Sunday, July 22, 2012

Lars P. Syll — The unknown knowns of modern macroeconomics


More on the folly of drawing sweeping conclusions from DSGE modeling. This time based on nature of statistical reasoning.

If one follows über-statistician Nate Silver's blog, Five Thirty Eight, at The New York Times, one has grasp of how difficult statistical modeling is socially. Politics is one of the most researched and and polled fields in existence, with huge amounts spent on data gathering and processing. Nate's record has been good so far, but he explains the difficulty of coming to any tight conclusions owing to a variety of factors and always qualifies his statements.

No one trying to figure out political outcomes would dream of assuming a representational agent or perfect knowledge to simplify the design problem. Where do economist get the pass to do this and not get called out for it, especially when predictions turn out to be wildly off the mark. After all, this flawed reasoning goes into the grinder of policy making.

Lars sums it up reagrding DSGE:
The root of our problem ultimately goes back to how we look upon the data we are handling. In modern neoclassical macroeconomics – Dynamic Stochastic General Equilibrium (DSGE), New Synthesis, New Classical and “New Keynesian” – variables are treated as if drawn from a known “data-generating process” that unfolds over time and on which we therefore have access to heaps of historical time-series. If we do not assume that we know the “data-generating process” – if we do not have the “true” model – the whole edifice collapses.
Economic actors behave no more predictably than voters in that they are the same people performing a similar function — choosing. The actors are just as diverse and volatile. A big difference is that voters have very limited choice well-recognized motives, and yet prediction is still dicey. On the other hand, economic actors have a wide range of choices and motives — and prediction can be relatively precise?

Read it at Lars P. Syll's Blog
The unknown knowns of modern macroeconomics
by Lars P. Syll

25 comments:

Letsgetitdone said...

Nice one Tom. Putting your finger on the pseudo-science of it all.

Major_Freedom said...

Good post, Hickey. It is almost as if a praxeologist wrote it :)

Anonymous said...

Excellent Tom!Lars Palson Syll is very intelligent,and wellreaden!Thank you!

Tom Hickey said...

On the other hand, Major Freedom, Nate Silver has been uncannily correct in his predictions, showing that with the right approach reasonably correct prediction of outcomes in complex systems involving human choices is possible. It's not like stats is useless because some people use it to draw inappropriate conclusions.

Tom Hickey said...

@Anonymous

Yes, Lars is very good at explaining rather complex economic ideas simply enough for non-economists to understand the basics of. He cuts right to the essentials.

Major_Freedom said...

Tom Hickey:

On the other hand, Major Freedom, Nate Silver has been uncannily correct in his predictions, showing that with the right approach reasonably correct prediction of outcomes in complex systems involving human choices is possible.

Scientific predictions based on constancies in human action, the way physicists make scientific predictions based on constancies in nature like the gravitational constant? I don't think so. If that were possible, Nate Silver would be a multi-billionaire, for he could just utilize such constants in making economic predictions.

It's not like stats is useless because some people use it to draw inappropriate conclusions.

It is always possible to get lucky in making predictions using statistics. Instances of correct predictions does not mean one has discovered constancies. The very nature of learning any alleged constancies presupposes no constancies in knowledge.

One can make correct predictions, but they will be entrepreneurial, not scientific.

Tom Hickey said...

One can make correct predictions, but they will be entrepreneurial, not scientific.

Proof or evidence? Oh right, it's synthetic apriori.

paul meli said...

@Major_Freedom

Some of the statements you make are so absurd you end up undermining your own credibility.

Are you deliberately trying to make yourself seem like the crazy guy on the street corner carrying a sign saying "THE END IS NEAR" so that every time you post we back away slowly?

Major_Freedom said...

Tom Hickey:

"One can make correct predictions, but they will be entrepreneurial, not scientific."

Proof or evidence?

Stylistic evidence is that economists who believe such constants exist are not the wealthiest people in the world.

The proof is one of logical necessity. Anyone who claims to be able to learn scientific constants exist in a particular phenomena, is logically presupposing that his own knowledge is not constant. Therefore, anyone who claims constants in knowledge can be learned, are contradicting themselves.

Oh right, it's synthetic apriori.

True synthetic a priori propositions exist. One can only accept it or deny it.

Paul:

Some of the statements you make are so absurd you end up undermining your own credibility.

Which statements? Why? Empty antagonism such as this just tells me you lack the intellectual wherewithal to show the validity of what you're saying.

Are you deliberately trying to make yourself seem like the crazy guy on the street corner carrying a sign saying "THE END IS NEAR" so that every time you post we back away slowly?

Do you still beat your wife?

Major_Freedom said...

Why isn't Nate Silver making billions in the market, if scientific constancies in knowledge and action can be learned?

Why aren't econometricians making billions?

For those who reject the idea that praxeologically grounded logical necessities are saying something true about reality, why aren't they proving this wrong by making billions on the basis of this rejection?

Why is Nate Silver busying himself with political analysis, instead of making billions utilizing the alleged constancies in knowledge and action that you say I have no valid basis for claiming do not exist?

Anonymous said...

Praxeology is just juvenile stupidity.The libertarian who insists that the state has no place beyond basic night-watchman duties is like a teenager who, having been given a car, promptly starts demanding the right to stay out all night. Sometimes, someone else really is looking out for your best interests by saying no. Glenn Beck might hyperventilate, the government doesn’t want to destroy the market. It wants to preserve it, and it does this job better than the market can on its own

Tom Hickey said...

MF: on what basis are the people who actually making billions in the market doing and getting in right consistently? Luck? Cheating?

Oh, right. It's the state that is giving them advantage.

paul meli said...

"Empty antagonism such as this just tells me you lack the intellectual wherewithal to show the validity of what you're saying"

I don't know about that but I am smart enough to know it's pointless to try to have a normal discussion with a nut.

See you on the street corner.

Major_Freedom said...

Anonymous:

Praxeology is just juvenile stupidity.

You just don't understand it.

The libertarian who insists that the state has no place beyond basic night-watchman duties is like a teenager who, having been given a car, promptly starts demanding the right to stay out all night.

It is the exact opposite. Those who demand to be taken care of, to have mommy and daddy government provide them with education, food, clothing, shelter, so that they can be lazy and exploit those who work, are juvenile. You are the teenager who refuses to grow up and be independent.

Sometimes, someone else really is looking out for your best interests by saying no.

That's exactly why saying no to you, saying no to your demand that others provide for you by force of government, is looking out for you.

Glenn Beck might hyperventilate, the government doesn’t want to destroy the market. It wants to preserve it, and it does this job better than the market can on its own

Glenn Beck can eat it.

Tom Hickey:

MF: on what basis are the people who actually making billions in the market doing and getting in right consistently? Luck? Cheating?

Entrepreneurial foresight, which is not scientific, but an art, which cannot be taught out of textbooks.

Oh, right. It's the state that is giving them advantage.

Advantage != Scientific predictions based on constancy.

You are not engaging the argument I am making and you're just hand waving and feigning skepticism.

Paul:

"Empty antagonism such as this just tells me you lack the intellectual wherewithal to show the validity of what you're saying"

I don't know about that but I am smart enough to know it's pointless to try to have a normal discussion with a nut.

What is this? When the first round of empty antagonism fails, you up the ante with more empty antagonism as if it suffices as an argument this time? Please.

Major_Freedom said...

Tom, yes the state confers advantages on certain people. But with or without such advantages, with or without a state, there will still be a separation between entrepreneurial foresight ability, and scientific prediction based on constancy ability.

You're changing the subject. We were talking about the scope of, or lack of, making predictions in the market. Now you're saying entrepreneurs make billions by utilizing state power. Well even in anarchy, where the vital service of protection and security are privately provided, entrepreneurship will still be an art, not a science.

Tom Hickey said...

"Entrepreneurial foresight, which is not scientific, but an art, which cannot be taught out of textbooks."

Folks like Ray Dalio and David Tepper are entrepreneurs in their trading? Entrepreneurs produce real resources last time I checked the definition. Traders take positions based on expected price movements. Those consistently successfully don't just guess.

Tom Hickey said...

Scholes had just moved to the University of Chicago. He and his colleagues had already been teaching the Black-Scholes formula and methodology to students for several years.
"There were many young traders who either had taken courses at MIT or Chicago in using the option pricing technology. On the other hand, there was a group of traders who had only intuition and previous experience. And in a very short period of time, the intuitive players were essentially eliminated by the more systematic players who had this pricing technology."

link

Anonymous said...

These high-frequency trading funds consistently seem to make billions. Basically they're involved in front-running.

Financial markets are hierarchical, with certain people granted greater access than others. Those at the top control the system and can't lose.

Major_Freedom said...

Tom Hickey:

"Entrepreneurial foresight, which is not scientific, but an art, which cannot be taught out of textbooks."

Folks like Ray Dalio and David Tepper are entrepreneurs in their trading?

Definitely.

"Dalio began investing at age 12 when he bought shares of Northeast Airlines for $300 and tripled his investment after the airline merged with another company."

Entrepreneurs produce real resources last time I checked the definition.

So did painters and sculpturists the last time I checked.

Traders take positions based on expected price movements. Those consistently successfully don't just guess.

It would be just as wrong to say that forecasting is nothing but successful or unsuccessful guesswork, as it is to say that there are empirical constants in the field of human knowledge and actions with scientific prediction implications. Rejecting the latter seems like the former is implied, but it is not. See "Human Action", pp. 51-59; and "Epistemological Problems of Economics", chapters 2-3, for the unique insight Mises made concerning the interplay between economic theory and history.

It is rather straightforward as to why social and economic future cannot be regarded as entirely and absolutely uncertain: The impossibility of causal predictions in the field of knowledge was proven by means of an a priori argument. This proof incorporates true a priori knowledge about action as such, namely, that they cannot be regarded as governed by time invariantly operating causes. Therefore, while economic forecasting will always be an unteachable art, it is still true that all predictions must be thought of as being constrained by the existence of a priori knowledge of actions as such.

Major_Freedom said...

Tom Hickey:


For example, consider the quantity theory of money, the praxeological proposition that says if there is an increase in the supply of money, and the demand for money stays constant, then the purchasing power of money will fall. The a priori knowledge about actions as such tells us that it is impossible to scientifically predict whether the money supply will increase, decrease, or stay the same. It also tells us that it is impossible to scientifically predict whether the demand for money will increase, decrease, or stay the same. You cannot claim to be able to predict these things because you cannot predict future states of people's knowledge, the very states of people's knowledge that influences what happens with respect to the quantity of money and demand for money.

The quantity theory of money would not allow you to scientifically predict future economic and social events even if it is a fact that the quantity of money had increased. One would still be unable to scientifically predict the demand for money.

It is a veritable contradiction to claim that subjective knowledge, the changes of which have impacts on actions, is predictable on the basis of antecedent variables and as capable of being held constant. For the very researcher who wanted to hold knowledge constant would have to presuppose that his own knowledge, specifically his knowledge regarding the outcome of the researcher's study, is not constant over time.

So the quantity theory of money cannot be used to make scientific predictions. What it CAN do is constrain the range of possibly correct entrepreneurial predictions. It would constrain possibly correct predictions not by way of empiricism, but by way of praxeological theory, which acts as a logical constraint on prediction-making. Predictions that are not in line with the quantity theory of money will be systematically flawed and lead to systematic forecasting errors. This doesn't mean one who based his predictions on correct praxeological reasoning would ipso facto be a better predictor than someone who makes predictions based on logically flawed reasoning, but rather that in the long run, those who are aware of the logical constraints would fare better on average than those who are not.

It is possible to make an incorrect prediction even if one knows the quantity theory of money has increased, because for example one could be wrong about the demand for money that makes one's prediction wrong. It is also possible to make a correct prediction even if one is wrong to believe that a rise in the quantity of money has nothing to do with its purchasing power, because for example one could be wrong about the demand for money that makes one's prediction correct.

Praxeological knowledge has very limited predictive utility. The logic of economic forecasting and the practical function of praxeological reasoning is to
view the a priori propositions of economics as logical constraints on empirical predictions.

Major_Freedom said...

Tom Hickey:

Scholes had just moved to the University of Chicago. He and his colleagues had already been teaching the Black-Scholes formula and methodology to students for several years.
"There were many young traders who either had taken courses at MIT or Chicago in using the option pricing technology. On the other hand, there was a group of traders who had only intuition and previous experience. And in a very short period of time, the intuitive players were essentially eliminated by the more systematic players who had this pricing technology.


You are misunderstanding the argument I am making. The Black Scholes model relies on an assumption for volatility of the underlying, which is not constant. Given a volatility assumption is correct, the logic of arbitrage constrains put and call option prices. Since those who don't use the BS model are also making assumptions concerning the volatility of the underlying, the use of the BS model is in fact a perfect example of praxeological constraints limiting the range of possibly correct predictions. Those who utilize the BS model fare, on average, better than those who do not.

Anonymous:

These high-frequency trading funds consistently seem to make billions. Basically they're involved in front-running.

Financial markets are hierarchical, with certain people granted greater access than others. Those at the top control the system and can't lose.

Will such hierarchy ALWAYS be present? Is there a constancy in human knowledge and action that makes such hierarchies, despite the myriad of different forms and laws it can take, a scientifically predictable field of inquiry?

Tom Hickey said...

MF, I don't know who you are arguing against here. Neoclassical models presume ergodicity and certainty. Keynesians argue non-ergodicity uncertainty against this and see equations as system parameters that have no causal implications in themselves.

If there is causality, it has to be shown in terms of transmission mechanism, e.g. involving direction of flow. Rather, the equations show relationships of variables without determining which are independent and which are dependent. Directions of flow can shift and it takes observation to understand what is happening in particular cases.

This doesn't imply that nothing constructive can be known, however. Humanity is not lost at see, completely dependent on an inherently unknowable natural order blowing it toward the chosen destination.

Operations are describable, and patterns are discernable. It's possible to catch the wind, realizing that the wind shifts, and the sail adjusted and the ship steered accordingly. Letting the wheel go and running full sail is a recipe for disaster.

Major_Freedom said...

Tom Hickey:

MF, I don't know who you are arguing against here.

I am arguing against an idea that you keep tacitly presuming is correct.

Neoclassical models presume ergodicity and certainty.

You have to ask in what precise respects. Praxeologists reject ergodicity/certainty in knowledge and actions.

Keynesians argue non-ergodicity uncertainty against this and see equations as system parameters that have no causal implications in themselves.

This is false. Keynesians argue that free market activity causes savings leakage, which results in high unemployment, without government budget deficits, which is to say, Keynesians believe government budget deficits are "stimulative" for unemployment.

If there is causality, it has to be shown in terms of transmission mechanism, e.g. involving direction of flow. Rather, the equations show relationships of variables without determining which are independent and which are dependent.

I highly suggest you rethink your position, because there is in fact a "direction of flow" aspect to Keynesianism. They believe in the causal flow "Spending -> employment/output"

Directions of flow can shift and it takes observation to understand what is happening in particular cases.

This is false. The quantity theory of money cannot ever shift, and cannot ever be otherwise in particular cases. It is always true.

This doesn't imply that nothing constructive can be known, however. Humanity is not lost at see, completely dependent on an inherently unknowable natural order blowing it toward the chosen destination.

Yet that is the logical outcome of claiming that all economic propositions are dependent on historical cases, that it can be sometimes this, and other times that. Knowledge accumulation would be impossible in such a method.

Operations are describable, and patterns are discernable.

There is no pattern in human knowledge or action that is dependent on past observations.

It's possible to catch the wind, realizing that the wind shifts, and the sail adjusted and the ship steered accordingly. Letting the wheel go and running full sail is a recipe for disaster.

State planning is not setting hand to a wheel. It is destroying/hampering the wheel of market coordination based on profit and loss.

Anonymous said...

Major Freedom i get the feelin you are indeed a joker or in other case as Paul says just that guy he meet at the streetcorner with some sign.What street corner do occupy?

Major_Freedom said...

Anonymous:

Major Freedom i get the feelin you are indeed a joker or in other case as Paul says just that guy he meet at the streetcorner with some sign.What street corner do occupy?

Do you still beat your wife?