Brian Romanchuk — DSGE Macro As An "All You Can Eat" Buffet (Part 1)

Brain states his position in the current debate on economic modeling.

The ongoing online debate regarding mainstream Dynamic Stochastic General Equilibrium (DSGE) models has again heated up. Professor Simon Wren-Lewis of Oxford discussed whether mainstream macro was eclectic; provoking a response from Professor Lars P. Syll of Malmö University, the latest of which is "'Deep Parameters' And Microfoundations". I am not interested in the entire spectrum of their debate, rather on the question of eclectic models. (This is the first part of a two-part series.)

Bond Economics
DSGE Macro As An "All You Can Eat" Buffet (Part 1)
Brian Romanchuk

Simon Wren-Lewis — Heterodox economists and mainstream eclecticism

The gloves are off.

I think that SWL misses the point. The objection is to "our way or the highway."

And Lars was right. The original post that got this debate going reflected that by the limits that SWL put on eclecticism in the choice of his example, which were different approaches with respect to economic formalism with a disregard for realism.

Oh, and SWL accuses Lars of being "angry," when it is SWL who clearly is angry.

Mainly Macro
Heterodox economists and mainstream eclecticismSimon Wren-Lewis | Professor of Economics, Oxford University

Jason Smith — On the use of hypotheses: or, what do you get when you assume non-ergodicity?

Jason Smith replies to Lars Syll (and Paul Davidson).

What comes out of assuming ergodicity? All of basic thermodynamics and much of basic economics. If we assume economic (or thermodynamic) systems aren't ergodic -- what does that give us?

Essentially, assuming non-ergodicity is analogous to the assumption that I(A) < I(B) in the information transfer framework (ergoditicy is the assumption that I(A) ≈ I(B) ... the information in the two macro observable is the same, from which you can derive supply and demand). 

What can we get from the assumption I(A) < I(B)? Nothing. 

That is to say that while ergodicity is a useful assumption, non-ergodicity is a completely useless assumption. It doesn't prove that economies are quasi-periodic chaotic systems or that they are some other kind of complex system -- you need evidence for that! Show us a model that that is empirically successful. Or at least more empirically successful than assuming ergodicity.

Yes, that's a point that Keynes made and which Davidson and Syll elaborate:

Many thanks for sending me your article I enjoyed it very much. I am sure these matters need discussing in that sort of way. There is one point, to which in practice I attach a great importance, you do not allude to. In many of these statistical researches, in order to get enough observations they have to be scattered over a lengthy period of time; and for a lengthy period of time it very seldom remains true that the environment is sufficiently stable. That is the dilemma of many of these enquiries, which they do not seem to me to face. Either they are dependent on too few observations, or they cannot rely on the stability of the environment. It is only rarely that this dilemma can be avoided.
Letter from J. M. Keynes to T. Koopmans, May 29, 1941

Of course, that is a bit of a hand wave but Keynes is much more specific about it in other places. But the idea is that the basis for neoclassical assumptions is too non-representation of the subject matter to yield a useful methodology. Neoclassical methods are not useful for telling us what we really need to know, in particular for policy formulation. Keynes proposed a new economic method based on a monetary production economy in which money is non-neutral and uncertainty dominates.

Keynes was not only a theoretician but an economic "engineer" who are active in the world of policy at the time of the Great Depression and his ideas are credited with saving the day — other than by neoclassical economists that have sought to "correct" this, for which the world is now suffering another prolonged contraction.

In the Keynesian view, econometric models are essentially a waste of time. According to old Keynesians and Post Keynesians, Paul Samuelson "bastardized" Keynes by introducing key assumptions that Keynes specifically rejected.

In this view, macroeconometricians should be doing something else, like looking for types of models that actually are useful, like the stock-flow consistent approach developed independently by James Tobin and Wynne Godley, and set forth in Godley & Cripps, Macroeconomics (1983) and Godley and Lavoie (2007, 2nd ed. rev., 2012). See Lavoie (2010).

Information Transfer Economics
On the use of hypotheses: or, what do you get when you assume non-ergodicity?

Jason Smith

Lars P. Syll — My new book is out

On the Use and Misuse of Theories and Models in Mainstream Economics

Congratulations!

Lars P. Syll’s Blog
My new book is outLars P. Syll | Professor, Malmo University

Dirk Ehnts — Krugman on Unreal Keynesians (IS/LM again)

Dirk Ehnts offers a Godley-based "gadget" to replace ISLM as a heuristic.

My own point of view is that IS/LM is mistaken in assuming that the central bank controls the money supply and that the sectoral balances (private and public) are not made explicit. You actually can get a lot of mileage out of the good old IS/LM model if you let the central bank set the interest rate on the short-term money market (horizontal LM curve) and – because of general depression – determine some level of expenditure (or demand) that does not react to changes in the interest rate (vertical IS curve). The resulting cross is so trivial that I tend to agree with Syll: maybe it is not the best idea to use a macroeconomic model to show that: 

• Demand is exogenous and smaller than potential output
• The central bank creates the interest rate, but that doesn’t matter because of 1.
• Demand is exogenous, but government spending can add to that 

Using a mathematical model with all eyes crossed and all teas dotted to then arrive at this conclusion really is a waste of time. How do we fix this? 

I have published the so-called IS/MY model to show what could be done to improve on the shortcomings of the IS/LM model (working paper version here). First of all, the main idea is that expenditure equals spending in equilibrium. Then, net deposits (money) are created through three mechanisms that rely on the same balance sheet trick. A rise in net debt leads to a rise in deposits for each of the three sectors: private, public and external. The monetary circuit works well as long as the amount of deposits is increasing (given velocity, and ignoring complications of what is money)....

The IS/LM model was not perfect, and never will be. Any alternative will face the same fate. However, it would be nice for the macroeconomist to have something small and “unbreakable” that works on the back of an envelope. The IS/MY model is based on (BoP) accounting relations and assume only that consumption and imports depend on income. Most economists should be able to live with these assumptions. What is left to the economist is to speculate about the quantity of investment, government spending and exports. These will, using the vocabulary of Wynne Godley, determine the fiscal and trade stance and allow discussions of sustainability of macroeconomic regimes.

econoblog 101
Krugman on Unreal Keynesians (IS/LM again)
Dirk Ehnts | Berlin School for Economics and Law

Nick Rowe — The orthodox New Keynesian position on liquidity preference and loanable funds

Nick Rowe jumps into the fray between Lars P Syll and the New Keynesians over loanable funds, first stating his understanding of the New Keynesian position.

Setting those problems aside, I have my own disagreements with the ONKM perspective on this question. But this post is not about my own views.

This post is about Lars Syll's views. I would like to ask Lars if he agrees or disagrees with the ONKM view, as I have presented it/translated it above. Because a lot of stuff really does get lost in translation sometimes.

[My guess is that both Paul Krugman and Greg Mankiw would roughly agree with the above, but I could be wrong.]

Worthwhile Canadian Initiative
The orthodox New Keynesian position on liquidity preference and loanable funds
Nick Rowe | Associate Professor of Economics, Carleton Univerity

Matias Vernengo — Krugman is actually right on ISLM and Minsky

I tend to disagree a lot with Krugman, at least on theoretical issues. His brand of Keynesianism supposes that the system doesn't work because of imperfections. For him, the current slow recovery is due to the fact that the natural rate of interest is basically negative and you cannot use monetary policy to stimulate the economy (see critique of this here). However, on his recent debate with Lars Syll (and here; Brad De Long also posted here), a post-Keynesian, with whom I probably share a more radical interpretation of Keynes and its relevance for economic theory, Krugman seems to get things right.

Naked Keynesianism
Krugman is actually right on ISLM and Minsky

Matias Vernengo | Associate Professor of Economics, University of Utah

It seems to me that there are two senses of "equilibrium" in play —

1) the neoclassical view of a single long run equilibrium in which all factors are in equilibrium, hence involuntary unemployment is impossible in the long run, and

2) the Keynesian view in which multiple equilibria are possible with differing use of the factors, so that long run unemployment is possible. The former view is that perfect markets are efficient, whereas the later view is that perfect markets exist only as a i Platonic deal and that confusing the ideal with the real overlooks the conditions of the real following upon uncertainty on one hand and the effect of cultural conventions and institutional arrangements on the other.

The third view is that economies are inherently unstable so the concept of equilibrium does not apply, although the level instability can be addressed institutionally and through policy.

As far as deciding definitely what Keynes held is probably an interminable debate that will never be resolved to the satisfaction of all parties. This is the story of interpretation in other fields.The debate is worth having to clarify both the history and the issues, and possibly to discover something new.

Lord Keynes — Lars P. Syll on Probability and Economics

Lord Keynes provides a list of links to Lars Syll's posts on probability and econ. Lars is fast becoming a go-to guy in methodology.

Social Democracy For The 21St Century: A Post Keynesian Perspective
Lars P. Syll on Probability and Economics
Lord Keynes

Lars Syll — Wynne Godley and the Fiscal Cliff

Looking at balance sheets from a macroeconomic perspective, it is of course important not to look at the different sectors in isolation. Assets and liabilities of households, banks and government have to be analyzed as interdependent parts in a cumulative process where one sector’s surplus is counterbalanced by another sector’s deficit.

To Wynne Godley – and those of us who have absorbed at least a rudiment of MMT – this was self-evident. A sectoral balance approach is a necessary ingredient in understanding financial crises – and that’s also one of the reasons why the Fiscal Cliffers are so wrong.

Lars P. Syll's Blog
Wynne Godley and the Fiscal Cliff
Lars P. Syll | Professor, Malmo University

Lars Syll — What is money?

On Hyman Minsky.

As all students of economics know, time is limited. Given that, there has to be better ways to optimize its utilization than spending hours and hours working through or constructing irrelevant economic models. Instead of risking to just reinvent the wheel, I would rather recommend my students allocating their time also studying great forerunners like Keynes and Minsky, to help them constructing better, real and relevant economic models – models that really help us to explain and understand reality.

Read in conjunction with Philip Pilkington's post on mainstream economics as metaphysics. Could have added Austrian economics, too. Assumptions that are not empirical and are not tested, or even cannot be tested empirically are metaphysical. They function as norms in the logical construction of a worldview. Let's get real.

Lars P. Syll's Blog
What is money?
Lars P. Syll

Lars Syll — Rational expectations – assuming we know what in fact we never know

In a laboratory experiment run by James Andreoni and Tymofiy Mylovanov and presentedhere, the researchers induced common probability priors, and then told all participants of the actions taken by the others. Their findings is very interesting, and says something rather profound on the value of the rational expectations hypothesis in standard neoclassical economic models:

Lars P. Syll's Blog
Rational expectations – assuming we know what in fact we never know

Lars P. Syll | Professor, Malmo University

Summary: REH doesn't take into account the moron factor. :)

Lars Syll — General equilibrium economics – a dead end

As long as we cannot show, except under exceedingly special assumptions, that there are convincing reasons to suppose there are forces which lead economies to equilibria – the value of general equilibrium theory is nil. As long as we cannot really demonstrate that there are forces operating – under reasonable, relevant and at least mildly realistic conditions – at moving markets to equilibria, there cannot really be any sustainable reason for anyone to pay any interest or attention to this theory.

Lars P. Syll's Blog
General equilibrium economics – a dead end
Lars P. Syll | Professor, Malmo University

Why did this quest turn out so poorly and why is it so difficult to give up? It's based on the myth of the invisible hand as the economic correlate of laws of nature in the hard sciences. This myth has been enshrined as neoliberal dogma, and it constitutes the supposed connection between Classical and Neoclassical economics (with Paul Samuelson introducing it into Keynesian analysis). This leads to the assumption that markets operate based on laws of nature as if guided by an invisible hand, so that there are natural rates that are determined and can be expressed mathematically as invariants. 

The explanations are meticulously crafted but the predictions have neither been uniformly accurate nor comprehensive. Global financial crisis? The model did not predict it. What path will the recovery take and when will it be over. The model doesn't predict that either. So now economists are toying with multiple equilibria, and shifting natural rates.

As Joe Stiglitz famously said recently, there is no "invisible hand." And as Adam Smith's biographer Gavin Kennedy (Adam Smith's Lost Legacy) observes, Smith never used the phrase "invisible hand" in the way that later neoclassical economists' interpreted it in light of 19th century physics. See Gavin Kennedy, Adam Smith and the Invisible Hand: From Metaphor to Myth Econ Journal Watch, Volume 6, Number 2, May 2009, pp 239-263.