Why? I see no relationship to today’s economy and the post-World War II years.

Too often economists start with theory and then furrow their brows in puzzlement when the theory doesn’t match up with reality (“How can there possibly be asset bubbles? Why doesn’t someone just step in, short the market, drive prices back down and make piles of money?”).

Which is exactly what should be happening. If economists just looked at reality and said “Oh, asset bubbles! Okay, existance noted. What’s for lunch?” they would not be doing their job. The point is to try to understand why the world is as it is, not just to collect data. This is because we look to sciences to try to make predictions about the future and to do that you need some theories.

Instead, the starting point ought to be that both economic history and experimental economics have documented the existence of asset bubbles beyond any doubt.

Nope, it most certainly should not be. Nothing in a science should be beyond any doubt. We should always be aware of the possibility we might be wrong. Furthermore, empericial evidence never comes to us raw, it is always dependent on interpretation (this is why we can be fooled by opticial illusions, our brains interpret visual data without us consciously being aware of the process). Just because we see something doesn’t mean it’s actually there and just because we don’t see something doesn’t mean it actually isn’t there – and few economic data points are as good quality as the light beams hitting our eyes. We cannot rule out the possibility that new theories will indicate that what we thought was there isn’t. The best we can say is that existance of asset bubbles is a strongly supported hypothesis.

This may sound pedantic about me, but I’ve learnt in life that you can’t trust statistical data. If data conflicts with theory sometimes the theory is right, and the data is wrong. The trouble is working out which.

davod: For all those who keep saying the country has a way of correcting itself every four years. How quickly do you recover from a tripling of the deficit and the institution of a command economy?

You could research the post-World War II years in the U.S. for your answer.

The problem with advocates of a command economy is to get their way you have to destroy the economy.

For all those who keep saying the country has a way of correcting itself every four years. How quickly do you recover from a tripling of the deficit and the institution of a command economy?

[Soros]hopes, however, to inspire a groundswell of support from students that will “shift demand” at universities to include economic ideas that are more reality based and less focused on rigid mathematical models.

In the grand tradition of monkeys typing at typewriters, Soros gets one thing right. The math fetish of modern mainstream economics subordinates active reasoning to the needs of differential equations. There’s an econ school that did anticipate the meltdown, that eschews mathematicization in favor of actual thought, that unlike the neoclassical mainstream actually does consistently favor free markets: namely, the Austrians. Among other things, the Austrians notice and talk about the elephant in the room, the Fed and its bubble-and-bust manipulation of the money supply. The neoclassical mainstream may well collapse. What a shame if Soros and his band of blithering collectivists get to pick up the pieces.

Reflexivity doesn’t sopund like much of a theory – basically it is a statement that bubbles exist, except that it assigns no blme and no cause to any individuals.

That probably has nothing much to do with what’s going on here.

One point worth making is let’s say theer is some dogma and it’s wrong – there are multiple alternatives some of thejm a lot worse.

You could come up with a theory that says – markets are not efficient – except when the government is the only buyer…well nobody would actually say anything so absurd, but sort of imply it and avoid contradicting it – to articulate it is to refute it.

As a case of “deregulation” increasing regulation, let me offer the California electric grid. Following the disaster of 2001, state control of the electric grid, generation construction, even customer demand has increased greatly. The largest utility in the state, PG&E, is now a servant of the Democratic majority in the legislature. The state wants to set your room thermostat, prohibit large screen TVs, and select your light bulbs.

My view of the economics profession is also that equilibrium is over emphasized. Every active economy has millions of players who STRIVE to upset equilibrium since that is the only way to make a profit! The academic infrastructure is increasingly a corrupt priesthood. Killing the tenure system would be my first recommendation.

As to asset bubbles, how the heck do you short residential real estate?

2. Even if that weren’t true, both quantity and quality matter. All the new financial regulations combined were less important to the regulated) and less effective in any sense than breaking down the wall between trading and banking.

3. On another topic,
This article does make me wonder: why hasn’t anyone done an in-depth study of human psychology and economics (or have they?) I mean, numbers are great and all, but people aren’t exactly rational numbers, and tend to do things despite what seems to be obvious

There are such studies. They are however outside the realm economists are familair with, since they are concentrated in religion departments. Virtually all economics (notably including behavioral economics) is founded on the idea that people only try to maximize their returns in this life. But all experience says this is simply not true. Some (not all) of the things economists see as non-rational are a desire to go to heaven, which accounts for (or at least says a lot about) a large part of everything from anonymous giving to all kinds of do-good organizations, to not cheating on your income tax.

But it seems like a strawman to me where he puts people at believing non-falsifiable economic models as perfection, then knocks them down. The same old leftist attack on free markets basically. It ignores the moral aspects of a free market for example where you accept flawed actors because a) it leaves them free and b) it assumes an outsider(like the state) doesn’t have perfect knowledge either. Outside of efficient pricing and distribution there are moral arguments for free market systems.

I just think Soros will be all too comfortable devising “superior” models which allow the state 1984 style to backdoor manipulate citizens into doing what they want. Philosophically/morally I’m opposed to “improving” social science in such a way. If he was looking for ways to replace State control with mechanisms that improved transparency and citizen freedom (like replacing central banks with feedback loops that control interest rates) I would be more pleased with where he is going. I’m just highly skeptical that is where he will end up.

richard: All types of industries, including the financial markets, were deregulated.

Rule of Thumb: A 500-page “deregulation bill” doesn’t actually reduce regulation, despite what the label says.

Ah yes. 30 years of steady deregulation, started by Saint Ronnie, and when the economy collapses, its because of regulation.

As has already been pointed out, the level of overall regulation has steadily increased over the last 30 years. Even if some sectors were de-regulated (generally in very minor ways). And the specific level and type of regulation in the financial sector, especially in housing, were almost completely responsible for the collapse of the housing market and subsequent recession.

What you and your ilk are trying to do is like blaming de-regulation in airline prices for the collapse of the housing market.

Tim: I don’t think that’s a correct assessment of the problem. Economists are married to their models because they do have an excellent explanatory power–they work. But, as you point out, there are observations that no model explains well.

This is a glass half-full v. half-empty debate. It would be awfully pathetic if economic models had absolutely no explanatory power. Instead, economists develop their models in such a way that you get certain results that reflect the real world. These models inevitably miss out on pretty important features of the real world at the same time. What economic models miss — for instance, asset bubbles cannot exist within the neoclassical framework — can lead to pretty serious consequences when people take them seriously. Too often economists start with theory and then furrow their brows in puzzlement when the theory doesn’t match up with reality (“How can there possibly be asset bubbles? Why doesn’t someone just step in, short the market, drive prices back down and make piles of money?”). Instead, the starting point ought to be that both economic history and experimental economics have documented the existence of asset bubbles beyond any doubt. It’s up to the theorists to then account for this fact in the models they develop.

Problem 1 is wrong. If that were true, there wouldn’t be so many critics of DSGE models. Paul Krugman’s recent rant in the NYT spent a lot of time attacking DGSE models and the efficient market hypothesis. His solution? Let’s return to 1935 Keynes and ignore the last 70 years of research. I think this criticism would have made more sense 50 years ago than today.

I don’t follow. First, note that Krugman published his “rant” in the New York Times, not in, say, American Economic Review or Quarterly Journal of Economics. When I was in grad school, DSGE was sold to us not because its assumptions are particularly realistic but rather because you need to know it in order to get a macro theory paper published in a top journal. This kind of cynicism is really at the heart of my point — a lot of economists don’t really believe a lot of the theoretical assumptions they make in their academic work yet they do it anyway because that’s the way things are done in the profession. You are right that lots and lots of people criticize DGSE (although many of the harshest critics are not macro people) but that’s not inconsistent with the fact that it is the default methodology you need to use to publish macro research.

True story: one development economist I know submitted a paper focusing on a field experiment done in a developing country to a prominent journal. The referee report basically said “What you say here is all true but how does it apply to the United States?” This same kind of narrow-minded provincialism applies to theoretical assumptions and frameworks.

Ricardo: The point here is that these problems have nothing to do with free-market fundamentalism but rather with a profession that is too used to certain methodologies and that doesn’t take too kindly to “outsiders” criticizing them.

I don’t think that’s a correct assessment of the problem. Economists are married to their models because they do have an excellent explanatory power–they work. But, as you point out, there are observations that no model explains well.

The problem, as I see it, is that critics aren’t interested in coming up with a new paradigm that gives testable predictions based on the empirical evidence. The “anti-market fundamentalists” aren’t interested in finding the truth–they simply focus on the conclusions with which they don’t agree and thus try to trivialize the work of the people making the observations that lead to those conclusions.

Problem 1 is wrong. If that were true, there wouldn’t be so many critics of DSGE models. Paul Krugman’s recent rant in the NYT spent a lot of time attacking DGSE models and the efficient market hypothesis. His solution? Let’s return to 1935 Keynes and ignore the last 70 years of research. I think this criticism would have made more sense 50 years ago than today.

Problem 2 is definitely legitimate. Hopefully more observations will help. Simplifying assumptions are always necessary, but they must be as robust as possible. This one isn’t.

Although I love math (even though I’m terrible at it), I do think that academic economics would be well-served to get away from its reliance on complex mathematical models. It seems to me that the only think every department wants its new Ph.D students to be capable of is to use econometrics to build a model that is as difficult as possible to criticize. Professor Mankiw’s statement about ‘take a lot of math’ if you want to be an economist is testimony to this. It’s very seldom that I ever use my skills of integration from my Calculus courses, and I have never seen trigonometry in any economics paper. I do find myself lacking in other types of mathematics that are not required for the degree. Additionally, this religious-like faith that math makes someone a good candidate for an Econ Ph.D program disfavors American students, who by world standards, have a very hard time competing with students from other education systems. Perhaps others’ experiences may vary.

I’ve enjoyed studying economics for the last four years, but it is shocking and awful to me that most people–even college educated people–lack even a principles level understanding of economic theory. Many of the people who control the debate in newspapers and such are blatantly ignorant which issues are actually contested in the discipline and which are settled. This post, based on this paper from the American Institute for Economic Research, explains this better.

1. Obsession with static equilibrium in economic models. The nature of equilibrium is that prices tend to stay where they are: this doesn’t allow for sudden swings in prices without some underlying big event triggering the price change.
2. Assuming that everything you don’t understand is a random variable with a normal distribution and a well-defined variance. Taleb devotes an entire book to this extreme assumption.
3. The premium that is placed on orthodox modeling rather than realistic modeling. It must have been 30 years ago, for instance, that the “free-market fundamentalist” Milton Friedman pointed out that many Americans buy both insurance and lottery tickets. Orthodox economic models (which assume that people are naturally risk-averse and have concave utility functions) cannot account for this anomaly. Yet still, economists use exactly the same models they were using 30 years ago because these models are easily and elegantly solved.

The point here is that these problems have nothing to do with free-market fundamentalism but rather with a profession that is too used to certain methodologies and that doesn’t take too kindly to “outsiders” criticizing them.

Gabriel McCall: What hypothetical proof would market opponents be willing to acknowledge as sufficient demonstration that the regulation is the problem? If it’s not falsifiable, it’s a faith, not a science.

You would have to do at least two of three things:

1. Show an actual connection between some specific regulation and the harm done — similar to a showing of proximate cause for the lawyers.
2. Show a cross-country comparison where there is a fairly strong correlation between presence of the given regulation and the outcome measure.
3. Show a time-series analysis where, again, existence of the given regulation coincides quite nicely with the outcome measure.

We don’t have any of these three on the subject of financial regulation. Instead we have a lot of handwaving about the CRA (which the Fed estimates contributed to an increase of about 2% in subprime loans) and Fannie and Freddie (which, as covered extensively in previous comment sections, did not play a central role in the crisis although their own business decisions were stupid and irresponsible).

brenatevi: This article does make me wonder: why hasn’t anyone done an in-depth study of human psychology and economics (or have they?)I mean, numbers are great and all, but people aren’t exactly rational numbers, and tend to do things despite what seems to be obvious evidence to the contrary.

There is an entire subdiscipline of psychology dedicated to answering that criticism. It’s called “Behavioral Economics.”

roger thistle says:
RJ: People who disagree with you are the “crazies”? Great argument.

Right out of the leftist playbook comes:
Rule 5: Ridicule is man’s most potent weapon.

Once you have ridiculed your opponent, you can claim that anything he says can be totally disregarded, and there is no further need to address his arguments.

richard: I just want to make the very simple point that you can’t have 30 years of increasing deregulation of all sectors of the economic landscape and then make the argument that the economic collapse was because of too much regulation. (Actually you can make the argument but only if your belief in the fairy tale of the benefits of unfettered [capitalism] causes you to simply ignore facts)

Yes, we had 30 years of booming growth and then a correction — a correction, not a collapse — that
a. started in one of the most regulated areas of the economy
b. started with players that were government-owned
c. caused us to give back about two-to-five years of growth
d. caused employment to zoom up almost, but not quite, as high as European levels during good times

so, no, I am still sort of skeptical that this is cause for condemnation of the free market. The most it suggest is that capitalism is like Churchill’s description of democracy: the worst choice except for all the others.

I’m not going to argue for or against that comment, but just wanted to point out that politics and government seems to be a part of human nature as much as any free market.

This article does make me wonder: why hasn’t anyone done an in-depth study of human psychology and economics (or have they?) I mean, numbers are great and all, but people aren’t exactly rational numbers, and tend to do things despite what seems to be obvious evidence to the contrary.

One would think so but unfortunately the meme is politicos are not responsible for anything and crises are useful for growing their power and the coffers of their benefactors. Blaming free markets is just grist for the mill among the useful idiots who somehow always think human nature unchecked is to blame for everything.

Did anyone asked yet, why the U.S. Constitution has limits to Political State power but no limits to Economic State power? The State can take everything from a person.

Until there are constitutional limits to taxes and debt USA is nothing more than a Social Republic.

You want to compare the current ‘economic collapse’ to Carter-era stagflation and 70s oil shocks? Oh yes, let’s do that. Please. God, that would be great. I would be so happy if you did that.

Per capita GDP rose under Carter. It fell in the recent recession.

You’re conflating two things. The Republican and Democratic administrations were lax and random with enforcement while the the number of laws and agency rules continued to increase. Both of these are problematic, but together they are disastrous.

I just want to make the very simple point that you can’t have 30 years of increasing deregulation of all sectors of the economic landscape and then make the argument that the economic collapse was because of too much regulation. (Actually you can make the argument but only if your belief in the fairy tale of the benefits of unfettered capitaliam causes you to simply ignore facts)

Stuff and nonsense. All types of industries, including the financial markets, were deregulated. Indeed, the Republican leaders – Bush, Cheney, Gingrich, etc, etc, etc – ran on their accomplishments in deregulating the economy and leading to the booming economy. But, as I said above, no use arguing with true believers. The economic collapse was caused by too much regulation because I say so – if only there had been total deregulation, everything would have been great. (Same thing on the far left- Communism didn’t succeed because it wasn’t every implemented in its pure form.) The same nonsense again and again and again.

It just hasn’t been done by the right group of right-thinking people. Things will be different, this time.

“the EMH is an empirical hypothesis that bears only as much weight as the evidence shows.”

Which is exactly right. But not so universally accepted. Too often it is taken as a given without any interest in empirical explanation. In its strongest form, it’s been clearly refuted but it continues to have considerable credence with a significant number of economists.

You want to compare the current ‘economic collapse’ to Carter-era stagflation and 70s oil shocks? Oh yes, let’s do that. Please. God, that would be great. I would be so happy if you did that.