The Future of Economics

This Big Think post by Ali Wyne asks eight young economists about the future of the subject.  My favorite response was by Xavier Gabaix of NYU.  He said:

The most central open question in economic theory, as I see it, is how to model realistic economic agents.  Traditionally, economists have relied on the rational-actor model, but it is clear that it is just a rough caricature.  It has been greatly enriched by behavioral economics in the past 30 years.  Still, we are far from a unified, versatile, believable alternative to the rational-actor model.  I am hopeful, though, that this might be overcome—in part because of progress in the sister disciplines (psychology and neuroscience) and basic modeling, and also because empirical anomalies are forcing the economic profession to be more open-minded.  Contributions by computer scientists and physicists will help inject new perspectives into economics.

This theme of post-rational actor economics was pervasive in the eight responses, but I thought this one captured the idea best.  Prof. Gabaix’s response goes on to explain how realistic models can inform policy.

Adam Smith a Hipster Behavioral Economist?

I’m not saying he liked PBR, but apparently…

Adam Smith was into behavioral economics before it was cool… this seems to be the implication of an article written in 2005 by Nava Ashraf, Colin Camerer, and George Loewenstein that I just came across today.

More on the gold standard

Not to beat a dead horse, but I just read a great post at The Economist on the gold standard. A highlight

Of all paper money systems ever devised, the vast majority are still in existence and haven’t collapsed yet. One could argue that “all previous bipedal apes have become extinct” on the grounds that Neanderthals and australopithecus are no longer around. But that would ignore the 7 billion humans still walking around.

Further comments on gold

This will be short and sweet and will hopefully sum up my position.

First I recognize gold has its advantages in long term average inflation (at least at the time that the gold standard was in place – things may not work out the same now). Generally, a gold standard had slightly lower average annual inflation.

However, my problems with the gold standard outweigh its inflationary advantage. In the short run, gold is more volatile than fiat currency. Also because of the fixed exchange rate that comes with a gold standard, recessions tend to spread more easily than without a gold standard.

While it may be true that financeers can influence fiat currency, I would argue that anything can be influenced unfairly.

I am sure this will not end our debate in the comments thread, but I wanted to offer a general response.

I recommend reading this summary of the gold standard from The Concise Encyclopedia of Economics.

Alfred Marshall commenting on America

From Grand Pursuit by Sylvia Nasar:

Indeed, everywhere [Alfred] Marshall looked he seemed to discover more, not less, than met the eye: American architects displayed “daring & strength,” their buildings being of “uniform thoroughness and solidity.” An “American drink called ‘mint-julep’” was “luxurious.”… As he reported to the Moral Sciences Club on his return to Cambridge in the fall, “I met no man or woman in America whose appearance indicated an utterly dull or insipid life.”

A Shameless Pat on the Back

Some time ago the Freakonomics blog solicited questions for Robert Frank the author of The Darwin Economy: Liberty, Competition, and the Common Good (something that has now moved up my reading list). Last week they posted the questions they selected with his answers; I was happy to see my question was chosen (it’s the one with my name beside it). In all seriousness, the two links are interesting to read independent of my question.

An Economic History Lesson

Lord Robert Skidelsky offers a comparison of Keynes and Hayek and their views of the workings of the economy.
He points out their differing views of the economic crisis’s cause. For Hayek, he says:

… the “crisis” results from over-investment relative to the supply of savings, made possible by excessive credit expansion. Banks lend at lower interest rates than genuine savers would have demanded, making all kinds of investment projects temporarily profitable.

While for Keynes, the cause is:

under-investment relative to the supply of saving – that is, too little consumption or aggregate demand to maintain a full-employment level of investment – which is bound to lead to a collapse of profit expectations.

Naturally, with such different perspectives on the source of the problem, the two camps have different solutions in mind. Skidelsky points out:

Whereas for Hayek recovery requires the liquidation of excessive investments and an increase in consumer saving, for Keynes it consists in reducing the propensity to save and increasing consumption in order to sustain companies’ profit expectations. Hayek demands more austerity, Keynes more spending.

Who’s correct? Regarding the cause(s) of recessions/contractions, the debate will wage on indefinitely (though I will say Hayek has strong evidence in his favor in the current case); however, when it comes to solutions, for Skidelsky, Hayek just doesn’t cut it. He opines that, “for all his distinction as a philosopher of freedom, Hayek deserved to lose his battle with Keynes in the 1930’s. He deserves to lose today’s rematch as well.”

The important takeaway from this history lesson is to remember in future booms, a bust will almost certainly follow and policymakers must maintain effective tools for dealing with such issues in order to avoid repeating economic catastrophe.

Old vs. New Keynesians According to Krugman

Paul Krugman has offered his distinction between old and new Keynesians; for him it is a matter of model complexity. The link is worth a read as he walks through some of the differences between old Keynesian models (i.e. IS-LM) and new Keynesian models (i.e. Mundell-Fleming). This took me back to my senior thesis when I learned how little I really know about economics.