10 October 2011

Zeno's Political Impossibility Paradox

...... and Reality

You might have noticed that the meetings, crisis, meetings, crisis .. are occurring at shorter intervals. There is a wise old Greek who might help us to understand this and why everyone is being pushed to and off their limits.

There is also the Box Bunny's carrot (less stick) version. The IMF  latest report recommends that countries should reverse their austerity measures. In very damning graphical detail, section 1.1 (Divergent Recoveries, but a Synchronized Slowdown?) shows the Euro as a very sub-optimal monetary union.

We could ask why Greece is not included in the recommendation to reverse austerity measures.  A Zeno swapping arrangement might have helped to explain -  but the following may serve better.

It's useful to remember above image when reading about "moral hazard" - it is after all about the control and exploitation of information.


A comment on a Nobel economics prize winner

Macroeconomics and Reality 2.0 – when will it be released?

Thomas Sargent and Christopher Sims won the Nobel economics prize on Monday. Many are speaking about their work on the impact of expectations on policy. I shall take a different line.

When Chistopher Sims published "Macroeconomics and reality" (Econometrica 1980) a revolution was instigated in macroeconometrics. C. Sims argued that existing macroeconomic models were strangled by "incredible overidentifying restrictions". Models were so prejudiced by the underlying assumptions and pet theories that were in vogue that hypothesis testing, policy analysis and forecasting were virtually rendered meaningless.  As Macroeconometric models failed to predict and handle the subsequent events of the 2008 global crisis, we might like to ask the same question today.

Learning, knowing or worrying about something affects the outcome (here enters Sargent and also the Alice-in-Wonderland Cheshire Cat) but, until Sargent's work on rational expectations, it was very difficult to build into macroeconometric models. Macroeconomics models were static representations of a complex dynamic reality. C. Sims provided a philosophy, co-developed a toolbox and opened the way to a new horizon of possibilities.

Back in 1980 C. Sims proposed freeing macroeconometric models from its cage by allow 'history' (past values of variables) to determined the shape of models and hopefully, if not visible, allow the causal nature and underlying structure of macroeconomic reality to feed into the models. The result was a revolution and an attempt to shift to move models away from classical statistical models.

He introduced a theoretical approach based on Vector AutoRegressions and Baynesian methods to allowing the data to speak to the structure of models (variables' past values could be switched on or off by he data) and/or the possibility of beliefs and theories to be imprinted on to the model without imprisoning it.  His subsequent contribution to the work on the econometrics package RATS (later CATS!) provided the tools for others join the revolution.

The possibilities seemed endless – that was also the problem.

Subsequent work by others, who were also to receive Nobel prizes, gave clues: Granger causality time series (testing if y is more related to x's past than x to y's past - or crudely - which comes first, the fire or fire engine?); Cointegration analysis (suppose a drunk is walking randomly around with his dog. Both are non-stationary. Both pull and tug with each other. Individual movements make no sense but there is a relationship), Error correction. Learning models, etc.  New tools seemed to be appearing all the time.

What went wrong?

Referring back to previous post: (How can blindness and Deafness be explained?), perhaps this gives an answer:
'I do not think that the currently popular DSGE models pass the smell test. They take it for granted that the whole economy can be thought about as if it were a single, consistent person or dynasty carrying out a rationally designed, long-term plan, occasionally disturbed by unexpected shocks, but adapting to them in a rational, consistent way... The advocates no doubt believe what they say, but they seem to have stopped sniffing or to have lost their sense of smell altogether.' 
Robert Solow, United States Congress hearings (July, 2010) investigating why macroeconomists failed to foresee the 2008 Financial crisis
The pioneering work of the 1980s opened up a new terrain. The same neoclassical building was built on it. Only a Walrasian auctioneer or single consistent rational super entity can occupy its premises.

The award to Christopher Sims comes at a good time.

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