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Where is Socrates When You Need Him? July 23, 2009

Posted by Dwight Furrow in Current Events, Dwight Furrow's Posts, Philosophy, Science.
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Probably hanging out at the mall with some young boys.

But we do need him; and Paul De Grauwe of the Financial Times explains why. (H/t Brad Delong)

Before the financial crisis, most macroeconomists were blinded by the idea that efficient markets would take care of themselves. They did not bother to put financial markets and the banking sector into their models. This is a major flaw.

There is a deeper problem, though, that will be more difficult to resolve. This is the underlying paradigm of macroeconomic models. Mainstream models take the view that economic agents are superbly informed and understand the deep complexities of the world. In the jargon, they have “rational expectations”. Not only that. Since they all understand the same “truth”, they all act in the same way. Thus modelling the behaviour of just one agent (the “representative” consumer and the “representative” producer) is all one has to do to fully describe the intricacies of the world. Rarely has such a ludicrous idea been taken so seriously by so many academics. (Other fields of economics have not been deluded by this implausible idea and therefore do not face the same criticism.)

We need a new science of macroeconomics. A science that starts from the assumption that individuals have severe cognitive limitations; that they do not understand much about the complexities of the world in which they live. This lack of understanding creates biased beliefs and collective movements of euphoria when agents underestimate risk, followed by collective depression in which perceptions of risk are dramatically increased. These collective movements turn uncorrelated risks into highly correlated ones. What Keynes called “animal spirits” are fundamental forces driving macroeconomic fluctuations.

This is precisely the wisdom embodied in the Socratic method. Human beings are prone to self-deception, weakness of the will, and all sorts of enthusiasms that distort our ability to reason. So we need to be hyper-critical of our ideas and constantly seek out counter-examples, especially when those ideas reside in the heads of influential people who have an interest in their theories being true.

Economics aspires to be a science. So it adopts the accoutrements of science—especially mathematical models. But they forgot the essential part of science—letting their models meet up with the real world. That requires patience, curiosity, and a willingness to seek the truth.

As De Grauwe writes:

Too many macro-economists are attached to their models because they want to live in the comfort of what they understand – the behaviour of rational and superbly informed individuals.

A real scientist seeks to explore that part of the world they don’t understand. Economics has a long way to go before it is a science.

 

book-section-book-cover2 Dwight Furrow is author of

Reviving the Left: The Need to Restore Liberal Values in America

or Visit the Website: www.revivingliberalism.com

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