Science As Well As Economics

I had largely managed to avoid writing virtually the latest angst inward the economic science blogosphere regarding mathematics, science, together with economics. I am non a fan of mainstream economics, but at the same time, I query some of the wide brush attacks on economics. The bespeak to pretend that economic science tin endure a scientific discipline similar physics is doomed, together with does non accept into line of piece of job concern human relationship the nature of what is beingness studied.

Empirics? 

This article past times Chris Dillow caught my eye, equally it gave an interesting background explanation of how mainstream economic science has obfuscated mightiness relationships out of economics, together with thence has some difficulties explaining inflation. (The snappy explanation is that the inflation procedure is the outcome of a mightiness struggle betwixt majuscule together with labour, together with that sounds likewise Marxist together with thence was airbrushed out of economical theory.)

However, the Dillow article  had a tangential link to "Why mathematics has non been effective inward economics" past times Tim Johnson, which is some other interesting read. In turn, it referenced "The novel astrology" past times Alan J. Levinovitz. The tag line of that article read:

By fetishising mathematical models, economists turned economic science into a highly paid pseudoscience.

The Levonovitz article caused a stir when it was showtime published. In fact, I lead maintain written similar things virtually economists, arguing that they are filling the social role of shamans inward our societies. However, I holler back that only tells us something virtually human societies: at that spot is a demand for shamans, together with so the economist shaman provide grew to tally that demand. (The post-Keynesian "Reverse Say's Law.") The vogue towards shamanism is ingrained, hence, nosotros cannot actually blame it on the contents of mainstream economical theory.

What pushed me into writing this article was this query on the Economics Stack Exchange on empirical enquiry inward economics.  It quotes an econophysicist Bertrand Roehner, who stated:

Economic journals, on the contrary, are real reluctant to set out empirical observations, peculiarly when they lead maintain no clear interpretation inside the existing theoretical framework.

The questioner together with so asked: "Are at that spot economical journals which are corking to set out puzzling empirical observations, i.e. those observations which lead maintain no clear interpretation inside the existing theoretical framework?"

Since the answers on the Economics Stack Exchange are supposed to endure somewhat authoritative together with non solely rants, I decided to laissez passer my rant here.

Problem is Falsification, Not Empirical Puzzles

In my view, the premise that economic science journals do non set out articles on empirical puzzles because of "reluctance" misunderstands the reality of mainstream economical research.

Mainstream economical theory cannot laissez passer a straightaway reply on whether raising the policy involvement charge per unit of measurement raises or lowers inflation, together with inflation targeting past times primal banks has been a major enquiry theme for decades. If the theory cannot laissez passer you lot the sign of the most-studied macro effect, what makes you lot holler back that whatsoever empirical information tin endure institute that cannot endure "interpreted" past times mainstream economical theory?

If you lot insist on having a to a greater extent than formal argument, I would propose generating roughly xx years of quarterly information using a somewhat realistic stock-flow consistent (SFC) model (which is roughly all nosotros lead maintain to operate alongside inward the existent basis for most countries due to structural changes), including some random noise. Then apply the quantitative techniques used past times mainstream researcher to that information set, together with reckon whether the mainstream DSGE models tin "explain" the data. I lead maintain non done that experiment, but I reckon lilliputian doubtfulness that the information could endure "explained." (Note for whatsoever post-graduate students: that would endure a fun thesis topic!)

If my guess is correct, nosotros reckon that a DSGE model tin "explain" a SFC model -- even though the truthful SFC model is based on assumptions that are antithetical to DSGE model assumptions. If nosotros were able to attempt out the validity of DSGE modelling, such an experiment would turn down DSGE models' mightiness to tally the data. If DSGE modelling techniques are non "falsified" past times information generated past times model-generated data, why would nosotros hold off that existent basis information to falsify the DSGE modelling framework?

In other words, most empirical investigations of the validity of mainstream theory tin say real little, together with fifty-fifty academic journals do non desire to waste matter column inches on them.

Can We Be Scientific?

Having done my obligatory ranting virtually mainstream economics, I at nowadays render to my declaration which defends economists (both mainstream together with post-Keynesian) from the accuse that "they are non scientific."

Since some philosophers sometimes read my writings, I am going to avoid whatsoever endeavour to laissez passer a highbrow Definition of "being scientific," I volition stick to a mutual sense Definition equally "making useful predictions."*

There is some other constituent to beingness "scientific" would endure to discovery causal mechanisms to explicate behaviour. In physics, the analogy would endure to come upwards up alongside an explanation why gravity exists, equally opposed to only observing the inverse foursquare law. In the domain of economics, nosotros are discussing human behaviour, together with the "causal explanation" comes downwardly to: why do people do what they do? This is usually viewed equally a split upwards question, together with studied inward the other social sciences. It seems quite unlikely that nosotros volition endure able to accept advances inward psychology (for example) to assist forecast the inflation charge per unit of measurement over the adjacent few quarters. Correspondingly, I ignore such issues inward my give-and-take of "being scientific."

We Can Use Economics Make Some Predictions. So What?

I lead maintain lilliputian sense (or involvement in) many areas of economics, such equally microeconomics. My comments hither are aimed only at the questions of predictions inward macroeconomics.

The showtime thing to realise is that at that spot are embedded relationships betwixt diverse economical fourth dimension series. If nosotros alternative serial at random (without agreement those relationships), nosotros volition eventually endure able to discovery serial that nosotros tin tally mathematical models to. However, most economists lead maintain an agreement of those underlying relationships, together with so are unimpressed past times such empirical efforts.

One instance would endure the human relationship betwixt currency outstanding (notes together with coins) together with nominal gross domestic product inward Canada from 1964-2015. As tin endure seen, the ratio of currency outstanding to nominal gross domestic product was stable. Although this may non appear to endure the most useful empirical relationship, nosotros tin discovery many other serial whose human relationship to gross domestic product follows smoothen trends that are amenable to modelling.

The empirical observation that currency outstanding runs or so 3.0-3.5% of Canadian nominal gross domestic product is somewhat interesting, but it begs a lot of questions. Why is this happening?

• The sensible viewpoint is that soul sector entities withdraw currency from the banking organisation based on their nominal incomes. Since nominal gross domestic product equals nominal Gross Domestic Income (by definition), this implies that currency holdings volition endure stable equally a percent of nominal GDP.
• The less sensible viewpoint is to fighting that currency holdings determine nominal GDP, together with that the primal banking concern tin laid the degree of nominal gross domestic product past times (somehow) changing currency holdings.

The upshot is that the empirical human relationship exists past times itself is meaningless; nosotros demand an overall theory to tally the observations into. We also demand to accept into line of piece of job concern human relationship that theory needs to endure useful for policy purposes: what happens when changes are made to policy parameters? Furthermore, nosotros demand to sympathise the information serial themselves inward fellowship to jurist that an empirical observation is non useless. (For example, it is possible to rediscover the relationships implied past times accounting identities.)

I could multiply examples of such partial theories. For example, modern fixed income pricing theory is a highly sophisticated framework for pricing all sorts of fixed income securities (many of which in all probability should non exist). The theory itself is stone solid. However, the empirical behavior revolves or so the correlation of forrad charge per unit of measurement movements. Meanwhile, the fair value of the forrad rates is what marketplace position participants believe what policy charge per unit of measurement volition endure laid past times the commission of real human primal bankers inward the future. No affair how deep the mathematics gets, the whims of primal bankers remains equally the ghost inward the machine.

Form of Models Informed past times Experience

An additional thing to travel on inward withdraw heed is that the way economists construct models reflects sense alongside the dependent matter. For example, nosotros know that yesterday's 10-year Treasury yield is a pretty skillful jurist for today's 10-year Treasury yield. If nosotros feed forrad yesterday's bond yield into today's model estimate, our model volition oft aspect much amend than the kind of bond valuation models that are typically produced past times strategists. (Link to the "World's Simplest Bond Valuation Model.") To the inexperienced eye, it seems reasonable to utilisation a model that has a much tighter tally to observed bond yields (by incorporating yesterday's yield).

The argue why practitioners are happy alongside valuation models alongside relatively large pricing prediction errors is that you lot brand money inward the bond marketplace position past times predicting large changes inward the bond yield, non predicting the electrical current degree (which you lot tin only aspect upwards on Bloomberg). Instead, you lot desire a model that indicates the direction of the adjacent large displace inward yields, together with feeding inward yesterday's bond yield to a greater extent than oft than non does non assist inward that quest.

In this example, the existent attempt out of the model is: tin nosotros brand money alongside it? (I would non set forth "The World's Simplest Bond Model" equally beingness the potential hush-hush sauce for a hedge fund, but someone could develop a amend model that looks similar.) We know how to determine the bond yield today exactly: nosotros aspect upwards a quote. In fellowship to brand money, nosotros demand a model that has errors that are pointed inward the right direction (most of the time). That is non a measure modelling criterion inward the physical sciences or engineering.

Can Comprehensive Economic Models Make Predictions?

In macro, all roads atomic number 82 to a comprehensive economical model. The query together with so arises: tin such models brand useful unconditional predictions?**

(When I refer to a comprehensive macro model, it is a model that attempts to copy all the major aggregates of the national accounts. Other economical fourth dimension serial should endure inferred from the simulated series. As a result, the empirical relationships betwixt arbitrary fourth dimension serial halt upwards beingness the outcome of the dynamics of the comprehensive model. We may lead maintain some pretty ugly simplifications, such equally throwing out unusual interactions together with only using a closed economic scheme model.)

Unfortunately, this is in all probability non the case. One of the key drivers of the economical wheel is fixed investment. If nosotros drib the supposition of mainstream economic science that everyone is the same, the determination of the degree of fixed investment inward a capitalist economic scheme is extremely difficult. Firms invest if they believe that the investment volition endure ratified past times futurity profits. Meanwhile, fixed investment is a major driver of aggregate profits (as per the Kalecki Profit Equation). Firms invest if they believe that other firms volition also invest.

(Someone who is to a greater extent than familiar alongside Keynes' General Theory could tell you lot what chapter(s) that declaration came from; I would demand to re-read the mass to laissez passer a to a greater extent than specific reference.)

You together with so demand to inquire yourself: do you lot know what the degree of fixed investment (and profitability) volition endure inward the future? If so, all firms would lead maintain access to this forecasting mechanism, together with so maybe all activity could endure coordinated. Unfortunately, at that spot is no prove that such a forecasting machinery exists, together with so actual investment is going to endure the outcome of multiple decisions past times multiple decision-makers, based on internally contradictory logic. Needless to say, such a province of affairs is non going to endure amenable to a create clean mathematical model. Without such a create clean model, quantitative predictions are hard to come upwards by.

Can nosotros travel the other way: detect a whole bunch of smaller empirical regularities, together with and so endeavour to dorsum out the comprehensive model? The declaration is that this is non feasible, equally economical outcomes are the outcome of economical actors attempting to forecast aggregate behaviour. We are non working alongside simple particles that mechanically react to local forces.

Although I lead maintain severe reservations virtually mainstream economics, the theory does reverberate the reality that outcomes are the results of humans forecasting macro outcomes. This way that they are correctly dismissive of arguments made past times non-economists who fighting that nosotros demand to accept random empirical regularities together with endeavour to construct a coherent macro theory out of them.

Peak Oil: The Horrible Example

If you lot read plenty "economics is flawed" articles, you lot volition come across the sentiments that economic science needs a multi-disciplinary approach, which needs to accept into line of piece of job concern human relationship things similar limitations of physical resources. Allegedly, the dependent area of physical scientists together with their appreciation of conservation laws would set analysis on the right track. This ignores the skeleton inward the closet: the Peak Oil movement.

As a disclaimer, I would consider myself to lead maintain been a fellow member of the "Peak Everything" crowd, but in all probability should refer to myself equally a "extreme resources limitations worrier." There was a lot of fantabulous Peak Oil analysis available, but the skillful analysis was tainted past times the association alongside proponents of "oil economical determinism." The logic went roughly similar this:

1. Economic increment together with crude production increment over the past times century rose together. Oil is of import for all economical processes (due to the high unloosen energy render on investment), together with hence, its utilisation caused the economical growth.
2. Conventional crude production volition peak (and I believe that this indeed happened; the debates arise over what to include inward "conventional oil.").
3. Therefore, when crude production declines, the size of the economic scheme volition decline (negative gross domestic product growth).

Once again, that is my summary of arguments made past times the to a greater extent than exuberant members of the online Peak Oil community, together with non the measured arguments of the Peak Oil analysts. I largely ignored the crude economical determinism arguments when they were popular, so my explanation may endure missing some details. However, it should endure noted that these arguments were the outcome of a multi-disciplinary collaboration past times applied together with pure physical scientists, together with were using analysis techniques that would endure considered best practices inward their disciplines. (My preparation was equally an engineer, together with I did non reckon technical problems alongside the arguments, rather the economical theory was faulty.)

When the peak inward crude production arose, together with at that spot was no ongoing economical apocalypse (only the relatively brief Financial Crisis), enthusiasm for "Peak Oil" waned, together with diverse websites declared victory together with unopen down.

Meanwhile, mainstream together with post-Keynesian models essentially predicted what happened: at that spot was no argue for a precipitous alter inward behavior solely because of a alter inward the sign of the derivative of crude production. Eventually, resources constraints volition matter, but measure economical models could easily endure modified to accept those into account. In summary, theories that are based on the supposition that human reactions to expected macro outcomes were much to a greater extent than successful than theories which suggested that humans react mechanically to particular economical variables.

Concluding Remarks

The thought that economic science tin endure similar physics is based on an extremely shaky assumption: that nosotros should hold off endure able to brand unconditional economical forecasts. Once nosotros sympathise reasonable economical theory (such equally post-Keynesian theory), nosotros reckon that such strong predictability inward macro is non going to happen. The defect of mainstream economic science is that it embeds likewise many assumptions inward how actors react to macro uncertainty, non that it is unscientific. That is, nosotros demand to brand some assumptions, nosotros only lead maintain to avoid making likewise many (or evidently wrong ones).

Footnotes:

* Which may or may non endure considered "philosophical pragmatism", which may or may non endure considered highbrow.

** We tin brand conditional predictions: "we believe that X volition travel on if nosotros avoid recession." Such a strategy appears to a greater extent than feasible, but it begs a lot of questions (what are the odds of a recession?).

(c) Brian Romanchuk 2017