On the Misuse of Data and Confirmation Bias

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When I was doing my undergraduate in journalism I became interested in economic reporting and commentary. One of the things that struck me was the inability of respected opinion-makers to handle data; a disease that Dean Baker documents daily on his Beat the Press blog. Much to my surprise when I began to study economics I found that the situation was not much better among academics and working economists. Often whole debates would disintegrate on a basic data-point.

A good recent example of this is the case of Jonathan Finegold Catalán, an Austrian economist and Mises.org contributor. (The Austrians, I should add, are serial offenders in the misuse of data…). Catalán was debating the blogger Lord Keynes on a rather obscure point of the equally obscure Austrian Business Cycle Theory. Without getting into the weeds of what is a rather unproductive and interminable debate, Catalán provided the following graph to prove that the price of finished capital equipment fluctuated in line with supply and demand:

PPI-Finished-Capital-Equipment-Whole-Series

Looks good, right? Wrong. Catalán committed the cardinal sin of data usage: he forgot to inquire whether the measure was nominal or real. If it is nominal the price fluctuations can be explained by changes in inflation, while if it is real Catalán’s point that there is something resembling a free-market for capital equipment might stand up. Is this hard to check? Nope. If the measure doesn’t say “real” or “inflation-adjusted” then it is likely nominal. We can further check this by mapping the CPI next to the data-points being used. If they approximately match up then most of the price fluctuations are just an illusion built into the data.

11EYQM9

Low and behold, the effects of inflation seem to be almost completely dominant! This should not be surprising at all to anyone familiar with the structure of the data produced by the Federal Reserve. Nor should it be surprising to someone who works with data often. (And I should say before the Austrians pile into the comments section: no, much of the inflation shown in the above time-series is not the result of demand-pull forces).

I would like to put such misuse of data down to poor education. And indeed, part of the blame lies there. There is, however, another reason for such misuse: confirmation bias. It is extremely pleasant when data fits nicely with our conception of the world; it gives us an ego-boost and reinforces our theories. But we must be extremely careful because oftentimes this desire to prove oneself right leads us astray. Better to deflate our egos and our figures at the same time then get caught up in errors.

It is for this reason that we should always let the data speak rather than our theories. It is the latter that should change in response to the former; not the other way around. The only way to get away from confirmation bias is to fully give oneself over to the data: the data is sacred; the theory is not. It seems to me unlikely, however, that certain types of economists can accomplish this; because, as I have argued elsewhere, their theories are not an attempt to understand the world but rather an active attempt to shape it in their phantasmatic image.

Update: Catalán has responded in the comments section saying that I have misrepresented his argument. He says that his point “doesn’t have anything to do whether the prices of capital goods have to do with supply and demand”. Let’s be very clear here so that we avoid confusion. He wrote:

I’m not saying that prices aren’t “administered,” because all prices, to some extent or another, are set by the firm (the real world isn’t perfectly competitive, where everyone is necessarily a price taker). I am saying that the idea that producers’ good prices aren’t flexible enough to change with flows of profit is wrong.

Now to me that does have to do with whether the price of capital goods has to do with supply and demand. What Catalán is arguing is that the price of capital equipment fluctuates with the change in the flow of profits (that is, the demand for the goods and services being produced by said capital equipment).

I do not, however, wish to argue semantics because I have no desire to handle the slippery fish that is Austrian capital theory. So, let us just say for the sake of argument that I have misrepresented his argument. Well, we are quite clear then that if he is saying anything at all it is that “producers’ good prices” are “flexible enough to change with flows of profit”. If this is the case then we would expect there to be some correlation between the change in the price of capital equipment and the flow of profits. Do we see such a correlation? Nope. See for yourself:

Capital Equipment vs. Profits

That graph is a bit pesky to read. I had to graph the two variables on different axes because the fluctuation of profits is so much greater than the fluctuation of the price of capital equipment. Nevertheless, if you can take the time to read it properly you will see that there is no correlation. Indeed, in some periods such as 1974-75 and 1979-1980 there is a strong negative correlation. (There is, however, some correlation in the late-1940s, but in order to say that there is a relationship between these two variables we would need a longer term correlation; this graph is, as can clearly be seen, all over the place).

Whatever way you cut it, Catalán’s argument doesn’t add up. What he was really seeing when he was looking at the price of capital equipment was inflation plain and simple. And inflation has nothing to do with the flow of profits in a capitalist economy as can be seen clearly above.

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About pilkingtonphil

Philip Pilkington is a London-based economist and member of the Political Economy Research Group (PERG) at Kingston University. You can follow him on Twitter at @pilkingtonphil.
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14 Responses to On the Misuse of Data and Confirmation Bias

  1. Jon Finegold says:

    That wasn’t my argument … at all. LK had made the claim that capital goods are subject to administered fixprice. I used that graph only to make the point that capital goods fluctuate in value pretty frequently. In fact, capital goods are more sensitive to booms/busts than consumer goods. This point doesn’t have anything to do whether the prices of capital goods have to do with supply and demand, and I don’t know where statements like these come from: “…while if it is real Catalán’s point that there is something resembling a free-market for capital equipment stands.”

    And the PPI is a price index like CPI. Would you deflate CPI by the PPI? No. The PPI is literally a measure of inflation.

    • That was just another way of wording it. We can use your terminology and its still false. Here you go:

      “I am saying that the idea that producers’ good prices aren’t flexible enough to change with flows of profit is wrong.”

      They’re not “changing with the flows of profit”. The price of these goods are rising and falling with changes in the rate of inflation. That indicates that it is input costs that are driving the prices not the “flows of profits”. That confirms the fix-price view which considers prices to be set in line with input costs.

      Regardless though, if you deflate the price of finished capital goods you clearly see that this has nothing to do with the “flow of profits”. Sorry, it just doesn’t. Your piece was totally wrong in that regard.

      Update: There I just updated the piece and dealt with your quote verbatim.

      • Jon Finegold says:

        The price of these goods are rising and falling with changes in the rate of inflation.

        Exactly. Flows of profits is a monetary phenomenon. Inflation is a monetary phenomenon. That’s why I used the PPI, and not some other index adjusted for the PPI (because it makes absolutely no sense to adjust any capital goods’ index by the CPI, since we’re talking about completely different sets of goods).

      • Yeah, nice story. Pity it doesn’t fit the data I presented above. Profits are clearly not correlated with the measure you used.

        The fact is you have actually grossly misused and misinterpreted the data. The deeper you dig the more clear that becomes. If you were correct we would see some relationship between the PPI and profits. We do not. So, you were wrong.

      • Jon Finegold says:

        Just to be as clear as possible: what I’m interested in is the rate of inflation in those goods. So, no, my piece is not “totally wrong in that regard.”

      • Jon Finegold says:

        Phil, I’m not sure how much clearer this can be. Your “data” is wrong. You try to deflate a PPI index by a CPI index. I shouldn’t have to explain this to you — that makes absolutely no sense. You can’t deflate one measure of inflation by another.

      • Ignore that for a moment, John. I could take it from that angle, but I want to be crystal clear so I’ll lay out the argument in your terms:

        (1) You said that the data you provided — the PPI — proved that prices of capital equipment were flexible enough to respond to changes in the flow of profits.

        (2) I disputed this for reasons to do with the measure you used. But let’s ignore this because it will take too long to explain.

        (3) I then laid out a graph showing the measure you claimed proved that prices of capital equipment responded to changes in the flows of profits (the PPI) next to the actual flow of profits. There is quite clearly no relationship.

        (4) Unless you can argue a relationship here your original post misused data. (Again there is another reason for this which is why I knew you were misusing it without even checking the figures for profits, but let’s focus on the present angle because its easier and 100% in your terms).

        Ball is in your court, buddy.

      • Here I did a quick post for you guys:

        https://fixingtheeconomists.wordpress.com/2013/08/06/misuse-of-data-part-deux-redux/

        Please try to keep this organised. You can debate my empirical points on the relationship between profits and the PPI here. And please debate my general points on whether you misused data in your attempt to “prove” that fix-price markets for capital goods don’t exist in the comments on the new post.

        Thanks.

  2. dkuehn says:

    “Inflation” doesn’t necessarily mean CPI adjusted (although in most cases it does because we’re communicating with the public who face consumer prices).

    By your logic here, one could also say that because CPI and PPI track each other nicely, consumer prices are stable for the most part and the variation is “dominated by inflation”.

    All you’re showing is that general price level fluctuations result in a general fluctuation of prices… consumer and producer. Ummm… ya. That’s the whole point.

    Thinking about real and nominal differences in price level changes is interesting, but you don’t get there by adjusting one price index by another price index! It would probably make more sense to adjust a specific price by a price index to clean out the nominal changes, but of course that’s not what Jonathan is doing here. Jonathan is looking at an index not a specific producer price.

    • I don’t think you understand what this is all about. Keep an eye on the exchange between me and Catalan.

      • dkuehn says:

        Catalan and I have talked about your little analysis here. I’m quite aware of what it’s all about. If you don’t have a response just say so Phil.

      • This has to do with whether Catalan’s measure says anything about the price of capital equipment as it changes in response to flows of profits. The data shows that this is not the case (see: update to the post). The reason for this is that the original data that Catalan used was not price deflated and so he could not see that it was just a general inflation measure. The reason Catalan (claims after the fact) to have done this is because he thinks that the flows of profits are tied to inflation (see his above comment). But the data shows that this is not the case.

        Catalan does not know how to handle this data. That was evident from the beginning. And the deeper he digs in here the more the data will prove him wrong.

  3. dkuehn says:

    This is like deflating the Dow by the NYSE and concluding that financial markets are largely placid.

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