Tag: economics

Steve Keen explained why the mainstream economists have completely failed to learn from their past failures at Brainstorm:

VOX: Why do you think the mainstream economists failed to learn anything from the 2008 crisis, given the fact that these minor school economists, the post-Keynesians and the Austrians in particular, have been correct about the crisis coming? Generally speaking, isn’t the idea that if the predictive model works, maybe we should pay attention to it?

KEEN: The reality is that economics is basically a set of competing religious schools. The case of the post-Keynesians predicting a crisis and some Austrians getting their heads around it as well and the Neoclassicals not predicting it is like saying the Muslims had discovered the body of Jesus Christ. The apt reply back from the Vatican is, no, you haven’t, because it isn’t here, it’s in heaven. So, in that sense, the religious side of it came out and they have their own interpretation of the crisis. It was an exogenous shock.

VOX: From where, Mars?

KEEN: Yeah, they were looking for the meteor right now to see where it landed. It was an exogenous shock from outside the solar system! So this idea of an exogenous shock became their explanation. There’s a classic paper over it by a guy who I think is named Peter Ireland, he’s actually from Boston College, and he began a paperback in 2010 saying that we failed to see the crisis coming but it doesn’t mean our models are useless. He dismissed the type of dynamic modeling that I do while simultaneously showing that he didn’t understand my modeling. He wasn’t reading a paper of mine, he was just saying that you can’t make a deterministic model of this sort of phenomenon, showing he knew nothing about complex systems. But he then said what actually caused the crisis was an exogenous shock just like those that caused the 1992 crisis. However, the shocks lasted longer and they got bigger. Which means, of course, that a randomly distributed variable, which is what the exogenous shocks have to be, remained permanently negative and got bigger while still remaining randomly distributed.

So therefore there has to be, at some point, a really big shock in the opposite direction which hasn’t arrived yet. So they just went back into saying that – and I have seen this happen so many times – that you can’t predict the crisis because in our model a crisis can only occur if there’s a large exogenous shock. Which, by definition can’t be predicted, therefore, you can’t predict it.

Now it really reminds me of one of the little questions I had in my mind. I said, how did Ptolemic astronomers explain comets? And it finally was explained to me that in that era, comets were considered an astronomic phenomenon because of course comets couldn’t occur in the heavens because the heavens are perfect. It’s the same thing with neoclassicals.

VOX: Yeah, it’s interesting to me how in any field of science or even quasi-science, you can almost always tell whose models are ineffective and who really doesn’t know what they’re talking about because they always have to bring in some sort of bizarre epicycle to explain things away. The more epicycles and explanations that they have to come up with, the more certain you can be, even if you have no idea what they’re talking about, the mere fact that they are engaging in the circles and epicycles means that you can be pretty confident that they’re going to be wrong.

I thought this was an unusually good event, even by the high standards of Brainstorm. We’ll try to get the transcript cleaned up and out to the members within the next two weeks or so.

As I mentioned previously, tomorrow night will be the much-anticipated Brainstorm with Dr. Steve Keen, one of, if not the most, significant economists working today. The event is open, it will take place on May 06, 2016 at 7:00 PM  Eastern, and you can register for it here.

As I was going over the second edition of his book, Debunking Economics, (which is also this week’s Book of the Week) in order to prepare a few questions, I was struck by the way in which his key observation, that demand is not stackable, completely demolishes the foundation of modern economics. I’m not entirely sure even Dr. Keen fully grasps the consequences of his revolutionary mathematical – and logical – observations. From the section entitled Don’t tell the children:

For many years, the leading text for Honors, Master’s and PhD programs was Hal Varian’s Microeconomic Analysis (Varian 1992). Varian ‘summarized’ this research so opaquely that it’s no surprise that most PhD students – including those who later went on to write the next generation of undergraduate textbooks – didn’t grasp how profoundly it challenged the foundations of neoclassical theory.

Varian started with the vaguest possible statement of the result: ‘Unfortunately […] The aggregate demand function will in general possess no interesting properties […] Hence, the theory of the consumer places no restrictions on aggregate behavior in general.’

The statement ‘no interesting properties’ could imply to the average student that the market demand curve didn’t differ in any substantive way from the individual demand curve – the exact opposite of the theoretical result. The next sentence was more honest, but rather than admitting outright that this meant that the ‘Law of Demand’ didn’t apply at the market level, he immediately reassured students that there was a way to get around this problem, which was to: ‘Suppose that all individual consumers’ indirect utility functions take the Gorman form [… where] the marginal propensity to consume good j is independent of the level of income of any consumer and also constant across consumers […] This demand function can in fact be generated by a representative consumer’ (ibid.: 153–4; emphases added. Curiously the innocuous word ‘generated’ in this edition replaced the more loaded word ‘rationalized’ in the 1984 edition.)

Finally, when discussing aggregate demand, he made a vague and reassuring reference to more technical work: ‘it is sometimes convenient to think of the aggregate demand as the demand of some “representative consumer” […] The conditions under which this can be done are rather stringent, but a discussion of this issue is beyond the scope of this book […]’ (Varian 1984: 268).

It’s little wonder that PhD students didn’t realize that these conditions, rather than merely being ‘rather stringent,’ undermined the very foundations of neoclassical economics. They then went on to build ‘representative agent’ models of the macroeconomy in which the entire economy is modeled as a single consumer, believing that these models have been shown to be valid. In fact, the exact opposite is the case.
The modern replacement for Varian is Andreu Mas-Colell’s hyper-mathematical – but utterly non-empirical – Microeconomic Theory (Mas-Colell, Whinston et al. 1995). At one level, this text is much more honest about the impact of the SMD conditions than was Varian’s. In a section accurately described as ‘Anything goes: the Sonnenschein-Mantel-Debreu Theorem,’ Mas-Colell concludes that a market demand curve can have any shape at all, even when derived from consumers whose individual demand curves are downward-sloping:

Can [… an arbitrary function] coincide with the excess demand function of an economy for every p [price …] Of course [… the arbitrary function] must be continuous, it must be homogeneous of degree zero, and it must satisfy Walras’ law. But for any [arbitrary function] satisfying these three conditions, it turns out that the answer is, again, ‘yes.’ (Ibid.: 602)

But still, the import of this result is buried in what appear to the student to be difficult problems in mathematics, rather than a fundamental reason to abandon supply and demand analysis. Earlier, when considering whether a market demand curve can be derived, Mas-Colell begins with the question: ‘When can we compute meaningful measures of aggregate welfare using […] the welfare measurement techniques […] for individual consumers? (ibid.: 116).

He then proves that this can be done when there is ‘a fictional individual whose utility maximization problem when facing society’s budget set would generate the economy’s aggregate demand function’ (ibid.: 116). However, for this to be possible, there must also exist a ‘social welfare function’ which: ‘accurately expresses society’s judgments on how individual utilities have to be compared to produce an ordering of possible social outcomes. We also assume that social welfare functions are increasing, concave, and whenever convenient, differentiable’ (ibid.: 117).

This is already a case of assuming what you wish to prove – any form of social conflict is assumed away – but it’s still not sufficient to generate the result Mas-Colell wants to arrive at. The problem is that the actual distribution of wealth and income in society will determine ‘how individual utilities are compared’ in the economy, and there is no guarantee that this will correspond to this ‘social welfare function.’

The next step in his ‘logic’ should make the truly logical – and the true believers in economic freedom – recoil in horror, but it is in fact typical of the sorts of assumptions that neoclassical economists routinely make to try to keep their vision of a perfectly functioning market economy together. To ensure that the actual distribution of wealth and income matches the social welfare function, Mas-Colell assumes the existence of a benevolent dictator who redistributes wealth and income prior to commerce taking place: ‘Let us now hypothesize that there is a process, a benevolent central authority perhaps, that, for any given prices p and aggregate wealth function w, redistributes wealth in order to maximize social welfare’ (ibid.: 117; emphases added).

So free market capitalism will maximize social welfare if, and only if, there is a benevolent dictator who redistributes wealth prior to trade??? Why don’t students in courses on advanced microeconomics simply walk out at this point?

I surmise that there are three main reasons, the first of which is banal. Mas-Colell’s book is huge – just short of 1,000 pages – and lecturers would cherry-pick the sections they teach. I doubt that most students are exposed to this statement by their instructors, and few are likely to read parts that aren’t required reading for pleasure alone.

Secondly, the entire text is presented as difficult exercises in applied mathematics. Students are probably so consumed with deriving the required answers that they gloss over English-language statements of these assumptions which make it blatantly obvious how insane they are.

Thirdly, by the time students get to this level – normally in PhD programs – they are so locked into the neoclassical ‘assumptions don’t matter’ mindset that I discuss in Chapter 8 that they don’t even worry if an assumption is insane.

If you followed that, then you can understand why this is critically fascinating material that is almost shockingly ignored by nearly everyone who should know better.

I am very pleased to be able to say that on Friday, May 6th, at 7 PM Eastern, we will be holding an Open Brainstorm with the most important economist working today, Dr. Steve Keen. Dr. Keen is the author of Debunking Economics, which is a work so fundamentally revolutionary that its implications will probably not be fully understood for at least another century.

He is the leading Post-Keynesian economist and he is one of the very few economists to have correctly anticipated both the 2008 financial crisis as well as what he describes as the Second Great Depression. (He is, of course, completely wrong; the correct term is Great Depression 2.0.) I will post an open registration link tomorrow after the Brainstorm members have had the chance to get their seats first, as I expect this will be a well-attended event. Invites to members will go out this evening along with a transcript of the recent William S. Lind event.

For those who attended the Lind event, I spoke with my ISP and it turned out there was a software-related problem in my connection on their end; they have fixed it and I don’t anticipate any further problems. But we will have a backup plan in place just in case similar problems present themselves.

Below is my 2012 review of Debunking Economics.

Stalking the Undead Economist

Since being presented with a copy of Milton Friedman’s “Free To Choose” as a schoolboy, I have read a considerable quantity of books devoted to economics. Unlike most socialists, I have read Marx, Veblen and Bakunin. Unlike most monetarists, I have read more than Friedman’s pop books focused on the mass audience, but his more scholarly works, too, as well as his massive ode to monetary policy, coauthored with Anna Jacobson Schwartz, titled, “A Monetary History of the United States, 1867-1960.” Unlike most neo-Keynesians, I have read both “The General Theory of Employment, Interest and Money” as well as Paul Samuelson’s landmark textbook, “Economics,” in its original 1948 edition. Unlike most free traders, I have read David Ricardo’s “The Principles of Political Economy and Taxation,” and while unlike most Austrians, I cannot quote chapter and verse of Ludwig von Mises’ “Human Action” from memory, I have read it.

I have no doubt this reading list would have astonished the late professor of my macroeconomics class, who was less bothered by my usual failure to attend class than by the fact that I never bothered to buy the textbook.

After nearly three decades of reading across a broad spectrum of economic thought, the two books on the subject I would most recommend are Joseph Schumpeter’s “History of Economic Analysis” and Murray Rothbard’s “An Austrian Perspective on the History of Economic Thought.” But now there is a third. After finishing “Debunking Economics: The Naked Emperor Dethroned?” I have to assert that Keen’s book is not only an absolute masterpiece, but may, in fact, represent the most important intellectual development in economics since “The General Theory” was published in 1936. And if some of Keen’s more controversial assertions hold up over time, it will be the most important contribution to the literature since “The Wealth of Nations.”

The title of the book is an appropriate one because Keen calls into very serious question some of the most basic assumptions that economists of all ideological strains have shared since 1776. This is not a book for the faint of heart, not due to the relatively sophisticated mathematics he utilizes in support of his arguments, but because it will be hard for anyone with even a modicum of education in economics to accept intrinsically revolutionary ideas such as the non-linear shape of a market demand curve or to believe that conventional economic models are absolutely reliant upon absurdities such as markets that consist of one solitary customer for a single commodity. And while it is one thing to notice that the conventional models don’t take into account factors such as time and debt (for I have written about these things myself), it is still eye-opening to witness Keen methodically explore the significance of such omissions and explicate the consequences of how these structural errors render the entire mainstream discipline fundamentally incapable of coherently describing, let alone predicting, economic activity in the real world.

Perhaps the most revelatory section of the book deals with the way the General Theory of John Maynard Keynes was converted into the practical neoclassical form that presently dominates mainstream economics in its two halves, Monetarist and Neo-Keynesian, by Paul Samuelson and J.R. Hicks. While it is no secret that Samuelson quantified many of the concepts introduced by Keynes, as one will search “The General Theory” in vain for gross domestic product or any of the macroeconomic terms that are so familiar today, I had always wondered about the basis for the IS/LM model that played such a central role in my macroeconomic class could be found in Keynes; none of my economics professors ever pointed out that it was provided in what was essentially a book review of Keynes’s magnum opus or admitted how this core function of “Keynesian” economics inherently contradicted what Keynes himself wrote.

Throughout the book, Keen proves himself to be an engaging writer who is able to break down and explain the most complex concepts in a manner that most interested readers will be able to follow without too much trouble. He wisely structures his arguments in such a way that if one does not wish to wrestle with the math or the more esoteric aspects of the subject, one can still understand the significance of the point that he is making and move on to the next issue.

One need not agree with all of Keen’s arguments or his conclusions to admire the serious and substantive challenge that he has posed here to neoclassical economics. The neoclassicals cannot ignore the divergence between their theories and the real world forever, and no amount of revisionist history from the likes of Brad DeLong will permit them to do so much longer in a world that is drowning in excessive public and private debt. If Keen convinces the reader of just one thing, it is that there is a dire need for a better economics. Consider the following statement in which he compares five alternative schools of economics, Austrian, Post-Keynesian, Sraffian, Econophysics and Evolutionary economics prior to describing the strengths and weaknesses of each:

“None of these is at present strong enough or complete enough to declare itself a contender for the title of ‘the’ economic theory of the twenty-first century. However, they all have strengths in areas where neoclassical economics is fundamentally flawed, and there is also a substantial degree of overlap and cross-fertilization between schools. It is possible that this century could finally see the development of a dominant economic theory which actually has some relevance to the dynamics of a modern capitalist economy. I would probably be regarded as partisan to the post-Keynesian approach. However, I can see varying degrees of merit in all five schools of thought, and I can imagine that a twenty-first-century economics could be a melange of all five.”

As can be seen by this quote, Keen is not a polemicist bent on defending his perspective, but a fair-minded inquirer after the truth. He may never be known as the father of whatever the future mainstream of economics turns out to be, but in driving this stake of a book through the heart of what can be reasonably characterized as the undead theory of neoclassical economics, he could rightly merit being described as its midwife.