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Not only climate alarmists "do it with models". Economists are into it as well. Perpetrating large scale fraud.
Modern economics describes a whole (the economy) brought into equilibrium by the interlocking of self-equilibrating parts (markets like the labour market or markets for products or investments). The respective equilibria are optimal, i. e. incapable of further improvement. These results are arrived at by a mathematical model, let us call it Model A, whose purpose it is to model a system of interlocking optimal equilibria rather than reflecting economic reality. To accommodate more features of economic reality, Model A is adapted and turned into Model B by adding features that are ad hoc in the sense that they are not part of a systematic theory of general equilibrium and arbitrary in as far as they serve to avoid the embarrassment of too large dissimilarities compared to the real world. They are fudge factors, stopgaps that shape the appearance of Model B making it resemble the real world a bit more, but they are independent of, diverge significantly from, and contradict the consistency and optimality conditions of the unrealistic Model A.
So, the promise of free market economics is represented by Model A, which is a consistent mathematical description of a system of interlocking optimal equilibria. However, this equilibrating system does not bear the hallmarks of a real economy. The reality of a free market is tentatively represented by Model B which is not a consistent mathematical description of a system of interlocking equilibria.
The the proof that the economy, if left to work its natural course, operates as a self-equilibrating system is schizophrenically split up into
- a generic demonstration that consistency and optimality can be theoretically achieved in properly parametrised kinds of equilibrating systems (but not in one corresponding to real markets), and
- a description of the economy that aspires to semblance with reality but fails to achieve the promised consistency and optimality of a supposedly self-regulating economy capable of general equilibrium.
In dealing with Model A, echos of Model B reverberate with the student, who vaguely senses that there is a practical application of this abstract theory. In dealing with Model B, echos of Model A reverberate with the student, who vaguely senses that there is a rigorous theory undergirding the messy picture of a real economy. The echos merge into a tune that makes general equilibrium sound right.
New Keynesians claim that their approach integrates so-called real business cycle theory elements (intertemporal optimisation, rational expectations, and market clearing) into a stochastic dynamic macroeconomic model, and because they build this on first principles (rationality, maximisation etc) the results they derive are ‘optimal’ and ‘welfare maximising’.
These ‘virtues’ are then held as the authority and New Keynesian economists are continually casting aspersions on other analytical approaches (within, say, the Post Keynesian tradition) that they claim lack ‘rigour’ because they lack the so-called ‘microfoundations’ (rationality, maximisation etc).
But to integrate those elements into a formal (mathematical) structural system of equations, which they claim adequately represents the economy, the New Keynesian specifications have to be overly simplistic and reliant on behavioural assumptions (rationality, information processing capacity of individuals, foresight, etc) that no self-respecting social scientist that actually studies human behaviour would consider to be credible in the least.
But without that simplicity and highly stylised (and ridiculous) assumptions about human behaviour, the mathematical solutions would be impossible.
I know this is tricky for non-economists but stay with it.
Then the problems begin.
Because the ‘optimal’ theory, specified in the basic structure (Calvo pricing, rational expectations, intertemporal utility maximising behaviour by consumers, who face a trade-off between consumption and leisure, etc) cannot say anything much about real world data, the empirical models are modified (adjustment lags are added, etc).
For example, in the applied world of macroeconomics there is usually a lagged dependence between output and inflation. However, in the standard New Keynesian model, so-called ‘Calvo price-setting’ (one of their assumptions about firm behaviour), which represents the microfoundational behaviour, does not allow lagged inflation to influence current inflation.
So the theoretical model cannot yield an empirical model that can be estimated to simulate policy options.
There are many examples of these anomalies.
It is virtually impossible to builds these ‘modifications’ into their theoretical models from the first principles (intertermporal optimisation, etc) that they start with.
How do New Keynesians deal with them?
Ad hocery enters the fray and we see econometric models with these lags built in – the primary justification being empirical.
Why is this problematic?
Well you cannot have it both ways!
The mainstream proponents want to claim virtue based on the fact that their models are rigourous (based on assumed microeconomic behavioural foundations) but then respond to empirical anomalies with ad hoc (non rigourous) tack ons.
These ad hoc responses have no correspondence to the theoretical properties of their models.
The results they end up producing in empirical papers (that feed into policy advice) are not ‘derivable’ from first-order, microfounded principles at all.Their claim to theoretical rigour fails.
At the end of the process there is no rigour at all. It becomes a false authority that they hide behind to justify their assertions.
The source.
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