Matt Nolan

In defence of neo-classical economics

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I have recently seen an increasing number of attacks on “neo-classical” economics from every section of the political spectrum.

Last week, I heard a number of commentators at the sustainable economics conference claim that neo-classical economics was:

  1. Based on falsified views of the individual,
  2. Static,
  3. Had no supply side.

Then I saw an attack on “neo-classical economics” from Roger Kerr at the Business Roundtable (and more) which seemed to imply:

  1. It ignores institutions,
  2. It ignores transaction costs,
  3. It is static.

I was surprised by these attacks.  More than surprised, I felt like the attacks were based on a straw man version of neo-classical economics – one that in many ways never existed, and if it was floating around it was during the 1950’s-1970’s when a lot of the focus was on a narrow neo-classical synthesis in macro theory.

Neo-classical economics is a term for the “core” of economic theory – primarily modern mainstream microeconomics.  I have discussed here how we get from scarcity to neo-classical economics, and I have discussed neo-classical economics in more detail here.

This “core” is different to the core in the 1970’s – as many of the fringe elements of theory have now shifted their way inside the core of economics (think game theory, endogenous growth theory, transaction cost economics).  However, this is the point, neo-classical economics has evolved and it is this modern version that is taught in universities (at least it is at Victoria) nowadays – contrary to the claims at the sustainability conference that economics hadn’t changed.

The reason I am so defensive about the definition of neo-classical economics is because people see it as the current core – which according to my definition it is.  Setting up an alternative definition of neo-classical economics and knocking it down is either equivalent to setting up a straw man to attack, or directly misleading people to make it sound like modern economists are incompetent.

Matt Nolan

Economic equations

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(ht SMBC)

Its true – if you think about an issue it is probably hidden in an equation somewhere 😉

Matt Nolan

Neuroscience, determinism, and free will

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The title sounds serious, but I am (sadly) not capable of steering into too much detail in this subject matter.  However, given that I have a rising interest in neuroeconomics I felt I should type something out about this quote (ht Andrew Sullivan):

Dualists about the mind and brain – those who hold that there are thinking substances like souls in the world as well as all the ordinary physical stuff – say that the mind sees and thinks and wants and calculates. Contemporary neuroscience dismisses this as crude, but Hacker argues that it just ends up swapping the mind with the brain, saying that the brain sees and thinks and wants and calculates. He says, “Merely replacing Cartesian ethereal stuff with glutinous grey matter and leaving everything else the same will not solve any problems. On the current neuroscientist’s view, it’s the brain that thinks and reasons and calculates and believes and fears and hopes. In fact, it’s human beings who do all these things, not their brains and not their minds. I don’t think it makes any sense to talk about the brain engaging in psychological or mental operations.”

Read more

Matt Nolan

The New Keynesian Framework and employment persistence

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Over at Econlog, Arnold Kling stated that “persistence” in employment implied that the New Keynesian story was off (ht Marginal Revolution)

This sounded a bit funny to me – New Keynesianism is a framework for models, one where I had seen the persistence in unemployment, and employment (which is a well known stylized fact) before.  So I went to google:

Awesome google search.

And it immediately came up with a working paper from two of the big boys – Blanchard and Gali.  Conclusion being:

The extent of real wage rigidities determines the amplitude of unemployment fuctuations under the optimal policy. Furthermore, unemployment displays intrinsic persistence, i.e. persistence beyond that inherited from productivity. The degree of persistence is decreasing in the job finding rate. Hence, the more sclerotic is the labor market the more persistence is unemployment.

In the paper there is discussion of models with hiring costs, labour market frictions, rigidities in the real wage, and in nominal prices.  They don’t discuss some other things I’ve seen from New Keynesians, such as employment/investment/production decisions made off the back of a lagged state variable, but those sorts of concepts are rolling around as well.

In essence, the New Keynesian framework is grappling with a large number of issues, and trying to analyse them in a consistent way.  I just find it a little strange that we would say “and so the New Keynesian story is wrong” just because some of the current models can’t pick some things – it is like saying “microeconomics is wrong, because it doesn’t perfectly describe all human behaviour”.  Yes, it is a discipline that needs investment and time – but as a framework for putting models inside, it is pretty useful right.

I’m not saying things are perfect now, but I am saying that all the hating on the New Keynesian framework seems a touch out of place – given that all it is doing is providing a transparent and internally consistent method where people can build their own model of the economy by introducing what they believe are realistic “core” assumptions.

Matt Nolan

Economists and values

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Another great comic from SMBC:

To (as usual) kill the fun a bit, I would note that the Economist is explicitly placing value on life in order to understand trade-offs.  The “normal person” is still placing an implicit value on life when they discuss the policy – they just don’t want to say it.  This implies that the “normal person” is hiding the trade-off, making any policy recommendation they make less transparent.

Matt Nolan

The pill, moral relativism, and economics

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“Raquel Welch has blamed the contraceptive pill for the breakdown of sexual morality.”

That is the first sentence from this newspaper article.  Now I have no doubt that the introduction of the pill led to a higher steady state level of promiscuity.  Yet, there is an undercurrent of negativity in the article – suggesting that this is a bad thing.   However, this is not necessarily the case.

This illustrates to me one of the issues that often makes explaining economics, or even trying to do analysis, difficult – moral relativism.  In the current case, the existence of the institution of marriage and the idea of low numbers of sexual partners is seen – in of itself – as a good thing.  People have followed a rule of thumb that the given set of outcomes in the social situation they are the best outcomes.  Anything that in turn undermines those institutions is “bad”.

I use the term moral relativism because that sort of behaviour is indicative of it – what people view as the appropriate set of institutions is based on the set of institutions that are in place at the time.  When we look back at what people believe is “morally right” we will often see rules based on the society they are in not some underlying true prior morality (although I believe that does exist to some degree as well).  As a result, if we try to say that the underlying situation has changed (the pill has turned up) and these old institutions that were optimal are now suboptimal, people get annoyed.

Economics is a great social discipline, because it tries to side-step the issue of moral judgments (and thereby the issues associated with moral relativism) for as long as it can in the process of analysis.  So following a “shock” an economist will try to describe the social elements, the trade-offs involved, the change in choices, how the corresponding change in institutions and choices impacts on future choices, and eventually where the social situation will settle.  Once we understand how the “distribution/allocation” of things changes, we can mix in some value judgments and come to a conclusion.

In the case of the pill, it seems highly believable that the introduction of something that made sex with a lot of partners much less costly lead to a lot more sex – that is fine.  However, we can’t conclude whether this is a good or a bad thing until we introduce value judgments to our analysis.

Those that are anti the pill will say that the introduction of the pill lead to greater promiscuity, but also made it more costly for people who didn’t want promiscuity to not be promiscuous – as a result, people who would have preferred a low sex but married social equilibrium may be worse off.  This analysis is fine, but it does rely on a set of value judgments.

Personally, I think the final steady state from the introduction of the pill will end up with more mature and responsible discussion around sex and relationship.  We can hardly say that the institutions of marriage and religion led to “magically optimal” outcomes in these matters – and people that bemoan the loss of such institutions are often looking through very rose tinted glasses.  Social interactions between people are supposed to be difficult, and I am sure individuals and the institutions that surround them will evolve in interesting ways given the pill.  However, my belief that the ultimate outcome will be better is again based on my set of value judgments.