The Daily Bail

Outstanding Krugman-Delong takedown from economist Eric Falkenstein.

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By Eric Falkenstein

Nobel prize winner Paul Krugman may say it's econ 101 to have the federal government spend more in recessions, and I agree, but it's also wrong. The highly rigorous yet ultimately naively simplistic macro models have not been useful in rectifying this incorrect intuition, which remains dominant. Gone are the days like in 1920, when during a nasty recession, the federal government cut expenditure by half from 1920 to 1922, and the economy rebounded nicely. Historically, whenever we are in a recession, economists generally call for more fiscal spending, all the better if it is deficit financed. Yet as Milton Friedman noted, "The fascinating thing to me is that the widespread faith in the potency of fiscal policy … rests on no evidence whatsoever." Evidence no, theory, yes (currently, unemployment is 9.7%)

You can create neat models where you have consumers maximizing their utility over time, and producers maximizing profits, and if you made some very heroic assumptions, you can anthropomorphize this situation as one single individual, supposedly represents millions of people acting this way. Add some assumptions about time series shocks to productivity and tastes, and you can then calibrate the interesting variables(output, investment), and say "I have a viable model of the macro-economy".

This always seemed a bit strained, but it highlights a lot of models I see, where one evaluates a model based on it being able to generate output with similar 'moments': means, variances, covariances. Correlation does not imply causation, but it's dirty little secret that probably 90+% of actual science in practice involves mere correlations with ex post theorizing. I remember most of my fellow grad-school classmates thought these models were rather naive, as if anthropomorphizing the economy as a single person explains growth rates and business cycles, but over time, yet those who stayed with the program got sucked in like the way individuals are absorbed into the Borg collective, and the rest of us, most of us, decided to chuck macro entirely.

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