Matt Nolan

Economic models

/11 Comments/in , /by

From Aaron Schiff:

A model should not be judged solely by its assumptions (although highly dubious assumptions are not a good thing). Rather we should focus on the model’s ability to teach us something, and its ability to explain the economics of something in a plausible way.

To summarise, a model does:

  • Highlight the incentives or tradeoffs that are relevant in a particular economic situation.
  • Generate predictions about the behaviour of economic agents in response to controlled changes in conditions.

I took this from a good post by Aaron Schiff.  I agree with it.

Note that the purpose of economic models isn’t prediction (as we have been discussing) – but we do want a testable hypothesis, in order to make our models scientifically valid.  So the model MUST be testable, but this is not a sufficient condition on models.

Furthermore, predicitive accuracy is not part of testability – as the difference could stem from a change from one of our ceteris paribus (CP) assumptions.

The goal is explanation and description.  And trust me the grey line between prediction and testablility is problematic.  But for the purpose of discussing economic models, the fact that our CP assumptions are the things that break unexpectedly does not invalidate the usefulness or purpose of economic models.

Note:  I will stop writing on this soon and go back to NZ economics.  For me this stuff is interesting, and I like to have a record of where my head is at.

Matt Nolan

Attacks from the left and the right on economics

/5 Comments/in , , /by

One thing I have noticed in my time is that people on the political left and right both attack “mainstream economics” with abandon.  This is good, as a discipline has to be able to explain itself widely and be willing to face criticism.

However, it is one of the elements of these attacks that interests me here.  Namely, how each side of the political spectrum attacks the “focus” of economics, or the framing – specifically in terms of the market and government.  Here is my oversimplified understanding of this element:

  • Left:  Economists are focused on markets.  They start from a place where markets are perfect, and markets provide the best outcomes and work from there – therefore they have a pro-market bias.
  • Right:  Economists focus on markets and resource allocation.  The focus on markets makes them dwell on policies that solve “market failures” rather than paying attention to the possibility of government failures!  As a result they have a bias to push policies that are anti-market.  Furthermore, by discussing the allocation of resources they drive the feeling that the economy can be controlled – which also leads to a bias towards government involvement.

I find both of these attacks suffer from the same problem, they avoid trying to understand why economists use the counter-factual they do, and the way economic analysis stems from it.

In itself, economics is not about giving policy prescriptions, it is about “trying” to “objectively” describe and explain an economic situation.  We find the elements of a market (which is the voluntary trade relevant to the issue at hand), and try to model them.  When then describe a “perfect counterfactual” and look at how these elements cause outcomes to differ.  We then do nothing.

In this case, the purpose of our counterfactual is to give some idea about how a more “realistic” outcome compares to an “ideal” outcome.  We do not say that the ideal outcome is possible, we do not say that any policies could move us towards the ideal outcome, and as strict economists we do not place hefty welfare judgments on the relative outcomes.  The counterfactual is solely there to allow us to describe, in some sense, how the elements in the model impact on the outcome – it helps us to describe.

The next stage is more “subjective” (I am putting commas around objective and subjective as even the “objective” analysis involves a number of subjective assumptions – but I digress), and it is not in the realm of economics per see.  Economists often move on to the policy analysis stage, but it is an additional element, that requires different skills than those that are central to economics.

The biases the left and right discuss tend from their view of the value judgments made by analysts at this stage of analysis – they are not relevant in a discussion about economists.  As a result, although the left and right often like to tarnish all economists with the same brush this is just not the case – economics is not the issues they disagree with here, but the value judgments made in the application of economic models.  The critique is of analysts they do not agree with, not the discipline as a whole.

Of course, I do not expect individuals with a political mind to ever properly accept or represent this significant difference – as there is too much satisfaction and political capital associated with attacking all economists 😀

Matt Nolan

Data and prediction

/4 Comments/in , , , /by

Via Scott Sumner we saw the following article that mentions economic data and economic predictions.  The statements that stood out to me were:

(Economic) predictions are, of course, the bread and butter of economic institutions. But can we believe them?

In recent years, some economists have begun to express doubts over predictions made from huge volumes of data, but they are in the minority. Most embrace the idea that more measurements mean better predictive abilities.

Hold up.

For one, as we have mentioned prediction is not the central element of what economists do – and even when they do predict the goal of such prediction is to give some view regarding risks and movements, not direct figures (it is more ordinal than cardinal in some sense).

Secondly, ever since the Lucas critique economists have been very nervous about predictions from large amounts of data without theory – I would say that the majority of economists doubt the usefulness of econometric models relying solely on huge amounts of data.

Economists would like data with less measurement error, that is closer to representing the true economic variables we discuss in theory – we aren’t looking for an infinite number of measures we can stick together to find a result.  An economist that doesn’t use theory to inform their discussions of the economic outlook, but uses lots of data, isn’t an economist – that is all.

Matt Nolan

Mankiw is right again – this time on prediction

/15 Comments/in /by

This time on how Economics as an academic discipline will not have to have the wholesale changes some peoples are suggesting.

He is right when he says the focus of economists and economic teaching is not on prediction.  However, I would also say that economists HAVE sold the idea that they can predict when talking to people, even if they personally realised this isn’t the primary role.

In some sense this comes back to Friedman.  During the positivist revolution in economics he stated that it didn’t matter so much what we assumed – as long as it was predicatively accurate.  Furthermore, our “value” for policy analysts and the such has often been tied to predictive accuracy.  Here we never agreed with this.

There are two ways to understand current economists methinks:

  1. Economists want to explain and understand – and that is where the value is:  This fits the academic economist view, but often ends up with no predictions.
  2. The Tarot card view:  This fits what economists do when they have to make predictions.  They use archetypes (models of aggregate behaviour), historical knowledge (data), and intuition to get a feeling of where the economy will head and the risks around it.  Even the more technical models (think DSGE models) have elements of this.

Both these services have value – by building knowledge and understanding.  But economics as a discipline should be based on its ability to adequately explain and provide understanding – not its ability to predict (especially given the issues with data).

Economists add value by describing, explaining, and painting risks – but they do not have magic time traveling powers.

This all reminds me of:

http://www.ritholtz.com/blog/wp-content/uploads/2009/09/economics03.jpg

Source (previous post)

Matt Nolan

Taxi cameras, why?

/55 Comments/in , /by

Ok, so the government is making it compulsory for taxi drivers to put cameras in there cars right?  They are doing this because some taxi drivers have been tragically injured – so its a safety issue.

But if its in the driver’s interest to have the camera, and they are the only ones getting a benefit from it, then surely they would only do it if the benefit of putting in the camera exceeded the cost.  In which case, regulating for them to put cameras in is either pointless, or forces taxi drivers to do something where the cost exceeds the benefit – and so is suboptimal.

What am I missing?  I must be missing something here, so just point it out to me and I’ll be happy 😀

Eric Crampton discusses here.

Matt Nolan

NZ scorecard: Hold up a second

/11 Comments/in /by

NZI gave New Zealand a C mark (ht Kiwiblog).  My response was “ok, whatever really, although it is a pretty site”.  This has told some people that the government should turn around and randomly do things.  My response to this is “what?”

Now don’t get me wrong here, the site is very pretty.  But I don’t see any reason for policy intervention on the basis of the arbitrary, subjective, grades provided by the site, with no actual analysis of the trade-offs that New Zealand faces.  Now I’m not sure if NZI actually asked for intervention, they have in the past, but I’m not going to pin it on them this time.

This time it was Fran O’Sullivan.  I do not know how she gets to this point:

Frankly, the metrics the institute has dug up on this score are deeply shocking and suggest that unless there is a co-ordinated response from Government at central and local levels, many more Kiwis will find themselves compelled to look outside NZ to build their futures – particularly in Australia.

I was under the impression that she fell on the New Zealand right.  Again this draws me to the question, “when did NZ’s right become communist“.  This isn’t a centrally planned economy, the government doesn’t directly control the allocation of resources.

Now, a government can influence the allocation of resources indirectly through policy – but any policy is likely to have trade-offs.  As a result, if the government is looking at putting in a policy we should be trying to get a good idea of the costs and benefits associated with said policy.

This arbitrary call to arms on the basis that New Zealand is different to other countries is ridiculous.  The goal should be to have the best society possible (based on the desire of New Zealanders) given our limited means.  To do this we need to look directly at the costs and benefits on policies – instead of simply saying “we are behind Australia so something must be done”.

Update:  Ok, NZI said it as well: “And there is still no convincing strategic plan in place to improve performance”.

So just a note, New Zealand isn’t a corporation.  Policy is based on trying to, in some sense, maximise welfare given the limitations of data, the countries limited means, and the fact that we have to use imperfect democratic or revealed preference mechanisms to get a feeling for what people value.  Individual policy changes must be on the basis of weighing up trade-offs, I can’t see how a general “strategic plan” comes into this.

Where does this distinction come from.  Well a corporation MAKES the products and sells on the market – the government doesn’t.  The government acts to redistribute and change the nature of the situation where production takes place.  Again, “strategic plans” are for Soviet Russia, individuals, and businesses, not free democratic societies …

Update 2:  Actually, the main point I forgot to make (as I was so busy talking about how the govt does not control NZ like a corporation) was:

Cross country comparisons (which this is) are notoriously hard to make because

  • data is inconsistent,
  • the trade-offs nations are willing to face differ,
  • the actual endowment of resources, and the trade-off associated with choices, differ between nations.

Given this these comparisons are a valueless exercise, and we should spend our time trying to understand the trade-offs inside New Zealand and make good policy based on this knowledge.