Economist Says His Discipline is Lost and Confused

Divided on the most important issues

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By Terry Burnham

Economists are divided on both fiscal and monetary policy, the most important economic issues of the day. The divide is on the direction of policy, not on some detail. A field cannot be more lost than to be clueless on its most important issues. This is the equivalent of Lewis and Clark disagreeing on whether they are going to the Mississippi or the Pacific. When you don’t know east from west, you are lost.

The fiscal policy question is the impact of government deficits and debt on the size of the economy. A concrete fiscal question is to determine the impact of an additional dollar, or trillion dollars, of spending and debt by the US federal government. In economic parlance if the government spends an additional $1, and borrows the $1, what is the impact on the economy?

The answer depends on whom you ask. Keynesian economists believe the $1 of extra spending is ‘stimulus’ that gets multiplied to become something more than $1. On the other extreme, some economists believe that the $1 has to come from somewhere. If the government uses the $1 to create, for example, an IRS Star Trek video (click here), then the additional spending makes the society poorer, because the $1 would have been used better by the private sector.

This intellectual disagreement over the impact of fiscal decisions has spilled into the public domain with the fight between Nobel Prize winner Paul Krugman and the Harvard Duo of Carmen Reinhart and Kenneth Rogoff. Here is the letter written by Reinhart and Rogoff labeling Krugman‘s comments on their work as “spectacularly uncivil behavior.” The spat is over the impact of debt on economic growth.

So what is the impact of an extra $1 of government spending? The answer, according to leading is economists, is somewhere between +$5 and -$5.

I want to repeat this to make the point clear. Economists do not know if government “stimulus” makes the economy bigger or smaller.

The battle over monetary policy is perhaps even more vicious than the battle of fiscal policy.

Federal Reserve Chairman Ben Bernanke stands at one extreme of this debate. According to “Helicopter Ben”, The Federal Reserve can make us richer by loose monetary policy. The first step in this approach was to cut interest rates to zero, the second step was to undertake “quantitative easing,” under which the Federal Reserve has purchased trillions of dollars of bonds, and is continuing to purchase more bonds at the rate of an additional $1 trillion a year.

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What is the impact of monetary looseness? Chairman Bernanke states that economic growth is “being supported” by quantitative easing and low interest rates; Federal Reserve Vice Chair Janet Yellen is more specific in stating that loose monetary policy has “raised private payroll employment by about 3 million jobs.”

In sharp contrast to Chairman Bernanke and Vice Chair Yellen, many economists believe that the Federal Reserve’s actions have hurt the economy. One of the most prominent critics is Stanford Professor John Taylor, inventor of the “Taylor Rule” of monetary policy. Testifying to Congress in April 2013, Professor Taylor argues that “these (Federal Reserve) policies have been a drag on the recovery.”

What is the impact of Federal Reserve policy? It ranges from having created 3 million jobs to have decreased the number of jobs.

Again, let me repeat the current state of economics. Economists do not know if monetary “stimulus” makes the economy bigger or smaller.

During the Manhattan project there was some debate about whether an atomic explosion would burn the atmosphere and end all life on earth. The scientists convinced themselves that life would not end, and continued with the program. The physicists of the Manhattan project were intellectually honest in admitting that the outcome of novel actions cannot be known.

Even without consensus on direction of impact, economists have taken historic actions. Recent US fiscal deficits are the largest in history outside of World War II. Similarly, monetary policy is in uncharted territory. Prior to 2008, the Federal Reserve had never undertaken quantitative easing.

If economists were honest, they would acknowledge that no one can know the impact, of the first-time-in-the-history-of-the-world policies. Reasonable people can debate these issues. What is not debatable is the field does not have a unified view on the most central economic issues.

Economics is a lost field.

Let me end this section with three less serious symptoms of the sorry state of economics.

1. The best-selling economic book explains Sumo, but not economics.

Freakonomics has sold more than 4 million copies making it one of the best-selling economic books in history. It tells us, for example, that Sumo wrestlers are likely to throw matches when their opponent is in danger of losing status with a loss. Freakonomics is, however, silent on monetary or fiscal policy. This is not negative statement about the book or the authors, but it is a negative statement on the field. Where is the best-selling book that correctly explains how to grow the economy?

2. Nobel Prize winner Professor Harry Markowitz does not use his own theory.

Professor Harry Markowitz won his Nobel Prize for a theory on how to make investments. When investors decide to buy stocks or bonds, for example, Professor Markowitz’s theory argues the optimal mix requires examination not only of historic risk and return, but also the correlation (or co-variance) between returns.

Does Professor Markowitz use his theory when he buys stocks and bonds? No. He splits his money 50-50. He is quoted as saying, “I should have computed the historical co-variances” but through psychological introspection he instead just split his money equally into stocks and bonds.

3. Nobel Prize winners Professor Myron Scholes and Robert C. Merton did use their own theory and almost blew up the world.

Q: What is worse than an economist who doesn’t use his Nobel prize winning theory?
A: Economists who do use their theory (and almost collapse the world economy).

Professor Myron S. Scholes and Robert C. Merton won the Nobel Prize in 1997. Both men were principals in the hedge fund Long-Term Capital Management (LTCM). Soon after their Nobel Prizes, LTCM went bust. The NY Times says the LTCM went bankrupt because of it “made a number of unsound, esoteric bets.” The bets were so large that the US government had to rescue LTCM. Then Federal Reserve Chairman, Alan Greenspan defended the action by stating to congress, “failure of LTCM … could have potentially impaired the economies of many nations, including our own”.

Economics is a lost field. More than 200 years after Adam Smith wrote the Wealth of Nations, economics has no answer to the most important economic questions. Fields go through periods of growth and periods of stasis; I believe we are in a period of prolonged stasis in that we do not know more than we did 10 or 100 years ago.

Furthermore, I fear that this is a dangerous time to be ignorant of economic realities. The financial crisis is not over, and, consequently, it would be good to know what policies to pursue.

Is there any good news on the state of economics? Yes. There are two meanings of lost. One is a permanent outcome such as the Soviet Union lost the cold war. The second is a temporary state of being confused about location and direction. I am optimistic that economics is lost in the second, temporary sense. Economics has great elements, and many great people. It has the ability to find its way, and that will be the subject of a separate essay.

28 November 2015

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  • Atin Basu

    Ah, more clickbail! By this argument both medicine (what causes diabetes — not known) and physics (what, no unified theory!) are also lost fields! Also fiscal and monetary policy is not the only focus in economics.

    • There is a doctor who knows the cause of diabetes and cures it. But it is not common knowledge and the powerful industry shouts ‘There is no scientific evidence!!’ which is true but irrelevant because there is emperical evidence: the treatment simply works.

      I agree that Medicine is a lost field because diseases are not understood and after 50 years of cancer research it still is not understood. Medicine rarely talks about causes and cures, but instead, Medicine tries to alleviate symptoms. There are also many differences of opinion and most disturbingly the end results (i.e. a patient gets better) is not considered a valid argument in the debate.

  • Seattle Sam

    I think you’re confusing something here. Fiscal and monetary actions are merely two of many variables in the equation that produces economic growth. Ceteris paribus, we know a lot about what they do. The world is not a laboratory where we can hold all other variables constant, however. While I know for a fact that if I exercise more, I will burn more calories, it does not necessarily allow me to predict weight loss accurately. In economics there are certain things that are facts with few exceptions. Among them are: When you make something relatively more expensive, you will get a lesser amount of it demanded. So, for instance, if New York sets a minimum wage for the fast food category that is above the market wage, you will have less labor demanded in that sector (ceteris paribus). This does not mean that you will necessarily be able to observe fewer people working in fast food restaurants, only that there will be fewer employed there than would be employed if you hadn’t imposed that action.

  • commiiiiie

    How do you know that business cycle theory is the most important field if there is no consensus on the answers to that set of questions? You’d have to know what optimal policy would be, and what it would achieve, to know the importance of that subfield.

  • a_____z

    please don’t refer to yourself as an economist in your byline. you apparently didn’t learn anything during your phd.

  • This whole article is based on flawed assumptions, which Sam comes closest to explicitly identifying.

    The article assumes that the outcome of actions can be predicted.

    Complexity theory tells us that there are many different sorts of systems, all of which are predictable only in a probabilistic sense.

    Some systems are sufficiently simple that the probabilities deliver a close approximation to hard predictability. Engineers love such systems, the economy as a whole is not such a system, though it does contain many component sub-systems that have this set of characteristics.

    Some systems are complicated, with less distinct boundary conditions and more obviously probability based outcomes. Much of human activity falls into this category, and hence much of economics.

    Some systems are complex, dispositional, and interactive. Such systems can respond in any manner, but some responses are much more probable than others. One must probe such systems, sense how they actually respond, then amplify desired trends and dampen down undesired ones. Much of economics falls into this class of complexity. It is simply not capable in either logic or mathematics of being predicted with consistency. One interacts with such systems, and is changed by the interaction, to a similar degree to the changes one wroughts on the system. Boundary conditions change with every action.

    And some systems are chaotic. Some sorts of chaos are causal, but unpredictable (like the Mandelbrot set), and other forms of chaos are completely random (not amenable to prediction at any level). Some aspects of economic systems are chaotic.

    So starting with an assumption that anyone can predict how the economy will respond simply displays an ignorance of the degrees of complexity present.

    And Goodhart’s Law is important:
    “Any observed statistical regularity will tend to collapse once pressure is put upon it for control purposes.”

    Having said that, there are other aspects at play as well, other paradigms available.

    A market based (exchange based) set of valuation measures (with all the many layers of derivative measures and tools) is only one possible paradigm.

    Markets have been very useful historically, in a context where the vast majority of goods and services were scarce, and where most people could be genuinely employed in tasks with social benefit.
    We are now entering an age where computers and automation can deliver any good or service (or at least a replica that is indistinguishable by human senses). In such a realm there is no need to employ people to do anything, as there is no need to exchange anything.
    That requires a complete re-examination of the concepts of the values we claim to hold most dear – life and liberty.

    What might liberty mean in an age where any discovery, any information or manufacturing technique perfected, can (in a matter of seconds) be replicated to every personalised production system on the planet and be available to every individual who might have use of it?

    We have the technical ability to produce such systems.
    The market value (exchange value) of such a system must be zero, as by its universal nature, it makes all goods and services as scarce and as valuable as oxygen in the air – of no market value due to universal abundance.

    For the most part, we are trapped within a paradigm that has collapsed a method of accounting (money) with the things represented (goods and services), and most minds can no longer keep them separate.

    The questions facing our society are far larger than those any first year student of complexity could instantly answer – ie why no one can predict how an economy will behave.

    The really deep question is, at the deepest (and or highest – depending on ones conceptual schema) levels of awareness and incentive structures, what are the values that deliver the greatest probability of life, and the greatest degrees of individual freedom?

    I am very clear, beyond any shadow of reasonable doubt, that market based values of exchange are rapidly approaching the point where they deliver greater threat to life and liberty than they deliver in opportunities. And the curve appears to be a tight exponential, when it crosses the axis it is going to go deeply negative very quickly. We have time to develop a replacement, but not a lot of time.

    • Aren’t patterns emerging from the “chaos”?

      Some refer to economics as a “business science” while others refer to it as a “philosophy” which are radically different in my view. I do know that most economics departments aren’t nestled among the school of business, nor can it be found nestled with humanities/philosophy classes.

      I do know that monetary supply theories via Milton Friedman have been used since the 1980’s (trickle-down theories). The end result is the worst income inequality our country, and much of the world, has ever witnessed.

      Also, didn’t you introduce laws which should be applied to assumptions? Didn’t you say there were about 4 or 5 levels?

      What were those laws?

      • Hi Todd,
        There are definitely many patterns present, with varying degrees of reliability (probability).
        Chaotic systems can’t be predicted.
        To the degree that the behaviour of any system as a whole is dependent upon chaos, it will be unpredictable.
        All systems have degrees of unpredictability.
        Working out the degrees of confidence in what is what is as much art as science.

        And sometimes, if one digs deeply enough, one can find reliable patterns.

        I think what I said about assumptions is it helps if one is explicit about them, and is willing to seriously question them as circumstances allow.

        One can take any concept to any degree of abstraction, and once one goes beyond 2 levels, communication with others becomes very difficult and uncertain.

    • Emmef

      It is not bad if a science cannot predict events accurately, as long as the scientists acknowledge that and refrain from influencing policy (1).

      In physics on a microscopic scale, the same unpredictability holds. On a larger scale things are more predictable. You can formulate a hypothesis and experiment to falsify the hypothesis or make it more probable. But physicists will tell you what the working domain and preconditions of their models are. Engineers need that to actually make stuff work.

      In economics, things are different. Most models are highly hypothetical and mostly not falsifiable of verifiable, some are even ideological. You need to interpret existing data – that was probably already pre-processed (“changing parameters” in society can be unethical). And there is a lot of disregard for using statistics correctly. And then: if you know your models are not compatible with, say, endogenous money creation (90+ percent of all money): why insist on using those models to determine policy?

      With a science in this state, experimenting on societies by means of influence (policy, finance) is unethical.

      (1) see Hayek on why he would never have established a prestigious price in economics:

  • Jan de Jonge

    In 2014 the Cambridge Journal of Economics devoted a whole issue (vol. 38) to the Whig
    history of economic science. This is the interpretation (of Samuelson) of the history of economic science that argues that present economists “not just (..) have reconstructed the ideas of some great economists of the past in the economics concepts and language of today, but also,
    miraculously, (..) have captured the very essence of those ideas better than even their inventors
    themselves understood them.” The past is rendered as a teleological evolution that was meant to end where today’s thinking is.
    In the Whig interpretation economic science is presented as a discipline in which rival
    schools and theories competed for dominance and the best won. In this volume of CJE this Whig interpretation is contested. Mainstream economics does not represent the best ideas but the successful negation of rival interpretations of writers in the past and the subsequent emerged heterodox schools. Instead of teaching a uniform discipline economic departments should attend to the pluralism of economic thought.
    This plea for pluralism opens the door for competing views about the consequences of fiscal
    and monetary policy to deal with economic crisis. It is not a signal of weakness but of a manifestation of the open exchange of ideas in a mature discipline in social science. In psychology or political science you witness the same kind of pluralism.
    However, there is one thing that distinguishes economic science from psychology and political science and that is its direct relation with the role of the state. Since the allocation of resources can be done in principle by the state or by the private sector (the market) and since historically the state (the king or emperor) managed a large part of the economic potentials, economic science has always been political economy. Conflicts over the consequences of fiscal and monetary
    policies are to large extent arguments about the proper involvement of the state in economic affairs. Of course these conflicts are fought with economic arguments (the role of public debt, taxes, incentives, externalities etcetera on economic growth). This discussion escalated in the USA since the Tea Party became a serious political factor and in the European Union since the
    neo-liberal turn and particular recently with the Greek crisis. In this debate an article by Reinhart and Rogoff in 2010 provided empirical foundation in support of austerity policies at reducing the high public debt levels that emerged in the aftermath of financial crisis in 2007-09. But research by
    Herndon, Ash and Pollin (CJE, 2014, vol. 38) detected major imperfections in the article by R&R (as exclusion of available data, coding errors and inappropriate methods for weighting summary statistics). They conclude that R&R created a false image that high public debt ratios (> 90%) inevitably entail sharp declines in GDP growth.
    Political economists even though they have political biases (or preferences related to such vital
    values as liberty and/or equality) remain faithful to their profession and try to proof their view empirically. R&R for instance provided their critics with the data they needed to replicate their findings.
    Refutable theories,not consensus, are what make sciences worthwhile. The economic science is
    anything but a lost field.

  • Mark Sloan


    I also have noticed that different schools of respected, professional economic thought confidently predict wildly contradictory results from the same economic actions – such as an extra dollar of government spending or ‘loose’ monetary policy. So the conclusion that economics is ‘lost’ (or at minimum has no consensus ‘grounding’ in reality) seems uncontroversial. So I am surprised at the negativity here by several commenters.

    I’ve gotten comparable responses from moral philosophy majors, each offended by my perceived attack on the rightness of their preferred school of moral philosophy, when I argue that current moral philosophy is similarly ‘ungrounded’ – again based on contradictions about essential fundamentals among respected professionals.

    Just as I argue morality can be grounded in cooperation strategies biologically and culturally selected for in our ancestors, perhaps we can gain similar insights from an evolutionary view of economics as, perhaps, a different category of cooperation strategies?

    I look forward to your coming description of how an evolutionary viewpoint can ground economics in reality and thus become ‘un-lost”.

  • jothwu

    I’m convinced to be a good economist one should first learn how the economy works on one’s own. You surely won’t learn it by what’s being offered at most schools.

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  • Greg Davidson

    We should question the assumption that economists are prioritizing empirical truth as the highest value, People may choose to believe an economic theory because it promotes their self-interest or is consistent with their moral or cultural values. The Austrian school (which is at the heart of conservative economics) fundamentally relies on what Mises called “praxeology”, which is essentially a faith-based system built on an assumption about human behavior that cannot be questioned. This may be why debates over economics can be as fruitless as debates over religious doctrine: if you are unable to formulate a test that could invalidate your fundamental assertion, then you have a theology not a science.

  • jim349

    Economists are the only profession held to a lower standard of accuracy than TV weathermen.

  • Leonardo Faccini Tavares Basto

    He is right. I know the answer.