Simon Wren-Lewis has a post on the state of macroeconomics that I mostly agree with — but part of which bothers me a lot....
Wren-Lewis argues against the many people insisting that the crisis means that we must rebuild macroeconomics from the ground up; he argues, on the contrary, that the crisis doesn’t require a fundamental rethink of macro. And I am very much in agreement there. Basic sensible macro — what we learned from Keynes and Hicks — has actually held up very well in the crisis. To the extent that we have a crisis in macroeconomics as practiced, it comes from the way many economists chose to reject sensible macro....
My liquidity trap work (pdf) has, I think, aged pretty well; and even back then I was very much worried about issues of debt overhangs and balance sheet effects....
Now, what’s true is that my old work on balance sheet stuff focused on corporate rather than household debt, and that I was entirely concerned with the balance sheet effects of a movement in the exchange rate as opposed to, say, a drop in housing prices. And I really, really should have connected the dots and seen how a burst housing bubble could produce similar effects — but I didn’t; I thought the end of the bubble would be nasty, but failed to realize how nasty. Mea culpa.
But this was a failure to look at the right variables, not a fundamental flaw in the theory — and once it became clear that we were in a balance-sheet crisis, it was quick work to slot that into our understanding.Read it at The New York Times
Gadgets Versus Fundamentals (Wonkish)
by Paul Krugman
Whaaat? Had the right model but didn't look at the right variables?
Doesn't he know that in hindsight one can get anything right by changing the assumptions?
Ah. That's why these people think that they missed the crisis. The the model worked fine, but they just didn't know how to use it correctly at the time. Next time will be different. Right-o.
The theory itself should tell you what to be looking for. The mainstream theories didn't so they got it wrong, wrong, wrong. Those using the theory based on Minsky's financial instability hypothesis and Godley's SFC macrro modeling based on sectoral balances, Wynne Godley and the MMT economists, for instance, got it right. Steve Keen got it right, too, using his model and Minsky. Others, too. See Dirk J. Bezemer, "No One Saw This Coming": Understanding Financial Crisis Through Accounting Models and James K. Galbraith, Who are these economists anyway?
20 comments:
Tom,
It's sad at this point really, just pathetic.
No class or honor with these people.
Tom,
Krugman's plaidoyer for "brilliantly silly" macroeconomic models is - just silly, actually.
For more on Krugman's weighing in on The Great Divide debate, see
http://larspsyll.wordpress.com/2012/07/14/krugmans-vindication-of-neoclassical-macroeconomics-brilliantly-silly/
Aren't Balance sheets an ex-post record?
So what is he saying... that when housing prices fall, a household balance sheet will have updated entries depicting the new lower value? Duh.
What is predictive about any of this?
I believe that MMT would have predicted that loans would default and thus housing would probably fall when the fiscal deficit got too small, an indication of over taxation that required a proactive fiscal adjustment which would have resulted in an increased deficit.
Here the real problem lies. They think the deficit is "bad" when it is simply another ex post record just like their beloved "balance sheet" that they are overly obsessed with.
They wont ever get anything until they get over this irrational and moron "deficit phobia" and "govt debt phobia".
When you are in a hole stop digging.
Thanks, Lars. I had already put up your post before I saw your comment here. :)
" issues of debt overhangs and balance sheet effects"
wtf is a "balance sheet effect"?
A balance sheet is quantitative ex post record of "something". Like if someone went out and took a picture of a bridge.
Then the bridge collapses.
Then that same someone went out and took another picture of the now collapsed bridge.
Then the photographer would look at this new picture and say to themselves: "wow I hope this picture of the collapsed bridge doesnt make the bridge collapse!"
Whaaaaat?????
These people are all INSANE!
The reality has set in that they were and are wrong and that the attacks from outside diminished their credibility. Now they are circling the wagons and trying to deny anything substantial has changed; convince themselves that the world will retain their privileged positions.
The public is weary. Companies and finance don't trust their analysis. Investors jettisoned their models. The orthodoxy controls academia and government but even there politicians distance themselves from any orthodox prescription because their unreliable performance. So let them keep believing that nothing needs to change but a variable or two as they continue the march toward uselessness and irrelevance.
Matt, I suspect that engineers do use very high resolution cameras to take pictures of structures like bridges, which they fit into the "big picture" to establish exact location. Then they blow up the pictures and look for structural defects not visible to the naked eye.
I take "balance sheet effects" as meaning something like this. Looking at a balance sheet gives an overview but it takes a trained person to see what may be going on and giving clues where to look. Auditors and analysts do this all the time.
What Krugman seems to be saying is that the model captured the necessary data OK but the folks using the model didn't know where and how to to look and therefore missed the structural defects that led to the collapse.
I would say that this is taking part of the blame but not placing it were it actually lies. Which is in the model's design, as Lars points out in his post.The assumptions are too far removed from reality to make the model very useful in the real world other than as a "gadget." Gadgets are not tools.
Well then at least his writing/terminology is inaccurate/sloppy.
Look here is what he wrote:
" I was entirely concerned with the balance sheet effects of a movement in the exchange rate as opposed to, say, a drop in housing prices."
If housing prices dropped, they would already be accounted for in a balance sheet.
There are NO further 'effects'.
We're talking about a post mortem after a collapse has already happened.
What K seems to be saying is that:
1. housing prices dropped and somehow nobody knew about this...
2. All of a sudden these facts became known thru the communication medium of a balance sheet...
3. then the fact that this new information was now in a 'balance sheet' format went on to have AN EFFECT on the macro economy and caused a collapse... when the collapse had already occurred...
This is like saying the next time you take a picture of a bridge you better be careful with the way the picture turns out because it may cause a collapse.
It looks like literally 'voodoo economics'....
I would say the same thing about anyone using the phrase "balance sheet recession"... the thought process seems out of whack. Ex post accounting reports do not cause recessions....
Next up: "Liquidity Trap"... wtf does this mean????? etc...
Engineers use models that they make sure correspond to reality. Mainstream economists, not some much, again, as Lars points out. "It's the assumptions, stupid."
What I find puzzling about PK is his emphasis on ISLM. Just how do "balance sheet effects," whatever he means by that, fit into this? I realize that there's not much space to go into detail in a short blog that's primarily for the print edition and necessarily limited in characters, but, as you say, Matt, what is he talking about, exactly.
And as far as "balance sheet recessions" goes, Warren has observed that all recessions are balance sheet recessions, which means that the term is redundant in that "balance sheet" adds nothing to "recession." How could it be otherwise, since all accounting data relative to stock shows up in summary on the balance sheet, all flow shows up in summary on the income statement, and all flows (channels) on the flow of funds report.
All of these guys are desperately trying to hang onto theories in which monetary policy is the chief policy tool. The monetarists think monetary policy works all the time. The Old Keynesians think it works as long as there is not a liquidity trap. The New Keynesians think it works as long as there are not serious sticky price issues. But as Bill Mitchell has written 1000 times, it doesn't matter whether there is a liquidity trap.
Krugman still doesn't get the special role of banks. And bank isn't just some sort of random economic unit, like a household or a manufacturing firm, that happens to have a lot of money, and that doesn't spend or lend because it has a temporary excess love of liquidity.
Why do economists love monetary policy? Because they dram of a world in which macroeconomic outcomes are determined by economists and bureaucrats working in central banks, and not self-determining people and their representatives fumbling along out in the democracy.
It looks to me that the whole existence of the IS curve and the use of IS-LM analysis defines out of existence the problems that Minsky, Mosler and Godley zeroed in on. The curve represents a locus of equilibrium points where total saving and total private investment are equal. So no demand leakages. All income is spent somewhere.
As for Minksy: Allegedly these guys love Minsky now, but they don't get him at all. The problem with classic macro - a problem which Keen totally gets - is that it is all based on equilibrium analysis. The natural state of things is equilibrium, and when equilibrium doesn't occur that is because of some shock or pathological deficiency. These guys don't understand the Minskyan and Schumpterian insight that a capitalist economy is always evolving, always transforming itself into something else, always unstable. Stability can only occur because of the efforts of human regulators to impose stability on the system. Stability is not natural.
Tom,
I really appreciate you putting up my posts here on this great blog!
Lars, I appreciate your writing great posts and enjoy sharing them with others.
Here's something to ponder:
It is necessary that heterodox theories would be better predictors than mainstream theories when in comes to depressions, for if the mainstream were right, then depressions would not have occurred in the first place.
"It is necessary that heterodox theories would be better predictors than mainstream theories when in comes to depressions, for if the mainstream were right, then depressions would not have occurred in the first place."
Smartest comment you've made so far.
Paul:
Smartest comment you've made so far.
Now that I have your honest attention, I will ask you what is common to all countries throughout history that have experienced the business cycle, given the fact that what constitutes "mainstream theory" in those countries have been different country to country, and have undergone changes within the same countries?
For example, what was common between the USSR 1917-1991, and the US 1917-1991, than made both nations experience the business cycle, despite there being different "mainstream" economic theories in each country, and despite mainstream theories changing within each country, and despite the different political structures?
I'll give you a hint: It starts with "fractional" and ends with "backed by a central bank", with a "reserve banking" in the middle.
You won't get a lot of argument from me on the folly of unregulated private banking backed by the government.
Fractional-Reserve-Banking is a myth though, although it doesn't really matter that much.
Under current arrangements, banks are unconstrained in their ability to lend as long as they have credit-worthy borrowers available to lend to.
The recent problems have a lot to do with banks ignoring their responsibilities with regard to qualifying their borrowers.
Instead they used the people's money to bet on longshots whereby they were able to skim their money off the top and leave the wreckage for the rest of us to deal with.
Bankers should be hanging in the streets visible to everyone.
Full-reserve banking wouldn't change anything, nor would allowing private entities to create their own currencies, which I see as unworkable and impracical.
Fiat currency is the only system that makes sense to me once the alternatives are thought through.
Maybe some system whereby currency is backed by energy credits may emarge and be effective.
I don't see much difference between that and the current system, where our currency is backed by our ability to produce stuff (labor), except that it takes into account limited resources, which is not a trivial matter.
Paul:
Full-reserve banking wouldn't change anything
Of COURSE full reserve banking would change things! It would mean investment will be a function of real savings, not the printing press. That will make for a more stable and sustainable economic structure!
nor would allowing private entities to create their own currencies, which I see as unworkable and impracical.
So if you had the idea of an energy backed currency, and I had the idea of a free market process determined currency idea, then your idea would require me to be forced into your currency idea, whereas my idea would not require you to be forced into my currency idea. My currency idea is by its very nature voluntary and non-binding. It is by nature inclusive of ALL currency ideas, subject of course to individuals choosing for themselves whether they want to accept it or not.
What you meant to say is not that it is "unworkable", since both economic logic and history have shown that it is, but rather that it is not controllable by a centralized power. That's what you really mean when you say it's not "workable." For you don't decide what is workable for me, and I don't decide what is workable for you. We decide what is workable on our own choice. The only people who won't find a free market in money "workable" is the state, whom you tacitly assumed is the relevant center of all things human related, where if the state can't "manage" it, then it is "unmanageable", where if the state can't "work with" it, then it is "unworkable", and so on.
You are completely ignoring how things can work according to individuals choose useful commodities on their own, and rejecting non-useful commodities on their own. Individuals don't need to have a state telling them what to do in order to know that one currency is better than another.
Fiat currency is the only system that makes sense to me once the alternatives are thought through.
Fiat currency makes no sense in a world where not every individual agrees on what is good for them individually in terms of the valuation of commodities.
Fiat money only makes sense if your only task is to figure out what money is good for the state. Yes, when the context is what is good for the state, then state controlled money is the best option.
But when you instead discover the context of individuals, then you will realize that the best option is money controlled by individuals, which is maximally decentralized.
Computer manufacturing is controlled by individuals. Look at how amazing they are. Seriously bad computers have been virtually eliminated. Yes, it hurt the interests of the sellers of those bad computers when they lost sales, but the end result is a population of incredibly powerful and efficient computer market.
Why can't you see the same principle would apply to money? Bad monies would eventually be driven from the market, and good monies will remain. Test your ideas against everyone else's ideas to see which one is best. Be humble and realize your idea might not be the best one in other individual's judgments. Don't force your preferred money on them. By forcing fiat money on other people, you make it impossible for good money to drive out bad money.
Maybe some system whereby currency is backed by energy credits may emarge and be effective.
The market process is the very melting pot of ideas where you can learn via choice testing to see if they work for people, including energy backed money "emerging".
How can you say "it won't change anything" if individuals can create their own currencies? That's how people can TEST the energy-backed currency idea!
You're oh so close to understanding the market process, and yet something is holding you back.
Paul:
You won't get a lot of argument from me on the folly of unregulated private banking backed by the government.
The Fed is not a free market institution, it's a state created institution. The Fed regulates the banks. The banks are not unregulated.
In reality, private banks that can issue as much credit as they want, with central banking backstop, is a regulated banking system. It is the state essentially deregulating itself.
"The Fed is not a free market institution"
True, it is a an institution captured by a crony capitalist system.
Full disclosure, I don't believe it is possible for a free market to exist, nor has one ever existed.
In a free market only the strongest survive and the strongest are the few. Fortunately we weaklings outnumber them.
"The Fed regulates the banks. The banks are not unregulated."
Correction. The Fed is supposed to regulate them. It has done a very poor job (see above) and th eresult is de-facto non-regulation.
Banks are prohibited from intentionally making loans to people that won't/can't repay. Need I say more?
"You're oh so close to understanding the market process, and yet something is holding you back."
The problem with private currency/many currency ideas is clearing and interstate commerce.
Will my Florida-bucks be able to buy something from a vendor in California? from Amazon?
I've been watching these various alternative-currency projects to see if and what other unintended consequences may emerge.
Until then I'm inclined to try to fix the system we have.
From my view our fundamental problem is corruption and re-setting the system isn't going to make that go away.
In reality, private banks that can issue as much credit as they want, with central banking backstop, is a regulated banking system. It is the state essentially deregulating itself."
This doesn't parse for me. Re-phrase maybe so I can be sure what you are saying?
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