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.