A great divide holds back the relevance of economists
By Mark Thoma The opinions expressed are his own.
Reuters invited leading economists to reply to Mark Thoma’s Op-Ed on the “great divide” in economics and will be publishing the responses. Here are responses from Ashwin Parameswaran, James Hamilton, Dean Baker, Lawrence Summers, and a recap of Paul Krugman’s.
How much confidence would you have in the medical profession if the teaching faculty in medical schools had very little experience actually treating patients, and very little connection to – even a lack of respect for – the practitioners in the field? Would your confidence be improved if medical research had little to do with the questions that are important to the doctors trying to serve patients?
Unfortunately, that’s a pretty good description of how economics has been practiced. The questions academic economists are trying to answer have little connection to the problems faced by business economists trying to help their firms make good, profitable decisions (and vice-versa). And though academics pay some attention to government policy, particularly Federal Reserve policy, addressing the problems faced by government economists trying to help policymakers make the best possible choices is not the main focus of this research.
This division between academic, government, and business economists is driven by the fact that economic theory and econometrics can be used for two different things. One is learning about how the world works. These “how and why” questions are the focus of academic research. For example, academic economists try to understand why demand curves slope downward, how business-cycle fluctuations in GDP come about, and how prices are determined in market economies.
The other use of theoretical and empirical economic models is forecasting, for example predicting where the economy is headed so that businesses can react accordingly, and predicting what might happen if various government policy proposals are implemented. These are the “what if” questions that economists in government and business are most interested in. What will happen to tax revenue if business taxes are cut? What will happen to the demand for my product if the Fed raises interest rates? What is the most likely course that the economy will take?
Again, a comparison with the medical field is useful. Science can help us to learn about how the body works, and that certainly aids our efforts to battle disease. This is an important area of research, and we wouldn’t want to cut it short. But knowing how the body works isn’t enough, we also need the ability to diagnose current illnesses and to predict when someone is going to get sick. In addition, we need to have treatments available to fix the problems that we’ve identified. Periodic checkups, for example, allow us to predict who might get coronary disease, and then take action to avoid much bigger problems down the road.
Forecasting and its discontents
“Prediction is very difficult, especially if it’s about the future,” is attributed to a long list of people. Even with that in mind, however, the first eight months of 2010 have been especially unkind to professional forecasters and investors as markets have lurched between extremes of pessimism and optimism.
Normally forecasters can benefit from diversification — publishing lots of forecasts ensures at least some prove correct. But heightened correlation between and within asset classes has denied forecasters and investors even that consolation.
Federal Reserve Chairman Ben Bernanke has complained about the “unusual uncertainty” clouding the outlook. And macro hedge funds have run into trouble, several prominent ones closing down and returning money to investors, as the big trends on which they thrive have disappeared amid volatility and sharp switchbacks.
The only clear trend has been the rush towards the safety of high-rated government bonds and corporate debt. Even that has some observers muttering darkly about irrationality and the probability of a bubble, implying a big reversal in future.
In that context, it is hardly surprising oil price predictions have come unstuck.
The median forecast for average U.S. crude oil prices in 2010 increased steadily from $74.00 per barrel in the first Reuters survey in October 2009 to $81.06 at the time of the April 2010 survey, before sliding in each of the next four months to a low of $78.63 in August. Further reductions seem likely when the next survey is published in September.
While the adjustments may not seem large, these are averages. Changes in individual predictions have been far larger in some cases.
from The Great Debate UK:
A reality check from Standard & Poor’s
-- Neil Collins is a Reuters columnist. The views expressed are his own --
Standard & Poor's could have chosen a better day to kick the British economy, by placing the UK onto "negative outlook", the usual precursor to a downgrade of S&P's rating of an issuer's debt.
The move came minutes before the Debt Management Office closed its massive auction of 5 billion pounds of 2014 stock, and minutes after the release of figures showing the Public Sector Net Borrowing Requirement leaping to 8.5 billion pounds in April, a sum which not long ago would have been considered high for a whole year.
Economist Howard Archer at Global Insight immediately called the figure "dire, starting the new fiscal year off as it is highly likely to continue."
S&P, meanwhile, now fears that the net general government debt burden "could approach 100 percent of GDP and remain near that level in the medium term."
It's hard to describe the UK public finances as anything other than a disaster area. The forecasts made in last month's Budget looked optimistic within days, and even these require the DMO to borrow 220 billion pounds this financial year, or almost a billion pounds every working day.
Yet while the DMO soaks up cash, the Bank of England is desperately creating it. Its "quantitative easing" programme has been in full swing this week, buying in 1.326 billion pounds of a stock which looks very like the one that the DMO was issuing just one day later.
Finally a global realist speaks of our enormous debt problem!
Sorry I made a mistake – W=VA. Watts equals Volts times Amps. I’m not an electrician and can’t remember formulas unless they bite me. But that’s a handy one to know for daily use. Another one that is handy is Hp=W/750 (Horsepower equals Watts/750).
All equations could be reduced to 1=1. Some are 0=0 And you didn’t debunk the equation you just caricatured it. You left out the prospects that some transactions can result in substantial profits. It can sit in a saving account and eventually be lent out (or cover prior loans?) or be immediately reinvested in high-speed trades. Where’s money circulating faster?