Neat, Plausible, & Wrong: The deluded discipline of economics Steve Keen University of Western Sydney Debunking Economics www.debtdeflation.com/blogs www.debunkingeconomics.com

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  • Neat, Plausible, & Wrong: The deluded discipline of economics Steve Keen University of Western Sydney Debunking Economics www.debtdeflation.com/blogs www.debunkingeconomics.com www.cfesi.org
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  • The Era of Crises Crises? What Crises? 1.Climatic Crisis of Global Warming 2.Energy Crisis of Peak Oil 3.Financial Crisis of 2007 First two hotly denied by some Climate change denialists vs scientists Peak Oil Sceptics vs geologists 3 rd undeniableits already happened, and ongoing If others occur, cant complain Why werent we warned? Numerous warnings by relevant scientists for decades Climate Change (Keeling 1958; Meadows 1972)Keeling 1958Meadows 1972 Peak Oil (King Hubbert 1956)King Hubbert 1956 Will occur because advice of professionals ignored
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  • An era of crisis Economic & Financial Crisis very different Consensus of economists gave no warning at all In fact predicted blissful economic future Crisis occurred because professional advice followed! How could economics be so wrong? Discipline holds tenaciously to Neoclassical beliefs Despite logical flaws Despite empirical failings Explanation partly ideological Justifies existing distribution of wealth & power But unsatisfactory total answer Most economists deny ideological badge Following advice also destroyed wealth, power Tenacity of belief has deeper, subtler cause
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  • Neat, Plausible, and Wrong Success of neoclassical economics in a nutshell: Explanations exist; they have existed for all time; there is always a well-known solution to every human problem neat, plausible, and wrong (H. L. Mencken) Fundamental flaws in theory Even manifest empirical failure to predict 2007 crisis Ignored because neoclassical theory is neat & plausible To defeat it Wrong has to trump neat & plausible Need complex, sensible & generally right alternative Ambition of Debunking Economics II Wider audience than DE I: neoclassicals as well, because
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  • A paradoxical but transcendental truth Neoclassical economists dont understand neoclassical economics Before the Crisis: founding editor of AER: Macro The state of macro is good Dynamic Stochastic General Equilibrium model is simple, analytically convenient, and has largely replaced the IS-LM model as the basic model of fluctuations in graduate courses Unlike the IS-LM model, it is formally, rather than informally, derived from optimization by firms and consumers. (Blanchard 2009)
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  • After the crisis The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater (Blanchard, Dell'Ariccia et al. 2010) Wrong: this baby should never have been conceived Base of DSGE macro is Solow-Ramsey growth model Yet Solow rejects DSGE models!
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  • Solow rejects DSGE Robert Solow 2001 The prototypical real-business-cycle model goes like this. There is a single, immortal householda representative consumerthat earns wages from supplying labor. It also owns the single price-taking firm This is nothing but the neoclassical growth model [When I built it] It was clear what I thought it did not apply to, namely short-run fluctuations... the business cycle... Now... an article today [on the] 'business cycle' will be... a slightly dressed up version of the neoclassical growth model. The question I want to circle around is: how did that happen?
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  • Solow: SMD conditions invalidate DSGE Suppose you wanted to defend the use of the Ramsey model as the basis for a descriptive macroeconomics. What could you say?... You could claim that there is no other tractable way to meet the claims of economic theory. I think this claim is a delusion. We know from the Sonnenschein-Mantel-Debreu theorems that (Solow 2008) Sonnenschein-Mantel-Debreu: demand curve for a single market can have any (polynomial) shape at all Even study of a single market cant be reduced to study of a single utility-maximizing agent Yet Neoclassical DSGE macro models the whole economy as a single utility-maximizing agent
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  • SMD: Anything goes for market demand curves SMD Conditions (Sonnenschein 1973): Market demand curves do not obey the Law of Demand Even if summing well behaved individual demand curves Proof by contradiction: Assume market demand curves do obey Law of Demand Derive conditions under which this is true Contradict initial assumption Therefore they dont obey the Law of Demand q P q P Q P
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  • Market demand curve any polynomial at all Only way to avoid this: Assume all consumers have identical tastes So there is only one consumer! Assume that tastes dont change with income So there is only one commodity! Contradicts starting assumption: Two consumers with different tastes Two different commodities Proof by contradiction that Law of Demand does not apply to market demand curve How did Neoclassical economists react?
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  • Should abandon methodological individualism A very few reacted rationally: Alan Kirman 1989 If we are to progress further we may well be forced to theories in terms of groups who have collectively coherent behavior. Thus demand and expenditure functions if they are to be set against reality must be defined at some reasonably high level of aggregation. The idea that we should start at the level of the isolated individual is one which we may well have to abandon. But most reacted irrationally
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  • Representative agent madness instead Gorman 1953 we will show that there is just one community indifference locus through each point if, and only if, the Engel curves for different individuals at the same prices are parallel straight lines The necessary and sufficient condition quoted above is intuitively reasonable. It says, in effect, that an extra unit of purchasing power should be spent in the same way no matter to whom it is given. Intuitively reasonable? No, its intuitively rubbish! Textbooks reproduced the rubbish
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  • Textbooks hide SMD results from undergrads Samuelson and Nordhaus 2010 The market demand curve is found by adding together the quantities demanded by all individuals at each price. Does the market demand curve obey the law of downward-sloping demand? It certainly does A provably false statement misleading undergraduates Varian 1984 it is sometimes convenient to think of the aggregate demand as the demand of some representative consumer The conditions under which this can be done are rather stringent, but a discussion of this issue is beyond the scope of this book A vague statement reassuring PhD students
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  • Macro an emergent property Real meaning of SMD conditions Macroeconomic behavior an emergent property of interaction of agents in a complex system Cannot deduce behavior of macroeconomy from behavior of utility-maximizing individuals Cannot reduce macroeconomics to applied microeconomics But that is what DSGE models do! Fallacy of Strong Reductionism Believe macroeconomics is applied microeconomics But SMD conditions prove otherwise macroeconomics cannot be applied microeconomics
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  • Fallacy of Strong Reductionism Cant deduce even market behavior from model of individual behavior Let alone deduce macro behavior from individual Common knowledge in real sciences: Anderson, More is Different, Science (1972) The behavior of large and complex aggregates of elementary particles, it turns out, is not to be understood in terms of a simple extrapolation of the properties of a few particles. Instead, at each level of complexity entirely new properties appear, and the understanding of the new behaviors requires research which I think is as fundamental in its nature as any other.
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  • Fallacy of Strong Reductionism one may array the sciences roughly linearly in a hierarchy, according to the idea: The elementary entities of science X obey the laws of science Y XY Solid state or many-body physicsElementary particle physics ChemistryMany-body physics Molecular biologyChemistry Cell biologyMolecular biology PsychologyPhysiology Social sciencesPsychology But this hierarchy does not imply that science X is just applied Y. At each stage entirely new laws, concepts, and generalizations are necessary, requiring inspiration and creativity to just as great a degree as in the previous one. Psychology is not applied biology, nor is biology applied chemistry.
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  • Poor Scholarship basis of neoclassical economics And macroeconomics is not applied microeconomics! Neoclassical Strong Reductionism maintained by: Poor scholarship; Poor technique; & Ideology Poor scholarship: Most Neoclassical economists dont read their own literature but rely upon sanitized textbook version Act as if theory vindicated Dont know that theory contradicted Lack of knowledge of SMD conditions just one instance of collective neoclassical ignorance of neoclassical economics
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  • Poor Scholarship basis of neoclassical economics Even Solow shows poor scholarship: For a while the dominant framework for thinking about the short run was roughly Keynesian'. I use that label for convenience; I have absolutely no interest in 'what Keynes really meant'. To be more specific, the framework I mean is what is sometimes called 'American Keynesianism' as taught to many t