Believe it or not, but Greenspan makes a lot of sense

I have often been critical about Alan Greenspan’s economic thinking, but listen to this Interview on CNBC. It is pretty good. Greenspan talks about the international financial linkages – particularly between the US and the euro zone. He makes a lot of sense (other than some odd cultural references, which the rather uneducated reporters just go along with…)

I think that US based Market Monetarists should pay attention here. The global financial markets are highly inter-linked. One can not ignore European issues if one want to understand US monetary policy issues as you can not understand the Great Depression without understand French goal hoarding and the collapse of the Austrian bank Creditanstalt.


Market Monetarist Methodology – Markets rather than econometric testing

When I wrote my book on Milton Friedman (sorry it is in Danish…) a decade ago I remember that the hardest chapter to write was the chapter on Friedman’s methodological views. It ended up being a tinny little chapter and I was never satisfied with it. The main reason was that even though I was and continue to be a Friedmanite in my general (macro) economic thinking I did not agree with Friedman methodological views.

My methodological views were – and I guess still are – pretty Austrian. In Ludwig von Mises’ “Human Action” the first sentence of Chapter one is “Human action is purposeful behaviour”. Mises and other Austrian school economists claim (I think more or less rightly) that all economic theory can be deducted from this dictum. That view kind of clashes with Friedman’s positivist thinking – that theory has to be empirically tested.

All in all, Friedman would probably have been happier about today’s Nobel Prizes in economics than I am (See my earlier post). That said, over time I have come to appreciate Friedman’s methodological views more and more and I no longer think that there is such a big conflict Friedman’s methodological views and the views of the Austrians. But yeah, I am pretty much like Friedman – you write one paper on methodology and then you forget about it. So maybe you might want to stop reading now.

However, in my paper on Market Monetarism I tried to find to common methodological views of blogging Market Monetarists. That said, you could have reached a Market Monetarist position coming from a deductive perspective (that is more or less how I have arrived here) or you could have come to your Market Monetarist views via econometric testing that tells you that Market Monetarism is empirically correct (the method Friedman recommend). So when I talk about methodology here it is clearly in a relatively broad sense.

Given that Market Monetarism as an economic school is very young and only really “live” in the blogosphere, it is difficult to discuss a methodological approach. However, there are some common attitudes to methodology among the Market Monetarists.

In particular, I highlight the following methodological commonalities.

1. Sceptical view of “large scale” macroeconomic models. The Market Monetarists tend to dislike the kind of large-scale macroeconomic – typical New Keynesian – models that, for example, most central banks utilise. Rather, Market Monetarists prefer simpler, smaller models and dictums.

2. “Story-telling” and a general case-by-case method of studying empirical facts rather than using econometric models. This is due to the Market Monetarists’ view of the monetary transmission mechanism as basically forward looking. Despite significant progress in econometric methods, common econometric methods basically cannot handle expectations and therefore any econometric study of “causality” is likely to be flawed, as monetary policy works with “long and variable leads”.

3. Market Monetarists’ preferred empirical method is to combine actual knowledge of relevant news about, for example, monetary policy initiatives with analysis of market reactions to such initiatives. As such, Market Monetarists’ methods are highly eclectic.

4. Market data is preferred to macroeconomic data. As markets are assumed to be efficient and forward looking, all available information is already reflected in market pricing, while macroeconomic data is basically historical and as such backward looking.

5. Economic reasoning rather than advanced maths. Market Monetarists base their thinking on rather stringent economic theorising and reasoning but are very critical of the kind of mathematically based models that dominate much of the teaching in economics these days.

That’s my two cents on Market Monetarist methodology, but don’t take it to serious – or at least that is what Deidre N. McCloskey would tell you. McClosky’s book “Knowledge and persuasion in economics” is that latest (of very few) book that I have read on Methodology. In it she tells us (page 32-33):

“Economists march to and fro under different banners, raising huzzahs for different candidates for the Nobel Prize. Party loyalty provides a career. The young upwardly mobile indoctrinated economist (YUMIE) always votes at his party’s call and never thinks of thinking for himself at all. Yet the existence of schools fits poorly with the receive theory of science. The theory most economists espouse says that “findings” will “falsity” the “observable hypothesis derived from higher order hypotheses” and then of course everyone will change his mind. But nobody changes his mind. The number of economists who have abandoned a hypothesis and have admitted so in public is close to zero. But that turns out to be true also of the Science that economists think they are emulating”.

I tell you, she writes like that all through the book! At the end you are slightly embarrassed to be an economist, but then after five minutes of putting down the book you are back to you all sectarian habits. BOOO! The Keynesians are clueless and so are the Austrians!

(BTW BUY that book it is damn good!)

Some (Un)pleasant Nobelmetrics…

Ok, I was wrong. I kind of expected that Scott Sumner would not get the Nobel Prize in economics (yeah, yeah I know that its not a real Nobel Prize…) and no I can hardly say that Thomas Sargent and Christopher Sims are not world class economists. Both certainly are, but I must say I am a bit disappointed by the increasing focus among economists on econometrics. But there is no reason to blame Sargent and Sims for that.

Sargent and Sims were awarded the Nobel Prize for“for their empirical research on cause and effect in the macroeconomy”

It might as well have said that they got the Nobel Prize in for developing the econometrics – particularly Vector AutoRegression (VAR). This is why I am slightly disappointed. Economics is not statistical method. To me, and his might make Bob Murphy happy, economics is mostly a deductive science or what Ludwig von Mises called Praxeology. That does not mean that we should not use math (as the Austrians are suggesting) or not test our theories empirically, but I find it highly problematic that economic reasoning has become less important for our profession than fancy statistically methods. I could of course also say as Nick Rowe usually say that we dislike econometrics because we are so bad at it, but frankly I have seen very few econometric results that have changed my mind on any particular issue.

From a Market Monetarist perspective there is reason to be sceptical about econometrics. Econometrics is about history – it basically by method assumes that expectations have no importance (yes, yes I know Sargent and Sims have tried to change that…). To Market Monetarists expectations about future monetary policy is key to how we understand monetary policy. Studying monetary policy in the rearview minor does not teach you anything. (I will later today put out a comment on Market Monetarist methodology as I see it…UPDATE: I JUST DID).

So do Sargent and Sims not deserve the Nobel Prize? Yes, let me say it again they certainly do deserve the Nobel Prize. It is well deserved. I am just unhappy that they get it for econometric work rather for economic thinking.

In fact Sargent have written a number of papers that I consider to be among the most import papers I have ever read.

In 1981 Sargent wrote the paper “Some Unpleasant Monetarist Arithmetic” with Neil Wallace. In my book that paper alone qualifies for a Nobel Prize. The story in their paper is pretty simple (a lot of good economics is). Sargent and Wallace tell us that public expenditure can be financed in three ways in the short-run: Taxes, borrowing (issuing bonds) and by printing money. In the long-run you have to pay back your debts so that will leave only two options – taxes and printing money. In a world with rational expectations – forward looking economic agents – this means that if a government is running large deficit then it will sooner or later lead to either higher taxes/lower expenditures or to higher inflation. And as agents are forward looking an unsustainable large budget deficit this could trigger a sharp rise in inflation already before the money printing starts. This is pretty Sumnerian: Monetary Policy works with long and variable LEADS. (Anybody who thinks the US will default should read this paper and look at US bond yields…).

A less well-known paper by Sargent (co-authored with Joseph Zeira in 2008) “Israel 1983: A Bout of Unpleasant Monetarist Arithmetic” is another of my other favourite economics papers. It is wonderfully written and very intriguing. Here is the abstract for you:

“From 1970 to 1985, Israel experienced high inflation. It rose in three jumps to new plateaus and eventually exceeded 400% per annum. This paper claims that anticipated monetary and fiscal effects of a massive government bailout of owners of fallen bank shares caused the last big jump in inflation that occurred in October 1983. Bank shares had just collapsed after a scandal in which it was revealed that banks had long manipulated their share prices. The government promised to reimburse innocent owners for the diminished value of their bank shares, but only after four or five years. The public believed that promise and public debt therefore implicitly increased by a large amount. That implied future monetary expansions. Because that was foreseen, inflation immediately rose as predicted by the unpleasant monetarist arithmetic of Sargent and Wallace (1981)”

So once again, I think Sargent and Sims deserve to win the Nobel Prize. They are world class economists, but I would so much have hope that they have gotten it for economics and not for statistical method.

Congratulation Thomas and Chris!

PS I am really just an angry Danish nationalist, if you want to award the Nobel Prize in economics to statisticians for their work on VAR why not give it to the best? My country man Søren Johansen and his wife Katarina Juselius. Maybe next year Søren and Katarina…ah sorry guys next year Scott Sumner will get it…

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