jamesz

Invalid opinions

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IF you follow the econ blogs in New Zealand you’ll have seen Matt and others getting pretty grumpy about the uninformed comments sometimes made in the media. That has only been exacerbated by the recent misunderstanding of quantitative easing. A philosopher writing in the Herald sums up how I think economists feel:

If “everyone’s entitled to their opinion” just means no one has the right to stop people thinking and saying whatever they want, then the statement is true, but fairly trivial. …But if “entitled to an opinion” means “entitled to have your views treated as serious candidates for the truth” then it’s pretty clearly false… [because it] implies an equal right to be heard on a matter in which only one of the two parties has the relevant expertise.

Economists are technical experts but work in a field that affects everybody’s daily lives. So, much like doctors, they have to cope with everybody thinking they’re an expert without a shred of real knowledge. And, just like in public health debates, credence is given to groups who have an opinion but no expertise. Understandably, economists get frustrated!

However, we need to be careful where we draw the line between those with expertise and those without it. Read more

Matt Nolan

Five W’s, an H, and an E: The method of economics based on primary school techniques

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I remember when I was a 7 year old sitting around at Kio Kio school and the teacher pulled out the five w’s and an h:  Who, what, where, when, why, and how.  They were repeated constantly, and we were told that these were questions we should repeat all the time.

Now at 7, we were a bit young to understand the gravity of these questions – and no doubt it merely led to annoying situations for our parents.  However, as Wikipedia informs me this is a method of teaching to primary school students – and as I inform me, this is a great way for understanding economics.  So let’s use them.

There are two ways we could use the wh method to understand economics – we could ask these questions about economics, or we could ask how economics deals with these questions.  I’m going to do the second.

Read more

Matt Nolan

Interpretation and the model

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Following the Jackson Hole speeches there was this post over at Uneasy Money.  The money section for me is:

The reductions in long-term interest rates reflect not the success of QE, but its failure. Why was QE a failure? Because the only way in which QE could have provided an economic stimulus was by increasing total spending (nominal GDP) which would have meant rising prices that would have called forth an increase in output. The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down. The success of QE would have been measured by the extent to which it would have produced rising, not falling, interest rates.

Now this is an interesting quotation for me.  There is one thing I think I know – and that is that market interest rates are very hard to interpret, given the number of different things they are representing!

This quote argues with the simplified standard economic model that is put out there.  In that model, when there is an output gap central banks aim to get the realise real interest rate below its “natural level”, taking from this paper we have:

Thus, the mechanism through which monetary policy influences aggregate demand can be thought of as working as follows: Given the sluggish adjustment of prices, by varying the short-term nominal interest rate, the central bank is able to influence the short-term real interest rate and, hence, the corresponding real interest rate gap. Through its current and expected future policy settings, the central bank is able to affect the corresponding path of [the short term real interest rate gap] and, in turn, influence the long-term real rate gap … and the gap in Tobin’s q.

In this setting, monetary policy works by pushing down real interest rates (which happens by boosting inflation expectations and lowering the nominal interest rate) and by boosting aggregate asset prices.

But it is also true that if monetary policy “succeeds”, long term interest rates should be representative of the “natural” rate of real growth and inflation (as well as including factors for risk and time preference) … essentially the long term real interest rate is a constant.

From what I can tell, the afformentioned quote by Uneasy money relies on two things outside the basic model:

  1. A central bank sets expectations of nominal income growth, not inflation
  2. There are multiple equilibrium in the macroeconomy, making unemployment of the current sort the result of a failure in a co-ordination game.

However, if anyone has any more insight that can tie these view together, I would appreciate hearing it in the comments.

jamesz

Black box modelling

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Nick Rowe is concerned that agent-based modelling (ABM) is a black box that provides no intuition and doesn’t really add to our knowledge:

Agent-based models, or any computer simulations, strike me as being a bit like [a] black box. A paper written by a very reliable economist where all the middle pages are missing and we’ve only got the assumptions and conclusions. I can see why computer simulations could be useful. If that’s the only way to figure out if a bridge will fall down, then please go ahead and run them. But if we put agents in one end of the computer, and recessions get printed out the other end, and that’s all we know, does that mean we understand recessions?

My question is how a model where you set the rules can ever be a black box? Shouldn’t the results always be understandable by reference to the initial conditions and ‘rules of the game’? Read more

jamesz

Economics envy?

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Apparently some historians want their discipline to become a predictive science. Because that worked out so well for economics back in the 60s.

What is needed is a systematic application of the scientific method to history: verbal theories should be translated into mathematical models, precise predictions derived, and then rigorously tested on empirical material. In short, history needs to become an analytical, predictive science (see Arise cliodynamics).

It seems the history of the social sciences rhymes as well as any other. Read more

jamesz

The forecaster as a storyteller

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Paul Krugman explaining the IS-LM model:

[T]he first thing you need to know is that there are multiple correct ways of explaining IS-LM. That’s because it’s a model of several interacting markets, and you can enter from multiple directions, any one of which is a valid starting point.

Which beautifully illustrates this point:

There seem to be two ways of understanding things; either by way of a metaphor or by way of a story, …[and] the metaphorical and narrative explanations answer to each other.

The metaphors McCloskey refers to are what we commonly term ‘models’; the narrative is the story that justifies the model’s existence. The metaphor provides a framework for the narrative, as the narrative provides a context for the metaphor. The importance of this interdependence is that models are empty without a narrative to explain why they exist. Equally, a historical narrative is of little help if it doesn’t give rise to a generalisable metaphor that we can use to simulate counterfactual worlds.

Krugman’s introduction to IS-LM (a macroeconomic metaphor) illustrates not only the importance of the narrative but also the fact that multiple narratives can support the same metaphor. This ties in really well to Matt’s discussions of the value of economic forecasting. The value in forecasting is not in the predictions that our models make about the future, but in the usefulness of the narrative the forecaster tells. That narrative varies across forecasters depending upon the relative importance of various actors in their story, despite the fact that they all have pretty much the same model of the economy in mind. That may help explain why they all tell a different story and yet profess to largely agree about all the important issues.