In a previous post, Pedro told us about the two first rounds of the lynching of macroeconomics in these times of crisis: the Economist debate in which Lucas engaged, and a “letter to the Queen” bringing to light the dissent with the british economic community. What comes next, Pedro asked.
What comes next, of course, is Krugman’s article on “how did economists get it so wrong” in the NYT and the additional comments he made last week and today on his blog on “mathematics and economists.”
Essentially, economists got it so wrong, he says, 1) « because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth » and 2) because Keynes-like realistic vision of markets and especially financial markets was replaced by the « elegant, convenient, and lucrative » efficient market and rationality hypotheses, two hypotheses that even the skeptical pragmatic new keynesiens were unable to relinquish decisively. « Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system ,» he concludes, arguing that economists should rediscover Keynes, and pay more attention to behavioral finance/economics.
He subsequently clarified/ qualified his position on his blog. He is not against mathematics, « they served an essential function — that of clarifying though », but against equating mathematical elegance with truth (like in these « silly », but « seductive » RBC models)
On unrealistic hypothese,« neoclassical economics radically oversimplifies both the individuals and the system — and gets a lot of mileage by doing that; I, for one, am not going to banish maximization-and-equilibrium from my toolbox. But the temptation is always to keep on applying these extreme simplifications, even where the evidence clearly shows that they’re wrong. What economists have to do is learn to resist that temptation. But doing so will, inevitably, lead to a much messier, less pretty view. »
His rules for research were
1)“listen to the gentiles” (pay attention to empirical evidence). Nevertheless,
“ I have no sympathy for those people who criticize the unrealistic simplifications of model-builders, and imagine that they achieve greater sophistication by avoiding stating their assumptions clearly. The point is to realize that economic models are metaphors, not truth. By all means express your thoughts in models, as pretty as possible. But always remember that you may have gotten the metaphor wrong, and that someone else with a different metaphor may be seeing something that you are missing. “
2) question the question (try to get back to simple question so as to write not too “messy” models)
3) Dare to be silly (in your assumptions)
“What seems terribly hard for many economists to accept is that all our models involve silly assumptions. Given what we know about cognitive psychology, utility maximization is a ludicrous concept; equilibrium pretty foolish outside of financial markets; perfect competition a howler for most industries. The reason for making these assumptions is not that they are reasonable but that they seem to help us produce models that are helpful metaphors for things that we think happen in the real world.”
4) Simplify, simplify
In the NYT piece, it now seems that there are two silliness. The good one (using small-scale, but real examples), and the bad one (the RBC type ). And that economists should accept more “messy” models.
But OK, the rules for research were written 15 years ago. The problem is that Krugman did it again. Last year, in the middle of the crisis, during his Nobel prize speech. Published in the AER in June. There, as befits a Nobel prize, he attemps to “samuelsonize” his work, that is, to establish the historical canon for his own discoveries. And he tells a fairy-tale history. At the beginning there were empirical puzzles (the growth of similar-similar trade) which could not be explained by the “old” theory of trade rooted in perfect competition. When the first models of monopolistic competition offered the possibility to integrate increasing return to scale into models in the late 70, Krugman proved able, with simple models, to account for intrasectorial trade, drawing on comparative advantages and increasing returns. This “new” theory of trade was made possible by a whole generation of economists’ “new willingness to explore the implications of illuminating special cases rather than trying to prove general results”, e.g., focusing on “silly-seeming cases” (quoting the rule again). On the unrealisticness of his assumptions, he interestingly notes that “The use of deliberately unrealistic assumptions is, of course, common in much of economics. Nonetheless, I can report from early experience that the new style of modeling was met with considerable hostility at first. Some discussants dismissed the whole enterprise as obviously pointless, given the unrealism of the setup.” The same historical pattern is seen in his research in “new” geographical economics. At the end of the story, “the impossible complexity that had previously daunted economists contemplating a major revision of trade theory had vanished, replaced by a surprisingly simple and elegant structure.
Economists’ claim that their positive science is in principle independent from values have made them seemingly schizophrenic, and proudly so. So far, contemporary economists have coped with the pretty and elegant silliness of doctor Paul and the messy realisticness of Mister Krugman. Here is for instance how Ed Gleaser is coping:
“In his public role, Paul Krugman is often a polarizing figure, loved by millions but also intensely disliked by his political opponents. I still chuckle over an old New Yorker cartoon with one plutocrat saying to another that he gets some satisfaction from the fact that his vote will cancel out the vote of Paul Krugman. Within the less divided world of the academy, Mr. Krugman’s economic research has generated plenty of light, but far less heat. His papers are universally acknowledged to be immense contributions that helped to create two distinct fields.”
But how long will it last?
Edit: Sumner, Cochrane, and Altig responses to Krugman.
Edit 2: also of interest is Krugman’s 1998 piece in the Economic Journal, “two cheers for formalism.”