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The Progressive Economics Forum

(Macro) Econ 101

On December 2, Chris Ragan wrote a column for the Globe and Mail titled “Another (Macro) Defense of Econ 101.”  The link to his column is available here .  My brief reply was published in the Globe and Mail on December 13.  The full version is below:

Professor Ragan defends conventional (macro) Econ 101 as a pedagogical tool for training students’ minds to confront and grapple with the complex economic problems they encounter in their daily lives.

I agree:  Econ 101 should begin training the mind to handle complexity.  Unfortunately, conventional Econ 101 doesn’t do this very well, often stranding one out in abstraction while under the illusion that one’s firmly grounded in the real world.

One need go no further than to see this inadequacy reflected in the failure of economists to reconcile the two solitudes of microeconomics (with its emphasis on individual markets) and macroeconomics (with its focus on the emergent effects of the assemblage of all markets, such as unemployment and inflation).  The macroeconomy is just not the aggregation of the micro, the sum of its parts behaving as though in isolation, but the complex interactions of the parts, often resulting in unintended consequences or paradoxes.

One attempt to reconcile micro and macro, the microfoundations project, was discredited by the 2008 financial crisis.  Quoting Paul Krugman in 2009, “there was nothing in the prevailing models suggesting the kind of collapse that happened last year.” This has been the greatest professional embarrassment faced by the economics discipline since its handling of stagflation in the 1970s, leading the Queen to summon economists to explain themselves.

There are at least three explanations for the failure of the microfoundations project, and they can be traced back to the content of conventional Econ 101.

Human behavior. The homo economicus assumption taught in Econ 101 of the self-interested rational super calculator fell out of favour even with the arch-libertarian Alan Greenspan, who expressed shock that American bankers did not self-regulate in a dangerous game of hot potato that ultimately collapsed.

Institutions.  The role of social norms, shared beliefs, or “rules of the game” are largely absent in Econ 101 and are often depicted as costly imperfections to the economy rather than as structures keeping it on the rails.  Ironically, institutions explain the perverse incentives that nudged many American mortgage lenders away from prudent monitoring of their loan portfolios, fuelling the subprime mortgage crisis.

History.  While there are analytic advantages to separating the flow of time into the short and long run, there is the risk of losing sight that the actual experienced moment of time features both the short and long run.  As a result, historical time and by extension, history, get marginalized.  Professor Ragan obviously recognizes the importance of history, as is evident in his November 18 column on “hysteresis”, which explains how the long run path of the macroeconomy can be influenced by disruptions in the short run, such as the 2008 financial crisis.  However, it is my experience that the idea of hysteresis is not introduced in Econ 101, as theoretical rigour tends to override analysis of real world historical processes.

Human behavior, institutions and history all contribute to the complexity of macroeconomics and can explain such emergent effects as the paradox of thrift, that in a nutshell, shows that if all players save en masse, the economy will shrink. These complex realities necessitate complex policies at time when we are confronted with the confounding challenges of climate change, growing income inequality, an aging work force and stagnating growth.

The stakes are high, and some first year students, like the 70 Harvard undergrads who in 2011 walked out of Econ 101, know this and are right to be questioning what they are taught.  Teaching Econ 101 should not about preaching from some sacred scriptural text but should rather be more of an evolving conversation among economists, and with their students.

Enjoy and share:

Comments

Comment from Larry Kazdan
Time: December 18, 2014, 8:02 pm

Letter in Toronto Star:

Financial literacy for politicians

http://www.thestar.com/opinion/letters_to_the_editors/2014/12/05/financial_literacy_for_politicians.html#

Published on Fri Dec 05 2014

Re: Quebec austerity could hurt Trudeau at the polls, Nov. 28

November is Financial Literacy Month — the time when overpaid bankers of highly leveraged institutions that market credit cards bearing exorbitant interest rates educate the lesser-informed public about personal responsibility.

More beneficial would be a Financial Literacy Month for politicians. The curriculum should explain that a province or country is not a household, nor is it a profit centre. Rather, democratic governments are agents whose mandate is to manage the economy in accordance with public purpose.

In order to avoid inflation when the economy is hot, the government must tamp down activity by increasing taxes and/or spending less. And when the economy is cool, the government must decrease taxes and spend more to preserve jobs and support the private sector. It’s that simple — Financial Literacy for Politicians 101.

Implementing fiscal austerity at a time when 1.3 million Canadians cannot find work is totally inappropriate and damaging. Stephen Harper and Quebec Premier Philippe Couillard need professional help — their enrolment in this course should be mandatory.

Footnotes:

1. Financial Literacy Month ends and the real challenge begins
http://www.nationalnewswatch.com/2014/11/28/financial-literacy-month-ends-and-the-real-challenge-begins/#.VHloacncTIh

2. Seven years after: why this recovery is still a turkey http://rwer.wordpress.com/2014/11/27/seven-years-after-why-this-recovery-is-still-a-turkey/

Firms don’t go on investment splurges in a weak economy. Nor is it plausible that consumers will spend at the same pace as in the bubble years now that the bubble wealth has disappeared. This means that we have to find another source of demand if we want to get back to full employment. We can do it with government spending. We can spend more on infrastructure, on education, on retrofitting buildings to make them more energy efficient and reduce greenhouse gas emissions.

Comment from Ken Howe
Time: December 23, 2014, 11:07 pm

Recently I was out protesting against the Quebec government’s attempts to balance its budget, for which I did up a sandwich board labelled “Macroeconomics 101” (actually “Macroéconomie 101” but who’s counting).
I firmly believed that any macroeconomist worth her salt would agree with my propositions, such as that the notion of a “balanced budget” had no place in macroeconomics (since macroeconomists know that a (provincial) government needs only (at best) to maintain a steady ratio of debt to GDP, making “balance” an entirely arbitrary figure, which could even lead to higher debt under the right circumstances), or that pushing the government sector toward surplus automatically pushes the nongovernment sector toward deficit (since the sum of government and nongovernment sector balances is by identity zero. Obvious, right?)
Imagine my surprise when, days later, Le Devoir reported that 2/3 of the economists somebody surveyed were of the view that the Quebec government should aim for a balanced budget in 2016–2017, as opposed to 1/3 who agreed with the government that 2015–2016 was the proper timetable for achieving this laudable and oh-so-important milestone. How many pointed out that a “balanced budget” was meaningless? None I heard of.
So is it the Economics 101 Chris Raglan defends that stopped the Le Devoir survey economists from addressing the dumbness of the question? Or did they just forget? Did it teach them that fiscal stimulus only works for a few years, since we “should not expect its effects to last beyond that”? Is Economics 101 responsible for Roosevelt ignoring Keynes and undoing the New Deal, or Europe and Canada switching from stimulus to austerity just after stimulus started working? By warning of the “dangers associated with having too much public debt” so clear to see on the Excel sheets of certain Harvard professors back in 2010?
No but seriously: I’ve never taken Economics 101, but I thought it introduced you to stuff like on Simon Wren-Lewis’s “Mainly Macro,” i.e., that currency-issuing governments can’t default, that austerity targets falling debt-to-GDP ratios not balanced budgets, and that government spending cuts have powerful contractionary effects.

Comment from Nigel Southway
Time: December 28, 2014, 9:15 am

It must be really hard to teach economics… I feel for those that must do this task…It’s clearly not a science, not even an applied science, as none of the given rules or formulas seem to work in practice, and the experts never agree on the answer anyway. I can image other more science orientated experts building bridges or aircraft that way. Of course when an engineer makes a mistake it’s reviewed and learned from and we move on to not go there again…. not so in economists minds. They are never wrong and keep making the same mistakes much like a religious fanatic would do. My New year’s resolution is to try harder to understand and fathom the deep and difficult mind of the economist. As so many conflicting flavors of the answer seem to prevail… O well… 🙂

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