Macroeconomics Is Hard

[koganbot]

My guess is that macroeconomics isn't all that hard once you've mastered the vocabulary and learned the theories - not as hard as physics or biochemistry or crossword puzzles or computer programming, anyway. Maybe not as hard as microeconomics, either. But macroeconomics gives counterintuitive results, so people like me who haven't done the work and mastered whatever it is I need to master are likely to be somewhat at sea, and people who've never made even a rudimentary effort to understand are likely to be drastically wrong in their ideas. Such people comprise almost all voters and most elected officials. The thing is, if governments of countries with large economies, like the U.S., make bad macroeconomic decisions, millions upon millions of people around the world suffer and lead blighted lives as a result.

We tangentially touched on macroeconomics a couple of months ago over on Freaky Trigger, Kat summarizing a radio show she heard thusly ("I Wanna Be A Macro Man"): "The evidence shows that most female economists at this level tend to come from an industry background, with practical experience in the markets. MPC members on the other hand almost entirely have their background in academia. The MPC favours the application of macro economics, which (roughly) involves attempting to find umbrella trends throughout the entire economy. Unfortunately, the business-orientated female economists generally agree that macro economics doesn't actually work in real life," the implication being that their own "real life" business experience is needed to counterbalance the ideas of the pointy heads. Anyhow, I read a recent Paul Krugman blog post ("Macroeconomics Is Hard") that's a counterargument to such contentions:

The thing is, no amount of experience meeting a payroll helps you understand issues that are critically affected by the way things add up at a macro level. Businesses are open systems; the world economy is a closed system, with feedback effects that are crucial but play no role in ordinary business experience. In particular, an individual businessman, no matter how brilliant, never has to worry about the fact that total income equals total spending, so that if some people spend less, either someone else must spend more, or aggregate income must fall.

This is why we have a field called macroeconomics. Unfortunately, the hard-won insights of macroeconomics are being rejected right now in favor of visceral feelings. And we'll all pay the price.

I assume the key assertion is "total income equals total spending so that if some people spend less, either someone else must spend more, or aggregate income must fall." Krugman most certainly isn't someone who thinks we can ignore evidence and real experience; rather, he'd argue that people with the wrong experience are dogmatically applying their ideas without taking account of what actually happens in the - broader - real world, with potentially disastrous results when their bad assumptions become policy. (E.g., lots of people - the unemployed, those needing to pay down debt, those who fear unemployment, those who run businesses but whose orders are down, etc. - are necessarily spending less right now, and the crucial entities able to counteract this by spending more are governments, but politicians gain points by calling for tax cuts and reduced spending.)

My guess is that not every one of you who reads my lj could tell say off the top of your head what the argument was for a bailout of investment banks in late '08 or a stimulus package in early '09.

Comments

[koganbot]

Not to imply that macroeconomists all take the same position. Here's a long piece Krugman wrote last year for the Sunday NY Times magazine section about the basic split in American macroeconomics between saltwater (neo-Keynesians) and freshwater (neoclassicists):

"How Did Economists Get It So Wrong?"

An "F" for Fatalism

[talrose.livejournal.com]

Well, off the top of my head: The argument for a bailout of the investment banks was that if we didn't make that investment, the aggregate impact created by the bankruptcy of our largest financial institutions would almost immediately sink the world into a global depression. A lot of this, from the admittedly little I've gleaned, has to do with the fact that the largest financial institutions, over the course of roughly a half-century, bought up many of the mid-level and small banks, thereby creating huge conglomerates that contain multiple banks. Therefore, if, say, Lehmann and Citibank and Bank of America and Morgan Stanley all collapsed, it would be the equivalent of about 60% of the international banking system collapsing in one day, which is basically end-of-world catastrophe. We were basically unable to do anything but bail out the banks.

Moreover, the collective knowledge of impending financial doom threw everyone into a panic, so people were afraid to invest or to purchase goods. So during this financial lull, in order for the banks to survive, the stimulus was necessary to once again default them into bankruptcy. I'm more unclear about the stimulus than I am about the bailout, but I'm not necessarily clear on either, even though I have read numerous articles on the economy this year, whereas beforehand I would have described my knowledge of even rudimentary econ. knowledge as equivalent to a kindergartner's understanding of the English language.

Krugman's assertion seems to be that an individual businessman should not have so much control over the world economy, and that they should, in fact, exist in completely separate realms. From what I gather, what he's saying is that individual businessmen exert too much power over the world economy, and what's frightening about this is that their knowledge of Macroecon, a significant component of the world economy, is very limited, and that this is frightening.

Re: An "F" for Fatalism

[talrose.livejournal.com]

Sorry, in the second paragraph: to prevent them from defaulting into bankruptcy.

Re: An "F" for Fatalism

[koganbot]

I'll hold off my own guesses explanations regarding TARP and the stimulus until I see if anyone else wants to play. (I'd assume that most kindergartners in English-speaking countries know English far better than most of us adults know econ.) But I don't think that Krugman here is concerning himself with whether individual businessmen have too much power, but rather that the insights one gets from running a business, whether the business is big or small (and the insights one gets from managing a household budget or an individual budget, for that matter), don't transfer to macroeconomics. So if we go with our "common sense" ideas of what we as individuals should do when times are hard, and then say that that's what governments should do as well, we are instructing governments to do the exact wrong thing.

Re: An "F" for Fatalism

[talrose.livejournal.com]

Well, when you say "what governments should do," are you referring to the Treasury, the Fed, economic advisers? And do the heads of the largest investment banks and corporations factor into "governments," since it's more or less obvious that either they or the lobbyists working for them possess a huge influence in how we (our government) makes financial policy decisions? And how do we jump from what individuals do when running a business to what governments do when running economies? And how do we necessarily instruct governments what to do by our actions?

I'm not trying to be antagonistic, I'm really just trying to understand.

Re: An "F" for Fatalism

[talrose.livejournal.com]

Sorry, I confused some of your points, and hopefully I won't continue to make these hasty errors: What I mean is why would we necessarily instruct governments what to do when times are hard, and why would they listen to us?

Re: An "F" for Fatalism

[koganbot]

Well, "we" here are voters and elected officials as well as bankers and businessmen and heads of state and so forth. Government here in the U.S. is not just an administration but e.g. the Senators whose votes they need to forestall a filibuster, the states that have balanced budget requirements, regional members of federal reserve, and so forth. Krugman's concern in his post isn't about whether individuals have too much power, but whether people don't know what they're doing. He's not saying that someone who, for instance, worked for an investment bank can't have good ideas about macro. He's just saying that it's your ideas about macro, and whether they're good or not, that qualify you, not your business experience.

The first sentence of his post, by the way, goes: "I'm getting some fairly hysterical reactions to today's column, many of them along the lines of 'You're an idiot — I know what it's like out there in the real world of business' etc."

My impression is that Krugman believes that the relevant people in the Obama administration are very well qualified but were too timid at crucial junctures. But that's not the subject of his post. And those gov't officials have to live in a political environment where people - including officials in other countries and so on - have ideas about macro that Krugman considers bad ones, or no idea of macro at all. (In that column of his on the day of the post, he specifically cited, as people perpetuating or acting on bad ideas, Rick Santelli on CNBC, John Boehner, an unnamed German official, moralizers in general, and voters.)