John Harvey on Neoclassical Economics causing the Economic Crisis
John T. Harvey is Professor of Economics at Texas Christian University and a leading non-neoclassical economist. He is doing his bit to raise awareness of alternative approaches to economics via a blog that is published by Forbes Magazine. John explains his motivation for establishing this blog as follows:
I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
John’s most recent blog entry takes aim at one of my favourite targets: neoclassical economists and their role in blindly leading the world into the biggest financial crisis since the Great Depression. He notes that “economists were the ones who provided the intellectual justification for the transformation of our economy over the past thirty years”, and shows just how bizarre their
When asked what was most important to success as an economist, students ranked these skills in this order:
1. Being smart in the sense of being good at problem solving.
2. Excellence in mathematics.
3. Being very knowledgeable about one particular field.
4. Ability to make connections with prominent professors.
5. Being interested in, and being good at, empirical research.
6. Having a broad knowledge of the economics literature.
7. Having a thorough knowledge of the economy.
No, I did not accidentally type the list backwards! And, if anything, the relegation of “knowledge of the economy” to dead last has become worse. Courses that would have provided context and empirical grounding to theory have been slowly replaced over the past thirty years by those teaching more mathematical methods. Today, students learn more about set theory than they do about the merger movements of the late 19th and early 20th centuries–if they hear about the latter at all, which is increasingly unlikely.
John is also very complimentary about my approach to economics.
I recommend reading “How Economics Contributed to the Financial Crisis“, and subscribing to John’s blog as well.
Discussion (18) ¬
There has been some good stuff on John’s blog esp. on monetarism
An aside The Major City of Bristol launched its own scrip currency today the difference from most currency scheme is that it is created and administered electronically – by the local credit union- and local tax payments are accepted in it.
http://www.bbc.co.uk/news/uk-england-bristol-16852326
q
‘Ben Yearsley understands money. Big money. He is an investment strategist at Hargreaves Lansdown, the Bristol finance house which looks after £22bn of people’s savings.
He points out that the scheme will do nothing to help Britain’s economic recovery.
“This won’t boost spending,” he explained. “It will merely move money from one sector to another, from national firms to local ones.”‘
What he misses is how it increases the velocity of money and changes its distributional impact.
If major local firms could lever their own positive balance sheets to such currency creation we might finally be on to something.
I’ve read a few articles by John Harvey before and thought he made a lot of sense. Excellent write up of you and your work Steve.
Off Topic,
If you’re a contributor or reader of this blog and you visit this blog and others like it to try and avoid the spin of the MSM then you might be interested in this. I only just found it, so it’s not a recommendation more an invitation to check it out. Anyone starting an alternative up in the current media environment IMO deserves encouragement.
“SYDNEY – A new not-for-profit media group was launched in Australia Monday entirely funded by a philanthropist who has pumped Aus$15 million into a start-up that promises “fearless, independent” journalism.”
http://www.theglobalmail.org
John T Harvey seems to be the ‘go to’ man for how exchange rates behave in the PK tradition.
I think his “it’s complicated” summary should be heeded and heeded well.
It seems that the entire open borders and open trade policies are based on models of the exchange system that have no empirical backing whatsoever (primarily that there is some magic force that pulls exports and imports back into balance over time).
It’s almost as jaw dropping to read this from John as it was to read the SMD stuff that Steve wrote.
You do feel like going around tapping economist’s heads and shouting “hello real world calling” in their ears.
It is encouraging to see there is recognition from others within the economics profession of Steve’s work and insights that have emerged from it.
There is still a long way to go though for mainstream economists. Here is a recent offering from Roger Farmer:
http://www.voxeu.org/index.php?q=node/6940
In his view the Great Depression and Great Recession had nothing to do with debt. In Farmer’s words “Both economic calamities were preceded by large drops in asset prices that were not associated with any fundamental trigger.”
If Farmer is right then one can only conclude that Steve Keen has immense psychic powers for his ability to predict in detail of how events unfolded in 2008.
The “D” word does not even get a mention in the linked paper. I am wondering if his policy solution of Fed market intervention is in play in some way now. What is underpinning the current rally in the US stock market?
Farmer, like Krugman, doesn’t seem to be able to connect the real world with theory. They fail to recognize that the public system has been progressively captured by private interests. They continue within a paradigm of perpetual growth and energy abundance. And, sadly, within the context of this current system, rightly conclude that destructive energy can in fact be economically positive.
As a sidebar here, note that the US FED has been attempting to boost private wealth (and municipal funds) directly for several years now via support of equity markets. It has not improved consumer confidence. Rather, consumers have been pulling record amounts of cash out of the markets in order to address debts and cope with rising cost of living. Meanwhile, housing continues to drop. And the cost of college education is becoming yet another debt bubble.
Yes, government debts are fundamentally different than private debts. But, in most cases the government debts are not born of public making. They are born private and bear interest due to private entities. They also serve most those who are closet to it’s creation. Consider that in a casino, the “house” edge may be small – but in time the “house” will eventually wind up with all the cash due to this slightly advantage. The current fiat cycle is simply nearing it’s logical conclusion as a result.
@steve
Asset Prices & Aggregate Demand
Some thoughts on the bus home. In recent papers you have introduced a term for the formula for effective demand based on the returns from ‘cashed in’ assets. This is important as it links debt and asset prices. For example in 2006 it is estimated that an incredible 4% of UK GDP was due to the effects of people cashing in on rising house prices – clearly not sustainable.
But great caution is needed as there is always a counterparty. If the money spent on assets is simply alternative use of income then it does not add to AD, however it does if it results from the disaving of otherwise idle cash balances, or if it results from additional debt creation (in which case there is a danger of double counting)
Can we simply say then that AD =Income +change in debt + disaving minus saving.
Yes and no. Assets matter because they are not liquid and they have varying degrees of depreciation and liquidity equivalence. If assets depreciate rapidly then the velocity of money remains high – but if like housing it depreciates very slowly (non land elements) then it locks up liquidity and slows down velocity. The equation above needs a depreciation and demurrage term. In periods though where there are lots of asset sales and drawing down of cash balances to help fund purchases it can significantly boost both velocity and AD. So the extent to which income (from whatever cause above) is spent on assets of varying degrees of liquidity and depreciation matters in predicting future periods of the monetary circuit, and again no shortcut from proper stock -flow consistent modelling of this.
Also hints at an alternative way of seeing liquidity preference, cash and idle balances as an illiquid residual from investment opportunities and day to day expenses. Much the same way that company profits are modelled.
Is it not true that monetarism fails to work largely because it relies upon the FED and Banks in general with their once removed non-direct paradigm so far as consumer finance is concerned? If you infused the consumer directly with non interest bearing costless cash and then kept inflation from developing with a discount to consumers in any given period,would this not go a long ways toward making it work?
On connecting the real world with theory.
The problem with the real world is that it keeps changing the rules, which makes it a bit difficult for theory to continue to be relevant. In saying that I think Steve has made a lot of progress here. However there is a danger of thinking that you’ve cracked it and have all the answers.
I’ve also noticed common amongst theoretically orientated individuals a theory first approach. Reality is only accepted if it fits into the theory. You can get away with that because reality is not very transparent and only people with a very close view and expierence in reality know any better anyway, most punters are totally naive and are receptive to the theory first approach.
Economics seems to become a study of how things should be, reality should change to conform to my theory. The real danger with that, as history shows time and time again is that the theory misses all the little details that make reality function properly and applying ideological ideas to reality ends up in a great big mess.
On that we’re in complete agreement TITINT.
Truthis,
I completely agree with what you say because paradoxically if there is one constant in the temporal universe……its change. However, you do have to start with theory and the deeper your theory impacts the basic ideas of upon which a theory is based the more profound those changes will be. If, consumer debt is the major stuck/sticking point for the workability of the economic system, and you change the whole paradigm upon which consumer finance is based from scarcity to relative abundance so that debt will be much less likely to build up, and finally have an unobtrusive to the normal busines process mechanism which will tend to balance the economy….I’d say that would be a good start.
Actually, without trying to sound like a parent or worse yet an over bearing cleric the first step even before trying to craft an economic theory might be to have something akin to a constitutional convention on the philosophy and values we in our respective socities want ALL of our systems and their policies based on. For the last several centuries finance and economics have kind of hijacked those values, purposes and consequently the policies. In order to have your society actually change directions as opposed to utilizing palliative “reforms” or even new theories you have to go to the source of it all. Do we want profit or work as an end in itself to be the primary ideas and values, or do we want something more universal, more basically human and so more resonant and profound? It doesn’t take a wise man to make that choice. It simply takes the understanding that…..its the correct first action….and then taking it.
I’m probably “preaching to the choir” on this forum, but the economic, financial and political authorities undoubtedly need to pause and consider such.
Back three years ago not long after TSHTF, I was looking for ways to understand Keynes and I ran onto Harvey’s 2002 paper on a system dynamics approach to the Keynes business cycle. It got me excited enough to take a stab at it myself, and I got it to run and do interesting things using Vensim. I also realized that I needed to know more basic economics than I did, so I put the system dynamics stuff aside for a while and set about trying to understand how other people thought what they did.
I was ripe for Debunking Economics II! Somehow, Steve, I missed your work during my early Google searches for systems approaches to economics. I’ll be model building again pretty soon!
Re: TruthIsThereIsNoTruth
February 7, 2012 at 6:53 am | #
On connecting the real world with theory.
The problem with the real world is that it keeps changing the rules, which makes it a bit difficult for theory to continue to be relevant. In saying that I think Steve has made a lot of progress here. However there is a danger of thinking that you’ve cracked it and have all the answers.
…….”
I believe Steve’s Minsky model will give a realistic basis for what occurs in the tangible economy. And to the extent that the derivative economy is linked to the tangible part that component will follow. The limitation is that the derivative economy is now about 10 times the tangible economy so there is potential for unexpected amplification of small instabilities.
Engineers familiar with control theory know how high gain systems can run away. Modeling the derivative economy with any meaning brings in additional complexity due to the leverage or gain in the system. Small variations can initiate huge swings. Ultimately there may be no circuit breaker that can prevent complete blow up if it keeps going with the current trajectory.
I do not think that any model of macro economy will be sound unless it also models the derivative economy. Alternatively constrain the derivative economy to a fraction of the tangible economy rather than multiples.
«I’ve also noticed common amongst theoretically orientated individuals a theory first approach. Reality is only accepted if it fits into the theory.»
But the story of Economics is not a story of «theoretically orientated individuals» it is a story of politically oriented individuals.
The central truthiness of Economics is that the distribution of income is determined uniquely by personal productivity, or equivalently that high income and wealth are deserved.
Every one of the intentional “mistakes” (both mathematical and economical) in the theory of Economics as listed in “Debunking Economics” is necessary to support that truthiness.
It is not that the practitioners of Economics and their sponsors are good-faith or deluded theorists that develop a theory and ignore reality that does not match the theory.
They are politicians who have vested interests and ignore any theory that does not advance their vested interests.
Some people argue that it goes further up, that the supporters of Economics are actually theologians, in the religious sense, with a theology of salvation that is in effect crass elitism (major example: Mankiw), and their politics are a consequence of that and their Economics are an indirect consequence of that.
Title: Taleb in Disguise?
TruthIsThereIsNoTruth,
With that piece, I would have mistaken you as Nassim Taleb, who is my hero in philosophy.
Blissex,
Modeling your economics while being motivated by religion is one thing, and economics which is unconsciously but accurately a policy reflection of basic universal human values like faith as in confidence, hope, love, a sense of grace and which values have the effect of liberating the individual not empowering a system, is another altogether.