Sunday, March 1, 2015

The Influence of MIT in the World of Economic Policy, Despite Faulty Equations

Paul Krugman writes at NYT:
Not long ago I received a copy of MIT and the Transformation of American Economics, a collection of essays on how American economics became model- and math-oriented after World War II, and of the special role played by the department Paul Samuelson built. There was a lot in there I didn’t know, despite the many years I spent at MIT first as a student, then as faculty. So I found it — as Spock would say — fascinating.

But the book only really covers Chapter I in the MIT saga; while it alludes a bit to the role MIT grads play in the world today, it mostly cuts off circa 1970. And I think it’s interesting — and maybe even important — to talk a bit about what happened in the decade or so that followed...

The basics: while there have been many articles discussing and either celebrating or deploring the influence of the Chicago School, it’s a less often noted fact that right now a remarkable number of the professional economists who either play important roles in making policy or appear to have influence on the discussion got their Ph.Ds from MIT in the second half of the 1970s. An incomplete list, with dates of degree:

Ben Bernanke 1979
Olivier Blanchard 1977
Mario Draghi 1976
Paul Krugman 1977
Maurice Obstfeld 1979
Kenneth Rogoff 1980

Larry Summers was at Harvard during the same period, but he was an MIT undergrad and very much part of that intellectual circle. Also, just about everyone on the list studied with Stan Fischer, who remains very much in the middle of policy-making.
Most fascinating about the essay is that Krugman pretty much admits that these mathematical Keynesians developed faulty mathematical equations:
The result was that MIT macroeconomics was teched up — everyone learned how to write down and solve rational expectations models, everyone learned how to emulate Lucas disciples — but didn’t unlearn Keynesian insights. And MIT students developed a style that was either wonderfully pragmatic or disgustingly lacking in rigor, depending on your tastes: models derived from microfoundations were always the goal, but when observed experience was clearly at odds with what the models predicted, you’d just impose realistic behavior and leave its ultimate explanation as a project for the future....
I think it’s obvious why this approach was better suited for producing future central bank governors, chief economists, and even pundits than an approach that elevated purity over realism. 
Of course, becasue of the complex nature of human action, and the things we can't know, it is the Austrian school that understands why the MIT equations,  which are sometimes "clearly at odds" with observed behavior, is an improper method to use in the study of economics. For more see the Hans-Hermann Hoppe: Economic Science and the Austrian Method.



  1. The End of Honest Money

    Yin and Yang

    Why? Because we wish to remember that periods of gluttony and wantonness must be followed by periods of fasting and correction.

    Yin and yang must be kept in balance. Pain and pleasure… good and bad… right and wrong – all must get what is coming to them. Otherwise, the entire world gets out of whack.

    We fast to remind ourselves that there are hardships… there are lean periods in life. Not just in our drinking lives… but in our economic lives… and in our emotional lives too.

    There is adversity. There is pain and penance. We fall in line, observing church rituals, so that we don’t fall apart when real adversity hits us in the face. We endure Lent so we can enjoy Easter.

    Yes: Corrections are a part of life. You correct your mistakes. Or they correct you. No other outcome is possible. But along comes the doctrine and practice of modern central banking.

    All these MIT-educated central bankers have a different idea.

    A “Wicked Project”

    To fully understand how this came about, we step back to the founding of the United States of America, in whose Constitution today’s central bank money was specifically prohibited.

    Recall that the states – which had the power to mint their own money – were not to “make any thing but gold and silver coin legal tender in payment of debts.” In The Federalist Papers, James Madison described allowing paper money as an “improper or wicked project.”

    And in his 1819 Dartmouth College v. Woodward decision, Chief Justice John Marshall explained that paper money had “weakened the confidence of man in man and embarrassed all transactions between individuals by dispensing with a faithful performance of engagements.”

    Not that paper money was necessarily the work of the devil. But Satan had a hand in it. When you can counterfeit money – and get away with it – it’s a hard habit to quit. You are soon hooked.

    Congress resorted to paper money – called “greenbacks” because the notes were printed in green on one side – during the War Between the States. Five hundred million paper dollars were issued. This led to higher prices, which pleased debtors. They borrowed in expensive money; they repaid in cheap greenbacks. Prices in the North rose 75% from 1860 to 1865.

  2. From the article....
    '"There was almost a hint of an inferiority complex."
    There is no complex Krugman.
    Statist Keynesians ARE morally and intellectually inferior.

  3. Microeconomics has lead to some insight and many of its ideas are accepted by most economists. Macroeconomics is faulty and its models have no such great acceptance among different economists. The economy, like the atmosphere, is too complex to model. They just can't do it.