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Source link: http://archive.mises.org/15083/what-is-the-current-state-of-economic-science/

What Is the Current State of Economic Science?

December 22, 2010 by

Just before the beginning of the crisis, work produced by a variety of leading economists was very positive on the state of macroeconomics; it concluded that the field had made big advances in the last decades. A sample of their comments is offered below. FULL ARTICLE by Erwin Rosen


Frediano December 22, 2010 at 10:18 am

RE:This is evident in the poor performance of the economics profession during the current financial crisis. Few economists saw it coming; once it started, its severity caught them by surprise; and now it is apparent that there is no agreement among them on how to end it.

Few is a relative term. There was broad condemnation by economist to the governments response to the LTCM fiasco in 1998, at or near the peak of the ‘Clinton Miracle’ 90′s economy. It was only a 3-4 billion backstop then, but it set a dangerous precedent into which the inevitable sharks raced to. Then, it was sold as a ‘once in a hundred year event.’ In only ten years, 3-4 billion became trillions, and we’d all kill for a ‘global economic meltdown’ that could be averted by unfettered access to ‘only’ 3-4 billion of OPM.

However, any Federal Reserve intervention that changes the market outcome from what would otherwise have occurred has the clear potential to exacerbate the moral hazard problem in financial markets. The Federal Reserve’s actions clearly raise a question about what its “lender-of-last-resort” policy is, and about whether in the future it intends to extend the Federal safety net that underpins financial markets to all financial institutions deemed “too large to fail.” The prospect of receiving federal assistance in times of market stress has the potential to affect private incentives in undesirable ways and to create additional moral hazard risk in the financial system. This concern provides an overriding public interest in the actions taken by the Federal Reserve in assisting LTCM , and the absence of any discussion of this event in the Report constitutes a glaring omission that needs to be corrected. At minimum, the Federal Reserve itself should have to demonstrate publicly that its actions in organizing LTCM’s rescue were a necessary and appropriate response to unusually disorderly market conditions, and that alternative solutions were not available or would have proved inadequate. Unsubstantiated assertions of “systemic risk” are not a sufficient justification.


Some economists had it exactly right long before the storm.

The criticism is, as you describe, there is no field-wide consensus– not on what will happen, not on what is happening, not on what already happened. The field is and has been over-run by politics, as exemplified by the rantings of Paul Krugman from his ‘Dept of Political Economy’ at Dust Bunny U. (Princeton as emblematic of those comfortable places of pure subsidy, choke points of indoctrination long ago targeted by freedom’s totalitarian leaning adversaries. Places where those of a certain bent on the left collect up like Dust Bunnies safely under the bed, comforting themselves in their existential terror at a universe in which they are increasingly dependent on the undecipherable math of others not only to prevail but to survive. That endless existential terror at being leads those of a certain bent to sell out freedom in a heartbeat, and become advocates for the running of other’s skins without their consent.The irrational existential terror of children is insufficient reason to sell out freedom.

J. Murray December 22, 2010 at 10:31 am

Most economists don’t understand the scientific method.It’s obvious since the term “theory” is being thrown around. A theory means you’ve tested a hypothesis extensively and it works without exception, thus far at least. The moment an exception is found, the hypothesis needs to be thrown away and redeveloped around the new observation. Modern economists don’t do this. A common claim is “my theory works if X didn’t happen”. X can be animal spirits, panic, etc. Keynesian economics and Chicago School moneterists are entire fields developed around a hypothesis. None of them have held up to observations. Instead of being good scientists and abandoning the field, they continue to insist it all works, we just need to force all the variables into place and stop being stubborn about it. This is one of the main reasons why economists are viewed in the same way as astrologists and psychics by other fields like physics and engineering.

The key point when mainstream economics ceased being a scientific field and turned into mysticism was the 1970s. Dumping money into the system didn’t work, yet the mainstream still insisted that it did, that this time was some rare exception to the rule. If the mainstream abandoned Keynes and Friedman during the 1970s, we’d be able to call it a science today. But here we are again, still trying to shake a chicken over the economy and chanting the magic words and all the various excuses as to why it isn’t working.

Economics will never be a science until its key players learn to abandon a hypothesis that doesn’t work.

billwald December 22, 2010 at 12:05 pm

If “theory” means “well demonstrated hypotheses” then there are no economic theories.
Econ isn’t a “hard” science because its hypothesis can’t be falsified.

Every sort of employment wants to be classified as “science” because science pays better than the arts. How’s that for an economic hypothesis? People think that anything which uses expensive technical toys is “scientific.” Economists use expensive computers thus economics is “scientific.” These days farmers use expensive technical toys to get rid of cow poop.

J. Murray December 22, 2010 at 1:06 pm

That’s the point. As it stands, there really are no economic theories. Nothing has been tested and proven right. Things like a legitimate free market have never been tested and all the varying degrees of regulatory interference always fail. I think it has most to do with the economics field refusing to redevelop new hypotheses and continue on with the falsified ones as if they’re still true.

greg December 22, 2010 at 12:02 pm

Most Austrians predicted the bust, but few predicted the booms. Most Keynesians predicted the booms, failed predicting the bust. As far as I am concerned most economist are no better than Jim Crammer.

The economy as I see it is all about odds. If you look back 50 years, we have 1 recession year for every 3 expansion years. So if you are like Roubini that constantly takes the doom side, you are going to be right 25% of the time. On the other hand if you are like Larry Kudlow, you will be right 75% of the time. The funny thing is that Roubini gets elevated to economic guru because when he is right, the economy downturn is making big news.

What I really love is those economist that make a prediction like there is a 50% chance of a double dip. Alan Greenspan did just that and the markets fell.

And there isn’t a single economist out there who is factoring in the impact of the media. You have economist that are making predictions that are holding positions that can be impacted by people following their trade.

Bottom line, all economist should learn how to report the weather and they will learn they should not predict snow in the summer.

Iain December 22, 2010 at 8:53 pm

Isn’t it Austrian theory that says the booms are artificially created by central banks? So they did predict it, eh?

Eric December 22, 2010 at 11:10 pm

>> few predicted the booms

Hmmm, I think that predicting a boom is impossible unless one knows beforehand what actions will take place. One can only predict a boom with the words, If such and such occurs, then a boom will occur. However, once the boom starts, then Austrians are pretty good at recognizing it.

Austrians don’t maintain that they can predict where exactly the boom will occur, i.e. which form (stocks, housing, etc.) and only say that it’s most likely that the boom occurs in an area that tends to be the fad at the time. ABCT does mention that the higher orders are affected the most since it is they that are affected most by the false signals of the artificially fixed interest rates.

The dot com boom was mentioned before the bust at this site, at least in this article:


And certainly, Peter Schiff was on T.V. mentioning the building up of the housing bubble, as all the you-tube videos document.

True, you said “few”. And it’s difficult to define few in this regard.

Still, I used the knowledge found here twice to shape my investment portfolio and so far I’ve saved myself twice. The most recent predictions are of a bond bubble. I’ve adjusted there. Time will tell if the Austrians are 3 for 3.

Jack Roberts December 23, 2010 at 5:26 pm

I thought that booms were caused by credit being easily available, without credit being easily available for whatever reason, be it government manipulation in some way or another or a fresh new industry that everyone involved thought would have good returns ie a market reason. I don’t think anyone realy predicted the booms years before hand. While a bust is more easily predictable because we can already identify the boom that is taking place. Surely if you can predict a boom then you can predict a bust ?

Deefburger December 22, 2010 at 12:13 pm

I find that there is a general misconception about the nature of equilibrium itself. It doesn’t exist in a complex system of unique elements, ever.

Instead, there are conditions of outcomes at the micro level as follows:

1. 0,0 – No exchange, no change.
2. A+, B- – unfair exchange favoring A or an error or cross purpose, Negative or 0 gain
3. A-, B+ – unfair exchange favoring B or and error or cross purpose, Negative or 0 gain
4. A+, B+ – Mutual gain, mutual profit from the exchange, Positive change.

There is no equilibrium. There is only the search for mutual gain. What makes this gain possible is the differences in the knowledge of A and B relative to the items or services exchanged and the conditions as known and understood by A and B. Any mutual gain comes as a result of the special knowledge of the players, A and B.

So any model of macro systems of economic exchange that assumes total knowledge for all “As and Bs” is bogus. Any assumptions of equilibrium can only survive testing for a short moment in a special circumstance and specific observation and measurement. After that, it becomes meaningless because the system is dynamic. You only see the equilibrium for a moment, and in the particular place and time that you looked! Very much like quantum mechanics. You cannot predict whether the cat is dead or alive, you can only open the door and look to see. And that looking will only tell you about the cat you looked at, not the state of all cats. (I’m referring to Schrödinger’s cat).

And to further the quantum analogy a little further, if the system under observation and modeling is tampered with, then the system no longer makes decisions the same way, and any predictive ability of the model becomes false prediction. You cannot model the activity of a system that is being willfully altered, say by government, or unwillfully altered by natural circumstance, such as a hurricane, except for a short moment, in one place and time, looking at one particle at a time.

The reason Austrians get it right is that they know they are looking at the micro-particle interaction of individuals in a larger system that is largely unpredictable. That is a much more scientific view of the natural world of economics than any Keynesian or monetarist view that assumes control exists. That assumption can only guarantee that the cat is dead, by forcing that situation on the cat!

(And then they sit back and say “See! Dead Cat, just like we predicted! because they shot it after they opened the door, thus, proving the model to be 100% capable of prediction.)

John B December 22, 2010 at 1:15 pm

The people who have made the mess though, I think, understand very well what has happened. Because they made it happen.
They got rich by “clipping the coin of the realm” and they are going to keep it that way, if they can.
And that is what one has to overcome?

R. Thomas Harding December 22, 2010 at 4:08 pm

No economic theory other than Keynesian will ever get tried in the US as long as it doesn’t include massive government spending and zero interest rates. Keynes’ models are the joy of every free-wheeling, spendthrift politition and nothing will change. That’s the reality.

Eric December 22, 2010 at 11:17 pm


Jonathan M. F. Catalán December 23, 2010 at 1:08 am

I think the poor state of modern macroeconomics can be seen even without taking into account the utter failure of most macroeconomists to predict the recession or the severity of the recession—let alone the inability for modern macroeconomists to accurately predict the net effect of fiscal and monetary stimulus. There is no “mainstream” macroeconomic theory. It is all an alphabet soup of different theories, each pieced together with dubious logic and with no central backbone except what amounts to poor reasoning and blind faith. Very few economists agree with each other entirely. For example, it would be inaccurate to claim that there is a true Keynesian school—it could be said, with slight exaggeration, that no two Keynesian economists completely agree with each other.

To me, this great disparity in different economic theories is what damns the profession. I would garner to guess that very little actual progress has been made since the 1950s. Or, that much less progress than would have otherwise been the case—had there been a unified theory everyone agreed with. There was definitely progress—Austrian entrepreneurship and market disequilibrium theories, for instance—, but for the most part this progress is probably divided and would have to be extracted only after developing an accurate theoretical backbone (similar to how many progressive insights were extracted out of classical texts, even though they too suffered from a lack of an accurate theoretical backbone).

I think the lack of general treatises on economics, except for textbooks (which are all too often mixtures of different theories and discuss economics as isolated theories), is particularly telling. How many people have recently tried writing a general treatise? How many people have tried to piece all the pieces of the puzzle together? It’s true that to a degree the academic publishing culture has turned toward journal articles and small books, but that is just another step in the wrong direction—it underscores my point.

I think modern economics is in a very poor condition. With a bit of luck and a lot of hard work, though, the Austrian school can provide a viable alternative to those who are impressed with the mainstream (the Austrian school being one of the few schools which is moderately unified).

David Roemer December 23, 2010 at 8:47 am

I get the feeling not too many people understand how grossly irrational macroeconomics is. It is based on the irrational concept of “equilibrium,” which was introduced not by Keynes or the guy who invented the concept of the GNP. It started with Alfred Marshall who introduced the concept of the “equilibrium price.” The way I understand it is this: The law of supply and demand is a causal theory of price. Prices are always fluctuating because supply and demand are always fluctuating.

When teaching the law to children, it is helpful to draw supply curves and demand curves and show them intersecting at some point. Marshall got it into his head that supply and demand were not in “equilibrium” except at the “equilibrium price.” He thought when prices change it is because of a “lack of equilibrium.” This is nonsense. Suppose the price of an apple is $1 in the morning and $2 in the evening. To think or say that there was a “lack of equilibrium” between supply and demand is absurd.

Evan Foreman December 23, 2010 at 9:32 am

In the final analysis the economic future of any economy rests on three legs, each of which is unknowable, as each leg is dynamic – always moving. They are (1) the actual value of of the elements of a transaction vs. the perceived value of the elements of the transaction at a given moment, (2) government regulation moving between political forces and public benefit, i.e. how much reelection benefit there is as opposed to public benefit, and (3) the interplay among all the forces in 2 and 3. While intermediate prediction is impossibly complex, long term results are
predictable and undeniable: Government regulation and government growth increase until the economic “system” collapses and new leaders and a new government begin the process all over again.

This is the history of man, and the U.S. is in its final collapse phase.

Ron Finch December 23, 2010 at 10:42 am

The correct model for the Federal Reserve fractional reserve banking (FRB) system is the pyramid scheme. FRB is a pyramid of debt. (Jaguar Inflation http://mises.org/daily/3329) How do you make a pyramid scheme stable? Avoid it. You honestly invest and take your genuine profits and losses. Honesty is not an option in central planning, however, since honest government is no government. Or if you prefer, “that which governs least.”
Science is difficult to discuss because people are as ignorant of it as they are of economics. By that I mean that even the practitioners do not understand the philosophical foundations of science. People think that science means mathematics. They fail to understand that math is just logic applied to quantitative reasoning. To be scientific one only need to be logical and accurate. Accuracy comes from comparing logical deductions with actual events. The above article clearly shows that the Austrians are better scientists.
The success of current main stream economics is completely due to government largess. Government subsidizes the colleges and hires most of the economists produced. What is truth? To most PhD’s truth is whatever the leader says it is.
The reason that the political leadership will not listen to us is that they don’t like us. They want to exercise power. We want them to stop. They want to raise taxes. We want them to lower taxes. They want to wage war. We want peace. We want to be free. That is a problem for them. How can they plan our lives for us if they don’t know what we will do? Yes the problem for them is that we are too free. They need to put us in the metaphorical car that they can steer. And don’t forget that they will run over anyone who stands in their way.

Troy Lynch December 26, 2010 at 2:28 pm

I just finished reading Larry Macdonald’s A Colossal Failure of Common Sense. Whether you agree this his view is one of a low-level trader, that it is simply a pot boiler, etc., it was interesting read. I do not care for any of the reasons Greenspan pushed the overnight rate so low (as is now the case with Bernanke) the unintended consequence is opportunity cost on the part of market players: when the state almost rules out time preference, players will seek a greater yield from somewhere.

With rates at an all time low in the 2000s, as well as plenty of easy money sloshing around and low lending standards, the market comes up with different ways to earn a greater yield; that innovation is not to be shunned, but the corruption that followed is palpable. And Macdonals showed the stupidity going on at Lehamn Bros – super leverage: up to 44+ times their net tangible assets.

DSGE economists are the great rear-view mirror watchers and adjust their models after the fact. Great insights fellas! Menger and Mises could and did tell ahead of time, due to the rational postulates that allow one to see distortions in market rates and money supply. However, it seems to me that Austrians do need to do more empirical work just to be in the game: not in order to discover theory but to prove it. The direct marketers refer to this as social proof.

The DSGE guys can point to their models, however faulty. Another amusing chestnut from the guys in the field of forecasting is the evidence on the erroneous nature of many types of forecasting, including ARIMA (Box-Jenkins). So many types of complex econometric models are not worth the paper they are written on, yet these guys still plow ahead, because they think their empirical work is going to lead to correct theory; Austrians need to do more empirical work to display the credibility of their theory.

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