Re: NYTimes.com Article: Devotion to Free-Market Makes for Ineffe

[Clifford Poirot <cpoirot@xxxxxxxxxxx>]

Ted asked me some questions several days ago. My responses are in ( ),
towards the bottom of this message.

-----Original Message-----
From: Ted Winslow [mailto:egwinslow@xxxxxxxxxx]
Sent: Friday, September 13, 2002 2:28 PM
To: pkt@xxxxxxxxxxxxxxxx
Subject: Re: NYTimes.com Article: Devotion to Free-Market Makes for
Ineffe



Clifford Poirot, responding to part of the column by Madrick, wrote:

>> Such theories depend greatly on one assumption: that buyers
>> and sellers are rational and seek to maximize their own
>> incomes and profits. These economists, perhaps best
>> represented by the work of the so-called new classical
>> economists, whose home base is the University of Chicago,
>> conclude that stocks are almost always sensibly priced.
>> They also conclude that unemployment cannot be reduced
>> without creating inflation, people save enough on their
>> own, regulations that limit the international flow of
>> capital are anathema, and even monetary policy has little
>> or no consequence.
>>
>> Mr. Akerlof argues, however, that market bubbles can exist
>> and should be kept under control; that unemployment can
>> often be pushed lower by government without generating
>> inflation; that people will not save enough on their own;
>> and that liberalized global capital flows have been
>> damaging. He argues that monetary and fiscal policies do
>> matter in creating jobs and raising incomes.
>>
>> The starting point for Mr. Akerlof and his colleagues is to
>> make the central assumption of economics realistic. People
>> are often not rational, maybe even most of the time.
>> Consider investors in stocks. Keynes implied long ago in
>> his "General Theory of Employment, Interest and Money," Mr.
>> Akerlof notes, that investors are subject to fads and
>> fashions.
>>
>> Behavioral economists have developed a lot of evidence to
>> support this idea. For example, Robert Shiller of Yale has
>> carefully shown that stock prices are much more volatile
>> than corporate profits and dividends.
>>
>> An important conclusion is that when stock prices are
>> historically far out of line with profits, there is a good
>> chance that it is a bubble, not a "new economy" of
>> ever-higher profits, as Mr. Greenspan often suggested in
>> the 1990's.
>
> My response:
> Interestingly, I think this interpretation leads the New Keynesians
> down the
> primrose path to Minsky-though not all the way to Davidson.

I'm not sure how much of the quoted passage this is responding to, but
at the start of the passage "Akerlof and his colleagues" are described
as claiming that  the "central assumption" "that buyers and sellers are
rational and seek to maximize their own incomes and profits" is
unrealistic and that "people  are often not rational, maybe even most of
the time."  It's this aspect of "behavioral economics" that Akerlof
identifies with "the spirit of Keynes."

It's not clear to me how this "leads the New Keynesians down the
primrose path to Minsky-though not all the way to Davidson."

( The reason I say this leads them down the primrose path to the
Post-Keynesian view, or rather, a Post-Keynesian view, is that it allows for
interdependent decision making, rather than independent decision making ).

My understanding is that Paul doesn't abandon the "rationality"
hypothesis; he amends it by reformulating the axioms involved to include
the axiom that agents are "sensible."

"sensible economic agents will disregard available market information
regarding relative frequencies, for the future is not statistically
calculable from past data and hence is truly uncertain.  Or as Hicks
(1979:
vii) succinctly put it, "One must assume that the people in one's models
do
not know what is going to happen , and know that they do not know just
what
is going to happen.'  In conditions of true uncertainty, people often
realize they just don't have a clue!"

(I will not try to speak for Paul about his use of the word "sensible".
Though what Paul is arguing for in the above passage is certainly not
"rationality" in the sense that it is used in standard neo-classical
analysis).

Minsky says of the relation of Post Keynesian economics to the
hypothesis of "maximimizing behavior":

"In this [Post Keynesian] modeling maximizing behavior remains important
but
the maximizing behavior of critical importance takes the form of present
decisions that the Ms [in M-C-M'] over time will exceed M with an ample
margin of safety.  The appropriate construct to use in modeling such
relations is the family of short- and long-term cost curves.
     "The maximizing decisions that lead to M [to] C action (financing M
of
spending on C of investment output) cannot be divorced from uncertainty."
(Minsky, "The Essential Characteristics of Post Keynesian Economics" in
Deleplace and Nell *Money in Motion* pp. 77-8)

(I would agree that agents "maximize" in the above sense. I am a little
pressed for time this morning so let me throw at a suggestion, possibly for
further discussion. I interpret this passage that Minsky is unconsciously
(or maybe consciously) adopting a Weberian notion of rationality and action
and departing from the standard neo-classical sense of the term. Weber noted
that capitalism depended on a certain type of rationality-which included
future oriented behavior and money oriented behavior, as well as a
dependence on contract as a form of transacting relations.)

This seems inconsistent with what Akerlof identifies with "the spirit of
Keynes,"  namely, the assumption that "people are often not rational,
maybe even most of the time."

(There needs to be a better, more full discussion of the uses and abuses of
the term rational. If by rational you mean maximizing a convex utility
function subject to a budget constraint, I entirely reject that definition
of rationality. Again, I take Akerlof's point to be that preferences,
behavior in general can be formed by interacting with people, thus leading
at times to "herd behavior"-which is not independently rational in the
neo-classical sense. I would accept that people act out of many
motivations-but I do not accept that human action is fundamentally
irrational most of the time.)

For reasons I've mentioned before, the "behavioral psychology"
underpinning "behavioral economics" is in very significant ways
inconsistent with the psychology underpinning Keynes's economics. As
I've been pointing out for a long time, however, the aspect pointed to
here is, in fact, "in the spirit of Keynes."  For instance, Keynes
assumes of financial market participants that:

"the vast majority of those who are concerned with the buying and
selling of securities know almost nothing whatever about what they are
doing.  They do not possess even the rudiments of what is required for a
valid judgment, and are the prey of hopes and fears easily aroused by
transient events and as easily dispelled.  This is one of the odd
characteristics of the capitalist system under which we live, which,
when we are dealing with the real world, is not to be overlooked."  (VI,
p. 323)

(Now I'm confused as to your meaning)