10 hours ago
"[T]he purpose of a model is not to be realistic. After all, we already possess a model that is completely realistic—the world itself. The problem with that “model” is that it is too complicated to understand. A model’s purpose is to provide insights about particular features of the world. If a simplifying assumption causes a model to give incorrect answers to the questions it is being used to address, then that lack of realism may be a defect. . . . If the simplification does not cause the model to provide incorrect answers to the questions it is being used to address, however, then the lack of realism is a virtue: by isolating the effect of interest more clearly, the simplification makes it easier to understand."Models are never perfectly realistic. I don't think I've ever suggested that perfect realism is necessary or even good, so I should hope Bob doesn't think that's my standard. But realism of assumptions matters so I will never say something like "all that matters is whether your predictions are accurate". It's not all that matters. One can plausibly sacrifice predictive power for realistic assumptions just as one can plausibly sacrifice realism in assumptions for predictive power.
--David Romer, Advanced Macroeconomics (New York: McGraw-Hill, 1996), pp. 11–12.
"Smith makes a lot of assumptions about human nature. He says that we have a natural propensity to truck, barter, and exchange, that we are naturally self-interested, and that we are naturally fairly equal in abilities. We learned yesterday that he also thinks humans have a natural preference for the country and for agriculture.
Although his model is non-technical, these are still modeling assumptions. How do these assumptions compare to the assumptions about economic agents today? Why are they different (in other words, what's different about the way our models work that leads us to keep some of Smith's assumptions and drop others)?"Thoughts?
"Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price, and thereby lessening the sale of their goods both at home and abroad. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people."Don responded with a common misperception that I thought I'd address. He wrote:
"Daniel: You do realize, I trust, that Smith was there complaining about the monopoly privileges granted by government to domestic suppliers - privileges justified by mercantilist principles."This is actually not true. This comes from chapter 9 of Wealth of Nations, in the section of the book where he's talking about factor income and price theory. This is in Book I - you don't get the discussion of the problems with mercantilist privileges until Book IV. So what is Smith complaining about?
1. They reject endogeneity and simultaneity problems - they don't think they are important at all in economics, or
2. They think endogeneity and simultaneity are important problems to think of in empirical economics and they just don't think we do a good job addressing the problems.
1. Russ went to Chicago and Bob went to NYU (ranked second and tenth respectively). I am currently attending American University (ranked 205th). Despite some peoples' complaints about these rankings, they fall out how they do for a reason. If I can provide detailed justifications for my thumbs ups and thumbs downs on empirical economics, they certainly should be up to the task.
2. Ramey, Barro, Redlick, Selgin, Lastrapes, and White all come down with conclusions that Russ likes. Feel free to name others that Russ has linked to favorably on Café Hayek and whom he has not called "intellectually bankrupt" for using modern empirical methods too. I can't recall a single case - in the years following the blog - that Russ has praised an empirical analysis that goes against his political views. This is troubling. It does not mean he is biased, but it is an AWFULLY good reason to expect more details on what he does and doesn't like about the analyses.
3. The other reasons they give are really bad. Stop complaining about how mainstream economists are copying physicists. Physicists don't use these methods. Economists INVENTED several of these methods after all. And if they did use them, who cares? In what universe is the unique usage of a method by one group of scientists anything like a standard for judging the validity of the method?
"George Stigler, who won the 1982 Nobel Prize in economics, thought the exciting part of Coase's insight was what happened when transactions costs were zero. Stigler labeled that insight the "Coase Theorem." If transactions costs were zero, no government intervention was needed.But I find the last part, where Pigou comes back into the discussion, a little odd. That made me turn over why Stigler might have presented the version of Coase that he did. One possible reason, it seems to me, is that, the high transaction cost world where liability matters and bargaining may be problematic is to a large extent a Pigovian world, and Stigler obviously knew that Coase was trying to add to - if not completely overthrow Pigou.
Deirdre McCloskey, an economist at the University of Illinois at Chicago Circle, thought the no-transactions-cost insight was trivial. The interesting part, according to Ms. McCloskey, is what happens when reality intrudes in the form of positive transactions costs. Then it matters how courts assign liability. If, in the above example, a court gave a rancher the right but the rancher valued the steer at less than the damages to the farmer's crop, transactions costs could prevent the efficient solution from emerging.
Coase himself rejected both the Stigler view (that zero transactions costs are the important case) and the Pigou view, both of which he derisively called "blackboard economics."
"The traditional approach has tended to obscure the nature of the choice that has to be made. The question is commonly thought of as one in which A inflicts harm on B and what has to be decided is: how should we restrain A? But this is wrong. We are dealing with a problem of a reciprocal nature. To avoid the harm to B would inflict harm on A. The real question that has to be decided is: should A be allowed to harm B or should B be allowed to harm A?"It's true. This is an important question. But in practice most people talk about Pigou because they have thought about that question and answered it or because the parties have resolved it themselves but we think that the resolution came about under duress.
Daniel Kuehn is a doctoral candidate and adjunct professor in the Economics Department at American University. He has a master's degree in public policy from George Washington University.