Macroeconomics After the Crisis

|Peter Boettke|

Continuing on the theme of "confirmation bias" in my posting (and I should say papers going back to my NYU days in the 1990s, such as "Where Did Economics Go Wrong?" or "What is Wrong with Neoclassical Economics"), I would like to suggest to readers the new working paper from Ricardo Caballero on the problem of the pretense of knowledge in modern macroeconomics.  The paper is forthcoming in the Journal of Economic Perspectives and makes the very important point that we should never confuse the precision achieved in our models (in this case DSGC models) with precision in understanding the real-world.

Machlup was very good at making this point in his critique of "misplaced concreteness" in the leap from modeling exercises to real-world policy applications.  And Caballero is drawing inspiration explicitly from Hayek to make his point.

Pete Leeson, Chris Coyne and I have a paper from 2006 dealing with the critique of economists as "high priests" and arguing instead that we should take our place in the world happily as "lowly philosophers".  In that paper, we also argue that a discipline that is asked to do things it cannot do, but nevertheless attempts to do them will loose its "intellectual soul".  Our position is more explicitly radical than Caballero's reassessment of the enterprise of macroeconomics, but I am not sure the implicit implications are.

Where do you think all of this is going?

 

Comments

[Mario Rizzo]

I do not think that the re-evaluation is going very far -- just yet. Consider what Alesina of Harvard recently said in response to an Economist survey:

"As for the methods of teaching and research nothing has changed. We kept all that is good about methods in economics: theoretical and empirical rigor. But one may say we kept also what is bad: a tendency to be too fond of technical elegance and empirical perfection at the expense of enlarging the scope of analysis and its realism. Those who found our methodology good should not worry about changes. Those who did not like it should not hold their breath for any sudden change due to the crisis.”

I wrote about this recently:

http://thinkmarkets.wordpress.com/2010/10/01/changes-in-teaching-economics/

[Jerry O'Driscoll]

I'm surprised this post didn't draw more comments. Surely Pete's reprise of Machlup's argument is exactly what should be learned from the crisis. Perhaps everyone else shares Mario's pessimism (realism?).

Another Machlup point worth considering is that there are different kinds of inflation: prices, wages, costs. They have different effects. I would add asset-price inflation.

[Roger Koppl]

Thanks for alerting us to the Caballero paper, Pete. I'm impressed by it. The only thing he didn't do was 1) quote Mises in hushed tones and 2) call for abolishing the Fed -- and I'm only half kidding. Caballero is clearly pointing to network topology, just as Haldane, whom he quotes, and Kirman have. He seems less into the sort of complexity theory that I've been on about, but leaves that door open. He is pointing toward a comparative institutions approach, rather than a "policy" approach. It strengthens my belief that macro is headed toward Bubbles, Radical uncertainty, Animal spirits, and Complexit dynamics, at least if network theory counts as "complexity theory." His policy suggestions sound pretty reasonable and appropriately modest.

Austrians should be pretty happy about this. We should give Caballero a friendly reception. No doubt some (pseudo)Austrian commenters will blast Caballero for his "complete failure" to understand this, that, or the other "fundamental" point of "Austrian" economics. That would be a mistake, however.

[Jerry O'Driscoll]

To follow up on what Roger said, Austrians have an opportunity to seize the moment on the boom and bust. There is plenty good going out there to link up with.

[Richard Ebeling]

The starting point for any such reevaluation of how economists do economics should begin with an acceptance of how little they can know or understanding about the complex market order.

If I may, I'd like to quote Oskar Morgenstern on this point, from a lecture he delivered at New York University in 1975:

"I find however that very few men, even few economists, or should I say regretfully, especially economists, have a real appreciation and understanding of the immense complexity of an economic system. Now I have used the world 'system' but it is not even clear whether the word 'system' is appropriate because we do not understand fully the organizing principles that make the economic life of a nation possible.

"One need only observe what happens in an ordinary person's day and what is considered to be absolutely obvious and normal. We take a bus in the morning, we take a train, we do to the stores, we buy, the money is accepted with which we pay, or we pay by a check which will be presented to an anonymous institution, possibly far away, transmitted by mails about which we have no control whatsoever; the stores order and have things in stock; they set prices on the basis of the expectation of what competitors might be doing; we are buying on the same basis of expectation as to what are needs might be in the future and how they will be met; we spend our money today because we expect or salaries or incomes from other sources actually will be paid at certain dates in the near or more distant future, etc., etc.

"In all of this, there is no central genetic regulation, nobody who plans for all; there is no one to whom everybody is responsible. We carry a great deal of information in our heads, and that which we do not carry we can find in newspapers which gather information and are printed, again motivated only by their own self-interest, namely to write, to publish, and to sell with profit.

" At present, at this very moment, raw materials are being produced, for which there is no conceivable way of telling how they will be finally molded, into which kind of finished products they will be turned. A steel producer has no idea whether his steel will be used for the making of tanks, or ships, or paper clips.

"And yet all this works and works miraculously well, although of course it is easily subject to great disturbances. The astonishing fact is not that the thing does not work well, but that it works at all. It is only when we realize the complexity of the economy that we begin to see, and possibly understand, how dangerous it is to interfere in these matters.

"The economic system is in addition subject to great changes, caused partly by technology, by strictly political events, partly by changes in desires and wishes of the final consumers. There is thus more than one uncertainty which governs everything. . .

It the light of such observations, one should be extremely modest in making proposals for policy. In general, I would say that unless we are reasonably sure that we know what the consequences of new policy measures will be -- for example of new taxes introduced, prices regulated, etc., etc., -- we should leave things along.

"One interferes only if one believes that one understands what the consequences of the interference are. . . For example, Keynesian policy ideas of the 1930s are now being adopted by the U. S. government at a time when they have virtually no applicability whatsoever."

In pointing all of this out, Morgenstern was certainly staying loyal to his Austrian roots.

Richard Ebeling

[Greg Ransom]

Is there any chance anyone is going to publish the Morgenstern diaries?

It's really a shame that such stuff remains locked up in research archives, where only those able to bankroll a great expense can ever see them.

[Richard Ebeling]

I have not heard anything about publishing Morgenstern's diaries.

But from Robert Leonard's recent book on "Von Neumann, Morgenstern, and the Creation of Game Theory" (which, by the way, is a fascinating and insightful book) Morgenstern had a checked past.

Leonard quotes from Morgenstern's diaries (usually in the footnotes) and it suggests that Morgenstern had a bit of an anti-Semitic element from the expressions of frustration about the dominance of "the Jews" in Viennese life (including economics and social sciences).

He is highly critical of many of his fellow "Austrian" colleagues. He especially was highly critical of Mises and Hayek. Indeed, in the 1930s, he believed that Hayek was empty of all creatively and would contribute nothing of real importance!!

He strongly disagreed and disapproved of Mises' classical liberalism and defense of the free market. In this context, Leonard (and Hansjoerg Klausinger in some other writings) points out the extent to which Morgentern was a political opportunist who was willing to "advise" the corporativist/semi-fascist government in Austria from 1934 t0 1938 to bolster his personal influence on Austrian politics, before the German annexation of the country.

His diaries also bring out clearly how inferior he felt in terms of his knowledge of mathematics, regretting the years he had spent studying philosophy and history, rather than his ability at quantitative methods. In this context, Karl Menger, Jr. was an extremely important influence on Morgenstern's outlook on the application of mathematics to the social sciences.

It also comes out from Leonard's account, how little Morgenstern really contributed to the development of game theory. Von Neumann was the true creative genius who had been working on the theory, application, and logic of games since the 1920s. Morgenstern's "contribution" was mostly limited to the explanation of the meaning and uses of game theory to economics in their book on "The Theory of Games and Economic Behavior." The theory's development and logical construction were really all Von Neumann's.

I found all of these things to be extremely frustrating and disappointing. In the mid-1970s I had the chance to get to know Morgenstern at NYU, talking with him in his office many times. And I took his last class before he died, on the History of Economic Thought. I liked him very much, and found him kind, helpful, and another example of the old-world Viennese gentleman.

And I had found many of his own economics writings from the 1930s (during his generally "Austrian" phase of his life) to be insightful and often highly suggestive.

Leonard's book shattered much of the image that I had of Morgenstern in my mind.

Richard Ebeling

[fundamentalist]

The stagflation of the 70's broke the complete dominance of Keynesian economics, but ushered in neo-classical. Now Keynesian econ has rebounded and the crisis seems to be making it stronger. Will a new synthesis emerge that is even worse than neo-Keynes and neo-classical?

[Jerry O'Driscoll]

I pull one key point out of Morgenstern's quote, namely the astonishing thing is that the economy works at all. Hayek made a similar point (to paraphrase): before explain why things could go wrong, we should explain why they would ever go right.

Morgenstern also formulates a version of the Hippocratic oath: first do harm.

[Peter Boettke]

Richard,

The Leonard biook is brilliant isn't it? But one of the things fascinating about it is the the back story to the between the wars period. I do think there are a few soft spots in interpretation from what I could tell from reading in comparison your work, Stephan's work and Bruce's work. But still the work is masterful.