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Economics is a science

cartoon-falisfying-theory

(Click on image to enlarge.)

When asked to list the five books that have most influenced his writings, the acclaimed British novelist Ian McEwan put a book called “What Science Offers the Humanities” on the top of his list. He goes on to suggest that science is “a matter of beauty”, to be admired just as we admire our favourite painting, song, or novel. He’s right. Science is beauty, and I would add, economics is a science.

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Macroeconomics celebrates its 80th birthday this year

 

John Maynard Keynes

John Maynard Keynes, the father of macroeconomics.

Macroeconomics was born exactly 80 years ago this year, in 1936.

John Maynard Keynes (pronounced “Canes”) published The General Theory of Employment, Interest and Money in 1936, and it was arguably one of the most influential books of the 20th century.

Macroeconomics was born almost out of necessity. Keynes purposed a new theory of the overall level of employment that sought to explain the sharp rise of joblessness during the late 1920s, and its stubborn persistence in the following years. But even if it was motivated by real life challenges, this was a book about theory, with the good professor from Cambridge University in the United Kingdom clearly stating in the opening sentences of the book’s preface:

This book is chiefly addressed to my fellow economists. I hope that it will be intelligible to others. But its main purpose is to deal with difficult questions of theory, and only in the second place with the applications of this theory to practice. for if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises. Thus I cannot achieve my object of persuading economists to re-examine critically certain of their basic assumptions except by a highly abstract argument and also by much controversy. I wish there could have been less of the latter. But I have thought it important, not only to explain my own point of view, but also to show in what respects it departs from the prevailing theory. Those, who are strongly wedded to what I shall call ‘the classical theory’, will fluctuate, I expect, between a belief that I am quite wrong and a belief that I am saying nothing new.

In other words, move aside Dude, I’m starting a revolution. Keynes targets the hapless Arthur C. Pigou, who makes a cameo appearance as the stand-in for the classical theory in the famous Chapter 2 of The General Theory.

The opening pages of Chapter 2 of Keynes's General Theory

The opening pages of Chapter 2 of Keynes’s General Theory. (Click on image to expand.)

The classical model assumes a market for labour services that works like any other perfectly competitive market.  The price of labour—the wage rate—will move up or down to clear any excess supply, or alleviate any excess demand. Unemployment doesn’t really exist, or if it does it is fleeting and transitory, reflecting frictions as workers move between jobs, needing time to gather information and find them. If unemployment persists, it must be because workers are for some reason refusing to take a cut in wages. There is an excess supply of labour—that is, unemployment—because the wage rate is too high.

Keynes objects to this blame-the-victim argument: “the contention that the unemployment which characterizes a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts” (Keynes 1936, page 9). The classical theory does not work, and we need something new, a new set of assumptions and logic that explains the facts.

There are two parts in today’s lecture. In the first we talk about the birth of macro-economics, and show that the high and persistent unemployment of the 1930s which motivated The General Theory, also characterizes what some of the rich countries have been through in the past eight or nine years. In the second, we begin our discussion of some of the basic vocabulary of macroeconomics, particularly the measurement of the macro-economy with national income accounting. Your prime objective is to fully understanding the meaning, the uses, and the abuses of “Gross Domestic Product.”

Rely on the readings listed in the course outline, and be prepared to discuss the meaning of unemployment and inflation for next class. The assignment will help guide you.

 

Welcome to your first course in economics

cartoon-dismal-science

This is an exciting time to be studying economics! The “Great Recession” still, after almost eight years, echoes in high unemployment in European countries, in lower earnings and wage rates in the United States, and is even more strongly imprinted in excessive debt, low employment, and outright despair in other countries like Greece and Spain. Inflation is low, unemployment is exceptionally high (particularly among young people), and exchange rates keep bouncing around. Globalization continues apace, the computer revolution has fundamentally changed the way people in the rich countries work and interact with others, and inequality is on the rise!

Every responsible citizen should have an understanding of the basic principles of economics. Without it how can you possibly understand some of the critical debates in almost every recent election in the rich countries: is a balanced government budget a good thing or a bad? how can governments create more jobs? why are interest rates so low, and should inflation be a worry? Is inequality something we should celebrate, or something to be concerned about?

This is the first class of a course that is designed to meet the needs of students in public policy who may have had only limited exposure to economics. But almost anyone can follow along. Upon completion of the course successful students will be familiar with the basic principles of economics, and be able to apply them critically to issues dealing with Canadian and international public policy.

Your next steps?

Download the course outline, and get the three required books. Then watch one prominent macro-economist—Joseph Stiglitz—explain his views of what caused the great recession and what government should do about it in this presentation given about one year after the Great Recession was unleashed in the autumn of 2008. Pay attention to the vocabulary he uses: list words that are not familiar to you, try to discern when he is speaking about “microeconomics” and when he is talking about “macroeconomics”, think about the logic he uses and what this says about the way economists think. Here is a list to help guide you.

Our studies start next week with a discussion of what we mean by “economics,” and what is the essence of the economic approach. To be prepared for our discussions read the readings listed in the course outline for September 19th.


 

Welcome to your first course in “Macroeconomic Policy”

keynesian-economics

This is an exciting time to be studying macroeconomics! The “Great Recession” still, after almost eight years, echoes in high unemployment in European countries, in lower earnings and wage rates in the United States, and is even more strongly imprinted in excessive debt, low employment, and outright despair in other countries like Greece and Spain. Interest rates have never been as low, indeed in some countries banks are charging negative interest rates … it costs money to save money! Inflation is low, unemployment is exceptionally high (particularly among young people), and exchange rates keep bouncing around.

What has caused this instability in the overall level of economic activity, in incomes, and in employment? And what role can, or for that matter should, public policy play in making things better? How can it play these roles?

Every responsible citizen should have an understanding of the basic principles of macroeconomics. Without it how can you possibly understand some of the critical debates in almost every recent election in the rich countries: is a balanced government budget a good thing or a bad? how can governments create more jobs? why are interest rates so low, and should inflation be a worry? How can you possibly understand why less rich economies sometimes hit a brick wall as prices increase without bound, as unemployment soars, and as investment capital leaves the country? It is not an exaggeration to suggest that poor macroeconomic management is sometimes the prequel to civil unrest.

This is the first class of a course that is designed to meet the needs of students in public policy who may have had only limited exposure to economics. But almost anyone can follow along. Upon completion of the course successful students will be familiar with the basic principles of macroeconomics, and be able to apply them critically to issues dealing with Canadian and international public policy.

Your next steps?

Download the course outline, and get the two required books. Then watch one prominent macro-economist—Joseph Stiglitz—explain his views of what caused the great recession and what government should do about it in this presentation given about one year after the Great Recession was unleashed in the autumn of 2008. Pay attention to the vocabulary he uses: list words that are not familiar to you, try to discern when he is speaking about “microeconomics” and when he is talking about “macroeconomics”, think about the logic he uses and what this says about the way economists think. Here is a list to help guide you.

Our studies start next week with a discussion of what we mean by “macroeconomics,” and how we measure the things central to gauging macroeconomic performance. To be prepared for our discussions read the readings listed in the course outline for September 15th.

Here’s a policy-relevant way to set the poverty line

Angus Deaton, the Princeton University economist, wrote in the opening paragraph of his acceptance speech for the 2015 Nobel Prize in economics that:

Measurement, even without understanding of mechanisms, can be of great importance in and of itself—policy change is frequently based on it—and is necessary if not sufficient for any reasoned assessment of policies, including the many that are advocated for the reduction of national or global poverty. We are wise to remember the importance of good data, and not to neglect the challenges that measurement continuously poses (Deaton 2016, page 1221).

This nicely sums up the tone of a previous post, that a conversation about Canadian public policy directed to poverty has not been well served by the confusing and conflicting information provided by official statistics.

Just how should we measure poverty in a way that is most helpful for public policy?

This is a particularly important issue given the mandate the Prime Minister has given his Minister of Families, Children and Social Development, directing him to “Lead the development of a Canadian Poverty Reduction Strategy that would set targets to reduce poverty and measure and publicly report on our progress.

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Understanding what poverty means and how it is measured are the first steps toward a poverty reduction strategy

Poverty rates in Canada LICO and LIM

Two most commonly used Statistics Canada poverty rates show radically different patterns.

The two most commonly used poverty rates produced by Statistics Canada tell very different stories. The patterns are curious, and confusing. The two statistics—the poverty rate according to the Low Income Cut-off and that according to the Low Income Measure—track each other rather closely up to the early 1990s, then diverge quite markedly as the Low Income Cut-off falls steadily to an unprecedented low, while the Low Income Measure drifts upward. Which statistic should we believe?

The cyclical patterns also differ, with the Low Income Measure registering higher poverty during recessions only before the 1990s, and in a way that is more muted and lagging the movement in the Low Income Cut-off. It also signals a rise in poverty only well after the onset of the 1990/92 recession, and both measures show no upturn in poverty during the Great Recession, which began in 2008 and led to a significant fall in employment.

For something that is central to so many policy debates, the Canadian “poverty” rate is notoriously confusing, and it is easy to imagine that public policy may be misled. The first step in devising a poverty reduction strategy is understanding what these numbers mean, and whether they are useful. Is poverty at unprecedented lows, or has it been stuck at high levels for decades? Both views can’t be right, but they can both be wrong.

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