Matt Nolan

Equilibrium

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Good Noah Smith post on economic equilibrium.

Equilibrium is a term that is often thrown around as an insult (I used to hear people talk dismissively about it at university), but in truth our concern with a model isn’t that it involves some sort of equilibrium but that we believe some of the core assumptions are inappropriate.  Articulating this claim, and why we think certain assumptions are inappropriate, is where value comes from specific criticism.

I find it quite cool that the main criticisms I hear nowadays are about equilibrium and the endogeneity of the money supply – as I’ve always felt those were issues where communication feel down.  Essentially, when discussing economic phenomenon I have always used the process of equilibrium as a way to describe tendencies – rather than pin down outcomes.  Interestingly, for a concept I’m saying is important I can only find four instances where I mentioned economists looking at tendencies (here, here, here, and here) … and one time when when I misspelt tendencies and compared Economists to Jedi 😛 .

Obviously, I need to actually write some blog posts on Mill.

jamesz

Economists vs historians

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Chris Blattman:

Most papers that show “history matters” try to convince us of some general theory of development from their very specific case study. We like our papers to tell us that the world is systematic and the forces of development are deterministic.

Judging by the paucity of papers that say so, however, we don’t like to hear that the world is complex and (sometimes) behaves in ways almost impossible to predict. Historians are more comfortable with the idea of “critical junctures”, and events that spin societies off in one direction or another.

jamesz

Practical experimentation at Microsoft

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The Microsoft Bing team responsible for conducting controlled experiments have a paper out that canvasses some practical problems they’ve come across in the thousands of experiments that they’ve run. It’s an interesting read, even if the subject matter isn’t particularly fascinating for those outside the search business. A lot of the things they find sound really obvious in the general sense but would be tricky to pick up in practice.

The main points are:

  • Very few ‘good ideas’ are actually good ideas because we dont’ really understand the behaviour of people outside our social group, even if they’re our customers. About 10% of ideas that make it to experimentation actually turn out to be beneficial to the business.
  • The criteria used to judge success are not always obvious and there can be a trade-off between short-run and long-run success. For example, degrading the quality of internet search results increases market share because users have to spend more time on your page. In the long run that wouldn’t hold up but it could take many weeks to see the drop-off in the results.
  • Understanding your instruments is crucial to interpreting results. Some results are an artifact of the survey method and that can often be really hard to pick up. This is often the case for economists when we don’t read the details of survey methods. The best applied economists actually take advantage of the design details of particular surveys to conduct natural experiments.
  • Don’t extrapolate from trends in the immediate aftermath of shocks. When you watch data in real-time after a shock you’re often just seeing a trend towards the long-run mean that will shortly stabilise.

HT: Andrew Gelman

Matt Nolan

Why is Nick Rowe so incredibly clear on monetary policy?

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Here read this:

Yes, if the central bank raises or lowers interest rates, this will affect financial markets. But I thought we had gone beyond thinking of monetary policy in terms of raising or lowering interest rates. Or buying or selling bonds in an open market operation. Or raising or lowering the money supply. Or raising or lowering the exchange rate. Those aren’t monetary policies.

Targeting 2% inflation is a monetary policy. Keeping the money supply growing at 4% per year is a monetary policy. Keeping the exchange rate fixed at $0.95US is a monetary policy. Targeting “full employment” (at least, trying and failing) is a monetary policy. Following the Taylor Rule is a monetary policy. Targeting a 5% level-path for NGDP is a monetary policy.

Yes.  Exactly.  When monetary policy rules are analysed by economists this is clearly kept in mind – but when it comes to discussing it to the public we feel compelled to “tell a story” that involves whatever people are interested in.  And this confusion, although it may not have caused the crisis, hasn’t helped matters.

And why is he so clear on it, he understands the way that policy has been framed differs from the truth of what monetary policy is as a targeted rule:

OK, this is probably the weirdest post I have ever written. I am going to argue that interest rate targeting is not what central banks really do; it’s a social construction of what they really do. Interest rate targeting is not reality, it’s a way of framing reality.

That was weird enough, but I’m now going to get really weird. The failure of monetary policy is not caused by anything central banks are actually doing; it’s caused by central banks’ way of framing what they are doing, and by the rest of us accepting that same framing. The current recession was caused by those (and that includes especially central bankers themselves) who think that central banks use an interest rate as the control instrument. It’s the framing of what central banks do that caused the mess, not anything central banks are actually doing. The social construction of reality is what dunnit!

Monetary policy is about expectations, and using rule based policy to help manage these expectations, take advantage of any perceived tasty looking trade-offs, and deal with “time inconsistency”.

Interest rates, exchange rates, asset prices, are all factors that help give us information about the stance of monetary policy (relative to some prior belief, or some set of expectations).  But monetary policy is about the rule, and being clearer about this rule and what it means instead of making “neat little (partial) causal stories, that only work part of the time” is a good way to go.

Don’t get me wrong – I believe strongly in the intertemporal substitution justification for active monetary policy.  But the interest rate can only be interpreted with prior assumptions around a bunch of other things, and that point is often lost.

jamesz

Changing figures of speech in economics

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We’ve been slightly obsessed with Deirdre McCloskey on TVHE for quite a while now but only just got around to reading her book, ‘The Rhetoric of Economics’, recently. The central premise of the book is that economists write to persuade, so we can use the theory of rhetoric to analyse economists’ writings and arguments. She describes many of the techniques that economists use to persuade others and what struck me is how different the dominant methods of persuasion are between academics and practitioners.

Academic economists tend to persuade largely through appeals to authority (references) and aesthetics (theory). They look down on computational work as insufficiently rigorous and too dependent on parameter selection. The lack of generality in computational results does not appeal to their tastes and they find it unpersuasive. I acknowledge that you can point to the entire field of econometrics as evidence to the contrary; however, there is a reason economists quip so often about the disregard they have for empirics that contradict the theory.

In contrast, economists outside academia tend to make far fewer appeals to theory or authority because those techniques are not persuasive to a lay audience. Unless one spend years marinating in economic theory its pronouncements carry little weight. Most people want to hear facts backed up with anecdotes that appeal to their personal experience. That leads professional economists to rely heavily on estimation and simulation to persuade their audiences. Those techniques generate firm predictions with a veneer of scienciness that lends them authority. Anecdotes then provide a comprehensible story that allows people to interpret the predictions. Obviously these descriptions are extreme generalisations but I think they represent at least the relative tendencies of each group.

Practitioners and academics tend to have a mutual disdain for each other. They accuse the other of being either irrelevant to policy decisions, or insufficiently sophisticated in their arguments. Could it be that a large part of the divide between them is due more to their implied audience than the type or subject matter of their investigation?

Matt Nolan

The symbol-archetype distinction when discussing economic primitives

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Note:  Edited for the raft of horrible typo’s in the post – my apologies.  Originally this wasn’t going to be a post but just turned into one.  I would use the excuse that my new keyboard doesn’t have key labels, but that wasn’t the reason for all of the typos!  Thanks to the heads up by a good samaritan.

One thing that was clear from my post about economic primitives (such as production functions) being archetypes was that my distinction between symbol and archetype in that context wasn’t clear.  I realised that even before the post went up.

At the base level, an archetype is a subset of symbols – it is a symbol that comes with some set of subjective meaning, whose meaning moves with the context and audience.  When I used the idea of symbol to start with (as opposed to archetype) this was to denote primitives which can be seen as objective.  This was a bit imprecise – as the term symbol includes both objective and subjective forms of symbology.

In my mind, the advantage of the economic method has been that we’ve left our primitives exposed for all to see.  The idea that these primitives, in a practical sense, are really archetypes economists call upon rather than objective symbols is an admission that we aren’t fully transparent.

And yet this isn’t really a criticism of the method – for people willing to put in the effort of learning about economic models they ARE very transparent.  However, economists have to communicate with a public and politicians who do not have the time or the patience to do this – and will still determine policy.

In order to make sure that the knowledge gleaned from economic science is taken in appropriately, we use the primitives of economics as archetypes to build a narrative – however, this raises the question of why people should believe our narrative rather than the other narratives they hear?  In order to do so, economists need to:

  1. Understand and frame the alternate narratives that exist,
  2. Use the archetypes that we’ve created to reframe the narrative,
  3. Convince the public why our narrative is preferable – both in terms of how our narrative captures the facts and nature of the issue, and where the other narrative has gaps (for me a key goal is to track back – and find the framework the narratives share, to expose the implicit assumptions that differ).

This is where rhetoric is important when communicating with non-economists – and where both applied and even some theoretic economics should differ from the idealised version of scientific economics.  This is not to undermine scientific economics – no it is to reinforce it by helping it to tighten its definitions and identify relevant variables and data in order to increase economic knowledge.  Science and rhetoric provide a complementary cycle.  [Note:  Yes I’ve been reading McCloskey, surprise surprise 😉 .  However, my focus is more on how we communicate with non-economists – outside of the oft overused appeal to authority]