On "mainstream" economics

“It doesn’t matter whether a cat is white or black, as long as it catches mice.” I was reminded of this quote from Deng Xiaoping by the debate between Simon, Brad and Unlearning Economics over the role of mainstream economics. For me, what matters isn’t whether economics is mainstream or not, but whether it does the job of explaining reality.

I’ll take three different examples.

The first is austerity. Brad’s right that some mainstream economists supported austerity. But so what? What matters is the strength of the arguments, not who makes them. And many mainstream arguments were weak. Reinhart and Rogoff’s claim that debt-GDP ratios above 90% reduced growth was just plain incorrect. And whilst Alberto Alesina was right to point out that there have been cases (pdf) of expansionary fiscal contraction, those cases aren’t relevant to the situation we’ve been in since 2010.

It looks as if austerity has depressed growth. That’s consistent with what Simon says is mainstream thinking about the economy at the zero bound, but also consistent with MMT*.

My second example comes from the day job: defensive stocks have for years done better than the textbook CAPM predicts around the world – a fact first pointed out by impeccably mainstream economists. This is a counter-example to Russ Roberts’ claim that “most economics claims are really not verifiable or replicable.”

There are (at least) three interpretations of this. The most mainstream, I suspect, is Frazzini and Pedersen’s (pdf) – that market imperfections (limits on borrowing) generate high demand for high-beta stocks, causing them to be overpriced. Alternatively, there might be a behavioural explanation: investors' lack of attention or overconfidence causes them to under-price defensives and over-price growth. (Is behavioural finance mainstream? I don’t give a damn). And even further from the mainstream is Falkenstein’s claim that there is in fact no trade-off between risk and return.

Which theory is most right? In one sense, it doesn’t matter. The fact that three different ideas both point to defensives doing well strengthens my belief that they’ll continue to do so.

My third example is inequality. It’s obvious that the simplest version of mainstream economics doesn’t explain a rising income share of the 1%: the idea that bosses are paid their marginal product fails because it implies that the men who brought down banks in 2008 should have had salaries of minus billions, which they did not. But what about the idea that inequality is due to superstar firms (pdf)? Or to agency failures? Or to shifts in bargaining (pdf) power? Are such theories “mainstream” or not? There might be a type of academic pedant who cares. But I don’t. What matters is: do they fit the facts? Do they do a better job than, say, Marxian theories?

What I’m trying to get at here is an agreement with both Simon and Unlearning Economics. I agree with Simon that economics should be a vocational subject which addresses real-world issues. But I also sympathize with UE. Economics should be more diverse simply because different perspectives help explain different problems: this is why we should study classical economic thought. The question is not: what’s mainstream? It is: what’s right?

* I’d be a lot more sympathetic to MMT if its proponents weren’t so damned longwinded.

Comments

[Ralph Musgrave]

Re the so called “economists” who promoted austerity during the recent crisis (Rogoff, Reinhart, etc) it’s a disgrace that they still have their jobs. Plus there are plenty of other guilty men (and perhaps a few women) e.g. at the IMF and OECD.

For anyone interested in the details on the IMF and OECD, Google “Billyblog”, “IMF”, “OECD” etc. “Billyblog” is the name of the blog of Bill Mitchell who has looked in detail at the IMF and OECD’s pro-austerity so called “ideas”.

Incidentally, in addition to Bill Mitchell, other advocates of Modern Monetary Theory (me included) were pointing out a good five years ago that Rogoff, Reinhart, etc were talking thru their rear ends. Brad DeLong is frankly a bit slow off the mark if he has only just tumbled to this one.

[Chris Herbert]

MMT long winded? This is what I understand from MMT. Monetary sovereigns don't need to borrow money from anyone in order to finance deficit spending. The restriction on monetary spending by sovereigns is resources. Either you got enough or you don't. Figure out the situation but always concentrate on spending that maximizes resource utilization. First up? Labor, which almost always under utilized. Job guarantee program. Problem fixed. Next?

[Luis Enrique]

These (endless) discussions might be more useful if organized around worthwhile ideas that mainstream economics excludes. If mainstream is somehow a problem that must mean it's ruling out things that should be ruled in.

As for bleeding MMT, all economists have always known governments can print their own money, the question is what follows if they try to money-finance deficit spending when they consider there to be under-utilised real resources. And I've never seen owt but long winded wibble on that.

[aragon]

Louis

We have Paul Romer's Post Real macro-economics where phlogiston shocks are a factor.

The whole foundation of macro economics and the RBC basis for DSGE models is critisised.

https://paulromer.net/trouble-with-macroeconomics-update/

And the use of barter and the role of banks, and yes, money is missing from economic modelling!

As for MMT Economists have known Governments can print their own money, so lets pretend we are still on the Gold Standard and they can't, so have to borrow from the banks.

The question is are we better letting the banks control the money supply as they are doing such a sterling job of maintaining stability and not in the least involved in speculation, fraud and destroying the real economy.

Especially as they have slipped any notional lead (first by over subscribing gold - fractional reserve banking), and now through the fantasy that are derivatives.

What follows when the bankers are only limited by their greed, I think we know the answer to that one, through bitter experience...

Warren Buffet
http://www.fintools.com/docs/Warren%20Buffet%20on%20Derivatives.pdf

Don't get me started on bailing out the banks as systematically 'too big to fail' or Q.E.

[aragon]

In the previous post. lead = leash

As in the leash or lead restrains a dog...

www.dictionary.com/browse/leash

In summary Macro-Economics is bunk and includes Austerity.

[Ralph Musgrave]

Louis Enrique,

I don’t disagree with your criticism of MMT, namely that “all economists have always known governments can print their own money”. Put another way, Simon Wren-Lewis once criticised MMT on the grounds that it is Keynes writ large (or words to that effect): not a bad point.

However, what MMT does do is take Keyes and cut out the cr*p: I mean have you ever tried reading Keynes General Theory? It’s near incomprehensible.

Next, you ask “what follows if they try to money-finance deficit spending when they consider there to be under-utilised real resources”? The answer is easy. As with other forms of stimulus, if the stimulus goes too far we get excess inflation. If the amount of stimulus is just right, we raise numbers employed to the maximum amount feasible without triggering excess inflation.

[Blissex]

«what matters isn’t whether economics is mainstream or not, but whether it does the job of explaining reality.»

NN Taleb makes a distinction between activities where success depends on winning the appreciation of peers, and those where what matters is winning:

«The Black Swan explains the domain-dependence of expertise: why the electrician, dentist, are experts, while the journalist, State Department bureaucrat, and macroeconomist are not.
... Given that the sole judge of a contributor is the “peers”, there is a mechanism of citation ring in place that can lead to all manner of pathologies. Macroeconomics for instance, can be nonsense since it is easier to macrobull**t than microbulls**t –given how abstract the effect on society, nobody can tell if a theory really works.
... Knowing “economics” doesn’t mean in the academic lingo knowing anything about economics in the sense of the real activity, but the theories produced by economists»

[Blissex]

«I agree with Simon that economics should be a vocational subject which addresses real-world issues.»

My understanding of SimonWL's argument is that he claims that "mainstream Economics" *is* a vocational subject, and does address real-world issues.
Because my impression is that he claims that "mainstream Economics" is papers in "top journals" by people in "top departments", and a significant number of those papers are about narrow empirical studies, usually in microeconomics, e.g. minimum wage studies, and that somehow means that the people like Prescott or Rogoff are not doing "mainstream Economics", or the number of empirical microeconomics papers whitewashes "mainstream Economics" from the impression it is largely ideological propaganda at the macro level supported by "citation rings".

[Blissex]

«I mean have you ever tried reading Keynes General Theory? It’s near incomprehensible.»

I understand many have that impression; as to me I have read and reread it many many times; it is one of those books dense with insight and meaning that it still reveals something new on the 10-20th reading. I think that book requires at least 4-6 readings to grasp the basics, because even the basics are nontrivial.

Part of story is that JM Keynes invents his own concepts and terminology and approach in that book, by contrast with the "classics", and it is quite important to follow those. For example I have noticed that a lot of readers don't appreciate that some of his arguments are defined in term of "wage units".
Another example is the central importance of interest rate being correctly identified as the price of liquidity, and the stark difference that JM Keynes makes between the many types of "money" and liquidity per se.
It is also quite important to understand the context against which JM Keynes was arguing, because some of his arguments can only be understood as a rejection of Walras and Marshall.

But then I am the guy who accidentally read the footnotes to chapter 25 of "The Capital" and realized that just those contain more political economy insights than almost every "Economics" book.

But more generally books like "The General Theory", "The Capital" and even the recent "Debt: the first 5000 years" are that kind of book that are structured brain dumps, where someone attempted to linearise into a sequence of pages an approximation of a large graph of knowledge and insights, and have to be interiorised with great repeated readings, without sitting back and expecting to be spoon-fed.