A new paper by the NY Fed:
The Failure to Forecast The Great Recession
Experience shows that what happens is always the thing against
which one has not made provision in advance.
-- John Maynard Keynes1
Our best plan is to plan for constant change and the potential for instability, and to recognize that the threats will constantly be changing in ways we cannot predict or fully understand.
-- Timothy Geithner2
...
How Bad Were the Forecasts for Real Activity? Economic forecasters never expect to predict precisely. One way of measuring the accuracy of their forecasts is against previous forecast errors. When judged by forecast error performance metrics from the macroeconomic quiescent period that many economists have labeled the Great Moderation, the New York Fed research staff forecasts, as well as most private sector forecasts for real activity before the Great Recession, look unusually far off the mark. One source for such metrics is a paper by Reifschneider and Tulip (2007). They analyzed the forecast error performance of a range of public and private forecasters over 1986 to 2006 (that is, roughly the period that most economists associate with the Great Moderation in the United States). On the basis of their analysis, one could have expected that an October 2007 forecast of real GDP growth for 2008 would be within 1.3 percentage points of the actual outcome 70 percent of the time. The New York Fed staff forecast at that time was for growth of 2.6 percent in 2008. Based on the forecast of 2.6 percent and the size of forecast errors over the Great Moderation period, one would have expected that 70 percent of the time, actual growth would be within the 1.3 to 3.9 percent range. The current estimate of actual growth in 2008 is-3.3 percent, indicating that our forecast was off by 5.9 percentage points. Using a similar approach to Reifschneider and Tulip but including forecast errors for 2007, one would have expected that 70 percent of the time the unemployment rate in the fourth quarter of 2009 should have been within 0.7 percentage point of a forecast made in April 2008. The actual forecast error was 4.4 percentage points, equivalent to an unexpected increase of over 6 million in the number of unemployed workers. Under the erroneous assumption that the 70 percent projection error band was based on a normal distribution, this would have been a 6 standard deviation error, a very unlikely occurrence indeed.
Three main failures in our real-time forecasting stand out:
Misunderstanding of the housing boom. Staff analysis of the increase in house prices did not find convincing evidence of overvaluation (see, for example, McCarthy and Peach [2004] and Himmelberg, Mayer, and Sinai [2005]). Thus, we downplayed the risk of a substantial fall in house prices. A robust approach would have put the bar much lower than convincing evidence.
A lack of analysis of the rapid growth of new forms of mortgage finance. Here the reliance on the assumption of efficient markets appears to have dulled our awareness of many of the risks building in financial markets in 2005-07. However, a March 2008 New York Fed staff report by Ashcraft and Schuermann provided a detailed analysis of how incentives were misaligned throughout the securitization process of subprime mortgages—meaning that the market was not functioning efficiently.
Insufficient weight given to the powerful adverse feedback loops between the financial system and the real economy. Despite a good understanding of the risk of a financial crisis from mid-2007 onward, we were unable to fully connect the dots to real activity until 2008. Eventually, by building on the insights of Adrian and Shin (2008), we gained a better grasp of the power of these feedback loops.
However, the biggest failure was the complacency resulting from the apparent ease of maintaining financial and economic stability during the Great Moderation. Perhaps most important, as noted by some analysts as early as the 1990s, these adverse consequences of the Great Moderation were most likely to arise from the actions, judgments, and decisions of financial market participants: Longer stretches of economic growth imply greater leverage and complacency and thus, greater financial problems when recessions do occur.
--William Dudley and Edward McKelvey3
Yeah, forecasting is.... very terrible. Though I don't entirely agree with your analysis. Meteorology is a very real science which is extremely terrible at forecasting beyond a very narrow horizon. I think "real sciencists" would be reasonably impressed with economics given the inherent difficulty in modelling non-linear dynamic systems.
MI, apparently no outcome exists that would shake your faith in this curve-fitting charade that you call econometrics. To a real scientist it is perfectly obvious that there is absolutely no knowledge (sublimation, robustness) contained in these models.
z1235,
Didn't address my counter-example of meteorology still being a "real science" despite having terrible forecasts, just went straight on to attack my character. And people wonder why I frequently become somewhat hostile?
FYI, you're equating econometrics with forecasting, and they are not the same. Forecasting is a very small sub-field of econometrics, and even econometricians take forecasts with a (very large) grain of salt. Perhaps take the time to learn what you're criticising?
Econometrics could only hope to come near meteorology's forecasting ability.
Forget forecasting. No outcomes (results, tests) exist that would support econometrics' ability to sublimate any knowledge whatsoever. Decades after Keynes, models are being haphazardly invented, deleted, tweaked and yet nothing sticks. There's no accumulation of knowledge, no improvement -- only "complex" models chasing complex reality in the dark. Real scientists know what they can't know. Charlatans have no idea.
I don't think real scientists would be impressed with mainstream economic models simply because they're difficult. What is impressive is accuracy and precision. I think that given the failure of the mainstream economists to foresee the housing bubble or hell, even to recognize how bad our situation actually is. The only economists I have heard of that foresaw the housing bubble were Austrians, although Krugman did advocate its initiation.
The Anarch is to the Anarchist what the Monarch is to the Monarchist. -Ernst Jünger
z1235: Econometrics could only hope to come near meteorology's forecasting ability. Forget forecasting. No outcomes (results, tests) exist that would support econometrics' ability to sublimate any knowledge whatsoever. Decades after Keynes, models are being haphazardly invented, deleted, tweaked and yet nothing sticks. There's no accumulation of knowledge, no improvement -- only "complex" models chasing complex reality in the dark. Real scientists know what they can't know. Charlatans have no idea.
Just gonna keep trolling away? Okay. If you don't want any productive conversation I just won't talk to you.
Jargon: I don't think real scientists would be impressed with mainstream economic models simply because they're difficult. What is impressive is accuracy and precision. I think that given the failure of the mainstream economists to foresee the housing bubble or hell, even to recognize how bad our situation actually is. The only economists I have heard of that foresaw the housing bubble were Austrians, although Krugman did advocate its initiation.
I didn't mean impressed because of how hard it is, I meant impressed with the amount we've managed to accomplish despite the very severe impediment. With the recent rise of Real Business Cycle models, macroeconomics is moving in the direction of a quantative theory. Give it some time. It's only a young field.
If any model could actually predict/identify a bubble, no bubbles would ever exist. As soon as a bubble becomes apparent it bursts immediately (everybody shorting whatever is inflated until the price falls to the point where it's not inflated anymore). Their very nature is that they're illusive. Either way, I don't think that's a very fair demand. It's kind of like saying, "Oh yeah. If doctors are so smart, why do people still die?".
Krugman didn't advocate its initiation. That was a joke he made. If Austrians foresaw the bubble, why didn't they short housing until its price returned in line with fundamentals, making shitloads of money in the process?
Jargon: What have we accomplished? I'm discouraged about the rise of the Real Business Cycle, because its proponents aren't putting forth a theory that has been logically deduced and it's probably gonna mean more and more money printing
What have we accomplished? I'm discouraged about the rise of the Real Business Cycle, because its proponents aren't putting forth a theory that has been logically deduced and it's probably gonna mean more and more money printing
They...absolutely are. Every major business cycle model is logically deduced. The old Keynesian model wasn't, it was just an ad hoc model. But since the 80s there's been a very strong drive to have every model microfounded on consumers maximising utility and firms maximising profit.
It's not gonna mean more money printing at all. Real Business Cycle theory is a market clearing theory of the business cycle. Most variants don't allow much room for nominal shocks (hence, "Real" business cycle as opposed to a "nominal" business cycle like Keynesianism/Monetarism). RBC theorists are strongly against economic stimulus.
They're elusive to most people, yes that's what allows them to grow. That didn't seem to stop the Misesians. They did identify the bubble. Schiff, Thornton, Paul. Here's the full list: http://www.lewrockwell.com/blog/lewrw/archives/73123.html. So they did identify the bubble using the Austrian methodology, yet the bubble continued to exist until the Lehman moment. I think it is a fair demand. Most sick people die because they can't afford the care.
Oh it was a joke? Didn't seem like that when I read it. Here's the quote: To fight this recession the Fed needs … soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. I fail to see an attempt at humour here. Identifying the existence of a bubble does not instantly grant the identifier the knowledge of when exactly the bubble would crash. If I knew there was a housing bubble in 2003 and started shorting a housing-based ETF, I would have lost way more money by 2008 than I would gain during the crash. Shorting is risky and for the most part not worth it.
EDIT: My apologies for making assumptions about RBC. I don't understand it completely yet but I'm sure there will be another time to discuss it.
The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needssoaring household spending to offset moribund business investment. And to do that,as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubbleto replace the Nasdaq bubble"
Can you substantiate your claim that this is an attempt at humor?
Jargon: Doctors are limited by technology. Economists are limited by the accuracy of their ideas. Also, pretty soon (next couple of decades) I think that diseases are going to drastically decrease with the advent of affordable nanotechnology.
Doctors are limited by technology. Economists are limited by the accuracy of their ideas. Also, pretty soon (next couple of decades) I think that diseases are going to drastically decrease with the advent of affordable nanotechnology.
Economists are limited by technology also. Specifically, the ability to collect data. That's changing. For example, normally to assess changes in the price level or labour force participation we send out interviewers to households, which is very costly in terms of both money and time. But now, as has been done with the BPP index (an independent measure of inflation), we can have a computer automatically search through millions of prices for goods and services online. The accuracy and precision of predictions economic models make is constrained, as in physics, by your ability to test for the marginal impact of each of your variables. The more access there is to data, the easier it will be to dispose of economic theories inconsistent with it.
Here's the full Krugman quote: "A few months ago the vast majority of business economists mocked concerns about a ''double dip,'' a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I've repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever. The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needssoaring household spending to offset moribund business investment. And to do that,as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubbleto replace the Nasdaq bubble" Can you substantiate your claim that this is an attempt at humor?
Here's the full Krugman quote:
"A few months ago the vast majority of business economists mocked concerns about a ''double dip,'' a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I've repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever.
So he's basically saying "People should be paying attention to those who say there's a real risk of a double-dip. The Fed isn't going to be able to avoid that just with bringing interest rates back down like normal. The only way a double-dip could possibly be averted is if there's a housing bubble to replace the Nasdaq bubble."
He's not making a recommendation that the Fed create a housing bubble. He's saying that the only reason the US wouldn't enter a double dip would be if there were a housing bubble. The US didn't have a double dip, and later Krugman said it's very likely there's a housing bubble. http://www.youtube.com/watch?v=qo4ExWEAl_k. I mean, who really cares though. This isn't especially important to the point.
It may well be that the housing market prices have yet to completely fall. Even if that were true, it still wouldn't make shorting them since 2003 or even 04 or 05 worth it. Every day you short and your pick doesn't fall, you lose money. And with less and less principal with which to invest, so the less profit you will get. So even if a stock goes up 5 points a day for a year and then down 1825 points in a day, you still will not have profited due to diminished principal. Therefore it is quite unreasonable to expect that Austrians should have shorted the housing market. That task remains to be fulfilled by the riskier investors.
Absolutely, shorting housing in 05 would be worth it. You're in it for the long run, remember. You're basically saying "Yeah, if I invest my principal now I'll end up getting a 7% return after ten years. But I'm still losing money, because every day I could be making capital gains by correctly predicting whether the stock market will go up or down". Yeah, but you can't correctly predict if the stock market will go up or down, or if the housing bubble will continue for another week or whether it'll burst tomorrow. You can predict that within ten years the price of houses will be back to trend, so you bet based on that. It doesn't matter that you could be making money while it's still going up, that's extremely risky. It's not risky to make money when you know it'll be down to trend in ten years time, but you still make a massive return (making this kind of riskless return is called arbitrage).
Economic theories, to be accurate, must be reasoned into existence and not deduced from data. Should they be reasoned in from data, one makes the mistake of confusing causation with correlation. A common example of this being Keynesians mistaking high spending as a cause of a wealthy society instead of an effect of one. To deduce theory from data and have the theory be useful one must be able to test your statements with controlled environments, i.e. all else being equal. If you cannot have this controlled environment then you cannot claim a causal relationship with any validity. How could you carry out this scenario? Making theories out of reason is a sounder approach because it does not seek to apply an inappropriate methodology: that which is appropriate for repeatable and controlled experiments to that which is unrepeatable and uncontrollable.
Also, even if you do get all the data in the world with which to put forth theories, you would very likely be using government statistics. Governments have a number of high incentives to misrepresent or lie about their economic statistics and this has been validated historically.
Moving goalposts? Not a joke anymore? Anyways let's use his own words instead of your editing. He says that to fight a recession they need high household spending, so they should inflate a bubble. Simple and in his own words. But you're right, it doesn't prove anything, although it lends support to my inital point.
Jargon: Economic theories, to be accurate, must be reasoned into existence and not deduced from data. Should they be reasoned in from data, one makes the mistake of confusing causation with correlation. A common example of this being Keynesians mistaking high spending as a cause of a wealthy society instead of an effect of one. To deduce theory from data and have the theory be useful one must be able to test your statements with controlled environments, i.e. all else being equal. If you cannot have this controlled environment then you cannot claim a causal relationship with any validity. How could you carry out this scenario? Making theories out of reason is a sounder approach because it does not seek to apply an inappropriate methodology: that which is appropriate for repeatable and controlled experiments to that which is unrepeatable and uncontrollable. Also, even if you do get all the data in the world with which to put forth theories, you would very likely be using government statistics. Governments have a number of high incentives to misrepresent or lie about their economic statistics and this has been validated historically.
I don't know what you've been told, but the Austrian School doesn't have a monopoly on logic. Every modern economic model is reasoned into existence and then confirmed or disconfirmed with data. As I said before, all modern macroeconomic models have microfoundations now, built up from the utility maximising consumer and the profit maximising producer. Data is there to test the models. It's all well and good having a theory of gravity that says every object on earth is accelerated towards the earth's centre of gravity at 9.8m/s/s irrespective of its mass. But it's not enough to just assume your model is complete and hasn't missed out on some vital steps or that your assumptions are in fact true, no matter how "self-evident" they are. You need to actually test that things are accelerated at 9.8m/s/s irrespective of mass. You may find that when you attempt to extrapolate the velocity of an object in freefall, you've missed out on a vital piece of information: air resistance (which is affected by mass).
It's still a joke, in that it's supposed to be funny... He didn't say "should". There were no normative statements there. He said that in order to avoid a double dip Greenspan would need to create a housing bubble. It's not a recommendation. I don't remember what your initial point was... sorry.
This response confounds me. Shorting a stock while it does not sink means the diminishment of principal with which one shorts. Thus the prolonged shorting of a floating stock pick means the diminishment of your investing principal such that even with a large jerk downards, you will have lost your money, not profited off of it. How could the Austrians know if the bubble was going to crash in 08, 09, 10? Or how high it would go before then? All these are essential knowledge bits for the preservation of your principal if you would consider shorting. Sadly they aren't knowable.
I don't understand what you're talking about when you say the principal diminishes. The principal doesn't diminish at all, no more than if you go long on a stock that doesn't rise every day. Are you talking about a margin call?
It is my understanding that non-Austrian schools use methodologies which roughly base off of statistical history to establish trends. Ex: "X historically rises with Z, thus when Z goes up X goes up." I believe that the Austrian school is unique in its employment of methodological individualism and subjectivity. I agree that economic history may lend support to a theory, but a reference to an incident which seems to contradict it is not a refutation. I hope there is a third poster that can lend insight on what the methodologies of the schools are. It was always my understanding that Keynesians worked that way, but perhaps not monetarists? To be frank I'm not sure but I was under the impression that the Austrians were the only ones to use logic alone to develop their theories.
He said: needs...needs...needs. Sounds normative to me. It is a suggestion to Greenspan to avoid a recession.
Jargon: It is my understanding that non-Austrian schools use methodologies which roughly base off of statistical history to establish trends. Ex: "X historically rises with Z, thus when Z goes up X goes up." I believe that the Austrian school is unique in its employment of methodological individualism and subjectivity. I agree that economic history may lend support to a theory, but a reference to an incident which seems to contradict it is not a refutation. I hope there is a third poster that can lend insight on what the methodologies of the schools are. It was always my understanding that Keynesians worked that way, but perhaps not monetarists? To be frank I'm not sure but I was under the impression that the Austrians were the only ones to use logic alone to develop their theories.
Well that's a misunderstanding. On all counts. In reference to the last one, "using logic alone", the models are built from logic, but data gives you a hint as to where you should be looking. For example, if you want to construct a theory of light scattering, it'd be very hard to do that a priori. However if you notice that the sky is blue, that gives you hint that your theory should be consistent with the fact that blue light scatters more easily in air than red light does.
needs, as in, is necessary. Like in, "If he wants to pass his test, he needs to study". Doesn't mean "I want him to study". It's just a statement of necessary condition. Either way, this is irrelevant. Krugman addressed this on his blog a while ago (which I'm sure you don't read anyway), but I can't be bothered finding it because this doesn't even matter. Who cares what Krugman said (even though it's being misinterpreted)?
Yes it does! Because it's in a bubble! Thus the price of the stock is rising until it crashes. "no more than if you go long on a stock that doesn't rise every day"; That is one important if. In a bubble, the stock rises.
This still makes no sense. The present value of your short will decrease, as the stock price rises, but you know that in the long run it will increase. Same as if you go long on a stock and the market corrects. You're not losing money; you don't have to do anything (unless there's a margin call). You know that in the long run the price of that stock will increase, and since it's the long run you're worried about, you don't care if the market corrects in the short run.
Fairly good discussion so far gentlemen, simply throwing in my two cents as to the focus of the discussion not the content as such
1. You're now getting into the more nitty-gritty details of methodology but the fact is that it would appear that you two have been misunderstanding the other one's use of 'logic'. The Austrians do employ an entirely different method based entirely upon a priori reasoning of human behavior with very limited reference to facts except insofar as they are applied a priori, whereas most economists reference external models after a general, and unpraxeological, theory is developed and then conform their theories to the models as much as possible.
2. I think it matters very much whether or not a very important, Nobel Prize winning, Keynesian economist wanted to inflate a housing bubble which dealt a serious blow to the American economy in every way imaginable. I've never heard it refered to as a joke before, I would like to see what Krugman said on the matter.
3. This actually matters a lot less, the fact is that many Austrians predicted the housing bubble and they are documented as doing so, their investment choices are fairly irrelevant and as for what is actually relevant to the discussion it should be their actual statemens about the matter.
The fact is that many Austrians predicted the housing bubble and they are documented as doing so, their investment choices are fairly irrelevant and as for what is actually relevant to the discussion it should be their actual statemens about the matter.
Many economists predicted some sort of crash, at varying levels of specificity, not just Austrians. See the paper here for a comprehensive list:
http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf. No school of thought has a monopoly on this prediction.
The Austrians do employ an entirely different method based entirely upon a priori reasoning of human behavior with very limited reference to facts except insofar as they are applied a priori, whereas most economists reference external models after a general, and unpraxeological, theory is developed and then conform their theories to the models as much as possible.
Austrians do employ some fairly stringent (implicit) empirical assumptions in their reasoning. They make assumptions about expectations and learning. Labor supply is assumed to be upward sloping. Income effects are assumed to be null.
However, I'm not sure RBC is that much better. Does a representative agent model really have firm microfoundations?
I'll rephrase. Austrian theories are developed independent of data. Other theories are developed dependent on data. Do you agree? This dependence on data is problematic for the reasons I discussed above.
It's a statement of opinion of necessary condition, as no school of economics has yet been proven objectively correct. Making statements such as 'need' in an article imply the writer's opinion on the needs of the subject. There's no way to detach opinion from the statement. A positive statement would be "the Nasdaq bubble has crashed". A normative statement is "here's what must/should/need/ has to be done for a more desirable situation". I agree with Neodoxy. That the modern-day shining knight of Keynes advocated a second bubble to fix the first speaks to the faultiness of the school's philosophy.
Neodoxy: Fairly good discussion so far gentlemen, simply throwing in my two cents as to the focus of the discussion not the content as such 1. You're now getting into the more nitty-gritty details of methodology but the fact is that it would appear that you two have been misunderstanding the other one's use of 'logic'. The Austrians do employ an entirely different method based entirely upon a priori reasoning of human behavior with very limited reference to facts except insofar as they are applied a priori, whereas most economists reference external models after a general, and unpraxeological, theory is developed and then conform their theories to the models as much as possible.
Which modern economic models do you think do this? The only example that comes to mind is something like the old simple Keynesian model, where, for example, people are assumed to consume out of current income.
Very well:
http://krugman.blogs.nytimes.com/2009/06/17/and-i-was-on-the-grassy-knoll-too/
http://econlog.econlib.org/archives/2009/06/defending_what.html
Well to me your investment choices are a signal to your confidence in, and the truthfullness of, your own theory. Your theory predicts an arbitrage opportunity. My question would be, why isn't it that investors quickly move to restore zero-arbitrage? The great thing about competition, as I'm sure you'll agree, is that businesses which provide a better good/service will thrive and eventually encompass the market, and the businesses which sell an inferior good/service will wither away and fail. Now this theory is saying that there exists a very large arbitrage opportunity; the ability for some firm to gain an exorbitant amount money with zero (or extremely low) risk. Why is it that some smart Austrian investors didn't make shitloads of riskless money, which would position them as one of the dominant fund managers now since they could say "hey look, we made massive shitloads of return on this and we didn't have to get bailed out for our excessie risk taking.". If markets are the least bit efficient, why are all investors systematically ignoring these easy gains? You don't find many $100 bills lying in the street because somebody will always quickly snatch it up. Why is this $100 bill being left on the ground?
Jargon: I'll rephrase. Austrian theories are developed independent of data. Other theories are developed dependent on data. Do you agree? This dependence on data is problematic for the reasons I discussed above.
I don't entirely agree. First, can you tell me what a priori assumptions the Austrian school makes which aren't present in other schools?
When creating models you don't just get a steady flow from one conclusion to the next that eventually lets you know everything about a certain reality. You get contingencies. An example would be your labour supply based on your wage. Does it slope up or down? The answer: It depends. There are two forces at work when your wage increase: The income effect and the substitution effect. These are basically your leisure-consumption preferences. If you have a preference for leisure, a wage increase will make you richer and you won't have to work as much to fund the same level of consumption. So you'll lower your labour supply. If you prefer consumption, your wage increase now means that an extra hour of work will give you a lot more extra consumption than it used to. So you'll increase your labour supply. Now the question of whether or not labour supply slopes up or down depends entirely on which effect dominates. The problem is, you can't just say a priori "rational people prefer consumption to leisure". These aren't things you can reason, These are subjective preferences that people decide based on emotion, not logic. So you can't determine which effect will dominate with logic alone. If you want to make statements about the impact of certain things on the labour market, you need to measure whether or not the labour supply curve slopes up or down.
Linked to that stuff above.
You're just repeating yourself. Take this example. I have $1000 and invest it in X. X goes down for five consecutive years for a total of B percent stock price. My $1000 is now worth $700. Should X rise B in one year or even one day, the principal with which it is rising is no longer $1000, but $700. Thus my possible profits were diminished from the slump period. Had I invested the day before X rose B, my $1000 would be worth 1000xB. This same principle applies to shorting. So when I buy the stock and it rises and falls, that's much worse than if I just buy the stock and it falls. Capiche?
No. You're describing exactly what I said before. You're just talking about the gains you could have made had you not shorted. The problem being, you can't predict whether it'll go up or down in the short run, but you can predict it'll go down in the long run. You care about long run gains, because they are certain. Not short run gains, which are random. Your principal never gets diminished. The current value of your asset will decrease, but you don't care. It'll increase significantly in the long run.
ziragt: Austrians do employ some fairly stringent (implicit) empirical assumptions in their reasoning. They make assumptions about expectations and learning. Labor supply is assumed to be upward sloping. Income effects are assumed to be null. However, I'm not sure RBC is that much better. Does a representative agent model really have firm microfoundations?
As rigorous as can be without becoming a useless abstraction that can't produce any results. It all begins with intertemporal utility/profit maximisation, but certain assumptions which make the theory unique are applied. There are the obvious ones which everybody uses like diminishing marginal utility and dominance of the substitution effect in current labour supply, but their special assumptions are high intertemporal elasticity of labour supply and random persistent shocks to TFP.
Marginal Interest: Now this theory is saying that there exists a very large arbitrage opportunity; the ability for some firm to gain an exorbitant amount money with zero (or extremely low) risk.
Now this theory is saying that there exists a very large arbitrage opportunity; the ability for some firm to gain an exorbitant amount money with zero (or extremely low) risk.
On the contrary, the risk of playing against an opponent who controls a printer of legal tender in his basement is extremely large. He can match whatever bet you make with an opposing bet of ten times your size. Plus, this system incentivizes his buddies (banks) -- who get first dibs to all newly created "capital" and control most other bets in this "free" market -- to bet in his direction. The risk/reward for this cabal is such that: (1) fail, everybody must bail us out lest ATM's stop giving out cash tomorrow morning, (2) win, well we win.
Are you sure you have the staying power (the capital needed to pay for your losses as prices are being pushed against you) to match theirs? Who do you think a smart trader would be betting with/against? Think again.
Your problem is that you've been brainwashed at school to view the above predicament as a free market, whereas it's pure Gosplan socialism. You will never get out of your Matrix and see reality for what it is unless you understand the workings of the central banking system.
The problem being, you can't predict whether it'll go up or down in the short run, but you can predict it'll go down in the long run. You care about long run gains, because they are certain. Not short run gains, which are random. Your principal never gets diminished. The current value of your asset will decrease, but you don't care. It'll increase significantly in the long run.
Spoken like a true trader. You must be making a killing in the markets.
This seems to have become quite a lively thread! @Marginal Interest, the problem with econometric forecasting as I see its implicit assumption of constancy in relationships of past variables. This is something Mises pointed out ad nauseum given that human action is necessarily and always a complex phenomenon, in which there are no quantitative constants and nothing is held equal as would be required to replicate laboratory settings and formulation of the type of theories found in the natural sciences.
When one forecasts, you are taking an econometric model estimated with parameters that best fit past data according to some criterion (Max. Likelihood, Least Squares etc.), and then further projecting that the underlying relationships will not change and using these to project into the future. The same goes for any "predictions" regarding the consequences on one variable given a shock in another. You are always making the untenable assumption of the constancy f these relationships among these variables, and hence identically, the invariance of their conditional probabillity distributions with respect to each other. Given this I don't find it shocking that after decades of abject failure, most econometricians don't take forecasting seriously. What I do find amazing is that anyone could ever take forecasting seriously.
What it does at best is not much better than tracing out a best fit line or relationship to data and project it to carry further into the future. The term "structural break" is used to label when these invariances stop and you cannot avoid the conclusion past relationships assumed to be invariant are broken. They could try to "solve" this problem by taking a larger set of time series data, but then it would probably dawn on them that these price data might not necessarily be comparable (again, a point Mises made continuously...).
Also, a comparison to the issues based on problems in forecasting in meteorology is further misguided. Meteorology is informed by theories developed in the natural sciences (just like good economic history is informed by praxeology), and hence the understanding of the fact that phenomena underlying weather are nonlinear and often chaotic is informed therefrom. Chaos theory gives us good reasons why as a matter of principle the behaviour fo these systems must be such that they must diverge from our predictions given the impossibillity of removing mesurement errors. These projections are made applying the theories of the natural sciences(tested and formulated in isolation) on a macroscopic scale where many elements interact. It would hence be incorrect to make an analogy with the above described methods og econometric forecasting, maing your defense of the latter by comparison to the former utterly erroneous.
"When the King is far the people are happy." Chinese proverb
For Alexander Zinoviev and the free market there is a shared delight:
"Where there are problems there is life."
z1235:On the contrary, the risk of playing against an opponent who controls a printer of legal tender in his basement is extremely large. He can match whatever bet you make with an opposing bet of ten times your size. Plus, this system incentivizes his buddies (banks) -- who get first dibs to all newly created "capital" and control most other bets in this "free" market -- to bet in his direction. The risk/reward for this cabal is such that: (1) fail, everybody must bail us out lest ATM's stop giving out cash tomorrow morning, (2) win, well we win. Are you sure you have the staying power (the capital needed to pay for your losses as prices are being pushed against you) to match theirs? Who do you think a smart trader would be betting with/against? Think again.
How does that risk exist? The only way it could possibly exist is if the ability to keep printing money would result in the real value of houses never coming down. That's absurd for two reasons: 1) It assumes a grotesque amount of money illusion; 2) if the prices never come down then it's not a bubble is it? So obviously you wouldn't short it.
Why would that be the case? I think it makes sense that markets are to a large degree efficient consistent with the semi-strong EMH. I can't consistently beat the market because I have no information that they don't already have long before me. The best I can hope for, without constantly having my finger on the buy/sell buttons to react within seconds of new news becoming available, is to do only as well as the market trend.
abskebabs: This seems to have become quite a lively thread! @Marginal Interest, the problem with econometric forecasting as I see its implicit assumption of constancy in relationships of past variables. This is something Mises pointed out ad nauseum given that human action is necessarily and always a complex phenomenon, in which there are no quantitative constants and nothing is held equal as would be required to replicate laboratory settings and formulation of the type of theories found in the natural sciences.
Yes. This problem, though not entirely the same as what Mises is saying, is known as the Lucas Critique in the mainstream.
The microeconomic concepts macro models are built on are reasonably well tested, both econometrically and experimentally. Whatever the reason for forecasts (economic or meteorological) being inherently inaccurate, the point is that the failure of such forecasts does not render the field unscientific; as was suggested by the OP.
z1235: Your problem is that you've been brainwashed at school to view the above predicament as a free market, whereas it's pure Gosplan socialism. You will never get out of your Matrix and see reality for what it is unless you understand the workings of the central banking system.
Yep. I hold a conflicting opinion, so I must have been brainwashed! I've been nothing but courteous and you give me this shit. You paying attention to this John James?
I don't think what I said above has much specifically to do with the Lucas critique. You claim these microeconomic theories are well tested, are you sure they're not just assuming what they are trying to prove? In order to "impute" utillity functions to consumers based on past purchase data you have to actually assume that their preferences were "constant." This is untestable, howver reasonable it might seem in a given scenario intuitively(which is usually how it is justified when push comes to shove, e.g. that desire for milk doesn't change each month).
Alternatively, similar problems are created if you try to find structural parameters from a simultaneous equations econometric model, e.g. of supply and demand. You have to input restrictions informed from economic theory in order to do this, but there is no way to actually test these restrictions themselves, leaving the frequent occurence that antagonistic and contradictory theories would simultaneously provide a good fit to the data (I guess I don't need to say who pointed this out again...). (In fact, I'm quite glad my econometrics lecturer was candid enough to admit this too).
However reasonable these assumptions of economic theory might be by "intuition" ( a word as definite as praxeology would probably make neoclassical economists want to run for the hills), they can't be tested or imputed from the data.
abskebabs: I don't think what I said above has much specifically to do with the Lucas critique.
I don't think what I said above has much specifically to do with the Lucas critique.
Well the problems of parameters being non-constant just due to the natural variation caused by "human complexity" is reflected in the fact that the estimators are given with a confidence interval whose width is proportional to the variance of the error term. So parameters which would change erratically in large magnitude would produce unusably large confidence intervals. So I think that problem isn't entirely valid. However the Lucas Critique remains a big issue with forecasting, so I f igured I'd mention it.
You claim these microeconomic theories are well tested, are you sure they're not just assuming what they are trying to prove? In order to "impute" utillity functions to consumers based on past purchase data you have to actually assume that their preferences were "constant." This is untestable, howver reasonable it might seem in a given scenario intuitively(which is usually how it is justified when push comes to shove, e.g. that desire for milk doesn't change each month). Alternatively, similar problems are created if you try to find structural parameters from a simultaneous equations econometric model, e.g. of supply and demand. You have to input restrictions informed from economic theory in order to do this, but there is no way to actually test these restrictions themselves, leaving the frequent occurence that antagonistic and contradictory theories would simultaneously provide a good fit to the data (I guess I don't need to say who pointed this out again...). (In fact, I'm quite glad my econometrics lecturer was candid enough to admit this too). However reasonable these assumptions of economic theory might be by "intuition" ( a word as definite as praxeology would probably make neoclassical economists want to run for the hills), they can't be tested or imputed from the data.
Well many of the assumptions are unfalsifiable, like that consumers maximise their expected utility. I'm not exactly sure how putting constraints on a model derived from that can be criticised when it's exactly praxeology... We find estimates of, say, labour supply elasticity, which if in every case of measurement happens to be negative would be good enough grounds to justify using upward sloping supply curves. Yes, the models used to form the estimates impose some theory on the data, however that's one of the great things about peer review. There are plenty of people out there who will check the sensitivity of your results to the model specification. Don't get me wrong, I by no means think econometrics is perfect. It faces amazingly difficult problems, especially with forecasting. But I don't think it's entirely useless.
Marginal Interest: Well the problems of parameters being non-constant just due to the natural variation caused by "human complexity" is reflected in the fact that the estimators are given with a confidence interval whose width is proportional to the variance of the error term.
I wasn't referring to anything as trivial as that. The variance of error terms used to inform confidence intervals, is again an instance of assuming constancy of relationships in projecting forward past relationships to future data. Shocks inherently can never effect the conditional distributions in such forecasting models, as that very fact is their operative assumption.
There isn't a problem with using insights that are ultimately praxeological (although of an often bastardised form, using untenable assumptions where they cannot apply), but in thinking that you are letting the data speak for itself, distinguish between the theories you're utillising(which ultimately it can't) and impute forward relationships based on it (though as you and I have already noted, nobody in their heart of hearts really seems to believe this anymore).
abskebabs: There isn't a problem with using insights that are ultimately praxeological (although of an often bastardised form, using untenable assumptions where they cannot apply)
There isn't a problem with using insights that are ultimately praxeological (although of an often bastardised form, using untenable assumptions where they cannot apply)
Example?
, but in thinking that you are letting the data speak for itself, distinguish between the theories you're utillising(which ultimately it can't) and impute forward relationships based on it (though as you and I have already noted, nobody in their heart of hearts really seems to believe this anymore).
Meanwhile, you can actually explain all instances of price formation with Bohm Bawerk's apparatus(as well as with Wicksteed and Fetter's variations along the same lines), as well as including the concept of expectations since all bids are based on them, but you don't need them to be anywhere near "exact" to explain price determination. Neither do you run into the nonsensical issue produced by the Cobweb Model, in which you don't have equilibrium convergence if demand and supply price elasticities around the equilibrium point are beyond a certain kind. These Walrasian price theories you can derive using reasoning that somehwat resembles praxeology, but my point is the errors produced are produced by the incorporation of bad assumptions and hence bad deductions based on them. They necessarily obscure the true explanation of price determination, inspite of the fact that one could gather data and pretend try to "test" and distinguish them.
With regard to income and substitution effects and attempts to distinguish them, I think I'll pass comment, aside of the and demand constancies often assumed in such an analysis. There are other issues too, like the fact that from a set of observations you might reckon e.g. demand is upward sloping, when what you're actually doing is finding different demands on a relatively stable "supply curve." Given that all you know are just the hypothesised intersections of 2 curves, it still seems to me that this kind of thing could never be determined by the data, rather, a prior udnerstanding is used to inform interpretation of the data always.
Finally, your final request, I think if carried out would probably lead to the complete (and deserved) discrediting of the vast majority of the economics profession. That's also why I don't think it'll happen.
I don't know if this has been brought up before [probably has, somewhere !], but Doug French on Mises Daily recently posted a good article that goes to the heart of the debate in this thread, called" The Folly of Forecasting" . regards, onebornfree
For more information about onebornfree, please see profile.[ i.e. click on forum name "onebornfree"].
Here is another good article I recently found on economic modeling [it is probably "old hat" to most regulars here] : "The Myth of the Model". by Max Borders at The Freeman.
Regards, onebornfree
Well many of the assumptions are unfalsifiable, like that consumers maximise their expected utility. I'm not exactly sure how putting constraints on a model derived from that can be criticised when it's exactly praxeology... We find estimates of, say, labour supply elasticity, which if in every case of measurement happens to be negative would be good enough grounds to justify using upward sloping supply curves.
The microeconomic concepts macro models are built on are reasonably well tested, both econometrically and experimentally.
Taken together, these claims are false. An RBC model with rational expectations assumes that the economy acts as a maximizing agent and is in general equilibrium. Estimates of microeconomic magnitudes that seem plausible at the individual/industry level do not necessarily aggregate up. Therefore, If one believes that Walrasian models of general equilibrium tell us anything at all, then RBC models have no microeconomic justification except in highly implausible circumstances (such as homothetic and identical preferences and wealth among all consumers).
In other words, RBC models are merely based on faith that microeconomic processes will somehow "behave nicely" at the aggregate level, without any justification for this in the neoclassical system. At the very least, Austrian macroeconomics does not have this problem (in most variants).
Marginal Interest: z1235:On the contrary, the risk of playing against an opponent who controls a printer of legal tender in his basement is extremely large. He can match whatever bet you make with an opposing bet of ten times your size. Plus, this system incentivizes his buddies (banks) -- who get first dibs to all newly created "capital" and control most other bets in this "free" market -- to bet in his direction. The risk/reward for this cabal is such that: (1) fail, everybody must bail us out lest ATM's stop giving out cash tomorrow morning, (2) win, well we win. Are you sure you have the staying power (the capital needed to pay for your losses as prices are being pushed against you) to match theirs? Who do you think a smart trader would be betting with/against? Think again. How does that risk exist? The only way it could possibly exist is if the ability to keep printing money would result in the real value of houses never coming down. That's absurd for two reasons: 1) It assumes a grotesque amount of money illusion; 2) if the prices never come down then it's not a bubble is it? So obviously you wouldn't short it.
I just explained the risk. Which part did you not understand? Do you even know how market bets work and how markets operate?
The best I can hope for, without constantly having my finger on the buy/sell buttons to react within seconds of new news becoming available, is to do only as well as the market trend.
Here you go speaking in aggregates again. What is a "market trend" and how does one do "as well" as it's doing?
abskebabs,
Not sure what you mean in regard to "trades not at the equilibrium price". If trade is being conducted at a non-equilibrium price (in absence of frictions), then necessarily consumers aren't maximising their utility or producers aren't maximising profit....
I don't think the complaint that "price determination is implicitly assumed to explain it" is justified. The model you reference is something done in intermediate micro because it's easy. It's an easy way to introduce people to constrained optimisation, so it's not going to be extremely general. The price is not "given". For simplicity initial endowments are given. Price is determined endogenously, along with the quantity demanded, from the supply=demand equilibrium condition.
Where exactly does praxeology diverge from mainstream micro? In the case of price determination, we get demand schedules from maximising utility subject to a budget constraint, and supply schedules from maximising profit subject to a cost structure; then solve from the equilibrium condition. How does praxeology do it differently?
ziragt: Well many of the assumptions are unfalsifiable, like that consumers maximise their expected utility. I'm not exactly sure how putting constraints on a model derived from that can be criticised when it's exactly praxeology... We find estimates of, say, labour supply elasticity, which if in every case of measurement happens to be negative would be good enough grounds to justify using upward sloping supply curves. The microeconomic concepts macro models are built on are reasonably well tested, both econometrically and experimentally. Taken together, these claims are false. An RBC model with rational expectations assumes that the economy acts as a maximizing agent and is in general equilibrium. Estimates of microeconomic magnitudes that seem plausible at the individual/industry level do not necessarily aggregate up. Therefore, If one believes that Walrasian models of general equilibrium tell us anything at all, then RBC models have no microeconomic justification except in highly implausible circumstances (such as homothetic and identical preferences and wealth among all consumers). In other words, RBC models are merely based on faith that microeconomic processes will somehow "behave nicely" at the aggregate level, without any justification for this in the neoclassical system. At the very least, Austrian macroeconomics does not have this problem (in most variants). You're not measuring a million individual elasticities, remember, you're measuring an aggregate. And the theory is trying to explain the movement of aggregate variables. Obviously it's absurd to try and predict the behaviour of millions of individual entities. Aggretation is a necessary evil in that what you lose in detailed information gets made up for in managability. So far it's done remarkably well at explaining quantitative movements in variables ex post. Now what we need is to move away from calibration and make some ex ante predictions. I did see a couple of papers a while ago with RBC models with many representative agents with differing preferences. If I remember correctly, it added much more tedium to the model but not much more explanatory power. | Post Points: 20
z1235: I just explained the risk. Which part did you not understand? Do you even know how market bets work and how markets operate?
There was no risk in what you explained. You talked about bigger agents placing bets against you, which wasn't coherent. I interpreted it as "the government will keep printing money to prop up the housing market", and I addressed that. Was that an incorrect interpretation? If so, please explain it again.
It means the value of a portfolio sufficiently diversified to remove unsystematic risk will follow a random walk with a drift. That's pretty obvious, right. If there's some arbitrage opportunity, everybody will do it until it's not there anymore. So basically if I pick some stock index, like the S&P 500, my portfolio won't be able to consistently produce larger expected returns than a portfolio that's just composed of that index.
Marginal Interest:There was no risk in what you explained. You talked about bigger agents placing bets against you, which wasn't coherent. I interpreted it as "the government will keep printing money to prop up the housing market", and I addressed that. Was that an incorrect interpretation? If so, please explain it again.
I'll paraphrase one of your buddies: Markets can be (and usually are) "wrong" much longer than you can remain solvent. Here's an example of what happens to a hedge fund legend that tries to "fight the Fed":
...For those unfamiliar with Robertson, then here's what you need to know: He is the definition of a hedge fund legend. After attending the University of North Carolina, Robertson served as an officer in the US Navy and worked as a stockbroker for Kidder Peabody. He then founded and grew his (now defunct) hedge fund Tiger Management from $8 million at launch to over $22 billion in 1998 at its peak. And, as listed on our Tiger Cub biographies page, Tiger compounded a gross rate of 31.5% between 1980 and 2000. But, after losses of 4% in 1998 and 19% in 1999, Tiger shut down as the dot-com bubble expanded right in front of his eyes. He avoided what he deemed to be 'irrational investing.' The tech bubble would indeed be irrational investing, but his fund wouldn't be around to see it through...
Have you stopped to think what the major component/contributor to this "drift" is? What is the main factor behind the econometric-derived "wisdoms" such as "60-40 stocks-bonds portfolio" and "buy and hold"? I could give you a hint, but it's better that you figure it out on your own. Let me ask you this: If all arbitrage is always and immediately eliminated, and there's no real $100 bills left on the pavement, why does an entrepreneur still get out of bed in the morning? Because he's stupid, and you're smart?