The Chicago coup

I already commented on this Paul Krugman post, but I thought of another angle that seems kind of odd.  See what you guys think.  Krugman was commenting on this statement by Laurence Meyer:

There’s also another tradition that began to build up in the late seventies to early eighties””the real business cycle or neoclassical models. It’s what’s taught in graduate schools. It’s the only kind of paper that can be published in journals. It is called “modern macroeconomics.”

I found this confusing, as it wasn’t clear where Meyer put new Keynesianism, which is surely the dominant macro paradigm in the last 30 years.  Paul Krugman also seemed a bit perplexed, and offered this interpretation:

My first reaction, on reading this, was to say that Meyer overstates the case “” and he does, a bit. It has been possible to publish New Keynesian models in the journals, and these models do, I think, provide some useful guidance “” if only as a consistency check on more ad hoc approaches.

But fundamentally Meyer is right. And it has been going on a long time. By the early 1980s it was already common knowledge among people I hung out with that the only way to get non-crazy macroeconomics published was to wrap sensible assumptions about output and employment in something else, something that involved rational expectations and intertemporal stuff and made the paper respectable. And yes, that was conscious knowledge, which shaped the kinds of papers we wrote.

When I left Wisconsin for Chicago in 1977, some of my professors suggested that it was a rather nutty place.  Most schools were Keynesian in 1977, only Chicago and a few others (Rochester, Minnesota, etc) dissented from this orthodoxy.  Certainly the elite Ivy League universities that dominated the field were not sympathetic to Chicago.

Here’s what I’d like to know.  How was it that just a few years later it was almost impossible to get anything published without assuming rational expectations, efficient markets, etc.  I’d like to offer two hypotheses:

1.  Sometime around 1980 an elite team of Chicago macroeconomists stormed the offices of all the major economics journals with AK-47s, ousting all the editors and replacing them with inferior people who just happened to have studied under Lucas and Fama.  Call it the academic equivalent of the Chilean coup.

2.  The discovery of rational expectations and the efficient market hypothesis at the University of Chicago caused a scientific revolution.  A paradigm shift.  Economists began to realize that the expectations assumed in a model ought to be consistent with the model’s predictions.  That it made no sense to have models that assume the world works one way, and populate it with people who believe the world works in an entirely different way.  And economists also realized that it made no sense to build models that implied it was easy to set up mutual funds that would out-perform an indexed fund, simply by following the implications of a model.  After all, it’s really hard to beat indexed funds, despite the fact that lots of very smart people try hard to do so.

So which view seems more plausible?

I hope I haven’t unfairly stacked the deck by presenting only these two hypotheses.  I’ve tried to present both views in an even-handed way.  Please let me know what you think.  (I don’t doubt that readers will provide a third hypothesis in the comment section.)

HT:  Matt Yglesias

PS,  I recall that Yglesias is highly critical of conservatives who reject the scientific consensus on global warming.  I agree.  But I wonder how he feels about liberals who reject the economic consensus about rational expectations and efficient markets.  Krugman says you can’t get published without assuming ratex—doesn’t that sound a lot like climate science, where it’s almost impossible to get published without assuming global warming?  (And don’t say economics is a soft science where proof is difficult to achieve.  Prediction is also difficult in climate science; and for the same reason—both the economy and the climate are very complex.)


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61 Responses to “The Chicago coup”

  1. Gravatar of StatsGuy StatsGuy
    12. October 2010 at 07:40

    “That it made no sense to have models that assume the world works one way, and populate it with people who believe the world works in an entirely different way.”

    This is only true if people are aware of how the world works. There is nothing that says that people can’t be consistently unaware of how the world works. You, yourself, have observed dozens of times how unintuitive macro is, and how many people misinterpret nominal interest rates, in spite of having repeatedly been exposed to Friedman and Schwartz, etc.

    Keynesianism, by introducing awareness of how the world works, altered how people behave. Monetarism, by observing this, further changed how people behave.

    Presumably, there could be a nash equilibrium (or more than one) in which believed structure and actual structure can be consistent, but perhaps there doesn’t _have_ to be. Consider the circularity problem. Or the role of ETFs in investing – if everyone assumes that the market is efficient (e.g. everyone assumes everyone else has done due diligence), then due diligence becomes a public good that is underprovided, and boom – we get ETF investments, which lead to 80% correlation in asset values. We further get spectacles like Greenspan’s famous declaration that subprime mortgages are good, because of the simple fact that lenders are making the loans.

    It may be the nash equillibria is a mixed strategy – which implies a lot of volatility.

    The shift from Keynes to Fama/Lucas was a switch from assumptions that everyone is dumb as a board to assumptions that everyone is hyper-rational (and not subject to behavioral/evolutionary biases). Virtually all social sciences went from one polar extreme to the other, with narry a pause in between. This then gave way to the return of biological/cognitive behavioralism.

    As to how this occurred – it doesn’t take any crazy scenarios. All it takes is heavy incentives to publish for career advancement, and the fact that notoriety wins citations. No conspiracies, it’s all quite pedestrian really – though no less perverse.

  2. Gravatar of Morgan Warstler Morgan Warstler
    12. October 2010 at 07:48

    Scott,

    Let’s say that this is the current RATEX: http://www.zerohedge.com/article/guest-post-bank-shot

    Please read the whole thing.

    OK, let’s just fiat for a second that Kunstler is 100% accurate about people’s expectations – it is all a big pile of shit – with this stipulated, please tell me how your policies aren’t, “papering over the problem since 2008.”

    Doesn’t your approach to targeting refuse to accept that all of banking is all a big pile of shit, and we have to burn the village down to save it?

  3. Gravatar of D. F. Linton D. F. Linton
    12. October 2010 at 07:59

    Most climate models have implicit assumptions about the effects (or lack thereof) of climate changes on human market behaviors, technology growth, etc. So if you doubt the long term predictions of econometric models, that probably should reduce confidence in climate models. Conversely, if you accept long-term climate model outputs as beyond doubt, then you can not doubt long-term econometrics.

  4. Gravatar of marcus nunes marcus nunes
    12. October 2010 at 08:02

    Initially, it was a combination of the two hypotheses. One has to “get rid” of all previous ideas. So we got things like “policy innefectiveness proposition”. Then the “pendulum” swings back to a “resting position”. But you are left with “diehards” that remain in the “extremes”.
    This is Meyer in April 24 1997:
    I am a strong and unapologetic proponent of the Phillips Curve and the NAIRU concept. Fundamentally, the NAIRU framework involves two principles. First, the proximate source of an increase in inflation is excess demand in labor and/or product markets. In the labor market, this excess demand gap is often expressed in this model as the difference between the prevailing unemployment rate and NAIRU, the non-accelerating inflation rate of unemployment. Second, once an excess demand gap opens up, inflation increases indefinitely and progressively until the excess demand gap is closed, and then stabilizes at the higher level until cumulative excess supply gaps reverse the process.
    http://www.federalreserve.gov/boarddocs/speeches/1997/19970424.htm
    This is Williamson (Oct 10 2010):
    “In spite of what Meyer seems to think, modern macro is very much at work in current policymaking circles. You can see this in the published speeches that Jim Bullard, Narayana Kocherlakota, Jeff Lacker, and Charles Plosser are making. These people are applying the key innovations in macroeconomics of the last 40 years, including: (i) Commitment by policymakers is important; (ii) The fact that aggregate output and employment are fluctuating need not imply a role for stabilization policy; (iii) Observed correlations in macroeconomic data need not reveal structural relationships; and many more. In none of the regional Federal Reserve Banks where I have had occasion to visit does discussion of founding-fathers models appear to enter the policy discussion, and for good reason. A 400-equation model has ceased to be a model. By definition a model is simple enough to help us understand something, and these models just do not do the job. When you are a dinosaur, I guess it can make you grumpy, but Meyer should get over it, and stick to his forecasting”.
    http://newmonetarism.blogspot.com/2010/10/why-are-forecasters-grumpy.html
    Krugman gets in the fray pretending he is the Meyer kind of “diehard” just because he “hates” the Williamson brand of “diehards”. After all, he made his name by being one of the first to apply RATEX to his analysis of the unsustainability of exchange rate bands!

  5. Gravatar of Greg Ransom Greg Ransom
    12. October 2010 at 08:23

    Once again, you report fake facts you must have learned from Katie Couric or Matt Lauer or a NY Times publication …

    It’s fairly well known that there here is no scientific consensus on global warming .. thousands of scientists in various domains of “climate science” reject the Big Media created legend of “scientific consensus” — and thousands are outraged by the scientific fraud at the heart of the science.

    Scott wrote:

    “the scientific consensus on global warming”

    Do this Google search: “climategate” .. and learn something about the scandal of politicized science and garbage-in, garbage-out computer programming.

  6. Gravatar of Greg Ransom Greg Ransom
    12. October 2010 at 08:26

    Note well — much the diesel gas regulations in California were constructed on the basis of fake science produced by “scientists” with fake academic credentials. The environmental “science” movement is a multi-billion dollar business with fraud beginning to expose itself here and there all over the place.

  7. Gravatar of Greg Ransom Greg Ransom
    12. October 2010 at 08:28

    Here’s the problem. “Macroeconomics” isn’t a science.

    Most of it is fake science, imitation science. What Hayek called “scientism”, an attempt to imitate a false understanding of real science.

    Scott wrote:

    “I wonder how he feels about liberals who reject the economic consensus about rational expectations and efficient markets.”

  8. Gravatar of Greg Ransom Greg Ransom
    12. October 2010 at 08:41

    Here’s a better parallel — both macro “science” and climate “science” make use of garbage-in, garbage-out computer simulations that reflect the politics and intuitions and programming snafus of a handful of people — and which necessarily fail to include all of the causal mechanisms in operations, and which use socially constructed “empirical” initial conditions — in areas were casual consequences are different depending on the sensitivity of the measurement of initial conditions — sensitivities which are insuperably existent, i.e. can never be eliminated (changing causal consequences depending on measurement differences all the way down).

    Scott wrote:

    “And don’t say economics is a soft science where proof is difficult to achieve. Prediction is also difficult in climate science; and for the same reason””both the economy and the climate are very complex.”

  9. Gravatar of Ram Ram
    12. October 2010 at 08:52

    A few observations about climate science v. macroeconomics:

    1. The ‘microfoundations’ of climate science (i.e., textbook physics & chemistry) are far more empirically secure than those of macroeconomics (i.e., microeconomic theory).

    2. The shift towards rational expectations was not, as you observe, motivated by a major inconsistency between the existing paradigm and hard data, but instead by a dissatisfaction with the tension between two theories of related phenomena. The consensus around climate change was not even a paradigm shift, just a reflection of increasingly unambiguous data showing a warming trend, together with the most natural explanation from physics/chemistry (C02 is a heat trapping gas, etc.)

    3. Climate science does study a very complex system, but that system behaves less erratically than many seem to think. People assume that because of the chaotic nature of weather systems, climate systems must be similarly unpredictable. Over longer periods, however, these chaotic movements tend to average out, and climate patterns become increasingly stable. One could make a similar argument for economics, but I think the data would be much less compelling than in the climate case. Economies and economic agents do really seem to be very erratic, even if there are interesting patterns that economists have succeeded in identifying within a large margin of error.

    But yes, I agree that the distinction between “hard” and “soft” sciences is fuzzier than we ordinarily think, even if this particular comparison is less than fully successful. And yes, I think that the current economic consensus, whatever it happens to be, is probably the best we can do at any given time.

  10. Gravatar of Benjamin Cole Benjamin Cole
    12. October 2010 at 08:58

    More excellent commentary from Sumner. Sure, not every person or event can be explained by EMH or RATEX, but in general it obviously works.

  11. Gravatar of Indy Indy
    12. October 2010 at 09:23

    Well, as for Yglesias’ criticisms, I think Hal Lewis’ APS resignation letter is relevant. From his biographical information, I find it unlikely that he’s crazy.

    As Michael Crichton said, “Consensus is not Science”. Paul Krugman is saying the same thing. Paradigms shift, but that doesn’t necessary imply “progress” if they don’t work, or especially if they don’t “shift back” or “shift again” when they fail to explain the real world in an important way.

  12. Gravatar of Morgan Warstler Morgan Warstler
    12. October 2010 at 09:31

    And in general right now RATEX is “corruption wins,” and we need to see bankers and public employees beaten with giant economic sticks.

    Then after we have relearned what and who is most important, we can get back a nice tight 2% and never a drop more inflation cuff.

    Also, IF we ever do find out global warming is real and IF the cause is carbon…

    Then there’s NOTHING we can do short of genocide – which is the same thing as praying for Peak Oil, so if you believe in Global Warming you are welcome to pray for starving hordes…

    But I’m not that religious. And besides… that’s too many IF’s and a horrible THEN, for me to sacrifice our own economic well being so the third world can catch up.

    Alt.energy will make sense when it makes sense. If I can trade the liberals for a $1-$1.50 gas tax to replace Corporate Taxes, and help it along… great.

    Scott, you can tell GW people aren’t serious because if they are they would be comfy with adopting solutions that don’t grow government.

    It is dumb to buy the science until they will let you decide the solution.

  13. Gravatar of David Pearson David Pearson
    12. October 2010 at 10:51

    Scott,

    Congratulations on the Fed minutes mention of price level AND NGDP level targeting:

    “A number of participants commented on the important role of inflation expectations for monetary policy: With short-term nominal interest rates constrained by the zero bound, a decline in short-term inflation expectations increases short-term real interest rates (that is, the difference between nominal interest rates and expected inflation), thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP.”

  14. Gravatar of JStephens JStephens
    12. October 2010 at 10:52

    I’ve always sort of wondered Scott, what label would you give yourself? Not that it’s really all that important, and I guess to an extent it sort of makes macro look like a sport with various competing teams… but I’m still curious.

    You seem to accept moderated versions of ratex and emh without accepting Real Business Cycles, so you don’t quite fit into the Lucas/Prescott/Sargent/Barro/Cochrane/Fama New Classical group.

    You’re not quite New Keynesian- they love monetary policy nearly as much as you but also generally support breaking out fiscal policy when the circumstances are absolutely dire. You also support NGDP targeting over the inflation targeting and think the focus on nominal interest rates is silly.

    You’re not really “monetarist” in the traditional sense either since you don’t support fixed money growth rules, but I guess in that sense no one is a monetarist these days. Is “New Monetarist” a classification yet? Maybe it should be.

  15. Gravatar of David Beckworth David Beckworth
    12. October 2010 at 10:59

    David Peason:

    Wow, that is an incredible quote! Be still my beating heart…

  16. Gravatar of David Pearson David Pearson
    12. October 2010 at 11:04

    Forgot the link:

    http://www.federalreserve.gov/monetarypolicy/fomcminutes20100921.htm

  17. Gravatar of Bababooey Bababooey
    12. October 2010 at 11:21

    I dunno whether it resonates with econometric models but one debatable point of climate science is data collection.

    In order to establish unnatural climate change, scientists use proxies- tree rings, ice cores, sediment- or scattered measurement stations. All of that has to be adjusted to cover non-similar adjacent areas and changing local environments. The recent controversy arises because some of the few people in charge of adjusting, tweaking, interpreting those proxies and measurements wrote things that indicate bad intentions.

  18. Gravatar of StatsGuy StatsGuy
    12. October 2010 at 11:25

    David – yes, _that_ was exciting. Price level targeting was mildly interesting, and we knew about that already (it’s been discussed in several speeches). That was the first mention of active NGDP targeting in this level of Fed-focused forum. I had to read it three times to make sure I wasn’t imagining it. Now, if we can just de-link all inflation indexed contracts, or alternatively simply consistently understate official inflation rates (which these contracts are linked to), the country’s fiscal situation may prove much better than everyone expected.

    So let’s all hope John Williams at ShadowStats is right.

  19. Gravatar of Jason Jason
    12. October 2010 at 11:37

    I can imagine your post will generate many, many comments.

    1. I like Planck’s quote on scientific revolutions: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.”

    2. Ratex and the EMH are theoretical assumptions constraining models. Global Warming is an effect predicted by several different models. The GW controversy is strange because it is as if, say, you using the EMH and Krugman using new Keynsian models came up with the same policy recommendations using entirely different arguments for entirely different reasons, yet some powerful interest, like say, the Fed, disagreed without any specific argument against the two of you.

    @D.F. Linton: Climate models use a vast range of future anthropogenic CO2 (and CH4, etc.) emission scenarios. The economic uncertainty is a fairly small component of the overall uncertainty (policy uncertainty being the largest — i.e. are we going to do anything?). Even at current levels of CO2 in the atmosphere, people are not wildly overreacting to consider future warming to be unacceptable. Another way, the range of future temperatures considered problematic climate-wise do not in any meaningful way constrain macroeconomic projections.

    Plus CO2 increase is *incredibly* smooth while interest rates have gone from a few % to 18% and back to 0%. (Not to say the US economy doesn’t wiggle the line a little.)

    http://www.esrl.noaa.gov/gmd/webdata/ccgg/trends/co2_data_mlo.png

    Disclaimer: My position in the global warming controversy is that it is of course happening, that it is going to cause hardship for a large swath of the world, but not necessarily the US, and that no policy changes will ever be implemented.

  20. Gravatar of Chaitanya Chaitanya
    12. October 2010 at 11:48

    This is the most disappointing post I have seen on this blog: Equating the Rational Expectations Hypothesis with a scientific revolution (Copernican or otherwise) is just idiocy. Science is the study of stable, predictable physical phenomena using the method of hypothesis, experiment, prediction..

    Is Scott Sumner arguing that Rational Expectations holds up to experiment (or empirical data) and that accurate predictions result? Really?

    It is nothing more or less than a *tool* that economists use in their thinking about the world – and has been abused as being a good approximation to reality by many a freshwater economist. Appeals to the scientific nature of the Ratex hypothesis is ludicrous.

    Global Warming on the other hand is handily backed up with empirical data and predictive capabilities.

    No comparison.

  21. Gravatar of David Pearson David Pearson
    12. October 2010 at 11:49

    Stasguy,

    Not to make too much out of it, but the Fed is careful in how it chooses its words in both the statements and minutes. Minority views are often referred to in the context of “a few participants noted…” or, “one participant commented that…”

    Today’s minutes tell us that, “Participants noted a number of possible strategies…” Notice the lack of a qualifier. That this was used to describe the discussion of both price and NGDP level targeting implies a surprising degree of consensus and openness around something never floated before in the minutes. Further, when someone pounds the table and says, “no way”, the minutes usually will say something like, “one participant expressed a concern that adopting such strategies might risk unanchoring expectations…” To do otherwise would be to pretend an strong objection was not raised.

    So apparently they all sat around a table discussing that price and NGDP level targeting might be a good thing, and no one blew a gasket. This, I believe, is news.

  22. Gravatar of David Beckworth David Beckworth
    12. October 2010 at 11:56

    David Pearson, does this mean the FOMC has been reading Scott’s blog?

  23. Gravatar of Benjamin Cole Benjamin Cole
    12. October 2010 at 12:01

    David Pearson–you stole my thunder.

    Other wonders are that the Fed noted that unit labor costs have been declining (deflation), and then predicted declines in core inflation 200 and 2012.

    (Keep in mind that the Boskin Commission found that the CPI overstates inflation, as will all static measures, as consumers and businesses constantly migrate to better products or prices).

    From the FOMC:

    “Overall inflation was projected to remain subdued, with the staff’s forecasts for headline and core inflation little changed from the previous projection. The current and projected wide margins of economic slack were expected to contribute to a small slowing in core inflation in 2011, which was anticipated to be tempered by stable inflation expectations. Inflation was projected to change little in 2012, as considerable economic slack was expected to remain even as economic activity was anticipated to strengthen.”

    So, basically Fed staff is we have declining unit labor costs, and predicting a Boskin-adjusted zero inflation for two years out.

    So why are some Fed officials pettifogging about inflation?

  24. Gravatar of Alejandro Alejandro
    12. October 2010 at 12:05

    A true Chicago economists would have never used an AK-47 in the 80´s. They used M-16´s which they bought from a gang on 53rd and Kimbark.

    Alex.

  25. Gravatar of David Pearson David Pearson
    12. October 2010 at 12:12

    After today, I think some of them have it bookmarked!

  26. Gravatar of Lorenzo from Oz Lorenzo from Oz
    12. October 2010 at 12:47

    You have mentioned climate science: see if this now becomes a Thread Of Doom 🙂

  27. Gravatar of Scott N Scott N
    12. October 2010 at 12:59

    I never thought I would see this in the Fed’s minutes: “targeting a path for the level of nominal GDP.”

    This is good news.

  28. Gravatar of Lee Kelly Lee Kelly
    12. October 2010 at 13:16

    NGDP level targeting may be a difficult pill for the Fed to swallow. After all, if the Fed suddenly announces a NDGP level target, then a lot of difficult questions will be asked about what happened in 2008. If NGDP level targeting is good for 2011 or 2012, then why wasn’t it good enough for 2008? Wouldn’t this put the Fed and its decision-makers directly in the line of fire when apportioning blame for the recession? Hopefully its members can rise above any egotistical preoccupation for saving face, admit error, and do the right thing.

    The Fed cultivates a reputation for being a wise and beneficent technocracy. It would seem politically difficult to risk that reputation by such a policy shift. Congress might use it as an excuse to wrangle more power for itself over monetary policy.

  29. Gravatar of Miguelito Miguelito
    12. October 2010 at 13:24

    Third hypothesis: by 1980, there wasn’t really a lot new to be learned by elaborating Old Keynes. That doesn’t mean what had been learned was wrong, just that the remaining 2-degree turns of the screw weren’t going to get you in QJE.

  30. Gravatar of Morgan Warstler Morgan Warstler
    12. October 2010 at 13:32

    “So why are some Fed officials pettifogging about inflation?”

    Because the right guys don’t have political power yet… and we have plenty of hippie punching to do to Public Employees, and the Fed will cheer lead this from the sidelines…

    GIVE IT TIME. All is well.

  31. Gravatar of Morgan Warstler Morgan Warstler
    12. October 2010 at 13:32

    “So why are some Fed officials pettifogging about inflation?”

    Because the right guys don’t have political power yet… and we have plenty of hippie punching to do to Public Employees, and the Fed will cheer lead this from the sidelines…

    GIVE IT TIME. All is well.

  32. Gravatar of W. Peden W. Peden
    12. October 2010 at 13:33

    Prof. Sumner,

    How literally do you take Ratex?

    I find myself going out of my way to disagree with anyone who didn’t win the Nobel Prize in 1976. However, it does seem that one can (extending Friedman’s broadly instrumentalist philosophy of economics from his 1953 article “The Methodology of Positive Economics”) say that Ratex can be useful, even if its assumptions are dodgy. The same could be said about any number of things in economics.

    (Regarding Ratex as a useful time-saver and empirical instrument seems very intuitive to me, but then again I have a background in philosophy and we tend to have biases against any sort of scientific realism, especially in social sciences like economics.)

    From a Friedmanite perspective, it seems quite possible to say that, while the assumptions behind Ratex may be untrue or even ridiculous, its scientific powers make it a useful tool. As Friedman is sometimes (somewhat inaccurately) summarised: “assumptions don’t matter”.

  33. Gravatar of W. Peden W. Peden
    12. October 2010 at 13:37

    JStephens,

    I agree that, if one makes “in favour of a strict money supply target” a necessary condition of being a monetarist, there are few (if any?) monetarists left. The word, in general, has become pretty vague: “monetarism” can mean anything from Thatcherism to Bundesbank financial culture, depending on who is using the word.

    “Friedmanite” has too many echoes of the idolatry of the Keynesians and I’m fairly sure that someone has already nabbed “New Monetarist”. “Nominalists” has already been taken by philosophers, for a few thousand years now.

  34. Gravatar of David E David E
    12. October 2010 at 14:14

    Just to be clear, the point of debate on climate science is not that humans produce CO2, or that CO2 is a greenhouse gas, or that global temperatures have been increasing recently. The first two are scientific facts and the third is generally agreed upon. The point of debate is 1) whether the recent increase in temperature is a result of human activity rather than the continuation of a trend that pre-dates the industrial revolution, and 2) even if the increase is man made what if anything can we practically do about it.

  35. Gravatar of Lee Kelly Lee Kelly
    12. October 2010 at 14:23

    If the brewing “debate” on global warming doesn’t fizzle out before it gets a chance to blow its load, then I hope Scott nips it in the bud before the thread is beyond the point of no return. (Mmmm … mixed metaphors)

  36. Gravatar of Josh Josh
    12. October 2010 at 14:23

    Michael Woodford has a paper on this entitled, “Convergence in Macroeconomics: Elements of a New Synthesis”. Here is the link:

    http://www.columbia.edu/~mw2230/Convergence_AEJ.pdf

  37. Gravatar of happyjuggler0 happyjuggler0
    12. October 2010 at 14:50

    I’d like to nominate Post-Monetarist as a label for what Scott Sumner believes.

  38. Gravatar of Mike Sandifer Mike Sandifer
    12. October 2010 at 16:23

    Scott,

    I’ll add to statsguy’s comments on this quote from you:

    “That it made no sense to have models that assume the world works one way, and populate it with people who believe the world works in an entirely different way.”

    Given that most investors don’t seem to believe in EMH and that this must be true for EMH to be valid, I see a contradiction there.

    Also, just look at the world we live in. Do a lot of people seem to know how much of it works, even in the aggregate. I mean, most people think they are more intelligent and better drivers than average. The same may be true of investors, given that most try yet fail to beat the markets.

  39. Gravatar of Morgan Warstler Morgan Warstler
    12. October 2010 at 20:23

    David E, that’s exactly what I said.

    Meanwhile, I still continue to nominate, “Papering over problems since 2008” for what Scott believes….

    But soon, after the election, when he comes to full stop Cochrane level targeting at 2% starting in 2011 moving onward… we’ll find a new mustache for his blog title.

    Last note: no one REALLY seems to be dealing with the best part… taking money OUT 6 months after CPI runs at 2.5%…. NO MATTER FRIGGIN WHAT. Like Fisher, that’s where Scott really excels and finds his long sexy legs (but no one hoots and whistles) – pissing on booms to protect savers.

  40. Gravatar of How macro theories become influential « Acme Quality Assurance How macro theories become influential « Acme Quality Assurance
    12. October 2010 at 21:25

    […] reply to Scott Sumner’s question How was it that just a few years later it was almost impossible to get anything published without […]

  41. Gravatar of Jeff Jeff
    12. October 2010 at 21:33

    I’ve commented on this over at my new blog Acme Quality Assurance.

    This blogging stuff is contagious, isn’t it?

  42. Gravatar of bill woolsey bill woolsey
    13. October 2010 at 03:01

    “Post monetarist”

    I like it. 🙂

  43. Gravatar of Full Employment Hawk Full Employment Hawk
    13. October 2010 at 05:32

    “reject the economic consensus about … efficient markets”

    What consensus? Robert Schiller is right about the efficient markets hypothesis. Actual real world events have repeatedly discredited it. After what happened in 1987, it was dead.

  44. Gravatar of Full Employment Hawk Full Employment Hawk
    13. October 2010 at 05:40

    DSGE models are a methodological straight jacket that the new classical economists have succeeded in imposing on the profession. Models that have infinitely lived representative agents optimizing into the infinite future with full knowledge of the mean and probablility distribution of all the relevant variables into the infinited future is patently out of touch with economic reality and makes the results derived from them not credible. Real world economic decision makers are myopic and make decisions facing Knightian uncertainty. Adding sticky prices and wages to these model makes them less blatently unrealistic but does not remove the counterfactual properties of the models.

  45. Gravatar of Full Employment Hawk Full Employment Hawk
    13. October 2010 at 05:57

    “That it made no sense to have models that assume the world works one way, and populate it with people who believe the world works in an entirely different way.”

    Models that assume the the economic decision makers believe that the world works the same way as the model specifies implicitly assume that the decision makers are endowed costlessly about the properties of the model, like manna from heaven. Once it is recognized that it is costly to collect and interpret information about the model, it follows that if the expected marginal cost of collecting and evaluating this information exceeds the expected marginal returns from doing so, it is efficient for the decision makers to remain rationally ignorant of the properties of the model and have expectations different from the model.

    In actual real world economies, this is frequently the case. Because of the high cost of collecting and evaluating information about the true model, real world decision makers are rationally ignorant of its properties. Under such conditions Muth “rational” expectations do not hold.

  46. Gravatar of Barry Ickes Barry Ickes
    13. October 2010 at 10:01

    First, the rational expectations revolution was discovered at Carnegie-Mellon not Chicago.

    Radner was the first to formalize the notion of a rational expectations equilibrium in 1967. So you could say Berkeley led the way.

    Your paradox combines anti-Keynesianism with rational expectations and efficient markets. But new Keynesian models also have rational expectations, and most economists assume efficient markets, so you are giving too much credence to the non-economists who think of ratex and efficient markets as right-wing policy tools.

  47. Gravatar of Full Employment Hawk Full Employment Hawk
    13. October 2010 at 11:14

    “most economists assume efficient markets”

    That’s why they failed to recognize the housing bubble, or the previous stock market bubble. To continue to assume efficient markets after we had two bubbles burst, and the crash of 1987, indicates an irrational adherence to extablished dogma by all too much of the economics profession. As long as they continue to do that, they are going to continue to be surprised by exonomic events that do not fit their dogma.

  48. Gravatar of Lucas Lucas
    13. October 2010 at 16:03

    @scott,
    “doesn’t that sound a lot like climate science, where it’s almost impossible to get published without assuming global warming? (And don’t say economics is a soft science where proof is difficult to achieve. Prediction is also difficult in climate science; and for the same reason””both the economy and the climate are very complex.)”
    You’re way off base here, Scott:
    – Climate science is a very broad subject. Disciplines as diverse as glaciology, forest ecology, oceanography, geochemistry and atmospheric physics contribute to the body of knowledge of climate science.
    – Accepting the AGW hypothesis is not a prerequisite for publishing something related to climate science. E.g. you can study ice sheet dynamics without a single mention of climate change.
    – Contrarian and “neutral” papers do get published in quality journals. The things that are not accepted in quality journals are the downright bad/cranky papers, although there are exceptions [1]
    – The core of climate science is not numerical modelling, it’s 19th century physics [2].
    – If you discard modelling and palaeoclimatology, AGW is still very evident.

    It’s foolish to make strong statements about subjects we know little about. That’s why I use very nuanced language when commenting on economics: my Economics 101 classes at college and my reading of classics and random papers are not enough to proclaim myself knowledgeable on economics and reach strong conclusions.

    1- http://rabett.blogspot.com/2009/07/best-of-worst-john-mashey-asks-maybe.html
    2- http://www.aip.org/history/climate/co2.htm

  49. Gravatar of scott sumner scott sumner
    13. October 2010 at 18:49

    Statsguy, You said;

    “Presumably, there could be a nash equilibrium (or more than one) in which believed structure and actual structure can be consistent, but perhaps there doesn’t _have_ to be. Consider the circularity problem. Or the role of ETFs in investing – if everyone assumes that the market is efficient (e.g. everyone assumes everyone else has done due diligence), then due diligence becomes a public good that is underprovided, and boom – we get ETF investments, which lead to 80% correlation in asset values. We further get spectacles like Greenspan’s famous declaration that subprime mortgages are good, because of the simple fact that lenders are making the loans.”

    The circularity problem does not violate ratex or the EMH. Greenspan’s statement makes about as much sense as saying bank robberies are good because people do them in equilibrium. FDIC massively distorts banking–hence the need for regulation. Do not blame the EMH for Greenspan’s silliness.

    You said;

    “The shift from Keynes to Fama/Lucas was a switch from assumptions that everyone is dumb as a board to assumptions that everyone is hyper-rational (and not subject to behavioral/evolutionary biases). Virtually all social sciences went from one polar extreme to the other, with narry a pause in between. This then gave way to the return of biological/cognitive behavioralism.”

    This is a common error. Ratex and the EMH do not imply hyperrationality, they imply unbiased forecasts. The average person has no idea how many jelly beans there are in a glass jar, but the consensus estimate is usually quite accurate. If you have a model assuming the public thinks there are twice as many beans as there actually are, it won’t perform well. And if you have a model that assumes people consistently over or under-estimate some macro variable–even though it costs them money, it also won’t work very well.

    The EMH doesn’t work perfectly, but I found it extremely valuable in my research. Markets are certainly far superior to Fed officials.

    Morgan, I don’t have time to read articles, if you’ve got a good argument beyond bogus “anomaly” studies, I’d love to hear it.

    DF Linton, I depends what’s being predicted. I believe climate models that predict global warming, but think there is vast uncertainty about how much. I believe economic models predicting China’s GDP will grow faster than the world average, but again think there is great uncertainty about how much faster. Climate science can’t tell me if it will rain in 20 days, and economics can’t tell me if the stock market will rise next Tuesday.

    The human element does make economics slightly different, I admit that.

    marcus, As you know I don’t like either extreme. I think nominal shocks matter, but don’t buy the NAIRU approach. We had much more inflation in 1933 (the worst year ever for jobs) than 2000, which was a boom year.

    Greg, I’ve read a lot of scientific papers on global warming. I don’t get my information from Katie Couric or FoxNews.

    Ram, I don’t entire agree about the empirical advantages of ratex. I agree that for some of the specific Phillips Curve issues being studied, adaptive expectations did almost as well. But there are many areas that I have studied where adaptive expectations do horribly, as when actual inflation expectations respond to news events. You can’t model that with adaptive expectations at all.

    My dig at the liberals here was because they make these appeals to authority: “Almost all economists agree that fiscal stimulus will boost output.” How often did we hear that from the Obama people? Well Krugman says all economic journals seem to agree that people need to put ratex into articles. So how’s that different?

    I’m not sure that climate science can predict well at all. It can predict global warming because that’s us changing the chemistry of the atmosphere. But in the 1970s some were worried about an ice age. Without CO2, I don’t think climate science is at all good at predicting natural weather variations.

    Ram You said;

    “But yes, I agree that the distinction between “hard” and “soft” sciences is fuzzier than we ordinarily think, even if this particular comparison is less than fully successful.”

    Physics people don’t like to admit that climate science is just applied physics, as this shows physics isn’t at all a hard science. It can predict some things well, and others very poorly–just like economics. I’ll predict next years’ core price level will be 1% above current levels, and I’ll probably be much closer than a physicist trying to predict next Tuesday’s weather.

    Thanks Benjamin.

    Indy, I agree that the consensus is often wrong. I’m arguing the consensus was wrong when they asserted money was easy in 2008.

    Morgan, We don’t have to buy the solutions of the scientists. I favor a carbon tax to replace the corp. income tax.

    Thanks David Pearson. I have a new post on that.

    JStephens, I have bits and pieces of monetarist, something called “New Monetary Economics” back in 1982, ratex, the EMH, moderate supply-sider, NGDP targeter, futarchy (I.e. let markets run policy.) and lots of other pieces. So I suppose I don’t completely fit in any one box. Milton Friedman was my favorite economist. I also like Irving Fisher and George Warren, Coase, Hume, Smith, Hayek, Hawtrey and many others.

    Bababooey, I agree, but I don’t think the scandals overturn the presumption that the Earth is warming. I’ve seen the evidence, and it is pretty strong.

    Jason, Thanks for the Planck quotation–I always thought that was Kuhn.

    Your second point is a good one, and is essentially what has happened.

    Chaitanya, I disagree, it has been very useful in my research. I’m a Rortian–scientific models aren’t True or False, they are useful or not useful.

    David Pearson, Your reply to Statsguy about the implied consensus was quite interesting, I wish I had read it before I posted. But it is also possible that people hadn’t thought about it, and thought it was not imminent, and thus didn’t bother to comment.

    David Beckworth, Both our blogs–you’re cited by Krugman on NGDP just as much as I am. Indeed I don’t know if he ever commented on my NGDP views. They might see our blogs second hand through Krugman.

    Alex, I lived on 51st and Lakeshore. I still possess a bullet I found at the site of a murder of a 26 year old white male walking home at 1:00am (in a holdup attempt.) I walked by the exact spot 30 minutes earlier by myself. Close call. The bullet was just lying there.

    Lorenzo, Thread of Doom? Is there a cultural reference I missed?

    Scott N, Yes, interesting news.

    Lee Kelly, I’m already fighting the next battle. I honestly think they won’t ever do all they need to in this cycle. I’d like to have a future Fed think “yes, we should have targeted NGDP in 2008”

    Miguelito, I happen to think the old Keynes is really obsolete. He doesn’t even have a theory of the price level, just an ad hoc theory of inflation.

    W. Peden, I think ratex is very useful. I don’t think any scientific theory is literally True, just more or less useful. People misunderstand ratex, confuse it with perfect foresight. Ratex allows people to make mistakes, lots of them. Every time an asset price moves it is an acknowledgment that the previous price was wrong, a mistake. But it was the best people could do given their limited knowledge.

    David E, I think those are fair points about global warming. I lean toward the view that there is causation, but agree it isn’t a 100% slam dunk. I’d say I’m about 95% sure, if I had to put a number on it. That’s plenty high for a carbon tax to replace the corporate income tax.

    Thanks Josh, I’ll take a look.

    happyjugglar0, Or neo-monetarist, since new monetarist is taken. Or post-modern monetarist

    Mike Sandifer, When students (in aggregate) correctly predict the number of jelly beans in a jar they usually don’t believe the “wisdom of crowds’ idea. So I don’t think investors need to believe the EMH for the EMH to be true. Indeed I think it helps if they don’t believe, so that they will go out and do research, rather than all buy index funds. In that case, who would make the markets efficient?

    Your comment about drivers just makes me more confident that the EMH is true. I think most people who don’t believe it, disbelieve for all the wrong reasons. Observed idiocy (and I see it all the time as well) as no bearing on the EMH theory. The EMH doesn’t assume people are smart, just that people on average don’t make predictable errors that are easy to profit from. How can I profit from people over-estimating their driving ability? In any case, 90% of drivers ARE ABOVE AVERAGE, according to their own criteria for good driving. Teenage boys are skillful in high speed driving, and librarians are skillful at avoiding fatal accidents. They just mean different things by “good”.

    more to come . . .

  50. Gravatar of scott sumner scott sumner
    13. October 2010 at 19:01

    Full employment hawk, I don’t agree, and have lots of posts on the topic. The arguments against the EMH are often based on “anomalies” which is not the way to test the EMH.

    I do agree it doesn’t explain 1987, but what economic theory always works?

    I am not a fan of DSGE models, I prefer Friedman’s partial equilibrium approach.

    I don’t agree with your last point. The question is not whether it is plausible that actual people understand complex models, the question is whether ratex has proven to be a useful assumption. In my view it has, and I don’t believe it requires any sort of hyper–rationality.

    Barry Ickes, Yes, I know that ratex is a part of new Keynesian economics. It is others that see ratex as right wing, not me.

    I still think the ratex revolution came out of Chicago, although I shouldn’t have implied they discovered it. I believe Muth did.

    FEH, Non-ratex believers are also poor at predicting bubbles, the difference is they think they are good. Galbraith believed he predicted the 1987 crash, but he didn’t.

  51. Gravatar of Doc Merlin Doc Merlin
    13. October 2010 at 23:16

    @Scott
    ‘FEH, Non-ratex believers are also poor at predicting bubbles, the difference is they think they are good. Galbraith believed he predicted the 1987 crash, but he didn’t.’

    The austrians are pretty good at predicting bubbles and crashes from them (hayek for example called the GD right on the nose), but then again, the Austrians believe in a soft form of ratex.

  52. Gravatar of Full Employment Hawk Full Employment Hawk
    14. October 2010 at 04:56

    “I do agree it doesn’t explain 1987”

    It doesn’t explain 1929 either.

    If EMH held you would not have bubbles. The existence of bubbles is not a mere anomality, it is a refutation of EMH.

  53. Gravatar of Doc Merlin Doc Merlin
    14. October 2010 at 05:28

    @Full Employment Hawk:
    “If EMH held you would not have bubbles. The existence of bubbles is not a mere anomality, it is a refutation of EMH.”

    No, this isn’t true at all. /Without/ bubbles EMH wouldn’t be true. This is because regression to the mean would be a reliable way to make money if bubbles didn’t exist. EMH actually *requires* the existence of bubble-like behavior for it to be true.

  54. Gravatar of StatsGuy StatsGuy
    14. October 2010 at 06:38

    ssumner:

    “This is a common error. Ratex and the EMH do not imply hyperrationality, they imply unbiased forecasts. The average person has no idea how many jelly beans there are in a glass jar, but the consensus estimate is usually quite accurate.”

    I hadn’t really intended to get into the “Is EMH right?” argument again, but rather to observe the shift in paradigms. But, since you addresed it, please note the language: “(and not subject to behavioral/evolutionary biases)”

    There are two issues: bias and noise

    Market-based information aggregation mechanisms have no reason to overcome bias, although in the long term the market does reward accurate forecasters with more control over the prediction (they get richer, and have more money to buy assets). This, of course, assumes a lot about funtioning capital markets and lack of fraud, etc.

    Market-based information aggregation mechanisms should help reduce bias in theory, but in an environment where information is fragmented among thousands of people, it only takes a TINY cognitive bias in over-interpreting prices to make markets massively unstable. Rationally, a person with 1/10000 of the information would discount their own information heavily vs. the other 9999 parts of information when interpreting prices (“if that’s the price, the crowd must know something”). People act as bayesian updaters – they update their personal beliefs based on the fact they know they only have a tiny amount of information. All it takes is a SLIGHT bias in how they update information to make market prices hugely unstable – not necessarily biased in the long run, but capable of sustaining huge innaccuracies for medium lengths of time.

    Imagine if you had a Jelly Bean jar contest, and you enact a survery (everyone votes privately). Alternatively, you have you have 10 people vote, then you start showing the average price from previous people.

    Repeat this thought experiment a few hundred times (a monte carlo simulation). Which system is more accurate? The simple survey, or the market?

    Actually, I can run the simulation with simulated RATIONAL voters, and compare the stability of the outcomes. I’ll run it for you, and post the results in a few hours.

  55. Gravatar of Pete L Pete L
    14. October 2010 at 08:00

    StatsGuy,

    None of what you are suggesting contradicts reasonable forms of EMH. EMH simply says that one cannot consistently beat the market over time unless one can effectively exploit non-public information or can somehow exploit large amounts of relatively rare human capital that’s generally unavailable to the market at large (e.g., talented entrepreneur). Though most reasonable people that study markets can agree there are probably some fleeting exceptions to this rule, we have no systematic way to identify those individuals or methods. It’s not inconsistent to say that markets are also subject to various forms of bias, that they over and under-react to events, or that volatility or noise confuses things.

    In short, the claim is not that the market is always right but that we don’t have a better way of determining value or allocating capital. The various central bankers, politicians, and regulators face the same sorts of biases and have to deal with the “noise” you speak of and are largely constrained to the same sets of tools that other market actors are. Unless or until they can consistently out perform the market (w/o manipulation, insider trading, etc) this is a very crucial point. Further, they are subject to various systematic problems like excessive risk aversion, interest group politics/regulatory capture, graft, and so on. While they might collectively prefer to avoid risk and thus reduce the number of bubbles (maybe) this will likely come at significant cost.

  56. Gravatar of ssumner ssumner
    15. October 2010 at 15:46

    Doc Merlin, I don’t believe the Austrians, or anyone else, is good at predicting bubbles. I think those who predicted the US housing bubble have an inflated opinion of their ability. If they lived in some other country they would have quietly fallen flat on their faces.

    Full Employment Hawk, Of course it explains 1929, why would you think otherwise? Studies have shown that stocks were fairly prices in 1929, assuming that we didn’t have a Great Depression. If I could go back to 1929 with two choices, buy and hold stocks and buy and hold Government bonds for 80 years, I’d pick stocks.

    And no, bubbles don’t refute the EMH unless bubble spotting has some policy implications–and it doesn’t. An example of a policy implication would be if government or academics could spot bubbles, but investors couldn’t.

    Statsguy, It seems to me you are saying that markets aren’t efficient if the average investor isn’t as rational and unemotional as Spock on Star Trek. But that’s the wrong criterion. The question isn’t whether EMH is true, it’s whether it’s useful. Or is the anti-EMH position more useful? Even if market particiapnts get swept up in emotion on occasion, there are no policy implications because potential regulators are equally emotional. Indeed in the housing bubble regulators of both parties complained the bubble wasn’t big enough. And we know from a study by Fama and French that “smart investors” have trouble beating the market. So what are the policy implications of the anti-EMH position? The problem is that papers deviating from the EMH asusmption generally ssume there are policy implications, or investment implications. That was my point.

    Pete, My views exactly.

  57. Gravatar of ssumner ssumner
    15. October 2010 at 15:55

    Lucas, You said;

    “doesn’t that sound a lot like climate science, where it’s almost impossible to get published without assuming global warming? (And don’t say economics is a soft science where proof is difficult to achieve. Prediction is also difficult in climate science; and for the same reason””both the economy and the climate are very complex.)”
    You’re way off base here, Scott:
    – Climate science is a very broad subject. Disciplines as diverse as glaciology, forest ecology, oceanography, geochemistry and atmospheric physics contribute to the body of knowledge of climate science.
    – Accepting the AGW hypothesis is not a prerequisite for publishing something related to climate science. E.g. you can study ice sheet dynamics without a single mention of climate change.
    – Contrarian and “neutral” papers do get published in quality journals. The things that are not accepted in quality journals are the downright bad/cranky papers, although there are exceptions [1]
    – The core of climate science is not numerical modelling, it’s 19th century physics [2].
    – If you discard modelling and palaeoclimatology, AGW is still very evident.
    It’s foolish to make strong statements about subjects we know little about. That’s why I use very nuanced language when commenting on economics: my Economics 101 classes at college and my reading of classics and random papers are not enough to proclaim myself knowledgeable on economics and reach strong conclusions.”

    1. I agree climate science is broad, and didn’t imply otherwise.

    2. You can publish things in economics without mentioning ratex or EMH. But almost everything that uses expectations assumes ratex, and almost everything published about global temperate change assumes global warming. Not everything, almost everything.

    3. I said in a comment above that climate science is applied physics, which just shows that physics is a soft science.

    4. I agree that AGW is evident in the data, and never said otherwise. There’s also lots of data supporting ratex and the EMH

    So I can’t see where you have found any reason to call my post “foolish.” But maybe I missed something.

  58. Gravatar of Doc Merlin Doc Merlin
    15. October 2010 at 19:34

    @ Pete L:
    Excelent wording.

  59. Gravatar of Greg Ransom Greg Ransom
    20. October 2010 at 23:09

    Scott, you are playing from the bottom of the deck again. The topic was “scientific consesnus”. You’ve never read a scientific paper on this topic — it isn’t a scientific subject. It is however somethin the network talking heads assert all of the time.

    Sxott writes,

    “Greg, I’ve read a lot of scientific papers on global warming. I don’t get my information from Katie Couric or FoxNews.”

    Again, this is spin, it isn’t playing straight, and it falsely implies something that isn’t true — the the papers you’ve read have anything to do with the patently false claim of scientific consensus.

  60. Gravatar of Scott Sumner Scott Sumner
    21. October 2010 at 05:54

    Greg, I assume you are joking, the jounrals are full of global warming papers.

  61. Gravatar of Lorenzo from Oz Lorenzo from Oz
    30. October 2010 at 22:01

    Scott: a Thread of Doom is one that just goes on and on and on without getting much in the way of any sort of resolution.

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