Wednesday, November 2, 2011

Do These Guys Deserve a Nobel in Economics? Errr... NO!

Shown: The two anti-Keynesians just awarded a Nobel Prize in Economics, Chris Sims (left) and Thomas Sargent. If extended unemployment benefits are permanently killed, and Medicare and Social Security permanently cut -you can thank these two!

Most of the past two weeks has been inundated with tons of blather about the two most recent winners of the Nobel Prize in Economics. (Let us also bear in mind that Economics wasn't originally part of the Nobels, and only added much later.) These two: Christopher Sims and Thomas Sargent, have evidently received their award for pouring bollocks on Keynesian stimulus from governments, which - let's face it - has seen a rash of attacks in the wake of the onset of the austerity virus.

In one unabashed paean, 'A Nobel For Non-Keynesians' (WSJ, Oct. 11, p. A17), author David R. Henderson waxes wildly about the "contributions" of each of them, e.g. in respect of Sargent:

"Mr. Sargent was an early and important contributor to the 'rational expectations' revolution in macroeconomics, and area for which his collaborator Robert E. Lucas, won the Nobel Prize in 1995.."

Sargent's more mathematical "rational expectations" model posited negative "rational" reactions of people to events like the Fed loosening the money supply, "a conclusion at odds with the Keynesian model". For example, it's claimed that people will adjust their "wage demands" higher if the Fed increases the money supply (as it has recently been doing by buying back hundreds of billions of treasury securities, under 'quantitative easing'). Then, by increasing the wage demands unemployment will increase, rather than decrease.

Sargent also argues that people will "make decisions now" based on how they rationally believe the government will deal with Social Security and Medicare. Thus, according to the Pareto Distribution basis, if government were to act for cuts now (such as being bruited about by the supercommittee) then people might invest more in the stock market (for higher returns) instead of depending on government.

As one former Fed economist put it ('Economists Win Nobel for Focus on Real World', WSJ, Oct. 11, p. A3):

"If you made a credible committment to do this now and the markets saw that, this theory would predict that you have a much more positive impact on the economy today".

In other words, as standard for Pareto optimality BS, sacrifice citizens' security for a generic market benefit, available only to the elites, mainly the 1%. See, e.g.

Meanwhile, allowing Medicare and Social Security benefits remain as they are would be "Pareto inefficient", reinforcing the old Pareto Parable that if a sheep and a wolf form a collective, it is always preferable for the wolf to eat the sheep for the "collective" to be maximally optimal, e.g.

Sargent's own bias in his development of his mathematical models to support his "theory" confirms this. For example, in one of his theoretical models Sargent arrives at a set of "competitive equilibria": C = {(x,y)! x = h(y)}, such as shown on the accompanying graph where "welfare" is plotted vs. "tax rate". Entering into the basis for generation of such equilibria is what is called a "utility function" framed for example as: U(L, c,g) where L denotes "leisure", c is the rate of consumption, and g is the per capita government expenditure. From this, Sargent purports to obtain some parameter 'alpha' spanning a range in a limited set from 0 to 1/2.

At some point later then, one also will find the tax rate τ, enter. Thus, he claims a government will in general balance its budget if: g = τ (1 - L). Meanwhile, he poses "welfare" within the constraints of competitive equilibria as defined by:

W(τ) = L(τ) + log {alpha + (1 - τ) [1 = L(τ)]} + log (alpha + τ[1 - L(τ)}

He argues that a "benevolent government" chooses L = 0, c = g = ½

while a "dictatorial" outcome yields: W = 2 log (alpha + ½)

This in itself is nonsense, given that any true benevolent government would never ever require a leisure L = 0! However, a dictatorial "slave camp" government, such as under Chairman Mao in the 1960s, would! SO, what the hell is he getting at? The graph shown sets it in perspective assuming an alpha = 0.3 or just past midway in the set {0, ½}. Thus, he argues that the "government problem in a Nash equilibrium" is defined by a limiting maximum tax rate, max(τ) such that: L = log [alpha + (1 - τ)(1 - L)] + log (alpha + τ(1 - L)]

Then, if L < 1, the option is τ = 0.5

However, as the tax rate moves beyond this limit, the welfare crashes! Well, by that I mean it reaches a Nash equilibrium lowest value of around -1.2.

Stripping away all the math and balderdash, what do we have? Well, a curve that fits perfectly within Pareto Distribution parameters of Pareto optimality or efficiency! (Notice the line marked "unconstrained optimum, which is really an optimum for maximal Pareto effciency). What we are being warned against here, is the use of too many government expenditures or resources for the common good, whether in Medicare, Social Security or even unemployment insurance. Any time one seeks to maximize a putative welfare within these limits, one ends up in a crash pile. The welfare drops and so does everything else.

Beware then of all those who wish to stimulate the economy by too high a tax rate! Hmmmm....wonder then why our unemployment was lowest during the 1950s when the marginal tax rate was 91%. Oh, these latter day anti-Keynesians will argue it was the aftermath of the war production, the lack of global competitors or some such rot, anything to deny any consistent Keynesian approach.

Meanwhile, there is Sargent's fellow prize winner Chris Sims who (Henderson, WSJ, ibid.) :

"undercut the large scale Keynesian economics models and....found the traditional Keynesian methods just not good enough"

One of Sims' complaints in the same piece was the government extending unemployment benefits for another 99 weeks, which "filled him with dread".

Oh really? It must be nice to merely be filled with dread while sitting on one's duff in a nice comfy office in the halls of academia- ruminating on the rarefied realms of macroeconomics. And meanwhile, the unemployed whose homes are now near foreclosure, and whose hungry kids cry out for food before bedtime each night, experience REAL dread as they face another possible cutoff date!

Jeebus, these two make me want to cold cock someone! But maybe it's already been done in a kind of surreptitious manner, given that all their pseudo-sophisticated efforts and models may be for nought. As The Economist has noted, in their review of the new book Thinking Fast and Slow (by Daniel Kahneman), that species paraded as 'Homo Economicus' (Economic Man always invested maximally in the most rational choices) is largely a figment of economists' imaginations. Or to use The Economist's words:

"Mr. Kahneman, an Israeli-American psychologist, has delivered a full catalogue of the biases, shortcuts and cognitive illusions to which our species regularly succumbs. In so doing he makes it plain that Homo Economicus - the rational model of human behavior beloved of economists - is as fantastical as a unicorn."

And I already gave examples of this irrational propensity in a previous blog referencing Kahneman's work, e.g.

Now, the question for all who have been paying rapt attention is as follows:

How far, or to what extent, shall we trust a model based on "rational expectations" theory, when the subject (humans) don't evince rational economic behavior at all?

And if the answer to that question in any way suggests or evinces minimal ballast or credibility, then exactly what was that Nobel Prize in Econ worth?

Inquiring minds want to know! Especially before our congress critters proceed to use these models to shaft us even further -so the 1 percent can own us even more!

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