|I'm a Not-So-Angry Bear...|
Wow, people other than the barristas at my local Starbucks know who I am! KNZN names me "The Bearish Smith". Compared to Karl that may be true, but compared to Yves I'm a ray of sunshine...
Anyway, KNZN (whose moniker, I am assuming, is an acronym for "Korea/New Zealand National", reflecting his unique heritage) goes on to say some very pessimistic things about macroeconomics:
But another post to which I was referred by the Bearish Smith’s blog leads me to think about the issue of macroeconomics as a field...
Here’s my take: to begin with, economics is basically bulls**t...
Economics is bulls**t because it relies on the premise that human beings behave in a systematic way, and they don’t. Once you have done enough research to convince yourself that they behave in a certain way, they will change and start behaving in another way. Particularly if they read your research and realize that you’re trying to manipulate them by expecting them to continue behaving the way they have. But even if they don’t read your research, they may change the way they behave just because the zeitgeist changes – cultural sunspots, if you will.
The last paragraph may vaguely remind you of the Lucas critique. Lucas basically said that macroeconomics (as it was being practiced at the time) was bulls**t, but he held out the hope that it could receive micro-foundations that wouldn’t be bulls**t.
The problem with Lucas’ argument, though, is that microeconomics is also bulls**t. And Noah Smith, writing some 36 years after the Lucas critique and observing its unwholesome results, takes it one step further by saying, if I may paraphrase, “Yes, the microeconomics upon which modern macro has now been founded is indeed bulls**t, but if we do the micro right, then we can come up with non-bulls**t macro.”
Yeah, I doubt it. Maybe we can come up with slightly better macro than what we’ve got now, but the underlying micro is never going to be right. Experimental results involving human subjects are inevitably subject to the micro version of the Lucas critique: once the results become well-known, they become part of a new environment that determines a new set of behavior. And the zeitgeist will screw with them also. And so on. And in any case, even if the results were robust, I’m skeptical that we can really build them into a macro model or that it would be worth the trouble even if we could. Economics will always be bulls**t.
Wow! After calling me bearish, KNZN out-bears me by several Standard Bearishness Units! I've written quite a lot on the less-than-ideal state of macroeconomics, but I feel a need to defend my optimism about the (potential) future of the discipline. As KNZN says, I really do think that better micro will help us do better macro.
First, let's look at this "cultural sunspots"/"zeitgeist" argument. Stuff like that may happen, but it just means we need to keep updating our data and our models as cultural conditions change. Maybe the change happens faster than science can keep track of it (in which case we definitely are in trouble) but I don't think anyone really knows if that is the case. To assume science can't keep up seems to me like unreasoning pessimism.
And maybe cultural change isn't driven by sunspots at all! Maybe it's predictable. For example, things like fertility transitions, urbanization, and the shift from manufacturing to services all seem pretty universal, and these things may have predictable effects on culture. In fact, from seeing Japan, my bet is that this is the case. And perhaps things like financial crises, globalization waves, and debt supercycles change consumption/saving/investing behavior in long-lasting and predictable ways. I would not be surprised.
I'm just generally very leery of the idea of "culture" as an inexplicable, chaotic force that makes economics hopeless.
Next, there is the idea that microeconomics is subject to a Lucas critique. I.e., that trying to exploit models of human behavior leads to changes in that behavior. This is two uber-pessimistic claims in one: 1) the claim that psychology is also bullshit and rather than science, and 2) the claim that market structure imposes no regularity on market outcomes.
First, psychology. Maybe it's because I'm the son of a cognitive psychologist, but I am highly skeptical of this claim. People have limitations on how much information they can process; telling them that you know this is not going to suddenly turn them into supercomputers. Furthermore, people have norms and values. Telling people that you know they think something is fair will not make them suddenly think it's unfair. Yes, some behavioral regularities disappear when you try to exploit them, but not all.
Case in point: the lottery. The lottery is a reliable way for a government to make lots of money. So far it has never failed. And it relies on human behavioral regularities; it's easy to imagine a species that wouldn't play the lottery. But we know that we are humans, and we know that humans like to play the lottery, so the government can run lotteries and get money again and again and again. That's microeconomic technology in action.
But microeconomists don't just study psychology, they study markets. The structure of markets makes a big difference. For example, continuous double auction markets very reliably produce the law of one price, while bilateral trade negotiations do not. That is a robust result! It doesn't go away when you tell people about it. And it doesn't seem to depend on people's preferences. Other examples come from auction theory; everyone knows that auction theory exists now, and yet that hasn't made the theory's predictions suddenly start to fail.
These are examples of outcomes that are predicted by theory and confirmed by experiment. That's called "science"! You can say "Well, maybe these things will go away tomorrow," and yes logically that is true, but that is true for any science, including physics. There's no guarantee that what holds today will hold tomorrow. Science rests on the assumption that the mechanisms of the Universe are stable. When that assumption fails, science fails. But I see no good reason to assume that this assumption always fails for economics. If you're just a pessimist, fine. But I'll need more convincing!
And there are LOTS of areas where we have barely begun to even study micro behavior. One big example is the behavior of firms. We don't understand this very well. In most macro models that you see today, the behavior of firms is even more hopelessly stylized and unrealistic-seeming than the behavior of consumers. A second, rather obviously, is financial markets. We need a lot better understanding of both how people behave in financial markets, and how the structure of these markets might produce certain regularities (like bubbles). And a lot of people, including myself, are working on this.
Now, note that I haven't talked about macroeconomics. Can we aggregate from micro to macro? That's something KNZN doesn't discuss, and it really deserves an entire post of its own (coming soon!), but basically, there are lots of reasons to think that the answer is "yes". Even if the macroeconomy is incredibly chaotic, we can use brute-force computer power to make short-term forecasts, like weather forecasters do. If there are emergent properties, agent-based modeling will give us a clue as to how complex the economy needs to get for these to take effect. And there may be many situations in which we can do things the old-fashioned way, i.e. by math - even if representative agents don't usually work (and I think they don't usually work), we can do things like OLG models and various other heterogeneous-agent models, and see if that works!
I think that lots of what people call "economics" is, in fact, bullshit. But I think that's true to a greater or lesser extent in every scientific field. I do not believe that economics must be bullshit. I don't think a convincing case has been made for that proposition. So even if I am The Bearish Smith when it comes to the current state of macro, I am bullishly optimistic that economic science will continue to move, however sluggishly, in the right direction.