Posted by: Dirk | April 16, 2015

One can never say an empirical quantity is exactly equal to a precise number.

I was at the INET conference last week and met many interesting and knowledgable people. One conversation was with somebody from the OECD. He called for heterodox modelers to improve their models so that they can be used for policy advice. I was a bit astonished, given that the IS/LM model, which is not heterodox, says that austerity would not work, but the OECD chose to ignore even the work horse model of the mainstream! It seems that the OECD now opposes austerity, if Euractiv is right.

Nevertheless I would like to point to a discussion of models and reality. Lopez and Assous in their book on Michal Kalecki dig out a nice discussion from 1933. Kalecki tried to show with a models that “his system gave rise to a cyclical solution of constant amplitude for a special value of parameters” (p. 91). The authors then produce a quote from Goodwin (1989) via Sebastiani (1989):

Alas, Frisch was there to point out that since the Greeks it has been accepted that one can never say an empirical quantity is exactly equal to a precise number. Given his aim, this was a deadly blow to Kalecki […].

Thus, if Kalecki cannot “prove” with a mathematical model that capitalism is unstable, than the same must be said about DSGE models “proving” that there cannot be any inter-temporal problems of demand since any change in savings triggers a change in investment of the same magnitude.

History does not repeat itself. It seems like the economists got things right in the Great Depression, but this time around we are way behind the curve.


Responses

  1. I’m obviously misunderstanding the point here. If somebody asks me “how many people are in the room with you” and I answer “three” is that not an empirical quantity equal to a precise number?
    I think what the OECD person probably meant, or at least what I mean when I call for heterodox models to improve, is for them to produce policy recommendations which are implementable. Take a conventional piece of economics, the Taylor Rule. I don’t think much of it but at least it provides clear guidance to interest rate setters on what they should do. Heterodox economics too often just says it’s all too complicated to know. Yet interest rate setters have to set interest rates.,

    • Thank you for your comment! I think we are not talking about the same thing. You are talking about empirical measurements in numbers, which indeed equal precise numbers in the case you have drawn up. On the other hand, I talked about numbers from a theoretical model and the comparison of the numerical outcome with reality’s precise numbers.

      The idea that using a Taylor rule to keep inflation in check has led to a near-repeat of the Great Depression. Einstein is supposed to have said: “We cannot solve our problems with the same thinking we used when we created them.” So, DSGE is dead. Saying that policy recommendations from heterodox models are not implementable only shows that you haven’t read the heterodox literature. (You are invited to discuss which heterodox interest rate policy is not implementable for what reason. So far, I have not seen anybody from the mainstream engaging in actual discussion of heterodox solutions, whereas the heterodox literature discusses itself plus the mainstream.)

      Even the IS/LM model can be used to set the central banks’ interest rate, by the way. Depending on the fiscal stance, adjust the interest rate so that you are at full employment. If you hit the zero lower bound, increase government spending or cut taxes. Raise the interest rate when inflation rises above some target or full employment has been reached.

      The problem seems to be a taboo in the heads of the political elite more than a problem with macroeconomics models. Our tool kit features demand-side models, and I am very sure that their application would be successful.

  2. I accept that your criticism of my knowledge of heterodox models is very limited. And I absolutely agree that the Taylor Rule has been a recipe for disaster. My own policy view is basically that we should rely much more on fiscal policy.
    But I have talked to a lot of policy makers over the years. And they all they the same thing when I make my critique of orthodox policies. They say ” yes, but I have to vote next week on what to do about interest rates.”
    I hope you are not suggesting that using IS/LM models is a heterodox solution.
    I don’t know if your OECD was actually of the view that conventional policies have failed and will fail again. But I certainly am and would be very keen to change the structure of thing. Where in the heterodox literature can I find the sort of implementable measures that are needed to make a policy shift saleable?

  3. I used to think that IS/LM would be mainstream, but I am not so sure now. It seems that the DSGE crowd does not “get” demand and focuses on supply exclusively. However, I developed the IS/MY model (see above) to improve the many flaws I find with IS/LM. Have a look at my model and my slides that come with it. It is based on the sectoral balances and requires only little understanding of macroeconomics. Other economists have their own models, they should not be hard to find. My former colleague Eckhard Hein has written a book called “The Macroeconomics of Finance-dominated Capitalism – and Its Crisis”, Hans-Jörg Herr and Sebastian Dullien wrote “Decent capitalism – a blue print for reforming our democracies”. Jörg Bibow has a proposal called “Lost at Sea: The Euro Needs a Euro Treasury”, and there a plenty more (see http://www.heterodoxnews.com/HEN/home.html, for instance)! My own book (in German) named “Geld und Kredit: eine €-päische Perspektive” also explains the euro zone and its problems from a heterodox perspective.


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