The financial crisis explained in simple terms

This email was passed on to me by my office manager. It makes what happened seam absurd:)

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her
loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps
track of the drinks consumed on a ledger (thereby granting the customers loans).

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Faux Marx

I just got  an email from an investment banking friend of mine with following quote attributed to Karl Marx

Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalised, and the State will have to take the road which will eventually lead to communism.

Karl Marx, Das Kapital, 1867

Apparently this has been doing the rounds on Wall St. If you are suspicious that this is actually Marx you have the right to be! The dead give away for me is the reference to buying “technology”. Not sure what technology workers were buying in 1867….

Megan McArdle has a good discussion of this quote here

Question: Have economists been over-confident regarding their ability to predict things?

My unequivocal answer here would be yes – but I’m not asking me, I’m asking you.

Do you guys think that economists have been over-confident about their ability to predict things?

We have repeatedly said on this blog that economic science “frames issues” – but predictions only stem from virtually untestable value judgments (although we can inform these, and narrow the band of judgments, by using data).

However, it appears that many economists have tried to sell their ability to predict – something that has caused issues.

This blog post really sums up how I think people think about economists right now (ht Market Movers).  I think the issue is that economists have sold this story to the public about their ability to predict – an ability that doesn’t exist.  The risk from this is that the value that economists can add (framing issues, even describing what has happened) may get ignored as a result of this perceived failure.

Arnold Kling: Economics>Macro

Arnold Kling is right that Macroeconomics is only a subset of economics – and as a result a failure in macroeconomics does not damn the whole economic method.

However, I think he might be giving macroeconomists a bit of a free ride here.  Think of it this way – microeconomics has evolved to generalise hypotheses and make them testable.  Microeconomists have also been careful to posit counter-factuals to their cases and discover necessary and sufficient conditions for their results.  The strength of microeconomics has lead to a burgeoning industry in “Freakonomics” style books.

Macroeconomic theory has followed micro, attempting to solve general economic situations from “individual rationality” and even applying some game theory.  However, as soon as the business hit the fan – they dumped their attempts at a framework and rushed back to arbitrary debates on the size of the “multiplier”.

Recent debates have illustrated that macroeconomists are really just “play economists” – stating that they believe in scarcity, and want to study the allocation of resources, but don’t want to put in the hard yards that microeconomists have.  Where is the general equilibrium theory?  Where is the study of multiple, heterogeneous, agents interacting in a dynamic system with poor information and imperfect institutional arrangements.  Do macroeconomists actually have a general framework (based on methodological individualism) that they agree on – like microeconomists do.

Some people posit that the separation between micro and macro is like the difference between general relativity and quantum physics – these people would have us believe that there is only one step left between reconciling these divergent disciplines and having a “general theory”.  However, doesn’t that give macro a little more credit than it deserves?

Note:  This post is supposed to be contentious – I would like to hear how macroeconomists would go about answering the claims I’ve made in this post 🙂

Remember history when thinking of Keynesian economics

Over at Think Markets Mario Rizzo follows the advice of Paul Krugman and discusses what Keynes has actually said about infrastructure spending (ht Greg Mankiw):

Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle

So infrastructural investment is good when we are in some sort of reinforcing hole where effective demand is deficient and “will not” go back to our primary equilibrium. However, Keynes appears to be deriding infrastructural investment as a way to smooth the “economic cycle”.

I see this quote as justification for the idea that, if we have multiple pareto ranked equilibrium and a large shock government can help – but if we have a temporary shock to demand infrastructural investment is not the way (furthermore it says nothing about structural shocks, which is part of the current story). I don’t actually think this conclusion leads to an ability to dismiss either the view of Krugman, or the views of Mankiw – given that they ultimately have different beliefs on what is the proper description of the current events we are facing …

The morality play of the “non-morality play”

In an interesting piece over at Economist’s View the case is made from moving away from “morality arguments” and just looking at how we can pull ourselves out of the depression now.

Although the piece provides a clean argument, and involves discussions by economists as intelligent and convincing as Martin Wolf and Paul Krugman I have to admit I nearly completely disagree with it.

Fundamentally, I believe that these economists are making an implicit moral judgment when they state that we need to “improve current outcomes” through employment and consumption. I am not saying that they are wrong, however trying to make their conclusions sound value free is incredibly misleading.

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