LARS P. SYLL

Economics and information

A balloonist, lost, sees someone walking down a country lane. The balloonist lowers the balloon and shouts down to the the walker:

“Where am I?”

“About 20 feet above the ground,” comes the reply.

After a moment’s pondering, the balloonist says:

“You must be an economist.”

“How did you know?”

“Your information is perfectly correct and totally useless.”

Grossman-Stiglitz-paradoxen visar att om marknaden vore effektiv – om priser fullt ut reflekterar tillgänglig information – skulle ingen aktör ha incitament att skaffa den information som priserna förutsätts bygga på. Om å andra sidan ingen aktör är informerad skulle det löna sig för en aktör att införskaffa information. Följaktligen kan marknadspriserna inte inkorporera all relevant information om de nyttigheter som byts på marknaden. Självklart är detta för (i regel marknadsapologetiska) mainstreamekonomer synnerligen störande. Därav ‘tystnaden’ kring artikeln och dess paradox!

Grossman & Stiglitz – precis som senare Frydman & Goldberg gör i Imperfect Knowledge Economics (Princeton University Press 2007) – utgår från och förhåller sig till Lucas et consortes. Deras värdering av det informationsparadigm som rationella förväntningar bygger på sammanfaller också så vitt jag kan bedöma helt med min egen. Det är ur relevans- och realismsynpunkt nonsens på styltor. Grossman-Stiglitz-paradoxen är kraftfull som ett yxhugg mot den neoklassiska roten. Det är därför den så gärna ”glöms” bort av neoklassiska ekonomer.

Kruxet med ”effektiva marknader” är – som Grossman & Stiglitz på ett lysande sätt visar – att de strikt teoretiskt bara kan föreligga när information är kostnadsfri. När information inte är gratis kan priset inte perfekt återspegla mängden tillgänglig information (nota bene – detta gäller vare sig asymmetrier föreligger eller ej).

Den i mitt tycke intressantaste funderingen utifrån Grossman & Stiglitz blir vad vi har för glädje av teorier som bygger på ”brusfria” marknader, när de inte bara är hopplöst orealistiska utan också visar sig vara teoretiskt inkonsistenta.

Trams är trams om än i vackra dosor.

Rethinking public debt

Public debt is normally — as emphasized again and again by MMT economists — nothing to fear, especially if it is financed within the country itself (but even foreign loans can be beneficent for the economy if invested in the right way). Some members of society hold bonds and earn interest on them, while others pay taxes that ultimately pay the interest on the debt. The debt is not a net burden for society as a whole since the debt ‘cancels’ itself out between the two groups. If the state issues bonds at a low-interest rate, unemployment can be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden is also not a real burden since — if used in a suitable way — the debt, through its effects on investments and employment, actually makes future generations net winners. There can, of course, be unwanted negative distributional side effects for the future generation, but that is mostly a minor problem since when our children and grandchildren ‘repay’ the public debt these payments will be made to our children and grandchildren.

The real issue … is not whether it is possible to shift a burden (either in the present or in the future) from some people to other people, but whether it is possible by internal borrowing to shift a real burden from the present generation, in the sense of the present economy as a whole, onto a future generation, in the sense of the future economy as a whole … The latter is impossible because a project that uses up resources needs the resources at the time that it uses them up, and not before or after.

This basic proposition is true of all projects that use up resources … The proposition holds as long as the project​ is financed internally, so that there are no outsiders to take over the current burden by providing the resources and to hand back the burden in the future by asking for the return of the resources.
It is necessary for economists to keep repeating​ this basic proposition because one of their main duties is to keep warning people against the fallacy of composition. To anyone who sees only a part of the economy it does seem possible to borrow from the future because he tends to assume that what is true of the part is true of the whole.

Abba Lerner

Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals — full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

MMT:s inflationary bias

A view yours truly often encounters when debating MMT is that there is an inflationary bias in MMT and that its framework ignores expectations.

Hmm …

It is extremely difficult to recognize that description. Given its roots in the writings of Keynes, Lerner, and Minsky, it is, to say the least, rather amazing to attribute those views to MMT. Let me just quote one source to show how ill-founded the critique is on this issue:

MMT recommends a different approach to the federal budgeting process, one that integrates inflation risk into the decision-making process so that lawmakers are forced to stop and think about whether they have taken the necessary steps to guard against inflation risk before approving any new spending. MMT would make us safer in this respect because it recognizes that the best defense against inflation is a good offense. We don’t want to allow excessive spending to cause inflation and then fight inflation after it happens. We want agencies like CBO helping to evaluate new legislation for potential inflation risk before Congress commits to funding new programs so that the risks can be mitigated preemptively. At its core, MMT is about replacing an artificial (revenue) constraint with a real (inflation) constraint.

Les problèmes clés de l’UE

Ouf ! La réunion des dirigeants des Etats de l’Union européenne (UE) n’a finalement pas accouché d’une souris. Le plan de relance qui vient d’être décidé est une avancée politique et institutionnelle très importante … Un tabou est tombé, celui du refus de principe de toute solidarité financière entre les Etats membres face à la crise.

Mais surtout, ce plan est inscrit dans la logique néolibérale de l’UE, et il l’est même triplement. D’abord, comme ses Etats-membres, l’UE empruntera sur les marchés et sera donc dépendante d’eux et des conditions qu’ils lui consentiront. La Banque centrale européenne (BCE), « indépendante », pièce maîtresse de l’ordre néolibéral, reste la banque des seuls marchés. Elle n’est pas celle des Etats, bien qu’elle tire d’eux son autorité !

Ensuite, dans le diagnostic que ce plan porte : le Nord, « frugal », se cotise et manifeste sa solidarité envers le Sud, dépensier et peu efficace. C’est là se tromper totalement, car le vrai problème reste non traité. La réalité, c’est que le mode de fonctionnement de l’UE, empêchant toute harmonisation vers le haut des règles sociales et fiscales, interdit toute véritable convergence des économies ; aussi l’euro est-il depuis l’origine bâti sur une incomplétude. Une monnaie unique ne peut se construire sans une législation pleinement harmonisée. Faute de cela, c’est la loi de la jungle, celle en l’occurrence du dumping fiscal et social. Faute d’harmonisation, c’est un alignement forcé par le bas qui se profile pour les réticents …

Sans rupture avec le dogme de la non-harmonisation par le haut des législations, il ne pourra y avoir de convergence que par le bas. L’essentiel des difficultés des finances publiques des pays du Sud vient de là. Quoi qu’on en dise, il n’y a pas de modèle social et fiscal européen, mais un choc permanent entre deux modèles : celui des pays du nord de l’Europe, jouant sur les excédents commerciaux, et celui qui s’est historiquement édifié dans les pays latins, qui permet à ces derniers d’absorber les excédents du Nord, sans lequel les pays soi-disant vertueux connaîtraient les affres de la récession.

Pierre Khalfa, Dominique Plihon, Jacques Rigaudiat, Aurélie Trouvé / Le Monde

Top economics influencers to follow

Economics influencers such as academics, journalists, industry professionals and even central bankers frequently take to Twitter to share their daily thoughts on all things economics, finance, monetary policy and politics … We put together a list of top 79 economics influencers that you can follow on Twitter. Nominees came from our team of at Focus Economics and we have ranked this list by number of followers.

1) Paul Krugman 13) Tim Harford 15) Thomas Piketty 17) Mariana Mazzucato
26) Steve Keen 33) Frances Coppola 57) Chris Dillow 76) Lars Syll

MMT — debunking the deficit myth

We have already shown that deficit spending increases our collective savings. But what happens if Uncle Sam borrows when he runs a deficit? Is that wht eats up savings and forces interest rates higher? The answer is no.

The financial crowding-out story asks us to imagine that there’s a fixed supply of savings from which anyone can attempt to borrow …

MMT rejects the loanable funds story, which is rooted in the idea that borrowing is limited by access to scarce financial resources …

Government deficits always lead to a dollar-for-dollar increase in the supply of net financial assets held in the nongovernment bucket. That’s not a theory. That’s not an opinion. It’s just the cold hard reality of stock-flow consistent accounting.

So fiscal deficits — even with government borrowing — can’t leave behind a smaller supply of dollar savings. And if that can’t happen, then a shrinking pool of dollar savings can’t be responsible for driving borrowing costs higher. Clearly, this presents a problem for the conventional crowding-out theory, which claims that government spending and private investment compete for a finite pool of savings.

The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credit, determined by supply and demand in the same way as the price of bread and butter on a village market. In the traditional loanable funds theory — as presented in mainstream macroeconomics textbooks — the amount of loans and credit available for financing investment is constrained by how much saving is available. Saving is the supply of loanable funds, investment is the demand for loanable funds and assumed to be negatively related to the interest rate.

As argued by Kelton in The Deficit Myth there are many problems with the standard presentation and formalization of the loanable funds theory. And more can be added to the list:

1 As already noticed by James Meade decades ago, the causal story told to explicate the accounting identities used gives the picture of “a dog called saving wagged its tail labeled investment.” In Keynes’s view — and later over and over again confirmed by empirical research — it’s not so much the interest rate at which firms can borrow that causally determines the amount of investment undertaken, but rather their internal funds, profit expectations, and capacity utilization.

2 As is typical of most mainstream macroeconomic formalizations and models, there is pretty little mention of real-world​ phenomena, like e. g. real money, credit rationing, and the existence of multiple interest rates, in the loanable funds theory. Loanable funds theory essentially reduces modern monetary economies to something akin to barter systems — something they definitely are not. As emphasized especially by Minsky, to understand and explain how much investment/loaning/ crediting is going on in an economy, it’s much more important to focus on the working of financial markets than staring at accounting identities like S = Y – C – G. The problems we meet on modern markets today have more to do with inadequate financial institutions than with the size of loanable-funds-savings.

3 The loanable funds theory in the “New Keynesian” approach means that the interest rate is endogenized by assuming that Central Banks can (try to) adjust it in response to an eventual output gap. This, of course, is essentially nothing but an assumption of Walras’ law being valid and applicable, and that a fortiori the attainment of equilibrium is secured by the Central Banks’ interest rate adjustments. From a realist Keynes-Minsky point of view, this can’t be considered anything else than a belief resting on nothing but sheer hope. [Not to mention that more and more Central Banks actually choose not to follow Taylor-like policy rules.] The age-old belief that Central Banks control the money supply has more an more come to be questioned and replaced by an “endogenous” money view, and I think the same will happen to the view that Central Banks determine “the” rate of interest.

4 A further problem in the traditional loanable funds theory is that it assumes that saving and investment can be treated as independent entities. To Keynes, this was seriously wrong. As he wrote in General Theory:

The classical theory of the rate of interest [the loanable funds theory] seems to suppose that if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shift or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shifts​, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.

There are always (at least) two parts in an economic transaction. Savers and investors have different liquidity preferences and face different choices — and their interactions usually only take place intermediated by financial institutions. This, importantly, also means that there is no “direct and immediate” automatic interest mechanism at work in modern monetary economies. What this ultimately boils done to is — iter — that what happens at the microeconomic level — both in and out of equilibrium —  is not always compatible with the macroeconomic outcome. The fallacy of composition (the “atomistic fallacy” of Keynes) has many faces — loanable funds is one of them.

5 Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.

What is “forgotten” in the loanable funds theory, is the insight that finance — in all its different shapes — has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterward, simply isn’t enough.

All real economic activities nowadays depend on a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channeling​ money/savings/credit — are more or less left in the dark in modern formalizations of the loanable funds theory.

Fallacy 2
Urging or providing incentives for individuals to try to save more is said to stimulate investment and economic growth.

Saving does not create “loanable funds” out of thin air. There is no presumption that the additional bank balance of the saver will increase the ability of his bank to extend credit by more than the credit supplying ability of the vendor’s bank will be reduced … With unemployed resources available, saving is neither a prerequisite nor a stimulus to, but a consequence of capital formation, as the income generated by capital formation provides a source of additional savings.

Fallacy 3
Government borrowing is supposed to “crowd out” private investment.

The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

How (not) to do economics

 

Great lecture on how to do — and not to do — economics, delivered by Robert Skidelsky.

How to use models in economics

The reason you study an issue at all is usually that you care about it, that there’s something you want to achieve or see happen. Motivation is always there; the trick is to do all you can to avoid motivated reasoning that validates what you want to hear.

In my experience, modeling is a helpful tool (among others) in avoiding that trap, in being self-aware when you’re starting to let your desired conclusions dictate your analysis. Why? Because when you try to write down a model, it often seems to lead some place you weren’t expecting or wanting to go. And if you catch yourself fiddling with the model to get something else out of it, that should set off a little alarm in your brain.

Paul Krugman 

Hmm …

So when Krugman and other ‘modern’ mainstream economists use their models — standardly assuming rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative agents with homothetic and identical preferences, etc. — and standardly ignoring complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc. — we are supposed to believe that this somehow helps them ‘to avoid motivated reasoning that validates what you want to hear.’

Yours truly is, to say the least, far from convinced. The alarm that sets off in my brain is that this, rather than being helpful for understanding real-world economic issues, sounds more like an ill-advised plaidoyer for voluntarily taking on a methodological straight-jacket of unsubstantiated and known to be false assumptions.

Modern (expected) utility theory is a good example of this. Leaving the specification of preferences without almost any restrictions whatsoever, every imaginable evidence is safely made compatible with the all-embracing ‘theory’ — and theory without informational content never risks being empirically tested and found falsified. Used in mainstream economics ‘thought experimental’ activities, it may, of course, be very ‘handy’, but totally void of any empirical value.

Utility theory has like so many other economic theories morphed into an empty theory of everything. And a theory of everything explains nothing — just as Gary Becker’s ‘economics of everything’ it only makes nonsense out of economic science.

Using false assumptions, mainstream modellers can derive whatever conclusions they want. Wanting to show that ‘all economists consider austerity to be the right policy,’ just e.g. assume ‘all economists are from Chicago’ and ‘all economists from Chicago consider austerity to be the right policy.’  The conclusions follow by deduction — but is of course factually wrong. Models and theories building on that kind of reasoning is nothing but a pointless waste of time.

Mainstream economics today is mainly an approach in which you think the goal is to be able to write down a set of empirically untested assumptions and then deductively infer conclusions from them. When applying this deductivist thinking to economics, economists usually set up ‘as if’ models based on a set of tight axiomatic assumptions from which consistent and precise inferences are made. The beauty of this procedure is of course that if the axiomatic premises are true, the conclusions necessarily follow. The snag is that if the models are to be relevant, we also have to argue that their precision and rigour still holds when they are applied to real-world situations. They often don’t do for the simple reason that empty theoretical exercises of this kind do not tell us anything about the world. When addressing real economies, the idealizations necessary for the deductivist machinery to work, simply don’t hold.

So how should we evaluate the search for ever-greater precision and the concomitant arsenal of mathematical and formalist models? To a large extent, the answer hinges on what we want our models to perform and how we basically understand the world.

The world as we know it has limited scope for certainty and perfect knowledge. Its intrinsic and almost unlimited complexity and the interrelatedness of its parts prevent the possibility of treating it as constituted by atoms with discretely distinct, separable and stable causal relations. Our knowledge accordingly has to be of a rather fallible kind. To search for deductive precision and rigour in such a world is self-defeating. The only way to defend such an endeavour is to restrict oneself to prove things in closed model-worlds. Why we should care about these and not ask questions of relevance is hard to see.

Macroeconomics and reality

Why would an academic profession sanction the use of theories based on crassly unrealistic assumptions? It is not an intuitively attractive idea. One suspects that the underlying reason is: economists are, in the main, committed to the defense of propositions that cannot be generated by models based on realistic assumptions. For example, a long string of unrealistic assumptions are necessary to generate the desired conclusion that unregulated financial markets perform optimally …

Milton Friedman was not only an economist; he was an energetic conservative political activist as well. His positivist methodology made it possible for conservative economists to use an absurd set of assumptions that no one would accept as a reasonable description of real- world capitalism to generate wide-spread acceptance of the proposition that unregulated capitalism is an ideal system.

Economics may be an informative tool for research. But if its practitioners do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its task. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics like James Crotty — and yours truly — will continue to consider its ultimate arguments as a mixture of rather unhelpful metaphors and metaphysics.

The marginal return on its ever higher technical sophistication in no way makes up for the lack of serious under-laboring of its deeper philosophical and methodological foundations.

A rigorous application of economic methods really presupposes that the phenomena of our real-world economies are ruled by stable causal relations. Unfortunately, real-world social systems are usually not governed by stable causal mechanisms or capacities. The kinds of ‘laws’ and relations that economics has established, are laws and relations about entities in models that presuppose causal mechanisms being invariant, atomistic, and additive. But — when causal mechanisms operate in the real world they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it as a rule only because we engineered them for that purpose. Outside man-made ‘nomological machines’ they are rare, or even non-existent.