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2013 in review

The WordPress.com stats helper monkeys prepared a 2013 annual report for this blog.

Here’s an excerpt:

The concert hall at the Sydney Opera House holds 2,700 people. This blog was viewed about 60,000 times in 2013. If it were a concert at Sydney Opera House, it would take about 22 sold-out performances for that many people to see it.

Click here to see the complete report.

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OMG Cat

Well, it seems that the Fed has finally decided to initiate the much talked about ‘taper’ of the QE program. The proposed taper will wind down asset purchases by $10bn a month. That means that they won’t actually stop or reverse purchases, rather they will just slow the rate at which they make said purchases.

For those who don’t follow the financial news tapering has been talked about on literally a daily basis in the press. And yet it is widely assumed to make no difference to most markets, as can be seen by the stock market rally that accompanied the Fed’s announcement.

There are two things that are particularly odd about all the tapering talk — two things that are tied up with one another. The first is that there is talk at all. If tapering evidently makes rather little difference to the markets and the economy then why do the press and financial analysts talk about it endlessly? The answer to this is rather simple: it is the nature of the press and wider society to talk about people and institutions that are perceived to wield power.

Human beings have a fascination with power, prestige and hierarchy. People basically exist within a system of symbols and these symbols are hierarchically organised — these symbols may be rather obvious, as in the case of the King’s throne and crown, or they may be more subtle, as in the case of Bernanke’s ‘Chairman’ title, but no matter what form they take they always operate in the same fashion.

The people living in such symbolic systems must reinforce them by constantly introducing and reintroducing them in day-to-day discourse; if the King’s subjects stopped talking about the King he would lose his power rather quickly. Authority must be given constant support in and through daily discourse. The Marxist philosopher Louis Althusser claimed that Blaise Pascal once said of religious belief: “Kneel down, move your lips in prayer, and you will believe”. I have never been able to source this quote but regardless of whether Pascal said it or not the logic is perfectly true. It is through the perpetuation of the discourse of power and authority that power and authority are enforced and reinforced.

Our modern day press basically functions in the same way; to a very large extent the press is an institution that reinforces the power dynamics of broader society by constantly introducing and reintroducing the names and titles of those in power. This is why, for example, politicians can basically make stuff up and the press will report it in an acritical way: such statements are not subject to verification because they have a different ‘truth value’ to normal statements in that it is their very utterance from a position of authority that lends them weight.

The second thing that was rather odd about all the tapering talk was the constant reference to the supposed fact that it had never been done before, that we were entering uncharted waters and that it was hard to predict what effect such tapering might have. This was just complete and utter rubbish.

In actual fact, as I noted on FT Alphaville back in April, a far more extreme version of tapering was undertaken by the Japanese central bank (JCB) in early 2006. In this period the central bank didn’t just slow the rate of purchases as the Fed are now doing but instead shrank their balance sheet. And what were the effects? I cannot find any serious effects in the data.

As I noted in that post there was no obvious correlation between QE and inflation or the exchange rate or GDP growth. The shrinking of the JCB’s balance sheet also appears to have had no effect on the stock market which continued to rally until the onset of the financial crisis in late-2007/early-2008.

So, why is no one reporting on this? Surely this should be a worthy news item. Given that barrels upon barrels of ink that are expended daily reflecting on the significance of the taper surely the press should be interested in considering a far more substantial move away from QE. Not really. That would be the equivalent of revealing that the emperor has no clothes.

Imagine if every day Bernanke was asked by the press something like: “Chairman, the Japanese central bank reversed their QE program in 2005-2006 and it appears not to have had very much effect on the economy or the market. Isn’t it reasonable to assume that your far less substantial tapering program will not make any difference?” Bernanke, being a rational person, would have to agree and this would then shut down the whole dog and pony show. The press would have nothing to report on, the power structure would not be reinforced and the tedious chatter that constitutes the markets would crawl to a stop.

It’s not just that power and hierarchy are reliant upon discourse but also that discourse is reliant upon power and hierarchy. Without power and hierarchy people would have to think for themselves — a terrifying prospect. It’s far, far easier for people to fall back on handed down truths — even if these handed down truths are not truths in the factual sense. As a wise man once said: “Welcome to the human race.”

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parody

What is the essence of parody? The dictionary defines it as,

an imitation of the style of a particular writer, artist, or genre with deliberate exaggeration for comic effect

But definitions aside, I think that everyone knows a parody when they see one… right? Parodies are usually undertaken to mock those you disagree with. But what about when something looks like a parody, feels like a parody but actually might not be a parody at all? Well, that’s usually referred to as an ‘accidental self-parody’.

I came across one such accidental self-parody today in the field of economics. Last year John Carney — a strange conservative supporter of MMT that works at CNBC — published a piece called A Modest Job Guarantee Proposal: Domestic Servant Subsidies.

The title, of course, mimics one of the most famous political-economic satires of all time — namely Jonathan Swift’s A Modest Proposal for Preventing the Children of Poor People From Being a Burthen to Their Parents or Country, and for Making Them Beneficial to the Publick which is more typically known as A Modest Proposal. The famous work is a parody of some of the tracts that mean-spirited ‘reformers’ of the day were publishing and in it Swift suggested that poor Irish children should be taken from their parents, because they cost too much to feed, and be prepared as food for the well-off.

Carney’s title seems to echo this. As Wikipedia states,

In English writing, the phrase “a modest proposal” is now conventionally an allusion to this style of straight-faced satire.

But if you read Carney’s article it is clear that it is not a satire at all. Indeed, he is absolutely serious about trying to get the unemployed to clean his dishes for him as part of government policy. He is not joking — he is not mocking the insular, selfish conservative who lacks empathy and thinks that others are only there as a convenience for themselves — no he really thinks that this is a viable idea. He thinks that it would avoid the problems of centralisation inherent in the Job Guarantee — although one wonders why domestic service came to Carney’s mind, why not give tax breaks to people to donate to the arts, for example… is it because Carney had to put on the washing before sitting down to write his piece?

Carney also engages in that same conservative trope that is often wheeled out to justify nonsense,

No doubt some will object to using domestic service as a buffer stock economic stabilizer, on the grounds that it would be demeaning to workers. But this only displays a prejudice against domestic service on the part of those raising the objection. In reality, there is a long and dignified history of domestic service that demonstrates such positions need not be demeaning.

This is a funny argument and you can replace “domestic servant” with all sorts of different jobs to achieve the same rhetorical effect — “sex worker”, “pornographer” and so on. The point is not that we are judging those who choose to do these jobs, rather we are judging whether the government should have a mandate to encourage employment in this particular sector.

The question raised by a program that is being put in place by a democratically elected government is this: since we are providing a massive incentive for unemployed people to do a given job is the best we can do to get them to clean Carney’s dishes for him? Is the US government really just an entity that exists to ensure that Carney doesn’t have to do his own washing?

And now we’re back to the question of parody. Is Carney’s piece a parody? If we assume some education and literacy on the part of the author the title indicates that it is — i.e. if Carney was self-conscious in his use of the term ‘modest proposal’ and did not just think the phrase vaguely literary so he threw it in to lend writerly weight to his piece. The content seems to me rather satirical too. But I fear that it is not, in fact, a parody at all. It is, as I intimated earlier, an accidental self-parody.

My sympathy here, I suppose, falls with the American satirists. They must have a terribly hard time. Perhaps it is these hard-working people, starved of material by the likes of Carney, that deserve to be compensated with our tax credits. And with that, I redirect the reader once again to a non-satirical program which uses tax-credits to get the unemployed back to work.

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something rotten

Paul Krugman is out again defending mainstream economics against students and others who rightly suspect that it has taken a wayward path. I won’t go too much here into Krugman’s own history as a gatekeeper for orthodox economics, having dug up some of the rather embarrassing historical record on this blog before.

Let me just note two rather large ironies with what Krugman is saying here. First of all there is the obvious one. On the one hand Krugman claims that all is right with the state of macro. Yet on the other hand he himself is publishing papers that try to absorb certain heterodox theories into the profession.

Thus he is talking out of two sides of his mouth. He is at once saying “ignore those heterodox guys” and at the same time saying “read my papers that integrates their important theoretical insights”. I don’t think it would require too much psychological subtlety on the part of the reader to understand what Krugman is doing here, whether consciously or unconsciously.

The second irony is rather more technical but also highlights something important about mainstreamers like Krugman: namely, that they don’t properly understand the implications or theoretical foundations of their own theories. In his recent post Krugman says,

Efficient markets theory arguably deserves more blame for the failure of too many economists to recognize the housing bubble, but textbook economics always presented EMT as a baseline, not a revealed truth.

That sounds nice, right? Well, not really. It’s become something of a cliche for mainstreamers to attack the EMH. This feeds into the whole ‘saltwater’ versus ‘freshwater’ pantomime that the mainstream has been playing at for over 30 years.

Beyond that many of Krugman’s own formulations require an implicit EMH. Krugman himself doesn’t understand this, of course, but again I contend that mainstreamers don’t understand a very good deal about their own theories because they lack detached theoretical and historical perspective on such matters.

So, which formulations require an implicit EMH? Well, the natural rate of interest theory for one. As I wrote here (apologies in advance for the long quotation but I see no point in repeating the argument here):

Note carefully that [mainstreamers like Krugman when they refer to a natural rate of interest] refer to this interest rate in the singular, not in the plural. This is because, as we have already seen, they assume that the rate that needs to be set in line with the natural rate is the central bank overnight interest rates – what used to be called the “money rate of interest”. However, the central bank overnight interest rate is but one of many interest rates in the economy. There are, in fact, distinct interest rates on every financial asset in the economy. There are separate interest rates, for example, on triple-A rated company debt and on low-rate junk bonds; there are separate interest rates on personal mortgages and on credit-card debt – and so on and so on.

The reason that the Bastard Keynesians ignore this fact is that they assume – quite correctly – that when the central bank raises or lowers the overnight interest rate, all these other interest rates respond accordingly. The central bank rate of interest can properly be seen as the “risk-free” rate of interest while all the other interest rates integrate whatever risks the borrower is seen to represent. To understand this better let us imagine that the central bank risk-free rate is set at, say, 4%. Investors and savers know that by parking their money in government bonds they can get this 4% without incurring any risk. So, if they are to put their money into, say, a risky junk bond that has a high risk of default they will demand maybe 15%.

Now, say that the central bank lowers the risk-free rate to 0%. Well, now the investors and savers are going to be willing to accept a much lower return from the risky junk bond. Their choice is no longer between a risk-free rate of 4% and a risky rate of 15% but is instead between a 0% rate of return that incurs no risk and a risky asset with a high default risk. Thus they might be willing to buy the junk bond if it has, maybe, an 11% rate of interest or so.

This is all well and good if we assume that savers and investors are perfectly rational and price in risk perfectly. After all, if investors and savers are not subject to irrational swings and do not misprice risk because they essentially know the future then this whole process should work like clockwork – or, more poignantly, like an enormous series of neoclassical supply and demand curves that exist all across the money markets. However, if investors and savers are not perfectly rational and cannot price in risk perfectly because they do not know the future, then the interest rates on everything except the risk-free rate set by the central bank is completely and utterly indeterminate and is subject to the whims of investors…

The idea of a natural rate of interest then implicitly rests on the idea that investors and savers in the economy are perfectly rational and have perfect information about the future. Indeed, it actually implicitly relies on the Efficient Market Hypothesis in its strongest form.

The natural rate of interest is, of course, central to Krugman’s basic understanding of macro. It is also central to many of the policy recommendations that he makes; such as the idea that in ‘normal times’ monetary policy alone can be used to steer macroeconomic activity.

This is the problem with people like Krugman. In their zealous defence of a status quo that has been failing them for years (again, see this post) they are completely blind to what their theories actually imply. Meanwhile they pick the bones of the heterodox economics that they actively try to suppress in order to form models with which to explain the crisis to one another. Something is rotten here indeed.

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Dazed and Confused

I recently reread a 2010 interview with Eugene Fama, who has just been awarded the Nobel Prize for his work on the Efficient Markets Hypothesis (EMH). In the interview Fama tries to defend the position that the EMH held up “quite well” in the financial crisis of 2008. The interview is worth reading in the original as it is quite bizarre.

Here, however, I want to deal with two points. One appears to me to be a willed contradiction on Fama’s part. The other surrounds his highly contradictory statements on asset price bubbles.

Now, some may tell me that I am being unfair to Fama. They might say that in interviews we often say things in a more careless and sloppy manner as we might in writing. I accept that this is true but nevertheless the oversights and contradictions in Fama’s arguments appear to me to paint a picture of a deeply confused man.

Let’s start with the second point; namely, that of how we define asset price bubbles. Fama starts by saying that he “doesn’t know what the term credit bubble means”. The interviewer then posits the following meaning,

I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals.

Although I don’t fully agree with that I think its a fairly robust definition. And Fama seems to agree in that he says “That’s what I would think it is”. Now here’s where the whole thing gets a bit weird. First of all he says the following,

It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time. (My emphasis)

Okay, that’s pretty clear, right? Fama is saying that people who make calls on asset bubbles are right about half the time and wrong about half the time. Well, I’m not sure if that’s true but I certainly agree that asset bubbles can be predicted. Indeed, Fama this year shared the Nobel with Robert Shiller and Shiller called both the tech bubble and the housing bubble. But Fama then goes on in literally the next breath to assert that asset bubbles are not predictable phenomena. When asked whether he is saying that bubbles do not exist he says,

They have to be predictable phenomena. I don’t think any of this was particularly predictable.

Now, Fama just said that those making predictions about asset bubbles were right about half the time. That seems to me to imply that there is some predictability to these phenomena. So, why does Fama go on to say that they are not predictable? I have no idea. Frankly I think that he is talking rubbish.

Fama then goes on to further tie himself in knots. With regards to recession he says that,

That’s where economics has always broken down. We don’t know what causes recessions.

Well by Fama’s own criteria that would surely mean that recessions do not exist, right? If in order for economics to recognise a phenomena it must be predictable then the discipline cannot, by Fama’s own criteria, recognise recessions. But in the second part of the interview Fama seeks to blame the financial collapse of 2008 on — you guessed it — a recession. The reason he posits that we cannot talk about asset bubbles is because they are, according to him, not predictable but then he goes on to discuss recessions which, again according to him, are also not predictable. This is very strange stuff altogether.

The next oversight/contradiction in the interview is slightly more difficult to detect but when recognised it seems to imply that Fama is probably not being honest with himself and is probably defending his theory based on a desire to do so rather than any real thinking through of the evidence.  When asked whether people were getting loans in credit markets that they shouldn’t be getting Fama wheels out the shaky old right-wing argument that this was due to government policy. He says,

That was government policy; that was not a failure of the market. The government decided that it wanted to expand home ownership. Fannie Mae and Freddie Mac were instructed to buy lower grade mortgages.

The interviewer then points out that this was only a small slice of the market. But we will ignore that and focus on the coherence of Fama’s own narrative. Because when pressed on this question he quickly points out, quite correctly, that you cannot blame subprime mortgages because many countries saw housing bubbles (of course, Fama would not call them bubbles…) even though they didn’t have subprime markets.

You can blame subprime mortgages, but if you want to explain the decline in real estate prices you have to explain why they declined in places that didn’t have subprime mortgages. It was a global phenomenon. Now, it took subprime down with it, but it took a lot of stuff down with it.

Fair enough. I actually agree with this. Ireland had the biggest housing bubble in the world and subprimes were nowhere to be seen. But here’s the kicker: neither were Fannie Mae and Freddie Mac.

You see Fama is picking and choosing arguments to suit his own purposes here. When it suits his argument he will pin the US housing bubble on Fannie Mae and Freddie Mac but then when he is pressed on this he will also highlight that rising house prices in other countries were not due to the same factors as were operating in the US. So, why not follow this through to its logical conclusion: this implies that Fannie Mae and Freddie Mac were not the real cause of the US housing bubble any more than subprimes were? Because, frankly, I don’t think Fama’s argument is in any way serious. I think that he is willing to basically say anything to defend his theory against criticism.

As I said though, the interview is worth reading in the original. It is a truly bizarre document which I’m sure will appear in many history books in the future. What the historians will have trouble explaining, I think, is why the person in the interview was given a Nobel Prize in Economics only three years later.

 

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criticism

A quick bit of fun regarding criticisms of economics. It is a post by a blogger listing 18 “bad criticisms of economics”. I think this might be worth engaging with because (a) some of the criticisms are highly subjective and would require further argument and (b) some of the criticisms should be listened to by critics of economics. I will list all 18 and provide responses below.

1. Treats macroeconomic forecasting as the major or only goal of economic analysis.

It is unclear what the author means. Surely most macro-based criticisms would also imply that policy formulations are important. The author needs to think this one through more as it strikes me as a strawman.

2. Frames critique in terms of politics, most commonly the claim that economists are market fundamentalists.

This is true. Poor criticism does do this. If the critics articulated themselves properly they would point out that marginalist economics is based on a core assumption of a market and then various inefficiencies etc. are added. If this latter is a poor criticism then the author has an issue with much contemporary philosophy of science (Lakatos etc.).

3. Uses “neoclassical” as if it refers to a political philosophy, set of policy prescriptions, or actual economies. Bonus: spells it “neo-classical” or “Neo-classical.

Agreed. As I laid out here, “neoclassical” refers to a very specific type of economic reasoning. When properly applied, however, the term is perfectly clear and functional. It is not a critical term per se (one could support the methodology) but it can be used to denote a field that can then be criticised.

4. Refers to “the” neoclassical model or otherwise suggests all of economic thought is contained in Walras (1874).

This can be fruitful in some circumstances (and provided the moniker “neoclassical” is not used). Walras’ model is the kernel of any model based on general equilibrium assumptions. General equilibrium modelling — including DSGE modelling — can and probably should be criticised and starting from Walras’ model is often not a bad idea because if the fundamental assumptions of this model are not worthy of consideration more advanced models likely are not either.

5. Uses “neoclassical economics” and “mainstream economics” interchangeably. Bonus: uses “neoliberal economics” interchangeably with either.

Agreed. Again because of the point made under point 3 above. Also, there is no such thing as “neoliberal economics”. Neoliberalism is a political ideology, not an economic doctrine.

6. Uses the word “neoliberal” for any reason.

“Neoliberalism” is well-defined in the literature and can be used in analysis. Using it to make critical comments about economic theory rather than policy does seem misguided though. But given that economic policy is also a part of “economics” and the author purports to be dealing with “criticisms of economics” then it is hard to see why this term should be censored. Perhaps the author would care to rewrite 6 as: “Uses the term “neoliberal” to criticise pure economic theory”.

7. Refers to “corporate masters” or otherwise implies economists are shills for the wealthy or corporations.

If they imply that all mainstream economists are such shills then yes, this is nonsense. If they imply that certain economists who are actively shilling for corporations are shills I see no such problems. If the critic is wrong a libel suit will sort that out rather quickly.

8. Claims economists think people are always rational.

Agreed. This is a poor criticism. Rather critics should note that marginalist economics generally assume rationality as a core component of their models and deviations from rationality to be anomalies. Criticism can then follow from there.

9. Claims financial crisis disproved mainstream economics.

I assume that the author means “the crisis of 2008″. Does this disprove mainstream theory per se? No. But it certainly calls into question many very important aspects of mainstream theory. I shall not list them here.

10. Explicitly claims that economics is not empirical, or does so implicitly by ignoring empirical economics.

This is tricky because some assume that econometric modelling is empirical while there are good reasons — highlighted by leading statistical mathematicians — to claim that it is not. If one disagrees that econometric modelling is empirical then much of mainstream economics is indeed non-empirical and true empiricism is rare. There is also the issue, which I think many critics are getting at, that some economics models are actually contradicted by available empirical evidence. This is self-evidently true.

11. Treats all of economics as if it’s battling schools of macroeconomics.

Certainly if you are trying to lay out debates in macroeconomics then the major schools have to be noted. Does this constitute economics as a whole? Of course not. I’m not sure who claims that it does.

12. Misconstrues jargon: “rational.”

Certainly. But defenders often also misconstrue this jargon. And there is a case to be made that this jargon is semantically meaningless.

13. Misconstrues jargon: “efficient” (financial sense) or “efficient” (Pareto sense).

As above.

14. Misconstrues jargon: “externality“.

I’m not clear on this one. I know what the term means but I do not see it regularly pop up in criticism.

15. Claims economists only care about money.

Most critics claim that mainstream economics neutralises money, so this is an odd point. But if some critics do this they should indeed be taken to task.

16. Claims economists ignore the environment. Variant: claims economics falters on point that “infinite growth on a finite planet is impossible.”

This is actually a pet peev of mine, so I have to pretty much resoundingly agree.

17. Goes out of its way to point out that the Economics Nobel is not a real Nobel.

Actually this is a very important thing to point out. The history of this is currently being written and from what I have seen this was a very important move to give economics a scientific mantle it likely does not deserve and suppress political criticism of central bank independence.

18. Cites Debunking Economics.

If a specific argument is not cited and fully understood then, yes, I agree. But there is much in Keen’s book that is interesting.

All in all, some good points, some bad. But I agree that criticism needs to be sharper. Some of the points, however, fall into the category of “signs that you’re not dealing with a first rate defender of mainstream economics”.

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reds under the bed

This morning I came across a rather awful piece on The Economist‘s website entitled A Marxist Theory is (Sort Of) Right. The piece is indicative of what I think to be a far more general trend in contemporary intellectual life: namely, the fact that Marxism exists as a sort of weird counterpart to what we generally call the ‘conventional wisdom’.

The other day I wrote a post dealing with JK Galbraith and what he called the ‘conventional wisdom’ but perhaps I should again provide a nice quote from his The Affluent Society that lays out once more what the conventional wisdom is.

Because familiarity is such an important test of acceptability, the acceptable ideas have great stability. They are highly predictable. It will be convenient to have a name for the ideas which are esteemed at any time for their acceptability, and it should be a term that emphasizes this predictability. I shall refer to these ideas henceforth as the Conventional Wisdom. (p18)

That’s a rather nice summary: the conventional wisdom is characterised by ideas that are stable, predictable and, above all, familiar. With this in mind we can approach The Economist article but first a word on the publication.

The Economist magazine is perhaps the prime organ that disseminates the conventional wisdom that exists in the economics profession today. It is geared toward a popular audience — unlike, the far more sophisticated and specialist Financial Times — and can thus regularly be found, for example, in the dentist’s waiting-room. Whereas the Financial Times is a serious organ that seeks to provide real, tangible information in fairly concentrated form to an audience that actually uses such information in their professional lives, The Economist is better thought of as a sort of upmarket glossy magazine providing whimsy for a middle manager or a lawyer awaiting a filling or a root canal.

Many — on the political left, for example — inaccurately portray the magazine as being right-wing. But it is only as right-wing as the politics of the day; no more, no less. If the politics were to take a left turn, The Economist would follow. Likewise many in the heterodox economics community mistake the magazine for being neoclassical or marginalist. This is slightly more accurate but nevertheless somewhat misleading: The Economist is as neoclassical or marginalist as the economics profession of the day. If economics were to take a more Keynesian turn — which it does on occasion these days — the magazine would follow.

The Economist is really a sort of mirror reflecting back on society the economic orthodoxy of the day and it is for this reason — and almost no other, barring perhaps the occasional attractively presented graph — that it is interesting.

But back to Marxism. Many — both on the political left and in the heterodox community — get a bit jumpy when The Economist uses the ‘M-word’, seeing in it a sort of victory. While the political left may be somewhat correct in that a dominant ideology on that side of the fence is getting the spotlight, the heterodox community are being wholly misled. This is because they misunderstand Marxism as being some sort of remedy to the conventional wisdom. But it is, in fact, no such thing.

Think about this for a moment. You’re in your late-teens or very early twenties. You’re attending university. How difficult is it for you to be exposed to Marxist ideas? Not very! In fact, it is almost a rite of passage. In the humanities department there is always a few Marxist professors; pamphleteering in the halls are members of some Marxian socialist faction or other; while heading up the protests against, say, cuts to the university budget is a Trotskyist from the socialist or Green party.

As I said above, Marxism exists as a sort of weird flipside to the conventional wisdom. “Don’t be fooled by all that,” the Marxists of various stripes will say, “its really the opposite of the propaganda they’re feeding you!” In the world of Marxism many of the tenets of the conventional wisdom are literally overturned rather than properly interrogated. What is good in the conventional wisdom becomes bad on the Marxist reading.

Free trade is a salient example, as this is what The Economist article above is dealing with. In the conventional wisdom free trade is universally a good thing. In economics this is backed up by what can only be called a dogma in the form of the Ricardian idea of the so-called law of comparative advantage. On the Marxist reading free trade is all about exploitation and imperialism plain and simple. The trick here is often not to really analyse the truth content of, for example, a given trade policy or the theory of comparative advantage, but rather to just label it ‘evil’ rather than ‘good’; thus inverting what one thinks to be the moral consensus in Western capitalist democracies.

Those that generally adhere to the conventional wisdom then latch onto this and begin to associate, in the discourses of economics and politics, any position taken that seems to run contrary to the conventional wisdom with Marxism. That is precisely what the anonymous writer of The Economist article in question has done.

In the article the author discusses an IMF study that tests the Singer-Prebisch hypothesis against data going back to 1650. The thesis states that the terms of trade between those who produce manufacturing goods (secondary goods) and those who produce commodities (primary goods) deteriorates over time. This, of course, leads to a questioning of the so-called law of comparative advantage which would generally encourage developing countries to produce primary goods for the developed world as it is in their comparative advantage to do so.

Is there anything Marxist about this idea? Certainly not at a theoretical level. Although a Marxist may use the Singer-Prebisch hypothesis as part of a more general assertion that the developed world is ‘exploiting’ the developing world and extracting surplus value from them, the hypothesis does not contain within it any such moral judgments. It is merely a hypothesis about empirical facts. (And one which, it would seem from both common sense and the IMF study in question, contains a great deal of truth.)

The only reason that it is seen as Marxist for those so heavily sedated by the conventional wisdom is that they know nothing else. Anything in economics and politics that fall outside of the conventional wisdom leads the adherent of said conventional wisdom on a trip down memory lane to their university days; to their Marxist sociology professor and their encounter with socialist pamphleteers. “If it sounds like it goes against free trade and comparative advantage,” reasons the adherent of the conventional wisdom, “then it must be Marxism.”

Such a view is completely bizarre for anyone with an ounce of knowledge of the history of free trade. By such a reading, of course, the founding father and first US Treasury Secretary Alexander Hamilton would be a Marxist given that he entirely rejected free trade and comparative advantage in his seminal Report on Manufactures. Keynes too rejected the doctrine of laissez faire and free trade as early as 1926 in his The End of Laissez Fairre. Does that make Keynes a Marxist? Well, that would certainly be rather odd since in the aforementioned essay he writes:

But Marxian socialism must always remain a portent to the historians of opinion — how a doctrine so illogical and so dull can have exercised so powerful and enduring an influence over the minds of men and, through them, the events of history.

Obviously Keynes did not see scepticism with regards to free trade and laissez fairre as being synonymous with Marxism.

One could think up numerous other examples; the German historical school would be a case in point. But I think, at this stage, the reader gets my point.

Marxism is the inverse of the conventional wisdom and in its own strange way it insulates and protects it. Marxists themselves are often just spouting the conventional wisdom in its inverted form and, by doing so, they give those who adhere to the conventional wisdom a perfect label which they can tack onto anything that doesn’t fit with their preconceived notions. Thus far from being anathema to the conventional wisdom, Marxism is a sort of negative foundation upon which it rests.

Marxism provides a nice dichotomy: if you reject the moral consensus invert everything you’re taught and become a Marxist; while if you support the moral consensus adhere to everything you’re taught and label anything that doesn’t fit the bill as Marxism so that your intellectual circuits don’t become scrambled and you don’t have to think through the merits and truth content of your ideas. Such a “good” versus “evil” battle serves everyone nicely, it would seem. That is, I think, largely the function of Marxism today. As to why it rose to such a position, this is tied up with the history of the 20th century; with the Soviet Union and the labour movements and that is another day’s discussion.

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clinton eulogy

Larry Summers has dropped out of the race for Fed chair — and the stock market has rallied! The irony should be noted, of course, because Summers has come to exemplify the Panglossian Wall Street liberal of the Clinton era and, one would hope, with the rather dramatic capsize of his political boat amidst a storm of opposition such an archetypal figure is now fading into the dusk; a dinosaur, from more primitive and regretful years, now long since past.

I will not, however, engage in a screed against Summers’ questionable career trajectory, his dubious opinions of women or anything else which I’m sure more capable people than me are eulogising on today now that Summers has, in a sense, passed on. Rather I would prefer to turn to a paper that Summers co-wrote in 1990 entitled Noise Trader Risk in Financial Markets. This paper, I think, gives us insight into the mind of the Panglossian Wall Street liberal of the Clinton era as it was in the process of formation.

The paper, as the title suggests, is part of the “noise trader” literature and is generally associated with the so-called New Keynesian school. The noise trader literature builds on the well-known Efficient Markets Hypothesis (EMH) literature and, in characteristic New Keynesian style, adds some frictions. The idea of “noise” lying behind the noise traders’ views, commonly associated with the name Fischer Black whose bogus nonsense I have written on before (here and here), basically states that markets cannot exist without noise because otherwise nobody would trade. Here is Black from his characteristically poorly written paper Noise:

Noise makes financial markets possible, but also makes them imperfect. If there is no noise trading, there will be very little trading in individual assets. People will hold individual assets, directly or indirectly, but they will rarely trade them.

The noise trader theorists then build models in which those traders that are trading on noise — which is effectively “bad information” — get the upper hand and, through a sort of process of intimidation, drive the typical EMH trader out of the market causing all sorts of chaos. Thus we have a sort of Gresham’s Law dynamic: bad traders drive out the good. The moral overtones so typical of theories based on mainstream microeconomics should be noted, and noted well. (It is also pallid nonsense based on the poor use of metaphor, as I have pointed out before).

The noise trader theory, however, is only used to show frictions in otherwise harmonious markets. Although the paper in question does entertain the idea that noise traders might take over the market and even that “rational” investors might then spend their time trying to anticipate said noise traders, the story is still a goodies and baddies narrative in which it is only when the baddies win out entirely that the market can become unstable. The proof, of course, is in the pudding: Summers only a few years later  became a zealous and infamous deregulator, crushing those who disagreed with him, thus proving beyond a shadow of a doubt that the noise trader theories were constructed to describe only minor deviations and “special cases”.

Thus, since the general case in financial markets, according to the New Keynesian Panglossians, is that they should be fit and healthy, it is assumed that noise is an exception that will not spread too far. One can clearly see this in the blog post Summers’ co-author of the paper in question Brad Delong published in the wake of 2008.

Among the things that Delong says that he was not expecting from the crisis were “the discovery that banks and mortgage companies had made no provision for how the loans they made would be renegotiated or serviced in the event of a housing-price downturn”; “the discovery that the rating agencies had failed in their assessment of lower-tail risk to make the standard analytical judgment: that when things get really bad all correlations go to one”; and “the panic flight from all risky assets – not just mortgages – upon the discovery of the problems in the mortgage market”.

Put simply, Delong assumed that were there noise in the financial markets, at the end of the day such noise was probably just a small ripple on an otherwise calm ocean. Even if housing did take a downturn in the late-00s the assumption that not just Delong but basically all New Keynesians made was that, since the rest of the components of the financial markets were efficient and thus robust, there would be no serious crisis. This would be forgivable perhaps, if one ignores the many crises that had arisen during the Clinton years — such as the East Asian crisis, the Russian debt crisis, and the implosion of Long Term Capital Management and the subsequent bailout.

Summers and many of his colleagues have, of course, had their Road to Damascus moment and have come to see the light — but only gradually, as Summers was the key figure in the Obama Administration blocking a larger and much needed bailout after the crisis. But in their conversion their legacy, as indicated by Summers’ fall from grace, may already be fading — and fast. Their contributions proved to be not merely irrelevant to real-world economic conditions, but potentially blinding myths responsible in part for the deregulatory zeal of the Clinton years — deregulation that is now proving so hard to reverse.

When Summers stands in front of those pearly gates I truly hope that St. Peter forgives him and lets him in, because it appears that us mere mortals here on earth have no such capacity to do so. Rest in peace, Lawrence Henry Summers.

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Model maketh the man

The New York Times recently ran an article appraising the work of Wynne Godley and his colleagues and followers. This is fantastic. It is great to see this approach to economics, which the NYT rightly notes predicted the 2008 crash, get the proper media attention it deserves. The article, however, while extremely well-written and well-informed, is indicative of a danger that I have long been pointing out on this blog.

The article in question is keen to point out the importance it, and others, attach to the fact that Wynne Godley not only predicted the crash but also built models. This is on the back of a comment that I find rather misleading by Dirk Bezemer who says that although quite a few economists predicted the crash Godley “was the most scientific in the sense of having a formal model”. Spurred on by this rather questionable remark the author goes on to write:

Why does a model matter? It explicitly details an economist’s thinking, Dr. Bezemer says. Other economists can use it. They cannot so easily clone intuition.

Mainstream models assume that, as individuals maximize their self-interest, markets move the economy to equilibrium. Booms and busts come from outside forces, like erratic government spending or technological dynamism or stagnation. Banks are at best an afterthought.

The Godley models, by contrast, see banks as central, promoting growth but also posing threats. Households and firms take out loans to build homes or invest in production. But their expectations can go awry, they wind up with excessive debt, and they cut back. Markets themselves drive booms and busts.

Why do I find this misleading? Simple. Because as everyone knows Godley didn’t predict the crash because his models told him so. He predicted it — together with the Eurozone crisis — based on a combination of intuition and informal logical reasoning. Indeed, the author of the NYT article actually goes on to note that the Godley models cannot generate a financial crisis. Quoting a rather unfair appraisal from Charles Goodhart he writes:

For all Mr. Godley’s foresight, even economists who are doubtful about traditional economic thinking do not necessarily see the Godley-Lavoie models as providing all the answers. Charles Goodhart of the London School of Economics called them a “gallant failure” in a review. He applauded their realism, especially the way they allowed sectors to make mistakes and correct, rather than assuming that individuals foresee the future. But they are still, he wrote, “insufficient” in crises.

Gennaro Zezza of the University of Cassino in Italy, who collaborated with Mr. Godley on a model of the American economy, concedes that he and his colleagues still need to develop better ways of describing how a financial crisis will spread. But he said the Godley-Lavoie approach already is useful to identify unsustainable processes that precede a crisis.

While I think that Goodhart’s comment is too harsh, I think Zezza’s is too generous. It gives the impression that the Godley models are the entities that predicted that the economy was moving toward a crash, not Godley himself. But this is not true. As everyone familiar with Godley’s work at the Levy Institute knows, it was the sectoral financial balances framework that Godley used to predict the crash; this framework tips off the person using it as to the possibility that the private sector in general and the household sector in particular are becoming indebted and that this process is likely unsustainable.

While it is true that the Godley models will take into account whether this process is occurring, they are in no way needed to give the intuitive insights that the sectoral financial balances framework give. A person who takes a glance at these balances — and who has broadly the same perspective on the economy as Godley — will have just as much relevant information about the unsustainability of the processes at work than the person toying with the models. Indeed, they may have even more as their thinking is not being clouded with irrelevant details.

This brings us back to something noted regarding models in the NYT article. Namely that they, as Bezemer says, “explicitly detail an economists thinking” and that this means that “other economists can use them”. This statement is misleading in two ways. First of all, I do not think that models detail an economists thinking at all. Rather they give, at best, an idea of the framework being used and, at worst, a misleading outline of the processes of reasoning involved in thinking through a particular economic problem.

Secondly, and tied to this, is the idea that provided an economist has built us a model we can become, in a sense, his or her clone by learning said model. Again, and for the reasons just mentioned, this is extremely misleading. It is an appealing idea to both the modeller and the student of the model in that, for the modeller it assures a certain immortality and for the student it assures immediate access to the wisdom of previous economists. But none of this is true and, frankly, I don’t think that Godley, who did so much intuitive empirical work, would claim that it was.

This piece touched on a personal note for me, however, which is probably what led me to write this post. As already noted above by Zezza, Godley’s models have not yet integrated a means by which they can produce the financial crises they hint at when private sector debts build up. I have recently been toying with the idea that this might be accomplished by integrating the theory of prices that I am currently working on. I do not want to make any promises, as I have not had time to think this through in any great detail (I have to finish the theory of prices first!), but I think that there is a fair chance that it could be done.

This, naturally, leaves me torn. One of the reasons I started trying to build an alternative theory of prices was because I thought we needed an intuitive and teachable alternative to the stodgy old market equilibrium framework. My approach is very much inspired by Godley’s “economics without equilibrium or disequilibrium” approach which he laid out in a paper entitled Macroeconomics Without Equilibrium or Disequilibrium — this, in turn, was inspired by Kaldor who I also owe an enormous debt to. (I should mention that I don’t think this description is entirely accurate, however, and I shall be updating it somewhat to instead take into account different types of equilibrium rather than throwing the concept out the window altogether). However, I now feel that my approach may not be properly appreciated unless it is integrated into a popular model in order to show its utility.

What I am doing has always, in my own mind, been in line with Keynes’ comment that the aim of economic theory is not to build cumbersome models but rather to provide “an organised and orderly method of thinking out particular problems”. So, if I am correct and I can integrate my approach to pricing into the Godley models in order to generate the possibility of financial crises, I think that I will only do so with great trepidation and reluctance.

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PE Ratio

My letter to the Financial Times regarding the recent article discussing stock market fragility and the debate over the interpretation of data between Robert Shiller and Jeremy Siegel has been published. In the letter I try to draw attention to an article I wrote for the FT Alphaville blog back in July showing how we could combine the Levy-Kalecki Profit Equation with Shiller’s index to make medium-term projections about the trajectory of the stock market.

While the FT Alphaville blog lays out my argument in more detail this is basically the crux of it:

The robustness of the stock market is generally gauged by looking at the price-earnings ratio (P/E Ratio). While this is by no means a perfect measure, it gives us a good idea of how solid stock market rallies might be. Now, the P/E Ratio has two components: prices, which are dictated by the buying mood of the markets, and earnings, which are largely driven by macroeconomic profits.

In the piece I point out that the best measure of the drivers of macroeconomic profits is the Levy-Kalecki equation. Thus by studying the evolution of macroeconomic profits in the economy we can then make projections about future corporate earnings. This, in turn, allows us to guess in what direction the P/E Ratio is heading; a fall in macro profits will cause it rise, while a rise in macro profits will cause it to fall.

Personally, I think that this is the best way to make medium-term macroeconomic projections about the stock market. It does not provide us with a ready-made answer — indeed, one would be hard to find the level that the P/E Ratio must reach before a crash definitely happens — but it does allow us to keep at the back of our minds the likely evolution given the macroeconomic fundamentals.

At the time of writing I took note that macroeconomic profits were likely on a downward course due to the sequestration at the beginning of the year and the subsequent fall in government deficits (the key driver of macro profits after the 2008 crisis). The figures for the P/E Ratio as they stood then were as follows:

January 2013: 21.90

July 2013: 23.49

And today they are as follows:

September 2013: 23.67

That’s a pretty slow crawl, of course, but the ratio certainly hasn’t fallen since I wrote that piece. Let’s have a look at where it is this coming January.

For now, as I pointed out in my letter, one really needs to keep an eye on the government deficit in the US as this is the main driver of macro profits. This is simplified advice for working investors, but one would do much better with proper data on all drivers of macro profits.

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