Category Archives: Economic theory

The excel error in Rogoff-Reinhart

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I see the Rogoff-Reinhart figures regarding the correlation between GDP growth and the size of the debt stock are currently under attack – due largely to an unfortunate excel error discovered reported by Mike Konczal.  Here are the list of posts about it at the moment:

All very nice.  Depending on the message people were trying to sell they either said the result was meaningless, or central, so I don’t think this makes any actual difference.  Honestly, without clear causal drivers there just were not good evidence based claims for actual policy adjustments – a lot of people were actually just saying we need to do X based on their preconceptions.  And they found this correlation either something that supports that (somehow) or something they need to rule out.

Over the last few years I have seen authors, at different times, use R-R as central to their argument on one thing, and then dismiss it for arguments regarding other issues (I’m not going to name names).  For example, you can’t use this result to say we need more savings policy because the stock of debt is to high, then complain that the study is flawed when you want more government borrowing … just focus on the actual core elements of your frikken argument instead!

My problem with the result isn’t the excel errors, or anything R-R appear to have said – it is the way it has been used as an inconsistent marketing tool by people for selling their own unrelated ideological policies.  I’m just hoping that this shuts that up.

As a side note, here are my feelings on twitter:

People who think the R&R result caused austerity overestimate the impact evidence has on government policy.

Two links that reinforce my priors

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On bubbles (My point:  I keep hearing bubbles matter because “financial stability influences monetary policy” like it is a big idea … but really, no sh*t.  Government spending “influences” monetary policy.  So does competition policy.  They all change the time profile of the natural interest rate.  The fact is that we have monetary policy to manage monetary outcomes given these things – have other sets of government policy for other areas of government concern, and just try to base them in sound economics.)

On the minimum wage and long-run effects (My point:  Good to see actual work on given so many empirical estimates are for short-run effects – and even those show pain to the young and unskilled even if the aggregate figure isn’t statistically significant – reminds me of McCloskey).

In a time and a place where I have both time and a place to do so – I will post on these.  Hopefully.

Ethics and description

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In the past couple of days I’ve run into a couple of places in the internet that left we confused.

First, via Education Directions I noticed this article on the way of “valuing assets” that takes into account social value.  The claim is that:

Western accounting needs to recast the narrow, individualistic and economically bound concept of asset, claiming that much would be gained from recognising that there are things of value beyond those defined by individual property rights and economic reckoning

This seems like an aimless statement to me.  Private individuals value their asset based on issues of private value – this is hardly surprising.  Government takes into account concepts of broader “social value” when they do accounts, or look at the value of policies.  What methodological value is there from using a different word for social value to describe it?

Giving things new names doesn’t actually add value to how we describe them, unless the context is to translate these broad concepts for a cultural specific context!  In truth, it isn’t “western accounting” that needs to learn from this – if the government is trying to work out social value, then we would want to use standard western accounting methodologies with these specific cultural contexts in mind.

Now don’t get me wrong, the willingness to attack “western” accounting immediately shows that the authors want to attack an arbitrary strawman, than to credibly discuss what organisations are trying to achieve with accounting values and then asking how to transparently represent that.  And this brings me to my second link – Buddhist economics.

Contrary to the description given of “western” economics on this post, there is a focus on “social value” in mainstream economics – there is a huge focus on it.

But the very description behind Buddhist economics here is worse than that – for some reason the author of the Wikipedia page has decided that the purpose of economics is to tell people how to live their lives, rather than describing scarcity and trade-offs.  Given this, the article finds fault with economics because it dares to assume that people act in a self-interested way.

Of course, we’ve seen this ethical confusion before – a million times.  People presume that since economists are willing to discuss trade-offs we lack morals.  Now, a clear moral and ethical standpoint IS required to decide on what SHOULD be done, and what policy SHOULD be picked by government.  But everything that I keep seeing economists attacked for, and in this case accountants as well, is merely describing something.

Now does this happen because people find it hard to distinguish between description and prescription?  Or is the issue that people think economists framing of issues IS the driver of certain ethical outcomes in policy, and that our pretense of separating “description” and “prescription” is flawed?

The issue of assumptions

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In a recent post, James recently raised an essential, and fascinating, point on assumptions.  To borrow his own words:

Assumptions are often made for tractability, rather than realism, yet still influence our conclusions. It isn’t possible to control for the unrealistic assumptions; if it were we wouldn’t have made them. That means our conclusions will be biased by assumptions we’ve made only for convenience and we need to bear that in mind when considering the policy implications of our models.

This reminded me of an essay by Maki which can be found in “New Directions in Economic Methodology“.  The essay was title “Reorienting the assumptions issue“.

In this essay, Maki does a number of interesting things – but in terms of this specific issue his key insight was to differentiate between “core” and “peripheral” assumptions.  This is an insight we have borrowed many times when talking here on the blog.

A core assumption “constitutes the theory” while a peripheral assumption does not.  What does this mean?  Well it means that the “core” makes up the central set of necessary assumptions required to achieve a certain result!

It is these core assumptions that need to be “realistic” in some sense of the word – while peripheral assumptions are merely there to increase tractability, or make a result easier to interpret.  Fundamentally, our core result should only rely on our core assumptions.

Core assumptions in econometrics

For those who are statistically inclined, this also fits neatly inside our view of econometric theory.  Fundamentally, the assumptions we make about error terms in a regression in econometrics are akin to checks regarding whether we have all the appropriate “core” assumptions for the econometric model and the question we are asking with that model.

For example, we may be trying to explain some independent variable (y) with a set of (presumed to be) exogenous dependent variables (x).  However, it turns out one of these x’s turns out to be correlated the error term – so that this variable is “endogenous“!  If we wanted to estimate the impact of this dependent variable on our independent variable through typical OLS, our estimate will be biased (this is the justification for instrumental variables).  In this case, the model is likely underspecified in some way – such as having missing “core” variables (omitted variable bias), or a missing “causal relationship” (reverse causation between the independent and dependent variables).

A conclusion

As the above example hopefully showed, what dictates a “core” assumption in a model depends strong on what question we are trying to answer with the model!  An analysis of what constitutes “core” assumptions for our analysis, and then a discussion regarding whether these core assumptions correspond to a realistic set of assumptions, should be an essential component of all model building exercises in economics.

Neuroeconomics is exciting, and scary

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Great article from Shiller on neuroeconomics.  The more justification, and more positive side, of neuroeconomics is mentioned here:

Under Samuelson’s guidance, generations of economists have based their research not on any physical structure underlying thought and behavior, but only on the assumption of rationality.

As a result, Glimcher is skeptical of prevailing economic theory, and is seeking a physical basis for it in the brain. He wants to transform “soft” utility theory into “hard” utility theory by discovering the brain mechanisms that underlie it.

This is cool.  Economists want to be reductionist, but we were unable to boil down our theory quite far enough and had to settle on some underlying assumptions of human nature – assumption that were based on “conducting experiments in our own heads”.  Neuroeconomics provides a route for us to actually push the ontological envelope and create a more objective, mechanistic, way to describe the underlying elements of human action.

However, the risk is that we allow this view to cloud our thinking on choice – no matter how far neuroeconomics evolves we will never clearly decipher whether actions are the result of determinism or free will.  By describing action in a deterministic way, we may treat human action as “too deterministic”, leading to a bias towards excessive control and meddling.

The importance of incentives

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This story is a great example of how institutions can shape incentives, in order to change outcomes.

The women of Barbacoas, Colombia have ended a three-month, 19-day “crossed legs” strike of sexual abstinence aimed at getting a road to their isolated town paved, after officials pledged to invest in the project.

The money quote is:

“The men’s first reaction was laughter, because they found the way we were protesting very curious,” Silva said.

Then reality set in, and work on the road finally began last week as the government had promised.

Now, my question is – is this optimal or not?

On one side, the women were signaling the high value they place on the project through their actions – and are in one sense trading sex for a road.

On the other hand, the women are in a position of power – and are changing the bargaining position so that they can extract more surplus from this trade.

Truly, there is economics everywhere