The Biggest Crock in All of Economics

This is the damage which Robert Lucas has done to macroeconomics:

Let’s deal with some of Mark’s specific complaints about what he thinks practicing macroeconomists have been up to:

Macroeconomic models have not fared well in recent years – the models didn’t predict the financial crisis…

I’m so sick of hearing that one I could scream. The economic agents living in a model in which a financial crisis can occur know that there is a possibility that this event can happen. But they cannot predict it, otherwise there would be an unexploited profit opportunity. Similarly, a real human being could not have used such a model to predict the financial crisis.

This is _the_ great fallacy introduced into economics by Robert Lucas (whether he still embraces it or not). The fallacy is so massive and significant that it arguably wipes out the significance of any other contribution Lucas might have made to economic science.

One of the properties of false price signals in an essentially complex network of millions of systematically related relative prices across time it that these false prices have the capacity to fool and mislead people systematically and structurally in an manner that isn’t immediately revealed, but can make itself felt — and unavoidably so — after the passage of an economically significant length of time.

What Stephen Williamson is giving us is excuse making for a research program (whatever other achievements it may claim) which has utterly failed at the one task that is non-optional: as a causal / explanatory enterprise.

More later.

UPDATE: Even more perversely, Stephen Williamson claims there is “no evidence” for “market failure” during a recession or depression.

Paul Krugman has written a post that encapsulates his thinking on macroeconomics – how he thinks other people do it, and how he thinks it should be done. His post is a comment on Barro’s WSJ article that I discussed here. Let’s take this apart. First paragraph:

As Glasner says, there’s something deeply weird about asking “where’s the market failure?” in the face of massive unemployment, huge unused capacity, an economy producing less than it did three and a half years ago despite population growth and advancing technology. Of course there’s some kind of market failure, which means that there’s nothing at all odd about asserting that better policy can yield free lunches.

We cannot observe a market failure. To deduce that a market failure exists, one needs a model. Given that we cannot observe market failure by looking at the state of the economy, we also can’t say what a “better policy” is. Again, for that we need a model.

We cannot observe a market failure? Take a drive, Stephen, outside of Bakersfield, CA or South of Olympia, WA or on the road to Joseph, OR or south of Corvallis, OR, and what you will see is mile after mile after mile of mothballed lumber hauling rail cars, given non-economic status by the artificial boom and inevitable bust of the 2002-2011 period. Or watch the nearly completely houses bulldozed in Victorville, CA in the wake of the housing boom & bust. And banks are still bulldozing homes all across the country.

But attempting to get Williamson to admit there are “market failures” in our midst is much like getting a philosopher teaching Descartes to admit there really is a white board in the room. Both are entranced by a perverse philosophical picture of “knowledge” and neither one of them wish to talk sense.

UPDATE: More than twenty-five percent of construction workers in America are unemployed in the post-boom phase, and construction unemployment by region systematically tracks the geography of the housing & commercial construction boom. You can see systematic patterns in the data — or you can get in a car and go look at the neighborhoods with “house for sale” signs everywhere, or you can get out of our car and go to the neighborhoods with huge numbers of unemployed construction workers and you can shake their hand and talk to them about it. All phenomena just as real as the philosophy professor’s white board …

UPDATE:  The pathology of Stephen Williamson in a nutshell:  “I tend not to think about the problem of people forecasting in different ways, as things are hard enough already and I want to focus on other things.”

This entry was posted in Lucas. Bookmark the permalink.

5 Responses to The Biggest Crock in All of Economics

  1. Ryan Murphy says:

    I’m all for attacking rational expectations and I do not think it’s an adequate response to ABCT. But it is in theory true that there was an unexploited profit opportunity. The amount of money Nassim Taleb made was the result of that opportunity.

    This might be all trivial, but consider this. Even if everyone is maxing profits, it might be profitable to ignore Austrian-type issues since they occur rarely enough that you rely on bailouts or bankruptcy law to make it worthwhile in the longrun. To the extent that you can do that is an empirical question.

    I myself have been very frustrated with Williamson’s blog as well lately, but I’m not completely sure if I understand if I see what you’re getting at here.

  2. Martin says:

    Greg, you’d think you’d at least agree with him that there is no ‘market failure’. If you think Hayek is right with regards to this recession, then the recession is the logical consequence of the boom, or is it not? The one failure you could point to, irrespective of school, is that the Fed failed, either during the boom or during the slump. However, I am hard pressed to find anyone who’d call the failure of the Fed a market failure.

  3. Greg Ransom says:

    Martin, the language of “market failure” has always been unfortunate — but that is the technical term the economics profession has stuck us with.

    Of course, this is something of an extension of the use of the term — and any extension of a bit of language use can mislead in one direction or another (often folks take advantage of this fact to purposely mislead or throw confusion into a conversation.)

    The key thing is that the artificial boom / inevitable bust is a systematic loss of welfare or coordination as compared to the coordination of either a) the ideal of pure theory; or b) the rough and non-distorted coordination of the which in important ways tracks the order ideal found in the equilibrium construction.

  4. Paul Johnson says:

    Maybe there was a government failure? Or rampant malfeasance? What about industry capture? And market failure – all at the same time. ALL these standard models and theories including Krugman’s assume that contracts are honored and people don’t cheat on a massive scale. And that government is always benevolent even if it can be incompetent.

  5. Will says:

    I’m rather amazed to see you and Krugman on the same side of an argument. I join you in finding Williamson’s nihilism frustrating — not just on this issue, but also the “impossibility” of fiscal or monetary easing having any effect whatsoever. It reminds me not so much of Descartes as of Zeno’s arguments that motion is impossible.

Comments are closed.