When ”failure” in economics is ”success” and vice versa?

This post fully lives op to the mantra of the blog, as it contains a lot of “stochastic ramblings” (a nod to Greg Mankiw’s mantra of “random observations”). “Stochastic” as I wander unplanned around important subjects on the developments of economic sciences, and “ramblings” as most of it is scientifically unsubstantiated talk with little coherency, which just emerge from my gut. You have been warned.

The backdrop of the following is a festive occasion. An occasion I am truly and deeply happy about. The Institute of New Economic Thinking (INET), which is partly funded by George Soros, has given a grant to establish a center on Imperfect Knowledge Economics (IKE) at the University of Copenhagen. It was therefore a deservedly happy colleague, Katarina Juselius (who will be director of the center) that opened the program marking the launch of the centre. Katarina Juselius and Søren Johansen have for a few years now worked on applying Søren Johansen’s econometric methods (which could have got him a Nobel Prize in my honest opinion) to asset pricing behavior together with Robert Frydman and Michael D. Goldberg. They, in turn, have developed a new concept of rational behavior that takes into account that agents may not know the true underlying probability distributions (i.e., Knightian uncertainty). This theory is presented in their 2007 book “Imperfect Knowledge Economics: Exchange Rates and Risk”. The new center is devoted to this line of research.

The executive director for INET, Robert A. Johnson, gave a speech on the necessity of new thinking (well, isn’t new thinking always needed?). The audience was presented with a standard statement of the kind “I know mathematics, and I like math, but . . .” followed by the now well-established, and politically correct, tirade against excessive use of mathematics in economics, and the potential blame one can put on the profession for not having foreseen the current financial crisis, since it mistook math for beauty and/or the truth. I could not help smiling. Not so much because this kind of statement is an extremely cheap shot at economics, but mostly because the IKE modeling and the co-integrated VAR model are both using math with hair on the chest. But maybe the math used is sufficiently ugly to be politically correct? I don’t know, but Robert A. Johnson concluded his talk with some words on economic education, where the punch line was that any economics student should learn to be critical towards the models and concepts they are presented with. I can only concur, and is happy that this is what we actually teach at my department. Indeed a group of our students has just won an international econometrics game, and the spokesperson for the group indeed said that the Copenhagen students were better because they were more critical towards the assignment, methods, and so on. In all fairness, some students, representing “critical students” (I don’t hope we have non-critical students), later talked about what they saw as a dogmatic current teaching with undue emphasis on mathematics and rational expectations. I wonder how these students will receive IKE and the co-integrated VAR: these are models made by very dogmatic persons (indeed, I hope the authors believe in what they are writings). Right now it seems that to some, “anything different” is better.

Roman Frydman talked about limits of knowledge and, of course, promoted his research with Goldberg, Juselius and Johansen. Most of the time was devoted to a critique of current paradigms in economic thinking and why it is important to break them. On this occasion, Frydman was understandable in a good mood, so the critique against “mainstream” thinking was not as stern as in his writings with Goldberg. Occasionally, in these writings they get quite vile and confrontational. As emphasized by Kevin Hoover in his review essay of Frydman and Goldberg’s recent book, “Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State“, there is something about talking about “The Orwellian world of ‘Rational Expectations’ ” that doesn’t make people embrace your new ideas right away. I may add that they also use metaphors as “A World of Stasis and Thought Uniformity”. Even though their thoughts here wander towards Germany, they thoughtfully do not draw the parallel to other kinds of (earlier) German thought uniformity. In any case, they apparently feel it necessary to be insulting to help sell their new, very interesting, ideas. I would probably have spent more time trying to pitch my ideas, instead of labeling a whole profession mindless sheep. (They do, e.g., write that the Rational Expectations Hypothesis “leads economists to imagine a world of perfect knowledge and universal thought uniformity” (p. 65); i.e., it is a theory that controls scientists. Please count me out.)

Something that was definitely new in Frydman’s talk was an announcement that the most recent paper he and Goldman, Juselius and Johansen had completed had just been submitted to the American Economic Review. Yes, he actually mentioned the name of the journal, which is a bit unusual. Of even more interest was his ensuing comment, said with a smile, that he did not have high hopes for acceptance. It got a laugh from the audience, but it struck me as being quite serious. It touches on the basics about quality measures in research. Normally, publishing in a journal like AER would be taken as a good sign. But clearly, in the case of these authors, who challenge Stasi thought uniformity, an acceptance would be a failure. It would mean that they are part of the uniformity they try to escape. So my guess is that Frydman actually hopes for a rejection, as this will confirm that he is up against Orwellian forces. If they are accepted at the AER, all he and Goldberg have written about the profession is at worst wrong, or at best outdated. So, conventional success would be failure for the new thinkers. This is the core issue: How is quality measured of truly new thinking? Is it of good quality when it is acknowledged by some academics, but not the majority? Is it bad quality if the majority embraces it?

All these important scientific matters did not get much attention in the press (and what they did pick up, they mostly got all wrong). What did get a lot of attention, on the other hand, was that George Soros himself came for the opening. This fact made me arrive in good time, as I anticipated that the conference venue and surroundings would be blocked by “Occupy Wall Street”-type protesters. After all, we are talking about a financial speculator of Olympic proportions who more or less singlehandedly brought down the British Pound in the early 1990s and who is convicted for insider trading in France. I reckoned he would be the symbol of all the financial speculation everybody is turning against after the crises started. But there were no protesters in sight. I found out that I was completely out of sync with reality. Soros is now considered a “good” speculator (whatever that is), and his criticism of financial speculation in recent times and his philanthropic activities have apparently made him politically correct. The most left-wing newspaper in Denmark gave him relatively good press, and they are normally hunting down anybody earning more than a million a year (in whatever currency).

Soros was featured in a conversation with my colleague Niels Thygesen, where the subject was mainly the current European crisis. Soros was not optimistic for the Euro, and conveyed a quite strong aversion towards Germany and the leading role it plays. Also he criticized the ECB’s alleged adoption of a “German Bundesbank model” of anti-inflationary policies. Much to my surprise, Soros saw such a price-stability objective as one that could be compatible with deflation. In relation to the main subject of the event, Soros mentioned that he had never examined rational expectations as he found it unrealistic. But he mentioned quite a few alternative theories he had developed over the years.

Finally, it was interesting that several speakers felt a need to emphasize their nationality, ethnicity and religion. This is normally, for good reasons, considered irrelevant at academic events. I will, however, follow suit and note that I am as pale as one can be, and born in the outskirts of Aarhus, which is located in Jutland, Denmark (and I have no God that I know of). A prominent feature of people from Jutland is humility. That is why I cannot help ending my ramblings by noting that this new center is simply doing what such a center should do (and is going to do): Carry on basic research on a high level. But apparently, to get attention and money, one must as a minimum present one’s work as revolutionary and as a complete change of paradigm, while desecrating years of “failed thinking” in the profession. With my ethnic background, I am not cut for that game.

But I do acknowledge that for a festive occasion, the truth that “we are going to do what we have always been doing” is definitely not a good sales pitch.

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