Friday, December 23, 2011

A satisfactory philosophy of ignorance (John Cochrane edition)

"I feel a responsibility as a scientist who knows the great value of a satisfactory philosophy of ignorance...I feel a teach that doubt is not to be feared."
- Richard Feynman

A few posts back, I blogged about a Hoover Institute panel organized by John Taylor, in which eminent macroeconomists were invited to give their thoughts on how to restore America to robust growth. Now, via David Glasner, I have found a transcript of John Cochrane's remarks at the panel. Given Cochrane's polemic tone in past writings, my hopes were not exactly high. But I went ahead and read the whole thing, and what I found left me (mostly) pleasantly surprised. Cochrane spends much of his time talking about how macroeconomists really don't understand that much about the economy:

Why are we stagnating? I don’t know. I don’t think anyone knows, really...Nothing on the conventional macro policy agenda reflects a clue why we’re stagnating... 
This conference, and our fellow economists, are chock full of brilliant new ideas both
macro and micro. But how do we apply new ideas? Here I think we economists are often a bit arrogant. The step from “wow my last paper is cool” to “the government should spend a trillion dollars on my idea” seems to take about 15 minutes... 
Compare the scientific evidence on fiscal stimulus to that on global warming . Even if you’re a skeptic, compared to global warming, our evidence for stimulus ‐‐ including coherent theory and decisive empirical work ‐‐ is on the level of “hey, it’s pretty hot outside.”... 
There are new ideas and great new ideas. But there are also bad new ideas, lots of warmed over bad old ideas, and good ideas that happen to be wrong. We don’t know which is which. If we apply anything like the standards we would demand of anyone else’s trillion‐dollar government policy to our new ideas, the result for policy, now, must again be, stick with what works and the stuff we know is broken and get out of the way. 
But keep working on those new ideas!
These quotes, in my opinion, are spot on. If there's one point I've consistently tried to push since I started writing about macro on this blog, it's that we don't really know that much about how business cycles work. Sure, we are reasonably sure of a few things, like that most recessions, and the biggest recessions, are driven by demand shocks (as is high unemployment). And it seems that having the government spend money boosts GDP growth during recessions. But in general, we are just very ignorant. We don't have a really good (i.e., quantitatively predictive) model of how aggregate demand works, or why stimulus has an effect.

Given this ignorance, the appearance of precision and "sciency-ness" offered by modern business-cycle models seems pernicious to me. It biases the field toward making minor modifications of the existing paradigm (Olivier Blanchard's "haikus") rather than exploring blue-sky ideas that might lead to real leaps in our understanding. I can't offer a ready alternative to the DSGE paradigm (maybe someday I will), but I think that in the absence of something that works, the best alternative is to adopt a "satisfactory philosophy of ignorance."

So I like what Cochrane is saying about our ignorance. And I think there is a powerful case to be made for policy inactivity - the idea of "first do no harm." If you are a doctor and your patient is in critical condition, but you don't know how to save him, you don't just pump him full of every drug you have. If I were an opponent of fiscal stimulus, that is exactly the argument I would make - that the burden of proof is on the proponents of stimulus, and that the evidence is too muddled to risk making the situation worse. 

Unfortunately, stimulus opponents typically make far bolder claims, like "stimulus can't possibly work." And in doing so they throw away their natural advantage, because instead of a "satisfactory philosophy of ignorance," they reach for a false certainty and end up overstating their claims.

This is also where John Cochrane, in my opinion, stumbles a bit. Even as he points out how ignorant macroeconomists are, he goes ahead and offers his own positive theory of the recession:
So what if this really is not a “macro” problem? What if this is Lee Ohanian’s 1937 – not about money, short term interest rates, taxes, inadequately stimulating (!) deficits, but a disease of tax rates, social programs that pay people not to work, and a “war on business.” Perhaps this is the beginning of eurosclerosis. (See Bob Lucas’s brilliant Millman lecture for a chilling exposition of this view).
Yes, Cochrane says "perhaps" and "what if." But it certainly seems as if he leans toward the Ohanian view. The problem is, this view is pretty easily debunked by a casual reading of history. Tax rates have not gone up since 2007, and social programs are not currently more generous than in the past. There is much we don't understand about the true causes of recessions, but at least we understand that much! 

But then Cochrane comes back and says this:
Our (microeconomic) garden is full of (policy) weeds. Yes, it was full of weeds before, but at least we know that pulling the weeds helps. Or maybe not. (emphasis mine)
This is great! Not only does Cochrane move away from Ohanian-land and back toward the "first do no harm" critique of stabilization policy, but he admits that even that might not be right!

So basically, even though it includes a number of substantive points with which I'd argue, I really, really like this Cochrane talk. Now there's a sentence I didn't expect to see myself writing when I first followed the link!

It has always been my opinion that the neoclassical revolution hit its high point with the Lucas Critique. It was a great thing to expose the inadequacy of the macro models then in use. But when the neoclassicals went ahead and replaced those models with RBC and Rational Expectations, I feel like the revolution really overreached. The inability of RBC (or DSGE in general) to explain our current economic woes has led some neoclassical-minded folks to reach for Ohanian-style explanations (it's the socialists' fault!). Instead, I think that they should go back to where Lucas started, and embrace a "satisfactory philosophy of ignorance." Even as someone who is very dubious of the neoclassical worldview, that is a perspective with which I would heartily agree.


  1. Anonymous12:48 AM

    While you're talking about these issues, can you please explain why macroeconomists care about Ohanian? I've never understood how his "The Great Depression happened because Hoover told some captains of industry that he was feeling sad" hypothesis is supposed to make any sense, but I am not trained in macro and might be missing some way his work links into the literature that makes it not ridiculous.

  2. Aren't the unreliable factors in macro always embedded in the psych of shifting individual preferences? Until neuroscientists can at least propose a testable whole system theory of mind that can justify their MRI research budgets macro economists will continue to base their theories in part on the sophomoric semi-predictable behavioral preferences of psych undergrads.

    In the meantime I can propose a layman's philosophy of ignorance.


    I The fundamental currency in all cultural transactions is certainty based on either evidence or belief.

    II The demand for certainty is always greater than the supply of evidence.

  3. Anonymous8:46 AM

    Hayek said this many years ago....the pretense of knowledge.
    We know no more about the economy than why are we wasting billions of pounds paying people to study it? Money better spent on biological/medical research.
    Perhaps econ meets a deep felt human need for assurance that "someone" understands how things work, even if it an illusion.

  4. I have a rule I follow: Follow the money.

    Credit creation, or lack of same, drives profits and economic activity. Banks create credit and they don't need government to do so.

    Follow the trend of credit creation and ask where it is going, and how fast. This function basically explains just about everything economic as far as I can determine.

    This may not sound very academic but it sure as heck works.

    A follow on corollary is to ask whether the credit flow is going into something productive, or just consumption. If it's mostly consumption, incomes had better be rising otherwise you're building debt based Ponzi business--and asset bubbles.

    Finally, markets are unstable. Tom Keen makes this point precisely--and mathematically. Forget equilibrium thinking. It's a total fantasy.

  5. Other things we do know.

    High Unemployment carries a high social cost. People who are jobless for several years fail to develop skills that make them employable. There is a high social value to programs that move people from unemployed to employment.

    States and local governments have shed millions of employees, especially school teachers. This has been done strictly as cost savings to governments that must make revenues match spending, not because these employees are no longer useful.

    The Federal Government can create jobs directly by appropriating money and mandating that the state and local governments use it to hire people.

    For the anti-stimulus argument, we hear that high unemployment is necessary for economic recovery. As you mention, there is no proof that direct job creation or austerity that accepts high unemployment will lead our economy to recovery. The "Do no harm" philosophy can cut two ways. We could "Do no harm" by creating jobs for the unemployed. We know this would reduce the social cost whether or not it leads to recovery. The anti-stimulus would argue that Stimulus/job creation would harm the wealthy who would have to pay the bills by increased tax revenue.

    While we argue the correct Macro steps, an army of unemployed is economically drowning. This is classic class warfare. CheapLabor/ High Unemployment and the taxes and privilege of the 1 percent Versus the Jobless.

  6. Anonymous9:42 AM

    Great post. There's actually a small theoretical literature about knowledge theory that addresses how to proceed with very uncertain information, and agrees with your analysis I think. One practical problem though is that it's often not straightforward to apply a practical philosophy of ignorance to economic policy. The policy status quo is often the result of past efforts to Do Something. So does doing nothing involve undoing previous efforts, and if so, how far back do you go?

  7. What Cochrane is doing here is trying to discredit ideas which are known to work. The man is a dishonest hack, and anything he does should be viewed in that light:

  8. "We don't have a really good (i.e., quantitatively predictive) model of how aggregate demand works"

    I'd settle for a good qualitatively predictive model -- or, rather, a good qualitatively qualitative line of reasoning adapted to our changing historical circumstances.

  9. "And I think there is a powerful case to be made for policy inactivity - the idea of "first do no harm.""

    Trouble is, none of us can agree on what "inactivity" means, when it comes to monetary policy. It could mean: holding a nominal interest rate constant, holding M1, M2, etc., constant, holding NGDP constant, holding the growth rate of one of those things constant, etc.

    "Doing nothing" could mean doing anything.

  10. "And I think there is a powerful case to be made for policy inactivity - the idea of "first do no harm."

    Seriously? In that case we would do nothing in the face of the current economic crisis. I'd prefer the judgment someone who has a good grasp of basic economic principles, a knowledge of economic history, and real-world experience in banking and business. Those were Keynes's qualifications. Bernanke's too to a lesser extent. Volker fit the bill.

  11. The very concept of a "model" is wrong. In practice it implies a system of simultaneous linear equations. If I am not mistaken.

  12. Nick: You're right, and that's why although the "first do no harm" argument is the most powerful argument against stabilization policy, I still don't buy it. But it's a lot better of an argument than what we usually see, wouldn't you agree?

  13. It is trivially easy to construct economic models that display boom and bust cycles. All you need to do is realize that Ricardian equivalence (so beloved in Chicago) is nonsense and that a significant number of economic actors are momentum players basing their predictions of the future on the immediate past. Throw in some risk aversion and changes in individual assessments of risk based on current volatility and events and you are away to the races. Irrational exuberance and irrational despair will follow each other like night and day. Government can help by taking the longer view and (a) establishing sound policies and (b) engaging in counter-cyclical fiscal, monetary and regulatory policies.

  14. It is morally wrong to suggest some equivalence between Feynman ( who is a god to those of us who studied physics ) and Cochrane. Noah - you studied physics, you should know better.

  15. For an example of what is wrong with modern economic thinking, consider this comment from this very blog post: "Credit creation, or lack of same, drives profits and economic activity. Banks create credit and they don't need government to do so."

    This implies that most economic activity is based on spending borrowed money. That's obviously bogus. Most economic activity is based on spending earned money, that is, money earned by working, producing goods or providing services, and that includes government services and CEO salaries.

    Sure, borrowing is useful for increasing income by investing in physical plant, inventory, research or education, but an awful lot of this is funded by equity sales and out of cash flow. Maybe borrowing was a major part of economic activity in the previous decade, but that level of borrowing could not be sustained indefinitely, eventually someone had to earn some money.

    Thinking one drives the economy by controlling interest rates is as silly a thinking one controls a car by varying the SAE rating of the oil in the crank shaft.

  16. The problem with that idea is the idea that stimulus is only about economics. Government spending can help relieve the suffering of individuals in a recession, or any time of need. In order to argue against increased government spending anti-stimulus people need to prove that it is actively harmful. To prevent stimulus they must find at least an excuse for the institution of the population to ignore the suffering of its people for their own good.

  17. beezer starts off well, then loses the scent.

    Follow the money, and you'll see that the finance sector now captures more than 40% of all corporate profits. This dog-wagging is a huge grasp by rentiers, and significantly disadvantages the productive economy. The wages of deregulation is wanton rentier activity.

    Kaleberg misses an important point re: borrowed vs earned money. Consider the ratio of the two.

    Someone who is actually interested might ponder how these phenomena could be related.


  18. What Cochrane seems to be trying to argue is that we don't know much, so therefore we should stick with what *he* thinks that we should do.