Randomized control trials and economic models: friends or foes?

Randomized control trial (RTC) studies are getting more and more attention among policymakers in the last few decades. In addition, the RCT is one of the core experimental methodologies used by the recent nobel prize laureates in economics Duflo, Kremer and Banerjee

Given the excitement around these methods, Chicago University has recently run the IGM Economic Experts Panel asking economic experts on whether the “ Randomized control trials are a valuable tool for making significant progress in poverty reduction”. The results of the poll are summarized in the graph below. 

The chart above highlights respondents’ agreement distribution. What struck me most from the results was Angus Deaton’s strong disagreement with the statement – especially given that he is an expert in the field.

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On MMT: An ideology wrapped in a strawman

NotePP on twitter asked for a post on MMT, and asked me to try to avoid making it technical.  I attempted to do that at much as I could – however, I was forced to use words like endogenous, as it was the cleanest way of trying to get across the point that by using supply and demand savings and investment are jointly determined … and the interest rate is set as the price.  The very idea that economists only think the causal chain goes only one way or the other is patently ridiculous – and does not represent economists, no matter how much people keep saying it does.  So try to keep that point in the back of your head until at least the end of the post if you read it 😉

I have nothing inherently against modern monetary theory, its proponents, or the value judgments involved.  But my impression is that MMT theorist view central bank independence and the framing of government policy as an ideological device to “shrink government” and so have decided to create a “strawman” mainstream economics to attack, rather than directly admitting they want a larger state (and the trade-offs involved in that).  For me this simply lacks transparency!

So how does MMT differ from mainstream economics.  Well in the words of Bill Mitchell (who I choose because he is clear, both here and on his blog – which is a good thing!) it comes from economists accepting three false premises:

  1. A government has to borrow to spend
  2. There is a fixed supply of savings at a point in time
  3. Governments crowd out investment for that fixed supply of savings, pushing up interest rates

Supposedly all three of these are in the core of economics, and they are all wrong.  Huzzah.

Ok, so if that is MMT then I’m not sure who in the world they are actually arguing with.  The government can print money, and this is in any graduate macro book, so that doesn’t hold as a premise.  Savings and investment are determined by supply and demand, they aren’t a “fixed thing”, so that isn’t a premise in mainstream economics (Sidenote:  Why do people keep saying “savings determines investment” or “investment determines savings” – I’ve never heard economists talk like this … remember the money multiplier is a ceteris paribus example, not a description of the causal device).   Crowding out is actually a premise – but it comes from government demand pushing up demand for underlying goods and services … because government demand for things is just like the demand of any institution.

Let me restate these premises in terms of what the mainstream actually has:

  1. A government can finance spending through taxation, selling bonds, or issuing money.  In the end, prices and expectations adjust such that someone pays for government consumption and investment.  More specifically the government has to match spending to taxes over time for a certain inflation target!
  2. Savings and investment are determined endogenously by demand and supply factors in the economy, where the “price” is the REAL interest rate (perhaps I should use the world natural/fundamental here) – as savings and investment are factors that are involved with transferring consumption (the thing we really want) over time due to technology, the rate of return on investment, our time preference, etc etc
  3. Additional government demand for goods and services will push up the price of those goods and services and push up the REAL interest rate in the economy … remember the real interest rate is a price, when the government is trying to push up investment of consumption this increases the demand for these given an underlying PRODUCTION FUNCTION, crowding out private investment and consumption … the real interest rate rises as investment/consumption demand has been pushed up and the lift in relative prices has to occur in a way that makes private agents defer consumption/investment in terms of the quantity of goods and services.  No amount of hammering the S=I identity in the face of fiat currency changes this 😉

These premises actually sound pretty good to me!

I remember my dad used to say “it isn’t money that matters when we think about people, it is the actual good and services that are made and consumed”.  He didn’t take the same point out of it I did, but I think on this statement he was right – we need to actually think about goods and services, capital, and labour here.

Now there are MMT people who claim they do (back to Bill again) – that they have a production function (which seemed to be a bit missing earlier) and they have a Phillips curve (tells us how this production function and prices pressures relate through time).  This is good, these two things are necessary!

But if that is what they are doing, then their inherent model IS the mainstream model.  The three “fallacies” that they mention don’t actually exist – and that third point they list down is WRONG … there is crowding out.  Instead their argument is that the “optimal size of government” is larger than they hear other people saying … which is both an empirical and subjective question that people have already written (and should continue writing) countless books on.

Yes, people should discuss this, and discuss trade-offs.  But misinterpreting mainstream economics and pretending to offer an alternative in order to sell your view as not being “subjective” (which all policy conclusions are) is both misleading and irritating for people who view themselves as part of the mainstream.  Personally I like the idea of “changing the frame” to think about issues – but to me that is just a good way of researching, rather than a sign of a militant revolution inside economics 🙂

A much better critique of MMT (albeit more technical) can be found here.

A great pile of links

Economist’s View has put up the best daily link fest I’ve seen in a while today.

The two I’m 100% going back to when I get a chance are the links on inequality (pet interest issue of mine, and all economists) and the nice summary of the actions taken by the Fed over the past four years.

There is also a piece where an academic economist attacks some consultants who attacked an OP-Ed they did, which attacked some work done by the consultants (or at least came to a different conclusion).

This is all well and good, and when it is the specialist field of the academic economist I would place more weight on their words than on a consultant (this is coming from a consultant/forecaster).  But this doesn’t just cut one way – if the academic economist is correct that their “clients” are the community they work in, then I would expect more academic economists to come out to help educate the public, and analysts such as myself, about the issuess.  Given how little this actually happens, it appears that at least the consultant he is criticising serves his clients in a better fashion that much of academia serves theres 😉

This comment is not meant to be harsh at all – hopefully it illustrates the huge respect I have for academic economists, and my burning pashion for them to get more involved in the public discourse!  Because that is exactly how I feel.

Prices provide a signal, not a cause

Over at the always awesome Stumbling and Mumbling blog (seriously, I could write a post about every single post this guy has done) the question is asked regarding whether society should set a “maximum wage”.  While he says that such a policy can be justified in theory he states the following:

My point here is that high CEO pay is not the disease, but the symptom – of the fact that CEOs have too much power. Treating the symptom is not sufficient, and might even be counter-productive.

I would note that, in terms of thinking about “excessive power” we need to ask ourselves about the framework that business works within.  Large businesses will be subject to waste, empire building, asymmetric information, and organisational issues – but just because there are issues does not mean that anything can be done to improve them, it may just be the way things are.

The key point is that an “excessive wage” just like a “price” that is “out of whack” is a signal, a symptom, of some underlying issue.  It should be a call to try and understand how the allocation of resources is working in the market, and whether any issues exist, not a call to arbitrarily mess around with prices.

In defence of neo-classical economics

I have recently seen an increasing number of attacks on “neo-classical” economics from every section of the political spectrum.

Last week, I heard a number of commentators at the sustainable economics conference claim that neo-classical economics was:

  1. Based on falsified views of the individual,
  2. Static,
  3. Had no supply side.

Then I saw an attack on “neo-classical economics” from Roger Kerr at the Business Roundtable (and more) which seemed to imply:

  1. It ignores institutions,
  2. It ignores transaction costs,
  3. It is static.

I was surprised by these attacks.  More than surprised, I felt like the attacks were based on a straw man version of neo-classical economics – one that in many ways never existed, and if it was floating around it was during the 1950’s-1970’s when a lot of the focus was on a narrow neo-classical synthesis in macro theory.

Neo-classical economics is a term for the “core” of economic theory – primarily modern mainstream microeconomics.  I have discussed here how we get from scarcity to neo-classical economics, and I have discussed neo-classical economics in more detail here.

This “core” is different to the core in the 1970’s – as many of the fringe elements of theory have now shifted their way inside the core of economics (think game theory, endogenous growth theory, transaction cost economics).  However, this is the point, neo-classical economics has evolved and it is this modern version that is taught in universities (at least it is at Victoria) nowadays – contrary to the claims at the sustainability conference that economics hadn’t changed.

The reason I am so defensive about the definition of neo-classical economics is because people see it as the current core – which according to my definition it is.  Setting up an alternative definition of neo-classical economics and knocking it down is either equivalent to setting up a straw man to attack, or directly misleading people to make it sound like modern economists are incompetent.

Seeing the future and determinism

As an economic forecaster, the idea of “seeing the future” is no doubt of interest to me.  Combined with the fact that I have compared economic forecasting to tarot card reading, it would seem that I have a prior belief that the ability to see the future exists – but in fact, I very much don’t.

In essence, my prior belief is that the future is not predetermined per see, but that there are current factors that influence future outcomes that are observable – as a result, we can use knowledge about the causal or empirical relationship between these factors to get some idea regarding what could happen and some of the risks around it.

However, in the face of genuine uncertainty I would believe we have no knowledge.  This specific view also indicates that the distinction between free will and determinism is unobservable – as there is no way to disentangle the relationship between cause and effect in a way that tells us whether there is choice, or whether the causal mechanism in itself determines the future.

Yet, a recent study that appears to show a mildly statistically significant relationship between people’s predictions of what will happen and what does happen BEFORE what occurs has been in any way determined.  In essence, there is complete uncertainty but people’s ability to judge what will happen in the face of this is greater than we would expect from chance! [ht Chris Blattman, Marginal Revolution *].

To me, this also provides a test of determinism vs free will – at least along some level of interaction.  Why?  If it is possible for people to “see the future” before it is ex-post determined then the future must in some sense exist before it appears to exist.

In the face of free will, we can still judge what will happen on the future given information, but we would not expect people to outperform chance in the face of no information.  In the face of determinism we would expect the ability to judge the future with no information would be related to the strength of the precognitive ability of the person – if, among people, this is on average greater than zero we would expect a statistically significant deviation from chance.

This is all very interesting, but I would like to see the results replicated and further testing done before I even begin to shift my posterior probability regarding such things.