Matt Nolan

Production function and preference relation: Archetypes of economics

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In my gradual process of trying to figure out what I am going to write when comparing Tarot Cards to Economics, it has become increasingly clear to me how the production function and preference relations of economics function (the primitives of an economic model) as “archetypes” for our discipline – and how many non-economists do not share these archetypes and as a result find it hard to translate what we are saying.

Now at first brush this seems strange – these relations are surely not archetypes, but are surely instead symbols. Why?  Well a symbol in the view I’m using here is a “given” descriptive term without any complicated cultural relations getting in its way – so a production function is a primitive as production comes from inputs being translated into outputs, preference relations merely state that people have preferences.

These symbols are then tied together to fit archetypes/models of situations.  We can then take these archetypes/models together in order to discuss or explain something in the real world. To me this is akin to the “Credible Worlds” view of economic models, or even the old school Mill view – we take these symbols/primitives and create models which capture some tendency in the real world.  We then tie together these tendencies that are captured by models in order to provide policy conclusions.

This is the way I did see the process of economic model building.

But now I’ve moved the status of production functions et al to the area of archetype.  From good old Wikipedia we have:

In Jung’s psychological framework, archetypes are innate, universal prototypes for ideas and may be used to interpret observations

The very idea of using a production function flavours the way economists interpret ideas and the way we understand phenomenon.  Often when communicating we do not observe the production function, or have any idea of all the inputs into it – in this more limited way of viewing the process, the fact that we apply an implicit view of a production function to it is akin to the production function being an archetype in our description of what is going on.  More importantly, the symbol of something like a production function becomes an archetype as it becomes accepted as a central part of the way economists communicate with each other – when we tell each other stories we ALWAYS have a production function in mind.

This matters as the fact we look at data and the world around us through the view of a production function and preference relations is probably the key difference between the way economists view phenomenon and the way non-economists interpret it.

Yes, the models that we build off of production functions et al are archetypes as well – but they of course rely on our prior assumptions about primitives (the production function).  The model can itself be boiled down to these fundamental primitives – primitives that when not used in their most general form are in fact archetypes.

As a result, when it comes to explaining, justifying, communicating, or educating and economist requires a clear head when it comes to looking at these fundamental archetypes – and needs to be able to justify why these archetypes are appropriate for describing social phenomenon.

This is just where my head is at right now – if anyone has any comments or wants to correct me on anything that would be super.

Matt Nolan

Limited knowledge provides the limits to government

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There was an interesting article by Mai Chen in the Herald on Wednesday.  There is a lot of lawyer rhetoric in there.  The only reason I really noticed is that I was reading McCloskey’s “the Rhetoric of Economics” and just yesterday went through the chapter on Coase when the rhetoric of lawyers was discussed.   This explains this:

At a high level, it requires New Zealanders to agree on a vision for our society – the kinds of things which make New Zealand a place we want to live and raise our children. But the hard edge also requires that we measure our progress towards achieving that vision, and hold Governments to account on their performance against such measures.

Sounds good doesn’t it.  Pity it involves no conception of whether the vision is attainable or the underlying trade-offs involved.  The lack of discussion of trade-offs, or comparisons of counterfactuals, is a perplexing feature of this sort of writing for an economist – and makes the statement mentioned above absolutely useless for policy analysis.

This sounds harsh – a lot harsher than I mean it to be, and as a result I want to point out the positives here.  The sort of aimless push for a “vision” is poppycock at a surface level – but it contains a strong grain of truth that we should recognise.  Ultimately, the decision about what trade-offs society is willing to make should be made by society!

Measurement and quantification are areas this article is supporting – and I agree 100% with Mai Chen here.  By measuring things, and understanding them, we can:

  1. try to understand the trade-offs
  2. explain the trade-offs to the public is a (hopefully) transparent way
  3. express whether the actions of the institution that is government are representative of the will of the people.

Quantification is an important tool for this, and to be fair to Mai Chen you could interpret the term “vision” as a way of communicating these trade-offs in a way the public can understand.  Rather than being poppycock as I have described it, such description way in fact be the way forward!

But the key point here is not to let ourselves get obsessed with targeting measures so directly (although the any benefits should be quantified and tested), and guiding the economy.  We should base policy on the trade-offs that exist and what society desires.

However, our knowledge of these trade-offs is imperfect and as a result the actions of government should be cautious.  As Noah Smith said “caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.””.  Remember, government is an institution that is intervening in the volutary trade of individuals and groups due to issues of equity or co-ordination – in the same way we don’t want a doctor arbitrarily fiddling with our body because he has “a vision” we wouldn’t want a government arbitrarily messing around with our ability to trade due to their “vision”.

 

Matt Nolan

The currency “war” myth that won’t die

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Over on Rate’s Blog I’ve seen an approving link to an article discussing the “currency wars” that are going on around the world.

As Lars Christensen says here, and as we’ve said on many occassions ourselves given that monetary policy is pegged to an implicit inflation target this isn’t “beggar thy neighbour” policy at all – this is just standard monetary easing.

Now in New Zealand the big complaint is about the exchange rate – many people feel that the New Zealand dollar is “too high”.  However, there are two issues here:

  1. Monetary policy – has NZ monetary policy just been too tight?
  2. Structural policy – are there structural reasons why our exchange rate has been (potentially) persistently over-valued.

We have discussed this before here.

This isn’t a currency war, let me requote something we’ve said before:

Central banks are not breaking the rules, this isn’t a prisoner’s dilemma – competitive devaluations HELP when demand is suppressed … just look at the Great Depression, and the choice of countries to go off the gold standard!

Yes, there likely are structural issues in the New Zealand economy.  But policy makers should be focused on those specifically (why is there insufficient residential building activity, why is the real exchange rate so high) – they cannot be solved by monetary policy or the Reserve Bank.   Even when we think a policy issue is clear we need to be careful, as Noah Smith points out:

It’s important to belabor this last point. Economists know some things, maybe a lot of things, but this is absolutely dwarfed by the size of the things we don’t know and don’t understand. If this blog has had one “unifying theme,” it would be the depth of our ignorance. So when economists urge caution in using policy to change large sectors of the economy, this doesn’t necessarily mean “We know that the free market is always perfect and good and that policy can’t help.”

Instead, caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.”

Matt Nolan

Joining in on the robot pileup

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Here is me talking about robots.  Here is the conclusion:

One of the concerns is that even with current technology robots can essentially work for an implied wage of $4 an hour achieving many of the same tasks that a low skilled worker can achieve. If robots could do all unskilled work for $4 an hour, where does that leave our hypothetical low skilled worker?

Even in the extreme case, where there are a set of people who could never have the skills to be gainfully employed due to the arrival of robots, the answer here is not to stand in the way of the technological improvement.

The key question to ask is how does the individual live in a society where the “reservation job” now pays a lot less?

The simple answer seems to be that we allow people in this situation the opportunity to increase their skills, and where they can’t redistribute some of the gains from mechanisation to these people in the form of an income payment – where the income payment represents the fact that the “reservation job” that previously gave an individual a certain standard of living no longer exists.

The existence of an unemployment benefit, the existence of student loans, and the subsidisation of education are clear and consistent methods that society has already taken on board to deal with the possibility of the increasing mechanisation of low skilled work – and it is this these types of solutions that are appropriate moving forward, not an arbitrary call to stand in the way of technological innovation.

As a result, the rise of the robots is not something to fear, as long as society and the government that represents it are conscious of the changes that are occurring – and that they provide a security net for those who may otherwise lose out.

Will Taylor

Looking for stock advice? Buy a cat…

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Via @NBR I came across this awesome article on the Guardian about a cat named Orlando that was pitted up against some investment professionals and students in a stock picking challenge. How did the cat pick stocks?

While the professionals used their decades of investment knowledge and traditional stock-picking methods, the cat selected stocks by throwing his favourite toy mouse on a grid of numbers allocated to different companies.

And the results? Orlando the cat unsurprisingly (to anyone who has studied finance and whose job isn’t giving investment advice) earned more money than the professionals.

At least the kids didn’t beat the pros, that would be embarrassing if they did….

jamesz

With great power comes great responsibility

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Romer and Romer think monetary policy could do more if only central bankers believed in themselves. Scott Sumner might agree these days.

Our thesis in this paper is that overly pessimistic views about the power of monetary policy have been a more important source of these errors than have overly optimistic views. There is little doubt that an overinflated belief in the power of monetary policy has contributed to some major policy errors. Most famously, policymakers in the mid-1960s believed that they faced an exploitable long-run inflation-unemployment tradeoff, and thus that monetary policy could move the economy to a sustained path of low unemployment and low inflation. This belief led them to pursue highly expansionary policy, starting the economy down the path to the inflation of the 1970s. The record of such errors has led many to argue that perhaps the most important attribute of a successful central banker is humility.

In this paper, we present evidence that the opposite belief—an unduly pessimistic view of what monetary policy can accomplish—has been a more important source of policy errors and poor outcomes over the history of the Federal Reserve. At various times in the 1930s, faced with the Great Depression, Federal Reserve officials believed that the power of monetary policy to combat the downturn or stimulate recovery was minimal. In both the midand late 1970s, faced with high inflation, policymakers believed that monetary policy could not reduce inflation at any reasonable cost. And there is evidence that in the past few years, faced with high unemployment and a weak recovery, monetary policymakers believed that policy was relatively weak and potentially costly. In each episode, the belief that monetary policy was ineffective led to a marked passivity in policymaking.

Matt Yglesias comments.