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A must read on the state of macroeconomics

Reis on the state of macro

This is a great read from John Cochrane on the many macroeconomics criticisms from the media. I won’t go into too much detail as I will do the piece a disservice, but I did provide a few humorous quotes.

The number one reason I fell in love with economics is that uncertainty is the only certainty. And attempting (and failing) to answer the uncertain questions – such as, how many more hours (and effort) will people work if their wages rise, and by how much – is exciting. But it is important to note that this differs significantly from other fields that build models and end up with certain answers. I always joke, you can tell you are speaking to an economist because they will weigh multiple variables when considering a simple yes or no answer.

The underlying ingredients of (say) a climate or aircraft design model are very well understood, so you can make complex models that work. The underlying ingredients of economic models are not so well understood — how much more will people work if their wages rise, how do they interpret statements by government officials, how do companies change their prices, and so on

 

There is a trope in the media that efficient markets finance caused the crisis. This shows appalling ignorance. If you listen to efficient market finance, it says to invest passively in the market index, not risky tranches of mortgage backed securities pools, or the hedge funds that buy them.  And no academic told our regulators to set up the preoposterous system of mortgage subsidy and too big to fail bailouts.

 

A big strain of macro and finance criticism berates us for not forecasting the great recession and financial crisis. Ricardo ends with a good reiteration of why prowess at unconditional forecasting is not a measure of economic science. The theory is efficient markets, not clairvoyant markets. That’s like berating climate science because weather forecasters can’t tell you if it will rain two weeks from now. It’s worse, as most theories, especially in finance, predict with great clarity that crises and consequent recessions will not be predictable. It’s like saying probability theory is wrong because you can’t use it to outsmart the slot machines at Las Vegas. Ricardo has a lovely analogy, that medicine is quite useful even though your doctor can’t predict the date of your death with great accuracy.

 

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