Sunday, June 27, 2010

Kartik Athreya's Letter To Consumers Of The Economics Blogosphere: Economics Is Hard

[Links to paper are corrected and working as of June 29, 10:15 PM.]
From "Economics is Hard. Don’t Let Bloggers Tell You Otherwise" by Kartik Athreya, Research Department, Federal Reserve Bank of Richmond, June 17, 2010:
The main problem is that economics, and certainly macroeconomics is not, by any reasonable measure, simple. Macroeconomics is most narrowly concerned with the tracing of individual actions into aggregate outcomes, and most fatally attractive to bloggers: vice versa. What makes macroeconomics very complicated is that economic actors... act. Firms think about how to make profits, households think about how to budget their resources. And both sets of actors forecast. They must. One has to take a view on one’s future income, health, and familial obligations to think about what to set aside for retirement, how much life insurance to buy, and so on. Of course, all parties may be terrible at forecasting, that’s certainly a possibility, but that’s not the issue. Even if one wanted to think of all economic actors as foolish and purposeless organisms making utterly random choices, one must accept that their decisions will still affect, and be affected by what others do. The finitude of resources ensures this “accounting” reality.

Beyond this, some may recall that Economics 101 is usually insistent on reminding students of the Fallacy of Composition: what is true for some may not be true for all. Much of macroeconomics is dedicated precisely making sure that when we talk about the “economy”, we don’t fall afoul of this fallacy. It is therefore not surprising that the majority of the training of new PhDs in their macroeconomic coursework is giving them a way to come to grips with the feedback effects that are likely present. Some of this is nothing more than (valuable) exercises in book-keeping. So much of my 1st year homework involved writing down tedious definitions of internally consistent outcomes. Not analyzing them, just defining them, and so trying to convincing my instructors that I wasn’t inadvertently describing something nonsensical, where resources were being allowed to “fly in (or out) through a window.” In discussions of fiscal policy, such as those regarding deficits, for example, the discipline imposed by an insistence on doing the accounting correctly helps focus economists on the real issue (total spending, and the expected future path of spending), and also learn what might be peripheral (the deficit at any given moment).

The punchline to all this is that when a professional research economist thinks or talks about social insurance, unemployment, taxes, budget deficits, or sovereign debt, among other things, they almost always have a very precisely articulated model that has been vetted repeatedly for internal coherence.
Read the entire paper here.

Thank you to Greg Mankiw for the link.

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