Tuesday, September 20, 2016

Romer's Magical Creatures.


(source)
I ain’t no economist. So, it is more with a kind of morbid fascination than with any real deep understanding that I have been following Paul Romer’s critique of economics.

Things began last year, with “Mathiness in the Theory of Economic Growth”, when Prof. Romer took aim at growth theory (one of his areas of expertise). Now, with “The Trouble with Macroeconomics” he extends his critique to macroeconomics (particularly to RBC and the much maligned DSGE).


In “Mathiness” Romer explained why some work was tainted by mathiness (emphasis mine):
“The mathiness in their paper also offers little guidance about the connections between its theoretical and empirical statements. The quantity of location has no unit of measurement. The term does not refer to anything a person could observe.”
In “The Trouble”, Romer reiterates that (among other more technical issues) and gives examples in a macroeconomic setting (emphasis mine):
“Once macroeconomists concluded that it was reasonable to invoke an imaginary forcing variable, they added more. The resulting menagerie, together with my suggested names, now includes:
“• A general type of phlogiston that increases the quantity of consumption goods produced by given inputs (…)
“• A troll who makes random changes to the wages paid to all workers
“• A gremlin who makes random changes to the price of output
(…)
“With the possible exception of phlogiston, the modelers assumed that there is no way to directly measure these forces. Phlogiston can in [sic] measured by growth accounting, at least in principle. In practice, the calculated residual is very sensitive to mismeasurement of the utilization rate of inputs, so even in this case, direct measurements are frequently ignored.”
One of his targets are mysterious exogenous causes of economic disturbance in the economy. Astute regular readers will guess that I, being interested in macroeconomic animal spiritism, sympathise with that. Still, I wonder how, upon compiling his own list of mythical creatures, Romer did not name the most obvious one? The one with the purest pedigree?

Try to guess its two main names (answer at the end). Okay, I’ll give you a hint:
“While ‘demand’ shocks such as the aether AKA risk premium, exogenous spending …”

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One also sees above his reference to “phlogiston”, which can hardly be considered measurable or even observable. He also mentions “aether” and “caloric” (not shown): all things with “no unit of measurement”, referring to nothing “a person could observe”.

Even for a layman, like yours truly, all of those points seem perfectly reasonable.

But here, again, Romer puzzles me. Is there any real difference between “phlogiston”, “caloric”, and “aether” and Gary Becker’s “human capital” (or the "production function"), which Prof. Romer commended in “Mathiness”? How about "utility"? Is it any less imaginary than phlogiston?

Those last three concepts are as problematic and unmeasurable; and although grafted into macroeconomics, they have something in common: a microeconomic origin.

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Okay, as promised, the answer to the $64,000 question: Animal Spirits/Confidence Fairy. As Fairfax Media senior economics columnist Ross Gittins put it:
"Animal spirits -- also known as 'confidence' and 'expectations' -- are the main factor causing the economy to speed up and slow down, speed up and slow down again". ("Economy Follows Wherever our Moods Take us")
A grunt like yours truly may well be wrong about Animal Spirits, the Confidence Fairy, Keynesian fundamental uncertainty, and expectations. But if so, it's nice to see that a real economist, like Paul  Romer, is saying quite similar things.

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