host the Festival of Economics, organised under the auspices of the Festival of Ideas. The programme for the Festival of Economics has been assembled by Diane Coyle of Enlightenment Economics. It brings together economic journalists, applied academic economists, and economists in the think tank world who seek to talk directly to policy makers. Some are relatively mainstream in their orientation. Some are decidedly more heterodox.
The arrival of the festival coincides with my finally getting the chance to finish Diane’s recent edited collection What’s the use of economics? Teaching the dismal science after the crisis (WTUOE). The book arises out of a seminar held back at the beginning of the year, which I would dearly have loved to have attended. Unfortunately it clashed with teaching my economics of public policy unit. The book comprises 22 brief chapters giving a range of perspectives on how economists should respond to the deficiencies exposed by the 2007-2008 financial crisis.
At least some parts of the economics community are in reflective mood. [Read more...]
That doesn’t seem to me to be entirely fair, for two reasons. First, there were some useful measures in the Speech – on banking or energy market reform, for example – that have the potential to make a difference to the performance of the economy. Second, it’s not obvious that the Queen’s Speech is the place you’d expect to find a menu of measures designed to stimulate the economy. If the Government wanted to get serious with the economy then much that it might consider doing can be achieved without the aid of new primary legislation.
So maybe we need to look back to the Cameron-Clegg relaunch event on Tuesday to get a better idea of policy action on the economy. After all:
The desirability of free capital movement is an article of faith for the international organisations that seek to govern the global economy. The perspective is shared by the governments of most developed countries. Liberalisation of capital markets is typically part of the medicine prescribed to ailing countries. A weakened country might consider imposing capital controls in a bid to gain some relief from a battering in the global financial markets, but international treaties can stand in its way. This is part of the challenge currently facing Hungary, as discussed by Frances Coppola here.
A month ago I blogged On the wisdom of free capital markets, in which I drew on James K Galbraith and Keynes to argue that an overwhelming emphasis upon retaining the free movement of capital is mistaken. This becomes even clearer when one looks at the issue from a development perspective. Successful development has not been founded upon free capital markets. Free capital markets have led, historically, in a different direction.
Given this starting point, my eye was drawn to an article by Heather Stewart in yesterday’s Observer entitled Financial crisis could turn the tide against unrestricted capital flows. [Read more...]
Lucas Papademos, former vice-president of the European Central Bank, has now been installed as the new Prime Minster of Greece. The imminent arrival of former European Commissioner Mario Monti as Prime Minister of Italy will get the post-Berlusconi era properly under way. This is to be an era of technocratic policy-making by market-approved placemen.
Defenders of democracy are deeply concerned about the way in which this process has evolved. It is not so much that crisis has precipitated change at the top of national governments. Nor even that these countries find themselves governed by interim governments that are appointed rather than elected. More concerning is the apparent erosion of sovereignty through the overt intervention of foreign governments in domestic affairs, and the apparent concentration of European power in the hands of the eight members of the Frankfurt Group, only two of whom are democratically elected politicians.
But this is not simply a crisis of politics and the economy. It is also a crisis of economic epistemology. Of economic knowledge. Paul Mason, BBC Newsnight’s Economics Editor, observed on Friday’s programme that “The economic orthodoxy of an entire generation of politicians seems to be failing. And they don’t know what to do.” [Read more...]
In a post at Liberal England yesterday entitled Clegg tells Lib Dems to come out from behind the sofa Jonathan Calder responds to a brief piece in the Independent on Sunday. The Indie reports that Lib Dem ministers have been instructed to be a bit less reticent in speaking about the distinctively Lib Dem successes in government. The party is suffering in the polls in a way that the Tories are not. Some better PR would help.
Calder offers two reasons why the Lib Dems were behind the sofa in the first place. First, the party is not used to being unpopular. “When you are the third party, being ignored is a far more familiar experience”. Second, “we are not really sure what Liberal Democrat economics look like”.
I’m not convinced the second of these reasons put the Lib Dems behind the sofa. But I am certain it is an issue. We really aren’t sure. [Read more...]
Leading active members of today’s economics profession … have formed themselves into a kind of Politburo for correct economic thinking. As a general rule—as one might generally expect from a gentleman’s club—this has placed them on the wrong side of every important policy issue, and not just recently but for decades. They predict disaster where none occurs. They deny the possibility of events that then happen. … They oppose the most basic, decent and sensible reforms, while offering placebos instead.
James K Galbraith
Last weekend in a brief post over at Pop Theory Clive poses one of the key social scientific questions of our time – What do economists know? Of course, the answer depends on which economists one is talking about. As the epigraph above notes, the mainstream of macroeconomics largely misses the point. It didn’t see the current economic turmoil coming and has little to offer by way of solutions. One striking thing about Galbraith’s comment is that it was written in 2000. Not a great deal has changed since then. These deficiencies with mainstream approaches have been recognised by some high profile mainstream practitioners, as I noted last month in the aftermath of this year’s Nobel prize in economics.
Yet, it is not as if economics has nothing sensible to say on the matter. [Read more...]