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Well, there is the general principle that things that cannot continue forever, don't. I would expect the things that stop the economy from galloping madly off in any given direction would be outside the model.

My understanding of the general run of European history would suggest that economies are inherently unstable. That world was run in favour of people with money, so deflation was considered good. But the pressures of deflation on people without money eventually triggered either a revolution or a war (usually war). That triggered inflation. Until the war was over and the people with money reinstituted deflation. You might want to check with some historians about the accuracy and details of this view.

Pre-darwinian economics:

Why don't you just join in? Make economics a subdiscipline of ecology.
Then the current macro closed economy of the world becomes a micro part of the open economy of "gaia". Money and other nominals are communication devices for the oranizatism. And badda boom badda bing. Only thing that matters is energy accounting.

Back to apples:

Nick, you need to break your "apple income" down into at least corporate income and wage income.

What does the model look like if productivity and/or cheap labor shift the supply curve for apples to the right, the fed adds bank reserves to shift the supply curve of loanable funds so that interest rates come down, the workers have a price inflationary attitude of 2% per year for apples and overestimate their permanent wage income (expectations are too high) so that they borrow using bank loans denominated in currency (NOT APPLES) based on that overly optimistic permanent wage income leading to the demand curve for apples being shifted to the right?

In the end, does the "apple corporation" get operating margin growth, quantity growth, and price inflation?

Do the workers get negative real wage growth and more bank loans denominated in currency, and the "apple corporation" gets positive real corporate income and possibly excess savings?

Does that scenario lead to more wealth/income inequality?

Sorry if this is a repeat and back to apples.

Nick, you need to break your "apple income" down into at least corporate income and wage income.

What does the model look like if productivity and/or cheap labor shift the supply curve for apples to the right, the fed adds bank reserves to shift the supply curve of loanable funds so that interest rates come down, the workers have a price inflationary attitude of 2% per year for apples and overestimate their permanent wage income (expectations are too high) so that they borrow using bank loans denominated in currency (NOT APPLES) based on that overly optimistic permanent wage income leading to the demand curve for apples being shifted to the right?

In the end, does the "apple corporation" get operating margin growth, quantity growth, and price inflation?

Do the workers get negative real wage growth and more bank loans denominated in currency, and the "apple corporation" gets positive real corporate income and possibly excess savings?

Does that scenario lead to more wealth/income inequality?

"Macroeconomic theory tells us how monetary policy is supposed to work; and it tells us how fiscal policy is supposed to work."

How about combine those two into how a "more debt" policy works? And by debt, I mean loans demoninated in currency.

"The central bank sets a nominal interest rate in those models; the nominal quantity of money, if it even appears in the model, is an endogenous irrelevancy."

By money, do you mean currency?

Ah,
but policy is not REALLY exogenous, and the response to policy isn't either.

In other words - something like what Jim Rootham said.

edeast - YES! I thought I was alone.

Besides which, why do you think the modern economy is the same as a pre-Keynesian economy?

Surely you must remember that pre-Keynes there was a gold standard, which meant that to some extent the supply of money was indeed exogenous. And governments didn't tend to be passive observers of financial probity either. So while no one may have been explicity following a Keynesian script, nobody was sticking to strict Laissez Faire either.

Besides which, part of the problem is also that your model probably only has a relatively range of applicability. The real world is problem more non-linear than your model.

oops - relatively NARROW range of applicability...

oops again - ... real world is PROBABLY more ....

Hmm...Darwin might clue us in ? Might it not be the case that the economy's self-equilibrating tendencies evolve over time as the economy becomes ever more complex ? That was certainly a big theme in Minsky's work. And monetary policy - lender of last resort - has been around since -early nineteenth century ? And what about various reform acts and the joint stock acts - 100 years before Keynes ? Didn't they affect the economy's tendencies ?

I figured this was like saying that population was fairly stable when we were all hunter gatherers, so we obviously don't need any new fangled contraceptive methods.

"In a closed economy (like the world) the only valid explanation for a downward-sloping AD curve is that a fall in the price level will cause an increase in the real money supply,..."

This is the Pigou effect.
You (pretty much) neglect what Tobin called the Keynes effect, the fall in interest rates as IS shifts down the LM curve. Brad de Long gave an alternative explanation of the same thing not too long ago, which can be dubbed the Friedman effect: interest rates decline as velocity falls. In either case, the fall in interest rates stimulates spending/aggregate demand. In the guise of the Keynes effect this obviously is limited by the Liquidity Trap, and as the Friedman effect it is similarly limited by the zero lower bound on interest rates.

You might also have mentioned falling wages, and chapter 19 of the General Theory.

Maybe in a classical sense like Too Much Fed would like, the economy would undergo general deflation as prices come down and production shuts down to new levels. Maybe like a micro market there is a new equilibrium of goods produced and consumed at the macro level.

But in a society that uses debt, and would prefer not to see an entire economy go bankrupt (even though net debt is zero). If all firms went bankrupt, and all means of production were collected in the hands of a few people with capital we could go back to a feudal society!! Fun!!! Every day is like a Renaissance Fair!

P.S. Money, any money

Exactly how is monetary policy stimulative?

The Fed's balance sheet expansion has flowed into excess reserves. Impact on Aggregate Demand: none.

What about zero interest rates? Has it stimulated lending? No.

And M2? Shouldn't M2 be rising if the Fed were stimulative? It was, until about June, and its been flat since. Not exactly a meaningful stimulus to aggregate demand.

Monetary policy has helped prevent a spiral of bank de-levering leading to deflation. It prevented AD from cratering. That's not the same as stimulating a recovery in AD.

If macroeconomics can identify ways in which monetary and fiscal policy can deal with a recession, but cannot identify a way in which the economy can heal itself, the policy choice should be obvious. It is not satisfying intellectually to decide what to do out of ignorance, but it is also intellectually not very grown up to refuse to do what you suspect will work, on the basis of not knowing whether doing nothing might be OK, too.

Even so, we hear a good bit of advice to do nothing. The good news is that those in charge appear to be fairly certain that action is needed. Modern economic theory may be flawed, but we have come to modern economic theory in part by rejecting the flawed components of older theories. Then, along comes a real world circumstance in which policy makers must choose whether to act, and they are bombarded with advice from adherents to older debunked theories, telling them to do the one thing which we are not sure will work, which is to do nothing.

While David Pearson seems to be right, his point may be no more than to point out that while demand is falling, it is not also rising. If demand eventually rises while monetary reserves are still high, do we then decide policy did stimulate aggregate demand? I'm not sure that our policy decision should be different if we know that monetary policy can keep demand from falling, even if we're unsure it will eventually cause demand to rise.

Further, to extent the financial sector functioned better than it would have, and that new lending did not fall to zero, monetary expansionary monetary policy did seem to work in that it prevented a worse outcome. The conduit through which policy flows was impaired, so it could not work as forcefully as it might otherwise, but at least in the case of monetary policy, that same impairment limits the risk of monetary policy. How ya gonna get inflation if money growth doesn't go anywhere?

David: I'm not an economist, so maybe this is an unsophisticated view, but it seems to me that it's the battered banks in the US that are subverting the normal transmission mechanism for monetary policy; they aren't lending as much as one would like. I've also read recently that increases in M2 anticipate increases in the base. Seems to me then that the banks stimulate in anticipation of looser money, and work out the details later. But if they are broke, uh I mean, risk averse they'll hold off and the economy will languish.

I know the Swedish central bank recently started charging interest on bank reserves sitting in the vault, presumably to make banks choke on their hoard and lend it out... I wonder if it helped?

Anyway, just a thought.

Jim: " I would expect the things that stop the economy from galloping madly off in any given direction would be outside the model." But something as central as the self-correcting forces out to be inside the model. They are in micro. In those macro models, they are not even outside the model.

"My understanding of the general run of European history would suggest that economies are inherently unstable." If by "unstable" you mean "not perfectly stable" (i.e. they fluctuate), I agree. But they are not totally unstable, in the sense of bouncing between 100% unemployment and hyperinflation. And if the neo-Wicksellian models were true, and there were no competent monetary or fiscal authority, I would expect 100% unemployment 49% of the time, and hyperinflation 49% of the time. In the modern sense of aggregate demand management, economies were not managed for the rich; they weren't managed at all. They didn't understand the concept.

edeast: No, let's make ecology a sub-discipline of economics! Darwin = Adam Smith + Malthus. We came first! ;)

Too much Fed: This post is not about the effect of the distribution of income on savings and debt. Not everything is. It's about self-equilibrating forces at the macro level.

reason: the gold standard is relevant for this question. But I think gold plays a role very similar to an exogenous stock of base money, and given the risk of destabilising expectations of inflation/deflation, that doesn't really seem to solve the problem. Non-linearities might matter, but which non-linearities? And which way does it curve? (Because the wrong sort of non-linearity would just make the problem worse.)

PE: Yes, the economy might have evolved over time, to become either more or less stable. But until I see it spelled out, and see how these changes have affected the slope of the AD curve, for example, this is just a "maybe".

Marcel: both the Pigou effect and the Keynes effect are a result of the increase in the real money supply. The Pigou effect is a wealth effect; the Keynes effect is a substitution effect. By talking about people substituting away from money, I was implicitly referring to the Keynes effect, and similar. I guess I should have been more explicit.

Joe: debt-deflation effects generally just add to the destabilising forces. Even without them, there is little self-correcting force in the models.

David: If monetary policy stopped AD falling as much as it would have otherwise done, I would say that monetary policy is then partly responsible for any recovery.

kharris: agreed. We do monetary and/or fiscal policy if we think they will work/help. But there still seems to be something wrong with models nevertheless, and if the models are wrong with respect to self-correcting properties, maybe they are wrong about monetary and fiscal policy too?

I can't wait to hear what Nick and Stephen have to say about Krugman's scathing essay in his essay in Sunday's New York Times.

Curses! It just ate my last comment! Test.

Trying again:

ClaudeB: Thanks for the link. I just skimmed through Paul Krugman's article. No immediate strong reactions, either pro or con. The part that matters is right at the very end (part VIII?) where he says what macroeconomists should do next. And he doesn't say much. He lists 3 things: listen to Keynes; do behavioural finance; put more finance into macro. It's the 3rd thing that's most important in my view. And it's part of what I've been trying to do in this blog for the past few months (emphasis on "trying").

patrick: I too think that "battered banks" may be hindering the monetary transmission mechanism. But I don't understand it very well. (Just one more example where it's easier to recommend putting more finance into macro than actually doing it!)

Joe said: "Maybe in a classical sense like Too Much Fed would like, the economy would undergo general deflation as prices come down and production shuts down to new levels."

And, "But in a society that uses debt, and would prefer not to see an entire economy go bankrupt (even though net debt is zero)."

I'm not in favor of price deflation. I am also NOT in favor of attempting to price inflate with debt (loans based on currency).

Joe said: "If all firms went bankrupt, and all means of production were collected in the hands of a few people with capital we could go back to a feudal society!! Fun!!! Every day is like a Renaissance Fair!"

Actually, I can see another way the world is becoming more like a feudal society.

David Pearson said: "Exactly how is monetary policy stimulative?

The Fed's balance sheet expansion has flowed into excess reserves. Impact on Aggregate Demand: none.

What about zero interest rates? Has it stimulated lending? No."

Maybe most of the lower and middle class have too much debt (loans based on currency) or are starting to figure out it is not a good idea to go further into debt if real earnings are negative or even nominal earnings are negative?

kharris said: "How ya gonna get [price] inflation if money growth doesn't go anywhere?"

See this link titled "Does USA 2009 = Argentina 2001?"

http://www.itulip.com/forums/showthread.php?p=106493

Some quotes:

"You might think that before Argentina’s economy blew up in a hyperinflationary conflagration that the central bank over-expanded the money supply leading to high inflation, and that the inflation spooked foreign investors. But as you may have already guessed from the first chart that shows negative and falling CPI going into the crisis, the opposite is true: the money supply fell in the year leading up to the crisis even as bond prices fell and yields increased."

And, "The economy was caught in a vicious cycle of declining economic output and negative credit expansion. The bond markets demanded higher interest rates to compensate for higher default risk. Credit contracted even more, and further reduced economic output. This is the liquidity trap that the Fed hopes to avoid by purchasing long-term debt directly to hold down long-term interest rates."

Unfortunately, the article does not talk about the differences of having the debt denominated in your own currency even though it is mentioned earlier. Plus, I read somewhere that no country has ever defaulted that had its debt denominated in its own currency (not sure if that is true). It seems to me that some of this depends on foreign access to domestic financial assets and political "access" (think bailout of Fannie and Freddie).

With respect,

your writing is excellent, but it is spoiled by the excessively wide column width. It is quite hard to read. Could you make your main column narrower, or add an extra column?
For example;
www.useit.com

Keep up the good work!

Patrick said: "David: I'm not an economist, so maybe this is an unsophisticated view, but it seems to me that it's the battered banks in the US that are subverting the normal transmission mechanism for monetary policy; they aren't lending as much as one would like."

Without credible collateral to back up the loan, maybe the banks are actually being forced to make the sure the borrower can realistically repay the loan?

Patrick said: "I've also read recently that increases in M2 anticipate increases in the base. Seems to me then that the banks stimulate in anticipation of looser money, and work out the details later. But if they are broke, uh I mean, risk averse they'll hold off and the economy will languish."

You might want to check out this post titled "The Roving Cavaliers of Credit"

http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

"Rather than bankers sitting back passively, waiting for depositors to give them excess reserves that they can then on-lend,

“In the real world, banks extend credit, creating deposits in the process, and look for reserves later”.[5]"

And, "If the entire banking system is at its reserve requirement limit, then the Federal Reserve has three choices:

refuse to issue new reserves and cause a credit crunch;
create new reserves; or
relax the reserve ratio.

Since the main role of the Federal Reserve is to try to ensure the smooth functioning of the credit system, option one is out—so it either adds Base Money to the system, or relaxes the reserve requirements, or both."

Nick's post said: "Too much Fed: This post is not about the effect of the distribution of income on savings and debt. Not everything is. It's about self-equilibrating forces at the macro level."

With about 98% of the fungible money supply debt (loans based on currency), can that debt "overpower" any self-equilibrating forces?

Has debt "infected" both aggregate demand and then and also aggregate supply?

Nick's post said: "kharris: agreed. We do monetary and/or fiscal policy if we think they will work/help. But there still seems to be something wrong with models nevertheless, and if the models are wrong with respect to self-correcting properties, maybe they are wrong about monetary and fiscal policy too?"

IMO, I don't see anything self-correcting when the fed and/or the federal gov't is involved with the fungible money supply. That is:

The solution to too much lower and middle class debt is not more lower and middle class debt (monetary policy) being owed to the rich.

The solution to too much lower and middle class debt is not more federal gov't debt (fiscal policy) being owed to the rich.

The key to improving macro theory/policy is to take a leaf out of micro theory.

If the interest rate will not necessarily equilibrate I and S, but instead the equality (and identity - it is confusing) of I=S is maintained by changes in whole output, then what could be done at the micro level - that is, in credit markets, to correct for this?

How about creating a small shortage in these markets? That is, deal with the problem the way a engineer might - by creating a buffer.

If the need is to maintain the planned equality of I and S, but the result can be planned I < S regardless of the interest rate, then creating a shortage in the I/S market so that I > S always occurs would eliminate the whole swings in output. No more general glut.

Drewfus: "That is, deal with the problem the way a engineer might - by creating a buffer."
Can you expand on this, to help me understand what you mean by "buffer"? Give me an engineering example? Thanks.

Nick: I agree that these models don't contain any self-correcting forces. It's also awkward to talk about monetary neutrality in models where money is endogenous. The best I can come up with when I teach as an analogue to the idea that the Fed doesn't control the interest rate in the long run is this: if the Fed's policy rule uses a target r other than the Wicksellian natural rate, then in equilibrium they will not obtain their inflation target.

Taylor rule models model the central bank rate as endogenous. Recently, they have been adapted to include exchange rates as an exogenous variable.

Perhaps it is just a matter of time before some general equilibrium whiz kid incorporates a Taylor rule into a larger model driven by let's say resource supply shocks or disruptions to market X that originate in one form of domestic rent-seeking or another.

Come to think of it, it not much of a stretch to go from domestic rent-seeking to resource supply shocks.....

Kevin: (welcome back; haven't seen you around here in a while).
But does it bother you, as it bothers me, that these models have zero self-correcting forces?

It is indeed awkward to talk about the neutrality of money when money is endogenous. But I think I've figured a way around the problem. Instead of saying "an increase in the money supply will cause....", we just note that for any equilibrium there exists another equilibrium with all real variables the same and all nominal variables changed in the same proportion. And I also say that any target for r other than the Wicksellian natural rate is unsustainable in the long run, at any finite rate of inflation/deflation.

westslope: Yes, incorporating a Taylor rule (or some such monetary policy reaction function) into the model will (generally) create a self-correcting force. But it's not really an automatic "self"-correcting force; more of a deliberately imposed policy to make it correct. It's a bit like adding an equation representing divine design into a biology model.

Nick, I'm somewhere in the seminar room groaning, and looking around to see if anybody else is buying your argument.... ;-)

That depends on how you design the central bank policy mechanism. I wonder if many naturally shy away from 'policy rules' because the prescriptive rules of monetarism were such a colossal failure. That doesn't mean that other policy rules cannot be used to explain behaviour. If you are automatically inserting the policy rule into a hyper rational, instantaneously and continuously clearing GE model, may I suggest that it doesn't have to be portrayed that way.

Not sure if this is relevant.....OT

A number of biology models (that pretend to be "ecological"), model the apex predator--humans--as little pac men that just keep eating read harvesting at a constant non-stop rate.

God is not present but the naive and innaccurate portrayal of human harvesting behaviour is not necessarily helpful nor the only way to model human predation especially when the empirical data is screaming that the model is wrong or at best incomplete.

"I feel the same way now, only more strongly, because the Neo-Wicksellian model doesn't just have no tendency to self-equilibrate; it has a tendency to self-disequilibrate. The Anthropic Principle rules it out. We haven't always had any sort of Keynesian monetary and fiscal policy, let alone good monetary and fiscal policy. If there were no self-correcting macroeconomic process, I wouldn't be sitting in front of a computer now and writing this blog post. I would be knapping flints, or something."

Do you consider war, plague, political and social upheaval, technological innovation (closely allied to war), and so on to be macroeconomic processes? Part of the runaway feedback loops of the Neo-Wicksellian model involves people's expectations. Lots of things can change people's expectations. For one thing, they can get mad as hell and not take it anymore. They can get swept up in movements, violent and non-violent. in the depths of despair they can find hope. At the pinnacle of greed they can know fear. Such things may sound irrational to homo economicus, but people create their own reality.

"if this model were true it would be a miracle if the economy worked at all, and chances are that we would have relapsed back into the Stone Age sometime over the last few centuries"

Roman Empire.

Dark Ages.

Enlightenment.

What makes you think we didn't almost relapse into the Stone Age?

I'm having some difficulty working through the original post, because it almost sounds like some of the naive interpretations of markets - namely "it will work out ok because the market works". Except - the market only works to set prices. There is no guarantee that the price you need to pay is something you can afford, or that the price you can get is enough survive on. "The market can stay irrational longer than you can stay solvent." (attribution of this quote is left as an exercise for the student...)

In a sense, it feels like Krugman could point at you as confusing beauty and truth. It certainly would be nice if economies were self-correcting, but it's not clear that "an economy" has any idea what that means. Messy rules the day.

Besides, why does an economy ever need "to recover"? If I lift a rock off the ground and let go, it's not stable, but it's in equilibrium all the way down. Forces and energy all balance out. The economy might not currently be in a position you like, but that's your problem, not the economy's.

(Dang - my soapbox just broke from over-use. Better stop now.)

good pts.

Energy
I just think that the social sciences and natural sciences have to meet somewhere and this means using some of the same variables eventually.


Having economists studying interactions between organisms, would put them under ecology and over organisms in a breakdown of biological organization. Atoms-molecules-organelles-cells-tissue-organ-etc up to biosphere. Now I don't think any level is privileged, the gaia side of it. And I'm not a vitalist, so inorganic matter is just as important. And I also think information(influence that leads to a transformation) is just as important. So I think the political economy is very real, (monopoly of force).

If economics is a form of analysis, it should be able to apply to other levels of biological organization. (I'm just thinking of the parallels of humans forming societies with unicellular organisms forming multicellular ones. We now have the ability to clone humans and genetically engineer them. So who's going to say that we(society) won't specialize, letting firms engineer our replacements.) Anyway this comment is hard to write because of tangents.


say Smith/Malthus is first and he's able to notice a fundamental property at the firm scale because the life cycle is shorter, changes happen quicker. There's no DNA heritability but information nonetheless, is co opted and passed down. But he still relies on the invisible hand metaphor to explain what the model cannot.

and what is the invisible hand? What do economies do? What does life do? It reduces entropy(locally) http://en.wikipedia.org/wiki/Entropy_and_life#Gibbs_free_energy

So economies are part of the control systems of humans, which help us minimize Gibb's free energy or be more productive, be more efficient. I still have yet to read Heath's efficient society, but I assume it's about this.


Sorry if that was choppy I'm having a hard time getting it short and concise. You mentioned the anthropic principle so I figured I had license to comment. Do not understand macro yet, thanks for the blog, Prof Gordon as well.

Basically, organic=inorganic=information in importance.
Life is closed system that tries to minimize energy.
Economy a problem solver to increase efficiency.

Nick,
the doubt that I and S will equilibrate simply due to the effect of the interest rate on the supply and demand of loanable funds is due to Keynes and his ideas regarding money demand, a herding propensity wrt risk aversion/seeking and his odd idea about bankers manipulating the interest rate 'reward' to entice us to "part with our liquidity". Most of his ideas are questionable in my view, but regardless they have stuck.

Anyway, you know about Keynes. So lets assume that yes, the equilibrium condition of I=S is not guaranteed by market forces, and can occur by changes in GDP. Fine. So the way i see it, we have a functional problem with credit markets. But the Keynesian approach is, in affect, to accept that credit markets can behave in a sub-optimal way, and to treat the symptom instead - 'demand management' of the whole economy. But this is really a case of waving the dog to shake the tail. It is a 'most-effort' approach.

Alternatively, i favor dealing with the problem at its source - by fixing the credit markets directly. Now in microeconomics, we want everything pushed to 'the margin' - otherwise there is misallocation of resources. That approach is optimal for individual markets, but not so for the macroeconomy. At the macro level, we don't want to 'marginalize' things, as this leaves no room for error. We want to leave some fat on the bones, so to speak. An engineer would not design a bridge that was 100% as strong as it had to be - he would add a substantial margin for error/tolerance. This should be the approach in macroeconomics too.

So to use the analogy of the engineer again, suppose he was told that at a given point on a river, the flow of water should always be in one direction - toward the sea. The flow of the river should never reverse. What would he do? Obviously he would design a dam - that is, create a buffer, so that there is always a differential of force, in the required direction. I think credit markets should be designed in a similar way, so that there is always more investment demand than savings supply. What is required is to lower the interest rate below the equilibrium rate, enough to create a small but persistant imbalance of demand over supply. This is my 'least-effort' approach.

Now if, ex ante, I > S always holds in this case, then i do not see how an output/deflationary gap can occur. With excess investment demand, capacity utilization is maximized, and unemployment minimized. It would however, be necessary to insure that the unmet investment demand did not 'spillover' into extra credit growth. This might be a problem given an endogenous money/credit supply, but the idea would be to minimize the buffering affect of the below-equilibrium interest rate policy to whatever was just enough to limit the swings in output to an acceptable tradeoff between inflationary/deflationary pressures. This buffering affect might have other, not so obvious benefits. For example, it would mean that consumers could, within a range, increase their rate of saving, given that the initial reduction of aggregate demand would be offset by the excess of investment demand, consequently avoiding the paradox of thrift. This should work to a point, such that a country with a low savings rate could become a higher savings rate country without threatening output levels.

I apologize for the gratuitously snarky remark made above. Uncalled for, my bad. Would remove it if I could.

------------------------------------

FWIW, I'll add that dynamic rational expectations models can be modified to take into account all kinds of impediments to immediate market clearing (contrary to what Krugman writes). Wouldn't be surprised if somebody could model in rent-seeking behaviour or anthropology type gift-sharing behaviour because at this moment, that strikes me as one way of characterizing discrete fiscal stimulation.

A central bank 'agent' could follow some kind of Taylor rule and perhaps use a version of yield-curve forecasting to imperfectly predict future events. Oh, oh. Now require a bond (asset) market with at two different instruments. This could quickly get intractable.... even before we get around to capital item overbuilds.

But none of this would necessarily overcome the primary challenge of modelling structural breaks or 'Black Swan events' similar to that experienced in the second half of 2008.

(Incidentally, just quickly read Krugman's 8-page opus in the New York Times dated 02 Sept 2009 and now wonder if economists will be spending a decade or more correcting the misconceptions in the piece.)

Westslope
So you know better than Professor Krugman? Careful, history has so far been kind to him, he is consistantly proved right by events.

"But none of this would necessarily overcome the primary challenge of modelling structural breaks or 'Black Swan events' similar to that experienced in the second half of 2008."

Why do you think it is a structural break. Did nobody know about Liquidity traps? Or debt-deflation? Could it not just be an assymetry?

I see that Krugman muses that macro models should probably look more like meteorological models. My understanding is that meteorological models work by chopping up the atmosphere into discrete chunks, then the laws of thermodynamics, fluid mechanics, etc... are applied to the chunks. It's essentially simultaneously solving a huge system of partial differential equations.

I can imagine models like this for behavioral macro where the chunks are various economic actors (consumers, banks, firms) that follow a set of behavioral heuristics appropriate for them (probably with some randomness thrown in for good measure), and constrained by various macro 'laws'.

Patrick,
yes that is what I have been arguing is the way foreward, and so people like Steve Keen and Barkley Rosser have been pushing a different but related approach (building mathematical systems of non-linear differential equations as models). But like weather forecasting, we shouldn't expect accurate long range forecast, there are too many influences external to the system and the system is chaotic. However, we can expect a better understanding of inter-relationship, and responses to policy. What is different, is that we can change the rules that the system operates by.

What appeals to me about Krugman, in contrast to many economists, is that he is intuitive, empirical, non-dogmatic and understands the difference between the map and the territory. That is, he understands the story of the elephant and the blind men, that my scientist father used to love - the most important parable ever told.

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