Economists and astronomers: Why are the former lost in space?
from Dean Baker
It is remarkable that the public has been convinced that the earth revolves around the sun. This is remarkable because we can all look up in the sky and see the sun revolving around the earth.
Most of us are willing to believe the direct opposite of what we can see with our own eyes because we accept the analysis of the solar system developed by astronomers through many centuries of careful observation. The overwhelming majority of people will never go through the measurements and reproduce the calculations. Rather, our belief that the earth revolves around the sun depends on our confidence in the competence and integrity of astronomers. If they all tell us that the earth in fact orbits the sun, we are prepared to accept this view.
Unfortunately the economics profession cannot claim to have a similar stature. This is both good and bad. It is good because it doesn’t deserve that stature. Economists too often work as hired guns for those with money and power. It is bad because the public needs expertise in economics, just as it needs expertise in medicine and other areas.
Theories for sale
If you head a big pharmaceutical company and you want to strengthen your patent monopolies to allow you to charge more money for your drugs for a longer time, there is no shortage of economists who are willing to argue your case. If you run an investment bank and you want to avoid regulations and oversight, there are plenty of economists who are willing to attest that government interference will slow growth and cost jobs. If you own a gas or oil company that wants to frack without paying for the damage done to farmland and drinking water, you can find economists to back you too.
In short, in keeping with economic theory, there are plenty of economists who, under the influence of moneyed interests, are willing to put forward arguments that don’t fit the data. For this reason, the public has rightly grown skeptical of economists.
The problem is that the public desperately needs economics knowledge now, when there is a strong need for measures by the government to boost demand and create jobs. The public needs to have economists it can trust to make this case because it involves measures that are counterintuitive.
The basic point is that the government must deliberately spend more money than it takes in from taxes — in other words, run large deficits — in order to create enough demand to get the economy back to full employment. This is counterintuitive because running deficits has the appearance of being irresponsible.
It is only natural that people would extrapolate from their own experience with borrowing and debt to conclude that the government should not spend more than it takes in from taxes. This is where it would be useful to have an economics profession that could explain to the public that the situation of the government is fundamentally different. It does not face the same constraints on borrowing as a household, and it has a responsibility to sustain demand in the economy, which certainly no individual household shares.
The fact that governments with their own currency, like the United States, do not face any near-term limits on borrowing is easy to show. The ratio of government debt to GDP in the United States is just over 100 percent. By contrast, the United Kingdom had debt-to-GDP ratios over 200 percent through much of the 19th century. Japan has a debt-to-GDP ratio of 250 percent and can still borrow long term at less than 1.0 percent interest. Clearly there is no basis for concern that the United States is about to hit some debt cliff at which point it would no longer be able to borrow.
Economists should be able to explain the other side of the story. Since the collapse of the housing bubble, the economy has faced a severe shortfall in demand. There was no plausible source of demand that could replace the $600 billion in lost construction demand when the housing bubble burst or the $500 billion in consumption demand that was fueled by massive amounts of home equity created by bubble-inflated prices. When the bubble burst and house prices fell back to trend levels, consumption fell back to more normal levels.
The combination of lost construction and lost consumption created a massive drop in demand in the economy that could be replaced only by government spending. This is the reason the federal government must run deficits; there is no other plausible way to compensate. In this context the decision not to run large budget deficits is a decision to leave millions of people unemployed or underemployed and to forgo trillions of dollars in potential output.
Inflicting needless suffering on tens of millions of people cannot be viewed as responsible. If economics had as much standing as astronomy, economists would be explaining this point to the public. They would be telling them why the rules for responsible household budgeting are not the same as the rules for responsible federal-government budgeting.
But economists are not scientists like astronomers, perhaps because there is so much money at stake. As a result, the United States and much of the rest of the world is likely to needlessly suffer from the collapse of the housing bubble for many years into the future.
Dean Baker is co-director of the Center for Economic and Policy Researchand author of
The End of Loser Liberalism: Making Markets Progressive.
Goofy macroeconomics
from Lars Syll
Price rigidities of all kinds are common in real economies. The nodal point, however, is not their existence, but rather that even if they did not exist, our economies would not turn into the kind of Panglossian full employ-ment equilibrium Walt-Disney-fiction-world that neoclassical economists seem to take more or less for granted.
If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around. As Keynes has it:
Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the natural science, the material to which it is applied is, in too many respects, not homogeneous through time.
To make sure that macroeconomic models – no matter of what ilk – are both real and relevant, macroeconomic modelers ought to do some ontological reflection and heed Keynes’ warnings on using thought-models in economics:
The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. Any other way of applying our formal principles of thought (without which, however, we shall be lost in the wood) will lead us into error.
People calling themselves macroeconomists ought to be rather embarrassed by the fact that the kind of microfounded DSGE models they use, cannot incorporate such a basic fact of reality as involuntary unemployment!
As Keynes wrote in General Theory:
Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment – if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight – as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.
What macroeconomics needs today is less of Goofy macroeconomics and more of realist and relevant theories and models that really help us to explain and understand reality — the kind of theories and models Keynes advocated.