Matthew Kahn Asks the Tough Question

He writes,

Is Professor Summers saying that the subset of scholars who were studying macro have been collectively wasting their lives?

Pointer from Mark Thoma. I believe that they have been wasting their lives. I believe it even more strongly after reading Randall Wray’s Why Minsky Matters. The time-wasters treat the history and institutional characteristics of financial intermediaries as irrelevant. Minsky, correctly, thought that these things were important.

Minsky Revisited

Olivier Blanchard says,

mainstream macroeconomics had taken the financial system for granted. The typical macro treatment of finance was a set of arbitrage equations, under the assumption that we did not need to look at who was doing what on Wall Street. That turned out to be badly wrong. . .

…As a result of the crisis, a hundred intellectual flowers are blooming. Some are very old flowers: Hyman Minsky’s financial instability hypothesis. . .

Pointer from Mark Thoma.

I have just finished a first reading of a review copy of L. Randall Wray’s forthcoming Why Minsky Matters. It is certain to be on my list of best books of the year. In my opinion, Wray succeeds in clarifying Minsky and in making his views more interesting and persuasive to me than they were previously (I still have my quarrels).

If I think about the economy in terms of patterns of specialization and trade, then Minsky thought of it in terms of financial intermediation. For Minsky, all of us are intermediaries. Because we do not barter, we trade either by issuing IOU’s or by passing along the IOU’s of others (fiat currency being an IOU of the government, if you will).

I am working on a review, which probably will not be out before the book.

A Short Read

I was sent a review copy of On Inequality, by Harry G. Frankfurt. On p. 11, he writes,

a preoccupation with the condition of others interferes with the most basic task on which a person’s intelligent selection of monetary goals for himself most decisively depends.

I imagine that an egalitarian could respond: yes, I need to focus on calculating what it is that I need to be happy. However, I also need to be concerned that others are taking more than they deserve. High levels of inequality are a symptom that some people are taking more than they deserve. They are defectors in that sense, and it is important that the rest of us punish defectors and reward cooperators, who are people who take only what they deserve.

In other words, I do not think that the book will persuade anyone who does not already agree.

A Fiery Analogy

Robert Shiller writes,

The reluctance to acknowledge the need for immediate intervention in a financial crisis is based on a school of economics that fails to account for the irrational exuberance that I have explored elsewhere, and that ignores the aggressive marketing and other realities of digital-age markets examined in Phishing for Phools. But adhering to an approach that overlooks these factors is akin to doing away with fire departments, on the grounds that without them people would be more careful – and so there would then be no fires.

Pointer from Mark Thoma.

There is a school of thought (I am not a member) that would instead compare the Fed to the 10-year-old boy who starts a fire and then claims to be a hero because he then calls the fire department to come in to save it. Similarly, this school would argue, the Fed’s expansionary policies caused the housing bubble, and now the Fed earns praise for saving the economy from the resulting crisis.

Indeed, in recent interviews, Shiller has warned that stock prices are too high and we could see a crash. He would say that this is because markets are irrational. As far as I know, he is not calling on the Fed to raise interest rates in order to try to stop what he might call another financial epidemic. Again, I am not of the school of thought that thinks that the Fed is responsible for the stock market boom. But I think that Shiller ought to engage with those who are of that school of thought.

Incidentally, I received a review copy of Phishing for Phools, by Shiller and fellow Nobel Laureate George Akerlof. My views of the financial crisis are informed by my knowledge of institutional characteristics and history of housing finance. Their views are not. I find that this is the case with many economists who have written on the crisis, but their book left me especially frustrated. UPDATE: Alex Tabarrok also reviewed the book negatively.

A Philosophy of Markets

from Jason Brennan:

Peter Jaworski and I have a book on commodification, Markets without Limits, coming out next month. Our thesis is that any service or good that you may give away for free, you may sell for money.

Pointer from Bryan Caplan.

If it’s worth doing, it’s worth doing for a profit. That sounds like what I said about Planned Parenthood controversy. If harvesting body parts from aborted babies is ok, then they should be allowed to profit from it. But if it’s not ok, then doing it for free would not make it better.

What I’m Reading

Why Him? Why Her? by Helen Fisher. A family member was reading this at the beach, and I picked it up. An attempt at personality psychology, sort of like the controversial Myers-Briggs with four main types. Think of her Explorer as an SP, her Builder as an SJ, her Director as an NT, and her Negotiator as an NF. Anyway, a couple of excerpts:

The Explorer-Explorer match does not appear to be a good strategy for raising children. Yet here, too, nature has a plan. Since Explorers are more likely to divorce and remarry, they are also more likely to bear children with more than one partner. In fact, it’s commonplace to encounter the man or woman who has married twice and had children with each spouse. I don’t recommend divorce and remarriage, but there’s genetic wisdom here…If ancestral Explorers produced more variety in their young, some of these children would survive hard times–passing on their DNA.

Recall that Robert Putnam talks about bifurcated family patterns. Perhaps a lot of Explorer-Explorer matches produce children out of wedlock.

Much later:

The Negotiator is far more idealistic. As a result, the Director can become annoyed by the Negotiator’s far-flung humanitarian concerns, while the Negotiator can begin to regard the Director’s more technological approach to fixing the world’s problems as narrow-minded and unfeeling.

The Negotiator sounds hard to argue with. To the Negotiator, economic logic just “feels” wrong.

The Epistemological Status of Economic Laws

I am reading Robert Murphy’s new book, Choice. Think of it as an English translation of Human Action. I am very happy with it so far. I can see how much of The Book of Arnold can be found in Mises, and yet. . .

I still do not buy into Mises on epistemology. Murphy writes,

Mises shows that economic laws are not obvious and that they do indeed enlarge our body of knowledge, even though economic laws do not need to be verified with empirical observation.

The Anglosphere is largely empiricist, or logical positivist. We tend to believe that there are two types of truths. There are tautologies, which are embedded in language; and there are truths about the world, which are learned by observation.

A claim that 2 + 2 = 5 can be falsified using logic. A claim that pigs know how to fly can be falsified using observation.

Milton Friedman takes an empiricist view of economics. For Friedman, the economist makes predictions about the world, and those predictions are verified or falsified on the basis of observation.

Empiricists give no epistemological status to anything that appears to be a claim about the world that cannot be falsified using observation. Such claims are classified as dogma or nonsense.

Mises was no empiricist. Murphy writes,

From the starting point that humans act, the economist could logically deduce–thereby forming a tautology, it’s true–that individuals have subjective preferences with ordinal rankings, that choices come with opportunity costs, and that the value of second-order capital goods is dependent on the value of the first-order consumer goods that the individual believes they have the technological power to produce.

The way I read Murphy/Mises, economic laws are derived from insight into human nature. At least some insight into human nature comes not from observation but from introspection. The insight that comes from introspection is not falsifiable. For example, suppose I find it inconceivable that I would make choices on some basis other than benefits and costs at the margin. This makes it inconceivable to me that other people would make choices on some other basis. Hence, I appear to arrive at a statement about the world–people make choices on the basis of benefits and costs at the margin–that is not falsifiable by observation.

My take on this is that a statement such as “people make choices on the basis of benefits and costs at the margin” falls into a category that I might term “guiding dogma.” We will use a guiding dogma to make predictions about the world. However, the guiding dogma is not testable. If our predictions go awry, we will not discard the guiding dogma. Instead, we will look for something else that made our prediction go wrong.

“Guiding dogma” may be synonymous with Kuhn’s notion of “paradigm.” In physics, there are some spectacular cases in which a guiding dogma came to be replaced by a new guiding dogma.

The interesting predictions are those which go beyond a guiding dogma. For example, a prediction that a rise in the minimum wage will reduce employment is based in part on the guiding dogma of the Law of Demand. However, the prediction about the effect of the minimum wage is falsifiable empirically. Suppose that a rise in the minimum wage does not produce a decline in employment. Will we throw out the Law of Demand, or will we look for some other factor at work? My claim is that we will do the latter.

Speaking of the minimum wage, consider this sarcastic assault on Larry Summers by John Cochrane:

Never mind centuries of supply and demand, centuries of experience with minimum wages and other price controls, or even the current controversies. Never mind that who works for what business and how many do so is a little bit endogenous. Larry has a new and very clever theory about monopsonistic wage setting in the presence of recruitment and motivation costs. (One that apparently only holds at the lower end of the wage scale where minimum wages bite?)

Thus, if we were to find that an increase in the minimum wage does not reduce employment, then we would credit something like “a new and very clever theory about monopsonistic wage setting in the presence of recruitment and motivation costs” rather than reject “centuries of supply and demand.”

Incidentally, the laws of probability are also not easy to fit into the empiricist framework. When we say that the probability of a coin landing on heads is 1/2, that sounds like a statement about the world, but it also might be thought of as the definition of a fair coin. Once again, the phrase “guiding dogma” comes to mind.

Ron Bailey’s New Book

It is called The End of Doom. From the final paragraph:

New technologies and wealth produced by human creativity will spark a vast environmental renewal in this century. . .the world will be populated with fewer and much wealthier people living mostly in cities fueled by cheap no-carbon energy sources. As the amount of land and sea needed to supply human needs decreases, both cities and wild nature will expand, with nature occupying or reoccupying the bulk of the land and sea freed up by human ingenuity.

Other notes:

1. Bailey is another devotee of North, Wallis, and Weingast. He argues that open access orders achieves sustainability, but limited-access orders do not and hence collapse. He worries less about environmental doomsday than about the United States slipping back into a limited-access order, in which political elites and business cronies are able to thwart human ingenuity.

2. From the introduction:

Canadian environmental researcher Vaclav Smil calculates that back in 1920 in the United States it took about 10 ounces of materials to produce a dollar’s worth of value, but that same value is now accomplished using only about 2.5 ounces

3. Also from the introduction:

wherever someone sees an environmental predicament in the world. . .the problem is occurring in an open-access commons, an area no one owns and for whose stewardship no one is responsible.

He is a fan of fish farms and private ownership of aquifers. For atmospheric pollution, such as chlorofluorocarbons that threaten the ozone layer, he sees a role for international treaties and regulations.

Bailey spoke here, and I enjoyed attending the talk.