Sunday, July 8, 2012

Heterodox and Mainstream Economics: The Great Confusion

Simon Wren-Lewis has a post on heterodox versus mainstream macroeconomics in which he seems surprised by what he calls the Great Divide between the two groups. He claims to be sympathetic to the heterodox project, at least along the lines of Steve Keen, but argues that the "rejectionist strategy is of course unlikely to win friends within the mainstream."

Wren-Lewis also suggests that a Minsky model developed by Keen (which according to Keen was rejected by several mainstream journals) is very similar to his ideas, but he fails to note that the Keen's model, as well as Minsky's theory, does not include a crucial characteristic of mainstream models, New Keynesian (NK), New Classical (NC), Real Business Cycle (RBC) and New Neoclassical Synthesis (NNS) alike, namely: Friedman's natural rate hypothesis.*

If you accept that cycles are just a shock (monetary or real) to an optimal trend and that the only thing that prevents the return of the economy to its optimal level is some sort of rigidity, then the obvious solution, at least in the long run, is to eliminate the rigidities. By the way, that is the reason why the NKs and NNSs authors end up believing in a confidence fairy, very much like NCs and RBCs authors. The NK and NNS fairy being about higher inflation expectations allowing for more investment demand, rather than directly about the less uncertainty allowing for more investment.

Wren-Lewis' confusion is to assume that the proximity of heterodox Keynesian groups and NKs like him on policy issues implies that on a deeper theoretical level there must be agreement too, and that this does not happen because of the sectarian nature of the heterodoxy.

Krugman's views, by the way, are very similar, in the sense that he seems to not quite understand why he is not seen as Keynesian by some heterodox economists. In a recent post, he argues that:
"Some devotees of Keynes claim that people like me aren’t really Keynesians – and while there are some serious grounds for the charge, part of the reason is precisely that we’ve treated Keynes as an inspiration to be modified in the face of evidence rather than as holy writ."
The confusion is incredible. Keynes himself accepted some neoclassical ideas that made his argument limited and heterodox authors actually have discarded a lot of Keynesian concepts (I myself believe that both the marginal efficiency of capital and liquidity preference are highly problematic, but that is material for other posts). The problem with Krugman is that he maintains (yes you guessed) the natural rate (a concept that a least Keynes wanted to drop from his theory), and suggests that unemployment and the recession are caused by the downward rigidity of the interest rate (a liquidity trap), propositions for which there is little evidence. Krugman is the one that treats neoclassical principles (the idea that a natural rate exists) as holy writ!

Both Krugman and Wren-Lewis seem to believe that economics (and science) is about convincing the others on a political level and are puzzled by the fact that heterodox do not fall in line with the NKs. That is why a less rejectionist, to use Wren-Lewis term, strategy is suggested (a similar view by Colander is criticized here). The problem is that evidence and logic (for the logical critique of the natural rate you must get the capital debates) suggest that the natural rate does not exist. Don't get me wrong, on political issues most heterodox authors are with Krugman, Wren-Lewis and company, against austerity, but science implies (as Krugman himself notes) adherence to facts.

So why don't NKs just renounce to the idea of a natural rate once and for all. For one they would make lots of friends within the heterodox community, which is way ahead in understanding the crisis (and foreseeing it too), and also would make their models more realistic.

* I have my own troubles with the kind of model presented in that paper by Keen, which are related to his profit driven investment function, but that is better discussed in another post.

4 comments:

  1. I largely agree with the concluding remarks from your paper ("If heterodox economists are in search of an audience I would suggest shooting for policy-makers that are often more pragmatic and clearly more relevant. In the meantime heterodox economists should be less concerned about dialogue with the mainstream and more preoccupied about the flaws, including the methodological ones, in the mainstream analysis, and working to show how heterodox approaches can provide more fruitful understanding of real economies").

    In my opinion, those guys' proposals for a mainstream-heterodox economic ecumenism are largely a waste of time, from a pragmatic point of view (although the exercise at times could have some interest from an academic point of view).

    I, however, do have a little quibble with your views, as expressed in the quote above: policy-makers certainly should be one of the main concerns, but not the only concern.

    I think people like Bill Mitchell are onto something when they write to the larger public.

    If you think about it, that's what the Austrians have done, and it seems to be working pretty well for them. Particularly in the US.

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  2. I love serendipity.

    After posting the comment above, I went to read Robert Viennau's latest. He's commenting on some outburst from Noah Smith.
    http://robertvienneau.blogspot.com.au/2012/07/vocabulary-for-marxism.html

    But Smith's real beef was with what looks like an Austrian/Tea Party forum. If you have the time and the inclination, you should read the comments.

    Their quality is really poor, even by right-whinger (yes, with h!) standards. The point is not that people really understand the finer points of theory. These people clearly don't. But they embrace the theory and exercise political pressure.

    A guy like Bill Mitchell adds to this one element: he actually knows what he's talking about and teaches the masses.

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  3. "Some devotees of Keynes claim that people like me aren’t really Keynesians – and while there are some serious grounds for the charge, part of the reason is precisely that we’ve treated Keynes as an inspiration to be modified in the face of evidence rather than as holy writ."

    This is a reprehensible quote and quite typical of Krugman's complete arrogance. The quote implies that Post-Keynesians don't modify their views in light of empirical evidence. However, I'll bet that Krugman can cite exactly ZERO instances in which dogmatic adherence to Keynes' work has led Post-Keynesians to circumvent empirical evidence.

    In fact, I'd argue that its New Keynesians like Krugman who refuse to look at the evidence that negative interest rate policies and QE don't work so that they can cling to their hopelessly out-of-date ISLM models. They're dogmatics Hicksians -- even though Hicks, much like Marx, was no Hicksian.

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  4. Nothing against broader audiences Magpie, hence a blog. In my further reply to Colander et al (which will be published in a book edited by Fred Lee and Marc Lavoie, forthcoming next year and called In Defense of Post Keynesian Economics)I actually have a quote from Krugman that I think defines the NKs TheIlussionist. It says:

    “By the early 1980s it was already common knowledge among people I hung out with that the only way to get non-crazy macroeconomics published was to wrap sensible assumptions about output and employment in something else, something that involved rational expectations and intertemporal stuff
    and made the paper respectable. And yes, that was conscious knowledge,which shaped the kinds of papers we wrote. So you could do exchange rate models that actually had realistic assumptions about prices and employment,but put the focus on rational expectations in the currency market, so that people really didn’t notice. Or you could model optimal investment choices, with the underlying framework fairly Keynesian, but hidden in the background. And so on.”

    So that's how attached to logic or evidence he was. Using crazy models to get published. Enough said.

    The whole paper is here: http://www.econ.utah.edu/activities/papers/2011_14.pdf

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