Matt Nolan

Production function and preference relation: Archetypes of economics

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In my gradual process of trying to figure out what I am going to write when comparing Tarot Cards to Economics, it has become increasingly clear to me how the production function and preference relations of economics function (the primitives of an economic model) as “archetypes” for our discipline – and how many non-economists do not share these archetypes and as a result find it hard to translate what we are saying.

Now at first brush this seems strange – these relations are surely not archetypes, but are surely instead symbols. Why?  Well a symbol in the view I’m using here is a “given” descriptive term without any complicated cultural relations getting in its way – so a production function is a primitive as production comes from inputs being translated into outputs, preference relations merely state that people have preferences.

These symbols are then tied together to fit archetypes/models of situations.  We can then take these archetypes/models together in order to discuss or explain something in the real world. To me this is akin to the “Credible Worlds” view of economic models, or even the old school Mill view – we take these symbols/primitives and create models which capture some tendency in the real world.  We then tie together these tendencies that are captured by models in order to provide policy conclusions.

This is the way I did see the process of economic model building.

But now I’ve moved the status of production functions et al to the area of archetype.  From good old Wikipedia we have:

In Jung’s psychological framework, archetypes are innate, universal prototypes for ideas and may be used to interpret observations

The very idea of using a production function flavours the way economists interpret ideas and the way we understand phenomenon.  Often when communicating we do not observe the production function, or have any idea of all the inputs into it – in this more limited way of viewing the process, the fact that we apply an implicit view of a production function to it is akin to the production function being an archetype in our description of what is going on.  More importantly, the symbol of something like a production function becomes an archetype as it becomes accepted as a central part of the way economists communicate with each other – when we tell each other stories we ALWAYS have a production function in mind.

This matters as the fact we look at data and the world around us through the view of a production function and preference relations is probably the key difference between the way economists view phenomenon and the way non-economists interpret it.

Yes, the models that we build off of production functions et al are archetypes as well – but they of course rely on our prior assumptions about primitives (the production function).  The model can itself be boiled down to these fundamental primitives – primitives that when not used in their most general form are in fact archetypes.

As a result, when it comes to explaining, justifying, communicating, or educating and economist requires a clear head when it comes to looking at these fundamental archetypes – and needs to be able to justify why these archetypes are appropriate for describing social phenomenon.

This is just where my head is at right now – if anyone has any comments or wants to correct me on anything that would be super.

Matt Nolan

Limited knowledge provides the limits to government

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There was an interesting article by Mai Chen in the Herald on Wednesday.  There is a lot of lawyer rhetoric in there.  The only reason I really noticed is that I was reading McCloskey’s “the Rhetoric of Economics” and just yesterday went through the chapter on Coase when the rhetoric of lawyers was discussed.   This explains this:

At a high level, it requires New Zealanders to agree on a vision for our society – the kinds of things which make New Zealand a place we want to live and raise our children. But the hard edge also requires that we measure our progress towards achieving that vision, and hold Governments to account on their performance against such measures.

Sounds good doesn’t it.  Pity it involves no conception of whether the vision is attainable or the underlying trade-offs involved.  The lack of discussion of trade-offs, or comparisons of counterfactuals, is a perplexing feature of this sort of writing for an economist – and makes the statement mentioned above absolutely useless for policy analysis.

This sounds harsh – a lot harsher than I mean it to be, and as a result I want to point out the positives here.  The sort of aimless push for a “vision” is poppycock at a surface level – but it contains a strong grain of truth that we should recognise.  Ultimately, the decision about what trade-offs society is willing to make should be made by society!

Measurement and quantification are areas this article is supporting – and I agree 100% with Mai Chen here.  By measuring things, and understanding them, we can:

  1. try to understand the trade-offs
  2. explain the trade-offs to the public is a (hopefully) transparent way
  3. express whether the actions of the institution that is government are representative of the will of the people.

Quantification is an important tool for this, and to be fair to Mai Chen you could interpret the term “vision” as a way of communicating these trade-offs in a way the public can understand.  Rather than being poppycock as I have described it, such description way in fact be the way forward!

But the key point here is not to let ourselves get obsessed with targeting measures so directly (although the any benefits should be quantified and tested), and guiding the economy.  We should base policy on the trade-offs that exist and what society desires.

However, our knowledge of these trade-offs is imperfect and as a result the actions of government should be cautious.  As Noah Smith said “caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.””.  Remember, government is an institution that is intervening in the volutary trade of individuals and groups due to issues of equity or co-ordination – in the same way we don’t want a doctor arbitrarily fiddling with our body because he has “a vision” we wouldn’t want a government arbitrarily messing around with our ability to trade due to their “vision”.

 

jamesz

Anomalies and market efficiency

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Tim Harford points to a paper on the EMH showing that:

…after an anomaly has been published, it quickly shrinks – although it does not disappear.

The anomalies are most likely to persist when they apply to small, illiquid markets – as one might expect, because there it is harder to profit from the anomaly.

It’s always good to remind ourselves that all anomalies are only fully priced in equilibrium, and we’re probably never in equilibrium. The process of moving towards equilibrium involves market participants seeking out those anomalies and exploiting them. So the continued discovery of new market anomalies isn’t evidence against market efficiency: it’s merely observation of the normal equilibrating process.

jamesz

Splitters and lumpers

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After reading this quote from Darwin, Matt asks whether there are too few lumpers in economics:

“It is good,” opined Charles Darwin in an 1857 letter to the botanist J. D. Hooker, “to have hair-splitters and lumpers.” He was talking about how best to classify varieties of flora; being Darwin, he managed to establish an enduring intellectual distinction in a parenthetical aside. A century and a half later, his observation still holds. Splitters, focusing on difference, make sense of the world by dividing it into many small categories. Lumpers, focusing on likeness, sort it into a few big groups.

The distinction seems to relate very closely to McCloskey’s idea of economic rhetoric, where narratives of events are interpreted through the lens of a particular metaphor. The splitters are the people who explore the details of the narrative, trying to understand the minutiae of a situation. The lumpers follow in their tracks, surveying the assembled work of the splitters and constructing new metaphors that draw together seemingly disparate strands of work. Often, the work of the lumpers is considered the true genius but, as Darwin observed, they are complementary and neither could exhibit their talent without the other. Read more

Matt Nolan

Institutional status report

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The jump in unemployment, and the fact that the labour market has been weak for a long time, is leading to understandable angst.  The government has been blamed as you often expect, the world has been blamed as it should, and the RBNZ is increasingly being blamed.  I would like to cover off a few things – just so when we discuss the issue of the economy, we are on the same page.

Update:

For the tl;dr audience, Kimble put together a neat summary:

Cliffs:
> The RBNZ bases their policy on forecasts, not the current state of the economy.

> Blaming them for the current state of affairs is to blame their previous forecasts.

> The argument they should take action to remedy the current state of the economy implies that you disagree with their forecasts.

> Making that argument without mentioning those forecasts seems completely insane.

I will have the post itself where I talk about these things, and justify why I am talking about them, below the fold.

Read more

Matt Nolan

Expectations formation, inflation, and a role of inflation targeting

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Ever since the Lucas Critique forced economists to recognise that we could not use data for policy in a purely theory free way, the concept of expectations, and how expectations are formed has become important.  The growing interest in behavioural and neuroeconomics are all in part a response to this realisation, and a clearer understanding of these issues will help give economists an idea of what to study, what to measure, and what policy trade0-offs exist.

It is encouraging then to see this study on the formation of inflation expectations.  In it they look at how shocks to food prices impact upon individuals expectations of future general inflation.

Our results suggest that consumers incorporate information about past food prices in forming and updating their own-basket inflation expectations but not their overall inflation expectations. The issue of pass-through to inflation is of particular concern during times of large supply shocks. Our finding that information about past food price inflation has limited pass-through to consumers’ expectations of the “rate of inflation” suggests that the RI question (and not the PP question, which as mentioned above is similar to the one used in the Michigan survey) is a more stable survey question (in the sense that it is less susceptible to volatile price changes), and that it should instead be used to elicit consumer inflation expectations.

This is all well and good, but we need to ask whether we are really gauging inflation here in the way we mean it when we discuss monetary policy.  We are interested in the way prices in general move together that is unrelated to “fundamentals”.  A lift in food prices is a change in those fundamentals, and tells us that there is a change with regards to how scarce food is relative to other goods and services and relative to labour.

This general “comovement” we are talking about is anchored by an inflation target, and as a result we want a description of how a “shock” to the price of one good has an impact on this over the complicated beast that is the economy.  We need to seperate out the bit that is due to households feeling “poorer” or “richer” following a change in the price of one good or service (a relative price, or supply shock) from the impact it has on the general price setting of households and firms (our inflation).

This is easier for us to think about if we assumed the “inflation target” was zero – in that case, as decision makers we know that a rise or drop in prices represents a lift or decline in scarcity relative to other goods and services.  Furthermore, a increase in wages represents productivity – or may represent a change in bargaining power.

However, with an inflation target, which is followed by decision makers, we can say the same thing by just taking off the inflation target from price growth.  This is one of the conceptual reasons why an inflation target is an attractive thing – we are helping to make price signals in the economy a clearer representation of underlying scarcity.

As the gold standard period showed us, inflation/deflation in itself can be very unstable, so an inflation target through inflation expectations can be used to help “co-ordinate” decision makers.

In this sense, it is nice to see expectations formation being discussed here – but I’m not sure the study is truly capturing “inflation” following a relative price shock, and is instead also capturing other factors related to economic fundamentals.