Fixing the economy: rebuilding macroeconomics

First year BSc Economics student Lydia Evans provides a recap of an event organised by Birkbeck’s Economics + Finance Society, at which Dr Angus Armstrong introduced the new research network he directs.

The story is infamous: the Queen visits the London School of Economics and asks why no one saw the recent global financial crisis coming. Angus Armstrong believes that it’s not that people didn’t see a catastrophe on the horizon, “it’s that the institutions almost didn’t want to listen to them”. Raghuram Rajan, Joseph Stiglitz and others attempted to warn the world that a seismic shock was going to take place. The main question is how have we moved forward? Armstrong thinks that the financial world has not, it continues to choose willful ignorance. He directs a new network that wants to re-evaluate the entrenched economic models and the collective consciousness of those who use them.

Rebuilding Macroeconomics, a network of economists and academics, are attempting research that is disruptive, not immune to failure but genuinely independent to ask uncomfortable questions. The key to the efficacy of this research is how it is sourced. The network’s blueprint is set out as three tributaries: Discovery Meetings, Research Hubs, and Pilot Projects. Discovery Meetings are notable for their inclusivity. They seek to attract people from all backgrounds to discuss the most important macroeconomic questions. These discussions lead to fresh insights and methodologies to be examined by policy-makers and scholars in the Research Hubs. The most promising ideas turn into pilot projects. The network is funded by the Economic and Social Research Council and hosted by the National Institute of Economic and Social Research.

Does the UK really need such reformatory research? He finds something “profoundly wrong” when a country as rich as the UK requires food banks to feed some of its population. Government debt is 90% of GDP. The Bank of England is only able to claim pyrrhic victories. It may hit its inflation target but other economic measures are in turmoil. Mark Carney has himself confessed that 95% of the movement in interest rates is determined by international events.  Current interest rates may not be what the UK actually needs them to be. Armstrong feels that the established institutions are reliant upon Knut Wicksell’s Rocking Horse. Whatever the instability, the assumption is that the status quo will always return. This is no longer the reality and nothing has been done about it. The failure is intellectual, not regulatory, and economists must be brave enough to confront the zeitgeist.

When Armstrong returned from study in America and expressed his wish to research financial crises, he was told that these were a problem only for the developing world. He mentions a new paper in the Journal of Economic Perspectives, considering how those who disagree with the mainstream in Economics are labelled dilettantes. Is the discipline consumed by an ill-conceived adherence to orthodoxy? Not all new ideas are worthy but it’s difficult to ignore a belligerent spirit against outliers. Whatever the future holds, Armstrong is not alone in arguing that the existing economic paradigm must urgently be confronted.

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One thought on “Fixing the economy: rebuilding macroeconomics

  1. Lydia Evans has written an interesting review of Dr Armstrong’s talk. But the author’s argument that the existing economic paradigm must urgently be confronted is itself in urgent need of being confronted. While it is convenient to think that there is some “economic paradigm”, some epistemic authority or even a typical way of doing research, this view is catastrophically wrong.

    Economics is, and throughout its history always has been, a chronically contested discipline. One reason for this is that the subject of economics has characteristics that make it a particularly inviting target and playground for philosophical argument and analysis. Even a casual survey of the literature will reveal that today economics already reflects a pluralism of approaches. And while it may be fashionable in some student circles to argue that the 2007/8 financial crisis was a symptom of some deep problem with economics, the actual situation is rather different.

    The reality we face now is that in the last two decades the economics research frontier has been significantly transformed by the emergence of a large set of new approaches which criticize traditional, so-called “neoclassical”, assumptions, and whose origins lie largely in other sciences and disciplines. These approaches include: game theory (behavioural, evolutionary or classical), evolutionary, behavioural, neuro-economics, and agent-based computational modelling. We have also witnessed considerable advances in probability theory and statistics. In many cases economic research draws on these advances; in many cases, economists do really valuable work which contributes to statistics. Modern economics is also more empirical than it has ever been, allowing the profession to move forward, increasing our understanding of human behaviour and markets, and coming to better conclusions using more powerful techniques.

    Then there is the often mentioned argument that economics, not being a hard science, should be put on a more “scientific” footing. Some might claim that economics should borrow empirical methods from other domains, such as physics or complexity science. Some might dispute that. These debates lead nowhere, because “science” is both ill-defined and a word with many strong associations. It would be better to argue the merits or demerits of economics directly, rather than arguing whether the label of science is appropriate.

    Most of the early discussions of topics such as “is economics a science?” are based on viewpoints that now lack relevance. The early position taken was that physics was the benchmark against which one measured a field being a science. The methodology of traditional physics was the one to use for comparison. In this area the world was deterministic and not stochastic, and experiments should get the correct answer if properly conducted, or if repeated often enough the average will converge to the correct value.

    With the advent of quantum physics and areas such as oceanography and meteorology, the definition of a science changed together with the appropriate methodology. The move from dealing with just inanimate objects, as with classical physics, to animate ones as with medicine and biology, greatly extends the range of the subjects being considered and of the topic “what is science?”

    To quote from a well-known economic theorist, John Hicks, economics is “on the edge of science and on the edge of history” as it tries to use the techniques of science but its subject matter behaves differently.

    I do not buy the idea that economics is really the failure some make it out to be. Yes, we can all recall when the Queen asked why nobody saw the recent global financial crisis coming. This is a nonsensical question since such prediction is in some sense impossible. Crises happen. If we could spot them, they would not be crises.
    If we had perfect foresight, there would be no markets. If everyone had perfect foresight the economy as we know it would cease to exist. There would be no markets as everyone would know the eventual price obtained, economic policies would not work as they are perfectly anticipated and everyone knows the impact, if any.

    In macroeconomics, the longest forecast horizons attempted are about three years, although forecasts up to ten years are sometimes presented. In finance, the longest forecast horizons are usually much shorter. In might be noted that evaluation is difficult for these long term forecasts as it takes many years for the actual value to become known to compare to the forecast.

    Some economic series contain what may appear to be clear trends; that is, a steadily increasing central value, such as a straight line, or a quadratic or exponential curve in time. A simple example would be Real Gross National Product. If such a variable grows steadily it will produce an exponential curve and such a curve is occasionally found in practice, but not in every country. However, economic time series such as prices or unemployment, do not contain trends, and so cannot be forecast over long periods, other than naively.

    Imagine that you are on a scientific committee which has the power to approve a non-trivial amount of funding for a research project, say £5 million. In front of you are several proposals, including the following:

    [1] A proposal to “rebuild” Political Science, which says Political Science is a failure because researchers did not predict the sequence of events during the Arab spring.

    [2] A proposal to “rebuild” Epidemiology, which says medical science is a failure because researchers did not predict the West Africa Ebola outbreak.

    [3] A proposal to “rebuild” Geology, which says that we should dismiss the current paradigm of geology for not predicting earthquakes.

    [4] etc

    Clearly, these are ridiculous ideas. Yet, this is the sort of discourse we are having.

    What about what happened after the recession? Did macroeconomics fail to provide a clear explanation for why the financial crisis led to a persistent slump in the real economy? In this case, we can probably all agree that there are a many superficially valid accounts, some of them grossly counterfactual, of how this happened. For example, in models descended from Kiyotaki-Moore, the impact of a financial crisis is given by virtue of a fall in TFP, which is not what happened in the most recent recession. There may be some truth in this. On the other hand, the last decade has revealed just how important nominal rigidities, and the traditional view of demand-side business cycles, really are.

    So what is the answer? There are no easy solutions. You see, doing economics well is hard. Very hard. One needs extensive formal training to correctly diagnose he problems. A lot of smart people have been working on these problems for decades. And so improving the discipline is tough. One needs to figure out where a lot of smart people have erred. And that takes a lot of time and struggle.

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