All 9 entries tagged Keynesian Economics

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May 12, 2017

What’s gone wrong with economics?

Lecture to Bath Royal Literary and Scientific Institution

10 May 2017

There is a lot of discussion going on about the state of economics today. A lot of criticism is coming from outside the academic establishment – from students, journalists, public intellectuals and policy makers. This has occurred since the financial crash of 2008 and subsequent recession, although it can also be seen as really an intensification of much older debates about economic thought that have been going on for many years before that. There has been intense debate, within the economics ‘profession’, about the way the subject was done, going back at least to the sixties if not earlier. However it had ceased to take place within the mainstream and nowadays most critical writing is confined to a few fringe academic journals, while the main journals have become almost exclusively the domain of a narrow range of orthodox thinking. This lack of open debate was very unhealthy.

(By the way, economics must be one of a very few academic disciplines whose members refer to themselves as a “profession”. I wonder if this terminology endows the orthodoxy that occupies the pages of the mainstream journals and textbooks with additional authority.)

One of the most remarkable instances of criticism emanating from government circles occurred in 2008 when the queen was visiting LSE just after the crash and she asked the assembled dignitaries why nobody had seen it coming.

One answer is to say that economics is concerned with understanding how the economy works rather than forecasting. After all, nobody would expect a political scientist to forecast the result of every election. But that begs another question: “if economists understand how the economy works, how come they have not been able to design institutions and policies to prevent such crises from happening?”

But anyway many economists are engaged in forecasting and their inability to spot the crash was a major failure of their methodology. The fact that the crash happened was also a consequence of seriously flawed thinking underpinning the policy regime in force.

Following the crash students intensified their complaints about the syllabuses of courses they were being taught. They complained that their courses were too preoccupied with the properties of abstract models not rooted in the real world and they demanded more relevance. For example a group that started at Manchester University called the Post-Crash Economics society
( was set up to campaign for more relevance and methodological pluralism in courses, but it met with limited success. This is actually a renewal of earlier campaigns such as the post- autistic economics movement that began in France in 2000, arguing against the dominance of a single method – which is known as neoclassical economics - and for a pluralism of approaches. They likened the mainstream discipline of economics to someone suffering from autism: someone who continues with the same asocial behaviour regardless of any outside influences. This gave rise to the Post Autistic Economic Review, now renamed the Real World Economic Review. Review. ( )

So what is the problem? Are the students and critics right? Or is it just that they lack the skills necessary to do mainstream economics?

Is economics too mathematical?

A very common criticism of economics teaching and scholarship generally is that it has become far too mathematical. Students today have to take and pass prerequisite courses in quantitative methods before they can study economic principles. Both mathematical and statistical techniques are required. Also scholarship is heavily mathematical with economics writing in academic journals and textbooks couched in algebraic symbolism which makes it extremely difficult to read for all but a few initiates who already have expertise in the area. The usual response is to say that complainers should just get on with it: that is the way economics is.

It is true that academic writing about economics should be written in clear language and not pretend to be something – mathematics - that it is not. This is a major and valid criticism of the way economics is done.

It is interesting and perhaps somewhat ironic that today’s economists who write in this way are failing to follow the advice of one of the founding fathers of neoclassical economics, Alfred Marshall,
( )
who was responsible for the supply and demand framework and partial equilibrium analysis of markets. He wrote:

“[I had] a growing feeling in the later years of my work at the subject thata good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules - (1) Use mathematics as a shorthand language, rather than an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics.”

His work was mathematically very rigorous but written so as to be comprehensible to the reader. That does not suggest that mathematics has to be a prerequisite to studying economics at undergraduate lev el though it might be needed before conducting research.

There is an issue about what sort of quantitative techniques students should be expected to know. Statistics is essential because economics is all about measurement. But in their first year students only need to be taught basic economic statistics – that is the measurement of the economy. Students should know about how an index number is constructed so they can understand things like the consumer price index, or the rate of growth of GDP, and graphical representation of trends. Only high school maths is required for this. This is quantitative methods for describing the economy at a very basic level, the foundations for a proper understanding.

More advanced topics such as optimization theory, statistical inference and parameter estimation have to do with economic modelling and not required for an economics degree. Some of the techniques students are taught are really of questionable use. It really does not aid understanding or develop useful skills to have to derive demand functions from first principles expressed exclusively in algebraic terms, with a given utility function – very few are likely to ever need to do that in their later career, only those who go on to very advanced theoretical research. Studying the idea of a demand function and the nature and meaning of a utility function are far more important.

So I do not agree with the simple proposition that the subject is just too mathematical. Quantification is intrinsic to economics. But I think that often what is taught is the wrong sort of quantitative methods – more to do with abstract economic modelling than with the measurement of the real world economy. And too much economics scholarship is expressed using needless mathematical notation, a form of jargon. Economists should heed the advice of Marshall and write in clear English.

The reduction of macro to micro: the neglect of Keynesian economics and the ascendency of neoclassical economics

What has gone wrong with economics is not only that there is too much writing couched in needlessly mathematical terms but something more fundamental than that. It is that there has occurred a major shift of focus away from macro to micro. There has also been a shift away from real-world empirical relevance to mainly theoretical argument. Macroeconomics – by which I mean primarily the economics of Keynes – is no longer taught in many universities. By that I mean it is not taught properly. The economics of Keynes has been sidelined.

To continue reading, download the full paper here.

April 25, 2015

Sense about the deficit by Simon Wren–Lewis

In his latest blog, Mediamacro myth 4: The immediate necessity of belt tightening ,Simon Wren-Lewis demonstrates the folly of governments trying to cut the deficit in a recession when interest rates are as low as they currently are.

We must always remember that a country is an economy not a company or a single household. Attempting to cut the government deficit in a recession only succeeds in making things worse.

November 10, 2013

The dangers of austerity policies: a lesson from history

A lletter published in the FinancialTimes recently spells out the likely consequences of the EU's austerity policies.

Comparing the present severe deflationary policies forced on the southern European countries with what the Treaty of Versailles did to Germany after the First World War, it quotes the prophetic words of Keynes in "The Economic Consequences of the Peace":

“If we take the view that Germany must be kept impoverished and her children starved and crippled . . . If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp.”

Fourteen years later Hitler and the Nazis came to power in Germany which led to the Second World War.

July 13, 2012

Arrogance and self–satisfaction among macroeconomists

Simon Wren-Lewis (Crisis, what crisis? Arrogance and self-satisfaction among macroeconomists) blogs that there is nothing fundamentally wrong with modern micro-based, so-called New Keynesian, macroeconomic models despite their evident failure during the financial crisis:

Let me be absolutely clear that I am not saying that macroeconomics has nothing to learn from the financial crisis. What I am suggesting is that when those lessons have been learnt, the basics of the macroeconomics we teach will still be there. .....However, this must surely use the intertemporal optimising framework that is the heart of modern macro.

The problem is in the last sentence. The use of a microeconomic optimising framework that he insists on severely limits the scientific value of the model. We cannot do meaningful macroeconomics, which is all about income, employment and the price level, using microeconomic tools.

First, it is surely unreasonable to model the behaviour of a single representative household as standing for a whole society of millions of individuals. That shifts the analysis away from the aggregate behaviour of the whole economy that we are interested in understanding. Instead of focussing on the problem of effective demand, which is all about the circular flow of spending among income-constrained households and firms, it nets out all that is important.

But, perhaps more importantly, it fails the fundamental test of a scientific model: that it must faithfully reflect the real world it is describing. There are strong grounds for believing that people, or a substantial number of them, are not doing the kind of continuous intertemporal optimisation at the centre of the model.

Compelling evidence for this is in the latest Scottish Widows Saving and Investment Report.

It finds overall retirement savings have hit an all-time low, with only 46 percent of working people in the UK saving enough for their retirement. It reveals stark differences between people's expectations and reality.

Despite a big fall in retirement savings, it seems that people's aspirations for their pension income have actually increased by £200 from 2011 to 2012. The survey findings show that the average level of annual income people would feel comfortable living on at 70 years-old is now £24,500 compared to £24,300 in 2011. But the savings rates reported are unlikely to be able to produce a pension at age 65 of more than half that figure. Moreover 41 percent say they would like to retire at age 60.

That is not all. More than one-in-five (22%) of people in work aged over 30 and earning more that £10k are saving nothing at all for their retirement.

This is evidence of great heterogeneity of behaviour, with some households optimising like the model says, but as many failing to do so. But what it does show clearly is that intertemporal optimisation is not at the heart of the real economy.

How, then, can we put any faith in an economic model that assumes everything to be driven by universal intertemporal optimisation of consumption by a single representative consumer?

Surely a truly scientific model that would have some chance of successfully tracking the real world would try to model the actual behaviour of real people. That means a statistical approach that captures behaviour and allows for heterogeneity - "by and large and on the average" was a phrase used by old Keynesians for this kind of behavioural economics.

June 28, 2012

Manifesto for Economic Sense

We are now four years into the recession that started with the 2008 banking crisis. Governments in the UK and other European countries are continuing with ill-thought-out policies that only serve to worsen the problem.

We as economists know from what we teach that this is repeating the mistakes that led to the 1930s depression with its terrible social and political consequences.

Paul Krugman and Richard Layard have issued a manifesto calling for a return to policies based on evidence, and asked that economists and others who agree should sign it.

As they say, "The whole world suffers when men and women are silent about what they know is wrong."

June 13, 2012

A deficit is not a fiscal stimulus

Many commentators have claimed that there is no austerity because there is still a large budget deficit. If the government is spending more than it receives in taxes then there must be - in effect - a fiscal stimulus. Therefore it is a myth that the government is pursuing an austerity policy because the real cuts have not started yet.

This argument was shown to be a fallacy some years ago by the American Keynesian economist Gardner Ackley in a paper called You Can't Balance the Budget by Amendment written in 1982. See the excellent discussion of it by Bill Mitchell where he says:

We cannot conclude that if the budget is in surplus then the fiscal impact of government is contractionary (withdrawing net spending) and if the budget is in deficit then the fiscal impact is expansionary (adding net spending).

A government budget deficit might simply reflect the fact the economy is in recession and does not in itself mean the government is adopting a Keynesian fiscal policy. In a recession tax revenues fall and benefit spending increases naturally - the so-called automatic stabilisers - and the govenment finds itself with a deficit without having any stimulus policy- the situation in the UK currently.

May 31, 2012

The case against austerity by Paul Krugman

Paul Krugman on Newsnight last night brilliantly argued the case for Keynesian stimulus against Newsnight regular austerians.

May 29, 2012

Dont believe the 'austerians': a fiscal stimulus is just what is needed

We know the coalition government's austerity policy is not working. The economy is not growing with output still 4% below its level before the crisis began in 2008. Output is estimated at a staggering 14% less than where it would have been had growth continued at the rate it was before the recession.

But we are told there is no plan B - that Keynesian fiscal stimulus is not available because it would have to be financed by more borrowing. This is economic nonsense that is doing immense damage to society.

All the evidence shows that cutting public spending in a recession simply makes things worse. And it does little - if anything at all - to reduce the deficit because other areas of government spending go up and tax revenues drop.

The deficit is a by-product of recession, not a cause. The only way to reduce the deficit is to promote economic growth which put unemployed people back to work. In the absence of any growth stimulus from the private sector, this means using government spending to provide the fiscal boost.

In my latest paper, published in the latest Royal Economic Society Newsletter, I have shown that a fiscal stimulus, aimed at pump priming the economy by getting the private sector growing again, is actually also good for fiscal solvency. The growth in output as a result of the operation of the Keynesian multiplier also means the debt to GDP ratio will come down. This happens even if the extra spending is funded by borrowing.

This result is true even under quite mild assumptions about the size of the fiscal multiplier. I assumed a multiplier of 1: that is, that an increase in government spending would induce an increase in GDP of the same amount. This is a very small effect. There is growing evidence that the effect will be much larger than this.

A similar case has recently been made in an important paper by Brad DeLong and Larry Summers.

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