Archive for the 'Thomas Sargent' Category

Romer v. Lucas

A couple of months ago, Paul Romer created a stir by publishing a paper in the American Economic Review “Mathiness in the Theory of Economic Growth,” an attack on two papers, one by McGrattan and Prescott and the other by Lucas and Moll on aspects of growth theory. He accused the authors of those papers of using mathematical modeling as a cover behind which to hide assumptions guaranteeing results by which the authors could promote their research agendas. In subsequent blog posts, Romer has sharpened his attack, focusing it more directly on Lucas, whom he accuses of a non-scientific attachment to ideological predispositions that have led him to violate what he calls Feynman integrity, a concept eloquently described by Feynman himself in a 1974 commencement address at Caltech.

It’s a kind of scientific integrity, a principle of scientific thought that corresponds to a kind of utter honesty–a kind of leaning over backwards. For example, if you’re doing an experiment, you should report everything that you think might make it invalid–not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you’ve eliminated by some other experiment, and how they worked–to make sure the other fellow can tell they have been eliminated.

Details that could throw doubt on your interpretation must be given, if you know them. You must do the best you can–if you know anything at all wrong, or possibly wrong–to explain it. If you make a theory, for example, and advertise it, or put it out, then you must also put down all the facts that disagree with it, as well as those that agree with it. There is also a more subtle problem. When you have put a lot of ideas together to make an elaborate theory, you want to make sure, when explaining what it fits, that those things it fits are not just the things that gave you the idea for the theory; but that the finished theory makes something else come out right, in addition.

Romer contrasts this admirable statement of what scientific integrity means with another by George Stigler, seemingly justifying, or at least excusing, a kind of special pleading on behalf of one’s own theory. And the institutional and perhaps ideological association between Stigler and Lucas seems to suggest that Lucas is inclined to follow the permissive and flexible Stiglerian ethic rather than rigorous Feynman standard of scientific integrity. Romer regards this as a breach of the scientific method and a step backward for economics as a science.

I am not going to comment on the specific infraction that Romer accuses Lucas of having committed; I am not familiar with the mathematical question in dispute. Certainly if Lucas was aware that his argument in the paper Romer criticizes depended on the particular mathematical assumption in question, Lucas should have acknowledged that to be the case. And even if, as Lucas asserted in responding to a direct question by Romer, he could have derived the result in a more roundabout way, then he should have pointed that out, too. However, I don’t regard the infraction alleged by Romer to be more than a misdemeanor, hardly a scandalous breach of the scientific method.

Why did Lucas, who as far as I can tell was originally guided by Feynman integrity, switch to the mode of Stigler conviction? Market clearing did not have to evolve from auxiliary hypothesis to dogma that could not be questioned.

My conjecture is economists let small accidents of intellectual history matter too much. If we had behaved like scientists, things could have turned out very differently. It is worth paying attention to these accidents because doing so might let us take more control over the process of scientific inquiry that we are engaged in. At the very least, we should try to reduce the odds that that personal frictions and simple misunderstandings could once again cause us to veer off on some damaging trajectory.

I suspect that it was personal friction and a misunderstanding that encouraged a turn toward isolation (or if you prefer, epistemic closure) by Lucas and colleagues. They circled the wagons because they thought that this was the only way to keep the rational expectations revolution alive. The misunderstanding is that Lucas and his colleagues interpreted the hostile reaction they received from such economists as Robert Solow to mean that they were facing implacable, unreasoning resistance from such departments as MIT. In fact, in a remarkably short period of time, rational expectations completely conquered the PhD program at MIT.

More recently Romer, having done graduate work both at MIT and Chicago in the late 1970s, has elaborated on the personal friction between Solow and Lucas and how that friction may have affected Lucas, causing him to disengage from the professional mainstream. Paul Krugman, who was at MIT when this nastiness was happening, is skeptical of Romer’s interpretation.

My own view is that being personally and emotionally attached to one’s own theories, whether for religious or ideological or other non-scientific reasons, is not necessarily a bad thing as long as there are social mechanisms allowing scientists with different scientific viewpoints an opportunity to make themselves heard. If there are such mechanisms, the need for Feynman integrity is minimized, because individual lapses of integrity will be exposed and remedied by criticism from other scientists; scientific progress is possible even if scientists don’t live up to the Feynman standards, and maintain their faith in their theories despite contradictory evidence. But, as I am going to suggest below, there are reasons to doubt that social mechanisms have been operating to discipline – not suppress, just discipline – dubious economic theorizing.

My favorite example of the importance of personal belief in, and commitment to the truth of, one’s own theories is Galileo. As discussed by T. S. Kuhn in The Structure of Scientific Revolutions. Galileo was arguing for a paradigm change in how to think about the universe, despite being confronted by empirical evidence that appeared to refute the Copernican worldview he believed in: the observations that the sun revolves around the earth, and that the earth, as we directly perceive it, is, apart from the occasional earthquake, totally stationary — good old terra firma. Despite that apparently contradictory evidence, Galileo had an alternative vision of the universe in which the obvious movement of the sun in the heavens was explained by the spinning of the earth on its axis, and the stationarity of the earth by the assumption that all our surroundings move along with the earth, rendering its motion imperceptible, our perception of motion being relative to a specific frame of reference.

At bottom, this was an almost metaphysical world view not directly refutable by any simple empirical test. But Galileo adopted this worldview or paradigm, because he deeply believed it to be true, and was therefore willing to defend it at great personal cost, refusing to recant his Copernican view when he could have easily appeased the Church by describing the Copernican theory as just a tool for predicting planetary motion rather than an actual representation of reality. Early empirical tests did not support heliocentrism over geocentrism, but Galileo had faith that theoretical advancements and improved measurements would eventually vindicate the Copernican theory. He was right of course, but strict empiricism would have led to a premature rejection of heliocentrism. Without a deep personal commitment to the Copernican worldview, Galileo might not have articulated the case for heliocentrism as persuasively as he did, and acceptance of heliocentrism might have been delayed for a long time.

Imre Lakatos called such deeply-held views underlying a scientific theory the hard core of the theory (aka scientific research program), a set of beliefs that are maintained despite apparent empirical refutation. The response to any empirical refutation is not to abandon or change the hard core but to adjust what Lakatos called the protective belt of the theory. Eventually, as refutations or empirical anomalies accumulate, the research program may undergo a crisis, leading to its abandonment, or it may simply degenerate if it fails to solve new problems or discover any new empirical facts or regularities. So Romer’s criticism of Lucas’s dogmatic attachment to market clearing – Lucas frequently makes use of ad hoc price stickiness assumptions; I don’t know why Romer identifies market-clearing as a Lucasian dogma — may be no more justified from a history of science perspective than would criticism of Galileo’s dogmatic attachment to heliocentrism.

So while I have many problems with Lucas, lack of Feynman integrity is not really one of them, certainly not in the top ten. What I find more disturbing is his narrow conception of what economics is. As he himself wrote in an autobiographical sketch for Lives of the Laureates, he was bewitched by the beauty and power of Samuelson’s Foundations of Economic Analysis when he read it the summer before starting his training as a graduate student at Chicago in 1960. Although it did not have the transformative effect on me that it had on Lucas, I greatly admire the Foundations, but regardless of whether Samuelson himself meant to suggest such an idea (which I doubt), it is absurd to draw this conclusion from it:

I loved the Foundations. Like so many others in my cohort, I internalized its view that if I couldn’t formulate a problem in economic theory mathematically, I didn’t know what I was doing. I came to the position that mathematical analysis is not one of many ways of doing economic theory: It is the only way. Economic theory is mathematical analysis. Everything else is just pictures and talk.

Oh, come on. Would anyone ever think that unless you can formulate the problem of whether the earth revolves around the sun or the sun around the earth mathematically, you don’t know what you are doing? And, yet, remarkably, on the page following that silly assertion, one finds a totally brilliant description of what it was like to take graduate price theory from Milton Friedman.

Friedman rarely lectured. His class discussions were often structured as debates, with student opinions or newspaper quotes serving to introduce a problem and some loosely stated opinions about it. Then Friedman would lead us into a clear statement of the problem, considering alternative formulations as thoroughly as anyone in the class wanted to. Once formulated, the problem was quickly analyzed—usually diagrammatically—on the board. So we learned how to formulate a model, to think about and decide which features of a problem we could safely abstract from and which he needed to put at the center of the analysis. Here “model” is my term: It was not a term that Friedman liked or used. I think that for him talking about modeling would have detracted from the substantive seriousness of the inquiry we were engaged in, would divert us away from the attempt to discover “what can be done” into a merely mathematical exercise. [my emphasis].

Despite his respect for Friedman, it’s clear that Lucas did not adopt and internalize Friedman’s approach to economic problem solving, but instead internalized the caricature he extracted from Samuelson’s Foundations: that mathematical analysis is the only legitimate way of doing economic theory, and that, in particular, the essence of macroeconomics consists in a combination of axiomatic formalism and philosophical reductionism (microfoundationalism). For Lucas, the only scientifically legitimate macroeconomic models are those that can be deduced from the axiomatized Arrow-Debreu-McKenzie general equilibrium model, with solutions that can be computed and simulated in such a way that the simulations can be matched up against the available macroeconomics time series on output, investment and consumption.

This was both bad methodology and bad science, restricting the formulation of economic problems to those for which mathematical techniques are available to be deployed in finding solutions. On the one hand, the rational-expectations assumption made finding solutions to certain intertemporal models tractable; on the other, the assumption was justified as being required by the rationality assumptions of neoclassical price theory.

In a recent review of Lucas’s Collected Papers on Monetary Theory, Thomas Sargent makes a fascinating reference to Kenneth Arrow’s 1967 review of the first two volumes of Paul Samuelson’s Collected Works in which Arrow referred to the problematic nature of the neoclassical synthesis of which Samuelson was a chief exponent.

Samuelson has not addressed himself to one of the major scandals of current price theory, the relation between microeconomics and macroeconomics. Neoclassical microeconomic equilibrium with fully flexible prices presents a beautiful picture of the mutual articulations of a complex structure, full employment being one of its major elements. What is the relation between this world and either the real world with its recurrent tendencies to unemployment of labor, and indeed of capital goods, or the Keynesian world of underemployment equilibrium? The most explicit statement of Samuelson’s position that I can find is the following: “Neoclassical analysis permits of fully stable underemployment equilibrium only on the assumption of either friction or a peculiar concatenation of wealth-liquidity-interest elasticities. . . . [The neoclassical analysis] goes far beyond the primitive notion that, by definition of a Walrasian system, equilibrium must be at full employment.” . . .

In view of the Phillips curve concept in which Samuelson has elsewhere shown such interest, I take the second sentence in the above quotation to mean that wages are stationary whenever unemployment is X percent, with X positive; thus stationary unemployment is possible. In general, one can have a neoclassical model modified by some elements of price rigidity which will yield Keynesian-type implications. But such a model has yet to be constructed in full detail, and the question of why certain prices remain rigid becomes of first importance. . . . Certainly, as Keynes emphasized the rigidity of prices has something to do with the properties of money; and the integration of the demand and supply of money with general competitive equilibrium theory remains incomplete despite attempts beginning with Walras himself.

If the neoclassical model with full price flexibility were sufficiently unrealistic that stable unemployment equilibrium be possible, then in all likelihood the bulk of the theorems derived by Samuelson, myself, and everyone else from the neoclassical assumptions are also contrafactual. The problem is not resolved by what Samuelson has called “the neoclassical synthesis,” in which it is held that the achievement of full employment requires Keynesian intervention but that neoclassical theory is valid when full employment is reached. . . .

Obviously, I believe firmly that the mutual adjustment of prices and quantities represented by the neoclassical model is an important aspect of economic reality worthy of the serious analysis that has been bestowed on it; and certain dramatic historical episodes – most recently the reconversion of the United States from World War II and the postwar European recovery – suggest that an economic mechanism exists which is capable of adaptation to radical shifts in demand and supply conditions. On the other hand, the Great Depression and the problems of developing countries remind us dramatically that something beyond, but including, neoclassical theory is needed.

Perhaps in a future post, I may discuss this passage, including a few sentences that I have omitted here, in greater detail. For now I will just say that Arrow’s reference to a “neoclassical microeconomic equilibrium with fully flexible prices” seems very strange inasmuch as price flexibility has absolutely no role in the proofs of the existence of a competitive general equilibrium for which Arrow and Debreu and McKenzie are justly famous. All the theorems Arrow et al. proved about the neoclassical equilibrium were related to existence, uniqueness and optimaiity of an equilibrium supported by an equilibrium set of prices. Price flexibility was not involved in those theorems, because the theorems had nothing to do with how prices adjust in response to a disequilibrium situation. What makes this juxtaposition of neoclassical microeconomic equilibrium with fully flexible prices even more remarkable is that about eight years earlier Arrow wrote a paper (“Toward a Theory of Price Adjustment”) whose main concern was the lack of any theory of price adjustment in competitive equilibrium, about which I will have more to say below.

Sargent also quotes from two lectures in which Lucas referred to Don Patinkin’s treatise Money, Interest and Prices which provided perhaps the definitive statement of the neoclassical synthesis Samuelson espoused. In one lecture (“My Keynesian Education” presented to the History of Economics Society in 2003) Lucas explains why he thinks Patinkin’s book did not succeed in its goal of integrating value theory and monetary theory:

I think Patinkin was absolutely right to try and use general equilibrium theory to think about macroeconomic problems. Patinkin and I are both Walrasians, whatever that means. I don’t see how anybody can not be. It’s pure hindsight, but now I think that Patinkin’s problem was that he was a student of Lange’s, and Lange’s version of the Walrasian model was already archaic by the end of the 1950s. Arrow and Debreu and McKenzie had redone the whole theory in a clearer, more rigorous, and more flexible way. Patinkin’s book was a reworking of his Chicago thesis from the middle 1940s and had not benefited from this more recent work.

In the other lecture, his 2003 Presidential address to the American Economic Association, Lucas commented further on why Patinkin fell short in his quest to unify monetary and value theory:

When Don Patinkin gave his Money, Interest, and Prices the subtitle “An Integration of Monetary and Value Theory,” value theory meant, to him, a purely static theory of general equilibrium. Fluctuations in production and employment, due to monetary disturbances or to shocks of any other kind, were viewed as inducing disequilibrium adjustments, unrelated to anyone’s purposeful behavior, modeled with vast numbers of free parameters. For us, today, value theory refers to models of dynamic economies subject to unpredictable shocks, populated by agents who are good at processing information and making choices over time. The macroeconomic research I have discussed today makes essential use of value theory in this modern sense: formulating explicit models, computing solutions, comparing their behavior quantitatively to observed time series and other data sets. As a result, we are able to form a much sharper quantitative view of the potential of changes in policy to improve peoples’ lives than was possible a generation ago.

So, as Sargent observes, Lucas recreated an updated neoclassical synthesis of his own based on the intertemporal Arrow-Debreu-McKenzie version of the Walrasian model, augmented by a rationale for the holding of money and perhaps some form of monetary policy, via the assumption of credit-market frictions and sticky prices. Despite the repudiation of the updated neoclassical synthesis by his friend Edward Prescott, for whom monetary policy is irrelevant, Lucas clings to neoclassical synthesis 2.0. Sargent quotes this passage from Lucas’s 1994 retrospective review of A Monetary History of the US by Friedman and Schwartz to show how tightly Lucas clings to neoclassical synthesis 2.0 :

In Kydland and Prescott’s original model, and in many (though not all) of its descendants, the equilibrium allocation coincides with the optimal allocation: Fluctuations generated by the model represent an efficient response to unavoidable shocks to productivity. One may thus think of the model not as a positive theory suited to all historical time periods but as a normative benchmark providing a good approximation to events when monetary policy is conducted well and a bad approximation when it is not. Viewed in this way, the theory’s relative success in accounting for postwar experience can be interpreted as evidence that postwar monetary policy has resulted in near-efficient behavior, not as evidence that money doesn’t matter.

Indeed, the discipline of real business cycle theory has made it more difficult to defend real alternaltives to a monetary account of the 1930s than it was 30 years ago. It would be a term-paper-size exercise, for example, to work out the possible effects of the 1930 Smoot-Hawley Tariff in a suitably adapted real business cycle model. By now, we have accumulated enough quantitative experience with such models to be sure that the aggregate effects of such a policy (in an economy with a 5% foreign trade sector before the Act and perhaps a percentage point less after) would be trivial.

Nevertheless, in the absence of some catastrophic error in monetary policy, Lucas evidently believes that the key features of the Arrow-Debreu-McKenzie model are closely approximated in the real world. That may well be true. But if it is, Lucas has no real theory to explain why.

In his 1959 paper (“Towards a Theory of Price Adjustment”) I just mentioned, Arrow noted that the theory of competitive equilibrium has no explanation of how equilibrium prices are actually set. Indeed, the idea of competitive price adjustment is beset by a paradox: all agents in a general equilibrium being assumed to be price takers, how is it that a new equilibrium price is ever arrived at following any disturbance to an initial equilibrium? Arrow had no answer to the question, but offered the suggestion that, out of equilibrium, agents are not price takers, but price searchers, possessing some measure of market power to set price in the transition between the old and new equilibrium. But the upshot of Arrow’s discussion was that the problem and the paradox awaited solution. Almost sixty years on, some of us are still waiting, but for Lucas and the Lucasians, there is neither problem nor paradox, because the actual price is the equilibrium price, and the equilibrium price is always the (rationally) expected price.

If the social functions of science were being efficiently discharged, this rather obvious replacement of problem solving by question begging would not have escaped effective challenge and opposition. But Lucas was able to provide cover for this substitution by persuading the profession to embrace his microfoundational methodology, while offering irresistible opportunities for professional advancement to younger economists who could master the new analytical techniques that Lucas and others were rapidly introducing, thereby neutralizing or coopting many of the natural opponents to what became modern macroeconomics. So while Romer considers the conquest of MIT by the rational-expectations revolution, despite the opposition of Robert Solow, to be evidence for the advance of economic science, I regard it as a sign of the social failure of science to discipline a regressive development driven by the elevation of technique over substance.

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Memo to Tom Sargent: Economics Is More than Just Common Sense

Paul Krugman was really not very happy with his fellow Nobel Laureate Tom Sargent this week, posting two consecutive rebuttals (here and here) to a 2006 commencement speech (five years before getting the prize) that Sargent gave at UC Berkeley.

Let’s look at what Sargent had to say. All of it.

I remember how happy I felt when I graduated from Berkeley many years ago. But I thought the graduation speeches were long. I will economize on words.

Economics is organized common sense. Here is a short list of valuable lessons that our beautiful subject teaches.

1. Many things that are desirable are not feasible.

2. Individuals and communities face trade-offs.

3. Other people have more information about their abilities, their efforts, and their preferences than you do.

4. Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.

5. There are tradeoffs between equality and efficiency.

6. In an equilibrium of a game or an economy, people are satisfied with their choices. That is why it is difficult for well-meaning outsiders to change things for better or worse.

7. In the future, you too will respond to incentives. That is why there are some promises that you’d like to make but can’t. No one will believe those promises because they know that later it will not be in your interest to deliver. The lesson here is this: before you make a promise, think about whether you will want to keep it if and when your circumstances change. This is how you earn a reputation.

8. Governments and voters respond to incentives too. That is why governments sometimes default on loans and other promises that they have made.

9. It is feasible for one generation to shift costs to subsequent ones. That is what national government debts and the U.S. social security system do (but not the social security system of Singapore).

10. When a government spends, its citizens eventually pay, either today or tomorrow, either through explicit taxes or implicit ones like inflation.

11. Most people want other people to pay for public goods and government transfers (especially transfers to themselves).

12. Because market prices aggregate traders’ information, it is difficult to forecast stock prices and interest rates and exchange rates.

I was mainly struck by two things about this speech:

First, the brevity of the speech is attributed to empathy toward the limited attention span of the audience, but it is hard to avoid the suspicion that Sargent was responding to the incentive to shirk the challenging responsibility of a commencement speaker to say something meaningful and memorable, instead patching together a list of truisms and platitudes interspersed with a few potentially problematic assertions, without distinguishing between the platitudinous and the problematic.

Second, the complacent tone, audible especially in the sentence: “Economics is organized common sense.” At the same time Sargent says that economics is a beautiful subject. It would be interesting to find out what it is about the organization of common sense that seems beautiful to Sargent, but let us not probe too deeply into Sargent’s thought processes. Nearly three years ago, just after starting this blog, I observed that common sense is not enough to do economics right. Things are not always what they seem to be. The earth is not really flat and the sun doesn’t really revolve around the earth. Our common sense has to be taught how to perceive reality, which means that we have to think more carefully about the world than just accepting what common sense tells us must be so.

That’s why reading Sargent, I couldn’t help but think of what John Stuart Mill, who very likely had an IQ even higher than Tom Sargent, said 165 years ago in his great treatise Principles of Political Economy.

Happily, there is nothing in the laws of Value which remains for the present or any future writer to clear up; the theory of the subject is complete.

So, in the spirit of not just taking things at face value, let me offer some brief comments on Sargent’s 12 maxims.

1 Many things that are desirable are not feasible. Comment: And the feasibility of many of those things that are desirable is uncertain. In fact, mention of uncertainty — a rather important feature of reality, or so it would seem to my common sense  — is conspicuous by its absence.

2 Individuals and communities face tradeoffs. Comment: Tradeoffs don’t necessarily exist in situations when individuals or communities are not optimizing. Even though every individual is optimizing, the community may not be.

3 Other individuals have more information about their abilities, their efforts, and their preferences than you do. Nitpicky Comment: Very badly written. Evidently he means that other individuals have more information about themselves than you have about them, but it could be interpreted to mean that they have more information about themselves than you have about yourself, some people being more self-aware than others.

4 Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always working as intended. Comment: None, but see 11 below.

5 There are tradeoffs between equality and efficiency. Comment: This is so vague and so simplistic as to be useless.

6 In an equilibrium of a game or an economy, people are satisfied with their choices. That is why it is difficult for well-meaning outsiders to change things for better or worse. Comment: What kind of equilibrium are we talking about? Not every equilibrium is a social optimum. How do we know that equilibrium is an appropriate way of analyzing a social state? In an equilibrium, can there be surprises? Regrets? If we observe people being surprised and being regretful, does that mean they are deluded or misinterpreting their feelings? What is the common sense understanding that one should attach to such frequently observed states of mind?

7. In the future, you too will respond to incentives. That is why there are some promises that you’d like to make but can’t. No one will believe those promises because they know that later it will not be in your interest to deliver. The lesson here is this: before you make a promise, think about whether you will want to keep it if and when your circumstances change. This is how you earn a reputation. Comment: None.

8. Governments and voters respond to incentives too. That is why governments sometimes default on loans and other promises that they have made. Comment: None.

9. It is feasible for one generation to shift costs to subsequent ones. That is what national government debts and the U.S. social security system do (but not the social security system of Singapore). Comment: The circumstances under which generational shifts occur and the magnitude of those shifts are not so clear. Also, if the growth of knowledge and productivity, which are not necessarily tied to the amount of current saving, is likely to make future generations substantially better off than the current generation, it is not obvious that imposing a debt burden on future generations is an unjust choice.

10. When a government spends, its citizens eventually pay, either today or tomorrow, either through explicit taxes or implicit ones like inflation. Comment: Depends on what governments spend on.

11. Most people want other people to pay for public goods and government transfers (especially transfers to themselves). Comment: Why most? Who does want to pay for public goods and who doesn’t want to receive transfers? I thought that everyone responds to incentives. See 4 above.

12. Because market prices aggregate traders’ information, it is difficult to forecast stock prices and interest rates and exchange rates. Comment: None.

 

 

 

 


About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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