The General Economics Thread

the other big problem with austrian theory is it tends to assume that there is absolutely no way to 100% determine economic trends from data, therefore they throw data out completely.

My understanding is that the Austrian School and other classical schools are based on a bottom-up approach. They start from what is readily apparent about the way people and businesses behave and use deductive logic to determine how the economy works on the larger scale. Keynesianism and similar modern schools are based on a top-down approach. They examine aggregated statistics and try to find patterns in them and draw conclusions based on that.

The thing is, neither method really leads to a comprehensive understanding of the system, although both methods are valid. It seems to me that if we really understood economics as a science, the two approaches would complement rather than contradict each other. Like epidemiology and germ theory.

the prob;lem with the austrian ideal is it completely throws out any evidence that cant be reached via inductive logic as though somehow humanity can be comprehended and predicted on pure rational logic.

I've actually heard Austrians make a similar criticism of Keynesianism, that it assumes that humanity can be understood in aggregate through mathematics.

Let me just throw in a reccomendation for an excellent book on the competing theories Keynes Hayek by Nicholas Wapshott. It's remarkably balanced.

Trump delenda est

that seems like a weird criticism to make, given that modern Keynesian models are very particular about not doing that.

In fact the whole of the rational expectations revolution in the 70s and 80s was about this problem...

You can't even write racist abuse in excrement on somebody's car without the politically correct brigade jumping down your throat!

Well, I don't really know about that, I'm still working my way through original Keynes. However, in contrast to some more classical economists I've read he generally seems to let his equations speak for themselves rather than bringing in real world case studies and hypothetical examples.

I'll have to check that out some day. For those of you with shorter attention spans, like me, here's the controversy in rap form:

• part 1
• part 2

edited 17th Dec '12 10:12:54 PM by Topazan

The original Keynesianism was pretty badly discredited in the '70s. New Keynesianism incorporates a lot of the criticisms leveled at the old model by Milton Friedman and the other monetarists and neoclassical economists (for example, rational expectations theory and the real business cycle).

I despise hypocrisy, unless of course it is my own.

For the two schools:

Austrians believe that boom/bust exists only because of interference within the market by low interest rates.

Keynesians believe its natural. Old-school Keynesianism caused heavy inflation and stagnating wages in the 1970s.

Also:

Macro deals with government and banks. Micro deals with consumers and businesses.

edited 18th Dec '12 1:26:19 AM by Completion

Ah yes, Stagflation.

Even though I have had some dealings with Economics*

, what's the view here on the reasons for the Micro / Macro-economics split? Why can't there be one integrated model? Or is this something like the Observer Effect in Physics?

Keep Rolling On

No: it's pure social psychology vs individual personality type deals. What rules and assumptions work for the individual and very small groups warps when you get to larger ones and social autonomic behaviour patterns (both learned and intrinsic) come into play.

People: we're chaotic systems with a veneer of order to confuse the issue.

edited 18th Dec '12 2:07:25 AM by Euodiachloris

Hence why I've never really believed in the "Rational Person" argument, Euo. We're humans, not some super-rational beings...

edited 18th Dec '12 2:10:58 AM by Greenmantle

Keep Rolling On

"Rational Actor" should only have remained what s/he was: a thought experiment and/or tool for philosophical argument. The moment people took the model and applied it to the real word as a base-assumption of human behaviour, and didn't apply real world behaviour patterns onto the Rational Actor to find out more about real human group behaviours... they misused the concept.

edited 18th Dec '12 2:27:50 AM by Euodiachloris

I can understand why it happened though — especially without the psychological techniques or the technology to pull off the modelling required. Mind you, Economics needs to cover a wide area — aspects of Psychology, Sociology, History and Geography need to be covered to form an accurate assessment.

Still seems like a copout, though...

edited 18th Dec '12 3:54:13 AM by Greenmantle

Keep Rolling On

Well, it's all about the assumptions really, which I actually think are pretty much wrong in conventional economic thought.

The problem is the labor model, or at least that's the main problem. It's not so much wrong as it's increasingly out of date. It's a supply-based model that really doesn't work for a service-based economy.

The traditional model, is one of marginal value. If an employee creates more value for the company than his wage, then you would hire him/her. Where that goes wrong, is that it assumes unlimited demand. Right now, and probably for the foreseeable future for a variety of reasons, we live in a demand limited economy. In this economy, businesses can reasonably predict the amount of business they're going to do, they find out the amount of labor to serve that demand, and they hire that many workers. The actual reality is that this is even further broken down into worker hours.

There are still some supply-based jobs out there. Direct, unsolicited sales is a good example. But for the most part, the labor market runs on a demand, not a supply model.

As an example for where this matters, in a demand-based market, productivity increases are actually a bad thing for workers. It means that less hours are needed to do the same amount of work, and as such less workers are needed, driving down wages due to competition for those remaining hours. This isn't a bad thing, per se, but it's something that needs to be recognized and accounted for systematically, or you get what we currently have, with virtually all the benefit of growth going to the rich.

Democracy is the process in which we determine the government that we deserve

Well, you've gotta have something to base your model on, which is why even New Keynesianism uses rational expectations theory. The current synthesis position is that rational expectations theory is about the best we have for modeling a "normal" macroeconomic situation, but it's also necessary to recognize that markets do not always clear, which allows for speculators to get very rich (or lose their shirts). For example, in the mortgage crisis...

• There was a market with absolutely no transparency,
• The system for insuring mortgages insulated individual banks from all the risk of a failed mortgage, causing said banks to shovel loans out the door with no regard for creditworthiness,
• The mortgage-backed securities were vetted by credit-rating agencies that were in a virtually incestuous relationship with the banks themselves,
• And the market for side bets on the insured mortgages not only dwarfed the actual mortgage market, but was set up by people who knew that the original mortgage market was going to fail, that the banks that were insuring the securities were going to collapse, and who were effectively short-selling the very mortgage-backed securities that their employers were insuring.

Rational expectations theory can't explain this, but New Keynesianism does fairly well at explaining it anyway; it points to this as a market failure brought on by imperfect information, conflicts of interest...and humanity going collectively insane.

edited 18th Dec '12 5:36:59 AM by Ramidel

I despise hypocrisy, unless of course it is my own.

I view things like the Rational Actor as a tendency. It's somewhat similar to natural selection- specimens that are poorly adapted to their environment exist, but are generally out-competed by those who are. No one is perfectly rational, but the more rational you are, the more wealth comes under your control, so in general the majority of wealth is under the control of people who are at least relatively rational, ceteris paribas.

Not sure if I understand. Who in that situation acted irrationally, from their point of view?

Surely, they can predict the amount of business they can do at a given price? If adding a new employee makes the production process cheaper, then they'll be making more money even without increasing sales.

Hate to burst your bubble, but... both psychopathic and sociopathic traits show up in leaders of business. The most important skill, it turns out, isn't rationality alone. It's being willing to do practically anything to get your goal, including manipulated all those around you.

And, that isn't particularly rational in a social setting in and of itself.

It may be rational from the standpoint of an individual seeking to maximize his/her own wealth, but not for society as a whole. And this is why Austrian-style rational actor theory breaks down when applied to the macro world.

When everyone is engaging in simultaneous wealth-seeking behavior, it has a tendency to result in suboptimal outcomes over the society as a whole. This is why Keynesian theory requires that the government step in to act as arbiter and regulator. Heck, even the father of modern economics, Adam Smith, agreed with this point.

In point of fact, superrational actors would recognize that the sacrifice of some individual wealth might lead to better overall outcomes both for others and for themselves, in the "rising tide lifts all boats" sense. We have some people like that; Warren Buffet is a prime example.

If you want to look at it in that manner, Austrian economics is the result of rational actor theory, whereas Keynesian is the result of superrational actor theory.

edited 18th Dec '12 11:25:42 AM by Fighteer

"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"

That's the definition of rationality in the economic sense. It doesn't mean "nice".

Seems to me that it's a matter of what incentives are offered to economic actors. More government can, but does not necessarily, mean a more socially optimal incentive structure.

And there we have that strange buzzword, "more government". It speaks to this notion that liberals want to increase government for the sake of increasing government; that we regard "more government" as a goal in and of itself. Nothing could be farther from the truth.

In fact, both liberals and conservatives want government to be the smallest possible size consistent with performing its functions. The disagreement is over what those functions should be. Making it about "size" alone is exactly the same kind of strawman argument that is wielded against the federal deficit and/or debt, as if the quantity is the only thing that matters.

Regarding incentives, that is a factor in both theories. The difference is that in Austrian theory, incentives need to be maximized at all costs so as to promote supply-side behavior: investment, business growth, etc. Keynesian theory, by contrast, seeks to minimize disincentives in order to optimize demand-side behavior: purchasing and consumption.

In an Austrian world, taxes should be as close to zero as possible to stimulate investment. In a Keynesian world, taxes should be balanced with spending so as to achieve the best overall outcome.

Edit: Quite frankly, if "more government" means hiring people to dig and fill ditches in order to improve the employment picture, it's preferable to the alternative, which is to do nothing while families starve. World War Two, as stated previously, was a giant exercise in politically acceptable stimulus, achieved by making tanks, planes, and bombs to kill Germans and Japanese. It's obviously not the best solution, but if you can't have the best, you might as well settle for what you can get. PPACA and ARRA are two prime examples, and the likely compromise over the so-called "fiscal cliff" is another.

edited 18th Dec '12 11:55:05 AM by Fighteer

"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"

No, I agree with that, although I think you will find people who think more regulation is an inherent good, even if they don't phrase it that way. I'm just saying it's more complicated than "the government step in to act as arbiter and regulator."

Keynesianism assigns a very specific role in regulating the economy. What it does not tell us is how to make sure the government fulfills this role and stays within it. In theory, the voters should watch out for it, but that only works if they actually know Keynesian theory. It seems to be the case that even many ardent supporters of Keynesianism do not completely understand what it is.

You talk about "superrational actors", but how do you guarantee that either politicians or voters would act in this way?

Anyways, it's a disservice to the field to judge the theories on the basis of their ideologies. As Trivialis said, the goal of a theory is to provide information more than policy. We should be discussing which theories provide a more accurate picture of the economy.

I'm pretty sure this is at best an oversimplification of Keynes.

Imagine if we drafted every single person of working age into the military. Would we have a healthy economy? On paper, maybe, if you ignored any indicators to the contrary, but the soliders would be starving and naked without production. WWII was pretty much a lite version of that. Supplies were rationed in both the civilian and military sectors. That prosperity looked a lot like poverty.*

Keynes called for stimulus in a specific set of circumstances. He recognized that the free market has to work at other times.

Well, of course. Like any guiding principle, it only works if people follow it. We have plenty of evidence that Keynesian theory provides a more accurate picture of the economy than its competitors; the problem is that the debate has been framed as an ideological one when it should be anything but.

There's no guarantee that we can compel government to follow these principles, but the same can be said for any set of principles. That's not an argument against trying, and it is demonstrable that from roughly 1940 to 1970, we were basically Keynesian and had the greatest prosperity in our nation's history.

You're getting into these wacky reduction to absurdity arguments, which I can't really take seriously unless your intention is to continue strawmanning.

Keynesian economics calls for government to take up the slack in demand. Investing in stimulus when we have full employment is counterproductive; it just drives inflation. However, if demand is below supply; that is, we're operating below peak capacity, government can and should step in and boost employment until the economy recovers. By contrast, if the economy is running too hot, it needs to step in with increased interest rates and monetary contraction to cool things off.

That's what was responsible for the recession of the 70's and the later recession under Bush — the Fed raised rates to keep the economy from hitting an inflationary bubble. There were other extrinsic factors, to be sure, but that's the basic principle. There was no demand crisis; we know this because as soon as rates were relaxed, the recovery was swift.

By the way, of course there was rationing during WWII as we had so much production dedicated to supporting the troops. What we did have, however, was a rapid jump from high unemployment to full employment, coupled with forced savings because there was nothing to spend excess cash on. When we exited WWII, we had the lowest amount of consumer debt in history and production apparatus set up to deliver vast amounts of consumer goods once retooled from war production. The result was that when the stimulus ebbed, the consumer markets were able to take up the slack immediately.

Krugman has written about all of this. It's out there if you want to check it out.

edited 18th Dec '12 12:54:32 PM by Fighteer

"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"

I was not strawmanning, I was simply pointing out your blanket statement about digging ditches suggested an oversimplified view of Keynesianism. You proved me wrong. Well done.

Well, what I see as the disadvantage of Keynesianism is that it required continual policy adjustment. The recommendations of many schools are straightforward, one-time things, much easier to implement and stick to over the long term.

Yep, so have many economists from many schools with the benefit of hindsight. All of them view past events as a vindication of their theories.

But only a few of them have been able to successfully predict future trends. Krugman has a damn good track record at this, and he admits where he has failed. Most people on the Austrian side... not so much. In fact, if you believed the inflation and deficit hawks and invested on the basis of their predictions over the past six years or so, you'd have lost a ton of money.

As for the disadvantage of Keynesianism being that it requires continual intervention and adjustment from a goverment that may not be politically or intellectually capable of it... again, it strikes me as terribly defeatist to throw out a proven policy just because we think we're too stupid to use it. That and we did have a period where government successfully employed those principles.

edited 18th Dec '12 2:02:29 PM by Fighteer

"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"