Wednesday, September 1, 2010

Mr. Sargent and the Keynesians, A Suggested Interpretation

The title, of course, is borrowed from Hicks's seminal article, Mr. Keynes and the "classics", a suggested interpretation, which outlined what would become the canonical way that economists would not just understand Keynes, but that they would understand how the Keynesian system was meant to operate as a general theory, of which the classical system was a special case.

So, why "Mr. Sargent and the Keynesians"? Because Mark Thoma shared a wonderful interview with Tom Sargent - the great rational expectations economist - that I think really highlights a basic agreement with and understanding of the proper relationship between Rational Expectations and New Classicism and Keynesianism. The key quote that Thoma highlighted - which also stood out to me in reading it - was:

"The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised. These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.

By the way, participants within both the real business cycle and new Keynesian traditions have been stern and constructive critics of their own works and have done valuable creative work pushing forward the ability of these models to match important properties of aggregate fluctuations. The authors of papers in this literature usually have made it clear what the models are designed to do and what they are not. Again, they are not designed to be theories of financial crises.

This, of course, is reminiscent of my post yesterday on Martin Feldman and the relationship between Reaganomics and Keynesianism. Feldman and Sargent don't sound like Keynesians, but that's largely because they made their names during eras when the demand-side wasn't really a problem, and they worked on questions and problems that didn't really feature weak demand cases or deflationary cases.

Hicks pointed out that Keynes's "depression economics" was simply the notable addition that he made (or, more accurately, the point that he synthesized, clarified, and expanded) - but the Keynesian/Hicksian system incorporated a quite classical world that was thoroughly developed by men like Sargent and Feldman. So - the "full employment by accident" is actually a special case of a more general (really Hickisian) system, and the "depression economics" we usually associate with Keynes is also a special condition of that system, with the system itself never guaranteeing employment and usually hovering in some sort of moderate underemployment that is proppd up (or not) by macroeconomic policymakers. To put a finer point on the relationship between Rational Expectations and the broader Hicksian paradigm (and the improvements that need to be made on that basic Hicksian approach that was introduced seventy years ago), Sargent says:

"To put it technically, the “new Keynesian IS [investment-savings] curve” is an asset pricing equation, one of a form very close to those exposed as empirically deficient by Hansen and Singleton. Efforts to repair the asset pricing theory are part and parcel of the important project of building an econometric model suitable for providing quantitative guidance to monetary and fiscal policymakers."

He also pushes back on some of the recent criticisms of macro:

"...aside from the foolish and intellectually lazy remark about mathematics [that macro is too highly mathematized], all of the criticisms that you have listed reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished. That said, it is true that modern macroeconomics uses mathematics and statistics to understand behavior in situations where there is uncertainty about how the future will unfold from the past. But a rule of thumb is that the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you are going to have to roll up your sleeves, and learn and use some math. That’s life."

I couldn't agree more. I can barely supress my laughter when someone tells me about how highly mathematical economics is problematic and that logical precision is required in the same breath. And I'm sorry, but this comes from the Mises crowd and it needs to be said. I haven't read much Mises but I've read enough chapters of Human Action to know that Mises's thought processes are considerably more scattered and imprecise than anything that I ever read in David Romer's macro textbook. You may be able to say things precisely without math, but (1.) it's considerably harder, and (2.) it's much harder when you're talking about the relationship between quantitative variables. As Sargent says "that's life".

One final point that I liked was one he made about the relationship between the generous welfare state in Europe and labor market turbulence in locking in high levels of unemployment. Here, Sargent agrees with the Krugman critique of the old argument that generous welfare states cause high unemployment, because the welfare states were also generous in the 50s and 60s, when Europe had much lower unemployment than the U.S.. Sargent argues that the important point is the interaction of high labor market turbulence - lots of job switching - and a strong welfare state. In a microeconomic environment characterized by low turnover, generous welfare programs can actually foster lower unemployment by making stronger, more productive matches. In highly turbulent labor markets these same welfare programs prevent rapid reallocation of labor, deplete human capital, and lock in high unemployment.


  1. This will sound completely repetitive, but you DON'T know what you're talking about when it comes to Mises.


  2. "...when Europe had much lower unemployment than the U.S."

    I did a fair amount of reading on this subject since you wrote this, and whether this was a real phenomena was a subject of greater controversy during that time. One can say though that much of this difference lies in the greater comprehensiveness of how Americans measured this variable.

    FYI: In the case of Britain, the government there measured unemployment there by those who registered with the unemployment service. In the U.S. at the time unemployment was measured by a sample of households.

    The U.S. was also more productive at the time, and the economy far more dynamic (and of course, Britain during the 1950s was still getting private relief from the U.S. in the form of food packages, etc.).

    I'm curious, does Krugman address any of these issues?

  3. No Mattheus, you're wrong on this one. I don't know enough about Mises to comment on Mises's economics. But I have read more than enough Mises to know how precise his thought process is.

    The question is - do you know enough of the kind of macro that Sargent does to be able to make the comparison. I remember you were befuddled by a Solow model before, so I have serious doubts about that. You rave against math in economics or empiricism in economics all the time, but I get the sense you really have no idea about or experience with how either are actually used.

  4. Xenophon -
    The ILO produces standardized measures of unemployment across the industrialized countries - they don't go back that far, though. I'm not sure if people were estimating comparable measures back then. You write "it was a subject of greater controversy during that time". It's not particularly controversial now - do you know something about why it was a controversy then but people seem to agree on the story now?

    You can also look at output statistics, which have a fairly stable relationship to unemployment, and EP ratios to get a sense of this too.

    Regardless of the levels, we still have to address the difference between the U.S. and Europe that emerged in the 70s - why did European unemployment rise so dramatically? They weren't counting it any different. I think Krugman is basically right that you can't simply point to institutions that were in place in good years and bad. But I think Sargent's point about the interaction of the institution with labor market dynamics makes sense too.

    Until reading this, I had always just bought into Barry Eichengreen's point that Europe had faster growth before the seventies because it was rebuilding and it was simply a matter of applying existing, well understood technologies at scale. Once that sort of intensive growth was accomplished, they had to take up more extensive, innovative growth which (1.) is harder anyway, and (2.) their centralized institutions were not equipped to handle.

  5. "It's not particularly controversial now - do you know something about why it was a controversy then but people seem to agree on the story now?"

    No, I don't. I did skimmed through about four papers from the time and each and every one of them (whatever side they fell on - whether it was just a measurement issue or an an actual real world phenomenon) made that point from the outset.

  6. In a (quasi) related note... I started watching the following Leo Roysten interview with Hayek yesterday:

    In answering a question starting about his intellectual development from the surroundings of Fabian socialism (+/- 3.55min mark), Hayek says: "... Both the Marxists and Freudians had the dreadful habit of insisting that their theories were irrefutable; they [were] logically and absolutely cogent... And that led me to see that a theory that cannot be refuted is not scientific..."

    The funny thing is that this is almost [i]exactly[/i] how I feel about the praexology crowd - or, at least a large portion of them. I'm not disputing the logic of Mises' general assertion that people undertake conscious actions to improve their situations (a claim completely unremarkable in of itself), but I certainly see problems of application and, of course, broader issues of falsifiability.

    So much of Austrian economics seems, to me at least, wrapped up in an infinitely tight tautology. "These are the inviolable tenets of human action; [i]only they[/i] can explain the economic phenomena that we observe in the world around us." I really sense a severe intolerance of other ideas, opinions or methods (in this case, mathematics), which I find pretty startling.

    Gotta run now - so don't have time to expand - but I'll just leave this as food for thought.

    Of course, I'm certainly open to having my misgivings corrected if some you think I've unfairly interpreted the principles of Mises. But I'm not particularly sure I'll be swayed on the mindset of a large section of his followers.

  7. I wasn't befuddled on Solow. The economics was just nonsense. The level of aggregation and his assumptions on homogeneous capital stock were ridiculous. I wasn't "puzzled" because of the math. It's just stupid.

    In the second place, what exactly do you know about mises' thought process if you don't comprehend his economics? They seem to be interlinked.

  8. If what Xenophon says is true, then it is clear that no accurate comparison can be made between the two statistics. That alone should leave the matter not settled. As far as European unemployment during the 70's, two things that should be considered: that decade began with the closing of the gold window in America, which could have caused enough of a disruption and enough inflation to be a contributing factor in European unemployment; and we must not forget either that shortly after the gold window was closed, the American government changed the way it accounted for unemployment statistics, thereby understating them. The U.S. was indeed "counting them any different."

    As far as mathematics in economics, I certainly think it has its place but is over-emphasized and often mis-applied. A lot of economics is NOT (CANNOT BE) quantitative. A lot of economics is quantitative in theory but not necessarily faithfully so in practice. And a lot of economics is quantitative but ultimately incompletely so, rendering quantitative analysis potentially problematic. (Hayek, for one, discusses this.) The so-called irony about calls for "logical precision" in conjunction with a rejection of mathematics is superficially correct but ultimately fallacious. Math can't describe everything. It can't do what it can't do. Using it where it is inappropriate will render meaningless results. As Mark Twain said, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.”

    As far as Mises's lack of precision in thought, I'm curious why you think that and exactly about what topics you were reading that led you to this belief. I have had quite the opposite impression of Mises and find him quite clear and precise. Could you give us some idea of what it was that you found so imprecise? And I'm curious what you think of this article concerning the very externalities we discussed not too long ago, Daniel. I had meant to bring it to your attention earlier (in fact, coincidentally, it was posted that same day if I recall on but have been lazy. It seemed like a compelling argument to me, but I'd like your thoughts, whenever you have the time. Here's the link:

  9. I couldn't agree with you more on the math. I think behavioral economics is particularly important, and that's largely not mathematical (although certainly amenable to statistical work). I also think institutional economics is extremely important because of how important externalized costs and benefits are. A lot of the extra-market social institutions we've developed have evolved to address various externalities: the state, the family, the law, etc. We need a good, solid, institutionalist approach to understand how these things relate to economic calculation and market activity - and that is largely non-mathematic.

    Let me read the Mises link and get back to you on that and Mises himself.

  10. Haha -
    well the first paragraph of your link provides a great example! Mises is engaging in something of an institutional analysis that - as I read it - is nothing but pure romanticism and conjecture:

    "Property rights as they are circumscribed by laws and protected by courts and the police are the outgrowth of an age-long evolution. The history of these ages is the record of struggles aiming at the abolition of private property."

    Really? That's quite a statement, which to my knowledge he doesn't provide additional evidence for. I make the same connection that stickman did via Hayek above - this sounds like Marxism only backwards. Mises wants to push property rights, so he declares that the history of human institutions is one of war against property rights. Nothing like a dramatic, unequivocal, undefended, nebulous proposition to base a discussion of science off of, eh? This isn't confused per se - but its a perfect example of the poor definition and weak defense of propositions that you see in much (not all) of the Austrian school.

  11. Well, first of all, you do me and yourself a disservice by not even finishing the article simply because you found the opening statement ridiculous. It's also somewhat disrespectful to me. Secondly, you're confusing the flourish of an introduction with imprecision of thought or with his actual argument--it is not, and this leads me to believe that you really haven't read any Mises at all and that your opinion is merely reactionary. If all you have read of Mises is opening paragraphs, then you have not read Mises and have no place dismissing him. The sentence you quote isn't an argument whatsoever concerning actual economics. You're correct: he doesn't support his claim, but its insertion is as a general theme to be remembered about a specific topic. He addresses statements like these in other works that are SPECIFICALLY about such things. All authors reference their own works, whether explicitly or no. Thirdly, we must keep in mind that Mises was in many instances personally directing his words AT MARXISTS, and thus it is no surprise that he would speak in such a manner. Finally, I think that what he says is a pretty self-evident truth; property rights, civil rights, democracy, freedom, etc., are all very recent phenomena in the Western World. Please read the rest of the article; feel free to ridicule it then, but do so after actually knowing what argument you're ridiculing and please give me logical specifics/refutations as to why you do so.

  12. I do no one a disservice by posting an off-hand, real-time reaction in an informal blog.

    See - I just did it again after reading only your first sentence!

  13. Agreed, but I think most people would have taken what you said the way that I did, as an indication that you had stopped reading. My bad, yo.

  14. For anyone revisiting this post (Daniel, you may even consider posting this separately), I've just read the following article by Robert Solow:
    “Science and ideology in economics”

    It is simply FAR too germane to the issues and historical figures (least of all Solow himself) that we've discussed above, not to mention now. Well worth a read and two choice excerpts for debate:

    1) First, more Freudian and Marxist abuse (p. 97)!

    "I have my doubts about that last bit of reasoning [that economists are cautious to be critical of the “System”, which provides for them]. It seals off discussion. If I disagree on an issue, the implication is that I am a paid lackey of the System. If I protest that I, like Professor Heilbroner, am above that, I am doubly suspect. It is like what happens if I say that Freudian theory is obvious nonsense: I am told that I only say that because of my relation with my mother. I protest that my mother had nothing to do with it. "See!" says my Freudian friend and walks away a sure winner. (Even in the days when I was a close student of Marxism I used to wonder about a similar question: if social theory is part of the ideological superstructure, hence not to be taken at face value, why is not Marxism also part of the superstructure---and in that case why should we take at face value the Marxist notion that social theory is part of the ideological superstructure?)"

    2) Second, quantifying the quantifiable in economics (p. 102):

    "Sometimes, when people say that economics limits itself to the "quantifiable" they really mean to the precisely definable. When they want economics to be broader and more interdisciplinary, they seem to mean that they want it to give up its standards of rigor, precision, and reliance on systematic observation interpreted by theory, and to go over instead to some looser kind of discourse in which propositions are not supposed to be tested or testable, and it is never clear what kind of observation would definitely mark a hypothesis as false. One should resist any tendency for bad social science to drive out good. Mind you, economists talk a better game than they play. The fact that one can't experiment but only analyze history's single run of data means that an ingenious and determined man can keep a played-out theory alive for years. Nevertheless, it is a sound instinct to want to look at "the numbers", because they define, in a sense, what you're talking about. But any precisely defined measurement or observation would do as well."

  15. Another excerpt (p. 105) from Solow’s essay – on individual valuation and externalities – that you might find interesting:

    “Now there are critical things that need be said about individualist welfare economics, but they are rather different things, well known inside the profession but not always understood outside it. For example, as I mentioned earlier, the individualist criterion is not complete. There are many questions on which it does not speak at all, and it must be supplemented by sharper value judgments that each society must make in its own characteristic way. For example, the strict individualist criterion does not imply that it would have been a good thing for the English government to have relieved starvation in Ireland during the potato famine. It was, however, a fallacy for the English to believe, as some of them did, that the criterion did imply that it would have been a bad thing. It is simply a separate decision. The individualist criterion does not say that the rich should be taxed to help the poor, nor that they shouldn't. It does say that if you decide to do so, it is in general better to give the poor money than to give them what you think they ought to consume. It takes a bit more than diminishing marginal utility to imply that you should in fact redistribute income toward the poor, but it sure helps...

    This is not a trivial matter. I said that the choices must be made, and default is merely a way of making them. The radical critique is right that merely to mumble something about not interfering with the market is to favor the current holders of wealth and power.

    Another problem arises not so much with the individualist welfare criterion itself as with its implementation through the market. The market mechanism works best when it deals with "private goods" which have to be divided up among individuals or families and consumed by them separately. When "consumption externalities" are important, when one person's consumption decisions have a strong effect on the satisfactions of others, or where different people consume the same "public good," like clean air or weather forecasts, the market need not work so well, and other, more directly political, decision methods may take its place. The trouble is that each producer and consumer compares the market price with benefits to himself; other benefits and costs are not taken into anyone's account. This is also a serious matter. As standards of living rise, population density increases, and technological interactions grow more pervasive, it may be that a greater and greater part of economic life will have to come under these rules of the game, which may turn out to be quite different from the rules of the private-property game.

    But notice that neither of these problems I have sketched involves superseding the individual as the best judge of his own satisfactions.”


All anonymous comments will be deleted. Consistent pseudonyms are fine.