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Review Essay: "Macroeconomics Turns to History" (David A. Westbrook, USA, 06/18/17 1:52 am)

Some of you may be interested in my book review essay, "The Paradigm Sways: Macroeconomics Turns to History." The piece will be published in International Finance, but the draft is available on SSRN.

Abstract

In The Euro and the Battle of Ideas, Markus Brunnermeier, Harold James, and Jean-Pierre Landau show how the Eurozone Crisis reveals deep-seated and sometimes incompatible European traditions in economic policy. In The Shifts and the Shocks, Martin Wolf uses the history of the GFC to analyze the global economy and highlight its vulnerabilities. In The End of Alchemy, Mervyn King argues that the GFC challenged basic understandings of money and finance, and proposes fundamental banking reforms.

Historian of science Thomas Kuhn called the failure of an explanatory model, and the emergence of a new framework that better fits the data, a "paradigm shift" (Kuhn 1970).  These three books suggest that a paradigm shift may be under way in macroeconomics. As each of these books shows, narrative understandings of history inform the actions of international institutions, governments, central banks, financial institutions, firms and households. Such narrative understandings are not reducible to objective facts. Instead, they are the subjective understandings of the past that economic actors use to make conjectures about the future. Such conjectures shape decisions about interest rates, investing, saving and spending. In this view markets look less objective and efficient than classical economics has traditionally held. Macroeconomic policy may be taking a "turn to interpretation" similar to shifts in other social sciences in the last third of the 20th century. The emergence of such a paradigm would be an exciting development for the discipline.

Westbrook, David A., "The Paradigm Sways: Macroeconomics Turns to History" (June 15, 2017). Westbrook, D. A. (2017) (DRAFT), to be published as The Paradigm Sways: Macroeconomics Turns to History. Int Finance 20 (2017, Forthcoming). Available at SSRN: https://ssrn.com/abstract=2987334

JE comments:  Look forward to reading Bert Westbrook's full essay, but perhaps I could ask for an appetizer:  what are two or three aspects of this macroeconomic "paradigm shift"?

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• A Macroeconomics Paradigm Shift? (David A. Westbrook, USA 06/19/17 5:57 PM)
  
  John E asked for an "appetizer" of my forthcoming review essay. First and importantly, the macroeconomics paradigm shift may not actually occur. Hence the title--the old paradigm is swaying, but I don't think has been abandoned yet. A paradigm shift is not just an intellectual, but also a social, phenomenon. So this is an unanswered question in the intellectual history of the present moment.
  
  
  
  On the other hand, these books are written by very notable people, not hermits on mountains like me, so perhaps we are watching the emergence of a new mainstream view. We shall come to know.
  
  
  
  Regardless of how influential the view becomes, however, it can be stated pretty plainly, which is what I tried to do with my little essay. The basic point that all three books make is that economic policy and even individual decisions are based not on simple "facts" but on complex and contestable narrative understandings, subject to revision. These understandings treat (i) the past (e.g. what does WWII teach?); (ii) the world as it is now, dimly perceived, and (iii) what might the future hold?
  
  
  
  But if central bankers and households are making interest rate and spending decisions based on shaky (and interconnected) understandings of the march of history, for pertinent examples, then economics is a much "softer" enterprise than many economists have often claimed.
  
  
  JE comments:  Bert Westbrook may be up on a (Colorado) mountain, but he's hardly a hermit!  I'm still intrigued about the paradigm shift, but shifting from what?  Put baldly, were economic decisions ever based (solely) on "facts"?
  
  
  
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  • Economics vs Economic Decisions (David A. Westbrook, USA 06/20/17 7:25 AM)
    
    It's a little hard to know how to respond to John E's question of June 19th, because it involves a fundamental slippage/category mistake. A paradigm shift is a shift in the model, not in the reality the model is used to explain. (At least at the first few cuts--I'm simplifying here.)  So "economics" is not the same thing as "economic decisions," if by the later we mean actions taken by marketplace actors. Markets have been around throughout history. The discipline of economics can be dated, more or less, from Adam Smith--we could of course play with intellectual history, but you get the point: a discipline (or science) is not the same thing as its subject. This point is very often lost.
    
    
    
    The question of a paradigm shift is thus, in the first instance, a question of elite sociology. Do the people who concern themselves with the movement of the planets shift their thinking from a picture or paradigm in which planets circle to the earth to a new picture, in which planets orbit (elliptically) the sun? The question is not: did the planets ever circle the earth? By the same token, the question is not "were marketplace decisions ever based on 'facts.'?" The question is will the people who influentially concern themselves with the economy as a whole adopt a new way of "seeing" the economy? The point of "Paradigm Sways" is maybe, and these books show it could happen.
    
    
    
    Economics, less plausibly macroeconomics, has traditionally thought of and presented itself as a science, based on facts, or best available approximations (much as climate science does). This is part of the reason why arguments over, for example, austerity after the GFC were so heated. Within the culture of economics, there is a "right" answer, which ideally can be mathematically modeled.
    
    
    
    I won't work back through the entire essay, but all three books--written by a former director of the Bank of England, the economics commentator for the Financial Times, and elite academics--put the epistemology of traditional economics under serious pressure. It's pretty different, for example, to say that responses to Greek sovereign debt rest, ultimately, in various partial understandings of the proper (?) relationship between entities called "the state" and "law" in the aftermath of World War II. It's even "squishier" to say that decisions to save, or to spend, rest on subjective narratives about future uncertainty.
    
    
    JE comments:  Thanks to Bert Westbrook for this patient explanation.  Paradigm shifts are especially difficult to see when they're taking place.  Yet with enough historical perspective, they become obvious (consider Bert's example of Heliocentrism.) 
    
    
    I suspect these new economic models will require new terminology as well.  Any early indicators in this regard?
    
    
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    • What Motivates Economic Decisions? (John Heelan, UK 06/20/17 3:38 PM)
      Bert Westbrook asked on June 20th, "The question is not 'were marketplace decisions ever based on "facts"?'"
      
      I always thought from my three years studying micro/macro economics at the university, wrongly perhaps, that market decisions were based not so much on "facts" but more on "expectations."
      
      
      JE comments: And what about the Mother of them All: Fear?
      
      
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      • What Motivates Economic Decisions? (David A. Westbrook, USA 06/21/17 4:04 AM)
        A response to John Heelan (20 June): Actually, I hadn't raised a question, but a critique of JE's question . . . but to your point: yes, economics traditionally understands marketplace decisions (certainly any investment) to be based on expectations.
        
        In the orthodox view, however, such expectations long have been understood to be "rational expectations" based upon facts and evident self-interest. And in the same view, fear (JE) is reduced to quantifiable risk, for which we have insurance and hedges. It's a very rational, objective, imagination of the world--and that is not what these authors are engaging. Again, the draft version of the fairly short "Paradigm Sways" is here: https://ssrn.com/abstract=2987334
        
        
        
        WAISers might also be interested in Out of Crisis: Rethinking Our Financial Markets, my own version of how the paradigm might shift. I actually thought it had shifted, in the heady days of the Global Financial Crisis. Kind words, notably from the doyen of English central bankers Charles Goodhart, at the link below. And the picture of the lions sleeping off the kill is cool and apropos.
        
        
        http://www.davidawestbrook.com/out-of-crisis.html
        
        
        JE comments:  My copy of Out of Crisis hasn't been touched since the early '10s.  In light of our current discussion of paradigm shifts, I'll have to get it off the shelf.  It would be fascinating to review Bert Westbrook's thoughts of 7 years ago--especially in the context of the 2016 surge of nativism and populism.
        
        
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  • The Art of Economic Analysis (Timothy Brown, USA 06/21/17 3:36 AM)
    During my decades doing economic analyses of various and sundry national or regional economies--from Paraguay and El Salvador to and Cuba to the European Union and foreign aid to the impact of an NGO--if I've learned one thing, it's that no economic analysis is or can be mathematically precise down to the penny or, more often than not, even down to the billion.
    
    Economic analysis is as much an art as it is a science.
    
    
    JE comments:  The Dismal Art?  Consider the gauging of "impact," which cannot be compared to a control group.  And how do you measure economic activity that is deliberately hidden?  I hope our statistics gurus will join this discussion.
    
    
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    • Experiences with Measuring Hidden Economies (Timothy Brown, USA 06/22/17 2:20 AM)
      Here are three things you can try if you want to try and measure an "economic activity" that's being deliberately ignored or hidden. You can just go along with the game, which is the most popular thing to do, you can try to estimate it, or you can get the goods on whoever is "deliberately" hiding it and threaten to blow the whistle on them if they don't come clean. The latter is the most fun--unless it's too risky.
      
      One of my favorite approaches was to follow the advice of a Ogden Nash quote some say he borrowed from Eleanor Parker: "Candy is dandy, but liquor is quicker." That worked especially well in a couple of Latin American countries, assuming what you heard when your target was coherent was right. That worked especially well in some countries in Latin America when I went looking for data on smuggling and off-the-books money movements.
      
      
      In Europe I was once able to find "someone" that knew how many illegal casinos or slot machines there were in The Netherlands and could cross-check with the foreign manager of an illegal "canal boat" casino before he went off to manage another in another country. And so forth.
      
      
      Then I would either argue which numbers were the more accurate with the "house" economists of one or another "foreign assistance" or "investment" houses whose jobs depended on accepting the official numbers--I would usually lose.
      
      
      JE comments: Pax, Lux et (in vino) Veritas?  Tim Brown is a tough Marine, but I presume some of his economic inquiries ventured into the Danger Zone.  No wonder most number-crunchers prefer to accept the official statistics.
      
      
      Any good Paraguay stories to share in this regard, Tim?  Smuggling has long been a cornerstone of the Paraguayan economy.
      
      
      
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